How China’s Silk Road Initiative Is Changing the Global Economic Landscape 9781138317451, 9780429455193

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How China’s Silk Road Initiative Is Changing the Global Economic Landscape

China’s New Silk Road initiative constitutes one of the most ambitious projects in recent decades, designed to change the pattern of the global economic division of labor as well as the geostrategic balance of power. It has the potential to create a new fabric of industrial value creation that links China and East Asia via Central and South Asia with Europe, and to forge new regional and multilateral institutions that complement or compete with existing regional and global governance systems. First proposed in 2013, the new initiative is only now starting to be rolled-out, with trade relations gradually intensifying, and the first investment projects and infrastructure clusters becoming manifest. However, the full impact of the evolving new regional value chains on global goods flows, investment activity, supra-­ national institution building, as well as their wider international implications remains undetermined. This book brings together leading scholars from economics, political science, and area studies, who present the latest cutting-edge knowledge and the latest state-of-the-art economic and political analysis on how the new initiative is developing and likely to develop. Yuan Li is a Professor of Business and Economic Studies of East Asia in the Mercator School of Management and Institute of East Asian Studies (INEAST), University of Duisburg-Essen, Germany. Markus Taube is a Professor of East Asian Economic Studies/China and Director of the IN-EAST School of Advanced Studies at the Mercator School of Management, University of Duisburg-Essen, Germany.

Routledge Studies in the Growth Economies of Asia

136 The Diffusion of Western Economic Ideas in East Asia Edited by Malcolm Warner 137 Employers’ Associations in Asia Employer Collective Action Edited by John Benson, Ying Zhu and Howard Gospel 138 Business Leaders and Leadership in Asia Ying Zhu, Shuang Ren, Ngan Collins and Malcolm Warner 139 Innovation, Investment and Intellectual Property in South Korea Park to Park Ruth Taplin 140 A Microcredit Alternative in South Asia Akhuwat’s Experiment Shahrukh Rafi Khan and Natasha Ansari 141 Development Agenda and Donor Influence in South Asia Bangladesh’s Experiences in the PRSP Regime Mohammad Mizanur Rahman 142 How China’s Silk Road Initiative is Changing the Global Economic Landscape Edited by Yuan Li and Markus Taube 143 Trade Unions and Labour Movements in the Asia-Pacific Region Edited by Byoung-Hoon Lee, Sek-Hong Ng and Russell Lansbury

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How China’s Silk Road Initiative Is Changing the Global Economic Landscape Edited by Yuan Li and Markus Taube

First published 2020 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 52 Vanderbilt Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2020 selection and editorial matter, Yuan Li and Markus Taube; individual chapters, the contributors The right of Yuan Li and Markus Taube to be identified as the authors of the editorial material, and of the authors for their individual chapters, has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data A catalog record has been requested for this book ISBN: 978-1-138-31745-1 (hbk) ISBN: 978-0-429-45519-3 (ebk) Typeset in Times New Roman by codeMantra

Contents

List of figures List of tables List of contributors Introduction: the Belt & Road Initiative—manifestations, driving forces, and international responses

vii ix xi

1

Y UA N L I & M A R KUS TAU BE

SECTION I

The logic of the BRI and its domestic economic impacts

19

1 China’s rejuvenation and the Belt and Road Initiative

21

J US T I N Y I F U L I N

2 Motivations, actors, and implications for the New Silk Road trains

37

M A R IO E S T E BA N & Y UA N L I

3 Can the Belt and Road Initiative promote the catching-up of China’s West and South-West?

55

GIOVA N N I F E R R I , L I - GA NG L I U, CA M I L L A M A S T ROM A RC O & L AU R A SE R L E NGA

4 “The Belt and Road” Initiative will promote the economic cooperation between China and the Western countries

70

C H E N YONGJ U N

SECTION II

BRI and its impact on the structure of global economic interaction 85 5 AIIB and the reform of international financial system X U N WA NG

87

vi Contents 6 Commodity structure of trade between China and the Belt and Road (B&R) countries and its implications for RMB internationalization

109

Y I BI NG DI NG , QI A N W E N SH E N & X I AO L I

7 One Belt One Road Initiative and China’s overseas direct investment

130

J U L A N DU & Y I F E I Z H A NG

8 The new dynamics of multilateral cooperation mechanisms in East Asia—China’s Belt and Road Initiative, the Asian Infrastructure Investment Bank, and Japan’s partnership for quality infrastructure

166

W E R N E R PA S C H A

SECTION III

The impact of the BRI on regional cooperation

187

9 The Belt and Road Initiative: a hybrid model of regionalism

189

A N DR E A S GR I M M E L A N D Y UA N L I

10 Bridging westward to open the gates of Europe: implementation of the Belt and Road Initiative in Central Asia and Belarus

207

M A R I A DA N I L OV IC H

11 New political cartography of Eurasia: China’s Belt and Road Initiative—The Eurasian Economic Union—India’s New Silk Road 228 N E L E NOE S SE LT

12 “Belt and Road Initiative” and the new China-EU relations

246

X I E SH U WA NG , JOË L RU E T, & X AV I E R R IC H E T

13 International relations and New Silk Road-BRI: European Union and China crucial roles

266

GIORGIO D OM I N E SE

Index

285

List of figures

2.1 China and US trade with the BRI countries and the world (2005–2014, in billion USD) 2.2 China’s outward FDI in the BRI countries and the rest of the world during 2006–2015 (in billion USD) 4.1 The background of raising “the Belt and Road” strategy 4.2 A basic model: the interaction and win-win between China and the Central and West Asian countries (CWA) and Southeast Asian countries (SEA) 4.3 An extended model: the multilateral win-win situation between China and other countries in Asia, Europe, and Africa 4.4 The comprehensive theoretical model of “the Belt and Road” strategy: the multilateral win-win situation including all member countries 5.1 China and global GDP growth rate: 2000–2020, % 5.2 China’s contribution on global economic growth: 2000–2020, % 5.3 Outward FDI stock in 2013: 100 billion USD 5.4 China’s outward FDI, 2000–2020: 100 billion USD 5.5 GDP growth 2001–2008, % 5.6 GDP growth: 2009–2016, % 5.7 Financial liberalization index: averaged 2000–2005 5.8 The output ratio and real GDP per capita 5.9 The industry output ratio and real GDP per capita 5.10 The service output ratio and real GDP per capita 6.1 Trade value and proportion between China and countries participating in the “Belt and Road” Initiative 6.2 Five classifications of China’s export trade products 7.1 Greenfield investment: Regional Distribution 7.2 Full Ownership Acquisitions: Regional Distribution 7.3 Majority Ownership Acquisitions: Regional Distribution 7.4 Minority Ownership Acquisitions: Regional Distribution 7.5 Industry distributions (a) Belt-Road countries vs. non-BeltRoad countries and (b) sea-belt countries vs. land-road countries 7.6 State Targets: Regional Distribution

40 41 74 75 76 77 89 89 90 91 92 92 96 100 101 102 116 117 141 142 143 144 145 150

List of tables

2.1 EU Trade Flows and Balance 48 3.1 GDP Per Capita Rankings (2010) and Provincial Share of GDP Growth (2014) 56 3.2 Distribution of Railway Infrastructure (Km of Railway by Km2 of Surface) 58 3.3 First- and Second-step Regressions (Province Level) 63 3.4 First- and Second-step-Regressions (Panel) 64 3.5 Correlation between Inefficiency, GDP Per Capita, and Rail Infrastructure 64 3.6 Distribution of Efficiency 65 6.1 The RMB Export Five Categorization IV Method 121 6.2 The RMB Import Five Categorization IV Method 122 6.3 The RMB Export Five Categorization IV Method (Samples along the Belt and Road) 123 6.4 The RMB Import Five Categorization IV Method (Samples along the Belt and Road) 123 6.5 The FGLS Estimation of the RMB Export Five Categorization (Samples along the Belt and Road) 124 6.6 The FGLS Estimation of the RMB Import Five Categorizations (Samples along the Belt and Road) 125 7.1 Definitions and Sources of Key Variables 139 7.2 Regional Industry Distribution (Total Deal Values) 147 7.3 The Effects of Policy Announcement on Belt-Road Countries 152 7.4 The Effects of Policy Announcement on Regional M&A Investment 154 7.5 The Effects of Policy Announcement on Infrastructure and Non-Infrastructure Investment 156 7.6 The Effects of Policy Announcement on Regional Infrastructure Investment 160 7.7 The Effects of Policy Announcement on Regional Non-Infrastructure Investment 161

x  List of tables 12.1 12.2 12.3 12.4 12.5

EU to China Trade Flows by SITC Section (2012–2015, €bn) 248 Chinese FDI Stock in the EU by Sector (€mn) 248 COSCO Investments in the Piraeus Port Authority 259 Chinese Investments in Spanish Ports 260 Chinese Investments in Portugal 261

List of contributors

Maria Danilovich is a guest researcher at the Institute for Russian and Eurasian Studies (IRES), Uppsala University, Sweden, and an associate professor and researcher at the Department of International Relations, Belarusian State University, Minsk, Belarus. Yibing Ding  is a professor at the School of Economics, Jilin University, Changchun, Jilin, China. Giorgio Dominese is a professor, Chair of Transition Studies Research Network, Venice, Italy, visiting professor at universities in Europe-Asia, China, Eastern and South Asia, and publisher of Transition Academia Press (www.transitionacademiapress.org). Julan Du is an associate professor at the Department of Economics, Chinese University of Hong Kong, China. Mario Esteban is a senior analyst at the Elcano Royal Institute and senior lecturer at the Centre for East Asian Studies of the Autonomous University of Madrid, Spain. Giovanni Ferri is a professor at the Department of Law, Economics, Politics and Modern Languages, Università di Roma LUMSA, Italy. Andreas Grimmel is a research associate and lecturer at the Institute of Political Science, University of Hamburg, Germany. Xiao Li is a professor at the School of Economics, Jilin University, Changchun, Jilin, China. Yuan Li is the Acting Professor of Business and Economic Studies of East Asia, Mercator School of Management and Institute of East Asian Studies (IN-EAST), University of Duisburg-Essen, Germany. Justin Yifu Lin is the dean of the Institute of New Structural Economics, dean of the Institute of South-South Cooperation and Development, and professor and honorary dean of the National School of Development at Peking University, China.

xii  List of contributors Li-Gang Liu is the Chief China Economist at Citigroup Inc., Hong Kong, China. Camilla Mastromarco is an associate professor at the Department of Economics, University of Salento, Italy. Nele Noesselt is a professor of Political Science with a special focus on East Asia/China at the Institute of East Asian Studies and Faculty of Social Sciences, University of Duisburg-Essen, Germany. Werner Pascha  is professor of East Asian Economic Studies /Japan and Korea at the Mercator School of Management and the Institute of East Asian Studies, University of Duisburg-Essen, Germany. Xavier Richet is a professor emeritus of International Business at University Sorbonne Nouvelle, France, and Corresponding Member at OEET, Italy. Joël Ruet is a CNRS Researcher at CEPN, University Paris 13, and associate researcher at CRG, Ecole Polytechnique, France. Laura Serlenga is an associate professor at the Department of Economics, University of Bari, Italy. Qianwen Shen is a professor at the School of Economics, Jilin University, Changchun, Jilin, China. Xun Wang  is a professor at the National School of Development, Peking University, China. Xieshu Wang is an associate researcher at The Bridge Tank and associate researcher at CEPN University Paris 13, France. Chen Yongjun is a professor at the Business School of Renmin University of China, Beijing, China. Yifei Zhang is an assistant professor at the Division of Business and Management, Beijing Normal University-Hong Kong Baptist University United International College, and Chinese University of Hong Kong, China.

Introduction The Belt & Road Initiative— manifestations, driving forces, and international responses Yuan Li & Markus Taube In 2013, Chinese President Xi Jinping officially announced China’s plan to collaboratively construct a “Silk Road Economic Belt” and a “21st Century Maritime Silk Road” with participating countries to achieve development gains and strengthen mutual connectivity. At that time, commentators were highly skeptical and wondered if these ideas would ever make it to implementation. Since then, the tone has changed. A flourish of activity has added considerable substance to the Belt and Road Initiative (BRI), as it has become known today. The BRI is today understood as a serious undertaking expected to have a lasting impact on economic structures, political alliances, and geostrategic power constellations not only on the regional but also on the global level. However, while commentators are united in their assessment of the significance of BRI, their interpretation of the quality of its effects varies widely. Some well-meaning voices understand the BRI as an economic initiative complementing existing multilateral institutions to integrate participating countries and thereby to enhance the level of welfare of their societies. Numerous more critical commentators, however, interpret the BRI rather as a hegemonic “Chinese Marshall plan”, “neo-colonial tool”, “debt trap”, and so forth. In a different (but not fully independent) discourse, observers discuss the geostrategic implications of the BRI on the global security architecture, focusing on the impact of BRI projects on the global power structure. Different perspectives and foci of interest will certainly result in diverse assessments of the positive and negative aspects brought up by the BRI. A full understanding of the phenomenon, however, requires a holistic view that brings credit to the various dimensions of the BRI in which the BRI becomes effective and changes existing structures. Of crucial importance in this context is the observation that the BRI cannot be reduced to a set of new East-West transport corridors between China and Europe as well as some other destinations in Southeast Asia and Africa. As a matter of fact, the greatest effects may be expected to manifest themselves not at the endpoints of the BRI structures, but rather in those regions linking up Eastern and Western participants.

2  Yuan Li & Markus Taube

Manifestations of the BRI From the outset, the BRI has been designed as a multidimensional enterprise encompassing all major dimensions of human existence and interaction (NDRC, 2015; Deloitte, 2018). While the economic dimension may be understood to the limelight as a most prominent and visible manifestation of the BRI, sociocultural exchanges amongst the participating nations provide for the foundation of intensive economic interaction. Diplomatic and geostrategic implications arise from the shifting qualities in interstate relations (and interdependencies), while the evolution of institutions facilitating the increasing dynamics of transnational interaction establishes path-­ dependencies structuring developments far into the future. On the national and domestic levels, impulses created by BRI activities may result in new regional agglomerations, shifting labor relations, cultural confrontations, and exchanges, as well as all the many conflicts and problems arising from the disintegration of existing equilibria, as well as relative wealth and power structures. The economic dimension of the BRI comes with promises for joint economic development and welfare enhancement for all participants. The most optimistic vision is one of a new fabric of (predominantly) industrial value creation that links China and East Asia via Central and South Asia as well as Africa with Europe and establishes a new welfare community. On the foundations of a substantially increased connectivity amongst all participating economies, the division of labor shall be improved, allowing for gains of specialization and the evolution of economies of scale (Bartley Johns et al., 2018; Boffa, 2018). Key to these new structures is massive infrastructure developments and dismantlement of regulatory and administrative hindrances to transnational economic cooperation (De Soyres et al., 2018). Industry zones established at ports and railway hubs are supposed to allow for the evolution of local agglomeration centers leveraging international goods transport for local economic development. Especially with regard to the railway network spreading through the Central Asian economies, it is hoped that this infrastructure will provide these landlocked economies with a chance to fully integrate into the global division of labor and participate in its welfare-creating operations. This fills the gap under the hegemonic guidance or in the framework of development programs setup by powers like Russia, the USA, or Europe (McKinsey, 2016; Bastian, 2017). While the BRI advocates point to the numerous achievements of projects along the “Belt” and the “Road”, its critics tend to highlight alternative potentially detrimental development scenarios under the BRI. Some authors have warned that China would leverage its economic and financial resources to drive other countries into overdependence (Hurley et al., 2018). The strongest critics of the BRI, such as the US Vice President Mike Pence, have accused Beijing of using “debt diplomacy” to expand its influence, for example, in taking over the managing rights of Hambantota Port in Sri

The Belt & Road Initiative  3 Lanka (Pence, 2018). Other critics highlight the danger of a crowding-out of local firms by Chinese enterprises, the creation of mono-structures, and a re-emergence of cases of Dutch disease, especially in Africa. An increased stratification of participating in firms and workers taking part in the BRI endeavors and sharing in its productivity and welfare-enhancing activities versus those not participating (due to sectoral reasons, discriminatory regulations, location in remote areas, etc.) are understood to potentially increase inequality and endanger social stability. Thus, levers to alleviate social inequalities and including redistributive mechanisms in the BRI projects need to be explored further. The economic dimension of the BRI could generate significant repercussions on the geostrategic constellation, in which major global and regional powers like China, Europe, the USA, Russia, and India are trying to promote their interests. Geostrategic might is here understood in the sense of the relative capacity of major players to influence developments in the region by means of diplomacy as well as to project power by military threats. Some commentators have warned that the massive economic involvement of China in regional economies and business activities has the potential to increase significantly the geostrategic positioning of China in the region and change global power balances in consequence. Key to this power shift is economic interdependencies that might allow China to better protect its interests due to rising opportunity costs of non-compliance for BRI participants. A massive undertaking like the BRI cannot have no impact on geostrategic constellations. A successful implementation of the BRI would probably increase significantly the weight of China in the region as well as in the global system. Commentators differ, however, in their assessment, if China’s geostrategic advancement constitutes a secondary effect of a successful BRI implementation or rather commands primacy in all Chinese BRI activities. As a basis for as well as consequence of strengthened economic and business relations, cultural exchanges are expected to intensify in the framework of the BRI. Amongst all participating countries, China is the one that is most pro-active in this respect. Chinese Confucius Institutes are being established in all BRI countries, promoting the teaching of Chinese language and providing a platform for cultural exchanges—predominantly the presentation of Chinese culture in the host countries. Since the launch of the BRI, China has also increased scholarships for students from countries along the Belt and Road. Culture is a representation of shared believes about reality by humans and shapes their fundamental social compact. As such, cultural expressions are the foundation of the institutional arrangements coordinating all types of interaction between human beings on a national and transnational level. As such, cultural exchanges that enhance mutual understanding and respect create a foundation for institutions that can better reflect the interests of participants and establish more stable winwin partnerships.

4  Yuan Li & Markus Taube Against this background, it becomes obvious that the BRI also affects the institutional setup of regional interaction and may even affect global governance regimes. Next to the cultural mechanisms outlined earlier, the influence China wields on institution-building in the context of the BRI relies on four major mechanisms: i Collaboration Institutions dedicated to the requirements of the BRI project implementation are established on the basis of existing institutional regimes. Alterations to the latter are only marginal and slow. The Asian Infrastructure Investment Bank (AIIB), which is built on the templates of the World Bank and the Asian Development Bank, constitutes a good example of the mechanism (Gabusi, 2017). ii Confrontation New institutional arrangements are being introduced in direct competition with already existing ordering structures. Examples for this mechanism can be identified in the Chinese “16+1” initiative, which undermines the integrity of the European Union as well as the conflict with the latter over public procurement regimes in the context of the Belgrade-Budapest railway project. iii Evolution Institutions with Chinese designs become implemented and displace existing arrangements as Chinese firms and actors become dominant counterparts to domestic players in specific fields of cooperation. Examples for this type of institution building include the proliferation of Chinese-managed industry and export zones along the BRI corridors (Lin, 2015) as well as the adoption of the RMB as an invoicing and official reserve currency following the dramatic increase of China-directed economic activities. iv Leadership Chinese players featuring business models and technologies at the forefront of regional development are in a position to set codes, norms, and so forth and establish new (first of their kind) institutional path dependencies. Examples of this type of institution-building include standard setting practices by Chinese firms in the field of telecommunication (5G), artificial intelligence, and mobile commerce. It remains to be seen, in how far these developments can and will forge new regional and multilateral institutions that complement or compete with existing regional/ global governance systems (Hoering, 2018). As becomes obvious from looking at these various manifestations, the BRI constitutes a highly complex undertaking, featuring a multitude of different facets, opportunities, and risks for all parties involved (Huang, 2016). One essential issue that has to be addressed when dealing with the BRI is, therefore, the question of why China’s leadership has committed itself so decisively to

The Belt & Road Initiative  5 this transnational development project. Implementation of the BRI requires massive financial, political, and human resources that could have been employed elsewhere. At the same time, the whole initiative is burdened with massive risks (The Economist Intelligence Unit, 2015)—risks that due to the transnational character of the endeavor lie mostly out of the control of ­Chinese leaders and other stakeholders (Deorukhkar & Xia, 2017). So, what has been the motivation for China’s leaders to initiate the BRI?

Motivations for China’s leadership to start the BRI The institutional theories and political economy literature postulate that political entrepreneurs will drive for changes of the status quo when they expect to gain from such changes at a foreseeable time horizon. These gains may manifest themselves in different spheres so that crucial parameters underlying the decision to initiate BRI can be understood to include first of all the political survival concerns of the ruling party, then specific incentives applying to political entrepreneurs and politically powerful groups, as well as geopolitical considerations and economic considerations. In the following, these parameters will be looked at in some greater detail. BRI as a catalyst for economic growth in China A comprehensive analysis of the Chinese Communist Party’s (CCP) rule over China in the recent decades indicates that all its ideological dogma and ideological reorientations, economic and social reform agendas, domestic and international policy doctrines, and so forth are based on the fundamental goal to maintain social stability in order to stay in power. When one decade after the beginning of the reform and opening-up policies—which had become a necessity to guarantee a minimum material basis for the largest part of the population—ideological considerations started to become insufficient to legitimize the CCP’s claim to power, China’s political elite changed its strategic approach and shifted its focus on economic growth. From the early 1990s onwards, the CCP focused on the facilitation of high economic growth in order to promote social stability to strengthen their grip to power. The strategy worked out well. Dynamic economic development facilitated year-by-year improvements in people’s living standards, greatly increasing general levels of overall satisfaction. The new focus on the attainment of material riches diverted interest from other social problems, and stymied potential demand for alternative political rule and democratic institutions (Gilli & Li, 2014). After four decades of exceptionally high economic growth made possible by fast-track catching-up development, the Chinese economy has reached a turning point (IMF, 2018). In the “post-miracle” era, China’s leaders must determine new drivers of economic development and growth in order to uphold the economic momentum and avert political instability in the “new normal”. China’s commitment to the BRI may provide one means

6  Yuan Li & Markus Taube to stem against declining growth dynamics. Massive infrastructure investments, new investments in industrial complexes along the Belt and Road region, and higher economic connectivity have the potential to significantly stimulate Chinese exports of manufactures and equipment as well as various types of services. BRI as a means to reduce intra-Chinese inequality Inequality is a problem understood to compromise socioeconomic stability and endanger the CCP’s claim to power. For more than two decades, ­China’s political leadership has been trying to fight against a widening regional income gap, but with limited success. In contrast to Deng Xiaoping’s original concept of a series of spillover waves that would carry development impulses and welfare from the coastal belt regions ever farther into the ­Chinese hinterland, transaction costs eventually determined that it was not the industrial plants that relocated to where cheap labor lived, but rather the laborers that migrated to the coastal belt to support local manufacturing. With the BRI, these regions can overcome these cost disadvantages, establish direct links to export markets along the Silk Road Economic Belt infrastructure, attract investment, and create new jobs (Li & Schmerer, 2017). BRI as a means to strengthen China’s SOE China’s leadership group is not subjected to democratic election processes. Nonetheless, it is dependent on the approval of a selectorate that wants to see its interests reflected in national policies (Bueno de Mesquita et al., 2003; Gilli & Li, 2015; Gehlbach et al., 2016). In this political system, ­China’s state-owned enterprises (SOEs) constitute an important part of the selectorate, whose support is essential for the leader to hold power. Against this background, the BRI can be understood as a means to support the domestic SOE sector and support its contemporary restructuring agenda. On the one hand, there exist substantial over-capacities in a multitude of manufacturing sectors bloated with debt-laden SOEs (IMF, 2018), and thus a need for the SOEs to either shut down facilities or relocate production to markets where production costs are low and demand vibrant. On the other hand, Chinese producers want to move up the value chains to higher value-­ added manufacturing. The Chinese leadership intends to use the BRI as a means to absorb excessive domestic industrial capacity and offer an “upgraded” version of China’s “Go Global” strategy of making overseas investments, infrastructure building, and conducting mergers and acquisitions, mostly by SOEs (Yu, 2017). In addition, successful implementation of the BRI can “release the growth potential of various countries and achieve economic integration and interconnected development” (Wang, 2016), which could, in turn, become an effective vehicle to deepen China’s domestic SOE reforms.

The Belt & Road Initiative  7 BRI as a means to secure China’s access energy carriers and raw materials The Chinese economy has become highly dependent on foreign supplies of carriers of energy like oil and natural gas as well as mineral ores. These imports are highly vulnerable to scenarios where China’s relations to other global powers deteriorate and transport routes become compromised. For example, at the time, more than 80% of China’s energy imports must be shipped through the Strait of Malacca; as a result, China’s energy supply is highly vulnerable to a blockade of this sea lane (Office of the Secretary of Defense, 2014). The BRI allows a significant hedge against such risks as it opens a multitude of alternative (overland and seaborne) transport corridors that can be better protected and facilitates diversified sourcing of energy from Central Asia, South Asia, as well as Southeast Asia. BRI as an expression of a new self-assertive Chinese foreign policy With the empowerment of Xi Jinping as head of China’s political system, the role of global governance in the pursuit of the country’s national interests has been reevaluated. Before this shift in their strategic analysis, China’s leading elite had adhered to a doctrine laid out by Deng Xiaoping as to “hide your capacities, bide your time, accomplish things where possible” (taoguang yanghui). With this guideline, Chinese politics focused strongly on domestic affairs did not proactively propagate Chinese interests, norms, and values. Under the Xi Jinping administration, this doctrine has been exchanged with the self-assertive ambition to “strive for achievement” (fenfa youwei). Chinese policy-making is now much more concerned with an enhancement of China’s international agenda-setting power and the projection of Chinese interests in an international environment (Menegazzi, 2017). The BRI underlines this new self-consciousness and the desire to play a leading role in the global arena (Esteban & Li, 2017). BRI as a means to de-escalate the US-Chinese contest for global hegemony As outlined earlier, geo-economic and geopolitical parameters have become increasingly important for Chinese policy determination. China’s leading elite have begun to reflect on the impact of their policies on other stakeholders in the global arena and ensuing reactions to these. In this context, the Chinese economic “miracle”, and especially its massive increase in relative importance to the global economic system over the last four decades, have raised fears amongst the established powers. At the core of this phenomenon lies an age-old predicament: as rising powers challenge the hegemony of incumbent powers, they face increasing fears, animosity, and risks to their own development. Allison’s (2017) concept of the “Thucydides

8  Yuan Li & Markus Taube Trap” takes up this very phenomenon, showing that in history such encounters have more often than not led to devastating wars and military conflict. China’s leadership has indicated that it is aware of this danger and is trying to defuse the situation. It has restricted itself to providing impulses for a gradual reform of the existing global governance regime, rather than trying to “Sinicize” the existing international order. The BRI may provide a highly suitable means to promote this strategy. By design, the BRI, and the Silk Road Economic Belt in particular, have the potential to integrate regions into a new (transnational) industrial fabric that, until today, have not been able to fully participate in the global economic system and its welfare-­ enhancing structures of labor division (Li & Taube, 2018). A “Chinese sphere of influence” arising from the roll-out and successful implementation of BRI infrastructure investments and industrial development in this region would not directly intrude on already expressed interests held by the USA as the incumbent hegemon. As such, the zero-sum game logic of the “Thucydides Trap” would be broken up in a constellation in which China gains influence in absolute and relative terms, while the USA, as the incumbent hegemon, keeps its existing spheres of influence but does not (proportionately) participate in the newly generated turf of the BRI region economic sphere. The overall picture arising from this discussion is that China’s leading decision-makers have a strong basis for strong arguments to promote the BRI and commit substantial resources to its roll-out. From the perspective of game theory, the promotion of the BRI appears as a “dominant strategy” for Chinese policy-making and a “best response” to the multitude of challenges China’s ruling elite are facing domestically as well as in the international arena.

Responses to China’s BRI China’s President, Xi Jinping, announced in 2013 that China would initiate and commit substantial resources to a major program to intensify transnational interaction and economic exchange amongst a group of countries, known as BRI member countries, prompted some highly diverging responses. While leaders of some participating countries, in expectation of massive infrastructure investments and dynamic economic development, expressed enthusiastic support (Laruelle, 2018), other voices have been much more skeptical or rejected the idea outright (Mardell, 2017). Most notably, the USA has, until today, stayed outside the BRI and has clearly expressed its critical position toward the endeavor. Obviously, the USA might have the most to lose as a successful BRI roll-out would directly encroach on its global hegemony and claim to global leadership (Cavanna, 2018; Hillman, 2018). Not only US-administrations have tried to stay away from the BRI, but also, to discourage BRI participation of third countries (most notably ­Japan), exerted diplomatic efforts to motivate the establishment of alternative regional integration initiatives without taking the lead itself (Reuters, 2018).

The Belt & Road Initiative  9 At the end of 2018, the number of countries participating in the BRI has swelled to 126, including the PR China (Office of the Leading Group for the Belt and Road Initiative, 2018). Motives for participation range from the hope to gain from a joint socioeconomic enterprise that may increase welfare and stabilize a transnational order of peaceful co-existence amongst participating countries, to the wish to be included in information flows amongst the BRI member countries, influence decision-making processes, or, in short, observe and control. Interestingly, most established powers that are pursuing geostrategic interests of their own have also brought forward alternative regional cooperation program, directly challenging the Chinese BRI. The European Union’s strategic approach falls strictly into the category of “engagement” (in contrast to “containment”) with China in a co-opetitive framework (Godement & Vasselier, 2017). The cooperative character of the EU’s approach toward the BRI manifests itself, for example, in the active participation of the EU governments in the BRI from the very beginning. At present, 17 EU member states are members of the AIIB, while 14 of them are also the founding members. France, Germany, and the UK are staffing three of five vice presidents at the AIIB, thereby exerting significant influence on the operations of the AIIB per se as well as the roll-out of the BRI projects in general. The competitive character of the relationship becomes obvious in a multitude of disputes and quarrels with China, mostly about operational issues in the context of the implementation of BRI projects. Some of the most prominent of these include, for example, the dispute over public procurement regimes arising in the context of the Hungary-Serbia railway project, or the EU’s protests against China’s diplomatic advances in the “16+1” format, which are perceived as an attempt to break the unity among EU member countries in their position vis-á-vis China and the BRI (Chen, 2018; Prasad, 2018; Vangeli, 2018). In September 2018, the European Commission published its own strategy for increasing connectivity between Europe and Asia, which can be seen as a delayed policy response by Brussels vis-à-vis Beijing. The blueprint emphasizes the harmonization of regulatory standards, the sustainability of connectivity, and the maintenance of a level playing field (European Union External Action, 2018a, 2018b). Both China’s BRI and the EU’s Europe-Asia connectivity platform can serve as catalysts for advancing connectivity and shared development. The future development could involve China and ­Europe working together to ensure the achievement of the UN’s Sustainable Development Goals (Bastian, 2018), or competing with each other over geopolitical influence in the BRI region (Cameron, 2018). Which scenario will dominate depends on how China and the EU can accommodate each other’s interests, and also on how current political disruptions shaking the global institutional landscape evolve. For Russia, the Chinese concept of the BRI amounts to a direct challenge to its hegemonic dominance in Central Asia encroaching on its historic

10  Yuan Li & Markus Taube sphere of interests (Gabuev, 2016; Blank, 2017). Russian participation in the BRI is consequentially not just based on the idea to improve economic interaction and political stability in the region, but also designed to directly influence developments under the BRI umbrella and uphold Russian interests in Central Asia. Against this background, Russia is not only leveraging its historical influence over the Central Asian countries and their elites in order to contain new Chinese influences in the context of BRI, but is also trying to add substance to the Eurasian Economic Union (EAEU), a Russian-­ dominated regional economic integration sphere born out of the Eurasian Economic Community (EAEC), and eventually the Commonwealth of Independent States (CIS) and the Soviet Union. The EAEU is clearly conceptualized as an alternative to the China-dominated BRI and has only very reluctantly opened for cooperative activities with the BRI programs (­Roberts & Moshes, 2016). India is another major strategic rival of China in the direct vicinity. Unlike Russia, however, India does not possess a strong hegemonic heritage in the region but is locked in a permanent struggle to assert itself in the Central and South Asia region. The BRI is encroaching on Indian interests and has the potential to substantially shift geostrategic power in favor of China, which has employed the BRI projects to establish strong footholds at the doorsteps of India: most prominently Sri Lanka and Pakistan (Chellaney, 2017). As such, India’s participation in the BRI has come only after years of hesitation. It comes with considerable reluctance and with the motive to monitor and control the development of the BRI as best as possible. Although urged by the USA to establish an “Indian Silk Road”, the Indian government has until now restricted itself to initiatives with much more limited reach. In general, India appears to be less proactive in the establishment of completely new initiatives, but rather tries to base on already existing structures. In February 2018, for example, India joined the Ashgabat Agreement, a multimodal network of transport corridors facilitating goods trade between Central Asia and the Persian Gulf and neighboring countries. In addition, Indian investments in the infrastructure of Chabahar Port in Iran provide a basis for an Indian trade corridor with Central Asia and Europe, bypassing the neighboring arch-rival Pakistan (Center for Strategic and International Studies, 2018). Japan, as the former East Asian superpower, has, for several decades, already seen a substantial decline in its relative economic strength and influence in Asia. A further rise of China in the regional and global arena that might be expedited by the BRI is seen with considerable reservation. Not the least due to strong US-influence, Japan has hesitated and deferred participation in the BRI and AIIB, until now. Although participation is brought up once, and again by leading politicians, no decisive steps have been conducted yet. Instead, the concept of a “Partnership for Quality Infrastructure” (PQI) has been launched as an alternative to the BRI. The PQI tries to address fears of an over-dependence on China amongst BRI participatory

The Belt & Road Initiative  11 countries by highlighting the role of domestic (versus transnational) development plans and responsible project finance. Its regional scope is more focused on Japanese spheres of interest (e.g., value chains) in Southeast and South Asia, with Central Asia only recently having been included in the scope of the PQI (Bhagawati, 2016).

Outline of the book The issues sketched represent only a fraction of the numerous topics arising with the implementation of the BRI. The BRI constitutes a highly complex multilevel enterprise that features as many chances and opportunities as it harbors dangers and risks. Nevertheless, it seems clear that if the BRI does not fizzle out in the coming years—and there are no indications for such a development—then it will have a substantial impact on regional and global structures in terms of the economy, political influence, geostrategic power, as well as socio-cultural interaction patterns. This book concerns itself with these issues. In order to gain a better understanding of what the BRI is all about, what motivates its major stakeholders and opponents, how transnational cooperation along the BRI territory unfolds and how it affects regional and eventually global developments, this volume brings together leading scholars from the fields of economics, political science, and area studies. The contributors to this volume have their academic home in different regions (Belarus, China, France, Germany, Italy, Spain, UK, and the USA) which guarantees the book to present a differentiated, multi-perspective analysis of the BRI and its impact on various parameters of our economic, political, and sociocultural lives. The book is structured in three parts addressing key issues of the BRI and its impact on the national, regional, and global economies: (1) the first part addresses the underlying general logic and motivations driving the BRI as well as its impact on various national economies, (2) the second part concerns itself with the transnational as well as the global dimension of the BRI, and (3) the third part deals with the role of the BRI for regional integration and global economic cooperation in general. Part I starts with four papers concerned with the overall logic of the BRI and its impact on various national economies. In the first contribution following this introductory chapter, Justin Yifu Lin sets the BRI into perspective with China’s economic development during the past 40 years of reform and opening up in Chapter 1. Using the example of the PR China, the author discusses the role of international connectivity for dynamic economic development in the context of catching up growth constellations. In a detailed analysis, he outlines the parameters supporting hindering the kick-off as well as the implementation of such development processes. On this basis, the author eventually determines the role the BRI can play to catalyze dynamic economic development in

12  Yuan Li & Markus Taube participating economies as a trigger for catching-up growth processes of economic “late-comers”. Chapter 2, written by Mario Esteban and Yuan Li, adds to Justin Yifu Lin’s study by taking a close look at the economic realities of two major BRI transport corridors: the Yuxinou and the Yixinou Railway links. The authors focus on the rationale underlying the BRI in general, and these railway links in particular. In their analysis of the drivers underlying the rolling-out of the BRI, the authors identify Chinese local government authorities as a major force—an insight which qualifies the standard narrative of Chinese central government in an important dimension. Departing from these insights, the paper shifts its focus to the other end of the railway link and analyzes how the BRI is perceived in the various European economies and what opportunities and risks European stakeholders see as key concerns. Chapter 3 returns to China and looks into the question if the BRI can actually promote economic development in China’s Western and South-­Western provinces, that is, the hinterland provinces that had been mostly left-out from China’s four-decade-long economic boom. Giovanni Ferri, Li-Gang Liu, Camilla Mastromarco, and Laura Serlenga start their analysis by establishing the role of transport infrastructure for economic development (or the lack of it). From this point of departure, they discuss what role the BRI—as a major infrastructure-creating endeavor—can play to catalyze catching-up growth in these provinces. Can the BRI link these regions to higher developed areas, induce spillover effects, and thereby create new convergence clubs? The authors conclude that this actually appears to be the case. In Chapter 4, Chen Yongjun extends the preceding discussions with a broader perspective of the economic implications for economic development and growth in Central, West, and Southeast Asia, Europe, Africa, and North America. The authors see a need for a holistic perspective, taking the various manifestations of the BRI into account. Departing from this postulate, he explores transmission channels by which the BRI may impact economic development in these regions and win-win constellations can arise. Overall, the author sees substantial potential for a combination of the different competitive advantages of participating economies and the evolution of inclusive growth patterns. Part II features four papers addressing China’s economic linkages with other countries participating in the BRI and analyzing its impact on the structural development of global economic interaction. The first contribution to this topic is Xun Wang’s discussion of the role of the AIIB for the implementation of the BRI projects and a (potential) reform of the global financial system in Chapter 5. The author sees a specific need for an institution like the AIIB to provide financial services to the BRI participatory countries. Large-scale national and transnational infrastructure development projects characteristic for the BRI are seen to require a dedicated financial institution to manage complex financial structures and implement suitable risk abatement policies. The AIIB is understood as a

The Belt & Road Initiative  13 complement and cooperative partner to the other key actors in development finance like the World Bank, the Asian Development Bank (ADB), as well as the International Monetary Fund (IMF). Chapter 6 authored by Yibing Ding, Qianwen Shen, and Xiao Li concerns itself with the question relating to how far an intensification of cross-border trade between China and countries participating in the BRI may promote the role of the RMB as an international invoicing and reserve currency. Analyzing not only the total values of bilateral trade but also the underlying commodity structure, the authors show that the latter plays a decisive role in the usage of the RMB as an international currency. According to their analysis, a larger share of components and capital goods (consumer goods) in Chinese exports (imports) promotes RMB internationalization. As this study shows, any analysis of the BRI and its impact on global economic interaction and its institutional foundation needs to reflect its full complexity and differentiate between the multitude of forms in which it becomes manifest. Chapter 7 deals with Foreign Direct Investment (FDI) originating in China and targeting the BRI region. Julan Du and Yifei Zhang explore in detail the manifestations and structural characteristics of Chinese FDI in the region. The inter-temporal analysis shows that Chinese investor’s behavior changed after the start of the BRI. It appears that greenfield investments were substituted for acquisitions, likely because these allow for faster market access and harness the opportunities created by the BRI. At the same time, 100% and majority ownership transactions increased substantially, indicating a stronger commitment of Chinese investors. Interestingly, Chinese private sector investments in the BRI region have seen significant increases, while state-sector investment did not expand at all. In Chapter 8, Werner Pascha discusses the BRI (and the AIIB) against the background of many years of multilateral cooperation initiatives in East Asia in which the Chinese initiative is only one of the most recent. Introducing concepts like hegemonic-benevolent and smart power, the author explores the motives to initiate such a multilateral cooperation agenda as well as the reasons for other countries to join and participate in such an initiative, and the BRI in particular. It appears that the willingness and capability to provide public goods to the region are key to such endeavors, while increased reputation and geostrategic influence provide the most valuable rewards for such investments to the lead countries. The specificity of the BRI becomes especially obvious in the author’s comparison with the Japanese alternative concept of a “Partnership for Quality Infrastructure” as proclaimed in 2015—two years after the BRI. The third part of his volume compiles five papers, which address the way in which the BRI contributes to regional integration among participating countries and its impact on global economic cooperation in general. Andreas Grimmel and Yuan Li discuss the BRI in its function as a regionally integrating force in Chapter 9. They show that the BRI, by design as well

14  Yuan Li & Markus Taube as its evolutionary development, incorporates elements of classical regional integration models stressing institutionalized cooperation as well as modern models that try to keep their institutional frameworks to a minimum and stress the independence of participants. The authors show that the BRI establishes a new hybrid form of regionalization and economic integration amongst the BRI participatory countries, which is still evolving and not yet clearly determined. As such, the BRI stands in line with the Chinese reform template of experimentation and pragmatic flexibility in terms of institutional regulation. In Chapter 10, Maria Danilovich adds to these more conceptual deliberations a case study focusing on the way implementation of the BRI projects changes the status quo as well as development perspectives in Central Asia and Belarus. The author outlines the crucial role of this region for the overall success of the BRI due to its geostrategic positioning at the interface of European, Russian, and Chinese interests. The paper explicates this topic by discussing the first experiences with the BRI projects in the Central Asian countries and Belarus. She clearly outlines the different perspectives held by local elites as well as the broad population toward the BRI and the strong manifestation of Chinese interests, including considerable Chinese immigration, going along with it. Nele Noesselt expands the discussion of a potential “region-­building”function of the BRI by raising awareness to a whole array of competing policy initiatives brought forward by stakeholders like the EU, India, Japan, and the USA in Chapter 11. The author sets out to map this plurality of overlapping, but obviously not mutually excluding, regional development programs and discuss the interests and motives of the key protagonists. The new political cartography of Eurasia she is able to draw is one of diversity, fragmentation, and permanently shifting lines of conflicts and alliances. The way China deals with this conundrum of interests and policies, alliances and conflicts, and its capability to devise reliable diplomatic solutions will be of decisive importance for the stability of the region as well as the global balance of power. In Chapter 12, Xieshu Wang, Joël Ruet, and Xavier Richet take a closer look at Chinese-European relations and the way the BRI is affecting economic and political relations. The authors find a necessity to differentiate between various regions in Europe that follow different strategies and harbor different motivations in their interaction with China. As such, they observe different BRI-infrastructures and interaction patterns evolving in Europe, while the critical dimension of Sino-European third country cooperation projects remains vastly underexplored. In fact, the authors deplore a lack of European-scale best response action plan with regard to the BRI, which results in a suboptimal capacity to generate value out of the BRI and leverage the latter for truly European interests. Chapter 13 concludes the selection of papers compiled in this volume by bridging contemporary developments with their historical antecedents

The Belt & Road Initiative  15 as well as (potential) future developments. Against the dim recollection of strong regional structures in long-past history, Giorgio Dominese identifies the foundation of contemporary developments in what he calls “the great failures accumulated in the last century”. In order to bring the BRI to success, in the coming years and decades, a whole array of ethnic, religious, political, and economic conflicts must be resolved. But Europe and China as anchor regions and key protagonists of the BRI may be in a position to drive this process forward by accepting responsibility, facilitating a continuous flow of resources in the region, and establishing a framework for mutually beneficial development. The editors of this book thank Angélica Vidal Sánchez and Janine Quach for their important assistance in the editing process.

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16  Yuan Li & Markus Taube Hillman, J. E. (2018). China’s Belt and Road Initiative: Five Years Later. Retrieved from Center for Strategic and International Studies, https://www.csis.org/ analysis/chinas-belt-and-road-initiative-five-years-later-0 Center for Strategic and International Studies. (2018). Competing Visions. Retrieved form https://reconnectingasia.csis.org/analysis/competing-visions/ Chellaney, B. (2017, December 24). Sri Lanka the Latest Victim of China’s Debttrap Diplomacy. Asia Times. Retrieved from http://www.atimes.com/article/ sri-lanka-latest-victim-chinas-debt-trap-diplomacy/ Chen, X. (Ed.) (2018). 16+1 Cooperation and China-EU Relationship. Budapest: China-­CEE Institute. De Soyres, F., Mulabdic, A., Murray, S., Rocha Gaffurri, N., & Ruta, M. (2018). How Much Will the Belt and Road Initiative Reduce Trade Costs? (English). Policy Research Working Paper No. WPS 8614. World Bank Group, Washington, DC. Retrieved from http://documents.worldbank.org/curated/en/592771539630482582/ How-Much-Will-the-Belt-and-Road-Initiative-Reduce-Trade-Costs Deloitte. (2018). Embracing the BRI Ecosystem in 2018. Navigating the Pitfalls and Seizing Opportunities. Retrieved November 11, 2018, from https://www2. deloitte.com/content/dam/insights/us/articles/4406_Belt-and-road-initiative/ 4406_Embracing-the-BRI-ecosystem.pdf Deorukhkar, S. & Xia, L. (2017). China | One Belt One Road – Progress and Prospects. Retrieved from BBVA Research, https://www.bbvaresearch.com/wp-­ content/uploads/2017/11/201710_ChinaWatch_OBOR.pdf Esteban, M., & Li, Y. (2017). Demystifying the Belt and Road Initiative: Scope, Actors and Repercussion for Europe, Working Papers on East Asian Studies 117/2017, University of Duisburg-Essen, Institute of East Asian Studies IN-EAST. European Union External Action. (2018a). The European Way to Connectivity  – A New Strategy on How to Better Connect Europe and Asia. Retrieved from http://eueuropaeeas.fpfis.slb.ec.europa.eu:8084/headquarters/headquarters-­ homepage/50752/european-way-connectivity-%E2%80%93-new-strategy-how-­ better-connect-europe-and-asia_en European Union External Action. (2018b). Connecting Europe & Asia. The EU Strategy. Retrieved from https://cdn2eas.fpfis.tech.ec.europa.eu/cdn/farfuture/ Nqd1l36P_4zLcndw5kEdAOq7lG0kGs_degOz-7TprJc/mtime:1537345558/sites/ eeas/files/europe_asia_connectivity_factsheet_1.pdf Gabuev, A. (2016). Crouching Bear, Hidden Dragon: “One Belt One Road” and Chinese-­Russian Jostling for Power in Central Asia. Journal of Contemporary East Asia Studies, 5(2), 61–78. Gabusi, G. (2017). Crossing the River by Feeling the Gold: The Asian Infrastructure Investment Bank and the Financial Support to the Belt and Road Initiative. China & World Economy, 25(5), 23–45. Gehlbach, S., Sonin, K., & Svolik, M. W. (2016). Formal Models of Nondemocratic Politics. Annual Review of Political Science, 19(1), 565–584. doi:10.1146/ annurev-polisci-042114-014927. Gilli, M., & Li, Y. (2014). Accountability in One-party Government: Rethinking the Success of Chinese Economic Reform. Journal of institutional and Theoretical Economics JITE, 170(4), 616–645. doi:10.1628/093245614X14113700937488. Gilli, M., & Li, Y. (2015). Coups, Revolutions and Efficient Policies in Autocracies. European Journal of Political Economy, 39, 109–124. doi:10.1016/ j.ejpoleco.2015.04.011.

The Belt & Road Initiative  17 Godement, F., & Vasselier, A. (2017). China at the Gates: A New Power Audit of EU-China Relations. London: European Council on Foreign Relations (ECFR). Hoering, U. (2018). China’s Long March 2.0. The Belt and Road Initiative as Development Model. Köln: Siftung Asienhaus. Retrieved from https://www.asienhaus. de/uploads/tx_news/Hoering_Chinas_Long-March_2.0.pdf Huang, Y. (2016). Understanding China’s Belt & Road Initiative: Motivation, Framework and Assessment. China Economic Review, 40, 314–321. Hurley, J., Morris, S., & Portelance, G. (2018). Examining the Debt Implications of the Belt and Road Initiative from a Policy Perspective. CGD Policy Paper, 121. IMF (International Monetary Fund). (2018). People’s Republic of China -2018 Article IV Consultation. IMF Country (Report No. 18/240). Retrieved from https:// www.imf.org/external/pubs/ft/scr/2016/cr16270.pdf Laruelle, M. (Ed.) (2018). China’s Belt and Road Initiative and Its Impact in Central Asia, George Washington University, Central Asia Program, Washington, DC. Retrieved November 15, 2018, from https://centralasiaprogram.org/wp-content/ uploads/2017/12/OBOR_Book_.pdf Li, Y., & Schmerer, H.-J. (2017). Trade and the New Silk Road: Opportunities, Challenges, and Solutions. Journal of Chinese Economic and Business Studies, 15, 205–213. doi:10.1080/14765284.2017.1347473. Li, Y., & Taube, M. (2018): The Implications of the ‘Belt and Road Initiative’ on Globalization and Inclusive Growth for the Eurasian Continent. Journal of Chinese Economic and Business Studies, 16(3), 233–240. doi:10.1080/14765284.2018.1491667. Lin, J. Y. (2015). “One Belt and One Road” and Free Trade Zones: China’s New Opening-up Initiatives. Frontiers of Economics in China, 10(4), 585–590. Mardell, J. (2017, December 15). One Belt, One Road, and One Big Competition. The Diplomat. Retrieved from https://thediplomat.com/2017/12/one-belt-one-roadand-one-big-competition/ Menegazzi, S. (2017). Global Economic Governance between China and the EU: The Case of the Asian Infrastructure Investment Bank. Asia Europe Journal, 15(2), 229–242. doi:10.1007/s10308-017-0477-2. McKinsey. (2016). China’s One Belt, One Road: Will It Reshape Global Trade? Retrieved from https://www.mckinsey.com/featured-insights/china/chinas-one-beltone-road-will-it-reshape-global-trade NDRC (National Development and Reform Commission). (2015). Vision and Actions on Jointly Building Silk Road Economic Belt and 21st-Century Maritime Silk Road. Retrieved from http://en.ndrc.gov.cn/newsrelease/201503/t20150330_669367.html Office of the Leading Group for the Belt and Road Initiative. (2018). Belt & Road Portal. International Cooperation. Retrieved from https://eng.yidaiyilu.gov.cn/ info/iList.jsp?cat_id=10076&cur_page=1 Office of the Secretary of Defense. (2014). Military and Security Developments Involving the People’s Republic of China 2014. Retrieved May 5, 2018, from https:// www.defense.gov/Portals/1/Documents/pubs/2014_DoD_China_Report.pdf Pence, M. (2018). Remarks by Vice President Pence on the Administration’s Policy toward China. The White House. Retrieved from August 1, 2019, from https://www.whitehouse.gov/briefings-statements/remarks-vice-presidentpence-administrations-policy-toward-china/ Prasad, R. (2018, April 21). EU Ambassadors Condemn China’s Belt and Road Initiative. The Diplomat. Retrieved from https://thediplomat.com/2018/04/euambassadors-condemn-chinas-belt-and-road-initiative/

18  Yuan Li & Markus Taube Reuters. (2018, February 19). Australia, U.S., India and Japan in Talks to Establish Belt and Road Alternative: Report. Reuters. Retrieved November 15, 2018, from https://www.reuters.com/article/us-china-beltandroad-quad/australia-u-s-indiaa n d - j a p a n - i n - t a l k s - t o - e s t a b l i s h - b e l t- a n d - r o a d - a l t e r n a t i v e - r e p o r t-­ idUSKCN1G20WG Roberts, S. P., & Moshes, A. (2016). The Eurasian Economic Union: A Case of ­Reproductive Integration? Post-Soviet Affairs, 32(6), 542–565. The Economist Intelligence Unit. (2015). Prospects and Challenges on China’s ‘One Belt, One Road’: A Risk Assessment Report. London: EIU. Vangeli, A. (2018). Global China and Symbolic Power: The Case of 16 + 1 Cooperation. Journal of Contemporary China, 27(113), 674–687. doi:10.1080/10670564. 2018.1458056. Wang, J. (2016). “Yi dai yi lu” jing ji zou lang yu qu yu jing ji yi ti hua. From corridor to regional economic integration on the formation and evolution of “the belt and road” economic corridor. Di 1 ban. Beijing Shi: She hui ke xue wen xian chu ban she (Zhongguo she hui ke xue yuan “yi dai yi lu” yan jiu xi lie. Zhi ku bao gao, 07). Yu, J. (2017, July 24). One Belt One Road A Reality Check. LSE IDEAS. Retrieved from https://medium.com/@lseideas/chinas-one-belt-one-road-a-reality-checkb28030ac6d3b

Section I

The logic of the BRI and its domestic economic impacts

1 China’s rejuvenation and the Belt and Road Initiative Justin Yifu Lin

Introduction China has had one of the most splendid civilizations in the world since before the modern times. The rejuvenation of China has been the dream of Chinese people in the last centuries. The realization of such a dream was unthinkable until it transitioned from a planned to a market economy in 1978. In 2018, China marked the 40th anniversary of its transition. It comes at a unique moment in history: The United States’ apparent retreat from globalization offers a distinct opportunity for China to accelerate its ascendance as a guardian of the global trading system. Meanwhile, the nation’s rise from poverty to a world power in the last few decades can provide valuable lessons for other developing countries, especially as the Trump administration continues to pursue anti-globalization policies. In 1978, China’s per capita gross domestic product was $156, less than a third of that of the nations in sub-Saharan Africa. China was an inward-­ looking country with a trade-to-GDP ratio of only 9.7%, versus 32.7% today. Unlike in other transition economies, which have encountered economic collapse, stagnation, and frequent crises, China’s economic growth has been phenomenal since the transition in 1978, with an average annual GDP growth rate of 9.5% and trade growth rate of 14.5% during the period 1978–2017. With that rapid growth, China overtook Japan as the world’s second-largest economy in 2009; it replaced Germany as the world’s largest exporter of merchandise in 2010; it became the world’s largest trading country in 2013; and it overtook the United States in 2014 as the world’s largest economy, when measured in purchasing power parity. During this period, more than 700 million Chinese people escaped poverty. China is the only emerging economy that has not suffered a home-grown financial crisis in the last four decades. Today, China is an upper-middle-income country with per capita GDP of $9,400 a year, and that figure is likely to cross the $12,700 threshold, the hallmark of a high-income country, around 2025. China is also the world’s largest producer of goods, and one of the most competitive countries in the world.

22  Justin Yifu Lin China embraces globalization. The country has championed the ambitious Belt and Road Initiative (BRI), which proposes to connect it with markets in Asia, Europe, and Africa through infrastructure development. Despite open opposition from the United States at the time of its inception, the Asian Infrastructure Investment Bank, proposed by China as a vehicle for the BRI, has 77 member countries today, making it one of the largest multilateral development institutions in the world. In this chapter, I will first provide answers to five questions related to China’s rejuvenation. Why was it possible for China to achieve such extraordinary performance during its transition? Why was China unable to attain similar success before its transition started? Why did most other transition economies, both socialist and nonsocialist, fail to achieve a similar performance? What costs does China pay for its extraordinary success? Will China sustain a similar dynamic growth in the coming decades? I will then explain the rationale behind China’s proposal for the BRI, why BRI has been enthusiastically received, and its likely impact on the world. The chapter will conclude with short remarks.

The reason for China’s extraordinary performance in transition Rapid, sustained increase in per capita income is a modern phenomenon. Studies by economic historians, such as Maddison (2001), show that average annual per capita income growth in the West was only 0.05% before the 18th century, jumping to about 1% in the 19th century, and reaching about 2% in the 20th century. That means that per capita income in Europe took 1,400  years to double before the 18th century, about 70 years in the 19th century, and 35 years thereafter. A continuous stream of technological innovation is the basis for sustained growth in any economy. The dramatic surge in growth in modern times is a result of a paradigm shift in technological innovation. Before the Industrial Revolution in the 18th century, technological innovations seen in the daily production were generated mostly as a result of the experiences of craftsmen and farmers. After the Industrial Revolution, experience-based innovation was increasingly replaced by field experimentation, and, later, by science-based experiments conducted in scientific laboratories (Lin, 1995; Landes, 1998). This shift accelerated the rate of technological innovation, marking the coming of modern economic growth and contributing to the dramatic acceleration of income growth in the 19th and 20th centuries (Kuznets, 1966). The Industrial Revolution not only accelerated the rate of technological innovation but also transformed industrial, economic, and social structures. Before the 18th century, every economy was agrarian; 85% or more of the labor force worked in agriculture, mostly in self-sufficient production for the family. The acceleration of growth was accompanied by a move of labor from agriculture to manufacturing and services. The manufacturing

China’s rejuvenation  23 sector gradually moved from very labor-intensive industries at the beginning to more capital-intensive, heavy and high-tech industries. Finally, the service sector came to dominate the economy. Accompanying the change in industrial structure was an increase in the scale of production, the required capital and skill, the market scope, and the risks. To exploit the potential unleashed by new technology and industry and to reduce the transaction costs and share risks require innovations as well as improvements in an economy’s hard infrastructure, such as power and road networks, and its soft infrastructure. Soft infrastructure consists of such elements as belief, the legal framework, financial institutions, and the education system (Lewis, 1954; Kuznets, 1966; North, 1981; Lin, 2011, 2012). A developing country such as China, which started its modernization drive in 1949, potentially has the advantage of backwardness in its pursuit of technological innovation and structural transformation (Gerschenkron, 1962). In advanced high-income countries, technological innovation and industrial upgrading require costly and risky investments in research and development because their technologies and industries are located on the global frontier. Moreover, the institutional innovation required for realizing the potential of new technology and industry often proceeds in a costly trial-and-error, path-dependent, evolutionary process (Fei & Ranis, 1997). By contrast, a latecomer country, in the catching-up process, can borrow technology, industry, and institutions from the advanced countries at low risks and costs. Therefore, if a developing country knows how to tap the advantage of backwardness in technology, industry, and social and economic institutions, it can grow for decades at an annual rate several times that of high-income countries before closing its income gap with those countries. In the post–World War II period, 13 of the world’s economies achieved average annual growth of 7% or above for 25 years or more. The Commission on Growth and Development, headed by Nobel Laureate Michael Spence, detected that the first of the 5 common features of these 13 economies is their ability to tap the potential of the advantage of backwardness. In the Commission’s language, the 13 economies “imported what the rest of the world knew and exported what it wanted” (World Bank, 2008, p. 22).1 After the transition was initiated by Deng Xiaoping in 1979, China adopted the opening-up strategy and started to tap the potential of importing what the rest of the world knows and exporting what the world wants. This is demonstrated by the rapid growth in its international trade, the dramatic increase in its trade dependence ratio, and the large inflows of foreign direct investment. While in 1979, primary and processed primary goods accounted for more than 75% of China’s exports, by 2009, the share of manufactured goods had increased to more than 95%. Moreover, China’s manufactured exports upgraded from simple toys, textiles, and other cheap products in the 1980s and 1990s to high-value and technologically sophisticated machinery and information and communication technology products in the 2000s. The exploitation of the advantage of backwardness

24  Justin Yifu Lin has allowed China to emerge as the world’s manufacturing workshop and to achieve extraordinary economic growth by reducing the costs of innovation, industrial upgrading, and social and economic transformation.

Why did China fail to achieve rapid growth before 1979? China possessed the advantage of backwardness long before the transition began in 1979. The socialist government won the revolution in 1949, and started modernizing earnestly in 1953. Why had China failed to tap the potential of the advantage of backwardness and achieve dynamic growth before 1979? This failure came about because China adopted the wrong development strategy at that time. China was the largest economy and among the most advanced, powerful countries in the world in pre-modern times (Maddison, 2007). Mao Zedong, Zhou Enlai, and other first-generation revolutionary leaders in China, like many other Chinese social and political elites, were inspired by the dream of achieving rapid modernization. The lack of industrialization—especially the lack of large heavy industries that were the basis of military strength and economic power—was perceived as the primary cause of the country’s backwardness. Thus, it was natural for the social and political elites in China to prioritize the development of large, heavy, advanced industries after the Revolution as they started building the nation.2 In the 19th century, the political leaders of France, Germany, the United States, and other Western countries pursued effectively the same strategy, motivated by the contrast between Britain’s rising industrial power and the backwardness of their own industry (Gerschenkron, 1962; Chang, 2003). Starting in 1953, China adopted a series of ambitious Five-Year Plans to accelerate the building of modern advanced industries with the goal of overtaking Britain in 10 years and catching up with the United States in 15. But China was a lower-income agrarian economy at that time. In 1953, a total of 83.5% of its labor force was employed in the primary sector, and its per capita income (measured in purchasing power parity terms) was only 4.8% of that of the United States (Maddison, 2001). Given China’s employment structure and income level, the country did not possess a comparative advantage in modern advanced industries of high-income countries, whether latent or overt, and Chinese firms in those industries were not viable in an open competitive market.3 To achieve its strategic goal, the Chinese government needed to protect the priority industries by giving firms in those sectors a monopoly and by subsidizing them through various price distortions, including suppressed interest rates, an overvalued exchange rate, and lower prices for inputs. The price distortions created shortages, and the government was obliged to use administrative measures to mobilize and allocate resources directly to nonviable firms (Lin, 2009; Lin & Li, 2009).

China’s rejuvenation  25 These interventions enabled China to quickly establish modern advanced industries, test nuclear bombs in the 1960s, and launch satellites in the 1970s. But the resources were misallocated, the incentives were distorted, and the labor-intensive sectors in which China held a comparative advantage were repressed. As a result, economic efficiency was low, and the growth before 1979 was driven mainly by an increase in inputs.4 Despite a very respectable average annual GDP growth rate of 6.1% in 1952–1978 and the establishment of large modern industries, China was almost a closed economy, with 71.3% of its labor force still in traditional agriculture. In 1952–1978, household consumption grew by only 2.3% a year, in sharp contrast to the 7.1% average growth after 1979.

Why didn’t other transition economies perform equally well? All other socialist countries and many developing countries after World War II adopted a development strategy similar to that of China. Most colonies gained political independence after the 1950s. Compared with developed countries, these newly independent developing countries had extremely low per capita income, high birth and death rates, low average educational attainment, and very little infrastructure; also, they heavily specialized in the production and export of primary commodities while importing most manufactured goods. The development of modern advanced industries was perceived as the only way to achieve rapid economic takeoff, avoid dependence on the Western industrial powers, and eliminate poverty (Prebisch, 1950). It became a fad after the 1950s for developing countries in both the socialist and the nonsocialist camps to adopt a development strategy oriented toward heavy industry and import substitution (Lal & Mynt, 1996). But the capital-intensive modern industries on their priority lists defied the comparative advantages determined by the endowment structure of their low-­income agrarian economies. To implement their development strategy, many socialist and non-socialist developing countries introduced distortions and government interventions like those in China.5 This strategy made it possible to establish some modern industries and achieve investment-led growth for one or two decades from the 1950s to the 1970s. Nevertheless, the distortions led to pervasive soft budget constraints, rent-seeking, and misallocation of resources. Economic efficiency was unavoidably low. Stagnation and frequent social and economic crises began to beset most socialist and non-socialist developing countries by the 1970s and 1980s. Liberalization from excessive state intervention became a trend in the 1980s and 1990s. The symptoms of poor economic performance and social and economic crises, and their root cause in distortions and government interventions, were common in China and other socialist transition economies as well as in other developing countries. But the academic and policy communities in the 1980s did not realize that those distortions came from second-best institutional arrangements, endogenous to the needs of providing protections to

26  Justin Yifu Lin firms in the priority sectors. Without such protection, those firms would not have been viable. As a result, policymakers and academics recommended that socialist and other developing countries immediately remove all distortions by implementing simultaneous programs of liberalization, privatization, and marketization with the aim of quickly achieving efficient, first-best outcomes. But if those distortions were eliminated immediately, many non-viable firms in the priority sectors would collapse, causing a contraction of GDP, a surge in unemployment, and acute social disorders. To avoid those dreadful consequences, many governments continued to subsidize the nonviable firms through other, disguised, less-efficient subsidies and protections (Lin & Tan, 1999). Transition and developing countries thus had even poorer growth performance and stability in the 1980s and 1990s than in the 1960s and 1970s (Easterly, 2001). During the transition process, China adopted a pragmatic, gradual, dual-­track approach. The government first improved the incentives and ­productivity by allowing the workers in the collective farms and stateowned firms to be residual claimants and to set the prices for selling at the market after delivering the quota obligations to the state at fixed prices (Lin, 1992). At the same time, the government continued to provide necessary protections to nonviable firms in the priority sectors and, simultaneously, liberalized the entry of private enterprises, joint ventures, and foreign direct investment in labor-intensive sectors in which China had a comparative advantage but that were repressed before the transition. This transition strategy allowed China both to maintain stability by avoiding the collapse of old priority industries and to achieve dynamic growth by simultaneously pursuing its comparative advantage and tapping the advantage of backwardness in the industrial upgrading process. In addition, the dynamic growth in the newly liberalized sectors created the conditions for reforming the old priority sectors. Through this gradual, dual-track approach, China achieved “reform without losers” (Naughton, 1995; Lau et al., 2000; Lin et al., 2003) and moved gradually but steadily to a well-functioning market economy. A few other socialist economies—such as Poland,6 Slovenia, and ­Vietnam, which achieved outstanding performance during their transitions—adopted a similar gradual, dual-track approach (Lin, 2009). Mauritius adopted a similar approach in the 1970s to reforming distortions caused by the country’s import-substitution strategy and became Africa’s success story (Subramanian & Roy, 2003).7

What price did China pay for its success? Although its economic progress was extremely good, China, however, also paid a very high price for its success. In addition to environmental degradation and food safety issues, which are the results of rapid industrialization and lack of appropriate regulations, the main prices China paid in the last

China’s rejuvenation  27 37 years were corruption and increased income disparities, which themselves were related to China’s pragmatic transition strategy. As already mentioned, the Chinese government wanted to give transitory protection and subsidies to already-existing advanced sectors in order to maintain stability. These industries were capital-intensive. One of the most important costs was the cost of capital. Before the start of transition in 1979, these industries did not pay any of the costs of fixed or working capital (including the wage fund) as these costs were covered by a government-provided fiscal appropriation. After 1979, however, the source of capital gradually changed from fiscal appropriations to bank loans. The Chinese government set up four large state banks and a stock market to meet the capital needs of large enterprises. To survive, however, these industries required low interest rates. As a result, interest rates and capital costs were artificially repressed. In 1979 and the 1980s, all firms in China were state-owned. Gradually, however, success in new sectors saw some domestic firms grow and become large firms. These firms could all borrow from the large state banks or could be listed on a stock market. As interest rates and capital costs were artificially repressed, whoever could borrow from the banking sector or from the emerging stock markets was therefore getting subsidized loans. These subsidies were paid for by households, farms, and small- medium-sized industrial and service firms who put their money into the banking sectors or into the stock market and who were poorer than the owners of the enterprises they financed. The subsidization of the operation of rich people’s firms by poorer people was one reason for increasing income disparities. Moreover, the acquisition of capital at depressed interest rates generates economic rents (excess profits) for the recipients, leading to bribery and corruption of the gatekeepers who control access to these sources of finance. Therefore, this state of affairs contributed to corruption. At the same time in banking and in some large-scale service industries, state-owned monopolies secured monopoly rents. Private enterprises in new sectors also sought monopoly rents. In the natural resource sectors, before 1979, in accordance with the provisions of the constitution, all the natural resources were “owned by the state, that is, by the whole people”. Before 1979, natural resources were managed free of charge by large-scale state-owned enterprises (SOEs) and were provided to them at very low prices. After 1979, the government allowed private firms to enter the mining sectors, and it liberalized control over prices while maintaining low concession fees. An acquisition of a concession promised overnight enrichment. The monopoly rents in service sectors, such as telecommunication and finance, were also sources of inequality and corruption and resulted from the pragmatic approach to transition. Unless these distortions are removed, corruption will be difficult to eradicate, no matter how hard the government tries. The main reason for maintaining temporary transitional distortions was the need to protect large-scale SOEs because they were capital-intensive

28  Justin Yifu Lin and were inconsistent with China’s comparative advantage. In the 1980s and 1990s, China was a poor country. Only in 2002 did it become a middle-­ income country. At that time, protection and subsidies were a precondition for the survival of these industries. After 37 years of rapid economic growth, however, the availability of capital in China has increased significantly, and many of the industries and SOEs that were protected in the past are now consistent rather than inconsistent with China’s comparative advantages. As a result, their products are competitive with those of global companies in international markets. Today, subsidies and protection have changed in nature, from subsidies and protection to their recipients into transformative wealth. As a result, it is time for China to complete the transition and remove all these distortions. Indeed, their removal was precisely the reform agenda’s goal announced by the Chinese government in the 3rd Plenary Session of the 18th Party Congress in 2013. Hopefully, the implementation of a reform agenda of this kind and the removal of these distortions will eliminate the main causes of income inequality and corruption in China.

Can China continue this kind of dynamic growth in the years ahead? The following question arises. If China removes all remaining distortions and completes this transition to a well-functioning market economy, for how long can it maintain dynamic economic growth? This question is hotly debated in China and closely followed globally. The reason for the debate was a persistent decline in growth rate from 10.6% in 2010 to 6.7% in 2016, the lowest level ever achieved after 1990. To answer the question of whether China can maintain its dynamic economic growth in the future after 30 years of two-digit growth, one needs to answer two other questions. How large is China’s growth potential? What were the reasons for the deceleration of China’s growth since 2010? China’s potential for rapid economic growth depends on the size of the advantage of backwardness that China still enjoys. To measure the size of the remaining advantage of backwardness, one should compare China’s per capita GDP with the per capita GDP of high-income countries such as the United States because per capita GDP is a proxy for a country’s average labor productivity. This is because average labor productivity is a measure of the degree of advancement of technology and value-added industries. In 2008, according to the last data published by Maddison, per capita GDP in China measured at PPP was 21% of the comparable figure for the United States in the same year. This proportion was similar to that for Japan in 1951, Singapore in 1967, Taiwan China in 1975, and South Korea in 1977. All stood at 21% of the US figure in the corresponding years. In the 20 years from 1951 to 1971, Japan grew at an average annual rate of 9.2%. From 1967 to 1987, Singapore grew at 8.6%. From 1975 to 1995, Taiwan China grew at 8.3%. From 1977

China’s rejuvenation  29 to 1997, South Korea grew at 7.6%. These four East Asian economies were among the 13 economies referred to earlier as having tapped into the growth potential deriving from the advantage of backwardness and as having enjoyed high growth rates of 7% or more continuously for 25 or more years. Just as these economies were able to utilize the technology gap and exploit the advantage of backwardness to grow for 20 years at between 7.6% and 9.2% per year, so too can China potentially grow for another 20 years at 8%  per year. From 2008 to 2016, eight years have passed. Another 12 years of potential growth at 8% per year remain. In that case, why has the growth rate continued to decline since 2010, and why does one still not see the end? The potential growth rate reflects the possibilities for technological innovation and industrial upgrading. It is a supply-side perspective. The realization of this potential growth rate also depends, however, on demand-side conditions. From a demand-side point of view, growth has three components: exports, investment, and consumption. High-income countries have not yet recovered from the global financial crisis of 2008. In these countries, per capita GDP is stagnant, there is a large pile of debts that they need to reduce, and consumption has increased very slowly. The stagnation of the United States, Western European countries, and Japan has depressed international trade, with a major impact on Chinese exports, as China is a major global supplier of consumption goods. From 1979 to 2015, China’s annual average export growth was about 16%. In 2015, it was −2.8%. This downturn was one of the reasons for deceleration in Chinese growth. This factor affects not only China but also many export-oriented countries. The second reason was that in 2008, most countries adopted countercyclical fiscal expansion to support investment and growth. After eight years, these projects were completed. The global economy has not fully recovered, and incentives for private sector investment remain low. Without a new round of stimulus programs, investment growth rates will drop, affecting all countries: growth has decelerated not only in China but also, and often more sharply, in other BRICS countries (Brazil, Russia, India, and South Africa), other high-performance export-oriented economies, and high-­ income countries themselves. Fortunately, China maintains a high employment rate. Household income has continued to grow rapidly at about 8% per year, with consumption growing at a similar rate. The growth of consumption is the reason why the country has managed to maintain a growth rate of around 7% per year. China, along with other developing countries, needs to complete a transition to address domestic structural problems. Deceleration was, however, mainly due to external and cyclical factors. Looking forward, high-income countries are very likely to be trapped in a situation similar to that of ­Japan after 1991 due to the lack of structural reforms. These economies are likely to grow at less than 3% per year. External demand is likely to remain sluggish.

30  Justin Yifu Lin Growth in China will depend on domestic demand where, fortunately, China still has a lot of room for improvement: although there is excess capacity in many sectors, as a middle-income country, China has very considerable possibilities for investment in industrial upgrading, urban and inter-urban infrastructure, and environmental protection. Not only has it plenty of good opportunities for investment, but also its fiscal position is still very sound. In 2015, national, provincial, and local government debt was less than 60% of GDP, amongst the lowest in the world. China still has more than US$3 trillion of foreign exchange reserves. With good investment opportunities and abundant funding, China will maintain a reasonable rate of investment growth, create jobs, and increase household income and consumption. Under these conditions, there is no reason why China cannot reach its annual growth target of 6.5% or more in the coming five years. If China does reach this target, it is very likely that Chinese per capita GDP will reach US$12,700 around 2025, making China a high-income country by the standards of that time (Lin et al., 2016).

Why China proposed the BRI? The global governance today was basically shaped after World War II. At  that time, the high-income countries contributed more than two-third of global GDP; at present, the emerging market economy has already contributed about 50% of global GDP. Emerging market economy and other developing countries are likely to grow faster than developed countries. So, the weight of global economy will tilt increasingly toward China and other developing countries. And certainly, global governance will have to reflect this new reality. With that, China and other developing countries will have more say in the global architecture. After the reform and opening-up, China has grown to be an upper-­m iddleincome country. For the sake of the great rejuvenation of the Chinese nation, China needs to further develop into a high-income country. Judging from the experiences of reform and opening-up, China should make the best of markets and resources at home and abroad. Besides, China is now the world’s largest trading country, the world’s second-largest economy measured by market exchange rate, and the world’s largest economy in terms of purchasing power parity. So internationally, China should assume corresponding responsibilities and have the corresponding influence and voice in determining international affairs and rules. The existing international governance was shaped by the US-led developed countries after World War II, reflecting the interests and development ideas of the developed countries. Considering significant changes in the global situation, if China is required to undertake more obligations, it should be given a bigger voice. In this regard, there is an international consensus. In 2009, President Hu Jintao reached an agreement with President Obama at the G20 Summit to increase China’s voting power in the World

China’s rejuvenation  31 Bank and International Monetary Fund. However, the agreement was denied by the United States Congress. Also, to maintain its benefits in the Asia-Pacific region, the United States proposed the strategy of “Pivoting to the Asia-Pacific”. Furthermore, in the US-led negotiations of “Trans-Pacific International Partnership”, China, the world’s largest trading country, was not invited to participate. Obviously, it reflects the intention of the USA to maintain its strategic advantages in the Asia-Pacific region and to ensure its geopolitical and geo-economic interests. Similar to the Warring States Period in Chinese history, the USA adopts a strategy of vertical alliance to contain China’s emergence. In such a situation, President Xi Jinping proposed the “Silk Road Economic Belt Initiative” during a visit to Kazakhstan in August 2013. In ­October of the same year, he proposed the “21st Century Maritime Silk Road Initiative” in Indonesia when attending an ASEAN meeting. The initiatives were aimed at establishing a regional cooperation framework from east to west, across Asia to Europe and Africa for the purposes of “policy communication, road connectivity, unimpeded trade, currency circulation and friendship building” and the building of “a community of common interest, destiny and responsibility” for countries along the BRI. The initiative, based on infrastructure connectivity, has contributed to the establishment of the Asian Infrastructure Investment Bank.

The popularity and the likely impact of BRI The Asia-Pacific region was in need of infrastructure investment, of which the USA was well aware. At the time it put forward the “Pivoting to the Asia-Pacific” strategy, the USA also proposed building the Indo-Pacific Economic Corridor and the New Silk Road connecting Afghanistan and Central Asian countries, which have got nowhere so far. But the Asian ­Infrastructure Investment Bank, proposed by China to promote the “One Belt and One Road” Initiative, has 57 founding countries from five continents, including major western countries (except for the USA, Japan, and Canada) and most countries in Asia and Europe, regardless of opposition from the USA. There are three reasons for such a popularity of China’s BRI: Firstly, it has advantages in the construction material industry and capacity in infrastructure construction, which are China’s comparative advantages. China produces more than half the construction materials including cement and steel annually in the world. China’s civil engineering firms are among the most competent and competitive in the world. Secondly, China now has an annual savings of around 50% of GDP and foreign exchange reserve of 3.7 trillion dollars. So, China has ample funds for financing investment in infrastructure construction for participating countries in the BRI. Infrastructure is generally a bottleneck for development in developing countries, so the investment will be well received.

32  Justin Yifu Lin Thirdly, China has an advantage in the developmental stage. Since reform and opening-up, China has become the world’s factory and the largest exporter through the development of labor-intensive processing industries. With constantly rising wages in China, these industries have gradually lost their comparative advantages and have to be relocated to other countries with a comparatively low wage level. Most countries along the BRI have a GDP per capita of less than half of China’s and thus are ideal destinations for the relocation of China’s labor-intensive industries. Infrastructure construction of the BRI will facilitate these countries to capture the window of opportunity of developing labor-intensive industries, creating more jobs, and increasing exports. Experience since World War II shows that a developing country that is capable of seizing the window of opportunity arising from the international relocation of labor-intensive industries will be able to achieve 20 to 30 years of rapid development, enabling it to shake off poverty and move into the ranks of middle-income and even high-income countries. Such rapid development will, in turn, bring an increasingly expanding market long coveted by developed countries. In the 1960s, when Japan started to transfer its labor-­intensive industries overseas, its manufacturing industry employed 9.7 million people; in the 1980s, when the Four Asian Tigers (Hong Kong, Singapore, South ­Korea, and Taiwan) went through the same stage, the manufacturing industry employed less than one million people in Hong Kong, 0.5 million people in Singapore, 2.3 million people in South Korea, and 1.5  m ­ illion people in ­Taiwan. By contrast, the figure for China, according to the third industrial census, is 125 million, with 85 million in labor-intensive industries, which means many opportunities for all the developing countries along the BRI to achieve industrialization and modernization simultaneously. These are the main reasons why the response to China’s BRI has been so positive. On the one hand, the initiative goes in line with China’s own interests and will create an internationally peaceful development environment so that China can make better use of the domestic and international markets and resources; on the other hand, it will bring unprecedented development opportunities for other developing countries along the route and promote their industrialization and modernization. From the perspective of policymaker seeking specific action plans to generate prosperity, the disappointments of growth research have led to a reassessment of validity and usefulness of existing knowledge, and to the development of radically new approaches. According to an important study of World Bank highlighted the complexity of economic growth and recognized that it is not amenable to simple formulas as thought it was in the 1990s. There is no unique or universal set of rules to guide policymakers. For the Eurasian region, different countries require different policy choices to facilitate growth, and the “big principles” that growth requires—openness, trade, industrial upgrading, market competition, government facilitation, infrastructure improvement—can be embodied in the BRI, a project of the century that will benefit people across the world.

China’s rejuvenation  33 China has worked with other countries involved in the BRI to promote trade and investment facilitation and improve the business environment. For Kazakhstan and other Central Asian countries alone, customs clearance time for agricultural products exported to China is cut by 90%. Total trade between China and other Belt and Road countries in 2014–2016 has exceeded US$3 trillion, and China’s investment in these countries has surpassed US$50 billion. Chinese companies have set up 56 economic cooperation zones in over 20 countries, generating some US$1.1 billion of tax revenue and 180,000 jobs for them. The BRI will bring new opportunity for many countries in the world. Countries like Kazakhstan and Uzbekistan, for instance used to be landlocked countries; now, with BRI, they can have a much better access to global market, and that is the reason why BRI has been welcomed by the countries along the route. China will uphold amity, sincerity, mutual benefit, and inclusiveness as well as the principle of joint discussion, common development, and shared growth as it looks to undertaking practical and mutually beneficial cooperation in multiple sectors with countries and regions involved in the BRI, with the aim of developing a new picture of allaround opening-up in which China is opened to the world through eastward and westward links and across land and sea.

Concluding remarks The analysis in this chapter suggests, first, that every developing country, like China, has the potential to grow dynamically and continuously for 30 or more years and to move from a low-income to a middle-income, and even to a high-income, economy if they develop their economies according to their comparative advantage. Countries can turn their comparative advantages into national competitive advantages. Competitive industries can accumulate capital and engage in processes of industrial upgrading that tap into the potential advantage of backwardness, enabling them to grow much faster than high-income countries and maintaining growth rates of 7% or more for several decades as in the rejuvenation of China in the last four decades. Although the potential is there for every country to grow, they need to have the right development strategy in order to fully tap into their potential. Second, every country has a lot of distortions. These distortions involve costs, and removing these distortions is desirable. Distortions exist, however, for certain reasons, and are, in economic terms, largely endogenous. Unless the causes of a distortion are dealt with, the attempt to remove it can do a lot of harm. If there is a distortion and the economy is accordingly in a “second-best” situation, the removal of the distortion without the removal of the cause will very often make the situation even worse. A country embarking on reform should, therefore, be pragmatic, employing transitory and transitional protection to the old comparative advantage-defying sectors to maintain stability while facilitating the growth of new comparative

34  Justin Yifu Lin advantage-following sectors to achieve dynamic growth as China did in the last 40 years. A pragmatic approach to transition and step-by-step development according to a country’s evolving comparative advantage is of great value for developing countries. At the same time, pragmatism is required in the transition itself. The final goal is the establishment of a well-functioning market economy, but it should be a process managed by the government paying attention to the needs of all sectors and providing business opportunities for them. With the increase of economic weight and influence in the world, China proposed the BRI in 2013. The response to China’s BRI has been positive from most countries in the world. On the one hand, the initiative goes in line with China’s own interests and will create an internationally peaceful development environment so that China can make better use of the domestic and international markets and resources; on the other hand, BRI creates a winwin situation which allows countries involved along the route to develop according to their own comparative advantages. It will bring unprecedented development opportunities for other developing countries along the route and promote their industrialization and modernization. With this new initiative, a faster development in the infrastructure connectivity can be seen, just like the railway from Chongqing to Duisburg. Overall, BRI will contribute to a faster growth in globalization and the economic development, for both China and the rest of the world.

Notes 1 The remaining features are, respectively, macroeconomic stability, high rates of saving and investment, market system, and committed, credible, and capable governments. Lin and Monga (2012) show that the first three features are the result of following the economy’s comparative advantages in developing industries at each stage of its development, and the last two features are the preconditions for the economy to follow its comparative advantages in developing industries. 2 The desire to develop heavy industries existed before the socialist elites obtained political power. Dr. Sun Yat-sen, the father of modern China, proposed the development of “key and basic industries” as a priority in his plan for China’s industrialization in 1919 (Sun, 1929). 3 While the policy goal of France, Germany, and the United States in the late 19th century was similar to that of China in the mid-1950s, the per capita incomes of the three countries were about 60%–75% of Britain’s at the time. The small gap in per capita incomes indicated that the industries on the governments’ priority lists were the latent comparative advantages of the three countries (Lin & Monga, 2011). 4 Estimates by Perkins and Rawski (2008) suggest that the average annual growth of total factor productivity was 0.5% in 1952–1978 and 3.8% in 1978–2005. 5 There are different explanations for the pervasive distortions in developing countries. Engerman and Sokoloff (1997), Grossman and Helpman (1996), and Acemoglu et al. (2005) proposed that these distortions were caused by the capture of government by powerful vested interests. Lin (2009, 2003) and Lin and Li (2009) propose that the distortions were a result of conflicts between the comparative advantages of the economies and the priority industries that political

China’s rejuvenation  35 elites, influenced by the dominant social thinking of the time, targeted for the modernization of their nations. 6 In spite of its attempt to implement a shock therapy at the beginning, Poland did not privatize its large state-owned enterprises until very late in the transition. 7 In the 1980s, the former Soviet Union, Hungary, and Poland adopted a gradual reform approach. However, unlike the case in China, their state-owned firms were not allowed to set the prices for selling at markets after fulfilling their quota obligations, and the private firms’ entry to the repressed sectors was subject to severe restrictions, but the wages were liberalized (while in China, the wage increase was subject to state regulation). These reforms led to wage inflations and exacerbated shortages. See the discussions about the differences in the gradual approach in China and the former Soviet Union and Eastern Europe in Lin (2009, pp. 88–89).

References Acemoglu, D., Johnson, S., & Robinson, J. A. (2005). Institutions as the Fundamental Cause of Long-Run Growth. In P. Aghion & S. N. Durlauf (Eds.), Handbook of Economic Growth (Vol. 1A, pp. 385–472). Amsterdam: Elsevier. Chang, H. (2003). Kicking Away the Ladder: Development Strategy in Historical Perspective. London: Anthem Press. Easterly, W. (2001). The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics. Cambridge, MA: MIT Press. Engerman, S. L., & Sokoloff, K. L. (1997). Factor Endowments, Institutions, and Differential Paths of Growth among New World Economies: A View from Economic Historians of the United States. In S. Haber (Ed.), How Latin America Fell Behind (pp. 260–304). Stanford, CA: Stanford University Press. Fei, J., & Ranis, G. (1997). Growth and Development from an Evolutionary Perspective. Malden, MA: Blackwell. Gerschenkron, A. (1962). Economic Backwardness in Historical Perspective: A Book of Essays. Cambridge, MA: Belknap Press of Harvard University Press. Grossman, G. M., & Helpman, E. (1996). Electoral Competition and Special Interest Politics. Review of Economic Studies, 63(2), 265–286. Kuznets, S. (1966). Modern Economic Growth: Rate, Structure and Spread. New ­Haven, CT: Yale University Press. Lal, D., & Mynt, H. (1996). The Political Economy of Poverty, Equity, and Growth: A Comparative Study. Oxford: Clarendon Press. Landes, D. (1998). The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor. New York and London: Norton. Lau, L. J., Qian, Y., & Roland, G. (2000). Reform without Losers: An Interpretation of China’s Dual-track Approach to Transition. Journal of Political Economy, 108(1), 120–143. Lewis, W. A. (1954). Economic Development with Unlimited Supply of Labour. Manchester School of Economic and Social Studies, 22(2), 139–191. Lin, J. Y. (1992). Rural reforms and Agricultural Growth in China. American Economic Review, 82(1), 34–51. Lin, J. Y. (1995). The Needham Puzzle: Why the Industrial Revolution Did Not Originate in China. Economic Development and Cultural Change, 43(2), 269–292. Lin, J. Y (2003). Development Strategy, Viability and Economic Convergence, Economic Development and Transition. Economic Development and Cultural Change, 53(2), 277–308.

36  Justin Yifu Lin Lin, J. Y (2009). Economic Development and Transition: Thought, Strategy, and ­Viability. New York: Cambridge University Press. Lin, J. Y. (2011). New Structural Economics: A Framework for Rethinking Development. The World Bank Research Observer, 26(2), 193–221. doi: 10.1093/wbro/ lkr007. Lin, J. Y. (2012). New Structural Economics: A Framework for Rethinking Development and Policy. Washington, DC: World Bank. Lin, J. Y., Cai, F., & Li, Z. (2003). The China Miracle: Development Strategy and Economic Reform. Hong Kong SAR: Chinese University Press. Lin, J. Y., & Li, F. (2009). Development Strategy, Viability, and Economic Distortions in Developing Countries. Issue Brief No. 4906. Washington, DC: World Bank. Lin, J. Y., & Monga, C. (2011). Growth Identification and Facilitation: The Role of the State in the Dynamics of Structural Change. Development Policy Review, 29(3), 259–310. Lin, J. Y., & Monga, C. (2012). The Growth Report and New Structural Economics. In J. Y. Lin (Ed.), New Structural Economics: A Framework for Rethinking Development and Policy (pp. 81–112). Washington, DC: World Bank. Lin, J. Y., & Tan, G. (1999). Policy Burdens, Accountability, and Soft Budget ­Constraints. American Economic Review, 89(2), 426–431. Lin, J. Y., Wan, G., & Morgan, P. (2016). Prospects for a Re-acceleration of Economic Growth in the PRC. Journal of Comparative Economics, 44(4), 842–853. Maddison, A. (2001). The World Economy: A Millennial Perspective. Paris: OECD Development Centre. Maddison, A. (2007). Chinese Economic Performance in the Long Run, 960–2030 AD. Paris: OECD Development Centre. Naughton, B. (1995). Growing Out of the Plan: Chinese Economic Reform, 1­ 978–1993. New York: Cambridge University Press. North, D. (1981). Structure and Change in Economic History. New York: W.W. Norton. Perkins, D. H., & Rawski, T. G. (2008). Forecasting China’s Economic Growth to 2025. In L. Brandt & T. G. Rawski (Eds.), China’s Great Economic Transformation (pp. 829–885). Cambridge: Cambridge University Press. Prebisch, R. (1950). The Economic Development of Latin America and Its Principal Problems. New York: United Nations. Reprinted in Economic Bulletin for Latin America 7, no. 1 (1962): 1–22. Subramanian, A., & D. Roy (2003). Who Can Explain the Mauritian Miracle? Mede, Romer, Sachs, or Rodrik? In D. Rodrik (Ed.), In Search of Prosperity: Analytic Narratives on Economic Growth (pp. 205–243). Princeton, NJ: Princeton University Press. Sun, Y. S. (1929). The International Development of China (Shih yeh chi hua) (2nd ed.). New York: G.P. Putnam’s Sons. World Bank (on behalf Commission on Growth and Development). (2008). The Growth Report: Strategies for Sustained Growth and Inclusive Development. ­Washington, DC: World Bank.

2 Motivations, actors, and implications for the New Silk Road trains Mario Esteban1 & Yuan Li

Introduction Launched in 2013, the Belt and Road Initiative (BRI) encompasses two main programs: The Silk Road Economic Belt and the 21st Century Maritime Silk Road. In both cases, improving connectivity between China and its partners along the route is one of their main goals. Whereas the former aims to improve overland connections, the latter focuses on maritime routes. The BRI is a very ambitious scheme involving more than 100 countries and international organizations (Xinhuanet, 2016), which make up 60% of the world’s population and its joint Gross Domestic Product (GDP). By its potentially immense impact, especially on the Eurasian continent, the New Silk Road has provoked considerable interest, both politically as well as academically. However, given its comprehensive character and the relatively short period that has passed since its inception in 2013, the BRI still poses many pending questions. The present paper will approach three of them concerning its scope, actors, and implications: – What is the rationale of the BRI? We question the reductionist analyses of the BRI, which focus either on the geostrategic or on the economic dimension. Looking at the governance structure of the initiative which embodies the logic of China’s bureaucratic institutions, we argue that the BRI is mainly an economic initiative. However, we sustain that its geostrategic repercussions should not be ignored because the economic effects of the BRI might not only transform the economic landscape of China but also increase the influence of China in world affairs. – What is the role played by local authorities in the implementation of the BRI? We argue that local governments play a vital role in the implementation as well as the conception of some of the most iconic BRI-related projects. Governments of different administrative levels cooperate in the development of those projects since the interests of central and local governments are vertically coherent. The collaboration between central, provincial, and municipal governments does not preclude competition among different cities to position themselves as key actors in the connectivity platforms created or enhanced by the BRI.

38  Mario Esteban & Yuan Li – What is the potential impact of the BRI on Europe and how EU countries react to the BRI? It is not surprising that the impact of the BRI differs significantly among EU members since China has identified the Mediterranean, Central, and Eastern parts of Europe as particularly relevant for the BRI. The divergence of attitudes between attracting more Chinese financing and accommodating China’s diplomatic positions has created some frictions among EU members. The evidence for supporting our argument comes from different case studies, particularly from the Yuxinou and the Yixinou cargo rail lines, the Belgrade-­Budapest high-speed rail line, and China Ocean Shipping Company (COSCO), investment in the Piraeus port. These projects are chosen because they are directly related to connectivity, which is the cornerstone of the BRI. Both secondary and primary sources have been used in this paper, including interviews with relevant officials, business people, and scholars from China and different EU member states.

The rationale of the BRI The rationale of the BRI is a heavily debated topic in academia, think tanks, and public media since its birth (Godement & Kratz, 2015; Swaine, 2015). There are three types of existing explanations: (1) The initiative is a new diplomatic strategy of China to enhance its foreign relations with countries along the Belt and Road; (2) the initiative is a new economic policy of China with the aim to further connect its domestic market with the global market and deepen economic reforms; (3) the initiative combines both economic and geostrategic motivations, which have strong synergies between them. Some tend to compare the BRI with the Marshall Plan and have underlined the geostrategic, security, and military considerations, portraying it as a threat to the Western hegemony (Tiezzi, 2014; Overholt, 2015; Curran, 2016; Mokry, 2016). For example, Fallon (2015) depicted the BRI mainly as a reaction to Obama’s Pivot to Asia, and labeled it as China’s “Pivot to Europe”. This view of the BRI tends to come together with a zero-sum, conflictual assessment of this policy. Some other analyses share this focus on the security dimension of the BRI but hold a more cooperative interpretation of this strategy. From this perspective, the BRI can help Beijing to assume the global responsibilities expected from a major power and to break the security dilemma faced by some countries due to the fast rise of China, opening even the possibility of establishing a more cooperative relationship with the United States (J. Wang, 2012; Y. Wang, 2016; Zheng & Zhang, 2016). On the other hand, the official position of the BRI presented by Chinese authorities is that it is mainly a cooperative economic initiative, focusing on the socioeconomic benefits that it could bring to China and the other participant countries (Ministry of Foreign Affairs of the People’s Republic of China, 2017a). Chinese media and official think tanks have been quite

The New Silk Road  39 adamant in their rejection not only of the analogy between the Marshall Plan and the BRI, due to the inclusive and non-conditional nature of the latter, but also of the pertinence of conducting a geostrategic analysis of the BRI. In their eyes, using a geostrategic lens to analyze an economic initiative is a pretext to be trapped again in a cold war, zero-sum-game mindset, which has hindered cooperation among nations and world development for decades (Li, 2017). In our view, sound theories of world politics should try to consider the interplay of both international and domestic dynamics (Rosenau, 1969). Policies like the BRI can be seen as an outcome (equilibrium) of games played among policy-makers at the domestic arena facing constraints from domestic institutions and society. After almost 35 years of high growth, the Chinese government indicates that China has been entering a “new normal”, expecting the average annual growth rate to be around 7 to 6.5% in the foreseeable future. Looking for new growth drivers is a very urgent task for the Chinese leaders because maintaining a growth rate of at least 6% is critical for social and political stability. To achieve this aim, in the reform decisions published in November 2013, the central government outlined a set of reforms that promise a major progress toward a better functioning and more open market economy. This document explicitly mentions the potential contributions of the Silk Road Economic Belt and the Maritime Silk Road “to form a new pattern of all-around opening” (Central Committee of the Communist Party of China, 2014). The BRI can also contribute to spur global demand, promote the internationalization of Chinese companies and the renminbi, and diversify trade routes (reducing China’s dependence on maritime routes) (Djankov & Miner, 2016). This centrality of the economic agenda on the BRI is also reflected at the institutional level. The Leading Group for Promoting the BRI was established in February 2015 under the leadership of Zhang Gaoli, first ranked Vice Premier and a member of the Standing Committee of the Politburo, whose portfolio focuses on economic issues, and its office has been placed under the National Development and Reform Commission, China’s top macroeconomic management agency (Xinhuanet, 2015). Additionally, according to Xi’s instructions during the fourth session of the 12th National People’s Congress, it is the National Development and Reform Commission rather than the Ministry of Foreign Affairs who takes the lead in implementing the BRI, which is another sign illustrating the focus on practical economic cooperation (Nie, 2016). At the end of the same month, on 28 March 2015, the official blueprint for the BRI, the Vision and Actions on Jointly Building Silk Road Economic Belt and 21st century Maritime Silk Road, was issued by the National Development and Reform Commission, the Ministry of Commerce, and the Ministry of Foreign Policy (National Development and Reform Commission, the Ministry of Commerce, and the Ministry of Foreign Policy Ministry of Foreign Affairs of the People’s Republic of China, 2015). Therefore, the domestic policy-making structure

40  Mario Esteban & Yuan Li shows the BRI is mainly an economic as well as diplomatic policy of the Chinese government since neither the military nor the security apparatus has a prominent role in its implementation. This point is reinforced looking at the five specific areas of cooperation identified in the official BRI action plan: policy coordination, infrastructures, trade, finance, and people-­topeople exchanges. However, even if geostrategic political considerations are not the main drivers behind the BRI, the implementation of the BRI would have significant geostrategic repercussions in Eurasia and beyond, due to the size and dynamism of the Chinese economy.2 The two most substantial geostrategic effects of the BRI would be (1) to dilute the dependence of traditional economic partners and (2) to reassure other international actors about the benefits of the rise of China. First, growing trade and financial links between China and other participants in the BRI will boost asymmetric economic interdependence among them, making the Chinese economy more important for the development of those countries rather than the other way around. While those states become increasingly dependent on Beijing in economic terms, China will enjoy greater influence over them, also at the expense of their traditional economic partners. Accordingly, Beijing increases its leverage for influencing those states to accommodate its strategic interests. At the same time, this diversification of China’s economic relations reduces the leverage of a single foreign country on the Chinese economy, which is particularly relevant for strategic imports, such as energy commodities (Qian, 2016). Figure 2.1 shows how China has overtaken the USA as the world’s largest trading nation since 2012, and how the share of China’s trade with all the 65 BRI countries has increased much more dramatically than in the case 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0

2005 2006 2007 China's trade with BRI

2008 2009 2010 2011 2012 China's trade with world US trade with BRI

2013 2014 US trade with world

Figure 2.1  China and US trade with the BRI countries and the world (2005–2014, in billion USD). Sources: National Bureau of Statistics of China, http://data.stats.gov.cn; The International Trade Administration, U.S. Department of Commerce, www.trade.gov.

The New Silk Road  41 of USA’s trade flows. Between 2005 and 2014, China’s share of total foreign trade of the Belt and Road countries jumped from 19% in 2005 to 26% in 2014, whereas the USA’s share experienced only a small increase, from 13% to 15%.3 In fact, China has become the largest trading partner of most of the BRI countries. This is the case even for the largest economy in Europe, Germany. In 2016, China became, for the first time, the largest trading partner of Germany in terms of total volume, while the United States dropped to the third place (DIHK, 2017). The picture is quite similar when looking at investment. According to the World Investment Report 2016 by United Nations Conference on Trade and Development (UNCTAD), China became the world’s second largest investor in 2015 (UNCTAD, 2016). Figure 2.2 shows that China’s outward Foreign Direct Investment (FDI) into the BRI countries has constantly risen, from only 9.08 billion in 2006 to 109.77 billion in 2015, constituting 75% of its total outward FDI for that year. After the launch of the BRI, China’s outward FDI into the BRI countries has increased from 75.94 billion in 2013 to 109.77 billion in 2015, while its outward FDI into the rest of world almost remained unchanged during the same period. Second, China uses the BRI to reassure other states of the peaceful and benign nature of the aforementioned growing economic engagement. C ­ hina’s increasing economic influence has caused anxiety in many countries. The spread of the anxiety is detrimental to Chinese interests since it makes those countries less prone to cooperate with China. To avoid this scenario, China tries to emphasize the win-win nature of its engagement with other countries and has adopted terms such as “community of shared destiny” (Arase, 2015; Swaine, 2015; Zeng, 2016). By doing so, China presents the BRI as an opportunity, instead of as a threat. For example, in November 2014, at 160 140 35.89

120 100

31.90

80

23.22

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12.09

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9.55 0 8.08 2006

38.01

9.48

13.02

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45.88

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64.59

75.94

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Figure 2.2  China’s outward FDI in the BRI countries and the rest of the world during 2006–2015 (in billion USD). Source: 2015 Statistical Bulletin of China’s Outward Foreign Direct Investment.

42  Mario Esteban & Yuan Li the Central Conference on Work on Foreign Affairs, Chinese President Xi Jinping stressed the importance of building the BRI and promoted win-win cooperation as China’s diplomatic strategy: We should step up results-oriented cooperation, actively advance the building of the Silk Road Economic Belt and the 21st Century Maritime Silk Road, work hard to expand the converging interests of various parties, and promote win-win cooperation through results-oriented cooperation.4 (Xinhuanet, 2014) This same image of the BRI has been consistently depicted by Chinese ­authorities since the inception of this initiative and has never received more international attention than during the First Belt and Road Initiative ­Forum for International Cooperation celebrated in Beijing in May 2017 (Xinhuanet, 2017a). In short, the BRI as an economic initiative has great potential for the countries involved, but it might also trigger substantial geopolitical concerns. China hopes the consolidation and development of the New Silk Road(s) could contribute to increasing trade and financial relations with the countries along the routes and to present relations with China as grounded on a win-win logic. This is not to argue that China is always successful in this endeavor as illustrated by the Indian boycott on the First Belt and Road Initiative Forum for International Cooperation (Ministry of External Affairs of the Government of India, 2017). Specifically, the West is nowadays more skeptical about globalization than has traditionally been the case, and there is little sign that this situation will reverse in the near future (Li & Schmerer, 2017). This might also affect the smooth implementation of the initiative.

The role of local authorities Even if most of the literature on the BRI follows a rational actor model in its analyses, it is evident that different sectors of the Chinese administration are involved in its development and implementation. This point is illustrated in the official action plan, which was written by three different organizations, although all are under the authority of the State Council. Section VI of the official action plan elaborates on the key role of local administrative units in its implementation (National Development and Reform Commission, Ministry of Foreign Affairs, and Ministry of Commerce of the People’s Republic of China, 2013). This plan shows a top-down dynamic in the interaction between central and local authorities. Note that over 20 provinces included the BRI on their working agenda for 2014, after Premier Li Keqiang listed the intensification of the planning for the BRI as one of the major national tasks for that year (Nie, 2016).

The New Silk Road  43 However, this hierarchical approach does not apply to all the projects included in the BRI and does not avoid different administrative units to put more emphasis on the various aspects of this multidimensional initiative. The following analysis of the China-Europe cargo freight trains not only provides evidence of hierarchical collaboration between the national, provincial, and local governments in developing BRI projects but also presents two facts which are not considered in most of the academic literature on the BRI (Summers, 2016). Firstly, some of the key elements of the BRI, particularly the idea of improving connectivity between China and other parts of Eurasia, were originally conceived at the local level and then elevated to the national level. Secondly, different governmental organizations sometimes attempt to take advantage of the BRI to promote their interest at the expense of the interests of other organizations. These two issues are quite consequential for understanding the BRI since they point to the advantage of resorting to a bureaucratic or to an organizational process model instead of to a monolithic rational actor model. Land transportation is the backbone of the Silk Road Economic Belt, which has spurred a significant increase in railway connectivity between China and the rest of Eurasia. Taking into consideration only the fast-­ growing freight train service linking China with Europe, in 2017, a total of 3,673 block trains, a 116% increase from 2016, were sent from China to 36 European cities in 13 different countries (GBTimes, 2018). Since the Silk Road Economic Belt relies on pivot cities to serve as platforms to foster economic integration in Eurasia, their local governments play a main role in proposing, designing, and implementing those transportation projects (Chongyang Institute for Financial Studies of Renmin University, 2016). In this context, where local authorities rush to develop Silk Road projects to attract economic activities and earn political favor, insufficient interorganizational and central-local coordination has been identified as one of the main risks in the implementation of the BRI (Hong, 2016) since the proliferation of overlapping projects is leading to an inefficient allocation of resources. For example, the central government has softened the limitations on municipal bonds for BRI-related projects. Local governments are not authorized to raise bonds beyond 40% of their assets, but they can go over that line, up to 35% more, for financing infrastructure and green projects. All the railway projects connecting China and Europe have been included under that category by the National Development and Reform Commission and the Ministry of Finance. In this context, some scholars have called attention to the “hidden perils” of “vicious competition between various localities in the process of goods train transport between China and Europe” (Huangfu & Wang as cited in Swaine, 2015), which is making more difficult for those railway lines to become profitable. To reverse this situation, some have advocated strengthening joint efforts between central and local governments to make the BRI successful (Chongyang Institute for Financial Studies of Renmin University, 2016).

44  Mario Esteban & Yuan Li The  National Development and Reform Commission (NDRC) is taking steps in that direction, aiming to strike the right balance between competition and coordination among different administrations. For example, in October 2016, a common brand name was employed for all those freight railway lines, the China Railway Express (Zhongguo banlie, 中国班列) (NDRC, 2016). The Yuxinou railway: connecting Chongqing and Duisburg The Yuxinou railway is the first direct railway connection between China and Europe, which connects Chongqing (the largest city of China) with Duisburg (the biggest inland harbor in Europe). This railway line began to operate in 2011, and for a long time, it has been treated as a symbol of the “New Silk Road”. In March 2014, Xi Jinping visited Duisburg to promote the construction of the “New Silk Road Economic Belt”, and at the railway station in Duisburg, he witnessed the arrival of a cargo train from Chongqing. The Yuxinou railway became operative over two years before the official introduction of the BRI in 2013, and, like many marketization reforms in China, it was a bottom-up process pushed by enterprises and local officials. Since 2009, giant notebook computer makers, such as HP, Acer, and ASUS, have settled their manufacturing bases in Chongqing, followed by other major Original Equipment Manufacturer (OEM) companies, such as Foxconn (China Daily, 2014). This made Chongqing a new industrial headquarter for notebook computer production. It is estimated that nowadays one out of three notebook computers sold in the world are from Chongqing, and around half of the computers produced there are sold to the ­European market (Financial Times, 2011). Such a large-scale production needs a smooth, cost-efficient logistic channel to ship the products out for sale. However, unlike eastern coastal provinces in China, Chongqing is located in the western inland region which is far away from deep-ocean transportation harbors that have connections to Europe. The transportation in Chongqing was its bottleneck. Around 70% of the notebook computers were first shipped from Chongqing to Shenzhen and Shanghai by railway and then shipped to Europe by sea, which makes the total transportation time to be nearly two months.5 The transportation time constitutes a significant part of the total cost of IT products according to the famous Moore’s Law. Sometimes the market price of these notebook computers dropped substantially by the time they reached Europe after such a long delivery time. The rest of the products were transported to Europe by air, but the delivery cost was very high. Companies like HP noticed the bottleneck of transportation and were eager to push for innovative solutions in logistics. For example, special teams were set up in the company to research the possibility to use the Eurasian Continental Bridge to ship their products to Europe. However, there were

The New Silk Road  45 so many problems involved in regional and national law and regulation that HP could not implement this plan successfully by itself. On the other hand, the local government of Chongqing, headed by the economic technocrat Huang Qifan, wanted to solve the transportation bottleneck to attract more investors like HP. So, the local government also became a key player in pushing for new ways of transportation. In August 2010, Huang Qifan and Tony Prophet, vice president of HP, went to B ­ eijing to talk to the national authorities from the General Administration of ­Customs and the Ministry of Railways to get their support for the transcontinental railway project connecting Chongqing to Europe. The national authorities in China were very supportive of this project.6 Besides China, the railway project involved many other countries, and in every country, support from the government was necessary to overcome regulatory barriers to advance the project. In Europe, HP coordinated with the Germany rail company, DB Schenker, to promote the transcontinental transportation project. However, sometimes, too many complex issues discussed in multilateral negotiations between countries along the route hindered the whole process. For example, different countries had different customs rules and the trains needed to stop in each country for customs clearance. Only the interference of national governments could solve this kind of a problem. The central government of China responded to the demands from companies like HP and local governments like Chongqing. In November 2010, during the state visit to Russia, Premier Wen Jiabao pushed the initiative and reached an agreement with Russia and Kazakhstan to facilitate the customs clearance procedures which would allow the express trains from China to avoid repeated customs inspection before the goods were shipped to ­Germany. Even so, the whole negotiation process was still long and complex.7 After another two trial runs in 2010, on 19 March 2011, the first train of the Yuxinou railway started to operate. A train packed with electronic goods that were produced in Chongqing successfully arrived in Duisburg after 16 days of travel across six countries. Nowadays, the Yuxinou railway operates regularly between Chongqing and Duisburg. There are five eastbound trains and four westbound trains per week. The transportation time has been shortened to 12 days. Also, Chongqing government has developed similar plans to connect with mainland Southeast Asia, following routes southwards through Kunming. The case of the Yuxinou railway shows several features of the BRI. First, some projects of the initiative are usually bottom-up and not top-down. Second, they largely rely on the market, rather than on political considerations. The Yixinou railway: connecting Yiwu and Madrid In January 2013, also before Xi Jinping presented the Silk Road Economic Belt concept at Nazarbayev University in September 2013, Yiwu began to

46  Mario Esteban & Yuan Li send freight trains to Central Asia looking for increasing its sales to that region. Since then, the government of Yiwu has sponsored other cargo train routes linking Yiwu with countries such as Afghanistan, Iran, Latvia, Russia, Spain, and the United Kingdom. All those railway lines have been presented as BRI projects, even those inaugurated before the BRI was announced.8 The local government of Yiwu has strongly supported the new freight railway lines, as illustrated by the example of the line connecting Yiwu with Madrid, Yixinou, which has received special media attention for becoming the longest rail route in the world (13,052 kilometers). The government of Yiwu has subsidized this line since its creation in November 2014 and has proved its commitment to this project in Spain, sending highlevel delegations to participate in meetings and events with Spanish authorities and business representatives. For example, Yiwu Deputy Mayor, Xiong Tao, participated in the Eighth Spain-China Forum, where he highlighted the business opportunities that come with the Silk Road Economic Belt and in particular with the Yixinou line. Moreover, in March 2016, the government of Yiwu established in Madrid the headquarters of the “Foundation for the Exchange between Yiwu and Spain”, which has been quite active in organizing activities to foster closer ties between Yiwu and Spain. In addition, the government of Yiwu also took other innovative measures to integrate into the national strategy of the BRI, such as implementing foreign exchange administration pilot reforms on individual trade and further performing the individual cross-border trade RMB settlement pilot, as well as planning the construction of a Silk Road new district and a land port new district (Chongyang Institute for Financial Studies of Renmin University, 2016). These actions of the local government of Yiwu were not taken in isolation, but in close cooperation with regional and national authorities. For example, the Zhejiang provincial government has granted Yiwu administrative powers (such as processing visas for foreigners, interior-port status, or a national reform test-area) not enjoyed by another county-level city in China and co-subsidizes the Yixinou line in equal proportion with the authorities of Yiwu (Jacobs, 2016). Also, the then governor of Zhejiang, Li Qiang, visited Madrid in December 2014 to receive the first freight train coming from Yiwu. To avoid competition among cities in Zhejiang, the only cargo railway line supported by the provincial government of Zhejiang through the New Eurasian Land Bridge is the one departing from Yiwu. By doing so, Zhejiang and Yiwu officials hope to strengthen the position of Yiwu as a commercial platform between Southeast China and Europe, in competition with other cities such as Nantong (Jiangsu) and Zhengzhou (Henan), which have developed their cargo railway lines through the New Eurasian Land Bridge. The government of Zhejiang also heads the Office of the Leadership Group in Yixinou, where local, provincial, and central authorities discuss the management of this railway line. The firm support of the national leaders to the BRI is key to understanding the availability of funds for the network

The New Silk Road  47 of railway lines connecting Yiwu with Central Asia, Russia, Europe, and Iran and has been directly expressed to the concerned foreign dignitaries. For instance, during the three times after announcing the BRI that President Xi Jinping has met with the President of the Government of Spain, Mariano Rajoy—during Rajoy’s official visit to China in September 2014, during their bilateral meetings on the sidelines of the G-20 meeting in Hangzhou, and during the First BRI Forum for International C ­ ooperation—Xi mentioned the BRI strategy, with particular emphasis on the Yixinou railway line. Throughout this coordination process among different administrative and governmental levels, the local authorities are also redefining their economic role. For example, in order to adjust to the win-win dynamic emphasized by China’s central authorities,9 the Yiwu local market has been gradually transformed from a single-dimensional export center to a triple-­ dimensional node integrating export, import, and transit trade. In this process, Yiwu is looking for a balance between “bringing in” and “going global” strategies by implementing a proactive import strategy and applying for the establishment of a “provincial level import platform” (Chongyang Institute for Financial Studies of Renmin University, 2016, p. 152).

The potential effects of the BRI for Europe The BRI was announced in 2013, but Central and Eastern Europe were not included until early 2014, and the rest of Europe until early 2015.10 Even if it is therefore too early to make any definitive assessment on the effects of the BRI in Europe, there is already some evidence on how this strategy is influencing EU-China relations. Unlike other countries with bigger strategic rivalry with China, the ­European governments are much more interested in the economic than in the geostrategic implications of the BRI, since China’s growing economic and political influence is not regarded as a threat in itself. In the words of the president of the European Commission, Jean-Claude Juncker: The European Union is a strong and reliable partner for China and our economies are ever more intertwined, to our mutual benefit (…) Let me say we take note with interest of China’s ‘One Belt One Road’ initiative. It is the kind of strategic thinking from which both Asia, China and Europe could benefit. We see the project as an open hand, an invitation to connect China and Europe better than ever before (…) A first step is the connectivity platform we will launch today. It will allow us to combine forces – uniting the expertise and strength of our companies to develop-high quality infrastructure, create new jobs in Europe, China, and Asia, and build bridges between our two continents along the old silk road. (Juncker, 2015)

48  Mario Esteban & Yuan Li This was also reflected at the Member State level when 9 of the 10 biggest EU economies joined the Asian Infrastructure Investment Bank (AIIB) as founding members, and in the very significant high-level political representation EU states sent to the Belt and Road Forum in May 2017, where they comprised over 20% of the total participating heads of state and governments.11 Keeping the emphasis on the economic dimension, especially increasing trade and finance flows, the main economic goal for China is to cooperate with Europe under the BRI framework. Trade creation effects of the BRI will likely be significant for both EU and China since BRI aims to eliminate bottlenecks in transport routes between Europe and China (NDRC, 2015). The planned reduction of the transaction costs would also be realized through institutional liberalization and harmonization. So far, EU imports from China have jumped from 16.6% of its total extra-EU exports in 2013, the year the BRI was announced, to 20.2% in 2016. Similarly, EU exports to China have mounted from 8.5% to 9.7% in the same period (Table 2.1). The China-Europe express trains are an iconic example of the BRI projects for boosting China-Europe trade. So far, the impact of these new railway lines on the volume of commercial exchanges between China and Europe is quite limited, only 17 billion dollars since 2011 and the first half of 2016, and has not helped to balance the bilateral trade; however, this is starting to change, since in the first half of 2016, the number of inbound trains to China increased 318% year-on-year (Xinhuanet, 2017b). Li et al. (2018) conducted a detailed empirical analysis of the impact of the China-­ Europe express on China-Europe trade and found that it has a positive effect on China’s exports to its trading partners, especially the export of manufactured goods, machinery and transport equipment, and miscellaneous manufactured articles. Moreover, it does not have any significant effect on China’s imports from its trading partners, except for the import of food and live animals. Table 2.1  EU Trade Flows and Balance Year

2010 2011 2012 2013 2014 2015 2016

Imports (Mill. €)

Exports (Mill. €)

Value

% Extra-EU

Value

% Extra-EU

283,931 295,055 292,122 280,15 302,149 350,64 344,468

18.5 17.1 16.2 16.6 17.9 20.3 20.2

113,454 136,415 144,227 148,115 164,623 170,257 170,083

8.4 8.8 8.6 8.5 9.7 9.5 9.7

Balance (Mill. €) −170,477 −158,61 −147,895 −132,035 −137,526 −180,283 −174,385

Source: European Union, Trade in goods with China European Commission (2017, p. 3).

The New Silk Road  49 In addition, these new railway lines are favoring a new round of institutional change which facilitates trade between China and the EU. For example, Spanish authorities have taken advantage of the momentum created by the BRI to intensify negotiations with their Chinese counterparts to finalize trade agreements related to products that could be transported by train. Thanks to successful diplomatic efforts to change phytosanitary regulations, in April 2016, Spain became the first European country allowed to export plums and peaches to China, and there are talks for concluding similar deals for other products. Currently, the Spanish authorities are negotiating specific protocols with their Chinese counterparts to eliminate phytosanitary non-tariff regulatory barriers for several products such as Spanish serrano ham (including on the bone) and seedless grapes. Some important advances in customs procedures have been agreed on too. For example, Yiwu Customs has opened a special cross-border “green channel”, which provides inspection, release, verification, customs clearance, and other onestop clearance services for the goods coming from Madrid by train. In addition, China and Spain are negotiating a trade facilitation agreement, which is expected to reduce the time needed for clearing customs procedures.12 Besides trade creation effects, the BRI may generate positive economic spillover effects due to higher growth rates and income levels in Asia, especially in the vast hinterland region between East Asia and Europe, which will be translated into higher demand for EU products. Moreover, the positive implications of trade for economic growth are not limited to countries that run surpluses since countries can benefit from technology transfers and other efficiency gains associated with international trade, as the availability of relatively low-cost products from China raises consumption and production possibilities in EU countries (Coe & Helpman, 1995). The BRI could also generate spillover effects on GDP growth of the EU through financial linkages. The BRI could enhance regional integration across Eurasia, which would offer European suppliers more scope for participating in the “Asian Factory”, that is cross-border value-added chains. Many countries covered by the BRI are mostly low-income economies. They have greater potential to grow rapidly, but lack the required capital, technology, and know-how. Chinese and European companies can work together on jointly investing in the inland areas between Europe and East Asia. Such investments will help these countries in creating more (and better) jobs, as well as in increasing exports, and in upgrading their industrial capabilities (Li, 2017). Therefore, the successful economic integration and development of the hinterland region along the BRI could create new markets for EU exports and FDI. On the other hand, the BRI may increase Chinese investment in Europe, especially in industries such as ICT, utilities, transport and infrastructure, and energy (Hanemann & Huotari, 2017, p. 7). The chapter “The Belt and Road Initiative and Sino-European Economic Cooperation” by Chen and Liu, and the chapter “The Belt and Road Initiative – Trade and Investment

50  Mario Esteban & Yuan Li Perspectives for EU and New Partnerships Along the New Silk Road” by Ilhéu offer more detailed analysis on the significant impacts of the BRI on Europe and the reaction of European countries.

Conclusion Like many other reforms in China, the creation of the BRI-related projects, such as the new Silk Road railway lines across the New Eurasian Land Bridge, was a mix of the bottom-up and top-down processes. The official narrative on the BRI and its institutional structure suggest that this is mainly an economic initiative, and it is quite apparent that its implementation will deepen economic integration between Asia and Europe, which will affect the overall economic market (goods, service, capital, labor, etc.), the production process, as well as all the economic sectors and players (consumers, producers, government, etc.). However, the significant economic leverage that China earns in the framework of this strategy can be translated into substantive geostrategic repercussions (Zhou & Esteban, 2018). It remains a tremendous challenge to forge a platform for multi-sectoral cooperation among such diversified players and to generate synergies between their actions. This only could be achieved through multilateral cooperation among the participant countries. The Joint Communiqué of the Leaders Roundtable of the Belt and Road Forum could be an encouraging sign for it: We reiterate the importance of expanding economic growth, trade, and investment based on level-playing field, on market rules and on universally recognized international norms (…) Recognizing the role of the market and that of business as key players, while ensuring that the government performs its proper role and highlighting the importance of open, transparent, and non-discriminatory procurement procedures. We endeavor to expand people-to-people exchanges, promote peace, justice, social cohesion, inclusiveness, democracy, good governance, the rule of law, human rights, gender equality and women empowerment; work together to fight against corruption and bribery in all their forms; to be more responsive to all the needs of those in vulnerable situations such as, children, persons with disabilities and older persons; and help improve global economic governance, and ensure equal access by all to development opportunities and benefits. (Ministry of Foreign Affairs of the People’s Republic of China, 2017b)

Notes 1 Mario Esteban would like to thank the Spanish Ministry of Economy, Industry and Competitiveness for supporting this research (I +D project CSO201782921-P).

The New Silk Road  51 2 For a more detailed discussion of the geostrategic repercussions of the BRI, see Zhou and Esteban (2018). 3 The BRI as an open and inclusive initiative is not limited to the 65 countries; please see the list of BRI countries at Hong Kong Trade Development Council, http://beltandroad.hktdc.com/en/country-profiles/country-profiles.aspx. 4 Xi Jinping and Premier Li Keqiang have also stressed the mutual benefit orientation of the BRI in their speeches during official visits to foreign countries, for example, to EU member states (See Van der Putten et al., 2016). The official action plan of the BRI has underlined the same idea too, National Development and Reform Commission, Ministry of Foreign Affairs, and Ministry of Commerce of the People’s Republic of China 2013. 5 Interview conducted at Chonqginq, March 2016. 6 Interview with local officials in Chonqginq, March 2016. 7 Interview with local officials in Chonqginq, March 2016. 8 Interview at the Yiwu Logistics and Port Authority, 15 November 2016. 9 Although China seems confident that its economic size and dynamism will make it a major beneficiary of any removal of barriers to trade and investment or improvement in the communications efficiency along the BRI, it is also aware that collaboration of the other countries is essential for this initiative to be successful. Xi Jinping himself has reiterated this point a few times, for example, in the opening of the Belt and Road Forum celebrated in Beijing in May 2017 (Xinhua Net, 2017b). 10 Two official documents marked this gradual inclusion of Europe in the BRI: The Joint Document of China-CEEC Ministerial Meeting on Promoting Trade and Economic Cooperation and The Vision and Actions on Jointly Building Silk Road Economic Belt and 21st-Century Maritime Silk Road. For more details see Zeng Jinghan (2017), pp. 1169–1172. 11 Belgium was the only top 10 EU economy that did not join the AIIB, and 6 out of the 29 heads of government and state who participated in the Belt and Road Forum were from EU member states. 12 Interviews with Spanish trade officials in Madrid and Beijing, and with Chinese diplomats in Madrid.

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3 Can the Belt and Road Initiative promote the catching-up of China’s West and South-West? Giovanni Ferri, Li-Gang Liu, Camilla Mastromarco & Laura Serlenga Introduction While most pundits view the Belt and Road Initiative (BRI) as a strategy mostly, if not exclusively, dominated by China’s need to reshape its foreign policy (see, e.g., Paal, 2013; Rolland, 2017), some commentators underline that it has also an important domestic policy dimension, namely, the BRI also aims at developing the Western parts of China, which have been left behind by the eastward export-oriented strategy of the last four decades (see, e.g., Ferdinand, 2016; Cai, 2017). Focusing on the latter dimension, in this chapter, we address one of the channels through which that might be achieved. Our channel concentrates on the evolution of efficiency in production and we study the possibility that efficiency in laggard areas might catch up with that typical of more advanced areas. Specifically, we ask the following question. Can the BRI help promote the development of China’s Western and South-Western provinces via technological spillovers induced by convergence clubs? To answer the question, we analyze technical efficiency of individual Chinese manufacturing firms in the SF framework considering spatial correlation. To deal with both weak and strong cross-sectional dependence in a flexible way, we follow Mastromarco et al. (2015) blending time and cross-sectional dependence in modeling technical efficiency in SF models by combining the exogenously driven factor-based approach and an endogenous threshold efficiency regime selection mechanism. Overall, we find (i) evidence of positive spatial spillover effects among endogenously determined networks of firms; (ii) those spillover effects on efficiency—leading to technological catching-up—stand out even when we calculate the correlation between inefficiency and the provincial GDP per capita and the railway infrastructure endowment of the province, where the latter two variables associate with lower inefficiency; and (iii) the pro-­ efficiency effects of the endowment of railway infrastructure seem to be stronger in less-developed provinces.

56  Giovanni Ferri et al. Hence, we conclude that, by reducing space barriers, the BRI could be really effective at helping bridge the development gap of China’s Western and South-Western provinces, potentially benefiting one-fourth of the Chinese.1 Though the initiative involves large infrastructure investment in other areas of China as well, this part of the country seems, in fact, the one which could benefit the most from the BRI. The rest of the chapter is organized as follows. The section “Background facts and literature” summarizes the basic facts about the lower economic development of China’s Western and South-Western provinces and underlines how economic underdevelopment is somewhat related to lack of transport infrastructure. In the section “Methodology”, we introduce our methodology of analysis. The section “Empirical application” describes the data that we use in our econometric estimates. Then, it reports and comments on the main results of our empirical analysis. Finally, the section “Conclusions and policy implications” recaps and addresses the chief policy implications of our results.

Background facts and literature It is well known that China’s Western and South-Western provinces still experience a noticeable GDP per capita gap with respect to the rest of China. For example, the relative per capita provincial GDP ranking for 2010 positioned in the lower rungs all of the Western and South-Western provinces of China (Table 3.1, column 4). Also, these disadvantaged provinces don’t seem to be able to grow faster than the more affluent provinces, and so close up their inherited GDP per capita gap. For instance, the provincial share of GDP growth in 2014 fell in the lower rungs for all Western and South-Western provinces, with the only exception of Sichuan, the fourth most populous among the Chinese provinces (Table 3.1, column 5). Table 3.1  GDP Per Capita Rankings (2010) and Provincial Share of GDP Growth (2014) Province

Area

Population GDP per Provincial share of in millions capita rankings GDP growth (2014) (2010) (2010)

1 – Beijing 2 – Tianjin 3 – Hebei 4 – Shanxi 5 – Inner Mongolia 6 – Liaoning 7 – Jilin 8 – Heilongjiang 9 – Shanghai

East East East Center Center (North) East East East East

19.6 12.9 71.9 35.7 24.7

1–2 3–4 11–12 17–18 5–6

Between 1% and 4% Between 1% and 4% Between 4% and 7% Between 1% and 4% Between 1% and 4%

43.7 27.5 38.3 23.0

7–8 11–12 15–16 1–2

Between 4% and 7% Between 1% and 4% Between 1% and 4% Between 1% and 4%

Can China’s West and Southwest catch up?  57 Province

Area

Population GDP per Provincial share of in millions capita rankings GDP growth (2014) (2010) (2010)

10 – Jiangsu 11 – Zhejiang 12 – Anhui 13 – Fujian 14 – Jiangxi 15 – Shandong

East East Center East Center East

78.7 54.4 59.5 36.9 44.6 95.8

16 – Henan 17 – Hubei 18 – Hunan 19 – Guangdong 20 – Guangxi 21 – Hainan 22 – Sichuan & Chongqing

Center Center Center East West West West

94.0 57.2 65.7 104.3 46.0 8.7 80.4 & 28.8

23 – Guizhou 24 – Yunnan 26 – Shaanxi 27 – Gansu 29 – Ningxia 30 – Xinjiang

West West West West West West

34.7 46.0 37.3 25.6 6.2 21.8

3–4 5–6 25–26 9–10 23–24 9–10 21–22 13–14 19–20 7–8 27–28 23–24 25–26 & 13–14 31 29–30 15–16 29–30 17–18 19–20

Over 10% Between 4% and 7% Between 1% and 4% Between 1% and 4% Between 1% and 4% Between 7% and 10% Between 4% and 7% Between 4% and 7% Between 4% and 7% Over 10% Between 1% and 4% Less than 1% Between 4% and 7% and between 1% and 4% Between 1% and 4% Between 1% and 4% Between 1% and 4% Between 1% and 4% Less than 1% Between 1% and 4%

Source: Our calculations on NBS data.

Among the others, Hao and Wei (2010) investigate the fundamental causes of the widening inland-coastal inequality in China during 1978–2004. They stress three inequality-enhancing policy—globalization, decentralization, and marketization—in determining the income gap between the inland and coastal regions. While finding significant but economically small spillover effects from the coastal to inland provinces, the authors suggest that more efforts should be made to improve the policies to reduce regional inequality in China. In turn, Ouyang and Fu (2012) examine the extent and possible mechanisms by which spatially concentrated FDI boosts economic growth in other regions. They find that “inter-regional spillovers” from FDI concentrated in China’s coastal regions have a positive and significant effect on the growth of inland regions. In addition, such spillovers rely on an inland city’s industrial development, consistent with a role for backward and forward linkages. Jefferson et  al. (2008) find an exceptional contribution to China’s industrial productivity growth made by exiting and entering firms, much of which is associated with restructuring. During 1998–2005, the phenomenon of firm exit and entry contributed substantially to China’s overall industrial productivity growth, to the relatively rapid growth of state industry productivity, and to substantial productivity catch-up with the coastal region by many of the interior provinces. Finally, something important for our

58  Giovanni Ferri et al. analysis later in the chapter, Tian et  al. (2010) employ spatial econometric techniques to empirically assess the growth performances of Chinese prefectures in the period 1991–2007. They find strong evidence of positive spatial dependence between Chinese prefectures after 1991. Also, spatial convergence clubs are detected and the spatial interactions and growth behavior is found to vary. Something that is also known is that Western and South-Western provinces experience a gap in terms of transport infrastructure endowments. That is the case if we look at the map of the diffusion of all types of transport infrastructure throughout China and even more so if we focus on railway lines only (Table 3.2). The causal link going from poor infrastructures to less economic growth has been repeatedly noticed for China’s provinces (Demurger, 2001; Zhang, 2007; Pravakar et  al., 2010; Banerjee et  al., 2012). Along these lines, after documenting the sizable disparities across China’s provinces and showing that those disparities are not disappearing, Fan et  al. (2011) propose the broad outline of a strategy to harmonize growth and regional equity based on three key elements: infrastructure, social investment and protection, and governance reform. Also, Sahoo et  al. (2010) investigate the role of infrastructure in promoting economic growth in China for the period 1975–2007. They find that infrastructure development in China has a more significant positive contribution to growth than both private and public investment. Further, there is unidirectional causality from infrastructure development to output. Accordingly, the authors advocate designing an economic policy that improves the physical infrastructure. In turn, Hong et al. (2011) study the nexus between transport infrastructure and regional economic growth for 31 Chinese provinces in the period between 1998–2007. They show strong evidence that transport infrastructure plays an important role in economic growth. Their retrospective analysis shows that uneven distribution of transport infrastructure is an important reason behind economic disparities across Chinese regions. On their part, Yu et al. (2012) find a significant Table 3.2  Distribution of Railway Infrastructure (Km of Railway by Km 2 of Surface) Infrastructure Km of railway by Provinces class (increasing) Km 2 of surface 1 2 3

X < 0.05 0.05 < X < 0.53 0.53 < X < 1.29

4

1.29 < X < 1.57

5 6

1.57 < X < 2.56 2.56 < X

Source: Our calculations on NBS data.

Hainan, Inner Mongolia, Tibet, Xinjiang Beijing, Qinghai, Shanghai, Tianjin Gansu, Guangdong, Guangxi, Guizhou, Heilongjiang, Ningxia, Sichuan, Yunnan Chongqing, Fujian, Hubei, Hunan, Jiangxi, Shaanxi, Zhejiang Anhui, Jiangsu, Jilin, Shandong, Shanxi Hebei, Henan, Liaoning

Can China’s West and Southwest catch up?  59 spatial variation in the productivity effects of transport infrastructure in a sample of 28 Chinese provinces and municipalities in the period between 1978–2008. They recommend that China should give priority to the development of transport facilities in the backland region to realize the rise of Central China. Instead, Yu et al. (2011) study the causal linkages between transport infrastructure investment and economic growth in China. Analyzing causality in a panel cointegration and a Granger causality framework for the period betwen 1978–2008, at the regional level, they find a long-run bidirectional causality in the affluent Eastern regions, while the low-income Central and Western regions exhibit unidirectional Granger causality from economic growth to transport infrastructure. Thus, they argue that an improvement in transport infrastructure alone is not sufficient for stimulating economic growth in the underdeveloped areas of China. Finally, Wang et al. (2014) study the impact of transport infrastructure on economic growth in China’s provinces for the period 1990–2010. They find that transport infrastructure has positive spillover effects on economic growth, though these became weaker with time. Finally, spatial spillover effect or network effects are also confirmed. Thus, it should not go unnoticed that any policy which tries to improve the infrastructure endowment in the less affluent provinces might favor a development catching-up across China. Since it is expected that the BRI will help partly upgrade the infrastructure endowment of Western and South-Western provinces through the creation of regional hubs and clusters (Rolland, 2015), it is also logical to anticipate that the BRI will have a favorable impact on stimulating stronger growth in those less favored regions. This argument might be even reinforced by the policy promoting high-speed railway transport services through China (see, e.g., Wang et al., 2012; Cao et al., 2013; Shaw et al., 2014). It is our contention that this favorable impact might be much larger than expected because of a specific but potentially very important effect, that is, if technological progress materializes to a large extent via spillovers induced by spatially determined convergence clubs. Then it becomes important to test that these spillovers have been present as factors explaining past convergence in efficiency levels across China. This is exactly the task undertaken in the later sections of this chapter. Indeed, the spreading out of technological innovation—as emphasized by the Schumpeterian growth view (e.g., Aghion & Howitt, 1998)—and the presence of agglomeration economies—as underlined by the new economic geography theory (e.g., Krugman, 1991)—are at the heart of convergence both across countries and regions. For example, Howitt and Mayer-Foulkes (2002) propose a Schumpeterian growth theory consistent with the divergence in per-capita income experimented across countries since the mid19th century, and with the convergence that occurred among the richest countries during the second half of the 20th century. They postulate that technological change underwent a transformation late in the 19th century,

60  Giovanni Ferri et al. associated with modern R&D labs. Countries sort themselves into three groups. Those in the highest group converge to a steady state where they do leading-edge R&D, while those in the intermediate group converge to a steady state where they implement technologies developed elsewhere. Countries in both of these groups grow at the same rate in the long run, as a result of technology transfer, but inequality between them increases during the transition. Countries in the lowest group grow at a slower rate. In their view, once modern R&D has been introduced, a country may have only a finite window of opportunity in which to introduce the institutions that support it. In turn, various scholars find evidence of regional convergence clubs within Europe (e.g., Baumont et al., 2003; Bartkowska & Riedl, 2012) and the USA (e.g., Rey & Montouri, 1999; Young et al., 2008). The presence of convergence clubs has been studied also across the various provinces of China. Unfortunately, differently from what was generally found for Europe and the USA, the evidence for China is conflicting. Some studies find evidence of different types of spatial convergence (e.g., Zhang et  al., 2001; Kunrong & Jun, 2002). On the contrary, other works highlight evidence suggestive of divergence across provinces (e.g., Yao and Zhang, 2001; Pedroni & Yao, 2006). Undeniably, the fact that different authors—­often referring to analogous time periods—reach opposite conclusions about economic convergence or divergence across China suggests that methodology is crucial.

Methodology An issue of heterogeneous club convergence has been extensively studied in the literature, for example, by Quah (1997), Le Gallo and Ertur (2003), and Canova (2004), though most studies employ the selection mechanism in a rather arbitrary manner. Instead, as in Mastromarco et al. (2015), we attempt to identify efficiency clubs endogenously in the framework of the SF literature. In what follows we adopt the SF approach, which builds on the concept of the boundary of production set and allows to identify inefficiencies in production (Kumbhakar & Lovell, 2000). In particular, this approach allows us to identify both inefficiency, the distance from the frontier that reflects the sluggish adoption of new technologies—that is, a direct measure of the potential technology transfer—and efficiency improvement that represents productivity catch-up via technology diffusion. Indeed, by means of the SF methodology, we examine productivity differences and estimate efficiency improvements. We analyze the determinants of the catching-up effect toward the frontier, the determinants of efficiency (forces that drive productivity catch-up from technology diffusion among countries/provinces), and the role of factor accumulation and technological change on efficiency. The proposed measure of efficiency will be employed to consistently estimate efficiency for cross-province comparisons.

Can China’s West and Southwest catch up?  61 The model we employ is the following,

( )

yit = ry yit ry + bxit +  e it e it = vit − uit

(1) (2)

)

)

uit = max (a i + ru uit ( ru ) + li′t − (a i + ru uit ( ru ) + li′t i

N

( )

1 mit

∑(y

uit ( ru ) =

1 mit

∑I ( u

yit ry =

it −1 −

)

(3)

)

(4)

y jt −1 < ry yit −1

j =1 N

* t −1 − u jt −1

j

(2a)

≤ ru u jt −1

where equation (1) represents the typical production function with output y and inputs x. The additional element yit ry represents a cluster effect which is equal to the average of enterprises that are close to each other, while the ry is a threshold parameter which is endogenously determined following the Hansen (2000) procedure. We estimate this additional element by Kapetanios et al. (2014), KMS hereafter. Importantly, including yit ry in the production function allows us to estimate the spatial spillover effects given by networks of firms that produce similar levels of output, which is represented by ry . Furthermore, a i is (unobserved) individual-specific effect, t is a time trend with heterogeneous loading, uit ( ru ) represents a cluster effect which is equal to the average of efficient enterprises that are close to the frontier with ut* −1 = min j u jt −1 , and vit is an idiosyncratic disturbance. In line with Mastromarco et al. (2015), ru is the threshold parameter (determined endogenously) and ut* −1   is the efficiency of the best performing enterprise at time t − 1. Notice that the term ut* −1 may be thought of capturing the cross-sectional local average of the best or the common technology, and the past average value of efficiency spillover from the best units forms the systematic or expected scores. This enables us to address the spatial spillover effects such as the diffusion of new technologies. A priori, we expect that such externalities can be captured by a negative value of ru . Furthermore, the extended approach in (4) can also identify heterogeneous technology clubs such as the frontier cluster formed by technology-­ leading countries and the other group of countries substantially below the frontier.2

( )

( )

(

)

Empirical application The data We employ the following enterprise-level data to run our estimates. Based on 2001–2007 National Bureau of Statistics (NBS) data, we analyze a

62  Giovanni Ferri et al. balanced panel from 2001 to 2007 for 28 provinces. Our data consist of the extensive database of the NBS that contains about 300,000 industrial firms with annual sales of more than 500 million yuan. The NBS started to conduct a census on this category of firms in 1998, with an initial firm number of 160,000 and gradually increasing to the current number. It is estimated that the firms included in this census represent about 80% of all industrial value-added activities among the total Chinese firms. Our main results Our econometric specification adopts a two-step method. In the first step, we estimate (1) by KMS. Here, the dependent variable is the log of value added, the independent variables are the log of the labor force employed at the firm (L), log of the firm’s capital (K), a dummy taking one for ­Chinese state-owned enterprises (SOE), a dummy taking 1 for Hong Kong-, ­Taiwan-, ­Macau-owned enterprises (HKMT), a dummy equal to one for foreign-owned enterprises (FOE), a dummy equal to one when the average number of workers is greater than 50 (DIM), and a time trend. All the ownership dummies are derived according to the classification proposed in Ferri and Liu (2010) and Ferri et al. (2013).3 In the second step, we compute inefficiency by equation (2) and estimate uit ( ru ) by KMS, as in Mastromarco et al. (2015). Table 3.3 shows results for each province. In the first step, the log of labor, the log of capital, and the trend are always significant—the only exception being capital in Jilin, Gansu, and Ningxia—and show the expected sign. Also, ry is always significant and positive, providing evidence of positive spatial spillover effects among endogenously determined networks of firms. At the same time, when significant, the effect of both dummies SOE and DIM are generally negative 4 (lower efficiency), whereas the effect of both the dummies for HKMT-owned enterprises and that for FOE often shows a positive coefficient5 (higher efficiency). This is generally in line with the evidence shown in Ferri, Liu and Mastromarco (2013). As expected, results of the second step show that the values of ρu are negative and significant for all the provinces. Next, in order to analyze the nexus between economic development, efficiency convergence clubs, and infrastructures, we estimate model (1) and (2) for the entire data set and then consider the correlation among the derived estimates of inefficiency, provincial GDP per capita, and length of railways in kilometers in the province. Table 3.4 shows results of the estimates of (1) and (2) for the entire panel. Evidence generally follows what is shown in single provinces. Table 3.5 presents results of correlation between our consistent measure of inefficiency derived as in (2a), and the log of provincial GDP per capita and the log of railways kilometers with province dummies. The negative value of provincial GDP on

0.132*** 0.127*** 0.087*** 0.080*** 0.082*** 0.053*** 0.108*** 0.085*** 0.163*** 0.115*** 0.166*** 0.099*** 0.147*** 0.062*** 0.134*** 0.046*** 0.148***

0.133*** 0.079*** 0.111*** 0.115*** 0.118*** 0.068***

0.128*** 0.132*** 0.174*** 0.106*** 0.185*** 0.170*** 0.198*** 0.116*** 0.235*** 0.220*** 0.213*** 0.121*** 0.230*** 0.186*** 0.222*** 0.224*** 0.197***

0.206*** 0.183*** 0.169*** 0.090*** 0.157*** 0.094***

2.760*** 2.705*** 3.739*** 5.718*** 4.136*** 4.155***

3.386*** 4.737*** 4.488*** 4.482*** 3.382*** 2.812*** 2.861*** 3.615*** 3.303*** 3.469*** 3.226*** 4.477*** 3.765*** 3.752*** 3.326*** 1.656*** 3.356***

3.623*** 4.307*** 3.042*** 2.316*** 3.358***

cons

***Statistical significance at 1% level of confidence. **Statistical significance at 5% level of confidence. *Statistical significance at 10% level of confidence.

0.028*** 0.070*** 0.096*** 0.048*** 0.112***

0.161*** 0.038** 0.237*** 0.231*** 0.282***

1 – Beijing 2 – Tianjin 3 – Hebei 4 – Shanxi 5 – Inner Mongolia 6 – Liaoning 7 – Jilin 8 – Heilongjiang 9 – Shanghai 10 – Jiangsu 11 – Zhejiang 12 – Anhui 13 – Fujian 14 – Jiangxi 15 – Shandong 16 – Henan 17 – Hubei 18 – Hunan 19 – Guangdong 20 – Guangxi 21 – Hainan 22 – Sichuan & Chongqing 23 – Guizhou 24 – Yunnan 26 – Shaanxi 27 – Gansu 29 – Ningxia 30 – Xinjiang

trend

rho

Province

First-step production function

0.482*** 0.506*** 0.497*** 0.313*** 0.597*** 0.416***

0.499*** 0.537*** 0.394*** 0.462*** 0.454*** 0.602*** 0.485*** 0.559*** 0.441*** 0.411*** 0.401*** 0.482*** 0.359*** 0.472*** 0.546*** 0.344*** 0.458***

0.499*** 0.646*** 0.477*** 0.432*** 0.390***

L

0.158*** 0.175*** 0.112*** 0.047 0.015 0.181***

0.184*** 0.032 0.099*** 0.126*** 0.173*** 0.157*** 0.168*** 0.148*** 0.102*** 0.155*** 0.172*** 0.104*** 0.108*** 0.115*** 0.062*** 0.253*** 0.124***

0.145*** 0.098*** 0.133*** 0.220*** 0.108***

K

Table 3.3  First- and Second-step Regressions (Province Level)

−0.052 −0.099 −0.057 −0.040 0.020 0.044

0.054 −0.164* −0.096 −0.075* −0.098*** −0.094* −0.053 −0.121* −0.082 0.050 0.017 −0.170*** −0.218*** 0.025 −0.063 −0.115 −0.082

0.058 −0.197* −0.041 −0.016 −0.110

SOE

0.129 0.208 0.332* 0.181 0.398 0.516

−0.052 −0.328* 0.150 0.107* 0.079*** 0.019 −0.007 −0.105* 0.075 0.089* 0.245* 0.077 −0.080 −0.025 −0.012 −0.163 −0.056

0.106 −0.228* −0.007 0.012 −0.137

HKMT

0.243* 0.108 0.123 −0.224 1.396*** 0.442*

−0.064 −0.501*** 0.023 0.016 0.044 0.078*** 0.011 −0.104* −0.112 0.051 −0.082 −0.039 −0.229* −0.005 0.075 0.319 −0.195*

−0.027 −0.118 −0.115 0.025 0.154

FOE

−0.131 0.118 −0.167* 0.018 −0.216 −0.069

−0.168*** −0.101 −0.167* −0.100*** −0.056*** −0.070*** −0.008 −0.034 −0.015 −0.038 −0.072* −0.116** −0.001 −0.087*** −0.029 1.137*** 0.025

−0.074* −0.060 0.006 0.163* 0.102

DIM

trend

cons

−0.096*** 0.157*** −0.432*** 0.003 −0.836*** 0.287*** −0.427*** 0.180*** −0.349*** 0.031* −0.235*** −0.056***

1.476*** 2.704*** 2.267*** 1.614*** 1.502*** 1.956***

−0.661*** 0.182*** 2.790*** −0.663*** 0.176*** 2.492*** −0.503*** −0.148*** 2.920*** −0.026*** 0.180*** 1.547*** −0.037*** −0.019*** 2.161*** −0.049*** 0.153*** 1.716*** −0.246*** 0.162*** 1.495*** −0.028*** 0.218*** 1.417*** −0.602*** 0.096*** 2.219*** −0.020* 0.188*** 1.593*** −0.217*** 0.091*** 2.171*** −0.042*** 0.003 1.642*** −0.490*** −0.120*** 2.860*** −0.233*** 0.200*** 2.219*** −0.069*** 0.085*** 1.524*** −0.207* 0.005 1.564*** −0.436*** 0.029*** 2.445***

−0.023*** −0.071*** 1.949*** −0.228*** −0.235*** 3.600*** −0.035*** −0.073*** 2.251*** −0.618*** 0.034*** 1.844*** −0.247*** 0.094*** 1.479***

rho

Second-step inefficiency

64  Giovanni Ferri et al. Table 3.4  First- and Second-step-Regressions (Panel) Dependent variable: First-step regression production Explanatory variables

Coefficient

Standard error

T ratio

Rho Trend Constant L K SOE HKMT FOE DIM

0.185*** 0.086*** 3.435*** 0.489*** 0.137*** −0.071*** 0.046* 0.010 −0.065***

0.005 0.001 0.061 0.009 0.006 0.020 0.024 0.026 0.015

35.647 62.465 55.911 55.631 23.857 −3.557 1.860 0.378 −4.261

Dependent variable: Second-step regression inefficiency Explanatory variables

Coefficient

Standard error

T ratio

Rho Trend Constant

−0.045*** 0.025*** 2.452***

0.004 0.002 0.006

−12.344 14.072 416.707

***Statistical significance at the 1% level of confidence. *Statistical significance at the 10% level of confidence.

Table 3.5  Correlation between Inefficiency, GDP Per Capita, and Rail Infrastructure

Lgdp Lrail Lgdprail

Coefficient

Standard error

T ratio

−0.642*** −0.162***   0.341***

0.069 0.023 0.022

−9.350 −7.180 15.400

***Statistical significance at 1% level of confidence.

inefficiency shows that economic growth generally sustains efficiency. In addition, the level of railway infrastructure is also significantly correlated to efficiency. More importantly, when considering an interaction variable between the GDP per capita and the endowment of railways, the correlation shows a positive and significant effect. This implies that the pro-efficiency effect of the rail infrastructure endowment is higher in less-developed provinces. Table 3.6 shows that our measure of efficiency concurs with the distribution of infrastructure and railway line (Table 3.2), with Western and South-Western provinces generally experiencing low efficiency.

Can China’s West and Southwest catch up?  65 Table 3.6  Distribution of Efficiency Efficiency class Efficiency (increasing) score

Provinces

1

X < 0.2307

2

0.2307 ≤ X < 0.2388 0.2388 ≤ X < 0.2466 0.2466 ≤ X

Chongqing, Gansu, Guizhou, Henan, Hunan, Inner Mongolia, Jiangxi, Sichuan Anhui, Guangxi, Hubei, Liaoning, Qinghai, Shaanxi, Shandong Fujian, Heilongjiang, Jiangsu, Jilin, Ningxia, Yunnan, Zhejiang Beijing, Guangdong, Hainan, Hebei, Shanghai, Shanxi, Tianjin, Xinjiang

3 4

Source: Calculations based on our estimates.

Conclusions and policy implications The BRI has been viewed by many experts as a strategy mostly, if not exclusively, dominated by China’s need to reshape its foreign policy (see, e.g., Paal, 2013; Rolland, 2017). In this vein, some commentators have also stressed how the ability of China to launch the Asian Infrastructure Investment Bank—a new multilateral Development Bank which is going to be functional to support the BRI—with worldwide qualified participation, in spite of the fierce opposition from the USA, is a clear signal that the global leadership is being reshaped (see, e.g., Summers, 2015). Other pundits, however, have underlined that the BRI contains an important domestic policy dimension as well. In particular, it also aims at developing various parts of China—such as the Western and South-­ Western provinces—which had been less involved by the eastward export-­oriented strategy of the last four decades (see, e.g., Ferdinand, 2016; Cai, 2017). In this chapter, we have focused on the latter view. Specifically, we have addressed one of the channels through which the catching-up of the less affluent parts of China—notably, the Western and South-Western provinces— might be achieved. Our channel of growth transmission concentrated on the evolution of efficiency in production, and we investigated the possibility that efficiency in laggard provinces might catch-up with that typical of more advanced provinces. We asked the following question. Can the BRI help promote the development of China’s less developed areas— especially, the Western and South-Western provinces—via technological spillovers induced by convergence clubs? Our answer to that question was based on studying technical efficiency of individual Chinese manufacturing firms in the SF framework considering spatial correlation. We proposed tackling both weak and strong cross-­sectional dependence in a flexible way. To that end, we followed Mastromarco et al. (2015) blending time and cross-sectional dependence in modeling technical efficiency in SF models by combining the exogenously driven

66  Giovanni Ferri et al. factor-based approach and an endogenous threshold efficiency regime selection mechanism (Kapetanios et al., 2014). Our main findings may be synthesized as follows. First, we found evidence of positive spatial spillover effects among endogenously determined networks of firms. Second, those positive spillover effects on efficiency— leading to technological catching-up—stood out even when we controlled for the provincial GDP per capita and for the railway infrastructure endowment of the province, where the latter two variables associated with lower inefficiency. Third, the pro-efficiency effects of the endowment of railway infrastructure seemed to be stronger in the less-developed provinces. Overall, our evidence supports a few policy conclusions. In the first place, the BRI might be, indeed, particularly beneficial for bridging the development gap through China—particularly in the Western and South-Western provinces—with respect to the more affluent provinces of the country. We reminded, in fact, that the GDP per capita gap across China’s provinces largely overlaps with the cross-provincial gap in terms of transport infrastructure. In that respect, with its westbound projection, the BRI would help boost the transport infrastructure endowment of the up-to-now disadvantaged Western and South-Western provinces. Our results, as a matter of fact, not only confirmed the pro-growth effect of railway infrastructure but showed that such effect is stronger in less-developed areas. Though the initiative involves large infrastructure investment in other areas of China as well, the Western and South-Western provinces including almost one-fourth of the country’s population seem, indeed, the ones which could benefit the most from the BRI. However, our additional point was that besides having the expected usual pro-development effect, the BRI might boost technological convergence of the West and South-West. In fact, this chapter has shown that spatially driven convergence clubs are a reality in China’s manufacturing. Therefore, the BRI could boost technological progress in the disadvantaged provinces, thus offering them a permanent and long-run support to development.

Notes 1 As it is well known, China is the most populous country of the entire world. In 2016, its population was estimated at 1,386.8 million inhabitants. Almost one out of four of those inhabitants—precisely, 23.5%—belonged to the 11 provinces that may be classified as Western and South-Western provinces: Chongqing, Gansu, Guizhou, Inner Mongolia, Ningxia, Qinghai, Shaanxi, Sichuan, Tibet, Xinjiang, and Yunnan. Indeed, by 2016, these provinces counted 325.8 million inhabitants. 2 An issue of heterogeneous club convergence has been extensively studied in the literature, for example, Quah (1997), Le Gallo and Ertur (2003), and Canova (2004), though most studies employ the selection mechanism in a rather arbitrary manner. Based on our knowledge, this is the first attempt to identify convergence clubs endogenously in a SF framework. 3 In particular, following the codes attributed by NBS, we classify firms as SOEs those with codes 110, 141, 143, 151. Next, we classify as Hong Kong, Macau,

Can China’s West and Southwest catch up?  67 Taiwan those firms with codes from 200 to 240. Finally, we classify as foreign-­ owned firms those with codes from 300 onwards. 4 Specifically, in all the eight cases in which the SOE dummy is statistically significant (Fujian, Hubei, Hunan, Jiangsu, Jilin, Shanghai, Tianjin, and Zhejiang), it bears a negative sign suggesting lower efficiency. 5 Specifically, the HKTM dummy is also statistically significant in eight cases: In three cases (Fujian, Jilin, and Tianjin), it is negative, while in the remaining five cases (Henan, Jiangsu, Shaanxi, Shandong, and Shanghai), it is positive. On its part, the FOE dummy is statistically significant in cases as well: in four cases (Fujian, Hunan, Jilin, and Sichuan & Chongqing), it is negative, while in the other 4 cases (Guizhou, Ningxia, Xinjiang, and Zhejiang), it is positive.

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4 “The Belt and Road” Initiative will promote the economic cooperation between China and the Western countries Chen Yongjun Introduction Considering that the recovery of world economy is weak and monetary policies of developed economies are moving toward differentiation, many countries’ economies are facing difficulties. There is a need for new economic growth points or a new economic locomotive to drive the world economy. After judging and considering the situation carefully, China is trying its best to integrate almost all nations’ strategies and policies into “the Belt and Road” and Asia-Pacific Economic Cooperation (APEC) to achieve a win-win situation. From the perspective of domestic economy, since the reform and ­opening-up in 1978 and the comprehensive construction of market economy in 1992, China’s economy showed a sustained and rapid growth trend which was rare in the economic history. Behind this, the effects of three driving forces (investment, consumption, and net export) are self-evident: on the one hand, the investment facilitates capital accumulation and promotes economic growth from the supply side1; on the other hand, consumption and net export facilitate domestic and external demand, and thus stimulate economic growth from the demand side. And now, “the Belt and Road” construction will not only promote the growth of investment directly (especially in the infrastructure sector2) but also contribute to the trade development indirectly. “The Belt and Road” is short for the Silk Road Economic Belt and the 21st Century Maritime Silk Road. The key directions of the Silk Road Economic Belt are from China, via Central Asia and Russia, to Europe (the Baltic Sea); from China, via Central Asia and West Asia, to the Persian Gulf and the Mediterranean; and from China to Southeast Asia, South Asia, and the ­Indian Ocean. The key directions of the 21st Century Maritime Silk Road are from Chinese coastal ports, via the South China Sea and the Indian Ocean, to Europe; and from Chinese coastal ports, via the South China Sea, to the South Pacific Ocean (National Development and Reform Commission, 2015). On April 7, 2013, Chinese President Xi Jinping in the keynote speech of Boao Forum for Asia put forward to build a regional financing platform

Economic cooperation  71 to promote regional economic integration and improve regional competitiveness (Xi, 2013). This became a preliminary conception for “the Belt and Road”. Subsequently, President Xi Jinping and Premier of the State Council Li Keqiang successively proposed the ideas to build the Silk Road Economic Belt and to build the 21st Century Maritime Silk Road in a number of different occasions and put forward to promote the construction of the Silk Road Economic Belt and the 21st Century Maritime Silk Road by building the Asia Infrastructure Investment Bank. On March 28, 2015, the National Development and Reform Commission, the Ministry of Foreign Affairs, and the Ministry of Commerce of China jointly issued “Vision and Actions on Jointly Building Silk the Road Economic Belt and the 21st Century Maritime Silk Road”. Afterward, “the Belt and Road” strategy was formally established as a national strategy. It is very important to study the nature and logic of “the Belt and Road” Initiative because it involves the cooperation among many countries, and it is imperative for these countries to reach an agreement about the core connotation of “the Belt and Road” Initiative so as to dispel their doubts. Understanding the reasons for putting forward “the Belt and Road” Initiative is good for finding the attractions of this initiative. Also pointing out the development directions of this initiative can help all related countries to focus on the fields they may cooperate in the future. This paper is devoted to analyzing the economic nature and logic of “the Belt and Road” and clarify how to cooperate with China and other countries. This paper is organized as follows. Section 2 is a literature review. Section  3 analyzes the domestic and international background of proposing “the Belt and Road” from a macroeconomic perspective. Section 4 proposes a basic model of understanding the economic nature of “the Belt and Road” from two different levels. Section 5 discusses the great strategic meaning of implementing “the Belt and Road” for China. Section 6 points out how to cooperate between China and European countries and between China and North American countries. Section 7 is a conclusion.

Literature review “The Belt and Road” Initiative is a very new research topic in China. Because of its practical value and strategic significance, many scholars chose “The Belt and Road” as their new research interest when this initiative was put forward for the first time. “The Belt and Road” brought about several new research themes in geography, including geopolitical studies, foreign direct investment theories and optimization of transcontinental transportation (Liu, 2015). For implementing this initiative, some relations should be handled first, such as government-enterprise relations and central and local authorities’ relations (Li, 2015). Some questions should be answered as well—for example, should it be based on multiple bilateral partnerships of cross-regional integration? (Chu & Gao, 2015). In the process of

72  Chen Yongjun implementing “The Belt and Road” Initiative, there are a lot of barriers to be faced, such as heavy cost in infrastructure construction and its maintenance (He et al., 2015). At the same time, “The Belt and Road” Initiative will have a great influence on the foreign investment (Yang & Yan, 2015), and it is said to be beneficial for upgrading the related industries of China (Dong & Liang, 2015) and for pushing the industrial transformation (Su, 2015). Although a lot of scholars have investigated “The Belt and Road” Initiative from different perspectives, very few did research on the economic nature and logic of “The Belt and Road” (Huang, 2015). Answering the question why “The Belt and Road” Initiative should be implemented is very important. Only if other countries understand the economic nature and the logic of “The Belt and Road” Initiative will they be willing to cooperate with China to implement this initiative. Thus, the topic of this paper is very meaningful and valuable.

The background of raising “The Belt and Road” strategy The recovery of world economy is weak, and emerging markets have become an important growth momentum After the financial crisis of 2008, the world economy is recovering gradually. According to “World Economic Situation and Prospects 2015”, which was issued by the United Nations, American GDP growth rate was 2.2% in 2013 and rose to 2.4% and 2.8% in 2014 and 2015, respectively. This was higher than the average GDP growth rate of developed countries3 (in 2013, the overall GDP growth rate of developed countries was 1.2%, and the expectations were 1.6% and 2.2% in 2014 and 2015, respectively). The growth rate of countries in Euro Zone was 0% in 2013, and the expectations were 1.3% and 1.9% in 2014 and 2015, respectively. Overall, economies of the United States and Japan have recovered, and their growth trends are strong, while countries in Euro Zone are affected by European debt crisis and their economies are declining mildly. In contrast, the overall growth rate of developing countries maintains over 4.4% (the GDP growth rate of developing countries was 4.7% in 2013, and the expectations were 4.4% and 4.4% in 2014 and 2015, respectively). After the financial crisis, the “two-speed” pattern of developed economies and emerging economies will be further deepened. According to the forecast of the International Monetary Fund, by 2050, GDP of “BRICS countries” (China, Brazil, Russia, India, South Africa) will exceed that of other large industrial countries such as the United States, Britain, Canada, France, Germany, Italy, and Japan. Emerging markets represented by China and the Central and West Asian countries will become important driving forces of world economic growth. Asian developing countries represented by the Central and West Asian countries have a vast market. According to the estimation of the Asian Development Bank (Bhattacharyay et al., 2012), the annual Asian infrastructure funding needs will

Economic cooperation  73 reach $730 billion in the next 8–10 years, and the World Bank estimates that this number will be $800 billion. But the sum of infrastructure investment in Asia from the Asian Development Bank and the World Bank is only about $30 billion. Therefore, the financing gap of infrastructure construction in Asia is huge. Lack of funding has restricted infrastructure construction and the economic growth of developing countries and regions represented by the Central and West Asian countries. New normal of China’s economy and the introduction of “the Belt and Road” initiative The “new normal” of China’s economy implies that China’s economy entered a normal growth phase after more than 30 years of rapid growth, and the speed of economic growth will be kept around 7%. There were plenty of important factors to promote the long-term stable growth of China’s economy over the last 30 years, such as a vast domestic market, the comparative advantage of labor, institution reform, and urbanization. However, labor costs are rising, the process of urbanization is becoming stable and the growth of investment and consumption is slowing down; therefore, it is urgent for China’s economy to seek for a new economic growth point. In addition, since the beginning of the 21st century, redundant construction and overcapacity have influenced the development of China’s economy. Especially since the financial crisis in 2008, blind investment stimulated by the “4 trillion” investment plan, the top ten industrial revitalization plan, and loose monetary policy exacerbated the overcapacity problem. At the same time, in the new round of adjusting industrial structure, transformation and upgrading of core elements (market, capital, talent, and product) has become the main melody. After 30 years of technology accumulation and upgrading, China’s manufacturing, especially middle-end manufacturing, has reached the middle or high level in the world. China’s economic growth needs to make use of the comparative advantage of the manufacturing industry to expand the foreign market and solve the problem of overcapacity. Besides, a new pattern of China’s regional development has been produced. In February 2014, the eastern coastal developed areas were the first to implement the regional planning strategy, such as collaborative development strategy of Beijing, Tianjin, and Hebei, and the Yangtze River economic belt strategy. By the end of 2014, the GDP growth speed of Guangxi, Hunan, and Sichuan exceeded the speed of eastern developed regions for seven successive years. How to achieve regional coordinated development, promote regional trade, and stimulate economic growth becomes another problem for China’s economy. In recent years, China has made a lot of strategies and plans to promote regional economic integration, including the Silk Road Economic Belt strategy, the 21st Century Maritime Silk Road strategy, BCIM (Bangladesh, China, India and Myanmar) Economic Corridor strategy, China and Pakistan Economic Corridor strategy, and the

74  Chen Yongjun Demand: Developing Countries in Central Asia

Supply: China’s New Economic Situations • Industrial structural transformation demands a new market

• Manufacturing capacity has reached a new level

• China’s huge FE reserves seeks safe and profitable investment opportunities

Macroeconomic conditions leading to the birth of the OBOR Initiative

• Capital required for infrastructural development amounts to US$800 billion per annum • infrastructural investment can create positive spill-over effects on the regional economies • Capital gap for infrastructural development reaches US$520 billion per annum

Figure 4.1  The background of raising “the Belt and Road” strategy.

Northeast Asia economic integration strategy. All of these strategies focus on regional economic integration based on China’s national strategies and are in line with member states’ strategic interests. In short, China’s economy under the “new normal” urgently needs to transform and upgrade. It is necessary for China to expand the sale channels of manufactured goods and expand foreign investment; meanwhile, the Asian developing countries, which are represented by Central and West Asian countries (CWA), are facing a huge demand of capital, manufactured goods, and technologies. So, the complementary needs of these two sides provided the basic conditions to initiate “the Belt and Road” in 2013, and formally implement it in 2015 (see Figure 4.1).

Research methods: basic models of understanding the nature of “The Belt and Road” A basic model: the interaction and win-win between China and the CWA and Southeast Asian countries (SEA) Considering that China has inherent demands to transfer its economic structure and expand market, that it holds huge foreign exchange reserves and seeks for steady investment projects and opportunity, and that other Asian countries which are represented by the Central Asian countries have vast domestic market but lack infrastructure funding, the basic model of understanding the nature of “The Belt and Road” can be built by designing an economic circular route: China facilitates its infrastructure construction projects to go out by providing low-interest loans to other countries, thus promoting their economic growth by this infrastructure construction; the other countries then use their economic benefits to return their loans (see Figure 4.2). Specifically, China provides low-interest loans to other Asian countries and executes infrastructure construction. The advantages for China are

Economic cooperation  75

A Basic Model: Win - Win

Central and West Asia

1

1

China provides soft loans to other Asian countries to carry out infrastructural development

2

These countries will repay China’s soft loans with incomes and social benefits generated from the projects

China

2

Figure 4.2  A basic model: the interaction and win-win between China and the Central and West Asian countries (CWA) and Southeast Asian countries (SEA).

to effectively expand international markets for overcapacity and find a robust investment channel for foreign exchange reserves. China’s funds mainly come from huge foreign exchange reserves, the local Silk Road Fund from these provinces along the road, and social capitals raised by the way of debt or other forms. The infrastructure construction includes roads, railways, high-speed rail, power, and other industries; the production capacity of related fields, such as communications, construction machinery, also can be outputted. The advantages for developing countries are to gain economic development through infrastructure construction, and governments and enterprises can pay the low-interest loans by using the revenue from tax and projects. Briefly, developing countries provide broad markets and get funds and technology for development. When infrastructure construction is completed, they can use the “spillover effects” of infrastructure to promote economic development and use the revenue surplus to pay loans. At last, both China and these developing countries achieve a win-win situation. An extended model: the multilateral win-win situation between China and other countries in Asia, Europe, and Africa “The Belt and Road” strategy was born of economic interaction between China and other Asian countries. It starts from the fundamental demand and supply of bilateral market and aims to satisfy bilateral benefits. In fact, the Silk Road Economic Belt connected Asia-Pacific economic circle from the east side and European economic circle from the west side, and it is considered as the longest and most potential economic corridor in the world. European industrial countries which face a mild recession are more likely to participate in the construction of “the Belt and Road” strategy on the basis of their technical advantages, so they can capture the vast markets in

76  Chen Yongjun Central Asian countries. As “the Belt and Road” leading country, China occupies a significant position in the basic model of “The Belt and Road”. Meanwhile, cooperating with European industrial countries to invest toward developing countries is conducive to providing a platform for Chinese enterprises to learn the advanced technology and marketing experience and help Chinese manufacturing upgrade its technology. So, letting European countries participate as the third party in the construction of “the Belt and Road” and achieving international cooperation in capacity came into being. African countries also need infrastructure construction. Considering these, the basic model of “the Belt and Road” strategy can be extended (see Figure 4.3) As “the Belt and Road” strategy is advancing, African countries will be beneficiaries in the next stage. According to “World Economic Situation and Prospects 2015” released by the United Nations, the GDP growth rate of African countries in 2013 was up to 3.3%, and it was expected to reach 4.0% in 2015 and 4.8% in 2016. Among them, the GDP growth rate of Eastern African countries was up to 6.5%, and it was expected to reach 6.6% in 2015 and 6.7% in 2016; thus, the growth rate of this area is far more than the rate of other countries and regions in the world. There are at least two aspects to understand why African countries benefit from “the Belt and Road” strategy: on the one hand, with the construction of infrastructure, some African countries will become the input market of capital and technology, and they could directly benefit from this infrastructure construction; on the other hand, the regional development driven by the Central Asian countries’ infrastructure construction will benefit African developing countries. The regional factors flow is in favor of the regional coordinated development. In recent years, the major European countries have improved their attitudes toward China after the latter advanced “The Belt and Road” Initiative reach; this not only certifies that “the Belt and Road” is very attractive to European countries, but also proves the logic of “The Belt and Road” idea is self-consistent. The active participation of European and African An Extended Model: Multilateral Win European industrialized countries, such as France and Germany, become involved in the OBOR strategy through their superiority in manufacturing technology, as well as entering the Central and West Asia markets). China would also receive access to advanced technology through such partnerships.

4

Africa would also benefit greatly from China’s “One Belt, One Road” strategy while common prosperity would be achieved through multilateral cooperation.

3

Europe

Central and west Asia Africa

3 China

4

Figure 4.3  A n extended model: the multilateral win-win situation between China and other countries in Asia, Europe, and Africa.

Economic cooperation  77 An Extended Model: Multilateral Win 5

5

Europe Central and west Asia

China

North America

6

Africa 6

North American countries, such as the USA and Canada, could also become involved in ”One Belt, One Road” through their superiority in manufacturing technology, as well as entering the Central and West Asian markets. Equally, North American countries would also benefit from becoming involved in China’s “One Belt, One Road” initiative.

Figure 4.4  The comprehensive theoretical model of “the Belt and Road” strategy: the multilateral win-win situation including all member countries.

countries greatly expands and enriches the connotation of “the Belt and Road” strategy. Taking Figures 4.2 and 4.3 together and considering that it is possible for the North American countries to join in the future, another extended model including the North American countries was established, and that is the comprehensive theoretical model of “The Belt and Road” strategy (see Figure 4.4). The theoretical model of “The Belt and Road” is based on the development status quo of China’s and other countries’ economies as well as the macro background of the international economy. It abstractly simplifies member countries as market entities, and from the perspective of supply and demand, analyzes the behaviors and benefits of all participating parties. It tries to prove that the logic of “the Belt and Road” is self-consistent. Finally, it is important to notice that it is unnecessary for a theoretical model to include all the contents of “The Belt and Road”, but a theoretical model really is an ideological weapon to help us understand the economic nature of “The Belt and Road”.

The significance of the implementation of “the Belt and Road” strategy for China’s development As a medium- and long-term national strategy, “The Belt and Road” Initiative is mainly to solve several important problems which are related to the development in the future, such as to create a new driving force of economic growth, to develop a new pattern of opening-up, to deepen national strategies and strengthen national security, to grasp the leadership of regional economy, and to promote the reform of the global governance structure. This is of great significance to the stable development after China’s economy entering into a “new normal”.

78  Chen Yongjun To create a new driving force of economic growth Overcapacity becomes a serious problem for economic operation. Traditional countries that China exports to are few, and among them, the United States, Japan, and European countries occupied the core position. China’s traditional export market is relatively fully developed, and the economic growth of the United States, Japan, and the European countries is weak; however, there is little room for expanding the export market in these countries, so it is difficult for these countries to digest China’s overcapacity. In the case that domestic consumption is hardly accelerated, expanding new export market through “The Belt and Road” is a realistic choice matched with China’s economic growth. In addition, maintaining and increasing the value of foreign exchange assets is another big problem for China at present. Due to the fund gap of infrastructure construction which exists in emerging countries and less-­ developed countries, China can use its foreign exchange reserves to invest in overseas infrastructure construction to stimulate global economic growth and digest its overcapacity by capital export. Therefore, “The Belt and Road” strategy creates a new driving force for China’s economic growth. To develop a new pattern of opening-up In the last 38 years of reform and opening-up, China has made remarkable achievements. But being affected by geographical location, natural resources, development foundation, and other factors, the pattern of ­China’s opening-up generally presents that the eastern areas are faster than the western areas, and the coastal areas are faster than the inland areas. The implementation of “the Belt and Road” strategy will help to build “one body with two wings” of new round opening-up, that is advancing the opening-up of the western regions and the inland areas. Following the Silk Road spirit which is peaceful cooperation, openness, inclusiveness, mutual learning, mutual benefit, and win-win, China carries out “The Belt and Road” strategy and cooperates with those countries along the line in aspects of infrastructure construction, trade and investment, energy, regional integration, internationalization of RMB, and so on. This would develop a new pattern for China’s opening-up. To deepen national strategies and strengthen national security At present, China imports resources mainly through the coastal sea lane, but sea route is directly exposed to external threats and is extremely fragile during the war. China’s industries and infrastructure are also concentrated in the coastal regions, so if these regions are attacked, China will lose core infrastructure. In central and west areas, especially the west areas, there are few people in wildland, the potential of developing industry and

Economic cooperation  79 infrastructure is great and the threats during the war are less. Exploiting the west areas via “the Belt and Road” strategy is beneficial to deepen national strategies and enhance national security. To grasp the leadership of regional economy and promote the reform of the global governance structure For China, “The Belt and Road” strategy is not only against the TPP (Trans-Pacific Partnership Agreement) and TTIP (Trans-Atlantic Trade and Investment Partnership) led by the United States and which exclude China, but it also gives China the opportunity to gain rights to make new global trade rules in the economic activities of “The Belt and Road”. For example, the 21st Century Maritime Silk Road will be constructed based on domestic and overseas ports and impels negotiations of various free-trade agreements. After the successful test of Shanghai free-trade zone, China can build an international transshipment port which relies on the deep-­ water ports of Shanghai (including Ningbo-Zhoushan) and Quanzhou and this means becoming the international center of economy, finance, trade, and shipment, so that China can obtain the leadership of international trade, pricing, and resource allocation. In one sentence, China can greatly enhance its regional economic influences through accelerating the regional economic integration.

The significances of “the Belt and Road” strategy to promote the cooperation between China and Western countries The significance of “the Belt and Road” strategy to promote the cooperation between China and European countries There is a long history of trade between China and European countries. Now, European countries look forward to economic revival and China hopes to “Go Out”; they are indispensable partners for each other in this new stage of economic growth. In 2015, the value of trade between China and European Union (EU) amounted to €521 billion, and it accounted for 15% of total EU’s trade value. EU has been the largest trade partner for China for 11 consecutive years, and China is also the second largest trade partner for EU. In the same year, the actual investment from EU to China was $7.11 billion, and its growth speed was 11.9%. The direct investment from China to EU was $23 billion, and its growth rate was 21.7%. The scale and growth rate of trade and investment reflect the close economic relations and common interests of China and the European countries. “The Belt and Road” construction is a new opportunity to extensively and intensively cooperate between China and European countries. As the starting point and end point of “the Belt and Road”, China and the European countries will be further integrated into the aspect of the economy.

80  Chen Yongjun Specifically, “The Belt and Road” construction will promote economic cooperation between China and the European countries in the following aspects. First, infrastructure construction is conducive to achieve connectivity between the two sides. The investment of infrastructure construction is the core of “The Belt and Road” strategy. The increasing trade value and the insufficient shipping also confirmed the necessity of transportation construction. The construction of the maritime Silk Road shortens the distance of shipping and reduces the cost of transportation; while the construction of overland railway creates new investment opportunities and leads to the development of regional economy. Cooperation in infrastructure construction is good for achieving the connectivity to Eurasia and is the cornerstone of economic integration between China and the European countries in the future. Second, the connection of strategic planning promotes the growth of investment and trade between China and the European countries. “The Belt and Road” strategy corresponds to several infrastructure investment plans. For example, at the end of 2014, The EU launched the European Strategic Investment Plan (Juncker plan) which focuses on stimulating the European economy, but it has a large funding gap. Connecting this plan with “The Belt and Road” strategy can not only get the funds but also strengthen bilateral cooperation in investment and trade. Third, the financial services ensure the smooth operation of real economy. In recent years, the speed of RMB internationalization has accelerated, and the cooperation between China and European countries in the field of monetary and finance also stepped up to a new level. European countries have actively joined the Asian Infrastructure Investment Bank, and this shows that China and the European countries are committed to building a twoway investment channel. A deep-level economic cooperation is conducive to the development of real economy. Finally, “The Belt and Road” strategy is in favor of carrying out all-round cooperation in the economic field. The construction of “Digital Silk Road” leads the bilateral economic cooperation from traditional fields to emerging fields, such as the Internet and communication. Information technology cooperation is conducive to the rise of e-commerce, Internet finance and other industries. The successful experience of European urbanization is worth learning by China; therefore, establishing friendship between cities can turn into fruitful cooperation for city’s facilities construction. China’s energy consumption is high, but its utilization rate is low; European countries have high dependence on foreign energy, so both have some problems of energy. “The Belt and Road” strategy can be a platform for cooperating in the aspect of energy. “The Belt and Road” construction makes a huge room for China and European countries to cooperate and the prospect is bright. However, advancing “The Belt and Road” construction is not without any strains. Trade disputes between China and the European countries, political

Economic cooperation  81 mutual trust and coordinating interests with other countries, such as Russia and the United States, are all challenges related to cooperation between China and the European countries. Under the framework of “The Belt and Road” strategy, how to control differences and achieve fruitful cooperation depends on the strategic wisdom of China and the European countries. The significance of “The Belt and Road” strategy to promote cooperation between China and North American countries As early as 2011, the United States put forward the strategy of “New Silk Road” and invested in Central and South Asia based on the bilateral relations. Despite there being profound differences between “The Belt and Road” strategy raised by China and “The New Silk Road” strategy raised by the United States, “The Belt and Road” strategy involves a large number of economic projects and a vast market, especially for promoting the implementation of this strategy in Central Asia, West Asia and Middle East; the United States and China have a lot of common interests and broad space for cooperation. China’s initiative of infrastructure construction is helpful for America to execute its planning in these areas, and America has a great advantage of transportation construction, environment management and marine exploitation and management which can be played very well under the framework of “The Belt and Road” strategy. Sino-US enterprises have many opportunities to cooperate in these aspects of ports, roads, transportation facilities, finance, energy, and so on. Under the framework of “the Belt and Road” strategy, China and the United States don’t play a zero-sum game; they need to have greater political trust so as to promote economic cooperation between two countries in a deeper level. On May 9, 2016, British Columbia and Guangdong province signed cooperation documents of mutual support, participating in “the Belt and Road” strategy and “Pacific Gateway Strategy”. This showed the extension of “the Belt and Road” strategy to North America for the first time. Since China is the second largest trade partner of Canada, and the Canadian companies have advantages in many aspects related to infrastructure construction and project management, the Canadian enterprises could collaborate in the projects for economic development of the countries along the line of “The Belt and Road” to achieve a win-win situation with China. In 2015, the first offshore RMB clearing center was launched in Toronto, Canada; the financial integration between China and Canada saves a lot of trade costs. Canada can also use the capital advantage of RMB to actively join in “The Belt and Road” construction in the future. Although current “The Belt and Road” strategy doesn’t cover the area of North America geographically, this strategy is inclusive enough, and the North American countries can play an important role in the implementation of this strategy by using their comparative advantages.

82  Chen Yongjun Implementing “The Belt and Road” strategy is not only an inevitable logic of China’s all-round opening-up and a certain trend of civilization renaissance but also a necessary requirement of inclusive development of globalization. It faces new opportunities in aspects of all-round ­opening-up, diplomacy, cooperation, and global development, and also faces various risks, such as geopolitics, security, economy, and market. Therefore, the study on this topic is definitely different from other studies; it has several characteristics such as being comprehensive, strategic, systematic, international, and long-term. Now, analyzing these specific issues in depth is particularly important, and this paper is an attempt in this respect.

Conclusions The Silk Road Economic Belt links Asia Pacific in the East and European countries in the West, which is regarded as the world’s longest economic corridor with a huge development potential. The 21st Century Maritime Silk Road is intended to strengthen China’s economic links with ASEAN countries. These two parts constitute the core of “The Belt and Road” Initiative. On one hand, “The Belt and Road” Initiative is strategic because it meets the requirements of structural transformation and seeks for profitable investment opportunities for China. On the other hand, it meets the requirements of infrastructural development of Central and West Asian countries. So, there is a big room for China and these developing countries to improve the cooperation; for example, China can provide the soft loans to other Asian countries to carry out infrastructure development, and then these countries can repay China’s soft loans with incomes and social benefits generated from the projects. Apart from the cooperation between China and CWA and African countries, it is possible and important to strengthen the cooperation between China and the European and North American countries. Industrialized countries, such as the UK and the USA, can get involved in the initiative through their superiority in manufacturing technology. In conclusion, “The Belt and Road” Initiative is a multilateral winwin development strategy which has a broad prospect, so more and more countries should be involved in.

Notes 1 Minjie Dong and Yongmei Liang (2013) estimated that capital contributed 85.4% to China’s economic growth from 1978 to 2010. In other calculations, capital contributed more than 50% to China’s economic growth (Xiaolu, 2000; Chow & Lin, 2002). 2 Many economic studies show that infrastructure construction significantly promotes the economic growth and social development of developing countries (Duflo & Pande, 2007; Kremer et al. 2011; Duranton & Turner, 2012; McRae, 2015).

Economic cooperation  83 3 A developed country is a sovereign state that has a highly developed economy and advanced technological infrastructure relative to other less industrialized nations. One criterion for defining developed countries is Human Development Index (HDI); the HDI of developed countries is no less than 0.9.

References Bhattacharyay, B. N., Kawai, M., & Nag, R. M. (Eds.) (2012) Infrastructure for Asian Connectivity. Cheltenham and Northampton: Edward Elgar Publishing. Chow, G., & Lin A. (2002). Accounting for Economic Growth in Taiwan and Mainland China: A Comparative Analysis. Journal of Comparative Economics, 30, 507–530. Chu, Y., & Gao, Y. (2015). China’s Belt and Road Initiative: Three Questions to be Answered. International Economic Review, 2, 90–99. Dong, M., & Liang, Y. (2013). The Source of China’s Economic Growth from 1978 to 2010: A Non-parameter Framework. Economic Research Journal, 5, 17–32. Duflo, E., & Pande, R. (2007). Dams. The Quarterly Journal of Economics, 2(122), 601–646. Duranton, C., & Turner, M. (2012). Urban growth and transportation. The Review of Economic Studies, 79(4), 1407–1440. Huang, S. (2015). A Study on the Transfer of China’s Manufacturing under “The Belt and Road” Initiative. International Trade, 3, 18–21. He, M., Zhang, J., Zhang, Y., & Tian, B. (2015). Strategy of “One Belt and One Road” Confronted with Barriers and Countermeasures. Journal of Xinjiang Normal University (Philosophy and Social Sciences), 36, 36–45. Kremer, M., Leino, J., Miguel, E., & Zwane, A. P. (2011). Spring Cleaning: Rural Water Impacts, Valuation, and Property Rights Institutions. Quarterly Journal of Economics, 126(1), 145–205. Liu, W. D. (2015). Scientific Understanding of the Belt and Road Initiative of China and Related Research Themes. Progress in Geography, 34(5), 538–544. McRae, S. (2015). Infrastructure Quality and the Subsidy Trap. American Economic Review, 105(1), 35–66. National Development and Reform Commission. (2015, March 28). Vision and Actions on Jointly Building Silk Road Economic Belt and 21st-Century Maritime Silk Road. People’s Daily. Retrieved from http://en.ndrc.gov.cn/newsrelease/201503/ t20150330_669367.html Su, H. (2015). A Study on the Transfer of China’s Manufacturing under “the Belt and Road” Initiative. International Trade, 3, 18–21. Xi, J. (2013, April 7). Working Together toward a Better Future for Asia and the World—The Keynote Speech at the Opening Plenary of the Boao Forum for Asia Annual Conference. Retrieved from http://news.xinhuanet.com/­politics/201304/07/c_115296408.htm Xiaolu, W. (2000). Sustainability of China’s Economic Growth and Institutional Changes. Economic Research Journal, 7, 3–15, 79. Yang, F. H., & Yan, C. F. (2015). A Study on the Implementation Mechanism of Chinese Direct Investment under “the Belt and Road” Initiative. Theoretical Investigation, 5, 80–83.

Section II

BRI and its impact on the structure of global economic interaction

5 AIIB and the reform of international financial system Xun Wang

Growth prospects of China and the emerging Asia Emerging Asia has been the fast-growing region in the world and has played an important role in contributing to the recovery of the world economy. Weak external demand and structural factors led to a slower growth rate in this region after 2008, while economic restructuring and investment in infrastructure facilitated the rebalancing and promoting the growth potentials. China is now transforming its economy from an export-driven growth to domestic demand and innovation-based growth. However, many emerging countries in Asia are still suffering from high transaction lost due to poor infrastructure. Enhancing connectivity and efficiency by improving infrastructure has increasingly become an important factor for sustainable growth in this region. China’s growth prospects under rebalancing and restructuring China’s economy is shifting from high to normal growth rate The Chinese economy is experiencing slower economic growth, service being the dominant industry, rising domestic demand, and improved environment and income distribution. China’s economy will graduate from an export-driven one to an economy fueled by domestic demand and innovation. Economic restructuring facilitates rebalancing and renders more sustainable growth. New engines will include consumption, infrastructure investment, industrial upgrading, and urbanization, which will ensure an annual growth rate of around 6–6.5% by the year 2020. A new open economic system will be built The economic transformation will stimulate import demands, open the service sector to foreign capital, and keep Outward Direct Investment (ODI) increasing. The Belt and Road Initiative enhances connectivity between China and neighboring countries, pushing forward regional economic

88  Xun Wang cooperation. The establishment of Shanghai Free Trade Zone, Free Trade Agreement (FTA) with New Zealand, Switzerland, Iceland, among others, and Bilateral Investment Treaty (BIT) can shed light on new ways and new experiences for further opening to the outside world and adapting to new international trade rules. A new supply-demand structure is being formed Income growth and changes in demographic structure are underlying causes. In decades to come, China will witness a decline in labor supply. It is estimated that the share of the working-age population will drop by 4% in 2020 compared with that in 2013. Declining labor supply leads to higher labor cost. The supply side will shift from labor-intensive low-end processing and manufacturing to high added value. Equal emphases on regular higher education and vocational education will offer human capital for industrial upgrading. An expanding middle class is becoming the main force to promote consumption and motivate the consumption structure toward midand high-grade goods, modern service, and intellectual products. New growth potential is expected to be released from further reforms Industrialization, urbanization, informatization, regionalization, and agriculture modernization remain the fundamental trends of economic development in China. Both industrialization and urbanization still have a long way to go. The ongoing market-oriented financial reform is effective in dealing with risks in the economy and helpful for the transformation. Liberalization of interest rate system and the capital account will improve the efficiency of capital allocation. The opening of the banking sector will provide foreign banks with opportunities to do RMB business in China as well as fuel the development of medium- and small-sized financial institutions. Income distribution is making improvements Gini coefficient in China has dropped from 0.491 in 2008 to 0.465 in 2016, and will be further below at 0.45 in 2020 by estimation. Rising income with regional efforts to address dualism between rural and urban areas, the gap between per capita income of rural and urban residents keeps shrinking. Regional structure is also witnessing new changes. Shanghai has become the growth engine in Yangtze River Delta; development gap between the Pearl River Delta and its surrounding areas has been narrowed with the process of industrial restructuring, and Beijing-Tianjin-Hebei megalopolis sees notably accelerated integration. Industrial transfer from developed regions and the implementation of Belt and Road Initiative will significantly promote development and structural adjustment in central and western part of China.

The international financial system reform  89 China’s economic growth: creating new jobs for other countries Sustainable economic growth in China drives global economic recovery and creates jobs in other countries through more imports and outbound investments. The Chinese economy grew by 6.9% in 2015. As estimated, the annual growth rate in China will be around 6.5% in the medium term. According to Organization for Economic Co-operation and Development (OECD), the average growth rate of global economy between 2016 and 2020 is estimated to be 3.6% (Figure 5.1). Under this estimate, by 2020, China will account for 15% of the global economy, with an average contribution rate of 26% (Figure 5.2). 16 14 12 10 8 6 4 2 0 Global Real GDP Growth

-2 -4

China Real GDP Growth 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Figure 5.1  China and global GDP growth rate: 2000–2020, %. Source: WDI, NBS, authors’ calculation.

60 50 40 30 20 10 0

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Figure 5.2  China’s contribution on global economic growth: 2000–2020, %. Source: WDI, NBS, authors’ calculation.

90  Xun Wang Economic growth improves employment market. According to a report released by International Labor Organization (World of Work Report, 2014), there will be 200 million jobs created from 2016 to 2020. For simplicity, suppose job creation, mainly through economic growth and the effect of growth on job creation, remains unchanged across countries. Under this assumption, based on China’s contribution rate to global economic growth, China will create 51.35 million jobs for global job market during this period. It is estimated that a 1% of China’s GDP growth will generate 1.5 million urban jobs. That is to say, a growth rate of 6.5% will add 9.75 million jobs annually in urban areas. Besides domestic job creation, China will help to contribute 2.6 million more jobs in total for the other counties from 2016 to 2020. China’s outward foreign direct investment (OFDI): providing host countries with capital and industry transfers In 2015, China became the world’s third largest investor, with a net OFDI of 118 billion USD, of which 14.8 billion is invested in countries along the Belt and Road, with an 18.2% year-on-year growth rate. According to United Nations Conference on Trade and Development (UNCTAD), by the end of 2014, China’s ODI stock reached 729.5 billion, ranking ninth globally. It was only as much as 11.5% of that of the USA, 46% of the UK, 46% of Germany, and 61.1% of Japan (Figure 5.3), showing a significant gap. As China pushes forward its opening up, its OFDI is bound 70 60 50 40 30 20 10 0

US

UK GER HK FRA JPN CHE NLD CHN CAD ESP

Figure 5.3  Outward FDI stock in 2013: 100 billion USD. Source: UNCTAD, authors’ calculation.

The international financial system reform  91 to increase steadily. It is estimated to surpass 500 billion in the next five years, and by 2020, the ODI stock will go above 1.2 trillion (Figure 5.4). Countries along the Belt and Road (e.g., ASEAN countries, Eurasia, and Africa) and developed economies will become the main destinations of Chinese investment that will primarily include fields like finance and commercial service, industrial zone, infrastructure construction, transportation, and warehousing. Rising labor cost and industrial upgrading will promote labor-­i ntensive manufacturing industry transferring from the eastern coastal area of China to central and western China and neighboring countries. With the development of China-ASEAN free trade zone and the implementation of “Belt and Road Initiative”, neighboring labor-abundant countries will bring lower labor cost advantage into play, which, in turn, will provide important opportunities for these countries to receive industrial transfer and build up modern manufacturing industrial system with China’s capital, appropriate technology, management experience, and development experience. The infrastructure needed for sustainable growth in emerging Asia Since the beginning of this century, emerging Asia has been the region with the highest growth rate in the world. According to the World Development Indicator Database, the average annual growth rate reached 9.2% during 2001–2008, which was 7.1, 6, and 2.9 percentage points higher than that of high-income countries, world average, and middle-income countries, respectively (Figure 5.5). Even during the post-crisis period of 2009–2016, due to the weak external demand, emerging Asia grew 7.5% 14 12 10 8 6 4 2 0

2000

2002

2004

2006

2008

2010

2012

2014

2016

Figure 5.4  China’s outward FDI, 2000–2020: 100 billion USD. Source: UNCTAD, authors’ calculation.

2018

2020

92  Xun Wang           

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Figure 5.5  GDP growth 2001–2008, %. Source: WDI, author calculation.         

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Figure 5.6  GDP growth: 2009–2016, %. Source: WDI, author calculation.

annually, which is 6.3, 5.1, and 2.7 percentage points higher than that of high-income countries, world average, and middle-income countries, respectively (Figure 5.6). Although having a relatively high growth rate, emerging Asia suffers from structural problems impeding its development potentials. Less-developed

The international financial system reform  93 infrastructure in emerging Asian is one of such factors. Literature show that better infrastructure is significantly associated with higher economic growth by enhancing economic efficiency and lowering transaction cost (Easterly & Rebelo, 1993; Gramlich, 1994; Donaldson, 2016). Under the weak external demand, investment in infrastructure can raise domestic demand in the short term and improve efficiency in the long term. However, there is no financial institution specialized in providing credit for infrastructure in this region.

AIIB as regional financial arrangement The establishment and network of the Asian Infrastructure Investment Bank (AIIB) The initiative of AIIB started with a visit to Indonesia by Xi Jinping, the president of P.R. China, in October 2013. When talking with the president of Indonesia, Zoko Widodo, for promoting connectivity and the process of economic integration in the region, Xi put forward that China would propose to establish AIIB and be willing to provide financial support to infrastructure construction of the developing economies including ASEAN countries. The new institution would cooperate with existing multilateral banks and jointly support the sustainable and stable development of Asian economy. In the same month, on a visit to Southeast Asia, Chinese Premier Li Keqiang proposed the founding of AIIB again. After nearly one year’s negotiation and preparation, on October 24, 2014, representatives from the first 21 Prospective Founding Members (PFMs) signed in Beijing and jointly decided to set up AIIB. With the application deadline approaching, Britain announced its application to join the AIIB in a high profile. On March 12, 2015, Britain formally submitted its written confirmation to China and expected to be one of the PFMs; other main European developed economies closely followed the UK: Germany, France, Italy, Luxembourg, and Switzerland, decided to join accordingly. On April 15, by the consent of existing PFMs, Sweden, Israel, South Africa, Azerbaijan, Iceland, Portugal, and Poland became the PFMs of AIIB. By now, all the 57 PFMs of AIIB are determined. Among the members of AIIB, there are emerging market economies and also developed economies; there are countries within Asia and also outside this region; there are main economies and also small- and medium-­ sized economies. Among the 57 PFMs, 37 are from Asia: Azerbaijan, ­Bangladesh, Brunei, Cambodia, China, India, Indonesia, Iran, Israel, Jordan, ­K azakhstan, South Korea, Kuwait, Kyrgyzstan, Laos, M ­ alaysia, ­Maldives, ­Mongolia, Myanmar, Nepal, Oman, Pakistan, Philippines, ­Qatar, Saudi Arabia, Singapore, Sri Lanka, Tajikistan, Thailand, Georgia, Turkey, United Arab Emirates, Uzbekistan, Vietnam, including A ­ ustralia, New Zealand, and Russia; 18 from Europe are as follows: Austria, Denmark,

94  Xun Wang France, Finland, Germany, Italy, Luxembourg, Malta, the Netherlands, Norway, Spain, Switzerland, United Kingdom, Sweden, Iceland, Portugal, Poland; 2 from Africa: South Africa and Egypt; and 1 from Latin America: Brazil. Share allocation is the core issue among the member states’ concerns. According to the agreement, AIIB’s share allocation is based on the economic size of the members. The ratio of the share by Asian members is approximately 70–75%. The remaining 25–30% share would be allocated to other members. This means that China would be the largest shareholder in AIIB. According to the preparation of AIIB, the final version of the constitution would be finished and signed by all the parties by the end of 2015. After the approval by all the PFMs, AIIB was founded at the end of 2015. AIIB welcomes other countries, others than the PFMs, joining as ordinary members. Then, what is the difference between PFMs and ordinary members? According to the existing multilateral development organizations, PFMs are entitled to formulate the constitution, while the ordinary members can only abide by the constitution. On the other hand, the ratio of share is related to the voting rights which indicates the difference in the power of decision-making. Thirdly, board seats can only be generated within PFMs. Moreover, PFMs have the right to set reservations. That is to say, when signing an international item, if one of the PFMs puts forward the reservation, then this item will not be applicable to this country. Specific targeting on infrastructure-related. At a global level, the World Bank and the International Monetary Fund (IMF) already exist. In Asia, there has been a similar regional arrangement, that is, the Asian Development Bank in Asia. So, a question comes up. Why do the member countries agree on establishing an AIIB when the World Bank, IMF, and even ADB already exist? As a matter of fact, the active response and support from Asian countries exhibit the need of development of Asia. Since the year 2000, Asia, as the fastest growing area in the world, has played an important role in world economy. The rise of emerging economies in Asia attracts worldwide attention. In this regard, 21st century has also been called as the Asia century. However, while Asia developed rapidly and saved a lot, without better financial arrangements, huge amounts of savings cannot find suitable instrument tools other than US assets, especially US treasury bonds, with a very low return. Infrastructure is the fundamental determinant of economic development. In order to promote the growth potentials in the future, investments in infrastructure are needed. Asian countries need to invest a lot to improve infrastructure. Due to the large demand for funds for infrastructure investment, the long construction period, and uncertainty of the cash flow, it is hard for the private sector to construct infrastructure projects. According to the

The international financial system reform  95 estimate of Asian Development Bank (ADB), in the coming 8–10 years, annual funding needs of infrastructure in Asia will reach 730 billion, in which 2.5 trillion will be used for building roads and railroads, 4.1 trillion for the construction of power plants and transmission facilities, 1.1 trillion for telecommunication equipment, and 400 billion for the construction of water supply and sanitation facilities. Evidently, the financing demand is so large that international banks altogether could only provide parts of the total needed amount. What Asia needs is the financial mechanism to mobilize the capital to promote the infrastructure construction. Therefore, an investment and financing platform for infrastructure to make better use of the abundant savings in Asia is needed. AIIB, advocated by China, is a multilateral development financial institution with obvious characteristics. The aim of AIIB is to meet the huge demand for funds in infrastructure in the area. Therefore, at the beginning, AIIB earned support from many Asian countries. At the same time, AIIB will cooperate with the existing multilateral development banks to promote the infrastructure improvement by mobilizing funds from the private sector and sharing risks and revenues rationally. Why did extra-regional countries choose to join? Investment objective and direction of the AIIB are very clear—to provide financial support for Asia’s infrastructure projects. Why countries out of Asia, especially in developed countries in Europe, decide to join? It is actually simple to understand. China has grown to be the main contributor to the world economy. It is the strategic choice for most countries to strengthen the economic and investment cooperation. Although China has entered its “new normal” in recent years and the growth potential has slowed down, but as the second largest economy, the growth rate is still relatively high. Europe still has not stepped out of the debt crisis completely, and the growth prospect is still not clear. It is economically attractive for slow recovering European countries to strengthen cooperation with China in Asia’s infrastructure development. More realistically, Asia remains the fastest-growing economic region. Advanced economies in Europe expect to share the outcome of the economic growth of emerging Asia and the benefits from infrastructure investment in Asia. The recovery of Eurozone is still unsatisfactory. Inflation in the zone has not reached the “less than but near 2%” objective set by the European Central Bank (ECB). Inflation rate even reduced to −0.2% which was for the first time negative in the recent five years. Besides economic problems, Europe is dragged by Greece and Ukraine crisis. Many unstable factors still exist in the political landscape. Although ECB issued quantitative easing of monetary policy trying to recover the sluggish economy, the outcome might not have been as was expected. In this regard, Europe is eager to find a new path of economic growth.

96  Xun Wang The establish of AIIB will provide necessary financial support for developing Asia, improve infrastructure conditions, motivate connectivity within the region, and promote regional economic development. This will no doubt bring lots of business opportunity. Therefore, due to the impact of the debt crisis, main European countries pay much more attention to potential investment opportunity out of Europe, especially relatively rapidly growing Asia. The joining of European advanced countries is also a motivation for the institutional establishment for the governance of the AIIB, which will help enhance the operational capability and international level of AIIB.

AIIB facilitating financial reforms and rebalancing the economies in Asia Lagged financial market reform in Asia Emerging Asia is characterized by lagged financial liberalization or financial repression. With repressed financial sectors, emerging Asia results efficiency loss due to resource misallocation: a relatively large manufacturing sector, while a less developed service sector. This inhibits the process of structural change and give rise to the accumulation of current account surplus by producing more and consuming less and saving more. According to the IMF’s financial reform dataset, after the year of 2000, the average financial liberalization index was 0.6, 32 percentage points lower than high-income countries, 17 percentage points lower than the world average, and even 9 percentage points lower than middle-income countries (Figure 5.7).           

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Figure 5.7  Financial liberalization index: averaged 2000–2005. Data Source: Abiad et al. (2008); IMF.

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The international financial system reform  97 The term “financial repression” was initially coined by McKinnon (1973), who defined it as government financial policies that strictly regulate interest rates, set high reserve requirement on bank deposits, and mandatorily allocate resources in the economy. Such repressive policies, more commonly seen in developing countries, are believed to impede financial deepening and lower the overall efficiency of the financial system. As a consequence, they should hold back economic growth (McKinnon, 1973; Shaw, 1973). The negative impact of financial repression on efficiency and growth is commonly accepted and constitutes the theme of a large body of literature. Pagano (1993) showed that financial policies such as interest rate control and reserve requirement decrease the amount of financial resources available for financial intermediation. Roubini and Sala-i-Martin (1992) presented theoretical and empirical analyses of the negative relationship between repressive financial policies and long-term growth. King and Levine (1993) developed an endogenous growth model to illustrate that financial sector distortions reduced growth by lowering the rate of innovation. While there are numerous theoretical and empirical studies on the negative relationship between financial repression and economic growth, other studies cast doubts on the significance of this relationship. Stiglitz (2000) attributed the increased frequency of financial crises around the world during the past decades to financial liberalization in the developing world. He argued that developing countries might be better able to manage their money supply and financial stability as well as improve the Pareto efficiency under policies based on financial restraints due to the problem of imperfect information (Stiglitz & Weiss, 1981; Stiglitz, 1994; Hellmann et al., 1997, 2000). The significance of the negative influence of financial repression on economic growth is thus not to be taken for granted. Levine (2005) provided an excellent review of the topic of financial development in general and its relation to economic growth. Therefore, the question of whether financial repression inhibits or facilitates economic growth needs to be determined empirically. The net impact is likely determined by a combination of two potential mechanisms—the negative effect suggested by McKinnon (1973) and Shaw (1973), and the positive effect highlighted by Stiglitz (1994) and Hellmann et al. (1997, 2000). The final outcome of an empirical analysis on the relationship between financial repression and economic development might be ambiguous and will depend on whether one of these effects will dominate the other. Huang and Wang (2011) examined the impact of financial repression on economic growth during ­China’s reform period. Their empirical results confirm that, on average, repressive policies helped economic growth, probably due to a prudent and gradual approach to liberalization. However, the impact turned from positive in the 1980s and 1990s, to negative in the 2000s, suggesting rising efficiency losses during the last decade. Their findings thus indicate that the effect of financial repression on economic development is most likely dependent on the general level of development and the institutional setting in the country in question.

98  Xun Wang The Chinese experience shows that the effect of financial repression on economic growth will be finally dominated not by the allocation but by the efficiency loss, which will shed light on the ongoing financial reforms for other emerging economies in Asia. To achieve sustainable growth, countries with repressed financial sector should promote market-oriented financial reforms to correct the distorted credit allocation and restructure the economy. AIIB, by collecting parts of savings in emerging Asia and collaborating with each other to identify promising infrastructure projects, will promote the financial cooperation and motivate financial reforms in the member countries of this region. Hence, as a regional financial arrangement, AIIB will help in rebalancing emerging economies in Asia by facilitating financial market-oriented reforms. Reducing current account imbalance During the first decade of the 21st century, the development of very large external imbalances has been the source of heated international debate. The USA has come to face large and persistent current account deficits, while East Asian countries, especially China, have exhibited large current account surpluses. However, this is not the first time in history that external imbalances have put pressure on policymakers around the world. In the 1970s, external imbalances constituted one of the main reasons for the end of the Bretton Woods system, and in the 1980s, increasing imbalances resulted in the Plaza and Louvre agreements that focused on exchange rate alignments. Increasing global imbalances have been seen by some as precursory for the global financial crisis that started in the USA in 2007, and later spread, in particular, to Europe. While some suggest that such imbalances may be due to the USA’s ability to provide financial assets for global savers (e.g. Milesi-­Ferretti & Blanchard, 2007; Caballero et al., 2008), others point to the lower investment levels and a saving glut in East Asia after the Asian Financial Crisis in 1997–1998 (e.g. Bernanke, 2005). Whatever the reason for the large external imbalances of many countries during the last decade, most observers would most likely agree that these imbalances are themselves a result of internal economic distortions. Typical examples of such domestic imbalances include very low savings in the USA, at least partly a result of negative public spending, and very high savings in China, at least partly due to a weakly developed welfare system (Milesi-Ferretti & Blanchard, 2009). In this subsection, we suggest that financial repression represents one important source of distortions that affect external balances. Why would repressive financial policies have an effect on external balances? We believe that this effect works mainly through the domestic industrial structure. Financial repression will result in structural imbalances, which, in turn, lead to external imbalances. In a previous paper, we developed a model for structural balances that incorporates financial repression (Johansson & Wang, 2011). The main outcome of the model, also supported

The international financial system reform  99 by empirical evidence, was that financial repression results in structural imbalances as the industry sector is promoted at the expense of the service sector. We build on that analysis in this paper. Since repressive financial policies lead to structural imbalances in which the industry sector grows much faster than in a balanced economy, we argue that the expansion of manufacturing, which constitutes a significant portion of industry output, will lead to exports increasing much faster than imports. This will, in turn, lead to a current account surplus that may persist as long as the government continues its repressive policies in the financial system. Wang (2018) analyzes the relationship between repressive financial policies and external balances. Empirical analysis on a panel for a large set of countries shows that financial repression has a significant and positive effect on the current account. The finding is robust when controlling for a large number of potential determinants of external imbalances. It also holds for several additional robustness checks, including focusing on longer-term determinants of the current account, alternative measures of the external imbalances, and alternative measures of financial repression. He also shows that distortions in the domestic industrial structure function as an important mechanism for the effect of financial repression on external balances. Then the specific effects of different types of repressive financial policies are examined, and the results show that it is primarily interest rate controls, insufficient competition within the banking sector, and capital controls that are positively associated with current account surpluses. To shed light on the saving glut hypothesis for global imbalances, we focus on the case of East Asia. We find that institutional quality and financial development do not have a significant effect on East Asian current accounts. Instead, financial repression has a larger effect on the current account in East Asia than in the rest of the world. When excluding China from the group of East Asian countries, we find that the effect is even larger than for the whole sample. This indicates that financial repression has a stronger effect on external balances in East Asia even when we exclude the special case of China. Promoting economic transformation Structural transformation constitutes one of the main stylized facts of economic development (Kuznets, 1957, 1973). All developed economies follow a similar pattern of structural change, with a falling production and employment share of the agricultural sector, an initially rising but eventually falling share of the industry sector, and a rising share of the service sector (Pandit  & Casette, 1989; Mokyr, 1993). This unbalanced growth pattern across sectors is not consistent with the “Kaldor facts” and not supported by traditional balanced growth models. While there are several demand-side- and supply-side-based analyses in the literature, few studies pay attention to the impact of institutional

100  Xun Wang

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distortions on the process of structural change. Among a plethora of potential institutional distortions, we argue that distortions in the financial system, or financial repression, may be one of the most important impediments to structural balances and balanced growth. Governments in financially repressed economies tend to allocate limited financial assets and provide financial facilities to the preferred industry sector by credit rationing and low real interest rates.1 Economies, particularly in developing countries, are eager to attract foreign exchange and foreign direct investment (FDI), which are seen as important ingredients in the quest for new technology and development in general. It is thus common for governments to implement preferable policies and allocate resources to support the development of the domestic industry sector. With an increased openness and economic takeoff, the industry sector as a primary tradable sector expands faster than the domestic service sector, which will thus be held back due to distorting financial policies. Literature on the structural transformation indicate that with the economic growth, development of the industry sector follows an initially rising but eventually falling share, and the service sector follows a rising share. These patterns of structural change are seen in Figure 5.8. The figure depicts the relationship between the sectoral output ratio and GDP per capita, which indicates a U-shaped effect of income level on sectoral transformation.

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The international financial system reform  101 Theories suggest that financial repression will retard the process of sectoral transformation by inhibiting the movement of resources from industry sector to service sector. The negative relationship between financial repression and the sector output ratio is seen in Figure 5.9. Figure 5.10 shows the negative relationship between financial repression and the sector employment ratio. The empirical investigation predicts that higher degree of financial repression will hold down the service sector and protect the development of industry sector by inhibiting financial resources and labor movement from industry to service sector. Based on the empirical analysis, the significantly negative sign of financial repression indicates that a higher level of repression in the financial system leads to a relatively lower service share compared to industry sector share of a country’s GDP. A higher level of financial repression enables the government to allocate more financial resources (bank loans, easy access to stock and bond markets, etc.) to the preferred industry sector. This means that the development of the service sector will be held back. Improving income distribution

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regulated interest rate may have at least two adverse effects on income equality. First, it may be used by the government for credit allocation, as often argued in the case of China (e.g. Johansson, 2012). This credit allocation may lead to what was mentioned earlier, that is, limited economic opportunities for large segments of the population. Second, regulated interest rate may affect people adversely, depending on how affluent they are. For poor people, a simple bank account may provide the only source of income on savings. For the more affluent, there is typically a wider range of ways to invest one’s savings. If interest rates are kept artificially low, those with limited alternative ways to invest their savings are thus affected more adversely. The same reasoning applies to repressive financial policies in the form of state control over the banking sector. If the banking sector is characterized by a high level of state control, as in the case of China, then credit is not allocated by markets. Policies that dictate credit allocations will then directly influence the potentially adverse effect of this specific form of financial repression on inequality. The Chinese experience during the reform period offers an interesting case study of the relationship between financial repression and inequality. During the last 30 years, China has managed to achieve a continuously high GDP growth, with an annual average of approximately 10%. However, despite substantial and wide-ranging economic reforms, the

The international financial system reform  103 Chinese economy is still characterized by a range of repressive financial policies, including regulated interest rates, state-controlled credit allocation, high and frequently adjusted reserve requirements, as well as a tightly controlled capital account. As Huang and Wang (2011) point out, most of these repressive policies were introduced before the beginning of the economic reforms during a time when the Chinese financial system was underdeveloped and financial resources were scarce. As mentioned earlier, the Chinese case seems to suggest that financial repression has had positive effects on growth during the initial stages of economic reforms and opening up. On the other hand, it has been argued by several observers that the negative effects of financial repression have increased over time in China. Li (2001) states that repressive financial policies have resulted in increasing inefficiencies and that they may have resulted in a low-efficiency trap which in itself prevents further financial liberalization. Huang and Wang (2011) take this argument to data and show that there was a structural break in the relationship between financial repression and economic growth around 2000. The increasing level of inequality in China suggests that there are rising efficiency losses as a result of financial repression during the more recent period of economic reforms. During the early years of reform, the state sector still dominated the national economy. Credit control, which ensured that bank lending went to the state sector, supported economic growth. More recently, however, the non-state sector has become more important while still facing serious financial constraints. Disproportionate loans to the state sector have implied an increasing misallocation of capital. Controlling interest rates prevented irrational interest rate competition among underdeveloped financial institutions in an early period of reform. Following significant reform and development of the domestic financial sector, however, such controls probably limited interest rate responses to the changing economic environment and resulted in a mispricing of capital. In the 1980s and much of the 1990s, the central bank managed monetary policy by employing a series of direct controlling measures such as credit quotas. In most cases, the reserve requirement ratio was not a binding variable. In the 21st century, however, the reserve requirement ratio became increasingly important in the central bank’s management of monetary policies. Despite direct management of liquidity, frequent adjustments of this ratio are likely to impose harsh quantitative constraints on commercial banks’ lending (often crowding out the more dynamic small- and medium-­ sized enterprises at times of tightening). Capital account controls in the early years of reform did not hurt economic growth but, over time, they could become a source of financial distortions or risks. Today, Chinese capital controls such as restrictions on cross-border borrowing and outward direct investment limit the ability of domestic companies and residents to access international capital markets and maximize investment returns.

104  Xun Wang In general, a decline in financial repression will further correct distortions in the financial sector, followed by corrections in the real economy, which will release more economic creativity. Efficiency improvement in the financial system means a relative increase in the activities of small- and medium-sized private companies and in economic opportunities for the poor, which are likely to create more job opportunities and absorb people who are laid off during the reform process and the economic transition that is still underway in China. Johansson and Wang (2014) support this argument and provide evidence of how individual repressive financial policies are associated with income inequality. They suggest priorities for future financial liberalization to improve income inequality: improving credit allocation between state and non-state sectors, abandoning frequent reserve requirement adjustments, introducing market-based interest rates, and liberalizing the capital account.

Reforming the international financial system Reforms on the international financial system motivated by emerging economies Besides economic consideration, the establishment of AIIB also implies the changing world order between developed countries, especially the USA and the emerging economies. Since the Breton Woods system in 1945, by controlling the World Bank and the IMF and building up US dollar-centered international monetary system, the USA has a dominant influence on the international financial system. However, with the rise of emerging economies in recent years, existing international financial organizations have not been able to reflect the rising status of emerging markets. According to the World Bank’s data, in 2013, the nominal GDP of USA was 16.8 trillion US dollars, and that of China was 9.24 trillion US dollars. Taking the example of the IMF, the USA as the biggest shareholder account for 17.69% of the voting rights. Although ­China’s GDP has exceeded half of that of USA, the share of China in the IMF is less than one-fourth of that of USA. When experiencing rapid economic growth, the international discourse power of the emerging economies has not been enhanced accordingly. Moreover, the IMF and the World Bank have not been able to meet the need of huge amount of loans from the developing countries. Even Africa, the most needed region for loans, in order to obtain several million loans from the IMF, needs to go through the complicated verifying process and also will be attached to numerous conditions. Emerging economies tried to seek changes within the existing system but were encountered with huge resistance from the United States. At the end of 2010, G20 agreed that advanced economies transfer 6% of the share to enhance the voting rights of emerging economies, and Europe transfer two executive board seats to increase the power of developing countries in the global financial system.

The international financial system reform  105 However, there had been no further progress after 4–5 years because every internal matter should be approved by the IMF board meeting. The voting right of the USA exceeds 15% and the USA has veto power. The USA’s decision requires the approval of the US Congress. However, the final result turned out to be that the US Congress rejected to approve this reform project. In the same year, China’s effort to incorporate RMB into the SDR currency basket was also denied by the USA with the excuse that the liberalization of the currency was not enough. Therefore, emerging economies had to find another outlet. In July 2014, New Development Bank was established. AIIB attracted 33 states before its establishment. American former financial minister Jack Lew’s statement in the Congress implied the worries of America: “Our international credibility and influence are under threat”. Lew talked to the Congress that promoting the IMF reform is the best way to maintain the dominant status of the USA in the IMF and protect America’s economic interest and the state security interest. AIIB and other international organizations: competitive or complementary? The establishment of AIIB when the World Bank, the IMF, and ADB already existed, will naturally lead to the following questions. Will AIIB challenge the existing multilateral institutions? Will AIIB replace the existing international financial organizations? To answer these questions, one needs to have a basic understanding of the main missions of these institutions. Generally speaking, the main task of the World Bank is poverty alleviation; the IMF aims to motivate international monetary cooperation. Established in 1966, ADB is the product that Japan attempted to pursue regional and international impact after its rise in 1960 by poverty alleviation in Asia. Clearly, infrastructure investment is not the main business of these institutions. Moreover, these institutions are not large enough to support infrastructure investment in Asia. Just as China’s former financial Minister Lou Jiwei said: “The relationship between AIIB and World Bank, IMF and ADB is complementary and cooperative”. The World Bank and ADB focus on poverty alleviation, and AIIB emphasizes infrastructure construction which helps to alleviate poverty indirectly. AIIB can cooperate with the World Bank and ADB through joint financing. As an intergovernmental multilateral development bank, AIIB will follow the principle and mode of the multilateral development banks, learn experience and good practice from the existing multilateral development banks, and focus on environment and immigrants. European countries joining AIIB as the founding members of AIIB indicates that those countries have a basic trust in AIIB. These economies are advanced in the finance sector and have accumulated rich experience in the evolution of the international financial system. By participating in

106  Xun Wang the infrastructure investment in Asia, European countries not only can enjoy the returns on investment but can create more market opportunities in Asia’s infrastructure investment for European enterprises. This is a typical all-win game. Moreover, their joining will no doubt raise the reputation of AIIB, which will contribute to the asset expansion and provide better supervision on the governance of AIIB. AIIB will set up sound governance framework and follow the rules of multilateral organizations and international practice. AIIB will be lean, clean, and green, playing main concerns over transparency and standards of governing the institution. Lean is cost-effective; clean means this bank will have zero-tolerance for corruption; green means AIIB will push through the adaptation of energy saving and environment-friendly technology in its projects. In general, AIIB is a new multilateral financial institution, collaborating with all the member states, representing every member country’s interest, and fully learning from the efficient practice of existing multilateral institutions. Based on this, AIIB will continue to develop innovations to set up a new multilateral financial institution with advanced governance in the 21st century. Toward a more inclusive international financial system With large funds demand for infrastructure investment in Asia, although there are many opportunities, there are also many challenges facing AIIB. It is often questioned whether China can successfully operate AIIB. It is true that China does not yet have enough experience, knowledge reservation, and relevant mechanism on running multilateral development organizations. Meanwhile, China is frequently questioned that projects in Latin America and Africa show lack of transparency, market-oriented operation, and evaluation mechanism, which are the basic principles that multilateral development agencies must follow. We also need to improve the operational capacity and international level of AIIB in the governance structure, decision-making mechanism, procurement of financing, project operations, risk management, information disclosure, and performance assessment. To improve the operational efficiency of AIIB, its nature and orientation must be properly dealt with. For a project with high risks, how to balance the political and economic relations to achieve economic effects? At the same time, social development is a big challenge to the member states, especially China. To ensure the success of the projects, AIIB must come up with standard rules and regulations to clarify the requirements on the due investigation, bidding, and procurement. The balance between project quality and efficiency should be noted as well. The financing party does not supervise the quality and process of the project, which is the prevailing practice of international project. After all, project survey will increase cost. Therefore, AIIB needs to consider whether to reserve the supervision rights on the projects.

The international financial system reform  107 However, challenges are always accompanied by opportunities. AIIB could make good use of the experience from Breton Woods system, coordinate and communicate with other international or regional financial institutions, and improve operational efficiency and project management capability incorporating Asia’s real needs. The membership of advanced economies in the AIIB increases the reach of China’s leadership, and at the same time, opens opportunities to AIIB to developing. At the same time, AIIB should improve its ability to set international rules and manage international relations in order to have a more inclusive and reasonable international financial system.

Note 1 Regardless of whether a government chooses a development strategy based on export-led growth or import substitution, it will allocate limited financial resources to develop the domestic industry sector. There is often a special initial focus on the manufacturing, a typical tradable sector. Another potential reason behind a government choice to give the domestic industry sector preferential treatment is that of national security.

References Abiad, A, Detragiache E., & Tressel, T. (2008). A New Database of Financial Reforms (No. 2008–2266). Washington, DC: International Monetary Fund. Bernanke, B. (2005, March 10). The Global Saving Glut and the U.S. Current Account. Remarks at the Sandridge Lecture. Virginia Association of Economics, Richmond, VA. Caballero, R. J., Farhi, E., & Gourinchas, P.-O. (2008). An Equilibrium Model of “Global Imbalances” and Low Interest Rates. American Economic Review, 98, 358–393. Easterly, W., & Rebelo, S. (1993). Fiscal Policy and Economic Growth. Journal of Monetary Economics, 32(3), 417–458. Donaldson, D. (2016). Railroads of the Raj: Estimating the Impact of Transportation Infrastructure. National Bureau of Economic Research, 16487. Cambridge, MA. Gramlich, E. M. (1994). Infrastructure Investment: A Review Essay. Journal of Economic Literature, 32(3), 1176–1196. Hellmann, T., Murdock, K., & Stiglitz, J. (1997). Financial Restraint: Toward a New Paradigm. In M. Aoki, H.-K. Kim, & M. Okuno-Fujuwara (Eds.), The Role of Government in East Asian Economic Development: Comparative Institutional Analysis (pp. 163–207). Oxford: Clarendon Press. Hellmann, T., Murdock, K., & Stiglitz, J. (2000). Liberalisation, Moral Hazard in Banking and Prudential Regulation: Are Capital Controls Enough?’ American Economic Review, 90, 147–165. Huang, Y., & Wang, X. (2011). Does Financial Repression Inhibit and Facilitate Economic Growth: A Case Study of China’s Reform Experience. Oxford Bulletin of Economics and Statistics, 73(6), 833–855. Johansson, A. C. (2012). Financial Repression and China’s Economic Imbalances. In H. McKay & L. Song (Eds.), Rebalancing and Sustaining Growth in China (pp. 45–64). ­Canberra: ANU E Press.

108  Xun Wang Johansson, A. C., & Wang, X. (2011). Financial Repression and Structural Imbalances. Stockholm School of Economics, China Economic Research Center Working Paper, 2011–2019. Johansson, A. C., &Wang, X. (2014) Financial Sector Policies and Income Inequality. China Economic Review, 31, 367–378. King, R. G., & Levine, R. (1993). Finance, Entrepreneurship, and Growth: Theory and Evidence. Journal of Monetary Economics, 32, 513–542. Kuznets, S. (1957). Quantitative Aspects of the Economic Growth of Nations: II. Industrial Distribution of National Product and Labor Force. Economic Development and Cultural Change, 4(5), 1–112. Kuznets, S. (1973). Modern Economic Growth: Findings and Reflections. American Economic Review, 63, 247–258. Levine, R. (2005). Finance and Growth: Theory, Mechanisms and Evidence. In P. Aghion & S. N. Durlauf (Eds.), Handbook of Economic Growth (Vol.  1A, pp. ­865–934). Amsterdam: Elsevier. Li, D. (2001). Beating the Trap of Financial Repression in China. Cato Journal, 21, 77–90. McKinnon, R. I. (1973). Money and Capital in Economic Development. Washington, DC: The Brookings Institution. Milesi-Ferretti, G. M., & Blanchard, O. J. (2009). Global Imbalances: In Midstream? [IMF Staff Position Notes 2009/29]. Washington, DC: International Monetary Fund. Mokyr, J. (1993). Introduction. In J. Mokyr (Ed.) The British Industrial Revolution (pp. 1–129). Boulder, CO: Westview Press. Pagano, M. (1993). Financial Markets and Growth: An Overview. European Economic Review, 37, 613–622. Pandit, K., & Casetti, E. (1989). The Shifting Pattern of Sectoral Labor Allocation during the Development: Developed versus Developing Countries. Annals of the Association of American Geographers, 79, 329–344. Roubini, N., & Sala-i-Martin, X. (1992). Financial Repression and Economic Growth. Journal of Development Economics, 39, 5–30. Shaw, A. S. (1973). Financial Deepening in Economic Development. New York: ­Oxford University Press. Stiglitz, J. E. (1994). The Role of the State in Financial Markets. In Bruno, M. & Pleskovic, B. (Eds.), Proceeding of the World Bank Annual Conference on Development Economics, 1993: Supplement to the World Bank Economic Review and the World Bank Research Observer. Washington, DC: World Bank. Stiglitz, J. E. (2000). Capital Market Liberalization, Economic Growth and Instability. World Development, 28, 1075–1086. Stiglitz, J. E., & Weiss, A. (1981). Credit Rationing in Markets with Imperfect Information. American Economic Review, 71, 393–410. Wang, X. (2018). Financial Sector Policies and External Imbalance: Implications for Emerging Asia. [NSD Working Paper] Peking University. World of Work Report. (2014). International Labour Organization. Retrieved from http://www.ilo.org/global/research/global-reports/world-of-work/2014/WCMS_ 243962/lang--en/index.htm

6 Commodity structure of trade between China and the Belt and Road (B&R) countries and its implications for RMB internationalization Yibing Ding, Qianwen Shen & Xiao Li The relationship between the Belt and Road Initiative and RMB internationalization The RMB cross-border trade settlement pilot projects started in the second half of 2009, which marked the real starting point of the process of renminbi (RMB) internationalization. According to the RMB internationalization index (RII) prepared by the International Monetary Institute of Renmin University of China, the internationalization of the RMB made rapid progress during 2009–2016. By the end of 2015, the RII reached 3.6, which was more than ten times the RII value of 0.22 in 2010. Although the RII dropped to 2.26 in 2016 due to the slowdown of the domestic economic growth and the “8.11” exchange rate reform, the overall trend of RMB internationalization remains positive. The RMB has also gained more acceptance in other areas. In 2016, it officially became a member of the SDR (special drawing right) basket, and became the SDR’s third-largest weighted currency, with a higher share than that of yen and the sterling. This recognition of the international status of the RMB by the international organization will also further promote the progress of RMB internationalization. In June 2017, the European Central Bank announced that it had completed an investment of 500 million euros of RMB for its foreign exchange reserves. For the sake of keeping the total amount of foreign exchange reserves unchanged, they decided to sell equivalent dollar assets. The European Central Bank, the second largest central bank in the world, indicated that the RMB is gaining more recognition in the international foreign exchange reserve market again. The Belt and Road Initiative was first proposed in 2013. In 2015, the ­National Development and Reform Commission, the Ministry of Foreign Affairs and the Ministry of Commerce jointly released Vision and Actions on Jointly Building Silk Road Economic Belt and 21st-Century Maritime Silk Road. So far, more than 60 countries from East Asia, Southeast Asia, West Asia, South Asia and Central and Eastern Europe have actively participated in the co-construction. China aims to achieve cooperation and improve connectivity with all the related countries in various fields, such as infrastructure connectivity, industrial investment, trade and financial cooperation.

110  Yibing Ding et al. The ultimate goal is to achieve win-win results with cooperation. The Belt and Road Initiative is a strategic choice considering the current international and domestic economic situation. First, the project has to serve the needs of China’s economic development. At present, China has entered a so-called economic “new normal”, the economic growth has slowed down and the pressure has increased. To achieve sustainable stable economic growth, the industrial structure and economic development model must be transformed, which requires a more favorable international environment. In addition, the proposed initiative will also improve the current unbalanced regional economic development situation within China. At this stage, the provinces and cities involved in the Belt and Road Initiative are mainly Xinjiang, Shaanxi, Gansu, Ningxia, Qinghai, Inner M ­ ongolia (in the ­Northwest), Heilongjiang, Jilin, Liaoning (in the northeast), Guangxi, ­Yunnan, Tibet (in the southwest), Shanghai, Chongqing, Fujian, G ­ uangdong, Zhejiang and Hainan. For a long time, there has been a large disparity in economic development between the eastern coastal areas of China and the central and western regions. The “Belt and Road” Initiative will provide unprecedented opportunities for the development of the central and western regions and new possibilities for China’s economy. There is an indirect but important connection between the process of the Belt and Road Initiative and RMB internationalization. The Belt and Road Initiative can impact RMB internationalization in three ways. First, the trade volume between China and countries along the Belt and Road has been growing rapidly, and the status of these countries as China’s trade partners has continuously improved. Consistent with the continuous changes in the product structure and geographical structure of trade in China, commercial interaction with these countries will become increasingly diversified and rationalized. As trade settlement is the cornerstone of the RMB internationalization, China could seize the opportunities of rapid trade growth with the countries along the “Belt and Road” to encourage enterprises to use the RMB for trade settlement so that the RMB internationalization can be pushed forward (Tu & Li, 2007). Second, the demand for funding in the field of investment offers opportunities to promote the internationalization of the RMB. The majority of the countries along the “Belt and Road” are developing countries. Many of them need China’s investment in the infrastructure sector. China can use the RMB, foreign exchange reserves or both to invest. With technical and financial advantages, the Chinese government and enterprises can invest in major projects such as high-speed railway construction and oil and gas exploitation in countries along the route. Investment in RMB can reduce the risk of exchange rates and simplify transaction costs. Currently, the rate of return on assets denominated in the US dollar and the euro is generally low. If China can provide high-yielding and low-risk financial products with RMB as the investment currency, there will be a broad market. The circulation mechanism of RMB overseas will also be improved.

The commodity trade structure  111 Third, the Belt and Road Initiative can further expand the reserve function of the RMB. Since 2009, the People’s Bank of China has signed currency swap agreements with 36 central banks or monetary authorities for a total of 33,437 billion yuan. Twenty of these countries are located along the “Belt and Road”, which accounts for 68.82% of the total agreement amount. The signing of currency swap agreements can reduce the impact of exchange rate changes on bilateral trade. This is a win-win decision, which not only reduces the risk and cost of doing business but also expands the scale of RMB circulation abroad. Moreover, Zhang et al. (2017) estimated the effect of currency swap agreements on bilateral trade using the gravity model. He found that currency swap agreements have great positive effects on bilateral trade. The countries that have signed currency swap agreements with China are more willing to settle in RMB; therefore, the agreement can indirectly promote the internationalization of the RMB. In addition, Singapore had announced it will fit RMB into the official foreign exchange reserves in June 2016. The RMB is widely circulated in Burma, Thailand and other border countries and is even known as the “small dollar”. With the continuous development of the Belt and Road Initiative, the RMB will eventually become one of the official foreign exchange reserves of more countries.

The significance of the expansion of Belt and Road trade relationships for RMB internationalization The internationalization of the RMB currently faces some obstacles and limitations. Finding the right starting point is an important driving force promoting this process. Considering the fact that China is the world’s largest trading nation, foreign trade has a pivotal position in the process of RMB internationalization. Under the background of global economic decline and China’s economy entering a new normal, the internationalization of the RMB cannot depend only on the increase of trade volume; more attention should be paid to the contribution of trade structure. The trade structure refers not only to the commodity structure but also to the geographical distribution of trade partners. The total volume of foreign trade has been increasing since China entered the WTO in 2001. Simultaneously, trading shares with different partners is also changing. There has been a gradual decline in the share of trade with developed countries and regions. The share of trade with emerging market countries and neighboring countries continues to increase. The proportion of China’s exports to developed and developing countries in 2000 was 83.2% and 16.8%, respectively. This figure changed to 64.7% and 35.3%, respectively, in 2014. The share of developing countries has doubled over the past decade, contributing to a promising market. Most of the countries along the “Belt and Road” Initiative are classified as developing countries. Currently, strengthening trade relations with these countries is very important for China’s export growth. According to international currency and invoicing

112  Yibing Ding et al. currency theory, the increased trade volume and the optimization of the trade structure will improve the level of currency internationalization. As an important member of the “Belt and Road” Initiative, the Association of Southeast Asian Nations (ASEAN) is China’s third largest trading partner after the United States and the European Union. The volume of bilateral trade between China and the ASEAN reached 452.2 billion dollars in 2016. Additionally, China is the ASEAN’s largest trading partner, and the proportion of Chinese imports from the ASEAN continues to increase, from 5.88% in 2001 to 15.54% in 2015. The proportion of Chinese exports to the ASEAN continues to increase, from 6.8% in 2002 to 19.52% in 2015. The five countries in Central Asia have the fastest trade volume growth rate with China. The average annual growth rate was 29.8% in 2001–2014, which is higher than the average annual growth rate for China and the “Belt and Road” countries (Zou et al., 2015). With the advantages of lower transportation costs and a closer cultural background, China should replicate the successful experience of trade with the ASEAN and further expand the scale of trade with other countries along the “Belt and Road”. For the moment, the invoicing and settlement currencies of bilateral trade between China and the “Belt and Road” countries are still dominated by the US dollar. The main reason for this is the absence of real international currency within this area. Using the US dollar for settlement is inconvenient for both parties, which is mainly manifested in the following ways. First, as the US dollar is the vehicle currency for bilateral trade, both the importing and exporting enterprises are exposed to great risk caused by exchange rate fluctuation and higher transaction costs. The enterprises’ motivation to further expand trade will decrease, which runs counter to the original intention of the “Belt and Road” Initiative. In recent years, in particular with the slowing growth of foreign trade, avoiding exchange rate risks became very important to both importers and exporters. Second, the traders must hold a large amount of US dollar foreign exchange reserves for settlement. As the scale of trade expands, increasing US dollar reserves will be needed. These reserves may face large losses due to the fluctuation in the value of the US dollar, resulting in the loss of national welfare. The internationalization of the RMB will provide a new possibility for this bilateral trade. As long as the Chinese economy continues to develop steadily and the RMB exchange rate remains stable, more enterprises will use the RMB for trade settlement. Currently, the RMB is the most likely currency within the area to be widely used for circulation and settlement in countries along the “Belt and Road”. There is a large difference in the trade scale and commodity structure between China and the other countries along the “Belt and Road”. This is due to differences in the level of economic development and trade environment, which indicates that the trade relations between China and these countries have a great deal of room in which to expand. President Xi Jinping spoke at the Belt and Road Forum for International Cooperation. He said that we need “to safeguard the multilateral trading system, promote

The commodity trade structure  113 the construction of a free trade zone, and promote trade and investment liberalization and facilitation”. The goal of “Trade Connectivity” will be achieved by constantly improving infrastructure construction, simplifying trade procedures and standardizing the trade process. In 2016, the actual use of cross-border RMB for trade between Chinese and countries along the “Belt and Road” Initiative accounted for only 13.9% of the bilateral trade volume. Further improving its status in these countries is one of the aims of RMB internationalization. From this perspective, “Belt and Road” trade expansion and RMB internationalization are mutually reinforcing. On one hand, the increase in trade volume produces more currency settlement demand. To avoid the risk of exchange rates, increasing numbers of companies will use the RMB for settlement as long as the value of the RMB remains stable. The increased circulation of RMB in the international market will further promote the need for RMB investment and financing. Gradually, the use of the RMB will extend from the trade field to the field of investment and financing. On the other hand, improvement in the recognition and status of the RMB in the international community will enhance governments’ and enterprises’ confidence in the RMB. These entities will be more confident in the prospect of the RMB as an international currency.

The influence of scale and commodity structure of trade on currency internationalization As an important part of the national economy, foreign trade’s impact on the internationalization of currencies is worth studying. The process of RMB internationalization formally started in 2009. In the same year, China became the largest exporter in the world. Later, in 2013, China became the largest trader in the world. We should pay attention to the impact of both the total volume and the commodity structure of China’s trade on RMB internationalization. There are numerous studies on the relationship between trade and currency internationalization. More of these studies focus on the scale of trade. Porters and Ray (1998) noted that to be an international currency, the currency-­issuing country must meet three conditions: high level of economic development, huge scale of international trade and highly developed domestic financial market. Shams (2002) pointed out that according to the traditional theory, the currencies issued by the countries with the highest trade volumes in the world are more likely to become international currencies. However, Shams noted that the type of trade balance also has a large but varied impact on the international status of currency. The trade deficit helps currency internationalization by stimulating the outflow of money. Related studies in China generally indicate that trade and finance development are the two major conditions for RMB internationalization. Liu (2007) draws the conclusion through empirical research that the development of trade is the basic condition and initial driving force of currency

114  Yibing Ding et al. internationalization. Trade development is an international path that cannot be ignored, especially in the early period of RMB internationalization. In addition, the domestic financial market is not yet developed (Liu 2007). After introducing relevant theories, models and an empirical analysis of the selection factors of pricing currency, Xu (2010) believed that countries with large trade product differences and low trade shares should be the key targets of RMB internationalization. There are relatively fewer studies focused on the relationship between commodity structure of trade and currency internationalization. The research on this topic is based mainly on the theory of invoicing currency selection. The basic point of this theory is that in addition to the relative trade scale, the commodity structure of the country’s trade has an impact on whether its currency is chosen as the invoicing currency of international transactions. The Grassman Law is the most representative argument. By studying the invoicing currencies for Sweden and Denmark, Grassman (1973) found that exporters in the manufacturing sectors are more inclined to use local currency for settlement than importers. Exporters seldom use vehicle currency for export settlement (Grassman 1973). According to the Grassman Law, exporters who export products with higher differences and lower substitutability will have greater pricing power in international transactions. The same situation applies to importers who import products with lower differences and higher substitutability. Thus, the country’s currency is more easily accepted as a medium of international transactions. In other words, the export and import expansion of different types of products has different effects on the international status of a country’s currency, which is precisely the focus of this paper that will be further discussed in the subsequent empirical study. McKinnon (1979) simplified trade products into two categories: highly differentiated manufactured products (the first kind of tradable goods) and relatively similar primary products (the second kind of tradable goods). Most products priced by exporters’ currency would be the first type of tradable goods. It is difficult for importers to find alternative products because of the low substitutability of the products. On the other hand, traders tend to use a single low-cost currency for the second type of tradable goods. Most of the primary products, such as oil and grain, are highly homogenized. The exporter does not have much pricing power in the transaction because the importer can easily find alternatives. As a result, exporters are usually the price takers and must accept the low-cost currency with greater exchange rate risks. The low-cost currency is often the dominant currency in the international monetary system, such as the US dollar. Goldberg and Tille (2008) analyzed the reasons for the widespread use of US dollars in international trade. First, the United States provides the largest market for most exporters. Foreign exporters face fierce competition, so they have no power in the choice of currency. Second, even if one country does not trade with the United States, exporters will still choose the US dollar as the

The commodity trade structure  115 pricing currency because they need to maintain price consistency with competitors and avoid price changes brought by exchange rate fluctuations due to the existence of homogeneous products (Goldberg & Tille, 2008). While most of the current studies discussed the relationship between trade and currency internationalization from the perspective of export, this paper also discusses the effect of volume and commodity structure of import on currency internationalization. Pei (2013) notes that the growth of foreign demand is limited after economic growth has entered a stage of structural deceleration. At present, China emphasizes supply-side structural reforms and pays more attention to the import than to the export (Pei 2013). Based on an empirical analysis of the Spatial Durbin Model, Ding et al. (2014) find that in the process of yen internationalization, the export of intermediate goods with a higher degree of differentiation helps to improve the level of yen internationalization. However, the Japanese import structure, which is dominated by primary products and final products, hinders yen internationalization (Ding et al., 2014). Foreign trade has experienced a period of rapid growth for years since China joined the WTO in 2001. The total export-import volume increased from 620 billion dollars to 3,416 billion dollars in 15 years. The average annual growth rate reached 13.96%. Actually, the growth of total trade can be divided into two periods, with 2012 as the boundary. During 2001–2012, the growth rate was approximately 20%, and at its peak, in 2004, it was 34.36%. After 2012, the annual growth rate had dropped to the single digits. There was even a negative growth rate of 10% in 2015. Considering factors such as China’s economic development has entered a new normal, the world economic situation is not optimistic and the anti-­ globalization is on the rise, it is difficult to maintain a high trade volume growth rate. So, the structure of trade would become more important for RMB internationalization. This structure includes not only the commodity structure but also the geographic structure. The implementation of the “Belt and Road” Initiative is likely to promote RMB internationalization in both the geographic structure and the product structure. The “Belt and Road” Initiative can optimize the geographic structure of China’s trade. There were several “black swan” events around the world since 2016.1 Trump’s election as president of the United States is the biggest example. Trump advocated trade protectionism and began to impose a trade war against China. This will not only affect the development of ­China’s trade but also bruise the trend of trade liberalization and economic globalization. A series of events has added uncertainty to global economic growth, such as Brexit, the increase in interest rates by the Fed and the new administration of Italy. When considering China’s future trade pattern and trend, the international political and economic environment must be taken into account. Against this background, the proposed “Belt and Road” Initiative is very significant because it provides a new path for the sustainable development of China’s trade and the internationalization of the RMB.

116  Yibing Ding et al. 12000

35

10000

30 25

8000

20 6000 15 4000

10 5

0

0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

2000

total trade value with 64 countries along the"belt and road" trade with countries along proportion

Figure 6.1  Trade value and proportion between China and countries participating in the “Belt and Road” Initiative. Source: National Bureau of Statistics of China.

Trade between China and these countries has grown rapidly in recent years, and these countries are becoming increasingly important to C ­ hina’s foreign trade (Figure 6.1). The importance of the “Belt and Road” Initiative is also reflected in the change in China’s trade partners. Now, China puts greater emphasis on developing countries and emerging market countries. In addition, the geographic structure of China’s trade tends to be diversified and rationalized. Furthermore, it is worth noticing that when the total volume of foreign trade decelerated, since 2015, the trade volume with the countries along the route remained relatively stable. The “Belt and Road” Initiative plays a positive role in relieving the pressure of economic development and promoting the transformation of economic structure in China. Before investigating the commodity structure of trade between China and the countries along the “Belt and Road”, we should provide a general understanding of the commodity structure of China’s total import and export trade, which can be a reference for comparative analysis. Through the data of the Research Institute of Economic, Trade, and Industry (RIETI), we found that there were big differences in the commodity structures of China’s import and export (Figure 6.2). For export, the ratio of consumption goods clearly changed from 48% in 2001, to 27% in 2015. Processed goods, parts and component goods and capital goods accounted for a slight increase, while the export of primary products was almost negligible; for import, the most obvious change was in primary products whose proportion increased from 13% in 2001 to a peak of 33% in 2013. Though this ration dropped to 26% in 2015, the import of primary products has still

The commodity trade structure  117 60

50

40 Primary goods 30

20

Processed goods parts and compornents Capital goods Consumption goods

10

0

Figure 6.2  Five classifications of China’s export trade products. Sources: RIETI-TID database.

doubled compared with that in 2001. The import of consumption goods has increased continuously. The proportion of capital goods and processed goods has decreased slowly.

Commodity structure of China’s trade with the B&R countries To determine whether the commodity structure of trade between China and countries along the Belt and Road has an impact on RMB internationalization, we need to analyze both the qualitative and quantitative aspects. Generally, there is an obvious difference between the commodity structures of export and import. China mainly exports mechanical equipment, such as manufactured products, to these countries. Primary product exports account for a small proportion and declines yearly. The import proportion of primary products increases every year, followed by other intermediate products, such as mechanical equipment and textiles. There are many countries along the Belt and Road. Their economic development level and factor endowment are different. All the countries along the “Belt and Road” can be divided into six groups: Russia and Mongolia constitute one group, 19 Central and Eastern European countries constitute another group, and the other four groups are composed of 19 Middle Eastern countries, five Central Asian countries, 11 Southeast Asian countries and 8

118  Yibing Ding et al. South Asian countries (the detailed list can be found in Appendix 6.1). We focus on two special areas, Southeast Asia and Central Asia. Both of these two areas have enjoyed rapid trade growth with China in recent years. Furthermore, the factor endowment and economic development levels of these countries can be regarded as representative of the regions in the qualitative analysis. The 11 countries of Southeast Asia are China’s major trade partners. The scale and structure of trade with these countries have great influence on the use of the RMB in the region. From 2001 to 2016, China’s exports to Southeast Asia were dominated by processed goods and capital goods. The proportion of processed goods increased significantly. The proportion of primary products was relatively low, and the proportion of parts and components continued to decrease from 25% to17% during 2001–2015. China’s import structure from Southeast Asia was more concentrated. The imports of intermediate products, which were made up of processed goods and parts and components, accounted for approximately 70% in 2016, followed by primary products. Imports of capital goods and consumer goods made up the smallest proportion. Theoretical research shows that the import and export structures with high levels of processed products should play a positive role in promoting RMB internationalization. It has also been proved that RMB is widely circulated in many Southeast Asian countries and is even known as the “small dollar”. The commodity structures of trade between China and Central Asian countries are quite different from those in Southeast Asia. The majority of China’s exports are the consumption goods, which account for nearly 55% of all export. For imports, the proportion of primary products increased from 40% in 2001 to nearly 80% in 2014. However, the ratio of primary products began to decrease in the following two years. Imports of consumption goods, capital goods and components are almost zero. The commodity structures are extremely unbalanced. According to the theory of invoicing currency, the majority of primary products are invoiced in US dollars. It is difficult to increase the usage of a country’s currency by importing primary products. On the other hand, importers tend to set the pricing currency of the consumption goods, which also does not promote the circulation of the RMB in Central Asia. Therefore, the trade between China and Central Asia is not so conducive to the development of RMB internationalization in view of the trade structure.

An empirical study of the relationship between trade volume, trade structure and currency internationalization We have a preliminary understanding of the trade scale and commodity structure between China and countries along the Belt and Road by combining theoretical analysis and related data. In this section, an empirical study will be carried out. The empirical analysis is divided into two parts. In the first part, we select all data-available sample countries and regions in the world. The

The commodity trade structure  119 second part involves countries and regions along the Belt and Road Initiative. The specific list of these B&R countries can be found in Appendix 6.2. The variables To accurately measure the change in a currency’s international status, we use the proportion of currencies in foreign exchange market of the sample countries (FES) as the dependent variable. The data are sourced from Triennial Surveys of the Bank for International Settlements (BIS). The data are from 2001 to 2016. Because the data are reported every three years, the actual data years are 2001, 2004, 2007, 2010, 2013 and 2016. The explanatory variables are divided into export and import indicators. The export indicator is the proportion of the currency-issuing countries’ exports to the sample countries’ total imports (EXP). The import indicator is the proportion of the currency-issuing countries’ imports from the sample countries to the total sample countries’ exports (IMP). Because the index of bilateral trade proportion can accurately depict the trade closeness between currency-­issuing countries and sample countries, it can also show the position of the currency-­issuing countries in relation to the trade partners of the sample countries. The trade scale uses total trade volume data, and the commodity structure uses five-category trade data; the classification of the categories was proposed by the RIETI. All the data come from the trade database R ­ IETI-TID in the RIETI. In addition, some control variables that may affect the explained variable are also added according to the existing documents. They are currency-issuing country’s GDP/ sample country’s GDP(GDP), currency-­issuing country’s PGDP/sample country’s PGDP­(PGDP), bilateral exchange rate (ER), currency-issuing country’s private sector credit ratio/ sample country’s private sector credit ratio (PCS). We make both multi-currency and single currency analyses of the RMB. The multi-currency test includes the US dollar, the sterling, the yen, the RMB, the Australian dollar, the Canadian dollar and the Swedish Krona, which have the largest proportions on the foreign exchange market. We abandon the euro because there are many Eurozone countries in the sample. The bilateral trade and exchange rate cannot be accurately calculated. The multi-currency regression analysis uses the trade volume as an explanatory variable. The analysis of the RMB uses both the regression of the trade volume and the five-category trade structure to provide a better reference for the internationalization of the RMB. Model specification and estimation method selection The basic form of the panel data model is Yit = ait + bit ∗ Xit + mit

In which i represents a cross-section sample, and t represents time. Panel data contain cross-sectional data and time series data, which can better reflect the heterogeneity effect. Panel data can also avoid the multicollinearity

120  Yibing Ding et al. problem in time series data. Therefore, the regression results are more reliable. The main models involved in this paper are as follows: When examining the impact of the total trade volume: FESit = ait + b1* EXPit + b 2 * GDPit + b 3* PGDPit + b 4* ERit + b 5* PCSit + mit FESit = ait + b1* IMPit + b 2 * GDPit + b 3* PGDPit + b 4* ERit + b 5* PCSit + mit When examining the impact of the trade structure: FESit = ait + b1* EXPprimaryit / EXPreocessedit / EXPpartsit / EXPcapitalit / EXPconsumptionit + b 2 * GDPit + b 3 * PGDPit + b 4 * ERit + b 5 * PCSit + mit FESit = ait + b1* IMPprimaryit / IMPreocessedit / IMPpartsit / IMPcapitalit /IMPconsumptionit + b 2 * GDPit + b 3 * PGDPit + b 4 * ERit + b 5 * PCSit + m it The fixed effects model and the random effects model are the most widely used panel data models. Whether the fixed effects model or the random effects model should be chosen depends on the result of the Hausman test. However, the precondition of using these two models is that there is no obvious endogenous explanatory variable. Once there is an endogeneity problem, all the estimated structures will be biased. Therefore, before the regression analysis is carried out, the data for each model need to be tested. The result of the ­Hausman test shows that the fixed effects model should be chosen. In addition, because of the existence of the heteroskedasticity, the clustering robust standard error fixed-effect model is the best choice. Second, the Davidson Mackinnon test shows that there is no obvious endogeneity in the total volume of trade data. Therefore, the fixed-effects model is feasible. There are endogenous explanatory variables in the five-category trade data. For this situation, the instrumental variable model will be more effective. We choose the lag of explanatory variables as the instrumental variables considering the availability. Analysis of empirical results The empirical results are divided into two groups based on the different sample countries and regions. The first group includes the global samples from which data can be obtained. The second group includes the samples along the Belt and Road from which data can be obtained. In each group, the results are further divided according to multiple currencies, single currency, and commodity structures of import and export. Therefore, we report the regression results and the related analysis in two parts. The software used in this paper is STATA12. Global group The results are shown in the following tables: A preliminary conclusion can be drawn from the results. The volume of total exports and imports has no obvious impact on the dependent

The commodity trade structure  121 variable in the global scope analysis of either the seven-currency or the RMB single-currency models. This result indicates that only the increase of trade volume cannot effectively improve the usage of a country’s currency in foreign exchange markets. On the other hand, GDP has a significant positive effect, which indicates that the improvement in economic development has a positive impact on currency internationalization (­Tables 6.1 and 6.2). Then we consider the commodity structure of China’s exports. Exports of primary goods and processed goods have no significant effect on the dependent variable, but the parts and component and capital good exports have significantly positive effects. This result shows that the increase in the export proportion of the differentiated products is conducive to the promotion of the usage of the RMB in foreign exchange markets. The impact of consumption goods exports is obviously negative, which is also in line with the theoretical expectations. Most consumption goods are priced by importers. Therefore, the increase in the export of consumption goods does not play a role in promoting currency internationalization. The effect of the commodity structure of import is not clear; it needs to be further investigated in the sample along the Belt and Road. Table 6.1  The RMB Export Five Categorization IV Method

EXPprimary GDP PGDP ER PCS EXPprocessed EXPparts

(1)

(2)

(3)

(4)

(5)

FES

FES

FES

FES

FES

0.0000148 (0.664) 0.00579 (0.338)

−0.00000628 (0.859) −0.0182** (0.020)

0.00000471 (0.886) −0.0144** (0.021)

0.0000382 (0.193) 0.0229*** (0.000)

0.00000735 0.0000135 (0.746) (0.472) −0.0000212 −0.000259 (0.989) (0.861) −0.0212 (0.782)

0.00000444 (0.819) 0.00315* (0.062)

−0.00000616 (0.741) 0.00304** (0.047)

0.0000118 (0.464) −0.00288** (0.022)

−0.227 (0.537) 0.0000173 (0.643) 0.00387 (0.457)

EXPcapital

0.267*** (0.000)

EXPconsumption _cons N

0.00422 (0.545) 220

0.00232 (0.714) 220

Note: * p < 0.1, ** p < 0.05, *** p < 0.01.

−0.0229*** (0.004) 220

0.152*** (0.000) −0.0215*** (0.001) 220

−0.375*** (0.000) 0.0468*** (0.000) 220

122  Yibing Ding et al. Table 6.2  The RMB Import Five Categorization IV Method

IMPprimary GDP PGDP ER PCS IMPprocessed

(1)

(2)

(3)

(4)

(5)

FES

FES

FES

FES

FES

0.0275 (0.261) 0.00000752 (0.830) 0.00382 (0.422) 0.0000118 (0.540) 0.000397 (0.791)

IMPparts IMPcapital

0.0000220 0.0000161 (0.518) (0.637) 0.0177*** 0.00512 (0.001) (0.276) 0.0000222 0.0000124 (0.241) (0.508) 0.000601 −0.000157 (0.670) (0.910) −0.358*** (0.000) −0.0270 (0.727)

IMPconsumption _cons

−0.00330 (0.571) 220

N

0.0151*** (0.004) 220

0.00251 (0.671) 219

0.0000163 (0.633) 0.00531 (0.274) 0.0000126 (0.504) −0.000000854 (1.000)

−0.0358 (0.708) 0.00224 (0.676) 220

0.00000338 (0.923) 0.00118 (0.818) 0.0000113 (0.550) −0.000221 (0.875)

0.161 (0.114) −0.000518 (0.907) 220

Note: *** p < 0.01.

The Belt and Road group In the previous section, we drew a primary conclusion. More emphasis should be placed on the influence of the commodity structure of trade between China and the countries along the Belt and Road (Tables 6.3 and 6.4). Related test and estimation methods were described earlier, and the specific results are shown in the following tables: Robust test of the model In this paper, two methods are adopted for the robust test. One method is to change the different combinations of control variables, and the other method is to change the estimation method. Considering the heteroskedasticity of the panel data, we choose the FGLS estimation method. The results show that there are no big differences in the significance and sign of coefficients of the explanatory variables. The model passes the robust test. Limited by the article space, detailed results are not listed. To avoid the problem of the FGLS estimation caused by a small total sample, the three-year data were interpolated into annual data using the SPSS software. The results were shown here as a reference: Compared with the results from the global group, there are significant differences in the regression results with the sample countries along the

The commodity trade structure  123 Table 6.3  The RMB Export Five Categorization IV Method (Samples along the Belt and Road)

EXPprimary GDP PGDP ER PCS EXPprocessed EXPparts

(1)

(2)

(3)

(4)

(5)

FES

FES

FES

FES

FES

−0.0000117 (0.601) −0.00723 (0.177) 0.00000681 (0.579) 0.00134 (0.241)

−0.00000328 −0.00000347 (0.881) (0.878) −0.00792* 0.00440 (0.081) (0.354) −0.00000472 0.0000148 (0.713) (0.212) 0.00210* −0.00000169 (0.070) (0.999)

−1.294*** (0.005) 0.00000670 −0.00000396 (0.811) (0.848) −0.00406 −0.000521 (0.424) (0.896) −0.0000184 0.0000130 (0.335) (0.246) 0.000961 0.000589 (0.473) (0.560) 0.125** (0.046)

EXPcapital

0.163*** (0.005)

EXPconsumption _cons N

0.0175** (0.021) 120

−0.00741 (0.129) 120

−0.0120** (0.029) 120

0.127*** (0.000) −0.0166*** (0.002) 120

0.00627 (0.936) −0.000748 (0.930) 120

Note: * p < 0.1, ** p < 0.05, *** p < 0.01.

Table 6.4  The RMB Import Five Categorization IV Method (Samples along the Belt and Road)

IMPprimary GDP PGDP ER PCS IMPprocessed

(1)

(2)

(3)

(4)

(5)

Fes

Fes

fes

fes

fes

−0.00000431 (0.851) −0.000539 (0.930) 0.00000637 (0.668) −0.000524 (0.654) 0.200 (0.309)

−0.0000153 (0.508) 0.00165 (0.630) 0.0000212* (0.087) 0.000230 (0.829)

−0.0000138 (0.526) 0.000699 (0.837) 0.0000193* (0.097) −0.000872 (0.401)

−0.0000101 (0.660) 0.000124 (0.974) 0.00000992 (0.423) −0.0000597 (0.955)

0.0222 (0.231) −0.00000774 (0.728) 0.00492 (0.122) 0.0000129 (0.277) 0.000349 (0.744)

IMPparts IMPcapital

0.213*** (0.001)

IMPconsumption _cons N

−0.00359 (0.423) 120

Note: * p < 0.1, ** p < 0.05, *** p < 0.01.

−0.00886 (0.341) 120

−0.0150*** (0.007) 120

0.186*** (0.004) −0.00816* (0.060) 120

0.268** (0.020) −0.00332 (0.382) 120

124  Yibing Ding et al. Belt and Road, which is precisely the opportunity brought by the “Belt and Road” Initiative to internationalize the RMB. The impact of total export volume remains insignificant for the seven currencies. However, the total volume of imports has a positive effect on the dependent variables. The effect of total exports and imports on the interpreted variables is positive in the model of the RMB. The increase in the trade volume will, to a certain extent, enhance the international status of the RMB in the countries and regions along the Belt and Road for the present stage (Tables 6.5 and 6.6). These results are related to the characteristics of the sample countries and should be monitored. In the empirical test of commodity structures for exports trade from China to the countries along the Belt and Road, the export of primary goods has an evidential inhibitory effect on the degree of RMB internationalization, and the effect is insignificant for consumption goods, but three other kinds of goods all show significant and positive effects. This is in line with our expectations. The export of primary products and consumption goods without pricing rights has no positive effect on RMB internationalization. The export of processed goods, parts and components goods and capital goods can improve the level of RMB internationalization. The results are Table 6.5  The FGLS Estimation of the RMB Export Five Categorization (Samples along the Belt and Road)

EXPprimary GDP PGDP ER PCS EXPprocessed

(1)

(2)

(3)

(4)

(5)

FES SPSS

FES SPSS

FES SPSS

FES SPSS

FES SPSS

−0.00328 (0.847) −0.00000253 (0.079) 0.00000617 (0.965) 0.00000319** (0.001) −0.000179 (0.057)

0.000000579 (0.422) −0.000693*** (0.000) 0.00000232** (0.007) −0.00000833 (0.870) 0.0280*** (0.000)

EXPparts EXPcapital

−0.00000243 (0.073) −0.000397 (0.121) 0.00000268** (0.003) −0.000118 (0.133) 0.0118** (0.002)

EXPconsumption _cons N

0.00112** (0.003) 384

−0.000372* (0.044) 384

Note: * p < 0.1, ** p < 0.05, *** p < 0.01.

0.000374 (0.345) 384

0.000000806 (0.624) −0.000679* (0.030) 0.00000180* (0.030) 0.0000330 (0.652)

0.0178*** (0.000) −0.000999* (0.018) 384

6.28e-08 (0.956) −0.000235 (0.128) 0.00000242* (0.019) −0.0000640 (0.369)

0.0107*** (0.000) −0.000135 (0.683) 384

The commodity trade structure  125 Table 6.6  The FGLS Estimation of the RMB Import Five Categorizations (Samples along the Belt and Road)

IMPprimary GDP PGDP ER PCS IMPprocessed

(1)

(2)

(3)

(4)

(5)

FES SPSS

FES SPSS

FES SPSS

FES SPSS

FES SPSS

−0.00000114*** (0.000) −0.000752*** (0.000) 0.00000145*** (0.000) −0.000600*** (0.000) 0.0323*** (0.000)

−0.00000253*** (0.000) −0.000636*** (0.000) 0.00000247*** (0.000) −0.000655*** (0.000)

−0.00000184*** (0.000) −0.000809*** (0.000) 0.00000188*** (0.000) −0.000616*** (0.000)

−0.00000330*** (0.000) −0.000380*** (0.000) 0.00000291*** (0.000) −0.000867*** (0.000)

0.00291*** (0.000) −0.00000852*** (0.000) −0.000635*** (0.000) 0.00000312*** (0.000) −0.000949*** (0.000)

IMPparts IMPcapital

0.0262*** (0.000)

IMPconsumption 0.00532*** (0.000) 384

_cons N

0.00250*** (0.000) 384

0.00266*** (0.000) 384

0.0363*** (0.000) 0.00221*** (0.000) 384

0.0803*** (0.000) 0.00321*** (0.000) 384

Note: *** p < 0.01.

similar to those of the global group. China should focus on increasing the export proportion of intermediate products and capital goods in trade with countries and regions along the Belt and Road. The empirical test of the import trade structure is different from the global results. The import of components, capital goods, and consumption goods has a significant positive effect, while the impact of imports of primary products and processed goods remains insignificant.

Concluding remarks Since it was initially proposed, the Belt and Road Initiative has attracted extensive attention at home and abroad. A number of research on the relationship between the Belt and Road Initiative and RMB internationalization has been conducted. In this paper, we discuss the influence mechanism of the volume and commodity structure of China’s trade on RMB internationalization, particularly with the countries and regions along the Belt and Road. An empirical quantitative analysis is conducted using a fixed-effects panel data model and the method of instrumental variables. The conclusions are as follows.

126  Yibing Ding et al. First, for the current stage of RMB internationalization, trade is still one of the important factors. We must pay full attention to developing trade, especially with countries along the Belt and Road. China and these countries should develop further close bilateral trade partnerships through policy, infrastructure, trade, and finance connectivity. The growth of trade has been slowed down by the changes in the domestic economic situation and the international political and economic pattern of the last two years. However, the trade scale with countries along the Belt and Road shows a trend of growth. Therefore, more attention should be paid to the Belt and Road Initiative. Second, regarding RMB internationalization, China should attach greater importance to the effect of the commodity structure adjustment of trade than to that of the trade volume. For export, China should further reduce the proportion of primary goods and final consumption goods. The proportion of component and capital goods needs to be increased appropriately. This measure is necessary not only to increase value-added of trade but also to promote the RMB’s international status. Third, China should minimize the proportion of primary products in import by reducing the dependence on external supply of energy. Improving the efficiency of the consummation is the key to reducing primary good imports. In addition, it is necessary to increase the import of consumption goods, for it to promote RMB internationalization. The import proportion of China’s consumption goods has long been lower than the world average. One of the reasons for this result is high import tariffs, which should be reduced. Domestic demand can also be stimulated by properly lowering the import tariffs of consumption goods. Fourth, the countries along the Belt and Road have varied trade partnerships with China. Southeast Asian countries, Mongolia and Russia generally have close commercial intercourse with China. The trade contacts between many countries in the Middle East Europe and China are still in an early stage. This fact is related more to cultural differences and infrastructure imperfections than to geographic distance. The core of the Belt and Road Initiative is interconnection. With the interoperability of policies, facilities, funds and people, trade will be smooth and currency circulation will finally be realized. We believe that with the development of infrastructure and the exchange of culture between countries, the trade relationship will become increasingly close. Finally, RMB internationalization has advanced considerably since it was first proposed, but it has also experienced setbacks. It is not easy to become an international currency. On the premise of giving full play to the impetus of trade, China needs to maintain sustained economic growth and reform the financial market. Furthermore, developing an offshore RMB market to expand the scope of RMB circulation outside the region is also necessary.

The commodity trade structure  127

Note 1 The concept of “Black swan” events was first advanced by Nassim Nicholas Taleb in his book The Black Swan Effect. The term refers to a big event that produces extreme effects besides expectation, and this event has post-predictability.

References Ding, Y., Fu, Y., & Chen, J. (2014). The Effects of Foreign Trade Commodity Structure and Outward FDI on the International Status of the Yen—An Empirical Study Based on Spatial Durbin Model. Contemporary Economy of Japan, 4, 1–9. Goldberg, L. S., & Tille, C. (2008). Vehicle Currency Use in International Trade. Journal of International Economics, 76(2), 177–192. Grassman, S. (1973). A Fundamental Symmetry in International Payment Patterns. Journal of International Economics, 3(2), 105–116. Liu, C. (2007). Promoting the Internationalization of RMB by Trade Development. South China Finance, 10, 21–24. McKinnon, R. (1979). Money in International Exchange. Oxford: The Convertible Currency System, Oxford University. Pei, C. (2013). Import Structure and Economic Growth: Rule and Enlightenment. Economic Research Journal, 48(7), 4–19. Portes, R., & Rey, H. (1998). The Emergence of the Euro as an International Currency. Economic Policy, 13(26), 305–343. Shams, R. (2002). Is It Time for a World Currency? HWWA Discussion Paper, No. 167, Hamburg Institute of International Economics (HWWA), Hamburg. Tu, Y., & Li, S. (2017). Improve Trade Development along One Belt One Road, Promote the RMB Internationalization. Overseas Investment & Export Credits, 2, 18–21. Xu, X. (2010). The Theoretical Progress of the Use of Price Currency in International Trade and Its Enlightenment to the Internationalization of RMB. Shanghai Finance, 1, 5–11. Zhang, F., Yu, M., & Yu, J. (2017). The “Belt and Road” Initiative and the Future of the RMB Internationalization. Frontiers, 9, 28–45. Zou, J., Liu, C., Yin, G., & Tang, Z. (2015). Chinese and the Belt and Road along the Country’s Trade Patterns and Economic Contribution. Progress in Geography, 34(5), 598–605.

Appendix 6.1

Group of countries along the Belt and Road (according to their economic development and factor endowment)

The Mongolia Russia region (2 countries): Mongolia, Russia Central and Eastern Europe (19 countries): Poland, Lithuania, Estonia, Latvia, Czech, Slovakia, Hungary, Slovenia, Croatia, Bosnia and Herzegovina, Montenegro, Serbia, Albania, Romania, Bulgaria, Macedonia, Ukraine, Belarus, Moldova West Asia and the Middle East (19 countries): Iran, Iraq, Turkey, Syria, Jordan, Lebanon, Palestine, Israel, Saudi Arabia, Yemen, UAE, Oman, Qatar, Kuwait, Bahrain, Egypt’s Sinai Peninsula, Armenia, Georgia, Azerbaijan Central Asia (5 countries): Kazakhstan, Uzbekistan, Turkmenistan, Tajikistan and Kyrgyzstan Southeast Asia (11 countries): Singapore, Malaysia, Indonesia, Burma, Thailand, Laos, Kampuchea, Vietnam, Brunei Philippines, Timor-Leste South Asia (8): India, Pakistan, Bangladesh, Afghanistan, Sri Lanka, Maldives, Nepal and Bhutan

Appendix 6.2

The list of the sample countries in the empirical analysis

The global group

France, Germany, Indonesia, Italy, India, Israel, South Korea, Malaysia, Poland, Russia, Saudi Arabia, Singapore, Thailand, Turkey, Philippines, Bulgaria, Czech, Estonia, Hungary, Latvia, Lithuania, Romania, Slovakia, Belgium, Argentina, Brazil, Austria, Chile, Columbia, Denmark, Spain, Finland, Greece, Hong Kong, Ireland, China Luxemburg, Mexico, Holland, Norway, New Zealand, Peru, Portugal, South Africa

The ‘Belt and Road’ group

France, Germany, Indonesia, Italy, India, Israel, South Korea, Malaysia, Poland, Russia, Saudi Arabia, Singapore, Thailand, Turkey, Philippines, Bulgaria, Czech, Estonia, Hungary, Latvia, Lithuania, Romania, Slovakia

7 One Belt One Road Initiative and China’s overseas direct investment Julan Du & Yifei Zhang

Introduction The One Belt One Road (OBOR) initiative, that is, the Silk Road Economic Belt and the 21st Century Maritime Silk Road policy, is a great vision for economic integration of China with Asia, Europe and Africa. The initiative was put forward and developed in an era of increasing populism and protectionism around the world, and it becomes a symbol of commitment to the continuation of global economic integration and the building of a community of shared future for mankind. Since President Xi Jinping first put it forward in autumn of 2013, the Chinese government has attached great importance to this vision. It has also attracted a great deal of attention from the international community. The OBOR Initiative is a dynamic process in which the content and scope of economic integration and the list of member countries and areas have been constantly enriched and expanded. No doubt the initiative provides a blueprint of a deepening of the integration of the Chinese economy into the world economy and represents the strong will and commitment of the Chinese government to the continuation of economic opening. From a broader perspective, the OBOR Initiative was formed at a critical point of China’s economic transformation. In recent years, the ­Chinese overseas direct investment (ODI) has increased at a rapid pace. Most recently, China has become the second largest capital-exporting economy, attracting the world attention. The surge in China’s ODI occurs against the backdrop of the country’s structural transformation and domestic production overcapacity. It is an integral part of Chinese economic ascendancy in the global economy. However, the concurrence of the rise in China’s ODI and the initiation of the OBOR Initiative prompts us to examine whether the Belt Road Initiative has stimulated the explosive growth of Chinese ODI. Albeit an important and intriguing question to the international community, it has not been carefully investigated. This study attempts to fill in the void. We examine China’s ODI in the forms of both greenfield investment and merger and acquisitions (M&As), before and after the initiation of the OBOR strategy. In view of the variations in data availability in the different

China’s overseas direct investment  131 parts of analysis, we provide both descriptive statistics and econometric analyses of the impact of the OBOR Initiative on China’s ODI. It is found that the Chinese overseas acquisitions of targets in the Belt Road countries increased considerably in the years following the announcement of the OBOR Initiative (years 2014 and 2015), but the greenfield investment in the Belt Road countries did not show significant growth. There are signs that Chinese investing firms shifted a portion of ODI from greenfield investment to acquisitions in the post-strategy years in order to capture the investment opportunities more quickly. In terms of acquisition target industries, energy & power and industrials remained as the top two in the Belt Road countries in the post-strategy years, but the importance of high technology and financials increased rather quickly, occupying the third and fourth positions. This is largely consistent with the trend of industrial diversification in the overall structure of target industries of China’s overseas acquisitions. The OBOR Initiative considerably raised the fractions of Chinese enterprises’ full ownership acquisitions and majority ownership acquisitions in the Belt Road countries. This illustrates the increasing commitment of Chinese investors toward the Belt Road countries. At the same time, the number of state-controlled targets in the Belt Road countries bought by Chinese acquirers was rising. Since full or majority ownership acquisitions and acquisitions of state-controlled targets could be politically and socially sensitive, it also reflects the friendly and accommodating attitudes of host country government and people toward Chinese capital in the wake of the announcement of the national strategy. We pay close attention to the overseas acquisition activities of stateowned enterprises (SOEs) and non-SOEs. The SOE acquisitions did not register an impressive growth, and it is the non-SOE acquisitions in the Belt Road countries that increased rapidly in the post-policy years 2014–2015. The warm responses of the non-SOEs to the Belt Road initiative are a good signal that this strategy is beneficial to non-SOEs in exploring new markets in the Belt Road countries. A close look at the destination countries of China’s overseas acquisitions demonstrates that non-SOEs, relative to their counterparts from other major acquirer countries, increased acquisitions in both land-based Silk Road (land-road) countries and the maritime Silk Road (sea-belt) countries. The increases in the SOE acquisitions were concentrated in Eastern Europe, while the rise in the non-SOE acquisitions occurred mostly in Western Europe, Russia and East Asia. A further look at the infrastructure-related sectors and non-­infrastructurerelated sectors shows that China’s SOE acquirers increased their acquisitions significantly in the infrastructure-related sectors, especially in the land-based Belt Road countries, whereas non-SOE acquirers delivered a significant increase in their acquisitions of targets in the non-­infrastructurerelated sectors, primarily in the land-based countries again. Moreover, Western Europe is the biggest recipient of SOE and non-SOE acquisitions in both infrastructure-related and non-infrastructure-related industries.

132  Julan Du & Yifei Zhang The rest of the chapter is organized as follows. The section “Background” provides some background information on the OBOR strategy and China’s ODI in recent years and discusses the rationale for the effects of the OBOR Initiative on China’s ODI. The section “Data and variables” discusses data and variables. The section “Greenfield investment” discusses China’s overseas greenfield investment. The section “M&A activities” presents descriptive empirical findings on China’s overseas M&A activities. The section “Regression analysis of M&A activities” presents and discusses the regression analysis results of China’s overseas M&A activities. The section “SOE and non-SOE ODI in infrastructure-related and non-infrastructure-related sectors” discusses the differences in the patterns of SOE and non-SOE acquisitions in the infrastructure-related sectors and non-infrastructure-­ related sectors. The section “Conclusion” concludes the chapter.

Background One Belt One Road strategy President Xi Jinping unveiled his vision of the Silk Road Economic Belt at Nazarbayev University on September 7, 2013, as part of his state visit to Kazakhstan. The concept of New Maritime Silk Road was announced by President Xi before the Indonesian Parliament on October 3, 2013, as part of his state visit to Indonesia. These two concepts, combined as the OBOR, are widely believed to envision the creation of an integrated, cooperative and mutually beneficial set of maritime and continental economic corridors linking European and Asian markets. The Belt and Road run through the continents of Asia, Europe and Africa, connecting the economic dynamism of East Asia with the developed markets of Western European countries. The Silk Road Economic Belt focuses on bringing together China, Central Asia, Russia, Central and Eastern Europe and Western Europe, linking China with the Persian Gulf and the Mediterranean Sea through Central Asia and West Asia, and connecting China with Southeast Asia, South Asia and the Indian Ocean. The 21st Century Maritime Silk Road runs through a vast sea area, starting from China’s coast and reaching Europe through the South China Sea and the Indian Ocean in one route, and reaching South Pacific through the South China Sea in the other route. It is estimated that the Belt Road regions encompass more than 60 emerging market economies, a total population of over four billion and a sizeable fraction of the world’s output (65% for the continental route and 30% for Maritime Silk Road) (Swaine, 2015). It is a grand plan for China’s economic integration with various parts of the world. The OBOR Initiative consists of several economic elements. Perhaps the most frequently mentioned one is a Chinese commitment to investing heavily in a wide variety of infrastructure projects in order to strengthen

China’s overseas direct investment  133 the economic capacity and connectivity among the nations within the Belt Road area and with China’s western regions. It is emphasized that there is a rarely high level of complementarity between the critical demand for infrastructure development among the Belt Road countries and China’s mature and strong infrastructure construction capabilities and financial strength. Several mechanisms are designed entirely or in part to support such ­infrastructure development, including the Silk Road Fund and the Asia Infrastructure Investment Bank (AIIB), as well as Chinese foreign aid and the private capital of both Chinese and foreign business entities. The OBOR Initiative is expected to help develop China’s vast western hinterland. The strategy will turn the western interior into the frontier by opening it to the world, and development opportunities in the central and western regions will increase and new growth points will emerge. The OBOR Initiative is also viewed as a tool for promoting national economic development by boosting exports, enhancing access to natural resources and providing support to important domestic industries. In this regard, the OBOR Initiative can be a way of relieving overcapacity in certain Chinese capital goods and construction-oriented industrial sectors. This could become an increasingly important component of C ­ hina’s adjustment to lower economic growth rates over the long term. It is also no doubt intended to reduce political and ethnic tensions both within ­China’s ethnic regions and among Central Asian and Middle Eastern states, and to strengthen China’s political ties with the energy-rich Central Asian countries. Regarding geographic priorities, it is stated that Central Asia, Russia, South Asia and Southeast Asian countries will be given priority consideration, while Middle Eastern and East African countries are also important as they are in the junction linking the Asian with European countries. China’s ODI China’s ODI has increased substantially over the past decade and become one of the important developments of the world economy. Today, outbound investment flow exceeds USD100 billion, making China the world’s third largest overseas investor. This marks the historical transformation of the role of Chinese companies from global manufacturers to global investors. In recent years, a range of new government policies have been providing strong support to Chinese companies’ overseas expansion as the government encourages them to go global. For example, under the newly revised Measures for Foreign Investment Management, the approval-based system has been replaced with a registration and filing system, and the administrative procedures for overseas investment have been simplified. Earlier, Chinese overseas investment activities were concentrated in the energy and mining sectors. Currently, the focus of China’s ODI is shifting from natural resources to high technology and consumption-oriented

134  Julan Du & Yifei Zhang sectors. It is reported that high technology, real estate, finance, agribusiness, health care sectors, and so on have become the favorable target sectors. The existing M&A market also shows clear diversification. In 2010, energy and mining accounted for 61% of the total value of Chinese companies’ M&A deals, but this had dropped to 16% in 2014. Conversely, the share of the technology, media and telecommunication (TMT) sector increased from 6% in 2010 to 21% in 2014; agriculture and real estate are also exciting M&A sectors (EY Report, 2015). This shift in the target industry structure reflects China’s accelerated economic transformation and evolving overseas investment interests. It has important implications for the pattern of China’s ODI. Chinese investors are now looking beyond resource-rich countries in Asia, Latin America and Africa, and turning more attention to developed economies in Europe and the Americas as their attractive investment destinations. At present, Chinese investment footprint expands tremendously. According to EY Report (2015), the number of destinations increased to 156 countries and regions in 2014. The main destinations for Chinese investment were the USA, ASEAN, the European Union (EU), Australia and Russia (but excluding destinations designated as Hong Kong, the Cayman Islands and the Virgin Islands). With the transformation and strengthening of the Chinese economy and the development of Chinese enterprises, the objective of investment has shifted from acquiring production factors such as resources to acquiring advanced technology and brands. This shift in focus is aimed at increasing the international competitiveness of Chinese companies and meeting the changing domestic consumption behavior. Furthermore, the slow economic recovery of developed countries after the 2008 financial crisis has also provided a good opportunity for Chinese companies to “buy on the dips”. In recent years, the growth of Chinese investment in developed countries significantly outpaced that in the developing countries. For instance, China’s investment in the USA increased 23.9% in 2014, and investment in the EU increased 1.7 times, much higher than the 14.1% overall FDI growth in the same period (EY Report, 2015). In 2016 and 2017, in view of the irrational growth of China’s ODI, especially those conglomerates borrowing heavily from domestic banks and investing in many highly risky sectors overseas, the Chinese government tightened the process of approval of ODI projects. Nonetheless, ODI in the Belt Road countries and high-technology sectors is still encouraged and protected. The OBOR Initiative and the promotion of China’s ODI As the OBOR Initiative is an infrastructure-led integration scheme, it is expected that China’s ODI in infrastructure sectors in the Belt and Road countries will increase as part of the infrastructure investment campaign. Given that large infrastructure investment projects are mainly initiated and

China’s overseas direct investment  135 coordinated by governments and SOEs play a leading part in China’s infrastructure sectors, SOEs are expected to be the primary force in ODI in infrastructure sectors in the Belt and Road countries. Meanwhile, the ODI of non-SOEs in infrastructure sectors can also increase because of their active participation in the OBOR Initiative in response to the start and the expected continuation and enlargement of massive state-led investment in infrastructure. The massive state-led ODI in infrastructure sectors can generate related investment opportunities for non-SOEs to play a complementary role. The massive investment of the OBOR Initiative is expected to improve the quality and availability of infrastructure in the Belt-Road countries, which, in turn, would attract more FDI from China as well as other countries. It is widely agreed in the literature that infrastructure development, such as the quality of and the access to transportations and telecommunication networks, plays a crucial role in attracting FDI. For example, when examining the determinants of FDI in US states for 1981–1983, Coughlin et al. (1991) find that more extensive transportation infrastructures were associated with increased FDI. Wheeler and Mody (1992) find that infrastructure quality is an important factor for developing countries in attracting FDI from the USA. Similarly, Cheng and Kwan (2000) find that good infrastructure (density of roads) is an important determinant of FDI in 29 Chinese regions from 1985 to 1995. Subsequent studies such as Asiedu (2002), Deichman et al. (2003), Li and Park (2006) and Bellak et al. (2009) confirm the importance of infrastructure development for attracting FDI. Thus, the expected development of infrastructure under the OBOR Initiative is likely to boost inward direct investment into the Belt-Road countries. Chinese enterprises, especially the non-SOEs, are likely to be motivated by the Chinese government’s commitment to the initiative and be encouraged by the bright prospects of improved facilities and business environment in the Belt-Road countries so as to respond more actively by investing in the Belt-Road countries than their counterparts from other countries. The improvement in infrastructure in the Belt-Road countries will also boost trade development. For instance, better infrastructure quality can reduce the direct outlays on communications, freight and so on and can improve the timeliness and reliability of delivery of intermediate goods and final outputs so as to reduce inventory costs, which contribute much to the development of international trade. Empirical studies have confirmed this prediction (e.g., Limao & Venables, 2001; Vijil & Wagner, 2012; Francois & Manchin, 2013). An increased trade link can further boost foreign direct investment because it opens up new market opportunities and facilitates cross-border economic activities. At the same time, the OBOR is expected to facilitate international trade through government policies, especially trade liberalization policies. Free trade agreements may promote FDI as the cross-border economic activities increase in the wake of free trade agreements. Some studies show that government policies, especially free trade agreements, can substantially promote

136  Julan Du & Yifei Zhang outbound direct investment of domestic firms. For instance, Globerman and Shapiro (1999) examine the effects of major policy changes toward FDI implemented by the Canadian government over the period 1950–1995. They find that free-trade agreements (FTA and NAFTA) significantly increased levels of both inward and outward foreign direct investment. The effects of free trade policies on ODI, however, could be negative under some circumstances. With lower trade barriers, it is not imperative to conduct ODI to get around trade barriers, which lowers the incentive of firms to carry out ODI. Carr et al. (2001) show that bilateral trade and investment may be substitutes for similar countries. Jang (2011) shows that trade treaties do not always generate positive effects on foreign direct investment. In particular, an analysis of a panel dataset of bilateral free trade agreements and outward FDI in 30 OECD countries and 32 non-OECD countries in the period 1982– 2005 demonstrates that bilateral free trade agreements have negative effects on bilateral FDI in developed-developed country pairs but positive effects in developed-developing country pairs. Reed et al. (2016) reexamine the impact of free trade agreements on outbound FDI. By using a panel of countries over 1990–2006 and accounting for endogeneity and dynamics, they find that outbound FDI is either unrelated to participation in a free trade agreement or is negatively affected. Since the majority of the Belt-Road countries are developing countries where there is still much space for the expansion of bilateral trade with China, the positive effects of trade expansion on FDI into the Belt-Road countries are likely to dominate the negative effects. Government policies in promoting ODI are also reflected in the programs launched by governments to facilitate outward investment. They provide information and technical assistance in support of outward investment; they offer financial schemes and fiscal incentives to firms going abroad; they provide investment insurance and guarantees. Many countries, especially developed countries, have established outward investment agencies and institutions to promote and facilitate investment abroad by carrying out specific outward investment programs. These agencies and institutions are typically outward investment promotion agencies, development finance institutions, and investment guarantee schemes (United Nations, 1999). Hayakawa et al. (2014) examine the role of investment promotion agencies in promoting ODI from Japan and Korea. They find that home-­country investment promotion agencies tend to be more effective in promoting outward FDI in politically risky host countries, especially for the unlisted home-country firms, which tend to be less productive. The OBOR contains plans and mechanisms to facilitate cross-border trade and investment. Under the direct supervision of the Chinese central leadership and the coordination of the Leading Group on the OBOR Work (established by the central government in February 2015), the OBOR campaign has established ODI promotion agencies and supporting mechanisms at various levels of government. As China is coping with production overcapacity, rising production costs at home and so on, ODI from China has kept increasing, and the trend is expected to continue even without the OBOR

China’s overseas direct investment  137 Initiative. The OBOR strategy can further push Chinese ODI, especially in the Belt-Road countries. Compared with China’s “go out” policy launched in the early 2000s, the OBOR Initiative not only encourages international economic integration in general but also promotes economic integration among OBOR countries in particular. It is therefore intriguing to examine whether the higher geographic specificity of the OBOR Initiative has promoted ODI of Chinese enterprises, especially in the Belt-Road countries. It is important to note that the OBOR is more than a vision for economic integration or a conventional free trade agreement. Political cooperation has played a significant role in this initiative. Political cooperation on OBOR has taken place at multiple levels. It extensively utilizes the existing regional organizations such as the Shanghai Cooperation Organization for Central Asia, ASEAN for Southeast Asia, the China-Arab States Cooperation Forum for the Middle East, the Forum on China-African Cooperation for Africa and, to a much lesser extent, the BRICS (Brazil, Russia, India, China and South Africa) format. For Europe, the 16+1 format (comprising 11 central and eastern European countries, five Western Balkan countries and China) was set up in 2012, one year before OBOR was launched. At the 2015 EU-China summit, OBOR was incorporated as a new dimension to the EU-China strategic partnership. It has added strength to the EU-China dialogue on connectivity in the Asia-Europe Meeting format, which has featured prominently on the ASEM agenda in recent years (European Parliament, 2016). This element of international political cooperation can help reduce considerably the policy uncertainty and political risks that Chinese firms could face when they carry out direct investment in the Belt-Road countries. In this sense, the OBOR Initiative contains more political support and intergovernment coordination than what a conventional free trade agreement has. In the general theory of FDI location choice, the primary motivations for FDI are largely said to seek foreign markets, efficiency (e.g., new technology to reduce cost) and resources including strategic assets (Dunning, 1993). When studying the determinants of China’s outward direct investment, Buckley et al. (2007) consider these three classical factors; in addition, they also consider political risk, cultural proximity, policy liberalization, exchange rate, host inflation, exports and imports, geographical distance to China and so forth. In a more recent study, Wang et al. (2015) show that institutions, taxation and resources all matter in Chinese firms’ ODI location choice. Against the backdrop of the framework of the determinants of Chinese firms’ ODI location choice, we expect that the OBOR Initiative can potentially contribute to Chinese enterprises’ ODI in the Belt-Road countries relative to the non-Belt-Road countries. In addition to the benefits that a conventional economic integration or free trade agreement can bring about, the OBOR is characterized with a high-level international political cooperation and government support, which can enable the OBOR strategy to considerably reduce host country policy uncertainty and political risks for Chinese firms investing in the Belt-Road countries. The cooperativeness of host country governments can also help mitigate the negative effects of

138  Julan Du & Yifei Zhang cultural dissimilarity and geographical distance on Chinese ODI in the Belt-Road countries. As the OBOR Initiative is regarded as a grand scheme of economic diplomacy (Wong, 2015), it is likely to facilitate Chinese firms’ ODI in the Belt-Road countries relative to the non-Belt-Road countries by overcoming the barriers to overseas investment through the reduction in political risks, policy uncertainty and so forth. The expected effect of the OBOR on ODI of Chinese firms is also associated with the state capitalism model of the Chinese economy (Du & Wang, 2013). As the Chinese government plays a very significant part in the national economy, the corporate sector is willing to follow the call of the government to achieve some goals in economic development. SOEs, as the main instruments of the government, are certainly instrumental to the implementation of the national economic objectives. At the same time, non-state enterprises are also typically active to respond proactively to the call of the government in order to gain favorable treatments from various levels of government. According to a survey conducted by the China Council for the Promotion of International Trade in 2011, the majority of Chinese firms identify ­Chinese government’s “go out” policy in encouraging ODI as an important or very important factor in their ODI decision-making process. The importance of government promotion policy surpasses that of host country’s legal system, natural resources and labor costs, and remains on par with that of host country’s market size and potential. Although the SOEs’ responses to government strategy is more active than that of non-SOEs’, the gap between the two types of enterprises is very small (Sauvant & Chen, 2014). This survey result points to the importance of government policy in guiding the business strategy formation of Chinese enterprises. Since the OBOR Initiative is one top national strategy of the Chinese government, we expect that the responses of Chinese firms, both state-owned and non-state-owned, would be quite enthusiastic. Moreover, M&A deals can be completed more rapidly than greenfield investment projects. If Chinese firms really respond to the OBOR Initiative, we expect that they would more frequently choose M&A as the mode of entry into the Belt-Road countries in order to take advantage of the opportunities offered by the OBOR strategy.

Data and variables Chinese greenfield investment data was obtained from China Global Investment Tracker. It is compiled by the American Enterprise Institute and the Heritage Foundation and is regarded as the most authoritative database for China’s greenfield investment. The dataset includes all greenfield investments that are no less than 100 million US dollars from 2012 to 2015. Information on both target nation and industry sector is available from the dataset. The data on the aggregate greenfield investments made by other countries are obtained from the World Investment Report. It is published by

China’s overseas direct investment  139 UNCTAD (United Nations Conference on Trade and Development). The annex table in the World Investment Report contains aggregate greenfield investments by their source as well as destination countries. Cross-border M&A data are obtained from Thomson One (formerly known as SDC Platinum). Our sample coverage is from 2012 to 2015. We exclude deals whose values are less than one million US dollars because these minor deals may not be meaningful direct investment projects and would create noise in estimating the size of acquisitions. We also drop deals involving China as a target nation. Industry and other variables, such as government involvement and acquirer’s deal sought percentage (ownership shares acquired), are included. In our analysis, we also pay attention to the differences between infrastructure-­related sectors and non-infrastructure-related sectors. In accordance with the literature on the relationship between infrastructure and foreign direct investment or trade such as those cited earlier, we designate energy and power, aerospace and defense, transportation and infrastructure, telecommunication equipment, building/construction and engineering and cable as infrastructure-related sectors, while the others as non-­infrastructure-related sectors. Table 7.1 illustrates the definitions and data sources for all aforementioned variables. The list of the Belt-Road countries is from the “One Belt One Road” database hosted by the Chinese Academy of Social Sciences Press (China). The database also provides the information about whether a country belongs to the sea-belt or land-road landscape. Online Appendix Table A1 lists all the Belt-Road countries and their affiliations to “Sea Belt” or “Land Road” blueprint. It is worth pointing out that Table 7.1  Definitions and Sources of Key Variables Variable

Source

Definitions

Buy side government involvement

Thomson one

Sought percent

Thomson one

Full ownership

Thomson one

Majority ownership

Thomson one

Minority ownership

Thomson one

Chinese total greenfield investment

China global investment tracker

Dummy variable and equals to 1 if the acquirers’ ultimate owner is a stateowned enterprise. Total percent of the target firm acquired by the acquirer after the deal. Dummy variable and equals to 1 if the sought percent equals to 100%. Dummy variable and equals to 1 if the sought percent is greater than or equal to 50% and less than 100%. Dummy variable and equals to 1 if the sought percent is less than 50%. Sum of all greenfield deal amount.

(Continued)

140  Julan Du & Yifei Zhang Variable

Source

Rest of world greenfield investment

China global World greenfield investment excluding Chinese total greenfield investment. investment tracker; world investment report; authors’ own calculation. Thomson one Total log number of deals announced. Thomson one Total log number of deals that the acquirer’s ultimate owner is stateowned enterprise. Thomson one Total log number of deals that the acquirer’s ultimate owner is NOT a state-owned enterprise. Thomson one Total log amount of deals announced. Thomson one Total log amount of deals that the acquirer’s ultimate owner is a stateowned enterprise. Thomson one Total log amount of deals that the acquirer’s ultimate owner is NOT a state-owned enterprise.

Initials SOE initials Non-SOE initials Amount SOE amount Non-SOE amount

Definitions

there is no official list of the Belt-Road countries released by the Chinese government. This is mainly because the group of the Belt-Road countries is and will be expanding over time, and the Chinese government is open to any potential candidate that is interested in joining the group. Nonetheless, the current list of Belt-Road countries is compiled from various information sources including government documents, which can largely reflect the current situations and should be an authoritative one.

Greenfield investment We first compare Chinese overseas greenfield investment in the pre-policy (2012–2013) and the post-policy (2014–2015) periods. We observe that the total number of initiations of greenfield investment projects decreased slightly from 46 to 42 in the Belt-Road countries, and increased from 39 to 51 in the non-Belt-Road countries. The total value of greenfield investment remained almost unchanged at a level of approximately 26 billion US dollars in the Belt-Road countries but increased slightly (from 30.42 billion to 42.64 billion US dollars) in the non-Belt-Road countries. Then we look at the land-based Silk-Road countries (land-road countries) and the maritime Silk-Road countries (sea-belt countries) separately. The total initiations and deal value increased a little (from 17 to 18, and from 9.68 to 11.03 billion US dollars, respectively) in the land-road countries, but dropped from 29 to 24 and from16.48 to 14.5 million, respectively, in the sea-belt countries. Figure 7.1 examines the regional distribution of greenfield investment among the Belt-Road countries. Both total initiations and total investment value produce similar changes in regional distributions. Strikingly, after

China’s overseas direct investment  141

Figure 7.1  Greenfield investment: Regional Distribution.

the outset of the OBOR Initiative, the proportion of China’s greenfield investment in South Asia increased considerably, occupying the top position. The share of Russia also increased. Southeast Asia and Eastern Europe used to claim the largest fractions in the pre-policy period. In the post-­policy years, their fractions decreased, but they still remained as important regions for Chinese greenfield investment. The relatively slow growth in or even shrinkage of China’s greenfield investment in the Belt-Road countries is perhaps due to the fact that Chinese corporations gave a higher priority to acquisitions of local targets in the Belt-Road countries in order to take advantage of the high speed of acquisition transactions to facilitate their entry into the Belt-Road countries. We next turn to examine M&A activities.

M&A activities Full, majority and minority ownership acquisitions We investigate the overseas acquisitions along the line of ownership shares acquired by Chinese companies. We first examine China’s overseas full ownership acquisitions. We compare the total initiations and total value of Chinese companies’ overseas full acquisitions in the Belt-Road countries and the non-Belt-Road countries before and after the launch of the Belt-Road strategy. Years 2012–2013 are the prior period and 2014–2015 are the post

142  Julan Du & Yifei Zhang years. We find both the initiations and the value increased to a larger degree in the Belt-Road countries than in the non-Belt-Road ones in response to the great strategy. In particular, the total deal value in the Belt-Road countries increased from 1.96 to 15.99 billion US dollars, compared with an increment from 20.10 to 34.16 billion US dollars in the non-Belt-Road countries. We then compare the sea-belt countries and the land-road countries. Strikingly, the total initiations and the total deal value of full acquisitions rose much more rapidly in the land-road countries than in the sea-belt countries. For instance, the deal value in land-road countries surged from 1.29 to 13.26 billion US dollars, whereas the sea-belt countries produced a much smaller increment from 0.67 to 2.74 billion US dollars. Figure 7.2 enables us to take a close look at the more detailed regional distribution of China’s overseas full acquisitions before and after the Belt-Road strategy. In terms of full acquisition initiations, Western Europe claimed the largest fraction (38%), both before and after the great initiative. The proportion of Southeast Asia dropped from 38% to 23%, whereas Central and Western Asia jumped from zero to 23%. The total value of full acquisitions produces a similar pattern. Western Europe made up the largest fraction in both the prior and post periods, and its share increased from 43% to 50%. Central and Western Asia jumped from zero to 17%. We examine the situations of majority ownership acquisitions. The number of initiations increased slightly (from 13 to 17), but the total deal value declined significantly (from 14.18 to 5.85 billion US dollars) in the non-Belt-Road countries in the post-policy period. On the contrary, the total initiations rose significantly (from 11 to 18), and the total deal value surged considerably (from

Figure 7.2  Full Ownership Acquisitions: Regional Distribution.

China’s overseas direct investment  143 876.81 million to 8.34 billion US dollars) in the Belt-Road countries. We also find that the total initiations increased in both sea-belt and land-road countries, and the increase in the latter (6–10) was slightly more than in the former (5–8). The differences in the changes in total value are much more striking. It jumped substantially in the land-road countries (from 606.98 million to 6.42 billion US dollars), which was much more than the increase in the sea-belt countries (from 269.83 million to 1.92 billion US dollars). From Figure 7.3, we examine in more detail the changes in the shares of different target regions. In terms of deal initiations, Western Europe remained as the largest target region, but its share declined from 36% to 22%. Africa, Eastern Europe and Russia were newly added to the target region list. In terms of total value of majority acquisitions, the fraction of Western Europe dropped from 65% to 51%, whereas the newly emerging target regions of Eastern Europe and Russia account for 6% and 1%, respectively. Finally, we examine minority ownership acquisitions. The number of initiations of minority ownership acquisitions remained unchanged in the Belt-Road countries (from 14 to 14) and dropped in the non-Belt-Road countries (down from 17 to 14). The total value dropped in both types of countries, and the decline was less significant in the Belt-Road countries (from 16.70 to 10.24 billion US dollars) than in the non-Belt-Road countries (from 16.37 to 7.10 billion US dollars). This suggests Chinese companies chose less frequently minority share acquisitions in the post-policy period, but the decline in minority acquisitions was less striking in the Belt-Road countries than in the non-Belt-Road ones.

Figure 7.3  Majority Ownership Acquisitions: Regional Distribution.

144  Julan Du & Yifei Zhang We then compare the minority acquisitions in the sea-belt countries and the land-road countries. The total initiations showed no change, while the total value declined considerably in the land-road countries (from 13.56 to 5.29 billion US dollars) but grew in the sea-belt countries (from 3.14 to 4.95 billion US dollars). This suggests that Chinese companies shifted from minority acquisitions to relying more on majority or full ownership acquisitions in the land-road countries. Figure 7.4 provides the detailed distributions across major regions. For total initiations, there were no salient changes. For total value of minority acquisitions, the share of Western Europe rose from 16% to 38%, whereas the fraction of Central and Western Europe dropped from 30% to 20%. Target industries of China’s M&A activities We first investigate the target industries of China’s overseas M&A investments. Figure 7.5(a) lists the top five target industries of the M&A investment value in the Belt-Road countries and the non-Belt-Road countries in the periods 2012–2013 and 2014–2015, respectively. The detailed sector classifications are illustrated in Online Appendix Table A3. From Figure 7.5(a), we observe considerable changes in the top five target industries for the non-Belt-Road countries. In the pre-policy period, they had been energy and power, industrials, consumer staples, materials and media and entertainment. In the post-policy period, they changed to industrials, high technology, financials and materials.

Figure 7.4  Minority Ownership Acquisitions: Regional Distribution.

China’s overseas direct investment  145

Figure 7.5  Industry distributions (a) Belt-Road countries vs. non-Belt-Road countries and (b) sea-belt countries vs. land-road countries.

Meanwhile, we observe that the top two target industries in the Belt-Road countries, that is, energy and power, and industrials, remained the same before and after the policy initiative, but the deal value of acquisitions in energy and power industry decreased considerably, while that in industrials rose substantially. However, the 3rd–5th ranked target industries changed considerably, from materials, telecommunications and real estate in descending order to high technology, financials and materials. A couple of points are worth noting. First, the top five industries in the Belt-Road countries and those in the non-Belt-Road countries were somewhat similar in both the pre-policy period and the post-policy period. Second, both regions displayed a tendency of moving toward high technology and financials in the post-policy period, which reflects the increasingly strong motives of Chinese acquirers to seek high technology and

146  Julan Du & Yifei Zhang high-end service industry. Third, the distributions of deal values among the top five target industries were extremely uneven for both the Belt-Road countries and the non-Belt-Road countries in the pre-policy period. Typically, energy and power industry had accounted for a disproportionately large fraction of receiving Chinese acquisitions. In the post-policy period, however, the distribution of deal values became much more even among the top five target industries for both Belt-Road and non-Belt-Road countries, which testifies to the diversification of target industries of Chinese acquirers. Figure 7.5(b) examines the top five target industries in the sea-belt countries and the land-road countries. Strikingly, energy and power, industrials and materials had been the top three target industries in both sea-belt and land-road countries in the pre-policy period. However, both regions show quite substantial changes in the post-policy period. For the sea-belt countries, energy and power remained as the largest target industry. However, financials, high technology and retail newly entered the top five list in the post-policy period and occupied the 2nd-4th positions, whereas industrials declined from the second to the fifth. For the landroad countries, energy and power dropped from the most popular target country in the pre-policy period to the fourth one in the post-policy period, whereas both industrials and materials rose in ranking to the first and third places, respectively. Furthermore, high technology and financials newly entered the top five list, occupying the second and fifth positions, respectively. Hence, the similarity in the top five target industries between the sea-belt and land-road countries declined in the post-policy period, but they both exhibited some tendency toward high-technology industries. Table 7.2 lists the top five target industries in terms of aggregate deal value, when available, for major regions in the Belt-Road country list. Acquisitions of African targets were concentrated in energy and power in the pre-policy period but changed to industrials in the post-policy period. In Central and Western Asia, energy and power used to be the dominant target industry in 2012–2013 but was surpassed by materials and consumer staples in 2014–2015. In East Asia, consumer staples, materials, industrials, telecommunications and financials had been the top five target industries in the pre-policy years, but financials, high technology, media and entertainment, real estate and industrials topped the list in the post-policy years. In Eastern Europe, industrials had been the dominant target industry in 2012–2013, but diversification of target industries occurred in 2014–2015 as energy and power, financials, industrials, consumer staples and materials were the five most popular target industries. In Russia, materials and energy and power had been two dominant target industries in the pre-policy period. In the post-policy period, energy and power, and consumer products and services made up a lion’s share of the China’s acquisitions.

China’s overseas direct investment  147 Table 7.2  Regional Industry Distribution (Total Deal Values) Before the Policy (2012–2013)

After the Policy (2014–2015)

Region

Industry

Amount (Mil $)

Region

Africa Central/ West Asia

Energy and Power Energy and Power Materials Healthcare

5,450 5,105 75.21 2.5

Africa Central/ West Asia

East Asia Consumer staples Materials Industrials

53.42 34.1 17.68

Telecommunications Financials Eastern Industrials Europe Consumer Products and Services

Russia

Materials Energy and power Media and entertainment

Southern Asia

Materials

Southeast Energy and Power Industrials Asia Real Estate Materials Telecommunications Western Industrials Europe Telecommunications Financials Media and Entertainment Materials

12.38 7.58 399.78 16.08

2,000 1,116

Industry

Industrials Materials Consumer Staples Energy and Power Financials Healthcare East Asia Financials High Technology Media and Entertainment Real Estate Industrials Eastern Energy and Power Europe Financials

Russia

13

Industrials Consumer Staples Materials Energy and Power Consumer Products and Services Materials

Industrials Retail Energy and Power High Technology 617.97 Southeast Industrials 226.38 High Technology Asia 190.69 Consumer Staples 85.37 Real Estate 26.18 Telecommunications 3,292.21 Western Industrials 484.29 Europe Energy and Power 82.79 High Technology 68.15 Financials 3.2

55.18

Southern Asia

Real Estate

Amount (Mil $) 3.84 3,578.09 1,206.46 1,104.89 315.57 204.65 1,022.12 736.52 432.73 293.01 264.3 2,295.12 536.55 135.48 63.66 28.05 1,206.97 223.21 100 45.83 500 51.51 15 1,671.6 861.22 748.08 557.97 264.22 5,086.25 4,100.52 3,062.22 1,781.38 1,445.25

China’s acquisitions in South Asia were very small and confined to materials industry in the pre-policy period but experienced a rapid increase in the post-policy period, expanding to retail, energy and power and high technology. In Southeast Asia, energy and power, industrials and real estate had been the three leading target industries in 2012–2013. However, industrials, high technology and consumer staples became the top three target industries in the post-policy years. In Western Europe, industrials were the

148  Julan Du & Yifei Zhang top target industry both before and after the Belt-Road policy initiative. But the second to the fifth popular target industries changed from telecommunications, financials, media and entertainment and materials to energy and power, high technology, financials and real estate in the aftermath of the Belt-Road strategy. In general, structural transformation of target industries has been taking place for China’s ODI. Energy and power, and industrials are still important ODI target industries, but at the same time high technology, financials and so forth are gaining increasing significance in the overseas expansion of Chinese corporations. M&A activities of SOEs and non-SOEs How SOE and non-SOE acquirers responded to the OBOR Initiative can help us further understand the implementation of national strategy in the economic sphere in China. The total number of initiations of acquisitions decreased in the non-Belt-Road countries (from 13 to 10) but increased in the Belt-Road countries (from 8 to 10). The total value of SOE acquisitions dropped slightly in the Belt-Road countries (from 17.81 to 14.94 billion US dollars) but precipitously in the non-Belt-Road countries (from 28.80 to 7.95 billion US dollars). Furthermore, within the Belt-Road countries, the total initiations of SOE acquisitions increased in the land-road countries (from 6 to 8) but remained flat in the sea-belt countries (from 2 to 2). The total value of SOE acquisitions displays an opposite pattern. It increased in the sea-belt countries (from 3.54 to 5.68 billion US dollars) but decreased in the land-road countries (from 14.27 to 9.25 billion US dollars). Online Appendix Figure A11 illustrates the detailed regional distribution of SOE acquisitions. In terms of total initiation, the share of Western Europe increased from 25% to 40% after the launch of the OBOR Initiative. Eastern Europe jumped from nil in the pre-policy period to 20% in the post-policy period. In terms of total deal value, the fraction of Western Europe displayed an even more striking surge: from 19% in 2012–2013 to 53% in 2014–2015. Eastern Europe claimed 16%, starting from nothing. Thus, SOE acquisitions increased sharply in Western and Eastern Europe. Combining this observation with the information on target industries, we infer that Chinese SOEs raised their weights of acquisition in Europe as they sought targets in energy and power, high technology and industrials in those countries. Next, we examine non-SOE acquisitions in the Belt-Road and non-BeltRoad countries. In terms of total initiations, non-SOEs increased acquisitions in both Belt-Road (from 17 to 23) and non-Belt-Road countries (from 21 to 26) after the great initiative. From the perspective of deal values, the increase in the Belt-Road countries (from 1.73 to 20.45 billion US dollars)

China’s overseas direct investment  149 was more significant than in the non-Belt-Road countries (from 23.97 to 40.06 billion US dollars). We also find that within the Belt-Road countries, the initiations of nonSOE acquisitions increased in both sea-belt (from 7 to 10) and land-road countries (from 10 to 13). The total deal value also increased in both landroad (from 1.19 to 15.89 billion US dollars) and sea-belt countries (from 541.88 million to 4.56 billion US dollars), but the increase in the former is much more striking. Online Appendix Figure A22 gives the detailed distribution of non-SOE acquisitions over major regions. In terms of the number of deal initiations, Central and Western Asia, East Asia and Eastern Europe accounted for large fractions in both periods. In terms of total deal value, in Central and Western Asia it increases the most, while West Europe was the largest target region. Acquisitions of State-controlled targets We examine the changes in the total initiations and total value of Chinese acquisitions of state-controlled targets in host countries. The total initiations of state-controlled targets decreased in the non-Belt-Road countries (from 6 to 3) but increased in the Belt-Road countries (from 3 to 7). The total value of acquisitions exhibits the same pattern, and the changes are even more striking. The total value of deals involving state-controlled targets decreased in the non-Belt-Road countries from 5.23 to 1.78 billion US dollars but increased in the Belt-Road countries from 5.23 to 12.62 billion US dollars. Given that acquisitions of state-controlled targets are often politically sensitive, the increase in the Belt-Road countries suggests that the Chinese government’s OBOR Initiative has been welcomed by the Belt-Road country governments. We also find that the total initiations of acquisitions of state-controlled targets increased in the land-road countries and began to emerge in sea-belt countries after the policy initiative. The total deal value increased slightly from 5.23 to 6.45 billion US dollars in the land-road countries in the wake of the Belt-Road strategy. It is striking that the total value of acquisitions of state-controlled targets in the sea-belt countries (6.17 billion US dollars) was almost equivalent to that in the land-road countries in the post-policy period. Figure 7.6 illustrates the detailed regional distribution of Chinese acquisitions of state-controlled targets in the Belt-Road countries. It is striking that this type of acquisitions is entirely confined to Western Europe, Central and West Asia, Eastern Europe and Southeast Asia. Western Europe made up 43% of total initiations and 47% of total deal value in the post-policy period. Central and West Asia accounted for 43% of total initiations and 31% of total deal value in 2014–2015.

150  Julan Du & Yifei Zhang

Figure 7.6  State Targets: Regional Distribution.

Regression analysis of M&A activities To quantitatively gauge the effects of the OBOR policy initiative on Chinese outward mergers and acquisitions, we employ Difference-in-Differences setting (DD strategy) to estimate the effect. We treat years 2012–2013 as the pre-policy period and 2014–2015 as the post-policy period. The two-year post-strategy period may be sufficiently long to incorporate the changes in the overseas acquisition behavioral patterns of the Chinese firms in response to the announcement of the national strategy. Because the firms from the Greater China area (Hong Kong, Taiwan, Macau) may be subject to the effects of the policy initiative for ethnic reasons, we exclude all acquisition deals that involve firms in the Greater China area as acquirers or targets from the sample. In order to construct a meaningful control group of acquirer countries, we select six other countries that initiated most of the cross-border M&A deals during the sample period, namely, Australia, Canada, Japan, Singapore, United Kingdom and the United States. This further reduces our deal sample to 6717 deals and 127 target countries. The acquirer and target countries are listed in the Online Appendix Table A2. Since we are interested in aggregate M&A activities, we further construct a yearly aggregate acquirer-target country-pair-balanced panel data sample by aggregating deals according to various criteria specified in the variable description part. Thus, our final aggregate-level sample contains 3556 (7 * 127 * 4) observations.

China’s overseas direct investment  151 The difference-in-differences (DD) regression equation is specified as follows: log ( M & A Dep )

ijt

= β1 Post*China i + Country Pair FE  + Year FE

(1)

+ Contant + ε ijt 

The dependent variable, log ( M & A Dep )ijt , is the logarithm of the number of acquisition initiations or the value of acquisition deals by acquirer country i in target country j in year t. The detailed definition of the dependent variable is summarized in Table 7.1. China is a dummy variable that equals 1 if the acquirer is from China and 0 otherwise. Post is a dummy variable that takes value 1 if the time interval belongs to the post-policy period (2014–2015) and zero otherwise. Year fixed effects capture the effects of macroeconomy, industry, markets and so forth on cross-border acquisitions in a specific year when the aggregate M&A activities take place. As countries’ culture matters in cross-border M&As (Ahern et al., 2015), we introduce the acquirer-target pair fixed effects to capture any bilateral country pair factors that do not change over time (e.g., geographical distance, cultural ties and so on). It is noteworthy that only the interaction terms of Post and Chinai are presented in the regression specification, as the effects of the separate terms of Post and Chinai are absorbed by the year fixed effects and country pair fixed effects, respectively. All the standard errors are clustered at the target country level to account for time-series correlation within each target country. To more rigorously analyze whether the OBOR Initiative has promoted China’s ODI, we carry out DD regressions to compare the changes in China’s ODI in the Belt-Road countries following the announcement of the national strategy with those in the non-Belt-Road countries, and further compare China’s ODI changes with the changes of six other major acquirer countries. Owing to data constraint, we only consider the case of acquisitions. Panel A of Table 7.3 compares the number of initiations of acquisitions and the size of acquisitions before and after the Belt-Road initiative. Columns (1) and (2) show that both increased considerably in the post-announcement period. Columns (3) and (4) provide DD regression results by comparing the changes between the Belt-Road and the non-Belt-Road countries. Quite clearly, the number of initiations and size of deal values of Chinese acquisitions in the Belt-Road countries increased more significantly than those in the non-Belt-Road countries, relative to the other major acquirer countries. Panel B of Table 7.3 analyzes the effects of the OBOR policy initiative on non-SOE acquisitions. The number and the size of non-SOEs’ overseas acquisitions rose significantly in the two years after the release of the policy initiative. More importantly, the increases in the number of acquisition initiations and the value of acquisition deals by non-SOEs are particularly strong in the Belt-Road countries. Panel C of Table 7.3 conducts similar regressions for SOE acquisitions. SOE acquirers did not significantly increase their overseas acquisitions in the post-strategy period in general, or in the Belt-Road countries in particular. The lack of significant responses of SOEs to the Belt-Road strategy could

152  Julan Du & Yifei Zhang be due to the fact that SOEs already conducted quite many acquisitions in the years before the launch of the Belt-Road Initiative. Consequently, the room for their further increases in overseas investments seems limited. It could also be due to the possibility that SOE acquirers are focused more on targets in the infrastructure-related sectors in the Belt-Road countries Table 7.3  The Effects of Policy Announcement on Belt-Road Countries Panel A: The Effects of Policy Announcement on Total M&A Investment (1)

(2)

(3)

(4)

Variables

Initials

Amount

Initials

Amount

Post X China

0.090*** 0.296* (0.029) (0.168)

Post X China X Belt-Road Countries Observations Country Pair FE Year FE Adjusted R-squared

3,556 Yes Yes 0.814

3,556 Yes Yes 0.663

0.012 −0.011 (0.033) (0.192) 0.185*** 0.734** (0.066) (0.357) 3,556 3,556 Yes Yes Yes Yes 0.814 0.664

Panel B: The Effects of Policy Announcement on Total Non-SOE M&A Investment (1)

(2)

(3)

(4)

Variables

Non-SOE Non-SOE Non-SOE Non-SOE Initials Amount Initials Amount

Post X China

0.119*** (0.028)

Post X China X Belt-Road Countries Observations Country Pair FE Year FE Adjusted R-squared

3,556 Yes Yes 0.813

0.567*** 0.050 (0.142) (0.032) 0.164*** (0.062) 3,556 3,556 Yes Yes Yes Yes 0.670 0.813

0.293* (0.168) 0.655** (0.286) 3,556 Yes Yes 0.671

Panel C: The Effects of Policy Announcement on Total SOE M&A Investment (1)

(2)

(3)

(4)

Variables

SOE Initials

SOE Amount

SOE Initials

SOE Amount

Post X China

−0.029 (0.019)

−0.205 (0.133)

3,556 Yes Yes 0.516

3,556 Yes Yes 0.411

−0.049* (0.026) 0.048 (0.039) 3,556 Yes Yes 0.517

−0.322** (0.158) 0.280 (0.291) 3,556 Yes Yes 0.411

Post X China X Belt-Road Countries Observations Country Pair FE Year FE Adjusted R-squared

China’s overseas direct investment  153 Panel D: The Effects of Policy Announcement on Total M&A Investment, LandRoad vs. Sea-Belt Countries (1)

(2)

Variables

Initials

Amount SOE Initials

Post X China X LandRoad Countries

0.163**

Post X China X SeaBelt Countries Post X China Observations Country Pair FE Year FE Adjusted R-squared

(3)

(4)

(5)

(6)

SOE Amount

NonNonSOE SOE Initials Amount

0.626

0.042

0.262

0.144** 0.564*

(0.071) 0.242*

(0.408) 1.006*

(0.041) 0.065

(0.317) 0.324

(0.067) (0.329) 0.213* 0.886**

(0.125) 0.012 (0.033) 3,556 Yes Yes 0.814

(0.567) −0.011 (0.192) 3,556 Yes Yes 0.664

(0.066) −0.049* (0.026) 3,556 Yes Yes 0.517

(0.533) −0.322** (0.158) 3,556 Yes Yes 0.411

(0.118) 0.050 (0.032) 3,556 Yes Yes 0.813

(0.438) 0.293* (0.168) 3,556 Yes Yes 0.671

Robust standard errors in parentheses. *** p