Daniel Lacalle

China’s New Silk Road Is Just Old White Elephants

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This will not be the first or last time that we question the merits of enormous infrastructure plans. As we have shown on so many occasions, huge spending on white elephants is partially responsible for global stagnation and excessive debt. Huge pharaonic works that promise billions of dollars of growth and benefits that, subsequently, are not achieved, leaving a trail of debt and massive operating costs. But we have also analyzed those infrastructure plans that make sense.

Proponents of the mega stimulus plans ignore the importance of real profitability in favor of “sustaining GDP” in any possible way. A study by Deepak Lal , UCLA professor of international development, discusses the devastating impact on potential growth and debt of stimulus plans in China, and Edward Glaeser’s ” If You Build ” analysis destroys the myth repeated by many of the multiplier effects of public infrastructure. Advocates of infrastructure spending at any cost ignore the most basic cost-benefit analysis, underestimating the cost and magnifying the estimated benefit through science-fiction-multipliers.

Professors Ansar and Flyvbjerg have also devoted a great deal of effort to analyzing the negative effect of large “stimulus” plans from hydraulic megaprojects to the organization of the Olympic Games.

Deepak Lal’s study citing Professors Ansar and Flyvbjerg shows that the actual cost-benefit analysis compared to the “estimated returns” when projects are approved, proves to be disastrous. Fifty-five percent of the analyzed projects generated a profit-to-cost ratio of less than one, that is, they created real losses. But, of the rest, only six projects of those analyzed showed positive returns. The rest, nothing. The country does not grow more, it makes the economy weaker.

This week, China has hit the accelerator with its project of new routes connecting with the rest of the world called “new silk road”. The media has immediately praised the $124 billion additional funds to relaunch communications with the world. Direct freight trains to more than twenty European cities such as Madrid, London, Warsaw or Rotterdam, a pan-Asian rail network, railway connections between African cities where China has invested hundreds of billions in oil and mining projects, and ports in Pakistan and other countries .

For China, it is an ambitious project that seeks three objectives: to redouble its bet, evacuating its enormous overcapacity, already close to 60%, to enhance collaboration with countries around the world so that they see China as an opportunity, not a risk, and finally, to reduce its huge indebtedness by encouraging growth.

The analysis looks positive, including savings in the sea routes, and the expected trade multiplier effect, but there are several elements of risk that we must not forget.

On the one hand, the estimated cost is simply too optimistic. The talk of huge projects ignores difficulties of all kinds, which, in some continents, includes military risks. It would not be difficult to see final figures that doubled those that are currently discussed.

On the other hand, China aims to place many more products in countries whose domestic demand is at least questionable and saturated, and ignores the risk that many countries will take the same measures that China implements, to “protect” their local industries.

Of course, the Chinese government presents itself to the world as the champion of globalization and a connection that benefits us all, but any dispassionate analysis shows that the new silk road is disproportionately more beneficial for China. Some think that China will adopt stricter rules of trade and working conditions. Given that the big beneficiaries of this mega-global-corridor are Chinese state-owned enterprises, many question that “change” in regulation.

Finally, these huge projects, with all their benefits, assume growth estimates that are, at the very least, optimistic, to cover the cost. What a good friend calls “the self-bail-out of Chinese overcapacity.” In this week’s presentations at the New Silk Road Forum, there were talks of multiplier effects for global economies that have neither occurred in the past nor can be considered realistic (including doubling estimated growth).

I fear the same old errors of optimism about growth and cost control that, as history shows, do not occur.

And no one has spoken of the deflationary effect . No one. While 27 central banks around the world and their governments are persistent in creating inflation by decree, does anyone think that huge access to cheap products from the Chinese giant will not create a greater risk of deflation? It’s amazing.

I’m not worried about that price-disinflation effect. It has positive consequences for consumers, but very negative consequences for the rent-seeking crony sectors that governments want to protect at all costs (China, too) because they are “strategic”. This new silk road is a time bomb for subsidized low productivity companies and for the inflationary aspirations of the indebted countries.

What about technology? These huge estimates of consumption and transportation of commodities used in the New Silk Road forum ignore the erosion of demand generated by efficiency and technology. In fact, the new silk road is a monument to the old economy, to inflate GDP via spending, and to transfer the surplus capacity of rent-seeking sectors from one country to another.

In 1992, only two G20 countries had China as one of their top five export destinations, now there are fifteen. However, in 1992 China had a productive capacity deficit, now it has 60% overcapacity, and – as it can not destroy that excess in a centralized planned economy – it intends to export it.

Let us take all that is good, but let us not doubt that there will be excesses. Let us not ignore that the new silk road is intended to alleviate Chinese overcapacity by evacuating it to other countries. It is not a project of globalization, but a bail-out of a Chinese model that starts to sink.

The risk that these megaprojects may become white elephants is not small.

Daniel Lacalle has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

@dlacalle_IA

Picture courtesy of Google, Bloomberg

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