China’s OBOR Initiative: Opportunities and Challenges for Canada

Beijing is hosting the Belt and Road Forum for International Cooperation on May 14 and 15, 2017. Worldwide response has been impressive; 29 heads of state and government, officials, scholars and entrepreneurs from all over the world have attend. What is the “One Belt, One Road” (OBOR) initiativeall about, and what are the implications for Canada?

The OBOR initiative

More than 2,000 years ago, China’s imperial envoy Zhang Qian helped to expand the Silk Road, a network of trade routes linking China to Central Asia and the Arab World. The name derived from the silk industry, historically one of China’s most important exports.

In 2013 China’s president, Xi Jinping, proposed establishinga modern equivalent to the traditional trade route, creating infrastructural connections between the continents of Asia, Europe and Africa incorporating two initiatives (as shown in the map below). The “One Belt” refers to the Silk Route Economic Belt (connecting China to Europe through Central Asia), and the“One Road” refers to the Maritime Silk Route (connecting China to Europe via the South China Sea and Indian Ocean).

OBOR is an initiative focusing on improving connectivity and cooperation among nations in Asia, Africa and Europe. OBOR is also a national strategy with the long-term goal of improving China’s economic security and reducing dependence on existing trade routes. This network is expected to stimulate trade and investment, secure China’s access to raw materials and resources, increase demand for Chinese capacity, help internationalize the Chinese currency, and create social and cultural cooperation among neighbouring countries.

To understand the OBOR initiative, we also need to take a look at China’s domestic economic development. China has experienced rapid growth since its open door policies in 1979. However, labour and environmental costs have risen rapidly over the past decade, reducing China’s comparative advantages as the world’s top manufacturing centre. Not surprisingly, Chinese companies are currently aggressively pursuing trade and investment opportunities overseas.

The Chinese government formally proposed the “go global” policy in 2001 designed to assist national firms in seeking opportunities abroad. A natural first stop for China’s export and foreign direct investment is its neighbours in Asia, due to geographic closeness, historical connections, and economic and cultural similarities. The OBOR initiative reflects China’s outward focus in three directions: West (West China, Central Asia, the Middle East and Europe), East (Southeast Asia) and South (South Asia and Africa).

The essence of the OBOR initiative is physical connectivity, which is contingent upon China’s loans and expertise in supporting infrastructure development. Infrastructure projects include ports, roads, railways, airports, power plants, energy pipelines and refineries, and free trade zones. These projects also deal with IT, telecom and financial infrastructure. In 2016, Pricewaterhouse Coopers tracked the equivalent of USD 250 billion inprojects already built, recently begun, or just contracted in relation to the OBOR initiative.

Many countries in Asia lack proper infrastructure, limiting potential trade and investment. China, on the other hand, has accumulated substantial experience and technology ready for export to its neighbours. From China’s perspective, assisting infrastructure development along the OBOR routes creates, in the short term, export and foreign direct investment opportunities for firms in infrastructure sectors and, in the long term, trade and investment opportunities for firms in all different sectors. From the recipient country’s perspective, loans from China provide an alternative source of financial resources, and China’s economic development model is relevant and applicable. As a result, apparent “win-win” situations and economic reciprocity can be achieved.

Can the OBOR initiative reach its full potential?

The effectiveness of the OBOR initiative has yet to be evaluated, given that infrastructure projects are often long-term, and systematic information on investment returns are not yet available. At least two sets of challenges may prevent the OBOR initiative from reaching its full potential. First, to what extent is the “loan plus infrastructure development” model sustainable? China is by far the greatest source of financing for the B&R region’s countries; in 2015, the Export and Import Bank of China alone lent USD 80 billion, compared with the Asian Development Bank’s loans of approximately USD 27 billion. Many countries along OBOR encounter persistent conflicts and corruption, making large investments in those countries risky. Moreover, doubt often exists over the effectiveness of the Chinese government (or maybe any government) inresource allocation in a domestic setting, let alone in an international setting where political and economic situations are far more complicated.

The second set of challenges relates to the lack of experience in internationalization by Chinese firms implementing infrastructure deals. Chinese firms are still at an early stage of internationalization, and the limitations in their cross-border experience and global talent make them less capable of managing, for example, relations with a variety of host-countrys take holders that include local communities, environmentalists and nongovernment organizations. Consequently, social conflicts are inevitable in some situations. Professors Daniel Shapiro and Jing Li at Simon Fraser University’s Beedie School of Business find in their research that although Chinese firms are likely to receive the political licence granted by a host country government to operate in a country as a result of the initiative discussed at the governmental level, these firms still face tremendous challenges in securing the social licence to operate.

Challenges for Canada

On the surface, the OBOR initiative seems irrelevant to Canada and Canadian firms because of its emphasis on Asia-Africa-Europe connections. A more careful examination suggests there are both challenges and opportunities for Canada. The rise of the OBOR initiative coincides with the dismantling of the Trans-Pacific Partnership, an agreement aimed at facilitating trade among 12 nations including Canada, United States, Australia, New Zealand, five countries in Asia and three in Latin America. Given that Asia has become an economic power house, what is the role of Canada in this region? China’s rising economic exchange with neighbours may hinder Canada’s pursuit of economic interests inthis region. Similarly, more exchange between China and the European Union, Canada’s second-largest trade partner, will likely reduce Canada’s importance as a business partner of the EU.

Canada’s economic relationship with China is likely to suffer given the increased trade and investment among Asian neighbours that is expected to result from OBOR. With better infrastructure in place, China will access therich natural resources of Central Asia and the Middle East, leaving Canada’s comparative advantages less attractive.

Opportunities for Canada

However, Canada can take advantage of many opportunities. China has an eye to cooperating with international governments, companies and investment funds. This will diversify investment risk for China and allow it to draw on external expertise while generating investment opportunities and economic benefits for international participants (for example, collaboration and partnership in infrastructure and natural resource projects). Canadian businesses focusing on infrastructure building—including providers of technology, raw materials, equipment and components—might consider supplying or partnering with Chinese construction companies.

Joint exploration of natural resource projects in Central Asia might be another area of consideration for Canadian firms, with Canadian technologies complementing China’s advantages. Meanwhile, the inexperience of Chinese firms in international business activities creates incentives for partnerships with multinational corporations from advanced economies. Substantial Chinese public sector financing and active involvement of the Chinese government in relationship building with the host country also drastically improve the projects’ risk-return profile.

Collaboration in these sectors not only leads to business opportunities in OBOR but may also lead to opportunities in China itself. Chinese companies involved in OBOR initiatives (especially the one-belt initiative) are primarily large, state-owned enterprises that are industry leaders in the domestic Chinese market; this may open new opportunities for Canadian firms in China. However, challenges should also be fully recognizedand carefully considered before making the decision to work with state-owned enterprises.

Opportunities also exist for Canadian financial players such as private-equity firms and other institutional investors. China has established two main funds to achieve objectives associated with the OBOR initiative: the Asian Infrastructure Investment Bank (AIIB), which governments from different countries can join to finance infrastructure projects, and the Silk Road Fund, worth about USD 40 billion. Canada is already a member of AIIB. As of April 2017, the Silk Road Fund had signed agreements on 15 projects with investment amounts reaching USD 6 billion, where equity investment accounts for 72 percent of total investment. Canadian financial sectors can participate through collaboration with the two funds or with infrastructure companies.

In the longer term, better infrastructure connecting Asia, Africa and Europe will reduce lead times and transportation costs, allowing Canadian businesses to better penetrate large consumer markets such as China, South Asia and Southeast Asia. For example, the railroad between China and Europe runs through five cities in China (Xi’an, Chongqing, Chengdu, Wuhan and Zhengzhou), all in newly formed free trade zones, meaning that efficiency of transporting goods across China to Europe will be substantially improved.

The OBOR initiative and the Belt and Road Forum place clear emphasis on inclusiveness and the characteristic of  “win-win.”  As China attracts more participants from advanced economies such as Canada, we can expect to see wiser investments improving connectivity among continents, ultimately leading to economic prosperity and regional stability across the new Silk Route.