Not All Silk Roads Are Created Equal
I recently published this opinion piece on the Saker website, & it was republished in Russia Insider. I also wanted to share it here as well (with a few minor grammatical corrections). Apologies in advance if the pictures turn out blurry, please refer to one of the links above.
Not All Silk Roads Are Created Equal
The Trans-Caspian International Transport Route is unlikely to see high-volume PRC adoption in the near term due to insufficient business and geopolitical value prop
Several months ago, there were quite a few news/analysis reports lauding the Trans-Caspian International Transport Route (TITR) as a new path for trade along the Silk Road, which is being revitalized by China and its regional partners under the One Belt, One Road (OBOR) project. The TITR is highly attractive to Russia’s geopolitical rivals, such as Georgia and post-Maidan Ukraine (& no doubt the US too), for it is a potential Sino-European trade route across the Eurasian continent that completely bypasses Russian territory. However, there is little/no incentive for China to actively promote or use TITR for large-scale trade in the near future. To expand on this conclusion, this article will cover the following: the basic business value proposition of the land-based Eurasian Silk Road, an outline of the TITR path, a side-by-side comparison of a comparable route (Chongqing-Duisburg, also known as ‘Yuxinou’), and the geopolitical factor.
BUSINESS VALUE PROPOSITION OF THE EURASIAN SILK ROAD
The PRC’s promotion of various OBOR projects is widely seen as a geopolitical maneuver designed to bypass American dominance of the high seas. A land-based trade route reduces China’s strategic vulnerability to potential American restriction of Chinese trade via maritime blockade, or threats of a blockade in the event of a military conflict or serious crisis. It offers the added benefit of expanding China’s influence on and relationships with nations of the Former USSR, Middle East, and Europe. While these are significant benefits in and of themselves, observers often overlook the concrete economic benefits of the Eurasian trade route – namely – the value of speed.
The Value of Speed
Imagine a Europe-based company – one that assembles and sells finished goods made in part from Chinese-supplied components. This company has to somehow bring these components from its China-based supplier to Europe. Airplanes are the fastest way, but also the most expensive; the next best alternative used to be maritime shipping, which took about 45 days. This means the company had to stock up on at least 45 days’ worth of parts (plus a few more days for safety stock, to mitigate the possibility of unforeseen delays), otherwise the assembly line stops before the next resupply. In today’s world of lean manufacturing, there is nothing worse for the financial bottom line than an entire assembly line, its workers, unfinished goods, and angry customers sitting idle due to a parts shortage. However, holding 45+ days’ worth of supply isn’t ideal either, for that increases inventory holding costs.
Roughly explained – “inventory holding cost” (or “inventory carrying cost” is the price a business pays for having to spend money upfront to buy lots of inventory at once, the opportunity cost of inventory sitting idle in storage and not generating revenue, the cost of real-estate (e.g. renting/building big warehouses) and labor for storing and managing inventory, the cost of insurance in case accidents damage the inventory, etc. Bottom line, inventory holding costs negatively impact the cash flow of a business, but it’s usually not as bad as having the entire assembly line sit idle to wait for parts, and worse yet, make customers angry in the process.
The land-based Silk Road reduces the need for holding such large inventories, by offering rail transport that can deliver goods in 15 days instead of 45 days by ship, eventually reducible to 12 days. However, it does so at a cost that is usually 100% higher than maritime shipping. Therefore, the aforementioned European company has the opportunity to reduce inventory holding costs by up to 67%, by paying an extra 100% for shipping. Is this a worthwhile tradeoff? Don’t be fooled by the percentages, the answer depends largely on the value of the inventory that has to be held. If the inventory in question are commodity goods (e.g. a pile of socks, cheap toys, printer paper, etc.), probably not. Conversely, if the inventory consists of high value goods – industrial machinery, critical assembly line components, renewable energy equipment, consumer electronics, luxury goods, time-sensitive items (e.g. refrigerated perishable food or pharmaceuticals), just to name a few – then the tradeoff will likely yield net savings.
As China continues to climb the economic and technology value chain, an increasing portion of Sino-European trade in the near future will likely consist of higher value items that would benefit from the aforementioned tradeoff – higher transport costs for lower inventory costs. Currently, ~90% of Sino-European trade travels through maritime routes, so the cost-saving and new market opportunities for switching to land-routes are immense.
TITR TRIP OUTLINE
A container of goods traveling along the TITR (see fig. 1) would start off in China, switch tracks in Kazakhstan, then traverse the horizontal length of Kazakhstan to the Caspian Sea. This container would then be offloaded from the train in Aktau and loaded onto a ship, which then sails across the Caspian Sea to be offloaded again onto a train in Baku. The Baku train would then haul the container across Azerbaijan and Georgia, to be loaded onto a container ship in Batumi. From Batumi, the container would be shipped across the Black Sea to the Ukrainian port of Ilyichevsk or an alternate port in Southeast Europe. From there, that container would travel the rest of its journey by train to reach European markets. All in all, a trip from China to Ukraine would take approximately 15-16 days on the TITR.
Figure 1: Trans-Caspian International Trade Route (TITR)
REALISTIC COMPETITIVE BENCHMARKING – TITR vs. YUXINOU
Proponents of the TITR route claim that this 14-16 day journey is a far faster path for Sino-European trade, relative to a 45-day maritime trip from China to Europe. This is obviously a misleading comparison. Any path that cuts across Eurasia will likely be faster than a container ship that has to set sail from Eastern China, go around Southeast Asia, India and the Middle East (and possibly Africa, depending on ship-width and Suez Canal tariff rates) to reach Europe. The TITR’s real competitors are other land-based trade routes that span the Eurasian landmass. When it is benchmarked against a route offering similar speeds – such as the 12–15 day Chongqing-Duisburg railway (otherwise known as the Yuxinou Railway), the TITR simply cannot compete. Its lack of competitiveness stems from two reasons – superfluous process flow and non-vital destination.
Figure 2. Red: Chongqing-Duisburg/Yuxinou route; blue: TITR
Figure 3. Process comparison: top – Yuxinou, bottom – TITR
As one can see from the figure 3 diagram, compared to the Yuxinou, the TITR requires four extra loading/unloading processes, and would require both rail and ship infrastructure. From a supply chain management perspective, every time a container has to be moved off a train and onto a ship (and vice versa) incurs additional labor cost, additional unloading/loading time, not to mention an additional opportunity to misplace or otherwise mishandle a container. In operations management, the ideal process flow model would have as few distinct steps as possible to complete any given job, because each additional step added to the process likely creates more work (e.g. repeated loading/unloading), creates a potential bottleneck if that step is slow (e.g. wait time at a dock), and creates rework when mistakes are made (e.g. placing a container in the wrong assembly area destined for the wrong ship, then going back and moving the container to the correct area). Not only does the TITR have a less efficient process flow, it requires both port and rail infrastructure to be functioning smoothly, meaning more upfront investment to set up the process in the first place. Given these limitations, it’s hard to see how the TITR can offer a competitive rate vs. Yuxinou and still operate profitably, unless governments along the TITR route are willing to subsidize Chinese and European traders for using the route (especially when Yuxinou prices have recently fallen by nearly 50%). In fact, current estimates suggest that the price of shipping through TITR would be 2-3X that of a route that utilizes the Trans-Siberian.
That said, Yuxinou has its own bottlenecks too. The Former USSR uses 1520mm gauge railroads, whereas China and Europe use 1435mm gauge. This means that there are gauge changes required at the Chinese-Kazakh border and the Belarusian-Polish border. However, variable gauge technology has existed since the late 50s, which allows trains to drive through a gauge changing facility instead of unloading its freight to another train of the appropriate gauge. Consequently, gauge variance presents a far less daunting obstacle than having to unload/reload containers four extra times.
The other factor that makes TITR far less attractive than Yuxinou is its destination. Simply put – where do the goods end up after a 15-16 day journey? If a company was using the Yuxinou, its good would land in Western Germany – the center of EU economic activity and a stone’s throw away from well-off consumers in Germany, France, the low countries, etc. TITR on the other hand, brings goods to the Odessa Region of Ukraine – far from the economic centers of Europe. By the way, Ukraine also uses 1520mm gauge, whereas the rest of Southeast Europe uses 1435mm. Therefore, if the final destination of these goods is anywhere outside of Ukraine or Moldova, an additional gauge change would be necessary.
This does not imply that access to Southeast Europe and the Balkans isn’t important to China, but the differences in destination links directly back to the earlier uncertainty on the tradeoff decision – would a company pay 100% more for transport, to decrease inventory holding costs by 67%? As discussed earlier, one would be more likely to answer ‘yes’ if the inventory was high-value enough. The core EU countries have far more advanced economies than those of Ukraine or the Balkans, and therefore are far more likely to engage in the type of high-value trade (e.g. industrial machinery, electronics, luxury goods, etc.) with China that makes the extra speed worthwhile.
Finally, geopolitical considerations for China. Beyond the aforementioned economic benefits of more efficient transportation, there are the strategic benefits. Primarily – bypassing the high-seas and paving an alternative trade route, one which is far less impacted by US naval superiority. Ukraine and Georgia are two countries that are demonstrably vulnerable to US political influence. For China, relying on a trade route that passes through staunch US allies negates one of the primary value props of revitalizing the Eurasian trade route in the first place.
China will not actively oppose the TITR initiative, because it does not want the OBOR project to be seen as exclusionary, nor is TITR particularly harmful to China. Countries such as Georgia and Ukraine will be free to use these routes as they see fit. However, China is unlikely to depend heavily on the TITR. Compared to better railway routes such as Yuxinou, the TITR is economically uncompetitive, and it does little to advance China’s geopolitical interests.