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Michał Makocki  9 lipca 2019

Chinese generosity may be futile

Michał Makocki  9 lipca 2019
przeczytanie zajmie 12 min

In recent years, China has swiftly expanded into the Western Balkans thanks to its flagship Belt and Road Initiative (BRI): a strategy which, among its many goals, has an objective of linking China with European markets through a network of overland routes. According to the local narrative, China’s key strength is bringing a business-oriented perspective to the region where the West only sees a gunpowder keg. On closer scrutiny, however, such a tale does not live up to reality. The promised benefits of Chinese logistical corridors to local economies seem to be exaggerated.

Thanks to their geographical location, the Western Balkans provide one of the vital links to Chinese plans. These plans play out primarily through the 16+1 format, through which China cyclically meets five Western Balkans countries (except for Kosovo) together with 11 Central European EU Member States. At a time when the EU grows suspicious of China’s geopolitical intentions, China seems to find open doors in the Balkan region. Local governments are also keen to tap into an alternative source of funding without Western demands for difficult reforms. The local attitude in the Balkans, slightly naive in hindsight, was that the officials could draw on any source of modernisation without compromising their professed goal of working towards the EU accession.

But such a rose-tinted approach brushes aside the aberration that the Chinese model of development funding exacerbates in the region, notably corruption and indebtedness. Moreover, Chinese money often comes with political demands, and when the systemic competition between China and the West grows, the balancing act that the Balkans countries try to perform becomes increasingly untenable.

The focus of this article is on the economic aspects of China’s engagement in the region and their local and European repercussions. This report will, firstly, detail Chinese investments and infrastructure projects in the area and describe their rationale. Next, it will sketch out the reply to the question of what makes the Western Balkan countries so interested in the Chinese offer. Finally, the concluding part will offer a European perspective on Chinese activities in the region and the reasons for criticism that they so frequently engender.

China conquers the Balkan construction sites…

Chronic stagnation, together with high youth unemployment, massive emigration and the resulting brain drain all serve as the backdrop to the region’s economic challenges. Bringing a new source of economic prosperity for the region was the key message that China aimed to convey through its 16+1 engagement with the Balkans. Infrastructure projects, new economic and technological zones and Chinese trade and investment missions were all parts of the promise made by the former Premier Wen Jiabao at the summit in Warsaw in 2012 when the cooperation was kickstarted. The message was amplified by the subsequent story of the BRI, which promised new infrastructure development and substantial increases in cargo flows and revenue. It struck the chord particularly among the Balkan states requiring financing for the outdated infrastructure, which has seen little maintenance since the dissolution of Yugoslavia and the wars that followed it. The length of railways in the Balkan countries (relative to their area and population) is about 40 percent shorter than the EU average, and highway densities fall 60 percent short of the European average. The Global Competitiveness Report ranks countries in the region at an average of about 85th place (out of 138 countries) on quality of infrastructure.

Hence the attractiveness of China’s BRI vision which puts the Balkans at the intersection of land and maritime routes linking China with the Black, Adriatic and Baltic Seas. The ports on the seas are supposed to be connected by a vast network of existing and future roads and railways, all to be built and financed the Chinese constructors. Countries in the region compete to serve as a hub for Chinese logistics for further shipments to the continent.

The prospects for China’s regional infrastructure plans rest upon the success of Piraeus in Greece, which serves as an anchor investment, providing logic for several other infrastructure projects meant to connect the harbour with European markets. China has also expressed interest in the Adriatic ports of Bar, Rijeka and Koper in Montenegro, Croatia and Slovenia respectively, and ports on the Black Sea. These harbours would need to be connected by inland connections with European markets. To this end, China is working on linking Serbia with the port of Bar and has expressed interest in expanding railroads linking Koper and Rijeka with Central Europe. Local officials tend to be grateful to China for bringing a fresh, strictly business-oriented perspective to the region and for spotting an economic opportunity. According to their views, China has brought innovative, competitively priced mode of investment funding, which already generates economic growth and delivers projects if not on schedule then without unreasonable delays.

But on closer scrutiny, such a perspective does not live up to the reality. The promised benefits of Chinese logistical corridors to local economies seem to be exaggerated. So far, additional trade flows generated by the Chinese routes are modest. For example, the flagship route from Piraeus to Central Europe serves only one train per day, what amounts to as little as 15,000 containers per year, an amount which would fit on just one large cargo ship.

It generates legitimate excitement from railway operators eager to cash in on increased freight fees, but they will not suffice to finance costly modernisation of outdated infrastructure, or, indeed, help repay Chinese loans. Countries shape their expectations based on Chinese aspirations (which run high) rather than any reliable forecasts. The weak economic fundamentals of the projects are becoming more and more visible as their terms are being revealed to the public. The infrastructure projects may generate insufficient returns and push the recipient countries well beyond the acceptable threshold of debt.

…but fails to deliver on investments…

Similarly, high expectations existed towards Chinese direct investments. But its current capital investments in the local economies are almost negligible. Even in Serbia, the biggest economy of the region, China was only the 11th largest investor in 2017.

China was presented as a solution for the restructuring of heavy industry in Serbia as international institutions were demanding privatisation of inefficient enterprises. The acquisition of the steel mill in Smederevo near Belgrade by a Chinese company was crucial for the survival of the regional economy since the steel mill directly employs more than 5,000 people and is also Serbia’s second-largest exporter.

Apart from that, there have been few notable Chinese direct investments in the country, with the total capital reaching as little as 139 million EUR by 2017. However, the reality might change with two significant purchases announced last year, namely, a 900 million USD tire producing factory by Shandong Linglong in the northern Serbian city of Zrenjanin, and acquisition by Zijin Mining Group of a major stake in Serbia’s biggest mining company, RTB Bor. In the result, China will end up directly employing up to 10,000 people, a potential source of influence on the host government. Apart from Serbia, only Northern Macedonia reported any significant direct investments from China – 37 million EUR in 2016.

How does China compare to the EU?

There are strong perceptions among the local population that China has overtaken the region’s traditional donors and lenders in terms of the volume of the economic opportunity offered. It is mainly because Chinese construction companies tend to focus on large-scale projects, with political dimensions and high visibility, thus inflating the perceived volume of Chinese development aid. In reality, however, the total EU financing in infrastructure and energy sectors, to which Chinese loans are limited, since the 1990s is twice as large as the combined lending by Chinese institutions (6.2 billion euro). When lending by other Western donors and International Financial Institutions (IFIs) is included, Chinese loans are further dwarfed.

Additionally, a large portion of Western financing is given in the form of grants, in contrast to Chinese loans. These will have to be repaid in full together with interest. Chinese capital commitments, as opposed to actual disbursements, to the region may catch up with those of the EU, but as we are going to see in the following section, there are serious doubts whether they will materialise.

When it comes to direct investments, the public perceptions again favour China despite the reality that Western investors are responsible for the majority of all investments in the region. Local government officials tend not to disambiguate between China’s infrastructure loans and direct investments in public, further inflating perceived China’s role to justify their China-oriented policies. It is essential to underline the difference between the two. The first type of investment are loans, which will need to be repaid by the local government. The second are direct investments, where Chinese operators acquire full ownership and take the corresponding risk of the projects. As we have seen above, the latter cases have been less numerous than the former. However, this may change, as this year’s investment transactions in Serbia mentioned above might suggest a stronger willingness of Chinese investors to take direct stakes in local economies. There is also an intense interest in local markets from Chinese IT giants, such as Huawei or Tencent. These companies, often unable to expand in Western Europe, are looking for alternative markets. Their investment, however, may give rise to cybersecurity concerns in the future.

Futile expectations

The expectations that China might be an economic saviour for the stagnant region are misguided. It has primarily been the Western disengagement that has facilitated China’s expansion. The EU’s internal problems and chaotic responses to the migration crisis in the Balkans undermined its credibility in the region. American disengagement and shift of attention to strategic priorities in Asia-Pacific followed. Both trends made the Balkans a contested space where China could easily expand. China sensed its first opportunity in 2012, the start of 16+1 cooperation. Then, the eurozone mired in the crisis, could not support the region’s economic growth.

But the prospects of further Chinese generosity may be futile. As the Chinese economy slows down and the global backlash against the unsustainable model of BRI grows, China will not replace or even match the constant flow of investments and infrastructure funding from Europe.

After the initial flurry of Chinese-funded projects in 2012, the subsequent ones were not forthcoming with equal magnitude, while the EU-funding gradually picked up speed. The extension of the TEN-T network and the attention given to the connectivity at the latest EU-Western Balkan Summit herald a renewed interest in the region’s infrastructure.  Migration crisis triggered significant increases of the regional envelope of the European Investment Bank under the Economic Resilience Initiative and increased guarantees by Western Balkans Investment Fund. It is now being intensified through the new EU strategy for Western Balkans and the Berlin Process.

European responses

The EU has reacted to Chinese activities in the Balkans with an increasing alarm. EU Commissioner Hahn described China as a Trojan horse. Its latest strategic statement labelled the country a systemic competitor. In fact, it is in the Western Balkans, the soft underbelly of Europe, where this competition plays out most visibly. First, China’s presence adds complexity to an already geopolitically sensitive region. Chinese money comes with an expectation that the recipient countries will support Chinese foreign policy objectives, as was the case when China asked local governments for support in the South China Sea.

Similarly, when the EU beefs up its strategic toolbox, notably through security screening of sensitive investments, the Western Balkan governments’ eagerness to brush aside security concerns when easy money is available may create problems down the road, when the countries eventually accede to the EU.

Secondly, Chinese projects adversely affect the prospects for the Western Balkans integration with the rest of Europe. China is pushing its projects in contravention of the EU rules. In the latest example, Chinese sponsored power plant in Tuzla in Bosnia and Herzegovina is in breach of both environmental standards and state aid policy of the EU. It pushes the country away not only from the somewhat distant EU accession but puts in questions even the country’s commitment to the vital pre-accession programmes. It amounts to a China-sponsored alternative to European demands for reforms. Up to 2012, and the start of the Chinese charm offensive, the region had limited options.

Western development aid and pre-accession funds were connected to demands for the rule of law reforms, which are seen locally as undermining the traditional way of doing politics. Additionally, international financing, be it from the EU or multilateral lenders, has strict safeguards which prevent direct awards of contracts to political cronies. China’s soft loans do not carry such limitations and allow for backroom deals and corruption opportunities. China’s offer allows Balkan decision-makers to fuel patronage networks and boost its electoral advantages. To give a perspective: the corruption scandal in 2016 revealed collusion between local politicians and Chinese state-owned companies engaged in the construction of two highways in Northern Macedonia. The new government of Zoran Zaev halted the construction amid allegations that their costs were inflated by more than 100 million euro and was forced to renegotiate with China the terms of the unfavourable agreement. Cost overruns, possibly suggesting corruption, are also connected to projects in Montenegro and Serbia. An investigation by local journalists showed that the award of the subcontracts for the construction of highways along Corridor 11 in Serbia was done without any oversight to politically-linked companies with no prior experience in highway building. Similarly, local politicians seemed to illicitly profit from licensing processes during the construction of Kostolac power plant.

***

China has been warmly welcomed by the Balkan countries, but for one crucial reason, this cosy relationship is bound to change. The accelerating geopolitical competition between the West and China will require a clear stance from the Balkan countries. The region could try to balance different its international partners, but the changed geopolitical situation makes this untenable. With the growing opposition to enlargement among some EU Member States, it is in the interest of the Balkan countries to dispel any doubts about their pro-European orientation and show their readiness to carry out even the politically most difficult reforms demanded by the EU. This means engaging China on European and not on Chinese terms and refusing to accept Chinese money when it contravenes EU rules.