By PwC

Whilst the opportunities for foreign companies to participate in B&R projects are numerous and diverse, such projects are frequently developed under conditions which are complex and often beyond a company’s control. Particularly in the growth markets in which most of the B&R projects are planned, institutional voids can prove to be very disruptive to project completion.

Foreign companies may well find their usual project management evaluation and approach inadequate amidst the institutional voids which characterise many of the countries along the B&R routes, such as inconsistency in regulatory regimes and underdeveloped credit markets.

Regulatory regime inconsistencies

Inconsistency in regulatory regimes affects many B&R projects, as many such projects are involved in monopoly sectors (e.g. power grids), or operate assets of national security interest (e.g. oil refinery and storage tanks) which require close regulations to avoid abuse of monopoly power or compromise of national interest. The investor returns are also closely tied to public subsidies for projects such as public transportation, therefore posing a direct impact on the firm’s ability to make revenue and service the loans. Given the direct and substantial impact of regulatory regimes on the projects, any inconsistency in the policy development and implementation could cause problems in project operations.

Underdeveloped credit markets

Even though China is committed to financing the B&R projects, many private investors are still concerned about the underdeveloped credit markets in many of these countries. Limited visibility for fund monitoring and the weak enforcement of contracts which is typical in a developing market can be amplified if the company gets involved in a large-scale B&R project which involves the management of a complicated and constantly-changing network of contractors and subcontractors. If not managed properly, companies risk getting trapped in a labyrinth of financial turmoil, which could eventually lead to cost overrun or even unbankability.

Therefore, acknowledging that these voids exist in a variety of forms depending on the specific growth market, it is important for companies to proactively identify, evaluate and manage the different types and scale of risks they might face when participating in B&R projects.

In this section, we will be highlighting three pertinent risks – geopolitical, funding and operational – which are most
associated with B&R projects, and how they manifest themselves.

Geopolitical risks

Geopolitical dynamics have a significant influence on regulations, which play a central role in many infrastructure projects. In addition, the long gestation periods that outlast political cycles, the significance to bilateral relationships and the cross-territorial involvement of B&R projects further heighten geopolitical risks.

Long gestation period

Infrastructure projects usually take a number of years to complete and they often outlast political mandates, exposing the project to potential policy changes under different administrations. With a long asset lifetime and contractual relationship, as well as the payback beyond political terms, companies need to be assured that the government currently in power meets the commitments so that their investments will not be adversely affected by future administrations. Therefore companies need to get a good grasp not only of the regional, but also the local political goals. The positions of the opposition parties are also critical, especially in understanding what they will support and block and their goals if successful in gaining power.

It takes consistent political will with sustained focus and a positive relationship with China to see the project through. Yet political will and sustained focus remain a greater challenge for many B&R projects, which are inevitably influenced by the changing local political dynamics in the host country. Governments need to assert their efforts against adversary consistently to ensure the progress of B&R projects.

Significance to bilateral relationships

Many B&R projects play a significant role in bilateral government relationships as they are often keynote projects pivotal to the economic development of the host countries. One such example is the Standard Gauge Railway project in Kenya. The US$3.8bn project, with China Road and Bridge Corporation as the prime contractor, plans to connect the relatively large economy with a port of East African importance to a number of landlocked economies, unlocking intra-Africa trade opportunities. In another instance, Laos will be embarking on a US$6.8bn high-speed railway project as part of the B&R initiative, which represents more than half of the impoverished country’s GDP. The B&R initiative projects are therefore regarded as a much-needed investment and economic stimulus to economies distressed by depressed energy prices and weak global demand.

As China’s B&R investment addresses critical developmental bottlenecks in host countries, it is often perceived as an affirmation of the political ties between the two countries. However, these ties cannot be taken as guarantees of success. As such, these government to government agreements can potentially draw reactions from opposition parties and private sector bodies.

Cross-territorial involvement

Aside from typical bilateral government relationship factors, the geographically expansive nature of the B&R initiative raises geopolitical concerns. Some countries have expressed concerns as to the dominant foreign ownership and presence across the different trade routes. Connectivity, the concept that the B&R initiative expounds on, was identified by India’s Foreign Secretary Subrahmanyam Jaishankar as having ‘emerged as a theatre of present-day geopolitics’. It is also noteworthy that the countries where B&R projects are planned and the nations which have concerns suffer from varying degrees of vulnerability from the lack of developed institutions and political stability.

B&R projects tend to straddle multiple territories, with the eventual objective of establishing a connection across large stretches of land and sea, and some of these projects are in the middle of cross-territorial disputes such as the Amu Darya River between Tajikistan and Uzbekistan. Therefore, given the projects’ influence on both internal political dynamics and unilateral relations, companies might see themselves in the nexus of greater geopolitical currents as the B&R projects reflect China’s relationship with the host country and its region.

Funding risks

Large infrastructure projects often hold a high financial risk. The high capital intensity of these projects leads to a high debt service ratio, long pay-off periods, and uncertainty of forecast demand. The challenges are often exacerbated in cross-border projects where the structuring of finance needs to take into account different currencies and national financial capacities.

Financial risk takes on a different facet in B&R projects. There are typically three main sources of global financing for B&R infrastructure – the Chinese government (mainly policydriven state funding), the host government and private institutions. Multilateral banks such as the World Bank, Asian Development Bank, and the AIIB also contribute some funds to B&R projects amongst other mandates.

To date, the Chinese government has taken on the lead financing role as many developing countries have limited means to fund the B&R projects in their country. Projects also vary in their ability to provide profitable returns.

Private funding is also still limited as many companies are concerned about the transparency of fund management, the effectiveness of the cross-border regulatory framework and the bankability of some of the projects. This funding gap therefore creates the most pertinent financial risk which needs to be addressed for B&R projects to take off.

Chinese government taking the lead

To date the Chinese government has taken the lead on B&R projects. Until 2016, there was at least US$186bn worth of investments or loans into B&R countries, of which a significant portion originates from China. However it only makes up a fraction of the potential infrastructure demand in the developing markets. PwC’s Strategy& estimates the potential infrastructure demand in the developing markets to be around US$10tn from 2015 to 2025, of which the main sources of financing identified only constitute about 2% of the financing needed to fulfil the infrastructure demand. While China might potentially increase its funding, it is unlikely to finance the B&R initiative entirely.

Host countries’ ability to pay

The host countries’ varied ability to pay is another concern. The B&R initiative is a debt-financed infrastructure development strategy. In contrast to aid packages or foreign direct investments, China’s lending plans place greater ownership of the financial risk on the recipients of the investment, most of which are developing countries with varied ability to finance them. Sixteen of the 65 countries on the B&R initiative are not rated on a sovereign basis. And of those that are rated, the countries’ creditworthiness ranges
from AAA down to B-.

The host countries’ varied ability to repay could also potentially lead to a network of interdependence guided by the exchange of resources and asset ownership. Some African countries are already approaching China to reschedule, freeze debt repayments or to pay back with resources for previous infrastructure projects.

Private funding cautiousness

Given that China is unlikely to fund the B&R initiative entirely, and host countries have varied ability to finance the projects, private capital is much needed to close the funding gap. However, the bankability of the B&R projects remains a pressing concern to the private investors. Many investors are still adopting a wait and see approach to see how the state capital will be deployed, and whether the initial investments will deliver their benefits. Private investors need to gain assurance in the transparency of fund management and the effectiveness of the cross-border regulatory framework supported by market principles to support a business case for business returns. China also needs to allay concerns that institutions might get entangled in projects where commercial logic and demand for public transportation are perceived to be secondary to political considerations. Until then, companies need to be mindful of the financial risk in many B&R projects.

Operational risks

Large-scale infrastructure projects are vulnerable to going off track whilst being executed with many suppliers and contractors over several years. The different legal frameworks, volatility of exchange rates, potential incompatibility of technical specifications, differences in trading terms and greater likelihood of political interference further exacerbate the challenges in multi-territorial projects. Many of these lead to risks of delay, cost overrun or even un-bankability of the projects.

These risks may be compounded in B&R projects where key stakeholders are still gaining experience in infrastructure development and international projects of the complexity of the B&R initiative. These struggles are prevalent across different phases of the project life cycles: before starting, during project delivery and after construction.

Before starting

As an unprecedented endeavour that covers multiple underdeveloped territories, the B&R initiative brings many projects into new markets. It is therefore critical to appreciate how labour resourcing, construction equipment, logistics and scheduling in multi-country projects can be affected by the culture, traditions, labour productivity and technical proficiency in the host country before a project begins. However, these are often learned in retrospect. It becomes even more challenging in some B&R projects, where assessment of economic viability and project governance sometimes play a supplementary role in the larger context of the high-profile government-to-government negotiations that are taking place.

During project delivery

As many B&R projects are being built in developing markets, companies have to contend with the fluidity of business in developing markets, such as a reduced sensitivity to timelines, having agreed positions re-opened, suggested recourse at every hurdle or sudden retraction of credit lines during project delivery. The gap in international experience could potentially make it even more challenging as the Chinese SOEs and the host countries work on improving their project controls, resources allocation and communication with stakeholders during project delivery. As a result, much of a firm’s finances and capabilities can risk getting caught in myriad project lapses.

After construction

Operational risks also go beyond the capability of defining and delivering the project. In many instances, it is not possible to extract the long-term value of the investments due to gaps in the development of consistent policies and supporting institutional arrangements in developing countries, which most B&R countries are. Without the establishment of a sound strategy which prioritises catalyst projects that set the economic activities in motion, or the development of supporting facilities and local competencies to maintain the asset, the project could easily descend from hyped expectations into a debt burden.

In summary, a B&R infrastructure project is not a one-time investment. Companies need to consider whether a cohesive programme of initiatives is planned to support the project during the evaluation, or they will face greater headwinds in operating profitably. It is therefore critical for companies to remain vigilant in operational planning, because without proper management of operational risks, even strong policy and financial support will not guarantee success.

B&R holds rich promise but has associated risks. The nature of B&R projects also further accentuates the geopolitical, funding and operational risks. Only with a clear understanding of the potential risks that B&R projects operate in, can companies find the best ways to manage them.

This article was first published in the PwC report “Repaving the ancient Silk Routes” June 2017 issue. Please click to read the full article.

By PwC

International partnerships

Since the late 1990s, China has sought to internationalise in order to enhance its competitiveness on the global stage. Its increased focus on overseas acquisitions has been a progressive approach to build on existing capabilities and create access to new markets, which has been further emphasised in China’s 13th Five-Year Plan announced last year.

From the Growth Markets Centre’s conversations with the Chinese players, we have found that they continue to be keen on partnering with global players, especially those from developed markets. Such partnerships not only help further push the boundaries of capability development for Chinese enterprises, but also offer a way to work with experienced companies across the value chain, in order to drive the optimisation of asset management. Partnering with other international players which have prior experience in markets can help Chinese enterprises benefit on many fronts.

Collaboration between China and foreign companies on B&R projects offers benefits for both parties in two main categories: ‘knowledge exchange’ for Chinese SOEs and ‘access to new mega projects’ and the associated ecosystems for foreign companies.

With this in mind, we believe that foreign companies, MNCs and financiers can partner with Chinese companies in B&R activities on three levels: supplies, construction partnerships, and financing and/or divestment.

1. Investment of assets

International investors and financiers can also tap into the opportunity to partner with Chinese companies by providing capital and investments. Belt & Road projects are usually explicitly or implicitly backed by the Chinese state and therefore there is an improved risk-return ratio in many situations. Furthermore, given that host governments along the B&R will have received significant financing and support from China and multilateral banks, these governments will take more care to minimise disruptions. However, it must be acknowledged that not all B&R projects are guaranteed sound investments, even with Chinese and host country support, as some projects will be deemed strategically important even if they are not obviously profitable. Nevertheless, it has been seen that China does welcome investment support, to bridge the funding gaps on many infrastructure projects.

For example, Qatar’s Al-Mirqab Capital partnered China’s SOE SINOHYDRO Resources with a 49% share in the construction of a thermal power plant in Port Qasim, Pakistan under the US$ 46 bn China – Pakistan Economic Corridor owing to the attractive returns and significantly mitigated risks made possible because of backing by SINOSURE to cover a wide scope of risks. As a result, the ‘multilateral publicprivate partnership (PPP)’ project built on a Build-Own-Operate (BOO) basis offered attractive returns with significantly mitigated risks, attracting further investments from Qatar’s Al-Mirqab Capital.

Foreign MNCs can also explore opportunities to invest in Chinese instruments such as entering into limited partnerships in a Silk Road Fund or CITIC fund, or by coinvesting
in Chinese led projects.

There have been several examples of private equity funds set up to invest in B&R projects, such as the US$4.8bn Green Ecological Silk Road Investment Fund. This is the first ever Chinese PE fund aimed at improving the environment, backing projects on solar panel construction, clean energy and ecological remediation in China and B&R countries. Investors were made up of top Chinese enterprises such as China Oceanwide Holdings Group, Huiyuan Group and Sino-Singapore Tianjin Eco-city.

General Electric has pledged a US$1bn infrastructure fund in Africa to help finance projects in the continent following the growth of its orders from Chinese SOEs and its increasingly close cooperation with Chinese EPC firms in the electric power, railway, and healthcare sectors in Africa.

Similarly, Maersk Group, a Danish container shipping and oil conglomerate, also has plans to co-invest to offer transport services to its Chinese partners on B&R projects in the next ten years. The company sees the B&R initiative as a platform to tap into growth opportunities both inside and outside China, after being hard hit by the decline in container freight rates and oil prices in recent years. One of its first ventures was with China’s Qingdao Port Group to jointly invest in a new port terminal in Vado Ligure in Italy, due to be opened in 2018.

China is also currently Maersk’s largest export market, accounting for 35% of the Danish company’s export volumes. It is seeking to further ‘develop closer links with Chinese companies involved in these two trading routes’. Its terminal arm, APM Terminals, is also working with the state-owned China Communications Construction Co. (CCCC) to build a port in Tema, Ghana, and has awarded lead contractor status to a subsidiary of CCCC.

2. Partnerships in Engineering, Procurement and Construction (EPC)

The B&R initiative also provides foreign companies with the opportunity to be an EPC partner with enterprises from both China and countries along the B&R in order to share their globally renowned technological expertise. This experience is even more valuable when it relates to knowledge of certain key geographies along the Belt and Road, which companies from China and the B&R countries might be new to. This has been seen to be successful with traditional Spanish partners in Latin America or French companies in Francophone countries.

Global partnerships also offer Chinese SOEs legitimate opportunities to learn about cutting-edge standards, technologies and solutions for developing markets. For example, foreign MNCs’ best practices on the environmental front – featuring environmentally-friendly designs and engineering, efficient buildings, advanced waste processing and energy-efficient transportation hubs. Chinese players can benefit and gain a competitive edge with host governments and constituents that increasingly care about the environment.

The benefits certainly go beyond the B&R project itself on both sides. The partnerships which are formed on the B&R project can often extend in home countries to provide foreign companies with strong partners for access to the China market and vice versa. It is necessary to strike a balance between collaboration and competition from a long-term perspective.

In other cases, partnerships with local EPC firms are sometimes favoured. KazMunayGas (KMG), a Kazahstani oil and gas company involved in the exploration, production, refining and transportation of hydrocarbons, has made a joint venture with the CEFC China Energy Company (CEFC China) to develop oil refining and gas station networks in Europe and Silk Road countries. Apart from possessing critical knowledge and experience of local EPC firms with infrastructure construction in their own countries, partnering with Chinese players also supports technology and know-how transfer, making it possible for the local firm to also eventually operate and manage the infrastructure.

In another example, Northern Railways, a subsidiary of Aspire Mining, an Australian exploration company focused on Mongolia, won the contract to build and operate a 546km railway to extend Mongolia’s national rail network from the city of Erdenet to to Ovoot, the site of the Ovoot Coking Coal Project, a large scale project in Mongolia. The project has since been included in the Northern Rail Corridor connecting Tianjin port on China’s east coast with Russia via Mongolia, and opens up the possibility of funding by the SRF and China Export and Credit Insurance Corporation (SINOSURE), etc.

3. International Project Management

The need for strong project management is even more pronounced when infrastructure projects straddle multiple territories or are based in remote locations. Although many enterprises from those countries along the Belt and Road, including China, may have plenty of experience in constructing large and complex infrastructure projects in one country, they might not have as much experience in doing so across multiple countries in remote locations. It is in this instance, that foreign companies with the experience of overseeing and managing complex infrastructure projects involving multiple countries and stakeholders have a potential role in partnering with companies along the B&R.

In remote locations, the regional community might have limited experience in supporting large projects with adequate services, such as sub-contracting work, supplying equipment and providing international banking services. Furthermore, lapses in the data communication infrastructure could potentially hinder communication between the work site and the decision making office. Given these risks, partnerships with foreign companies with proven experience in the delivery of cross-territory projects in remote locations will be critical for success.

4. Supplying construction equipment and machinery

Chinese EPC players have already been working closely with foreign MNCs on B&R projects, especially those which possess global expertise in manufacturing technologically advanced equipment and solutions as well.

Equipment and technology suppliers can support Chinese companies’ overseas infrastructure and industrial projects in much the same way as they have been supporting Chinese customers’ projects within China for the past decades.

General Electric, which supplies construction equipment to Chinese EPC companies, reported that its total orders from Chinese EPC companies – of which 40% of equipment will be manufactured in China – have increased threefold from a year ago. Its involvement and cooperation with Chinese SOEs is also deepening, from being an equipment supplier to an integrated solutions provider in financing and operations.

General Electric’s most recent order was to supply equipment including steam turbines, boilers and generators for a power plant along the China–Pakistan Economic Corridor. According to the general manager of the joint venture established for this project, General Electric was chosen for its ‘global expertise in manufacturing key equipment for coal-fired power plants’ and ‘proven track record in Pakistan’.

Such partnerships with Chinese customers outside China, as described above, can sometimes bring benefits to foreign companies’ business inside China.

5. Operation of assets

The experience and skills needed in constructing a new railroad, highway, dam, port or airport as compared to operating it efficiently and profitably are very different. This is accentuated in Belt & Road projects due to the numerous geographies, governments and stakeholders involved. This therefore provides an opportunity for operators with experience in managing such complex facilities. For example, the operators of foreign airports such as in Europe, may find that their knowledge and expertise is of value to governments along the Belt & Road, who have built new airports, but need support in running them effectively and profitably.

Operators can bring their expertise in managing not only the infrastructure facility itself, but also aspects of the supporting ecosystems such as key suppliers, labour unions and key customers. Experience in effectively managing these aspects will help to ensure that the facility operates effectively, meets its expected targets and also is well maintained, thereby ensuring its projected lifespan is met. Both of these factors lead to the increased effectiveness and profitability of the facility.

6. Divestment of assets

In addition to supplies and sales, foreign companies can also leverage Chinese outbound investments as sources of financing for their divestments. This falls in line with China’s progressive acquisitions to enhance capability in its enterprises, and at the same time offers the foreign company a way to liquidate its assets for financing.

For example, Gamesa Corporacion Tecnologica, a Spanish manufacturing company principally involved in the fabrication of wind turbines and the construction of wind farms, sold its 28MW Barchin project to one of China’s five largest state-owned electricity providers, China Huadian Group Corporation, at US$161mn. The Barchin project, located in Cuenca in east central Spain, features 14 Gamesa G90 2MW turbines and began operating in 2012. For Gamesa, the deal was a way to unload its assets and reduce debt. Beyond this, the deal could also help Gamesa cement its ties with Huadian, another long-standing customer and partner in China, possibly even opening up access to China’s growing offshore wind market.

This article was first published in the PwC report “Repaving the ancient Silk Routes” June 2017 issue. Please click to read the full article.

By Frans-Paul van der Putten, Senior research fellow, Clingendael Institute

On 24-26 May 2017, the first Balkans and Black Sea Cooperation Forum took place in Serres, Greece. The forum aims to strengthen cooperation throughout this region in various regards, including in terms of transport and infrastructure. One of the topics debated at the forum related to the role of China and its Belt and Road (also known as ‘One Belt, One Road’ or OBOR) initiative to build a modern-day silk road.

It is in the Balkans and Black Sea region that the contemporary equivalents of the silk road on land (via Central Asia) and the maritime silk road (via the Indian Ocean and the eastern Mediterranean Sea) meet each other and connect to Europe. A land route via the Black Sea region would provide China with a transport corridor to Europe that avoids areas that are part of, or militarily controlled by, Russia or the United States. It is to China’s strategic benefit if it succeeds in decreasing its dependence on trade routes that can easily be disrupted by other great powers. The greatest relevance of the Balkans peninsula at this time relates to the port of Piraeus in Greece, which is the main Mediterranean base of China’s largest shipping company, COSCO Shipping. China’s involvement in Piraeus may develop into a greater Chinese role in trade, finance and manufacturing throughout the Balkans and Central Europe. This would then further strengthen China’s interest in developing the Black Sea region as a part of the China-Central Asia-Europe trade corridor.

China’s focus points

The Chinese government engages with countries in the region mostly on a bilateral basis rather than collectively. There exists a platform for cooperation between China and 16 countries of Central and East Europe (the so-called CEEC 16+1) that involves the Balkans region and that is strongly focused on OBOR, but most actual projects between China and Balkans countries are the outcome of bilateral interaction. A similar regional platform for engagement between the Black Sea region and China does not exist. The Organization of the Black Sea Economic Cooperation (BSEC) could potentially fill this gap, but the Chinese government has so far not yet made use of this platform to discuss OBOR multilaterally.

Notable focus points for Chinese companies and the Chinese government in the Balkans and Black Sea region are port management in Greece, infrastructure construction in the Western Balkans and Turkey, agricultural production in Ukraine and the energy sector in Romania and Greece. In addition, Chinese companies are also active in the region in telecommunication, manufacturing and banking.

Two key countries in the region are Greece and Serbia. Both countries were visited by President Xi Jinping in recent years. They provide China with footholds within the region from where it can build up its OBOR activities by way of a step-by-step approach. Progress is slow: the privatization of the port of Piraeus met with substantial delays until Cosco was able to acquire a majority share in the port in 2016. Currently the construction of a new railway track between Belgrade and Budapest is also being delayed as a result of concerns from the European Commission as to whether the agreement between Hungary and China follows EU government procurement rules. Under this agreement Chinese entities will finance and build the railway. The Chinese government and Chinese investors appear to be waiting until the so-called Land Sea Express Route (the transport corridor from Greece via the Western Balkans to Central Europe) has progressed further before engaging in major new OBOR projects in other parts of the Balkans.

With regard to the Black Sea region, the involvement of the Chinese government in OBOR projects is more limited than in the Balkans region. China seems to be cautious not to antagonize Russia and to be taking into account Russian geopolitical sensitivities in the Black Sea region. Given their location, both Georgia and Ukraine could potentially be close diplomatic partners and hosts to major China-funded infrastructure projects. However, they are also former Soviet republics that have strained relations with Russia. Judging from maps with projected railway links that circulate in China, the Chinese government seems to favour a transport corridor to Southeast Europe from China via Iran and Turkey rather than via Georgia or Ukraine. This suggests that China's approach cannot be understood exclusively on the basis of economic factors: geopolitical considerations should also be taken into account.

Seizing the initiative

In terms of geography, the potential of the Balkans and Black Sea region is promising but the Chinese government and Chinese investors seem hesitant to commit to major projects in the region apart from the current flagship projects in Greece (Piraeus port) and Serbia (railway to Hungary). To realize this potential, local governments, regional organizations and the private sector could take the initiative. The new silk road is being shaped not only by China but also by non-Chinese actors. By investing in infrastructure and facilitating east-west (across the Black Sea) and north-south (across the Balkans) corridors, regional actors can enhance their role in OBOR and stimulate engagement by China.

Geopolitical implications

The new silk road will increase China’s influence in the region. This could further complicate the unstable relationship between Russia and the West. In the longer run, Sino-US and/or Sino-Russian geopolitical competition could destabilize the region. However, China is careful to avoid this outcome, and its growing influence also provides new opportunities for Russia, the EU and the US to work with China towards regional stability. The formula used to stabilize Sino-Russian relations in Central Asia, by way of the Shanghai Cooperation Organization, could provide a starting point for a joint mechanism for the Black Sea region that involves regional countries as well as Russia, NATO and China.

The European Union needs to signal clearly that it favours regional development and that it is open to cooperating with China to this end. If OBOR can contribute to the economic development of the Balkans and Black Sea Region then the EU should take an active approach that seeks to maximize this contribution within its strategic interests. There is a danger that countries in Southeast Europe and around the Black Sea, whether they are EU member states or not, will increasingly feel that their interests are ignored as a result of geopolitical and economic competition between China and the EU as a whole, and between China and Western Europe in particular. If these sentiments are not adequately addressed the EU’s south-eastern flank will be vulnerable to destabilizing forces such as great power competition and conflict in the Middle East.

Please click to read the full report.

By Suan Teck Kin, CFA and Ho Woei Chen, UOB Group

Belt & Road Forum Reaffirms China’s Stance On Mutual Cooperation

In the recently concluded Belt and Road Forum for International Cooperation (“BRF”, held in Beijing on 14-15 May), attended by more than 1,500 delegates from over 130  countries and some 70 international organizations, Chinese President Xi Jinping noted the need to join hands to meet the global challenges in the principle of extensive consultation, joint contribution and shared benefits. Therefore the Belt and Road Initiative (B&R) will be one means to align countries’ policies and integrate economic factors and resources in a global scale to create synergy to promote world peace, stability and shared development.

Chinese President Xi Jinping noted that Belt and Road Initiative (B&R) is about building partnership and not forming alliances, suggesting the initiative is leaning largely towards a trade/commerce approach rather than from political angle. Another contrast is the position China has taken with B&R, that is towards more open, inclusive, and globalized trade, investment, commercial, cultural, and peopleto-people exchanges, compared to increasing trends towards inward looking, nationalistic, exclusionary, and populist policies adopted by some major economies. The BRF also serves as a checkpoint for the Initiative first mooted by President Xi in 2013, to gauge the successes and challenges as it moves forward. The next BRF is scheduled to be held two years later in 2019.

Size Of B&R A Force To Be Reckoned With

As seen in the table below, B&R countries along with China, are an economic force to be reckoned with as its size is equivalent or even larger than some of the trade blocs. While B&R is not a trade bloc, its economic size is equivalent to that of the TPP (including US) at 40% of global GDP, though with the US’ withdrawal, TPP will be just a shadow its former self. B&R countries also have access to large block of population at 4.4bn, which is the largest compared to other potential trading blocs. This means that with infrastructure especially transportation and communications network being built up, B&R will indeed present large scope of opportunities for commercial and people-to-people exchanges.

As nearly 40% of the global economy consists of emerging economies (in 2016, vs. 20% share in 1996), a more inclusive and open arrangement such as B&R, will be beneficial to their development, as that allows for greater participation of opportunities.

Lining Up Financing Support

Financing is at the centre of B&R Initiative and the Chinese government has announced a list at the BRF 2017 session in Beijing (see table below). Based on the figures disclosed, China will be committing at least RMB780bn at this stage. Two questions arise: what is
the source of funding and whether this figure is sufficient for the B&R Initiative.

As for the source of funding, the bulk of the funding is in denominated in RMB, which means that Chinese government is eyeing greater use of the domestic currency in this project. With the Chinese central government debt ratio well below 20% of China’s GDP, there is room to leverage up should there be a need to do so.

In terms of sufficiency, there is certainly much financial gap to fill as ADB estimates that Asia alone needs to spend US$1.7tn per year in infrastructure investments until 2030. As the B&R Initiative is meant to be a mutual cooperation project, financing is expected to be coming from different sources, including multilateral agencies such as AIIB, ADB, World Bank, and private sector participation.

B&R By The Numbers:

• B&R which was first unveiled in 2013 consists of 6 economic corridors and spans 68 countries representing more than 60% ofthe global population and around 40% of global GDP. The B&R will connect Asia, Africa, the Middle East and Europe.

• Chinese investments related to the B&R Initiative have totalled US$60bn since 2013 and set to pick up with US$600-800bn investments planned for the next five years – equivalent to US$120-130bn per year over the period. Although the amount is large, it dwarfs in comparison with Asian Development Bank’s (ADB) estimates that developing Asia alone needs to spend US$1.7tn per year in infrastructure investments until 2030 of which Southeast Asia’s annual requirement is US$210bn. The greatest requirements will be in the power and transport sectors. China is expected to fill a large part of the infrastructure investment gap.

• China’s annual trade with countries involved in B&R is expected to exceed $2.5tn within a decade, from US$954bn in 2016 (25.7% share of China’s total cross-border trade) and US$877.2bn in 2012 (25.1% share of China’s total cross-border trade volume).

• Top 10 largest B&R trade partners with China (total trade): Vietnam, Thailand, Singapore, UAE, Russia, Indonesia, Philippines, India, Malaysia, Saudi Arabia.

• The investment and trade opportunities arising from the B&R Initiative will lead to economic development and jobs creation. Between 2013 to 2016, more than 180,000 local jobs were created and paid US$1.1bn in tax to local governments.

• The China-led Asian Infrastructure Investment Bank (AIIB) which was launched in early 2016 with US$100bn of initial capital, has granted US$1.7bn loans for nine projects, while the government-backed Silk Road Fund has lent about US$4bn of funds, including for a water dam project in Pakistan. Shanghai-based New Development Bank is another source of funding with US$50bn initial capital.

• China Development Bank has granted US$168.2bn worth of loans for more than 600 projects since the Initiative was unveiled in 2013 while Export and Import Bank of China has loaned out about US$100bn.

• China has committed to inject at least RMB780bn (US$113bn) via its state funds and banks to finance projects in the B&R Initiative. This comprises RMB100bn increase to the Silk Road Fund, increase special overseas loans by China Development Bank and Export and Import Bank of China by RMB250bn and RMB130bn respectively, and encourage Chinese banks to set up overseas funds worth about RMB300bn to help belt and road funding.

Potential Beneficiaries Of B&R Initiative

RMB Internationalization

From trade and investment flows’ perspective, increased activities in B&R would naturally lead to greater scope for RMB usage and internationalization. Of note is that the Chinese government has committed RMB300bn to Overseas Fund Business in RMB to promote the usage of RMB, according to official document.

Expanded goods and services trade (“current account” flows), financing the supply and demand gap for infrastructure investment in B&R countries coupled with increased outward direct investment (ODI) by Chinese enterprises, banks and government (“capital account” flows) are likely to provide enlarged RMB flows going forward. The share of
total goods trade by B&R countries accounted for about 34% of world’s total trade. B&R countries’ total trade with China accounted for 25.7% share of China’s total trade in 2016. China’s total services trade with B&R countries reached US$122.2bn in 2016, accounting for 15.2% of China’s total services trade, and 3.4% point higher than in 2015. According to one estimate, from January 2012 to September 2015, the amount of China’s ODI settled in RMB increased from RMB 0.2bn to RMB 20.8bn, the latter accounting for 20% of China’s total ODI as of September 2015.

ASEAN

Due to geographic proximity, historic relations, availability of resources and an emerging market, ASEAN is expected to benefit as activities pick up in B&R. This is already reflected in the top 10 trade partners’ list with China, where ASEAN countries comprised of 60% of the share. In addition, under B&R, China has a range of arrangements and agreements with ASEAN, including the China-Indochina Peninsula Economic Corridor (as one of the 6 B&R economic corridors), China-ASEAN Free Trade Area, ASEAN and China Production Capacity Cooperation, and in areas such as maritime, port development,
connectivity, tourism, health, environment, among others.

Industries/Sectors To Benefit In B&R Initiative

While it is obvious that infrastructure-related development would be the first areas to benefit from B&R, the Initiative is more than just infrastructure such as sea/land/air transport, energy, water, information communications, and pipelines. Greater flows of commercial, cultural and people-to-people exchanges will help boost demand for tourism-related industries such as F&B, hotel, recreational, and shopping, education, and healthcare.

Closer Integration Amidst A Protectionist/Anti-Globalization Environment

Amidst a rising protectionist, populist, and anti-globalization tendency in parts of the world, the B&R Initiative stands in sharp contrast as it aims to promote peaceful cooperation and common development around the world to promote efficiency in the flow of production factors and integration of markets, in order to achieve diversified, independent, balanced and sustainable development. As such, the Initiative should bring about greater level of economic activities among the participants as compared to an isolationist approach.

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By Richard Ghiasy and Jiayi Zhou, Stockholm International Peace Research Institute (sipri)

The EU and China both have an interest in promoting greater connectivity and stability in Eurasia. In China’s case, this is largely achieved through its visionary Belt and Road Initiative (BRI). So far, the EU has given the initiative a lukewarm welcome and is still pondering how to engage it strategically. This is partly because the BRI remains operationally uncoordinated, and the EU remains concerned about commercial feasibility, transparency, sustainability and environmental issues.

But differences in need, interest and strategic planning among EU member states in relation to China also hamper a common response. While the EU’s cautious approach could certainly lead to a more well-informed and gauged response, an overly long delay may come at the risk of the EU being left behind as China takes a stronger lead in shaping the Eurasian landscape.

The various EU interests in the Belt and Road Initiative

The BRI is China’s vision for comprehensive connectivity and economic cooperation, mostly focused on, but not limited to, the whole of Eurasia. The initiative has generated diverse degrees of interest throughout the EU. Member states in Central and Eastern Europe, as well as Greece, Portugal and Spain have mostly reacted enthusiastically to it. Given their own poor economies, these states have welcomed Chinese investment in large infrastructure projects, and they see Chinese investment as a way to boost their local economies and employment.

In Italy, commercial prospects have led local business communities to take active steps towards engaging with the BRI, and at the national level the Italian Government itself is seemingly becoming more interested. Ahead of the Belt and Road Forum held in Beijing on 14–15 May, Italian Prime Minister Paolo Gentiloni said that Italy is ‘enormously interested’ in the BRI.

France’s policy community interest in the BRI seems to have peaked already, although the incoming Macron administration could revisit the initiative. Many regional and municipal governments in Germany have indicated a strong desire to engage with China on the BRI, but at the national level the response has been more restrained. The German and Dutch Governments do not want to engage too closely without a better understanding of the BRI’s long-term strategic implications, and do not want to sideline the EU in the process. Nordic governments have so far not indicated much interest in the BRI, although interest in Denmark is starting to pick up.

At the supranational level, the EU has established together with China, the EU-China Connectivity Platform, through which the two have agreed to cooperate on a number of investment projects within the EU and China. This has been the EU’s most progressive response to the initiative.

But beyond this limited economic cooperation, the EU has not so far not engaged with China’s BRI on a more strategic level, despite it having strategic implications for the EU’s political, economic and security interests abroad.

‘A Global Strategy for the European Union’s Foreign and Security Policy’, the EU’s policy document of June 2016, obliquely references the BRI, positing the need for a ‘coherent approach to China’s connectivity drives westward’ and improved connectivity between the EU and Asia.

The Global Strategy also refers to the need for improving the ‘resilience’—the ability of states and societies to withstand and recover from internal and external crises—of EU neighbouring states, including those stretching into Central Asia. This is a core BRI region, and improving the resilience of these ‘fragile’ states is in fact explicitly pursued by China through the BRI.

Both China and the EU see economic development as a pillar of stability, but their development support approaches differ. China has tended to emphasize physical infrastructure and no-strings-attached investment, while the EU has tended to promote institutional reform, good governance and rule of law as pre-conditions for inclusive economic growth. Both approaches are necessary but neither are alone sufficient achieve sustainable development. And while these different approaches in theory are complementary, the EU emphasizes normative values such as human rights, democracy and civil society in a way that makes it more difficult for the two sides to engage in cooperation.

Indeed, that divergent approaches and standards are a major sticking point for cooperation was made apparent at the recent Belt and Road Forum. The EU rejected a key trade statement because it did not include commitments to free trade, social and environmental sustainability and transparency on tendering processes.

Nevertheless, to foster the kind of developmental outcomes sought, the EU needs to engage not only with states in Eurasia, but also with other larger powers, in order to build a common and coordinated agenda. This includes not only China, but also major actors such as India, Japan, and the USA, as well as multilateral organizations such as the Association of Southeast Asian Nations (ASEAN). Of these actors, however, it is China that has the most ambitious vision for Eurasian connectivity and development, along with the financial and political clout to back much of it.

Influencing the BRI through engagement

As the BRI unfolds over the next few years and decades, the EU needs to be aware that China’s BRI efforts and stepped-up presence in Eurasia will probably be a significant shaper of future regional governance in economic, financial, political and even security terms. As China’s overseas investments and economic footprint grows, so will its political and security presence. The Chinese naval base in Djibouti is one such example of how China’s overseas interests have evolved in recent years.

Leaving China so much space to pursue the BRI alone may eventually impinge on the EU’s long-term strategic interests. Thus, it is even more pertinent for the EU and other Eurasian stakeholders to engage strategically with China in order to jointly shape the vision of the BRI and its practical implementation. China has actually welcomed such involvement: Chinese President Xi Jinping reiterated the aim and need for inclusiveness at the recent Belt and Road Forum.

There are several ways in which this engagement might be achieved, some more feasible than others. In the medium-term, EU-based companies and investment banks, such as the European Investment Bank or European Bank for Reconstruction and Development, could pursue joint investment projects in third countries outside of the EU and China. This kind of concrete economic cooperation could help align Chinese and local investment standards with EU and global regulatory, environmental and labour standards, and increase transparency and reduce corruption.

Beyond engaging with China bilaterally, the EU could also work multilaterally to participate in joint consultations with relevant stakeholders. A consultation and coordination mechanism with BRI stakeholders, including China, could allow for more information sharing, joint planning and monitoring, and also mitigate some of the more political and geopolitical tensions related to the BRI. Such consultations could take place within existing mechanisms, such as the biennial Asia–Europe Meeting (ASEM).

The BRI also represents an opportunity for the EU to work towards more formal development cooperation with China and other stakeholders. One such cooperation platform could, for instance, be through the United Nations Sustainable Development Goals (SDGs). China has already partnered with the UN in the context of the BRI, and the SDGs—being universal in scope and in acceptance—are a relatively apolitical development framework worth much further exploration.

Of course, there remain concerns: namely, that the BRI ultimately serves China’s geostrategic aims, and is unilateral (or at best bilateral) rather than multilateral in nature—at least so far. Moreover, many EU policy advisors and policymakers are still not quite sure of the BRI’s political longevity, or the BRI’s financial and commercial feasibility.

Furthermore, several (sub)regions in which BRI projects will be implemented are politically and economically fragile, conflict-affected, or marked by poor governance. This puts into doubt the degree to which these investment projects will be successful.

At the same time, however, the public goods that the BRI intends to provide could certainly catalyse socioeconomic development and a spirit of cooperation throughout Eurasia and further many of the EU’s own strategic aims. Admittedly, EU–China cooperation, and that of other stakeholders, on improving third states’ resilience might take place only gradually given geopolitical realities and varying values and norms.

That said, the EU should recognize that influencing an initiative such as the BRI is easier done from the inside than from the outside.

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By Eric Collins, Editor-In-Chief of “CITY BUSINESS Magazine”

Frank Leung is President of the Federation of Hong Kong Footwear Ltd. and a learning partner on the College of Business DBA programme. Mr Leung recently won the London GG2 Leadership Awards 2016 — Entrepreneur of the Year Award. With extensive experience of shoe manufacturing in Guangdong and Ethiopia, his story illustrates the contemporary shift of manufacturing away from China. Here he shares hisexperiences in starting up factories in Ethiopia.

At first, there were some customs I really didn’t understand,” Frank Leung recalls. His workers told him, “If there is no moon tonight, we will see you tomorrow. But if the new moon comes, we can’t be there.”

With 200 pairs of high fashion shoes to send to Milan by the end of the week, Ethiopia was not looking like the best choice for a startup.

“So, that night,” Leung remembers, “I went out and there was no new moon. I thought: Great, the shoes will be ready for Milan! Then the next day I went to the factory and nobody was there.”

“I said, where is everyone? They told me the new moon had been seen, not in Ethiopia but in Mecca. I said how do you know? They said, oh, everybody called us.”

Welcome to Ethiopia! The workers were celebrating the Eid festival for the next week, and the fashion shoes for Milan had to wait. And there were other issues.

“The fasting period affects us a lot. People don’t eat from sunrise to sunset, and we work right through Ramadhan. Some people have fainted from tiredness during their shift. At first, we didn’t know what to do. But now we have a rest room for workers.”

The world’s factory

It’s all a far cry from Leung’s trusted factories back in Dongguan.

When he started out in the early nineties, Dongguan was the world’s factory. From air conditioners to zip lock bags, everything was manufactured there. Heavy industry was to be found in larger cities. Shipping, and the motor industry were in Shanghai. One country, China, made everything.

But the investment environment was changing. Labour costs were rising, land was becoming expensive. So, manufacturers started looking elsewhere.

“Each industry looked for the best location to move to. Garments were the first to move out. Buckles can be easily imported. They don’t require a strong supporting industry. So, they tried many places, Sri Lanka, Vietnam, Malaysia, and now Myanmar.”

The toy industry is a bit more complex, combining injection mould-making and electronics. “Preliminary work is typically still done in China, but the bulk of manufacturing nowadays is often in Indonesia.”

Electronics has an even larger eco-system. This might include component making, circuit boards, and injection moulding. When more than two or three specialist factories have to move together, it is more complicated. So, a lot of higher-end manufacturing, especially if it can be readily automated, is staying put in China.

Getting to Ethiopia

“I have an Italian partner, and one day he told me he wanted to go to Ethiopia to source leather. After that, for two years, he kept asking me to come along, and finally I went with him. My first impressions of Ethiopia were very positive,” Leung remembers.

“I was surprised by how happy the people were, despite their suffering over the past 20 or 30 years. They didn’t have much. There were no mobile phones.”

“The first thing I did was buy leather to get some kind of connection to the place. After that I gave some orders to a government-owned factory to run production for shoes. Workmanship was good and we were happy. After two years’ experience, we decided to start our own factory.”

Logistics

Ethiopia is a landlocked country so logistics are a challenge.

“It took six months to get the machinery from China. We had to go through the port of Djibouti, then overland to Addis Ababa. At that time, port facility management was not up to international standards.”

“Now it is getting better. The journey takes only 35 days, and cross border transportation is improved with a new railway line between Djibouti and Addis.” Raw material supply or components is crucial as it affects delivery time. Leung has settled on a mix of sea and air freight.

Manufacturing

Setting up shop in Africa was also challenging compared to the predictability of home.

“China was a settled farming society, which works around seasons, and we share a common culture. At Chinese Lunar New Year, which is the biggest disruption to manufacturing, there are only three days’ official holiday, but it is understood that workers take off two weeks. I know exactly when my workers go away, and when they will come back. This is all agreed and known.”

It took time to adjust to Ethiopia. “Their new year is in September. It’s officially a one-day holiday but actually stretches to one week. Then the two main communities are Christian and Muslim, but they both take each other’s holidays! Manufacturing is more difficult to schedule.”

Work mentality

Ethiopia was partly an animal herding society. Adjusting to the demands of factory work has taken time.

“Herders take their animals to graze on the hillside. They would sit in the shade under a tree and guard their animals. The journey to the hillside and the sitting were all considered work. They were at work — but not necessarily doing things at work.”

“Then they come to the factory. Whether they move or they don’t move, whether they do or they don’t do, it is all still work in their mind. This was their mentality at first and it took time to change.”

Time was another issue. Almost all Ethiopians use a 12-hour clock, with one cycle of 1 to 12 from dawn to dusk, and the other cycle from dusk to dawn.

“At sunrise, people get up and at sunset they go back home. This caused difficulty with the idea of ‘overtime’. They really couldn’t understand it!”

Enter the Smartphone

But change came fast. In the last three or four years, young entrepreneurs from China have introduced smartphone manufacture to Ethiopia.

“The young Chinese are very ambitious and eager to try everything,” Leung says.

“They buy machinery and ship it to Addis Ababa and make an assembly line. It’s old, labour-intensive technology. But they buy at a low price, and make smartphones suitable for the local market.”

The result is that mobile phone usage has taken off in Ethiopia.

“They sell phones for about half a month’s salary.” And as Leung relates, the mobile is a real Trojan horse: “When they start using the smartphone they become more modern, they need more things and they are willing to work longer hours. One simple phone can change a lot. Now they don’t feel any suffering from working overtime! They feel enjoyment after they receive their wages.”

Made in Ethiopia

“When I started out in Africa, I didn’t factor in customer resistance to ‘Made in Ethiopia’. But for the first three years the buyers gave me very small orders. They were checking the product and they didn’t want to take risks. For their own job security, they want to buy shoes that guaranteed no problems.”

That has changed now, and Leung manufactures about 30% more shoes in Ethiopia than in Guangdong. Short-run production is still best in Guangdong. But anything from 20,000 up goes to Ethiopia.

“There are inefficiencies in starting-up a new model in Addis Ababa. It takes about one week to get up to speed with one style,” he says, explaining the strategy.

Tensions

Ethiopia is a federal government, not centralized like China. With a population of over three million, the footprint of Addis Ababa is still relatively small. But in the last 10 years, Chinese companies have built a lot of new roads, and now the city is expanding into the surrounding land. This is causing problems.

“I have two facilities, one very close to the airport, the other was about 1 hour 40 minutes. But six months ago, a new road reduced that time to about 30 minutes. The government wants to expand the capital city area, acquire more land, and build more public housing. As it is made more accessible, the land is becoming more and more expensive. There have been tensions between the city authorities and the other provinces and village leaders leading to strikes. The state government is opposed to the provinces. And some provinces want to increase their seats in parliament.”

“During the strikes, my Chinese supervisors feared for their lives, but our workers assured them that it is only a show of support for local village leaders in their struggle with the city.”

Jobs for Africa

Frank Leung recently won the GG2 Leadership Awards 2016 — Entrepreneur of the Year Award, in London. “My story in Ethiopia was very relevant to what the UK was going through with Brexit. I told the panel judges that I thought the best way to deal with the refugee crisis in Europe was to help African and Middle Eastern countries like Ethiopia and Syria to develop their own economies, rather than focussing on stopping refugees crossing the Mediterranean Sea.”

“Some of the Ethiopians may even think about taking the boat to Turkey. I try to help them build their home better, and create more jobs. So, to a certain extent, I think my winning this award speaks to concerns around immigration and refugees at the time of Brexit.”

At peak season, from September to December, manufacturing for the US Spring market, Leung employs up to 1,700 people in Ethiopia, with about 30 Chinese supervisors. For the future, does he plan to expand into neighbouring countries?

“As a SME one can’t do too many things at the same time. If I can make a success of Ethiopia that will already be a great result for me.”

DBA

These days Frank Leung has an unusual monthly commute between Hong Kong, Addis Ababa and his home in London. In the middle of his busy working life, he has signed up for a College of Business DBA. Unsurprisingly perhaps, the theme of his research is Ethiopia. He is researching into why less developed countries with abundant raw material resources and cheap labour force receive less Foreign Direct Investment.

“The main problems in Ethiopia are resources and logistics, so dependency theory is very relevant, and how to bring all the resources together to make a successful business.”

In pursuing his vision, Leung is bridging both cultural and geographical distance. Differences in work concept and time keeping, infrastructure and logistics, with political instability thrown into the mix, make for a challenging life. As he puts it: “The DBA is talking about everything that I am suffering!”

This article was firstly published in “CITY BUSINESS Magazine (Spring 2017)” by College of Business, City University of Hong Kong magazine. Please click to read the full article.

By Zhang Ping, editor of “China-US Focus Digest”

In China’s view, relations with the U.S. were put on a steadier footing after President Xi Jinping’s meeting with President Donald Trump in Florida in April. The 100-day action plan, one of the outcomes from the summit, has reaped early harvests, dismantling fears of a trade war. Trump also sent one of his senior advisors to the “Belt & Road” international forum in Beijing, despite the lukewarm reception to the China-led initiative from the Obama administration. To prevent the situation on the Korean Peninsula from exploding, Beijing and Washington are working together more closely than ever.

Hiccups exist in the bilateral ties – the USS Dewey conducted a “routine” Freedom of Navigation patrol in the South China Sea in May, the first since Trump took office; China twice dispatched fighter jets to intercept U.S. planes along China’s shores during the month; the U.S. deployment of THAAD anti-missile system in South Korea, put on hold, still presents uncertainties.

There has been much talk in the news media and corridors of power and offices of think tanks in each country’s capitals, and among the public, about the prospect of a more assertive China filling the leadership void left by the U.S. Trump’s policy initiatives, including the U.S. withdrawal from TPP and his “America First”, as well of pulling out from the Paris Climate Accord, appear to point to a more isolationist America. Many seem to have also turned to China in the hope that it can step up to the plate to be the guardian of free trade and globalization and the chief cheerleader in climate change.

To some degree the hope and expectations are hyped. China has its eyes on the prize – that is growing its economy, managing a variety of domestic priorities, including an anti-poverty campaign and implementing the regional “Belt and Road” infrastructure plan that has a direct impact on the country’s economy. Its global role, while growing significantly, will be limited with its means, and aligned with its domestic priorities.

So far, there has been no indication that China is bucking its head against the U.S. in managing bilateral relations and global issues. Instead, China seems fine going along with the established rules within the existing global governance structure. Chinese initiatives, such as the “Belt &Road”, aim to improve upon the global system and bring about new opportunities. Our contributors Douglas Paal and Matt Ferchen suggest that China is largely a rule-taker rather than a rule-maker in many aspects of the international order.

For this issue, the highlighted commentaries are on the “Belt & Road” initiative. Chen Dongxiao, who chairs the Shanghai Institutes for International Studies, participated in the May 13-14 “Belt & Road” international forum. He calls for better expectation management when it comes to implementing the initiative and a “collective identity” among the participating countries. Paul Sedille and Vasilis Trigkas suggest that the initiative can be viewed as part of an emerging “Sino-centric” “Silk Road system” very symbiotic to the U.S.-shaped Bretton Woods.

Another theme is the 100-day trade talks between China and the U.S. He Weiwen, while lauding the “early harvests”, lists high-tech, energy, steel and infrastructure financing as bankable opportunities beyond the 100-day action plan. Christopher McNally pinpoints the transactional approach to the talks that he believes will lead to an impasse.

This article was firstly published in the China-US Focus magazine “China-US Focus Digest” June 2017 issue VOL 14. Please click to read the full article.

By Dr Isabel Yan, City University of Hong Kong

There is no doubt that the globalization project is set to travel a bumpy road in 2017. A number of unprecedented events are poised to stall its progress. Brexit and Trump’s protectionist agenda are significant obstacles, and will challenge the globalization project as we know it. On the other hand, China’s One Belt One Road (OBOR) based on open borders and boosting economic cooperation offers an alternative vision. Time will tell which of these countervailing forces will prove more influential. Are we witnessing the end of an era, or will globalization arise anew from the ashes?

The Trump Presidency

The cozy Clinton-Bush-Obama era Globalization project has already taken some hard knocks, and international policy since January 2017 has turned largely protectionist. The Trump-led administration consistently criticizes pre-Trump trade and immigration policies as insufficient in advancing US interests and in paying too little attention to the interests of US workers. As a result, it advocates policies that put major restrictions on two aspects of globalization: trade and immigration.

Restrictions on trade

As promised, one of President Trump’s first acts was to sign a presidential memorandum to withdraw the US from the Trans-Pacific Partnership (TPP). He also intends to renegotiate the North American Free Trade Agreement (NAFTA), crucial to North American economic integration since 1994. NAFTA abolished tariffs on over one-half of Mexico’s exports to the US and over one-third of US exports to Mexico. It also set up the CANAMEX Corridor that strengthens connection among the three member countries via telecommunications, railway and pipeline infrastructure. Nevertheless, Article 2205 of the NAFTA agreement gives a provision for members to withdraw with six months’ notice.

Trump’s opposition to TPP and NAFTA is largely on the grounds of their effect on US employment. Trade liberalization enables large US corporations to outsource their production, which arguably leads to job losses and lower wages for US workers. Nevertheless, this argument has ignored at least three important stylized facts in economic development.

Firstly, trade liberalization can generally increase the welfare of low-income households by reducing the cost of subsistence manufactured goods like textiles or packaged food. It also broadens the choice of consumer goods available to US customers. Secondly, the comparative advantage of the US is in  knowledge-intensive services which are skilled labour-intensive rather than in manufacturing industries which are unskilled labour-intensive. Competing with developing countries in secondary industries will not be a suitable strategy to maintain long-term economic growth for the US. Innovations and technological improvements are well-documented drivers of sustainable long-term growth.

Product life cycle theory

Thirdly, product life cycle theory shows that any product will generally go through three stages during its production life-time. The first stage is the “new product” stage during which products are invented in advanced countries with abundant capital and skilled labour such as the US, and are marketed there at relatively high prices. Exports are predominately from the invention country. The second stage is the maturing product” stage in which there is growing consumption demand from other advanced countries and the invention country starts to set up production facilities there. The invention country’s exports to these advanced countries thus gradually reduce. The last stage is the “standardized product” stage during which the production of the product becomes more standardized and the price lowered. The invention country will take advantage of the lower production cost in developing countries (e.g. China, South Asia) and outsource its production there. The invention country becomes an importer at this stage.

Based on this theory, outsourcing production to developing countries is a natural evolution process in the product life cycle. To maintain its exports, invention countries should focus on continuing to invent new products, rather than restricting the production of mature products to itself which is against its best economic interests. Overall, withdrawing from international free trade agreements will do little to bring factory work back to the US. Instead, it will lead to a reallocation of direct investment to other developing countries and possibly retaliation from countries which are being discriminated against.

Allegations of currency manipulation

Trump’s administration also threatens to take a tough line on countries identified as having “violated global trade rules”. In particular, it declares an interest in bringing cases against major exporters who allegedly “compete unfairly”, including China. Trump accuses China of manipulating its currency to gain trade advantages, which, if confirmed, would allow other countries to impose trade restrictions against China’s exports. However, on 28th February 2017, Trump’s currency manipulation claim against China was dismissed by the US Treasury itself. In fact, the plot of China’s nominal exchange rate over the last two decades shows that the Renminbi broadly followed a persistent appreciation trend against the US dollar until early 2014. There was no evidence that China actively engaged in one-sided intervention to push down its currency value.

In fact, Trump’s radical agenda to restrict trade and immigration is not without potential downside. If the US were to start a trade war, affected countries would be likely to retaliate. And there has been a history of Chinese retaliation. In 2009, China responded to the US imposition of tariffs on its tire exports by taking antidumping measures against US’s food exports. Besides, any trade cases against China would require a formal dispute settlement from the World Trade Organisation (WTO), a process based upon the WTO’s past decisions.

Restrictions on immigration

In the first 90 days of his presidency, Trump has signed Executive Orders suspending entry of citizens of seven (later six) Muslim-majority countries for 90 days. Those countries were Iraq, Iran, Libya, Somalia, Sudan, Syria and Yemen. (Iraq later excepted). Trump’s future trade and immigration policy is uncertain, but the US’s more protectionist policy is expected to result in a redistribution of economic power. Nations whose global trade position is being jeopardized are likely to find ways to lock in their trade position by identifying alternative economic partners. The One Belt One Road Initiative provides just such an opportunity to build new economic connections.

Brexit

The outcome of the June 2016 British referendum on European Union (EU) membership shocked the world, and set the UK off on the path of departure from the union. The EU currently comprises 28 member countries, of which 19 are in the Euro area. The departure can potentially deprive the UK of four major freedoms with member countries: the free movement of goods, the free movement of services and freedom of establishment, the free movement of persons including workers, and the free movement of capital. These dramatic changes are set to start from the date of the UK’s entry into any withdrawal agreement with the European Council, or two years after its notification to the Council of the intention to withdraw.

Until new trade and economic agreements between the UK and other EU members are established, the UK’s net exports of goods and services to the European Single Market, especially in its key financial services sector, could decline significantly due to the loss of its passporting rights in the EU. In 2014, the UK’s trade surplus in financial services and insurance amounted to around £20 billion. Much of this can be attributed to the UK’s passporting rights for UK banks and investment companies to provide services to clients in other European Economic Area (EEA) states by establishing branches or providing services across borders without further authorization requirements. Moreover, the UK’s position as the top global euro trading centre (the UK accounted for 45% of total global euro trading in 2016) was challenged by the European Central Bank (ECB) whose “location policy” requires euro-denominated trades to be cleared by Central Counterparty Clearing Houses (CCPs) based in the Eurozone. A PwC report estimates a reduction of 70,000-100,000 jobs in the UK’s financial services sector as a result of Brexit. The future of a new UK-EU free trade agreement is still uncertain, and represents a backlash against the current process of globalization.

One Belt One Road

Counter to the prevailing protectionist trend, the OBOR plan lays down an economic framework that boosts economic cooperation. First introduced by President Xi Jinping in 2013, it is arguably the largest cross-region infrastructure development project in history. The project aims to connect countries in Africa, Central Asia, Eastern Europe, the Middle East, Russia, South Asia and South-east Asia along the Silk Road Economic Belt and the 21st century Maritime Silk Road. The total population in these countries amounts to about 4.4 billion, relative to 0.3 billion in the US, 0.5 billion in the whole EU and 7.4 billion globally (2016 figures). This multifaceted project includes the construction of port facilities, air transport facilities, IT infrastructure, retail and distribution networks, as well as communications, road, power, and rail networks. The success and widespread acceptance of the OBOR plan serves as a counterforce to Trump’s protectionist policy. OBOR is connecting countries in Eurasia interested in reducing poverty, attracting syndicated funding for infrastructure development, and forming ever-closer economic partnerships with China.

The globalization project in 2017 is facing a number of backlashes, but the need for greater cooperation among countries continues to be strong. It is essential that countries work collectively to arrive at win-win situations, not only in boosting mutual economic growth, but also in promoting good governance and environmental protection. For Eurasia and Africa, One Belt One Road is showing the way.

This article was firstly published in “CITY BUSINESS Magazine (Spring 2017)” by College of Business, City University of Hong Kong magazine. Please click to read the full article.

By Chen Dongxiao, President, Shanghai Institutes for Int'l Studies

The much anticipated inaugural Belt and Road Forum for International Cooperation has been successfully concluded, producing a fair number of agreements. More importantly, Chinese President Xi Jinping announced at the closing ceremony that China would host the second Belt and Road Forum in 2019, marking the institutionalization of the forum as a brand-new platform for closer international cooperation.  As a formal attendee at this important event, I have witnessed the keen interest and enthusiasm on the part of all the participants and the press corps with respect to the forum per se and its positive outcomes.

Contrary to the doubts of some international media outlets and observers in the past few years, all the participants that I talked with praised the event itself and China’s relentless efforts to translate the Belt and Road vision into a detailed blueprint and remarkable achievements. In my view, this contrast between what naysayers had anticipated and the highly positive evaluations I heard at the conference is attributable to three factors. First, all the outcomes of the Belt and Road Initiative presented during the forum, including a long list of 76 items comprising more than 270 concrete results in five key areas, have far exceeded expectations and reinforced a sense of gain on the part of the countries and regions along the two routes, increasing their confidence and dispelling initial suspicions. Second, a new concept of international cooperation based on the principle of “extensive consultation, joint building, and benefit sharing”—the New Silk Road Spirit, or in my own phrase, a Belt & Road Initiative Doctrine — has begun to take shape as a governing norm for Belt and Road cooperation, creating a reassuring effect among all relevant parties. Third, the Belt and Road Initiative is now converging with other major development agendas, such as the United Nations’ 2030 Agenda for Sustainable Development and the Paris Agreement on Climate Change, indicating that instead of reinventing the wheel, Beijing’s effort aims to complement and enhance existing international economic cooperation and global economic governance. So the initiative is, to some degree, leading the way in strengthening current multilateral cooperation.

As a milestone event, the first forum has been not only about stocktaking but more importantly about sound planning for expanded international cooperation. In order to steer the Belt and Road Initiative toward greater success, I think greater efforts should be made in the following aspects.

First, improving expectation management, i.e., shaping, coordinating, and stabilizing domestic and international expectations concerning the Belt and Road Initiative will maximize the positive effect of economic policy and minimize possible negative side effects. Four years of achievements and experience have made it clear that as a “project of the century” with a vast span in time and space, the Belt and Road Initiative not only promises huge immediate and potential business opportunities and economic interests but also presents a variety of political, economic and security risks and uncertainties. As a market entity, the enterprise should strike a balance between seizing every opportunity available and guarding against possible risks. As a policy entity, the government should effectively and regularly communicate information and policies on the Belt and Road Initiative so as to help market entities reduce miscalculations in their decision-making.

Second, it is vital to reduce the constraining effect of institutional transaction costs on the Belt and Road Initiative. On the one hand, history shows that an essential indicator of the efficacy of international cooperation is whether such cooperation can substantially reduce the transaction costs between and among partners with diverse policies, regulations, standards and laws. Those incurred costs are also defined as institutional transaction costs. That is why policy consultation at the governmental level is always given precedence and “dovetailing” of policies, rules and standards is regarded as an institutional safeguard for enhancing further cooperation. On the other hand, as one of the means to reduce institutional transaction costs, policy consultation at governmental level involves potential resource re-allocation and interest redistribution among all stakeholders, and is sure to encounter considerable obstruction unless there is broad-based social consensus and approval.

Therefore, it makes strategic sense to working on the consensus-making and confidence-building by strengthening people-to-people bonds and promoting cultural, educational, science and technology, think tank, and personal exchanges between China and countries along the routes. Just like philosophy of traditional Chinese medicine goes, opening the human body’s main and collateral channels will ensure the smooth circulation of vital energy. Strengthened people-to-people bonds, which function as the social basis for reducing transaction costs, will facilitate the reconciliation of policies, rules, and standards among all stakeholders.

Third, sustain the provision of public goods for the Belt and Road Initiative. Such an epochal project requires the steady supply of public goods, including a peaceful environment and sound institutions, to create any positive “spillover” effect. Therefore, all stakeholders in the project, including national governments, international organizations, enterprises and nongovernmental organizations need to make their respective input. National governments should provide adequate security and legal safeguards by leading the efforts of policy coordination and strategy synergy. Meanwhile, international organizations, enterprises, and nongovernmental organizations should be actively involved in policy consultations on trade and investment connectivity in order to promote greater transparency and benefit sharing in rule-making and expand the institutional spillover effect of Belt and Road cooperation. Continued provision of public goods for the Belt and Road Initiative also requires recruitment of high-caliber thinkers and innovators to provide intellectual support, creating an “Intellectual Silk Road.”

Last but not least, a sense of collective identity needs to be fostered.  The history of the evolution of human society has shown that a common historical memory and shared experience of concerted efforts constitute the basis of a collective identity, which, if strengthened, can reduce or even resolve conflicting interests and ideas. Coordinating policy consultation, trade promotion, infrastructure connectivity, financial cooperation and people-to-people exchanges will enable all stakeholders in this grand project to raise their awareness of burden sharing and increase mutual trust. It is not only a viable way to break through the traditional pattern of international politics, which is all about interest, but also an integral part of the effort to build a community of shared destiny.

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By Professor Frank Chen, City University of Hong Kong

Against a background of rising costs, Chinese manufacturing is on the move —— to the US and Southeast Asia. Professor Frank Chen, Head and Chair Professor of Management Sciences, investigates latest trends and how a record inflow of Chinese investment is helping revitalize the American economy.

When the then President-elect Donald Trump met Alibaba executive chairman Jack Ma in January 2017, he characteristically said he had a “great meeting”. They discussed one of the incoming President’s favourite topics, American jobs. The headline news? One million new US jobs to be created.

“We’re focused on small business,” Ma told reporters after the meeting. “We specifically talked about ... supporting one million small businesses, especially in the Midwest of America.”

Ma said that Alibaba’s expansion would focus on products like garments, wine and fruits, with a special focus on trade between the American Midwest and Southeast Asia.

Of course, Alibaba has clout. With more than 10 million active sellers as of 2015, the company estimates its China retail marketplaces has contributed to the creation of over 15 million job opportunities.

The meeting came against a background of stalled US reshoring (US companies returning to their homeland) whilst Chinese investment remains buoyant. Every year since 2012, Chinese investment in America has exceeded investment flows in the other direction. And in 2016 Chinese companies’ investment in the US economy was at a record US$18 billion. This embraced sectors from entertainment to micro-electronics, information technology, household appliances, and hotels. The investment went beyond financial sector mergers and acquisitions to include the building of new manufacturing plant on green or brown field sites.

The world’s workshop?

As early as 2010, Bloomberg Business Week ran the title “Why Factories Are Leaving China”. Chief Economist at the Industrial Bank, Lu Zhengwei, dates the shift to 2012, when China’s services sector overtook manufacturing for the first time as the biggest contributor to nominal gross domestic product. At the time this was heralded as a milestone towards industrial restructuring.

“The process began to get serious a long time ago… When we spoke highly of the increasing role of the service industry in our economic structure, it had already kicked in. That was 2012,” Lu said, adding that China’s high taxes and high land costs are now turning business away.

China’s manufacturing base is indeed transforming. Lower end manufacturing is moving offshore to Southeast Asia countries such as Vietnam, Indonesia and African countries such as Ethiopia, whilst higher value added manufacturing is encouraged against a background of increasing automation. The heyday of China’s manufacturing boom is long gone. These were the 1980s and ’90s, and especially the years after China joined the World Trade Organisation in 2001. In these years, the gains to China’s manufacturing base can often be directly correlated to losses in the US. Some sources state that the US trade deficit with China cost 3.2 million jobs between 2001 and 2013.Manufacturing was eager to relocate from the advanced economies, and within a decade China was the world’s second-largest economy.

Southeast Asia boom

A confluence of political and economic factors is now producing another decisive shift — away from China. On both sides of the Pacific, government policy is playing a role. In China, Beijing has encouraged labour-intensive businesses to move elsewhere as it tries to steer the economy towards higher value-added services and automation. In the US, President Trump has suggested that a tariff barrier may be placed between the two countries, and encourages “Made in America”. The question remains, who by?

For China, the new policy means less emphasis on shoes and apparel. Vietnam has overtaken China to become the largest producer for Nike shoes. Garment exports from Southeast Asian nations to the EU, US, and Japan have been very strong in recent years, sharply contrasting with the performance from China. Companies such as Eclat Textile, Taiwan’s largest apparel company, are pulling out of China completely due to deteriorating business conditions and surging wage costs.

Even the high-tech sector is affected. More than 50% of Samsung smartphones are now assembled in Vietnam, and one more Samsung factory is currently under construction. It is reported that 80% of Samsung’s China capacity will be moved to Vietnam. When such giants move, so do their immediate supply chain partners, sooner or later, followed by secondtier and accessory suppliers. The result — many Vietnamese companies are also intensifying investment in the electronics supporting industry.

Exodus

The exodus of Chinese manufacturing goes hand-in-hand with a surge of outbound investment. This is up more than 50% in the first 11 months of 2016 from a year earlier, with manufacturers involved in more than a third of China’s overseas mergers during that period. At the same time, China’s private sector investment at home rose just 3.1%.

The prospect of reaching a Trans-Pacific Partnership (TPP) agreement accelerated such supply chain shifts. TPP would make Vietnam an open economy and a favourable destination for FDI. With other ASEAN countries intent on joining too, a pattern similar to 1990s’ Pearl River Delta was emerging with countries such as Indonesia introducing economic stimulus packages to encourage foreign investment, and keeping currency at low levels. The whole regional block was poised to replace the Pearl River Delta region, benefit from lower labour costs, and emerge as the world’s low cost manufacturing centre.

President Trump’s abrupt cancellation of TPP has now thrown doubt on the viability of importing to the US. In the short-term, reshoring and FDI in the US should gain renewed impetus. But one thing is for sure, these manufacturers will not be returning to China.

FDI trumps reshoring

Ironically, Foreign Direct Investment seems to be playing a much greater role in the American manufacturing revival than the much-vaunted US reshoring phenomenon.

“The US Reshoring phenomenon, once viewed by many as the leading edge of a decisive shift in global manufacturing, may actually have been just a one-off aberration,” says Patrick Van den Bossche, A.T. Kearney partner and co-author of an April 2016 Reshoring Index study. Industries vulnerable to rising labour costs in China have been successfully relocating to other Asian countries, rather than returning to the US, the report confirms. Vietnam has absorbed the lion’s share of China’s manufacturing outflow, especially in apparel. US imports of manufactured goods from Vietnam in 2015 were nearly triple the level of imports in 2010.

2016 Record - breaking Chinese investment in the US

January In the largest China-Hollywood deal to date, conglomerate Dalian Wanda Group Co. acquires production and finance company Legendary Entertainment for US$3.5 billion.

April Omnivision Technologies, whose camera sensors have been used in Apple Inc.’s iPhone, is acquired by a consortium of Chinese private equity firms including CITIC Capital Holdings, Hua Capital Management and Goldstone Investment Co. for US$1.9 billion.

April Tianjin Tianhai buys Ingram Micro for US$6.07 billion. The deal marks the largest Chinese takeover of a US information technology company to date.

June Qingdao Haier Co. spends US$5.6 billion to buy the appliance division of General Electric, giving the Chinese appliance manufacturer an opportunity to boost its presence in the US market.

September Anbang Insurance's, one of China's largest insurance companies, completes a US$6.5 billion deal for Strategic Hotels and Resorts.

October Chinese conglomerate HNA agrees to pay private equity firm Blackstone Group US$6.49 billion for a 25% stake in Hilton. The move is part of HNA's efforts to enhance its global tourism business.

'Made by China' in America

China companies are entering manufacturing in the US in a variety of industries.

Paper In June 2014 Shandong Tranlin announced it would invest about US$2 billion to build a pulp and paper factory outside Richmond, Virginia.

Textiles The Keer Group has built a US$218 million cotton yarn factory in South Carolina, and “are now hiring in places where cotton was king”.

Construction Machinery SANY has made a US$60 million investment in office and manufacturing space for construction machinery in Georgia.

Computers Lenovo opened a computer production plant in North Carolina in June 2013.

Auto Parts China's largest auto parts maker, Wanxiang Group, has 28 factories in 14 US states with 6,500 employees.

Garments In October 2016, Chinese garment manufacturer Tianyuan Garments Co. made a US$20 million investment to produce clothes for brands like Adidas, Reebok and Armani — the first Chinese manufacturer to make clothing in the US.

Paper In April 2016, Chinese paper products maker Sun Paper Industry said it was opening its first North America factory in South Arkansas, investing more than US$1 billion to construct a new bio-products mill that would create 250 local jobs.

Steel Pipe Tianjin Pipe has invested more than US$1 billion in a steel pipe plant in Texas, designed to produce 500,000 metric tons per year of steel pipe that is used in the oil and gas industry.

This article was firstly published in “CITY BUSINESS Magazine (Spring 2017)” by College of Business, City University of Hong Kong magazine. Please click to read the full article.