Conservative Fiscal Policy Driving Countries to China
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Summary
China introduced the ‘One Belt, One Road’ (OBOR) initiative to foster a Chinese-driven international trade initiative focused on regional economic collaboration. While the West may be concerned about the geopolitical undertone of OBOR, certain Western policies are instead spurring global participation in the initiative. Italy and Iran are two such examples, with restrictive economic policies from the West driving them to seek alternative sources of funding.
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Officially launched in 2013, ‘One Belt, One Road’ (OBOR) is a Chinese-driven global initiative intended to spur trade through large-scale infrastructure projects and investment across Asia, Europe, Africa, and the Americas. As of Q1 2020, the initiative included participants from 138 countries and 30 organizations around the world. Participation is tailored to the particular needs of each country, with all projects serviced by Chinese banks, companies, and labor, and are driven by the pursuit of enhanced regional economic connectivity.
While the West may be suspicious of China’s motives underscoring OBOR, many of its policies are instead pushing countries to participate in the initiative. For example, the EU’s high austerity measures have driven Italy to seek an economic partnership with China while US sanctions have pushed Iran to seek help from China. China’s use of OBOR to challenge the West’s control over the global economy has many leaders worried; however, as long as the West continues to pursue restrictive economic action, there will be a constant demand for the unique economic opportunity that OBOR offers.
The Italy Case
A New Silk Road
Among the European Union member states, Italy has experienced comparatively more economic and political isolation than many of its peers. From the 2008 Great Recession to the 2015 refugee crisis, Italy’s inability to solve its problems amid a lack of solidarity from the governing EU has introduced a variety of severe issues, including high levels of debt and crumbling infrastructure.
Beginning with the 2008 economic crisis, the Eurozone began initiating large fiscal programs designed to minimize the economic fallout following the 2008 Great Recession, leading to burdensome debt levels. In the wake of the crisis, the ECB mandated high austerity measures and banned member nations from exceeding yearly debt increases over 3% to combat rising debt loads and safeguard against events like Greece’s government debt-crisis and the subsequent ECB bailout. Governing more than 7 major economies near or above the 100% debt to GDP mark, the ECB has prioritized fiscal tightening in order to prevent future bailouts — a costly endeavour for the Eurozone. The ECB’s conservative approach has managed risk at the expense of growth.
Eurozone Debt to GDP Levels
Italy has the fourth largest economy in the EU, but teeters on the brink of a debt crisis with a debt to GDP ratio exceeding 130%. The ECB has deemed Italy ‘too big to fail’ and taken a particularly cautious stance by restricting Italy’s annual debt growth to a meager 1.8%. The ECB’s conservatism has been far from successful, as Italian real economic growth has stagnated between 0–1% for the past five years. Meanwhile, other high debt states like France and Spain have been allowed to push limits of 3% spending; Italy alone remains under Brussels’ scrutinous watch.
Numerous studies have pointed to a decisive gap in GDP growth between the United States and Europe over the same period as evidence of austerity’s ineffectiveness. The correlation of GDP growth to debt is clear: over the 10 year period of 2009 to 2019, US debt to GDP grew by 12.7% over the Eurozone, while US GDP growth surpassed the Eurozone by 33.8%.
US-EU Post-Great Recession Debt to GDP Growth Trend
Italy’s infrastructure has suffered due to the ECB’s debt limitations. As an EU member, Italy has little autonomy to guide monetary policy, and as such needs to be able to leverage fiscal tools to stimulate the economy. With consumer demand driving nearly 60% of the Italian economy, infrastructure projects could be a boon to job growth, which would in turn build domestic consumer demand, thus further bolstering the economy.
Despite the ECB’s strict monetary limitations, Italy cannot afford to leave the Eurozone. If Italy were to exit, the country would likely default on its obligations to the ECB, its largest debt holder. Given the ECB holds 341 billion euros (US$369b) worth of Italian sovereign debt, this would be the largest default in economic history. Though largely dependent on how Italy would restructure its debt, the aftermath of Brexit implies that a new Italian currency could face severe immediate devaluation. On one hand, Italy could sell off all publicly owned assets and tax financial assets. On the other, it could reduce the nominal value of government bonds and extend maturity dates, likely leading to significant legal complexities. If it were to use its new devalued currency to pay off its debts, all of which are denominated in euros, Italy would be left with few reserves and its economy would face a severe liquidity crisis, further crippling the economy. With little monetary maneuverability as an EU member and lacking the ability to exit the Eurozone, Italy naturally turned to OBOR for economic stimulus.
Italy recently joined the OBOR initiative in March 2019 and, as such, Italy and China are still discussing the extent of stimulus needed and how best to inject liquidity into the Italian economy. With tourism and port access being two large drivers of Italy’s economy, the two countries are turning to maritime interests as a major point of inclusion within the OBOR initiative.
Maritime Interests
Italy is currently the only G7 country to sign into the OBOR initiative, desiring to improve their standing in the Mediterranean maritime trade economy. Given Italy’s abundance of ports on the Mediterranean, maritime trade has always been a key economic driver. According to the World Bank, the import and export of goods and services in 2018 was 28.95% and 31.45% of Italy’s total GDP, respectively.
Maritime shipping and transport is an important aspect of China’s trade relationship with many European countries as the majority of Sino-European trade is carried out by ships. A 2017 study by the University of Bologna showed that 13% of Chinese trade in the region passed through Greece after China purchased a stake in the Greek Port of Piraeus — a marked increase from only 2% in 2010. China is placing an increased emphasis on the Mediterranean as a regional trade hub between China and Europe, and OBOR participation will be the main determinant for the primary ports of trade.
OBOR Trade Routes
Italian trade experts warned that Italy would forego crucial trade opportunities by neglecting the OBOR initiative. If the Port of Piraeus were to be linked to the rest of Europe by rail, the entirety of Asian maritime trade could bypass Italy by routing through Greek ports. In order to keep Italian ports and railways relevant to Sino-European trade, Italy was left with little choice other than to join into the OBOR initiative to serve as an alternative hub in the Mediterranean for Asian trade. This also enabled Italy to secure desperately needed funding to maintain infrastructure while raising capital to pay off debt.
Infrastructure Revitalization
Italy has also been struggling with crumbling infrastructure. Italy’s decade-long decrease in public infrastructure investment has resulted in deteriorating bridges and roads. As a result, Italy has emphasized leveraging OBOR-related investment to renovate and rebuild public infrastructure around the country.
Ponte Morandi Bridge Collapse, 2018
One of the more notable examples of Italy’s dilapidated infrastructure in recent years was the tragic collapse of the Ponte Morandi bridge in August 2018. During a torrential rainstorm on August 14, 2018, a 690-foot section of the Ponte Morandi bridge in the Italian city of Genoa collapsed, resulting in 43 deaths. Investigators initially hypothesized that the bridge collapsed due to structural weaknesses and a landslide caused by the rainstorm, and it was also reported that critical bridge supports gave way due to corrosion and neglect. While an official investigation never concluded the cause of the collapse, it was discovered that the bridge was poorly maintained. Several years after construction, the bridge’s steel cables began showing signs of erosion; however, the company responsible for upkeep elected the cheaper solution of adding new cables instead of replacing those damaged. This turned out to be a tragic shortcut that exemplifies the state of degradation plaguing Italian infrastructure brought on by a lack of public funding.
Italy hopes to see major investment into its port and public infrastructure from Chinese companies through OBOR partnerships. According to a 2018 study, US$41 billion worth of projects have already been initiated across the Mediterranean, 20% of which are in ports, and there are plans to bring this number up to US$1.2 trillion. A high level of investment will give Italy the funds it desperately needs to pay off its debts and rebuild its fragile economy.
The Iran Case
Economic Isolation
Iran stood to gain a great deal from participating in OBOR. Iran suffers from a failing economy defined by rampant inflation and high unemployment. US sanctions and widespread public dissent have ultimately led to economic collapse amid high unemployment and societal unrest.
In 2017, Iran began experiencing serious economic disruption. After the Trump administration withdrew from the Iranian nuclear deal in May 2018, Washington restored the economic sanctions on Iran that had been previously lifted under the 2015 nuclear accord. The sanctions were intended to reduce Iranian oil exports to zero, with the US government threatening to penalize any country that bought oil from Iran. As a result, Iran’s GDP dropped 4.9% in the fiscal year 2018–19, with industrial growth sinking 10%. Without oil income, inflation rose from 9.64% to 30.49% between 2017–18 and 35% in 2019.
Oil Rents as % of Iranian GDP
Facing mounting economic pressure, Iran needed to offset the rapid loss of domestic liquidity. Losing major global trading partners spurred Iran to begin searching for alternative trade partners. China answered the call and quickly became the largest importer of Iranian oil at 200,000 barrels per day, nearly 7.5% of Iran’s overall average export of 2.7 million barrels per day. Additionally, with many countries withdrawing funds from Iran for fear of US retaliatory measures, the Iranian government urgently pursued OBOR as an external capital source from which to fund public investment.
The Chinese economy is sufficiently financially decoupled from the West to shoulder the impact of US sanctions. In 2018, China signed a US$12b infrastructure development loan with Iran — approximately 2.7% of Iran’s US$446 billion 2018 GDP. Chinese institutions also extended an additional US$4.2 billion in credit facilities, ensuring that Iran would turn to China through OBOR amid any economic worries.
What’s Next for OBOR?
While the coronavirus pandemic has stalled many OBOR-related projects, its economic fallout in highly affected countries like Italy and Iran have opened the door for additional OBOR-led funding requests. Once COVID-19 is brought under control, severely affected economies will require large investments in order to revitalize growth and rebuild infrastructure. If Chinese institutions have the capacity to continue collaborating with these governments, China’s influence around the globe could be significantly strengthened and Beijing may find a new opportunity to further internationalize the RMB. Challenged by a legitimate alternative to traditionally Western-led trade pacts, Western governments must be increasingly thoughtful in their approach to global economic policy, otherwise they may find a growing list of nations forming unprecedented relationships with China that serve to solidify Beijing’s hegemony in the East.
Originally published at https://www.thechinaguys.com on April 28, 2020.
