Enter the dragon: Rising Chinese influence in Serbia

Since the People’s Republic of China began its One Belt One Road (OBOR) initiative, there has been much discussion on how this initiative would affect the countries it covers. The main goal of this project, as proclaimed, is to increase connectivity between China and other markets through the development of infrastructure and eliminating transport choke points.

This would enable a higher level of economic cooperation by reducing the costs of freight transport and the time necessary for the goods to reach their target markets. However, does this economic project come with political strings attached? Would China be able to leverage this new influence in Serbia and the Western Balkans, and thus gain a strong foothold in Europe?

Would China be able to leverage this new influence in Serbia and the Western Balkans, and thus gain a strong foothold in Europe?

I argue that much of the discussion in this area is either misplaced at present, or overlooks the real reasons why Chinese influence is rising in the WB and particularly Serbia; and I offer a list of policy recommendations that would make Serbia more resilient to this influence.

Loans passed off as investments

Whenever Serbia’s President Vučić discusses infrastructure projects that involve Chinese partners, he always depicts them as ‘investments’. In a country where media freedom is severely limited at best, these reports have been picked up by the media and widely disseminated, without any fact-checking. One should also understand why the country’s president – a figure who has no constitutional role in the conduct of economic or foreign policy – has been so vocal in promoting Chinese influence: Mr Vucić, as the president of the most important party in the country, has been able to dismantle almost all institutional checks and balances and put almost all state institutions under his political control ‘à la Orbán’.

Hence, Chinese investments in the country seem to be multiplying; this sheds a good light on the current regime, which bases its legitimacy on economic issues, making public finances stable and promoting economic growth. Growth is probably the most pressing issue in the country; public opinion polls show that the vast majority of citizens regard the overall economic situation, unemployment and low salaries as the most pressing matters to be addressed.

Furthermore, the sluggish growth in the previous decade stemming from the weak rule of law means that Serbia was only able to regain its 2008 pre-crisis GDP per capita level in 2016. However, in reality the true level of Chinese investments in Serbia is very low. Apart from two already completed acquisitions (the Smederevo steel mill in 2016 and the Bor mines in 2018) and one big investment that has been announced for the near future (a car tyre factory in Zrenjanin), there are few Chinese investments in the country.

But these investments are strategically located; the cities of Smederevo and Bor are almost completely economically dependent on these facilities. Since these two companies incurred substantive losses when in government hands, the state was more than happy to sell them off to interested investors. However, it seems that this process was not transparent or fair, since the names of the buyers were effectively already known before the tenders were completed. Although the Chinese companies are there to make a profit, their influence can also reach higher political levels, as they are among the most important economic players in that region of Serbia.

But since their total stock is very limited, the Chinese economic presence in Serbia is overall rather modest in actual numbers… Serbia is just a springboard for reaching the more developed, and therefore more important, markets in the EU. This is well reflected in the fact that Serbia, which is not yet a member of the WTO (so its trade barriers are higher than in other comparable countries), has signed free trade agreements with all its important political and economic partners (including the EU, CEFTA, Russia and Turkey), in addition to China.

Less bureaucracy, more appealing loans

For the time being the loans from the Chinese government are being used to fund infrastructure projects. The overall infrastructure in the country needs to recover after two decades of low investments: during the 1990s, military conflicts swallowed up most of the state’s financing capabilities, and public investments were the first to be cut after the 2008 economic crisis.

This is well portrayed in the Global Competitiveness Report 2018, which ranks the quality of the roads in Serbia as 95th in the world (out of 140 economies listed). To respond to this need for infrastructure investment, multilateral financial institutions such as the World Bank, the European Investment Bank and the European Bank for Reconstruction and Development have provided significant assistance and loans. However, these institutions were more concerned with projects of international importance, such as the international E10 highway running from Budapest to Sofia or Thessaloniki, than with those of local importance, such as the E11 highway from Belgrade to Bar.

Furthermore, these institutions have rather strict regulations, including financial supervision and auditing, while construction companies need to pass well-designed tender procedures. Therefore, there is little room to siphon off funds. Meanwhile, the public procurement system in Serbia is notorious for its corruption scandals, many of which have been connected to government-sponsored infrastructure projects. China does not labour under these constraints.

The only condition Beijing has is that a Chinese company will get most of the construction work at the price determined beforehand, without submitting to any tender procedures. A smaller part of the work goes to local sub-contractors, also without a public tender, so that the local partners can also gain a (smaller) piece of the pie. For a political elite well-versed in political clientelism, this is a win-win situation. This is what mainly explains the attractiveness of the Chinese investment loans in the region. The interest rates on the Chinese loans are not that important.

For most of the loans the interest rate applied is 2-3%, a figure similar or just slightly higher than the rates applied by the international financial institutions. The interest rates on government bonds have recently also declined significantly (Eurobonds for 10-year loans in 2014 carried a rate of 5.5%, while in 2018 the rate was 3.5%, and the most recent Eurobond carried 1.6%).

So, since there is no big difference between direct state financing and Chinese loans, the latter are actually probably more expensive, because there is no pressure on costs from the competition, in the absence of tender procedures.

The actual level of Chinese loans is still low

In some countries, the Chinese infrastructure investment loans were renegotiated when the total debt level became unsustainable. Since the Chinese took over the Sri Lankan port of Humbantota in 2017 in a debt/equity swap, there has been rising concern over whether this situation could also occur in other countries, such as Zambia, but also in Serbia. If the government proved unable to meet its rising obligations to its Chinese partner, would the latter then take over some important infrastructure, or increase their political leverage in the country in some other manner?

The level of Serbia’s public debt is still high, but it is not yet at an alarming level. The fiscal consolidation measures put in place in 2014, together with the higher growth rates of the economy that followed curbed the level of public debt, whose share in GDP significantly decreased. Furthermore, the share of Chinese loans in total government debt is rather low, making up just €895 million euros, or just under 4% of the total public debt. But if the lack of bureaucracy or checks on how the money is spent makes Chinese loans appealing, why have there not been more of them?

The answer is: because the level of discretionary power which politicians have over regular loans financed through the international market is already significant – they can spend the money only in line with local regulations, which are easy to disregard or circumvent. Therefore, the Chinese loans are only being used in place of financing from international financial institutions.

A strong economy with limited soft power

Chinese soft power in the country is still weak. Many different initiatives regarding cultural, educational and scientific cooperation have been started, but these are restricted to a rather limited number of experts. The two Confucius Institutes in the country (in Belgrade and Novi Sad) are active in these fields (especially regarding language training), and have for the time being avoided entering into political debate.

Chinese state media does not have a local media affiliate, but is content with a cooperation agreement with a local radio station in Belgrade, which rebroadcasts their programmes on Chinese culture. The number of Serbian nationals working or living in China is also rather limited (most of them are teachers of English), so their perspective on the country does not affect how most Serbs perceive China.

The main drivers of Chinese soft power in Serbia are the fact that the Asian giant is perceived as a strong and growing economy, as well as the political support that China has provided to the Serbian government by not recognising Kosovo as an independent entity. Therefore, the wider population perceives China as a benevolent actor that supports Serbian interests – something which could easily be used as political leverage.

Serbia as a future Trojan horse inside the EU?

An important argument mentioned by regional policy experts, and even by high-ranking politicians such as Johannes Hahn, the EU Commissioner for European Neighbourhood Policy and Enlargement Negotiations, is that the rising Chinese influence in the country could make Serbia a Trojan horse within the EU. This is a valid argument, but it is based on false premises: Serbian accession to the EU lies in the rather distant future, and the Chinese have much more important friends who are already inside ‘fortress Europe’. First of all, there is rising anti-accession sentiment within the most important EU countries, such as France. As Nathalie Loiseau, the top candidate of La République en Marche party for the EU elections stated during her visit to Belgrade as French Minister for European Affairs in March 2019, there would not be a new wave of EU accession any time soon.

This is not only because of Serbia’s lacklustre track record in meeting EU criteria, but mostly because the EU itself is not ready for the accession of new members. Furthermore, if one wants to look for Chinese Trojan horses, one should not look at the gates, but beyond the walls. The two most important candidates for this title are Viktor Orbán’s Hungary and Matteo Salvini’s Italy.

Both these countries are dissatisfied with certain EU policies, and are trying to establish strong political connections with non-Western stakeholders. Both countries are also vying for Chinese investments and loans, although this economic segment is probably more important for the Italian government, due to the sluggish performance of the Italian economy and weak public finances.

Hence, overemphasising Serbian cooperation with China as a political problem could seem simply hypocritical and insincere, bearing in mind the much higher levels of cooperation between the EU core countries and China.

How can the West take on the Chinese challenge?

For the time being, it seems that the West has not been able to counteract China’s rising influence in Serbia, as well as in the Western Balkans. Brussels needs to make some strategy changes. It needs to communicate with the Serbian people (who still wrongly believe that Russia is Serbia’s most generous donor!), not just their government – something the US seems to have acknowledged too: the US Embassy in Belgrade has recently stopped focusing on the painful past or on Kosovo, and turned to future fruitful cooperation.

Overemphasising Serbian cooperation with China as a political problem could seem simply hypocritical and insincere, bearing in mind the much higher levels of cooperation between the EU core countries and China.

It should also not come as a surprise that few EU flags were spotted during the street protests against Mr. Vučić’s government in recent months. It is hard for Serbians to see the EU as a supporter of freedom, when the president of the European Council Donald Tusk called Vučić his ‘friend’ and ‘soulmate’ at a press conference.

The very technical language of accession reform conditionalities is hard to understand for the general public, whereas EU support for Vučić is plainly clear. The EU should place more emphasis on the rule of law and media freedoms in the country (most programmes so far have not produced any significant outcomes), as well as the centralisation of political power, which could be tackled through changes in election system and judicial appointments.

The Kosovo issue should be resolved as soon as possible, but on a more inclusive and participatory basis, in order for a long-term compromise to be reached. These changes would eliminate most of the factors that enable China, Russia and other external factors to exert their influence in the country. Mutually beneficial cooperation with these countries could still take place, but Serbian society would then be able to distinguish between opportunities and traps.

For the time being, the EU’s actions as an external factor in the region are not strengthening or developing local resilience to foreign influence, but are in fact supporting the very forces that are undermining it.

Development disparities and Europeanisation in Central and Eastern Europe

Central and Eastern Europe (CEE) is facing a historical turning point, as the European Union is in the process of implementing a project of deeper integration in various domains—from energy and public finances to security and foreign policy. For CEE countries, the process of Europeanisation has brought about significant gains, both financial (in terms of economic growth and development) and normative (in terms of the quality of democracy and governance).

However, human rights and rule of law are increasingly being challenged by anti-establishment or Eurosceptic parties in the EU. The nationalist and sovereignist platforms are gaining force. Beyond the posturing of incumbents, such as Viktor Orbán in Hungary, Jarosław Kaczyński in Poland, or more recently, Matteo Salvini in Italy, power is coming under increasing contestation by the Rassemblement National (National Rally) in France, the Freedom Party in Austria and the Alternative für Deutschland (AfD) in Germany.

So, how will the political balance tilt in Central and Eastern Europe (CEE) beyond the European elections? It is unlikely that the nationalist parties will be able to impose a drastic shift in the policy agenda (either in the European Parliament or in the individual nations). Although increasingly loud nationalist and Eurosceptic sentiments are resonating within leading political parties across Europe, the fact remains that integrationist policies have indeed taken effect at a steady pace and will likely continue to do so. With regard to the major threats that Europe is facing nowadays (i.e. migration, security, competitiveness on global markets) there is simply no solution at an exclusively national level—only together can member states prevail.

Still, within CEE there are persistent sentiments of being left behind: from Macron’s two-speed Europe project and the increased perception that Germany shapes Europe, to the persistent developmental divisions, there is mounting pressure for a new approach towards the newer member states in Europe. How will the EU address these sentiments in CEE?

The main offer so far has been based on investing in efforts to overcome the development divide and the feelings of inequality and unfairness that it breeds, with the aim of strengthening resilient pro-European attitudes. While this might be a useful long-term response to short-term outbursts of discontent, any integrationist agenda or political platform (see the recent efforts by the French president Emmanuel Macron and the German chancellor Angela Merkel) at the EU level should be as inclusive as possible towards CEE member states, whose nationalist parties are currently gaining ground. Secondly, CEE member states should seek increased partnership in terms of energy, transport and digital infrastructure, to mention only the most important areas of intervention. In the face of Russian posturing and cyber threats, CEE must seek security through interdependence.

Regional specialisation and factor endowment

The current global economy can be characterised by the term ‘New Economy’, that is, economic growth driven by new, highgrowth industries that are on the cutting edge of technology. While the term ‘new economy’ has been popping up since the early 1990s, there is an argument to be made in favour of current developments.

On the one hand, there has been an increase in the use of disruptive technologies in economic sectors, and innovative solutions for financing are clearly paramount in this overall context. On the other hand, the institutional and regulatory frameworks are increasingly responsive to these new developments, and whether they are adequate or not, it is clearer than ever that there has to be dialogue between the financing sector and European & national regulators in a meaningful, considerate manner. There is no one-size-fits-all economic model for development across Europe; not all the member states have reached the same level of development and convergence.

In CEE for example, Romania and neighbouring countries are good examples of how to move from a low-value economy to a higher value-added economy. Achieving this transition is very important in order to achieve sustainable development. It is also the right recipe to escape the middle-income trap in these countries.

The middle-income trap refers to a situation where the level of wages in a country stagnate as a result of its own economic development; more specifically, when the economic model based on low wages (e.g. manufacturing) changes given a certain increase in wages, but at the same time, the development of new high value-added industries lags behind.

The path to sustainable growth is very much influenced by the availability of factors of production in a given country. For example, Romania benefits from very high-quality human capital (e.g. trained and skilled professionals), but very poor infrastructure.

As such, we see a value increase in human capital-intensive sectors such as ITC, where we no longer see the highest frequency in call–centre-type activities, but rather in high-tech and RDI-intensive activities. In contrast, due to the poor infrastructure, there is slow progress in the industrial sectors reliant on physical activities and logistics. Industrialisation is essentially hampered by the very poor infrastructure. Also, the issue of financing is important for economic agents, particularly SMEs.

In Romania 75% of SMEs are self-funded; furthermore, approximately half of them display no activity, and of those that are active, many do not report profits. Therefore a vicious cycle develops between lack of capitalisation in the start-up segment and the lack of sophistication in developing markets.

Subnational disparities

New division lines are appearing in the European Union, without the historical disparities of development between the member states and regions having necessarily been resolved. The divisions within the different categories of the population both across Europe and within member states are currently just as important as the traditional divides across member states.

Regional divisions are persistent in the EU, and they no longer align to the classical categories of old vs. new member states. The latter are facing challenges of convergence, or catching up, as the European Commission has recently labelled many of them as ‘lagging regions’.

However, although CEE is still struggling with low incomes in some of its regions, high economic growth rates have been recorded across the area as a whole, as opposed to older member states in Southern Europe (i.e. Portugal, Spain, Italy and Greece) whose lagging regions are marked by low economic growth. Many of the EU member states have seen rising regional inequality, as convergence stalled during and since the economic crisis. Social divisions have become increasingly apparent according to various Eurobarometer data from the past decade.

Many of the EU member states have seen rising regional inequality, as convergence stalled during and since the economic crisis.

Social divisions have become increasingly apparent according to various Eurobarometer data from the past decade.

The values and beliefs of European citizens reflect new division lines on top of the persistent socio-economic ones, as social insecurity across Europe has been amplified by the economic crisis in Southern Europe and its strong negative social impact, as well as the current migration crisis. Capital cities are increasingly behaving very differently from rural areas in elections (e.g. Poland, Hungary, Bulgaria, UK, and increasingly Romania, as the latest European elections showed urban voters’ preference for liberal and cosmopolitan platforms to sovereignist and anti-EU rhetoric), according to different alignments of values: as the major cities remain predominantly liberal and cosmopolitan, the rural areas are increasingly turning to traditional or even fundamentalist values.

Economic divisions were meant to be tackled from the very beginning of the cohesion policy and the integration process. Still, economic grievances persist and amplify social and cultural insecurities. According to a recent survey of CEE states, EU membership has made prosperity more achievable for countries in transition, but has also made the consequences of failure more apparent. EU-wide income inequality declined notably prior to 2008, driven by a strong process of income convergence between European countries; but the Great Recession broke this trend and pushed inequalities upwards, both for the EU as a whole and across most countries.

Also, according to recent surveys, both inter- and intra-generational mobility has stagnated or decreased in several member states. Nevertheless, in a number of CEE countries (such as the Czech Republic) citizens still believe they are better off economically than they ever were before. Furthermore, several regions in CEE countries have changed their status from ‘less developed regions’ to ‘developed regions’ over the course of the current multiannual financial frameworks (MFF 2014-2020).

While member states in Central and Eastern Europe (CEE) have showcased steady economic growth over the past years, the area still lags behind its Western counterparts. It now stands at a crossroads, attempting to avoid the ‘middle-income trap’. In order for this region to continue its path to prosperity, it must enhance the competitiveness of its domestic SMEs and push forward in new technologies and innovation.

Drivers of economic development: Romania’s local business environment

In the current context, in which global markets are marked by growing uncertainty, ensuring sources of capital for investments is one of the paramount conditions for achieving and sustaining economic growth and development. For the EU member states, there is the added benefit of accessing EU structural funding for investments, besides the capital markets, national budgets and public-private partnership. Whatever the source of funding might be, it is necessary to identify the specific needs of a given economy, and to prioritise investment projects according to those needs. It is clear that in the case of Romania there is an essential need to develop several priority infrastructure projects. However, it is often difficult to properly understand and address the investment needs from a national, or increasingly a European view-point.

Meanwhile, in a context in which structural funding is mostly directed to projects that provide ‘European added value’, decreasing attention is paid to local needs and opportunities. In a recent paper with George Ștefan, we present an original metric to assess economic activity at the local level: the Local Business Environment Index (LBEI).[i]

In the development of this metric we explored a large set of variables that are disaggregated at municipal level. Following the extant literature on the different drivers of economic development, we proposed four major axes of assessment: entrepreneurship, innovation, investment financing, and support from public authorities.

The highest scores in the 2018 overall ranking of the level of attractiveness of the local business environment went to cities of various sizes: Bucharest, Cluj-Napoca, Timișoara, Alba-Iulia and Sibiu. Each municipality has a different distribution of its specific strengths. Interestingly enough, it is not just the capital city of Bucharest that dominates the different components of the LBEI.

In the case of the sub-index for Innovation for example, the rankings are dominated by Timișoara, Cluj and Sibiu, and not the capital city of Bucharest. In the case of the sub-index for Entrepreneurship, the top-ranking city is Cluj, and not Bucharest. As such, we can see that there are elements (competitive advantages) that define some Romanian cities and lead them to excel in certain areas over others.

The two-tier approach of the EU might shelter Western countries from economic and social risks, but it also fuels tensions with new member states.

These rearrangements in the ranking of Romanian cities in the sub-indexes of our proposed LBEI metric show the extent to which there are specific local and regional economic opportunities and challenges. In the cities that occupy the top positions, the economic growth rate and general development level surpass those of many Western European cities.

It is important to understand the drivers of this economic performance, as this is key to remedying the disparities across the wider EU.

Rethinking CEE: Bridging the divides

It is becoming increasingly obvious that the two-tier approach of the European Union might shelter Western countries from economic and social risks, but it also fuels tensions between old and new member states. Economic development in many of the newer member states has been robust, albeit heavily concentrated in major cities.

As shown in the case of Romania, the economic development of many cities in Central and Eastern Europe depends on the extent to which these are integrated into the larger European market: whether in terms of innovation or access to capital, connectivity remains a central driver. Social integration often comes by way of economic integration. For Central and Eastern Europe (CEE) the path to further economic integration into the European Union lies through (1) market linkages (e.g. integration into regional value chains, development of high value-added economic agents, increased FDIs) and (2[ii]) institutional and policy instruments (e.g. adopting the Euro, EU-funded investment projects).

In terms of institutional performance and policy choices, political will and knowledge are essential in order to further economic integration and effectively reduce disparities. For example, in the upcoming Multiannual Financial Framework (MFF 2021-2027)2, the process of negotiation will be very important as the EU may lose a net-contributing member state through Brexit, which would cause a deficit in EU budget revenues estimated at over €10 billion.

Central and Eastern European (CEE) member states are generally net beneficiaries from the EU budget, and are heavily invested in programmes such as those funded through the Cohesion Policy and the Common Agricultural Policy (CAP) which specifically address the current disparities. As far as Romania is concerned, it draws approximately four times the amount of money from the EU budget as it contributes. Still, it is important to maintain the same level of absorption of EU funds, as these are the third largest source of financing for public investments apart from the national budget and capital loans.

At this stage, it looks likely that Romania will be allocated more resources than in the previous financial year (in current prices), but the conditions of eligibility and the context are considerably different, making it harder to draw the pre-allocated funding. Other CEE countries whose regions have moved from ‘less developed’ to ‘more developed’ are likely to see their funding diminished, but they have a great deal of experience in using the available funds optimally (e.g. Poland, Hungary).

Overall, the negotiations for the future MFF will be more difficult for CEE member states in the coming period. With the growing concerns regarding the future and sustainability of the European construction, we should rethink the Central and Eastern European region not as a peripheral area, but rather as a region in which further integration will yield higher rewards for the EU as a whole.

This shift towards the core of the EU is based on three elements. Firstly, there is a sociological component: in CEE member states there is still a predominantly pro-European attitude, in contrast to the increasing wave of Euroscepticism in Western Europe.

Secondly, there is an economic element, as CEE has also presented a strong economic outlook over the past years, making it a key market for larger European economies such as Germany. Finally, there is a geopolitical argument, as many CEE countries have strong incentives to increase their interconnectivity with Western Europe, so that they are sheltered from instability, such as that in neighbouring Ukraine.

[i] Volintiru, Clara & Ștefan, George (2018). ‘Economic Development and Opportunities in Romania: Local Business Environment Index (LBEI)’. Aspen White Paper; cf. Volintiru, C. et al. (2018). ‘Economic Development and Innovation at Local Level-Local Business Environment Index’, Romanian Journal of European Affairs, 18, 5

[ii] 2. Dăianu, D., Fugaru, A., Mihailovici, G., and Volintiru, C. (2018). ‘Multiannual Financial Framework Post-2020: Risks and Opportunities’, European Institute from Romania (IER) Strategy and Policy Study, no. 1/2018 [in Romanian].