China Research

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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