October 2017

One Belt One Road has the potential to transform global trade, but the countries along the way do not have the most attractive risk profile. Economist Rebecca Harding examines the opportunity and the challenges and takes a closer look at Kazakhstan

As the US increases its protectionist rhetoric, it seems appropriate to ask: is the global trade fulcrum shifting to the east? Since 2013, China has had ambitious plans to build trade infrastructure and connections through Eurasia and into Europe, but also to enhance its marine presence by substantial investments in ports in East Asia. Given that China’s economic policy is foreign policy, this seems like a plan to extend its influence across the landmass through Kazakhstan, Mongolia, Russia and Iran, although its policymakers regard the plans as peaceful and aimed at fuelling economic prosperity in these, and other, countries in the region. Its goal is to afford the benefits of development through trade that it has experienced to other nations by facilitating infrastructure investments along what was its ‘Silk Road’ some 2,000 years ago.

For this reason, McKinsey likens the project, if successful, to a 21st-Century Marshall Plan that could amount to an annual infrastructure expenditure across the Eurasia, East Asia and Middle East region of some US$2–3bn. The reach covers some 65% of the world’s population, one third of world GDP and more than a quarter of all cross-border goods and services trade.1 

Structure

The ‘Belt’ is a railway from Asia to Scandinavia while the ‘Road’, somewhat confusingly, is the old maritime Silk Road that covers the ports and shipping lanes from China to Venice. The ports along the Silk Road will not just act as trade hubs. Gwadar in Pakistan, for example, is potentially earmarked as a temporary naval base, and this creates potential tensions between China and India.

Yet, throughout China’s history, trade has been the vehicle for what it calls cultural exchange and regional collaboration. The reasons for being more explicit about those ambitions now may well be associated with the somewhat isolationist stance that the US is currently taking towards the World Trade Organisation (WTO), its exit from the Trans-Pacific Partnership (TPP) and its concerns about its engagement with the North America Free Trade Area (NAFTA). China’s proposed Regional Comprehensive Economic Partnership does not substitute for TPP and the One Belt One Road (OBOR) project is not a free trade area, nor is it a customs union. OBOR is simply an ambition to provide trade infrastructure across the region, not to be a vehicle for regional integration.

There are 15 countries apart from China in East Asia, the Middle East and Eurasia that are most obviously within the OBOR project and China’s trade is highly focused on Russia, India and Iran, although Turkmenistan, Kazakhstan and Mongolia are important as import partners as well.

Trade transformation

These are all classified as emerging economies yet, including China, the OBOR countries’ importance as a share of world trade has grown substantially over the past 20 years (see Figure 1). Each country has had its own challenges as they have started to integrate into the global trading system. Russia and Iran, for example, have both been subject to UN sanctions and, specifically, oil embargoes; Russia since 2014 and Iran since 2012. Kazakhstan has similarly been affected by high levels of corruption and bribery that have undermined its attempts to attract inward investment and grow through trade. Despite the fact that trade has slipped back since 2012, as a result of these challenges, the OBOR group of countries represented nearly 34% of world trade in 2016.

However, the same group of countries (minus China) only account for a relatively small proportion of China’s total trade. Although this has more than doubled since 1996, it is still only just above 6% of China’s trade and highly concentrated in oil and gas.

Is it the case, then, that China’s interests are not trade-related? The fact that these countries are such a small proportion of China’s trade might suggest so, but a closer look at the data points out just how important these countries are in terms of China’s overall supply of energy.

Figure 2 takes just the four countries that are most directly impacted by the OBOR’s Mongolia-Russia route and by the proposed Eurasia land bridge: Mongolia, Russia, Kazakhstan and Iran. These countries alone accounted for 17% of China’s oil imports in 2016. Again, this share fell after 2012, but the value of imports remained very similar until 2014–15, when the oil price dropped. This suggests that China’s oil demand had increased during that period and that it had been met from other sources as well.

From a Chinese perspective, there is not only a need to update the infrastructure in the region to reduce the risk to its own energy supply. The routes through these regions also provide a cheaper way of transporting goods to Europe while providing the countries in the region with potential for infrastructure investment that will allow their economies to grow and therefore overcome some of the political and development issues that they have had. In Xi Jinping’s words, China is aiming to demonstrate with the OBOR initiative that it is a “peace-loving explorer set on transforming the world with treasure-laden galleys, not warships, guns or swords.”2

Kazakh potential

In terms of how this plays out at a country level, the case of Kazakhstan is interesting. Kazakhstan has been keen to be at the centre of the policy since it was first announced at a Kazakh university in 2013.
It sees itself as a key corridor between Russia and China and it has cultural and historical links with both countries. As such, it sees itself as a cultural integrator between the traditionally nomadic peoples of Kazakhstan, Turkmenistan, Uzbekistan and Mongolia and is similarly keen to demonstrate that it is independent from Russia politically and economically.

As a country rich in resources, it was the focus of substantial inward investment in oil and gas reserves immediately after the financial crisis and it is keen to re-establish itself as a major commodity trading nation.

Its regional partners are far less important to it in trade terms than Europe, or even China, however (see Figures 3 and 4). Although China is its second largest trading partner, and its fastest-growing top-ten partner, Kazakhstan’s interests are in developing its trade with Europe, particularly Italy.

Annualised growth with European partners over the period has been substantial – with Italy, its largest partner, the rate of annual growth has averaged nearly 22% since 1996 and with the Netherlands 21%. This is because of the importance of Kazakhstan’s oil and gas supplies, and reinforces the perspective that the country has much to gain from a land-based infrastructure which connects it more easily and cheaply with Europe. Interestingly, the fastest-growing top-ten partner has been Switzerland.
This reflects Switzerland’s importance as a financial hub through which commodity deals are booked, rather than its direct trade with the country.

The importance of Russia and China in terms of proximity is obvious, however, and the two nations dwarf others in terms of their importance to Kazakhstan (see Figures 5 and 6).

 Figure 6 shows the potential benefits to Kazakhstan, in particular of the OBOR initiative in terms of its regional partners. Its fastest-growing partners have been, with the notable exceptions of India and Ukraine, in the immediate proximity of its borders. This suggests that some form of economic partnerships through the OBOR policy – if not free trade, then at least infrastructure partnerships – may benefit all of the countries. This is not least the case because they are all oil and gas producers with strong relationships with Europe, China and Russia. The case of Kazakhstan shows how one country, and one that has stumbled in terms of its trade integration with the rest of the world in recent years, is likely to be able to form closer, potentially multilateral, trade and infrastructure arrangements with its regional partners that may help it reach its bigger markets in Europe.

Cost of delivery

However, much will depend on China. This is not because China is not committed to the project. Nor is it because China does not have the ambition to grow its influence through trade by connecting Europe to Asia through its 21st-Century Silk Road. The initiative could help China too – in 2013 it was over-supplying infrastructure products which, as its strategy changed towards demand-led growth, created a surplus that could be manufactured elsewhere. Since then, it has run down its foreign currency reserves and, while it wants to share the benefits of its own export-led model, the regions in the economy do not have the financial clout that it had as it was developing through the heady days of globalisation.

Indeed, nor does China itself have that financial clout now. It is wary of capital flight as its economy grows more slowly.
The Asia Infrastructure and Investment Bank (AIIB) and the BRICS Bank have US$200bn available between them, but this is a fraction of the amount that will be required to fund the project on the scale that it is currently imagined. A further US$40bn from the Silk Road private equity fund is also only a drop in the ocean.

So much of the short- and medium-term success of the project will depend on the appetite of global banks and global investors to fund infrastructure development in some of the world’s most difficult countries from a compliance perspective – the countries themselves score highly on corruption indices and political instability indices and the trade values are small. In the current global trade climate, these are significant hurdles.

Sun Tzu, China’s ancient strategist, advised: “Appear weak when you are strong and strong when you are weak.” This may reflect the reality of China’s current position in relation to the OBOR initiative, since it has manifest problems in the near term that create headaches for domestic policymakers. As to the long term, it is worth reflecting on how this philosophy was translated into the over-arching principle of Chinese foreign policy by Deng Xiaping: “Hide your strength; bide your time.”3 

Dr Rebecca Harding is an independent economist and the founder and CEO of Equant Analytics, a big data analytics and supply company specialising in trade and trade finance


Appear weak when you are strong and strong when you are weak

Sun Tzu, The Art of War, 5th Century BC

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Sources:
1 See
http://bit.ly/2aeQW8L at mckinsey.com
2 See
http://bit.ly/2qeTtq3 at guardian.com
3 See
http://bit.ly/2vZbCut at nationalinterest.org

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