China’s Increased Trade and Investment in South Asia (Spoiler Alert: It’s The Economy)
Prepared for the U.S. Government Office of South Asia Policy
By Emily Brunjes Nicholas Levine Miriam Palmer Addison Smith
Workshop in International Public Affairs Spring 2013
©2013 Board of Regents of the University of Wisconsin System All rights reserved.
For additional copies: Publications Office La Follette School of Public Affairs 1225 Observatory Drive, Madison, WI 53706 www.lafollette.wisc.edu/publications/workshops.html [email protected]
The Robert M. La Follette School of Public Affairs is a teaching and research department of the University of Wisconsin–Madison. The school takes no stand on policy issues; opinions expressed in these pages reflect the views of the authors.
The University of Wisconsin-Madison is an equal opportunity and affirmative-action educator and employer. We promote excellence through diversity in all programs.
Table of Contents
List of Figures ...... iv List of Tables ...... v Foreword ...... vii Acknowledgments...... viii Executive Summary ...... ix I Introduction ...... 1 II Background ...... 2 A Chinese Outward Direct Investment ...... 2 B India-China Rivalry ...... 3 III China’s Current Involvement in South Asia ...... 3 A Trade ...... 3 A.1 Rivaling Indian Trade ...... 5 B Outward Direct Investment ...... 8 C Big Projects ...... 13 D Diplomatic Overtures and Aid ...... 14 IV Modeling Trade and Outward Direct Investment ...... 15 A Trade ...... 15 A.1 Trade Model ...... 15 A.2 Trade Model Data ...... 16 A.3 Trade Results ...... 17 B Outward Direct Investment ...... 19 B.1 Applying an ODI theory to China ...... 20 B.2 ODI Model ...... 20 B.3 ODI Model Data ...... 22 B.4 ODI Results ...... 23 B.5 Comparison to Cheung and Qian Model ...... 25 B.6 ODI Model Sensitivity Analysis ...... 26 C Interpretation ...... 26 V Qualitative Analysis of Big Projects ...... 27 A Possible Geopolitical Explanations of Big Projects ...... 31 VI Putting the Pieces Together ...... 31 VII Going Forward ...... 32 VIII Conclusion ...... 33 Appendix A Variable Descriptions and Sources ...... 34 Appendix B Interpreting Underlying Variables Based on Log Results ...... 36 Appendix C ODI Model Country Set ...... 38 Appendix D ODI Sensitivity Analysis Results...... 39 Appendix E Big Projects Details ...... 44 Appendix F Projecting Trends of Chinese ODI and Trade ...... 47 References ...... 56
List of Figures
Figure 1: Focus Countries’ Trade with China, 2003-2011 ...... 4 Figure 2: China’s Share of Focus Countries’ Trade, 2003-2011 ...... 5 Figure 3: China’s Share of Exports from Bangladesh, Nepal, and Sri Lanka, 2003-2011 ...... 5 Figure 4: India vs. China Share of Focus Countries’ Exports, 2003-2011 ...... 6 Figure 5: India vs. China Share of Focus Countries’ Imports, 2003-2011 ...... 6 Figure 6: Imports from India vs. China, 2011: Bangladesh, Nepal, and Sri Lanka ...... 7 Figure 7: Imports from India vs. China, 2011: Bhutan and Maldives ...... 7 Figure 8: Exports to India vs. China, 2011: Bangladesh, Nepal, and Sri Lanka ...... 8 Figure 9: Chinese ODI Flow, World vs. Asia, 2003-2011 ...... 9 Figure 10: Chinese ODI Flow to Focus Countries, 2003-2011 ...... 10 Figure 11: Focus Countries’ Percentage of China’s ODI, 2003-2011 ...... 11 Figure 12: Focus Countries’ FDI Inflow, 2003-2011 ...... 11 Figure 13: China’s Percentage of Focus Countries’ Inward FDI Stock, 2003- 2011 ...... 12 Figure 14: Bangladesh’s Inward FDI Stock: India vs. China, 2003-2011 ...... 12 Figure 15: Nepal’s Inward FDI Stock: India vs. China, 2003-2011 ...... 13 Figure 16: Sri Lanka’s Inward FDI Stock: India vs. China, 2003-2011 ...... 13 Figure F1: Chinese ODI Stock Trend in Bangladesh, 2003-2020 ...... 47 Figure F2: Chinese and Indian ODI Stock Trend in Bangladesh, 2003-2020 ...... 48 Figure F3: Chinese ODI Stock Trend in Nepal, 2003-2020 ...... 48 Figure F4: Chinese and Indian ODI Stock Trend in Nepal, 2003-2020 ...... 49 Figure F5: Chinese ODI Stock Trend in Sri Lanka, 2003-2020 ...... 49 Figure F6: Chinese and Indian ODI Stock Trend in Sri Lanka, 2003-2020 ...... 50 Figure F7: Trend of China’s Exports to Bangladesh, 2003-2020 ...... 51 Figure F8: China and India Export Trends to Bangladesh, 2003-2020 ...... 51 Figure F9: Trend of China’s Exports to Bhutan, 2003-2020 ...... 52 Figure F10: China and India Export Trend to Bhutan, 2003-2020 ...... 52 Figure F11: Trend of China’s Exports to Maldives, 2003-2020 ...... 53 Figure F12: China and India Export Trend to Maldives, 2003-2020 ...... 53 Figure F13: Trend of China’s Exports to Nepal, 2003-2020 ...... 54 Figure F14: China and India Export Trend to Nepal, 2003-2020 ...... 54 Figure F15: Trend of China’s Exports to Sri Lanka, 2003-2020 ...... 55 Figure F16: China and India Export Trend to Sri Lanka, 2003-2020 ...... 55
iv List of Tables
Table 1: Trade Model Results ...... 17 Table 2: Error Terms for Trade Flows between Focus Countries and China ...... 18 Table 3: Expected Versus Actual Trade Flows ...... 18 Table 4: ODI Model Results ...... 23 Table 5: ODI Country Fixed Effects ...... 24 Table 6: Estimated Deviation from Expected ODI, by Country ...... 25 Table 7: China’s Big Projects in Bangladesh ...... 28 Table 8: China’s Big Projects in Nepal ...... 29 Table 9: China’s Big Projects in Sri Lanka ...... 30 Table 10: Red Flags ...... 33 Table A1: ODI Model Variables and Sources ...... 34 Table A2: Trade Model Variables and Sources ...... 35 Table C1: ODI Model Country Set ...... 38 Table D1: ODI Sensitivity Analysis with Logged Independent Variables ...... 39 Table D2: ODI Sensitivity Analysis with Logged Independent Variables, Country Fixed Effects ...... 40 Table D3: ODI Sensitivity Analysis with ODI Flows as Dependent Variable ..... 40 Table D4: ODI Sensitivity Analysis with ODI Flows as Dependent Variable, Country Fixed Effects ...... 41 Table D5: ODI Sensitivity Analysis: Full Sample with Recession Indicator Beginning in 2008 ...... 42 Table D6: ODI Sensitivity Analysis: Developing Sample with Indicator Beginning in 2008 ...... 42 Table D7: ODI Sensitivity Analysis: Full Sample with Recession Indicator Beginning in 2009 ...... 43 Table D8: ODI Sensitivity Analysis: Developing Sample with Recession Indicator Beginning in 2009 ...... 43 Table E1: Big Project Details: Bangladesh ...... 44 Table E2: Big Project Details: Nepal ...... 45 Table E3: Big Project Details: Sri Lanka ...... 46
v
vi Foreword
The La Follette School of Public Affairs at the University of Wisconsin–Madison offers a two-year graduate program leading to a Master of Public Affairs or a Master of International Public Affairs degree. In both programs, students develop analytic tools with which to assess policy responses to issues, evaluate implications of policies for efficiency and equity, and interpret and present data relevant to policy considerations.
Students in the Master of International Public Affairs program produced this report for the U.S. Government Office of South Asia Policy. The students are enrolled in the Workshop in International Public Affairs, the capstone course in their graduate program. The workshop challenges the students to improve their analytical skills by applying them to an issue with a substantial international component and to contribute useful knowledge and recommendations to their client. It provides them with practical experience applying the tools of analysis acquired during three semesters of prior coursework to actual problems clients face in the public, non-governmental, and private sectors. Students work in teams to produce carefully crafted policy reports that meet high professional standards. The reports are research-based, analytical, evaluative, and (where relevant) prescriptive responses for real-world clients. This culminating experience is the ideal equivalent of the thesis for the La Follette School degrees in public affairs. While the acquisition of a set of analytical skills is important, it is no substitute for learning by doing.
The opinions and judgments presented in the report do not represent the views, official or unofficial, of the La Follette School or of the client for which the report was prepared.
Melanie Frances Manion Professor of Public Affairs and Political Science May 2013
vii Acknowledgments
This project could not have been accomplished without the help of a number of University of Wisconsin–Madison professors. First and foremost, we are grateful for Professor Melanie Manion’s guidance and invaluable critiques, which kept us on track and provided structure to our project and final product. Professors Mark Copelovitch and Jon Pevehouse offered very helpful advice on issues of international trade and investment. Professor Menzie Chinn’s knowledge and expertise helped us a great deal in finding the appropriate economic models and data for our report. We would also like to thank Qian Xingwang of State University of New York at Buffalo for providing guidance on the use of the econometric model that he and Yin-Wong Cheung developed. Finally, we would like to thank Keith and the U.S. Government Office of South Asia Policy for the opportunity to work on this project.
viii Executive Summary
Chinese economic engagement in South Asia has grown quickly in recent years: trade expanded from approximately $40 billion to $85 billion from 2006 to 2011; bilateral investment grew even more quickly, rising from $500 million in 2005 to $2.8 billion in 2010. These increases create opportunities for growth and development as a wider variety of exports flow from China into the region, and as Chinese outward direct investment improves infrastructure and creates jobs. At the same time, this involvement may challenge India’s regional dominance. In this report we examine Chinese trade and investment flows to South Asia using econometric modeling. We also qualitatively analyze large infrastructure projects China has undertaken in the region. Based on the combined results of these analyses, we conclude that China’s primary motive for increasing involvement in South Asia is economic profit.
In examining China’s economic relationship with South Asia, we focus exclusively on Bangladesh, Bhutan, Maldives, Nepal, and Sri Lanka. We use econometric models to determine what China’s expected trade and outward direct investment would be according to normal economic interests. We then compare these predictions to China’s actual economic activity with our focus countries. We conclude that increases in Chinese trade with South Asia grow out of China’s search for wider export markets. Investment reflects Chinese diversification of outward direct investment across developing markets and is consistent with normal economic interests.
Large construction projects, while sometimes pursued for diplomatic reasons, are usually profitable for Chinese firms. To put these diplomacy projects in perspective, we consider China’s increasing diplomatic and economic involvement in Asia and the world. We conclude that China’s behavior is not a specific attempt to counter-balance India’s influence in South Asia, but rather is part of the country’s wider goal to rise in prominence in international affairs. We caution the U.S. government against reading specific geopolitical motives into China’s economic involvement with South Asia.
ix
x I Introduction
China invests heavily in Asia. A large portion of that investment is aimed toward Southeast Asian countries (Shambaugh 2005); however, since 2003 Chinese economic involvement in South Asia has risen noticeably. Between 2003 and 2012, China more than doubled its exports to Bangladesh, Bhutan, Maldives, Nepal, and Sri Lanka. Just over a quarter of Bangladesh’s imports now come from China. Additionally, China has offered hundreds of millions of dollars in investment for large infrastructure projects, including port facilities in Bangladesh, Burma, Pakistan, and Sri Lanka (Curtis 2011).
Many possible explanations exist for China’s increased economic activity in South Asia. Normal profit-seeking behavior by Chinese firms and the Chinese state may explain the increase. Geopolitical explanations are equally plausible, especially given the close proximity of Bangladesh, Bhutan, Maldives, Nepal, and Sri Lanka to India. Border disputes between China and India dating to the 1960s continue, and the two countries are natural competitors for influence and resources in the region. A desire to project power in the region could motivate China’s strengthening of economic ties with these countries surrounding India.
Such a projection of power through trade, aid, and investment has historical precedent in the rise of other global powers, particularly the United States. In the early 20th century, the United States used a strategy of “dollar diplomacy” to purchase the friendship of countries around the world. Much of its rise to superpower status can be attributed to the network of naval bases and military alliances that dollar diplomacy allowed the United States to build and the preferential access to natural resources abroad that dollar diplomacy secured. Following World War II, the United States invested massively in rebuilding the infrastructure of the former Axis powers and in rebuilding the rest of Europe through the Marshall Plan. This generosity was meant to ensure that as many countries as possible aligned themselves with the United States instead of with the Soviet bloc. Is China acting in a similar way to expand its sphere of influence?
In this report, we explore China’s increasing economic activity in Bangladesh, Bhutan, Maldives, Nepal, and Sri Lanka. Specifically, we examine trends of increasing trade flows and increasing outward direct investment (ODI) in these countries. In doing so, we seek to discover whether this phenomenon reflects China’s normal economic interests or if it is an attempt to increase influence and alter the balance of power in the region. In our analysis, we exclude India because we are concerned with China’s challenge to India, not the economic interdependence of the two nations. We also exclude Pakistan and Myanmar because of difficulties in obtaining data.
Our analysis proceeds in four steps. First, we provide background on China’s economic and diplomatic engagement in our focus countries. Second, we use statistical models to examine Chinese trade levels and ODI in these countries, discussing how involvement with each compares to a broader group of China’s
1 trade and ODI partners. Third, we qualitatively assess whether economic interests can explain large investment projects and aid. Finally, we present our conclusion about the most plausible explanations for China’s increasing economic engagement in our focus countries.
II Background
China has been diplomatically engaged with South Asia for many decades, but increased economic engagement is relatively recent. Below we provide background for these relations and China’s investment and trade behavior generally. We also outline recent developments on economic and diplomatic fronts with our focus countries.
A Chinese Outward Direct Investment
China formally began setting up international firms after implementing its Open Door Policy in 1978. Until the late 1980s, however, the Chinese government restricted the low level of ODI to state-owned enterprises and incentivized domestic over international investment (Sauvant 2005). Chinese ODI increased slightly in the 1990s. Later, in response to the 1997-1998 Asian financial crisis, the Chinese government tightened government approval procedures to rein in ODI. A fear of capital flight and loss of control of state assets motivated these more stringent policies (Buckley et al. 2008).
Since the implementation of China’s “Go Global” initiative in 2001, the Chinese government has relaxed its foreign exchange controls, approval procedures, and investment restrictions. From 2003 onward, privately owned enterprises have been allowed to apply for permission to invest internationally (Buckley et al. 2008). Since this time, Chinese ODI has rapidly expanded, from less than $3 billion in 2003 to more than $70 billion in 2011 (China Commerce Yearbook 2010 and 2012). While state-owned enterprises continue to be the largest investors—mainly in petroleum, construction, telecommunications, and shipping—private companies such as Lenovo have started to invest abroad (Morck et al. 2008).
Although the majority of China’s ODI is directed toward Southeast Asia, since 2003 China has increased its diplomatic and economic focus on South Asia. It is difficult to discern whether China has geopolitical reasons for strengthening economic ties with South Asia. On the one hand, Chinese objectives could be strictly a function of export-led growth strategies and a desire to expand trade routes. On the other hand, ties to the region could be equally important for China to exercise diplomatic pressure and extend the reach of its military. This potential development is the particular fear of India, China’s prime rival in South Asia.
2 B India-China Rivalry
India and China have a complex and sometimes openly contentious relationship. Both countries have rapidly expanding economies and face increasing pressure to secure reliable supplies of natural resources. As rising powers, both countries have ambitious space programs, naval aspirations, and motivations to stake out a sphere of influence in their surrounding region.
More specifically, border disputes arising out of the 1962 Sino-Indian War remain unresolved and continue to cause friction between the two countries. To date, China continues to question Indian sovereignty over the Indian states of Arunachal Pradesh, Jammu, and Kashmir (Curtis 2011). India also continues to host the Dalai Lama and over 100,000 Tibetan refugees, a source of ongoing tension between Beijing and New Delhi.
Moreover, China’s relationship with India’s rival, Pakistan, continues to be a point of tension between the two countries. China has helped Pakistan build nuclear facilities (Times of India 2009) and deep seaports and has provided Pakistan with military hardware such as JF-17 fighter jets (Perlez 2011).
III China’s Current Involvement in South Asia
China is building bridges to South Asia. In 2005, the China Council for the Promotion of International Trade inaugurated the China South Asia Business Forum and the South Asian Countries Trade Fair in Kunming, Yunnan (Sunday Observer 2012). Five hundred South Asian businesspeople and officials attended the fair in 2011 (Plus News Pakistan 2011). Chengdu, Sichuan, began hosting the new China-South Asia Economic Trade Cooperation Fair in 2011 (Ti 2012). China is also developing transportation links from Southwest China to South Asia. Thirty-one international flights fly from Yunnan to 19 countries (Plus News Pakistan 2011), a new direct flight from Chengdu to Sri Lanka was slated to begin in early 2013 (Ti 2012), and plans for a trans-Asian railway project are in progress. The railway is to extend 114,000 kilometers through 28 countries (Plus News Pakistan 2011).
A Trade
China’s trade volume with our South Asian focus countries (Bangladesh, Bhutan, Maldives, Nepal, and Sri Lanka) grew roughly six-fold between 2003 and 2011, as shown in Figure 1. This expansion surpasses the increase in China’s world trade volume, which increased four-fold over the same time period. The vast majority of China’s trade growth with the group, however, was in imports by the focus countries; their exports to China increased only slightly. Although focus countries' import growth has been swift, the starting point was very low: China’s exports to these five countries combined made up 0.45 percent of China’s total exports in 2003. In short, imports by these five countries are of small importance to China’s overall trade profile.
3 Figure 1: Focus Countries’ Trade with China, 2003-2011
14 700
12 600 USD) (Millions Exports
10 500
8 400 Imports from China 6 300 (left axis)
4 200 Exports to China Imports (Billions USD) 2 100 (right axis) 0 0
Year
Data Source: United Nations Statistics Division (2013)
As for China’s geopolitical motives, the importance of trade flows for these South Asian economies is even more pertinent to consider. If Chinese trade flows figure large in their economic interests, China stands to have more leverage with these countries if regional disputes arise. Looking again at the 2003 to 2011 time period, China’s share in trade flows for our focus countries has grown. As shown in Figure 2, these countries are growing in their dependence on Chinese imports. The overall share of imports from China has grown for this group from under 15 percent of imports to nearly 25 percent over eight years. The export share bound for China has also increased, but the absolute value of this share is still less than 2 percent of the total. Export share to China for the group quickened after 2009. As shown in Figure 3, Bangladesh, Nepal, and Sri Lanka all saw considerable increases in the share of exports bound for China at that time. This pattern is noteworthy because only eight Asian countries experienced export growth to China between 2008 and 2011 (Sunday Observer 2012).
4 Figure 2: China’s Share of Focus Countries’ Trade, 2003-2011 30 1.8 1.6 25 1.4 20 1.2 1.0 15 Imports from China 0.8 (Left Axis) 10 0.6 Exports to China 0.4 (Right Axis)
Percentage of Trade Flow Percentage 5 0.2 0 0.0
Year
Data Source: United Nations Statistics Division (2013)
Figure 3: China’s Share of Exports from Bangladesh, Nepal, and Sri Lanka, 2003-2011 2.5
2.0
1.5 Bangladesh 1.0 Sri Lanka Nepal 0.5 Percentage of Total Exports
0.0
Year
Data Source: United Nations Statistics Division (2013)
A.1 Rivaling Indian Trade
Finally, because we are asking a question about regional dominance, China’s share of trade should be compared to that of India. In contrast to China’s rising share of trade with our focus countries, India’s share fluctuates, with no clear trend. As shown in Figure 4, India clearly dominates in imports from the group: although the trend for export share to China is certainly on the upward slant, it is still far from catching up with India. Imports are an entirely different matter. As
5 shown in Figure 5, China surpassed India for import share in 2009, and this edge continues into 2011.
Figure 4: India vs. China Share of Focus Countries’ Exports, 2003-2011 7
6
5
4
3 Exports to China 2 Exports to India
Percentage of Total Exports 1
0
Year
Data Source: United Nations Statistics Division (2013)
Figure 5: India vs. China Share of Focus Countries’ Imports, 2003-2011 30
25
20
15 Imports from China 10 Imports from India
5 Percentage of Total Imports
0
Year
Data Source: United Nations Statistics Division (2013)
In addition to the overall trend for the group, in Figure 6 through Figure 8 we present snapshots of Indian versus Chinese export and import volumes for each of our focus countries in 2011. This country-by-country comparison shows that the China-Bangladesh trade relationship is particularly strong. Bangladeshi imports from China far surpass those from India, while export volumes to China are nearly as large as those to India. China has much less trade with the other four
6 countries. India continues to dominate trade flows there. Bhutan and Maldives had no exports to China in 2011.
Figure 6: Imports from India vs. China, 2011: Bangladesh, Nepal, and Sri Lanka 9
8
7
6
5 Imports from China 4 Imports from India 3
Imports (Billions USD) 2
1
0 Bangladesh Nepal Sri Lanka
Data Source: United Nations Statistics Division (2013)
Figure 7: Imports from India vs. China, 2011: Bhutan and Maldives 250
200
150 Imports from China
100 Imports from India Impors (Millions USD) 50
0 Bhutan Maldives
Data Source: United Nations Statistics Division (2013)
7 Figure 8: Exports to India vs. China, 2011: Bangladesh, Nepal, and Sri Lanka 800
700
600
500
400 Exports to China Exports to India 300
Exports (Millions USD) 200
100
0 Bangladesh Nepal Sri Lanka
Data Source: United Nations Statistics Division (2013)
B Outward Direct Investment
Chinese ODI has been expanding rapidly over the last 10 years. Initially, China directed this investment almost exclusively toward other Asian countries. As shown in Figure 9, however, beginning in 2008, the rise in investment outside the region has been more rapid. Over this same period, annual ODI flows to Asia as a whole have held steady, while ODI flows to our focus countries have been on the rise, as shown in Figure 10.1
1 ODI can be expressed in terms of the total stock of investment outside the home country or in terms of the flow of new investment in a given year. The value of ODI flow to a particular country can be positive or negative depending on the net of new investments being made and old investments being withdrawn in a given year.
8 Figure 9: Chinese ODI Flow, World vs. Asia, 2003-2011 80 70 60 50
40 World, 30 including Asia Asia only 20
ODI Flow (Billions USD) 10 0
Year
Data Source: China Commerce Yearbook (2010, 2012)
China’s annual ODI flow to Bangladesh shows an overall upward trend; there the Chinese have been active in mining, electricity, and chemical industries (Xinhua News 2012). Increases in ODI flow to Sri Lanka and Nepal have taken off since 2009. In Nepal, “China House” supermarket already does business in five locations and plans to open 10 more stores soon. The Nepalese also hope the Chinese will invest in natural resource extraction (Ti 2012). Chinese investment in Sri Lanka has garnered the most attention, both in the region and in the United States, because of Sri Lanka’s strategic location along trade routes in the Indian Ocean and its location just off the coast of India. The increase in ODI flow to Sri Lanka is very dramatic. At the same time it is not unusual, given the end of the Sri Lankan civil war in 2009 and a similar increase in Sri Lankan total foreign direct investment (FDI). China reports no ODI flow directed toward Bhutan or Maldives.
9 Figure 10: Chinese ODI Flow to Focus Countries, 2003-2011 90 80 70 60 50 40 Sri Lanka 30 Bangladesh 20 Nepal 10 ODI Flow (Millions USD) 0 -10
Year
Note: China reports no ODI to Bhutan or Maldives. Data Source: China Commerce Yearbook (2010, 2012) Compared to ODI flow, ODI stock better illustrates the amount of influence China may have in a given country. The Bangladeshi share of Chinese ODI stock spiked in 2005 and has declined since, as shown in Figure 11. This reduction does not reflect a retreat from Bangladesh (total Chinese ODI stock steadily increased over the time period observed), but rather faster increases in Chinese ODI to the rest of the world. Sri Lanka, on the other hand, has seen its percentage of Chinese ODI stock rise roughly four-fold between 2009 and 2011. Yet this percentage remains quite low (0.04 percent in 2011).
As with trade, it is instructive to examine overall FDI trends within our focus countries and compare these to the Chinese ODI trends in each. Figure 12 shows that in each of the three countries in our focus group that receive ODI from China, total FDI flows are rising. Sri Lanka stands out, because of the large jump in total inward FDI in 2011. This overall trend for Sri Lankan FDI is mirrored in the Chinese ODI trend to Sri Lanka, suggesting that China is not alone in increasing investment in the country since 2009. At the same time, as shown in Figure 13, China’s share in the total Sri Lanka inward FDI has risen since 2009, albeit from a very low point. China has the strongest position in Nepal: Chinese FDI share is greater in Nepal than in Bangladesh or Sri Lanka and is on the rise, although the 0.07 percent share in 2011 is hardly impressive. For all of these countries, most FDI comes from elsewhere.
10 Figure 11: Focus Countries’ Percentage of China’s ODI, 2003-2011 0.07
0.06
0.05
0.04 Sri Lanka 0.03 Bangladesh 0.02 Nepal 0.01 Percentage of Total ODI Stock of Total Percentage 0.00
Year
Data Source: China Commerce Yearbook (2010, 2012)
Figure 12: Focus Countries’ FDI Inflow, 2003-2011 1,200
1,000
800
600 Bangladesh 400 Sri Lanka 200 Nepal 0 FDI Inflows (Millions USD) FDI Inflows
-200
Year
Data Source: World Bank (2013), World Development Indicators (2013)
11 Figure 13: China’s Percentage of Focus Countries’ Inward FDI Stock, 2003-2011 0.09 0.08 0.07 0.06 0.05 0.04 Nepal 0.03 Bangladesh 0.02 Sri Lanka Percentage of Total FDI 0.01 0
Year
Data Sources: China Commerce Yearbook (2010, 2012); UNCTAD (2013)
Finally, we compare Chinese FDI stock with Indian FDI stock to investigate whether Chinese political leverage in the form of FDI may be a challenge to India. Although Chinese FDI stock has been increasing, Indian FDI stock in each of these countries is also increasing. Bangladesh has seen increasing FDI from both countries. China dominated in the early 2000s, but India has outpaced China in investment in 2010 and 2011, as shown in Figure 14. From 2003 to 2011, India has consistently been a more important investor than China in Nepal and Sri Lanka, as shown in Figure 15 and Figure 16.
Figure 14: Bangladesh’s Inward FDI Stock: India vs. China, 2003-2011 180 160 140 120 100 80 China 60 India 40 FDI Stock (Millions USD) 20 0
Year
Data Sources: India Department of Economic Affairs (2013); IMF Coordinated Direct Investment Survey (2013a)
12 Figure 15: Nepal’s Inward FDI Stock: India vs. China, 2003-2011 120
100
80
60 China 40 India
FDI Stock (Millions USD) 20
0
Year
Data Sources: India Department of Economic Affairs (2013); IMF Coordinated Direct Investment Survey (2013a)
Figure 16: Sri Lanka’s Inward FDI Stock: India vs. China, 2003-2011 700
600
500
400
300 China 200 India
FDI Stock (Millions USD) 100
0
Year
Data Sources: India Department of Economic Affairs (2013); IMF Coordinated Direct Investment Survey (2013a)
C Big Projects
A sizable portion of Chinese ODI has come in the form of large construction projects, mainly in the sectors of agriculture, energy, and transportation. Of the countries examined in this report, China’s 2010 and 2011 annual investments were highest in Sri Lanka, where Chinese firms have completed or are in the process of completing a number of large-scale projects. These projects span multiple sectors, including investments in transportation (MENA Report 2013). Many large projects have been conducted in Hambantota, the home province of
13 President Rajapaksa. These projects include a 35,000-seat cricket stadium, a large convention center, a $209 million international airport, and a $1.5 billion deep seaport located on strategic sea-lanes (Aneez 2013). Most workers and materials for these projects come from China (Devichand 2010).
China has several ongoing large-scale projects in Bangladesh. These projects are similar to those in Sri Lanka and include deep seaports in Chittagong (Pant 2007) and Sonadia Island (Frankel 2011). China also has plans to build a road and rail link through Myanmar to connect the Chinese city of Kunming with Chittagong (Economist 2013, January 9). Moreover, China has invested in Bangladesh’s agricultural sector, providing $226 million for the Pagla Water Treatment Plant project (Daily Star 2012) and $559 million for a fertilizer factory in Shahjalal (Genota and Luk 2010).
Similar to its portfolio in Sri Lanka and Bangladesh, China has invested heavily in Nepalese energy and transportation, including a $1.6 billion hydropower plant and a $1.9 billion railroad project to connect Lhasa to Kathmandu (Unnithan 2011). Other transportation projects include the Pokhara Regional International Airport (MENA Report 2013), a number of roads, bridges, and container depots (Ashok et al. 2010).
D Diplomatic Overtures and Aid
China has been cultivating diplomatic ties with our South Asian focus countries. Most of these overtures build on longstanding diplomatic relations. Nepal-China and Sri Lanka-China diplomatic relations date back to the 1950s; Maldives and Bangladesh have diplomatic ties with China going back to the 1970s. Bhutan has been the one holdout, having left its diplomatic relations management to India for decades. That situation may soon change; Bhutan is now in talks with China to establish formal diplomatic relations as well (Sharma 2013). During the 2003 to 2011 time period, Chinese high officials interfaced regularly with their counterparts in these countries. Headlines surrounding these diplomatic exchanges involve commitments repeated year after year to “strengthen ties,” “deepen relations,” and “promote friendship.” Our review of news reports indicates an increase in the frequency and intensity of exchanges between China and these small South Asian countries since 2005, when the South Asian Association for Regional Cooperation granted China observer status. China is intent on becoming a permanent member of the association to further enhance its influence in the region. Nepal promoted this bid and Pakistan and Bangladesh seconded, but it was rejected due to opposition from India, backed up by objections from Bhutan, Maldives, and Afghanistan (Abdi 2010).
14 IV Modeling Trade and Outward Direct Investment
In this section we present economic theories of trade and ODI and discuss their relevance for China. We then apply econometric models based on these theories to datasets including our focus countries and discuss the results.
Economists have developed a variety of theories to explain patterns of trade and investment among countries. Most of these theories, however, are based on economically developed countries, calling into question their usefulness for developing countries such as China and the countries of South Asia. Furthermore, China’s institutional environment and history of government involvement in business affairs complicate the analysis. In the following section we explain the theories and models we apply, paying special attention to reasons China’s behavior may deviate from the predictions of conventional economic models.
A Trade
Economic trade theory assumes that comparative advantage between countries and barriers to trade determine trade levels. The gravity model of trade assumes that exports and imports between any two countries are inversely proportional to the geographic distance between the countries, because transport costs are one of the most significant trade barriers. This theoretical model has inspired a number of econometric models. Analysis using these models has established the empirical consistency of the gravity model for a wide range of cases. For this reason, we use the gravity model as the basis for our study of China’s exports. The gravity model assumes that export levels will have the form: