As the National People's Congress (NPC) -- China's rubber stamp parliament -- concluded on Sunday, China's historic leadership transition came to an end after more than two years of political intrigue and factional infighting. In the carefully choreographed tradition of previous transitions, the 3,000 parliamentary delegates convened in Beijing and elected the new government with an overwhelming majority. Xi Jinping was voted president with one opposing vote, just like Mao Zedong in 1949, and Li Keqiang became China's new premier, with three opposing votes.

But something was decidedly different this time around. It was a combination of the smog-filled skies, the reports of thousands of dead pigs floating in Shanghai's water source, and a growing public disenchantment with the Communist Party. Expectations for change were high, and tolerance for another orchestrated Communist gathering was low.

The signals coming from the NPC reflected a clear recognition from Xi and Li that something has to change. Over the past year, the party's domestic credibility has taken a serious beating: from the ouster of Chongqing Party Secretary Bo Xilai last March in a tale of murder and betrayal fit for a novel to foreign press accounts of unseemly wealth amassed by family members of Xi and outgoing premier Wen Jiabao to strikes earlier this year by journalists at liberal media outlets.

At the NPC, the leadership moved to address popular criticism. By dismantling two highly unpopular administrations -- the Railways Ministry and the family planning commission -- China's new leaders made the first real attempt to streamline the bureaucracy since reformer Premier Zhu Rongji in 1998. They vowed to improve food safety and fight environmental degradation, two issues of great public concern. The government also pledged to reduce the state's role in the economy and society.

Thus far, these moves amount to political symbolism rather than substantial change, but there is a lingering sense that this time is different. Since coming to power in November, Xi Jinping has consolidated his power base in the party and army more rapidly than his predecessor. He also has greater credibility and a more appealing public persona than the outgoing Hu Jintao, in part thanks to the aggressive promotion of the anti-corruption and frugality campaigns.

But while Xi Jinping is better placed than his predecessors to take on that broad agenda, the high expectations that come with that recognition are not always helpful. The new president will spend the year setting priorities and consolidating internal support for them even as pent-up internal and popular pressure on the young administration continues to build. Xi will have to move quickly. Beyond the signals, he will have to give substance to his reform agenda by the third plenum in the fall of 2013. The symbolism will not be lost on Chinese leaders, since it was Deng Xiaoping who also announced his transformative "reform and opening up" policy at the third plenum in 1978.

Only then will it be clearer if this time it really is different -- and if Xi's the one to bring about lasting and substantive change for a party and a country that needs it.

Michael Meidan is an analyst in Eurasia Group's Asia practice.

Eurasia Group's weekly selection of essential reading for the political risk junkie -- presented in no particular order. As always, feel free to give us your feedback or selections @EurasiaGroup  or @IanBremmer.

China has been all over the news this week, with the New York Times hacking episode dominating headlines. But recent stories related to China venture much further than cyberspace. This week's must-reads has a China theme.

Must-reads

1. "The resource race: China dips toes in Arctic waters"
Christoph Seidler, Spiegel Online

This piece outlines China's new ventures to the Arctic -- and how China's diplomatic tactics are shifting.

2. "China's love affair with cars chokes city air"
Louise Walt, Associated Press

Over the last decade, the automobile industry has skyrocketed in China. Last year, 13 million cars were sold. But what kind of environmental impact will such a rapid shift have?

3. "Making room" 
The Economist

In 2010, there were roughly 4,000 cities with populations of 100,000 or more. (China had about 400 of those). But between 2010 and 2050, the UN anticipates that the world's urban population will double. This piece reviews a new book by Shlomo Angel called Planet of Cities -- the book predicts how future urbanization will play out. Here's an interesting rule of thumb: usually, a country's biggest cities break down such that the largest city has twice the population of the second largest, three times that of the third largest...etc.

4. "Chinese labour pool begins to drain"
Jamil Anderlini and Ed Crooks, Financial Times

China's working age population unexpectedly shrank last year -- a trend that wasn't meant to begin until later this decade. What do China's shifting demographics mean for the economy?

5. "Mexico: the new China"
Chris Anderson, The New York Times

Is cheaper always better? This piece highlights some of the advantages of using Mexican manufacturing from an American business perspective. Anderson argues that it allows for more product evolution, innovation, and customization -- and Chinese labor is getting less and less cheap.

Note: Today is the first in a series of posts that detail Eurasia Group's Top Risks for 2013.

Since the onset of the financial crisis in 2008, investors and companies have focused mainly on risks in developed world markets. But as conditions in the U.S. and Europe continue to improve in 2013, the most worrisome risks will again come from emerging market countries. These countries are fundamentally less stable than their developed world counterparts, and some of their governments used a period of favorable commodities prices and the benefits from earlier reform to avoid the tough choices needed to reach the next stage of their political and economic development.

Some of these emerging market nations face more difficult challenges than others, and much depends on the degree of political capital each leader will have in order to make unpopular but necessary changes. These countries can be divided into three broad categories according to the complexity and immediacy of the risks they face and the longer-term upside they offer.

The first category includes the best bets:

• Mexico: Newly elected President Enrique Peña Nieto is one of the few leaders of an emerging market country both willing and able to advance structural economic reforms.

• Turkey: Despite unrest near its borders and elite infighting over constitutional change, Turkey's institutions and balance of power support a stable and dynamic economy.

• South Korea: Seoul has demonstrated an ability to diversify its trade partnerships, has concluded free trade agreements with the U.S., the EU, and ASEAN, and is negotiating similar deals with Canada, Indonesia, and Vietnam.

The second category of emerging market economies are at risk of considerable volatility.

• India: Regardless of significant long-term structural and demographic advantages, dysfunctional politics and upcoming elections will probably paralyze reform efforts.

• Indonesia: President Susilo Bambang Yudhoyono is a lame duck, and the economic reform process is stalling.

• Thailand: Elites in Bangkok continue to fight over unresolved issues, generating unrest.

• South Africa: Political leadership has deteriorated steadily since Nelson Mandela's 1999 retirement, and populist pressures are increasing.

• China: The government's continued focus on social welfare, infrastructure, and industrial policy spending in 2013 will help bolster near-term growth. But geopolitical tensions and more competitive Chinese firms will make it more difficult for foreign companies and investors to secure profits.

Lastly, there are the underperformers, those countries where risks will overshadow returns.

• Russia: President Vladimir Putin retains a strong hold on power, but he has lost significant support from upper- and middle-class Russians, particularly in major urban areas. As a result, reliance on support from conservative Russians and economic elites will likely reduce his willingness to undertake needed reforms. Relations with both Europe and the U.S. are increasingly troubled.

• Pakistan: Political risk could reach critical levels due to a volatile election season.

• Venezuela: Challenges to restore economic health will probably suffer without the dynamic presence of the recently re-elected, but seriously ill, President Hugo Chavez.

• Argentina: Policymaking challenges are widespread due to populist pressure.

On Friday, we'll profile Risk #2: China vs Information.

Eurasia Group's weekly selection of essential reading for the political risk junkie-presented in no particular order. As always, feel free to give us your feedback or selections @EurasiaGroup or @IanBremmer. 

Must-Reads

1. "Al Qaeda 3.0: Terrorism's Emergent New Power Bases"
Bruce Riedel, The Daily Beast

In a world where international governance is breaking down, leaders are focused more on domestic than on foreign policy challenges. This trend extends to al Qaeda, an organization transitioning from global to local goals.

2. "India's African ‘Safari'"
Sudha Ramachandran, The Diplomat

We hear a lot about the US and China's conflicting investment approaches in Africa, but there's precious little written on Africa's fourth largest trading partner: India. With trade increasing by a factor of 17 over the last decade, India-Africa relations are becoming much more interesting. 

3. "How Crash Cover-Up Altered China's Succession"
Jonathan Ansfield, New York Times

How will Beijing's leadership manage the challenges that come with an era of more open information? What will the rest of us learn about the Chinese leadership's taste in cars, clothes and once-hidden power politics?

4. "Merkel's mastery of politics"
Michael Fry, The Scotsman

Is Angela Merkel the most talented politician in the world?  Her domestic political tactics shed light on her policies with regard to the Eurozone and beyond. 

5. "A free-trade agreement with Europe?"
David Ignatius, The Washington Post

Though still on the drawing board, the Trans-Pacific Partnership has far-reaching security and economic implications for North America and the Asia Pacific region.  Progress on an Atlantic equivalent seems beyond the horizon. But is an ‘economic NATO' already in the planning stages? 

6. "The mother of all worst-case assumptions about Iran"
Stephen M. Walt, Foreign Policy

Would a nuclear Iran carry "shattering geopolitical significance?" This piece overstates its case at times, but it's a question that demands consideration.

The Weekly Bonus:

"Floating Housing (And Golf Courses) For Post-Climate-Change Island Paradises"
Co.EXIST blog, Fast Company

In a G-Zero world, don't expect political leaders to tackle climate change. An ineffectual climate summit meeting in Doha this week makes that all the more obvious.  If climate change continues unabated, the Maldives will end up underwater.  The government knows it, hosting a cabinet meeting on the ocean floor in full scuba gear in 2009, and inquiring about land purchases abroad. But even the most daunting risks come with opportunities, however whimsical they may seem.

Scott Seaman and Ross Schaap

The fight to increase Japan's consumption tax may yet spark significant party system realignment -- something the country needs in order to secure a government that can more effectively address Japan's fiscal challenges and increase economic competition, especially through trade. Any move toward such change is now tied to the next Lower House election, with its timing depending largely on the behavior of former prime minister Yukio Hatoyama.

Hatoyama has returned to the limelight after Prime Minister Yoshihiko Noda managed to secure Lower House approval on June 26 of legislation that will increase the consumption tax. That process prompted a split of the ruling Democratic Party of Japan (DPJ) when Ichiro Ozawa and a group of his followers defected on the vote and formed a new party. Despite fears that Ozawa (nicknamed the "Destroyer" for his habit of creating and then wrecking political parties) would bring down Noda's government by leaving the DPJ with a large contingent of disaffected backbenchers, the DPJ has retained its Lower House majority. But the risk of a no-confidence motion has increased, and Hatoyama may yet snatch away Ozawa's moniker if he decides to defect as well.

Hatoyama is a DPJ stalwart, having helped found this party and lead it to victory in the 2009 general election. But as a backbencher he voted against the consumption tax hike and continues to criticize Noda's decision to pursue it. If Hatoyama were to defect along with 13 or more other Lower House members, Noda would not survive a no-confidence motion backed by a united opposition.

Despite stressing that he doesn't want to leave the DPJ, Hatoyama continues to speak out against Noda and has hinted that he may intensify efforts to challenge the party leadership if the Upper House fails to dilute the tax hike legislation (though he isn't clear about what he actually wants). Hatoyama will probably stay put when the Upper House passes the hike into law, likely in August without any major changes. If he defects and brings Noda's government down, Hatoyama could lose in the subsequent election. (The opposition Liberal Democratic Party is preparing to run a popular Olympic speed skater against him.)

If Hatoyama remains in place, Noda is likely to weather the current political storm and work to delay any snap election until after he secures reelection as the DPJ president in September. Such an outcome would slow any move toward restructuring of Japan's party system, which will likely advance fastest if elections occur that shake up representation in the Diet. There are other scenarios that could result in early elections, including other defections from the DPJ or an opposition refusal to help approve legislation to issue bonds to fund the budget, but they are less likely.

As a result, the odds are increasing that an election (and any resulting political party realignment) will not occur until mid-fall or later -- perhaps even next summer. A later election would allow Noda more time to position the DPJ and canvass potential allies and prepare the way for mergers or the formation of a formal coalition with reform-minded elements of the LDP and other parties. But if Hatoyama is appeased or cowed and the tax hike row dies down, pressure for an election will wane and Japan's gridlock would likely persist.

Ironically then, any hope for more rapid reforms in Japan would be best served at this point by Hatoyama jumping ship after the Upper House passes the tax hike, likely forcing Noda to call an election and potentially setting a broader realignment process in motion. For Hatoyama, replacing Ozawa as Japan's "Destroyer" by helping to dissolve the DPJ could end up being his most lasting contribution to Japanese politics.

Scott Seaman is an analyst with Eurasia Group's Asia practice; Ross Schaap is the director of the Eurasia Group's Comparative Analytics practice.

By Nicholas Consonery and Willis Sparks

For China's top leaders, this is not a good time for confrontations with the neighbors. The country's once-a-decade leadership transition is expected to unfold this fall, and neither outgoing nor incoming officials want uncertainty or ugly international headlines to interfere with the official choreography.

Thus the worry that Asian governments like the Philippines and Vietnam, emboldened by a commitment from Washington to maintain a robust strategic presence in the region, are pushing more aggressively to assert territorial claims in the South China Sea. More worrisome still, China's leaders face patriotic pressures from within for a forceful response.

China and its neighbors could be working together on joint oil and gas exploration in these disputed waters. Proven and undiscovered oil reserves in the South China Sea are estimated to be as high as 213 billion barrels, according to a 2008 report from the U.S. Energy Information Administration. If accurate, that's larger than the proven oil reserves of all but Saudi Arabia and Venezuela. But territorial disputes continue to block efforts to prove these estimates, and the potential for open hostilities in the area is growing, threatening to disrupt trade flows and stoking regional tensions.

The most recent conflict is the impasse between the Philippines and China over the Scarborough Shoal, a small island 100 miles off the coast of the Philippines claimed by both countries. In April, Philippine naval vessels discovered Chinese fishing boats in a lagoon of the Scarborough Shoal, provoking a three-month standoff in which Beijing used trade barriers to pressure Manila, which called on Washington for help. Though the standoff seemed to have been resolved in June, there are still Chinese fishing boats in the shoal.

Manila is pressing the issue both to stoke national pride at home, to justify greater defense spending, and to draw the U.S. deeper into territorial disputes. Vietnam has similar motivations, though Hanoi appears to have less appetite for tension than Manila at the moment. Neither Chinese neighbor wants to punch toe-to-toe with Beijing, and cooler heads are always likely to prevail. But confrontations at sea can spin beyond the control of state officials back on shore.

There is a similar problem in Beijing. When Chinese officials discuss how best to manage territorial claims in the South China Sea, there are lots of negotiators seated around the table. Local leaders, maritime police, customs and border officials, as well as representatives of national oil companies and the Chinese Navy each have their interests to assert. Any of these actors can play to increasingly hawkish public opinion to operate outside the limits set down by senior leaders.

That's why, though the leadership would like to put a lid on territorial tensions, China has been making so much South China Sea news in recent weeks. Two weeks ago, the state-owned China National Offshore Oil Company (CNOOC) opened nine blocks for exploration in waters also claimed by Vietnam. Not long after, a spokesperson for China's Defense Ministry announced that the navy was conducting combat-ready patrols in the area.

In months to come, China's top leaders will do their best to strike a delicate balance-to appease belligerent voices at home and within the government while reassuring outsiders that China is not becoming more aggressive. But each time one of the neighbors makes another provocative move, Beijing's balance becomes a bit harder to maintain.

Nicholas Consonery is an analyst in Eurasia Group's Asia practice. Willis Sparks is an analyst in the firm's Global Macro practice.

By Jiakun Jack Zhang

In an attempt to reorient its economy toward consumption and allow its masses to share more of its record growth, China is quietly undertaking the largest social welfare project in human history.

Decades of rapid economic growth have created vast inequalities, and populism is consequently on the rise. China's 99 percent feel left out of their country's rapid development and are increasingly lodging their complaints online. A recent study of Chinese internet trends in 2011 reveals a shift away from nationalism toward issues of public welfare. The government is paying greater attention to social media and taking notice of this trend. In 2011, mentions of Weibo (Chinese twitter) in The People's Daily (the Party mouthpiece newspaper) increased by an astonishing 83,900 percent.

In its battle to retain political legitimacy, the Chinese Communist Party has announced that it will sacrifice growth for development quality. It realizes that raising the GDP growth bar is no longer adequate and has launched its own version of the New Deal by introducing ambitious reforms and hiking spending on affordable housing, social security, healthcare, and education. If China's leaders bungle this massive undertaking, it will spell trouble for the country's state capitalist system.

If they get it right, the next five years, covered by the 12^th Five Year Plan (FYP), could prove to be the most transformative in modern Chinese history. As Beijing attempts to extend the social safety net to cover all of its 1.3 billion people, it could reshape China's economic landscape by furthering urbanization, bolstering domestic consumption, creating a better-educated workforce, and improving social stability. There are two simultaneous goals: preserve the legitimacy of the political system and contribute to the country's economic re-balancing.

For a nominally communist country, China's lack of a social safety net is somewhat ironic. When Beijing dismantled the country's communes and privatized state-owned enterprises in the 1980s and 1990s, China's ‘iron rice bowl' welfare system collapsed. The national savings rate rose during the 2000s as Chinese households struggled to pay for increasingly expensive housing, healthcare, and education while putting away enough for retirement. Ordinary citizens had little choice but to deposit their savings into state-owned banks, earning negative real returns. The savings glut fueled the country's export- and investment-driven model, but household consumption lagged.

This model seemed to work until the global financial crisis shook Beijing out of its complacency. After several abortive attempts at reform over the past decade, China's leaders finally seem committed to mending the country's broken social safety net. The government plans to construct seven million affordable housing units in 2012 alone-the project is estimated to cost 1.3 trillion yuan ($198 billion) and aims to make 20 percent of the housing market "affordable" by 2015. Last year it implemented regulations that will provide basic pension and insurance coverage for all citizens and ramp up spending by 21.9 percent to 575 billion yuan ($91 billion). A new set of health care reform goals were set in the 12th FYP: universal health care, drug pricing reform, and public hospital reform. The 2012 appropriation for healthcare is 203 billion yuan ($32 billion), an increase of 16.4 percent from 2011. Education spending is slated to expand by 16.4 percent to 378 billion yuan ($60 billion). For more details, refer to the Ministry of Finance Budget Report for 2012.

Yet pushing through reforms will prove a significant challenge for China's fifth generation of leaders. The window for reform is rapidly closing and implementation will be hindered by entrenched interests and bureaucratic inefficiencies at the local level. China's economic growth is slowing and its demographic advantage is fading. The government acknowledges that while its revenues are projected to shrink, its expenditures will expand in order to finance these new entitlement projects. The Communist Party risks losing political legitimacy and will confront growing social unrest if these efforts stall or fail. Political reforms may be the only way to create a civil service capable of administering these programs effectively (and without corruption). Having recognized that headline-grabbing GDP growth isn't enough, China's political system will have little to fall back on if it can't make this New Deal work.

Jiakun Jack Zhang is a researcher in Eurasia Group’s Asia practice.

By Jennifer Lee

The new, young regime in North Korea surprised more than a few observers when it agreed last week to a moratorium on its nuclear activities in return for 240,000 tons of U.S. food aid so soon after Kim Jong Un assumed leadership. Instead of the legitimacy-building provocations expected from the young Kim (who is in his late 20s), the world got a measured concession from a totalitarian regime that demonstrated a degree of consensus and decision-making ability. In some ways, it was the story of the young son continuing his father Kim Jong Il's efforts to improve relations with the U.S. prior to his death.

There is general optimism surrounding the agreement, which stalls North Korea's uranium enrichment program, and nuclear and long-range missile tests, and allows the International Atomic Energy Agency to inspect the Yongbyon nuclear facility. Last week's step forward, however, does not necessarily presage a more substantive shift in North Korea's posture. The agreement allows North Korea to possibly address its immediate concerns (economic sanctions) and affect domestic politics in South Korea, without ceding its ability to provoke or flip the switch (again) on its nuclear program.

While it is easy to think that the U.S. food aid "carrot" must have been the main reason behind North Korea agreeing to this deal, it is unlikely the case. North Korea is not known for being particularly concerned about the hunger of its people (allegedly more than one million people died during the famine in the 90s, and food security has been dismal for the past few decades); and the totalitarian nature of the regime means that its leaders are not very concerned about their approval ratings.

North Korea is more concerned about the economic condition of the state and the long-term implications of sanctions (North Korea's version of the statement mentions that it would want to discuss the lifting of sanctions and provision of light water reactors if the Six Party Talks resume). The current move is probably a gambit to see if it can resume the Six Party Talks and have sanctions lifted without giving up the nuclear program. The deal is also likely an effort by Pyongyang to slight the Lee Myung-bak administration in Seoul, which it views with hostility, in the hope of increasing the chances of the liberal parties in South Korea's presidential election in December.

The U.S. and South Korea both have presidential elections this year. The agreement is likely North Korea's way of buying time for a year or so until the South Korean administration changes, while trying to extract concessions from an Obama administration that does not want any more conflicts on its hands during an election year. This is also a moratorium that is to last only while "productive dialogue continues." Everything North Korea has promised is reversible if it decides to back out. And it certainly has set a precedent for doing so. Furthermore, this moratorium applies only to the Yongbyun nuclear facilities; it is widely believed that there are several other nuclear development sites throughout North Korea that will be out of reach under this agreement.

It should not be forgotten that North Korea's nuclear capability has been extolled within North Korea as Kim Jong Il's most important legacy. It is undoubtedly seen as the single most powerful card that North Korea has, and with the recent leadership transition to a young new leader, there is little chance that the country will completely forgo this leverage, especially after the NATO operation in Libya that removed Muammar Qaddafi.

There is still a possibility that this could turn into something positive and lasting for U/S.-North Korea relations or North Korea's future behavior. Last week's agreement demonstrates that the totalitarian regime in North Korea was able to take a rational step for its self-interest. But it does not demonstrate that North Korea is contemplating giving up its nuclear weapons, or that it is on the verge of changing its behavior.

Jennifer Lee is an associate in Eurasia Group's Asia practice.

By Willis Sparks

Western officials (and more than a few Western celebrities) have criticized China in recent years for its protection of Sudan's government. They've charged Omar al-Bashir's regime in Khartoum with support for ethnically motivated militia attacks on civilians in the country's Darfur region -- and China's government with complicity. Bashir, the world's only fugitive head of state, was indicted by the International Criminal Court in 2008 for Darfur-related crimes against humanity. Beijing uses its veto power to block international efforts to supply UN peacekeepers for Darfur, critics say, to protect its oil interests in the country.

It's ironic then that China's energy needs are now helping forestall a broader (and perhaps bloodier) confrontation in Sudan.

Last July, Sudan became two countries. The mostly Muslim North and mainly Christian South finalized a relatively amicable break-up as South Sudan became an internationally recognized independent state. But like most divorces, this one did not produce a clean break, because the two countries share custody of the country's oil wealth.

Before the separation, Sudan produced about 500,000 barrels of crude oil per day. South Sudan now sits atop 75 percent of that total, but the pipelines that transport the oil and the ports that move it to market lie in the North. Since July, the northern government in Khartoum has faced a series of political and economic crises, and its foreign reserves have dwindled to dangerously low levels. Bashir's government needs some way to draw more cash from the oil it has lost.

Not surprisingly, North and South have yet to agree on how to share oil revenue, and each side has used its leverage to pressure the other. An opening of negotiations offered little promise of progress: Khartoum demanded a transit fee of $36 per barrel. The southern government in Juba offered less than a dollar.

On Nov. 8, President Salva Kiir of South Sudan dramatically upped the stakes in the dispute by ordering the expulsion from the south of Sudapet, the North's national oil company and a financial lifeline for its government. Khartoum countered with an announcement that oil exports from South Sudan would be suspended.

China quickly jumped in.

This oil is especially important to the China National Petroleum Corporation (CNPC), which has equity production in Sudan of about 200,000 bpd, 15 percent of its total overseas output. Despite its growing involvement in oil exploration and production abroad, CNPC is still a newcomer to this game, with fewer options than its international peers.

And CNPC is important for China's government, because the company is a guarantor of China's energy security. Most of the crude that CNPC draws from Sudan is not shipped home to China but is sold on international markets. Yet Beijing has emphasized the importance of holding oil assets overseas, providing fuel that can be directed to China if events threaten a sharp drop in supply.

The country's thirst for energy -- and management of the political vulnerabilities it creates -- remain a top priority for Beijing. Sudan represents less than 5 percent of China's crude oil imports, but add an extended export shutdown in Sudan to the current range of worries and headaches across oil-producing North Africa and the Middle East, and you could have significant upward pressure on global oil prices at a time when the Chinese leadership is already worried over price inflation and the risk of unexpected foreign economic shocks.

This is an especially anxious time for Beijing's economic policymakers. Volatility in Europe and the slow recovery in the United States -- China's largest trading partners -- fuel fears of a sharper-than-expected slowdown inside China. It's also a delicate moment for the country's politics as a leadership transition begins in earnest in 2012.  That's why China moved quickly to pressure the North to renounce its threatened blockade.

To save face, Khartoum announced it would allow the oil to pass but would seize about a quarter of the profits as compensation. Low-level violence will continue, and we can expect to see more of the increasingly common attacks on oil fields along the two countries' poorly demarcated border. There will be more turmoil in restive oil-producing regions in the North. But thanks to aggressive Chinese mediation, the oil continues to flow, and Chinese diplomats are now trying to broker a long-term deal on transit fees.

Don't expect China to dive more deeply into conflict resolution in other countries. On foreign policy, China's leadership is risk-averse even in the most confident of times, and the looming transition to a new president, premier, and party elite over the next two years will make officials even more cautious. Only when political and commercial interests clearly coincide, as they do in Sudan, will Beijing move quickly to intervene in the politics of other countries.

In this case, however, Chinese intervention helped avoid a dangerous foreign conflict -- at least so far -- even if Western critics are cynical about its motives.

Willis Sparks in an analyst in Eurasia Group's Global Macro practice. 

By Michal Meidan 

The Senate bill that aims to punish China for holding down the value of its currency and that is now in the hands of the House will not trigger a trade war between China and the United States (as feverish speculation has suggested). That said, as both Beijing and Washington head toward political transitions in 2012, politicians will have to take tough stances on sensitive issues to please domestic audiences-while trying to keep bilateral relations stable. Maintaining its footing between these sometimes opposing demands will become increasingly challenging for Beijing as its campaign season revs up.

China's leaders aren't formally campaigning the way U.S. presidential candidates do, but jockeying for the country's top political positions is underway. Current leaders, as well as the younger crop they hope to promote, are therefore vulnerable to criticism from hardliners within the government, as well as from an increasingly nationalistic public. China's expanding economic clout, combined with a sense that American primacy has reached its end, is fuelling calls for more assertive responses to perceived provocations from Washington. In the run up to the Senate vote, Beijing therefore made every effort to lobby U.S. lawmakers to reject the bill. And once the bill had passed, Chinese politicians were compelled to express their displeasure vociferously. Government spokespeople slammed the bill as a protectionist move that could hinder the global economic recovery, while the state-run media denounced Washington's attempts to use the yuan as "a scapegoat for the U.S. politicians' incompetence."

Now that Beijing's rhetorical dues to its people are paid, though, it is unlikely to rock the boat further. By retaliating with currency devaluation or a trade war, Beijing could embolden lawmakers in Washington to push the bill forward. Instead, Beijing reckons that as things stand there's only a slim chance that the bill will become law. Even if the bill moves forward, China's leaders will likely wait for President Barack Obama to either water it down or veto it altogether. That is, Beijing will give the White House a chance to uphold the tacit bilateral agreement to keep cool.

Such conciliatory logic prevailed around the $5.9 billion arms sale to Taiwan that the United States announced last month. The Obama administration agreed to refurbish the F-16 jets it sold to Taiwan in 1992, but did not sell the island the latest model of the fighter plane, as some in both Washington and Taipei had hoped. China's response was low-key: Beijing called off a few military-to-military dialogues but did not sever ties (as it did after the previous announcement, in January 2010), despite strong calls at home to be more assertive. As long as Washington keeps its side of the bargain, Beijing can get away with such moderation.

But appeasing nationalistic voices while keeping bilateral ties on an even keel will be increasingly difficult for Beijing in the coming year, as contentious issues are likely to emerge. Presidential elections in Taipei in January could rattle nerves in both Beijing and Washington, as might flare-ups in the South China Sea. Particularly as the two countries grapple with an uncertain global economic outlook and try to coordinate their approach to the Middle East, any or all of these issues could make the campaign season acrimonious.

Michal Meidan is an analyst in Eurasia Group's Asia practice.

By Nick Consonery

The U.S. and Chinese governments have just wrapped up the third annual Strategic and Economic Dialogue (S&ED) talks, which were a vital opportunity to "tune up" one of the world's most important relationships. With the Chinese delegation now back in Beijing, the United States at least will bill the latest round as a success.

Washington secured a commitment from Beijing that it would follow through on an earlier promise to open up its massive government procurement market. Beijing also gave ground on a few other market-access issues, including in its domestic financial services market. These developments are significant for some companies in some sectors. But despite this progress, the current longer-term outlook for the U.S.-China relationship is muddled at best, and fractious at worst.

There a several areas of concern. The massive trade imbalance that haunts the relationship will not be resolved any time soon, especially given low expectations for meaningful economic change in China over the next few years. Another worry is that commercial relations-which helped smooth over several periods of high tension in the past two decades-will become more fraught, as business competition surges.

In this context, the S&ED talks-while important-are insufficient to ensure that relations stay on a positive trajectory. Sub-national contacts between the two sides must also be expanded more aggressively, in tandem with the S&ED.

Fortunately, both national governments recognize this and are working to bolster sub-national contacts. The leading efforts are the U.S.-China EcoPartnership program (which was expanded during the S&ED), and the newly formed U.S.-China Governor's Forum, which will have its first annual meeting in Salt Lake City, Utah in July this year. Individual U.S. states are also expanding dialogues and connections with China. South Carolina's Department of Commerce, for example, has a permanent representative office in Shanghai. And just this week Virginia opened its own trade office in Shanghai.

Of course, sub-national contact between the United States and China is not exactly new. As a U.S. government fact sheet, agreed on during Chinese President Hu Jintao's January visit to Washington, points out, eight governors led trade visits to China in 2010, and equivalent Chinese politicians made 100 visits to the United States in the same year.

Admittedly, these moves are driven largely by commercial interests. In particular, U.S. states are angling to get their share of a hoped-for flood of Chinese investment into the United States. But this grass-roots contact will also improve the U.S.-China relationship in a way that no high-level bilateral dialogue could hope to accomplish.

There is still a real risk, however, that politics could get in the way of the relationship-as Dan Rosen and Thilo Hanemann point out in their recent report on China's global investments. That may make it harder for states to capitalize on Chinese commercial interests, and reduce the benefits those investments would carry, such as new job growth. In the end, a more robust network of sub-national personal and business relationships between the United States and China will go a long way towards averting that outcome.

Nick Consonery is an Asia Analyst at Eurasia Group.

By Damien Ma

In the midst of strident declarations that the global nuclear renaissance is over, it is worth pointing out that in China at least, the rebirth of nuclear power is for all intents and purposes a done deal, especially now that Japan's nuclear crisis seems to have turned a corner. Many thought Beijing's immediate announcement of a safety review and a freeze on new approvals meant the industry was effectively on life support. But that's not true. Nuclear power features prominently in the 12th Five-Year Plan (FYP) as an essential base-load alternative to coal. And because there are no easy substitutes, nuclear power is a key part of achieving China's clean energy goals.

The recently ratified 12th FYP contains binding targets to have non-fossil fuels account for 11.4 percent of China's primary energy mix and for a carbon intensity reduction of 17 percent by 2015. Those goals are likely to be reached only by meaningfully expanding nuclear power because renewables alone (including hydro) are unlikely to be sufficient in offsetting coal and meeting the plan's objective. Nuclear capacity is expected to quadruple from the current 10.8GW to around 40GW by 2015. The State Council has reportedly already approved 34 plants totaling 36.9GW, with work on 25 of those projects (totaling 27.7GW) having already started. Even if the new regulatory review delays construction of the remaining nine projects on the drawing board, China's nuclear power capacity would eventually still be just shy of 40GW.

The review process will have some effect though. Yet-to-be approved projects may be shelved. Existing projects and those yet to break ground could temporarily see delays or receive more scrutiny to determine whether they need to be retrofitted. But decommissioning reactors seems unlikely. China's fleet of reactors is relatively young, compare to the 40-year-old ones in Fukushima. Siting future plants in interior China, such as in Chongqing and Hunan, may also be reconsidered because of their proximity to notable quake zones. It is also worth noting that though China stated in 2010 that it is aiming for 70GW-86GW of installed capacity by 2020 (with some proposing total capacity as high as 100GW), that figure could ultimately err on the conservative side once Beijing reassesses its energy needs for the 13th FYP. But even at 70GW, China would be one of the largest nuclear markets in the world.

The support for nuclear energy reflects the political strength of its champions in the Chinese government. Top energy officials, such as former National Energy Administration (NEA) head Zhang Guobao and current NEA chief Liu Tienan, have publicly stated in recent days that China needs to develop its nuclear industry, with safety as a prerequisite. Other officials from the environment ministry, which has a hand in managing the nuclear sector, have also argued that China needs nuclear power to ensure energy security amid growing demand. Indeed, energy security and clean development have been invoked as compelling arguments. The head of the China National Nuclear Corp., one of the country's two nuclear giants, recently pointed to data indicating that China's existing nuclear capacity reduced annual emissions (67 million tons less of CO2 and 250,000 tons less of SO2) compared to equivalent coal-fired capacity.

Yet the effusive support elides legitimate concerns about whether China can produce a sufficient number of properly trained operators and managers that can keep up with the expansion of plants. (The Chinese obviously would prefer technicians like those handling the Fukushima crisis.) And the Japanese crisis has lent ammunition to some critics of the pace and scope of China's nuclear pursuit, with some likening it to a "great leap forward." The episode could perhaps inspire a more open debate about China's nuclear trajectory. It is also possible that bottom-up populism, particularly in a more "progressive" province such as Guangdong, could fight local governments over future plant sites. But ultimately, a sudden reversal of the civilian nuclear program that began in earnest 20 years ago seems unlikely.

Damien Ma is an analyst in Eurasia Group's Asia practice.

I hosted a dinner last night along with a couple of Harvard folks -- economic historian Niall Ferguson and economist Ken Rogoff. It seems Ferguson and I have been facing off a lot recently -- him doing the run-up to today's changing geoeconomic environment (starting from about the 14th century) and me looking ahead. This time, Ken was there to keep us honest on facts and figures.

Niall's pretty much a Davos fixture, with a studied but effortless presentation style and pretty extraordinary range when it comes to European/Eurasian/Asian historical trends. He also tends to get a haircut right before the summit, and so looked disarmingly boyish. (I guess that puts me in the middle, since Rogoff has a rather more adult do.)

The talk moved swiftly to whether Asia (and China in particular) has the ability to structurally eat the west's lunch. Niall thinks so -- and points to six "killer apps" that the west has dominated for a couple of centuries that now the east has picked up (things like innovation and competition). I'm skeptical on the innovation side, but generally they're strong drivers.  

My primary rejoinder was to what extent China has also imported some killer apps from the west that are going to prove, well, problematic, for their model. The first, and the less controversial, is growth. When they get to around $10,000 per capita (from just under half that at present), growth's going to slow substantially. The economy has to be restructured, and largely into the hands of consumers ... out of the hands of the state. An extremely difficult thing for a consensus-driven state capitalist system to do.

But there's a second, more controversial "killer app": representative government. Not in the sense that Beijing is moving towards western-style democracy. But rather that over time, the Chinese government has indeed become much more responsive (and has had to become much more responsive) to the demands of the domestic constituency. That's a trend that's likely to prove extremely difficult to slow down. It's also one that likely makes the Chinese government more short term...and less strategic. One of the biggest advantages China has had (in addition to extraordinary amounts of productive cheap labor) is the ability to direct resources strategically in a way that the west, with their continual electoral cycles and need to placate constituents, really can't. When does that start seriously changing in China? Quite possibly at the worst possible time...when there's a slowdown.

Anyway, at the end of the presentation, we did a snap poll of the roughly 75 attendees at the dinner: how many thought emerging market growth was, on balance, a good or a bad thing for the developed world? A plurality actually voted "bad." (I'd say 40/45 percent, 25 percent good, and the rest thoughtfully abstaining). Food for thought.

By Ian Bremmer and David Gordon

Amid a sluggish global recovery, China's return to go-go growth will generate plenty of resentment in 2011 -- and not just in Washington. Though China has become the world's second-largest economy, its leadership insists it must continue to manage the country's development at a measured pace. For some of China's biggest trading partners, that argument is beginning to ring hollow.

To rebalance the global economy, policymakers in both the developed and developing world have called on China to reduce its enormous trade surpluses by reducing the country's dependence for growth on exports and increasing Chinese consumer demand, both for foreign and domestically made products. Chinese policymakers would like to do exactly that. The Western financial crisis briefly created turmoil in China, not because Chinese banks were exposed to contagion from Western banks, but because reduced demand for Chinese products in Europe, the United States, and Japan hit local manufacturers hard and forced millions of Chinese from their jobs. Beijing scrambled to create new jobs, primarily by targeting massive state stimulus spending at infrastructure projects that required lots of manual labor. For the Chinese leadership, generating much greater domestic demand would make China less vulnerable to hard times elsewhere.

But China's plans for rebalancing will take a generation to accomplish, and a lot of its trade partners would like to see the change come much faster than that. In the near term, Beijing will offer only small adjustments to accommodate them because the leadership must negotiate demands from various interest groups within the leadership and because this transition will put many more workers on the street than the slowdown did, and the Chinese leadership knows it must manage that challenge carefully to avoid a dramatic surge in civil unrest.

Unsatisfied, outsiders will grouse that China's rate of export growth remains twice its rate of economic growth. In 2010, relations between the United States and China became much more contentious. In 2011, China will likely face increased pressure from Europe, Japan, and probably from emerging markets like India and Brazil. Further, China's security-driven assertiveness in East Asia will continue to provoke tensions with many of its Asian neighbors even as trade relations deepen.

In the past, China has taken the edge off international pressure by adjusting the pace of its reform efforts modestly just before major multinational gatherings -- for example, by depegging the renminbi from the U.S. dollar in advance of the June 2010 Toronto G-20 summit. But there aren't many "steam-releasing" events on the calendar in 2011. President Hu Jintao visits Washington later this month, but the North Korea crisis will occupy much of that conversation, decreasing the likelihood that China will see much value in any major moves on rebalancing.

The next G-20 meeting, this one in Cannes, won't be held until November. French President Nicolas Sarkozy has grand ambitions for this event, but frustration with China will build over the next 10 months and so too will the risks of market-moving international reactions to China's incremental, deliberate, consensus-driven policymaking process. At Cannes, tensions may come to a head as more countries than ever prove ready to confront Beijing on issues from industrial policy to intellectual property rights protections to currency valuation.

On Monday, we'll examine the threat from North Korea, which hits our list of this year's top risks at No. 5.

Ian Bremmer is president of Eurasia Group. David Gordon is the firm's head of research.