How China helps developing countries reduce debt instead of increasing it

“The Belt and Road, with infrastructure connectivity as its grip, is building a community of human destiny, which, in terms of its operational effects, reflects the common aspirations, experiences and common pursuits of the countries of the South.”

Professor Justin Yifu Lin 

With the rising debt crisis in Sri Lanka, Western mainstream media is again propagandizing the so-called Chinese “debt trap theory” using examples like the Hambantota Port in Sri Lanka. In this interview, Lin Yifu points out that there is no so-called Chinese debt trap.

Sri Lanka’s Hambantota Port project initially in 2009, was operating at a loss. In December 2017, the Sri Lanka Ports Authority  renegotiated a deal with China Merchant Port Holdings. Only 10 percent t of Sri Lanka’s government debt was incurred through Chinese loans. Image Credits: Jonas Blättermann / Unsplash

Lin refutes the Western media’s distortion of China’s overseas development cooperation, points out the ineffectiveness of aid from Western countries and their multilateral financial institutions, and explains how China’s overseas development cooperation has transcended the Western model to achieve mutual development with the Global South.

If the economies of developing countries do not grow, the regions will suffer from unemployment and social and political turmoil. Developing countries should discover a path suitable for their own development based on their own failures and successes.

Key points

  • The debt problems of many developing countries have accumulated over a long period of time. For example, studies by scholars show that 90 percent of Sri Lanka’s government debt was incurred through loans from other countries, and only 10 percent was credited to Chinese loans. Eighty-five percent of the debt of Africa’s “heavily indebted countries” was incurred from developed countries prior to China’s investments in Africa.
  • After the 1980s, with the rise of neoliberalism, the West pushed the narrative that the infrastructure gap could be narrowed by the private sector. Following the advice of the IMF and the World Bank, most developing countries implemented reforms to reduce government public spending and enhance the role of the market. It has led to a deterioration of economic conditions.
  • One example of Western “conditional” loan assistance from the IMF is that Burkina Faso was requested to implement 500 institutional reforms per year.
  • Western loan assistance in developing countries was based on the experience of developed countries. Their investments, by and large, were made in sectors such as education, healthcare, human rights, and political transparency, which could not reduce development bottlenecks.
  • Based on its own experience as a developing country, China created a development model of infrastructure plus industrial park cooperation based on the principles of extensive consultation, joint contributions, and shared benefits. The model has not only helped create a continuous cycle of economic growth for developing countries but has also enhanced their ability to repay their debts. This is the reason why China’s overseas infrastructure projects are supported by many countries.

Source: Chinese Voices, No 43, 01 May 2022.

Full Interview

SourceRead China, 18 April 2022.

Author: Justin Yifu Lin is Dean of Institute of New Structural Economics, at Peking University. He was the Senior Vice President and Chief Economist of the World Bank, 2008-2012.

Observer: We have seen China’s great achievements in areas such as “One Belt, One Road” and China-Africa cooperation, but we also see from time to time distortions in Western public opinion about China’s overseas development assistance projects. You may also face such questions from overseas people, how do you respond?

Justin Yifu Lin: I think we don’t want to dance to the dance of others. We just need to be realistic and talk about what China has done. What are the ideas and measures that China has followed in the construction of the “Belt and Road” and in international development cooperation? From China’s experience, what are the bottlenecks that must be solved in order for a country to develop well?

As a developing country, the biggest bottleneck that China used to face in its development is infrastructure. Without infrastructure, as in agriculture without infrastructure like irrigation systems, there is no way to adopt modern agricultural techniques to increase yields and raise farmers’ incomes.

And agriculture alone is not enough, so China must develop its manufacturing industry. But in the development of manufacturing, without electricity, there is no way to adopt modern machinery and equipment; without roads, it is impossible to sell products to the domestic market as well as the international market, so it cannot develop. From China’s own experience, in order to develop, we must first overcome the infrastructure bottleneck, this idea we call “to get rich, first build roads”.

But in reality, to build roads, investment is definitely needed. After the roads are built, the economy will grow faster, create jobs, raise income levels, increase government tax revenues, and generate foreign exchange for exports. This will not only pay off the debt of investing in infrastructure, but also create more resources for the next round of investment.

We can clearly see that when China carries out international cooperation along these lines, it requires a large amount of capital investment upfront. Moreover, there is no return on the capital investment early on, only an increase in debt. But what we value is the virtuous cycle of economic growth that comes after the infrastructure is built.

It is true that many developing countries have debt problems, but they have accumulated over time in the past, and although Chinese projects add to their debt when they are built, the share of this debt in the country’s total liabilities is quite small.

For example, the familiar so-called “Sri Lanka’s Hambantota port debt trap”, China did do a lot of infrastructure in Sri Lanka, including Colombo port and Hambantota port. However, the debt incurred by China’s infrastructure in Sri Lanka is only 10% of Sri Lanka’s total debt, and the remaining 90% of the debt is incurred by other countries before. (For more details, please refer to “Sri Lanka as an example of “debt trap theory”” by Sha Bo Li and Yan Hai Rong

The US has falsely alleged that China’s involvement in financing Hambantota Port in Sri Lanka was to establish a forward base for its navy. 
Similar claims are now being made about Chinese “ambitions” in the South Pacific, again with no evidence, by the US and its client states such as Australia (Photo: AFP)

Sri Lanka leased the right to operate the Hambantota port for 99 years to a Chinese company and thus received a sum of money to pay off the debt. But it is not China’s debt they are paying off, it is a debt owed in the past. If there is a debt trap, it is a previous debt trap. China’s investment provided them with funds to help build on the one hand, and funds to help pay off the debt on the other, so how can it be said that China created the “debt trap”?

Looking at the “heavily indebted countries” in Africa, the debt incurred by China’s infrastructure is on average only 15% of the debt of these countries, which means that 85% of the debt is owed to other countries, especially developed countries.

So, the proportion of debt that China’s projects bring to these countries is very small, but it is true that these countries have low debt servicing capacity. Why is the debt service capacity low? Because the debts raised by African countries in the past were not used to solve the bottlenecks of development: they could not increase employment, economic development, government tax revenue and export earnings, so they could not repay their debts. But China’s investment in infrastructure can help “heavily indebted countries” to solve their development bottlenecks, so that their debt repayment capacity will be enhanced.

So, to deal with these misunderstandings, the most important thing is to tell the facts clearly, but also to see the actual results brought. I believe that as long as there is no ulterior motive, then in front of the facts, they should understand that the reason why China’s overseas aid has been supported by so many countries in such a short period of time is because of China’s thinking and approach, which can really help these countries.

The ineffectiveness of traditional Western aid is the result of problems in development thinking

Observer: You mentioned that 85% of the debt of African heavily indebted countries was incurred by other countries, especially developed countries, in the past. Remember that you also mentioned a figure earlier that the developed countries and multilateral financial institutions have provided $4.7 trillion in various kinds of aid since World War II, yet developing countries are still in poverty.

Justin Yifu Lin: Why traditional Western aid is neither effective nor sufficient to help developing countries come to grips with their growth bottlenecks is because mainstream economics ignores structural transformation. Investing in education, health, human rights, political transparency, etc. alone is not enough to drive the engine of growth and create jobs unless it is combined with productive assets and human capital. According to the new structural economics, we argue that infrastructure needs to be linked to special economic zones or urban development and structural transformation.

“The Washington Consensus and Washington-based institutions have given too much bad advice on capital account liberalization, and most developing countries have followed the advice of the IMF and the Bank since the 1990s to implement reforms that reduce government intervention and enhance the role of markets. However, the results have been disappointing. The economic performance of most developing countries continued to deteriorate during this period.

In addition, traditional Western “conditional” aid is not conducive to the recipient country’s ability to seize development opportunities. A concrete example is the complaint by Burkina Faso’s finance minister that the various institutional reforms required of them by the IMF amount to almost 500 a year, an average of 1.5 a day! The important lesson from successful emerging economies – such as China – is that these developing countries have always taken control of their own reform and development agendas, mobilizing available resources to seize opportunities as they arise. In our discussions with African policy makers, they all emphasized that an effective development partnership with Africa is critical. In order to put Africa in the driver’s seat, one of the things to do is to give up aid that is not tied to projects, a lesson that international institutions in Washington have spent many years trading off.

Observer: You discussed in your 2016 publication Beyond Development Aid that one of the long-standing problems with the effectiveness of traditional Western-led official aid is the neglect of addressing infrastructure bottlenecks, and recently you published an article calling for overseas aid to help developing countries address infrastructure bottlenecks, what is the crux of the problem that causes this?

Justin Yifu Lin: I think the main thing is that when doing international development research, developed countries often judge what is important based on their own experience, without putting themselves in the shoes of developing countries and considering what is really needed in developing countries.

They often go to learn what developed countries have, what they can do well, what they value, and then compare with developing countries, that is, developing countries should have what developed countries have, do what developed countries do, and value what developed countries value. These starting points are very good, but the actual results are not ideal, are very different from the original expectations.

For example, developed countries emphasize health, education and transparency, all of which are important. Even if developed countries give a lot of aid and improve health and education in developing countries, but it does not increase employment opportunities and does not lead to economic growth, then the problem still remains. If there are no job opportunities in developing countries, it will lead to rising unemployment and social class tensions; governments will borrow to cover government spending and solve problems such as domestic social stability because there is no economic growth and no increase in fiscal and tax revenues.

However, the same debt borrowed does not promote employment as well as economic growth, and government tax revenues are not boosted, nor do exports generate foreign exchange, which then becomes a debt burden.

If developing countries want to change the status quo, there is a great need to change the way they think about development. They need to look at it from a different perspective, according to what developing countries have, according to what they have that can be done well, and to make what can be done well bigger and stronger is what developing countries need most urgently.

What poor developing countries have are natural resources and labor, and what they can do well are resource-intensive and labor-intensive industries.

How can we make those that can do well bigger and stronger? If you want to develop agriculture, you need to have irrigation infrastructure in order to use modern varieties, improve agricultural productivity and farmers. There is also a need to keep shifting from agriculture to modern manufacturing, and to develop manufacturing there must be electricity, and also transportation infrastructure and ports to enable modern manufacturing to reach economies of scale, all of which are necessary factors needed to make industries with comparative advantages bigger and stronger.

IFI Sustainable Framework Debt Framework Disadvantages

Observer: When you mentioned World Bank loans in Beyond Development Aid, you pointed out the drawbacks of the debt sustainability framework of the International Monetary Fund and international financial institutions such as the World Bank. At a concrete operational level, is it this debt sustainability framework that also contributes to the limitations of Western-led traditional development aid?

Justin Yifu Lin: Yes, the World Bank uses a series of indicators to assess whether the debt of developing countries is sustainable or not. For example, one of the indicators is when the debt-to-GDP ratio of developing countries, after that ratio reaches a standard, they will consider that the country’s future debt repayment capacity is insufficient and stop lending to these countries, and this is the debt sustainability framework. But the system of indicators to assess this sustainability framework is not scientific.

First of all, in the classification of debt, the World Bank does not distinguish where that debt is going. For example, it is used to support consumption, including social security and unemployment benefits, or to support government operations, or to remove bottlenecks to economic growth. As we said earlier, investments to remove bottlenecks to growth (investment in infrastructure projects) gradually increase the debt during construction, but when it is completed, the country’s debt service capacity increases and the debt decreases. If international financial institutions take into account the specificity of this type of debt for developing countries to invest in infrastructure, they can get more loan support.

Secondly, the World Bank calculates it in terms of total debt, they don’t bother to distinguish the possibility of whether the debt will form assets or not, if it’s used to support government spending, whether it’s unemployment benefits, or government operations, it’s used and gone. But if it’s doing infrastructure investment, then it will form an asset, the asset is gainful, and then the net debt will be less than the total debt.

So, at the time I started advocating at the World Bank to rethink the debt sustainability framework and to make a distinction between whether debt can be used for investment to remove bottlenecks to growth or whether it can be used to support the consumption side of spending. So, when considering debt sustainability, the two mean different things and a distinction should be made.

I am happy to see that international development agencies, including the IMF and the World Bank, have begun to change direction, measuring the debt of borrowing countries, not only to consider the total debt, but also to look at assets, because with assets, the net debt is low; and also to see what the purpose of debt, is it for consumption or for investment? If it is an investment-based debt project to raise debt, not only will the debt not increase in the future, but also the past debt can be paid off.

China’s Overseas Aid Model Is a Departure from the Washington Consensus

Observer: As you mentioned, both the traditional official aid development ideas and the specific technical aspects of implementation have not been able to play a more important and effective aid role for developing countries. This is one of the reasons why China’s overseas infrastructure aid is gradually gaining international popularity. China’s foreign aid, as you mentioned earlier, combines infrastructure and economic transformation, and gradually develops the cooperative zone model.

Justin Yifu Lin: First of all, the Washington Consensus considered the development of infrastructure as an investment that the market would take care of itself, for example, the World Bank helped countries recover after the war after World War II, when infrastructure was the largest sector of the World Bank. However, when I went to the World Bank as chief economist in 2008, infrastructure, the largest sector, had disappeared. Because of the rise of neoliberal thinking after the 1980s, Western countries thought that the market would solve the problem of infrastructure investment bottlenecks.

But in reality, developing countries have invested very little in infrastructure since the 1980s without the support of governments and international agencies, and only one infrastructure investment, mobile communications, would be of interest to the market. Why? There are two reasons: first, natural monopoly, and second, easy to charge. Therefore, if mobile communications were fully opened up, different actors in the market would really be active in investing.

And other infrastructure, such as irrigation, electricity, roads, basically the market can not be solved, which is why developing countries are everywhere the problem of infrastructure bottlenecks, from a certain point of view, this is also the cause of the current infrastructure in developed countries is old, mainly or the problem of development thinking.

As I mentioned before, developing countries have two advantages, resource advantage and labor advantage. If you develop labor-intensive industries, you must have infrastructure such as roads and electricity. These infrastructures can’t be spread all over the country in a short time. Then our solution is like what Chairman Mao said, “Concentrate superior forces to fight a war of annihilation”: first build a park in a region, so that the infrastructure in the park can reach the standard first, and then we can quickly develop labor-intensive industries by combining the local labor advantage, and after the development, we can create jobs, increase exports and government tax revenue.

With the tax revenue, the government can repay the infrastructure investment and have more funds for further investment. Our overseas infrastructure development projects are all combined with local strengths and needs, thus being able to help overseas aid countries create jobs, people get more income, and related enterprises do well, grow bigger and stronger, which are two completely different ideas from the Washington Consensus.

China and Sri Lanka formally signed a concession agreement for Hambantota port. Photo credit: Vision China
International criticism of China is based on dogmatic experience

Observer: Investment in infrastructure development is an important experience in China’s development, but even so, there are many people (including in China) who have strong opinions about infrastructure investment, such as “overbuilding” and “big but inappropriate”. We have invested in a large number of infrastructure projects in overseas country partnerships and have faced criticism from some overseas media. We know it’s a bit of a cliché, but we still seem to have to keep explaining to them in order to make more people understand.

Justin Yifu Lin: The reasoning is simple, we need to be clear about the role that infrastructure plays. Building infrastructure investment is to remove bottlenecks to growth, but if projects that are not removing bottlenecks to growth are still insisted on being built, then they may become a burden. Therefore, not any infrastructure investment is good. When investing, we need to consider where the project will be built, how it will be built, and also what industries the facility can positively impact after completion and how long it will take to produce a boost; at the same time, we also need to study whether the debt will be paid back by government taxes or by fees from post-commissioning use? How long will it take to pay off the debt? And so on.

The quality of the project can only be high if the investment project is well thought out upfront, as China promotes high quality infrastructure projects. Therefore, we have to make the landing countries of infrastructure projects consider clearly whether they have the ability to repay their debts.

China is promoting the concept of green and sustainable development, and this concept needs to be implemented in the process of project implementation. There are bottlenecks everywhere in the infrastructure of developing countries, which cannot be removed by one country or one institution, but need to be accomplished by multiple parties, so we should welcome cooperation with an open attitude.

We should follow the principles set forth in the Belt and Road Initiative: “Co-business, co-build, share, open, transparent, green, and sustainable.” All these principles should be carefully considered when doing infrastructure projects. Many criticisms from international sources are based on past experiences that have been dogmatized and in reality are not in line with reality, and when faced with these criticisms, we just need to take it as a kind reminder.

Most importantly, if developing countries do not develop, that is the biggest trap. Because the hopeless development of a country will lead to employment problems, which will affect social stability and political stability, so that the people will suffer. Even in developed countries, if one place is unstable, it will spread to other places.

For developing countries, the biggest problem is the development trap. They have to overcome the development trap and drive development through infrastructure construction, which is the most critical bottleneck at the moment.

As long as we are truly concerned about the development of developing countries, even if we are criticized, we should have the spirit of “I will go ahead even though there are millions of people”. And I believe that the eyes of the masses are discerning, as long as we can really help developing countries and solve their urgent problems, the facts will always speak louder than words in the end.

The most important thing for Southern countries is to find the right path for their development

Observer: You mentioned “shared learning and collaborative transformation” as a more effective approach to South-South development cooperation, and this is also applicable to China’s cooperation with Belt and Road countries. This idea is highly consistent with what General Secretary Xi said: “The Belt and Road is not a private road for one party, but a sunny road for everyone to move forward together”. In your opinion, how should China benefit from its foreign aid and overseas cooperation with the aid donors?

Justin Yifu Lin: In the past, it has been the global South that has learned theories and experiences from the countries of the North. These theories and experiences were actually based on the economic, social and political culture of the developed countries of the North.

The industry, technology, development stage, socio-political-legal culture, etc. of the northern countries become the implied premise of these theories. In overseas international cooperation, if these theories and experiences are taken to developing countries, the implied premise is different, and the problem of “Huainan becomes orange, Huainan becomes hedge orange” will arise. Although the starting point is very good, the effect is very different from the original expectation.

Therefore, the countries of the South should draw from their successes and failures the reasons for their successes and lessons from their failures. The people of the South share a common desire to develop their countries and to improve the lives of their people. To realize this common aspiration, the most important thing is to find new ideas suitable for their own development.

The “Belt and Road”, with infrastructure connectivity as its grip, is building a community of human destiny, which, in terms of its operational effects, reflects the common aspirations, experiences and common pursuits of the countries of the South.

Source: Read China, 18 April 2022.

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