China's new trade network energises the global and Latin American construction industry

From 206 BCE to 220 CE, China’s Han dynasty fostered a booming trade industry for silk, a precious commodity in high demand among the elites of the Mediterranean. The Silk Road was the name given to the network of trade routes connecting the East and West at the time. Later, spices and other precious cargo would be traded using the system, fostering not only economic, but also cultural links between Asia and its contiguous continents. As such, the network became the information superhighway of its time as well, transmitting knowledge and expertise across distance and cultures.

Extremely rapid economic expansion in China in the four decades since Deng Xiaoping’s reforms in 1978 has seen the country once again emerge as a global economic powerhouse. It is the largest country by population and is on course to become the world’s largest economy in dollar terms in the coming decades.

Global Vision

Upon assuming leadership in 2013, President Xi Jinping launched the Belt and Road Initiative (BRI) as a means to strategically expand China’s economic footprint and diplomatic leverage, as well as to facilitate east-west trade. In essence, the BRI is the Silk Road of the 21st century – a network of terrestrial (the “belt”) and maritime (the “road”) trade routes connecting China with Western Europe via South-east and Central Asia, the Middle East, Africa and Eastern Europe. In the Pacific, Latin America and Australasia have been included in the trade network.

The BRI is multifaceted, but its cornerstone is the vast amount of Chinese investment in hard transport infrastructure across the network. As such, it is perhaps the most significant development in the global construction sector since the beginning of the 21st century, particularly in emerging markets. Projects often come with financing on attractive terms provided by China’s state-run banks, with the retention of a Chinese construction company as a precondition. Infrastructure is typically transferred to local institutions or organisations following construction, although Chinese companies are also beginning to offer operation and maintenance contracts as well.

Sector Shifts

Breakneck economic growth in China has allowed for enormous public investment in construction. This has meant decreasing marginal returns on infrastructure projects in some cases, as well as overcapacity in the industrial sector, notably in cement and steel production. To employ this excess capacity productively, Chinese firms have increasingly looked abroad. As such, they have become a cost-competitive option for infrastructure investment in lower- and middle-income countries, while also developing increasingly sophisticated expertise in the sector.

The BRI has had a significant impact on the global market for heavy building materials, with Chinese overproduction of cement leading to price pressures internationally. According to the “Global Cement Report”, China’s overcapacity in cement production rose from 23% in 2010 to 42% in 2017. This poses challenges for domestic producers in BRI-recipient countries that import building materials from China, particularly in East Africa and South-east Asia.

Furthermore, the BRI is shaping the competitive landscape of the global construction and civil engineering sectors. Budding Chinese players now compete with established rivals in the West and popular local providers. This competition is most fierce in emerging markets, where price pressures are particularly acute. Although Chinese firms provide stiff competition to local construction companies, the vast scale of BRI investment tends to minimise the disruption to the bottom line of the latter. At the same time, BRI works generate major opportunities for local firms to provide localised knowledge and manpower in exchange for specialised expertise and training.

By the Numbers

The BRI rounded out its first six years in 2019, by which time it had already grown to include 71 countries as of April – encompassing half the world’s population – and is ultimately forecast to cost more than $1trn. India, Russia and Indonesia are likely to be the three largest recipients of BRI investments over the 2017-21 period, while Nigeria, Iran, Egypt, South Africa and the Philippines are also expected to be among its top beneficiaries.

China has also established more than 113 economic and trade cooperation zones in BRI countries, to which some 302,000 local jobs have been attributed. As well as direct investment, Chinese financial institutions are providing tailored resources that enable BRI countries to pay for their own infrastructure upgrades. By end-2016, five of China’s state-run banks had extended $425bn in credits and loans for BRI projects, and the rate of lending was steady in 2017 and 2018 as well.

Trade Costs

In October 2018 the World Bank estimated that full implementation of the BRI could yield an average reduction in global shipment times of 1. 2-2.5%, consequently lowering trade costs by 1.1-2.2%. These gains are likely to be concentrated in economies participating in the BRI. Countries located along BRI corridors could see shipment times and trades costs lowered by 11.9% and 10.2%, respectively.

Asia

One of the single largest elements of the plan is the Pan-Asia Railway Network, which will upgrade and fill gaps in the existing rail networks of South-east Asia, eventually linking Kunming in southern China with Singapore along three axes: an eastern route via Vietnam, a central route through Laos and a western route across Myanmar. All three will converge near Bangkok, Thailand, before continuing south through Malaysia.

In the energy space, in addition to the flagship 3666-km gas pipeline connecting Gedaim on the Turkmenistan-Uzbekistan border to Horgos at China’s border with Kazakhstan, the BRI entails multiple localised energy projects across Asia. This has given rise to power plant construction opportunities with local partners, including hydropower (as in Indonesia), coal-fired (as in Mongolia and Bangladesh) and nuclear (as in Pakistan).

Africa

Morocco became the first African country to officially become a member of the BRI, following the signing of a memorandum of understanding (MoU) with China in November 2017. That same year, it was announced that Chinese firms would be linchpin investors over the course of the next decade in the planned $10bn Mohammed VI Tangier Tech City, although the initial stages of the project have moved slower than hoped. Algeria, for its part, became a member of the BRI in September 2018, with the flagship project being the $3.3bn Port of El Hamdania, to be constructed over a seven-year period by two Chinese firms.

The strengthening economic relations between sub-Saharan Africa and China are also well documented. China has played a leading role in developing infrastructure across the continent for decades, and remains a crucial destination for African raw materials exports, while acting as a significant source of financing. Indeed, China accounts for over 70% of the external debt of Cameroon and Kenya, while the figure rises to 80% in the case of Djibouti. China even established its first military base on foreign territory in Djibouti in 2017, at the southern Red Sea gateway to the Suez Canal.

Notable projects include the 472-km Nairobi-Mombasa rail line in Kenya, and the 756-km electrified railway linking landlocked Ethiopia with Djibouti and its port infrastructure. These entered into service in mid-2017 and early 2018, respectively.

Latin America & The Caribbean

High-profile examples of Chinese involvement in the Latin American and Caribbean region include the Belgrano Cargas Railway in Argentina and the Central Bi-Oceanic Railway linking the Atlantic to the Pacific via Brazil and Peru. Chile, Bolivia, Panama, Trinidad and Tobago, and Antigua and Barbuda had all signed formal BRI cooperation agreements with China as of April 2019, with more countries expected to do so in the future.

The Gulf

While Iraq, Iran and Pakistan were regarded as pivotal to the BRI from the outset, as the size and scope of the BRI increased, it came to encompass the Gulf in a significant way. One of the first major projects announced in the region came in 2016: the $10.7bn transformation of Duqm, a small fishing village in Oman, into a major port and transit-oriented industrial city. Located within the Duqm Special Economic Zone, this new “Sino-Oman Industrial City” is eventually expected to have an oil refinery and methanol plant, in addition to factories producing automobiles as well as oil, gas and solar energy equipment. That same year also saw China’s Cosco Shipping Ports selected for a 35-year concession to operate Khalifa Port Container Terminal 2 in Abu Dhabi. In December 2018 Cosco announced an investment of $200m to expand the terminal, having already invested some $300m in the facility and $130m in a nearby container freight station. In November 2018 China signed a MoU to participate in the $86bn development of Kuwait’s new Silk City initiative. This 250-sq-km project is to be phased in over a 25-year period and is expected to ultimately house up to 700,000 people.

Potential Over-Indebtness

One concern raised about the BRI is the possibility of lower-income countries increasing their debt burden without the capacity to repay loans. Moreover, China has been criticised for requiring that public assets be pledged as collateral in the event of non-payment. One highly publicised example is that of Sri Lanka, which in December 2017 transferred control of the new Chinese-built Hambantota Port to a Chinese state-run port operator on a 99-year lease after it failed to fulfil its repayment commitments. Countries considered by the non-profit Centre for Global Development to be particularly at risk of not being able to service their debts as a result of the BRI include Dijbouti, Kyrgyzstan, Laos, the Maldives, Mongolia, Montenegro, Pakistan and Tajikistan.

Tools of the Trade

The rollout of the BRI highlights the dual role of Chinese FDI as both an economic proposition and a tool of diplomacy. Beyond construction and financing, government-backed firms have also begun offering contracts to operate and maintain new infrastructure, a trend that has raised concerns about China’s influence in BRI-recipient countries and the resulting lack of skills transfer and local job creation. How China handles debt defaults will also be watched closely by the international community going forward.