05 March 2016

The Limits of Growth: Economic Headwinds Inform China’s Latest Military Budget

Andrew S. Erickson and Adam P. Liff, “The Limits of Growth: Economic Headwinds Inform China’s Latest Military Budget,” China Real Time Report (中国实时报), Wall Street Journal, 5 March 2016.

With an official defense budget increase of 7.6% to 954 billion yuan ($147 billion) announced today, Beijing’s quest to restore China’s historic “greatness” and to attain international status as a military power commensurate with its economic standing continues. Yet with GDP growth slowing and social and demographic headwinds mounting, Chinese leaders face increasingly difficult tradeoffs concerning how to allocate government largesse.

With Beijing’s 2016 official defense budget, it is clear that even military spending is not immune to China’s economic and fiscal realities. Advance reports that this year’s official budget would entail an increase of as much as 20% proved significantly off-the-mark. So, what’s in a number? Nothing short of this: Beijing’s latest defense spending figure provides further evidence that it is determined to avoid succumbing to Soviet-style military overextension — yet it remains committed to enhancing capabilities to further its priorities, especially vis-à-vis contested island and maritime claims in the East and South China Seas.

Make no mistake: drawing on the world’s second-largest (and growing) economy, the People’s Liberation Army (PLA) is increasingly well-endowed and capable of asserting China’s regional interests. Even as GDP growth continues to slow, President Xi Jinping appears determined to order, and fund, ambitious military modernization and PLA reforms. The PLA is now far-and-away the world’s second best-resourced military and, unlike the globally-distributed and -deployed U.S. military, is focused overwhelmingly on its immediate neighborhood.

While analysts generally consider China’s GDP growth to be exaggerated, the official military budget is widely believed to be underreported, and to exclude significant military-related spending. As a percentage of GDP, China’s military spending growth is not exceptionally high, and even at its current, relatively high rates, it appears sustainable. Meanwhile, at $573 billion for 2016, the U.S. military budget is not growing rapidly and must fund constant efforts around the globe.

Though it is smaller than usual in percentage terms, the 2016 7.6% increase is still growth, and it significantly outpaces that of other major regional players. Case-in-point: the latest (and far more transparent) defense budget of the world’s third-largest economy, Japan—which is engaged in its own tense dispute with China in the East China Sea—constituted a mere 1.5% increase over the previous year. Russia embarked on an ambitious military modernization push in 2011 — and has seen that effort significantly challenged by falling revenues, sanctions and negative GDP growth. Defense budgets are likewise under considerable strain in Europe and Brazil, while India remains far behind China in overall capacity. In short, despite its recent challenges, the rest of the world is falling increasingly behind regionally-focused China—especially its neighbors.

In light of the rapid, across-the-board expansion of China’s national power, coupled with Beijing’s lack of transparency about the details of its military budget, the annual March announcement of its official defense spending rightly attracts global interest. Yet what is unknown need not blind us to what is clearly established. Beyond its immediate region the impact of China’s defense spending increases remains limited. This is one reason why side-by-side comparisons of the official U.S. and Chinese defense budgets, which Beijing supports, are in important ways misleading—especially in the context of security affairs in East Asia.

Beijing is modernizing its overall forces expeditiously while prioritizing certain asymmetric weapons—missiles foremost among them—to assert China’s interests on its contested periphery. This threatens to place the U.S. and China’s neighbors on the costly end of a capabilities competition. The PLA’s current development trajectory affords China the potential to severely challenge the interests of the U.S. and its security partners in East Asia. Among them: unfettered access to, and the security of, international waters and airspace upon which all nations rely for economic well-being.

The overall trend in China’s military spending over the past three decades has been double-digit growth roughly pegged to GDP growth, with the exception of 2010—and now 2016 as well, as economic growth has slowed well below 10% and competing priorities for domestic spending mount. With inflation largely under control since the turn of the century, this pace of investment in the PLA has bought China’s leaders a significantly modernized and capable fighting force—all with military spending growing roughly in parallel with the economy that funded it. For the past four years, Beijing’s leaders, in an apparent reversal of historic average trends, had increased military spending at a rate exceeding GDP growth. That divergence persists in the latest budget, but the gap appears to have narrowed.

In defending this year’s military growth, Chinese officials build on past justifications. Additionally, they emphasize two emerging areas: funding a major PLA reorganization that requires retiring many soldiers and paying them improved pensions, and engaging in further activities to uphold China’s “maritime rights and interests”—particularly in the South China Sea—in the face of growing U.S. and regional pushback.

Forging a leaner, meaner PLA more capable of the sophisticated joint operations critical to modern high-technology warfare is expensive. While this reform is tied to a 300,000-person force reduction and a panoply of stringent anticorruption measures designed to wring out additional savings, costs typically accrue up front, while savings typically take years to realize. Moreover, some demobilized forces could be shifted from PLA books to other security organizations, remaining a government expense.

Activities in the East and South China Seas, meanwhile, would likely continue to be prioritized even if China faces even worse economic and social headwinds. But the costs are considerable and growing, and not just diplomatic. They include maintaining the world’s largest blue water coast guard and a powerful maritime militia, both growing rapidly in personnel—typically the greatest cost driver of any modern force—and number and size of ships. Also costly: engaging in artificial features construction and fortification of areas of the South China Sea on an unparalleled scale.

Other efforts, not emphasized by Chinese officials publicly, likewise draw major funding. By 2020, China is on track to have the world’s second largest blue water naval fleet. It boasts the world’s foremost sub-strategic ballistic missile force and is modernizing it rapidly. Not only do all these actions cost money today, they impose major and growing long-term costs on China’s coffers. Some of the very military funding challenges long widely recognized to plague the Pentagon—growing cohorts of retirees drawing more generous benefits, aging hardware demanding maintenance and retrofitting—will increasingly burden China.

All these factors surely weigh on Xi as he attempts to give China’s slowing economy a shot in the arm while shoring up Party legitimacy. Even what at least until recently was the world’s fastest-growing multi-trillion dollar economy faces limits to its defense spending. Xi is likely to face increasingly difficult tradeoffs going forward.