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