Corporate Concentration, Intellectual Property Rights, and US Public Policy

Dominant corporations have dramatically increased their market power in the US over the last decades, allowing them to boost their profits and, by extension, political power. And, although rarely acknowledged by the media, this trend owes much to the way public policy has promoted corporate intellectual property rights at the public expense.

The growing concentration of market power

Gwynn Guilford, drawing on a study published in the Journal of Economic Perspectives, highlights the growing concentration of market power with the aid of the following charts.

The first chart shows that while 109 public corporations captured half of the total profits earned by all public corporations in 1975, that number fell to just 30 by 2015.  And as the second chart reveals, this growth in market concentration is reflected in other key market indicators as well, such as control over assets, cash flow, and cash holdings.

A recent International Monetary Fund working paper provides additional evidence of the growth in corporate market power, highlighting the ability of leading corporations to markup their prices and increase their profit share.  Defining market power as “the ability of a firm to maintain prices above marginal cost—the level that would prevail under perfect competition,” the authors of the IMF paper “estimate markups between prices and marginal costs for publicly traded firms in 33 advanced economies and 41 emerging market and developing economies from 1980-2016.” According to the authors, “this is the first study . . . to report firm-level markups for such a broad range of economies over such an extended period.”

The figure below shows a dramatic increase in markups by US publicly listed firms, which means that US firms have enjoyed growing power to push up their prices relative to their costs of production.

As the authors report:

markups of U.S. firms have increased by a sales-weighted average of 42 percent during 1980-2016.  Markups increased across all major industries, and not only technology ones, with the sales-weighted average increase ranging between 7 and 137 percent for the 10 broad FTSE/Dow Jones Industrial Classification Benchmark industries available within Thomson Reuters Worldscope.

Some industry subsectors, especially those in Health Care, like Biotechnology and Pharmaceuticals, have seen extreme increases (as shown in the following figure).  “The sub-sector featuring the largest increase in markups over this period (by 419 percent) is ‘Biotechnology,’ part of the ‘Health Care’ industry.”

An IMF blog post commenting on this study notes:

The growing economic wealth and power of big companies—from airlines to pharmaceuticals to high-tech companies—has raised concerns about too much concentration and market power in the hands of too few. In particular, in advanced economies, rising corporate market power has been blamed for low investment despite rising corporate profits, declining business dynamism, weak productivity, and a falling share of income paid to workers.

The role of public policy in promoting market concentration, profits, and power

Public policy, in particular, government efforts to promote and protect corporate intellectual property rights (e.g. patents and copyrights), is one reason for the trend in market concentration.  As Dean Baker, co-director of the Center for Economic and Policy Research, explains:

Patents, copyrights, and other forms of intellectual property are public policy. They are not facts given to us by the world or the structure of technology somehow. While this point should be self-evident, it is rarely noted in discussions of inequality or ways to address it.

[And] there is an enormous amount of money at stake with intellectual property rules. Many items that sell at high prices as a result of patent or copyright protection would be free or nearly free in the absence of these government granted monopolies. Perhaps the most notable example is prescription drugs where we will spend over $420 billion in 2018 in the United States for drugs that would almost certainly cost less than $105 billion in a free market. The difference is $315 billion annually or 1.6 percent of GDP. If we add in software, medical equipment, pesticides, fertilizer, and other areas where these protections account for a large percentage of the cost, the gap between protected prices and free market prices likely approaches $1 trillion annually, a sum that is more than 60 percent of after-tax corporate profits.

The US patent system has helped boost the monopoly power of many of the country’s most profitable firms in numerous ways.  For example, the government has increased the duration of both patents and copyrights.  Even more importantly, the government has steadily expanded the scope of what can be patented to “include biological organisms, software, and business methods.” This expansion has enabled corporations to lockup an ever-growing number of products and processes, and force other companies to pay them for their use.

US laws also generally privilege patent and copyright holders when it comes to challenges.  For example, a company that feels its copyright is being infringed can sue not only to reclaim lost royalty payments but also for damages, which can greatly increase the financial stakes.  In addition, the government often prosecutes copyright cases criminally, turning a possibly small financial violation into a potentially major criminal offense.

Baker offers another example of the one-sided nature of the US intellectual property rights regime:

the Digital Millennial Copyright Act of 1998 holds third parties potentially liable for infringement. In order to protect themselves from liability, a web intermediary has the responsibility for promptly taking down allegedly infringing material after being notified. This effectively requires an intermediary to take the side of the person alleging infringement against their customer or friend. By contrast, the law in Canada simply requires that the intermediary notify the person posting the alleged infringing material, after which point they have ended their potential liability.

Perhaps even more revealing of the pro-corporate nature of government policy is the fact that government spending has often financed the innovations that private firms then patent and benefit from.  Considering prescription drugs again, the US National Institutes of Health spends approximately $37 billion a year on biomedical research.  Other government agencies, such as the Centers for Disease Control, spend smaller but still significant amounts.  But, following the passage of the Boyh-Dale act in December 1980, the government, as Baker explains, has allowed “researchers on government contracts to gain ownership rights to their research. This meant they could get patents or other types of protection on work for which the government incurred much or all of the cost. While Bayh–Dole applied to all types of research supported by the government it had the largest impact on the market for prescription drugs.”

Paris Marx offers another example of this public subsidization of private profit-making, noting the ways public research provided key discoveries that made possible the success of the iphone:

Steve Jobs may have been a genius—he certainly had an eye for design—but his most successful product would not exist if it weren’t for the billions of dollars that the US government spends every year on research and development. The best accounting of this has been done by Mariana Mazzucato, author of “The Entrepreneurial State,” who skillfully explains that touch-screen displays, GPS, the Internet and even Siri were the product of public research funding—features the iPhone wouldn’t be very compelling without.

And that’s not to say that Apple should get no credit for the revolutionary product it created. The company assembled those technologies in a compelling package and has developed many of its own innovations to enhance it along the way. But that doesn’t change the fact that the fundamentals wouldn’t exist without the government.

And here is yet another example from Mazzucato:

we continue to romanticize private actors in innovative industries, ignoring their dependence on the products of public investment. Elon Musk, for example, has not only received over $5 billion in subsidies from the US government; his companies, SpaceX and Tesla, have been built on the work of NASA and the Department of Energy, respectively.

Recognizing the value of strong private industry-protecting intellectual property rights, leading corporations have been pushing their respective governments to demand tougher rights as part of new trade agreements, making this a global problem.  Here is what the United Nations Conference on Trade and Development has to say:

Paradoxically, even as tangible barriers to trade imposed by governments, such as tariffs and quotas, have been declining over the last 30 years or so, intangible barriers to competition rooted in “free trade” treaties and erected by large firms themselves have surged, as they exploit the increased legal protection of intellectual property and the broadening scope for intangible intra-firm trade. According to some estimates, intangible assets may represent up to two thirds of the value of large firms. . . .

Returns to knowledge-intensive intangible assets proxied by charges for the use of foreign IPR rose almost unabated throughout the [global financial crisis] and its after­math, even as returns to tangible assets declined. At the global level, charges (i.e. payments) for the use of foreign IPR rose from less than $50 billion in 1995 to $367 billion in 2015. . . .

The rise of intangible barriers that further distort competition, increase corporate leverage and foster monopolistic rents has been partly supported by changes to domestic laws in many countries. But international treaties may have been even more significant, such as double non-taxation agreements and new generation trade agreements that include provisions strengthening the protection of IPR, foreign investment, etc.

The US government has been one of the most aggressive governments pushing this international expansion of restrictive intellectual property rights. The recently negotiated US-Mexico-Canada agreement is, as Peter Dolack describes, a prime example:

It appears that corporate wish lists for intellectual property, financial services and other areas were largely granted. New IP rules, if this agreement is passed into law, include stepped-up enforcement against “camcording of movies” and “cable signal theft,” as well as “Broad protection against trade secret theft.”

The IP rules would extend copyrights to 75 years, long a U.S. demand (and one opposed by the Canadian government); increase pressure on Internet service providers to take works alleged to infringe copyrights (in actuality a tool for censorship); and provide for “strong protection for pharmaceutical and agricultural innovators,” which can be presumed to be code for enabling further medicine price-gouging and crimping accessibility to generic and cheaper alternatives. The last of these was a prominent U.S. goal for the Trans-Pacific Partnership, which, inter alia, sought to eliminate the New Zealand government’s program to provide medicines in bulk at discounted prices at the behest of U.S. pharmaceutical companies. Related to this is a measure to include 10 years’ protection for biologic drugs and an expansion of products eligible for “protection.”

We need a different public policy

In short, it appears that the existing IPR regime has largely helped to promote monopoly power, higher prices, and greater inequality, and at the public expense.  We need a new policy, and, setting aside the daunting political obstacles to change, it is easy to see possibilities for a different and more publicly spirited policy.

For example, we could reduce both the scope of what is patentable as well as the length of patents, thereby weakening monopoly power and promoting lower prices.  And likely at little “economic” cost. Patents and copyrights are supposed to encourage innovation and productivity gains.  Yet, as Baker notes:

A cross-country analysis assessing the impact of stronger protections on productivity growth found no evidence of a positive relationship. In fact, most of the regressions found a negative relationship between patent strength and productivity growth. Similarly, an analysis that looked at multi-factor productivity growth across industries found no relationship between the number of patents issued and the rate of productivity growth.

And we could also end the government’s direct subsidization of privately patented products.  For example, the government could boost its funding of health research though long-term contracts with drug and other health related businesses, with the requirement “that all research findings and patents are placed in the public domain. An advantage of [this] approach is that all research findings would be available for both clinicians and other researchers.”  The public gains from a change in policy, especially in the health field, would likely be enormous.

In sum, we need to go beyond bemoaning current trends, which impoverish us in a variety of ways.  Rather, we need to press for an end to the existing public policies that encourage them and for the development of a new intellectual property rights regime that actually serves the public interest.

The US Medical System: Healthy Profits At People’s Expense

Health care is a big and profitable business.  As a Wall Street Journal article points out:

[The US] will soon spend close to 20% of its GDP on health–significantly more than the percentage spent by major Organization for Economic Cooperation and Development nations. . . .

Health care has become a larger part of the economy, creating powerful constituencies resistant to changing the way the system operates.

The health-care industry overtook the retail sector as the nation’s largest employer in December, giving local economies and their workers a stake in the industry’s growth. Health jobs surpassed manufacturing jobs in 2008.

The revenues of health-care companies represented nearly 16% of the total revenues of firms in the S&P 500 last year, up from about 4% in 1984.

Health-care companies have more than doubled overall lobbying spending since 1998, and have become a bigger percentage of total lobbying by industries.

Unfortunately, as the Wall Street Journal article also goes on to say, “Despite the higher spending, the U.S. fares worse than the OECD on most major measures of health.”

The following chart provides one illustration of the distorted nature of our health care system.  As we can see, the US spends a far higher share of its GDP on health care than the OECD average, yet has a significantly lower life expectancy.

The article highlights drug prices as one of the key drivers of US health care costs, noting that that they “have risen the most of the three largest components of health spending since 2000, followed by hospital care and physician services.”

The power of the drug industry is immense, and their lobbyists actively work to ensure that the industry’s profits will remain healthy regardless of the social consequences.  The text of the recently negotiated United States-Mexico-Canada Agreement (USMCA) makes this clear.

As a Washington Post story explains:

A handful of major industries scored big wins in President Trump’s North American trade agreement — at times at the expense of ordinary consumers in the United States, Canada and Mexico.

The winners include oil companies, technology firms and retailers, but chief among them are pharmaceutical companies, which gained guarantees against competition from cheaper generic drugs. . . .

The pharmaceutical industry won stronger protection for sales of so-called biologic drugs, which are typically derived from living organisms and are administered by injection or infusion. The medicines are among the most costly and innovative on the market and are a major driver of drug spending.

USMCA guards new biologic drugs from cheaper generic competition for “at least ten years,” compared with current protection of eight years in Canada and five years in Mexico.

“By increasing the term to 10 years, there will be less competition and higher prices,” said Valeria Moy, an economics professor and the director of Mexico Como Vamos, a think tank in Mexico City. “Having more protection in that area means higher prices for consumers.”

The agreement provides extra protection to drug companies in the much larger U.S. market, as well. Current U.S. law protects biologic drugs from generic competition for 12 years, but some Democrats, including in the Obama administration, have pushed to lower that to seven years as a way to speed cheaper generics to the market and lower drug spending.

Critics of the trade agreement argued that by setting a minimum of 10 years of protection, the trilateral pact shields the pharmaceutical industry from future legislative attempts in the United States to shorten biologic drug monopolies.

It “decreases U.S. sovereignty,” said Jeff Francer, general counsel for the Association for Accessible Medicines, a lobbying group for generic drugmakers. “It would be much harder for Congress to try to roll back 12 years to seven years if we’re enshrining 10 years in a free-trade agreement.”

In short, our health care system operates very efficiently for the health care industry, and the industry appears well organized to keep it that way.

A Critical Look at China’s One Belt, One Road Initiative

China’s growth rate remains impressive, even if on the decline. The country’s continuing economic gains owe much to the Chinese state’s (1) still considerable ability to direct the activity of critical economic enterprises and sectors such as finance, (2) commitment to policies of economic expansion, and (3) flexibility in economic strategy.  It appears that China’s leaders view their recently adopted One Belt, One Road Initiative as key to the country’s future economic vitality.  However, there are reasons to believe that this strategy is seriously flawed, with working people, including in China, destined to pay a high price for its shortcomings.

Chinese growth trends downward

China grew rapidly over the decades of the 1980s, 1990s, and 2000s with production and investment increasingly powered by the country’s growing integration into regional cross-border production networks.  By 2002 China had become the world’s biggest recipient of foreign direct investment and by 2009 it had overtaken Germany to become the world’s biggest exporter.  Not surprisingly, the Great Recession and the decline in world trade that followed represented a major challenge to the county’s export-oriented growth strategy.

The government’s response was to counter the effects of declining external demand with a major investment program financed by massive money creation and low interest rates. Investment as a share of GDP rose to an all-time high of 48 percent in December 2011 and remains at over 44 percent of GDP.

But, despite the government’s efforts, growth steadily declined, from 10.6% in 2010 to 6.7% in 2016, before registering an increase of 6.9% in 2017.  See the chart below. Current predictions are for a further decline in 2018.

Beginning in 2012, the Chinese government began promoting the idea of a “new normal”— centered around a target rate of growth of 6.5%. The government claimed that the benefits of this new normal growth rate would include greater stability and a more domestically-oriented growth process that would benefit Chinese workers.

However, in contrast to its rhetoric, the state continued to pursue a high grow rate by promoting a massive state-supported construction boom tied to a policy of expanded urbanization.  New roads, railways, airports, shopping centers, and apartment complexes were built.

As might be expected, such a big construction push has left the country with excess facilities and infrastructure, highlighted by a growing number of ghost towns.  As the South China Morning Post describes:

Six skyscrapers overlooking a huge, man-made lake once seemed like a dazzling illustration of a city’s ambition, the transformation of desert on the edge of Ordos in Inner Mongolia into a gleaming residential and commercial complex to help secure its future prosperity.

At noon on a cold winter’s day the reality seemed rather different.

Only a handful of people could be seen entering or exiting the buildings, with hardly a trace of activity in the 42-storey skyscrapers.

The complex opened five years ago, but just three of its buildings have been sold to the city government and another is occupied by its developer, a bank and an energy company. The remaining two are empty – gates blocked and dust piled on the ground.

Ordos, however, was just one project in China’s rush to urbanize. The nation used more cement in the three years from 2011 to 2013 than the United States used in the entire 20th century. . . .

Other mostly empty ghost towns can be found across China, including the Yujiapu financial district in Tianjin, the Chenggong district in Kunming in Yunnan and Yingkou in Liaoning province.

This building boom was financed by a rapid increase in debt, creating repayment concerns. Corporate debt in particular soared, as shown below, but local government and household debt also grew substantially.

The boom also caused several industries to dramatically increase their scale of production, creating serious overcapacity problems.   As the researcher Xin Zhang points out:

Over the past decade, scholars and government officials have held a stable consensus that “nine traditional industries” in China are most severely exposed to the excess capacity problem: steel, cement, plate glass, electrolytic aluminium, coal, ship-building, solar energy, wind energy and petrochemical. All of these nine sectors are related to energy, infrastructural construction and real estate development, reflecting the nature of a heavily investment-driven economy for China.

Not surprisingly, this situation has also led to a significant decline in economy-wide rates of return.  According to Xin Zhang:

despite strong overall growth performance, the capital return rate of the Chinese economy has started to be on a sharp decline recently. Although the results vary by different estimation methods, research in and outside China points out a recent downward trend. For example, two economists show that all through the 1980s and the first half of the 1990s, the capital return rate of the Chinese economy had been relatively stable at about 0.22, much higher than the US counterpart. However, since the mid-1990s, the capital return rate experienced more ups and downs, until the dramatic drop to about 0.14 in 2013.  Since then, the return to capital within Chinese economy has decreased even further, creating the phenomenon of a “capital glut”.

In other words, it was becoming increasingly unlikely that the Chinese state could stabilize growth pursuing its existing strategy.   In fact, it appears that many wealthy Chinese have decided that their best play is to move their money out of the country.  A China Economic Review article highlights this development:

Since 2015, the specter of capital flight has been haunting the Chinese economy. In that year, faced with the threat of a currency devaluation and an aggressive anti-corruption campaign, investors and savers began moving their wealth out of China. The outflow was so large that the central bank was forced to spend more than $1 trillion of its foreign exchange reserves to defend the exchange rate.

The Chinese government was eventually able to dam up the flow of capital out of its borders by imposing strict capital controls, and China’s balance of payments, exchange rate and foreign currency reserves have all stabilized. But even the largest dam cannot stop the rain; it can only keep water from flowing further downstream. There are now several signs that the conditions that originally led to the first massive wave of capital flight have returned. The strength of China’s capital controls might soon be put to the test.

Chinese leaders were not blind to the mounting economic difficulties. Limits to domestic construction were apparent, as was the danger that unused buildings and factories coupled with excess capacity in key industries could easily trigger widespread defaults on the part of borrowers and threaten the stability of the financial sector. Growing labor activism on the part of workers struggling with low salaries and dangerous working conditions added to their concern.

However, despite earlier voiced support for the notion of a “new normal” growth tied to slower but more worker-friendly and domestically-oriented economic activity, the party leadership appears to have chosen a new strategy, one that seeks to maintain the existing growth process by expanding it beyond China’s national borders: its One Belt and One Road Initiative.

The One Belt, One Road Initiative

Xi Jinping was elected President by the National People’s Congress in 2013.  And soon after his election, he announced his support for perhaps the world’s largest economic project, the One Belt, One Road Initiative (BRI).  However, it was not until 2015, after consultations between various commissions and Ministries, that an action plan was published and the state aggressively moved forward with the initiative.

The initial aim of the BRI was to link China with 70 other countries across Asia, Africa, Europe, and Oceania.  There are two parts to the initial BRI vision: The “Belt”, which seeks to recreate the old Silk Road land trade route, and the “Road,” which is not actually a road, but a series of ports creating a sea-based trade route spanning several oceans. The initiative was to be given form through a number of separate but linked investments in large-scale gas and oil pipelines, roads, railroads, and ports as well as connecting “economic corridors.” Although there is no official BRI map, the following provides an illustration of its proposed territorial reach.

One reason that there is yet no official BRI map is that the initiative has continued to evolve.  In addition to infrastructure it now includes efforts at “financial integration,” “cooperation in science and technology,”, “cultural and academic exchanges,” and the establishment of trade “cooperation mechanisms.”

Moreover, its geographic focus has also expanded.  For example, in September 2018, Venezuela announced that the country “will now join China’s ambitious New Silk Road commercial plan which is allegedly worth U.S. $900 billion.”  Venezuela follows Uruguay, which was the first South American country to receive BRI funds.

Xi’s initiative did not come out of the blue.  As noted above, Chinese economic growth had become ever more reliant on foreign investment and exports.  And, in support of the process, the Chinese government had used its own foreign investment and loans to secure markets and the raw materials needed to support its export activity.  In fact, Chinese official aid to developing countries in 2010 and 2011 surpassed the value of all World Bank loans to these countries.  China’s leading role in the creation of the BRICs New Development Bank, Asia Infrastructural Investment Bank and the proposed Shanghai Cooperation Organization Bank demonstrates the importance Chinese leaders place on having a more active role in shaping regional and international economic activity.

But, the BRI, if one is to take Chinese state pronouncements at their word, appears to have the highest priority of all these efforts and in fact serves as the “umbrella project” for all of China’s growing external initiatives.  In brief, the BRI appears to represent nothing less than an attempt to solve China’s problems of overcapacity and surplus capital, declining trade opportunities, growing debt, and falling rates of profit through a geographic expansion of China’s economic activity and processes.

Sadly this effort to sustain the basic core of the existing Chinese growth model is far from worker friendly. The same year that the BRI action plan was published, the Chinese government began a massive crackdown on labor activism.  For example, in 2015 the government launched an unprecedented crackdown on several worker-centers operating in the southern part of the country, placing a number of its worker-activists in detention centers. This move coincided with renewed repression of the work of worker-friendly journalists and activist lawyers.  The Financial Times noted that these actions may well represent “the harshest crackdown against organized labor by the Chinese authorities in two decades.”

And attacks against workers and those who support them continue.  A case in point: in August of this year, police in riot gear broke into a house in Huizhou occupied by recent graduates from some of China’s top universities who had come to the city to support worker organizing efforts. Some 50 people were detained; 14 remain in custody or under house arrest.

A flawed strategy                                            

To achieve its aims, the BRI has largely involved the promotion of projects that mandate the use of Chinese enterprises and workers, are financed by loans that host countries must repay, and either by necessity or design lead to direct Chinese ownership of strategic infrastructure.  For example, the Center for Strategic Studies recently calculated that approximately 90% of Belt and Road projects are being built by Chinese companies.

While BRI investments might temporarily help sustain key Chinese industries suffering from overcapacity, absorb surplus capital, and boost enterprise profit margins, they are unlikely to serve as a permanent fix for China’s growing economic challenges; they will only push off the day of reckoning.

One reason for this negative view is that in the rush to generate projects, many are not financially viable.  Andreea Brinza, writing in Foreign Policy, illustrates this problem with an examination of European railway projects:

If one image has come to define the Belt and Road Initiative (BRI), China’s ambitious, amorphous project of overseas investment, it’s the railway. Every few months or so, the media praises a new line that will supposedly connect a Chinese city with a European capital. Today it’s Budapest. Yesterday it was London. They are the newest additions to China’s iron network of transcontinental railway routes spanning Eurasia. But the vast majority of these routes are economically pointless, unlikely to operate at a profit, and driven far more by political need than market demand. . . .

Chongqing-Duisburg, Yiwu-London, Yiwu-Madrid, Zhengzhou-Hamburg, Suzhou-Warsaw, and Xi’an-Budapest are among the more than 40 routes that now connect China with Europe. Yet out of all these, only Chongqing-Duisburg, connecting China with Germany, was created out of a genuine market need. The other routes are political creations by Beijing to nourish its relations with European states like Poland, Hungary, and Britain.

The Chongqing-Duisburg route has been described as a benchmark for the “Belt,” the part of the project that crosses Eurasia by land. (The “Road” is a series of nominally linked ports with little coherence.) But paradoxically enough, the Chongqing-Duisburg route was created before Chinese President Xi Jinping announced what has become his flagship project, then “One Belt, One Road” and now the BRI. It was an existing route reused and redeveloped by Hewlett-Packard and launched in 2011 to halve the time it took for the computing firm’s laptops to reach Europe from China by sea. . . .

Unlike the HP route, in which trains arrived in Europe full of laptops and other gadgets, the containers on the new routes come to Europe full of low-tech Chinese products — but they leave empty, as there’s little worth transporting by rail that Chinese consumers want. With only half the route effectively being used, the whole trip often loses money. For Chinese companies that export toys, home products, or decorations, the maritime route is far more profitable, because it comes at half the price tag even though it’s slower.

The Europe-China railroads are unproductive not only because of the transportation price, as each container needs to be insulated to withstand huge temperature differences, but also because Russia has imposed a ban on both the import and the transport of European food through its territory. Food is one of the product categories that can actually turn a profit on a Europe-China land run — without it, filling China-bound containers isn’t an easy job. For example, it took more than three months to refill and resend to China a train that came to London from Yiwu, although the route was heavily promoted by both a British government desperate for post-Brexit trade and a Chinese one determined to talk up the BRI.

Today, most of the BRI’s rail routes function only thanks to Chinese government subsidies. The average subsidy per trip for a 20-foot container is between $3,500 and $4,000, depending on the local government. For example, Chinese cities like Wuhan and Zhengzhou offer almost $30 million in subsidies every year to cargo companies. Thanks to this financial assistance, Chinese and Western companies can pay a more affordable price per container. Without subsidies, it would cost around $9,000 to send a 20-foot container by railway, compared with $5,000 after subsidies. Although the Chinese government is losing money on each trip, it plans to increase the yearly number of trips from around 1,900 in 2016 to 5,000 cargo trains in 2020.

Another reason to doubt the viability of the BRI is that a growing number of countries are becoming reluctant to participate because it means that they will have to borrow funds for projects that may or may not benefit the country and/or generate the foreign exchange necessary to repay the loans.  As a result, the actual value of projects is far less than reported in the media.  Thomas S. Eder and Jacob Mardell make this point in their discussion of BRI activities with 16 Central and Eastern European countries (the 16+1):

Numbers on Chinese investment connected to the Belt and Road Initiative tend to be inflated and misleading. Only a fraction of the reported sums is connected to actual infrastructure projects on the ground. And most of the projects that are underway are financed by Chinese loans, exposing debt-ridden governments to additional risks. . . .

Depending on the source, BRI is called either a 900 billion USD or an up to 8 trillion USD global initiative. Yet only a fraction of the lower number is backed up by actual projects on the ground. BRI investments in 16+1 countries are similarly plagued by confusion over figures and a tendency towards inflation.

Media reports often arrive at their figures for the sum of “deals announced” by collating planned projects based on vague Memoranda of Understanding (MoUs) and expressions of interest by Chinese companies. Many parties share an interest to push Belt and Road-related figures upwards: local officials in BRI target countries like to impress constituencies, journalists like to capture readers, and Chinese officials are keen to cultivate the hype surrounding BRI.

The Banja Luka – Mlinište Highway in Bosnia Herzegovina, for example, is strongly associated with 16+1 investment. Sinohydro signed a preliminary agreement on implementing the project in 2014, for 1.4 billion USD, and this figure was then widely reported in English-language media. Four years later, though, final approval for an Export-Import Bank loan financing the highway section was still pending. This highway is actually one of the projects emerging in the region that we have fairly good information on, but the preliminary nature of the agreement is not reflected in media reports on the project.

Also in 2014, China Huadian signed an agreement on the construction of a 500MW power station in Romania, reportedly for 1 billion USD. Talks faltered, appeared to resume in 2017, and there has been no progress reported since. It is unclear whether and when this project will materialize, but it is the sort of “deal” counted by those totting up the value of Chinese investment in 16+1 countries. An even larger figure – 1.3 billion – was reported in connection with Kolubara B, though it was later claimed that a cooperation agreement with Italian company Edison had already been signed, three years prior to the expression of interest by Sinomach.

Another important point is that Chinese “investment” in the region – and this very clearly emerges from the MERICS database – often refers to concessional loans from Chinese policy banks. This is financing that needs to be paid back, with interest, whether the project delivers commensurate economic benefits or not.

As with Belt and Road projects elsewhere in the world, loans made by Beijing to CEE countries create potential for financial instability. Smaller countries, which might lack the institutional capacity to assess agreements (such as risks associated with currency fluctuation), are particularly vulnerable.

The Bar-Boljare motorway in Montenegro illustrates this point. It is being built by the China Road and Bridge Corporation (CRBC) with an 809 million EUR loan from Exim Bank. The IMF claims that, without construction of the highway, Montenegro’s debt would have declined to 59% of GDP, rather than rising to 78% of GDP in 2019. It warns that continued construction of the highway “would again endanger debt sustainability.”

The motorway is typical of many BRI projects in that it is being built by a Chinese state-owned company, using mostly Chinese workers and materials, and with a loan that the Montenegrin government must pay back, but which a Chinese policy bank will earn interest on. On top of this, Chinese contractors working on the highway are exempt from paying VAT or customs duties on imported materials.

Because of these investment requirements, many countries are either canceling or scaling back their BRI projects.  The South China Morning Post recently reported that the Malaysian government decided to:

cancel two China-financed mega projects in the country, the US$20 billion East Coast Rail Link and two gas pipeline projects worth US$2.3 billion. Malaysian Prime Minister said his country could not afford those projects and they were not needed at the moment. . . .

Indeed, Mahathir’s decision is just the latest setback for the plan, as politicians and economists in an increasing number of countries that once courted Chinese investments have now publicly expressed fears that some of the projects are too costly and would saddle them with too much debt.

Myanmar is, as Reuters reports, one of those countries:

Myanmar has scaled back plans for a Chinese-backed port on its western coast, sharply reducing the cost of the project after concerns it could leave the Southeast Asian nation heavily indebted, a top government official and an advisor told Reuters.

The initial $7.3 billion price tag on the Kyauk Pyu deepwater port, on the western tip of Myanmar’s conflict-torn Rakhine state, set off alarm bells due to reports of troubled Chinese-backed projects in Sri Lanka and Pakistan, the official and the advisor said.

Deputy Finance Minister Set Aung, who was appointed to lead project negotiations in May, told Reuters the “project size has been tremendously scaled down”.

The revised cost would be “around $1.3 billion, something that’s much more plausible for Myanmar’s use”, said Sean Turnell, economic advisor to Myanmar’s civilian leader, Aung San Suu Kyi.

A third reason for doubting the viability of the BRI to solve Chinese economic problems is the building political blowback from China’s growing ownership position of key infrastructure that is either the result of, or built into, the terms of its BRI investment activity.  An example of the former outcome: the Sri Lankan government was forced to hand over the strategic port of Hambantota to China on a 99-year lease after it could not repay its more than $8 billion in loans from Chinese firms.

Unfortunately, Africa offers many examples of both outcomes, as described in a policy brief survey of China-Africa BRI activities:

In BRI projects, Chinese SOEs overseas are moving away from ‘turnkey’ engineering, procurement, and construction (EPC) projects, towards longer term Chinese participation as managers and stakeholders in running projects. China Merchants Holding, which constructed the new multipurpose port and industrial zone complex in Djibouti, is also a stakeholder and will be jointly managing the zone, in a consortium with Djiboutian port authorities, for ten years. Likewise, SOE contractors for new standard gauge railway projects in Ethiopia and Kenya will also be tasked with railway maintenance and operations for five to ten years after construction is completed. . . .

Beyond transportation, the BRI is spurring expansion of digital infrastructure through an “information silk road”. This is an extension of the ‘going out’ of China’s telecommunications companies, including private mobile giants Huawei and ZTE, who have constructed a number of telecommunications infrastructure projects in Africa, but also the expansion of large SOEs such as China Telecoms. China Telecoms has established a new data center in Djibouti that will connect it to the company’s other regional hubs in Asia, Europe, and to China, and potentially facilitate the development of submarine fibre cable networks in East Africa. . . .

Countries linked to the BRI, including Morocco, Egypt, and Ethiopia, have also been singled out [as] ‘industrial cooperation demonstration and pioneering countries’ and ‘priority partners for production capacity cooperation countries’; these countries have seen a rapid expansion of Chinese-built industrial zones, presaging not only greater trade but also industrial investment from China. . . .

However, the rapid expansion in infrastructure credit that the BRI offers also brings significant risks. Many of these large infrastructure projects are supported through debt -based finance, raising questions over African economies’ rising debt levels and its sustainability. For resource-rich economies, low commodity values have strained government revenues and precipitated exchange rate crises—both of which constrain a government’s ability to repay external borrowing.

In Tanzania, the BRI-associated Bagamoyo Deepwater Port was suspended by the government in 2016 due to lack of funds. The port was originally a joint investment between Tanzanian and Chinese partners China Merchants Holding, which would construct the port and road infrastructure, along with a special economic zone. While project construction has continued, funding constraints have meant that the government has had to forego its equity stake. This represents a case where African governments may risk losing ownership of projects, as well as the long-term revenues they bring.

Adding to political tensions is the fact that many BRI projects “displace or disrupt existing communities or sensitive ecological areas.”   It is no wonder that China has seen a rapid growth in the number of private security companies that serve Chinese companies participating in BRI projects.  In the words of the Asia Times, these firms are:

described as China’s ‘Private Army.’ Fueled by growing demand from domestic companies involved in the multi-trillion-dollar Belt and Road Initiative, independent security groups are expanding in the country.

In 2013, there were 4,000-registered firms, employing more than 4.3 million personnel. By 2017, the figure had jumped to 5,000 with staff numbers hovering around the five-million mark.

What lies ahead?

The reasons highlighted above make it highly unlikely that the BRI will significantly improve Chinese long-term economic prospects.  Thus, it seems likely that Chinese growth will continue to decline, leading to new internal tensions as the government’s response to the BRI’s limitations will likely include new efforts to constrain labor activism and repress wages.  Hopefully, the strength of Chinese resistance to this repression will create the space for meaningful public discussion of new options that truly are responsive to majority needs.