China is taking further steps towards peaceful development. On October 24th 2014, China announced the establishment of Asian Infrastructure Investment Bank together with 21 Asian countries aiming to lend money for infrastructure construction. After several days, China declared a 40 billion dollar fund “Silk Road Fund” with initial principal of 10 billion dollar, 65% of which is funded by its foreign reserves. All these actions are a part of a larger blueprint “One Belt, One Road”, a strategy of China to collaborate with neighboring Asian countries. This essay analyses the pros and cons of implementing “OBOR” regarding China and other Asian countries.
Marshall Plan Junior?
The press often would like to call “one belt, one road” as the new form of the Marshall Plan led by China. However, this is not totally true. On the one hand, both schemes plan to export excessive capital, technology and capacity to foreign countries in need; but on the other, there are several differences between the two. Firstly, the ways to help other countries are different. In the Marshall Plan, the US provided aid money to European countries and most of the money flowed back from the export of US consumer goods. In “OBOR” plan, the benefit are mutual in that it is an FDI contract helping neighbor countries develop their infrastructure facilities and China can earn back from following returns (e.g. fees to use the bridge). It is also estimated that the support of infrastructure is much larger since infrastructure is an upstream industry and it can generate economic externality to downstream ones. Secondly, the political stand is different. While the Marshall Plan also serves the ambition of the US implementing its strategy of containment, “OBOR” is economic. It focuses on the economic development of Asian countries. Thirdly, the positions of countries are different. European countries in the Marshall Plan are passive receivers who were desperately in need of foreign reserves and necessities. Asian countries, however, are the equal counterparties of mutually beneficial contracts. In all, “OBOR” is not another form of the Marshall Plan, although it does need to learn from its successful implementation. For example, the way to exchange RMB with other currencies of counterparties should be carefully designed so as to guarantee a smooth transaction.
To China: A stone that kills two birds
A strategy such as “one belt, one road” can surely trigger many initiatives. The first one is relevant to China’s foreign reserves. These reserves have always been large due to the long-term trade surplus (see Exhibit 1). As a matter of fact, it is important for China to figure out how to make use of these reserves. Foreign Direct Investment (FDI) is one of the options. As mentioned above, the Silk Road Fund will be backed by 6.5 billion dollars of foreign reserves. The fund is designed to help boosting up the implementation of “OBOR” by providing funds for construction projects. This will reduce China’s reliance on its dollar assets that take up nearly 70% of the total reserves. In addition, it may also help the country to gain a larger pricing power in natural resources and commodities through overseas mergers and acquisitions. A much more important reason is to induce private sectors to make investment “out of the door”. Even though government investment can be large, its effect as a role model to private sectors should be considered a more important function. The example is the huge amount of private sector investment that outnumbered government investment during the Marshall Plan. As Professor Zhijie Ding pointed out, it is a good way to transfer the nation’s wealth to private sectors and to loosen the regulations regarding FDI.
Another initiative of “OBOR” to China is the shift of excessive capacity. This has always been a big problem, especially in cement, steel, aluminum and other building materials industries. For the last decade, the performance of these companies in China is bad. Many of these enterprises are state-owned, and hence the government has proposed a series of reforms to save them. The proposition of “OBOR” is one of these measures. It is beneficial in that there is a larger demand to fit its supply of infrastructure construction. Neighbor countries can also enjoy the opportunity to import technology from China. In addition, “OBOR” helps to improve China’s international image as a responsible country, which is of vital importance to China’s global strategy. Therefore, it seems China does have every reason to implement it.
To Asian countries: A source of positive externality
In economics, a positive (negative) externality is the benefit (cost) that affects a party who did not choose to incur that benefit (cost). When a production process starts, it will generate a positive externality to the down-stream industries. As the final products through the production chains, consumption goods generate the least positive externality because they do not support construction. But for infrastructures, things are very different. Public facilities such as bridges and roads can benefit a lot of other industries. According to Yu (2014), a unit of infrastructure investment can generate 3.05 units of production expansion from other industries. This is compared to 0.87 units of production expansion caused by fashion industry. Therefore, it is reasonable for Asian countries to take part in this large cooperation. In fact, their identities as members of AIIB have already proven their interests, and several contracts have already been under discussion.
All seems well, but…
While most of the opinions are giving out compliments and high expectation to the “OBOR” idea, it is worth noting that the challenges are not small. The largest one to all the participating Asian countries is the necessity of “being invested”. Although infrastructure construction is vital to economic growth, it cannot play the role of superhero—save the whole world with its bare hands. Ironically, this opinion was already proved by China itself. The large costs in constructing railways and highways in remote areas in China have been proved a waste to boost the economy because of the lack of disposable income among local residents. Income level determines the purchasing power, which is not high enough to provide demand for other items that require the construction of railways and highways. In fact, these costs have done little except contributing to the GDP figure. Yale School of Management Professor Zhiwu Chen also expressed similar opinions. Fortunately, this worry has been somewhat mitigated by the report of World Bank. It claimed that in Southeast Asia, a further $2.5 trillion should be invested to narrow down the infrastructure gap in the next ten years (World Bank, 2012). But still there are further questions: what ways is China using to invest? Is it going to invest money only, or will it send along its own labor force? All these questions are yet to be answered.
China also has its own concern. The country is very famous for its investment driven economy, and this form of development mode has its problems. As mentioned before, there are a lot of infrastructure projects taken place in the northwestern area that sadly cannot meet the purpose of boosting local economic development. This leads to a failure to provide returns to initial investment. Similar to this, investment in emerging markets in Asia are high risk. Two specific examples can further illustrate this: The first is Myanmar’s Myitsone Dam Project which was built by Burmese government contractors (Asia World) and the China Power Investment Corporation (CPI). On 30 September 2011, due to the democratic reforms in the country, President Thein Sein announced that the Myitsone dam project was to be suspended during his tenure. Tens of millions are lost per month solely to pay maintenance fees and leases. The second example is Venezuela. Since 2006, Venezuela has received 50 billion dollar support from China. In return, it promised to export 330,000 barrels of petrol daily and to pay back all the debt in three years. Although being a close ally of China, it failed to follow its promise because of domestic turbulence as well as a plummet in oil price. The Heritage Foundation has established a database called China’s Global Reach to track China’s overseas investment projects (see Exhibit 2). It shows that the energy sector, a part of infrastructure industries, is the largest FDI segment of China. Half of the total $396 billion invested goes to Asian and African countries. Meanwhile, from the dataset, there were altogether 130 troubled transactions with total of 235.9 billion dollars in the last decade. From all these examples it is clear that the only guarantee of all investment returns is a good local economic development.
Exhibit 2. Illustration of China’s Foreign Direct Investment
Another problem is more relevant to geopolitics. For many Asian countries, the word “China” has too many meanings. On the one hand, it represents a massive pool of opportunities; but on the other, its power is considered a threat to all countries around. While mutual economic benefit may play the main part, cultural conflicts, boundary issues and political disputes are also problems to consider.
Future Prospect: A Rose with thorns
There is no doubt that most people think positively about the “one belt, one road” blueprint. The stock market has been proving this: the market is in a strong upward trend that is very rare for recent years. Among the listed stocks, construction-related ones are leading the market. Exhibit 3 compares several typical construction listed companies (601800.ss China Communication Construction, 601390.ss China Railway Engineering Corporation, 601186.ss China Railway Construction Corporation, 600528.ss China Railway No.2 Engineering Group) with recent Shanghai Stock Exchange Composite Index (000001.ss).
Exhibit 3 Comparisons Between Typical Construction Companies and Shanghai Stock Exchange Composite Index
Source: Yahoo Finance
From Exhibit 3 an upward trend of 50% can be observed in the market represented by the composite index. This trend is led by an even larger rise of 200% in the stocks of construction companies. A market signal like this indicates the strong confidence that investors have on construction companies. Southeast Asian countries enjoy a huge benefit as well. The infrastructure gap in Southeast Asian countries is large. As mentioned before, a $2.5 trillion gap will appear in the next decade in south Asian countries. Therefore, there is a potential of mutual benefit. Despite this, problems such as the modes to investment and the risk of investment are yet solved. The biggest problem for China, as well as other developing countries, is the same: how to guarantee their economic growth so as to guarantee the return to investment. The stakeholders, of course, will take actions and think of some ways to answer these questions through negotiation. After all, finding a beautiful rose is much harder than pulling out its thorns.