Dueling Investment in Southeast Asia

Introduction:

ASEAN centrality is being put to the test with the increasing relevance of Great Power politics in the region. Although competition between the United States and China in the newly branded Indo-Pacific has received the bulk of attention due to the high stakes risk of more antagonistic relations between the world’s two largest economies, both of whom possess nuclear weapons, Japan and China’s dueling visions for Southeast Asia and the Indo-Pacific at large have had some of the most tangible impacts so far. 

Under Xi Jinping’s Belt and Road Initiative (BRI), China seeks to expand its influence and provide more markets for China’s domestic construction industry. Prime Minister Abe Shinzo of Japan provided his own alternate view for regional stability with his Free and Open Indo-Pacific (FOIP) and the Partnership for Quality Infrastructure (PQI). The BRI seeks to increase connectivity and trade with an emphasis on a shared respect for each other’s sovereignty, meaning that it is pragmatically and not ideologically driven. The FOIP vision seeks to cement the US’s contested “rules based order,” with an emphasis on freedom of navigation in international waters (a pushback against Chinese actions in the South China Sea) as well as increased connectivity and trade, while the PQI stands as a more focused effort for economic competition with China’s infrastructure industries and acts as a subtle insult of the safety of China’s infrastructure.

According to Digital Minister Taro Kono of Japan, ASEAN is the “heart” of the FOIP, and it is one of the most intense regions of competition for Chinese and Japanese businesses looking to spend their excess capital. ASEAN is neither monolithic, nor just an arena for Sino-Japanese competition, however. Although it has come under pressure due to its increasing strategic and economic significance, each country in Southeast Asia remains committed to advancing its own self interest. The question then must be asked: how does ASEAN choose to operate in the face of Sino-Japanese infrastructure competition, and what is the decision making process for individual Southeast Asian states when choosing between these two competing visions?

This paper will outline the existing relevant literature to Southeast Asia’s hedging strategy and the analytical framework used. Next, ASEAN’s view as an institution in its own right on these competing views for their region and vying for influence will be discussed. The bulk of the paper consists of case studies of major infrastructure deals broken down by each country. Next, the paper will discuss trends and outliers observed in the case studies, followed by the paper’s conclusion.

Theoretical framework:

The term “hedging” was introduced into international relations literature in the 1990s as an alternative strategy for weaker states to use between the binary of “bandwagoning” and “balancing.” Balancing is used to describe a strategy that entails allying with other powers against a mutual threat. Bandwagoning is when a weaker country accepts a subordinate role in the face of a great power. Hedging refers to a situation where, due to great uncertainty about the balance of power, a state chooses a middle path of enacting differing policies that keep competing powers in their region involved while reducing individual dominance by either power over their country.

Southeast Asia is one of the most commonly used examples of a region that utilizes hedging tactics. Although it is used to describe their tactics, these countries do not use the term to describe their own actions because of the negative connotation of indecisiveness that comes with it and instead prefer to describe their actions as non-alignment.

Economic hedging is when a middle power allows both competing great powers to be involved in the country’s economy as long as they do not lose their sovereignty. This allows for strategic autonomy by increasing relations with both sides while usually keeping the one seen as a threat at more of a distance. The importance here is that it does not close off any options for the middle power, therefore, allowing them to take advantage of the opportunities presented by both sides.

Hedging is often described as an undesirable strategy. It is true that this strategy emerges from a position in the midst of great power competition that is thrust upon these states, but as the rest of this paper will lay out, countries can benefit tremendously from increased competition. Economic hedging pits the two powers against each other to compete for whoever can secure the greater deal for the middle power. The point of hedging is benefit maximization in the face of uncertain risk.

ASEAN wedged between two powers:

Although the bulk of its activities are not focused on Sino-Japanese competition, ASEAN has been compelled to release a number of statements regarding their relationships with their respective frameworks for regional integration and stability. After all, ASEAN continues to proclaim its centrality in its decision making. It is in the attempt to maintain that centrality, that they push for a hedging strategy, siding with neither China nor the US and Japan.

Since 2016, ASEAN has been releasing joint statements with China on their relationship with the Belt and Road Initiative. ASEAN is open and welcome to Chinese investment, joining the BRI as well as the Maritime Silk Road. In addition to their agreements, the two commit to trying to find a resolution to their territorial disputes through consensus, but no steps to resolving these are actually given.

In 2019,  ASEAN released a statement titled, “ASEAN Outlook on the Indo-Pacific.” This document seems to align itself fairly consistently with Japan’s Free and Open Indo-Pacific. Contrary to China and Japan’s claims that they are complementary visions for the region, FOIP and BRI are in opposition to each other. ASEAN’s announcement of an acceptance of the Indo-Pacific framework as a region, affirmation of good governance and the rules based order, and confirmation of the UN Convention on the Law of the Sea in this document indicate that ASEAN is more partial to Japan’s prospective order.

In ASEAN’s “The State of Southeast Asia 2023” report in which they interview and survey academics, business people, civil society representatives, government officials, and personnel from regional and international organizations from across Southeast Asia, China is consistently viewed with suspicion. Comparatively, Japan had the highest trust with 54.5% saying that they would “‘do the right thing’ to contribute to global peace, security, prosperity, and governance,” ranking about the United States, the European Union, China, and India. In response to the last question, 49.8% of respondents said they had little to no confidence that China would “do the right thing.” China’s increasing economic and regional influence was also noted as a concern, with 64.5% saying that they were worried.

Given this concern held by the movers, shakers, and policy makers of ASEAN countries over China’s rise and their seeming alignment with the FOIP, one may expect an overt shift to accepting Japan’s investment in the region over China’s, but this is not the case. While there are no questions directly comparing ASEAN’s opinions on vying influence between Japan and China, Japan is largely seen as in line with the US’s broad goals for the region, and in the 2023 report, an overwhelming majority, 94.1% of respondents said that they should not take a side in the event of ASEAN being caught in the crossfires of US and Chinese competition. They either said ASEAN should seek help from third parties (18.1%), fend off US and Chinese pressure (45.5%), or just continue to assert their neutrality (30.5%).

As the next section will show, ASEAN finds themselves in a precarious situation in an environment of heightened tensions, but they have a lot to gain from this competition.

Case Studies in Competition:

Behind-the-scenes business negotiations and bidding processes remain opaque, but the sheer amount of new infrastructure projects launched and agreed upon in Southeast Asia since Japan and China’s respective initiatives began gives enough examples that we can start to sort through and find patterns of investment. In the following section, this will be done for the sample of Southeast Asian countries covered in the cases of competition. Some high-profile cases have more information publicly available on them that can also be used to understand the finer details of these negotiation processes. This next section will break down different infrastructure projects on a country by country basis. 

Indonesia

The high profile Jakarta-Bandung High Speed Rail (HSR) deal is a useful starting point for analysis because it was a well documented bidding process that pitted Japanese and Chinese firms directly against each other. Japan had been the undisputed financier for the project since 2008, but the visit to Beijing of Joko Widodo (Jokowi), the President of Indonesia, in 2015 set the ground for possible Chinese competition for the deal. China’s bid was as follows: 75% of funding by China Development Bank, a business to business funding framework (B2B), a 2% interest rate on loans, a shorter time frame for building the project than Japan’s proposal, and a lower overall price (5.5 billion USD as opposed Japan’s 6.2 billion USD).

Japan responded quickly with a counter offer “bringing down the minimum government guarantee from 100% to 50% of the project value, reducing the portion of the project to be covered through government budget, and promising more local procurement for the line’s construction.” As the competition reached a new intensity with officials from both sides constantly contending for Jokowi’s attention, he temporarily turned both parties down, reconsidering whether a high speed rail was even needed over a regular rail project. In this reprieve, Jokowi eventually made the decision to award the project to the China Railway Group Ltd.

The reason Indonesia chose China to helm the project over Japan is twofold. The most important reason was due to China’s willingness to engage in a B2B framework as opposed to Japan’s insistence on a government to government deal (G2G). The importance of this distinction for Jokowi is because the Indonesian government is not allowed to have a deficit more than 3% of GDP. This inherently limits the ability for SOEs to fund the project as Japan had intended in their negotiations. China proved to be more flexible by waiving the government guarantee for loan financing, pushing the financing to the private sector. 

Jokowi also wanted to prevent overreliance on Japanese investment that Indonesia has depended on since their post-colonial period. Japanese predominance in infrastructure was the norm before Joko Widodo came into office. Jokowi had pushed for a more friendly and open stance on Chinese investment that received domestic backlash because of worries over the BRI’s reputation for “debt trap diplomacy.”

Beyond just this specific deal, Indonesia has been a nexus for Chinese and Japanese competition. A few years after the Jakarta-Bandung deal sent Japan into a crisis of confidence, Indonesia awarded a Japanese company a deal for the Jakarta-Surabaya rail project. This decision was largely seen to be a strategic one to keep Japanese interest. Japan most certainly has kept its interest. Since 2013, the Ministry of Land, Infrastructure, Transport, and Tourism has designated the Jakarta Metropolitan Area as a Priority Area for Investment and Industry. Indonesia has by far received the most investment in Southeast Asia from the Japan Overseas Infrastructure Investment Corporation for Transport & Urban Development (JOIN) that Japan created to oversee the success of its Infrastructure Export Strategy with 10 projects amounting to 56.5 billion JPY. They are also the third highest Japanese ODA recipient in Southeast Asia since 2013 with 16.32% of Southeast Asian ODA awards amounting to 548 billion JPY.

Meanwhile, Indonesia continues to accept the courting of China. “In March 2019, Indonesia offered China the opportunity to invest in 28 projects worth approximately $127.5 billion, as part of BRI, while expecting to reach a deal on at least 2 or 3 of those projects.” These projects ranged from power plants to tourist sites to smelters. But Indonesia is aware of its negotiating power and established four conditions to accept Chinese investment: “(1) adhere to environmental standards, (2) use local labor, (3) facilitate technology transfer to local partners, and (4) bring economic benefit to Indonesia.”

Vietnam

Vietnam is an important case to study due to the security framing around its hedging against China. Territorial disputes have plagued their relationship, with Vietnam only engaging in economic cooperation with China after the resolution of their border dispute. During this period of Sino-Viet friction in the 90s, Vietnam relied heavily on Japan for infrastructure. In the 2000s, Vietnam became more economically dependent on China and Chinese infrastructure investment. Relations would reverse course again after a number of disputes in the South China Sea, leading to a renewed calculus and suspicion of Chinese investment on Vietnam’s part. Once leading the region in Chinese infrastructure investment, Vietnam has actually seen a major drop in Chinese construction projects since Xi Jingping launched the BRI. Infrastructure investment stands at a third of pre-BRI levels and ranks below Thailand, the Philippines, Indonesia, and Malaysia.

Vietnam has exhibited some hedging tactics, however. In its granting of rail projects, it followed the Indonesian model. In an attempt to balance the two interests, they have awarded Chinese firms to build the Hanoi Metro Line 2 and awarded Japanese firms to build the rail line in Ho Chi Minh City.

But by most metrics, Vietnam has engaged in what seems to be a balancing strategy with China. Increasing Chinese assertiveness in the South China Sea led to Vietnam backing out of talks with Chinese firms on building thermal power projects. Instead, they granted these projects to Japanese firms. The Vietnamese finance minister even advocated reneging on their Hanoi rail deal with China, instead advocating to grant it to Japan. Vietnam also declined a Chinese offer for funding the construction of a highway connecting HaLong Bay to the Chinese border.

In 2017, Japan became Vietnam’s biggest investor. They are the largest recipient of Japanese ODA loans in Southeast Asia since 2014, accounting for 30.56% of all their ODA loans in the region. Chinese investment is comparatively only a fifth of Japan’s. Vietnamese balancing is a strategic departure from the region’s characteristic hedging. 

Thailand

Thailand sits at the heart of one of China’s ambitious overtures to increasing ASEAN connectivity. China envisions a Pan-Asia Railway network connecting three lines from Southeast Asia to China running through Laos, Myanmar, Malaysia, Singapore, and Vietnam with Bangkok being a central hub. All of these railways are also planned to connect with Kunming in China as well.

With uneasy political relationships with Vietnam and Myanmar, China attempted to begin this rail construction in Thailand. Japan, however, is the biggest investor in Thailand by far. Thailand pursued a fairly straightforward hedging strategy in response to these dueling pressures. Thailand envisions a North-South corridor built by China and connecting to the Kuala Lumpur-Singapore high speed rail. Japan, on the other hand, will be responsible for constructing Thailand’s East-West corridor. In 2015, the two countries signed an MOU on a Bangkok-Chiang Mai railway line and a Bangkok-Laem Chang railway line. Thailand has been pushing for a lower East-West rail line connecting Kanchanaburi bordering Myanmar with Aryanprathet bordering Laos and an upper East-West rail line connecting Mae Sot bordering Myanmar with Mukdahan bordering Laos.

Thailand has also taken advantage of the opportunity that Indonesia opened up with the renegotiating of their HSR deal with China. In the wake of this high profile event, Thailand announced that they would be self financing a scaled back version of their Bangkok-Nong Khai project after China refused to renegotiate to allow for a 2% interest rate as they did in Indonesia. Eventually, in 2017, China agreed to finance 25-30% of the project with a revised 2.3-2.5% interest rate. In light of the Jakarta-Bandung deal, Thailand was also able to flex its negotiating power and use Sino-Japanese competition to its advantage.

Philippines

The Philippines has historically largely fallen in line as a reliable US partner in the region and has long been a recipient of Japanese infrastructure investment. In contrast, the Sino-Philippine relationship has always been mired by tensions over Chinese claims in the South China Sea. In recent years, the Philippines has responded to Chinese infrastructure investment with different strategies depending on the president in office.

Under President Aquino, Philippine sovereignty was the most important consideration in economic cooperation due to worries of Chinese coercive economic diplomacy. Aquino allowed for the continued building of already agreed upon Chinese projects, but did not increase investment. After the election of Duterte in 2016, the new administration took a much more skeptical view of the US led order and was much more open to increasing Chinese investment. Duterte still counted on Japanese infrastructure investment as well though. Under his Build, Build, Build campaign, the most important goal was to close the gap in infrastructure with other parts of Southeast Asia, no matter the source.

Both Japan and China poured a lot of money into the Philippines under Duterte’s inclusive infrastructure push. The Philippines received the third highest amount of infrastructure funding from China in Southeast Asia. The two countries agreed to move forward on 49 infrastructure projects. Chinese funding has been guaranteed for eighteen of the projects, but the rest have not and may still fail through.

Japan committed 1 trillion yen to Philippine infrastructure in the five years after they agreed on it in 2017. This is the largest commitment in infrastructure investment Japan has given for a single country. They also created the Joint Committee on Infrastructure Development and Economic Cooperation to coordinate the one-trillion-yen assistance, a first of its kind committee to increase the ease of investment in the country.

Japan has an inherent advantage due to its years of investment prior to the current infrastructure competition. As a long time investor, Japan benefits from their familiarity with the Philippine ODA management system. There is also strong trust that has been built between the two countries after years of economic integration. Manila has also pushed to revisit 3 Chinese loans for rail projects in light of Japan’s post-Jakarta-Bandung debacle 0.1% rates to many other similar rail projects. China is actually willing to play ball because it says this is an important diplomatic effort with the new Marcos administration. Here is yet another example of the realization of increased negotiating power due to Sino-Japanese competition. Although the Philippines is now engaging in hedging with a much more open approach to China, Japan still dominates in the construction of new infrastructure because, even with competition, they are usually better suited to best serve Philippine interests.

Malaysia

Malaysia and Japan have historically had close ties with each other since Malaysia was granted its independence and especially since Prime Minister Mahathir’s signature Look East Policy (LEP) from when he was first elected in the 1980s. Japan contributed significantly to Malaysia's infrastructure, but the last decade was a marked shift in policy towards increased openness with China under PM Abdullah and Najib. 

When Mahathir’s first 20-year run as prime minister ended, China’s ascendancy as the economic power in the region was increasingly evident. From the start of the Belt and Road Initiative in 2013 till 2018, Malaysia was the number one recipient of Chinese investment and infrastructure, offering mostly G2G loans as was preferred by Malaysia. Japan’s investment in contrast was quite dismal. Malaysia accounted for only about 1.3% of ODA contributions in Southeast Asia during the same period.

China’s impact on Malaysia is incredibly visible. China has built or is in the process of building several high profile infrastructure projects such as the East Coast Railway Line (ECRL), Melaka Gateway, Trans-Sabah Gas pipeline, Malaysia-China Kuantan Industrial Park, and Bandar Malaysia, but China’s economic preeminence in Malaysia as its largest investor and trade partner eventually led to domestic pushback. Mahathir ushered in a pivot back to closer relations with Japan after his political revival with his re-election in 2018. Mahathir’s re-election highlighted domestic concerns that Najib gave up Malaysian sovereignty to China in his support for the BRI. 

When he was back in office, Mahathir canceled several BRI mega-projects including the ECRL which was especially politically important for China due to the project enabling a way to bypass the Strait of Malacca. Mahathir showed that his preference was for more investment from Japan rather than China, and his first overseas visit of his second tenure as Prime Minister was to Japan to meet with Abe. Eventually he backtracked and allowed the projects to continue under a better deal that was negotiated with China. Project costs were cut by a third and more Malaysian firms were incorporated to work in downstream industries for the project. Mahathir did genuinely seem concerned with China’s influence, however, which makes it all the more surprising that Japanese investment does not appear to be increasing at all. 

Trends and outliers in Southeast Asian responses:

Although the selection of countries and infrastructure projects examined in the previous section is by no means comprehensive due to the sheer number of projects under the BRI and PQI, some trends in investment can be detected in this sample. 

Jakarta-Bandung HSR as a pivot point

First, it is important to note the effects of the highly publicized Jakarta-Bandung High Speed Rail bidding process in framing the way the two countries approached infrastructure negotiations after this pivotal deal. The deal ultimately was secured by China because of their greater flexibility to comply with Indonesian preferences. The loss of the project that Japan originally was the undisputed financier of was a heavy blow, leading the government to reconsider its lending procedures. Japan emerged from these talks with a higher appetite for risk, opening up a process to waive government guarantees to back loans for projects of “diplomatic importance,” streamlining and expediting the approval process for ODA loans, as well as dropping many of the interest rates for their loans to 0.1 per cent.

Other Southeast Asian nations also changed their behavior in response to the Jakarta-Bandung HSR deal. The Philippines responded by asking to renegotiate 3 Chinese loans in light of Japan’s new 0.1% rates. Laos, a small country largely dependent on China, was able to get China to drop their exchange for potash mines in the aftermath. Thailand negotiated to get their interest rates lowered to 2.3-2.5% with less Chinese financing. Indonesia’s ability to gain major concessions from China and Japan’s shift to match China’s easy money led to a greater awareness of the bargaining power that Southeast Asian nations had with increased Sino-Japanese competition.

The importance of flexibility

The greatest determinant of infrastructure project awards is flexibility in being able to adapt to a country’s individual needs and preferences. A country’s preferences for investment are set by their own unique institutions and circumstances, so a one-size fits all model is not sufficient. 

For instance, Indonesia’s government has structural restrictions that make a B2B framework more appealing. China’s flexibility in being amenable to these circumstances was crucial in securing the deal as opposed to Japan’s rigidity in not budging from their G2G framework. Malaysia on the other hand prefers a G2G framework, so China deals in G2G loans with the Malaysian government.

Under the presidency of Duterte in the Philippines, their stance on Sino-Japanese competition was neutral. If anything, Duterte showed tendencies to shift away from the US led order and, in turn, away from Japan, but he made it clear that his most important goal was to increase infrastructure no matter the source country with his Build, Build, Build agenda. Both China and Japan dramatically increased infrastructure investment into the Philippines, but Japan’s long term knowledge of Philippine procurement procedures and bureaucracy ensured that they would still hold a tremendous advantage despite the government’s shift to a more friendly position on Chinese investment.

Hedging with timing

Southeast Asian countries also display strategic decision making when it comes to the timeline of the awarding for mega-projects. Thailand, Indonesia, and even Vietnam have announced projects funded by one country soon after a deal with the opposite country has been made. After the Jakarta-Bandung deal with China, Jokowi awarded a Japanese firm to build the Jakarta-Surabaya rail project. Thailand plans for Japanese countries to build East-West corridors across the country while China builds the North-South corridor. Vietnam awarded China to build the metro in Hanoi while Japan was awarded to build the one in Ho Chi Minh City. This is a clear sign of hedging, keeping both parties interested in order to secure future investment. Southeast Asia gains tremendously from this competition and ensures better deals by playing these two economic powers off of each other.

Changes in government

It is also important to note a rather obvious point, that changes in government often result in different foreign policies. New leaders are often the result of structural changes or shifting dynamics, but the priorities of a new government have an effect on a country’s international relations. Aquino had very different policies to Duterte in the Philippines. Jokowi’s inauguration signaled a shift to a policy more open to Chinese investment in Indonesia. 

The literature reviewed for this paper on Malaysia was not conclusive about the effect of leadership change from Najib to Mahathir on infrastructure investment. Mahathir’s new term marked a shift in hawkishness against China and a revival of diplomatic closeness with Japan, but the effect on actual investment seems to be negligible. 

When security trumps economics

Vietnam is a special case when it comes to the Southeast Asian countries reviewed in this paper. Vietnam is the only country reviewed that decidedly seems to take a balancing strategy as opposed to hedging. Vietnam has had long-term territorial disputes with China over the South China Sea, but so have the Philippines and they have managed to mostly separate their security concerns from the economic benefits they have reaped from Chinese investment.

Vietnam has an increasingly securitized view of economics. It views Chinese investment as a risk to their sovereignty. This economic securitization rhetoric is what Mahathir used in Malaysia to come to power, but as stated in the previous section, there was little tangible change. This may be a course correction from the overreliance on Chinese infrastructure in the 2000s, but the divergence in Vietnamese and Philippine acceptance of Chinese investment merits further research.

Conclusion:

In the face of Sino-Japanese infrastructure export competition in their region, Southeast Asian countries broadly choose a hedging strategy. Vietnam is the only country analyzed in this paper that takes a balancing strategy towards China and is not friendly to Chinese infrastructure investment due to its security concerns overriding any potential economic benefits. Being open to investment from both countries has allowed for every other country examined to play the two competing powers off of each other to ensure a better deal. With this increased bargaining power in the hands of Southeast Asia, Japan and China have rushed to provide projects tailored to their specific wants and needs. 

Concerns over Chinese domination and over reliance on Japanese investment are also different factors that push Southeast Asian countries to ensure a balanced amount of investment by country origin. Public opinion amongst influential actors in ASEAN countries is much more positive for Japan and negative for China. The hedging strategy dictates that they do not overtly depend on one power over the other so that both parties remain interested. ASEAN as an institution remains neutral but seems to rhetorically side more with Japan’s FOIP vision for the region while being open to the BRI. Ultimately, each country is looking for the best deal available while ensuring that both China and Japan are interested in future investment. 

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