The Asian Infrastructure Investment Bank (AIIB) is only one of China’s financial initiatives designed to improve the regional investment landscape.
Others include another development bank, the New Development Bank (NDB), and the Twenty-first Century Silk Road project (also known as the One-Belt One-Road, OBOR) announced in October 2013, backed by the creation of the USD40 billion Silk Road Fund by Beijing.
Such China-led initiatives will target infrastructure investment and foster economic integration with countries across Central Asia, India, South Asia, the BRICS economies and towards Europe via land and sea routes.
Strategically, Beijing sees the AIIB (and the NDB) as a multilateral tool to support its policy banks in financing overseas investment and encouraging Chinese companies to “go out” (or globalize). It also wants to cement its position at the centre of a new economic order with all roads leading to Beijing.
Economically, the “go out” policy will help revive China’s investment efficiency by providing new opportunities overseas.
China’s investment-led growth model is unsustainable, with declining marginal returns on investment since 2000.
Its gradual rebalancing away from investment has left many sectors with excess capacity, notably steel, cement, solar energy and construction. Promoting infrastructure development abroad helps China export this excess capacity while boosting the market share of its companies overseas.
Meanwhile, Beijing also wants to globalize the renminbi. To do so, it needs to let the currency flow abroad. This can be done by becoming a net importer of goods and services (i.e. worsening the current account balance), by becoming a large exporter of capital (i.e. buying foreign assets, expanding Chinese lending overseas etc.), or by replicating the post-WWII US strategy of creating the Marshall Plan, World Bank, IMF and the like, or a combination of these moves.
Clearly, the AIIB, NDB and OBOR are geared towards the third way of internationalizing the renminbi. This also implies an accelerating trend of Chinese capital outflow in the form of foreign direct investment in the coming years. Financing infrastructure projects is a more attractive alternative than keeping China’s foreign exchange reserves in low-yielding US financial assets.
It is not entirely correct to view the AIIB-facilitated infrastructure investment drive as a way for China to export its excess investment and, hence, revive the investment-led growth model. The rebalancing from investment-led growth to consumption-driven growth can only happen very gradually in order to minimize the shock on the economy during the transition period.
This is because the marginal propensity to consume (defined as the change in private consumption per unit change in income) is less than 1, meaning that a one-yuan increase in income will only elicit less than a yuan increase in consumption. But a one-yuan cut in investment will reduce GDP by one yuan (or more, if the knock-on effect of investment in one sector on other sectors is considered). Thus, a one-for-one rebalancing from investment to consumption is inherently negative for growth.
This is an especially acute problem for China because its marginal propensity to consume (MPC) is significantly lower than that of many other countries. According to our research, on average, China’s MPC is only about 0.34, while in many other countries it is 0.6 or higher.
In other words, if the Chinese government were to push for a fast rebalancing (as some observers argue it should) by cutting investment, say by one yuan, and offset that investment reduction by giving one yuan back to the people, GDP would fall by one yuan (or more depending on the knock-on effect) while private consumption would only rise by 34 cents, resulting in a net 66 cents contraction in income.
Hence, the medium-term measures to rebalance the economy should be to cut investment at a very gradual pace, or even to keep the investment-GDP ratio stable, and at the same time encourage private consumption growth by boosting the MPC through structural reforms, such as financial liberalization (to allow inter-temporal consumption choice), social safety net improvement (to strengthen consumer confidence) and income growth and redistribution.
In a nutshell, investment cannot fall too fast. It has to remain large in the short- to medium-term to generate jobs and income in order to generate consumption. Other structural changes are needed to complement the rebalancing effort.
The AIIB has the potential to facilitate this expenditure-switching by boosting infrastructure investment to minimize the negative income shock resulting from China’s weak MPC. At the same time, it will improve the economic outlook of Asia by boosting regional investment.
However, for this to happen, the AIIB needs to be managed properly by addressing the potential global governance problems that have been raised.
Opinions here are of the author’s and do not necessarily reflect those of BNPP IP.
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