Repaving the Silk Road

China hopes reviving Eurasian trade will do the same for its economy

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When facing adversity, it makes sense to draw on the experience of history, and with 5,000 years to review, China’s leaders have no shortage of comparisons to make with the current era. China is on the rise economically and politically, but the economy is struggling to transition to a more sustainable mode of development. Moreover, infrastructure-driven growth has created an overcapacity hangover that threatens to unravel excessively leveraged lending systems in the provinces. What to do?

China has always gone through cycles of global integration and isolation, and it looks like the period of isolation is now coming to a convincing end. By reviving the Silk Road, a set of ancient trading routes that once connected the Middle Kingdom with the rest of the world, China could head off some of its growing problems and endear itself to nervous neighbors.

“By asking Chinese companies to work outside the country, they can use capacity and learn how to operate abroad, as well as build infrastructure and connections with China,” said Professor Li Haitao, Assistant Dean at the Cheung Kong Graduate School of Business. “The new Silk Road will bring us back to the old Silk Road – a China that is prosperous, innovative and working with neighboring countries.”

Lessons from history

The history of the Silk Road provides some guidance on its perceived relevance to contemporary China. Although the name “Silk Road” was coined only in the middle of the 19th century, it was first formed during the Han dynasty around 200 B.C. and its success or otherwise has reflected that of China’s. Demand for silk from the wealthy Roman Empire was an early spur for trade along what became a series of routes linking East and West. When the Roman Empire collapsed and China’s Western areas become less stable, the trade routes saw a temporary sharp decline in traffic.

The heyday for the Silk Road lasted several hundred years from the start of the Tang Dynasty around 639, when trade flourished between the prosperous empires of China and Byzantium. It was also during this period that maritime trade developed rapidly, with Chinese traders reaching Africa and various places in the Middle East. The importance of the land route continued with the expansion of the Mongol empire, which reached deep into Europe. 

As well as silk, Chinese exports included ceramics, spices and bronzeware. China imported horses, carpets and gold. But the routes were also important in helping the movement of people, their ideas, philosophies and cultures. Buddhist monasteries sprang up along the route, Islam spread and Christian missionaries traveled from Europe. Marco Polo wrote about his trip to China along the Silk Road in the Travels of Marco Polo, and it is thought that the Black Death that plagued Europe in the 1340s arrived via the Silk Road. 

But the disintegration of the Mongol Empire and the rise of the Ottoman Empire in the West marked the end of trading between East and West by land, being largely replaced by a sea trade dominated by the European powers.

Although described in the singular, there was never any single Silk Road, but rather various trails connecting China with Europe via Central Asia, plus others leading to Pakistan, India and Southeast Asia. In 2014, the United Nations Educational, Scientific and Cultural Organization designated around 5,000 km of roads and 33 places in China, Kazakhstan and Kirghizstan as a World Heritage Site. The paths include palaces, settlements, fortifications, temples, tombs and towers, reflecting the diversity of activity along the routes.

Map design by Jin Peng

Back to the future

Some things have changed little since the last time traders plied the Silk Road. Even though the Byzantine Empire acquired the secret to silk production by around the year 550, China to this day dominates production, churning out more than three-quarters of the world’s silk. However, with silk comprising less than 1 percent of the world’s textiles, and the textile industry itself far from the fastest growing, the latest incarnation of the Silk Road will have to find a new purpose.

The attempt to relive the golden days is represented by the One Belt, One Road strategy, which was first announced in 2013 and refers to a land route – New Silk Road Economic Belt – and a sea route, the 21st Century Maritime Silk Road. Neither has been defined but they allude to general directions rather than specific geographical paths. By some estimates, it will directly impact 60 countries, representing 70 percent of the world’s population and more than half its economic output. The regions involved include Central Asia, the Middle East, Europe, Southeast Asia, India and the Horn of Africa, as well as China itself.

An unexpected addition has been Russia, which wasn’t considered part of any previous Silk Road network. It is also host to the only existing east-west land transportation route, the Trans-Siberian Railway, which has branches in China. However, with many former members of the Union of Soviet Socialist Republics along the Silk Road route, it would have been unthinkable for any projects of significance to go ahead without agreement between China and Russia.

“Russia is an important country in the international community, whether in regards to natural resources, political power or simply in terms of size and scale,” said Professor Wanjun Jiang, Associate Professor of Finance at Peking University, Guanghua School of Management. “China and Russia are strong economic partners with a diplomatic history of over 65 years. Furthermore, in the last two years, the trade between Russia and China has increased.”

Indeed Russia itself was the driving force behind the creation at the beginning of this year of the Eurasian Economic Union (EEU), comprising Soviet Bloc countries Belarus, Kazakhstan, Armenia and Kyrgyzstan along with itself. In May this year, Xi and Russian President Vladimir Putin signed a deal linking the One Belt, One Road initiative with the EEU, and maps depicting the new Silk Road now indicate an improbable detour via Moscow.

Mostly Chinese money to realize the dream of the Silk Road initiative will be disbursed through various organizations. China itself has committed around $100 billion already, including $40 billion to a Silk Road Fund and $10 billion to the New Development Bank, previously known as the BRICS Development Bank, operated by Brazil, Russia, India, China and South Africa. A further $50 billion is going to the foundation of the Asian Infrastructure Investment Bank, which some see as a challenge to the existing structure of the Western-dominated World Bank and International Monetary Fund, and the Asian Development Bank, in which Japan is the largest shareholder. Despite governance concerns expressed by the US, 50 countries signed the Articles of Agreement to become founding members of the AIIB in June this year.

Some have compared One Belt, One Road with the Marshall Plan – the US-financed plan that helped rebuild Western Europe after the Second World War. Chinese officials have been at pains to point out that while the Marshall Plan also had geopolitical objectives in promoting US-friendly Western democracy, the One Belt, One Road strategy carries none of that kind of baggage.

Even comparisons with previous incarnations of the Silk Road are difficult. “The old Silk Road wasn't a Chinese initiative, and operated purely as an international trade route feeding from China across the Eurasian land mass and down into the Middle East and East African coast,” said Chris Devonshire Ellis, Chairman of Dezan Shira & Associates and author of the book China’s New Economic Silk Road. “The One Belt, One Road project is more a Beijing initiative, and focused on infrastructure and settlements as much as trade.”

The five priorities

According to an announcement in March that provided if not flesh, then a skeleton for the Silk Road, the initiative was “aimed at promoting orderly and free flow of economic factors, highly efficient allocation of resources and deep integration of markets; encouraging the countries along the Belt and Road to achieve economic policy coordination and carry out broader and more in-depth regional cooperation of higher standards; and jointly creating an open, inclusive and balanced regional economic cooperation architecture that benefits all.” It lists five priorities:

  1. Policy Coordination
  2. Facilities Connectivity – Including transport and communications infrastructure
  3. Unimpeded Trade – Including customs cooperation, trade in services, cross-border e-commerce, lowering non-tariff barriers, taxation agreements, investment protections
  4. Financial Integration – Including a currency stability system, opening bond markets
  5. People-to-People Bonds – Including cultural exchanges and scholarships

For China, the attempt to revive these dormant trade routes serves several purposes. Economically, it can augment programs already underway to balance out growth and prosperity between the affluent eastern coast and the poorer inland areas, particularly in the western parts of the country. Furthermore, major infrastructure projects can help offset some of the effects of the current downturn in the economy and the overcapacity in several sectors that is undermining financial stability as well as reform efforts. For example, China produced slightly more aluminum than the rest of the world put together last year, and capacity is still expanding. This year Chinese companies on their own are expected to be able to produce significantly more than the whole world needs.

“At a time when many large state-owned enterprises are struggling to stay afloat and banks are stuck in a cycle of rolling over ever-growing and progressively less viable loan portfolios, the projects that make up the Belt and Road could provide vital life support and serve as a useful patronage tool for compensating vested interests threatened by efforts to implement market-oriented reforms,” wrote David Parker and Scott Kennedy of the Center for Strategic and International Studies.

They also note the geopolitical benefits that could accrue to China. With the Asian Development Bank forecasting an average annual shortfall of $800 billion in infrastructure spending in Asia between 2010 and 2020, China can use what Parker and Kennedy describe as a “major financial carrot” to help shore up recently strained relationships with neighbors and secure energy resources from Central Asia.

Colm Rafferty, Vice President for Asia Pacific and China Chairman for industrial equipment maker Vermeer, believes that China will still need to deal with its overcapacity in many sectors, but that the One Belt, One Road strategy makes a lot of sense in reducing the pain of adjustment for companies in those sectors and expanding China’s influence by helping partner countries to build much-needed infrastructure.

“One amazing strength China has is this impressive engine for building infrastructure on a massive scale,” Rafferty said. He points to various statistics on the unparalleled amounts of highways, high-speed rail, airports, and urban infrastructure built since 2000. “It’s a competitive advantage of scale and expertise that is tough to match, so it’s a brilliant plan to use this to help partner countries that need it while offsetting some of the problems caused by overcapacity.”

Win-win development model

The question now is how the routes will develop. It appears that a likely model is one that China has adopted in several other areas. In Venezuela, for example, China Development Bank has lent more than $40 million since 2008, much of which has gone straight back to Chinese companies to complete infrastructure projects. State Grid, ZTE and Sinohydro all won infrastructure contracts in Venezuela.

There is already evidence a similar model will be adopted elsewhere. In October, China Railway International signed a deal to build a 150-kilometer railroad from Jakarta to Bandung in Indonesia using China Development Bank funds. The China Daily cited a National Development and Reform Commission spokesperson as saying the high-speed rail line “will be a model for further infrastructure and industrial cooperation in the region, under the framework of One Belt, One Road initiative.”

The initiative can also help China secure supplies of raw materials and power. China Development Bank has also been involved with financing a $2 billion deal in Kazakhstan for three projects in the iron ore, aluminum and power sectors. Overall, the China Securities Journal quoted the Ministry of Commerce saying that in the first eight months of the year, Chinese companies had invested $10.73 billion in the countries along the One Belt, One Road routes, up nearly 50 percent from the same period a year ago.

It seems therefore that the biggest winners from this grandiose project will be state-owned enterprises, especially those with provincial backgrounds. According to the Economist, two-thirds of provinces have made One Belt, One Road a development priority this year, including Qinghai in the west and Guangdong on the coast. Cement maker Anhui Conch is building cement plants in several nearby countries, and steel exports from Shijiazhuang, the biggest steel-producing area in China, rose by half in the first seven months of the year, according to Reuters.

So is there anything for foreign companies to be excited about?

Anything that can arrest the slowdown in the economy, which in the third quarter expanded at its slowest rate since the global financial crisis, would be beneficial for all companies operating in China. But when it comes to specific opportunities, they could be harder to come by.

Risky business

There are also substantial risks for both China and the companies involved in specific projects. The Economist Intelligence Unit specifies these in a report showing that many countries in Central Asia and the Middle East score highly on overall country risk, which measures 10 items including security, political, regulatory, and government effectiveness. Pakistan and Ukraine present particularly high security risks, while Syria, Iraq and Greece are high sovereign debt default risks.

China also doesn’t have particularly stable relationships with its neighbors. A change of government in Sri Lanka has cast doubt on a $1.4 billion port project following an election in January 2015 where China was a major campaign issue. And hydro-electric projects in Cambodia and Myanmar have stalled after reviews by newly elected governments. But the biggest risks could be more straightforward. 

“The biggest risk is these projects might not be economically beneficial. These are fast growing countries but they have big trade deficits and narrowly focused, undiversified economies,” said Li at the Cheung Kong Graduate School of Business. “But even if the return isn’t great it’s still worth doing for China because it can ease the pain of reducing overcapacity and the returns on alternative investments such as US Treasuries aren’t great either. Not only that, but if you look far into the future, 30 to 50 years down the road, China and its neighbors will be one of the most important economic blocs in the world, and this infrastructure will help serve that.”