This note is an addendum to our recently published Red Paper Reimagining infrastructure amid transformative change. The Red Paper traversed five transformative changes – megatrends – that will impact almost every area of human life, with particular focus on those touching the infrastructure asset class.
The New Silk Road, which is a short-hand descriptor for the shift of global economic power from the West to the China-driven East, was one of the five megatrends discussed.
Describing a country as ‘charismatic’ may be unusual, but apt if applied to China. The Middle Kingdom’s iconic status as a great, continuing civilisation means that its contemporary actions and aspirations are steeped in history.
The much-talked about New Silk Road is a modern reboot of The Silk Road (see chart below) – a network of trade routes, formally established during the Han Dynasty of China, which linked the regions of the ancient world in commerce. It was used regularly from 130 BCE, when the Han officially opened trade with the West, to 1453 CE, when the Ottoman Empire boycotted trade with the West and closed the routes.
That remarkable, ancient commercial network may simply have remained something to pique the occasional interest of Sinophiles had China remained poor and isolated. Chinese leader Deng Xiaoping’s launch of ‘The Open Door’ in 1978 was the first step in the country’s return to being a major world economic power. See China’s economy set to leap-frog Western powers for more on this.
Now a rising China is developing strategies and building institutions in keeping with its return as a leader on the world stage.
The New Silk Road refers to the expansion of China’s sphere of influence and investments in Asia, notably through plans like the ‘One Belt, One Road’ (OBOR) and institutions like the Asian Infrastructure Investment Bank (AIIB).
China’s economy set to leap-frog Western powers
Back in 1820 Chinese production made up 30 per cent of the world’s GDP. This number dropped dramatically in the wake of the industrial revolution when Western Europe and North America production expanded rapidly.
China’s contribution to global GDP bottomed to below 5 per cent in the 1970’s but has made a staggering recovery since reaching 17 per cent of global GDP (at power purchase parity).
China’s share of global GDP is set to hit 19 per cent by 2020, driven by urbanisation and consumption, with the EU and the USA each expected to make up a diminishing 15 per cent. By 2030, nine additional Chinese cities (to bring the total to 17 Chinese cities) are expected to join the list of the world’s top 50 cities by GDP and displace eight European cities from the list by doing so. From a regional perspective, while China is expected to account for 37 per cent of Asian regional GDP (at power purchase parity), India will also be a strong force contributing 16 per cent.
The dynamics driving these significant trends transcend the kind of month-by-month/quarter-by-quarter economic statistics – such as the fact that China’s GDP growth rate has slipped just below 7 per cent – that have been contributing to recent financial markets unease.
Millions of Chinese citizens continue to be pulled out of poverty and moving up the income and life opportunity ladder. Wealth creation is shifting to second-tier cities. Production will move away from manufacturing and transition towards service industries. Internal demand growth is the key. The emergence of a vast middle class will represent a new commercial force demanding far more resources than China can produce.
A rising China is a tailwind for Asia more generally with 66 per cent of the global middle class forecast to be in Asia and 12 of the top 50 global cities in number of middle class households projected to be in China by 2030.
The number of high-income households in China is also soaring. There could be as many as 45 million households with annual incomes in excess of US$70,000 by 2030 and China will be ahead of Europe and close to the US in the number of high-income households.
While not all households will see the same income growth, aggregate demand for food and energy is going to explode in coming decades, in our view. So too is demand for consumer products, services and tourism.
This trend has already started changing the nature and volume of trade between China and its commercial partners.
This is intertwined with China’s economic growth and the millions of Chinese households joining the middle class.
China’s economic growth relies on trade: on the one hand, the country exports its manufactured products around the globe. On the other hand, it is significantly dependent on energy and food imports far from its territory. See China’s changing trade mix creating opportunity for more on this.
The OBOR is deeply rooted in China’s need to find markets for its construction companies, steel and cement production, and investment opportunities to secure supply of key commodities. It includes investments in infrastructure to enable China to diversify its energy supply sources and routes which it views as potential choke-points upon which China has little influence.
Chinese Premier Xi Jinping’s recent visit to Iran was a live illustration of the strategy in action. In warming up to Iran, China achieves two things. Primarily, it becomes the first mover in a large oil-rich country desperate for investments in infrastructure. Secondarily, it can now access the Caspian Sea and the Persian Gulf through Iran. Someone will have to build the infrastructure to carry goods from western China to Turkey's door step and that will most likely be China.
Infrastructure has played an important role in China’s rapid development and it will continue to do so. The country has built roads, high speed rail networks and more apartment buildings than can be counted. While this process is slowing, the country’s Asian neighbours are embarking on their own development drives and China is well positioned to capitalise on this demand for construction expertise.
To compliment this ambition, China holds the highest amount of reserves (monetary gold and foreign exchange holdings) in the world, estimated at US$3.9 trillion in 2014, three times more than Japan (the second largest holder of reserves), and nine times more than the United States.
As part of the New Silk Road strategy, China is seeking to deploy capital to build and control the infrastructure it needs along its trade routes. These investments will most likely be ports, pipelines, freight railways and energy infrastructure.
China is not the first, nor will it be the last major power that, despite its strengths, is mindful of its vulnerabilities.
A case in point; the country is highly dependent on oil and gas imports. One study suggests that its dependence on imported oil and gas will hit 97 per cent by 2050 and still be over 75 per cent under more optimistic scenarios related to China’s own oil and gas reserves. China’s primary energy use is forecast to grow by up to fourfold by 2050.
So when the country’s leadership thinks of the issue, it does so with a measure of unease. In 2013, 82 per cent of oil imports and 30 per cent of gas imports transited through the Straits of Malacca. That choke-point and related sea lines of communication have long been the domains of the US and its Asian allies.
To mitigate risk, China has through the OBOR plan developed a strategy for energy supply diversification that is less dependent on the Straits of Malacca. Instead, linking oil and gas from central Asia to the western Chinese province of Xinjiang becomes a focus. This includes the Chinese government’s US$392 billion investment in freight high-speed rail extensions, US$196 billion investment in telecommunications networks to mines to 2020, and plans for 35 sea infrastructure projects as of 2015 in Xinjiang.
Construction of pipelines and transportation corridors through Pakistan and Myanmar are on the drawing board to ease some of the current overwhelming reliance on transporting oil and gas through the Straits of Malacca and China Sea.
China is also investing in various port facilities along the New Silk Road sea route in efforts to protect its supply as well as to exert political influence through the Straits of Malacca.
The OBOR plan could include dozens of countries (including Western Europe according to some observers), over 3 billion people, and account for 26 per cent of Chinese foreign trade.
In addition to individual investment commitments with specific central Asian countries, the Chinese government has created national and international institutions dedicated to infrastructure investments in the silk road region. Included are a US$62 billion investment in three state-owned policy banks to finance The New Silk Road’s expansion, a US$40 billion investment in the New Silk Road fund and potentially a US$100 investment by the AIIB.
Such institutional building has economic as well as geo-political motivations.
In the World Bank and the Asian Development Bank, the US has the prominent position with China having only around 5 per cent of the votes. By contrast, China has 34 per cent of the votes in the AIIB and the US none. Australia has 4.9 per cent of the voting shares in the AIIB and the Asian Development Bank.
China’s changing trade mix creating opportunity
In 1980, China barely rated a mention in global trade statistics. Fast forward several decades and the picture is profoundly different. China’s share of global trade hit 10 per cent in 2015 sitting just below the United States.
Asian countries made up a little more than half of China’s imports (55 per cent) and exports (51 per cent) in 2014. At the same time, the share of North American, Australian, Canadian and European’s exports to China is growing, owing to the country’s dependence on food imports (notably cereals and dairy), as well as energy (mainly oil and gas).
More than 90 per cent of China’s exports in value in 2014 were manufactured products, but just under 30 per cent of its imports were fuels and mining products, and almost 10 per cent were agricultural products. Australia’s trade with China was particularly skewed as 90 per cent of Australia’s exports to China were primary commodities (energy sources and agricultural products).
China’s New Silk Road vision is inextricably linked to the demands of its growing middle class. Access to raw materials is vital, but so is efficient infrastructure to move it. The OBOR and the AIIB are important to this, but so it ensuring healthy relationships with countries, like Australia, that have the key commodities China needs.
China is in a state of transition and major opportunities will flow from the demands of its growing middle class and growth of second-tier cities. Tourism presents a compelling opportunity as well as trade in energy and agricultural products. There will also be big requirements for major infrastructure investment.
China has become a powerful source of funding for major projects both domestically and around the world. With so much activity in the Asia Pacific region, there is potential for Australian infrastructure investors to partner with Chinese counterparts as well as to build on each other’s experience and relationships to successfully deliver infrastructure projects along the New Silk Road and beyond.
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 IMF 2015
 Oxford Economics, “Global Cities 2030”, 2015
 World Development Indicators
 Lawrence Berkeley National Lab. https://china.lbl.gov/sites/all/files/lbl-4472e-energy-2050april-2011.pdf
 Stratfor 2015, citing the US Department of Defence, RAND Corp.
 CCTV news, 08-05-2015, One Belt, One Road initiative sees growth, Wang Tongxuan. http://english.cntv.cn/2015/08/05/VIDE1438705562724800.shtml
 ABC: http://www.abc.net.au/news/2015-04-02/asian-infrastructure-investment-bank-what-is-it/6367154
 UNCTAD Statistics Database, accessed in 2015, data for 2014