Welcome to Pacific Exchanges, a podcast from the Federal Reserve Bank of San Francisco. I’m Paul Tierno.
And I’m Sean Creehan. We’re analysts in the country analysis unit and our job is to monitor financial and economic developments in Asia. Today, we continue our series, Rethinking Asia as we consider noteworthy and unusual trends in Asia in finance and economics. We sat down with Matthew Goodman, the William E. Simon Chair in political economy at the Center for Strategic and International Studies where he oversees its Reconnecting Asia program, which documents how infrastructure is shaping economic and geopolitical realities in the region.
The Asian Development Bank estimates that Asia will require a staggering $20 trillion in infrastructure investment over the next decade to encourage continued economic development. That’s a figure that represents more than 5% of the region’s GDP, and with relatively new infrastructure initiatives like the Asia Infrastructure Investment Bank and China’s Belt and Road policy taking shape, the topic is as timely as ever.
Yeah, and I think infrastructure though at sometimes sounds dry and jargony in the abstract, is something that everyone can relate to. Modern life doesn’t work without roads, plumbing or electricity and Asia needs lots of all of those things. Let’s hear what Matthew has to say about it.
Thanks for joining us today, Matt.
Maybe we could just jump in and get an overview of your own research into this topic of infrastructure development in Asia and why it’s so important.
Sure. Well, we’ve been tracking this infrastructure story in broadly defined Eurasia for a couple of years now. We’re reading about all this effort by China and Japan and others to build hard infrastructure and we were interested in what was the ground reality, what was actually being built as opposed to the talk, and what were the drivers of this? What are the implications for connectivity across this broad, vast region?
Expanding on that, what is the scope of Asia’s infrastructure need over say the next decade, 10 years or so?
Well, the estimate that most people use is the one from the Asian Development Bank from a couple of years ago. They estimated between 2016 and 2030, about a 15-year period, there would be a need for a total of $26 trillion of infrastructure. That’s to promote economic development, to alleviate poverty, and mitigate climate change. So it was the most expansive number, but even if that’s off by an order of magnitude, that’s still, it’s a huge number.
Yeah, one way people think of these numbers is they back it out from a percentage of GDP. So I’m wondering if that’s where that come from and is it a larger challenge in Asia because of the developing nature of so many of these economies? I mean, would we see some similar demand in countries like the United States where there’s a lot of coverage of deteriorating bridges and roads, and the need to refurbish?
Yeah, I think a lot of parts of Asia, whether you’re talking central Asia, Kazakhstan and Kyrgyzstan and so forth, or Southeast Asia, Laos, Cambodia, these are countries that are still emerging and have a huge need for basic things. Roads, bridges, and in the places that aren’t landlocked, ports of course, and so it’s a huge development need across this region.
And considering the need and also the fiscal constraints of some governments, right? Where I’m thinking of specifically Indonesia, right? You have a 3% of GDP budget deficit cap, and then a relatively small tax base. They’re going to require outside help, right? They’re going to require global initiatives, independent states that are sort of wanting to assist. How do you wrap your head around all of the various initiatives that are taking place, whether it’s China’s One Belt One Road, or the Asian Infrastructure Investment Bank? How do you wrap your head around that?
Well, we have this web platform called Reconnecting Asia at CSIS, and if you look on there, you’ll see a map of the Eurasian supercontinent and a database of currently about 2,300 projects. At the moment, transport infrastructure, but we’re planning to add energy pipelines, power grids, ICT infrastructure, any kind of connectivity infrastructure. And we have a feature on the site called competing visions and it basically has a kind of an impressionistic map and short story about what China’s doing in Belt and Road, as you mentioned. Japan has this partnership for quality infrastructure. They’re building a lot in Southeast Asia in particular. And then Korea, Russia, India, Iran, the European Union, a lot of players in this story. And yes, I mean I think there is a huge need for outside capital, but the money will come if there are projects, if they’re bankable projects. That’s the nub of the problem.
So you used a word there of competing visions and when you read common media narratives of a lot of these infrastructure projects, I guess it’s natural to say, Oh, it’s China versus Japan or other kind of geopolitical actors that are really competing as they’re trying to build infrastructure. So I’m wondering if you could comment a bit about that? Clearly, there is a geopolitical aspect to it, there’s national strategy at play, but to what extent is it competitive versus complementary? I mean, in theory a country could welcome investment from all of these different initiatives.
Right. Well, we use the term competing in all its senses. I mean, it’s not necessarily a bad thing. I think it creates a dynamic where countries want to participate in this and build the best infrastructure, and certainly I think that’s some of the dynamic among these countries. There is a geopolitical play too and we’re not ignoring that, but whether it’s between China and Russia, between China and Japan, or maybe Korea and Japan even, there are different players here who are trying to play in this space. But yes, it can be complementary and in some cases you see that on the ground and in some of these countries like, you know, whether it’s Vietnam or parts of Kazakhstan in Central Asia. There’s some things that China and Russia are doing together. So, it’s certainly not zero sum and I think a lot of it is getting the best out of each player that’s trying to bring both a good economic benefits, broad economic benefits, commercial benefits for them and for the rest of the region. And then some geopolitical advantage in some cases.
It’s interesting when you talk about the various actors and all of their different mentalities and the competing interests, but also what’s driving them to operate in these developing countries. But some of these emerging market economies are sophisticated, right? They’re no longer just going to allow investor countries to have their way with sort of new infrastructure. And how are you seeing the dynamic between investors and recipients of those funds?
Yeah, you’re right. A lot of the recipient countries are … I mean, none of them are stupid. They know that some of this infrastructure is going to create … I mean, it’s going to be whether it’s poor quality stuff or stuff that’s going to create a debt burden for them, or it’s going to create geopolitical problems. I think they’re all very sensitive to that … I was just in Myanmar and Vietnam and you could definitely see there that while there’s a desire, a need for the infrastructure … in fact in Myanmar, it’s the only thing you hear. Infrastructure, roads, electricity, and then human capacity is the other thing they obviously need. But they’re also wary of some of this external support and they’re not sure whether this is going to end up being economically beneficial to them, whether it’s going to create these debt burdens, whether it’s going to create a dependency.
And so there’s a kind of complicated view of this on the part of the recipient countries. They’re getting smart, but they need the infrastructure so they’re on one level welcoming it.
Does the competitive nature of some of the bidding from these external parties allow some of these recipients to negotiate a bit better to say, “Look, well, we’re not sure about these demands or we want a little bit more independence. We don’t want to use your country’s state-owned enterprise to construct this dam or what have you.” I’m just making up an example here, but is that something that you’re seeing?
Yeah, I mean, in fact, I mentioned Myanmar, there was a dam project that China was building and actually the previous regime pushed the Chinese out. They were not happy with the way it was proceeding. They’ve brought them back, so it’s complicated. But people are looking …
In Indonesia there was a competition between China and Japan for building a high speed rail, which the Japanese seemed to have the upper hand, but then the Chinese came in and got the deal, and it’s sort of stuck frankly. So the Indonesians are not happy with anybody really right now. So, you see a lot of that competition going on as well, and that probably sometimes works to the advantage of the recipient country or sometimes they get sort of caught up in some of this competition and it doesn’t turn out well.
Shifting gears a little, what is the role of the non-Asian and foreign investor in the infrastructure investment and fundraising space? Thinking of institutional investors who are looking for yield ultimately and see this as an opportunity?
Yeah, I think there is a real draw to this asset class because it is a nice source of long-term return. The problem is that infrastructure is really hard to make work and make a return on. I mean, here in the US, we have challenges in that regard. But if you imagine on top of all the things that you have to deal with in the US, you add political risk, and corruption, and even basic legal questions about land rights. That’s one of the problems in the Indonesia a case that I mentioned. And so there are a lot of obstacles to bankability, as it were, of these projects and I think that’s going to make it harder for international investors to come into this. But I think the money would come if you could get at some of those underlying issues and show a path to long-term returns on some of these projects.
So some of those risks, how do you mitigate them? Is there technical assistance? Is it the role of these multilateral organizations, is it just kind of gradual knowledge transfer, kind of the development of legal systems, bankruptcy codes, that sort of thing that gives people more comfort? I mean, how do you see this developing? I mean you kind of are alluding to a little earlier, but it is the nut of the problem.
Yes, it’s really all of that. And you know, the World Bank, the Asian Development Bank, now the new player, the Asian Infrastructure Investment Bank, the Chinese sponsored bank that is getting into this game, are all doing some of that. They’re, trying to get at some of those issues of bankability, getting it legal systems and some of the corruption issues and political issues and providing technical assistance. Actually, I’m not sure the AIIB is yet providing technical assistance, they’re just too small and new. But I think, I imagine that will be their plan over time. And then some of the bilateral donors, the Japanese, through JBIC — the Japan Bank for International Cooperation, they’re effectively their export-import bank — also working with the aid agency in Japan provides both the infrastructure, finance and technical capacity.
In the US, we have OPIC, we have the US Trade and Development Agency, works with USAID, the agency for International Development, to provide some of that technical assistance. And then policy dialogue at a higher level in government also tries to get at some of these questions of legal and regulatory and other risk, but it’s challenging.
So, you’ve used the word bankable project several times throughout the conversation so far and I’m wondering from the perspective of investors looking to get involved but also from a political perspective, how do countries avoid this sort of proverbial bridge to nowhere? Where projects aren’t just sort of Nice-to-haves, or political sort of footballs, but that they’re actually something that can be useful for the populace and that can provide a return. How can countries sort of avoid the pitfall of that?
Well, it’s difficult because sometimes there is a political impulse in the recipient country. So the famous example that people are talking about a lot these days is the port and associated projects in Sri Lanka that the previous president wanted to build with Chinese support in his local home constituency. The port’s built but doesn’t seem to have a whole lot of throughput going in terms of ships and cargo. There’s a nearby airport that was also financed by the Chinese that is so underused that they actually sell tickets for tourist visits to the airport to see the empty airport. My colleague who runs the Reconnecting Asia project was down there and did the tour. So, it’s sort of inevitable you’re going have a certain number of these boondoggles, and I guess it’s up to really the donors at the end of the day or the investors to demand a return of some kind.
Now sometimes that’s going to be from countries that are using their aid mechanisms or whatever they want to create better development outcomes for the good reasons without a particular return. But in China’s case for example, China said they expect a return on these investments in the Belt and Road Initiative. And so they should be doing the kind of due diligence and hard work preparing the ground for these projects before going into them. I’ve talked to people in China who say that that IRR analysis is done before all these projects, a rate of return analysis to ensure that there is going to be some return. But it’s not clear whether that always happens and so you get white elephants in some cases.
Or in other cases where the intentions are good, like I’ve been to Kazakhstan and seen some of the developments there which could lead to broader economic development, and more commerce and so forth. But you wonder when it takes five hours to drive from the major city in Almaty down to one of these places, and there’s really nothing and no one there. You start thinking about how much economic impact is there going to be here? And so, it’s inevitable in this business. Again, it happens in the U.S. too.
So we talk a lot about China on this podcast, it’s inevitable, and clearly in this discussion we’ve already mentioned the looming presence of a lot of Chinese initiatives. So I’m wondering if maybe we could spend a little bit of time on unpacking this? So for our listeners at home who may have read about One Belt One Road, the Asian Infrastructure Investment Bank, how did all of these initiatives come into play? How do they coordinate? You know, you also have large Chinese state-owned banks that are clearly going outside of China with financing activity. You have a lot of state-owned enterprises and private companies that may be involved in the actual delivery of new technology, and help build infrastructure projects. What is this kind of complicated landscape from the Chinese perspective? Maybe you could help us understand that a little bit.
Well, formally this all got everybody’s attention in November 2013. That’s when new president Xi Jinping of China announced in Kazakhstan this plan to build hard infrastructure and soft infrastructure and other connections across both the land mass of Eurasia and then to the Southern rim on the maritime rim of China. And so everybody’s focused on that as a new new thing. The reality is it wasn’t very well fleshed out and it took a long time to develop into actual activity. And even today it’s not clear exactly what a Belt and Road project is. But on the other hand, it’s actually was nothing new in the sense that, as you mentioned, the policy banks like the China Development Bank and the Export Import Bank of China had been funding infrastructure projects around both central and southeast Asia, and other parts of the region.
And so it wasn’t really a new thing, but it was the packaging was certainly new and the ambition was new and perhaps new financial mechanisms within China, which some of us are trying to get our hands around but don’t have a clear sense of were part of this plan as well. AIIB, the Asian Infrastructure Investment Bank that China announced a couple of years after that Xi Jinping speech was a little bit different. I think that’s an effort to try to create a Chinese-led institution that was aspiring to not only international standards but better than international standards. They have a motto at the AIIB that they’re going do everything lean, clean and green, meaning efficiently without corruption and obviously in an environmentally sustainable way.
And I think they deliberately wanted to do that to try to demonstrate that China could lead an effort like that. And it was a kind of self-discipline on China, who had not always some of those policy bank activities particularly in Africa and parts of Asia had not been done up to international standard and had not met those tests of leanness, cleanness and greenness. And so I think the Chinese wanted to sort of self-discipline themselves and show the world that they could lead an institution like this.
It’s interesting because it seems like a lot of the rhetoric and the momentum behind One Belt One Road, sort of, coincided with … and this is something of a cynical view, but it sort of coincided with overcapacity issues in China, right?—especially at some state owned enterprises—leading some to say that this new initiative was just a way to a certain extent to export overcapacity. And I’m wondering what your view is on that, and as a follow up as China sort of rebalances it’s model away from heavy industry, what does that say about the China’s current commitments and how will that change over time?
Right. Well, and that’s a good point, and I think that it’s clearly part of the story. I think this overcapacity problem in China, they needed to sustain growth. I mean, growth was slowing from the unsustainable 10%-plus range down to now 6%, 7%. If that’s a real number it may be a little exaggerated, but anyway, it’s still slower still significant. But in the face of that they needed to find an outlet for this excess capacity and that was a driving factor behind this expansion of or repackaging of some of the things that were already happening through Belt and Road.
And usually, when I present this in a PowerPoint form, I usually show a one slide has a kind of spectrum of motivations for why China did this. From kind of the green end of the spectrum to the red end. The green end being to promote international public goods, to promote broader economic development, trade. Then slightly more mercantilist, trade motivations, which is where it may be some of this overcapacity stuff fits in, to more political influence, to real geostrategic things at the heart … and even military purposes for some of these ports, for example, at one end. I think there’s a little bit of all of that in this, but certainly overcapacity was part of the story.
So China isn’t the only Asian country interested in infrastructure investment. You mentioned the role of Japan before. It was interesting to me, when we looked at this issue earlier last year, to see that in terms of project finance the Japanese banks actually are still the world leaders in infrastructure financing and more so than all of these Chinese banks combined. I’m wondering, could you compare and contrast the Japanese efforts to take part in this infrastructure development in Asia and again, kind of whether it’s competitive or complementary? Just give us your sense of how the Japanese fit into this challenge.
Yeah. Well, the Japanese have been playing in this space for three decades, particularly in Southeast Asia where they were, you know, again, mixed motives. Partly some political motives, but I think largely to support their own manufacturer supply chain networks across Southeast Asia. So, for example, the automotive industry in Japan has a major hub in Thailand and to support that there’s infrastructure around that that then gets financed by Japanese policy and private banks. And so that’s been going on for, as I say, two, three decades and Japan … I haven’t done that sort of numerical analysis of comparing exactly how much Japan’s doing where a vis-a-vis China but certainly Japan’s a major player in, for example, the countries I mentioned, I visited both Myanmar and Vietnam.
Japan is a heavy investor and providing a lot of that, both the actual infrastructure itself and the financing behind it. So yeah, they’ve been major players and they’re trying to do many of the same things China is. They’re trying to create growth opportunities for themselves, commercial opportunities and some political influence.
Yeah, I think looking at the data, I mean, I haven’t dug into all of the different structures for Chinese investment in infrastructure. I think part of it is just the way that Chinese foreign aid may work in terms of not necessarily directly funding some of these projects, but sending aid to certain governments that are then going to throw it into an infrastructure project. Whereas the Japanese model is much more private bank driven at this point at least.
Yeah. I think that’s my sense as well. The Japanese at a public level are more constrained by international rules and norms which China is not yet party to. Like the OECD export credit arrangements and so forth. and they have robust private banks that have been active internationally for many years. So that is I think a fair assessment.
Announcements of large infrastructure projects tend to generate a lot of press, but the reality is often far less glamorous, right? It can take time before pledged funds are mobilized and then projects are constantly plagued by delays. How does your organization track the status of the various projects?
Yeah, well our database actually, and we’ve been doing this very much sort of bottom up from documents in the public domain, from whether it’s national plans, or World Bank documents, or policy banks like JBIC or others to the extent we can get our hands on the Chinese data and we’re just recording what’s there, what they say. For example, the total cost of the project and the timeline, and without sort of comment at that level we have a sort of separate part of our site where we do analysis of this. But in the actual data we have five categories of what stage the project is at: announced, launched, in progress, completed or terminated. And we are actually doing as we speak an analysis of, just from our 2,300 project data set, which is not, by the way, not to pretend that this is a fully random set. We’ve, tried to be as broad as we can, but we’re looking at certain parts.
We’re looking at Southeast Asia, we’re looking at East Europe, we’re looking at the Central Asia connection, so it’s not a totally scientific data set, but looking through it, I think we are finding that a lot of projects end up being over time, over budget and in many cases terminated. And that’s not surprising because that happens in the West again as well. There’s a very well known scholar at Oxford Saïd Business School named Bent Flyvbjerg who’s done analysis of major projects and found that almost invariably they’re over cost and over time. And so we haven’t done the deep enough analysis to look at whether localized factors or other issues play a part, but that’s certainly something we’re trying to do in our project.
Reading through some of your research in preparation for today’s interview I was struck by one stat that roughly 90% of international trade takes place via sea. And I’m wondering if we can talk a little bit about the connection between Asia’s growing trade and these infrastructure projects? So currently Asia represents roughly a third of global trade, I think with current economic growth trends and just general increasing connectivity we’ll see the majority of global trade take place within Asia. So what is the role of infrastructure in that? Is it something where trade creates a demand for more infrastructure development or is it better infrastructure will allow for alternative ways of trading? Whether it’s train routes, truck routes, ways other than the obvious sea lanes.
Well, good question. First of all, this whole project Reconnecting Asia at CSIS was inspired by the big question about whether the patterns of international trade that we’ve seen over the last 500 years since Vasco da Gama set sail from Portugal in 1497 arrived in India. And started the great maritime trade that is now the dominant form of global shipping, replacing what had been the historical norm, which was to the extent there was trade across the Eurasian continent, it was by land. And so the big question, the uber question we’re asking is: is there going to be a significant dent in that 90% of global commerce that goes by sea?
And so far the jury is out, but I’d say a little but not much. I mean the economics of shipping or still so compelling since you can put 19,000 of these containers onto one of these huge ships, it may take five weeks to get from Shanghai to Rotterdam. But as compared to 10 days now with some of these rail connections across Europe, but you can only put 40 to 80 of these containers on one of these trains. So you can just do the math and see that the economics is going to be, still for a long time, I think the seaborne is going to dominate. Where there may be an opportunity, particularly with these rail connections, is to pull down some of the lower-value air shipment. Because obviously the value of air is that it’s very expensive, but it gets stuff overnight as it were to, to its destination.
There are cases where, particularly with new supply chains, with regional hubs and so forth, where air shippers, and we’ve talked to one of them, are saying, “You know, these rail linkages actually may make sense for some of the parts and components and things that our customers want to get prepositioned somewhere. It’s too expensive to fly them. They don’t need them overnight, so they can use one of these new rail connections that are now … They’re now 30, 35 of these rail connections across the land mass.” So that’s an interesting business proposition that we’re looking at a little more deeply. And then some of the higher value stuff that would go by ship that needs to get to, say, Europe faster may also able to take advantage of some of these land based connections.
Yeah, and I’m wondering if another element here is the changing nature of Asia’s own intra-regional trade, because of course you’re talking about long haul shipments between North America, South America and Asia or to Europe, but if we’re talking about a growing regional market for Asia to consume its own goods, I think that might also drive some of this land-based demand. I mean, I remember a few years ago seeing Warren Buffet buy a major American railroad company being like, “Well, I wonder why that was?” And it’s because rail freight is a really important way of getting goods within North America because of our own large domestic consumption-based economy.
And so that may be another driver of that sort of non-sea based infrastructure developed?
Exactly. And again, I haven’t done that analysis in great detail or our team hasn’t yet, but it is one of the questions we’re looking at as well because as you say, Asia Pacific broadly defined is going to be where most of global commerce is going to happen and these infrastructure connections are making things possible that weren’t possible before. Particularly in sort of peninsular, or Southeast Asia potentially and again from India to Central Asia, China across to Central Asia. And so I think those are things to watch in this story, but I don’t have the definitive answer yet.
So we’ve talked a little bit about what makes a project, ultimately what allows the project to move forward, right, especially if it’s bankable, especially if it does have a need, it has the supply, has the demand. What are some of the biggest challenges once a country realizes that it has an infrastructure need or it realizes it needs a new road, it needs a new rail line? What are some of the biggest challenges that a country faces just on a practical level?
Yeah, I think it starts with human capacity because you have to have people who can sort of understand those needs and come up with a plan to address them. And again, I was struck, not to pick on Myanmar, but I mean they are country that’s emerging from five decades of being really isolated and they’re trying to deal with some of these issues and they just don’t have the human capacity to really think this stuff through. I met probably the handful of people who were really far sighted and thinking about this, who had the expertise, so that’s one thing. I think you need to have the right legal and regulatory mechanisms in place, and that’s something that takes time and advice and outside assistance in many cases. And you need to have, I think, sources of capital including ultimately for now, probably the international capital is going to provide, including from the multilateral development banks and so forth, is going to provide a lot of the need, but you’re going to need to have domestic capital markets that can generate an ability to raise funds locally.
Those need to be integrated with other capital markets across this region. So there are a huge number of challenges. But I think that for most of these countries that we’ve been looking at, they’re realizing that this is a primary need and they’re putting attention to it, and they’re getting more or less help with this from these various outside players. And I think it’s going to take more time than probably they would like, but the role of international institutions, including the bilateral ones, I think it’s very interesting that the Trump administration has picked up on this story … Perhaps they’re motivated by a slightly dark view of what China is doing, which may exaggerate the risk there, but although I think there is some risk.
But they are looking to establish, for example, a new development finance institution that merges parts of OPIC with the US Trade and Development Agency with parts of the USAID to provide a mix of finance and capacity, technical assistance and project preparation, and other support to promote this investment. So, the needs are huge, the money is there but it’s a question of making the conditions right for that money to come in. That’s the key thing.
The conditions need to be right, but also the financial infrastructure needs to be there. I’m glad that you brought up capital markets because in some instances, this could actually be a sequencing issue where a country needs physical infrastructure, but in order to finance that infrastructure, it’s also going to need functioning capital markets, and they may not actually exist at the same time, right? And so they’re being developed in tandem with-
—a different kind of infrastructure—
Right exactly. And by the way, that’s a point that we should really emphasize. I think and we are, I mean ourselves focusing at the core in our Reconnecting Asia project, on the hard infrastructure. But the soft infrastructure including development of capital markets and other sources of finance, but also customs procedures, other things that facilitate trade and business, and the legal, as you said, legal and regulatory regime and so forth. All of those things are critical. Some countries are doing better in that regard than others, but it’s still, there’s a long way to go. Again, I also went to Vietnam, a more developed country, they really have pretty primitive capital markets still, and I think that’s a real need for them. The world bank and ADB are there specifically helping with that, but that is something that’s part of the story.
Great. Well, thank you for joining us today. That was very helpful.
We hope you enjoyed today’s conversation with Matthew. For more episodes like this, you can find us on iTunes, Google Play, and Stitcher. If you like what you hear, please leave a review. Feedback from listeners like you will help more people find us. And for even more content, look up our Pacific Exchange blog available at frbsf.org. Thanks for joining us.