CHINA has embarked on a series of initiatives of late that could add up to a game changer for the world economy. It has set up the New Development Bank (NDB) and the Asian Infrastructure Investment Bank (AIIB), seemingly challenging the positions of Western-dominated institutions such as the World Bank and the Asian Development Bank (ADB). China
has also launched several grand schemes to build infrastructure around the world — its One Belt, One Road (OBOR) idea to re-create the old silk roads that connected China to other empires 1,000 years ago being only the biggest of these. On his recent trip to Latin America, Chinese Premier Li Keqiang offered infrastructure spending of more than US$100 billion to the region, and Pakistan was promised an additional US$46 billion on top of the large amounts already promised. No doubt, more of such offers will follow in Africa and elsewhere.
China is also accelerating its efforts to make its renminbi an international currency, gradually liberalising its capital account and phasing in progressively greater international access to renminbi funding. It is only a matter of time before the renminbi is made part of the Special Drawing Rights basket (the SDR is the unit of account that the International Monetary Fund uses in some of its work, a currency with SDR status will tend to become an international reserve currency such as the US dollar, euro, yen and pound sterling).
So, what does all this add up to for the world economy? We would argue that these initiatives are hugely positive win-wins for both China and the beneficiaries in Asia and the rest of the world. For some of these initiatives to work, however, there are several obstacles that will have to be cleared — there are practical barriers in the recipient countries, while China may have to re-think its modus operandi in promoting these schemes, given some of the problems it has faced in some countries.
A potential win-win for all involved
There are many reasons China’s multiple initiatives will be a substantial positive for the world economy:
• First, China’s initiatives are in tune with local strategic plans and visions in recipient countries. For example, the OBOR initiative is in synch with Asean’s plans such as the Master Plan on Asean Connectivity. For Indonesia, President Joko Widodo’s vision of maritime power will benefit from the OBOR plans. The OBOR projects will also tie in well with other countries’ infrastructure visions such as the Thai government’s big push for mega-infrastructure projects to revitalise its growth through improving connectivity throughout the Mekong region, whose growth Thailand wants to leverage off;
• Second, again taking OBOR as an example, it comes at a point at which more than a decade and a half of under-investment in infrastructure is creating binding constraints on economic growth in Asean. One reason economic growth rates in Southeast Asia have not returned to the high rates of the 1990s is the low share of investment, particularly private sector investment, in GDP. And one reason for that is that poor infrastructure limits the risk-reward calculus for private investment — lack of public goods such as good roads and ports reduces potential returns and raises risks. A surge in infrastructure spending will therefore crowd in private investment and so raise economic growth;
• ADB has estimated that Asian countries will need to invest US$8 trillion in national infrastructure and another US$290 billion in inter-regional infrastructure construction between 2010 and 2020. Given these vast sums, any funding assistance is helpful. Thailand, Malaysia, Indonesia and the Philippines will need up to US$550 billion in investment between 2013 and 2020; the railroad sector alone will need US$119 billion investment, accounting for 22% of total projected investment needs; and
• Third, China’s imminent opening-up of its capital account and liberalising of the renminbi will have profound financial implications in Asia specifically and the world as a whole. Only a tiny proportion of Chinese savings is allocated to external investments, well below what is likely to be optimal. Liberalising its capital account could see hundreds of billions of renminbi flow out, seeking diversification and higher returns elsewhere. The option of using the renminbi as a reserve currency will also enhance Asian central banks’ diversification of their foreign exchange reserves, rather than be forced to take on excessive exposure to US dollar assets.
So, there are undoubted benefits that will flow from China’s recent initiatives. But what about the potential pitfalls?
Funding is not the binding constraint, governance is
China is basically offering huge amounts of capital to fund infrastructure: an initial US$40 billion for OBOR, which will probably grow, plus countless billions to capitalise on NDB and AIIB. In many cases, Chinese companies will provide the planning, engineering, design and other project assistance while Chinese suppliers are likely to be providing the steel, cement and other basic materials needed to build infrastructure.
However, is funding the real constraint? Our sense is that, in many countries we study, the domestic pool of funds exist to finance large infrastructure projects. Yet, infrastructure projects have not taken off in earnest. This is because the real constraint is the lack of governance:
• Indonesia, for example, has had sizeable allocations from its budget for infrastructure development but much of this has not been spent. The country also has many large business groups that have the financial resources and desire to invest in infrastructure but struggle to realise their wishes.There is no shortage of political will either — Indonesian leaders have been talking about making infrastructure a priority since President Susilo Bambang Yudhoyono’s inaugural speech in October 2004, yet nothing has happened. Thus, even with political will and funding, infrastructure did not take off because the government failed to provide the right enabling environment for investors; and
• Pakistan’s debt-ridden energy sector has enough capacity to meet power demand but fails to do so because of the policy environment. Monies due to power producers from the government have not been paid, deterring many from producing at all. Ineffective law enforcement means that theft of power is on a grand scale.
So, the key is not funding. What needs to be addressed are the following issues and it is not clear whether China alone can resolve these challenges. Projects have to be made investible in the first place. There has to be the right pricing policies and safeguards in the legal system so that private investors have confidence that they will indeed make money. The legal infrastructure has to be put in place to facilitate land acquisition, which is a huge problem in countries such as India and Indonesia. Appropriate models of public-private partnership arrangements are also needed.
China may need to re-think its traditional approach to infrastructure development
There are lessons to be learnt by China from its setbacks in relations with Myanmar and Sri Lanka as well as troubles in its projects in Africa:
• China should not replicate its approach in Africa, where Chinese companies and even labour did all the work, leaving little value for local entrepreneurs or workers. This created resentment against China and, in some cases, new governments were elected that were less supportive of taking China’s largesse;
• Sri Lanka has threatened to cancel some Chinese mega-projects that had been approved by the previous president before he was ousted from office in recent elections. Becoming overly dependent on one particular leader or ruling party can be risky;
• Myanmar showed how deep nationalistic feelings and resentment against perceived foreign domination can go. Chinese involvement had created such a large footprint of Chinese presence in the form of Chinese migrants and Chinese companies dominating particular segments that there was a political backlash, which the current government has responded to by either cancelling or postponing some big Chinese projects; and
• China also needs to consider how its assertive stance in the South China Sea is causing even countries that are not directly involved in those territorial disputes to become wary of China’s intentions.
Basically, then, while most countries would be happy to take Chinese money and advice, nationalism is a growing force that could derail the best-laid plans.
In other words, China has done well in articulating an exciting vision and in generously committing the funding needed to make these initiatives real. But its grand plans now involve about 65 countries and 4.4 billion people. It needs to build a cadre of implementers with the language skills, enough understanding of each country’s culture and regulatory and other idiosyncrasies before these grand schemes are likely to take off. The new institutions China is setting up do not yet have the institutional knowledge — which the World Bank and ADB have built up over decades — of how to deal with the practical difficulties on the ground. China needs to undertake the deep research and build enough administrative capacity to help overcome the governance deficits in many countries that are the real binding constraints on successfully building infrastructure. These tasks are gargantuan ones that will take time to be put in place.
In essence, China’s initiatives are welcome, and they will do a lot of good. But a huge amount of hard work lies ahead before these initiatives will really produce the transformational changes that they are intended to.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy
This article first appeared in Forum, The Edge Malaysia Weekly, on June 15 - 21, 2015.