Written by Ryan McGuine //
On an official visit to Kazakhstan in 2013, Chinese president Xi Jinping announced the Belt and Road Initiative (BRI), breaking with China’s longstanding foreign policy of maintaining a low profile. In doing so, he touted the BRI as a “new Silk Road,” recalling the historic trade routes between Europe and Asia. Initially meant to link China with western Europe through physical infrastructure, the BRI has grown in scope to encompass a vast network of railways, energy pipelines, and highways across countries spanning Oceania, Africa, and Latin America.
Between 1949 and 1976, Mao Zedong ran the young People’s Republic of China as a controlled economy. The central government planned infrastructure projects and built them using mass mobilization of rural labor. The state allocated resources based on Communist ideology, which emphasized rapid industrialization, focusing investment on huge projects like steel mills, railroads, and irrigation and drainage works. Funding for these construction projects came from central government fiscal revenues, state-owned enterprise profits, and low-interest loans from the Soviet Union. Throughout this period, the common theme was that money flowed from Beijing, through local bureaucracies, to specific projects. Despite attempts to industrialize, when Mao died in 1976, China had one of the lowest incomes per capita of any country for which data exists.
While his successor Deng Xiaoping maintained single-party control over political life, he oversaw a series of market-oriented reforms across China’s economy. Chief among these was the “open door policy,” permitting the introduction of foreign capital and technology. Foreign direct investment benefits development by boosting an economy’s capital per capita without reducing the domestic savings rate, and often enables knowledge transfer across markets. China also began to allow small-scale entrepreneurs and relaxed price controls. Enterprises could now make decisions about contracts, suppliers, and employees, and profits and losses became the responsibility of the managers making those decisions. This economic decentralization and shift from ideology-based management to evidence-based management under Mr Deng released a spectacular amount of latent potential, regardless of the metric – between 1980 and the early 2000s, per capita income grew by 30 times with total factor productivity accounting for 40.1% of that increase, and absolute poverty declined from 41% of the population to 5%.
Following these reforms, China’s central government created three policy banks in 1994: the China Development Bank, the Export-Import Bank of China, and the Agricultural Development Bank of China. While China long had a group of state-owned commercial banks, these new banks were established to focus on lending for less profitable but publicly important projects, freeing up the existing banks to focus on more commercially-viable projects. The policy banks have a dual mandate to serve the aims of the Chinese government and engage in financial lending, making them neither fully centrally-planned nor fully market-driven. Chinese policy banks are uniquely structured, but public financing agencies are common around the world. For example, Japan and Germany each have their own national development banks, and many Western countries have insurers designed to support domestic companies doing business abroad.
Between the 1990s and 2000s, China underwent a major infrastructure build-out. Local governments could borrow almost indefinitely from the policy banks, using land as collateral for loans to build infrastructure which increased land value, and later selling that land to private developers. At a time when most Western countries were struggling to build enough housing and infrastructure, China was excelling at mobilizing huge amounts of resources. Today, no country on earth can build rail lines, power stations, airports, and expressways as quickly and effectively. However, this development pattern created a fragile system, dependent on ever-rising land values and a continuous stream of new construction projects. It is now common to see bridges that do not connect anything, and skyscrapers filled with empty apartments.
American institutions fund infrastructure through market-based mechanisms. Public projects like libraries, airports, or public works facilities are typically paid for by municipal bonds which can be repaid by the revenue generated by the facility or the government’s tax collection. For private projects like transmission lines, telecom towers, or liquified natural gas terminals, the funding mechanism depends on whether the project’s risks and revenues are separable from the rest of the business. If they are, the owner often utilizes project financing like taking out loans from a commercial bank. If not, the project might be paid for through corporate financing such as issuing new bonds or tapping into operational revenues. Roads are unique – interstate projects are primarily funded by the national government, while state roads are funded through a variety of sources including gas taxes, tolls, or vehicle and driver’s license fees.
Centrally-planned models of infrastructure financing can mobilize resources for projects with less direct economic benefits and operate fully removed from market sentiment. However, less transparency raises the risk of resource misallocation through corruption and overcapacity. Market-driven models of infrastructure financing allocate capital more efficiently and improve transparency for investors and the public, but have their own downsides. For example, they often lead to underinvestment in publicly-beneficial but low-margin projects and are slowed down by review processes and political gridlock. China’s model of using policy banks combines some of the good aspects of both to incorporate government guidance with market discipline. Nevertheless, doing so also creates a unique set of bad aspects – the complex relationships can blur accountability and create hidden liabilities for the government.
Around the early 2000s, China’s banks faced increasing debt and diminishing returns to more construction at home, while its manufacturers dealt with excess capacity in industries like steel and cement. Meanwhile, developing countries lacked either commercial banks or sufficient fiscal revenue to address their huge need for infrastructure. Proving well-matched partners, Chinese SOEs began signing contracts for construction projects abroad, which were financed through Chinese banks. In 2013, Xi Jinping formalized this activity by state-owned contractors as the Belt and Road Initiative. The BRI represents an extension of the core mechanisms within China’s domestic developmental state beyond the country’s borders. Indeed, the very same actors responsible for China’s massive infrastructure boom became some of today’s largest actors in infrastructure construction globally.
The BRI charted a new proactive approach to dealing with neighboring countries by fostering closer economic and social ties. Over the next few years, China drafted a strategy for the BRI, seeking to unify its strategic foreign policy agenda while developing industrial linkages across the domestic Chinese economy. For example, contractors working abroad could import Chinese heavy machinery, collaborate with Chinese mining companies to extract resources, or build special economic zones to export agricultural goods to China. Chinese institutions proved uniquely well-matched for this task – whereas Western banks and contractors had already moved up the value chain, China itself was a middle-income country, giving its contractors ample experience building large-scale basic infrastructure at home and its banks ample experience financing it.
By the end of its first decade, outstanding loans for BRI projects exceeded $1.3 trillion across more than 150 countries, while cumulative trade between China and participating countries totaled over $20 trillion. The appeal in Chinese support is clear – the Western approach to the developing world had become stagnant, gaining a reputation for commercial actors exporting resource wealth, in exchange for patronizing rhetoric about the importance of corruption and small-scale interventions by their foreign aid agencies. China meanwhile views them as business opportunities rather than charity cases, with a long history of close ties between its commercial and foreign aid activities. To be clear, they also export resources, but crucially give countries something concrete to show for their partnership with China in the form of infrastructure without any strings attached.
However, the development model that ran out of steam domestically shows signs of faltering abroad in some predictable ways. Just as Chinese banks continued to lend to local governments even if projects were wasteful or unproductive, they now prioritize the quantity of overseas projects ahead of all else. Nearly one-third of BRI projects face issues like corruption scandals, labor violations, or budget and schedule overruns, while some debtor countries are running out of debt capacity entirely. This has led to accusations of “debt-trap diplomacy,” extending credit for the purpose of gaining political leverage.
This narrative includes some truth. Taking on a BRI loan involves significant risk for the debtor countries – since loans from Chinese banks are typically collateralized by the infrastructure being built, China can take ownership of the infrastructure if a project fails to bring in sufficient revenue to repay the loans. In one infamous case China did exactly this, swapping debt forgiveness on construction of a Sri Lankan port for ownership of the port itself. However, little evidence exists that loans are given with this explicit goal, or any centralized goal for that matter. The BRI comprises a complex web of government officials, financiers, and contractors competing for profit and influence, with the central government left trying to balance competition between actors. In the disjointed race to execute more projects, Chinese organizations simply ignored debt sustainability considerations like frameworks followed by Western lenders, learning the hard way why those were instituted in the first place.
More recently, the pace of new BRI loans has slowed considerably as China has begun loaning money to rescue countries from outstanding BRI loans. New BRI loans are shifting away from large basic infrastructure projects in far-off countries toward higher-margin projects closer to home. Rather than a highway or an airport in Uganda funded by the Export-Import Bank of China, one is more likely to see a 5G project in Thailand funded through the Chinese-led Asian Infrastructure Investment Bank. This new focus on profitability suggests a growing detachment between China’s foreign aid and commercial activities. The former includes grants and concessional loans toward social sectors like health and education, while the latter includes larger commercial loans and equity investing. Chinese leaders advertise their country as a peer to developing countries, but this is becoming less and less the case. Its approach to foreign policy increasingly mirrors that of Western countries, and its rhetoric of “south-south cooperation” begins to ring hollow.
Western countries have launched some efforts to counter China’s BRI by building infrastructure abroad, like America’s BUILD Act, Europe’s Global Gateway, and the G-7’s Build Back Better World initiative. These have largely languished though. Beyond their meager size relative to the BRI, they are structured poorly to present real alternatives. Competing with China on infrastructure construction, an area where they have a clear comparative advantage, is a loser’s game. Instead, the West should focus on its strengths – welcome more foreigners in higher education, encourage private companies to invest abroad, and reduce trade barriers. While Western leaders are rightly skeptical of the BRI, it represents a genuinely new approach to the developing world by a burgeoning superpower. The West has an opportunity to consider what makes China an appealing partner to the developing world, and retool their own approach accordingly. They would do well to seize it.