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

 

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Alibaba IPO Underlines Rise of Chinese Private Sector

November 5, 2014

On Friday, September 5, Alibaba Group filed details about its forthcoming Initial Public Offering, suggesting a mid-range valuation of 155 billion US dollars. This would make the Hangzhou-based web retailer the most valuable listed private-sector company headquartered on the Chinese mainland, ahead of its Shenzhen-based online rival Tencent Holdings.

Alibaba’s coming of age underlines a continuous trend of the last half-decade, illuminatingly analysed by the Peterson Institute’s Nick Lardy in his forthcoming book Markets over Mao. For all the fashionable talk of China’s dominant state capitalism and “Guo Jin Min Tui” (“the state advances, the private sector retreats”), the numbers tell a slightly different story, as illustrated by the following chart:

Aggregate Market Value of Large Listed Cinese Companies

 

This chart shows the shares of four categories of companies in the aggregate market value of the largest listed Chinese firms, namely those that feature in the FT Global 500 list of the world’s 500 largest listed companies by market capitalization which is regularly compiled by the Financial Times. Companies are included irrespective of the location of their main stock market listing, whether Hong Kong, Shenzhen, Shanghai or, in Alibaba’s case, New York. The three main groups are state-owned enterprises (SOEs) of the People’s Republic of China (PRC), such as Petrochina, Industrial & Commercial Bank of China, or China Mobile; companies from Hong Kong and Macao (mostly private-sector but also including municipal companies such as MTR, which operates the profitable Hong Kong metro system), such as Hutchison Whampoa, AIA Insurance, or Sands China; and private-sector companies from the mainland, such as Tencent or Ping An. A smaller fourth group includes banks with hybrid ownership of state and private-sector shareholders (with a public-sector majority), such as China Merchants, Industrial Bank, or Shanghai Pudong Development Bank.

The numbers are as of December 31 of each year except in 2014, where the ranking as of June 30 is used. In the right-hand bar, Alibaba is added to the list on June 30 with the notional market value of USD155bn. This inclusion results in a corresponding expansion of the relative share of the mainland private sector. (The other companies’ market values were not adjusted from their June 30 amount, but this would not materially change the overall picture.)

The chart suggests three observations. First, with about two-thirds of the total, the PRC’s government retains a firm control of the “commanding heights” of Chinese business, as has been plain since the massive IPOs of state-owned enterprises in the mid-2000s. Second, however, this measure suggests a continuous erosion of state control for the past half-decade, as new entrants such as Tencent and Alibaba gain ground – and as private firms in Hong Kong and Macao have also comparatively recovered somewhat from their low point of the late 2000s. Third, and for the first time with Alibaba’s addition to the mix, large private-sector companies from the mainland collectively weigh as much as their peers from Hong Kong and Macao when measured by aggregate value.

As always in China, one must keep in mind that the distinction between public and private sector remains somewhat fuzzy. Ultimate ownership of private-sector firms is often unclear, and the Communist Party of China retains ways to influence the strategy and behaviour of many nominally private-sector companies. Nevertheless, the gradual rise of private-sector companies as compared with the state-owned giants is too continuous to be ignored. Alibaba’s IPO is likely to be remembered as the symbolic moment of this momentous transformation of the Chinese corporate landscape.

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



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China’s Historical Options

October 1, 2014

Summary

In this article, this year’s annual position paper of the European Union Chamber of Commerce in China (EUCCC) is described.

This time, the angle of the European Chamber is to comment on the far-reaching reforms from the decision document of the Third Plenum last year and to suggest what needs to be done by China to succeed with its ambitious reform plans.

The Chamber goes as far as to say that China has no other choice but to stick to reforms. If China makes the wrong choices at the critical crossroads where the country is at present, China may risk never getting past the “middle income trap”. The core issue of the reforms is to truly allow the market forces to play a decisive role in the resource allocation of the Chinese society.

The Executive Summary of the Chamber is divided into three headlines:

1) The role of the market: the need of rebalancing the economy, of financial reforms, fiscal reforms, State Owned Enterprises reforms, market access and the freedom of companies to choose strategic service providers.

2) Quality of life: China is now shifting focus from blind pursuit of growth at any price to enhancing the quality of life of its inhabitants. This section covers areas such as the environment, urbanisation, health care, food safety, internet management, the rule of law and the role of the marketplace in innovation.

3) China and the world: This chapter welcomes China’s awakened leadership ambitions in the global rule-setting organisations. Convergence of the Chinese regulatory frameworks with international norms will ensure that China will strengthen its position as an integrated part of global supply chains and that the global competitiveness of Chinese innovations will grow.

To summarize: The recommendations provided by the European industry in China will not only further strengthen the interests of European companies in China, but will also help China to build a much better general business environment to the benefit of all companies irrespective of ownership form or national origins.

 

Kina vid ett historiskt vägval

Genom fyrtiotalet arbetsgrupper framför Europeiska Handelskammaren i Kina (EUCCC) årligen rekommendationer från sina dryga 1800 medlemmar till den kinesiska regeringen om hur affärsklimatet i Kina skall kunna bli bättre. Detta omfattande arbete presenteras i ett positionspapper.

Sedan några år tillbaka är den så kallade executive summary kanske den intressantaste delen, i varje fall om man vill förstå hur europeisk industri ser på Kinas stora utmaningar. I årets executive summary är texten indelad i tre avdelningar: 1) Marknadens roll i samhället, 2) Livskvalitet och 3) Kinas roll i världen.

Sedan Kina presenterade sitt sextiopunkts beslutdokument om ekonomiska och sociala reformer står det helt klart att Kina befinner sig vid – förmodligen – det viktigaste vägvalet i modern kinesisk historia; antingen genomför man reformerna fullt ut och med kraft och har en chans att övervinna de stora och otaliga utmaningar som Kina står inför. Eller så tvekar man och riskerar att
få en stagnerande utveckling, där problemens svårighetsgrad kan komma att utgöra ett hot mot Kina, så som vi känner det idag. Eftersom Kina redan är en mycket viktig del av världsekonomin och en allt viktigare politisk supermakt är Kinas öde vårt allas öde.

Kammaren vill i sitt executive summary peka på de löften till reform som Kina presenterade i sextiopunktsdokumentet för knappt ett år sedan. EUCCC kommer med konstruktiva förslag till hur dessa skall kunna genomföras. Nyckelfrågan för framgång är att låta marknaden spela den avgörande rollen i allokeringen av resurser som sextiopunktsdokumentet har som centralt tema. Detta i sin tur innebär att staten måste omdefiniera sin roll i samhället för att den organiskt växande delen av ekonomin skall kunna frodas.

Utan långtgående finansiella reformer blir detta svårt. Utan att minska de statliga företagens dominans i ekonomin kommer glastak fortsätta att existera som försvårar för privata företag att växa sig riktigt stora och livskraftiga. För att staten fullt ut skall kunna spela sin nya roll och för att minska de snedvridande effekterna av att underfinansierade städer, kommuner och distrikt för sin försörjning säljer ut mark och lånar upp pengar inom den informella lånesektorn måste genomgripande reformer av skattesystemet genomföras.

Vidare måste marknaderna öppnas för jämlik konkurrens mellan alla marknadsaktörer – oavsett deras ägarbakgrund. Statens uppgift är att stå som garant för öppna och transparenta marknader med tydliga ramar innanför vilka marknadskrafterna kan spela sin roll. Slutligen måste marknadsaktörer tillåtas full frihet att arbeta med den kommersiella infrastruktur som de behöver för att fatta välavvägda beslut där risk ställs mot affärsmöjligheter. Det innebär konkret att banker, jurister, redovisningsfirmor, strategikonsulter, kvalitetsinspektörer osv måste kunna erbjuda sina tjänster utan begränsningar pådyvlade av staten.

Under de första trettiofem åren av den stora reformprocessen sedan 1979 har mycket av statens fokus handlat om att återupprätta landet Kina. I denna ambition har staten oftast stått på (de statliga) företagens sida. Medan Kina blivit allt rikare frågar sig alltfler människor i Kina om deras liv egentligen blivit så mycket bättre. De tänker på miljöproblem, arbetslöshet, skyhöga priser på bostäder, matsäkerhet, korruption, trafikstockningar, fula och opersonliga bostadsområden osv. Att nu återvinna folkets förtroende har kommit att bli en överlevnadsfråga för partiet. Från och med nu måste människans livskvalitet sättas i centrum.

Den Europeiska Handelskammaren delar denna uppfattning om livskvalitén och kan lätt dra på Europas egen erfarenhet från de olika medlemsländernas utveckling sedan andra världskrigets slut. Den nya kinesiska regeringen under premiärminister Li Keqiang ser därför en ny typ av urbanisering som svaret på livskvalitetsfrågan. Beboeliga städer kräver ett systemtänkande som Kina hittills visat lite prov på, men nya tag skulle kunna leda till både mer hållbara städer, högre innovationskraft och ett mer omfattande socialt skyddsnät. Den enskildes rätt till ett drägligt och tryggt liv kan ej separeras från ett väl fungerande och oberoende rättssystem. Även om Kina nu aviserat att just rättssystemet kommer att vara huvudfrågan vid partiets kommande fjärde plenarsession menar Handelskammaren att här finns mycket att önska med hänsyn till de mycket djupa reformbehoven. Vi menar också att ett ocensurerat och snabbt internet är kanske den enskilde människans största garant för att kunna värja sig mot maktmissbruk och andra missförhållanden.

Slutligen har Kina, som är väl bekant, redan blivit världen största handelsnation. Tillverkningsaktiviteter i Kina är redan djupt integrerade i globala leverantörs- och värdeförädlingskedjor. När arbetskraftskostnader och andra produktionskostnader nu stiger är det ännu viktigare att Kina på andra sätt behåller sin konkurrenskraft och attraktivitet. Detta sker bäst genom en konvergens mot omvärlden med hänsyn till internationell handelspolitik, standards, investeringsavtal och annat som gör det effektivt att producera och utveckla i Kina. Kina måste ta sitt ansvar genom att göra WTO till den viktigaste internationella plattformen för handelspolitik och genom att söka inflytande i andra viktiga internationella organisationer som skapar en bättre fungerande världsekonomi.

Vi européer välkomnar kinesiska investeringar i Europa och garanterar att kinesiska företag kommer att behandlas på samma sätt som vilka andra företag som helst i våra ekonomier.

Europeiska Handelskammaren i Kina företräder inte bara sina drygt 1800 medlemmar och deras intressen. Faktum är att alla rekommendationer i EUCCC:s positionspapper syftar till att göra Kina till en bättre marknad för alla aktörer – vare sig de är kinesiska, utländska, privata eller statliga.

 

 

 

 

 

 

Mats Harborn
Vice Chairman, European Union Chamber of Commerce in China (EUCCC)

 

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