China's Belt and Road Initiative, an analytical and economic breakdown

Author: Hubert Kucharski

Disclaimer: This article has been entered as an academic essay part of the Fitzwilliam College Economics Essay Competition which has now concluded.

Date Submitted: 19th of May 2021

The following article will analyse the development of the Belt and Road Initiative, BRI, a large-scale Chinese infrastructure project. Before examining BRI, we will first illustrate China’s economic reforms to show how reforms combined with low labour costs lead to growth and rising exports. Then, China’s present performance will be evaluated to show how rising labour costs are hurting China by decreasing exports and future growth. This will then be used to examine why China has begun BRI, once this is established, the article will explain the benefits and costs to China as well as other nations/regions which are affected by BRI. Finally, A conclusion will be reached after evaluating BRI’s overall impacts.

In the past, China has seen fast growth rates after drastic economic reforms (People's Daily Online, 2005). These reforms restructured the Chinese economy by decreasing state influence over markets by privatising state-owned businesses and lifting price controls (Brødsgaard et al., 2017). This increased productivity as private firms are more efficient compared to the public sector which has lower output due to X-inefficiency. A UK example of this is the NHS, which, due to being the largest health service (Farzana and Kiernan, 2015), benefits from monopsony and monopoly power. However, despite these advantages, which should reduce costs through higher purchasing power, before COVID-19, the NHS has received record funding from the government (TheKingsFund, 2020), and, with this funding, it is yet unable to satisfy demand, shown by decreasing bed capacity (TRADINGECONOMICS, 2018). This is because the lack of competition leads to a lack of profit incentive and a lack of incentive to reduce costs. Therefore, despite having monopoly and monopsony power, the NHS is unable to allocate resources efficiently, thus illustrating how public sector organisations lead to X-inefficiency and wasted resources. This means once China became more privatised, China began to be much dynamically efficient as profit-motivated private firms, which compete with one another, are incentivised to cut costs, leading to growth. This is shown by China’s rapid increase in real GDP (The World Bank, 2015). So, because there is competition and a profit incentive due to removing price controls, private firms are forced to innovate to be more competitive to make more profit. Hence, this combined with cutting costs decreases wasted resources within the economy as private firms avoid X-inefficiency and strive to achieve dynamic and productive efficiency, which leads to higher output and reduces the output gap of China, thus driving economic growth by increasing the Real GDP of the Chinese economy and illustrating why Chinese economic reforms have led to fast growth rates.

Additionally, China’s fast growth is also applicable to low labour costs. China has massively benefited from FDI as it has been the largest recipient of investment from foreign countries for many years since the reforms (Huang, 2016a). This is because these reforms incentivised private firms to set up in China as increased privatisation meant less risk of expropriation of assets. This combined with low labour costs within China (Huang, 2016b), made China a large recipient of FDI (Reuters, 2021) as opportunistic private firms from developed nations, who were looking to cut costs, expanded into China. FDI involves foreign firms investing organically expanding their operations into China. This means, because of FDI, China saw the creation of new capital in its economy through Gross Investment, increasing output. Therefore, because China can produce more at a cheap cost, China’s exports increased (TRADINGECONOMICS, 2019a) as the nation’s output increased. Hence, this combined with FDI expands the productive capacity of the economy as industrialisation occurs, leading to long term economic growth and illustrating how low labour costs have positively impacted China’s growth rates by turning China into an investment and export-led economy.

However, industrialisation and FDI has led to rising wealth and labour costs. This is illustrated by the rising GDP per capita of China (TRADINGECONOMICS, 2019b). When industrialisation occurs foreign firms invest new capital into the economy. Consequently, foreign firms within China make a profit as they organically expand, which can then be taxed by the Chinese government through corporation tax, thus increasing the budget of the government, enabling them to spend more on public goods such as education and healthcare. This creates a healthier and smarter workforce, allowing for specialisation in highly innovative fields due to their technological proficiency. Therefore, because these fields have a limited supply of labour, wages of Chinese workers increase (Yan, 2017) as China transitions away from manufacturing into a technological and service-based economy, thus avoiding the middle-income trap and moving China into being a fully developed economy, illustrating how industrialisation leads to higher wages and rising labour costs.

Unfortunately, for China, whose economy has mainly been fueled by FDI, rising labour costs disincentive firms to set up in China, instead, firms may leave China and opt for more emerging economies such as India and Vietnam, (Rapoza, 2020a). Hence, as more firms leave, China may see decreasing exports as it will no longer be able to provide labour-intensive manufactured goods. Therefore, because exports, a component of net trade which is part of aggregate demand are likely to decrease, China’s growth is predicted to slow down (Wolf, 2018a) as its economy moves towards being dependent on consumption due to rising wages rather than FDI and exports (Jiu and World Bank, 2013, p.8). Thus, to ensure that China still retains its share of global trade and to improve economic growth in the long term, China has begun constructing BRI.

The Belt and Road Initiative, BRI, is a massive infrastructure project that plans to connect many countries’ trade (SETH, 2019). The main benefit to China of constructing BRI is BRI’s scheme's ability to retain China’s influence on global trade. BRI does this by providing China with better terms of trade. During the Trump Administration, China’s trade was hurt by American Tariffs (Karabell, 2020). The construction of BRI will serve as a trade bloc between China and its member countries as factor inputs can move much more easily. Consequently, because China owns BRI, BRI will enable China to have a regional land monopoly as it acts as a middle-man for trade, thus giving China collateral as BRI countries have a significant share of global GDP (Lu et al., 2018). Therefore, this gives China more political dominance as it can use BRI to negotiate terms of trade that are in China’s favour, if a nation disagrees with China, China can use BRI to significantly disrupt said nations trade, forcing them into an agreement due to its monopoly power, similarly to how Crossrail trade unions have collateral over London's operations (BBC, 2017). Hence, even though increased political and bargaining power does not directly increase China’s value of exports and its share of global trade, it does indirectly contribute to their influence over it as China will have a regional land monopoly by acting as a middle-man for a portion of world trade, illustrating how BRI will retain China’s influence over global trade.

The main way BRI will help China keep their share of global trade is by making Chinese labour cheap once again. As previously stated, China’s exports are decreasing and investment is declining (Wolf, 2018b) as firms are leaving China due to rising labour costs (Rapoza, 2020b). This means China's TFP is decreasing (Huang, 2016c), meaning that China is becoming increasingly inefficient at exporting goods and services. Consequently, it may be wasteful for China's economy to continue increasing exports to control global trade, instead, China should focus on developing a comparative advantage over technological goods as it moves to be a service-based, developed economy. This is where BRI comes in, China does not have to develop its goods and services domestically. BRI will make its member countries, such as Kenya, a nation which China already has expanded into, (Miriri, 2019) much more intertwined economically as the railway link will allow for free movement of factor inputs, especially labour as a trading bloc forms. Meaning BRI will help China outsource cheap labour to more underdeveloped nations. Therefore, because BRI will lead to China producing goods outside of the nation, China will potentially see an increase in GNI as overseas profits are funnelled back into the Chinese economy. Consequently, this rising GNI will result in rising aggregate demand as more cash is injected into the economy. Thus, because aggregate demand has risen due to GNI, China will see increased growth rates, yielding an increase in price levels. At the same time, these profits can be taxed through corporation tax by the Chinese government, enabling higher spending on education due to an expansion in the governments budget. Hence, these rising price levels combined with a higher educated workforce incentivises investment from domestic and foreign firms as they can make larger profits. Consequently, firms will organically expand into China, creating new technology-based specialised industries, which are more efficient, in China’s enterprise zones, helping boost China’s exports as excess production is sold overseas as the nation develops a new specialised industry which is specifically catered towards the strengths of its labour-force, leading to China regaining its share of global trade and potentially increase TFP as workers are employed in work best suited to them, illustrating how BRI will help China retain its international influence over global trade by reducing China’s rising labour costs and potentially increasing investment and export growth.

This economic cooperation through BRI will also help in developing countries that are part of the scheme by providing infrastructure. A lot of BRI countries are developing or underdeveloped (The World Bank, 2019), meaning they have little infrastructure. This is because the governments of these nations have small budgets as their nations produce little value meaning governments gain little tax revenue. Consequently, roads and infrastructure are underdeveloped. This means LEDC’s, such as Kenya, do not benefit from free trade as much compared to their developed counterparts as cities where FDI is being funnelled into are harder to access as factor inputs, such as labour, cannot migrate towards these prosperous industries as lack of infrastructure increases geographical immobility of labour. Therefore, it is much harder for LEDCs to develop specialised areas without infrastructure thus stunting their growth. Hence, BRI, an infrastructure project designed to intertwine economies and cities with railway lines will help alleviate this problem as BRI will increase the free movement of factor inputs. Thus, LEDC’s will not only have access to their domestic factor inputs but ones abroad too, such as migrant workers, who, because of BRI, will be able to travel to specialised regions. Hence, this develops LEDC’s as specialised industries are supported with sufficient resources to bring these economies into their further stages of development as governments make additional revenue from increased taxes from sources such as VAT when excess production from specialised industries is exported, which, can then be spent on public goods to improve the health and education of their respective workforces, which incentivises further FDI and illustrates how Chinese infrastructure part of BRI can help develop LEDC’s.

However, the main cost of China’s BRI is the debt associated with loans. BRI is funded through low-interest loans which are supplied by China (Gerstel, 2018a). This is significant as BRI is made up of LEDC’s, nations that are at risk of taking on significant debt (World Bank, 2019a). This means there is a risk when it comes to partaking in BRI for these nations as there is high uncertainty regarding if some of these LEDC’s could ever pay the debt back. Therefore, some of these nations may choose to not take part in BRI, such as Malaysia (Shepard, 2020). This poses a cost for China as any slowdown in BRI’s construction may render BRI unsuccessful. This is because the current construction of Western projects will interfere with BRI (Peel and Fleming, 2021). If successful, this will likely reduce BRI’s effectiveness LEDC’s will have a choice between participating in either project, meaning that China’s position of becoming a middleman of trade with regional land monopoly power in these regions will be significantly reduced as they will compete with the west. Hence, if more nations continue to leave BRI due to debt, China will see a slowdown in BRI’s construction, reducing BRI’s capabilities of maintaining and increasing Chinese dominance over global trade as Western alternatives enter China’s sphere of influence. Additionally, rejection of BRI loans will also harm LEDC’s as BRI’s slowdown will decrease their development. This is because BRI’s promise of building infrastructure promotes free movement of factor inputs, boosting specialised industry by incentivising FDI as firms can easily gain workers as geographical immobility of labour is decreased, thus helping LEDC’s to develop. Hence, a slowdown of BRI will inhibit these nations ability to improve their economic status, illustrating how the risk of debt for BRI participant nations decreases chances of economic prosperity for member nations and poses a threat to China’s development of BRI and ultimately China’s global influence.

However, for the majority of BRI nations, the economic prosperity of BRI is too much to pass upon. BRI improves the free movement of factor inputs which improves geographical mobility leading to an increase in FDI and specialisation as firms have an increased supply of factor inputs, thus driving economic growth and development in LEDC’s as governments gain extra tax revenue from VAT, which can be spent on upskilling workforces, leading to FDI and an expansion in productive capacity. So, despite debt, these nations simply cannot pass upon this prospect of future, long term growth. This means it is unlikely that many nations will leave BRI, the aforementioned benefits are too great and they outweigh the costs of a potential ‘Debt Trap,’ which is what China wants. This is illustrated in Sri Lanka, where China gave the nation loans to fund a port that promised economic prosperity to the nation, but the port was unsuccessful, resulting in Sri Lanka being in debt to China (Hurley, Morris and Portelance, 2018). This caused a ‘Debt Trap,’ as China managed to coerce Sri Lanka to meet their demands through using debt as collateral, which they then used to seize the port and land around it (Abi-Habib, 2018).

Similarly to Sri Lanka, BRI also uses loans (Gerstel, 2018b). This means, even if BRI fails in some nations, who are inherently at risk of defaulting on their loan payments (World Bank, 2019b), China still wins as China can use debt to seize assets in foreign nations. Therefore, despite BRI’s potential failures and risks, China still gains capital, resources and influence by seizing areas of land through debt. Consequently, this strategy minimises the risk of constructing BRI as either outcome results in China gaining assets and increasing its sphere of influence over global trade and its neighbouring countries. Hence, although ‘Debt Traps,’ harm LEDC’s as they result in capital and assets being seized, for China, it is a lucrative model of conducting deals due to how it minimises risk when it comes to developing BRI. Thus, even though BRI’s fiscal cost is immense (Hillman, 2018), China’s ability to use debt to seize assets and recoup its losses makes BRI’s construction incredibly safe from a fiscal standpoint, therefore, BRI’s low-risk nature combined with its positive effects of decreasing labour costs and increasing China’s influence over terms of trade make it logical to conclude that BRI’s construction is the rational next step for China to expand and sustain its influence over global trade.


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