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Europe must respond to China’s Belt and Road initiative

Chinese trade

Europe must respond to China’s Belt and Road initiative

Beijing is using the laws of economic gravity and physics to shape the global economy

© Bloomberg

China has just hosted a summit on its Belt and Road initiative, the boldest attempt at economic integration. The massive project of improved sea and land transport links stretching across the Eurasian continent from China to Europe has already lined up nearly a $1tn list of investments, no doubt with more to come. (For a taste of the projects, look up the interactive graphic the FT produced last year on some of the ports, railways, roads and gas pipelines that are part of the initiative.) Despite false starts and investment spending that is currently stalling, President Xi Jinping can safely label the Belt and Road the “project of the century”.

The summit was an attempt by China to drum up support for its plans, and no doubt to coax some co-financing out of the countries it wants to tie together with this new Silk Road. So it is a good time to ask what China, and its potential partners, should expect the Belt and Road to achieve.

One should not rely on a conventional financial return. While infrastructure can be a massive boost to economic productivity, that does not guarantee those involved a satisfactory share of the rewards. It is certainly possible to monetise transport links — and probably easier with ports and pipelines than with roads — but China’s own development finance institution reportedly expects to make losses on many of the projects.

The standard account is that China wants better outlets to offload its excess goods production. But that would be curiously unambitious. As European companies lament, two-way traffic would make better use of new trade routes.

To use a metaphor that is unoriginal but still enlightening, China understands the laws of economic gravity and physics and is doing its best to exploit them to shape the global economy to its liking.

The gravity metaphor is well established in the so-called “gravity models” of international trade, which relate the size of trade flows to the “mass” (economic size) and distance between trading partners. The indisputable finding is that physical distance remains monumentally important in international economics. My colleague Alan Beattie nicely summarised the evidence in an article last year: as a rule of thumb, goods trade falls by half as the distance doubles; more surprisingly, service trade also tapers off with physical distance. This is why as international supply chains have grown over recent decades, the most complex ones are regional more than global. Richard Baldwin, accordingly, has described the “Factory Europe”, “Factory Asia”, and “Factory North America” supply chains at the core of the globalisation economic convergence and economic convergence process in the late 20th century.

As for physics metaphors, the relevant concept is friction. Gravity affects all bodies equally in a vacuum; friction, however, can change the speed at which they fall. So, too, in economics, where the frictions are the costs of trade. These can be physical — in the case of landlocked countries with poor infrastructure, say — and man-made. The most significant man-made trade costs are no longer border tariffs but regulatory, administrative and cultural barriers to doing business across national borders. They remain high.

(An aside: it is a sad fact that the Brexit debate ignores the importance of both gravity — the much greater ease of trade with the immediate geographic neighbourhood than far-flung Commonwealth countries or emerging economies — and friction. The supposedly liberalising move of leaving the EU is in fact set to increase trade costs by erecting a customs border where there is currently none and introducing divergent regulations that are at present harmonised.)

China, in contrast, understands both concepts very well. The Belt and Road aims to overcome the bounds of gravity by reducing frictions, and to use the forces of attraction this unleashes to centre a growing part of global economic activity on China. The ultimate goal is, to echo the Roman empire, that all roads lead to Beijing. That means much more than easier exports for Chinese producers. It means drawing all of the Eurasian land mass, and no doubt more of Africa and the Pacific Rim, into a web of global value chains that would differ from today’s in two ways: their reach would go beyond the current regional chains, and therefore have no equally sized rival; and they will have China as the unipolar central hub.

This understandably raises concerns, especially with Russia as there is an element of “this town is not big enough for two of us”. But it does not need to be nefarious. The infrastructure investments themselves could clearly do a lot of good. The question is whether the Belt and Road is carried out in a way so as to concentrate effective power over global economic relations in Chinese hands.

That will depend on how the rest of the world engages with the project, and above all Europe. As Bruno Maçaes, the former Portuguese secretary of state, has written, the EU needs a conscious strategy for how to act as a power on the Eurasian continent. Having a much more ambitious infrastructure spending programme of its own would be one part of such a strategy, aimed at maintaining Europe as a leading pole of global economic attraction rather than see eastern European countries orient their economic activity eastward as China draws them into its supply chains.

But what matters even more is for Europe to retain influence over the rules by which goods and services flow across borders. This will depend on the success of the EU’s effort to pursue an enlightened deepening of economic globalisation (which we described on Monday). In the end, the “software” of trade will shape what the “hardware” can do. Europeans should know better than anyone that Lex Romana was at least as important for Roman hegemony as was imperial road-building.

Numbers news

  • UK inflation hits a four-year high. The Resolution Foundation calculates that real pay is now falling at a rate it estimates at 0.3 to 0.6 per cent in the three months to April.

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