Development of Belt and Road rail routes and new market opportunities for European companies

How can European companies benefit from new market opportunities opened by the BRI induced change in global value chains and international trade structure due to development of rail routes?

 

Executive Summary

The research question and the scope of the analysis

This paper investigates the structure of the current EU‑China Global Value Chain (GVC) trade with regard to the volume, direction, and composition of trade (final goods vs. intermediate goods) and the modes of transport used in two key GVC sectors, the automotive sector and the machinery and equipment sector (including electronics), in eight different EU countries, focusing on rail transport. A thorough analysis of historical patterns of the EU-China trade informs our approach to the following overarching research question of the study:

What are the potential opportunities and threats of the railway BRI for the European GVC participants depending on eventual relative trade cost reductions that it can bring?

We tackle this overarching research question by dividing it into a number of specific research questions, which we address as we proceed with our analysis. In each case, we propose one or two hypotheses that we advance based on available evidence.

In the period 2014‑2016, railway transportation of goods between Europe and China was growing at an astonishing pace of around 140% annually (International Union of Railways, 2017). The rapid increase in the Eurasian railway traffic has been stimulated and coordinated by China, including by

  1. (1) bringing a number of individual national operators under a single brand of China Railway Express;
  2. (2) heavy subsidisation of the Eurasian railway routes by China, involving the central government, the local (provincial) governments, and logistics companies;
  3. (3) the development of infrastructure along the railway corridors (including, for example, the Chengdu International Railway Port in the province of Sichuan in mainland China and the modern inter-modal container terminal in Kutno, Poland, on the intersection of train routes connecting the country’s south and north as well as Berlin, Warsaw, Moscow and eventually Beijing; and
  4. (4) improvement of customs clearances and other procedures along the railway corridors, possible thanks to increased levels of cooperation between the countries on the railway corridors. Despite the recent growth in railway transport between China and the EU and the publicity it generated, there remain several challenges and uncertainties rooted in the economic and political contexts (see below).

We select  the automotive sector and the machinery and equipment sector (including electronics) for a detailed examination, that is the industries that together account for 88% of exports and 86% of imports in the EU‑China railway trade. In either case, we try to anticipate the potential impact of the BRI based on the expected evolution of the relative competitiveness levels of the EU on the one hand and China on the other hand, the type of goods traded (final goods or component goods), and the very relevance of the BRI to those industries. To do this, we use OECD’s Trade in Value Added (TiVA) and Eurostat’s EXTRA EU Trade Since 2000 by Mode of Transport database as well as available reports and articles.

The automotive sector

With regard to the automotive sector, we propose the following set of hypotheses:

Further expansion of EU car producers to China is likely to prevail over the expansion of Chinese car producers to the EU, at least in the short to medium run – although not without caveats.

In the EU‑China automotive trade, both groups of products – component and final – are important and both are relevant in the context of the BRI.

The railroad BRI is playing an increasingly important role in the automotive industry, but local presence will act as a mitigating factor.

The automotive trade between Europe and China is dominated by EU exports, both of ready vehicles and of components, with the EU boasting a sizeable surplus of trade with China in this sector. Assuming that the BRI will result in a symmetric reduction in costs of rail transport in both directions, this could generate a number of positive micro‑ and macroeconomic effects. Given the strong competitive position of the EU industry as a whole, which benefits from competitively priced and timely delivered Chinese auto parts and components, the BRI could bring a doubly positive effect of increasing productivity and growing sales market for the automotive sector.

But Chinese automotive firms would also profit from reduced trade costs, which could mean increased level of competition for some EU automotive companies. Judging from the structure of current trade, this could be particularly relevant for producers of parts and components successfully produced by Chinese competitors – arguably less advanced segments of the EU auto supply chains. To the extent it is possible to generalise, this could expose some less advanced and smaller producers in the EU13. One mitigating factor is possibly higher demand for parts and components of leading EU firms brought about by the BRI. Another one is that EU13 auto firms tend to benefit from the rail EU-China transport corridors more than their Western partners.

The machinery and equipment sector

With regard to the machinery and equipment sector, we propose the following set of hypotheses:

At least in the short to medium term, further expansion of Chinese machinery and equipment firms to Europe under the BRI is likely in the low‑tech to mid‑tech sectors, while the presence of the EU firms on the Chinese machinery and equipment market is likely to be limited to the high‑tech sectors.

In the EU‑China machinery and equipment trade, both groups of products – component and final – are important and both are relevant in the context of the BRI.

The development of the rail corridors through Eurasia may be an impulse for machinery and equipment trade between the EU and China, although this trade may be unbalanced.

In the machinery sector, where Chinese firms in many segments already have or are starting to have a competitive edge, and where a similar situation had been observed for a number of decades with Japanese, Korean, and other Far Asian firms, the outlook is rather different.  The sector is  characterised by EU’s large trade deficit. Rail transport in general plays a moderate role. This suggests that, if there is a significant impact at all, the BRI is more likely to result in mounting competitive pressure on the remaining leading EU firms, although this effect would likely be compensated to a certain extent by the lowering of costs of Chinese parts and components. It is also clear that the BRI could have significant positive effects for EU consumers.

Conclusion

To the extent it succeeds in bi-directional lowering of costs of shipment of products against a level playing field in trade between the EU and China, the BRI can unlock new opportunities for European companies operating in global value chains. In such a positive scenario, particularly the leading EU manufacturing firms operating in GVCs, which hold cutting-edge technology and other intangible capital assets (for example in the automotive industry), could benefit significantly in short to medium‑term from both the increased access to Chinese markets and better access to Chinese intermediate inputs used in production. At the same time, less competitive European suppliers of intermediate inputs or final products could possibly face competitive pressures from their Chinese competitors. In the longer term, the BRI-related trade costs reduction could also contribute to competitive pressures already felt by some leading EU firms related to continued innovation, technology acquisition and upgrading of their Chinese peers. While these increased competitive pressures associated with increased trade with China could result in market exit in some cases, the required restructuring, upgrading and reorientation of activity towards areas of more sustainable competitive advantage would nevertheless have a potential to create a generally healthier and more productive European industry.

Uncertainties

The realisation of the positive scenario depends on several conditions, many of which have a significant probability of not being fulfilled. Some of these include:

  • considerable uncertainty as to the extent of the BRI;
  • uncertainty as to whether the BRI will actually result in a significant further lowering of costs of railway transport between the EU and China;
  • uncertainty as to whether China will continue to subsidise the movement of trains across Eurasia;
  • more generally, uncertainty as to the extent to which the volume and composition of EU‑China trade is based on market principles rather than being significantly influenced by state policies (mainly in China);
  • infrastructural deficiencies, differences of standards, and remaining red tape.

Recommendations

All the uncertainties put into question the potential benefits of the BRI to European GVC players. In fact, these less optimistic developments are in our mind more likely scenarios, or our ‘winning precautionary scenarios,’ around which we provide some strategy recommendations for various stakeholders.

Issue 1: Lack of transparency around the BRI, including the railway BRI

Recommendation for Chinese authorities:

1.1 Provide more clarity on the exact scope of the BRI.

Recommendations for the EU:

1.2 Provide more clarity on the EU’s position towards the BRI and co-operate with China to make the scale of infrastructural investments significant and compatible with EU infrastructural plans and economic interests.

1.3 Continue to exercise diplomatic and commercial pressure to make sure the BRI does not deviate too much from the EU policy standards and has a potential to deliver sustainable outcomes.

Recommendation for the EU Member States:

1.4 Coordinate with all other EU Member States and the European Commission to maintain a unified position on opportunities and risks associated with the BRI.

Recommendation for European companies:

1.5 Keep track of the developments along the Eurasian railway rotes.

Issue 2: Competitive pressure from the Chinese Companies

Recommendation for the EU Member States:

2.1 Prepare to address competitive pressures and develop survival strategies for sectors facing competition from China by providing sustainable assistance.

Recommendation for European companies:

2.2 Continue to invest in technology and intangible assets and their protection – the only way of surviving the growing competition from China.

2.3 Focus on services and customisation.

2.4 Co-operate with national governments and the EU authorities to promote level playing field in relations with China.

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Strategy Development Section 

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