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China’s Export Infrastructure Strategy at Risk in South China Sea?

Jun 15 , 2015

Infrastructure is now among China’s largest employers. Keeping those workers employed is important for Chinese social stability. If the South China Sea controversy creates blow-back effects on China’s export infrastructure drive, it could moderate Chinese behavior.

Over the medium term, China may need to choose between infrastructure exports and territorial expansion. After decades of building domestic roads, rail, airports and skyscrapers, China now has a world-class infrastructure industry.

It now employs roughly three percent of China’s working age population. By contrast, the People’s Liberation Army, China’s next largest labor sink, employs two percent. Keeping this ‘three percent’ employed is important to maintaining China’s social stability.

This stability is now largely based almost wholly upon a social contract of jobs and rising incomes in return for putting up with pollution, corruption and stifled civil discourse.

As China reaches the limits of sensible domestic infrastructure investment, China’s now re-orienting her labor-intensive, world-class infrastructure industry to foreign markets. China calls this its ‘going out’ strategy.

This will be funded by recycling some of China’s accumulated $5 trillion foreign reserve hoard, though its size has potential to be destabilizing.

A big channel for recycling reserves is China’s newly created Asian Infrastructure Investment Bank. The AIIB is a logical, economically orthodox solution as China moves up the value chain.

By loaning billions to other countries, resulting in contracts won by Chinese national champion infrastructure companies like State Grid Corp. of China (in electricity transmission) and China National Overseas Oil Company (CNOOC) in energy, China can maintain current domestic infrastructure industry employment levels.

On the flip side, AIIB borrowing countries will gain from lower-cost upgrades of aging infrastructure. This is something where atrophied domestic infrastructure companies may struggle to do well.
This process already is underway.

China’s State Grid has made sizable infrastructure investments through local partners in the Philippines, Australia, Italy and Brazil. This makes economic sense; but providing a foreign country access to internal infrastructure requires trust.

China’s vague claims to the entire South China Sea now rest almost wholly upon Chinese repetition the claims are ‘indisputable’ and that other countries are demonstrating bad faith and engaging in ‘troublemaking’ if they disagree. Confidence is further dented by China’s rejection of international arbitration in the South China Sea as sought by the Philippines under the United Nations Convention on the Law of the Sea (UNCLOS).

These kinds of issues may be irrelevant inside China. There, the Communist Party sets the agenda. But in business relations with other countries, confidence is key.

One legitimate — albeit exaggerated — worry is that Chinese companies building roads and electricity transmission infrastructure other countries could make unilateral non-arbitral ‘indisputable’ claims as ‘Chinese territory’ to land beneath roadways or power lines built by Chinese companies.
Analyzed charitably, all this can be seen as the adjustment of an authoritarian government to doing business overseas in industries where long-term trust is crucial. Ultimately, international business is a much different arena than controlling a domestic economy where its writ is unchallengeable.

Resolving this contradiction is important for China. Failing to resolve it may create internal economic instability. Consider the Philippines as an instructive case.

In 2007, State Grid won a groundbreaking 25-year contract to upgrade and operate the Philippines’ ramshackle electricity grid in a joint venture. In March of this year, eight years into the contract, the Philippines summarily expelled State Grid’s technicians over largely unsupported claims a security ‘virus’ may have been inserted into the Philippine grid. In contrast to its stridency over the South China Sea claims, China’s response to the Philippine expulsions was notably low key.

Instead of claiming ‘indisputable’ rights and/or accusing the Philippines of ‘troublemaking’ (claims China has made about the Philippines over the South China Sea), China’s muted response to the technician expulsions was meekly to appeal for ‘fairness’ and ‘respect for contracts.’

Spot any difference in tone?

Ultimately, China may have to choose between a trouble free ‘going out’ strategy, and an aggressive ‘island-building’ South China Sea policy. The two look linked. At the very least, dented confidence in China may be tougher terms for overseas infrastructure contracts.

This could lower ceilings for Chinese minority stakes in overseas joint ventures, more demanding technology transfer requirements, more onerous local staffing requirements on ‘security’ grounds and other limitations.

The world needs new infrastructure. China has the means and companies to provide it. Cooperation provides benefits all around.

One way to finesse the South China Sea situation is joint development by China and her smaller neighbors in offshore areas. Joint Development Areas allow final territorial determination of disputed areas to be put off for decades. By that time, the stakes are lower because the resources have been developed.

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