Ever since the announcement of One-Belt-One-Road (OBOR) initiative, countries along the route of the initiatives have shown great enthusiasm towards this plan. However, the key question is: How can China increase the success of OBOR?
Based the viewpoint of transaction costs, which I discussed in my previous blog, we can further translate the above question into: How can China reduce the transaction costs in OBOR?
Coase suggests that he intended “transaction costs” to include the costs of finding a suitable relationship partner. Therefore, in order to increase the success of OBOR, China needs to adopt a mechanism with the lowest transaction costs. Specifically, this mechanism should vary among the trading countries with different types of transactions, and it should benefit not only China but also other trading partners. Since every country sets out to pursue its own interest, a trading mechanism that offers mutual benefits to all parties is the only way to achieve equilibrium in the long run.
When considering whether or not to form a relationship with another country inside OBOR, China should consider the following factors:
1. Geographic locations: Although the role of spatial transaction costs has been reduced by modern technologies such as the internet, it remains significant in the real economy. Because OBOR spans across many countries in Asia, Europe and Africa, spatial transaction cost will become an important consideration.
In recent years, China has been aggressively investing in infrastructures in the six economic corridors in the Belt and Road. The reduction in spatial costs can activate many transactions within the OBOR regions.
Taking Gwadar Port in Pakistan for example, the China-Pakistan railway can directly connect the Far East (China, Japan and South Korea) with the Middle East, South Europe and North Africa. Otherwise, the Far East has to make a long detour around the Strait of Malacca.
2. Political environment: Unlike geographic factors, political factors are very complicated, which has to take into account political friendliness, efficiency and uncertainty. In the long-term oriented OBOR plan, different countries should fall into different pecking orders. Let’s take a look at each of them closely.
2.1. Political friendliness: To ensure the success of OBOR, China should focus on its allies, such as Pakistan, Mongolia and Russia, rather than countries such as Japan and Vietnam. Doing business with friendly countries would be smoother, with less implicit costs than unfriendly countries.
2.2. Government efficiency: It will be more efficient for China to sign contracts with dictatorial countries than with democratic countries. Dictatorial governments are more efficient whereas in democratic countries, decisions are made by many parties which take a lot more time. This is why negotiation costs with dictatorial countries are much lower than in democratic countries.
2.3. Political uncertainty: There is no doubt that every country should invest less in politically uncertain regions where deals and contracts can easily become invalid when the authority changes. Moreover, the expected return in these uncertain regions is extremely hard to forecast.
Pakistan and Myanmar are two good examples. They share some geographic similarities: both countries lie within the OBOR regions and there is a railway running between each of them and China. If successfully built, it can greatly reduce the spatial costs between the Far East and the West.
However, the two have very different political relationships with China: Pakistan is friendly to China, with a dictatorial government and politically stable. The priority of Pakistan in the OBOR plan should be credited to the favorable political environment. As Mushahid Hussain Syed, Chairman of Pakistan-China Institute and Secretary-General of Pakistan Muslim League, said at a CUHK Conference on One Belt One Road: “Pakistan has been a very old and the best friend of China. It is a very resilient relationship.”
On the contrary, in Myanmar, anti-Chinese sentiment is on the rise. Also, significant political, economic and social changes are taking place. The unfavorable political environment could cause unpredictable huge losses to the OBOR projects. One example is the first phase of Myitsone Dam project funded by a Chinese company with US$3.6 billion but was suddenly suspended in 2011 by the new government.
3. Types of transactions: China should sell/buy different goods or services to/from different countries. Specifically, China is selling infrastructures and technologies to developing countries within OBOR. But this kind of goods or services is unnecessary with developed countries, as the transactions can be carried out directly via the market rather than through OBOR. For example, if German wants to trade its advanced technologies to China, it should do so in the market rather than relying on the OBOR plan, which will take too long.
Finding the Right Market
The OBOR plan, if successful, can tie the region’s economies closely, and increasing China’s global influence in the world. That is probably why China has been promoting the plan so aggressively. However, in the end, its chance of success depends on whether there is a market for transactions among OBOR members. For China, its focus should be on “who need China most”. With the right market, China can then focus on choosing the right mechanism to achieve the lowest transactions costs.
This article was published with permission from China Business Knowledge at CUHK Business School.