China Road and Bridge Corporation, a Chinese state-owned enterprise, is building a high-speed railway line to connect Nairobi, the capital city of Kenya, to the port city of Mombasa. Many see the railway line—one of China’s many high profile investments in East Africa—as a game changer for the Kenyan economy. Many such projects are underway and tens, if not hundreds, more will be undertaken across three continents under China’s Belt and Road Initiative (BRI) or One Belt One Road (Obor).
While the exact contours of the entire Obor initiative are not yet very clear, the idea has already been dissected inside out in the global media. One of the more interesting takes came from the redoubtable economist Branko Milanović in The Guardian. Arguing in favour of Obor, Milanović lamented the drift in the focus of international development lending from the “brick-and-mortar building of factories and bridges” to softer areas involving institution building, deregulation, privatization and market incentives, etc. The Chinese initiative, Milanović contends, brings the “hard” stuff back into vogue. “For development to happen,” he explains, “you need roads for farmers to bring their goods, you need fast railroads, bridges to cross the rivers, tunnels to link communities living at different ends of a mountain.” Just the right prices, taxes and regulatory institutions will not do.
There are two parts to analyzing Obor in the light of Milanović’s observations: 1) recapitulating the debate on development lending, and 2) locating Obor in the wider matrix of international development cooperation. The first part is well known but I will briefly summarise the key points. Led by Jeffrey Sachs of Columbia University, one school of thought advocates a prominent role for foreign aid in eliminating poverty from the planet. Free markets and liberal democracy, argue the advocates of foreign aid, are inadequate to lift poor countries out of their “poverty traps.” A large bout of foreign aid, therefore, is necessary to push those countries into a virtuous cycle of higher productivity and further investment.
The other school of thought, led by William Easterly of New York University, argues that countries are poor because of poor institutions, poor governance and poor leadership. Foreign aid impedes the transformation of these countries by discouraging the local people from building a market economy and the right institutions and incentives for the same. Moreover, politically directed foreign aid also lubricates the corrupt and venal political economies in these poor countries. A disruptor group, led by the likes of Abhijit Banerjee and Esther Duflo, has used the techniques of randomized control trials (RCTs) borrowed from the field of medicine, to evaluate which aid project-design combination can yield the best result. While this technique sounds appealing, it has its own set of shortcomings.
Milanović clearly does not abhor the idea of foreign development lending but supports, in particular, a specific kind of investment: in “hard” stuff or infrastructure. An investment in infrastructure is not contradictory to building up a market economy but in fact enables the functioning of markets by reducing transaction costs. Investment in infrastructure increases the economic productivity and the consequent surge in gross domestic product (GDP) is realised in far quicker time than the same investment in human resources (education and healthcare). Such investment is, therefore, preferred by leaders of poor countries which also face the problem of a low savings rate.
Foreign capital for infrastructure can be a good way of bridging the gap between required levels of investment rate and the national savings rate that the local economy can muster. But since most of such infrastructure lending—including the currently underway and proposed Obor projects—is in the form of loans (rather than grants), the projects must be able to yield sufficient return to be commercially viable. The assumption is that the infrastructure project will boost the forward- and backward- linked industries, generate massive employment and create national wealth. The high-speed rail in Kenya, for example, is expected to boost the industries supplying input material and equipment, connect Kenya to the other economies in East Africa and other continents through the Indian Ocean coast, helping the export sector, which can earn foreign exchange, and generate employment for local skilled and unskilled workers.
But Obor projects are not so amenable to such favourable outcomes. The loans come attached with conditions of sourcing input resources from China. A large number of labourers are also imported from China. Moreover, most of these loan recipient countries run trade deficits with China with Obor serving only to widen those deficits. The projected spurt in the local economy, therefore, remains a pipe dream. The wealth generated is often not enough to create demand for the infrastructure built, thus saddling poor countries with unaffordable white elephants. For instance, the China-built Mattala Rajapaksa International Airport near Hambantota in Sri Lanka has earned the dubious title of “world’s emptiest airport”. The aforementioned factors severely cripple the ability of recipient countries to service the loans.
The underlying logic of Obor is China’s own experience of “build it and they will come” development strategy. But without institutional reforms in loan-recipient countries, this logic can quickly lead to rampant building of “bridges to nowhere”. The savings rate that enabled China’s massive infrastructure buildup was consistently above 34% of GDP since 1978—it even breached the level of 50% in the previous decade. In contrast, Kenya’s savings rate is around 16% of GDP; it will have to double to sustain a high investment rate and a stable period of economic growth.
Even Sachs concedes that “countries must maintain their efforts to mobilize domestic revenue and foster domestic saving and investment in order to support long-term economic growth.” If this is indeed the golden key out of the poverty trap, policies that will help poor countries are the one which incentivize higher savings by controlling inflation, reducing budget deficits, and liberalizing the economy, especially sectors like banking. In other words, the influence of “the intellectual climate of the Reagan-Thatcher era” may have had a propitious impact on the international development cooperation, contrary to what Milanović argues.
The author tweets at @d_extrovert