By Cecilia Joy-Perez and Derek Scissors
The initiative’s success and the validation of China’s as an economic leader depends largely on each partner country’s capabilities.
(This piece was originally published on the website of American Enterprise Institute. Republished with permission.)
With the Trump administration considering protectionist policies, some commentators see the end of American economic leadership in Asia. The country perhaps capable—and definitely interested—in filling any leadership gap is China. Recently, Beijing hosted 29 heads of state for the Belt and Road Forum for International Cooperation, a diplomatic event aimed to garner support for the One Belt, One Road (OBOR) initiative. Communist Party General Secretary Xi Jinping has highlighted plans to boost OBOR as part of a strategy that puts China at the center of globalization.
Can OBOR deliver? Probably not. While OBOR will help both China and the host countries in the short term, its benefits are unlikely to prove durable.
The China Global Investmenti Tracker shows the actual impact of OBOR to this point, going beyond Chinese boasts and American fears, neither of which turns out to be well grounded. The tracker shows the majority of Chinese commitments in OBOR countries come in the form of construction projects taken on by large state-owned enterprises (SOEs.) Thus far, China has won $135 billion in construction projects and invested $86 billion in OBOR countries.
Whether these projects lead to sustained growth and thus validate China’s as an economic leader depends largely on each OBOR country’s capabilities. Gains may be short-lived because of the challenge of maintaining infrastructure assets once Chinese contractors are gone. In addition, while US observers are concerned about China’s influence, the temporary nature of construction limits the geopolitical gains China can reap from OBOR. Finally, we will continue to see significant Chinese overseas commitments, but footing the OBOR bill is becoming a heavier challenge. China is overleveraged at home and has seen available foreign exchange plummet (from extremely high levels). It faces sharp choices about where to spend resources.
Xi introduced OBOR in September 2013. The initiative aims to connect China to countries along the ancient Tang Dynasty Silk Road through construction and investment. It originally targeted 64 countries (plus China itself). Currently, it includes about 70 countries. The exact number has become malleable, and for the sake of clarity, OBOR here is the original 64.
With the announcement of OBOR in late 2013, the operational start can be taken as January 2014. The $135 billion in construction and $86 billion in investment accrued from then until the end of 2016. In the previous three-year period (2011–13), China already had a strong presence in OBOR countries with $93 billion in construction and $62 billion in investment. OBOR therefore constitutes an expansion of already considerable Chinese activity, but not a particularly impressive one. Further, construction has consistently been more prominent than investment.
Since Chinese companies act primarily as contractors, they may not have a long-term presence in OBOR countries, making for frailer links. Large construction contracts yield diplomatic capital during the deal process, but it is less certain they will help China sustain influence once the projects are complete. Local firms may build lasting partnerships with Chinese firms in order to maintain engineering projects. If not, though, political gains will either be temporary or require constant refreshment in the form of new projects or partnerships, which China may not be able to afford.
On the investment side, $86 billion may seem impressive, but it falls short in comparison to Chinese investment elsewhere. For instance, combined investment in all OBOR countries since the program began is no larger than Chinese investment in the US alone over the same period, and investment in the US has grown faster.
Since 2014, Malaysia ($11 billion), Israel ($10 billion), and Russia ($9 billion) lead in drawing Chinese investment. Chinese investment in Russia follows the narrative of going out to secure natural resources, with investment concentrated in commodities. Investment from 2011 to 2013 stood at $12 billion, more than after OBOR was inaugurated.
Drilling down, almost $5 billion of the smaller $9 billion in investment in Russia under OBOR has been in natural gas. In light of Russian state ownership in natural gas, it is difficult to make the case that Chinese investment in Russia has advanced its leadership.
Similarly, the Chinese investment in Israel since OBOR ($10 billion) in itself is unlikely to greatly expand China’s role in Israel, much less in the Middle East as a whole. The largest transaction is privately owned Shanghai Giant–led consortium’s $4.4 billion acquisition of Playtika, an entertainment company. The second-largest sector receiving investment is agriculture, at about $3 billion. Chinese firms are investing to learn about agricultural practices, not because it will translate to any influence.
In Malaysia, Chinese investment took off with the almost $6 billion (including debt) acquisition by China General Nuclear of Edra Global Energy. At the time, the firm was in distress, and there is no doubt Edra and the Malaysian government appreciated China’s bailout. Yet just a few weeks ago a $2.4 billion deal with state-owned China Railway Engineering for Bandar Malaysia was canceled by the Malaysian side. Influence again seems tenuous.
What’s in It for OBOR Countries?
Chinese overseas construction is improving power supply, transportation, water systems, housing, and more in OBOR countries. But will these (chiefly) developing countries have the capability to maintain the assets once ownership is transferred to local entities? Chinese firms typically enter through engineering-procurement-construction agreements or gain a build-operate-transfer (BOT) option. Once ownership is transferred, if the host country is unable to keep up these infrastructure projects, the facilities and their benefits will deteriorate.
In contrast, investments create jobs that can become embedded in the local economy. The impact of investment in OBOR countries varies with the nature of the deal. Joint ventures hold the potential of passing knowledge along, typically in this case from the Chinese firm to the OBOR partner. Green field investments do not necessarily boost host country capability but more clearly add to economic activity, including employment.
From 2011 to 2013, more than half of Chinese investment in the eventual OBOR countries was green field investment. After OBOR, this fell to a little over a third, a drop consistent with the global pattern in which Chinese acquisitions have become more prominent. The trend will reduce short-term benefits for OBOR countries but can increase long-term benefits if the acquisitions involved local partners. Presently, about half of Chinese OBOR investments involve local partners.
The top draw for both construction and investment in OBOR countries is energy, at $55 billion in construction and $42 billion in investment. Energy projects can have very high short-term value but also involve high maintenance costs.
Pakistan, for example, sees the most Chinese construction (by value), including large energy projects. From 2014 through 2016, Chinese companies initiated construction projects worth $19 billion and invested $7 billion. The chief activity is helping build power plants, such as Power Construction Corporation (PCC) on behalf of Oracle Coalfields. Less frequently, they buy into energy assets, such as PCC’s $1.07 billion venture with Al Mirqab Capital to build a coal plant in Karachi. And there are hybrid endeavors. Prior to the start of OBOR, China Three Gorges Corporation entered into a BOT agreement for a hydroelectric project, in which they operate the plant for 30 years before transferring. This may be beneficial for Pakistan if local firms learn from the Chinese company.
The other main area of activity is building transportation links, which accounts for $46 billion in construction and $12 billion in investment. This is no surprise, since OBOR naturally features transportation as a means to improve connectivity. Chinese investment is minimal because transportation systems are usually managed at the country level. The biggest OBOR transportation construction project to date is China Railway Engineering’s $3.1 billion project in Bangladesh.
In developing countries, such as Bangladesh, there may be serious risk of transportation assets deteriorating quickly because of a lack of capabilities to manage upkeep. One possibility is that Chinese firms take on the upkeep of the infrastructure. This would mean a longer Chinese presence in OBOR countries, with geopolitical ramifications. For example, if Chinese SOEs are indefinitely responsible for maintenance of national railways, then national transportation bureaus would need strong ties to China, offering leverage to Beijing.
Much attention has been paid to very expensive rail contracts. Some of these are undertaken outside OBOR, such as the $1.46 billion expansion of high-speed railways in Kenya; others are stunted. There have been successes, such as China Railway Engineering $360 million project in Russia to connect Moscow and Kazan. But there have been more failures, at least to date. For instance, construction of a $1.5 billion, 150-kilometer high-speed rail linking Jakarta to Bandung has stalled. Similarly, in Myanmar a $760 million high-speed railway was shelved by the government. The high costs of the technology and the potential shortage of demand for high-speed transportation in less populous and less wealthy countries affects the feasibility of high-speed railways. Moreover, public criticism of the project in Myanmar and Indonesia has clouded the deals.
Growing Burden on China
Lastly, OBOR is becoming a heavier financial burden for China. The vast majority of construction contracts are awarded to state-owned enterprises, such as China National Machinery and its subsidiaries. This contrasts with China’s global investment patterns, in which private firms have become progressively more important. The construction side is different because it is partially intended to remedy overcapacity at home, which is concentrated in SOEs. These companies do not necessarily operate to make money, rather they operate in accordance to state goals. When a Chinese SOE is not performing well, it is almost never permitted to fail, making for excess capacity. Of course, SOEs do not magically become efficient when they head overseas. In fact, operating overseas in developing countries is typically more challenging for SOEs. As a result, they need financial support.
China is no longer in a strong financial position in terms of foreign exchange or domestic debt, and OBOR unavoidably involves a further burden. While the stock of Chinese forex has stabilized for the moment at $3 trillion, 2015 and 2016 saw reported negative outflows of $350 billion and $550 billion, respectively. As foreign exchange reserves drop, Chinese domestic loans continue to outpace, reaching $14 trillion.
China claims a new normal in economic growth at 6.5 percent of gross domestic product (GDP). But GDP does not itself finance OBOR. Credit Suisse’s net private wealth survey, a measure of the resources ultimately available to the public sector, shows China’s net wealth stagnating. If wealth does not start to expand again, China will face spending choices, perhaps impinging on OBOR.
While substantial, OBOR therefore seems overhyped in some quarters. Construction activity remains impressive, but investment is not, and the geopolitical gains for China may be minor. The benefits for OBOR countries are contingent on their capabilities in managing large assets. The financing requirements add to China’s concerns about capital outflow and debt. In a China challenge to US leadership in Asia, OBOR would play a loud but secondary
(Derek Scissors is a resident scholar at AEI and creator of the China Global Investment Tracker. Cecilia Joy-Perez is a research assistant in foreign and defense policy at the American Enterprise Institute.)