China's Ministry of Finance recently announced a new "debt sustainability framework" for the Belt and Road Initiative--the plan that China announced in 2013 for supporting construction of overland and overseas transportation infrastructure that would build closer links from China across Asia, and reaching to Africa, the Middle East and Europe.
There's often a strong theoretical case for lending money to build more infrastructure in low-income countries. International lenders ranging from government and private debt markets to organizations like the World Bank and regional development banks have lists of rules and standards to try to assure that such projects work out. The problem for China is that many of its Belt and Road Initiative projects were previously discouraged or turned down by the standard international lenders. As the Economist magazine wrote in the November 3, 2018 issue in an article called "Think of China as a giant sub-prime lender in Latin America":
Instead China stands out for its willingness to invest in risky or corrupt places with few alternative sources of capital or of cheap, robust technology. Its approach might be called sub-prime globalisation. At best, sub-prime lenders are non-judgmental sources of second chances. At worst, they are see-no-evil profiteers, and vulnerable to backlashes. China is a bit of both.
More recently, the Economist reported in its June 29, 2019, issue that "China is thinking twice about lending to Africa: Too many past projects have been costly flops." Yasheng Huang at the MIT Sloan School of Management wrote an op-ed on May 23, 2019 asking: "Can the Belt and Road become a trap for China? Program risks leaving Beijing vulnerable to the growing bargaining power of recipient states."
The dynamics that China is now learning are familiar to the US and other high-income countries. The starting point is often a combination of a high-minded desire to help economic development in low-income countries and a baser desire for a high-income country to help its exports and spread its foreign policy clout. Taken together, these seem to justify substantial infrastructure loans. But by the time the infrastructure plan is digested by political forces and logistical problems, a number of project end up either incomplete or not generating the expected revenue. When the loan and the project goes bad, the country that borrowed the money feels hostile toward the lender, and cheated by promises that failed to materialize. The lender feels aggrieved that the loan isn't being repaid.
China is now getting enough of this blowback that it is tightening its rules for making Belt and Road Initiative loans--basically saying that it's going to follow World Bank standards. This shift toward greater caution in China's attitudes toward the Belt and Road Initiative offers a moment to take stock of current thinking about the program. For recent overviews of the issues, some useful starting points are:
"China’s Massive Belt and Road Initiative: China’s Belt and Road Initiative is the most ambitious infrastructure investment effort in history. But is it also a plan to remake the global balance of power?" Andrew Chatzky and James McBride wrote this "backgrounder" for the Council on Foreign Relations (updated May 21, 2019).
Crony Capitalism: Misdiagnosing the Chinese Infrastructure Push-- China’s Belt and Road Initiative does not pose a military or strategic threat to the West so much as an economic one." Deborah Brautigam wrote this essay for the American Interest (April 4, 2019).
"Can China's Belt and Road Initiative Save the World from a Mud Fight?"A report from the credit insurance firm Euler Hermes (January 30, 2019).
In the rest of this post, I'll refer to these essays and also some more more specializes work.
As Brautigam points out in the American Interest essay:
[T]he BRI slots neatly into low-income countries’ development aspirations. China has excess foreign exchange, construction capacity, and mid-level manufacturing and needs to send all of these overseas. According to the Asian Development Bank, the developing countries of Asia alone require infrastructure investments of about $1.7 trillion per year to maintain growth, reduce poverty, and mitigate climate change. In Africa, on the periphery of the BRI, the African Development Bank estimates annual infrastructure requirements to be $130 to $170 billion. The World Bank and donors in wealthy countries are only tentatively restarting their funding for developing country infrastructure after decades of decline.
Better infrastructure does support an increase in trade. Suprabha Baniya, Nadia Rocha, and Michele Ruta offer some estimates in "Trade Effects of the New Silk Road A Gravity Analysis" (World Bank Policy Research Working Paper 8694, January 2019). They find that "a one‐day reduction in trading times increases exports between BRI economies by 5.2 percent on average. In addition, trading times are particularly important for time sensitive products that are used as inputs in production processes, suggesting that reductions in shipping times are key in the presence of global value chains ..." Overall, "[t]he paper finds that (i) the Belt and Road Initiative increases trade flows among participating countries by up to 4.1 percent; (ii) these effects would be three times as large on average if trade reforms complemented the upgrading in transport infrastructure ..."
Although it doesn't seem a fashionable point of view in 2019, growth in trade do have the potential to benefit both sides. As the Euler Hermes report emphasizes, China can lend out some of it large supply of foreign reserves, open up access to additional markets, re-deploy some of the overcapacity in its construction industry, and see its currency more widely used in the world. The 80 or so countries with BRI infrastructure investments have the potential to expand their exports and productivity.
But what about the projects that don't work out, and the conflicts over debt? There's a paradox here, which is that China's policy of no-strings and few-strings lending for BRI projects made it very popular, until projects started going back. As Chatzky and McBride note in the CFR backgrounder:
Christopher Balding, a former professor at the HSBC Business School in Shenzhen, says that the BRI’s “no-strings approach” has, counterintuitively, made some of its investments less attractive. The approach “has fueled corruption while allowing governments to burden their countries with unpayable debts,” he says. Political backlash is perhaps less of a concern in authoritarian countries taking part in the BRI, where autocrats face less public scrutiny and where the Chinese model of governance might hold more appeal. But some governments, in places such as Kenya and Zambia, are carefully studying BRI investments before they sign up, and candidates in Malaysia have explicitly run—and won—campaigns on anti-BRI platforms.
Indeed, back in 2018 Chinese President Xi Jinping started offering public warnings about BRI funds going to "vanity projects," which clearly wasn't a good sign. As Brautigam notes:
On the other hand, China’s control over banking, and the close ties between state and capital prized by the East Asian model, have their own significant weak spot. The system can encourage investment; but it can and usually does also lead to rent-seeking and cronyism. Just as the pen is proverbially mightier than the sword, the pens that sign warped economic arrangements can be as devastating to prosperity, and at times to peace, as military tension and conflict. The Achilles Heel of China’s bank financing model is that it relies heavily on Chinese companies to develop projects together with host country officials. This creates strong incentives for kickbacks and inflated project costs. Particularly in election years, companies and public works ministers may collude to get projects approved.
How many countries could be at severe risk from BRI borrowing? John Hurley, Scott Morris, and Gailyn Portelance looked in more detail at "Examining the Debt Implications of the Belt and Road Initiative from a Policy Perspective" in Center for Global Development Policy Paper 121 (March 2018). They note: "[T]here are 10-15 that could suffer from debt distress due to future BRI-related financing, with eight countries of particular concern. These countries are Djibouti, the Kyrgyz Republic (Kyrgyzstan), Lao People’s Democratic Republic (Laos), the Maldives, Mongolia, Montenegro, Pakistan, and Tajikistan." But there are a number of other countries where the BRI debt might end up being quite unpopular, even if it was technically not unbearable.
When discussing the Belt and Road Initiative, the issues go beyond the purely economic, and into topics of geopolitics and great power rivalry. For example, a concern is that China would not only be involved in financing and building port infrastructure, but that China's government would then exert control over those ports. For an example of this line of argument, Judd Devermont, Amelia Cheatham, and Catherine Chiang have written "Assessing the Risks of Chinese Investments in Sub-Saharan African Ports" for the Center for Strategic & International Studies (June 2019).
More broadly, the concern is over whether China can exert "debt-trap diplomacy," where a combination of financial ties, local companies on the ground, and an ongoing debt relationship brings the country under China's geopolitical influence. I suspect that this may have been one of China's goals in pushing the Belt and Road Initiative. But at least so far, this does not seem to have happened in a widespread way, and the issues here are tricky ones.
If infrastructure loans go well and create substantial new economic value and trade, then yes, China's influence will grow. But if infrastructure loans go badly, then debtor countries and their politicians are going to push back hard against China--just as they have pushed back hard against western lender and the World Bank when infrastructure lending turned out badly. China is in the process of learning that when you lend to a government, the issues that arise in repayment are quite different than when you lend to a private company.
A version of this article first appeared on Conversable Economist.
Timothy Taylor is an American economist. He is managing editor of the Journal of Economic Perspectives, a quarterly academic journal produced at Macalester College and published by the American Economic Association. Taylor received his Bachelor of Arts degree from Haverford College and a master's degree in economics from Stanford University. At Stanford, he was winner of the award for excellent teaching in a large class (more than 30 students) given by the Associated Students of Stanford University. At Minnesota, he was named a Distinguished Lecturer by the Department of Economics and voted Teacher of the Year by the master's degree students at the Hubert H. Humphrey Institute of Public Affairs. Taylor has been a guest speaker for groups of teachers of high school economics, visiting diplomats from eastern Europe, talk-radio shows, and community groups. From 1989 to 1997, Professor Taylor wrote an economics opinion column for the San Jose Mercury-News. He has published multiple lectures on economics through The Teaching Company. With Rudolph Penner and Isabel Sawhill, he is co-author of Updating America's Social Contract (2000), whose first chapter provided an early radical centrist perspective, "An Agenda for the Radical Middle". Taylor is also the author of The Instant Economist: Everything You Need to Know About How the Economy Works, published by the Penguin Group in 2012. The fourth edition of Taylor's Principles of Economics textbook was published by Textbook Media in 2017.