The Silk Road Economic Belt and the 21st-century Maritime Silk Road, also known as The Belt and Road (abbreviated B&R), One Belt, One Road(abbreviated OBOR) or the Belt and Road Initiative is a development strategy and framework, proposed by Chinese paramount leader Xi Jinping that focuses on connectivity and cooperation among countries primarily between the People’s Republic of China and the rest of Eurasia, which consists of two main components, the land-based “Silk Road Economic Belt” (SREB) and oceangoing “Maritime Silk Road” (MSR). The strategy underlines China’s push to take a bigger role in global affairs, and its need for priority capacity cooperation in areas such as steel manufacturing.
It was unveiled in September and October 2013 in announcements revealing the SREB and MSR, respectively. It was also promoted by Premier Li Keqiang during the State visit in Asia and Europe.
CHINA has been growing extremely rapidly for a long time, but an important shift in its growth pattern occurred at the time of the global financial crisis.
During the six years up to 2007 China’s GDP grew at an average rate of 11 percent, with investment equaling 41.5 percent of GDP. The current account surplus was rising in this period, reaching over 10 percent of GDP. In the six years since the global crisis, the external surplus has fallen sharply into the range of two to three percent of GDP, but the shortfall in demand was made up almost completely by an increase in investment, which has reached more than 50 percent of GDP in recent years.
China’s growth has been impressive compared to the rest of the world, but lost in the admiration is the fact that the growth rate has slowed down to around seven percent—down more than four percentage points from the pre-crisis period. Thus, in the recent period China has been using a lot more investment in order to grow significantly more slowly than in the past.
This pattern of growth manifests three problems. First, technological advance, as measured by Total Factor Productivity (TFP) growth, has slowed down. Second, and closely related, the marginal product of capital is dropping (it takes more and more investment to produce less and less growth). The real world indicators of this falling capital productivity are empty apartment buildings, unused airports, and serious excess capacity in important manufacturing sectors. The third manifestation of China’s growth pattern is that consumption is very low, especially household consumption, which is at only one-third of GDP.
China’s response to this changing growth dynamic is partly external and partly internal. On the external side, it is no coincidence that this period of excess capacity at home is the moment at which China launched expensive new initiatives, such as the Asian Infrastructure Investment Bank (AIIB), the BRICS Bank, and the ‘One Belt, One Road’ initiative in order to strengthen infrastructure both on the westward land route from China through Central Asia and on the southerly maritime routes from China through Southeast Asia and on to South Asia, Africa, and Europe.
These initiatives are largely welcomed by China’s Asian neighbors and this essay’s next section will examine how they can contribute positively to Asian integration. However, the thinking in China that these initiatives can be a major solution to China’s excess capacity problems is largely misguided. The contributions that these initiatives together make to China’s demand are likely to be too small to be macroeconomically meaningful.
The domestic response to China’s over-capacity problem is a set of reforms that emerged from the Third Party Plenum in November 2013. Together, these form a coherent set of measures that would rein in wasteful investment, increase innovation and productivity growth, and enhance consumption. A further section of this essay reviews the key reform measures, as well as progress to date with regard to reform. Success in this area will enable China to continue to grow well for another decade or more.
China’s initiatives in Asia are seen in many quarters as a setback for the United States. The U.S. government contributed to this narrative through its efforts to discourage allies from joining the new AIIB. In the end, major American allies, such as the United Kingdom, Australia, and South Korea, did join the Chinese initiative, and Japan is seriously considering becoming a member. However, this is likely to be a temporary diplomatic setback for the United States.
America’s own main economic initiative in the Asia-Pacific — namely the Trans-Pacific Partnership (TPP) — now seems likely to be completed by the end of 2015. Many major economies in Asia, such as Australia, Singapore, South Korea, and Vietnam want to be part of both Chinese initiatives (the AIIB and the ‘One Belt, One Road’) and the American effort to reduce trade barriers.
The Bank, the Belt, and the Road
Some of the impetus for China to launch the new Asian Infrastructure Investment Bank was Beijing’s concern that the governance structure of existing International Financial Institutions (IFIs) was evolving too slowly. An important agreement to increase the resources of the IMF, and to raise the voting shares of fast-growing emerging markets, has been stalled in the U.S. Congress, whereas all other nations have already ratified it. There is a certain irony that one of China’s frustrations with the American-dominated institutions is that China thinks that they need more resources and is willing to contribute, whereas the different parts of the United States government cannot agree to this expansion.
China’s frustration is not just about the size of the IFIs and China’s weight within them. In the case of the World Bank, China has argued for years for more focus on infrastructure and growth. Several years ago, former Mexican President Ernesto Zedillo chaired what was called a High-Level Commission on Modernization of World Bank Group Governance.
It is worth looking at its key recommendations, because this was a serious effort by a distinguished international committee that included good representation from major developing countries (e.g., Zhou Xiaochuan from China, Arminio Fraga from Brazil, Montek Ahluwalia from India, and Ernesto Zedillo from Mexico). The Zedillo Report is quite critical of the current World Bank arrangement of a resident board that approves all loans. The resident board represents both a large financial cost to the bank ($70 million per year) and an extra layer of management that slows down project preparation and makes the bank less efficient. Slowness of project preparation is one of the main criticisms of clients concerning the poor performance of the Multilateral Development Banks (MDBs).
The Chinese officials charged with developing the AIIB are looking at the Zedillo Report for good ideas. The AIIB will have a non-resident board that meets periodically both in Beijing and via videoconference. Given its newness, a likely compromise among the countries that have signed up is that its board will approve many of the initial projects and eventually delegate more decisionmaking to management. The Zedillo Report recognizes the importance of environmental and social safeguards, but argues that the World Bank has become so risk-averse that the implementation of these policies imposes an unnecessary burden on borrowing countries. In practice, developing countries have moved away from using the existing MDBs to finance infrastructure, because the institutions are so slow and bureaucratic.
I think that the enthusiastic response of developing countries in Asia to the AIIB concept reflects their sympathy with the idea that a new MDB can have good safeguards and still be quicker and more efficient than existing ones.
Some of the Western commentary on the AIIB expresses a fear that China will use it for narrow political or economic ends. Now that a diverse group of nearly 60 countries have signed up, it would be difficult for China to use the AIIB to finance projects in favored countries over the exclusion of other members.
And the idea that this would help with China’s over-capacity problems does not make any sense at all. If the AIIB is very successful, then in five years it might lend $20 billion per year—that is to say, on a scale with the World Bank’s IBRD lending. But just in steel alone, China would need $60 billion per year of extra demand to absorb excess capacity. This figure excludes excess capacity in cement, construction, and heavy machinery; the point is that the bank is, simply put, much too small to make any dent in China’s excess capacity problem—even if it were the sole supplier for these projects, which it won’t be.
The ‘One Belt, One Road’ initiative is larger than the AIIB. It started with the idea that nearby countries in Central Asia—spread along the traditional Silk Road—could benefit from more transport infrastructure, some of which China could finance bilaterally. However, the economies of Central Asia are not that large, and the potential for investment is limited. Overland transportation will remain expensive, compared to sea-going shipments. For that reason, China added the idea of a maritime road—that is, the expansion of infrastructure along the sea-going routes from the Chinese coast through Southeast Asia to the Indian Ocean and all the way to Europe. A vast amount of world trade already traverses this route.
Because ‘One Belt, One Road’ will be implemented bilaterally between China and different partners, it may seem that there is more potential for China to use this initiative to vent some of its surplus. But I still doubt that this will be on a scale that would make a macroeconomic difference for China.
Among the various developing countries along ‘One Belt, One Road’ routes, there are some with relatively strong governance—India, Indonesia, and Vietnam, for example—which will be hard for China to push around. Those countries will not want to accept large numbers of Chinese workers or take on large amounts of debt relative to their GDP. On the other hand, there are weak governance countries—Cambodia and Pakistan, for instance. It may be more feasible for China to send some of its surplus production to these countries, but there is a reasonable prospect that in the long run, China will not be paid.
The West has a long history of debt forgiveness to weakly governed states. It would be smart for China to learn from that history.