A strategy for growth: China’s development initiatives

The world economy needs a growth-lifting strategy, and infrastructure financing appears to hold the key. The vision of China’s leaders for the Silk Road Economic Belt and 21st Century Maritime Silk Road (One Belt One Road) is winning the support of leaders throughout Asia and beyond. Two new development banks have been established focusing on infrastructure: the New Development Bank (NDB) and the Asian Infrastructure Investment Bank (AIIB). A Silk Road Fund was established in January 2015 and a China-Africa Industrial Capacity Cooperation Fund (CAICCF, $10 billion in size), designed to aid Africa’s development, became operational in January 2016. However, what conceptual framework will they formulate? This section links infrastructure investment with special economic zones for industrial upgrading and structural transformation, which provides the foundation of the One Belt One Road vision.1

Wang Yan

During the past eight years, the global economy has experienced its most tumultuous times since the Great Depression. Despite the coordinated policy response of the G20 nations and expansionary monetary policy, the global economy – especially the advanced countries – has not fully recovered. The US unemployment rate declined signifciantly but the economy grew only 2.4% in 2015. The eurozone and Japan face ongoing growth challenges, with their respective central banks embracing unprecedentedly loose monetary policy. The European Central Bank and the Bank of Japan are both pursuing negative interest rates in addition to quantitative easing. But monetary stimulus is insufficient to propel a seemingly leaderless global economy towards steady growth. There is a need for a grand investment scheme and a changed mindset.

Based on the intellectual foundation of the new structural economics2, infrastructure investment looks to hold the key to long-term growth. Support for the One Belt One Road vision could motivate use of excess global savings to help development and improve employment, while also generating sound returns. It should also increase demand and jobs in advanced countries, giving them room to implement needed structural reforms. In particular, investment in bottleneck-releasing infrastructure would unleash particularly large spillover benefits.

Infrastructure provision may also have a disproportionate effect on the income and welfare of the poor by raising the value of the assets they hold (such as land or human capital), or by lowering transaction costs (such as transport and logistic costs) they incur to access the markets for their inputs and outputs. These effects may occur through a variety of mechanisms.3

Both the macroeconomic externality and income equality benefits point to the need for public investment in providing certain types of infrastructure, because they represent either non-rival public goods as in the case of rural roads, or a natural monopoly as in the case of electricity generation and distribution systems. Without government intervention or public investment, the critical infrastructure for development would be undersupplied.

But investing in infrastructure alone is not sufficient to propel growth and generate jobs unless it is combined with productive assets and human capital. One new idea is to combine infrastructural building with green urban development, eco-industrial parks and structural transformation to generate employment, revenue, growth and poverty reduction, making the environment more sustainable and the infrastructure financially viable.4

There is a huge infrastructural funding and capacity gap in developing countries, especially in the area of renewable energy and green technology. The One Belt One Road vision and associated funds (such as the Silk Road Fund) can help ‘crowd in’ funding and increase utilisation of green technology by transforming existing cities into green cities, and building new clusters of eco-friendly industries. It will attract emerging market economies such as China and India as well as Arab countries to invest overseas and relocate some of their excess production capacity to low-income developing countries, where there is a demand. This will also help the rebalancing or structural upgrading in their domestic economies.

Staggering shortfalls

Infrastructure shortfalls in the developing world are staggering. Roughly 1.4 billion people have no access to electricity, about 880 million people still live without safe drinking water and 2.6 billion without access to basic sanitation. Around 900 million rural dwellers worldwide are estimated to have no access to all-weather roads within two kilometers.5 It is estimated that Asia alone will need about $8 trillion in national infrastructure and $290 billion in regional infrastructure development through 2020 and beyond.6

Estimates of the growth impact of infrastructure investment in developing countries support this notion. Caldéron and Servén7 estimate that, on average, annual growth among developing countries increased by 1.6% in 2001-05 relative to 1991-95, as a result of infrastructure developments. This effect was particularly large in south Asia, reaching 2.7% per year. Caldéron and Servén8 find that if low-income countries in Sub-Saharan African were to develop infrastructure at the same rate as Indonesia, the growth of west African low-income countries would rise by 1.7% per year. An increase in power generation in India to the levels of Israel and Hong Kong would enhance growth by 1.7%. Similarly, if Latin American countries can have the same level of infrastructure as east Asia’s middle-income countries, their annual growth will increase 2%.9

As shown in Box 1, the median net IRR for infrastructure funds across all vintages remains consistent at around 10%. Investing in the infrastructure of developing countries is riskier, but it could have rates of returns ranging from 0% to more than 100% in the case of releasing bottlenecks.10

Closing the funding gap

The World Bank estimates that annual investments of more than $1 trillion – about 7% of developing country GDP – are required to meet basic infrastructure needs in the medium term. Countries that grew rapidly – such as China, Japan and the Republic of Korea – invested upwards of 9% of GDP every year for decades. Assuming that infrastructure financing in developing countries continues at historical trend levels, there remains an infrastructure financing gap of more than $500 billion per year over the medium term.

The One Belt One Road vision and associated funds could help to close this gap. However, investing in infrastructure alone is not sufficient to propel growth unless it is combined with productive assets and human capital. There is a need for infrastructure to be associated with special economic zones or urban development to ensure structural transformation becomes self-sustainable.

Comparative advantages

New structural economics postulates that each country at any specific time possesses given factor endowments consisting of land (natural resources), labour and capital (both human and physical), which represent the total available budget that the country can allocate to primary, secondary and tertiary industries to produce goods and services. The relative abundance of endowments in a country is given at any given specific time, but is changeable over time. In addition, infrastructure is a fourth endowment that is fixed at any given specific time and changeable over time.11

From the angle of land-based financing, investment in appropriate infrastructure and industrial assets would increase the value of land (a commonly accepted principle). Land-based financing offers powerful tools that can help pay for urban infrastructure investment.12 And these options have been explored during China’s experimentation with special economic zones and the infrastructure around these zones.13

Therefore, it can be proposed that: Other things being equal, a piece of land with the proper level of infrastructure is always more valuable than a piece of land without. Thus it can be well used as collateral for infrastructure development loans.

This proposition is supported by empirical evidence that infrastructure benefits the poor because it adds value to land or human capital and reduces inequality.14 Since infrastructure is often sector-specific, the ‘proper’ level of infrastructure must be affordable to the population and be consistent with the country’s existing or latent comparative advantage. Thus, market mechanisms should be relied upon to have the right relative prices and to determine which infrastructure is bottleneck-releasing. In addition, the government must provide information, identify the comparative advantages and the associated appropriate infrastructure, and facilitate this process by developing a self-discovery process by the private sector.

Therefore, it can also be proposed that: Transformative infrastructure helps link a country’s endowment structure with its existing and latent comparative advantages, and translates them into competitive advantages in the global market. Thus, it can be made financially viable. In other words, combining infrastructural building with industrial upgrading, as well as real estate development, can help make both financially sustainable. Potentially this approach has high rates of returns.

Based on these two propositions, any low-income country can have the ability to pay for its appropriate infrastructure in the long term, as long as it can develop a strategy that is consistent with its comparative advantages. In other words, we should focus more on "what these countries have" rather than "what they do not have", as suggested by Justin Yifu Lin in his farewell blog at the World Bank. See Figure 2.

What these countries need is a bridge fund in the medium to long term for 10-15 years or longer to build a productive and export base. One example shows how quickly the development results can be seen: Huajian Shoe Manufacturing Company established a large manufacturing facility in the Eastern Industrial Zone in Ethiopia, trained workers and started exporting, all within four months.15

China utilises its comparative advantage in construction

In the IFF China Report 2015 (Section 3), we used empirical evidence to shown that China has been utilising its comparative advantage in construction and helping African countries tackle their bottlenecks. Between 2000 and 2010, 50% of China’s commitment on infrastructure was allocated to electricity and its transmission in Africa – a key bottleneck. A recent study found that China has contributed, and is still contributing, to a total of 9.024 gigawatts of electricity-generating capacity, including completed, ongoing and committed power projects.16 The impact of this investment is likely to be transformative when one considers that the entire installed capacity of the 47 Sub-Saharan Africa countries excluding South Africa is 28 gigawatts.

China has comparative advantages in constructing infrastructure. This was shown on page 65 of the IFF China Report 2015, where the graph shows that China’s labour cost in construction (at about $10-15 per hour) is only 15% of those in the industrial countries such as the US or Europe. China’s demonstrated comparative advantage is determined by the following factors: 1) existing domestic infrastructure such as highways, high speed railways, and hydropower; 2) low cost of labour including foremen and engineers; 3) ability to bring in financiers to these projects; 4) large number of infrastructure projects that have been implemented in Asia, Africa and the rest of the world. Now this argument is made stronger (see Box 2).

The benefits of special economic zones

China itself has had a favourable experience using special economic zones. The idea that industrial parks or zones can promote structural transformation as well as industrial upgrading is not new. Economists have emphasised that clusters take advantage of economies of scale and reduce transactions and search- and learning-costs.17 Agglomeration helps firms to benefit from knowledge spillovers, create a market for specialised skills, and use backward and forward linkages (good access to large input suppliers, logistics, privileged network with customers and so on). These agglomeration benefits reduce the individual firm’s transaction costs and increase the competitiveness of a nation’s industry.18

Around the world, and in particular in Africa, China has been supporting 15 or so special economic zones – or ‘overseas economic and trade cooperation zones’ – aimed to improve the investment climate and encourage direct investment into low income developing countries (see Table 1). According to detailed studies by Bräutigam and Tang (2012), in total China has jointly established six industrial zones in Africa. More than 80 companies have signed agreements and settled in these industrial zones, creating tens of thousands of jobs for African workers.

During recent years, China’s labour cost has been rising rapidly, from $150 per month in 2005, to $500 per month in 2012, and to more than $600 per month in coastal regions in 2013 (growing at the rate of 15% annually plus currency appreciation). China has an estimated 124 million workers in manufacturing, most of them in labour-intensive sectors (85 million), as compared to 9.7 million in Japan in 1960 and 2.3 million in the Republic of Korea in 1980. The reallocation of China’s manufacturing to more sophisticated, higher value-added products and tasks will open great opportunities for lower income countries to produce the labour-intensive light-manufacturing goods that China leaves behind19.

Future prospects for the Belt and Road

Economic and trade theory tell us that when countries trade with their respective comparative advantages determined by their natural and factor endowments, both sides will gain naturally from this trade.

The future prospects for the One Belt One Road initiative are bright because it is based on sound economics and trade foundation, benefiting both sides, including utilising comparative advantages, although its implementation may take as long as 20-30 years.

China has used expansionary monetary and fiscal and investment policy to overcome the contractionary pressure during two crises – the 1998 Asian financial crisis, and the 2008-09 global financial crisis – and in the aftermath of the Great Recession. Now, after seven years of resistance, the idea of building infrastructure as a countercyclical measure in a low interest environment is well accepted (see Larry Summers 2014) and is recommended by the IMF.20

In the post-2015 era, the emergence of new multilateral or regional development banks and funds such as the AIIB, the New Development Bank and the Silk Road Fund is encouraging, bringing positive energy and momentum to the world economic development arena. In a multipolar world, it seems inevitable to have different plurilateral and multilateral development banks, as well as various bilateral and plurilateral investment funds. We are cautiously optimistic that a common ground can be found for partners from the ‘North’ and the ‘South’ to work together on win-win solutions for sustainable development and world peace. 

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