The Belt and Road from the other end: A European Perspective Alicia Garcia Herrero, NATIXIS Chief Economist Asia Pacific and Senior Research Fellow at BRUEGEL

April 2016

Outline

1) Xi’s Grand Plan: What it is about?

2) Any lessons from a similar Grand Plan for Europe: The Marshall Plan 3)   An empirical analysis of trade impact of Belt and Road: Who is to benefit? What about Europe?

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1.   Xi’s Grand Plan: What it is about? Based on Natixis Research

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Outline of Section 1: Xi’s Grand Plan

1.1 What is it?

1.2 Key drivers a)   Trade as the key reason b)   Infrastructure key to further foster trade c)   New funds/institutions serving the Belt and Road vision d)   RMB internationalization

1.3 How much so far?

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1.1 What is it? Roadmap of the initiative

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Source: HKTDC

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1.1 What is it? Trade facilitation through infrastructure

•  China proposed the Belt and Road (B&R) Initiative to enhance the connectivity and cooperation among countries in Eurasian area.

•  The main target of the initiative is to integrate Central Asia, West Asia, the Middle East and Europe into a economic zone through building infrastructure, enhancing regional trade cooperation to increase international trade within the region.

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Key figures of B&R countries Value Why is this important?

Total population 4.4 billions 63% of world population

Total GDP USD 2.1 trillion 29% of global economy

Transport and Infrastructure Investment

USD 5 trillion in the next 5 years

2.5 times the market size in China

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1.2a Trade as the key reason Growth flat but in a dual mode

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6.0

6.5

7.0

7.5

8.0

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GDP,RetailSalesandIndustrialProduc5on(%YoY)

RealGDPRetailSales(rhs)IndustrialProducBon(rhs)

Source: Bloomberg, Natixis

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40

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50

55

60

35

40

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50

55

60

07 08 09 10 11 12 13 14 15 16

PurchasingManagerIndex(PMI)

Caixin(Manufacturing)Caixin(Services)Official(Manufacturing)

Sources : Markit, China Federation of Logistics and Purchasing, Natixis

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1.2a Trade as the key reason …and therefore China starts exporting its overcapacity

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2%

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6%

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12%

14%

16%

65%

70%

75%

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90%

95%

100%

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

SteelProduc5onU5liza5onRateandGlobalExportsMarketShare(%)

UBlizaBonRate(lhs) GlobalMarketShare(rhs)Source: China Iron and Steel Association, UNCTAD, Bloomberg, Natixis

60%

65%

70%

75%

80%

60%

65%

70%

75%

80%

08 09 10 11 12 13 14

CementU5liza5onRate(%)

China WorldSource: China Cement Association, Bloomberg, Natixis

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1.2b Infrastructure key to further foster trade

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1.2b Infrastructure key to further foster trade The need is for infrastructure is there

0 2 4 6 8

Total

Water and Sanitation

Transport

Telcom

Energy

8trillionUSDinvestmentisneededto2020

Source: ADB, Natixis

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1.0

2.0

3.0

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5.0

6.0

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MY CN TH ID IN VN PH PK

QualityofInfrastructureinAsiaisbelowaverage(1=lowest,7=highest)

Score Avg

Source: WEF, Natixis

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1.2c New funds/institutions serving the B&R vision The AIIB, BRICS Bank and the Silk Road Fund

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50

100

103

129

163

223

331

ERBD

IslamDevelopmentBank

BRICSDevelopmentBank

AIIB

AfricanDevelopmentBank

Inter-AmericanDevelopment

AsianDevelopmentBank

WorldBank

EuropeanInvestmentBank

Source: Stratfor, Natixis

European Bank for Reconstruction and Development

Asian Infrastructure Development Bank

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Capitalbaseofworlddevelopmentbank(USDbn) SilkRoadFundInvestment

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1.2c New fund/institutions serving the B&R vision …but it’s also about diplomatic battle and sphere of influence

Top 5 shareholders Top 5 by vote share

0 5 10 15 20 25 30 35

Korea

Germany

Russia

India

China

0 10 20 30

Korea

Germany

Russia

India

China

0 5 10 15 20

France

Germany

China

Japan

U.S.

0 5 10 15 20

France

Germany

China

Japan

U.S.

AIIB

W

orld

Ban

k

Source: AIIB, World Bank, Natixis

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1.2d RMB internationalization

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RMBTradeSeUlement

Trade(RMBbn,lhs)

%ofChina'stotalcrossbordertrade(rhs)

Source: SWIFT, Natixis

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Shareasinterna5onalpaymentcurrency(%)

USD EUR GBP JPY CNYSource: SWIFT, Bloomberg, Natixis

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Table1:ToptradingpartnersofAsiancountries

Country 2008 Latest

Indonesia Japan China

Malaysia Singapore China

Philippines US Japan

Singapore Malaysia China

Thailand Japan China

Vietnam China China

India US China

Pakistan SaudiArabia China

Source:Bloomberg,Na1xis

1.2d RMB internationalization Increasing trade means potential in more RMB settlement

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1.3 How much so far?

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Russia OtherAsia ASEAN Africa Europe

Belt&RoadInvestmentsbyCountry(bnUSD)

Energy Rail IndustrialPark Materials Port RoadSource:Na1xis *Confirmedandhighlylikelyprojectsincluded.

Telecom0%

Road2%

Port3%

Materials5%

IndustrialPark6%

Rail41%

Energy43%

Belt&RoadInvestmentsbyIndustry

Source:Na1xis *Confirmedandhighlylikelyprojectsincluded.

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2. Any lessons from a similar Grand Plan for Europe: The Marshall Plan Based on Lessons for China’s Road and Belt Strategy from Europe’s Marshall Plan by Juan Carlos Martinez Oliva

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A European perspective to the Belt and Road: The Marshall Plan

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•  For some, unwarranted comparison •  Marshall Plan (1848-1952) perceived as a US geopolitical device to

control Western European nations and containing the Soviet Union. •  Belt and Road not seen as an alliance or coming with any political strings.

•  China stresses that Belt and Road is based on “open cooperation” regardless of the state of their relations with China.

•  We move to describing some of the key features of the Marshall Plan (MP) and how the may compared with Belt and Road.

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•  Two years after creation, in 1950, Marshall plan started to shift from original purpose of Europe’s reconstruction to security and military cooperation.

•  Based on recommendations by the US National Security Council for military spending to be the number one priority of the US federal government.

•  Can this happen with Belt and Road as China’s military becomes more powerful and more eager to pursue a similar objective?

2.1 MP: From an economic device to a security one

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•  MP was meant to be a jump starter which should activate a self-feeding virtuous circle, and then evaporate.

•  Stimulated by the conditionality imposed by the plan on its beneficiaries, European countries found themselves forced to coordinate/cooperate and create their own multilateral institutions.

•  Origin of EU

•  Belt and Road also meant to be a visionary and long sighted strategy but China’s pragmatism will make it such that its survival will depend on its ongoing success. For this, Belt and Road must be a win-win strategy rather than a zero-sum game.

2.2 MP: Helping activating a self-feeding virtuous circle

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•  The European Payments Union enabled the European countries to restore multilateral trade and currency convertibility in only eight years.

•  By forcing the European governments to pursue, and eventually establish, currency convertibility, the US accomplished the Bretton Woods’ goal to have an international monetary system fully based on the dollar.

•  Belt and Road also has the objective of supporting RMB internationalization by using RMB for trade and infrastructure finance

2.3 MP as catalyst for free movement of capital

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•  MP told to have contributed to the world polarization which prevailed during the Cold War era.

•  By keeping the Soviet Union and its satellites outside MP, US were able to concentrate their resources on selected countries, thus easing management issues, and making the Plan’s action more effective.

•  Belt and Road also has a sense of China dominance rather than inclusivity. For some it is China’s response to China’s exclusion from TPP

2.4 Challenges brought by MP

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2.5 All in all

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•  The Europe’s experience with the Marshal Plan indicates that the Belt and Road could be come more than a device for China to expand its exports of goods and services (construction of infrastructure).

•  It could help China foster the use of its currency/develop a regional payment system and perhaps even create a security zone as the US did with Europe.

•  Still, such ambitious project can only be successful in a win-win situation as Belt and Road countries may be in a relatively stronger position to explore other options than war-torn Europe in 1948.

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3. The trade aspect of the Belt and Road: Who is to benefit? Also Europe? Based on One Belt One Road and the China-EU Trade Alicia Garcia-Herrero, Bruegel & NATIXIS Jianwei Xu, Bruegel & Beijing Normal University

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Outline of Section 3: Empirical analysis of the impact of B&R on trade

3.1 Trade and transportation costs: Maritime and Railway routes to be improved

3.2 Empirical exercise a)   Literature b)   Purpose and results c)   Conclusions

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3.1 Trade transportation

Maritime •  Cheap but Slow. Still dominant for China’s trade

Air

•  Expensive but quick. Not relevant yet Road

•  Cheap but only applies to short-distance transportation Rail

•  Medium priced •  Suitable for both short-distance and long-distance travel but needs huge

infrastructure investment

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3.1 Trade transportation New maritime routes under the Belt and Road

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3.1 Trade transportation And new Railway ones for the Northern Route of the B&R

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Data Source: Eurostat http://ec.europa.eu/eurostat/statistics-explained/index.php/Freight_transport_statistics_-_modal_split

3.1 Trade transportation Europe dominated by road transportation

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3.1 Trade transportation China dominated by maritime one

Maritime, 60.5%

Rail, 0.4%

Road, 17.4%

Air, 21.0%

Other, 0.6%

Maritime Rail Road Air Other

Maritime 57.0%

Rail 0.3%

Road 18.5%

Air 23.7%

Other 0.6%

Maritime Rail Road Air Other

Data Source: Calculated using 2013 China Custom Data by the Authors

Chinese Exports by type of transportation Chinese Imports by type of transportation

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3.2a Transportation Time/Cost as a Trade Barrier

•  Hummels et al.(2013, AER) finds that time is a important, but long ignored, type of trade cost in international trade.

•  Each day in transit is equivalent to an advalorem tariff of 0.6% to 2.1%.

•  Belt and Road related projects estimated to reduce average shipping time by 15 days (360 hours): equivalent to a reduction in tariffs by 10% to 30%!

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VARIABLES w/o. MR term w/o. controls

w/o. MR term w/. controls.

w. MR term w/o. controls

w. MR term w/. controls.

OLS Bilateral tariff -0.03** -0.01** -0.03** -0.03***

Ln Rail Distance -0.16* 0.01 -0.23*** -0.13*** Ln Martime Distance -0.64*** -0.39*** -0.38*** -0.28***

Ln Air Distance -0.14 -0.18** -0.30** -0.07 PPML

Bilateral tariff -0.10*** -0.04 -0.17*** -0.18*** Ln Rail Distance -0.38** 0.06 -0.49*** -0.17***

Ln Maritime Distance -0.65*** -0.25 -0.33** -0.21 Ln Air Distance -0.50* -0.58** -0.37* 0.20

, ,

,

ln( ) ln( ) ln( ) 'ln( ' ) °l ln( ' )ln( ' )

ij i j ij

ij ij

ij ij ij

T rade Y X TariffRailC A irCOceanC controls

b b b bb bb b e

+ = + + ++ ++ + +

0 1 2 3

41 4 2

4 3 5

1A 1% reduction in air and rail transportation cost can lead to 0.1% to 0.5% increase in international trade, which is equivalent to 3 to 15 times a similar reduction in tariffs

3.2b Estimation results: trade to be fostered by reduction in transportation costs

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•  We suppose that B&R initiative reduce railway cost by 20%. Most European countries to win while others to lose in terms of increase in trade with rest of world

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FRA DEU BEL CHE RUS HUN NLD CZE BLR DNK -4%

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AFG PHL ISR QAT NPL OMN JOR AZE PAK GEO

Top 10 Winners

Top 10 Losers

3.2b Impact of Belt and Road very heterogeneous: What about Europe?

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3.2b Impact on Trade: Who Win Trade with China?

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BEL NLD FRA DEU CHE RUS CZE HUN SVN BLR

Increase in trade with China

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3.2b Regional impact: Europe as a major winner More trade generally and also more trade with China

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European Countires Asian Countries(except

China)

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China-Asian Trade

China-EU Trade

Asian-EU Trade

Impact on Trade by Region Impact on Inter-regional Trade

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3.2b Interpretation of the Results

•  Apparently most European countries will benefit from the B&R initiative.

•  There is no gain without a corresponding loss. With better connections to Europe, some Asian countries is possible to lose their trade with China.

•  China’s trade with both the Europe and Asian region is enhanced, though most benefits still come from the European countries.

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3.2c All in all

•  The Belt and Road is really a Grand Plan which will require enormous focus and leadership from the part of the Chinese authorities.

•  Based on the experience of the Marshal Plan, it has the potential to evolve

into other areas, such as security but also relevant support for RMB internationalization.

•  Still, even if the better known objectives of the Belt and Road, namely fostering trade, the impact looks pretty large and especially positive for European countries (as a reduction of railway transportation costs).

•  Europe has not yet given to much thought about the Belt and Road but it should certainly start doing so.

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