Will the New Silk Road be smooth or bumpy?

I feel like too much of the media coverage of China’s New Silk Road initiative (the official slogan is the rather unfelicitous “One Belt, One Road“) focuses on explaining and understanding the intended consequences: What is China’s plan? How much money is it going to spend? How much influence will it win? etc etc. This is understandable, since the whole program is apparently large, probably important, and rather confusing. But now that the basic outlines are increasingly well understood (China wants to spend a lot of money on infrastructure projects in developing countries to boost its geopolitical influence and swell the order books of its SOEs), I think we should put more effort into understanding the potential unintended consequences. After all, if there is any lesson about China’s ambitions that we can learn from history, it is that large amounts of foreign capital flowing into smaller economies can have many unintended consequences.

Using a simple but surprisingly useful rule of thumb–China is like Japan but a few decades later and ten times bigger–we can look to Japan in the early 1970s for some interesting parallels. Japan’s outward investment only really started to take off in the early 1970s, as exchange controls were relaxed and the first wave of resource-driven projects was succeeded by projects aimed at developing markets for Japan’s manufactured goods (sound familiar yet?). The major destinations for its FDI were Europe, North America, and Southeast Asia, and among Asian countries none received more Japanese investment than Indonesia. But the Indonesians did not perceive this as an unequivocally good thing, and in January 1974 a visit by prime minister Kakuei Tanaka sparked massive demonstrations. The so-called Malari riots ended up being a very consequential event for Indonesia, as they sparked a domestic political reshuffling and a turn toward policies favoring local businesses:

Unhappiness over rising food prices, rice shortages, and the growing power of Suharto’s personal assistants had been stewing for more than a year. The number of business ventures undertaken by Chinese businessmen with high-ranking military men continued apace, and it was apparent that the president was clearly taking no action at the widespread corruption. At the same time, foreign capital was flowing in, most obviously by the Japanese, who were courted by Suharto’s financial advisors.

The Japanese had been taking a more high-profile role in the country, providing up to one-third of Indonesia’s foreign economic assistance. An academic noted: Japanese aid was “large and visible, and that much of it was tied to the purchase of goods manufactured in Japan was widely known and criticised. It was assumed…that the principal aim of the aid was to develop markets for Japanese products.” The growing presence of the Japanese in Indonesia sparked resentment against the influx of foreign capital. The fact that many Japanese firms partnered Chinese businesses in ventures gave critics added fuel.

The events are covered in all standard histories of Indonesia; the quote above is from the recent book Liem Sioe Liong’s Salim Group: The Business Pillar of Suharto’s Indonesia, by Richard Borsuk and Nany Chng (an incredibly impressive piece of research about how business and politics actually worked in Indonesia during this period). Of course, the riots were really about domestic political issues, and divisions among the Indonesian elite and between ethnic groups were probably the most significant factor for how the consequences played out. But the protesters were also not imagining things: Japan was putting a huge amount of money into Indonesia, for a while as much as it was putting into all other Asian countries combined.

Japan-FDI-into-Asia

The point is a simple one: big inflows of foreign capital can interact with domestic political issues in highly unpredictable ways.

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