Rocky Road Ahead for China’s $1 Trillion Overseas Building Plan

Art by Brian Stauffer

China, the export juggernaut with the fast-growing economy that seeks to overtake the US, has an international strategy to achieve its goal. The plan involves building infrastructure for emerging nations, winning the Chinese both good will and the means to ship more goods to new customers.

The trillion-dollar question is: Will One Belt, One Road, as the daunting undertaking is called, succeed? It could be a geopolitical and macroeconomic master stroke. Yet a solid case exists that this initiative could end up an ineffectual boondoggle.

For investors who study China, the No. 2 economy and No. 1 exporter, the enterprise’s progress will be a key factor in whether the nation will eclipse the US. President Donald Trump, with his talk of imposing tough tariffs on the Chinese, clearly does not want to see a dominant China in the world’s future.

Modeled on the Silk Road, the old trading route leading to China, One Belt, One Road (or OBOR) is orchestrated by the Beijing regime – which announced this idea in 2013 and is busily trying to implement the $1 trillion venture. OBOR is focused on building seaports, highways, railroads, power plants and all the groundwork needed to expand China’s export customer base.

Trouble is, China’s enormous infrastructure effort beyond its borders, meant to benefit more than 60 countries, is very risky and already has run into a number of snafus. OBOR’s list of projects is ”a tall order, and expectations are low that China would be able to build them,” according to Maudlin Economics.

That said, there’s a more optimistic view that China has the resources and the staying power to bull through much of OBOR, obstacles be damned. The Chinese “play the long game, thinking in terms of decades, not years,” noted Crit Thomas, global market strategist at Touchstone Investments.  

To Frank Rybinski, chief macro strategist at Aegon Asset Management, “this is China’s Marshall Plan,” the US’s ambitious effort to re-build Western Europe after the devastation of World War II. OBOR, he said, lets the Chinese “use their economic heft to influence politics, and also to secure base ores,” the raw materials like bauxite needed for manufacturing back in China.

Any stumbles by Beijing give heart to those in the West who hope that China will end up like Japan, the one-time rising Asian power seemingly destined to supplant the US. Japan’s economy stagnated in the 1990s – in part because it refused to follow the more brutal US approach to capitalism by shucking assets and employees that had outlived their usefulness.

China does suffer from similar problems: heavy debt, an aging workforce and the economic drag of zombie companies.  “Just as in Japan, the Chinese will not allow the market process to do its magic to get the economy back on a stable footing,” a post on the ZeroHedge website predicted.

To the Chinese, the need for OBOR arose from the 2008-09 financial crisis, which shook the West and also harmed China, whose shipping to its established-nation trading partners plummeted. “As the crisis took root, it became obvious to the Chinese how much they depended on the US economy,” their primary export consumer, said Scott Clemons, chief investment strategist at Brown Brothers Harriman. So they realized they had to diversify their export recipients, many of which are poor countries.

Increasingly, China can afford to do so. In 2017, the US economy had a decent lead, with $19.3 trillion to China’s $11.9 trillion. The problem for America is that the gross domestic product growth rate is just 2% or so yearly, versus 6.9% for the Chinese. China, which a quarter-century ago had just $623 billion in GDP, has enjoyed a tremendous growth spurt. At current rates, it should overtake the US in a couple of decades, if not sooner.

Provided, of course, that it can keep up the pace and not flag like Japan. With OBOR, there are worrying (to Beijing) signs that the road is strewn with potholes, not silk. The impediments:

Stalled or stopped projects. A number of infrastructure efforts have been cancelled or are in limbo.  A lot of this stems from resentment that Chinese contractors get favored and that host countries don’t have a big enough stake in the projects.  

Work on a high-speed railway in Thailand was suspended in 2016, for instance, amid Thai complaints that too little construction work went to their homegrown companies. Last fall, Pakistan’s water and power authority withdrew from development of a dam over a dispute about the Pakistani stake. Sri Lanka grudgingly handed over its portion of a seaport project to the Chinese company building the development – the host nation couldn’t come up with enough money for its share, and complained that the deal was tilted toward China.

Sketchy track record. China’s history delivering massive public works is checkered, to say the least. In Kenya, the new $3.8 billion Nairobi-Mombasa railway, built by Chinese contractors and funded by Chinese loans, had huge cost overruns. The rail line, opening last year to join Kenya’s capital with its major port, cost $5.6 million per kilometer, almost three times the international standard and four times the original estimate.   

“When China actively invests in infrastructure, the host governments are pleased,” said John Yonemoto, co-founder of Albright Capital. “Then they find there’s a lot of Chinese labor and material. The knock-on effects of the projects aren’t quite what [the hosts] hoped for.” Meaning local laborers and contractors too often don’t get enough of the pie.

Risky financing. The trouble with OBOR is that it revolves around making Chinese loans to nations that are default risks, which potentially hinders getting these public works completed.

A Fitch Ratings report last year said that, while OBOR can help overcome infrastructure shortfalls and construction expertise vacuums in emerging nations, the program’s projects too often lack commercial viability. Politics is more important in greenlighting something. “This subjugation of market forces means there is a heightened risk of projects proving unprofitable,” Fitch wrote.

China’s banks, Fitch pointed out, have done a lousy job at home allocating capital – witness the many unoccupied housing tracts they’ve underwritten across the Chinese landscape. Plus, many of the countries that borrow from China have speculative credit ratings, and so are default risks.

Indeed, the question of how effective OBOR will be for China, and its client states, may find an answer in the history of US foreign aid over the last 70 years. A 2017 study by the Brookings Institution concluded that large dollops of aid have boosted recipients’ economies by a percentage point, which sounds small but can make a big difference.

Despite missteps, Daniel Rune, a scholar at the Center for Strategic and International Studies, argued in Foreign Policy magazine last year that the US benefited in influence globally from its foreign aid efforts. After all, who won the Cold War?

How China’s overseas infrastructure endeavor fares depends on how well it delivers its bounty.