Responding to Belt & Road and Beyond:

What Washington is Getting Right and Wrong about Chinese Development Finance

Scott Morris

Senior Fellow, Center for Global Development

Let me start by reading a quote to you from a senior USAID official:

“We are going to absolutely call this stuff out and to be more clear about the choice that our partner countries have, and be clear that if you decide to work with China, it is bad.”

If you decide to work with China, it is bad. This statement perfectly captures where US policy stands today when it comes to Chinese development finance. And while I do want to focus on the Trump administration, which is setting the tone and the policy, it is also important to note that the wider Washington policy community, certainly Congress but also the think tank community, is not so distant from this simplistic stance. For the think tanks, I attribute this to the outsized voice of the national security expert community, and the fact that they have only recently woken up to the fact of Chinese finance, given prominence under the Belt & Road initiative.  The dominant analytical framework in Washington for assessing BRI is a security one, and the dominant view in Washington right now is that Chinese finance globally represents a national security threat here it home. As a result, we have moved seemingly overnight from the language of development cooperation to competition and conflict, in which an emerging and potentially leading objective of US foreign assistance is to counter China.

As a framework for engaging with other countries, “Chinese money bad, US money good” has some problems. It is counterproductive and misses the mark when it comes to grounded and needed criticism of Chinese behavior. So, let me spend a few minutes on what I think current US policy is getting wrong and then focus on what actually is wrong with Chinese financing, with some thoughts about getting to a more productive US policy stance.

First, let’s consider the language of administration officials more generally, which often portrays the fundamental weakness of a “state-driven” development model, the need for “market-driven” solutions, and more generally has sought to convince developing country officials that Chinese finance everywhere and always leads to bad outcomes. Locked in a Cold War mentality, the administration seems to be obsessed with the idea that China is spreading Karl Marx around the world one loan at a time. The problem here is that they are fixated on the wrong Marx. It was Chico Marx in the movie Duck Soup, who famously asked, “who are you going to believe, me or your own eyes?” And so you can picture Secretary Pompeo in meeting after meeting with developing country officials preaching the sins of Chinese finance when these officials only need to look out their windows and see the roads, bridges, power plants and ports brought to them by China.

An extreme version of the administration’s approach, apparently being given serious consideration, would force countries to choose between US assistance and Chinese finance. They are calling this the “Clear Choice” policy. If they pursue this all or nothing approach, the administration may be surprised at just how clear the choice will be for most developing countries. Yes, these countries undoubtedly value the support from PEPFAR and US humanitarian assistance in times of natural disasters or pandemics, but when it comes to their day-to-day development priorities, infrastructure is typically first, second, and third on the list.

The anti-China rhetoric has found particular force in the charge of “debt trap diplomacy,” the notion that Chinese lending is deliberately seeking to drive debt distress in developing countries in order to extract things from these governments when they cannot repay the loans—those things being military or strategic concessions, diplomatic stances, or commercial interests.  Now, I have to confess that this term debt trap diplomacy doesn’t sit well with me because, more often than not, when it is invoked, it is linked to research that I did with co-authors at CGD earlier this year. You will not find the phrase in our study. Where we sought to identify and contextualize debt vulnerabilities arising from Chinese lending and to focus on the specific policy shortcomings unique to Chinese lending, the debt trap diplomacists only seem to want to level the term as a sweeping indictment. But ultimately the charge doesn’t stick because it uses the facts of a few extreme cases to generalize about all Chinese lending. If every country looked like Djibouti—which has effectively become a client state with unsustainable levels of external debt, nearly all of it owed to China—if this were the norm, then the picture would be very bad indeed. But the broader program of Chinese lending is more complex than that.

And this is what’s particularly frustrating about the US stance – it misses the opportunity to focus in a concrete way on what is wrong with Chinese finance and what can be done about it at the policy level. So what are the specific charges we could level against Chinese lending?

1. It is not transparent, with far too little information about volumes and terms reported by the Chinese government. It’s remarkable and absurd that for the largest single source of development finance in the world, a cottage research industry has sprung up simply attempting to report in a piecemeal fashion what every other major official creditor reports for itself. So, instead of China’s Finance Ministry being the definitive source on Chinese finance, we have William & Mary College. Of course, there are two parties to every loan, and this is as much a problem with borrowing government transparency and a lack of accountability to their own citizens.
2. It is by design a good deal for Chinese lenders and goods/service providers, but may or may not be a good deal for the borrowing country. Meaning: lending terms favor commercial rates over concessionality; debt may be collateralized in ways that other major official creditors have foresworn as bad practice for development; procurement outcomes consistently favor Chinese firms; and there are no discernable measures of development “impact” associated with the selection of these projects.
3. However limited, the Djibouti’s are real, and in some cases the Chinese do appear to exploit some financing relationships to obtain other things. On this list of countries we might put Sri Lanka, Tajikistan, or Venezuela. Each represents a case where debt distress leads to concessions on the part of the borrower – either because the debt was collateralized with things like extractive revenue streams or because Chinese negotiators have sought things in exchange for debt reschedulings or forgiveness. To be clear, I don’t believe these case represent the norm, and it’s worth noting that China has provided nearly 100 debt reschedulings over the past 15 years with most seemingly designed to ensure repayment in the face of a potential default and nothing more.
4. Finally, I believe China’s approach to finance is reverberating through the system of official development finance (by which I mean other bilateral actors, including the United States, as well as multilateral institutions like the World Bank and Asian Development Bank) in a way that has diminished the already limited propensity of some of these actors to address abuses and bad behavior in various forms. Let me give you one example. The UN has implicated the Myanmar government in the Rohingya genocide. The World Bank and ADB are providing this government with about $5 billion in subsidized loans. There is some limited precedent in the multilateral development banks for withholding support in the face of atrocities, but it’s not happening in this case. When it has happened, it is typically driven by the G7 members of these banks and just as typically encounters resistance from China in particular. In the case of Myanmar, China is all the more relevant because of the scale of its financing in the country. And this I believe, explains the silence of the G7 when it comes to cutting off MDB assistance—they do not want to cede their influence in a “battleground” country.

So I want to pause here to emphasize the point I made earlier: even with all of these identified shortcomings, Chinese development finance does not everywhere and always lead to bad outcomes. I would argue, based on available evidence, that development outcomes in many cases are quite good, in all cases they are not as good as they could be, and in some cases they are clearly bad. I can’t assign weights to these categories, but I do think our understanding of the policy shortcomings is strong enough to inform an approach to reform without arriving at a summary judgement pro or con.

So if the United States were interested in a more nuanced approach to addressing the problems with Chinese finance, what would that look like?

First, I’m cautiously in favor of the United States itself doing more in the way of development finance. US and Chinese official assistance actually rival each other in scale, but are radically different in composition. Where China is mostly a lender (including subsidized or “concessional” lending), the United States has not emphasized lending for development, instead providing grants particularly for health and humanitarian purposes. I believe a lot of this work is highly effective and highly valued by developing country partners and it should be sustained.

But the US approach to assistance may be changing, perhaps radically so. Just a few weeks ago, the US Congress, with the support of the administration, passed legislation to change the assistance portfolio, putting more emphasis on development finance, ie, lending. The existing Overseas Private Investment Corporation, with an exposure limit of $29 billion, will become the US International Development Finance Corporation, with a limit of $60 billion. (Bigger portfolio, bigger name apparently). I’m all for more development finance to support good infrastructure with good standards attached to it, and the legislation lays key markers that seek to ensure maximum development impact.

But this big push on lending for development is happening even as the traditional aid budget is under attack by the administration. Each budget put forward by this White House has sought to gut traditional aid and to reallocate money away from clearly-defined programs like PEPFAR in favor of essentially slush funds.

The talking points for the new development finance initiative are telling: it’s all about competing with China. Again, the “state-driven” versus “market-driven” argument.

The problem here is that the more the United States sets a goal of competing with China, the more prone our government will be to either missing the mark in terms of meeting development needs, or worse, to mimicking some of the very problems associated with Chinese financing.

Much of the public infrastructure agenda is, well, public and is best financed by governments. China does a lot of lending to governments. The new US IDFC will have the ability to lend to governments, even though that seemingly would be at odds with the administration’s “market-driven” rhetoric.  It’s worth noting that the United States once did a lot of lending to development country governments but moved away from this practice following multiple rounds of debt forgiveness initiatives, which convinced US policymakers that lending to sovereign governments created a lot of headaches for them and for all parties. Now that the new IDFC has the ability to go down this road, it remains to be seen if it will have retained the lessons from the past.

More generally, by going big with a development finance institution, the United States will be more vulnerable to a set of pressures facing all bilateral Development Finance Institutions, including China: choosing and structuring deals in ways that clearly benefit a domestic firm or interest but less clearly deliver development impact in the developing country. This practice is essentially tied aid but without the aid component. To be fair, the legislation actually eases up on any hard requirement that the IDFC work with US firms, but it is stated as a preference and I expect the political pressure to demonstrate support for US firms will be very hard to resist in practice.

And as pressure mounts to compete with China, there will also be pressure to weaken the very standards that are meant to distinguish US finance from Chinese finance: things like holding potential projects to a high threshold for development impact; and employing costly and time consuming environmental and social impact measures.

If the IDFC and the rest of US assistance becomes captured by a “Clear Choice” framework that seeks to divide up the world in the fashion of the Cold War era, then we will undoubtedly see a real deterioration in the quality of US assistance. Development objectives will increasingly take a back seat to political considerations, which seek to size up developing country governments in terms of whether they’re with us or against us and is ready to deploy cash to our friends in ways that have little to do with development.

Rather than competing head to head with China, the better objective for US policy would be to change Chinese lending behavior through direct engagement and by working with allies. This is not as naive as it might sound.

For example, there were strong indications that China would join the Paris Club of creditors at the end of Obama administration, now less certain as the bilateral US-China dialogue has been all but dismantled. Membership in this club brings with it significant obligations when it comes to lending transparency and adherence to appropriate lending practices on the part of governments. Good comments from Chinese officials, including in Bali last week, continue to suggest that they are at least sounding responsive to this agenda.

And I don’t think we should underestimate the degree to which Chinese officials are attempting to take on and respond to the backlash of criticism around their lending practices. Not just with blanket denials that there are problems, but by starting the difficult process of using policy to discipline the various and competing domestic interests implicated in Chinese finance.

For the United States and its allies, it is an important moment to encourage greater Chinese reliance on multilateral mechanisms and those within China who are championing these mechanisms. It’s worth noting that some of the rationale within the US Treasury for the Bretton Woods institutions in 1944 was to bind the United States itself to the agenda it was championing, recognizing the fact that there were competing views within the government about the direction of US policy.

What’s the evidence that multilateralizing Chinese finance could have a good effect? Look at Asian Infrastructure Investment Bank, which is multilateral in character, even with a dominant Chinese position. Its rules align very well with those of other multilateral development banks, and where it has departed from the norms, it has often been to introduce better practice rather than to bolster Chinese power.

But for US policy, the focus ought to be on the World Bank in particular. China prizes its relationship with the Bank. It is always remarkable to hear just how much Chinese officials attribute China’s economic successes to the country’s partnership with the Bank during the opening up period. Whether it’s about Chinese voting power in the institution or China’s ability to keep borrowing from the bank, there’s no question that China cares about the World Bank.

But as this relationship enters a new phase, with the bank advising, partnering, or perhaps merely along for the ride when it comes to China’s activities in other countries, there’s a key role for the United States as the World Bank’s largest shareholder. As much as I think multilateralizing BRI through partnership with the Bank can be a good thing, I’m also disappointed by the institution’s uncritical eye on the Belt & Road initiative to date. As a priority for World Bank president Jim Kim, the bank has committed considerable resources to a multi-year technical engagement around the BRI at the behest of the Chinese. A preview of that project in Bali last week revealed detailed modeling of the initiative’s benefits (sizable according to early estimates!) and vague comments about potential risks. Worse, these risks were characterized by a senior bank official as general risks associated with infrastructure projects and not anything to do with the shortcomings of China’s approach to financing.

So yes, the World Bank should be a key partner in BRI. But multilateralism is a two-way street, and the bank in particular simply hasn’t been asking enough of the Chinese. For the bank to devote the resources and profile to its BRI partnership that was on display in Bali and in every other annual meeting since BRI was launched, only to spend much of that effort on constructing a piecemeal database of BRI because the Chinese themselves won’t report their data…Well, it suggests far more deference than leadership coming from the World Bank.

Here is where tougher rhetoric and engagement from the US could have a good effect. By affirming a legitimate role for the multilateral institutions, US officials, working with allies in Europe, Japan, and Inda, could then delineate the terms of multilateral engagement.

What would those terms look like? By lending their name and offices to BRI, the leading multilaterals (WB, IMF, ADB, EBRD) should strike a framework agreement that binds the leading Chinese financiers (CDB, China Exim, Silk Road Fund):

• join the Paris Club, or adoption of club principles in some other fashion;
• operationalizing G20 Sustainable Financing Principles;
• commit to match financing terms to country circumstances, with higher overall levels of concessionality;
• commit to other uses of grant and TA support that help to level the playing field in the lender-borrower relationship, making use of multilateral initiatives like the Legal Support Facility, the IMF-WB Debt Management Facility, and UNCTAD’s Debt Management and Financial Analysis System;
• adopt open procurement rules when local procurement rules are weak;
• and adopt other safeguard arrangements when local rules are inadequate.

This stuff isn’t widely unrealistic. China has already reportedly made a significant grant contribution to the IMF’s technical assistance work on public financial management in the context of BRI.

And let’s understand China’s motivations here. To some degree, they are struggling to respond to a political backlash in their borrowing countries and within the G7/G20. But they are also realizing the limitations of going it alone when the going gets tough. After all, the Paris Club is not a debt forgiveness mechanism. It is a mechanism for official creditors to band together in order to get repaid. Increasingly, I think Chinese officials view multilateralism as a means to protecting their reputation and their financing.

So I am guardedly optimist about progress in a number of these areas.

I am less optimistic about a behavior change from China on human rights and political issues, which is why I think the US does need to take a tougher stand when these issues intersect with development finance. Unfortunately, the concern about competing with China that is driving Trump administration policy seems less anchored in a firm commitment to human rights and liberal values than it is in winning the favor of countries one deal at a time.

If we are truly going to offer the developing world a “clear choice”, then we need clarity on what makes US policy and money different from China’s, even as China takes steps to improve some of its practices. How much clearer the choice would be if, in the face of genocide, the United States went to the rest of the G7 and struck an agreement to vote down any new World Bank or ADB project for the Myanmar government as leverage to extract a change in behavior. This approach would be squarely at odds with China, and critically, it just might, alongside other sanctions, have some positive effect. Yes, it risks further ceding influence in Myanmar to the Chinese. But if we can’t even muster a punitive response to this scale of atrocity, then the clear choice we are offering gets defined solely by things like the interest rate on our loans. And that seems like a pretty hollow development agenda to me.

Thank you.