May 17, 2017 5:00 pm JST
Minxin Pei

A bridge, belt and road too far for China?

Beijing's grand scheme could turn out to be a financial boondoggle

When Beijing announced its ambitious plan in 2013 to develop infrastructure connecting Asia and Europe, known as the Belt and Road Initiative, the strategic and economic logic seemed overwhelming.

With decades of experience in building large and complex infrastructure projects at home, China had accumulated world-class engineering and construction capabilities. Beijing's coffers were also overflowing with foreign exchange reserves (more than $3.2 trillion at the end of 2012). Instead of parking this mountain of cash in low-yielding U.S. treasury bonds (and subsidizing ungrateful Americans), China could invest some of it in more profitable projects, such as power plants, toll roads and ports.

The Belt and Road Initiative could also solve one of Beijing's economic headaches -- massive overcapacity in steel and cement, the two key ingredients in building roads and bridges. An infrastructure boom financed by Chinese money and built by Chinese companies could absorb steel and cement unneeded at home.

In geopolitical terms, the initiative also appeared to be a smart move. By connecting Asian and European countries to China through roads and ports, Beijing could reroute global commerce and greatly increase its influence.

Although BRI may have gotten off to a relatively slow start in the last four years, Chinese leaders have apparently decided to double down on this gamble because they remain convinced of the enormous potential benefits.

Chinese President Xi Jinping convened the first BRI summit in Beijing on May 14-15. In front of 28 heads of state and 1,500 delegates from nearly 60 countries and international organizations, Xi pledged that China's development banks would devote an additional $100 billion to BRI in the coming years.

Since Chinese banks have already doled out $284 billion to countries included in BRI as of the end of 2016, an additional infusion of $100 billion underscores Beijing's determination to keep the BRI show on the road despite skepticism, lackluster initial results and huge risks.

Signs of skepticism

Even at the first BRI summit, skepticism about China's ambitious venture was easy to detect. Except for Italian Prime Minister Paolo Gentiloni, major Western nations were represented by ministers or junior officials. India did not even send a delegation. The European Union refused to support a statement on trade proposed by China at the summit because the language did not commit to rules governing transparency and standards of contracts.

But BRI has its own fans, especially among strongmen. Russian President Vladimir Putin, Hungarian Prime Minister Viktor Orban, Philippine President Rodrigo Duterte, Polish Prime Minister Beata Szydlo and Turkish President Recep Tayyip Erdogan all showed up for the BRI summit. Their presence -- and the absence of nearly all the leaders of western democracies -- reflected the underlying ideological divide created by BRI, the first major international development initiative launched by a powerful autocratic regime in the post-Cold War era.

Those hoping that BRI will allow China to showcase the advantages of its version of authoritarian state capitalism will likely be disappointed. On paper, BRI may seem a brilliant idea. In reality, it could end up as one of history's biggest white elephants.

The biggest mistake made by Chinese leaders in conceiving their grand vision was to assume they could replicate in other countries the favorable conditions that have allowed Beijing to spend $1 trillion a year and build challenging infrastructure projects at a record pace.

For instance, China has a level of political stability that does not exist in many BRI participating countries. Violent ethnic conflict and terrorism in China present no serious threat to security and are confined almost exclusively to Xinjiang. But in many countries in Central Asia and South Asia (particularly Pakistan), instability and violent conflict would make building and maintaining infrastructure more expensive and vulnerable.

In addition, the Chinese state owns all the land and can evict farmers and urban residents without paying them much or having to worry about courts, the media, opposition parties or violent protests (they do occur in China, but are invariably suppressed by the country's efficient security forces). In other countries, land acquisition for large infrastructure projects will cost far more, both in terms of time and compensation. If governments in these countries try to emulate China and kick the owners off the land without adequate compensation, they should expect fierce resistance and violent protest. In January, a riot broke out in Sri Lanka when the government was trying to requisition private land for an industrial zone being developed with Chinese financing.

Beijing may also have assumed that since China provides the financing (mostly loans), it should be able to control the contracting process. Specifically, it should be able to demand that Chinese materials and construction companies be used for BRI projects. Chinese leaders should know better. In developing countries, where most BRI projects will be located, infrastructure contracting represents a lucrative opportunity for official corruption.

Best-laid plans

On purely economic grounds, China is fully justified to insist on using its firms and materials to ensure quality and timeliness. But why would powerful elites in BRI-connected countries throw away such opportunities to make a killing at China's expense? They will insist on picking their own construction firms and materials. Besides defeating BRI's key purpose (exporting excess capacity in construction and heavy industry), such an outcome will guarantee corruption, shoddy quality and poor financial performance of BRI projects.

Finally, debt financing of infrastructure may have worked in China mainly because the country's rapid economic growth could support rising debt and help infrastructure generate sufficient returns. It is too optimistic to assume that countries that borrow heavily from China to finance their BRI projects will be able to service their debts. In some cases, these countries are simply too poor to take on the mountain of debt needed to build big ticket infrastructure projects.

For example, China is currently building a 260-mile [418-km] railway at a cost of $6 billion in Laos, an impoverished Southeast Asian nation with a gross domestic product of about $12 billion. In other cases, weak economic growth will make BRI projects uneconomical and unable to service their debt. In the case of default on Chinese loans used to finance BRI projects, we should expect a lose-lose situation and deterioration of relations between China and its debtor nations.

China will have limited leverage over its debtors and may get pennies on the dollar if the hundreds of billions of dollars in BRI projects become dud loans. Chinese taxpayers will be left holding the bag. But governments which have borrowed from China will be worse off as well. Their default on Chinese loans will cut their credit ratings and block their access to credit markets.

Because of these economic fundamentals, the actual progress of BRI has been modest so far despite Beijing's propaganda blitz. According to China's Ministry of Commerce, total construction and engineering contracts signed by China in countries that have expressed an interest in participating in BRI since 2014 amounted to $304.9 billion. Since a significant portion of these contracts may be unrelated to BRI, China's actual amount of spending on BRI could be much less.

Ironically, the lackluster record of BRI so far may be blessing in disguise. China's economic conditions have deteriorated since BRI was unveiled four years ago. The country's foreign exchange reserves have dipped below $3 trillion due to capital flight, reducing China's capacity to finance BRI. China's own debt level has risen dramatically, requiring all the resources Beijing can muster, including its hoard of hard currencies, to stave off a potential financial crisis.

Given the huge risks and doubtful economic returns of BRI, Beijing may be making a huge mistake by doubling down. The smarter thing to do is to quit while it appears to be still ahead.

Minxin Pei is a professor of government at Claremont McKenna College and author of China's Crony Capitalism (2016)

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