Over at “India Ink,” the India blog of The New York Times, there’s a terrific interview with Ajay Banga—the CEO of Mastercard and the new chair of the U.S.-India Business Council. It’s a striking presentation at a time when there’s been little but gloom and doom about India in the markets.

Why all that gloom? Here are six reasons:

First, India’s tumultuous politics have, from a corporate perspective, stalled essential reforms. Tax, pension, and FDI reforms have made little headway under the United Progressive Alliance government, and, as I noted in an earlier blog, parliamentary business has been tied up in knots as the leading national and regional parties squabble.

Second, there has been mixed news from the capital markets. Flows of foreign direct investment into India were up in 2011 over the same period in 2010, but Mumbai’s SENSEX stock index was the world’s worst major performer in 2011. And what is more, the rupee has been among Asia’s worst performing currencies amid fiscal problems, including India’s current account deficit, and persistent concerns about capital flows. S&P recently threatened to downgrade India’s credit rating—a threat that India’s finance minister, Pranab Mukherjee, called “a timely warning.”

Third, India’s proposed retroactive law to tax cross-border deals has met with derision internationally. U.S., British, and Japanese trade groups have threatened to turn away from investing in India as a result. Ajay Banga puts it this way: imposing such a tax retroactively “make[s] companies and business very confused. The ability to make sensible predictions about what happens is very important to any business model.”

Fourth, big uncertainties about growth persist. Once high-flying India slowed to 6.1 percent growth year-on-year in the fourth quarter of 2011, the slowest pace since 2008.

Fifth, several sectoral stories are ugly (and growing uglier), including power, mining, telecom, oil and gas, insurance, and aviation.

Finally, Indian companies continue to dazzle the world, but signs abound that they are skeptical about their own country’s investment climate. Take this ominous set of figures: At the end of 2011, the amount that Indians had invested in businesses overseas over the previous year exceeded the amount foreigners were investing in India. Here’s another point of comparison from the Associated Press: “In 2008, foreigners poured roughly twice as much direct investment into India—$33 billion—as Indians plowed into businesses overseas. By 2010, that had reversed: Indians invested $40 billion abroad—twice as much as foreigners invested in India—a trend that continued [in 2011].”

This particular source of gloom matters greatly. With their global ambitions, India’s leading companies now bestride the international stage. They have been responsible for both high- and low-profile mergers and acquisitions in recent years. For instance, the Economic Times notes that “Indian companies (listed and unlisted) announced 1,995 overseas acquisitions from 2000 to April 2012, involving an investment of nearly $116 billion, as per data sourced from Bloomberg.”

But corporate India will need to lead the way in India too. Put bluntly, investment is essential to India’s growth story. So is it not ominous to read depressing quotes like this one from Jamshyd Godrej, one of India’s most distinguished business leaders? Godrej told the Associated Press: “If you are an honest businessman in India, it’s very difficult to start up anything … Companies are going to operate where they see the best opportunities and efficiency for their capital.”

The bottom line? There’s plenty of gloom and doom. And much of it seems to emanate from India itself.

But from my perspective, at least, it’s important to temper all the gloom with a sense of recent history:

For one, India has consistently surprised on the upside for two decades. It remains a high-growth story. And India has proved that, in one country at least, you can still squeeze out plenty of growth without very much reform.

Second, even without aggressive reform, greater predictability might still go a long way. Banga puts this point nicely in his interview with “India Ink.” “Reform is needed,” he says, “and everyone gets it. The problem is politics and its compulsions … [But] who are we to talk about India[‘s] politics, look at U.S. politics. Politics doesn’t always allow reform in the way that corporations would like to see. What we can do is talk about Indian leadership. Recent policies coming out of India have confused investors and not just in the U.S.”

Sure, bold reform would be best. But there’s still room for greater predictability, stability, and transparency, even though it’s clear that India’s fractious politics are unlikely to settle down before the next general election in 2014.

Third, India’s most exciting stories are in the states, not at the federal level. And the reality is that companies and investors will increasingly have opportunities in business-friendly states that are less regulated from New Delhi and, thus, are less subject to government control.

India’s constitution divides jurisdiction between New Delhi and the states in far-reaching and significant ways. The center has power over finance, defense, trade, telecommunications, foreign investment policy, and some infrastructure. But the states have wide authorities too on subjects that matter greatly to India’s investment climate, not least over power, agriculture, land, domestic investment, and policing.

States, then, are increasingly masters of their own fate. And strong managers and competent chief ministers have, in some places, delivered striking results.

Such improvements are good for growth. Ultimately, they should be good for investment too.

And this too is true: good governance turns out to be smart politics. Indeed, while India has seen the highest rates of anti-incumbency of any democratic country in the world, there are now strong signs this trend is slowing. And this is especially true at the state level: governments that have successfully improved governance, for example in Bihar and Orissa, have held on to power.

I heard this morning the news that Tadashi Yamamoto passed away in Tokyo on Sunday. There will be a flood of tributes from the many people who knew him better than I did, but I wanted to add my modest voice to these many remembrances.

I first met Tadashi Yamamoto in the 1990s through a U.S.-Japan-China trilateral project that he put together at the Japan Center for International Exchange. I had studied Japanese in Tokyo in the late 1980s and continued to stay involved with Japan. But through Tadashi Yamamoto and JCIE, I met Japanese colleagues at the very outset of my professional career who became close friends and have remained important associates ever since.

I was, of course, very early in my career—still just a postdoctoral fellow. But he and JCIE worked in so many ways to promote and advance the U.S.-Japan partnership. In fact, JCIE itself was only one of his many lasting contributions to the alliance. These included every conceivable type of exchange between the United States and Japan. He promoted parliamentary exchanges, corporate exchanges, exchanges between students and scholars, and much, much more.

My modest personal remembrance reflects the legacy of having met him as a twentysomething, just launching off on a career studying Asia professionally. He provided a lasting link to a community of Japanese specialists, scholars, officials, and journalists devoted to the idea of partnership with the United States.

As for that JCIE trilateral project, he was convinced that the rise of China was going to change Asia in big, important ways—and that, in turn, was going to have vast implications for the U.S.-Japan alliance. So he wanted to explore whether and how the United States and Japan might work with China on new challenges, not least in the aftermath of the 1997-98 Asian financial crisis, which had sent shockwaves throughout Asia. But more, he wanted to make sure that the United States and Japan were preparing and adapting as Asia evolved.

He was, as the Wall Street Journal put it this morning, an ardent champion of the U.S.-Japan alliance. His legacy will stand for a long time.

As for what I learned, well, I tried to carry some of his lessons into my subsequent work. When I worked on East Asia for the State Department’s Policy Planning Staff, the opportunities to work with Japanese colleagues were many and frequent. But I tried to continue reflecting these early lessons even after I moved on to other things. For example, while working on Central Asia, I helped launch broadened U.S.-Japan consultations on the region, not just between the State Department and the Ministry of Foreign Affairs but also with project finance experts from the Japan Bank for International Cooperation, officials from the Ministry of Economy, Trade, and Industry, development officials from the Japan International Cooperation Agency, and experts on energy and defense. And when I subsequently shifted to working on India and South Asia, I tried to continue making a small contribution to U.S.-Japan coordination and cooperation.

Today, there are far more tests to global order than when I first attended that JCIE conference. But the U.S.-Japan alliance remains a force for progress. One of Tadashi Yamamoto’s many legacies was to tend it across generations, ensuring that younger Japanese and Americans—a young scholar like me, for example—would develop a body of shared experience, much as their seniors had over the postwar decades.

It was so sad to hear this morning of Tadashi Yamamoto’s passing. His was a life to celebrate. He left a mark on me.

Actually, the lack of economic integration in South Asia is endemic. It’s not just a challenge for India and Pakistan but for many other countries in South Asia as well.

So it’s interesting that Indian foreign policymakers seem, in various ways, to be reemphasizing the economic dimensions of their country’s strategy. At a conference in New Delhi last week, for example, Shivshankar Menon, India’s savvy national security advisor, urged India and its neighbors to refocus on economic integration. Ironically, Menon argued, economic success has raised the costs of not doing business.

To see that, take a look around the region: India, even amid a post-crisis slowdown, continues to grow rapidly. Bangladesh has become attractive to global market participants. Pakistan is, for others, a profitable frontier market, despite gathering investment risks. And the opportunities and challenges are on display in Sri Lanka as well: its economy has grown rapidly as new economic opportunities have opened with the end of the civil war in 2009.

But to sustain growth, Sri Lanka needs to shift from public sector to private sector-driven growth—and that will require new investment in key sectors, such as tourism, agriculture, fisheries, business process outsourcing, and infrastructure. China has picked up some of the slack. But India is a more proximate economic partner. And the same is true of various South Asian countries and one another.

Cronyism, protectionist tendencies, and political risks remain considerable obstacles across the region, including in Colombo. But growth continues across South Asia. And various studies have demonstrated the potential gains from trade. One recent report from an Indian consumer research group, with support from the Asia Foundation, argues that further integration of trade among South Asian economies could yield as much as $2 billion to consumers.

This is why it’s encouraging that Menon and others in India seem to be giving regional trade integration new emphasis. After all, India’s size and rapid growth give it some potential to help lead the way.

Here are three areas that bear watching:

The Strategic Consequences of Indian Growth

First, how will India choose to play the strategic consequences of its economic growth?

My friend, Sanjaya Baru, has long argued that India should work not just for India-Pakistan bilateral cooperation or regional cooperation within the South Asian Association for Regional Cooperation (SAARC) but also on a parallel track. Given the slow pace of the former two efforts, Sanjaya has written, “it may be necessary for India to … see if regional economic cooperation can be pursued at a faster pace in a wider South Asian context.”

One vehicle, he has argued, might be an expanded “Bay of Bengal Community.” This would build eastward off the platform of an existing effort, “BIMSTEC,” which involves technical cooperation among Bangladesh, Bhutan, India, Nepal, Sri Lanka, and two Southeast Asian countries—Myanmar and Thailand. And if Myanmar’s process of political opening ultimately proves to be real (and is matched by an economic opening), then India would be well positioned to help forge new patterns of integration between South and Southeast Asia.

Melding Economics into Indian Strategy

Now, flip from the strategic consequences of economic growth to the economic dimensions of Indian strategy.

Will India increasingly meld economics into its strategic thinking? That will be especially important if Indian foreign policy continues to so ambitiously “look east” in Asia.

Strategically, India has been bottled up in the subcontinent for generations, but it wasn’t always so: Southeast Asia bears the hallmarks of a bygone era in names like “Indonesia” and “Indochina,” and Indian sailors once plied the trade routes from the Indian Ocean to the strait of Malacca. But as it once again “looks East,” India risks being left behind in Asia because of the significant mismatch between its lofty strategic goals and more earthbound economic realities.

Trade plays a growing role in the Indian economy and India has signed preferential trade agreements with the Association of Southeast Asian Nations (ASEAN) and Singapore. Yet scale remains a handicap: in 2009, 11.6 percent of ASEAN’s trade was with China but just 2.5 percent with India. Meanwhile, the backbone of East Asian economies remains integrated supply and production chains to which India is still largely irrelevant.

More manufacturing in India’s southern states could mean greater integration into East Asian supply and production chains. Likewise with outbound investment from corporate India: it could, perhaps, transform India’s interactions with Southeast Asia; but, here too, scale remains a handicap.

Domestic Indian policy choices will matter, in particular. The national manufacturing policy could yield new manufacturing zones with industrial parks, warehousing, and opportunities in special economic zones. And as the Indian government works to increase the share of manufacturing in GDP from around 16 per cent to 25 per cent in a decade, India need not compete only at the bottom of the value chain. It could also aim to compete in machinery, auto parts, and even automobiles, particularly through the adoption of new policies at the state level.

But huge obstacles remain, and some in India view this as a backdoor to relaxing labor laws. Such policies could falter, too, on land acquisition.

South Asia: Watch this Space

Third, various new initiatives in South Asia bear watching, not least among them recent developments between India and Pakistan.

Mohsin Khan of the Peterson Institute has argued that Pakistan’s November 2011 decision to grant most favored nation (MFN) status to India could prove especially significant. Of course obstacles remain, but Pakistan has continued to take important and constructive steps—for example, shifting from a “positive” to a “negative list”-based import regime with a February 29 Cabinet decision. India’s trade minister, Anand Sharma, has noted that this step will increase from 17% to about 90% the number of items that India can trade with Pakistan.

There has been movement elsewhere as well—with Bangladesh and Sri Lanka, for example. Over at Ajay Shah’s blog on the Indian economy, there is a good debate about whether and how India’s growth may have spillover effects elsewhere in South Asia.

The bottom line is this: India’s debate about economics and strategy is intensifying. And to my mind, at least, that is a decidedly good thing. After all, India’s success will increasingly depend on how New Delhi (and India’s states) respond to opportunities generated beyond the country’s borders.

Last summer, I wrote a lot for this blog about a report from Eurasia Group called China’s Great Rebalancing Act.  I wrote the report with my colleagues Nicholas Consonery, Damien Ma, Michal Meidan, and Henry Hoyle, and our punchline was simple: China’s growth model is no longer sustainable and the country’s savvy leaders know it. And, we argued, they are committed in principle to rebalancing China’s economy because their capital-intensive, export-oriented approach is delivering diminishing returns and threatens to become a major political vulnerability for the government.

But, we continued, making these changes will be incredibly difficult. To do so, China’s leaders will have to make serious and deep reforms to many elements of their country’s political economy. They will have to overcome inertia and “reform fatigue,” fight through the opposition of powerful constituencies among state-owned enterprises and entrenched financial interests, introduce a more market-based approach to energy policy, roll back subsidies (for example on land and energy), reform financial markets to free up capital for entrepreneurs and private business, boost domestic consumption, and so on. In short, they will have to alter the underlying structure of China’s political economy.

The operative word here is “political” economy. Do such reforms sound daunting? They should—and mostly for political reasons.

Nick, Damien, Michal, Henry, and I were skeptical of China’s ability to undertake such deep reforms. Put bluntly, we argued that Beijing ultimately would “lack the political stomach and sense of the moment to implement a comprehensive and ambitious rebalancing agenda.”

So the release of an important new World Bank report, China 2030, makes this an especially good time to reexamine these propositions.

Let’s go back to my point about Chinese leaders looking at their country in the mirror. China 2030, echoes some of the themes we touched on in China’s Great Rebalancing Act. But it does so at greater depth and in a more prescriptive, not simply analytical, way. And, very interestingly, it does so with the apparent buy-in of China’s leaders. The Wall Street Journal reported last week that some of China’s incoming crop of top leaders has been loosely or indirectly associated with the report.

The China 2030 project emerged from a proposal to China’s leaders from the World Bank’s president, Robert Zoellick, who suggested a joint study on China’s medium-term development challenges. As the report’s preface lays out, “the research was organized jointly by China’s Ministry of Finance, the Development Research Center of the State Council (DRC), and the World Bank. The report was written and produced by a joint team from DRC and the World Bank who worked together as equal partners.”

So, some political and economic elites in China have taken ownership of this study.

The DRC’s president, Li Wei—whose prior career includes stints at such pillars of the entrenched establishment as the State-Owned Assets Supervision and Administration Commission (SASAC), which oversees China’s 120-odd central state-owned enterprises—co-signed the foreword with Zoellick. But the Journal reports that his deputy, Liu He, may be the key figure, not least because he helped to author China’s 12th Five Year Plan, which runs from 2011-15, and which many (including our report) argue offers a blueprint—at least on paper—for many aspects of the rebalancing agenda.

Not surprisingly, then, the World Bank’s important new report is getting a lot of headlines. China’s leaders clearly recognize that their growth model, which depends disproportionately on exports and investment in fixed assets, isn’t sustainable. And they appear to be self-reflective enough to weigh how (and how deeply) to change it.

You can read the World Bank report here, along with supporting data and technical studies.

And you can watch a video of Zoellick introducing the report here.

One of the Bank’s most important conclusions is that private enterprise needs more space to thrive. Industrial, financial, and political resources are heavily skewed toward state-owned enterprises in China. So the major banks, for example, give household depositors a negative return on their savings while bankrolling industrial policies through state-backed firms. This is one of many reasons for deeper financial reform in China.

But more broadly, it’s clear that China is, therefore, at an economic crossroads. And the Bank’s report shows why.

In our own study last year, my colleagues and I outlined some of the problems Beijing will need to overcome:

Producing too much and consuming too little

China’s economy is overly dependent on fixed asset investment and exports. Consumption is about 35% of GDP, a figure well below those of developing countries such as India. And the perpetuation of a production-intensive economic model owes much to inefficient capital allocation. This condition is buttressed by an illiberal and politicized financial system, as well as distorted input costs including subsidized energy and land prices.

The rich are getting richer

One of the more troubling consequences of China’s capital-intensive growth model has been that companies (and the government) have captured much of the enormous wealth generated in the last three decades at the expense of Chinese households. This dynamic is not only exacerbating an already yawning gap between the government and business elite on the one hand and average Chinese citizens on the other, it is also repressing consumption. A broken social welfare system, which cannot adequately deliver public goods such as pensions and healthcare, constrains consumption and encourages saving further.

The developed/developing country paradox

China’s vast regional disparities in living standards and average incomes—from booming Shanghai to impoverished Ningxia—are often likened to the contrast between different centuries. Policymakers in Beijing face the unique problem of having to deal with issues typical of both 21st-century middle-income countries and 20th-century developing countries. And these inequalities play out across a continent-sized economy: the wealthy coast contrasts starkly with the continental hinterlands, which comprise poor western provinces and regions populated by ethnic minorities. While China’s efforts to reduce poverty have been impressive, barriers to urban residency and the lack of progress on land reform have exacerbated regional inequality.

Inefficient and excessive energy use

Capital-intensive growth has exacted steep environmental and resource costs. Subsidized energy and land prices have encouraged companies to exploit China’s natural resources and ignore debilitating energy inefficiencies. Beijing sought to industrialize in a compressed timeframe, but in China’s haste to catch up to the advanced industrial economies, the country has found itself on an increasingly unsustainable trajectory from both an environmental degradation and a natural resource-security perspective.

The question, then, is largely a political one, not principally an intellectual one: Even if China’s leaders know they must implement necessary reforms, can they overcome the entrenched constituencies that will fight hard to block them?

The reaction to the World Bank’s new report should offer some interesting hints. But the real tests will come next year once China’s political transition is settled and China’s leaders refocus on underlying economic structural challenges. Their choices will shape China’s next decade and beyond.

Traders stand near a screen showing the Indonesia Stock Exchange Composite Index during the first day of trading for 2012 in Jakarta January 2, 2012. Courtesy Reuters/Stringer.

It’s been a fascinating year for Asia. The region has continued to consolidate its role as the essential player driving global recovery. Developing Asia, including China, India, and the major ASEAN economies, maintained robust growth, in contrast to the advanced economies’ collective anemic growth over the same period.

But 2012 promises to be more fraught as domestic politics take command amid new challenges to growth.

Here are twelve trends I see coming for Asia in 2012—risks, opportunities, and emerging patterns that will shape Asia during the next twelve months, and beyond.

1.         New Political Risks

It’s often said that, in Asia, economics is in command. But one lesson of Europe’s current struggles is that politics (and especially German domestic politics) matters deeply to choices about the EU’s economic and financial future. Asia isn’t Europe, of course, but in Asia too politics will matter greatly in 2012. Electoral outcomes and succession arrangements are likely to roil markets, bring to power governments more (or, in some cases, less) committed to institutional, regulatory, and trade-related reforms, and possibly yield greater international tension. Three elections—in the United States, South Korea, and Taiwan—will feature candidates and parties with distinct policies and priorities. China will complete a scheduled, if unelected, leadership change. And North Korea’s elite, whose members aim above all to preserve themselves in power, must now navigate an earlier-than-expected transition that could yet produce infighting and vast new challenges for Pyongyang’s neighbors. Thailand bears watching too, as former Prime Minister Thaksin Shinawatra looks to return from exile. And such political risks will likely intensify well into 2014, when India and Indonesia hold elections. A possible return to Golkar rule in Indonesia, in particular, could slow institutional and policy reforms there.

2.         A Coming Asian Slowdown?

Asia has sustained robust growth amid austerity in Europe and sluggish growth in the United States. But despite decent December data, new challenges are emerging for Asia’s most export-dependent economies. The Asian Development Bank predicts “much greater downside risks“ in 2012 because the threat of recession in the U.S. and Europe remains, as does the prospect of destabilizing capital flows. Who’s most vulnerable? The markets will watch China especially closely because the world economy can hardly afford to have its three principal growth engines facing a crisis simultaneously. Beijing’s landmark 12^th Five Year Plan deliberately aims to get slower but more balanced growth. But such structural adjustments will come only gradually, and, in the meantime, China’s economy continues to rely on exports and investment in fixed assets. That’s one reason the Chinese economy has slowed for four consecutive quarters. My friend Damien Ma has noted a big contradiction in the market’s view of China: Market participants have long hoped for a more sustainable growth trajectory (and, inevitably, more “sustainable” growth will mean slower growth); but now, with the world economy facing a slowdown, market participants have mostly reversed themselves: they no longer want slower but “sustainable” Chinese growth but rather even faster growth to bolster the world economy. Meanwhile, others, such as South Korea, will also be vulnerable in 2012. They have relied, in part, on Chinese demand to power their economies, so even a modest slowdown in China would have contagion effects elsewhere in Asia.

3.         Model vs. Model

Preferential trade agreements (PTA) have proliferated in Asia. And the U.S. (finally!) entered the trade fray in 2011 by more fully embracing the Trans-Pacific Partnership (TPP), a once-modest effort among some members of the Asia Pacific Economic Cooperation (APEC) forum to move beyond consensus decision-making. In my view, TPP has considerable potential. But critics, like Jagdish Bhagwati, charge that TPP “includes numerous agendas unrelated to trade, such as labor standards and restraints on the use of capital-account controls” that would, among other things, preclude China’s membership. Beijing has in essence, criticized TPP as part of a U.S. strategy to “contain” China. Yet Beijing has promoted its own brand of PTAs across the region—with ASEAN, Pakistan, Singapore, and others. The Doha round is going nowhere fast, so debates will intensify in 2012 about what types of agreements make sense as global trade negotiations continue to stall.

4.         Can the United States Get its Act Together?

So much was made in 2011 of Washington’s supposed strategic “pivot” to Asia. But the reality is that the “pivot,” such as it is, mostly reflects longstanding U.S. policies in Asia and is anchored in strategic and policy pillars that date back decades. A bigger issue for Washington’s partners in Asia is that the United States, for all its inherent strengths, still doesn’t have its economic act together. Thus the principal strategic issue for most in Asia is whether America restores its economy and addresses its fiscal deficit and growth outlook. Dealing vigorously with debt, entitlement and tax reform, questions of business competitiveness, and energy and education policies, among others, will loom ever larger as Asians contemplate America. The weaker America’s fiscal and economic position becomes in 2012, the less relevant the United States will be to Asia’s future.

5.        More Gloom About India

India will grow robustly, but more slowly in 2012. And that’s one of many sources of gloom about India’s prospects. Tax, pension, and FDI reforms have stalled. Parliamentary business has been tied up in knots as the leading national and regional parties squabble. Mumbai’s SENSEX stock index was the world’s worst major performer in 2011, declining from 20,561.05 on January 3 to 15,175.08 on December 19. Will India’s politicians become bolder in 2012? It’s unlikely. Bellwether state elections, especially in Uttar Pradesh, are almost certain to make the major parties more cautious still. With a few exceptions, the markets (and many in India’s own political class) will express more gloom, and ask even tougher questions, about India’s trajectory in 2012. This piece from Tarun Das is a terrific example.

6.         A Farewell to Reform?

But India won’t be the only country to face intensified scrutiny of its reform trajectory in 2012. In Vietnam and Indonesia, too, FDI, regulatory, or financial reforms have largely stalled and show little sign of revival. And by far the biggest question mark about reform is China. Some in Beijing, for example, argue that China now has “reform fatigue,” made worse by a sensitive political transition. But resistance to reform is also anchored in interest group politics and, thus, is more endemic and likely to be stubborn. Chinese leaders, as cautious technocrats, tend to split the difference between competing groups in China’s increasingly pluralistic polity. And the result has been a strong bias toward incremental policy change rather than bold reforms. One bright spot in 2012 may be Malaysia, which has begun to shed elements of its 1970s era “New Economic Policy.”

7.         ASEAN’s Burma Opportunity

Are political reforms in Burma for real? We will learn much more in 2012 as the regime weighs further prisoner releases, the future of the now legalized National League for Democracy, and Aung San Suu Kyi’s own desire to run for office. But another question mark will be ASEAN’s response to this change. Balancing the role of great powers to the north—China and Japan—has long provided an impetus to ASEAN community building. And concern about China, in particular, helped drive the transformation of ASEAN after the end of the Vietnam War. ASEAN’s founding members wanted all ten countries joined as a cohesive force to help balance China. But their timing in expanding ASEAN’s membership was poor: unlike Vietnam, Burma, which joined in 1997 (two years after Hanoi) has stubbornly resisted ASEAN ways. So with Burma now scheduled to assume the ASEAN chairmanship in 2014, regional heavyweights, like Indonesia, will face tough decisions about how hard to push the regime. And they must weigh how to assimilate Burma to ASEAN ways as the date of Naypyidaw’s stewardship approaches.

8.         China Inc. … Coming West

Beijing is sitting on over $3 trillion in foreign exchange reserves (much of it in U.S. dollars), with billions more in the hands of corporations eager to invest in U.S. and European markets. The U.S. and Europe will press Beijing harder on currency values, intellectual property, and market opening in 2012. But for its part, China is certain to press harder for more openness to direct investment from China Inc., including its state-owned companies. That will yield intense political debate, especially in the U.S. Some have argued that Chinese investments, especially from non-state companies, would be on a sounder political footing if they created jobs through greenfield investments rather than the portfolio investment and corporate mergers and acquisitions that Chinese companies have tended to prefer. The fact is, the level of job-creating Chinese investment remains very small. In 2010, Chinese FDI stock in the United States was $5.9 billion—just about one-tenth of the $50 billion of U.S. FDI stock in China. And while FDI from all countries has created 5.6 million U.S. jobs, including over 2 million in manufacturing, affiliates of Chinese firms in the U.S. employed barely more than 4,000 Americans in 2009.

9.      The Big Hedge Gets Thornier

This central strategic reality of Asia will remain in 2012: Asian countries are deepening defense and political coordination with the United States (and each other) as a hedge against Beijing’s growing strategic weight; but, even against that backdrop, slack global demand means that China will continue to power the growth of nearly every major economy in Asia. Put simply, economics and security are increasingly in collision. So one reason Washington’s best friends are rooting so hard for U.S. recovery in 2012 is precisely because they fear this balancing act cannot prove sustainable forever. The United States continues to provide Asia’s principal security-related public goods through its forward-deployed military presence and role as a strategic balancer. But Asian economies will increasingly provide one another with their principal economic-related public good—namely, the demand that can provide a pathway to sustained economic growth. This collision between economics and security may well intensify in 2012.

10.       More Trade Conflict

Protectionist pressures will rise in 2012. But, just as important, so too will the tolerance for trade conflict, particularly in Washington and Beijing. China has grown more comfortable with the World Trade Organization’s dispute-resolution procedures. And, having learned to leverage the system to its own advantage, Beijing is vigorously fighting U.S. suits in many areas. It has investigated numerous anti-dumping cases brought by Chinese producers, lent its ear to a proliferation of Chinese business lobbies, and recently slapped countervailing duties on U.S. auto exports in response to a U.S. case on chicken parts. For their part, U.S. political and business elites are certain to complain ever more loudly about Chinese currency, intellectual property, procurement, and cyber-related practices. Most in Asia will watch warily, fearing greater protectionism. But some will jump on the bandwagon: India has already initiated 149 anti-dumping cases against China.

11.        Learning from Asia

Robert Zoellick, the World Bank president, has argued that the economic models now being emulated in Africa and beyond will come increasingly from outside the advanced G7 economies. The rich world, Zoellick argues, cannot patronize developing nations with aid conditions and policy guidance when its own recent performance has been so dismal. In 2012, others will continue to look to Asia in this way. Zoellick noted two examples in a recent speech: India’s model for information technology services, copied by Ghana, Kenya, Nigeria, and others; and Singapore’s combination of “open economy, services cluster, anti-corruption, and relentless adaptation to changing conditions.”

12.       State Building or Economic Disintegration in Continental Asia?

Finally, 2012 should be another rough year for Afghanistan, Central Asia, and Pakistan. War, terrorism, narcotics, and weak political institutions steal headlines, of course. But the region’s future will depend as much on whether governments improve their poor macro- and microeconomic fundamentals and expand opportunity—for example by improving trade and transit regimes. Central Asia suffers from a poisonous combination of landlocked geography and especially bad economic policies. Major initiatives, including from the international financial institutions, seek to change this. In its own way, so does infrastructure construction by China. But the sad reality is that enthusiasm for cooperation remains far greater outside the region than among the states themselves. Economic change will remain elusive unless these states better cooperate in 2012. Meanwhile, Pakistan’s economy has considerable potential. But the country lacks a credible growth strategy. And Islamabad will remain burdened by a high debt-to-GDP ratio that crossed 60 percent in 2010, painful debt service obligations to its creditors, a large fiscal deficit, double-digit inflation, a depreciating rupee, and a trade deficit worsened by high global commodity prices. These economic realities will compound intensifying political risks in Pakistan.

A Pakistani policeman keeps watch near a Pakistan-China friendship billboard in Islamabad February 3, 2002. (Claro Cortes IV / Courtesy Reuters)

 I’ve written a think piece for Foreign Affairs on two subjects:

(1) China’s calculus in Pakistan, or, as the editors asked me, “Could China’s calculus ever change and, if so, what would change it?” and

(2) China’s approach to risk management, which, I argue, increasingly includes an effort to balance three baskets of risk: geopolitical risk, political risk, and investment risk.

The punchline? China’s calculus in Pakistan is becoming more diverse. So the central question will be the extent to which political, and especially investment, risks begin to complicate the straightforward geopolitical calculus that has long yielded a remarkable intimacy between Beijing and Islamabad. Beijing is too strategically tied to Pakistan—and too timid in its diplomacy, in any case—to off-load an erstwhile ally. But China is unlikely to be such an accommodating patron, either. Thus it will prove less willing to fund the ambitious infrastructure development schemes Islamabad favors. And what is more, the scope and scale of future Chinese economic activity will not, in itself, produce rapid, sustained, and balanced Pakistani growth. In the long term, economic interaction with India—the restoration of traditional regional ties and natural economic affinities in the subcontinent—will almost certainly be more decisive.

The principal focus of the piece is China’s increasingly diverse approach to managing risks.

You can read the essay here on the Foreign Affairs website.

For the next several days, President Obama is hosting leaders from around the Asia-Pacific region in Hawaii for the annual summit of the Asia-Pacific Economic Cooperation (APEC) forum. So this seemed like a good time to repost a Council on Foreign Relations special report on Asian regionalism that I co-wrote with my colleague, Bob Manning, in the run up to the 2009 meeting.

Our report, The United States in the New Asia, is two years old. But in my view, it’s still deeply relevant.

You can download the report here.

Some good things have happened since we wrote our paper in 2009. For one, the United States has joined the Trans-Pacific Partnership (TPP) negotiations, and that is a decidedly good thing. There isn’t likely to be a successful Doha Round nor is another global trade round likely anytime soon. So TPP can fill in some of the gaps between global trade liberalization and bilateral and regional agreements. The United States has also—finally—completed the Korea-U.S. Free Trade Agreement (KORUS).

And yet the larger questions Bob and I raised about the United States and Asian regionalism remain important and mostly unanswered.

Yes, the United States is more engaged on issues of regionalism in this part of the world than when Bob and I fretted and complained two years ago. We worried that the United States risked marginalizing itself by failing to appreciate that pan-Asian institutions were gelling without American participation. And this was especially true, we argued, on issues related to economics and finance:

Some multilateral institutions that exclude the United States have become the locus of economic and financial trends that will increasingly disadvantage U.S. firms and work against U.S. objectives.  Certain preferential trade agreements and financial arrangements, as well as regionally-based regulations and standards, threaten American interests. And some of the new institutions created without U.S. involvement, notably ASEAN Plus Three, hold the potential to marginalize the United States in Asia over time.

But more, Bob and I worried that institution building in this part of the world had become stale, devoid of strategy, and increasingly meaningless. We encouraged the United States to show greater leadership on behalf of what we called “a more purposeful multilateralism.”

And that’s where the two largest questions we raised remain especially relevant:

First, is there a purpose to all of this region’s redundant and overlapping geometry?

Second, what can the United States do in concrete terms to promote a more purposeful multilateralism? Put differently: How can Washington begin to ensure that function drives form rather than the other way around?

Bob and I argued that groups will need to emerge that can solve real problems by pooling real capabilities. But unfortunately, we argued, most of the region’s institutions have only demonstrated that “process has become an end in itself …

… Innovation has been sadly lacking in both pan-Asian and Asia-Pacific forums. Instead, the region has seen a good deal of hollow process, driven by bureaucratic inertia or path dependence: groups are formed, ritualistically meet, ritualistically issue statements, and then ritualistically persist.

These underlying questions about the relationship between form and function remain relevant in both pan-Asian and trans-Pacific regionalism.

Sure, the United States has solved its Woody Allen problem—as Woody put it, “90 percent of life is just showing up.” But have pan-Asian or trans-Pacific architectures become any more functional? Not enough. And so the United States should be working with partners across the region to help answer these and other questions. A good place to start would be with like-minded partners not least in Canberra, Tokyo, Seoul, Singapore, Jakarta, Hanoi, and Wellington.

As to this year’s summit, well it could be a more interesting meeting than usual because the United States and China appear to have different ambitions and expectations, not just for the future of APEC but for the agendas around which regional groups are organized. A back-and-forth is playing out in the APEC context on issues like tariffs on environmental goods and services. And that dynamic will likely emerge in other forums too—for instance, at the upcoming East Asia Summit, where the United States and Japan, among others, aim to discuss issues related to maritime security.

With APEC now upon us, I hope you’ll take a second look at what Bob and I wrote in The United States in the New Asia.

A Kyrgyz customs officer talks on a radio in front of workers as they reload cargo from a Chinese truck to Kyrgyz one at the Irkeshtam border crossing in southern Kyrgyzstan. Courtesy Reuters/Vladimir Pirogov.

Chris Rickleton, a Bishkek-based journalist, has a fascinating piece up on EurasiaNet about prospective Chinese rail construction in Kyrgyzstan. The piece cuts directly to tough political choices—namely, the push and pull between Russian and Chinese interests in Central Asia and, more important, how politicians in landlocked countries, like Kyrgyzstan, must try to balance among the larger countries on whom their economies depend for transit.

I’ve written a lot on efforts to reconnect trade and transit routes across continental Asia. You can read some of what I’ve argued here, here, here, here, and here.

But Rickleton’s piece got me thinking about two questions:

(1) Since the obstacles to continental trade and transit are so high, is the game really worth the candle?

This is especially relevant because Secretary of State Hillary Clinton is vigorously promoting a “New Silk Road” concept, drawing heavily on a decade of prior efforts and experiences.

(2) With so much focus on the interests of the outside powers—Russia, China, Iran, and the United States, among others—what about the interests of the landlocked countries themselves?

There has been a lot of criticism, not least of the Clinton effort. And the critiques bear careful reading. See here and here for two examples.

But frankly, I do think the game is worth the candle—although there is no reason why these efforts must be done multilaterally in some kind of regional “grand bargain.” They can be done well enough by cumulating separate and self-interested, but complementary, bilateral and minilateral efforts and agreements among relevant countries.

Landlocked economies can face a growth deficit as high as 1.5 percentage points because transaction and other costs are so high. So why not try to help reconnect them to the world economy and reduce their dependence on a single point of transit? Central Asia has suffered greatly from a poisonous combination of landlocked geography and very bad economic policies. So as the United States prepares to draw down its military commitments in Afghanistan, it is wise, in my view, to renew attention to regional economics. In fact, that’s where a parallel strand of attention should have been squarely placed all along.

Still, there’s no question but that tangible progress will be slow. There has already been a decade of effort by the international financial institutions, particularly the Asian Development Bank, through its Central Asia Regional Economic Cooperation program, and the World Bank. And regional governments, leading scholars, and the Bush administration (in which I served) have also been in this mix.

Here are some of the central challenges:

For one thing, enthusiasm for cooperation is often far greater in Washington than in Central Asian capitals. The United States has been actively involved in promoting regional arrangements for two decades but has had very few successes.

At the same time, Central Asian countries desperately need to cooperate. But for nearly twenty years, their need for cooperation has too rarely translated into complementary policies. Central Asians and their neighbors are deeply dependent on one another, yet this reality is deeply disquieting to many.

Finally, an Afghan-centered effort is bound to meet especially big obstacles. We advocates need, therefore, to be intellectually honest enough to admit that this would all be a lot easier with Iran in the picture. But that’s just not going to happen. Iran’s noncompliance with its International Atomic Energy Agency safeguards agreements, and its defiance of United Nations Security Council resolutions, virtually guarantee that the United States will oppose such linkages. And Washington should be prepared for growing tension with Central Asian states as it enforces Security Council resolutions that call for enhanced vigilance over financial transactions.

But let’s also put the United States aside for a moment.

The more interesting question is whether the game is worth the candle for Central Asian states themselves. And there, I think the answer is also “yes.”

It’s worth revisiting this 2004 paper by Columbia University’s Michael Faye, John McArthur, Jeffrey Sachs, and Michael Snowe. The paper highlighted four types of dependence that hamper the development prospects of landlocked economies: dependence on neighbors’ infrastructure; dependence on sound cross-border political relations; dependence on neighbors’ peace and stability; and dependence on neighbors’ administrative practices.

Landlocked geography can be poisonous. But such dependencies on neighbors can be pretty pernicious as well.

What to do? Well, the Columbia team is blunt:

(1) Invest in internal infrastructure to lower transportation costs.

(2) Invest in regional integration strategies—somewhat as the “New Silk Road” and various prior efforts have aimed to do. It won’t matter if only one Central Asian country, like Kazakhstan, gets its infrastructure right. The point is, everyone needs to get it right. Or as the Columbia team put it in the context of landlocked African economies, “internal infrastructure investments in Burundi and Rwanda will yield limited returns if not accompanied by similar investments in Kenya, Tanzania and Uganda.”

(3) Regional integration strategies “need to focus on administrative coordination.” And that means getting customs and border procedures right—something the international financial institutions and the United States have focused on for years.

(4) Invest, where possible, in sectors less affected by transport costs. This will be difficult for Central Asian countries to do, but Kazakhstan, for example, has sought to develop some elements of a services economy.

One of the more trenchant critiques of these various regional efforts in continental Asia is that its origins lie in geopolitics, not economics. But there is plenty of research on the economics of landlocked countries to show why unfortunate geography can be tragic.

It doesn’t have to be.

U.S. Treasury Secretary Henry Paulson leaves after making closing statements after the 5th U.S.-China Strategic Economic Dialogue in Beijing, December 5, 2008. (Jason Lee/Courtesy Reuters)

With the glaring exception of Japan, Asian economies are recovering earlier and stronger from the crisis than nearly all others. And China has now cemented its place alongside the United States and Europe as a growth engine.

But China faces large—and intensifying—vulnerabilities.

Readers of Asia Unbound will know that I’ve talked here and written here about some of these challenges.

And so I thought I’d flag for interested readers a major speech delivered this morning in Washington by former Treasury Secretary Hank Paulson (full disclosure: my boss).

He has a deep history with the U.S. and Chinese economies—at Goldman Sachs, and then as the Treasury Secretary. As a banker, he worked on historic but thorny issues in China, like privatizations. And at the Treasury, he established the Strategic Economic Dialogue and played a central role in the creation of the Ten Year Energy and Environment Cooperation Framework.

The basic thrust of his speech is twofold:

First, both countries face growing economic challenges and vulnerabilities. And for its part, it is decidedly in the U.S. interest for China to get ahead of these challenges. As Paulson puts it, “China’s success at sustaining growth, fighting inflation, and transitioning from an economic model too dependent on exports and fixed asset investment is closely connected to our own success.”

Second, “the U.S. and China need to take steps—mostly individually, sometimes together—that will have the mutually beneficial effect of supporting and sustaining economic growth.”

That’s a striking formulation because it’s not focused on “cooperation” for its own sake. Rather, as Paulson argues, the U.S. and China “don’t always need to act jointly.” They can take separate and self-interested steps that, in the bargain, put their two economies onto a more complementary footing.

You can read the entire speech here, or watch it delivered here.

But for the central message, here are his five principles—let’s call them, ”Paulson’s Principles”—quoted verbatim from the speech:

“Principle one:  Unlock the promise of capital and cross-investment. 

For the United States, this means assuring greater openness to Chinese investment, leading to the creation of American jobs.

For China, it means undertaking financial reforms now that Beijing might well prefer to kick down the road.

Principle two:  Assure financial markets that are transparent and have strong oversight.

For the United States, this means clarifying new regulations and implementing sensible regulatory practices.  It also means correcting flawed policies that led to massive consumer debt, a housing bubble, and unsustainable household leverage ratios.

For China, it means speeding up financial reforms and strengthening oversight and transparency of non-bank lending.  It also means correcting flawed practices that have led to massive producer debt and the misallocation of capital.

Principle three:  Work to strengthen market confidence in our economies.

For the United States, this means overcoming the markets’ lack of confidence in our government’s ability to take the necessary steps to protect our economy and keep it competitive.

For China, it means overcoming a lack of transparency—not least a dearth of trust in government data and questions about corporate accounting and disclosure.

Principle four:  Free up bilateral trade.

For the United States, this argues for moving toward bilateral trade negotiations with China.  The global trade round is going nowhere fast.  And it also means granting China market economy status on a sector by sector basis.

For China, this means getting more serious about three things:  first, boosting domestic consumption, so that its market becomes a much bigger export destination for U.S. goods and services; second, expanding market access, including by completing residual WTO commitments; and third, ending an array of discriminatory and anti-competitive practices.

Principle five:  Help technology flow more efficiently, and promote innovation.

For the United States, this means reforming our outdated export control system while assuring our national security.  Too often, we restrict trade that would create U.S. jobs and is in our national interest.  Separately, the clean energy policy challenge is now so great that we should have a U.S.-China pilot project, relying on scientific input and evidence, to make it easier for the world’s two largest economies, energy consumers, and carbon emitters to use the best technologies available.

For China, it means respecting and enforcing intellectual property commitments.  But ultimately, it means making the shift from a consumer to a producer of intellectual property by legitimate means—not using access to its market as a backdoor to obtain the intellectual property developed by others.  Only when China innovates, not just assimilates, technology will it have enduring incentives to protect it.”

Paulson’s speech goes into considerable detail in all five of these areas and is well worth reading.

India's BSF soldiers ride their camels in front of the Presidential Palace during the full-dress rehearsal for "Beating the Retreat" ceremony in New Delhi. (B. Mathur/Courtesy Reuters)

Liz’s post on India got me thinking about an article I published last year in Foreign Affairs on the fate of the U.S.-Indian partnership.

Liz bluntly titled her post, “India’s message to China and the United States: we’ll go it alone.” And that could mean two things:

(1)  India’s fate is in India’s hands, not yours, or

(2) We’ll stay non-aligned, thank you very much.

But the fact is, India has moved well beyond non-alignment. And Indian policy will increasingly intersect with Chinese and American policies in important ways.

Sure, India’s fate is largely in India’s hands because the country can hardly bolster its emergence as a major power without economic growth. And while trade has grown, India’s growth remains mostly internally driven.

What’s more, India needs to advance several important domestic social and economic transitions. And so the bottom line is that the central questions about India’s future are indeed India’s to answer. They include:

-       Will India’s choices facilitate an economically open, globally integrated India?

-       Will India’s choices shrink its wealth divide?

-       Will India’s choices expand its middle class?

-       Will India’s choices strengthen its physical infrastructure?

And so on.

But here’s the thing about “going to alone”: India’s success will increasingly depend on how New Delhi (and especially India’s 29 states) respond to opportunities generated beyond the country’s borders.

Take India’s economic transition:

India manufactures too little.  And despite an enthusiastic “Look East” policy that aims to better integrate India with East Asia, its prospects are constrained by a lack of economic integration, not least into Asian supply chains.

But China’s choices—and India’s response to them—could change all that. Rising costs in China—some the deliberate result of continuous wage hikes and other policy changes in Beijing and the provinces—will give India an opportunity to make radically different policy choices itself.  Such choices include bolstering manufacturing through new manufacturing zones, but also tax reform and labor reform. And all of these have either stalled out or are politically fraught in India.

It’s true, then: India’s fate is in India’s hands. But it’s also true that India’s success will increasingly be a function of how it does or does not seize opportunities being created by shifts taking place more widely in Asia and globally.

Then there’s the fate of India’s nonalignment. Debates rage in New Delhi; Indian foreign policy is in transition. Indeed, India has moved beyond nonalignment. But its new foreign policies and strategic doctrines are emerging only slowly. This evolution may ultimately prove conducive to a more expansive partnership with the United States around the world, but that is not assured.

So that’s one reason why a new report from CFR and the Aspen Institute India should be widely read. It offers tantalizing possibilities.

But the big questions are these:

-       What will replace nonalignment as the basis of Indian foreign policy? And

-       Will India leverage its growth, not to mention its seat at the new top tables of international relations, like the G20, into political influence and leverage?

For their part, the United States and others have choices to make about their relations with India too.

Washington will need to figure out how to be sensitive to Indian equities (and especially core security interests) as it disengages militarily from Afghanistan and attempts to renegotiate its increasingly fraught relationship with Pakistan.

But India is not going it alone in this important sense: notwithstanding differences at the United Nations, particularly over New Delhi’s abstention on a key Libya-related vote, India continues to publicly associate itself with the United States in unprecedented ways.

It has backed U.S.-supported resolutions against Iran in the International Atomic Energy Agency and enforces UN Security Council resolutions against Tehran.

It has stopped North Korean shipping in its waters and inspected cargo.

It is the fifth-largest donor of reconstruction assistance to Afghanistan.

It participates in nearly every U.S.-supported multinational technology initiative for tackling supply side answers to climate change, including projects on hydrogen, carbon sequestration, and nuclear fusion.

It is struggling to deal with the fallout of its nuclear liability law, in part to accommodate U.S. companies.

It provided tsunami relief in 2004 through an ad hoc naval partnership with the United States and two of Washington’s closest military allies. And that type of cooperation continues on an ad hoc basis:  India’s military conducts exercises with every U.S. armed service, and has exercised trilaterally with the United States and Japan, despite Chinese protests.

Taken together, these questions and realities mean that India’s choices are certainly its own. But few in India believe that remaining aloof will ever again be a viable strategic or economic option.