China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

The “Hype” on Infrastructure Investment in Developing Economies and Emerging Markets: Too Much of a Good Thing?

December 3, 2014

Assumed underinvestment in infrastructure is not only a political issue in developed countries, for instance, in Europe. For quite some time, it has also been identified as a major impediment of growth in developing countries and emerging markets. The World Bank has estimated the need for annual infrastructure expenditure (including maintenance) of about 7% of GDP in these countries. The gap between current funds available from the established development banks and from the budgets of the countries and the amount needed has been estimated at more than 1 trill. US $.

The reasons for the reluctance of the banks to invest more in infrastructure are well-known. There are chicken-and-egg-problems between public and private investment with the risk that the sequence of public investment first and private investment later leaves the countries with highways in no-men’s land without private investors. Furthermore, there are long gestation periods with technical indivisibilities resulting in lump-sum investment and cluster risks, problems of ensuring that the maintenance costs are at least partly financed from the countries’ budgets, maturity mismatches in financing long-term investment with short-term funds with the risk that refinancing leads to an unexpected debt burden, and, finally, there is the fact that infrastructure investment benefits the construction sector which is normally seen as a non-traded service. So, there is little competition and productivity increases if building the infrastructure is either in the hands of the donors (quasi “tied aid”) or of domestic companies trying to defend the domestic market against foreign competitors which would bring also foreign labor into the country.

Now, very recently, there has been a number of initiatives from the emerging markets’ side to close the gap. In July 2014, five leading emerging markets (Brazil, Russia, India, China, and South Africa) established the New Development Bank (“BRICS Bank”) targeted not only as a substitute to the IMF as stand-by agency but also as a bank to finance infrastructure. In October 2014, the Chinese government paved the way to the foundation of the Asian Infrastructure Investment Bank (AIIB) with 21 APEC countries (excluding the US, Australia, South Korea and Indonesia), and in November 2014, the Chinese government offered to pour 40 Bill. US $ into a “New Silk Road Fund” to break connectivity bottlenecks in Asia – including maritime infrastructure.

The common denominator in these initiatives is China, the no. 3 in world exports of construction services, next to the EU and South Korea. Yet, China’s active role has not been without self-serving motives. It has suffered strongly from declines in its construction exports in 2012 and 2013 due to the remnants of the 2008 financial and economic crisis and hopes that the new funds pave the way for a recovery of its construction exports.

Host countries are aware that China finances infrastructure investment in developing countries and emerging markets under income and employment targets on the one hand and under strategic targets of access to resources on the other hand. A third target is omnipresent: becoming independent of transport routes controlled by the developed countries. All these targets must not necessarily match with those of the host countries. Building highways in Brazil, for instance, with thousands of Chinese workers, would certainly meet resistance from local suppliers and the population, and could turn into idle capacities if declining world market prices and technological innovations make the extraction of resources unprofitable. Another caveat is finance. Should loans be given in the Chinese currency RMB while the returns from infrastructure investment are in local currency of the host country, then an appreciation of the RMB against the host country’s currency would create an expensive currency mismatch for the host country.

Finally, apart from China’s role, the key chicken-and-egg problem still is unsolved. How much infrastructure investment is needed to attract private investment and how can a blackmailing dilemma for the public budgets be avoided if the private sector demands a generous endowment with infrastructure as a prerequisite for private investment but for whatever reasons do not deliver once the infrastructure has been built? Linking public and private investment through private-public partnership arrangements could perhaps ease the blackmailing dilemma.

After many years of obvious neglect of infrastructure investment, the pendulum seems to shift in the opposite direction. Now, infrastructure investment is hailed as an important source of economic growth and in times of super-expansionary monetary policies financial resources seem abundant. However, there can be too much of a good thing and good things can turn sour if the monetary and economic environment changes. In particular, host countries should be aware of exuberance, “white elephants”, and self-serving interests of non-traditional donors.

Open resentment about the traditional Western donor agencies should not cloud the sight that also in “South-South” relationship between emerging markets and developing countries, free lunches are very rare.

 

 

 

 

Rolf J. Langhammer
Kiel Institute for the World Economy

 

Back to Start Page

Japan’s (Abenomics’) Failure – are there Growing Risks for other Asian Countries and the World Economy?

In the third quarter, Japan’s economy tumbled again into a recession. “Abenomics” – i.e. the economic program of prime minister Shinzo Abe (LDP) – proved to be a failure. Expressed very briefly, “Abenomics” means that the Bank of Japan (Nippon Ginko) two years ago was committed to massively print money in completely uncharted waters in order to combat the long-lasting deflationary problem.

Furthermore, Abe wanted to do something about the excessive government debt (more than 240 % of GDP), for example by raising the VAT from 5 to 8 last April – a measure that obviously contributed to the current recession and made Japanese consumers even more reluctant. For this reason, another planned VAT hike has been postponed.

Bad advice

One of the intellectual fathers of “Abenomics” was Nobel Prize winner Paul Krugman who during a long time had complained about Japan’s “irresponsible monetary policy” (and who also had accused the Swedish Riksbank for a similar failure – and who, unfortunately, has quite a number of supporters among Swedish academics and financial analysts). The idea of the whole experiment was to print money in borderless amounts for government expenditure – government expenditure that should give positive multiplier effects on consumers and private corporate investors. Furthermore, some inflation should be created this way.

Today, it seems to be obvious that the Krugman-/Abe-experiment has failed. Extreme monetary expansion cannot work in the long run and never replace a structurally well-founded growth/supply side policy. If it was that easy…Something to remember in Sweden and in Frankfurt (ECB) as well.

It would be good idea if the world listened less to Krugman and consortes. With quite some luck, the previous monetarization in the U.S. by the Fed may be managed without major distortions. Janet Yellen understands economics. But Japan and Europe (ECB; Sweden included) function quite differently and have probably very different reactions functions for increased liquidity.

M x V = P x Q

Old fundamentals may help. Let’s for example, look at Irving Fisher’s so-called “equation of exchange” (1911): M x V = P x Q (M = money in circulation, money supply, V = velocity of money circulation, P = price level, Q = expenditures in real terms).

In our context, V, P and Q are the interesting variables. V stands for the average frequency that one unit of the currency/money is spent. An important point in this context is the fact that the “equation of exchange” is an identity equation which means that it is always valid whatever number you put in it. Consequently, the new number for V is not known in advance when M is changed. The same can be said about P (inflation) and Q. These simple facts make the effects of strongly extended money supply uncertain and, consequently, the whole basket of different kinds of quantitative easing (QE) – an instrument which central banks so actively apply these days or intend to use as an instrument for better growth and higher inflation (the Riksbank, unfortunately, included).

Now, in order to make the whole process of monetarization work, it is necessary that the velocity of money circulation increases visibly. Consumers and investors should be willing to spend more money more rapidly. And here we come finally to the point: consumers and investors must believe in the future. This is about behavioral economics.

Behavioral economics needs more attention

In the Japanese case, this necessary condition for a successful expansion of the money supply is not there. The Japanese are not showing enough confidence in the future. This is why any continuation of Abenomics will fail again under current structural conditions. A new policy failure – and the economic outlook for the currently third largest economy in the world will worsen much more.

In this case: at some point – within the forthcoming decade – negative contagion from Japan on other Asian countries and the whole global economy could happen. Consequently, the next Japanese government has to think more about giving real confidence in the economic future. So far, 25 years have gone without positive results. Institutional economics and the lack of behavioral studies explain a lot of this ineffective economic policy.

Economic history tells us that printing money and other liquidity-creating measures never really could cure long-term problems in the real economy.

This is indeed an important experience that academic researchers, decision-makers in central banks/governments and on financial markets should remember more actively.

 

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

 

Back to Start Page

The G-20 Financial Reform Agenda after Five Years

November 5, 2014

Highlights

  • Five years ago, the declarations of the G20 in landmark leaders’ summits in London and Pittsburgh listed specific commitments on financial regulatory reform. When measured against these declarations, as opposed to the surrounding rhetorical hype, most (though not all) commitments have been met to a substantial degree.
  • However, the effectiveness of these reforms in making global finance more stable is not so far proven. This uncertainty on impact mirrors the absence of an analytical consensus on the crisis itself. In addition, unintended consequences of the reforms are appearing gradually, even as their initial implementation is still unfinished.
  • At a broader level, the G20 has established neither an adequate institutional infrastructure nor a consistent policy vision for a globally integrated financial system. This shortcoming justifies increasing concerns about economically harmful market fragmentation. One key aim should be to make international regulatory bodies more representative of the rapidly-changing geography of global finance, not only in terms of their membership but also of their leadership and location.

 

1 This Policy Contribution from September 2014 is an updated version of the author’s contribution to the 2014 China-US-Euro Economists Symposium “Reform: Challenges and Opportunities” jointly organized in Beijing on May 17-18, 2014, by Bruegel, the China Finance 40 Forum, and the Peterson Institute for International Economics.

 

Read the whole report The G-20 Financial Reform Agenda after Five Years

Nicolas Véron
Senior fellow at Bruegel, Brussels, Visiting fellow at the Peterson Institute for International Economics, Washington DC



Back to Start Page