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  For South China Sea littoral states, the specter of Chinese naval and coast-guard assets patrolling vital shipping sea lines and waters adjacent to these ports may actually dissuade them from participating in the scheme lest it be seen as jeopardizing their own territorial and maritime claims.23 Every entanglement with the initiative, however, offers pressure points that China can use to promote new projects and closer relationships.

  In 2014 an article in the Mandarin-language Pacific Journal spelled out the country’s Indian Ocean strategy in the form of a sixteen-character guideline: “Select locations meticulously, make deployments discreetly, give priority to cooperative activities and penetrate gradually.” This expansion must be done with caution, low-pitched and slow-paced, doing its utmost to maintain the relative balance of power in the Indian Ocean. The so-called “meticulous selection” refers to the current development of China’s maritime power. It proceeds carefully by selecting several key ports to build overseas bases, the sinews of Chinese maritime power. China needs to build at least one military base in each of the key waters of the Indian Ocean. First, in the Bay of Bengal, China’s maritime power needs to exert effective strategic influence on the western mouth of the Malacca Strait, and it must also implement reliable protection for the Sino-Myanmar oil and gas pipeline. Second, in the Arabian Sea and the Persian Gulf, China’s maritime power has to ensure that the oil produced from the Persian Gulf is safely transported and the national energy supply guaranteed. Third, in the Western Indian Ocean, China’s maritime powers need to respond to non-traditional security threats such as the Suez-Red Sea-Aden Gulf route and piracy on the east coast of Africa.

  “Slow penetration” aims to reduce the suspicion of hostile maritime hegemony in India and the United States. “When constructing a point layout, try to construct as low as possible, develop as high-profile as possible in security cooperation, and do more meticulous work such as marine survey, marine surveying and mapping, port assistance, disaster relief, and try to extend the tentacles and build a good relationship. Embrace the ground, lay a solid foundation, accumulate strength, wait and use appropriate opportunities, take advantage of opportunities like the United Nations mandate to fight Somali pirates.”24

  3

  THE BELT AND ROAD AND THE WORLD ECONOMY

  The main question to which the Belt and Road aims to offer an answer is that of China’s position in the global economic system. For more than thirty years, China has moved along a fast trajectory of economic growth exhibiting a remarkably stable trend, but the inevitable consequence is that its economy has changed along the way. Many of the factors that made this economic miracle possible are no longer present, which means that more radical changes have become mandatory. The story of the past thirty years is unlikely to repeat itself, even if China remains a success story. Growth dynamics in the real world do not follow linear relations. To some extent they remain unpredictable. Many famous success stories have ended in rapid slowdowns and long periods of stagnation, appearing just at those times when everyone had stopped fearing them.

  Until now the story in China has been one of supple adaptation. After Deng’s liberal reforms, the Chinese economy was quickly integrated into the global economy, taking full advantage of newly developing value chains. The fact that these international value chains were increasingly fragmented meant that China could specialize in limited segments, where it had obvious advantages of scale or low-labor costs. In the past, many developing countries had struggled with the challenges of having to learn too much in too short a period, the only way to catch up with more advanced economies. To give one example, it was difficult to learn how to produce an automobile that could compete in the global market, while becoming a world leader in auto components can be done far more easily. Instead of having to make the whole car industry competitive, a developing nation can gain competitiveness in a single stage of production. Taking advantage of internationally fragmented value chains, China was able to approach the development process in a piecemeal fashion. “By allowing developing nations to focus on one part or one stage at a time, the global value chain revolution made knowledge absorption easier. The requisite technology and skills base for making a product could be digested bit by bit.”1

  The offshoring of production stages meant that rich-nation firms sent their marketing, managerial, and technical know-how along with the production stages that had been moved offshore. What Richard Baldwin calls the “second unbundling”—or the “global value chain revolution”—redrew the boundaries of competitiveness. Revolutionary advances in information and communication technology changed the cost-benefit analysis by making it much easier to coordinate different stages of production at great distances. Suddenly it became possible to move knowledge across continents almost as easily as it had been to move commodities and finished goods—and if knowledge was evenly available, why not put it to use where labor was cheaper? Many multinationals did just that and this high-tech low-wage combination quickly became the model for every major multinational. All the Chinese authorities needed to do was create the channels through which knowledge could flow unimpeded.

  The serendipitous coincidence of so many favorable factors has only recently begun to erode. In late 2003 labour shortages first started to appear in southeastern coastal cities in China. To solve the problem, cities in Guangdong, southern China, were forced to increase the local minimum wage level. It was only the start of a self-feeding process which has predictably picked up speed, no doubt helped by the swift aging of the country’s population. Between 2009 and 2013, Chinese wages surged 5.7 per cent, 19.3 per cent, 21.2 per cent, 11.8 per cent and 13.9 per cent, according to data from China’s National Bureau of Statistics. The 2013 wages of Chinese migrant workers increased at nearly twice the growth rate of China’s GDP.

  Many who see China’s huge labor force as a decisive advantage also worry that robots and artificial intelligence will eventually take away the majority of jobs. Intriguingly, if robots and artificial intelligence are to become the dominant drivers of production in the coming century, having too large a population to care for could turn out to be more of a hindrance than an advantage. Perhaps this consideration helps explain why the Chinese Communist Party is fixated on the social and economic impact of artificial intelligence.2

  The disappearance of traditional sources of growth is not limited to abundant unskilled labour. Technology transfers from advanced economies and high returns on capital investment have started to peter out. Local governments’ heavy reliance on fiscal policy periodically results in large property bubbles and massive investment in heavy industry and construction threatens environmental sustainability. All these signs seem to indicate that China is a prime candidate for what development economists call “a middle-income trap”. The term captures a situation where a country can no longer compete internationally in standardized, labor-intensive commodities because wages are relatively too high, but neither can it compete in higher value added activities on a broad enough scale because productivity—constrained by structural factors—remains relatively too low.

  In 2015 China’s finance minister, Lou Jiwei, took the unusual step of publicly conceding that China had a 50 per cent chance of falling into the much-dreaded trap. Speaking at a conference at Tsinghua University, Lou argued that the government needed to solve the problem of structural imbalances and market distortions in the economy within the next five to seven years while maintaining 6.5 to 7 per cent growth in order to avoid the middle-income trap. To that end, he highlighted reforms in five sectors, including encouraging imports of agricultural products, accelerating reform of the hukou (household registration) system, speeding up human resources reform, pushing rural land reforms, as well as tackling social security system-related issues. Agriculture is a particularly important case. Lou argued that China needs to encourage more food imports so that it can transfer rural laborers to fill vacancies at industrial and services sectors. He called for a reduction in subsidies for fa
rmers, urging the country to import more farm goods from abroad. “Many Chinese have this war mentality and believe the country’s food security will be endangered if war breaks out.” Encouraging more farm goods imports in a secure and reliable way is, as we shall see, one of the goals of the Belt and Road.

  Middle-income economies typically struggle to replace the old growth drivers with productivity growth, which depends on the accumulation of human capital and innovation and has a much longer time scale. Fostering innovation on a broad scale is a complex process and requires time to diffuse knowledge across the production process and build the necessary institutional structures. In the absence of major reforms, China will get squeezed between low-wage competitors in mature industries, and rich-country innovators in industries with rapid technological change. As Wang Jisi puts it, “it is being obstructed from the front and pursued at the rear. At the front there are developed countries, which occupy the high end of the industry chain, possess advanced technology, and are pushing for the revival of their own manufacturing industries. To the rear there are the South East Asian, South Asian, and African countries, which are catching up by using their advantage in low cost manufacturing.”3 The metaphor of the Middle Kingdom has acquired a new and ominous meaning.

  How is China to catapult itself from the position of a middle-income country to the top of the pyramid? A number of difficulties immediately present themselves. In the past the Chinese economy has been moving into empty economic space, occupying the segments of production vacated by earlier developers. The task now—moving to the top—is structurally different since, in some dimensions at least, that space is already occupied. Can China find markets for its growing high-tech industry and services if global markets in those areas are dominated by American and European firms? Can it reliably invest in a new economic paradigm without access to those markets? And how can it expect to enter them if standards—key technologies—are owned by foreign firms who thus have access to steady flows of revenue from royalties and licensing fees? Finally, were China to move into higher-value production segments, who would take its place producing lower-value goods, which in many cases are actually indispensable components and inputs? Countries like South Korea and Singapore could rely on the massive Chinese manufacturing base for that, but what happens when China tries to replicate the same process?

  I am highlighting these questions to show the ways in which the world economy must be perceived as an interdependent whole. A trajectory of economic growth is not incompatible with taking a lower position in the hierarchical ladder—being on the periphery of the system rather than the center—but contradictions between the needs of the system and those of some countries are bound to arise. In many cases, a country will be unable to change its economy in a particular direction without altering the way the world economy is organized. A policy of economic development—if it is to chart a sustainable course—must take the form of a global policy. The Belt and Road is China’s global development policy.

  This approach comes naturally to the Chinese authorities. The tradition of Tianxia is—as we saw in an earlier chapter—a way to think about the “world” rather than the individual state. It stresses the relations of interdependence between individual units in a system and takes that insight to its logical conclusion. It is reinforced by Marxist thought, perhaps the Western intellectual tradition that comes closest to Tianxia on this point. From Lenin’s theory of imperialism to Wallerstein’s world-systems theory, a range of Marxist writers have insisted that the unit of social reality within which we operate, whose rules constrain us, is for the most part the world economy. In Beijing, these writers have been and remain in vogue.

  Chinese decision-makers share with their Western counterparts the premise that economic and financial globalization has made it difficult for a single country to pursue a specific economic vision. But the Chinese are much less inclined to renounce all forms of economic planning than to redefine the rules of the globalization game. A priority identified in the Vision and Actions document is to improve the “division of labor and distribution of industrial chains.” When it comes to the division of labor along the value chains of industrial production, positions and preferences that reflect the national interests of countries in the regions of the Belt and Road may differ or even contradict each other. In such cases, observers should be under no illusions that China, as the promoter of the initiative, is uniquely placed to pursue its interests.

  Patterns of international specialization and division of labor are particularly relevant in the age of global value chains. Today, very few products are manufactured in a single country. A country’s manufacturing imports are more likely to be intermediate goods—that is, commodities, components, or semi-finished products that a country uses to make its own products. These could be final products or new segments in a global network of producers and suppliers. One third of China’s imports are destined for export processing zones, which account for almost half of the country’s exports. Global value chains can become so complex that imports can also contain returned value added that originated in the importing country. In China, nearly 7 per cent of the total value of imported intermediate goods reflects value added that originated in China. For electronic goods, Chinese intermediate imports contain over 12 per cent of returned Chinese domestic value added.4

  With the emergence of global value chains, the mercantilist approach that views exports as good and imports as bad starts to look counterproductive and even self-contradictory. If a country imposes high tariffs and obstacles on the imports of intermediate goods, its exports will be the first to suffer. As a number of studies by the OECD have shown, nominal duties on gross exports are an incomplete measure of effective tariff barriers. We must strip out the value of imported intermediaries used in making exports. The effective burden for the exporter is better measured by tariffs on the domestic value added of exports, and these tariffs can be larger than duties on gross exports by several orders of magnitude.

  Domestic firms therefore need reliable access to imports of world-class goods and service inputs to improve their productivity and ability to export. In this new age, it pays to think across national borders. The global economy has a Tianxia feel. When intermediate inputs tend to cross borders many times, even small tariffs and border bottlenecks have a cumulative effect, and protective measures against imports increase the costs of production and reduce a country’s export competitiveness.

  These are all good arguments for trade liberalization—and it should therefore not surprise us that China has started vocally to defend the removal of barriers to cross-border flows of goods and services—but consider what happens to a country’s ability to organize production along the most efficient lines. If goods are produced entirely in one country, that country has full control over the whole process. Once goods are produced in several countries as the combined result of an intricate division of labor in each value chain, things become more difficult. What a country wants is to pick and choose the best segments in each value chain. Industrial policy increasingly targets tasks rather than industries, but for that, a government would have to gain access to the levers of industrial policy in other countries, to be able to organize production across the whole value chain.

  A country has far more to gain by moving into higher-value segments in a supply chain than by increasing productivity in an already-occupied segment. In truth, however, it is less a question of somersaulting to the top of extant value chains than building new ones, allowing one to specialize in capital-intensive and technology-intensive activities. If a country wants to compete with the most advanced economies, it must do so by establishing new—more efficient and more dynamic—value chains. We no longer live in a world where German and Chinese products compete against each other. More often what happens is that German-led value chains—including many international production stages—will be competing against Chinese-led value chains. As Richard Baldwin puts it, the offshoring of production tasks
shifts the effective geographic boundaries of competition. The units facing each other in the global market are no longer nations but value chains—and that changes everything.5

  Thus when China develops a policy toward important commodity producers, it is less interested in securing access to commodity markets than in building highly efficient value chains where it can occupy the top segment. It knows that its competitive advantage results from this organizing role.

  An example may help understand the strategy at play. Because it wants to be the world leader in the electric-car market, China has been moving to lock up the supply for cobalt, an essential material to produce the lithium-ion batteries used in laptops, smartphones and, of course, electric cars. About 54 per cent of the global cobalt supply comes from the Democratic Republic of Congo and Chinese imports of cobalt from Congo totaled $1.2 billion last year. The second largest importer was India but with a negligible $3.2 million. Expectations of fast growth in the electric car market have caused cobalt prices to explode. But China is not interested in producing batteries. It wants to control the electric vehicles market. Given its size in the future and the need for reliable access to cobalt supplies, it may soon be in a position to determine who gets to become the largest electric car producer in the world.6 Who rules cobalt commands the battery market; who rules the battery market commands the electric car market; who rules the electric car market commands the world.

  Maximizing the value that is added by a nation’s productive resources now involves deploying some of the resources abroad in global value chains. If China seeks to focus on certain segments of a given value chain, it needs high levels of complementarity in other countries. These will develop only if the right transportation and communications infrastructures have been put in place and if those countries adopt the right economic policy decisions. One Chinese expert told me that the Belt and Road is the first example of “transnational” industrial policy. “Formerly, all industrial policy was national,” he said. He has a point, as even the European Union, when it created an ambitious transnational framework of rules and institutions, tended to abandon industrial policy on the grounds that it could not be reproduced at a transnational level. This points to the clash between different integration models.