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The New Silk Road, part I: a stocktaking and economic assessment

By Stephan Barisitz, Foreign Research Division, Oesterreichische Nationalbank; and
Alice Radzyner, European Affairs and International Financial Organizations Division, Oesterreichische Nationalbank

China’s New Silk Road (NSR) initiative was officially launched in 2013. It aims at enhancing overall connectivity between China and Europe by both building new and modernizing existing – overland as well as maritime – infrastructures. The NSR runs through a number of Eurasian emerging markets with important growth potential. The Chinese authorities have entrusted the Silk Road Fund, the Asian Infrastructure Investment Bank and other institutions with financially supporting NSR activities. Most drivers of the initiative are of an economic or a geopolitical nature. Given the generous financial means at Beijing’s disposal and Chinese firms’ accumulated expertise in infrastructure projects, many undertakings are currently well under way and promise to (eventually) bring about considerable changes in connectivity, commerce and economic dynamism. While most Chinese NSR investments go to large countries (e.g. Pakistan, Malaysia, Indonesia, Russia, Kazakhstan and Kenya), the strategically situated smaller countries (e.g. Djibouti, Sri Lanka, Kyrgyzstan, Laos, Serbia and Montenegro) typically benefit the most (in relation to the size of their economies). Progress has been made in strengthening the maritime infrastructural trade links with the EU (e.g. through the modernization of deep-water ports) while the upgrading of the currently rather weak trans-Eurasian railroad and highway links (e.g. via Kazakhstan and Russia) is clearly improving overland transportation’s yet modest competitive position.

This study is the first of a set of twin studies on the New Silk Road (NSR). In part I, we provide a project-oriented overview of China’s initiative to establish a New Silk Road linking China and Europe via a number of Eurasian and Asian emerging markets with important growth potential. In part II, we focus on the NSR’s implications for Europe, or more precisely, Southeastern Europe (SEE), through which it connects to the heart of the continent. We feel that our brief discussion of concrete projects can provide valuable geoeconomic and geopolitical insights that help us understand the motives, goals and implications of this major endeavor. As far as we know, no other study has yet analyzed the NSR’s impact from a project-oriented perspective, i.e. based on essential details of salient NSR projects in various parts of Eurasia and Africa. This contribution is intended to facilitate grasping the overall (potential) connectivity impact of the (strived-for) substantial modernization of trading networks.

Part I is structured as follows: Section 1 describes the most important features of the NSR, which is officially called the “One Belt, One Road” (OBOR) initiative, and the respective Chinese or multilateral financing institutions. Some motivations and reasons, but also risks and limitations, of the Chinese initiative are subject of section 2. Section 3 provides a snapshot of the approximate locations of the “economic corridors” of the NSR and a succinct discussion of the economic advantages and drawbacks of competing modes of transport, with important implications for OBOR projects. It also analyzes some major OBOR projects. Section 4 finally summarizes and draws some conclusions which help prepare the ground for part II …..

2. The New Silk Road: some motivations and reasons, challenges and risks

China’s OBOR initiative has been motivated and driven by a number of quite heterogeneous aims, which primarily include economic, but also geopolitical and even ecological issues:

•    Improvement of transportation links, reduction of trade costs to Europe and other parts of Eurasia

The basic idea of the OBOR initiative is to better link up the “vibrant East Asian economic circle at one end and the developed European economic circle at the other”, following the example of the NSR’s predecessor, the traditional Silk Road, which lasted for about two millennia, witnessed many ups and downs, and linked the same two major traditional hubs of economic activity: the Middle Kingdom and Europe, or the Orient and the Occident. As, once again today, the world’s biggest trading nation, modern China’s interest is to reduce the costs of transporting goods (by land and sea) to other destinations. More efficient and secure and, if possible, shorter trade routes to Europe can further this goal.

The fact that about three-quarters of Chinese imports from Russia and 60% of Chinese imports from Kazakhstan are reportedly carried out via the ports of St. Petersburg and Vladivostok, although both Russia and Kazakhstan are immediate neighbors of China and share more than 2000 km of common borders with China, points to the relatively modest level of logistical development of intra-Eurasian overland trade. This may indicate vast connective potential for infrastructural projects in this area.

•    Redirection of Chinese surplus savings, reutilization of domestic productive capacities and technical expertise for NSR investments

The NSR initiative can serve as a means of countering the recent marked downturn or weakened growth of the Chinese economy. The country probably has more savings than it can profitably invest at home. After many domestic infrastructure projects have been finished, Chinese infrastructure-related industrial and service sectors are saddled with overcapacities. OBOR’s economic dimension includes generating substantial foreign demand for reutilizing these domestic resources. This also relates to Chinese high-speed rail expertise: Chinese enterprises have gained great experience in high-speed rail construction within the country and are looking to apply their expertise in projects abroad now. While such aims are quite understandable, they would also appear to constitute an extension or resuscitation of China’s traditional economic model of export-led growth or at least a slowdown or interruption of its intended transition to domestic consumption-led economic expansion.

•    Diversification of investments, markets and suppliers

One particular aim of the OBOR initiative is to hedge substantial existing Chinese placements in U.S. financial assets by investing in Eurasia. The NSR also promises to help diversify markets and suppliers through stimulating trade with landlocked or (so far) more difficult-to-access neighbors not yet trading that much with China. Infrastructure development in countries along the OBOR routes may raise growth in their economies and thus contribute to increasing demand for China’s goods and services.

•    Creation of “strategic propellers of hinterland development”

This OBOR objective with respect to China’s less-developed central and western provinces has been put forward by Premier Li Keqiang. While Chinese growth has in recent decades favored the country’s eastern and coastal provinces, the NSR is to transform the northwestern province of Xinjiang into China’s infrastructural gateway to Central and Western Asia, which will open up opportunities for investment and stepped-up economic activity in this remote, politically somewhat restive, province. Correspondingly, in the southwest, the province of Yunnan should become the modernized “open door” to South Asia and the Indian Ocean. Thus, the authorities hope to tackle the socioeconomic divide (gross income inequalities) between economically peripheral inland and “connected” coastal provinces. Since all OBOR corridors depart from central or western provinces, the intended geoeconomic rebalancing could mitigate these disparities.

•    Contribution to the internationalization of the Chinese renminbi-yuan

Alongside the development of closer trade and investment relations and deeper financial integration among OBOR countries, the Chinese authorities will promote the use of the renminbi-yuan in international transactions. The aim is to expand the scope and scale of bilateral currency swaps and settlements with other countries along the NSR. Efforts of governments of partner countries and their companies and financial institutions with good credit ratings to issue renminbi yuan-denominated bonds in China will be encouraged.

•    Hedge in case of possible trade war

Since U.S. President Trump withdrew the U.S.A. from the Transpacific Partnership (TPP) in late January 2017, the TPP has lost much of its importance. Prospects for the conclusion of the Transatlantic Trade and Investment Partnership (TTIP) have also diminished considerably. Thus, the OBOR appears to be less under pressure than in the past to counterbalance potential rival trade initiatives. However, if a trade war between China and the U.S.A. were to break out, Beijing may expect enhanced connectivity and cooperation with NSR countries, notably with European partners, to soften the impact somewhat.

•    Pragmatic infrastructural project cooperation as a possible way forward where trade integration areas have lost popularity

Pragmatic cooperation between one or more states and enterprises focusing on a particular infrastructural project (like a pipeline, a rail or highway link, a hydropower dam or electricity grid, a deep-sea port, etc.) provides task-oriented experience and may improve connectivity and intergovernmental relations. In a time of growing skepticism about trade and economic integration treaties such concrete, if limited, advances may promise greater success than traditional “deepening” efforts. At the same time, physical and nonphysical trade facilitation measures (the latter include the harmonization of customs, import, export and border crossing procedures) can arguably only be seen as complementary measures and not as alternatives.

•    Venue for addressing strategic energy and resource security issues

Approximately 75% of China’s oil imports and an even higher share of its total imports are seaborne and pass through the Strait of Malacca between the Indian Ocean and the South China Sea (Escobar, 2015, p. 7; Grieger, 2016, p. 8). This geopolitical bottleneck could be closed by a military adversary in the case of conflict, which makes China potentially strategically vulnerable. China’s energy security is also put at risk by piracy that is rife in and near the area. China’s dependence on shipments through the Strait of Malacca has already been partly reduced by the creation of alternate (overland) trade channels, including the construction of pipelines from Central Asia10 and of corridors linking China directly to the Indian Ocean (via Pakistan and via Myanmar, see subsections 3.1 and 3.2).

•    Ecological goal: reduction of China’s heavy reliance on polluting coal

China’s reliance on coal for about 40% of its heating and electricity has substantially contributed to pollution in its cities. The authorities have set ambitious goals for dealing with the pollution problem, including switching from coal to cleaner – but so far mostly imported – energy sources, e.g. natural gas from Central Asia and Russia.
 
Needless to say, the OBOR initiative also faces a number of challenges and risks:

•    Weak local governance, sprawling bureaucracy and potential political instability

OBOR partner countries feature quite diverse political and economic conditions, with inherent risks ranging from possible legal and financial challenges to political or social instability and regional disparities. Given that many partner countries are not members of a political or economic integration area, border constraints (including possibly cumbersome clearance procedures and long waiting periods) may have to be coped with. The implementation of large infrastructure projects in the absence of well-performing and accountable government procurement systems may even add to local corruption and/or governance challenges.

•    Frequent Chinese dominance in projects and possibly limited regard for local conditions may give rise to concern

While the preeminent position that Chinese project partners often assume in OBOR projects as regards finance, management and the deployment of Chinese firms and their workers may help speeding up a project, it may not favor broad positive spillover effects for local economies. In some cases, there may be the risk that insensitive behavior of investors (e.g. as regards labor, health and safety standards, quality of inputs used, respect for traditional local communities and the environment) gives rise to irritation and even protests on the part of the local population.

•    Possible fallout from heightened geopolitical tensions or rivalry

A totally different risk is the possible negative (political) fallout from military tensions, e.g. in the South China Sea, which cannot be entirely discarded, either. Another risk is that projects may fall victim to a flare-up of geopolitical competition with other powers …..

4. Summary and conclusions

China’s New Silk Road (NSR) or One Belt, One Road (OBOR) initiative was officially launched in 2013. It focuses on linking China and Europe through increased connectivity and building or modernizing infrastructural trajectories, which include rail, road, port, airport, pipeline, energy and communication infrastructure and logistics. OBOR consists of an overland and a maritime branch. The overland Silk Road Economic Belt (SREB) comprises various economic corridors which aim to bring China, Central Asia, Russia and Europe closer together (e.g. the New Eurasian Land Bridge) as well as to connect China to the Indian Ocean and the Mediterranean Sea through Central Asia and West Asia (e.g. the China-Pakistan Economic Corridor) or to strengthen links with Southeast and South Asia. The 21st Century Maritime Silk Road (MSR) is designed to go from China’s coast to Europe through the South China Sea and the Indian Ocean, linking up en route with Southeast Asia, South Asia, East Africa and the Mediterranean.

The Chinese authorities have entrusted specific institutions with supporting NSR schemes: the Silk Road Fund (SRF, capital: ca. USD 55 billion), the Asian Infrastructure Investment Bank (AIIB), the New Development Bank (established by the BRICS member states), the China EXIM Bank, the China Development Bank and the Agricultural Development Bank of China.

The motivations and drivers of China’s OBOR initiative are mostly of an economic or geopolitical nature: improvement of transport links; reduction of trade costs; reutilization of domestic overcapacities; diversification of investments, markets and suppliers; development of peripheral domestic regions (e.g. Xinjiang); contribution to the internationalization of the renminbi-yuan; enhancement of security of access to strategic energy and resource supplies; hedging against possible trade wars, etc.

Challenges and risks include weak local governance and possible political instability in host countries. Given that maritime container transportation is substantially cheaper over long distances than transcontinental rail or road conveyance, the lion’s share of long distance trade over the NSR is likely to remain seaborne. However, apart from the fact that overland transportation is faster, the modernization of overland links, which are relatively weakly developed across Eurasia, is bound to reduce the price difference somewhat. A profitable niche for long-haul rail conveyance of high value-added and/or time-sensitive products seems to have emerged (including the Trans-Eurasia-Express, running from Chongqing via Astana and Moscow to Duisburg). Moreover, China’s trade with its immediate Eurasian neighbors (where there is little or no maritime competition) should clearly benefit from such efforts.
 
As of end-2016, all NSR projects actually in development are estimated to represent a total value of about USD 290 billion. Overall, while considerable resources have been devoted to MSR development, investments in SREB rail and road connections, against the backdrop of the huge modernization potential in this latter area, are now somewhat improving the competitiveness of Eurasian overland links. Thanks to the generous financial means at Beijing’s disposal (funds of at least USD 130 billion, not including funds from multilateral institutions) and the considerable experience Chinese firms have already accumulated in realizing domestic infrastructure projects, many OBOR investments are currently in full swing.

The lion’s share of Chinese NSR investments currently goes to Pakistan, Bangladesh, Malaysia, Indonesia, Russia, Kazakhstan and Kenya. However, compared to the size of respective host economies, strategically situated smaller countries typically benefit the most: Djibouti, Sri Lanka, Mongolia, Kyrgyzstan, Laos, Cambodia, Serbia and Montenegro. The NSR promises to (eventually) bring about palpable changes as regards connectivity, commerce and economic dynamism in some important parts of Eurasia (including Southeastern Europe), which will be better linked up with – and more interdependent with – China once the NSR projects have been implemented.

This article was first published in Focus on European Economic Integration, issue Q3/17. Please click to read the full article.

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