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China’s Increased Trade andInvestment in South Asia(Spoiler Alert: It’s The Economy)Prepared for the U.S. Government Office of South Asia PolicyByEmily BrunjesNicholas LevineMiriam PalmerAddison SmithWorkshop in International Public AffairsSpring 2013

2013 Board of Regents of the University of Wisconsin SystemAll rights reserved.For additional copies:Publications OfficeLa Follette School of Public Affairs1225 Observatory Drive, Madison, WI [email protected] Robert M. La Follette School of Public Affairs is a teaching and research departmentof the University of Wisconsin–Madison. The school takes no stand on policy issues;opinions expressed in these pages reflect the views of the authors.The University of Wisconsin-Madison is an equal opportunity and affirmative-action educator and employer.We promote excellence through diversity in all programs.

Table of ContentsList of Figures . ivList of Tables . vForeword . viiAcknowledgments. viiiExecutive Summary . ixIIntroduction . 1II Background . 2A Chinese Outward Direct Investment . 2B India-China Rivalry. 3III China’s Current Involvement in South Asia . 3A Trade . 3A.1 Rivaling Indian Trade . 5B Outward Direct Investment . 8C Big Projects . 13D Diplomatic Overtures and Aid . 14IV Modeling Trade and Outward Direct Investment . 15A Trade . 15A.1 Trade Model . 15A.2 Trade Model Data . 16A.3 Trade Results . 17B Outward Direct Investment . 19B.1 Applying an ODI theory to China . 20B.2 ODI Model . 20B.3 ODI Model Data . 22B.4 ODI Results . 23B.5 Comparison to Cheung and Qian Model . 25B.6 ODI Model Sensitivity Analysis . 26C Interpretation . 26V Qualitative Analysis of Big Projects . 27A Possible Geopolitical Explanations of Big Projects . 31VI Putting the Pieces Together. 31VII Going Forward . 32VIII Conclusion . 33Appendix A Variable Descriptions and Sources . 34Appendix B Interpreting Underlying Variables Based on Log Results . 36Appendix C ODI Model Country Set . 38Appendix D ODI Sensitivity Analysis Results. 39Appendix E Big Projects Details. 44Appendix F Projecting Trends of Chinese ODI and Trade. 47References . 56

List of FiguresFigure 1: Focus Countries’ Trade with China, 2003-2011 . 4Figure 2: China’s Share of Focus Countries’ Trade, 2003-2011 . 5Figure 3: China’s Share of Exports from Bangladesh, Nepal, and Sri Lanka,2003-2011 . 5Figure 4: India vs. China Share of Focus Countries’ Exports, 2003-2011 . 6Figure 5: India vs. China Share of Focus Countries’ Imports, 2003-2011 . 6Figure 6: Imports from India vs. China, 2011: Bangladesh, Nepal, and SriLanka. 7Figure 7: Imports from India vs. China, 2011: Bhutan and Maldives . 7Figure 8: Exports to India vs. China, 2011: Bangladesh, Nepal, and SriLanka. 8Figure 9: Chinese ODI Flow, World vs. Asia, 2003-2011 . 9Figure 10: Chinese ODI Flow to Focus Countries, 2003-2011 . 10Figure 11: Focus Countries’ Percentage of China’s ODI, 2003-2011 . 11Figure 12: Focus Countries’ FDI Inflow, 2003-2011 . 11Figure 13: China’s Percentage of Focus Countries’ Inward FDI Stock, 20032011. 12Figure 14: Bangladesh’s Inward FDI Stock: India vs. China, 2003-2011 . 12Figure 15: Nepal’s Inward FDI Stock: India vs. China, 2003-2011 . 13Figure 16: Sri Lanka’s Inward FDI Stock: India vs. China, 2003-2011 . 13Figure F1: Chinese ODI Stock Trend in Bangladesh, 2003-2020 . 47Figure F2: Chinese and Indian ODI Stock Trend in Bangladesh, 2003-2020 . 48Figure F3: Chinese ODI Stock Trend in Nepal, 2003-2020 . 48Figure F4: Chinese and Indian ODI Stock Trend in Nepal, 2003-2020 . 49Figure F5: Chinese ODI Stock Trend in Sri Lanka, 2003-2020 . 49Figure F6: Chinese and Indian ODI Stock Trend in Sri Lanka, 2003-2020 . 50Figure F7: Trend of China’s Exports to Bangladesh, 2003-2020 . 51Figure F8: China and India Export Trends to Bangladesh, 2003-2020 . 51Figure F9: Trend of China’s Exports to Bhutan, 2003-2020 . 52Figure F10: China and India Export Trend to Bhutan, 2003-2020 . 52Figure F11: Trend of China’s Exports to Maldives, 2003-2020. 53Figure F12: China and India Export Trend to Maldives, 2003-2020 . 53Figure F13: Trend of China’s Exports to Nepal, 2003-2020 . 54Figure F14: China and India Export Trend to Nepal, 2003-2020 . 54Figure F15: Trend of China’s Exports to Sri Lanka, 2003-2020 . 55Figure F16: China and India Export Trend to Sri Lanka, 2003-2020 . 55iv

List of TablesTable 1: Trade Model Results . 17Table 2: Error Terms for Trade Flows between Focus Countries and China . 18Table 3: Expected Versus Actual Trade Flows. 18Table 4: ODI Model Results . 23Table 5: ODI Country Fixed Effects . 24Table 6: Estimated Deviation from Expected ODI, by Country . 25Table 7: China’s Big Projects in Bangladesh . 28Table 8: China’s Big Projects in Nepal. 29Table 9: China’s Big Projects in Sri Lanka . 30Table 10: Red Flags . 33Table A1: ODI Model Variables and Sources . 34Table A2: Trade Model Variables and Sources . 35Table C1: ODI Model Country Set . 38Table D1: ODI Sensitivity Analysis with Logged Independent Variables . 39Table D2: ODI Sensitivity Analysis with Logged Independent Variables,Country Fixed Effects . 40Table D3: ODI Sensitivity Analysis with ODI Flows as Dependent Variable . 40Table D4: ODI Sensitivity Analysis with ODI Flows as Dependent Variable,Country Fixed Effects . 41Table D5: ODI Sensitivity Analysis: Full Sample with Recession IndicatorBeginning in 2008 . 42Table D6: ODI Sensitivity Analysis: Developing Sample with IndicatorBeginning in 2008 . 42Table D7: ODI Sensitivity Analysis: Full Sample with Recession IndicatorBeginning in 2009 . 43Table D8: ODI Sensitivity Analysis: Developing Sample with RecessionIndicator Beginning in 2009 . 43Table E1: Big Project Details: Bangladesh . 44Table E2: Big Project Details: Nepal . 45Table E3: Big Project Details: Sri Lanka . 46v

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ForewordThe La Follette School of Public Affairs at the University of Wisconsin–Madisonoffers a two-year graduate program leading to a Master of Public Affairs ora Master of International Public Affairs degree. In both programs, studentsdevelop analytic tools with which to assess policy responses to issues, evaluateimplications of policies for efficiency and equity, and interpret and presentdata relevant to policy considerations.Students in the Master of International Public Affairs program produced thisreport for the U.S. Government Office of South Asia Policy. The students areenrolled in the Workshop in International Public Affairs, the capstone coursein their graduate program. The workshop challenges the students to improve theiranalytical skills by applying them to an issue with a substantial internationalcomponent and to contribute useful knowledge and recommendations to theirclient. It provides them with practical experience applying the tools of analysisacquired during three semesters of prior coursework to actual problems clientsface in the public, non-governmental, and private sectors. Students work in teamsto produce carefully crafted policy reports that meet high professional standards.The reports are research-based, analytical, evaluative, and (where relevant)prescriptive responses for real-world clients. This culminating experience is theideal equivalent of the thesis for the La Follette School degrees in public affairs.While the acquisition of a set of analytical skills is important, it is no substitutefor learning by doing.The opinions and judgments presented in the report do not represent the views,official or unofficial, of the La Follette School or of the client for which the reportwas prepared.Melanie Frances ManionProfessor of Public Affairs and Political ScienceMay 2013vii

AcknowledgmentsThis project could not have been accomplished without the help of a number ofUniversity of Wisconsin–Madison professors. First and foremost, we are gratefulfor Professor Melanie Manion’s guidance and invaluable critiques, which kept uson track and provided structure to our project and final product. Professors MarkCopelovitch and Jon Pevehouse offered very helpful advice on issues ofinternational trade and investment. Professor Menzie Chinn’s knowledge andexpertise helped us a great deal in finding the appropriate economic models anddata for our report. We would also like to thank Qian Xingwang of StateUniversity of New York at Buffalo for providing guidance on the use of theeconometric model that he and Yin-Wong Cheung developed. Finally, we wouldlike to thank Keith and the U.S. Government Office of South Asia Policy for theopportunity to work on this project.viii

Executive Summar