I listened to an episode of the McKinsey podcast yesterday about China’s One Belt, One Road initiative. What is One Belt, One Road (OBOR)? A combination of land- and water-based trade passages that will help Chinese companies find foreign customers. It’s a modernized version of the Silk Road of antiquity.
OBOR as an important relic of the “old” economy
The OBOR effort immediately reminds me of a post Ben Thompson recently published at Stratechery. Thompson contrasts the “old” economy with the “new” economy. In the “old” economy, businesses relied on governments to open international markets and protect trade channels. In the “new” economy, with technology at the center, markets are open by default. Government interference is less necessary, and less desirable.
The OBOR initiative is a great example of why the “old” economic order will never vanish completely. While technology-driven economic activity is increasing, the global economy is still predicated on physical exchanges of goods. And as countries continue to develop, and begin to saturate their domestic markets, they will increasingly seek ways to connect their businesses with foreign markets. In this sense, global trade is part of the natural evolution of maturing economies.
If there’s one thing the Chinese government does to help its economy…it’s invest in infrastructure. You have the high-speed rail network. You have the world’s longest bridge. You have one of the world’s largest space programs. And you have OBOR.
The cost of public infrastructure investment
But all this investment has a price. A part of that price is the destruction of the global steel industry. What do rail systems, bridges, space programs, and trade routes all require? Steel. What happened? As soon as the pace of infrastructure investment slowed, the world was awash in steel…primarily Chinese steel. That means steel prices fell through the floor, and steel manufacturers had a tough time staying in business.
(We had a similar story with copper.)
The steel story shows one part of the delicate relationship between business and government. In a market economy, the laws of supply and demand dictate pricing, volume, and the ultimate success of businesses. Government can put its thumb on the scale, perturbing market forces in ways that advantage some businesses, and disadvantage other businesses. Haphazard or inconsistent government action (or inaction) can introduce substantial market turmoil.
Infrastructure investment is one way the government can throttle demand. The government wants to build more railways and bridges, so it needs more steel. Naturally, more steel suppliers emerge, or existing suppliers ramp up their capacity. Then, when government pulls back on its own demand, or private demand relaxes in the face of government intervention, you have an oversupply problem.
When facing oversupply, it’s not like the suppliers immediately vanish. It takes a while for a company to go out of business. Take an asset-heavy steel manufacturer, and their only hope is to keep producing, praying that market forces equalize quickly, in a favorable way. (This is story is not unlike what’s happening with crude oil, something I’m familiar with from my day job.)
Infrastructure investment as a way to open new markets
We just described how infrastructure investment can distort existing markets. It’s important to recognize the flip side, though…how infrastructure investment can open new markets. OBOR is a great example.
OBOR is an international example of what many countries first do domestically. As connections between people increase, frictions in the market decrease. It’s a pretty simple idea. Businesses have to connect with their customers. It’s the only way to execute a transaction. In today’s world, we’re increasingly familiar with electronic connections. There’s still an enormous amount of activity, though, that relies on physical connection.
Many countries, as they develop, focus on transportation. It’s the way we get people and goods from one place to another. What do you need for commerce? A robust monetary system. A robust legal system (for mediating disputes). And a robust way to connect buyers and sellers, either physically or electronically. The systems that enable connections are where governments tend to focus their investment dollars.
Why OBOR is China’s next step
Why OBOR? Why move from domestic investment, like rails and bridges, to international investment?
The short answer: China’s economic growth is slowing. Domestic investment dollars aren’t yielding the same return they used to. That’s not a huge surprise. No economy can sustain double digit growth rates indefinitely. China realizes that to continue to grow more quickly than the global economy, it needs to open new markets. Even though it has a population of 1.4 billion people, it needs access to other nearby economies.
The OBOR initiative will more deeply connect China with Asia, Europe, the Middle East, and Africa. It’s difficult to understate how transformative this kind of network could be. There are immense political challenges involved, as referenced during the McKinsey podcast. Still, China’s government is doing what any business community would want: combating the obstacles to doing business internationally. Further, China is building connections to many up-and-coming economies that should fuel substantial future growth.
The delicate relationship between government and business
It’s election season in the United States. We’re hearing plenty of talk about the relationship between government and business. Even something as simple as infrastructure investment should make clear how nuanced this relationship actually is. Government action isn’t always the right answer. Government inaction isn’t always the right answer.
The right answer is collaboration. Government has a role to play. Government can open doors to new markets, doors that require political maneuvering. Government can accelerate demand for critical goods and services that benefit the economy as a whole. Government can design and enforce regulatory frameworks that inspire confidence in both buyers and sellers.
China and the United States are following very different paths in the area of infrastructure investment. No one path is perfect. Risks abound. Still, we need to find ways for government and business to reliably work together. Hopefully OBOR is a positive example that the world can follow. Our global economic growth could sure use the boost.