16+1: Failed Dreams or Failed Economics?

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The 16+1 platform that China coincidentally created and subsequently nurtured has recently seen increasing disengagement on the European side. The smaller central and eastern European (CEE) countries have initially enthusiastically jumped on the opportunity China ambiguously presented to them. Expectations were high: the vision of an increased Chinese investment, enhanced exports to China, and perhaps cheap, no-questions-asked loans in support of their domestic infrastructure.

Fast forward five years and the reality paints a different picture. Comparatively tiny amounts of Chinese investment have flown into the countries, trade balances with China continued to worsen and the infrastructure projects are still in the planning phase. What went wrong? The answer is short and sweet: nothing. Every sound observer knew already back in 2012 that the expectations of the European leaders were out of touch with reality. Let us examine them one by one.

16+1 meeting in Bucharest, source: wikimedia

Greenfield investment delusion

We shall start with the Chinese investment in these 16 countries. There are two problems associated with their analysis, one perceptional and the other structural. The countries of “new” Europe needed a lot of foreign direct investment (FDI) in the period immediately after the fall of Communism to upgrade their economies and catch up with the West. Much of this has been already accomplished. In the process, however, the countries got used to receiving more greenfield than brownfield investment. There are multiple reasons explaining this: foreign investors found it cheaper to build a modern factory from scratch rather than building on the existing ones; lots of Communist built factories ended up in the ownership of the newly minted domestic oligarchy that set their eyes on an immediate extraction of value (‘tunneling’); a number of old factories were built – under the auspices of central planning – in regions with little economic rationale. Both the politicians and the public thus learnt to treat greenfield investment as something that moves their economy forward and brownfield as a link tying them to the past.

In 2018, it is time to get past such perceptions. After almost three decades of rebalancing, the capacity for greenfield investments has come close to the point of saturation. Moreover, waves of mergers and acquisitions have made turns around the globe in the past 5 years and the region is not an exception. To make it clear: M&As are predominantly about the change of ownership, not a greenfield expansion.

Not much to invest into

The second part of the answer is structural. Let’s face it: these countries are more or less extended supply chains of west European, mostly German, producers. Most of the output are intermediary products that head westward for finalization. What should the Chinese invest into? Build railways and highways that streamline logistics for Germany’s suppliers, thus enhancing German competitiveness? Or should they buy into their supply chains? Perhaps, but then the ownership is outside the 16 countries, so would that count as an investment? And, as mentioned above, this would not constitute a greenfield investment anyway.

Certainly, the Chinese could start building from the scratch. They can build mega factories and their Chinese suppliers would follow suit. Just as the Japanese, Koreans, and Taiwanese did. Except – let us remember that the 16+1 platform is profiled as a part of the Belt and Road Initiative (BRI). Isn’t BRI to a large degree about the export of Chinese overcapacity? How much sense does it make to replicate domestic structures in Europe?

Central and Eastern Europe has been a great place for investment. But the countries provide the most value for investors coming from the neighboring countries as the region mostly hosts suppliers of Western manufacturing giants. Not much investment appeal for someone from afar, who is not keen to establish their supply chain half way across the globe.

Get over the nation state

Now that we established that the countries are not going to see much investment from China – let alone greenfield investment – let us look at the trade balance.

Keeping in mind that the CE region is an extension of the western European supply chains, the structure of the exports should come as no surprise: unfinished products that head to the West for completion. Now, two things are important. Firstly, these countries simply do not produce top notch, highest quality products that can compete on the world markets. Reasons abound, let us mention the underperforming educational system, low investment into research and development, historically given lag, but also their size simply not allowing for economies of scale. Corruption, oligarchy, brain drain does play a role, too.

Secondly, one should forget the nation state and try to see the whole picture. Certainly, the products from CEE countries do mostly end up in Germany and its neighbors, however, the finished products go further: mostly to China and the United States. When measuring the sensitivities of these small economies to the economic developments in the world, the results show a high level of dependence on the performance of the Chinese and US economies.

CEE countries do export to China a lot. But before their products reach China, they do a stopover in Germany where they get an upgrade. Measuring trade balances with individual countries gives us a distorted picture. Germans do not need all those tires and steering wheels coming from CE. They just plug them into their cars and export further.

CEE countries should abandon the dated practice of chasing a positive trade balance with each country and embrace a more comprehensive approach that embraces the economic realities of the interconnected world we live in.

Keep China warm

What that means for economic and other relations with China? Firstly, the expectations should be tamed as the trade balance is not going to improve and a lot of large investment is not going to come. And the countries should not court China with hopes of an imminent change. It is not that China does not like the region, it is because there is not much the Chinese can do or get there. Economic logic thus trumps the political agenda.

China keeps the countries warm by promising more and more and by presenting each new investment, however small, as a proof of delivering on the promise. The countries should adopt a reciprocal attitude. Just express a friendly nod – “well done to you, China” – as it does not hurt to be on good terms with world’s second biggest economy. But they should not go out of their way in luring Chinese investment into their countries. Just keep China warm.

 

Martin Šebeňa