Journey to the West: Chinese opportunities in European infrastructure expansion

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Maximilian Gebhardt explores the implications and challenges of China’s Belt and Road Initiative (BRI) for European Union infrastructure investments in the latest issue brief from the Atlantic Council’s Future Europe Initiative: “Journey to the West: Chinese Opportunities in European Infrastructure Expansion.”

As the European Union aims to deepen integration, particularly in the field of infrastructure, “it is necessary to understand those goals from a Chinese context, especially in light of China’s [BRI] infrastructure project,” writes Gebhardt. He explains that the BRI, with its emphasis on the role of the Shanghai Cooperation Organization (SCO), could provide incentives to promote geopolitical alignment, particularly in creating a security sphere in Central Asia. Before any realization of the grand dream of ‘One Belt, One Road,’ however, there are a number of issues that need to be taken into consideration–from the lack of a successful precedent for Chinese-built or Chinese-financed transport projects in the EU to date to the possibility of the EU supporting the BRI’s southern route which would go through Hungary, Bulgaria, Turkey, Iran, and Pakistan.

Given the “the economic reality . . . that China and Europe are already deeply interconnected” and more Chinese firms pushing to enter the EU transport and infrastructure procurement market, Gebhardt argues the European Union must develop a clear plan forward for meaningful and specific engagement with China’s BRI goals

Introduction

Brexit and the rise of Eurosceptic parties now pose an existential threat to the European Union (EU), and the natural response of the European Commission (EC) should be to strengthen the EU and support deeper integration, particularly in infrastructure. The Atlantic Council’s 2014 Completing Europe¹ publication produced an in-depth analysis of the future of infrastructure integration in Europe, but it is necessary to understand those goals from a Chinese context, especially in light of China’s Belt and Road Initiative (BRI) infrastructure project. the “Belt and Road Initiative” (BRI), previously known as “One Belt, One Road,” seeks to improve overland transport infrastructure to interconnect China and Europe through a land trade route and enhance maritime transport infrastructure to support existing sea trade routes. The project is especially ambitious in scale, although it suffers from a lack of articulated, specific goals as is common in many large Chinese projects. What China has put forward is an ambitious plan to invest and finance infrastructure projects to create an overland “Silk Road Economic Belt” that will connect China, Central Asia, Russia, and Europe, and a “Maritime Silk Road” that will connect China, South Asia, Africa, and Europe by sea.

In the long term, China has promised support for projects across Asia, Europe, and Africa, committing to put billions of dollars into investment vehicles like the Silk Road Fund and the Asian Infrastructure Investment Bank (AIIB), which could potentially underwrite the creation of BRI through strategic investment. New capital provided via these channels may be leveraged by EU member states to finance infrastructure projects of national interest—including projects that the EU is willing to co-fund and those that the EU declines to fund. China has also emphasized the role of the Shanghai Cooperation Organization (SCO) in strengthening intergovernmental cooperation on infrastructure and infrastructure policy. This is especially interesting considering the SCO’s focus on security in Central Asia, showing China’s interest in making the SCO seem different from traditional organizations like NATO by emphasizing goals beyond security. BRI and its related investment infrastructure can be seen as an incentive to promote geopolitical alignment with the SCO and major power SCO members Russia and China rather than the EU or Russia’s Eurasian Economic Union.

In the medium term, there are legitimate economic reasons for China to link BRI with EU infrastructure goals—Chinese firms are increasingly looking internationally for projects and procurement opportunities as Chinese domestic construction demand wanes. The EU presents a major market for Chinese firms seeking to win construction and procurement contracts. Some Chinese-backed infrastructure projects already are underway, such as Chinese investment in the port at Piraeus, Greece, and Chinese investment into a nuclear reactor expansion in Romania and the United Kingdom. In the past, however, Chinese infrastructure projects have encountered high profile failures, such as the attempt of a Chinese company to construct the A2 highway in Poland by undercutting local competitors.

Chinese firms will certainly begin to play a more significant role in the EU infrastructure market; however, it will be important to see whether that role is one of cooperation with EU investment and development interests, or one of support for projects in conflict with those interests. Of particular interest is a proposed $2.9 billion Chinese investment in high speed rail infrastructure between Belgrade and Budapest that would move towards completing a modern rail link between Piraeus and more developed EU states. Hungary and Serbia have emphasized the importance of the project and the EU has made it clear that the corridor is not a priority for the EU—this project in particular may be an early litmus test as to China’s role going forward.

One Belt, One Road: The Grand Dream

China’s dream of interconnecting Eurasia through One Belt and One Road may be promoted with rhetoric steeped in the historical story of the Silk Road, but the economic reality is that China and Europe are already deeply interconnected. According to the EC, China is the EU’s second largest trading partner after the United States and the EU has become China’s number one trading partner.² While this is primarily maritime trade, rail traffic has flowed overland between China and the EU reliably since 2008, mainly along the venerable and well-traveled Trans-Siberian Railway. BRI’s major infrastructure investments would grow trade between China and Europe, as well as Central Asia, by enhancing transportation infrastructure to reduce the cost and time needed to get Chinese goods to Europe. Current sea routes take roughly thirty days to bring goods from coastal China to Hamburg, while the first Chinese direct freight train from Beijing to Hamburg in 2008 managed to complete the route in fifteen days.³ Although rail transport between China and the EU has grown, significant investment will be needed to boost rail capacity for overland transport. Deutsche Bahn (DB) and China Railway (CR) are jointly looking at new routes to develop, under the auspices of BRI, to reduce transport times and boost capacity to one hundred thousand containers of rail traffic a year between China and Germany by 2020.⁴

To accomplish this, China publicly committed to providing $40 billion in funds through a Silk Road Fund at an Asia-Pacific Economic Cooperation meeting in November 2014. The Silk Road Fund was set up in December of that year, and the first announced project backed by the fund was Chinese investment into Pakistan’s Karot hydropower project in April 2015.⁵ Additionally, China has emphasized the role of AIIB in promoting BRI, which officially opened in 2016 with a $100 billion capital cap, half of which China has committed to provide.⁶ Chinese officials have encouraged cooperation between the EU, European Bank for Reconstruction and Development, European Investment Bank, and other international financial institutions to achieve the aims of BRI, which the EU and European Commission have echoed with the creation of the EU-China Connectivity Platform in January 2016.⁷ China also publicly committed to contribute to the EU’s Investment Plan for Europe, although no fixed amount of contribution has been set.⁸

Beyond simply providing capital for investment in regional projects of interest to BRI, the SCO has been specifically tasked with supporting BRI by fostering regional coordination on infrastructure development. At a heads of state meeting of the SCO in 2016 in Tashkent, Uzbekistan, Chinese President Xi Jinping called on the SCO to “play an active role in integrating the ‘Belt and Road’ initiative with the development strategies of all member states.”⁹ The SCO has gone beyond discussion of transport and infrastructure cooperation, creating an Agreement on International Road Transportation Facilitation that all SCO members agreed to and that entered force on January 20, 2017. Of particular interest is that the agreement harmonizes regulations and allows vehicles registered and approved for road transport in one SCO member state to operate in the territories of all other SCO member states.¹⁰ This is critical to enabling effective overland trucking from China to destinations in Central Europe and potentially as far as Western Europe. With India and Pakistan having officially acceded to the SCO in June 2017, there is the potential to allow for easier overland trucking from China through Pakistan and onward by sea to Piraeus, avoiding the treacherous Strait of Malacca. However, the main thrust of President Xi’s speech to SCO heads of state was continuing the SCO’s focus on being an effective organization on security issues such as anti-extremism and drug control.¹¹

Military leaders in the People’s Liberation Army—and by extension China as a whole—have long taken the view that American military bases and alliances in Asia are specifically positioned to contain China. Chinese championing of the SCO, and in particular the emphasis on creating a security sphere in Central Asia, can be seen as an effort to secure Chinese security interests on their western borders and counter this perceived containment strategy. The SCO specifically called for the United States to provide a timeline for the closure and withdrawal of American forces from KarshiKhanabad Air Base in Uzbekistan and Manas Air Base in Kyrgyzstan on July 5, 2005, in one of the earliest public actions taken by the SCO to assert its focus on security in the region.¹² It is important to monitor both the development of the SCO and development of BRI as the two are symbiotically linked—development of BRI is supported by the SCO and expanding SCO membership is used to grant new members greater access to Silk Road Fund and AIIB investments earmarked for BRI.

One internal dynamic within the SCO that is also helpful for understanding BRI and potential EU cooperation with BRI goals is the relationship between Russia and China, particularly differences in the economic space. SCO is primarily a security-focused organization in which Russia and China have ostensibly equal standing. China and Russia both see the presence of American military forces in Central Asia as a security challenge; however, Russia’s Eurasian Economic Union and China’s interest in using the SCO to champion BRI and its economic goals are potentially in competition. While China pressed for a free trade zone within the SCO at the latest SCO meeting of heads of government in November 2016,¹³ Russian Prime Minister Dmitry Medvedev’s statement seemed to deflect China’s thrust for creating a free trade zone.¹⁴ An SCO free trade zone where China and Russia are equals in the SCO would be at odds with the single-market Eurasian Economic Union, in which China is, notably, not a member.

The five year plan

From a volume perspective, only thirty thousand containers move by rail between China and Europe per year, and even DB’s expectation to more than triple that to one hundred thousand containers by 2020 is insignificant—the largest container ships can carry twenty thousand containers and the combined top twenty EU ports handled seventy-four million containers in 2015.¹⁵ In the next five years, sea routes will continue to dominate EU-China trade, and infrastructure supporting those routes is critical for BRI. Following the China COSCO Shipping Company’s buyout of operations at Piraeus, COSCO announced that it will invest €500 million ($553 million) to improve operations at the port, specifically citing the investment as a component of BRI.¹⁶ Rail infrastructure between Greece and the rest of the EU is outdated, with only a single rail connecting Belgrade and Budapest that cannot support high speed rail. China had targeted the Budapest-Belgrade link as the first major step in a process to upgrade rail infrastructure between the heart of Europe and Piraeus, planning to invest some $2.9 billion to upgrade infrastructure.

Chinese investment in overseas projects is a priority not only to support existing trade routes, but also to promote Chinese entry into overseas markets, which have become increasingly important for Chinese construction firms. According to Zhang Xingfu, deputy director of the Foreign Investment and Economic Cooperation Department in China’s Ministry of Commerce, overseas contracts for Chinese firms in 2016 totaled some $244 billion, 51 percent of which are for construction projects that support BRI.¹⁷ While overseas contracts amount to just over 9 percent of the total Chinese construction market, these contracts are a priority for China both from a prestige standpoint and from the perspective of continued economic growth.

China General Nuclear Power Corporation (CGN) aims to have non-Chinese projects account for 15 percent of revenue by 2020; it has already invested heavily in the EU, holding a large stake in Britain’s Hinkley Point plant and a majority stake in a joint venture to expand Romania’s Cernavodă plant.¹⁸ CGN will participate in the construction of the new reactors in Romania, although the technology and design to be used is not Chinese. In the transport sector, DB has voiced interest in using Chinese-made rolling stock and potentially cooperating with CR on rail projects in Europe, adding that it expects China will invest €300 billion ($320 billion) in transport infrastructure.¹⁹ All of this matches with both BRI and the older Go Out policy, which was launched in 1999 to encourage Chinese firms to compete globally.

Here and now

Chinese firms seeking to enter the EU market will encounter a steep learning curve. There are no major Chinese-built or Chinese-financed transport projects that have succeeded in the EU to date, and the majority of China’s overseas experience in the space is either in the developing world where regulations are less stringent or as the supplier to established construction firms in the EU and United States. Chinese firms are used to operating in China where the Chinese government ensures a strong home-field advantage for domestic firms participating in infrastructure projects, or overseas in countries like Congo and Kenya where governments are willing to bend regulatory rules to accommodate large Chinese firms. The EU public procurement market, by comparison, has stringent oversight and competition rules that will not change for Chinese firms.

The most high-profile Chinese-led European project, an attempt by China Overseas Engineering Group Company (COVEC) to build a thirty-mile stretch of highway in Poland, ended in failure.²⁰ COVEC won a public tender to construct thirty miles of the A2 highway between Lodz and Warsaw underbidding the competition with a bid of $450 million, far lower than the $900 million cost that Poland expected. COVEC quickly found that it underestimated the regulatory hurdles of building in the EU and also underestimated the willingness of local subcontractors to support construction. Eventually COVEC was forced to abandon the project after failing to pay subcontractors, falling far behind schedule, and notifying the Polish government that the project could not be completed without an additional $370 million in funding, prompting Poland to fire COVEC and hire a European firm to complete the project.

The Budapest-Belgrade railway is a significantly larger project at $2.9 billion; however, the project may already be in jeopardy. While Hungary, Serbia, and China made incremental progress moving China to finance the process, the Financial Times reported in February that the EU was investigating the project and was prepared to launch infringement procedures as Hungary had failed to provide a public tender for the $1.8 billion section of rail to be constructed in Hungary.²¹ An EU investigation into non-public tenders is a familiar problem in Hungary; however, a failure or delay of this rail project would be a dark omen for Chinese firms entering the EU infrastructure market. This project would also be the first project funded by the ExportImport Bank of China following China’s announcement that $10 billion in financing would be made available through the Export-Import Bank for projects in Central Europe. Success would open the door to future investment in infrastructure projects in the region while even a delay could mean the next Chinese-attempted entry into the transport infrastructure market would be after 2020. Hungary’s most recent major infrastructure clash with the EU, an infringement investigation into the Paks Nuclear Power Plant expansion that also was awarded without public tender in January 2014, resulted in the EC finally approving the project in March 2017. While this might seem like a positive sign for China, guaranteeing the success of the BudapestBelgrade railway, a three-year delay would mean that ground would not be broken on this new railway before 2020, which would be a major blow to the prestige of Chinese entry into the market.

Chinese interest in pushing this project forward should not be underestimated. Not only is this rail project key to completing a connection between Piraeus and the core EU rail network, it is also a critical piece of rail needed to support a proposed southern rail line stretching from China through Iran and Turkey and into Europe, bypassing Russia’s Trans-Siberian Railway entirely. Creating a Chinese-built high speed rail link equal in length to Russia’s Trans-Siberian Railway would be a major engineering achievement for China. In the past, China has moved swiftly past setbacks and failures. Only two years after CR introduced high speed rail in 2009, 2011 saw both a high profile removal of CR Minister Liu Zhijun over corruption and a high speed rail accident in Wenzhou that killed forty and triggered a widespread public response questioning the safety of CR’s rapidly expanding high speed rail network. Despite an initially botched public relations response, CR pushed ahead and currently boasts more operational high speed rail track than the rest of the world combined.²²

Conclusions

China has made it clear that Chinese firms will enter into the EU transport and infrastructure procurement market, and the EU has made commitments to ensure that all firms are given equal chances to compete on tenders for public procurement. While safety and quality have been stumbling blocks in the past, Chinese rail, road, and infrastructure projects have improved quickly and substantially, and dismissive broad claims that Chinese infrastructure would be unsafe or inferior are outdated and naive. In the transport sphere, China has gone from using imported high speed rolling stock to transferring technology and building locally, to finally producing indigenous designs. Similarly, in the energy sphere, China has developed adaptations of nuclear plant designs specifically for export. On that front in particular, Chinese firms have realized that their Achilles’ heel in breaking into foreign markets can be overcome by using joint ventures to make initial inroads. China’s State Nuclear Power Technology Company has partnered with Westinghouse for just that purpose to provide lower cost Westinghouse-designed AP1000 reactors with Chinese-made parts for foreign markets. A similar approach might serve new projects in the EU to avoid another failure along the lines of the Polish A2 highway project.

Cooperation with non-Chinese firms is not the end goal of Chinese industries; as China increases its involvement in the European market, European firms may find their pinnacle position in their local markets under direct threat. Chinese state-owned banks and state-owned construction firms can cooperate in a way that European firms cannot to provide advantageous financing that undercuts competing bids. However, any promises of localization will need to be considered carefully. After all, while the EU infrastructure market is open to Chinese firms, China continues to exhibit protectionist control over its infrastructure market. There is no reason why Chinese firms would not take a similar approach to keeping domestic EU firms from profiting from Chinese-financed contracts in Europe.

Politically, Chinese entry into the EU market may feed back into the same Euroscepticism that drives deeper EU investment into deeper intra-EU infrastructure ties—causing well-intentioned EU investment to unintentionally further destabilize the European experiment.

So far the EC has expressed only a general willingness to work with China and BRI; however, there is no clear framework for what goals the EC hopes to achieve. Similarly, China’s BRI seeks only to connect to Europe— the EC must take the lead and produce clear goals for EU-China cooperation on BRI if it hopes to ensure that BRI projects also meet EU goals, as China has no incentive to do so on its own. The EC must begin to evaluate transport corridors with EU neighbors. It is simply not sustainable in the long run to focus only on intra-EU transport corridors.

The most difficult decision that the EC will face is whether to support BRI’s southern route, which would involve developing a rail interconnection and infrastructure corridor between Hungary, Bulgaria, Turkey, Iran, and Pakistan. While improving EUTurkey interconnection is already politically difficult considering Turkey’s constitutional referendum and continued democratic backsliding, connecting to Iran will be significantly more difficult for Europe, while China has no similar domestic political concerns with partnering with Iran and Turkey. Similarly, BRI envisions pipelines and energy projects along the route. Bypassing the Trans-Siberian Railway may be safely supportable, but EU support for bypassing Russian oil and gas by building infrastructure ties directly to Iran and the Middle East will certainly provoke a major Russian response.

Recommendations

The EC must develop a clear plan forward for meaningful and specific engagement with China’s BRI goals, and that plan must also specifically address the Budapest-Belgrade railway in addition to identifying priority EU transport and infrastructure routes that align with BRI goals. Above all, the EC must ensure that it abandons the illusion that withholding EU funds or adding bureaucratic hurdles will prevent or change a proposed BRI project. There are some categories, such as the lack of reciprocal access to the Chinese market for EU firms, where the EC can legitimately push back on Chinese entry into the transport infrastructure market. In most other cases, while politicians might cite safety concerns, the EC and EU regulatory authorities must be careful to use only evidence-backed reasons to delay Chinese projects, and even then they must ensure that they first attempt to move Chinese firms into compliance with existing regulations rather than engage in base protectionist blocking of projects. Politically, this will be difficult as there will be substantial domestic political pressure to use regulations in a protectionist manner.

In the case of the Budapest-Belgrade railway, the EC must focus on engaging the Chinese directly to ensure that they approach the project in a transparent and legal manner, rather than allowing the Hungarian government to turn this into another fight between the EU and Hungary for domestic Hungarian political purposes. Generally, Chinese companies and the Chinese government strongly value public showings of corporate social responsibility, and engaging the EU market directly in a transparent manner in conjunction with the EC would meet that aim.

More to the point, the EU’s long, complex dialogue with China on BRI development would benefit from consultative cooperation with all stakeholders. The EC would see a multitude of benefits from funding deeper analysis and research into the implications of BRI on the EU, both politically and economically, especially as EU-China Bilateral Investment Treaty negotiations are ongoing. Such research would need to include viewpoints from the EU—as well as those from China, Russia, Central Asia, the Middle East, and the United States—and incorporate both a high-level picture of China’s relationship with the EU and a more granular region-by-region view. The EU’s greatest strength is its ability to provide a venue for open discussion, and it is high time that it gives BRI and interaction with China on EU development an appropriate level of focus.

Maximilian Gebhardt is the CEO and Principal Consultant of Golden Horizon LLC, providing regional analysis and business support in Central and Eastern Europe and China for private clients. Prior to this, he served as a career diplomat and economic officer for the Department of State from 2010 to 2015, where he was posted to China and Hungary and specialized in trade and investment issues, counter-corruption, and counter-fraud.

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