But many questions remain about whether creditors truly are prepared to meaningfully reduce debt burdens. These issues likely will be on the table in India this week (July 14 to 18) when the Group of Twenty (G20) finance ministers and central bank governors gather to discuss debt restructuring and other global economic issues.

In Zambia, which defaulted on its debts in 2021, government creditors led by China have resolved months of jostling and agreed to a restructuring of $6.3 billion of the country’s more than $8 billion of debt. The agreement extends for 20 years the country’s debt-repayment schedule and lowers its annual interest bill to one percent until economic growth recovers. Now, the country’s private-sector lenders, who hold billions of dollars of government IOUs, are talking about writing down some of their Zambia loans, and in Ghana are writing off loans and restructuring dollar-denominated bonds. Meanwhile, both classes of creditors are deep in restructuring discussions with Sri Lanka, which has requested a 30 percent haircut on some bonds.

These settlements would pave the way for assistance from the International Monetary Fund (IMF) and provide a way forward—albeit a difficult one—for dozens of low-income countries that are in or nearing debt distress. This represents progress compared with a year ago, when China and the private sector were balking at a transparent negotiating process. But there are still many issues to address—especially how far China really is prepared to go in reducing the burden of its vast lending. Unlike previous global debt episodes, notably the Latin America debt crisis of the 1980s and debt relief to low-income countries early this century, there is unlikely to be a grand bargain this time around.

While the preliminary agreement with Zambia has been heralded as “an epochal shift in global finance,” the reality is that negotiations there and elsewhere are following a well-trodden path: first the seal of approval of an IMF rescue program (which in Zambia’s case was reached in 2022), with promises of IMF money once a debt restructuring is agreed to. Then the hard bargaining with government lenders, followed by talks with private creditors. This slow progress is a far cry from late 2020 when the G20 agreed on a restructuring process for the poorest countries called the Common Framework that briefly raised hopes of a rapid succession of debt reductions—hopes that were dashed largely because of foot-dragging by China and foreign lenders.

Before the emergence of China as a major creditor to middle and low-income countries during the lending spree that accompanied its Belt and Road Initiative, debt negotiations went through the IMF and the Paris Club of advanced-economy lenders. It was arguably a simpler world, not least because private-sector lenders’ debt exposure in developing countries was marginal. That changed after 2010, when institutional investors joined China in shoveling money out the door to what became known as “frontier economy” borrowers. Between 2007 and 2020, an unprecedented 21 African countries accessed international debt markets. Today, debtors must proceed on multiple tracks—the Paris Club, the Chinese government, China’s state banks and state-controlled commercial banks, and Western fund managers and money-center banks.

Some creditors question the true nature of the debt restructuring now on offer. For example, private sector lenders and analysts say privately it is not clear whether, in Zambia’s case, China has negotiated bilateral conditions that have been concealed from other lenders. They say that this could cast doubt on assurances that government creditors have provided to the IMF about restructuring arrangements. In addition, China’s insistence on extending debt repayments for decades conflicts with the Paris Club’s track record of providing relief in the form of reductions in principal owed. That could become an issue if China pursues its approach in countries where other governments are major creditors—for example, India and Japan in Sri Lanka. In that case, the model of the Zambia agreement could quickly become a muddle.

The private sector has arguably made significant strides in recognizing their loan losses, as the situation in Ghana illustrates. Lenders such as the big four South African banks are writing off as much as $270 million of their loan exposures, which equates to a haircut of almost 60 percent. And Standard Chartered Bank has set aside some $160 million for Ghanaian write-downs. This loan-loss recognition serves two purposes. First, it is an effort to inform shareholders about the banks’ overall sovereign exposure and the steps they are taking to reduce it. Second, by setting a floor on the losses they are prepared to absorb, they have a better negotiating hand in the restructuring conversations.

Meanwhile, bondholders are likely to face increasing pressure to restructure Eurobond issues—and accept haircuts—as the repayment schedule accelerates in the next two years.

A looming issue may be the response of Western banks and bondholders to China’s success in having some of its loans by state-controlled banks exempted from the Zambia agreement and classified as commercial lending. How those Chinese loans are treated—in Zambia and elsewhere—while the real private-sector creditors negotiate settlements will be a test of China’s willingness to accept the principle of “comparability of treatment” for all creditors, a key principle that Beijing publicly insisted upon as recently as April.

There are real-world ramifications to these nuts-and-bolts issues that extend beyond the politics of the restructuring process. The human cost of the debt crisis for poor countries has been severe. The UN estimated last year that fifty-four countries with severe debt problems represented about three percent of global gross domestic product, but accounted for more than one-half of the 600 million people worldwide living in extreme poverty. That number has risen sharply since the pandemic hit in 2020.

Debt payments by these countries siphon off resources that are desperately needed for health, education, and other social programs. Defaults and restructuring only make this scarcity worse. That points to the need for new sources of funding. The World Bank is under pressure to free up more money for grants and lending. Meanwhile, the IMF has increased funding for two trusts designed to meet the needs of low-income countries, including one created to help developing countries meet the immediate and long-term challenge of climate change and pandemics. About $100 billion of new resources come, in part, from the 2021 allocation of $650 billion of Special Drawing Rights to IMF member countries.

But demand for help is rising faster than the available resources, especially for the Poverty Reduction and Growth Trust, a perpetually underfunded IMF vehicle that subsidizes zero-interest loans to the poorest countries. As new lending to these nations from China and private creditors dries up, the World Bank and IMF will be hard-pressed to pick up the slack. Debt restructuring that merely extends repayment for decades without any forgiveness will only entrench the imbalance between needy borrowers and lenders whose priority is to recoup their capital.

Jeremy Mark is a senior fellow with the Atlantic Council’s Geoeconomics Center. He previously worked for the IMF and the Asian Wall Street Journal. Follow him on Twitter: @JedMark888.

Vasuki Shastry, formerly with the IMF, Monetary Authority of Singapore, and Standard Chartered Bank, is the author of Has Asia Lost It? Dynamic Past, Turbulent Future. Follow him on Twitter: @vshastry.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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The post Progress on debt restructuring provides a glimmer of hope for developing countries appeared first on Atlantic Council.

The United States has reshaped how it uses military and economic tools to compete with China, Russia, and other adversaries. The United States is increasingly adept at deploying military assets, as well as a range of financial sanctions or trade deals, to weaken China or Russia’s position and advance its own. Yet, the United States has not calibrated all statecraft tools for this competition. This includes how and where it uses foreign aid.

For more than fifty years, foreign aid has been a core form of US engagement in the developing world. To advance its interests, the United States has provided loans, technical assistance, and direct budget support to developing nations to promote economic growth and more representative forms of governance.

A fully developed strategy for using foreign aid across all sectors—economic, education, security assistance, and democracy support—can provide critical reinforcement to the military and economic pillars of strategic competition. To be sure, the United States has reorganized parts of its bureaucracy and launched new initiatives to enhance how it uses foreign aid to compete with China. The US Department of State recently launched a new Office of China Coordination, informally known as China House, to coordinate China policy. The Biden administration announced a flagship Group of Seven Plus (G7+) initiative for the advancement of strategic, values-driven, and high-standard infrastructure and investment in low- and middle-income countries. Congress initiated foreign-aid funds dedicated to countering Chinese malign influence in foreign political systems.¹ New embassies in Vanuatu, the Solomon Islands, and Tonga, among other potential locations, are welcome developments that will provide the sustained presence necessary to engage governments and push back against Beijing’s influence, as well as help identify ways to use foreign aid to compete.

These changes are necessary, but far from sufficient to maximize the impact of foreign aid to compete with China and Russia. The power of foreign aid as a tool of US influence is not lost on its adversaries. The most prevalent example is China’s Belt and Road Initiative (BRI), through which the People’s Republic of China (PRC) has spent hundreds of billions of dollars for years to expand its influence in developing nations. Recently, China has increased BRI spending and shifted from its original focus on infrastructure megaprojects to the less capital-intensive, but still impactful, fields of governance (e.g., training elected officials in Beijing’s governance model); funding for academic departments to promote pro-Chinese narratives; green-energy projects; and funding for pro-China media outlets.² Under the BRI umbrella, China uses foreign aid in these and other sectors to promote policies and politicians favorable to PRC interests. The United States is, therefore, compelled to play a game of catchup.

Fully harnessing the potential of US foreign aid in this struggle requires fundamental reforms to the congressional processes involved in overseeing aid allocations and earmarks; reforms to bureaucratic agencies tasked with spending foreign aid; improvements to US modes for delivering this assistance; and a narrowing of scope to areas most critical for advancing US interests. Needed reforms include the following.

• Realign spending to focus on allies and countries strategically important to US competition with China and Russia, including reconsidering assistance mechanisms based solely on income level, with an aim of investing in allies and partners that advance US interests.
• Make delivering for allies and shoring up democracy core pillars guiding how the United States uses foreign aid to compete with China and Russia. Investments in strong democratic institutions—such as political parties, independent legislators, independent media, and civil society—will yield dividends in countering foreign authoritarian influence.
• Invest to empower pro-democracy elements in backsliding or authoritarian countries. The United States must respond asymmetrically in countries with pervasive authoritarian capture, using foreign assistance in ways that empower individuals and institutions to expose and put pressure on the regime elements that perpetuate corruption and enable foreign influence.
• Congress should pass legislation (the Non-Kinetic Competition Act) requiring the executive to submit multiyear plans outlining the US approach—harnessing all nonmilitary statecraft tools, including foreign aid—to competing with China in select priority countries.
• Focus on geography and interests, rather than sectors, to ensure maximum flexibility, strategies rooted in country-specific needs, and longer-term planning.
• Increase spending to expand partner-nation resilience to Beijing and Moscow coercion and cooptation. Strong democratic institutions increase a country’s ability to detect, prevent, and mitigate Chinese Communist Party (CCP) influence operations. Priorities should include support for independent media, parliamentary diplomacy, and educational and technical exchanges, all of which have proven effective at building democratic resilience to foreign authoritarian influence.
• Empower the State Department’s Office of Foreign Assistance Resources to fulfill its mandate of aligning foreign aid with policy goals and maximizing impact. Enabling the Department of State to take the lead on foreign policy and control aid allocations will ensure that aid is appropriately leveraged to advance specific foreign policy objectives.
• Lengthen the time horizon for US foreign-aid programs and objectives from a single year to ten. Democracy, rights, and governance programming—as well as initiatives in other sectors germane to competition—requires longer-term investment to develop strong and resilient institutions, political parties, and processes. US agencies and implementing partners need longer project times to maximize impact.
• Limit branding waivers. The United States benefits from populations and governments knowing who provides aid, and its marketing needs to reflect as much.
• Focus on advancing interests, rather than “localization” targets. The US Agency for International Development (USAID) and State Department should pursue partnership approaches best positioned to achieve US interests in the target country. In most, if not all, cases, this will involve working through international nongovernmental organizations (NGOs) that collaborate with and, as needed, build the capacity of local partners.

With the aim of encouraging the United States to more strategically use foreign assistance to advance its policy objectives, this paper outlines why the threat posed by China and Russia requires more than a kinetic solution, and why and how foreign aid is essential to winning this competition; the current US approach to foreign assistance—where it spends, on what, and via which bureaucratic mechanisms—and its strengths and shortcomings; historical lessons from using US foreign aid for strategic competition, principally during the Cold War, that are applicable today; and recommendations for reforming the US foreign-aid infrastructure, regulations, and approach to better position the United States to compete.

I. The authoritarian threat has no purely military solution

China and Russia are often portrayed as purely military threats that warrant entirely kinetic solutions. To be sure, US military deterrence through a strong Army, Navy, and Air Force—with nuclear capabilities as a foundation—will remain essential to strategic competition. Kinetic options are necessary, but not sufficient. Competition with China and Russia is playing out not only in the sea lanes of the Indo-Pacific or Ukraine’s battlefields, but in the halls of parliaments in developing nations, in efforts to influence the post-conflict political systems of war-torn countries, and at the United Nations (UN), where both China and Russia endeavor to reshape the liberal world order.

China’s primary threat to the United States is undoubtedly a military one. It is amassing weapons sufficient to invade Taiwan, and has expanded its blue-water navy with an eye toward rivaling, if not supplanting, US capabilities. Yet, the PRC is also using political and economic tools to expand its influence in developing states at the expense of US objectives.

The CCP is increasingly using economic leverage and elite capture to exert political influence, deploying information operations, party-to-party ties, and, in some cases, export of its authoritarian governance model to create favorable conditions in other countries that enable the PRC to advance its local and global interests. This includes extracting natural resources critical to its domestic production and economic growth, expanding military basing essential to Chinese military deterrence and expanded control, and coopting politicians who serve these ends and can be counted on to vote with China at the UN on issues ranging from criticism of human-rights violations in Xinjiang to the future of the International Telecommunications Union and global internet governance. Together, these tactics are corroding democratic governance and popularizing authoritarian governance in countries the world over.

The BRI has been the crown jewel in the CCP’s global influence campaign. Nearly one hundred and fifty countries from every region of the world have signed on to the BRI, presenting a significant opportunity for the PRC to exert economic and political influence on a regional and global scale.³ According to research conducted by the International Republican Institute looking at PRC influence across country contexts, “growing trade, financial, and business ties are the foundation of the PRC’s efforts to build influence in other countries’ politics.”⁴ The CCP strategically deploys economic dependence, leverage, and coercion, in addition to elite capture, to develop pro-PRC constituencies in partner countries and advance pro-PRC policies. Thus, the BRI fits into the CCP’s broader efforts to create a world safe for the party and its interests, which Chinese leader Xi  Jinping proposes achieving via three initiatives that collectively articulate the CCP’s vision for the globe, titled the Global Development Initiative, the Global Security Initiative, and the Global Civilization Initiative.⁵

The Global Development Initiative (GDI) seeks to expand the BRI to advance “people-centered” development, China’s catchphrase for its model of development that prioritizes economic advancement at the expense of human rights. The GDI—and PRC promotion of it—is explicit in its rejection of “Western” definitions of development, which incorporate human rights as a core tenet.⁶ China has been rallying countries to join the GDI, with vague promises of PRC support to help them achieve their Sustainable Development Goals for 2030, with a focus on poverty and hunger alleviation and increased access to clean energy. The PRC has established a group of “Friends of the Global Development Initiative” at the UN, which counts some sixty members.⁷ The Global Security Initiative (GSI) is the CCP’s vision for building a new global “security architecture” rooted in the CCP’s definition—and model—of security and stability.⁸ With aims to increase CCP influence at the UN through increased funding and diplomatic engagement, the expansion of PRC training programs to military and police, and an expanded role serving as an arbiter in international conflicts, the GSI signals China’s intent to return to its self-avowed rightful place at “the center for the world stage.”⁹ Without naming the United States and Europe, the CCP through GSI makes clear that it seeks to provide an alternative model of alliances or “circle of friends” to counter US interests, with a particular focus on the developing world in Africa, Southeast Asia, the Middle East, Latin America, and the Pacific islands.¹⁰

The Global Civilization Initiative (GCI) is the PRC’s new framework for promoting its governance model globally, building on the foundational work of the International Liaison Department supporting political parties around the world. Whereas such party-to-party exchanges once sought to build the legitimacy of the CCP, they are now focused on advertising the value of the PRC’s system of governance more generally. The GCI formalizes this recent trend, emphasizing the need for respect for a plurality of governance models. Speaking at the World Political Parties’ Conference, organized by the CCP in March 2023, General Secretary Xi Jinping extolled the PRC’s model of “a better social system,” noting that China’s experience has broken the myth that “modernization=Westernization.”¹¹ Implicit in the GCI, with its calls for understanding “different civilizations’ understanding of values” and models, is an attempt to popularize the CCP’s model of governance and help it realize its vision of a revised global order with a CCP-led China as the central node of globalization and global governance in the decades to come.

Collectively, these three initiatives are part of China’s overall strategy to promote authoritarian solutions to the mounting challenges facing developing democracies. They have the potential to undermine the principles of liberal democracy that buttress the extant rules-based world order. For many developing countries, PRC investment and trade are an economic necessity. They are, however, never free of conditions, despite PRC claims to the contrary. Whether the terms mandate that PRC-financed infrastructure be awarded to PRC-based companies, eschew existing environmental standards, or subvert transparency and accountability disclosure terms on the contractual arrangements, PRC entities’ business and negotiating practices often have adverse effects on the recipient countries’ finances and political systems.¹²

From a security standpoint, China’s promotion of the concept of “indivisible security,” used to justify Russia’s invasion of Ukraine, and its “aims to reshape norms of international security to be favorable to China and other authoritarian regimes while delegitimizing traditional military alliances,” as the US-China Economic and Security Review Commission has noted, are deeply worrying.¹³ Moreover, its proclivity to export repression beyond its borders poses a serious threat to developed and developing nations alike.

China has utilized “public security” as an entry point for establishing overseas police stations in fifty-three countries around the world, providing an entry point for PRC law enforcement to engage in transnational repression and crack down on dissent and political expression among the Chinese diaspora.¹⁴ In countries with large diaspora populations, the CCP has also relied upon triads, or crime syndicates, to intimidate its critics and further its objectives at the local level. Moreover, politically, China’s promotion of its authoritarian governance model undermines good governance globally, fueling democratic backsliding and legitimizing the rise of authoritarian actors from El Salvador to Belarus.

All of this has the potential to undermine US interests on everything from internet governance to human rights, while undermining US global leadership. These tactics have dire consequences for the United States, yet the United States cannot effectively address them with purely military or trade/sanctions solutions. Military responses, whether ship deployments or arms transfers, do not help strengthen the institutions and civil society needed for countries to be resilient to PRC influence operations, or to build an alliance of democracies to counter a growing autocratic threat.

Like China, Russia poses a threat to US interests that cannot be countered with armaments or economic tools alone. Russia is squarely focused on winning its illegal war with Ukraine. Even so, we can expect Vladimir Putin’s regime will continue using a range of non-kinetic means to advance its interests in Europe, Latin America, Africa, and Asia. The Kremlin’s principal goal is to foster instability and undermine alliances that counter its influence regionally and globally. It deploys a mix of political, economic, and military tactics to divide and rule.¹⁵

In the political arena, the Kremlin directly interferes in other countries’ political and electoral processes. Russia tries to influence the political playing field to be more amenable to its interests, and to inject the Kremlin’s point of view into the political discourse. The Kremlin and its affiliated entities provide financial and other incentives to political parties and politicians willing to represent and advance favorable policies in national parliaments or international institutions. Such support can include legal and illicit campaign contributions, often made by organizations set up by Russia’s agents of influence, individuals linked to Russia and Russian businesses, or Russian organizations directly. According to a recent report by the US State Department, Russia has covertly given at least $300 million to officials and politicians in more than two dozen countries since 2014, with plans to transfer more.¹⁶

Russia also targets electoral processes. Russian hackers have been accused of interfering in many elections and electoral campaigns around the world. In the 2018 presidential election in Mexico, they were reportedly involved in the spread of false information aimed at discrediting candidates to stir up divisions and polarization among voters.¹⁷ Russia similarly deploys cyberattacks, internet trolling, social media campaigns, and intrusions into state voter-registration systems to undermine political and electoral processes and create confusion as people head to the polls.¹⁸

Economically, the Kremlin employs strategic corruption to coopt elites and create pro-Kremlin proxies in media, politics, and business to push its agenda. This strategy aims to influence debates, gain support, and shape legislation in the Kremlin’s favor. This tactic is particularly effective in countries with favorable views of Russia. It helps galvanize public support and weakens alliances that conflict with the Kremlin’s interests. The Organized Crime and Corruption Reporting Project (OCCRP), a group of investigative journalists, recently revealed an expansive Kremlin operation to bribe politicians and businesspeople in Europe.¹⁹ The International Agency for Current Policy, an informal group connected to Moscow, is behind the bribes, arranged payments, and all-expenses-paid trips to luxury resorts for numerous European politicians and investors to encourage pro-Russian political and economic actions.

Militarily, the Kremlin is deploying proxy forces like the Wagner Group to support authoritarian governments or provoke low-scale conflict across Africa, including in Mali and the Central African Republic.²⁰ Wagner Group security deployments across the continent have been at the forefront of Russian efforts to influence African politics, and have been accompanied by disinformation campaigns to advance Russia’s political and security influence.²¹ The Wagner Group has also led Kremlin efforts to develop a pro-Russia infrastructure across Africa. This infrastructure includes the Internet Research Agency troll farm to conduct disinformation campaigns, captured antidemocratic political elites, coopted companies that exploit Africa’s natural resources, and front companies posing as nongovernmental organizations.

Russia’s influence efforts around the world are supported by wide-scale propaganda and disinformation campaigns to delegitimize independent, expert journalism—and the very concept of truth—in the eyes of consumers, exploit fissures in democratic societies and exacerbate polarization in conflicted ones, undermine support for democracy and the West, and advance pro-Kremlin narratives and policies. One approach Moscow deploys are Russian-funded media outlets like RT and Sputnik. RT, formerly Russia Today, is part of a state-sponsored propaganda corporation that masquerades as a legitimate, Western-looking news and opinion-making outlet that produces content in seven languages.²² With almost $400 million coming from Russian state subsidies in 2022 alone, the company has hired Western journalists to mislead its viewers, and to make its false content seem credible to legitimate media outlets around the world. Another tactic Russia uses is fake media outlets and social media accounts to dilute legitimate media reporting and inject messaging that serves Russia’s strategic objectives. Social media have been a particularly powerful tool for Russia, whose agents have been creating tailored content to influence the beliefs of groups of voters and sway them away from anti-Russia political forces. 

The contours of this challenge—from Beijing and Moscow—make clear that military and economic tools are not enough for the United States to compete and win. Kinetic efforts cannot bolster partner countries against the malign influence of the CCP and Kremlin and the associated cooptation of elites. Military tools, either security assistance or indirect effects of deterrence, cannot shape the politics and development trajectories of partner countries so that they take forms more favorable to the prosperity of their own people and US interests.

Economic-statecraft tools are more amenable to these ends—and complementary to foreign aid—but still not sufficient. Trade deals can increase US economic competitiveness vis-à-vis China by bolstering the US industrial base through opening markets to US citizens and businesses. The United States can use trade deals as an incentive for potential allies to align with US interests over those of the PRC or Kremlin and to help countries reduce their economic dependence on China and Russia. The United States can use economic sanctions to punish countries or individuals for a range of behaviors—from repressing their citizens, as in Belarus, to invading Ukraine, as with Russia—with the aim of stopping said targets from continuing these actions. Moreover, the United States can use economic measures to build a collective economic defense against economic coercion, and to deter PRC and Kremlin economic aggression.

Foreign aid is a necessary complement to kinetic and economic tools. It cannot single-handedly address all challenges listed above, but can help lead to changes—like making a country’s governance systems more resilient to foreign interference—that benefit the United States at the expense of its rivals.

II. US foreign aid: Effective tool, dated toolbox

The United States has utilized foreign assistance to advance its geopolitical interests since the end of World War II, and introduced the Marshall Plan to secure Europe’s (and Japan’s) social and economic foundations in the face of Soviet expansionism and restive communist factions.²³ The United States continued to use foreign aid as part of its strategy of containment over the next four decades, providing valuable lessons for advancing US interests in a new age of competition.

Foreign aid (interchangeably referred to as “foreign assistance”) consists of money, technical assistance, or commodities the United States provides to another country to advance a common objective. US foreign assistance can be organized into three overarching categories based on intent of spending: economic and development assistance that addresses political, economic, and development needs; humanitarian assistance that supports disaster relief and emergency operations to alleviate suffering and save lives; and security assistance, which strengthens the capacity of the military and law enforcement in other countries.²⁴

Across these three categories, foreign-aid-funded initiatives can include training rural farmers in more sustainable harvesting techniques, helping construct roadways linking peripheral towns to urban centers, or deploying specialists to advise government ministries on economic or political reform options.

The throughline connecting the three foreign-aid types—and the variation therein—is that US taxpayer dollars spent to fund these initiatives help lead to changes in the target country that benefit US interests. For instance, spending to increase the capacity and independence of government institutions can enhance transparency and provide more favorable investment conditions for US companies.

Yet, the United States spends less than 1 percent of its discretionary budget on foreign assistance, which for fiscal year (FY) 2022 amounted to$52.76 billion.²⁵ Comparatively speaking, this is a small portion of the federal budget. For the sake of contrast, it is 7 percent of the military’s FY22 $777.7-billion budget, and is nearly the exact amount the Department of Defense paid for fewer than one hundred new aircraft in FY22.²⁶

Illustrating the overall downward trend in foreign-aid spending, the United States spends roughly 50 percent less on foreign aid today, as a portion of gross domestic product (GDP), than it did during Ronald Reagan’s presidency. The similarities in the challenges the United States faced in the 1980s and today—and the disparity in resources it is marshalling to address those threats—is stark.

The United States allocates foreign aid through several departments and agencies, with the main entities being USAID and the Department of State. President John F. Kennedy established USAID in 1961 to lead the implementation of US foreign aid. Through the 1970s, USAID provided emergency food assistance that helped avert famines and helped newly independent countries establish basic governing structures. In the 1980s, USAID assistance guided economic reforms across Latin America and other regions around the world, helping stabilize economies in the face of currency and debt crises. After the Soviet Union’s fall, USAID helped new countries transition from autocracies to nascent democracies. From 2000 onward, USAID has played a central role in combatting HIV/AIDS, addressing violent extremism in fragile states, and solidifying democratic gains from the immediate post-Cold War era. In 2004, the United States expanded the agencies responsible for allocating foreign aid by establishing the Millennium Challenge Corporation (MCC) and, in 2019, the International Development Finance Corporation (DFC).²⁷ These changes that foreign aid helped enable or cause have, directly or indirectly, benefited US security and economic prosperity.

What the United States has gained in scope and scale through this range of foreign-aid entities, it has lost in not having them unified by a common directive and mission for spending. The George W. Bush administration worked to address this drift by disbanding USAID policy offices, and transferred those associated oversight and policy responsibilities to a new Office of Foreign Assistance Resources at the Department of State. This change aimed to further align foreign-aid spending with foreign policymaking, which is the State Department’s purview (USAID, per a 1988 law, reports to the secretary of state). Despite this change, the United States continues to struggle with developing comprehensive strategies for issues and countries—and harnessing all elements of US foreign assistance (in tandem with other statecraft tools, like diplomacy and economic engagement) toward a common end. Some feel USAID operates too independently, and its spending is insufficiently aligned with US foreign policy objectives.

Why foreign aid is critical to strategic competition

A solid base of rigorous research shows that foreign aid is effective across a range of sectors in contributing to changes in recipient countries that favor the United States and advantage it in its competition with China, Russia, and other rivals.

Foreign aid can lead to three primary types of impact that are beneficial to strategic competition: economic development that opens markets to US businesses, which increases US economic competitiveness with China and Russia; stronger governance and political institutions, which can serve as a robust check on Russian and Chinese attempts to undermine or coopt allies or potential partners; and more favorable views of the United States by a government and/or its people, which the United States can then leverage for cooperation on mutually beneficial interests or against China and Russia.

Foreign aid supports US economic competitiveness by helping develop new economies for US businesses and trade. It does so by promoting a country’s overall development, as well as sound, transparent regulation.²⁸ Foreign assistance increases economic potential within a state, especially when developing basic industry, improving basic infrastructure, or rebuilding an area after conflict. Today, for example, eleven of the United States’ top fifteen trade partners are previous recipients of foreign aid. Access to overseas markets matters for people at home; roughly one in five US jobs is linked to international trade, and one in three US manufacturing jobs is linked to exporting US products overseas. When considering investments overseas, US businesses need predictable regulations managed by independent institutions, which, collectively, minimize risk of loss of capital. By fostering foreign markets for US goods and businesses, foreign aid can help bolster the United States’ industrial base.

Foreign aid also helps strengthen governance and democracy in countries around the world. A study of US foreign assistance focused on “democracy promotion” programs from 1990 to 2003 found that democracy assistance had “clear and consistent impacts” on overall democratization—as well as civil society, judicial and electoral processes, and media independence.²⁹ Despite a global democratic recession from 2012 to 2022, eight countries that were autocracies actually bounced back and are now democracies in 2023—with international democracy support and protection being an important factor in securing these gains.³⁰ The benefits of these changes, enabled by foreign aid, are clear. The world is safer and more secure with more—not fewer—democracies. Democracies do not launch wars against other democracies, are more reliable allies to the United States, and are far less prone to intrastate civil conflict.³¹ By strengthening independent institutions and civil-society oversight, foreign aid can help make countries more resilient to interference from foreign rivals like China and Russia. Robust institutions and vibrant civil society make it difficult for China and Russia to exert influence and coopt elites.

Finally, foreign aid can help improve citizens’ and governments’ views of the United States, often at the expense of its principal rivals. The long-term aspect is important here. Chinese and Russian foreign-assistance programs tend to favor physical projects that advance their economic interests and solidify partnerships with authoritarian actors.³² Populations, genuinely appreciative and benefiting from such investments, look favorably upon these efforts in the short term. Over time, there is growing evidence that these projects eventually begin to erode local support for Beijing and Moscow.³³ In the case of China, this is partially due to shoddy construction work, a feeling of Chinese neocolonialism and loss of sovereignty, and discomfort with authoritarian moves by parties in power. While there is much reporting on China’s BRI and Russia’s recent use of Wagner Group mercenaries in Africa, both countries’ programs lack transparency—increasingly alienating potential local partners as long-term consequences become more apparent.³⁴

By contrast, US foreign-assistance spending is transparent, involves clear conditions guiding where and how funds are to be used, and favors working with local partners to identify real needs and inform project design and implementation.³⁵ Well-implemented, effective, and large-scale initiatives focused on addressing pressing needs of populations—like the President’s Emergency Plan for AIDS Relief (PEPFAR)—solve problems for local populations and generate positive perceptions of the aid provider, the United States. Several studies find that US investments in PEPFAR foreign assistance (as one example) are strongly associated with improved perceptions of the United States across the globe.³⁶ A potent mix of project transparency, exposure to US government institutional practices and customs, and an earnest desire to help recipient countries prosper underpins US foreign aid’s impact and success.³⁷

III. Looking back to chart a path forward: Lessons from the Cold War

Today’s threat landscape is not analogous to the Cold War for several reasons: China and the United States are far more intertwined economically than the United States and Soviet Union; technological advances have minimized geographical advantages; and states and citizens are more connected, with a magnitude of information access that was unthinkable in the immediate post-World War II era.

Despite these differences, the period in which the United States was grappling with a seemingly mighty Soviet Union and today’s competition with China share some similarities. Today, like then, the United States faces an array of threats across military, social, economic, and political domains from a formidable power that kinetic tools alone cannot address; as a result, the United States is looking to harness all statecraft tools to its advantage. Three key lessons from how the United States used foreign aid during the Cold War can help inform how it uses this non-kinetic tool for strategic competition today.

To maximize foreign aid’s impact, strategic patience is essential. Foreign aid can produce meaningful outcomes, but changes can take years to occur.³⁸ It took a decade for the Marshall Plan and associated US foreign assistance to transform Western European nations into the staunch democratic-minded, market-oriented partners that they are today. While US foreign aid that began in 1948 helped prevent socialist uprisings across Europe, NATO integration and rearmament took the 1950s to accomplish.³⁹ The European Economic Community only truly began to develop in the 1960s.⁴⁰ And the dismantling of European colonial empires and the move toward the US view of the liberal order took until the 1970s to be fully realized.⁴¹

Beyond Europe, US foreign assistance to African and Latin American governments highlights how approaching regions with a longer-term perspective and approach provides opportunities to augment engagement when conditions become more favorable.⁴² Throughout the 1960s and 1970s, US work in both regions haphazardly shifted between supporting anticommunist militarism, encouraging economic liberalization and development, and improving living conditions.⁴³ Moreover, post-colonial struggles in Africa and regional interference from the Cubans and Soviets in Latin America limited the overall effectiveness of US foreign-assistance programs until the 1980s.⁴⁴ Previous US engagement then allowed it to become a preferred partner as the Soviet Union began to withdraw from the “third world” and the global financial order introduced new requirements for integration and development.⁴⁵

Just as foreign assistance takes time to generate outcomes, assistance strategies should have flexibility to adapt to changes in the country or region over the lifetime of a given initiative. Identifying an end state, and methodically working toward it over the course of years or decades, allows second- and third-order effects of investments to occur.

Second, policymakers need to be realistic about what foreign aid can achieve—and avoid overpromising and under-delivering. More often than not, success has been achieved when US policymakers used foreign assistance to secure practical and realistic outcomes. While often criticized for partnering with autocrats over the course of the Cold War, the United States’ incremental investments slowly eroded the Soviet Union’s theory of victory and allowed the United States to encourage democratic progress over time.⁴⁶ US foreign assistance supported strategic aims that ultimately led to a more peaceful, prosperous, and representative world.

A final lesson is that foreign assistance works best when it is part of a broader whole-of-government strategy.⁴⁷ When the United States synchronizes foreign-aid interventions, these efforts tend to build on each other to promote long-term cultural change and alignment with US interests and policy.⁴⁸ Some clear examples of whole-of-government success are Western Europe, Colombia, South Korea, and Chile.⁴⁹ Each of these examples shares a US assistance approach and series of programs that combined security guarantees with cooperation and reform programs; economic-development packages that paired investment monies with revitalization of key industries; social initiatives intended to soften cultural cleavages while improving social determinants of health; and incentives for local governments to improve their capacity, resiliency, and responsiveness. When foreign-assistance efforts remained siloed between agencies, efforts fell short and minimized impact of taxpayer dollars.

IV. Recommendations: Maximizing US foreign aid to compete

The United States has the infrastructure and expertise to re-elevate foreign aid as a tool of statecraft and use it to help compete with China, Russia, and other adversaries. Doing so will require making changes to where the United States spends foreign assistance and on what, and reforming structures within the US government that dictate how said funds are allocated. These changes are based on lessons from the past, as well as a sober assessment of today’s threat landscape and the need to position the United States for today’s challenges.

1. Where the United States allocates foreign aid and on what

The United States should realign spending to focus on allies and countries strategically important to competition with China and Russia. Foreign aid can help lead to changes in countries that advantage the United States in that competition (e.g., by making a country’s political system more resilient to Chinese or Russian influence), as well as address other pressing challenges (e.g., by addressing causes of migration in Central America to curb flows of people into the United States). Foreign aid can also be used to help US allies or countries of strategic importance in ways that maintain or cement extant alignment of interests (e.g., via infrastructure development that benefits the government in power) or help move a country that is on the fence between cooperating with China and the United States (e.g., Pacific islands).

The current approach to, and regulations governing, allocating foreign aid is not set up to enable the United States to use funds in ways that directly and efficiently advance US interests. It forces the United States to center spending in many aid sectors on predominantly low-income countries (where the perceived greatest development needs are) and disincentivizes spending on middle-income nations (with some plans in place to phase out spending in middle-income states), disregarding how important these nations, despite their income level, might be to the United States.

The Trump administration explored realigning how the United States uses foreign assistance of all stripes—from economic aid to health assistance—to make competing with China the primary objective. This realignment did not gain traction. However, the review elements that called for revisiting stipulations to spend based on a country’s income level—and instead center decisions around a country’s importance to the United States—are welcome and worth revisiting.

The United States should make delivering for allies and shoring up democracy core pillars guiding how it uses foreign aid to compete with China and Russia. The United States has rightfully increased funding for infrastructure projects in developing nations—along and through multilateral forums—to offer an alternative to China’s BRI. These projects, from highways to hospitals, help the United States compete with China because they buy goodwill with recipient governments and—given the transparent way in which they are managed—provide important investment to support countries’ development needs. But they only address one part of the China challenge, and do not address the root causes enabling Chinese interference and influence—weak governance and political institutions.

Strong democratic institutions are the most reliable form of defense against Russian, Chinese, and other external efforts to shape a country’s domestic politics to the benefit of the external actor. Political parties channel citizens’ views into policy and law. Independent legislatures and capable executives craft and enforce legislation that makes markets favorable to foreign (and US) investment, and inhibit the type of opaque deals favored by the PRC. Independent media play a crucial role in identifying and exposing harmful authoritarian influence, while civil-society organizations (CSOs) work to push governments to take corrective action. Across borders, a diverse group of activists, media figures, religious leaders, researchers, and policymakers is collaborating to confront the challenge of foreign authoritarian influence, forming a strong and growing network of likeminded individuals committed to building democratic resilience worldwide. This network is using innovative methods to uncover and bring attention to the harmful influence of authoritarian actors, such as the PRC and Kremlin. They are devising advocacy and policy solutions tailored to the individual needs of local communities, with the goal of promoting lasting change and ensuring accountability from domestic and foreign authoritarian actors. They need US support.

Invest to empower pro-democracy elements in backsliding or authoritarian countries. In democratically backsliding or authoritarian countries, the scope and scale of elite capture by the PRC or the Kremlin—and conditions on US foreign assistance over human-rights concerns and corruption—limit the potential for political change to build democratic resilience to foreign authoritarian influence. In such contexts, it is extremely challenging to compete symmetrically with the PRC or the Kremlin, which do not impose conditions related to human rights or democracy, and routinely end up worsening both. The United States must respond asymmetrically, using foreign assistance in ways that empower individuals and institutions to expose and put pressure on the regime elements that perpetuate corruption and enable foreign influence. Ongoing investments in media, civil society, and small “d” democratic political parties and opposition movements can sustain important pro-democracy elements to effectively push back against authoritarian influence, in closed and closing countries.

2. Congressional action

Given its constitutional role of oversight and resource appropriation, Congress has an important role to play in ensuring the United States maximizes use and impact of foreign aid in its competition with China and Russia.

Congress should pass legislation (the Non-Kinetic Competition Act) requiring the executive to submit multiyear plans outlining the US approach—harnessing all nonmilitary statecraft tools, including foreign aid—to compete with China in select priority countries. Absent congressional requirements or oversight, it is unclear if the executive branch will be able to swiftly make the needed changes outlined above to where and how the United States spends aid, including ensuring whether it is part of a broader strategy for each country. To accelerate these efforts, Congress could pass legislation requiring the executive to deliver plans for select priority countries, outlining how it intends to use all aspects of US power and resources—including foreign aid, linked to diplomacy—to compete with China. The strategies should include a clearly defined goal, as well as a theory of the case. The legislation could be modeled on the Global Fragility Act (GFA), which requires the executive to deliver a strategy for preventing violent conflict and promoting stability globally, and ten-year plans for achieving these aims in select priority countries. Unlike the GFA, however, the legislation proposed here need not require the executive to publicly release plans, given the sensitive nature of the content.

Focus on geography and interests, rather than sectors. US foreign aid is largely organized around sectors (e.g., health, education) and driven by congressional earmarks. This makes it exceedingly difficult for the United States to craft geography-specific strategies (e.g., for sub-Saharan Africa) with a single source of foreign aid as an available resource. Ideally, the United States would craft a competition strategy for a given region that clearly identifies an end state, theory of the case, and associated inputs required to realize it (kinetic and non-kinetic, including foreign aid). Instead, the current system predetermines (via earmarks) how the United States spends a significant portion of foreign aid (with some exceptions), forcing planners to use aid in suboptimal ways that seldom advance country-specific strategies.

Congress, considering its increased attention to position the United States to prevail against China, should review extant earmarks, do away with as many as feasible, help the executive conduct longer-term planning, and provide greater flexibility in using foreign aid to compete. The legislation cited below could help set parameters and ensure funds are spent on the highest priorities.

Increase spending to expand partner-nation resilience to Beijing and Moscow coercion and cooptation. Strong democratic institutions increase a country’s ability to detect, prevent, and mitigate CCP influence operations, but must be coupled with other work focused squarely on detecting, preventing, and countering CCP and Kremlin interference—whether attempts by the PRC to train political parties in Kenya on the China “model” or direct Kremlin funding to political parties to influence electoral outcomes and ensure pro-Kremlin voices are voted into office. Foreign assistance in this category can fund a range of programming, from technical assistance to countries negotiating BRI deals to support for independent media in countries vulnerable to foreign influence. Priorities should include the following types of democracy, rights, and governance programming, which have proven effective in building democratic resilience to foreign authoritarian influence.

• Supporting independent media: Supporting independent journalism can be a powerful tool in countering the influence of the PRC and Kremlin in the Global South. It is a wise investment of limited US resources to empower well-trained journalists in vulnerable countries, who can provide free and unbiased reporting to expose the impact of foreign authoritarian influence. Every dollar spent in this direction can make a significant difference.
• Legislative dialogues: In legislatures throughout the world, a growing number of elected officials are committed to democratic resilience. From engaging with partners like Taiwan and Ukraine to exposing concerns around the domestic impacts of deepened political and economic engagement with China and Russia, these officials have been successful in advocating for measures to counteract foreign influence and building global democratic unity to confront it. Facilitating and supporting such dialogues, by both the US Congress and parliaments globally, is a critical and effective means to counter PRC and Kremlin influence.
• People-to-people exchanges: China is making a significant investment in people-to-people exchanges, sponsoring fellowships, scholarships, and exchanges to showcase the China model across the Global South. This soft-power initiative is an area in which the United States has a strategic advantage; it just needs to leverage it. The exchange programs sponsored by the Department of State’s Bureau of Educational and Cultural Affairs are an effective mechanism for engaging youth, students, educators, artists, athletes, and rising leaders to promote US interests—and democracy. More than 99 percent of participants in the bureau’s Sports Visitors exchange program come away expressing positive views of the United States, while its exchange programs have brought almost seven hundred officials who would go on to run their countries’ governments to the United States. However, only forty thousand international participants engage in such programming annually, given the bureau’s $777.5-million annual budget for exchanges. By comparison, in 2018, the PRC provided scholarships to sixty-three thousand students to study in China, a figure that doesn’t include party-to-party exchanges run by the International Liaison Department or journalist and parliamentary exchanges. Additional investment in this area would be a cost-effective win-win.

The United States spends a paltry amount combatting Russian and Chinese malign influence around the world, despite this being the foremost challenge of the time. The United States spends less than $325 million a year countering Chinese influence and $300 million countering Russian influence via foreign aid. In fact, the $625 million the United State spends annually on this threat from China and Russia is less than the Defense Department spends on printing each year.⁵⁰

US policymakers argue that prevailing against China is a national imperative, but have only appropriately resourced its kinetic toolkit. Foreign-aid spending focused on this aim needs to increase fourfold, to $1 billion annually. It should center on countries already exposed to CCP and Kremlin interference, at the cusp of such interventions, or likely to experience them moving forward.

3. Intra-US government structural changes

Several changes to intra-US government processes and structure would help better align foreign-aid spending with core national security interests and increase its impact in the competition with China and Russia.

Empower the State Department’s Office of Foreign Assistance Resources to fulfill its mandate of aligning foreign aid with policy goals and maximizing impact. US foreign-aid spending should directly align with, and advance, US interests in priority states, competing with China and Russia chief among them. This means enabling the Department of State to take the lead on foreign policy and control aid allocations in a way that concretely advances specific foreign policy objectives, rather than a development goal that might be tangentially related to US interests. The secretary of state should empower the Office of Foreign Assistance Resources to truly lead on foreign-aid coordination and alignment, deputizing its director to ensure aid spending aligns with policy goals. The USAID administrator should continue reporting to the secretary. The United States needs to maximize the impact of foreign aid for immediate political wins and incorporate foreign aid into longer-term planning.

Lengthen the time horizon for US foreign-aid programs and objectives from a single year to ten. The United States used foreign aid to significant effect during the Cold War. Flexibility in what and how to spend, as well as the time horizon on which success was measured (noting the struggle with the Soviet Union was the central objective) were extremely important. In the last 15–20 years, and in line with shorter-term goals (e.g., health), the time horizon for gauging success has shortened to 1–2 years. This is counterproductive. Democracy, rights, and governance programming—as well as initiatives in other sectors germane to competition—requires longer-term investment to develop strong and resilient institutions, political parties, and processes. US agencies and implementing partners need longer project times to maximize impact.

Limit branding waivers. Projects or initiatives funded by US foreign aid typically are branded as “from the American people,” and include the funding agency’s logo (e.g., that of USAID) to enable attribution for the work to the United States. Yet, the United States often allows organizations implementing foreign-aid projects to forego this branding requirement—thereby granting a waiver—on security or other grounds. For example, an NGO offering training to local farmers in an area contested by militias known to have anti-American views might request a waiver citing potential risk to personnel from said armed groups. Similar exceptions are granted for construction or other projects in areas perceived to be contested or at risk. Meanwhile, there are hospitals, schools, trainings, and so on in the same areas with “from China” branding readily visible. The United States benefits from populations and governments knowing who provides aid, and its marketing needs to reflect as much. The United States should only issue waivers when said branding could pose harm to implementers or beneficiaries, or when it is counterproductive to achieving results.

Focus on advancing interests, rather than “localization” targets. Under current Administrator Samantha Power’s leadership, USAID has articulated a commitment to the localization of US foreign assistance. This includes, but is not limited to, channeling a greater portion of US foreign assistance to local partners and taking additional steps to ensure US-funded projects build sustainable capacity of these local organizations. The United States has considered requiring international nongovernmental organizations that receive the “primary” grant from USAID to allocate a set percentage—up to 20 percent—to go directly to local partners. The rationale for this change, which the Barack Obama administration shared, is that US foreign assistance should help build local capacity to address needs. The intent is noble, but this arguably detracts from US foreign assistance achieving its actual and main intent—advancing US interests.

Rather than set aside an arbitrary amount of foreign aid for channeling to local NGOs, USAID and the State Department should pursue partnership approaches best positioned to achieve US interests in the target country. In most, if not all, cases, this will involve working through international NGOs that collaborate with—and, as needed, build the capacity of—local partners. Foreign aid should focus on building capacity and localizing aid, insofar as doing so advances US interests.

Conclusion

The United States’ overall approach to statecraft—how it forms strategy and uses tools to execute that strategy—has not caught up to the state of the world today. The current approach too often places bureaucratic prerogatives above policy priorities. The United States needs to be on high alert, shaping all aspects of government work toward its competition with China.

Patrick Quirk, PhD, is vice president for strategy, innovation, and impact at the International Republican Institute (IRI) and nonresident senior fellow in the Atlantic Council’s Scowcroft Center for Strategy and Security.

Caitlin Dearing Scott is the director for countering foreign authoritarian influence at the International Republican Institute.

The authors would like to thank Owen Myers for his research assistance.

The Scowcroft Center for Strategy and Security works to develop sustainable, nonpartisan strategies to address the most important security challenges facing the United States and the world.

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The completion or near completion of those measures is indeed helpful to DLICs, even if the measures fall short of what is needed—the sustainable development gap of those countries has been estimated to be $2.5 trillion per year. What the DLICs really need are concrete initiatives and the less said about grand strategy the better. Dressing those initiatives up as parts of a “new global financial architecture” risks conflating them with the geopolitical conflict centered around changing or preserving the current world order. That conflation will only make it more difficult to develop the international consensus required to adopt those measures. 

The Paris Summit showcases the potential and limits of the plurilateral approach  

The Paris Summit brought together senior representatives of about thirty-two countries, international organizations such as the World Bank (WB) and the International Monetary Fund (IMF), civil society organizations advocating debt relief and climate financing for DLICs, as well as private-sector businesses. Besides Macron, presidents and prime ministers from South Africa, Brazil, Germany, China, and a dozen or so African countries attended. The United States was represented by Treasury Secretary Janet Yellen and Special Climate Envoy John Kerry. The Summit represents an example of a plurilateral approach where a relatively small group of countries get together around a common agenda instead of the multilateral approach involving all members of the international community. Other examples include the World Trade Organization (WTO), which has been able to push through a few plurilateral trade agreements on specific issues, having failed to facilitate any round of multilateral trade liberalization since its inception in 1995; and the IMF which has recognized that working with smaller groups of like-minded countries can be a practical way forward. 

The Paris Summit exhibited the potential and limitations of the plurilateral approach. The results of the Summit were contained in the Chair’s summary of discussion, essentially reflecting participants’ appeals and statements of wishes rather than new commitments by countries. In fact the United States—a key country in any international undertaking—has been lukewarm at best about several proposals to raise funding, including worldwide taxation of CO2 emission in shipping and aviation, of financial transactions, and of fossil fuels in general. Yellen reiterated that multilateral development banks (MDBs) should try to optimize the use of their balance sheets to provide more finance to climate-related projects before asking members for more capital. 

Concrete results from the Paris Summit 

Nevertheless, the Paris Summit managed to produce two sets of results. One is a Road Map highlighting important events and meetings such as the G20 Summit in September in New Delhi and the IMF/WB annual meetings in October in Marrakech. Also noteworthy is the meeting of the 175-member International Maritime Organization in July to discuss the idea of taxing emissions from shipping, and the United Nations Summit on the Future in September 2024. The road map is useful in focusing international attention on important gatherings to push for further progress on the various commitments and initiatives already on the table. 

More useful to DLICs are announcements of the completion or near completion of previous pledges. Specifically, President Macron expressed confidence that the 2009 pledge by developed countries to spend $100 billion a year to help DLICs deal with the impacts of climate change will be fulfilled later this year. The OECD has reported that in 2020 the total amount reached $83 billion—the failure to meet this promise on time has been a disappointment for DLICs. More positively, the IMF reported that it has met its goal of asking countries with excess SDR reserves to re-channel $100 billion of the SDRs allocated in 2021 to help DLICs—with $60 billion pledged for its Resilience and Sustainability Trust (RST) and Poverty Reduction and Growth Trust (PRGT). In particular, the RST is aiming to help DLICs deal with climate change through an exception to the short-term nature of IMF lending, offering loans with a 20-year maturity and a 10-year grace period. 

The WB also outlined a toolkit that had been in the works for some time and includes offering a pause in debt repayments during extreme climate events (but only for new loans, not existing ones), providing new types of insurance for development projects (to help make those more attractive to private sector investors), and funding advance-warning emergency systems. In particular, it has announced the launching of a Private Sector Investment Lab to develop and scale up solutions to barriers to private investment in emerging markets. Progress has been reported in efforts by MDBs, especially the WB, to optimize their balance sheets according to the G20-endorsed Capital Adequacy Framework in order to be able lend $200 billion more over 10 years—with the hope of catalyzing a similar amount of investment from the private sector (which is easier said than done). 

Most concretely, after years of procrastination, the official bilateral creditor committee agreed to restructure $6.3 billion of Zambia’s bilateral debt, a portion of its total public external liabilities of more than $18 billion. The deal extends maturities of bilateral debt to 2043, with a 3-year grace period; an interest rate of 1 percent until 2037 then rising to a maximum of 2.5 percent in a baseline scenario; but up to 4 percent if Zambia’s debt/GDP ratio improves sufficiently. In the baseline scenario, the present value (PV) of the debt will be reduced by 40 percent, assuming a 5 percent discount rate. This is lower than the 50 percent PV haircut accorded to some other countries in debt crises and is insufficient to meaningfully reduce Zambia’s debt load. Nevertheless it is helpful, especially in allowing Zambia to receive a $188 million disbursement from its $1.3 billion IMF program. The deal was reached contingent on Zambia negotiating comparable agreements with its private creditors and after the multilateral development banks (MDBs) pledged to provide concessional loans and grants to DLICs in crises. 

Key takeaways  

First and foremost, the results of the Paris Summit show that it is useful to maintain pressure on governments and international organizations to deliver on their pledges and commitments to various initiatives, as well as to agree to new ones to help DLICs. Even though each of the measures is insignificant compared to the overall needs, cumulatively many of them can provide tangible support to DLICs.  

Secondly, progress on any of these initiatives requires agreement by all key countries, including China. For example, the Zambia debt restructuring deal was achieved only when China’s preferences have been honored—including no cut in the principal amount of debt, relying instead on maturity extension and low interest rates; classifying several loans including from China Development Bank as commercial, not official; and requiring other creditors including MDBs and private sector investors to participate on a comparable basis in the debt relief. Hopefully, the Zambia deal can represent a template to speed up the restructuring process for DLICs, as flagged in an earlier Atlantic Council post.  

And that leads to the last takeaway from the Paris Summit, mentioned earlier. Countries should not let debt alleviation and climate change mitigation initiatives be used as political scoring points in the geopolitical conflict between the West and China. This will make it difficult to build the consensus required to move forward in these efforts.  

Hung Tran is a nonresident senior fellow at the GeoEconomics Center, Atlantic Council, and former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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However, it’s possible that investors would try to buy more US Treasuries in the wake of default. Why? Because there is no viable alternative. Think back to the start of the Global Financial Crisis or COVID-19. In both situations, the world scooped up US bonds. That’s because there is nothing else like US Treasuries.

In a crisis, investors search for safety. Safe assets have a high likelihood of payout and can be traded easily. In practice, that usually means bonds issued by a handful of stable governments in advanced economies. The problem for any investor looking for safety in the wake of a US default is that the US Treasury market is much larger than any similarly-rated government bond market.

Would the world turn to German bunds, the only other AAA-rated sovereign debt in the G7? Maybe, but as the chart above illustrates, their market is less than 1/10th of the size of the US Treasury market. And German fiscal rules make it basically impossible for them to ever catch-up.

Where else to go? The UK gilt market? Beyond its small scale, you will recall the UK had its own credibility crisis just last year.

China? If you’re looking for a reliable, transparent, liquid market where you can turn your holdings into cash quickly without question, China is not it. 

Japan seems like a reasonable option until you realize the amount of Japanese government bonds (JGBs) available is overwhelmingly influenced by the central bank’s intervention in its bond market.

Where else could investors turn? They could hold more cash, but the opportunity cost of doing so has risen in the form of higher interest rates. They could look for relatively safe private sector assets, like the bonds of large, stable firms. But as the crisis of 2008-09 showed, even highly-rated private sector securities can be risky in a crisis.

There simply are not enough safe assets available for investors to move off of Treasuries. This is one reason why flirting with a default is so maddening. The US government issues something the rest of the world desperately wishes it had.

In the immediate aftermath of a default, Secretary Yellen may calm the Treasury market by promising to continue to pay interest on debt even as other bills go unpaid. But no one should mistake that for a solution. There would be massive fallout both for the US and global economy in this scenario. The bottom line is that in a default, even if US Treasuries have a short-term win, everyone—including the US—will still lose.

Josh Lipsky is the senior director of the Atlantic Council’s GeoEconomics Center and a former adviser at the International Monetary Fund.

Phillip Meng contributed research to this piece. A version of this piece appeared in the GeoEconomics Center’s private Sunday night newsletter  Guide to the Global Economy. To subscribe to the newsletter please email sbusch@atlanticcouncil.org.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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By legal mandate, the Bank of Japan is primarily tasked with achieving price stability—avoiding inflation and deflation. However, as with many other central banks, it has two additional unwritten mandates. The first is “financial stability”: a mix of regulatory authority and emergency powers that give it the capacity to intervene in markets in the event of a systemic shock. The second is what might be called a “fiscal separation mandate”: a commitment to avoid conducting monetary policy in ways that substitute for or badly distort fiscal policy.

These three mandates have become dangerously intertwined such that making progress on one may require ceding ground on the others. And while the specifics of the Japanese case are inevitably unique, it’s only a matter of time before the difficult choices facing the BOJ show up in Washington, London, Brussels, Frankfurt, and beyond.

The Bank of Japan has struggled with price stability since 1989

Prior to the COVID-19 pandemic, the BOJ was in a long-running struggle against deflation, which prompted it to pioneer an extraordinary combination of exceptionally low interest rates and quantitative easing (QE).

Japan’s problems with low inflation began with the real estate and stock market bubble of the late 1980s, which ended with a financial crash that put the economy into a tailspin. That crash shocked companies and households into saving as much of their income as possible. Events were so severe that the “precautionary savings” mindset has never really abated, resulting in persistently low domestic demand, and downward pressure on prices.

However, in the post-bubble years two other global factors kept prices down, in Japan and across the developed world. Technology and global trade fundamentally changed the cost and location of producing goods and services. A typical product sold in the year 2020 was produced using far less labor than the equivalent product in 1990 and was more likely to be produced in an emerging market. Less demand for labor meant that household incomes in developed markets struggled to rise even as GDP went up substantially. Less labor pricing power and lower household incomes meant less upward pressure on overall prices. Put simply, technological advances together with increasing amounts of global trade were deflationary.

And Japan was early to face an additional challenge to price stability: a rapidly aging population. Japan’s prime working age population started to decline in the early 1990s. There is no expert consensus regarding the relationship between population growth and inflation, but in Japan’s case there’s a plausible argument that a declining population added to deflationary pressure. In a rapidly aging (and declining) population, the demand for goods and services may decrease more quickly than the supply.

Fast forward to 2023, and inflation has replaced deflation as the prevailing issue in Japan. Inflation is well above the BOJ’s 2% target, but policymakers still need to factor in the trends that kept inflation too low for decades: very high savings rates, global trade and technology, and an aging population. Two of the three are applicable well beyond Japan, and as the BOJ’s experience shows, they’re challenging to deal with—even before factoring in the central bank’s two other mandates.

Financial instability after years of low interest rates

Globally, instances of financial instability have become more frequent as central banks have raised interest rates to combat inflation in the US, Europe, and elsewhere. Further instability isn’t a certainty, but the events of SVB, First Republic, and others suggest it’s a good bet. Against that backdrop, Japan may be the poster child for an unpleasant paradox: the low interest rates and quantitative easing which rendered the Japanese financial system remarkably stable for almost 20 years may have sown the seeds of extraordinary financial instability to come.

Why a poster child? Because the BOJ started its “exceptional” policy interventions as early as 2001, which implies that the banks, borrowers, and securities markets have internalized historically abnormal BOJ policy settings as “normal.” The result has been stability but not normality. Trading volumes in government bonds (JGBs) have become anemic to the point where the benchmark 10-year bonds don’t trade at all on some days. And over this period, Japanese markets have been operationally hollowed out. The largest of the global brokers have reduced trader headcount and moved trading staff offshore due to minimal activity. There is little or no “living memory” among JGB market participants of how to operate amid volatility. And operational infrastructure may not be up to the task either: There’s reason to doubt that Tokyo market makers invested in state-of-the-art trading and risk management systems.

Finally, the “real economy” is vulnerable to higher rates and increased volatility—especially real estate, “mom-and-pop” businesses, and “zombie firms” with high debt.

The third imperative: fiscal separation

The third mandate—set by law in some countries and by tradition in most—is that central banks are committed to minimizing interference with fiscal operations. Rule One of fiscal separation is don’t lend to your government. The theory is that governments which borrow money that is “funded with a central bank’s fountain pen” lose all fiscal discipline, and that people stop believing that their government will return to anything like properly balanced budgets. They also stop believing that the central bank cares about price stability.

Alas, Rule Two is that there is always some linkage between monetary and fiscal policy, irrespective of commitments to “non-interference.” Why? Because governments which fund themselves in their home currencies do so at interest rates which are immediately and continuously impacted by central bank policy rates, and expectations about changes in those rates. When central bank rates go up, governments pay more to refinance maturing bonds and to finance any new deficits.

Japan, again, may provide the world with a test case that will either mitigate concerns, or magnify them. Japanese government debt as a percentage of GDP is the highest in the G7, according to the IMF, followed by Italy and the US. If the BOJ makes a material change to its interest rate policy, the flow-through to the fiscal accounts will be substantial.

Japan on the horns of a trilemma

The BOJ is in a difficult spot: a trilemma where strictly adhering to any one of its mandates may require sacrificing the other two. If it raises rates aggressively to fight inflation, financial stability will be threatened, and the fiscal consequences may be large enough to provoke political counter-reactions. By contrast, a focus on maximizing financial stability implies keeping rates too low for too long, and may result in ongoing, elevated inflation. Lastly, a compulsive focus on “non-interference” in fiscal affairs—for example, by staying out of the market for government bonds—could spark financial instability.

So now what?

Schadenfreude is not the appropriate response. Japan’s challenges are or will be common to much of the G7, if not the entire West. The West should be working constructively with Japan as it strives to balance its three mandates. Its success will be ours too, and we all need to learn what we can from the steps the BOJ takes and the consequences that follow. Our own “trilemmas” are not far behind.

Mark Siegel is a contributor to the GeoEconomics Center and Managing Partner at Chancellors Point Partners LLC. He previously worked in banking and investment management.

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The post <strong>Japan’s monetary trilemma is a warning to the world</strong> appeared first on Atlantic Council.

China reopened its borders in the first quarter of 2023 and rolled out the rhetorical welcome mat for foreign investors. This included pledges to promote foreign investment and imports, restoration of suspended long-term visas, and high-level visits by Chinese leaders abroad and foreign leaders in China. But an aggressive public campaign to allay concerns about the direction of China’s economy has not been underpinned by a convincing shift in policy. The restructuring plan that emerged from the “Two Sessions” meetings in March did not reassure the private sector, nor did it suggest that Beijing is poised to tackle the root causes of its macroeconomic malaise.

Meanwhile, pressure on foreign companies (Bain & Company, Mintz Group, Deloitte, Micron and others) further dampens business confidence. Heightened geopolitical tensions with the US also cloud the picture. Turning a cold shoulder to perceived American hostility, Beijing sought to warm relations with Europe: it had success with French President Macron, but faced setbacks at the European Commission, including a universally condemned comment by China’s ambassador to France that some European nations aren’t sovereign.

The bottom-line assessment for Q1 2023 finds that Chinese authorities were active in three of the six economic clusters that make up the China Pathfinder analytical framework: financial system development, competition policy, and portfolio investment. There were fewer developments in the innovation, trade, and direct investment clusters. In assessing whether China’s economic system moved toward or away from market economy norms in Q1, our analysis shows a negative picture. 

At the 2023 Two Sessions, the government released a major restructuring plan, involving the establishment of new departments, consolidation of responsibilities, and an overhaul of the financial system. While the extensive nature of this restructuring may suggest the government is focused on maximizing efficiency in the economy to boost growth, the reality is more complex and less positive. Rather than implementing policies that address systemic problems in the country’s economy—such as the fragile property sector, the loss of consumer and business confidence following destabilizing zero-COVID measures and unpredictable government intervention in different sectors, and high levels of local government debt—the restructuring plan overall does not enhance transparency and only increases Party control within the bureaucratic system.  

Restructuring plan centralizes authority and consolidates party power in China’s bureaucratic system

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The speed and scale of digital bank runs have upended regulatory guardrails and left regulators no time to formulate proper responses. As a result, regulatory reforms are needed. In addition to changing the 2018 law that exempted US banks with assets of less than $250 billion (instead of $50 billion) from the full force of the 2010 Dodd-Frank law and strengthening bank supervisory practices, reforms should focus on the liquidity coverage ratio (LCR) requirement and the deposit insurance scheme. Reform is urgent, since banking crises can happen at any time and a possible recession is looming. At the same time, the Biden administration should proceed carefully, given the important ramifications of the measures in question.

Strengthened liquidity coverage requirements

A key plank of the Basel III reforms following the 2008 global financial crisis is the LCR, designed to address bank liquidity risks. Under the LCR requirement, banks must keep enough high-quality liquid assets (HQLA)—those that can be monetized quickly with no or little loss of value—to cover outflows of at least 3 percent of stable deposits and at least 10 percent of less stable deposits over thirty days. This requirement is intended to allow time for bank executives to take corrective actions and regulators to formulate appropriate responses. However, these ratio and time specifications are now rendered obsolete by the speed of digital bank runs. For example, SVB suffered a $42 billion deposit outflow on March 9 and a scheduled outflow of $100 billion the next day, when the Federal Deposit Insurance Corporation (FDIC) stepped in—totaling $142 billion, or 81 percent of the bank’s total deposits, in two days. In other words, banks satisfying their LCR requirements, as SVB did, can still be brought down by digital bank runs.

Moreover, the calculation of HQLA is flawed because it focuses on credit risk and not interest rate risk as well. HQLA consist of Level I assets (such as government bonds, which do not need to have haircuts, or discounts in calculating the numerator of the LCR); and Level II assets (such as corporate bonds, which have a 15 percent haircut). However, when SVB tried to sell its high-quality bond portfolio, including many US Treasury securities, it realized losses due to the increase in interest rates. This was another blow to the ebbing market confidence in SVB, accelerating the collapse. 

To address these shortcomings, the LCR should be strengthened to increase the coverage of expected outflows of at least 25 percent of deposits—and probably more for uninsured deposits. Furthermore, all securities included in the HQLA should be marked to market, or priced according to prevailing market conditions, to avoid surprise losses when needed to cover deposit outflows. Interest rate risks—not just credit risks—must be fully incorporated in regulatory frameworks and supervisory practices.

A better way to protect deposits

US authorities invoked the “systemic risk exception” to protect large uninsured deposits at SVB and Signature Bank to prevent contagion to the banking system. They are expected to do so again if another bank with large uninsured deposits fails. However, they cannot raise the current $250,000 deposit insurance limit per customer per bank without congressional approval. Leaving aside the low chances of congressional action in this time of political polarization, two important issues need to be considered in deciding whether and how to insure all deposits.

First, costs matter. The FDIC insures $9.9 trillion, or 56 percent, of total bank deposits. Its Deposit Insurance Fund (DIF) has accumulated $128.2 billion from assessments on banks, amounting to 1.27 percent of insured deposits. The assessment rates range from 2.5 to 32 basis points (of total liabilities) for small banks and 2.5 to 42 basis points for large banks—the actual rates depend on banks’ risk profiles.

Resolving SVB and Signature Bank while protecting all their depositors has generated $22.5 billion of losses to the FDIC—which it will have to recoup by making additional assessments on banks ex post. Obviously, the FDIC would need more resources if it insures all deposits, as requested by the Mid-Size Bank Coalition of America, among others. At a minimum, the FDIC would have to double the assessment rates, significantly increasing the costs to US banks (and to their clients).

More importantly, even with higher assessment rates, the DIF would likely be in no position to deal with a widespread banking crisis if it has to protect all deposits—worth $17.7 trillion, or 75 percent of US gross domestic product. The public backstop to the FDIC would likely be used more often than just in “exceptional” cases if the government stands ready to protect all bank deposits. This would significantly enhance the extraordinary privileges accorded to banks in exchange for their provision of payment and other banking services. In other words, banks would take and create (when making loans) government-protected deposits at low or zero cost. Then they would reap the profits by investing the money while the government assumes the risk of their possible failures threatening the deposits. Such a business model would draw ample and justified criticism. It’s not the right move.

A better approach is to confirm that deposits rank higher than debt and equity in bank capital structure; and in case of failures, large depositors will get paid—beyond the insured minimum of $250,000—by using the bank’s HQLA as collateral to borrow from the Federal Reserve. This can be done either through the recently launched Bank Term Funding Program or, better still, the Discount Window, which does not involve any government subsidies. Any residual claims depositors have would be settled out of the proceeds of the sale or liquidation of the failed bank—accepting possible losses if these proceeds fall short. This procedure would expedite the payment of a meaningful chunk of uninsured deposits to avoid disrupting business transactions but still subject large depositors to some degree of market discipline.

In short, reforms are needed to address the problems revealed by the March banking crisis—even though there could be strong resistance from various quarters. But the implications of inaction and of some reform measures, especially protecting all deposits, are so important that they should be discussed publicly—and more seriously than they have been so far.

Hung Tran is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, former executive managing director at the Institute of International Finance, and former deputy director at the International Monetary Fund.

The post These reforms can help stop digital bank runs appeared first on Atlantic Council.

Distinguished guests at the workshop included H.E Laurence Boone, Minister of State for Europe for the French Foreign Ministry; Ms. Kerstin Jorna, Director General of the Directorate-General for Internal Market, Industry, Entrepreneurship and SMEs (DG GROW); Mr. Olivier Guersent, Director-General of the Directorate General for Competition; Mr. Emmanuel Moulin, Director General at the French Treasury; and Mr. Benoît Potier, Chief Executive Officer of Air Liquide, among others. In addition to these guests, the Atlantic Council, DGAP and GEG were honored to host other key policymakers, analysts, and private sector representatives.  

One year on from the Russian invasion of Ukraine, Europe has managed to mitigate the worst effects of the energy crisis and maintain its support for Ukrainians’ defense of their homeland. Participants noted the significant number of initiatives taken at the European level on a vast array of subjects, including diversifying imports, deploying clean energy, and building supply chain capacity. The conversation in Paris ranged from how to meet basic energy needs now to building a resilient net zero economy in the future, with a focus placed on industrial strategy, infrastructure needs, and scaling up public and private funding, and infrastructure needs.

Whereas participants at the first workshop in Berlin highlighted the successful cooperation between European member states in the face of the energy crisis, discussants in Paris underscored increasing tensions between member states on several vital issues. Attendees emphasized the crisis of trust between member states, evidenced by disagreements on electricity market reform, divergences on the role of nuclear and natural gas in the energy transition, state aid rules, and even the lack of progress made towards a Capital Markets Union. Some panelists argued that Franco-German disagreements on nuclear energy inhibit Europe’s ability to make progress in its energy transition, while others expressed concerns around the necessity of nuclear support schemes at the EU level. There were also diverging perspectives around how loosening the state aid rules would impact market unity.  

Participants also emphasized the need for European cooperation, especially in building common energy infrastructure. Indeed, renewable energy deployment must go hand in hand with infrastructure investments, such as electricity grids, hydrogen pipelines, and electric vehicle charging stations. Panelists shared the view that, to meet these many goals, Europe would need to strengthen its infrastructure planning capacities, accelerate reforms in project permitting, and scale up access to funding if it is to meet its ambitious decarbonization objectives. Increasing and diversifying the number of long-term energy contracts signed with producers, such as contracts for difference and power purchase agreements, could help incentivize investments in clean power.  

Looking beyond the continent, European participants described the United States’ Inflation Reduction Act (IRA) as a welcomed shift in US climate policy and positive shock for Europe’s own decarbonization efforts. Several participants argued that the IRA would encourage Europe to build its own resiliency in clean industry supply chains and open potential avenues of cooperation with the United States. But European panelists also expressed concerns regarding its impact on European industry due to the law’s national preference rules, seen as discriminatory against European manufacturers, even though the EU offers comparable, but perhaps harder to navigate incentives. This highlighted a remarkable shift in focus from the workshop in Berlin a few months prior, where policymakers and analysts had debated Europe’s capacity to meet energy demand. In Paris, however, the conversation focused not on energy supply, but on low-cost, low-carbon energy as a prerequisite for a competitive industry.  

The Atlantic Council looks forward to continuing this workshop series throughout 2023.  

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Central bankers, finance ministers, executives, and civil-society leaders are meeting at the International Monetary Fund (IMF) and World Bank Spring Meetings this week with an ambitious economic-reform and fiscal agenda. The talks come six months after IMF Managing Director Kristalina Georgieva told the world’s economic leaders to “buckle up and keep going” in the face of multiple financial crises stemming from the pandemic, Russia’s invasion of Ukraine, global debt distress, high inflation, and more.

Amid all the uncertainty, a parade of central bank governors and finance ministers are visiting the Atlantic Council on the sidelines of the meetings and getting together with our experts to decode what is—and is not—happening behind the meeting’s closed doors. Below are our experts’ takeaways from our convenings, which feature leaders such as World Bank Group President David Malpass, and insights as the meetings unfold.

The latest from Washington

• Three new ways to support Ukraine, from Poland’s finance minister
• Sovereign debt restructuring: The kitchen lights are on, but where’s the beef? 
• The UAE’s trade minister on the new multilateralism
• How Ukraine’s digital innovations will shape reconstruction
• Economic policymakers shouldn’t fall into the trap of complacency
• The IMF missed an opportunity to take on the US debt ceiling debate
• What the World Economic Outlook didn’t say
• Who’s first and what’s second is this week’s central debate
• Central banks shouldn’t use IMF projections as an excuse to get too loose again
• Inside the World Bank’s digital governance agenda
• Spain’s economy minister aims to fight ‘fragmentation’
• ‘Sustainability, resiliency, and inclusion’ must top the reform agenda, says Cameroon’s minister of economy
• Senegal’s economy minister: ‘the US private sector is missing’
• David Malpass: Today’s economic double whammy may slam development into reverse

Three new ways to support Ukraine, from Poland’s finance minister

As Russia’s war on Ukraine puts major stress on the Polish economy, Poland’s Minister of Finance Magdalena Rzeczkowska visited the Atlantic Council on Friday to outline three ways how Western partners and multilateral institutions can support Poland’s goal of increasing military and financial assistance to Ukraine:

1. The European Union (EU) should provide funds to Poland for covering Ukraine-related expenses. Rzeczkowska drew attention to the fact that Poland’s total Ukraine-related spending, including military equipment and refugee accommodation, amounts to 2 percent of Poland’s gross domestic product. But Poland has not received funding from the EU to cover those expenses. Poland plans to increase spending both on Ukraine’s military equipment and its own defense. “It’s something that needs to be done because Ukraine is fighting for our future and freedom”, she said.
2. Multilateral organizations should allocate more funding for Ukraine. Rzeczkowska said that Poland is “very engaged with the IMF and the World Bank” and praised the institutions for the “proper answer” to the war, a program that has helped maintain Ukraine’s macro financial stability. Poland pushed the IMF to allocate its funding package for Ukraine, which will close Kyiv’s immediate budgetary needs and “give financial stability to Ukraine for four years.” Moreover, the European Bank for Reconstruction and Development has provided humanitarian aid to Ukrainian refugees in Poland. Rzeczkowska said that “Poland also wants to contribute to the fund which was created for Ukraine” by the European Investment Bank.
3. The Three Seas Initiative portfolio should include Ukraine’s reconstruction. Rzeczkowska believes that the Three Seas Initiative—a forum supported by the Atlantic Council—“is an important instrument for leveraging Central and Eastern European countries and building the North-South axis of infrastructure.” She argued that apart from its regular infrastructure-building and digitization agenda, the Three Seas portfolio should also include Ukraine’s reconstruction. While the Initiative struggles with the financing of projects and often requires compromises from member states, Rzeczkowska said it can be a strong and resilient instrument for Ukraine’s reconstruction and future growth of Europe.

—Maia Nikoladze is an assistant director with the Economic Statecraft Initiative in the Atlantic Council’s GeoEconomics Center.

Sovereign debt restructuring: The kitchen lights are on, but where’s the beef? 

As the Spring Meetings of the IMF and World Bank are winding down, more details are beginning to emerge from the closed-door meetings that were held on the touchy question of sovereign debt restructuring. The atmosphere around the new Global Sovereign Debt Roundtable appears to have been friendly and constructive, no doubt helped by the fact that Chinese officials were able to participate again in person. After all, despite extensive Zoom contacts over the past months, face-to-face meetings remain indispensable for finding a path through controversial, and possibly expensive, policy disagreements. 

The upshot is that the roundtable came to an agreement around several technical steps that could eventually facilitate the operation of the Group of Twenty (G20) Common Framework, but expectations for any concrete decisions or debt deals were (again) disappointed. Nevertheless, the areas of future work are concrete enough to suggest that progress on specific country cases may not be too far off. They include steps toward improving transparency around restructuring needs (where the IMF and World Bank would provide earlier insights into their debt sustainability assessments), a clarification of the role of multilateral development banks (MDBs), and further work on defining what constitutes comparable treatment of different credit classes. 

While China has not yet abandoned its demand that the World Bank and other MDBs share in any haircuts to official and private creditors, the latest signal from Beijing opens room for compromise, depending on the amounts of fresh concessional financing (and grants) that may be provided by multilateral lenders. One should of course not underestimate the capacity of international finance officials to make process look like progress, and it will be primarily up to China to demonstrate its willingness to help some of its poorest creditor countries back on its feet. 

China may still be hesitant to move fast, given that the long-overdue restructuring of Zambia’s debt could provide a hard-to-reverse model for the Common Framework. But there are now clear signs that the chefs are back in the kitchen, and one might hope that, with a few more ingredients, a palatable compromise may yet emerge.

—Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF chief of staff.

The UAE’s trade minister on the new multilateralism

Economic fragmentation may be the hot topic at this year’s World Bank-IMF Spring Meetings, but that does not mean that all countries have lost faith in multilateralism. Just ask Thani Al Zeyoudi, the United Arab Emirates’ (UAE) trade minister. “While others talk about de-globalization,” he said at the Atlantic Council on Thursday, “we’re focused on economic expansion.” 

For Al Zeyoudi, that means establishing a wide network of trade partnerships from Israel to Indonesia, while liberalizing trade and foreign ownership regulations at home. The UAE’s aspirations to become a “global market” are vital to its economic health: With a post-hydrocarbon future on the horizon, the country is banking on finance, transport, and logistics as the foundation for future growth. But as we have heard throughout this week, the UAE is only one of a growing number of countries unconvinced by rising protectionism.

Countries in the Global South and their major hubs, like the UAE, have been some of the most vocal supporters of multilateralism. But this does not mean that these new champions are content with the trading order as it is. Al Zeyoudi argued that “there is a consensus that we need urgent reform for the multilateral trading system,” and his country has sought modernized trade mechanisms and new free trade agreements even as many of its partners pursue stricter trade controls. At this week’s meetings, we may see whether more countries heed his call.

—Phillip Meng is a young global professional at the Atlantic Council’s GeoEconomics Center.

How Ukraine’s digital innovations will shape reconstruction

Ukraine has emerged as an example of resilience against all odds, and on Thursday morning, Deputy Minister of Digital Transformation Alex Bornyakov discussed the digital infrastructure that will enable better outcomes for Ukrainians a year into the war. He was joined at the Atlantic Council by Mark Simakovsky, deputy assistant administrator at the US Agency for International Development’s bureau for Europe and Eurasia; Denelle Dixon, the CEO of Stellar Development Foundation; and Anatoly Motkin, president and founder of StrategEast. 

The panelists discussed the Diia app, which has become a hub for services such as education and skill improvement, health care, digital identification, and other government services. “We have shown through example how the interaction between the government and the citizen can be done in the twenty-first century, ” Bornyakov said.

The panelists emphasized the resilience of technology during the war, the role of the private sector (both domestic and international) in reconstruction and development, and the challenges of corruption and accountability. “The private sector will have to be induced to go to Ukraine,” Simakovsky said. “Ukrainians will have to accelerate the reform and have to ensure that the decentralization that happened before the war is going to continue.”

Both Dixon and Bornyakov spoke about the role of women in building resilient infrastructure for the future and how technology can bridge the existing gap. The panelists also discussed innovation in payments architecture, such as central bank digital currencies, as well as the role of cryptocurrency in Ukraine’s economy. 

—Ananya Kumar is the associate director of digital currencies at the Atlantic Council’s GeoEconomics Center.

Economic policymakers shouldn’t fall into the trap of complacency

During the IMF/World Bank Spring Meetings, some officials—in particular US Treasury Secretary Janet Yellen—have downplayed the risks and negative impacts of last month’s bank failures, repeating the mantra that major banking systems are healthy. While banking turmoil has indeed subsided, it is important to guard against being complacent about the threat of “further bouts of financial instability… [due to] stresses triggered by the tighter stance of monetary policy”—as the IMF pointed out in its Global Financial Stability Report.

Tellingly, the report estimated that almost 9 percent of US banks with assets between ten billion and three hundred billion dollars would become undercapitalized (with their Common Equity Tier 1 capital ratios falling below the regulatory minimum of 7 percent) if forced to fully account for the unrealized losses on their holdings of US Treasuries and agency mortgage-backed securities (due to rising interest rates). Going forward, if the coming recession turns out to be more severe than expected, credit risk losses on bank lending, especially in the commercial real estate sector, would be significant.

On top of banks’ interest rate and credit losses, there have been tremendous deposit outflows from banks to money market funds. JPMorgan Chase has estimated that “vulnerable banks” have lost about one trillion dollars of deposits in the past year. Specifically, the top three US banks (JPMorgan, Wells Fargo, and Bank of America) have revealed a huge $521 billion deposit drop over the past year. The combination of losses on assets and deposits proved fatal to the failed banks last month and could yet strike vulnerable banks again.

More broadly, banking stresses have significantly tightened financing conditions, leading to a record contraction in US bank lending of nearly $105 billion in the two weeks ending on March 29. If this continues, declines in bank lending will tip the US economy into a recession sooner than expected, causing credit losses in a negative feedback loop. Policymakers need to be aware of this trend and try their best to mitigate it.

—Hung Tran is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, a former executive managing director at the Institute of International Finance, and former deputy director at the IMF.

The IMF missed an opportunity to take on the US debt ceiling debate

Rarely have the IMF’s World Economic Outlook and associated documents been written under as much uncertainty as now, with two significant bank failures happening in the middle of the drafting process. Yet, the IMF has managed to get together a set of sensible reports, with the uncertainty reflected not so much in this year’s growth projections than in the fairly sober medium-term outlook and the extensive discussion of risks.

The reports highlight the tight constraints on growth and policy faced by policymakers around the globe, and the IMF is right that, barring major financial shocks, monetary policy will need to focus on bringing down inflation expectations and fiscal policy will need to be supportive in this regard.

Given that they are vetted by the IMF membership in what is usually a very long board discussion, it is normal that the reports end up a little on the bland side, with carefully worded country-specific references, if any. Still, it is surprising that there is no discussion of the debt ceiling talks that currently appear stalled in the US Congress. The risk of a breach of the United States’ fiscal obligations, even if temporary, would have major repercussions both for the United States and the world economy—and possibly for the broader global financial system. 

The IMF missed a major opportunity this time around to remind the United States of the severe consequences for itself—and the rest of the world—of not living up to its responsibilities as the issuer of the world’s major reserve currency. One would hope that IMF delegates still use these Spring Meetings to drive home this point to their US counterparts. 

—Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF chief of staff.

What the World Economic Outlook didn’t say

On Wednesday, Atlantic Council senior fellows gathered to discuss the World Economic Outlook (WEO) report that was released by the IMF this week. The WEO is published twice a year and presents the IMF’s analysis of global economic developments over the near and medium term. This year, the report comes in the midst of tightening financial conditions in most regions and the aftermath of a banking crisis. The IMF forecasted that global growth will slow from 6 percent in 2021 to 2.7 percent in 2023.

The former IMF officials led a discussion to decode the WEO and address which elements they felt were missing. While participants cannot be quoted directly as the conversation was conducted under Chatham House rules, the experts generally agreed that the report was missing important discussions in several areas: the US debt ceiling, artificial intelligence, structural reforms to address aging populations and declining productivity, and the normal analysis of specific countries or regions. The group talked about the report’s increased attention toward economic fragmentation despite the political sensitivity of this issue. In addition, they discussed the potential for stagnation versus stagflation and the complexity of debt relief with China and private creditors. The experts also gave a defense of the WEO and why it matters in an economically divided world.

—Jessie Yin is a young global professional at the Atlantic Council’s GeoEconomics Center.

See more expert reactions from our WEO roundtable:

Who’s first and what’s second is this week’s central debate

Whether the topic at hand is COVID-19 debt fallout, the Ukraine conflict, climate finance, food security, or supporting small states, a common theme in deliberations thus far during the IMF-Word Bank Spring Meetings has been how to balance clear but competing needs in the short term versus the medium and long term. The threat of a “lost decade” of global growth adds urgency to figuring a path forward quickly.

There does seem to be consensus that multilateral financial institutions—and indeed, the entire global financial and development system—need to walk and chew gum at the same time. That is, they need to respond to urgent and basic needs, such as widespread food insecurity, while simultaneously investing in what is needed for economic recovery and inclusive growth; for example, investing in infrastructure and health systems. Some argue education is a medium-to-long term economic development need, but the 70 percent of the world’s ten-year-olds in low- and medium-income countries who cannot understand simple text and the hundreds of millions of unemployed youth might disagree. Climate change is seen as both an immediate and an existential threat—and, increasingly, a market opportunity. 

The debate this week in Washington, then, is less about which crises or challenges to address, and more about who should do what, when, and how. There are arguments for the IMF returning to a focus on liquidity and macro-fiscal and short-term stabilization, while the World Bank should focus on medium- to longer-term recovery and economic growth and development. It is too soon, however, to know if the arguments for this way forward will win out. Importantly, there is agreement that to tackle these problems both sides of 19th Street, along which the institutions sit (with the International Finance Corporation just up the road), need to incentivize and mobilize more private-sector capital and engagement, and better coordinate with other multilateral and bilateral agencies. Watch this space.

—Nicole Goldin is a nonresident senior fellow at the GeoEconomics Center and global head of inclusive economic growth at Abt Associates, a consulting and research firm.

Central banks shouldn’t use IMF projections as an excuse to get too loose again

The IMF’s World Economic Outlook expects global growth to remain around 3 percent in the next few years—lower than the 3.9 percent annual average from 2000-2009 and 3.7 percent from 2010-2019. This low growth estimate is based on expectations of a return to secular stagnation driven by long-term trends such as aging populations and slowing productivity growth, pushing the natural real interest rate (known as r*) to ultra-low levels comfortably below 1 percent.

This may or may not be the case. But the World Economic Outlook does not clearly mention the chance that secular stagflation is equally likely as secular stagnation to happen—especially since geopolitically driven fragmentation will likely reduce output and increase costs and prices. This comes on top of the fact that deglobalization has reversed the disinflationary benefits of the globalization period when hundreds of millions of low-wage workers in China and other emerging markets joined the global economy.

Consequently, the possibility of ultra-low r* should be viewed cautiously, as both inflation and nominal interest rates may be higher than in previous decades. Central banks should not use that as an excuse to implement extraordinary loose monetary policies like they did in the decade or so after the Global Financial Crisis—policies that boosted financial asset prices, causing recurring financial instability and now persistently high inflation requiring central banks to sharply raise interest rates. This is a hard-earned lesson that should not be quickly forgotten.

—Hung Tran is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, a former executive managing director at the Institute of International Finance, and former deputy director at the IMF.

Inside the World Bank’s digital governance agenda

As global conversations accelerate around digital-first governance, the emerging agenda must be based on “inclusion, competition, and trust,” said Priya Vora, managing director at Digital Impact Alliance (DIAL). 

Vora spoke Tuesday at an Atlantic Council event along with Arturo Herrera Gutiérrez, global director for governance at the World Bank, and Tim Murphy, chief administrative officer at MasterCard, to discuss how the World Bank should address digitalization. 

Participants in the roundtable, conducted in partnership with the Mastercard Policy Center for the Digital Economy, had one clear message: “The public sector cannot sit back anymore.” The real role of the US government, as Vora underscored, is to create the tools for an equitable and safe digital economy, then lead by setting global standards. 

This process starts with people-centric innovation coupled with comprehensive regulation. Gutiérrez stressed that countries cannot simply provide a technical solution, rather they need to create an “engagement strategy” to best inform consumers about the benefits and risks of that technology. 

The United States, as Murphy noted, is falling behind. As countries trend towards digitalization, Murphy warned about the threat of fragmentation, in which different countries have their own siloed digital priorities and issues of privacy, data protection, and consumer transparency are often ignored because of a focus on geopolitical competition. Therefore, the panelists agreed, global leadership and cooperation are crucial, especially to understand both the negative and positive opportunities of technology development.

The World Bank’s governance agenda will need to adapt to reflect the dynamics of the digital economy, including issues of privacy, cybersecurity, consumer protection, and sustainability. The next wave of innovation should be about “giving more tools of transparency and control to people,” said Vora. 

—Alisha Chhangani is a program assistant at the Atlantic Council’s GeoEconomics Center.

Spain’s economy minister aims to fight ‘fragmentation’

Nadia Calviño, Spain’s vice president and minister of economic affairs and digital transformation, declared on Tuesday that economic fragmentation would be a “lose-lose” situation for major economies. At an event at the Atlantic Council, Calviño noted that a “massive tectonic plates shift” is taking place within the post-World War II geopolitical order that has benefited the global economy. Economic ties are increasingly linked to geopolitical allies, and new research from the IMF shows that if geoeconomic fragmentation were to deepen, the global economy would contract by about 2 percent. This contraction would be far worse for developing economies.

Calviño believes that the World Bank and IMF will play key roles in avoiding such fragmentation and ensuring prosperity for all. Difficult discussions around debt relief, climate change, and economic slowdowns should not weaken the role of the institutions as financial stabilizers and promoters of development, she said. If the Bretton Woods Institutions didn’t already exist, “we’d have to invent them now.”

As the chair of the IMF’s International Monetary and Financial Committee, Calviño has three goals for the meetings this week. First, she aims to generate a consensus on reinforcing the global safety net and supporting the most vulnerable economies. Second, she plans to deliver a message of confidence that will also bring confidence to global economic markets. And third, which would be a bonus, she hopes to build a framework to coordinate economic policies that would encourage financial stability and prevent geoeconomic fragmentation.

This will not be an easy task. But Calviño is “neither optimistic nor pessimistic but determined” to make progress on these issues in a period of global economic uncertainty and volatility.

—Mrugank Bhusari is an assistant director at the Atlantic Council’s GeoEconomics Center.

‘Sustainability, resiliency, and inclusion’ must top the reform agenda, says Cameroon’s minister of economy

At the Atlantic Council, Cameroon’s minister of economy laid out the country’s economic trajectory in conversation with Julian Pecquet, the Washington/UN correspondent for Jeune Afrique and the Africa Report. Despite modest growth in the face of significant global pressures, it is “not enough for [Cameroon] to get to [its] goals of becoming an emerging country by 2035,” Ousmane Mey said.

A “paradigm shift” is underway in Cameroon’s economic planning, the minister of economy explained, as the country continues to learn from the disruptions of the COVID-19 pandemic and the pressures of the war in Ukraine. He said that in particular, the Cameroonian government wants to “take advantage of the situation to reengineer [its] production capacity to be able to produce more locally, cover the national demand, and export more in this environment.” At a broader level, the African Union is also working to “integrate and trade more between the countries” to promote resiliency and insulation from global crises at a continental level, Ousame Mey explained.

At the same time, he said, the stressors climate change is imposing on Africa, even though the continent contributes the least to global pollution, are closely tied to Cameroon’s economic goals. The minister noted that “sustainability, resiliency, and inclusion” must be at the forefront of the agenda for international monetary institutions. These issues are informing Cameroon’s position going into the Spring Meetings, explained the minister, who expects the talks to focus on “the future of the [Bretton Woods] institutions,” “reforms,” and “global challenges.” Particularly on the topic of reforms, he praised the “debt service suspension initiatives” that were introduced in 2020 under the Group of Twenty common framework to alleviate Cameroon’s burden in a time of crisis. “This is certainly something we should include in the reform of the financial architecture in the future,” he said.

—Alexandra Gorman is a young global professional at the Atlantic Council’s Africa Center.

Senegal’s economy minister: ‘the US private sector is missing’

Senegal’s newly appointed Minister for Economy, Planning, and Cooperation Oulimata Sarr has one clear message for international partners going into the IMF/World Bank Spring Meetings: “Senegal is open for business.”

In a conversation at the Atlantic Council with Julian Pecquet, the Washington/UN correspondent for Jeune Afrique and the Africa Report, Sarr acknowledged that she wants “the private sector to a play a much bigger role” in the country’s economy, which has grown rapidly in the past few years. In particular, “the US private sector is missing” in Senegal, she acknowledged, because it tends to view “Africa as a whole as a risky investment place.”

A major factor that shapes these views is sovereign debt credit ratings, which have historically been administered by foreign-based entities that rely on faulty metrics, Sarr said. The rise of credit rating agencies on the continent (currently there are two) will more accurately reflect the reliability and investment potential of African economies, Sarr noted.

Ultimately, “development cannot wait,” she told US viewers, noting the urgency of the issue. “Fast-tracking” solutions is the country’s top priority in all economic considerations, from “the reform of the Bretton Woods Institutions” to the choice of partners between the US and China. The current Biden administration clearly sees “Africa as a very, very important player” and “as a land of opportunity,” but she believes that the “US can do much more.”

—Alexandra Gorman is a young global professional at the Atlantic Council’s Africa Center.

David Malpass: Today’s economic double whammy may slam development into reverse

As World Bank President David Malpass prepares to hand over the reins to his successor, he has one big worry about the global economy: a “reversal in development.” 

“That means poverty is higher… than five years ago, that education and literacy problems are worse than they were five years ago,” he said at an Atlantic Council Front Page event on Tuesday hosted by the GeoEconomics Center. That reversal is unfolding, he explained, because of the COVID-19 pandemic and Russia’s full-scale invasion of Ukraine, which together hit the global economy with a “double whammy.” 

But even if these crises come to an end, development won’t necessarily get right back on track, warned Malpass, who will be succeeded in the coming weeks by former Mastercard Chief Executive Officer Ajay Banga. Next week, the boards of governors of the World Bank and International Monetary Fund (IMF) will meet in Washington to discuss reshaping development for a new era as central banks around the world raise interest rates to fight inflation.  

“The dislocation is huge,” Malpass said, explaining that countries looking to continue their growth strategies from the past decade will now see higher interest rates reflected on their contracts. Thus, instead of looking to return to pre-COVID development economics, Malpass explained, countries should be looking at this moment as “an inflection point into some new [economic] growth model”—and adjusting their strategies accordingly. 

“We don’t want it to be a lost decade for growth,” Malpass said. Preventing one, he added, will require sorting out global debt restructuring and increasing the resources available to the World Bank. 

—Katherine Walla is an associate director of editorial at the Atlantic Council.

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Apr 5, 2023

David Malpass on China’s role in the World Bank and how to prevent a ‘lost decade for growth’

By Katherine Walla

The president of the World Bank, speaking at the Atlantic Council as he prepares to hand over the reins to his successor, has one big worry about the global economy: a “reversal in development.” 

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IMF-World Bank Week at the Atlantic Council

APRIL 10–APRIL 14, 2023

Highlights from the Atlantic Council’s IMF-World Bank Spring Meetings. Watch the special events with finance ministers and central bank governors from around the world.

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The compounding crises of COVID-19, the war in Ukraine, persistent inflation, and climate change have battered the global economy. Meanwhile, debt, digital, and demographic disruptions are reorganizing the needs for and nature of development investments. To deliver on its mission to “end extreme poverty and promote shared prosperity in a sustainable way,” the World Bank should seize this moment and redefine its role in the global economy. It can start by focusing on these five policy priorities to help address the challenges to inclusive growth in the global economy today.

1. Address the uptick in extreme poverty due to COVID, conflict, and climate

COVID-19 ended the decline in global poverty dating back to 1998. More than seventy million people were pushed into extreme poverty in 2020. By its own admission, the World Bank will no longer be able to achieve its goal of reducing extreme poverty (currently around 9 percent of the world’s population) to 3 percent by 2030. Slow vaccine rollout in poorer economies has prolonged COVID’s impact. Since the start of the pandemic, inequality within and between countries has grown; young people and women disproportionately have carried the costs of these crises.

Russia’s full-scale invasion of Ukraine in 2022 sent global prices of food, fuel, and fertilizer skyrocketing. The World Food Programme estimated that 345 million people will face acute food insecurity in 2023, double the amount of 2020. Meanwhile the climate crisis and weather-related events continue to undercut infrastructure, impact agriculture production, and intensify humanitarian disasters that displace millions globally. The World Bank should devote as much as possible of its lending and advisory might to social protection and tackling the immediate shortfalls in food, energy, and raw materials that are driving higher inflation and exacerbating poverty. At the same time, it should work to support longer-term recovery and resilience, including through data, infrastructure, governance, and economic reform.

2. Deal with debt distress 

Throughout the 2010s, countries increased external borrowing in a long period of low interest rates and high liquidity and then accumulated even more debt in response to the pandemic. Now as financial conditions tighten, questions over the sustainability of this debt are rising. Fifty-four countries are already in debt crises. The private sector has fared no better; looming corporate debt distress poses systemic risks. A growing problem of non-performing loans and the recent banking sector crisis will likely lead to a credit crunch, disproportionately hampering lending to small- and medium-sized enterprises that dominate emerging market and developing economies.

While the International Monetary Fund is on the front line of financial crises, it is up to the World Bank to keep developing countries focused on projects and reforms that support long-term economic growth prospects. When key projects are at risk of being canceled or deferred, the World Bank should engage with all stakeholders, from creditors and ratings agencies to domestic policymakers, to isolate these from cuts. The World Bank has the resources to do this, for example, through its Development Policy Financing tools. But it should redouble efforts and consider raising more money on markets to lend into debt-distressed countries and companies (especially small businesses) and to restructure existing debts.

3. Embrace the digital revolution

Commerce, public administration, and education are all evolving with rapid digitization. As technology becomes part of most jobs or business processes and creates entirely new ones, the World Bank should prioritize projects providing new and accessible ways to upskill youth and reskill older workers who are not digital natives, as well as technologies that make physical activities easier to perform. The World Bank has already taken encouraging steps in this direction, such as Skilling Up Mashreq and other programs. The World Bank should also provide support for innovation and entrepreneurship across government, education, health care, finance, green energy, and agriculture to increase digital and technology integration at the sector level. It should further develop infrastructures, policy frameworks, and regulatory reform that improves the availability, access, and affordability of new technologies. That should include incentivizing public-private partnerships and directly engaging with the private sector.

4. Change incentive structures for private capital

Interest rates have been hiked in response to high inflation, raising borrowing costs for governments and the private sector. At the same time, higher interest rates in developed markets mean higher rates of return, which, combined with increased risk in lower- and middle-income countries, could lure emerging-market investors to the United States and Europe. In order to maintain the flow of investment into projects in emerging economies, it is crucial for investment contracts to be well thought through, with protections against inflation. The World Bank’s lending for a project, even when small, will continue to play a key role in reassuring investors and “crowding in” funding and financing—including climate finance for adaptation and mitigation.

5. Reestablish that inclusive growth begins with inclusive governance

The Group of Seven (G7) and European Union member states together control more than 50 percent of all votes at the World Bank, even as they represent under 13 percent of the global population. As part of its overall reforms, the World Bank should seriously consider voting reforms to address criticism from its members of unequal voice and representation. The organization should increase coordination with regional development banks, which are more sensitive to the dynamics of their operating regions and have demonstrated their capacities in helping respond to the pandemic and to climate change. It should deepen engagement with sovereign wealth funds, multinational corporations, and pension funds, which play a far greater role in the global economy than they did in 1944, when the Bretton Woods Institutions were created. At the same time, operationally, the World Bank should re-double its consultation with and support to young people, women, and small- and medium-sized enterprises—each has seen substantial pre-COVID gains erased. This support can include helping them tap into recovery initiatives and opportunities in the expanding green, social, and industrial sectors.

The challenges facing the World Bank are daunting. But the appointment of a new president and an appetite for reform in the United States and elsewhere mean that the World Bank has a unique opportunity to anticipate changes to its mandate and prepare for a stronger future.

Nicole Goldin is a nonresident senior fellow at the GeoEconomics Center and global head of inclusive economic growth at Abt Associates, a consulting and research firm.

Mrugank Bhusari is an assistant director at the Atlantic Council GeoEconomics Center.

The post <strong>Five ways the World Bank can redefine its role in the global economy</strong> appeared first on Atlantic Council.

He expressed the Chinese Communist Party’s (CCP) surprise and unease over how problems reverberating from the US financial sector hurt China and promised to re-examine the Chinese financial sector’s linkages to the US. He then announced the party’s new strategic priority to refocus Chinese finance on its domestic economy as a way to tackle the crisis and stave off future shocks from overseas.

At the time, the declaration went largely unnoticed. There were too many other problems to deal with. But nearly fifteen years later, as the global economy confronts another wave of bank failures, it’s clear China followed through on Wen’s promise. 

The effects of Silicon Valley Bank’s (SVB) and Credit Suisse’s collapse have reverberated across every major economy—except one. The KBW Nasdaq Bank Index, which tracks the performance of the world’s leading Globally Systemically Important Banks (G-SIBS) is down 17 percent from March 7 to its trough on March 24. China, however, remains an outlier. Why? 

Scars of the Great Recession

2008 was a turning point in China’s liberalization of its financial sector. The crisis exposed what Beijing perceived to be unacceptable cross-border risks between the United States and China. The collapse of Lehman Brothers shocked China’s leaders. Not because they were overly concerned about contagion—they had fiscal and monetary tools to deal with the immediate economic problems. But because they saw that the United States was willing to let its major financial institutions fail. This made connections to the US system overly risky.

The Great Recession also forced the CCP to reassess the model it would structure its financial system around. The crisis revealed a more volatile and risky face of Western banking. Leading government-affiliated scholars became increasingly skeptical of a market approach to finance, which they saw as driving financial instability in the United States and Europe. 

China’s immediate response to the crisis was to rely on its state-owned banks. In conjunction with a massive fiscal stimulus program, Beijing instructed these institutions to substantially increase lending. Total domestic credit grew by more than one-third in 2009. It was through these state-owned banks and enterprises that China’s real economy—unlike Western economies—escaped relatively unscathed by the financial crisis and maintained employment despite a collapse of global trade. 

As China recovered from the recession, the dominant perception among policy makers and influential scholars became that insufficiently regulated financial markets caused the crisis. State-ownership, on the other hand, was fundamental to ensuring China could weather and then quickly exit it. 

These lessons laid the foundation for policy changes that have insulated the Chinese banking system from the collapse of SVB and Credit Suisse. 

Banking with Chinese characteristics

While 2008 forced Chinese policy makers to recognize these risks, other priorities delayed any action. They still wanted to integrate some parts of their economy into the global financial system such as including the Yuan in the IMF’s Special Drawing Right (SDR) basket. It was only in the later part of the decade, following its 2015 stock market crash that Beijing began implementing this policy pivot.

In 2015 the pop of a market bubble saw the Shanghai Stock Exchange lose more than 48 percent of its overall value. After the incident, financial regulation was named a top political priority at the 2017 National Financial Work Conference, a twice-a-decade event which set the scene for the country’s financial sector for the next five years. 

In the ensuing months, Beijing appointed a new top bank regulator who began implementing a “windstorm” of new regulations. In order to de-risk the sector, policymakers tightened controls on cross-border transactions, capital movement, and overall exposure to other markets. The following year Beijing also drew banks closer to the state. Regulators pushed banks to establish Communist Party Committees with a wide oversight purview. Most were formed with the stipulation that they would be consulted before corporate strategy was agreed upon. As our China Pathfinder project, a collaboration with Rhodium Group, shows, this—in conjunction with other measures—has led to a financial system with intense state supervision.

These reforms, as well as the banking structure that predated them, has generated major differences between China and Western approaches to banking. China has a high level of state ownership and control of its banking sector, and a government that more actively intervenes in banking decisions. 

As Premier Jiaboa promised, the result is a banking sector that is exceptionally focused on China’s domestic economy and adverse to cross-border risk, especially from Western economies. In 2021 cross-border lending of Chinese banks represented less than 5 percent of their total balance sheet. In the United States, cross-border lending constitutes more than 22 percent of its banks’ balance sheets. What little cross-border lending China does engage in is focused on emerging and developing economies. This lending can often be understood as a policy choice serving strategic goals, such as the Belt and Road Initiative. 

These policy choices have led to a financial system with more immunity to the problems facing the United States and Europe. While the collapse of Credit Suisse and SVB reverberated across all major Western financial capitals, China, with the world’s largest banking sector, was largely unimpacted. 

But that protection comes with its own costs.

First, Chinese finance is continually plagued with inefficient capital allocation. This is prominently playing out in the semiconductor industry with reports that senior officials are increasingly angry at the lack of development progress despite the tens of billions of dollars they have funneled into the industry over the past decade. Second, China’s lack of international and advanced economy banking connections mean it plays an undersized role in global banking standard setting such as the Basel Committee. For a country that has promised more international leadership in recent years, its lack of a large international financial presence often precludes it a seat at the rulemaking table (time will tell if China’s ambitions toward Hong Kong change this dynamic). Finally, its banking system is unable to offer Chinese savers attractive investment products, leading to other economic imbalances—including an asset price bubble in the country’s property sector. 

Similar to China’s zero-COVID policy, financial isolation comes with tradeoffs. While it may create a system that is relatively unphased by crises abroad, it also can generate and amplify endogenous issues within China’s own economy. 

Josh Lipsky is the senior director of the Atlantic Council’s GeoEconomics Center and a former adviser at the International Monetary Fund.

Niels Graham is an Assistant Director with the Atlantic Council GeoEconomics Center focusing on the Chinese economy.

The authors would like to thank GeoEconomics Center YGP Phillip Meng for his excellent research support.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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The post Chinese banking’s SVB resilience  appeared first on Atlantic Council.

Debt limits—which act as a ceiling on the central government’s ability to borrow money to finance existing legal obligations—are self-imposed. They are not a legal obligation to any lender. Ceilings are often intended to signal fiscal discipline to international investors or to enact checks and balances on a country’s public finances. But investors rarely like them because they can be easily skirted, making them a mild irritant. Worse, they can trigger full-scale political chaos and directly jeopardize investments.

In the United States, debt limits are set as a nominal value. Two important pieces of legislation concerning the debt limit were adopted during World War I in 1917 and right before World War II in 1939. The ballooning and unknowable costs of war and the intervening economic depression made it cumbersome for Congress to oversee each instance of debt issuance. Congress therefore gave the US Department of the Treasury considerable flexibility on the issuance and management of debt—while imposing a ceiling on total debt. Since 1960, Congress has permanently raised, temporarily extended, or revised the definition of the debt limit seventy-eight times under both Democratic and Republican presidents. 

Many of these negotiations have been fraught with political deadlock, leading to serious concerns over a possible default on US debt obligations. Hitting the debt limit could paralyze the government’s ability to finance its operations—including national security initiatives, Medicare, and Social Security. It could result in a downgrade from credit rating agencies, making borrowing more expensive for the public sector, private sector, and households alike. It could also shake the dollar’s foundations, threatening its centrality in the global economy. Even the mere prospect of any of this happening worries global investors.

Debt limits like the United States’, however, are not the norm—and they rarely cause major deadlocks in the few countries that have adopted this tool. Other countries have avoided deadlocks through one of these four routes: 

1. The ceiling is intentionally set sufficiently high such that it will not plausibly be crossed.
2. The law is either amended or suspended during periods of heightened stress necessitating indebtedness.
3. No punishments are tied to the legislation, meaning states often cross the limit with impunity.
4. The law was scrapped altogether when it was severely curtailing the government’s policy space.

How do other countries manage debt limits? 

Denmark

Like the United States, Denmark also sets its debt limit as a nominal value. But that’s where the similarity ends. The Danish Parliament intentionally sets the ceiling sufficiently high such that it will not be crossed, rendering it no more than a formality.

The Danish Parliament first passed debt ceiling legislation in 1993 as a constitutional necessity resulting from administrative reorganization of government institutions. Since then, the debt limit was amended just once in 2010, when the country’s debt remained far under the limit. The ceiling was doubled to DKK two thousand billion or 115 percent of 2010 Danish gross domestic product (GDP), far higher than actual debt levels. Denmark’s outstanding general government debt in 2023 is DKK 327 billion, which is only 16 percent of the debt ceiling. The 2010 doubling was executed with the explicit intention of avoiding any risk of nominal gross debt ceilings affecting ongoing fiscal policies in response to the 2008 recession.

Kenya

Like the United States and Denmark, Kenya also has a nominal debt limit. However, it is under the process of replacing the nominal limit with a limit as percentage of GDP at 55 percent. The intention is to make debt management more sustainable—or in other words, to finance budget deficits in the medium term without needing to repeatedly negotiate the debt limit.

The government has typically stayed within the constraints of debt limit legislation. But when push came to shove, the Parliament of Kenya has increased the limit in advance to avoid an economic impasse. Parliament recently increased the debt limit from KES nine trillion to KES ten trillion to enable complete financing of the 2022 / 2023 budget. The legislation had a majority in parliament. Opposition from a few members of parliament leading up to the limit raise had less to do with political infighting, and more to do with concerns regarding vulnerability to debt distress. This raise is nevertheless understood to be an interim measure while Kenya moves to debt limits as a percentage of GDP.

European Union 

The European Union (EU) joins the United States as the only other Group of Twenty member to stipulate a formal debt limit—albeit of a different type. The EU’s Stability and Growth Pact (SGP) stipulates that a member’s debt cannot exceed 60 percent of its GDP. If a state breaches that ceiling, the excessive debt procedure (EDP) is automatically launched by the European Commission. It consists of several steps—culminating in sanctions—that intend to pressure the state to return to that 60 percent figure. This debt limit is meant to safeguard the stability of the common currency. 

The EU’s debt limit legislation imposes strict penalties on transgressors, but exhibits adaptability to extreme economic duress. The legislation includes a “general escape clause” which can only be triggered in a severe economic downturn. It was triggered in response to the pandemic in 2020 and has yet to be reinstated. The EU is now actively exploring fiscal reforms including the debt limit, particularly to help countries implement the green and digital transitions, meaning the debt limit may not return in its current form.  

Poland 

Within the EU, Poland also has domestic laws to limit debt. Constitutional articles stipulate that national public debt cannot exceed 60 percent of the annual GDP. Here too, the law has shown flexibility to circumstance.For instance, some of the toughest measures to manage debt levels were suspended to facilitate response to the economic slump in 2013. 

Malaysia 

Malaysia’s debt limit is set at 60 percent of GDP, lifted from 55 percent in 2020 to aid the government’s response to the pandemic. It was lifted further temporarily to 65 percent of GDP in 2021 to make room for additional borrowing and fiscal stimulus, and this temporary provision lapsed on December 31, 2022. Unlike the United States, the debt limit is not governed by any act and is self-imposed by the Ministry of Finance. Parliamentary approval is not necessary to raise the debt ceiling and the government will not “shut down” in the event of exceeding the limit. The government can simply revise the limit when needed. Subsequent governments have nevertheless remained approximately within bounds of the debt limit. Now that the limit has returned to 60 percent following the temporary raise to 65 percent, the Malaysian prime minister has assured that the government will gradually lower the nation’s debt and return within bounds of the debt limit.

Namibia

The Namibian debt ceiling is set at 35 percent of its GDP. However, this figure is non-legislative and the Namibian debt-to-GDP has been above that level for years. In 2021, Namibia’s debt was 72 percent of its GDP.

The Namibian government has attempted to return to that 35 percent figure. It has cut its national budget and created a sovereign wealth fund. These efforts, however, have been severely hampered by government spending during the COVID-19 pandemic and food shortages resulting from the war in Ukraine. 

Pakistan

The Fiscal Responsibility and Debt Limitation Act of 2005 requires the Pakistani government to reduce total public debt to 60 percent of GDP by 2018. But the legislation does not stipulate any punishment for breaching that limit. Without an incentive to stay under it, Pakistan’s debt has continually been over the limit. The debt-to-GDP ratio this fiscal year is 75 percent. 

Limitations of the debt limit

Australia briefly experimented with a debt limit similar to that of the United States, experienced the political infighting that Washington is familiar with, and abolished it soon after. In response to the Global Financial Crisis, the government introduced a debt ceiling of AUD seventy-five billion in 2008 to signal its commitment to fiscal prudence. But deficits persisted, and the government raised the ceiling multiple times to staunch resistance from the opposition, culminating at a limit of AUD three hundred billion. When the new government in 2013 was met with strong resistance to increasing the limit yet again, it ultimately decided to scrap the law altogether. 

Debt limits are self-imposed tools to facilitate sound fiscal policy. But in practice they serve as orienting goals or tools of political bargaining at best, and triggers of economic chaos at worst. It is unsurprising that most of the world chooses to have no such limit.

The United States is one among the few polities that have adopted and retained debt limits. Within that tiny group, it is unique in its inability to find workarounds which could inadvertently harm its national interest.

Mrugank Bhusari is an assistant director with the GeoEconomics Center focusing on international finance and global governance. Follow him on Twitter @BhusariMrugank.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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The post The US debt limit is a global outlier appeared first on Atlantic Council.

The Atlantic Council, the German Council on Foreign Relations (DGAP), and Groupe d’études géopolitiques (GEG) were honored to host “Decarbonization solutions for addressing Europe’s green industrial policy challenge,” a high-level workshop on decarbonization in Paris on March 20. The event promoted an open discussion between policymakers, analysts, and the private sector on Europe’s energy challenges, and to discuss what could be a common approach to on Europe’s energy security and climate challenges, and to discuss what could be a common approach to resolving threats to US-EU solidarity as well as Europe’s internal fissures.

Featuring

H.E. Laurence Boone

Secretary of State for European Affairs

Ministry for Europe and Foreign Affairs of the French Republic

Kerstin Jorna

Director General, Directorate-General for Internal Market, Industry, Entrepreneurship and SMEs (GROW)

European Commission

Fellow

Ben Judah

Director

Europe Center Transform Europe Initiative

Economy & Business European Union

Sena Latif

Acting Chief of Mission

Embassy of Romania in Paris

Benoît Potier

Chief Executive Officer

Air Liquide

Laurence Tubiana

Chief Executive Officer

European Climate Foundation

In conversation with

Board director

Ambassador Paula J. Dobriansky

Vice Chair, Scowcroft Center for Strategy and Security

Scowcroft Center for Strategy and Security

Latin America China

Guntram Wolff

Chief Executive Officer

German Council on Foreign Relations

Transform Europe Initiative

The Atlantic Council’s Transform Europe Initiative (TEI) is a critical element of the Europe Center’s drive towards structural reforms in Europe.

TEI leverages a robust body of work in strategic decarbonization.

Explore the program

Europe Center

Providing expertise and building communities to promote transatlantic leadership and a strong Europe in turbulent times.

The Europe Center promotes the transatlantic leadership and strategies required to ensure a strong Europe.

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The Global Energy Center promotes energy security by working alongside government, industry, civil society, and public stakeholders to devise pragmatic solutions to the geopolitical, sustainability, and economic challenges of the changing global energy landscape.

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The post Decarbonization solutions for addressing Europe’s green industrial policy challenge appeared first on Atlantic Council.

Europe faced a perfect storm in 2022, following the Russian invasion of Ukraine. Russia cut off gas supplies at a vulnerable time for Europe: a combination of low European gas storage levels and hindered domestic production capacities in nuclear and hydropower from climate change-related extreme heat and drought. Participants noted the war has challenged Europe’s prevailing energy and security policies, as well as the continent’s climate prestige and green industrial ambitions. It is also a challenge to achieving Europe’s climate change ambitions and green industrial growth. Several participants argued that Europe now faces a new impossible trilemma: to reduce greenhouse gas emissions, maintain continuity in its energy supply, and ensure the survival of industry and affordable energy prices for households. The last issue is especially difficult to navigate, as Europe’s industry is threatened by high energy prices, rendering it uncompetitive against US and Chinese counterparts with access to cheaper fossil fuel energy.

Participants agreed that while the energy crisis has affected individual member states in different ways, the response must be found at the European level. This requires increased coordination within Europe, notably on emergency measures to address the crisis,  simplification of regulatory frameworks, enhanced energy interconnections, and agreements on how various clean energy and low-carbon energy sources can enhance security and decarbonization. In particular, while nuclear energy remained a point of contention, all participants stressed the need to move forward in a constructive and cooperative manner. Panelists widely shared the view that Russian aggression in Ukraine must “shift attention, not the priorities”, meaning that Europe’s climate objectives, in terms of renewable energy generation, energy efficiency and electrification, remain more relevant than ever.

Participants argued that, while Europe now looks to Africa as an alternative supplier of fossil fuels to replace Russian imports, Europe should increase cooperation with the African continent for clean energy imports, green hydrogen, and critical raw materials, all key components of Europe’s decarbonization trajectory. Looking eastwards, participants noted the importance of China in renewable energy supply chains, and warned against the threat that European industry faces in several key sectors including wind, noting China’s long-established near-monopoly in the solar industry as an example.

In 2022, Europe responded to Russia in a decisive manner, ensuring its domestic energy needs were largely met by attracting LNG cargoes (albeit at high prices) and reducing demand. Participants agreed that this was a result of critical policy decisions, combined with beneficial external factors: low demand in COVID-stricken China, and record-breaking warm weather over the European winter. Discussants acknowledged that Europe had narrowly avoided a catastrophe, but that coming winters would provide new challenges and opportunities due to resurgent demand from China and uncertainty over whether future winters will be so mild. In short, the energy crisis of 2022 has offered key lessons for Europe to continue its decarbonization journey.

Transform Europe Initiative

The Atlantic Council’s Transform Europe Initiative (TEI) is a critical element of the Europe Center’s drive towards structural reforms in Europe.

TEI leverages a robust body of work in strategic decarbonization.

Explore the program

Europe Center

Providing expertise and building communities to promote transatlantic leadership and a strong Europe in turbulent times.

The Europe Center promotes the transatlantic leadership and strategies required to ensure a strong Europe.

Explore the program

The Global Energy Center promotes energy security by working alongside government, industry, civil society, and public stakeholders to devise pragmatic solutions to the geopolitical, sustainability, and economic challenges of the changing global energy landscape.

learn more

The post The energy and climate challenge: How Europe can achieve decarbonization appeared first on Atlantic Council.

In part, the shock came because Banga hails from the private sector. He is the vice chairman of the private equity firm General Atlantic and a former chief executive officer of Mastercard. Names floated as potential nominees in recent weeks favored current and former government officials. 

Banga’s nomination comes after the current World Bank president, David Malpass, announced that he will step down in June, ahead of the end of this five-year term. It also comes as the nearly eighty-year-old organization faces an array of global crises, from the COVID-19 pandemic and food insecurity to climate change. In fiscal year 2022 alone, the World Bank provided more than $104 billion in loans, equity investments, grants, and guarantees to partner countries and private businesses. 

Below, experts from our GeoEconomics Center answer the burning questions around this announcement. 

Do you expect any pushback on Banga’s nomination?

Other countries can put forward their nominees, and then the World Bank’s executive board will consider the nominees. The board has signaled they will decide by the end of May. However, per an informal agreement at the creation of the Bretton Woods Institutions in 1944, the United States has always chosen the World Bank president and has always selected an American. The Europeans are informally granted the privilege of selecting the head of the IMF (currently Kristalina Georgieva, a Bulgarian economist who was actually a former acting president of the World Bank herself). It is possible that other countries from emerging markets may try to oppose this arrangement this time around, but it seems unlikely that they could prevent Banga from ultimately being selected.

—Josh Lipsky is the senior director of the GeoEconomics Center.

There has been explicit signaling from the World Bank’s executive board, as well as a push from the nongovernmental-organization community, including ONE, that it’s time for a woman to (finally) helm the World Bank. There has also been an increasing sense that emerging markets and developing economies should have a stronger role in governance. With this nomination of Banga, we could very well see an alternative candidate emerge. 

—Nicole Goldin is a nonresident senior fellow with the GeoEconomics Center and the global head of inclusive economic growth at Abt Associates.

What does Banga’s nomination reveal about how the Biden administration views the World Bank?

The US nomination of Banga as the next president of the World Bank seems to convey the priorities the Biden administration expects from the institution going forward. Besides sharing the administration’s concerns about mobilizing resources to combat the effects of climate change, Banga brings to the table his track record as a successful chief executive officer of Mastercard, skill in mobilizing public and private capital, and experience doing business in developing countries. These skills and knowledge are important in leading the World Bank in the period ahead. 

—Hung Tran is a nonresident senior fellow with the GeoEconomics Center and a former IMF official.

Selecting a former leader of a major international company (which is not the typical mold for a president) suggests that the United States is focused as much on internal reform of the bank as it is on changing World Bank lending policy on climate and China. Reforming the inner workings of the World Bank has been a perennial mission for the institution’s presidents, and it’s unclear if Banga will have more success than others. 

We have done work on this issue at the Atlantic Council through our Bretton Woods 2.0 project, and what we show is that the World Bank’s ability to lend effectively to countries around the world ties directly to how it is structured internally.

—Josh Lipsky

What is the most pressing issue the next World Bank president will face?

The next World Bank president will have to contend with compounding crises: COVID-19, climate change, and conflict. The fallout from them includes learning loss, the reversal of gains against poverty, inflation and food insecurity, widening inequality between and within countries, and debt.

—Nicole Goldin

While the White House announcement of Banga’s nomination highlighted climate change among “the most urgent challenges of our time” facing the World Bank, there are several other issues that will require his immediate attention, notably the debt crisis that has enveloped dozens of countries since the COVID-19 pandemic hit. An estimated 60 percent of low-income countries are in, or at high risk of, debt distress, and a solution to their plight has been elusive because of an impasse in getting private-sector lenders and China (the World Bank’s third-largest shareholder) to agree to debt-restructuring deals.

The US government and Malpass have repeatedly criticized China over the issue, and the White House likely will expect Banga to keep up the pressure. But as China cuts its lending to developing countries, the World Bank will face calls to increase its commitment of funds not just to climate change programs, but in traditional areas such as infrastructure and poverty reduction.

—Jeremy Mark is a nonresident senior fellow with the GeoEconomics Center. He previously worked for the IMF and the Asian Wall Street Journal.

The post The big questions (and answers) about Ajay Banga’s nomination to lead the World Bank appeared first on Atlantic Council.

In the second half of 2022, China veered from one extreme to the other, with carefully choreographed control followed by sudden turmoil. In October, President Xi Jinping was elevated to an unprecedented third term, underscoring his iron grip on China’s Communist Party and the country. Two months later, the chaotic abandonment of zero-COVID measures, in place for nearly three years, triggered a nationwide health crisis. Throughout, the Chinese government has continued to claim that the path it has chosen for China’s economy and its people is the only right one.

Nevertheless, China’s economic weakness is pushing leadership to strike a more business-friendly tone. In recent months, Chinese officials have been reassuring a private sector hammered by regulatory crackdowns and rolling out the welcome mat for foreign investors who have been turned off by years of draconian COVID lockdowns. The defining question of 2023 will be whether the shift in policy and rhetoric is merely a short-term tactic by the Chinese government to shore up growth. So far, evidence of a more meaningful commitment to structural reform is hard to find.

The bottom-line assessment for H2 2022 shows that Chinese authorities were active in five of the six economic clusters that make up the China Pathfinder analytical framework: financial system development, competition policy, trade, direct investment, and portfolio investment. There were fewer developments in the innovation cluster, though we are watching to see if Beijing can muster a response to profound semiconductor controls imposed by the United States on China in October 2022. In assessing whether China’s economic system moved toward or away from market economy norms in H2, our analysis shows a mixed picture.

This issue of the China Pathfinder Update looks ahead to China’s post-COVID era and analyzes the “two confidences”—that of domestic consumers and businesses, and foreign investors—the Chinese government needs to rebuild in order to restart the economy. The end of zero-COVID restrictions and the resumption of travel and services sector activities for Lunar New Year will bring about an improvement in China’s economy—especially the consumer-facing segments—in the first half of 2023. However, an end to zero-COVID does nothing to remedy long-running structural problems. Distress in the property sector, lingering unemployment for new graduates, and weak growth in disposable income all stand in the way of a rebound. China’s charm offensive on the international front will also require follow-through, as foreign governments and investors await evidence of the country’s commitment to structural reforms.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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The unitary globalized economy no longer exists. Driven in significant part by security considerations, a new and more diverse globalization is both required and being built. The transition is ongoing, and its final form is yet to be determined.

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The post China Pathfinder: H2 2022 update appeared first on Atlantic Council.

How grave is Britain’s stagnation?

As Britain faces a historical rupture from its historical trend with flatlining productivity growth, Ben Judah spoke with Professor Adam Tooze, Director of the European Institute and Kathryn and Shelby Cullom Davis Professor of History at Columbia University on how this crisis looks from a historical perspective.

Why does the economic data suggest this is more serious than previous moments of feared decline? How does this stagnation compare to previous instances in the 1930s and 1970s? What impact has Brexit had on this trend? Would a Labour government under Keir Starmer be able to turn this around?

You can watch #BritainDebrief on YouTube and as a podcast on Apple Podcasts and Spotify.

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The post #BritainDebrief – How grave is Britain’s stagnation? | A debrief from Dr. Adam Tooze appeared first on Atlantic Council.

A hidden web of power revealed itself to Internet users in early 2022. Following a brutal government crackdown in Kazakhstan in January, anyone using open-source flight-tracking websites could watch kleptocratic elites flee the country on private jets.

A little more than a month later, Russia’s invasion of Ukraine brought a new spectacle: social media users were able to track various oligarchs’ superyachts as they jumped from port to port to evade Western sanctions. These feeds captured a national security problem in near real time: In Eurasia and beyond, kleptocratic elites with deep ties to the West were able to move themselves and their assets freely despite a host of speeches by senior officials, sanctions, and structures designed to stop them.

Kleptocratic regimes—kleptocracy means “rule by thieves”—have exploited the lax and uneven regulatory environments of the global financial system to hide their ill-gotten gains and interfere in politics abroad, especially in the United States, the United Kingdom, and the European Union. They are aided in this task by a large cast of professional enablers within these jurisdictions. The stronger these forces get, the more they erode the principles of democracy and the rule of law. Furthermore, the international sanctions regime imposed on Russia in response to its invasion of Ukraine has little hope of long-term success if the global financial system itself continues to weaken.

The West still has a long way to go to rein in the authoritarian kleptocrats who have thrived on the institutional dysfunction, regulatory failure, and bureaucratic weakness of the transatlantic community for far too long. We need to rethink not just how we combat kleptocracy, but also how we define it. Policy makers need to understand that authoritarian regimes that threaten transatlantic security are closely linked to illicit financial systems. As it stands, our thinking about how foreign corruption spreads is too constrained by stereotypes about kleptocratic goals and actions.

Outdated mental images of kleptocracy hobble the West’s response

Most transatlantic policy makers have in mind the first wave of kleptocracy, which primarily flourished in the late twentieth century. Its rise was intertwined with that of transatlantic offshore finance, which prompted a race to the bottom in financial regulation and a rise in baroque forms of corruption across the post-independence “Third World.”

The corrupt autocrats of the Cold War era flaunted the wealth they stole from their own people. These kleptocrats, many of whom are still spending large today, usually did not weaponize their corruption to influence the foreign policies of the United States or its allies. They were content to offshore their ill-gotten gains in US, UK, and EU jurisdictions with lax oversight over these types of transactions.

But this mental image of the kleptocrat is outdated: These kinds of kleptocratic leaders are not extinct, but they are curtailed. It is no longer a simple matter for first-wave kleptocrats to access the global financial system. Many of the regulatory loopholes exploited by these classic kleptocrats have either already been addressed or are in the process of being closed.

The second wave of kleptocracy, which emerged since the 2000s, is more sophisticated, authoritarian, and integrated into the global financial system than its predecessor. Second-wave kleptocrats intend to use the global financial system for strategic gains—either for self-gain and/or to reshape it in their image—instead of just hiding or securing the money they have stolen. Most notably, this evolution accelerated in Russia under President Vladimir Putin before February 2022, with the agendas of oligarchs and kleptocrats being subordinated to and intertwined with the plans of an ambitious state authoritarian.

Alongside this weaponized corruption, there has arisen in the West a coterie of enablers among the policy makers targeted by second-wave kleptocrats.

The second wave of kleptocracy is more sophisticated, more authoritarian—and more dangerous

Though our understanding of the threat posed by illicit finance has grown ever more sophisticated, our conception of a kleptocrat remains frozen in the mid-to-late 2000s: halfway between David Cronenberg’s 2007 London Russian gangster movie Eastern Promises, which depicted ties between the Russian state and overseas mafia groups, and the 2011 case of Teodoro Nguema Obiang Mangue, vice president of Equatorial Guinea, in which the US Justice Department seized a Gulfstream jet, yachts, cars, and Michael Jackson memorabilia. Both depictions—one fictional, one real—describe the world of ten years ago, when the second wave of kleptocracy was still relatively new.

So what does kleptocracy look like today?

The natural resources tycoon

The tycoon is a figure who has “assimilated” into the global financial system and been recognized as a legitimate businessperson because they provide a consistent source of fossil fuels to the United States and its allies. They view the transatlantic world above all as a market, but they cannot deviate too far from loyalty to the regime in the country from which they extract natural resources. As a result, the kleptocrat as natural resources tycoon has a strongly supportive relationship with the regime, which turns a blind eye to their criminal techniques. These tycoons often “donate” parts of their revenue to leadership figures. Several Russian oligarchs would seem to fit this typology, such as Gennady Timchenko, if many of the allegations against him are true.

The private corporation subordinated to authoritarian objectives

Private corporations can be a vector for state-sponsored weaponized corruption, especially if the state is controlled by a one-party authoritarian regime at odds with the United States, its allies, and the liberal international order. US officials remain suspicious of one private corporation’s connections to the Chinese Communist Party. Even though the corporation is officially privately owned, 98.99 percent of this corporation’s stock is officially owned by a trade union committee representing employees (with the remainder held by the corporation’s founder). However, all trade unions in China are required to be part of a CCP-run labor federation. A British parliamentary inquiry into the potential security risks of Chinese technology companies noted that, even if they were not directly led by the CCP, they tended to maintain very strong links, including receiving billions of dollars’ worth of funding from the Chinese government.

The Western enablers

A respected mainstream democratic politician was the leader of a major bloc in the Parliamentary Assembly of the Council of Europe (PACE). In this capacity, he led other PACE members to vote down a resolution based on a 2013 Council of Europe report that condemned Azerbaijan’s human rights record. However, it was later revealed that the enabler’s actions had been influenced by extravagant bribes from Ilham Aliyev’s regime in Azerbaijan.

These cases of second-wave kleptocracy show why, despite a decade of transatlantic anti-corruption activism and the sanctions imposed on the Kremlin’s cronies and war chest, the kleptocrats are still winning even as their objectives have evolved.

Chronically underregulated industries fuel the problem

As regulations have caught up to the first wave of kleptocracy, foreign kleptocrats are increasingly switching to different channels for illicit finance. 

Central to both the failure of transatlantic regulation and the strategies of second-wave kleptocrats are chronically underregulated financial industries: private investment firms, art dealerships, real estate agents, and luxury goods providers. The global arts trade industry was estimated to be worth $65 billion in 2021, with the United States, the UK, and the EU accounting for at least 70 percent ($45.5 billion) of worldwide sales.

As of 2020, the total value of assets under management in the global private investment industry was estimated at $115 trillion, more than $89 trillion of which was in the US, UK, and EU.

In 2020, the global value of residential real estate was an estimated $258.5 trillion, with North America and Europe together composing at least 43 percent of that value (approximately $111.155 trillion).

The cryptocurrency market is the newest. It is also less stable than other financial industries, so its relative size and value fluctuates more dramatically.

Weaponized corruption in action

The 1Malaysia Development Berhad (1MDB) scandal was the largest political scandal in Malaysian history and the most publicly known case of kleptocracy in the world before the release of the Panama Papers in 2016.

Photos: Reuters

A large amount of the stolen wealth remains in US real estate and fine art, which the Department of Justice is continuing to recover on behalf of Malaysia. As of August 2021, more than $1.2 billion had been recovered. Yet, given the number of private investment firms, real estate traders, film producers, and arts dealers that were involved in the 1MDB-related illicit finance, it is highly likely the stolen funds have been dispersed across a variety of industries. With better financial intelligence sharing between US, UK, and Dutch authorities, these suspicious dark money flows might have been identified before the money was moved across US financial institutions.

What needs to happen to take on the second-wave kleptocrats?

The US, UK, and EU need a more structured relationship to develop anti-corruption policies. We propose a new mechanism for the transatlantic community to harmonize its necessary response: a Transatlantic Anti-Corruption Council to coordinate anti-corruption policies between the United States, the UK, and the EU. It could connect the various US, UK, and EU agencies and directorates that work on corruption and kleptocracy-related issues, and organize them into expert groups focused on illicit finance, tax evasion, acquisition of luxury goods, and more. Recent cases of weaponized corruption have exploited the lack of regulatory coordination and financial intelligence sharing between transatlantic jurisdictions to evade detection and to corrupt transatlantic democratic and financial institutions. The TACC can work on closing these gaps—but it is only the beginning of a larger transatlantic strategy against weaponized corruption.

The anti-corruption policy to-do list

United States

In the United States, much of the problem stems from a lack of legislation enabling more comprehensive law enforcement and regulatory compliance within these underregulated industries. The United States should:

• Follow through on the US legislative national anti-corruption strategy. Many of the existing flaws in the US regulatory sphere were correctly identified and should be addressed accordingly. This includes the strategy’s commitment to increasing regulation on the private investment industry, including on firms managing assets totaling less than $100 million.
• FinCEN, the US FIU, is chronically understaffed, underbudgeted, and relies on outdated technology. Even if legislative reform was passed and/or executive action taken to extend BSA/AML obligations to more financial institutions, FinCEN would be hard-pressed to fully investigate reports it received and to enforce its authority in cases in which financial crime was present.

United Kingdom

The UK, on the other hand, already has much of the legislation it needs to address anti-money-laundering (AML) deficiencies and sanctions evasion occurring in its jurisdictions. It needs to implement that legislation—and address the close connections between the City of London and British Overseas Territories and Crown Dependencies. The UK should:

• Share legalistic principles and good practices of unexplained wealth orders (UWOs) with allies. UWOs have already proven to be very effective in bringing more investigative power to bear on to foreign kleptocrats based in the United Kingdom
• Reduce regulatory mismatches between the primary UK jurisdictions and the Crown Dependencies and Overseas Territories, especially with beneficial ownership registries and sanctions compliance
• Improve verification standards for companies registered in Companies House to identify shell companies
• Fully implement and enforce existing transparency and national security laws, especially the National Security and Investment Act

European Union

Much like the UK, many of the EU’s problems stem less from a lack of legislation than from the implementation of those policies. The EU faces additional hurdles in ensuring that all its member states harmonize their AML policies. The EU should:

• Increase compliance requirements for private investment firms managing assets totaling less than €100 million
• Fully implement the 6th Anti-Money Laundering Directive (6AMLD) across EU jurisdictions. The establishment of an EU Anti-Money Laundering Authority will be essential for harmonizing regulations across the European Union (EU).
• 6AMLD measures should also be applied to overseas autonomous territories like Aruba.
• Increase enforcement of laws that prohibit the spread of corruption in foreign territories, particularly for cases that involve spreading corruption to fellow EU member states

Transatlantic community

The transatlantic community should:

• Work closely with the United States in its national anti-corruption strategy. The strategy’s success will be heavily dependent on the degree of cooperation between US allies and the Biden administration in its implementation.
• Match regulatory legislation on both sides of the Atlantic. This will permit better coordination of sanctions between allies and reduce tensions between the United States and its allies when the United States relies on extraterritorial action.
• Create channels for financial intelligence units and private sector actors in transatlantic jurisdictions to share information about suspicious clients, transactions, and transfers. The Europol Financial Intelligence Public Private Partnership (EFIPPP) may be a good platform for increased intelligence sharing.
• Establish the Transatlantic Anti-Corruption Council (TACC). Its main purpose would be to coordinate legislation on improving anti-money laundering/Know Your Customer (AML/KYC) policies, share good governance policies (such as beneficial ownership registries) to harmonize regulations, crack down on sanctions evasion, and share financial intelligence on transnational financial criminals to shut down their operations.
• The TACC should also regularly convene expert working groups on, at a minimum:
• trade-based illicit finance,
• market-based illicit finance,
• bribery and other enabling forms of corruption,
• acquisition of luxury goods by kleptocrats,
• asset returns,
• tax evasion,
• terrorist financing, and
• future threats.
• Financial intelligence working groups should similarly cover individual cases of financial crime at the tactical level. At the executive level, primary stakeholders in the TACC should be
• the Departments of State, Treasury, and Justice, and USAID on the US side,
• the Foreign, Commonwealth & Development Office (FCDO); His Majesty’s Treasury; and the Home Office on the UK side, and
• the Directorate-General for Economic and Financial Affairs; Directorate-General for Financial Stability, Financial Services and Capital Markets Union; and Directorate-General for Justice and Consumers on the EU side

The late United Nations secretary-general Kofi Annan once said: “If corruption is a disease, transparency is a central part of its treatment.” Annan spoke in a time before the crisis of weaponized corruption rose to prominence, but his words ring clearer now that foreign kleptocrats are spreading their malign influence by means of the money they stole from their own people. The United States and its allies must choose the partners with which it engages more carefully. Otherwise, it may find that some of its partners are in fact proxies for strategic competitors of the transatlantic community who will undermine the West’s security and the integrity of its democracies from the inside.

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Russia’s 2022 invasion of Ukraine, as well as G7 sanctions imposed in retribution, have expedited Moscow’s pivot to Beijing. While Russia’s economic reorientation has most prominently played out in its goods trade, particularly with hydrocarbons, Russia’s financial relationships have undergone a parallel shift. As a result, Russia’s economy is now heavily reliant on Chinese capital. Though this may be favorable for Russia now, overreliance on Chinese finance will reinforce Russia’s status as the junior partner in the two countries’ relationship.

Chinese authorities do not publicly report their banks’ consolidated positions, but alternative data sources suggest that Chinese lenders may have maintained or extended additional credit to Russian borrowers in the aftermath of Russia’s invasion of Ukraine. One notable example is syndicated lending—a type of loan provided by a group of lenders and preferred by international financiers, as it allows them to share risk. Syndicated lending data suggests loans originating from Chinese banks now account for nearly half the global total of syndicated loans to Russia. In the coming months, this overreliance will likely grow as financial institutions in other parts of the world, namely Europe, halt new lending to Russia and refuse to refinance or roll over existing loans, with many banks pulling out of the country altogether. 

Russia first identified China as a viable source of alternative financing in 2014 after Moscow found itself blocked or ostracized in the Western financial hubs of London and New York. Hoping to instead rely on Shanghai and Hong Kong, Russia began to more intentionally engage Beijing to foster a stronger economic and financial relationship. The Kremlin lifted political barriers such as a ban on asset purchases in the natural resource sector and investment in infrastructure contracts in sensitive industries like roads and railways. Beijing, in turn, encouraged its firms to invest or enter the Russian market. Borrowers and lenders followed, and the portion of Chinese lending in the Russian economy tripled from where it stood in 2014 to 2022. 

Although Moscow began to look elsewhere for its financing, not all European financial institutions saw the writing on the wall. While the UK, France, and Germany viewed Russia’s 2014 annexation of Crimea as an inflection point in their relationship with the Kremlin and began to reduce their exposure to Russia, Italy, and to a lesser extent Austria, did the opposite. Driven by a combination of high returns and a domestic political climate with more favorable views towards Russia, Italian banks increased their syndicated loan exposure to Russia from around 4.6 percent in the months following the seizure of Crimea to around 7.5 percent going into Q3 2022. Italy’s banking sector, led by the banking group UniCredit, is now forced to deleverage itself from Russia by writing off its cross border exposure, swapping loans with Russian banks, and identifying international buyers for its loans to Russian clients. 

Beware of financial overreliance 

While the Kremlin’s eastern pivot worked well in the aftermath of 2014 when the Chinese economy was booming, today Shanghai and Hong Kong may be less willing to fill the new gaps that are opening as Western lenders exit the Russian market. Chinese lending is typically shaped by the geopolitical and economic objectives of the Chinese Communist Party. In 2014, this benefited Russia. The Chinese economy was growing at upwards of 7 percent, its financial sector was flush with capital, and its government encouraged its firms to look internationally via a “going out” strategy. 

The opposite is now true. In 2022, China grew at a meager 3 percent—well below its target rate of 5.5 percent. Under Beijing’s direction, its financial sector is now focused on ensuring ample liquidity in domestic markets and low funding costs for businesses. Consequently, Chinese international lending has dropped by around 14 percent from the start of 2022 to July, when the latest data is available. In the short term, Beijing is far more likely to direct its banks to support its own ailing economy to meet its GDP target than to shore up any gaps opening in Russia. 

In the medium to long term, however, Chinese lenders will likely increase their exposure to the Russian economy. As western lenders shun the Russian market, Shanghai and Hong Kong will be able to extract new deals with more favorable terms for China. Russia could provide a friendly market for Beijing to test new financial policies it will eventually need to implement as it opens its own financial system to the rest of the world. 

While China remains Russia’s best option as a source of finance, Moscow is becoming overdependent. Even with a strong Chinese economy, the Chinese financial sector’s willingness to cover all gaps left by other lenders remains unclear. State-owned banks dominate the Chinese financial sector, and these banks are subservient to Beijing’s political interests. If they provide a foreign company access to credit, this implies that the project meets a strategic or economic interest for China. While this may be fine for a Russian firm hoping to raise capital to develop a new oil field for export to the Chinese market, if the final buyer resides in India or Turkey, Chinese banks may lose interest. Without a diverse lending base, otherwise viable projects will go unfunded. 

China’s dominance in Russian external financing will also amplify Beijing’s leverage in its relationships with Moscow. As the relationship becomes increasingly asymmetric, China will be able to force Russia to accept previously untenable concessions. China is already using this influence to its advantage in negotiations on a new pipeline to connect Siberian gas fields to China by asking for a price structure that benefits Chinese consumers, additional legal allowances that benefit Beijing, and, naturally, the use of the renminbi as the contract currency.

While Putin and Chinese President Xi Jinping present their countries’ partnership as a “no limits” friendship, Russia’s invasion of Ukraine has cemented Russia’s status as the junior partner of an increasingly one-sided relationship. As the West decouples itself from Russia, Moscow will increasingly rely on Beijing, not just for financing but a range of areas including trade, technology, and international diplomatic support.

Niels Graham is an Assistant Director with the Atlantic Council GeoEconomics Center focusing on the Chinese economy.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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The post Russian finance pivots east appeared first on Atlantic Council.

While many countries are still on the rebound from the COVID-19 pandemic, new crises—and their effects—are emerging, and are expected to continue into the next year. From global inflation to a costly energy crisis, and from food insecurity to new political shifts, how can the region meet changing dynamics head-on? And how might risks turn into opportunities as we enter a highly consequential 2023?

Join the Adrienne Arsht Latin America Center as we look at some of the key questions that may shape the year ahead for Latin America and the Caribbean, then take our signature annual poll to see how your opinions shape up against our predictions.

How might new regional collaboration take shape across Latin America and the Caribbean with a wave of new leaders? What decision points might shape government policy? Will Bitcoin continue to see the light of day in El Salvador? Are the harmful economic effects of Russia’s war in Ukraine in the rearview mirror for the region, or is the worse yet to come? Will China’s new foreign policy ambition translate to closer relations with LAC?

Take our ten-question poll in less than five minutes!

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Latin America and the Caribbean is in the midst of a delicate economic transition, with five of the LAC6 countries attempting a tax reform before their GDPs recovered to pre-pandemic levels.¹ As the region confronts rising inflation, the economic spillovers of the war in Ukraine, and budgetary pressures left behind by the pandemic, governments should improve their taxation systems to rebuild fiscal stability, stimulate growth, and enhance equity – a delicate balancing act among overlapping policy priorities.

Regional taxes are a heavy administrative burden, requiring nearly twice the time to complete in LAC as in the OECD.² At the same time, the region struggles with average tax evasion of 5.6 percent of GDP³ and a continued overreliance on corporate income taxes.⁴ With still-high public debts and fiscal deficits, governments must respond by implementing policies to streamline and modernize revenue collection and management.

What are the pros and cons and trade-offs involved in increasing or decreasing the region’s three main taxes (VAT, PIT, and CIT)? How can governments optimize enforcement and collection without resorting to rate changes? What policies outside the tax authority are needed to support tax reforms? How can policymakers better navigate the thorny politics of tax reforms?

The following pages provide new analysis and concrete recommendations to address these questions. Drawing on the powerful expertise of its authors in addition to valuable commentary and insight from private, nonpartisan strategy sessions, legal experts, and regional governments, this report is a strong addition to the Adrienne Arsht Latin America Center’s #ProactiveLAC Series, which aims to provide insight and foresight to LAC countries on how to advance economic reactivation and long-term prosperity.

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Report Sep 27, 2022

The economic impact of a more efficient US-Mexico border: How reducing wait times at land ports of entry would promote commerce, resilience, and job creation

By Alejandro Brugués Rodríguez, John Byrd, Noé Arón Fuentes Flores, David Gaytan, John Gibson, Camila Hernández, Mayra Maldonado, Jason Marczak, Jorge Eduardo Mendoza Cota, Roberto Ransom, and Ignacia Ulloa

Improvements in border management and the adoption of new technologies at the US-Mexico border have the potential to enhance border security and generate economic benefits for the United States and Mexico through expedited flows of goods and people.

Economy & Business Latin America

The post Improving tax policy in Latin America and the Caribbean: A balancing act appeared first on Atlantic Council.

Now into its tenth year, CPEC has delivered the most ambitious upgradations to Pakistan’s physical infrastructure in more than a generation, with new power plants, roads, and trains being constructed at unprecedented speed and scale. At the same time, there is an increasing perception that the upgradation of Pakistan’s “software” has lagged behind its shiny new “hardware.” This mismatch was showcased strikingly last Monday, when Pakistan approved impressive new transport projects under CPEC. This occurred, however, in an emergency meeting of the country’s apex economic planning body that based approvals on four-month old currency exchange rates and ignored a lower body’s earlier directive to revise project plans.

Rolling out new projects without core reforms in Pakistan is akin to planting seeds in infertile lands. 

As CPEC enters its second phase, each side needs to review how they can improve the program’s effectiveness for mutual benefit. Pakistan needs to learn more about what China got right in the late 1970s through the 1980s. The year former Pakistani president and dictator Zia ul-Haq grabbed power (1977), China’s income per capita was half that of Pakistan’s. Within the decade, the two were identical. Nearly half a century after the death of Chairman Mao Zedong, those lessons are sufficiently well documented that the basic contours of Deng Xiaoping’s reforms are easy to learn from.

So, what specific lessons can Islamabad learn from Beijing?

CPEC’s success is contingent upon a strong export economy

Pakistan must ask why its exports are half those of peer countries (in proportionate terms). Speaking in 1984, Deng said, “no country that wishes to become developed today can pursue closed door policies.” Exports must be encouraged through providing competitively priced energy, reducing opportunities for inefficient import-substitution industries, reducing disruptions to our supply chains from political events, and upgrading the country’s trade missions. Without such reforms, Pakistan cannot sufficiently benefit from the trade possibilities created by CPEC.

An educated and trained workforce is key to growth

Deng embarked on the “Four Modernizations” of agriculture, industry, defense, and science & technology. Within five years of his historic visit to the United States, the number of Chinese students studying there rose from zero to fourteen thousand, with two-thirds studying the sciences. That policy of gradual increases in the education of China’s labor force continues today: between 1999 and 2009, China increased post-secondary enrollment by 600 percent, and college education amongst urban workers by more than 60 percent.

Writing in 1922, the Chinese philosopher Feng Youlan observed that “(w)hat keeps China back is that she has no science.” Yet, by the time of Deng’s modernization, China had already laid the foundations of a culture that emphasized the importance of science in the country’s progress. Pakistan’s leadership must understand that simply liberalizing markets or establishing Special Economic Zones will not result in Chinese-style growth unless both higher education and workforce training are attended to. 

Expanding the number of Pakistani students studying science in China would be a good place to start.

Taxation and spending must be more decentralized

China has been one of the world’s most fiscally decentralized countries since the Great Leap Forward in the late 1950s. Today, local governments in China (with average populations similar to smaller Pakistani tehsils, or district sub-divisions) make 85 percent of the country’s spending decisions and raise nearly half its taxes. In contrast, less than 16 percent of Pakistan’s provincial expenditures are financed by revenues raised by the provinces.

University of Michigan political scientist Dr. Yuen Yuen Ang argues that this fiscal decentralization served two useful purposes in China. First, allowing subnational governments to raise their own funds meant that public spending could outpace improvements in China’s tax machinery. Second, because subnational governments were allowed to spend some of the money raised through levies and service fees on their workers, bureaucrats were incentivized to establish business-friendly practices since they shared in the value created as business flourished.

There has been much hand-wringing in Pakistan about the Eighteenth Amendment to the country’s Constitution, which devolved many service delivery functions and revenue to provincial governments. While the broad principles of that Amendment were sound, it failed to push provinces to devolve powers further to smaller sub-provincial units and incentivize provinces to invest in tax collection.

Regional competition incentivizes reform

Relatedly, China successfully created healthy competition between subnational governments, and bureaucrat career prospects were linked to whether their region outperformed others. Creating a similarly competitive environment for regions and officials will be key for Pakistan to improve the productivity of its public sector. Additionally, the bureaucracy must become more specialized, so officials can apply sector-level learnings to be more effective. At the moment, top Pakistani bureaucrats are rotated excessively. To quote just one prominent example, one official has over the last decade served as a top executive in running a power plant, in running the affairs of a province’s agricultural services, in tending to its schools, and in building metropolitan roads!

Pakistan’s CPEC plans need greater discipline

The poor quality of Pakistan’s government capacity directly impacted how CPEC has unfolded already. In 2017, a senior government official projected that 4 percent of global trade—which, for context, is equal to one-third of China’s international trade or twenty-five times that of Pakistan’s—would pass through CPEC routes by the year 2020, and that the resultant transit fees would more than pay for CPEC-related liabilities. That trade, of course, remains a trickle. Pakistan’s unrealistic projections about how CPEC would unfold has created financial liabilities as well as adverse implications for the continued progress of this agenda.

Moving forward, Pakistan needs to strengthen government plans and projections with a special focus on CPEC-related ones. One way to do this is for China to scrutinize CPEC plans more strictly—asking tough questions—and then the two countries might subsequently agree to have China train a core of CPEC managers on the Pakistani side. China could also consider creating conditionalities for Pakistan to “graduate” to increasingly greater CPEC support by meeting reasonable goals along the way. Ultimately, the two countries’ interests are perfectly aligned in ensuring CPEC’s long-term sustainability and financial health. Chinese officials have reportedly already asked why Pakistan insisted on more power plants in CPEC’s first phase without a plan to raise exports that would have allowed it to pay for the plants.

These concerns should be raised more forcefully and earlier in the process.

State-owned enterprises should also compete with each other

China did not increase healthy competition amongst regional governments and bureaucrats alone, but also amongst its state-owned enterprises (SOEs). These enterprises make up about a quarter of China’s economy, and although their profitability is half those of private Chinese companies, they have not proven to be laggards, having built most of China’s modern infrastructure. China’s secret to success here appears to be what it refers to as “orderly competition.” This is thought to comprise two components. First, China tries to ensure that there are at least two viable SOEs in any sector that compete with one another for business. Second, it appears to reallocate human and capital resources across these firms in order to ensure that the SOEs remain competitive with one another. 

The contrast with Pakistan’s own SOEs couldn’t be more stark, and the country’s leadership would do well to pay attention to how China has built its public sector. On the Chinese side, while SOEs are managed to compete in the domestic market, they do not always compete in Belt and Road Initiative (BRI) projects, with BRI regions and countries often being engaged with by a single Chinese contractor. While expedient, this lack of contestability is likely to reduce the efficiency of BRI investments. 

Together, China and Pakistan should seek to ensure that the spirit of orderly competition remains alive in CPEC.

Islamabad must solidify its legitimacy and monopoly on power

Finally and most crucially, China established the state’s writ and created stability long before it embarked on economic reforms. In his 2006 memoir In the Line of Fire, former Pakistani president and dictator Pervez Musharraf narrated the advice he received from Premier Zhu Rongji: “Investors, he said, are like pigeons. When a government frightens them with poor decisions, they all fly off together. When the government improves its policies to attract them back, they return only one by one.”

As ongoing events attest, no significant power center in Pakistan appears to have learned this lesson yet.

Chinese reforms after 1978 have yielded, by some estimates, an average of 4.2 percent higher gross domestic product growth over a sustained period, transforming the country. There is no reason Pakistan can’t tread the same path, but this requires the country’s leadership to move beyond its current fixation with Chinese hardware to learn the real lessons that China offers. 

Dr. Ali Hasanain is an Associate Professor of Economics at the Lahore University of Management Sciences (LUMS) and a non-resident senior fellow at the Atlantic Council’s South Asia Center.

The South Asia Center serves as the Atlantic Council’s focal point for work on the region as well as relations between these countries, neighboring regions, Europe, and the United States.

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Masood Khan, Ambassador of Pakistan to the United States, joined the Atlantic Council’s 2022 conference on the future of the US-Pakistan relationship to give the keynote address.

Economy & Business Pakistan

SouthAsiaSource Oct 25, 2022

State capacity and support for the Tehreek-i-Taliban Pakistan

By Federico Masera & Hasin Yousaf

Violent, criminal, and terrorist organizations’ functioning and success often rely on the support of the population in which they operate. Some scholars have hypothesized that to gain and maintain this vital support, violent organizations engage in the provision of goods and services.

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SouthAsiaSource Oct 24, 2022

US National Security Strategy: Takeaways for Pakistan

By Syed Ali Zia Jaffery

To ignore Washington’s new National Security Strategy just because it does not mention Pakistan would be incredibly shortsighted for Islamabad, primarily because whatever the United States plans to do—directly and indirectly—will affect it.

National Security Pakistan

The post What Pakistan can learn from Chinese growth appeared first on Atlantic Council.

Faced with a challenging international environment and hostile efforts by the United States to restrict China’s access to high technology and its products, China has adopted a dual circulation strategy to make its economy more balanced and resilient. Dual circulation means reducing the role of foreign trade in driving the Chinese economy while improving the quality of trade. This includes diversifying trade away from reliance on the United States and Europe to lessen Chinese vulnerability to political pressures from the West. At the same time, it also means improving supply chains inside China and promoting the role of private consumption and services within China’s economy to lessen its dependence on fixed asset investment, which has shown diminishing returns.

The dual circulation strategy has been formalized by consolidating various earlier policy initiatives aiming to rebalance the Chinese economy. The policy has been recommended by international financial institutions such as the International Monetary Fund and the World Bank. This piece assesses the effects of Chinese efforts over the past decade or so.

Progress can be observed more visibly in the international side of dual circulation than in the domestic sphere. However, progress seems to have stalled in recent years, complicated by the Covid-19 pandemic and China’s rigid zero-Covid policy. Both have caused significant economic disruptions, depressing growth in 2022 on top of the fallout from the debt crisis in the real property sector. Developments in the next few years will determine if the rebalancing of the Chinese economy can resume when the effects of the pandemic subside, and more importantly, if such rebalancing can generate the “quality growth” Xi Jinping is aiming for.

The international leg of dual circulation

In the international side of dual circulation, the pandemic has clouded the picture in recent years after earlier impressive progress. The share of goods traded (export plus import) to GDP, having fallen substantially from the peak of 64 percent in 2006 to the low of 34 percent in 2020, made China more open to trade than the United States (at 27.6%), but much less so than the European Union (EU—at 93.3%). However, trade share has increased to 37 percent of GDP in 2021 and remained strong so far in 2022.

By contrast, trade diversification has proceeded as planned. The volume of trade with Belt and Road Initiative (BRI) participating countries has grown significantly to reach RMB 11.6 trillion ($1.6 trillion) in 2021 (from RMB 8 trillion ($ 1.1 trillion) in 2014). This almost doubles the trade volume between China and Association of Southeast Asian Nations countries at $878 billion. These countries participate in the BRI to various degrees, so the comparison highlights the trade relationship with two overlapping blocs of countries. Most importantly, both of these relationships stand well ahead of trade with the EU at $695 billion and the United States at $657 billion. The resulting ranking of trade partners gives China some room for maneuvering in the face of economic pressures, including sanctions, from the West—by increasing trade with the rest of the world.

China has captured more value added activities through trade by increasing the share of its value added in the exports of foreign countries while reducing their value added in China’s exports—thus improving the quality of its trade with the world.

China has also taken steps to diversify the sources of supply of key inputs it needs to import—including oil, gas, and grains (buying more from allied Russia); iron ore (stepping up investment in Guinea and Cameroon), and bauxite (more investment in Guinea and Ghana). These efforts aim to lessen China’s dependence on oil from the volatile Middle East and on iron ore from Australia, which China deems politically unreliable.

The domestic leg of dual circulation

On the domestic side, the pandemic has reversed the growth of both private consumption and services as a share of GDP. From a low of 34.6 percent of GDP in 2010, private consumption has increased to a high of 39.1 percent in 2019, to fall back to 37.8 percent in 2020. It has recovered somewhat, reaching 38.5 percent in 2021, but will probably decline again in 2022 due to the aftereffects of the Omicron variant infection. The share of services in GDP has increased from 44.3 percent in 2011 to a high of 54.5 percent in 2020, to decline to 53.3 percent in 2021.

By comparison, the investment to GDP ratio has inched upward to 43 percent in 2021 from 42.9 percent in 2020. It is likely to rise again as China has stepped up fixed asset investment to support faltering growth so far this year. Over the past decade, this ratio has declined from a high of 47 percent in 2011 to a low of 42.6 percent in 2016 then fluctuating in a range of 42.6 percent and 44 percent (in 2018). Private investment has slowed a bit so far this year but still accounts for 56.9 percent of overall investment, continuing to exceed 55 percent since 2012.

While the gap in favor of investment over private consumption has narrowed from 8.4 percentage points to 4.5 percentage points over the past decade, it has become stickier in recent years. This reflects the difficulties in reversing the relative shares of GDP of these two key sectors—which is a key goal of the dual circulation strategy.

Conclusion

On balance, dual circulation represents a rational effort to rebalance the Chinese economy by reducing its reliance on net export and fixed asset investment, both of which have become unsustainable in driving growth. It has made some progress in doing so. However, it will take time—especially after the pandemic subsides—to see if and how this strategy can sustain “quality growth” for China in the face of strong international headwinds; structural impediments such as population aging and decline as well as falling productivity growth; and Xi Jinping’s emphases on securing common prosperity and ”holistic security” for the country.

Hung Tran is a nonresident senior fellow at the Atlantic Council, former executive managing director at the Institute of International Finance, and former deputy director at the International Monetary Fund.

The post Dual circulation in China: A progress report appeared first on Atlantic Council.

According to data from the National Bank of Ukraine, IT industry export revenues actually increased by 23% year-on-year during the first six months of 2022 to reach $3.74 billion. This remarkable performance is part of a far longer growth trend stretching back to the turn of the millennium that has seen the Ukrainian tech sector emerge as an engine of the national economy and an increasingly influential factor shaping the broader development of the country.

Ukraine’s tech potential first began to attract international attention around a decade ago with the emergence of Ukrainian-founded companies such as Grammarly, GitLab, airSlate, and Preply. These success stories sparked speculation over whether Ukraine was set to become the world’s next “unicorn factory.” By 2020, the Ukrainian IT sector accounted for 8.3% of total exports and was a key contributor to Ukrainian GDP.

The rise of the country’s tech sector is driving the digitization of Ukrainian society. In recent years, Ukraine has witnessed a dramatic increase in cashless payments and other FinTech innovations. Following his election in 2019, Ukrainian President Volodymyr Zelenskyy established the Ministry of Digital Transformation to facilitate what Zelenskyy has called the creation of “a state within a smartphone.”

Prior to this year’s Russian invasion, the ministry oversaw the launch of digital options to replace a range of bureaucratic processes and secured legal recognition for digital versions of state-issued documents such as passports and driving licenses. With the tech sector now demonstrating remarkable wartime resilience, many believe this ongoing digitalization holds the key to Ukraine’s future.

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The IT industry has played a crucial role in expanding the Ukrainian middle class thanks to average salaries in the range of $3,000 per month compared to a national average of approximately $500. One continuing IT industry trend is the strong market share of IT outsourcing. At present, pure product development accounts for only 16% of the IT industry in Ukraine.

Efforts to find investors for new projects have long been complicated by security concerns related to Russian aggression. Eveline Buchatskiy, VP of Special Projects at Ukrainian IT company airSlate, recalls a time when investing in the next Ukrainian startup was a competitive affair. Unfortunately, she says, the venture capital investment climate deteriorated following the outbreak of hostilities with Russia in 2014. Today, airSlate focuses heavily on Ukrainian-based product development, with Buchatskiy confident that the appeal of Ukrainian tech creativity still outweighs the obvious threats created by Russia’s ongoing invasion.

DroneUA founder Valerii Iakovenko is a good example of this creativity. Iakovenko is a medical doctor, turned insurance banker, turned tech entrepreneur. Nine years ago, he and his business partner set out to create ecosystems that support the use of tech in the agricultural industry. According to his data, use of DroneUA’s agriculture drones helps farmers increase agricultural yield by 4% for corn and 2% for wheat. At scale, these percentages are significant, especially given Ukraine’s status as one of the world’s leading agricultural producers.

Last year, the DroneUA team set their sights on the task of providing additional reliable energy sources, with Iakovenko’s team working toward a sustainable marketplace for energy production. This is easier said than done. Not only are supply chains problematic, but increased production requires a growing network of installers and maintenance techs. Additionally, self-sufficient energy production systems are cost-prohibitive. Iakovenko sees the electric independence segment of the tech sector as ready for investment, “once we win the war.” In the meantime, he is focusing on his current priority of providing self-supporting power for Starlink systems.

In order to reach its true potential, Ukraine’s tech sector requires a suitable legal framework. Former US Ambassador to Ukraine Steven Pifer highlights the need for increased legislative stability moving forward. This is particularly salient in the IT sector where proprietary data protection is a key element of business success.

In 2020, Ukraine established the Ukrainian Intellectual Property Institute to address these concerns. The same year, Ukraine also launched the National Intellectual Property Authority (NIPA). More recently, the Ukraine IT Association formed an IT Law Committee to address IP protection concerns specifically in the tech space.

These efforts are needed for many reasons, but it is also important to acknowledge the risks they create in the current environment. Establishing extensive legal protections places potential limitations on innovation within the tech sector. This is particularly relevant for businesses that are trying to innovate and adapt rapidly to changing circumstances. Businesses are faced with the choice of holding on to the advantages of IP protections or sharing data to support Ukrainian innovation and accepting the risk therein.

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In recent years, there has been significant discussion over how to help the IT sector transition from IT outsourcing to IT service. Recommendations have centered on targeted taxation, sector integration, talent acquisition, and intellectual property protection. Ukraine looked to increase taxes on non-Ukrainian-owned companies in 2022 to promote local innovation. However, increasing taxes on foreign companies willing to accept the risk of operating in Ukraine could further stall progress. Meanwhile, the December 2021 launch of Ukrainian tech hub Diia City aims to offer further taxation incentives. Diia City significantly reduces the tax burden on IT sector businesses and employees. The project looks to create the largest innovation hub in Europe.

Sector integration continues to provide market growth opportunities. The drive for tech solutions is particularly palpable in the Ukrainian agriculture sector. According to Iakovenko, Ukrainian farmers are often young, eager for tech adoption, and unburdened by a bias for traditional practices. Ukrainian farmers are already utilizing satellite data to determine crop fertility and planting schedules. They also lead the world in terms of drone usage in agriculture.

One key problem facing Ukrainian IT companies is finding enough qualified recruits to maintain the tech sector’s robust growth rate. In order to overcome mounting personnel shortages, the sector has previously sought to attract international talent from nearby Poland, Romania, and elsewhere. However, this is currently unrealistic due to the ongoing Russian invasion.

The Ukrainian government can address shortages through scholarships, increased trade school-style education, and an expansion of the Ukrainian IT Creative Fund. These intermediate and long-term solutions make good sense but do not directly address the current situation. With the increase of Ukrainians moving abroad to escape the war, the government could offer tax waivers to Ukrainian workers outside the country continuing to work for Ukrainian companies remotely. While this will not grow the workforce, it will help diminish the talent drain.

The Ukrainian IT industry is moving forward while adapting to the extreme circumstances created by Russia’s invasion. Much still needs to be done in order to maximize the obvious potential of the country’s tech talent, but the mood within the sector remains overwhelmingly optimistic. This optimism is based on the many resourceful and committed people who are driving Ukraine’s digital progress and shaping the country’s future.

Dathan Duplichen is a graduate of the Ford Dorsey Master’s in International Policy program at Stanford University and a European Foreign Area Officer for the United States Department of Defense. Opinions expressed in this article are those of the author and do not represent the United States Department of Defense.

Further reading

UkraineAlert Oct 11, 2022

Russia’s terror tactics: Putin escalates attacks on Ukrainian civilian targets

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Vladimir Putin has launched a new phase of his Ukraine invasion and ordered the destruction of the country’s civilian infrastructure. Ukraine’s Western partners must urgently provide air defense systems to avert disaster.

Conflict Geopolitics & Energy Security

UkraineAlert Oct 18, 2022

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The views expressed in UkraineAlert are solely those of the authors and do not necessarily reflect the views of the Atlantic Council, its staff, or its supporters.

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The post Ukraine’s growing tech sector offers hope amid wartime economic pain appeared first on Atlantic Council.

Since their creation in 1944, the International Monetary Fund (IMF) and other Bretton Woods Institutions (BWI) have made significant contributions to the growth and stability of the world economy. However, they are now faced with enormous challenges going forward in the remainder of the twenty-first century. A century likely marked by increasing frequency of climate-related acute events, global inflation, rising public debt beyond sustainable levels, and growing geoeconomic rivalry among the world’s largest economies.

Many ideas have been put forward to reform these institutions to make them fit for the new era.

Unfortunately, ambitious and comprehensive reform proposals are not likely to be seriously considered due to high geopolitical tension and mistrust among major countries. An example of these ambitious ideas includes changing the quota and voting shares among members to better reflect the increasing weight of emerging and developing economies, most importantly China. Other ideas consider raising the capital of the IMF and the World Bank Group (WBG) and promoting the SDRs as the main international reserve currency. Clearly, these proposals will not attract much attention in today’s strained geopolitical environment.

Nevertheless, the need for reform is pressing. Therefore, it is important to look at more practical and feasible reform, narrower in scope and technocratic in nature, to improve the working of those institutions in the current difficult environment. This paper argues for IMF 1.5 in the short and medium run as a path to IMF 2.0 in the long run. These practical reforms include equitably allocating lending resources among member countries, more specifically, a relative shift from Latin America to Sub-Saharan Africa. Also, the IMF should scale back structural reform as conditionality and offer coordination to different providers of emergency liquidity to make them more effective. Moreover, the IMF should avoid mission creep by focusing on and leveraging its institutional expertise in economic analysis and assessment of risks. The success or failure of these smaller-scale feasible reforms today will determine the path forward to more substantive reforms of Bretton Woods Institutions in the long run.

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Report Oct 17, 2022

Modernizing the Bretton Woods Institutions for the twenty-first century

By Ajay Chhibber

The challenges that led to World War II have resurfaced and created the dire need for reform of the Bretton Woods Institutions. A new system to address these challenges requires the three core “Rs”—a revised global remit, an enhanced resource base, and a mandate to monitor agreed-upon global rules.

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Report Oct 17, 2022

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At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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The post The evolution of the IMF: A case for IMF 1.5 before Bretton Woods 2.0 appeared first on Atlantic Council.

This paper outlines reforms for Bretton Woods Institutions – such as the World Bank Group (WGB), the International Monetary Fund (IMF), and the World Trade Organization (WTO). The world needs a Bretton Woods 2.0 for the twenty-first century. The challenges that led to World War II — inequality, protectionism, and rising nationalism — have resurfaced and created the dire need for reform of these institutions.

New, even bigger challenges — such as climate change, pandemics, global inflation, and supply chain disruptions — now threaten the global economy and trade. The current institutions are too small and ill-equipped to adequately address the threats of widening wars and surging food and fuel prices. This paper argues that a new international financial and economic architecture is needed. Bretton Woods Institutions must be modernized and revamped to help address these problems for the remainder of the twenty-first century.

The new system requires three core “Rs” – a revised global remit, an enhanced resource base to help individual countries confront collective global problems, and the mandate to monitor agreed-upon global rules. The IMF must refocus itself on addressing global financial instability and macroeconomic policy. The World Bank must become a financial institution focused on planetary sustainability and shared prosperity. A strengthened WTO must become the forum for freer and fairer trade in goods, services, and cross-border transactions.

These institutions must work with regional and other United Nations (UN) specialized bodies. They should coordinate with bilateral aid agencies, sovereign wealth funds, pension funds, and private philanthropic organizations. The IMF, WTO, and WBG need to leverage their power and resources to draw in private capital at much higher levels. This would provide the Bretton Woods institutions with the needed resources and expertise to address rising global challenges and development needs. These reforms would create a stronger international economic and financial architecture suitable for the twenty-first century.

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The post Modernizing the Bretton Woods Institutions for the twenty-first century appeared first on Atlantic Council.

The Bretton Woods institutions continue to serve as the champions of international development and financial stability, but several factors create a challenge for their continued effectiveness and relevance. The growing finance gap from rising poverty, income and gender inequality and poor infrastructure are threatening global sustainable development. Emerging and developing countries, still recovering from pandemic, are also dealing with challenges related to climate change, food and energy security issues and access to technological innovation. Both the International Monetary Fund (IMF) and the World Bank, on their own, will not be able to effectively tackle these issues in the long-run. An increasingly connected world had led to the emergence of new and increasingly relevant, actors in the global development field.

The emergence of these actors, both non-state and quasi-state actors, which include Multi-National Corporations, Sovereign Wealth Funds, Pension Funds, and Non-Governmental Organizations (NGOs) has demonstrated how critical their inclusion in development-finance is for the BWIs. MNCs are continuing to expand their footprints globally, shifting supply chains and additional economic benefits to both emerging and developing markets, while SWFs and Pension Funds are accessing their growing pool of assets to boost disadvantaged markets and promote sustainability. Despite the recognition of their valuable contribution, the IMF and the World Bank, have been limited in the scope of the inclusion of these actors. The opportunity to create more effective and impactful Bretton Woods institutions will depend on both the willingness and capacity of the institutions to effectively integrate these non-state and quasi-state actors into a constructive operational framework.

This new report examines the increasingly influential role of non-state and quasi-public actors in global development and sustainable finance, specifically through the rising level of sustainable investments in emerging and development markets. Implementing near-term solutions that include these actors in future capital mobilization and development financing will be critical to ensuring the gap between the North and South does not continue to expand. Moreover, integrating the data and expertise these actors into streamlined thematic initiatives and consultations and country-level analysis between the Bretton Woods institutions can strengthen efforts in meeting the Sustainable Development Goals in an increasingly high risk environment.

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By Victor Shih

Despite its size, China has an inadequate voice in traditional Bretton Woods Institutions. This paper examines aspects of the dissatisfaction China has with existing global governance institutions such as the World Trade Organization (WTO) and the International Monetary Fund (IMF). It also discusses the proposed changes to these institutions according to discussions with Chinese experts.

China Economy & Business

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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The post Changing Bretton Woods Institutions: How non-state and quasi-state actors can help drive the global development agenda appeared first on Atlantic Council.

Despite being the second largest economy in the world and the largest trading partner for a majority of the world’s economies, China has an inadequate voice in traditional international economic institutions, leaving many of its experts and policymakers dissatisfied. For example, on a per capita basis, 170 out of 189 member countries in the World Bank Group’s International Bank for Reconstruction and Development (IBRD), have more voting power than China. This paper examines different aspects of the dissatisfaction that Chinese scholars and officials’ have with existing global governance institutions (GGIs), with a special focus on the World Trade Organization (WTO) and the International Monetary Fund (IMF). It also discusses the underlying aspirations that drive proposed changes to various GGIs according to discussions with Chinese experts.

In the IMF, China is pursuing greater representation in the decision-making process while in the WTO China seeks to revise rules so that the United States can no longer dominate the organization’s case flows. China is also prepared to navigate an increasingly fragmented and complex set of GGIs, including new ones it has established –New Development Bank or BRICS Bank and Asian Infrastructure Investment Bank (AIIB) or the BRI Bank, across different regions and issue areas.

For Bretton Woods Institutions to remain relevant and effective in the twenty-first century and address ongoing global challenges in a timely manner, China’s active engagement in these institutions is crucial. However, the lack or slow pace of substantial reforms in these institutions increases the risk of China becoming disillusioned and disengaging with them. Therefore, the United States alongside its G7 allies and Organization for Economic Cooperation and Development (OECD) countries should take meaningful steps to make existing GGIs more inclusive of all developing and emerging economies, with an emphasis on China, and also actively engage with regional multilateral development banks and financial institutions around the world.

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The evolution of the IMF: A case for IMF 1.5 before Bretton Woods 2.0

By Hung Tran

Bretton Woods Institutions will face enormous challenges going forward. While ambitious reforms are needed, its unlikely they will be seriously considered due to high geopolitical tension and mistrust among major countries. Nevertheless, the need for reform is pressing. Therefore, it is important to look at more feasible reform, narrower in scope and technocratic in nature, to improve the these institutions.

China Economy & Business

Report Oct 17, 2022

Changing Bretton Woods Institutions: How non-state and quasi-state actors can help drive the global development agenda

By Nisha Narayanan

This new report examines the increasingly influential role of non-state and quasi-public actors in global development and sustainable finance, specifically through the rising level of sustainable investments in emerging and development markets.

Economy & Business Fiscal and Structural Reform

Report Oct 17, 2022

How China would like to reshape international economic institutions

By Victor Shih

Despite its size, China has an inadequate voice in traditional Bretton Woods Institutions. This paper examines aspects of the dissatisfaction China has with existing global governance institutions such as the World Trade Organization (WTO) and the International Monetary Fund (IMF). It also discusses the proposed changes to these institutions according to discussions with Chinese experts.

China Economy & Business

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post How China would like to reshape international economic institutions appeared first on Atlantic Council.

China is a global economic powerhouse, but its system remains opaque. With distress in the property sector, Beijing’s crackdown on technology companies, and the draconian zero-Covid policy being perpetuated through 2022, questions are mounting about Beijing’s economic trajectory. Both policymakers and businesses around the world are assessing how to respond and position themselves. Leaders need a shared language to describe China’s economic system that can be trusted by all sides for its accuracy and objectivity. This is the goal of the China Pathfinder Project.

Building on the framework they launched in 2021, over the past year teams from the Atlantic Council and Rhodium Group have taken a dive into China’s economy to address a fundamental question: Is China becoming more or less like other open-market economies?

To conduct this cross-country comparison, the China Pathfinder report looks at six components of the market model: financial system development, competition, innovation system, trade openness, direct investment openness, and portfolio investment openness. Our annual scorecard places China in relation to ten leading OECD economies to establish a data-centered benchmark for discussion and analysis. It finds China’s progress toward market economy norms slowed in most areas from 2020 to 2021, though not enough to undermine the market opening efforts that took place since 2010. 

China only showed considerable improvement in innovation and trade compared to 2010; the gap was further narrowed as scores for several OECD economies sagged. In other economic areas, the report finds that China is not the only country pulling back from market economy norms. Compared to 2010, we find that backsliding occurred in Australia, Italy and Spain in the areas of financial system development and market competition, while quite a few market economies turned less open to foreign direct investment.

These trends unfold as the world looks to Beijing for its twice-a-decade Party congress. While a third term could free Xi Jinping’s hand to take bolder action in the face of China’s formidable economic challenges, doing so will mean accepting greater economic disruption in the short to medium-term and some loss of control for the Communist Party. Xi’s most urgent domestic task will be to reform the financial system and promote greater market competition. On the external side, greater openness to foreign portfolio and direct investment will be critical. If China’s leadership fails to tackle the structural problems in the economy, growth could languish in the zero to two percent range for a prolonged period.

View the full report below

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

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The 2021 Economic Scorecard: How China stacks up with the US and its allies

By Josh Lipsky

With China, the story is never so simple. The truth is that China still hasn’t decided which direction its economy is ultimately headed. And we need a credible way to track its trajectory.

China Economy & Business

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China Pathfinder: Q2 2022 Update

By GeoEconomics Center and Rhodium Group

Over the past ten months, teams from the Atlantic Council and Rhodium Group have taken a dive into China’s economy to address a fundamental question: Is China becoming more or less like other open-market economies? 

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Why China’s leadership must respond to the country’s property crisis

By Jeremy Mark

The country’s rapidly metastasizing property downturn threatens to engulf heavily indebted developers, homeowners, financial institutions, and local governments.

China Economy & Business

The post China Pathfinder: 2022 annual scorecard appeared first on Atlantic Council.

The COVID-19 pandemic and Russia’s war against Ukraine have caused significant economic disruptions, including shortages and rising prices for energy, fertilizer, and grains. But poorly timed policies and a lack of coordination among major countries have exacerbated these problems, pushing the global economy to the precipice. 

The current economic crisis is something the IMF was designed to deal with—namely, to promote policy coordination among major countries to ensure the stability of the international monetary system. That’s why its ruling body, the International Monetary and Financial Committee (IMFC), which consists of finance ministers and central bank governors of member countries, must produce a coherent plan to help the world navigate the current dangerous situation.

This is especially urgent since the Group of Twenty (G20)—once the premier forum for policy cooperation and coordination—has descended into dysfunction thanks to geopolitical spats between China and Russia against the United States and Europe. If the IMFC fails to rise to the occasion, the IMF risks making news only by announcing downward revisions of growth estimates.

The following should be the IMFC’s three key priorities during next week’s meetings:

Promote coordination and stabilize exchange-rate movements

Among the policy failures that has aggravated stagflation, the US Federal Reserve was slow to tighten monetary policy when inflation started to accelerate, focusing on current instead of prospective inflation performance. It then tightened more aggressively than expected, sending shock waves throughout the rest of the world. 

Meanwhile, the newly formed British government has adopted a major unfunded and uncosted tax-cut package despite the fact that public debt hovers around 100 percent of gross domestic product. That has led to market turmoil, the pound sterling dropping to record lows against the dollar, and historic selloffs in the British government bond market—requiring the Bank of England to intervene and restore order. Faced with adverse market reactions and political opposition, the government abandoned the part of the package that cuts the top 45 percent income tax rate. 

For its part, the European Central Bank was among the last major central banks to raise rates as inflation in the eurozone reached 10 percent last month. Its task has been complicated by the war- and sanctions-related increases in energy prices and its desire to contain the government yield spread between Italy and Germany so as not to threaten the integrity of the euro. But that could conflict with the anti-inflation thrust of its monetary policy. The Italy-Germany spread—reflecting the credit risk of highly indebted Italy—has widened steadily recently to 240 basis points, a nearly three-year high. By contrast, the People’s Bank of China has continued to gradually ease monetary conditions to support a visibly slowing economy amid China’s strict zero-COVID policy.

Those uncoordinated, even contradictory, policies have significantly undermined consumer, business, and investor confidence, triggered sharp declines and heightened volatility in financial markets, and depressed economic activity. The Fed’s aggressive tightening has supercharged the dollar to multi-decade highs, creating serious problems for the rest of the world. In particular, the pound sterling has depreciated by more than 20 percent since the beginning of the year, falling to record lows against the dollar. The yen has also weakened by 20 percent, prompting the Bank of Japan to intervene significantly in foreign exchange markets, the first time in decades, while the euro has fallen by more than 15 percent (to below parity against the dollar). And the renminbi has also weakened by more than 11 percent against the dollar. 

Overall, the depreciation of major currencies against the dollar has exacerbated inflation problems in those countries, forcing many of them to tighten—leading to a synchronized weakening of large economies to the verge of a global recession.

The IMFC needs to fulfill its mandate to promote the stability of the international monetary system—in this case, by coordinating coherent policies and avoiding excessive exchange-rate movements. At the very least, major member countries should acknowledge the international impacts of their domestic policies aiming to curb inflation. They should find ways together with other countries to manage the spillover effects of such policies—including measures such as foreign-exchange market intervention and temporary capital control. The Fed can also clarify that the strengthening dollar could play a role in determining the necessary magnitude of rate hikes. It should also more clearly communicate its policy goals, measures, and performance benchmarks, and—possibly in a coordinated way with other central banks—reduce the huge uncertainty prevalent in financial markets at the moment.

Individually, IMF members should be encouraged to align their fiscal and monetary policies to fight inflation and to avoid having those policies working at cross purposes. Policymakers need to find ways to encourage more supply instead of just focusing on reducing demand to tame inflation. They should also reverse recently imposed restrictions on food exports to avoid exacerbating the food crisis.

Help developing and low-income countries 

Emerging-market and developing countries, especially low-income ones, have been battered the most, with the specter of famine even haunting some. Higher US interest rates and a stronger dollar have triggered net-portfolio capital outflows from emerging markets as investors have withdrawn a record seventy billion dollars from bond funds this year. Emerging-market stock and bond markets have declined more substantially—by 28 percent and 20 percent, respectively—than their mature-market counterparts. This has further tightened their financing conditions, reducing growth. Meanwhile, the slowing Chinese economy and weakness of the renminbi have made the products of those countries less competitive in Chinese markets, curtailing the growth of their exports to China.

The IMF should provide assistance to those countries in serious distress. It has about $140 billion in outstanding loans to forty-four member countries and has launched a new Food Shock Window under its emergency-lending instruments, the Rapid Credit Facility (RCF) and the Rapid Financing Instrument—both of which feature low conditionality. But while these measures are welcome, the IMF should do more to help its poor members cope with the extraordinary challenges. For example, it should increase the resources earmarked for the RCF and raise access levels to that facility beyond the normal 50 percent of quota (the share of each IMF member’s capital base reflecting its relative standing in the world economy) per year and 100 percent of quota cumulatively. In particular, the seven poor countries identified by the World Bank as suffering a combined food and debt crisis (Afghanistan, Eritrea, Mauritania, Somalia, Sudan, Tajikistan, and Yemen) should get expedited access to the Food Shock Window/RCF.

Promote a sovereign-debt restructuring framework 

The IMF has been negotiating (or has already approved) assistance programs for several countries, including Zambia ($1.3 billion), Sri Lanka ($2.9 billion), Pakistan ($1 billion), and Argentina (a $3.9 billion second-tranche disbursement under the current thirty-month, $44 billion program), among others. The IMF should use these opportunities to press the recipient countries to request their creditors to form a country-specific Official Bilateral Creditor Committee and a Private Sector Bondholder Committee as well as communications channels between the two. These committees should discuss the parameters of a sovereign-debt restructuring deal being informed by the IMF/World Bank debt sustainability analysis of the country—more or less following the Zambia debt restructuring template. The suggestion would go beyond the provisions of the G20 Common Framework for Debt Treatment, which is only available to low-income countries; it will also help provide a needed structure for sovereign-debt restructuring, encouraging full participation of all creditors in the process. This is increasingly required as 60 percent of low-income countries and 30 percent of emerging-market countries are already in debt distress or crisis.

Hung Tran is a nonresident senior fellow at the Atlantic Council, former executive managing director at the Institute of International Finance, and former deputy director at the International Monetary Fund.

The post Three priorities for the IMF to fix the global economic crunch appeared first on Atlantic Council.

So far, party leaders have appeared hesitant to respond to the crisis with the kind of powerful financial resources that the central government has at its disposal to avoid a meltdown. Instead, they have adopted what one economist calls a “whack-a-mole” strategy of piecemeal bailouts. It’s unclear whether they’ll even tackle the issue head-on at the party congress, which is expected to focus on solidifying Xi’s rule with a third five-year term. Such an outcome would symbolize the victory of party politics over actual problem-solving. 

The announcement of the congress trumpeted the concept of “Common Prosperity,” a long-forgotten Maoist nostrum that has been used to justify policies ranging from restraining “the disorderly expansion of capital” to cracking down on China’s high-tech titans. The party’s official view of home ownership, as viewed through this prism, is that “houses are for living in, not for speculation,” an idea that Xi voiced at the last congress in 2017. Property speculation is a major reason housing prices rose almost without pause from the 1990s until last year. By one estimate, only 20 percent of home purchases in 2018 were by people buying their first home; a decade earlier, 70 percent of buyers were first-timers.

China’s leaders cannot afford to give short shrift to this crisis. As the country faces the reality of a rapidly deflating asset bubble, the technocrats charged with controlling the situation will have a hard time avoiding a hard landing if they’re being guided by party orthodoxy instead of pragmatism. Property represents some 70 percent of the assets of China’s urban population, and those homeowners will not be happy if their middle-class status is undermined by a reassertion of politics over economics.

Economic anchor

It’s hard to overstate the importance of real estate for the Chinese economy. Property represents up to 30 percent of China’s GDP and some 25 percent of fixed investment and bank lending between 2015 and 2020. It has provided a crucial engine of growth for China and, by extension, the world economy since the global financial crisis of 2008.

But the buildup of property-related debt has become a threat to China’s economic and financial stability. Bloomberg estimates that the total exposure of China’s financial system to the property sector at the end of March was about $8.56 trillion, with more than three-quarters of that amount in mortgages. That debt includes substantial lending by shadow lending institutions operating in a regulatory gray zone. The International Monetary Fund calculates that 16-20 percent of real-estate investment was financed by trusts as of 2021. Moreover, bad-debt funds set up by Beijing to take over nonperforming loans during an earlier debt crisis, as well as financing vehicles controlled by local governments, have been major sources of financing and investment. 

The chickens started coming home to roost in 2020, when Beijing imposed strict controls on bank lending to property developers based on debt parameters—called the ”three red lines” —which cut off the flow of easy money to many companies. By mid-2021, the property market began experiencing a sharp contraction, and Xi’s strict zero-COVID policy, which has shut down some of China’s largest cities for extended periods, then made matters worse by choking off consumer spending. House sales in China’s largest cities dropped for fourteen straight months through August, and prices fell for twelve months.

At least eighteen property developers have defaulted on nearly thirty billion dollars of dollar-denominated bonds traded in overseas markets over the past year, and several others have asked to delay payments. Some of the country’s largest private and state-owned property firms are unable to meet their financial obligations, a trend led by China Evergrande Group, a privately owned developer whose liabilities exceed three hundred billion dollars with hundreds of unfinished housing projects nationwide. Bad debt climbed to about 29 percent of property loans in the first half of 2022, Citi Group said in a recent report, and even state-owned developers are at risk of default.

The landscape of abandoned construction projects has trapped large numbers of homebuyers who pay in full for apartments—with cash and mortgages—before completion under widely used pre-sale arrangements. This is because developers have engaged in what amounts to a massive Ponzi scheme by investing pre-sale revenue in new projects instead of using that money to finish apartments.

In July, mortgage boycotts by purchasers waiting for unfinished apartments broke out in almost one hundred cities. Although government censors cracked down on social media posts and local governments promised relief, more than 340 developments were reported to have been hit by the boycotts by mid-September. It was just the most visible sign of emerging systemic distress.

A lack of action

As Chinese economic growth in the second quarter of 2022 fell to just 0.4 percent, the government appeared hesitant to employ the kind of firepower that other countries have brought to bear in response to their own bursting property bubbles. Instead, Beijing has put in place a series of interest-rate cuts and spending plans aimed at increasing infrastructure spending and providing loans and other resources to local governments to take over some non-performing loans and unfinished housing projects. 

In July, Premier Li Keqiang announced that the government won’t “overdraw the future for an overly high growth target.” He may have been referring to the government’s unattainable goal of “around 5.5 percent growth” this year, but it provided little comfort to financial markets.

Beijing’s reflexive lack of transparency has only added to the uncertainty hanging over the crisis. For example, it’s unclear whether any significant steps have been taken to shore up or restructure insolvent companies like Evergrande, whose massive debts present a systemic threat. 

Additional government actions to stabilize the property market have been announced in recent weeks, with one government newspaper reporting that some seventy-five cities have introduced measures to make buying apartments more attractive. More actions may be announced after the party congress. But an incremental response that shifts the responsibility to overstretched local governments only puts off the eventual day when Beijing will need to orchestrate expensive bailouts that shift vast amounts of bad debt onto central government balance sheets. 

This leads some analysts to suggest the Chinese leadership is only putting off the day of reckoning. As Bert Hofman, former World Bank chief economist for East Asia, recently wrote, Beijing risks “perpetuating the misallocation of capital that has plagued China for years.”

That raises the question: What happens to the hundreds of millions of Chinese homeowners whose dreams of economic security are tied up in homes whose value is falling? As my Atlantic Council colleague Dexter Tiff Roberts has pointed out, Xi’s Common Prosperity envisions an “olive-shaped distribution” of wealth, with a large middle-class and small extremes of wealth and poverty. But if the leadership about to be anointed at the Communist Party Congress does not come to grips with the property crisis, Common Prosperity could end up resembling a broken egg.

Jeremy Mark is a senior fellow with the Atlantic Council‘s GeoEconomics Center. He previously worked for the International Monetary Fund and the Asian Wall Street Journal. Follow him on Twitter: @JedMark888.

The post Why China’s leadership must respond to the country’s property crisis appeared first on Atlantic Council.

Instead, over decades, an abysmal series of obstacles have repeatedly hindered the country’s development. A poorly managed decolonization process by Belgium, multiple rebellions, and the failure to promote good governance—combined with living in a state of war since 1996, particularly in the east—have resulted in profound setbacks in health, education, the economy, society, and governance.

Those obstacles led to deep and pervasive effects on Congolese society, and they make a good case for massive assistance. There is a model already in place for the United States and other friends of the DRC around the world to follow: the 1948­–1951 European Recovery Program, otherwise known as the Marshall Plan. Advanced by then US Secretary of State George C. Marshall, the plan gave countries that were devastated by World War II mostly donations to restore industry, support agriculture, and increase international trade. The United States appropriated $13.3 billion over four years. In the end, the plan helped Western and Southern European countries boost industrial production by 55 percent and average gross national product by 33 percent, laying the foundations for a prosperous Europe. Since then, the expression “Marshall Plan” has been used to refer to massive assistance or economic stimulus programs worldwide, the latest case being the European Recovery Plan.

Comparable assistance focused on improving governance could help the DRC develop while laying a similar foundation for a prosperous African Great Lakes region—and even African continent. Yet, achieving this goal will require focusing the plan more on building strong institutions and less on building infrastructure, the beloved child of many development partners. Then US President Barack Obama emphasized a need for updated partnership programs with Africa in a July 2009 speech in Accra, Ghana, declaring: “The true sign of success is not whether we are a source of perpetual aid that helps people scrape by… It’s whether we are partners in building the capacity for transformational change.”

Decades of development lost

A bit like in the 1960s and 1970s, military conflicts and violence are entrenched in  the DRC. The death toll of near-weekly attacks by the allied Democratic Forces (ADF), an insurgent group with ties to the Islamic State of Iraq and al-Sham (ISIS), practically tripled between 2020 and 2022. Furthermore, the militant March 23 Movement, after a deceptive slumber, has occupied the strategic town of Bunagana since June.

After former President Mobutu Sese Seko’s three-decade single-party rule and former President Joseph Kabila’s tumultuous terms from 2001 to 2019, Congolese people hoped that their political class would mobilize in favor of development. This has not yet fully happened; and far from rallying the much-needed unity required to end the conflict in the east, political parties seem preoccupied with the 2023 presidential election.

Despite recent social and economic progress—notably a solid annual gross domestic product (GDP) growth rate that has averaged above 5 percent over the last ten years—many long-term per capita indicators have worsened since the 1970s, according to the World Bank: Electricity consumption per capita (159 kilowatt hours in 1972 and 109 kilowatt hours in 2015) and the number of hospital beds per thousand people (3.2 in 1975 against 0.8 in 2006) have dropped. Gross domestic product (GDP) per capita remains less than half of values in the 1970s ​​($1,372 in 1974 versus $518 in 2021, in constant 2015 US dollars).

There are several other indicators that raise concerns about the country’s economic and social progress: As of the beginning of this year, twenty-one diseases under surveillance in the DRC had the potential to become epidemics—and in the year before, six had done so, including measles, cholera, and COVID-19. According to the United Nations (UN) Office for the Coordination of Humanitarian Affairs, 4.2 million people, including 2.4 million children under five years old, suffer from acute severe malnutrition. Roughly six million people are internally displaced, and 74,000 cases of sexual and gender-based violence were reported over the period, with the majority occurring in the eastern conflict-torn part of the country.

These economic and social indicators are a sign of an unhealthy ecosystem that cannot support development. Contributing factors include political instability, wars, a lack of economic diversification, an overreliance on natural resources, and the consequences of a conflict economy—in which investment is dampened by the uncertainty caused by wartime disruptions to local and national activities, and Congolese don’t benefit from the revenues created by their natural resources. These factors make it difficult to uproot corruption, mismanagement, and state capture, even more than half a century after the DRC’s independence, despite recent efforts, such as reforms within the central bank and the publication of mining contracts.

Thus, the country’s lack of development, caused by its political, social, and economic conditions, is likely to be long-lasting.

The “big push” to prosperity

In his farewell letter, Lumumba was optimistic about the destiny of his country because he believed that the DRC could overcome its afflictions, just as other countries that have experienced war and political instability have done.

Germany experienced such a period of economic and social adversity after World War II: In 1947, industrial output was only one-third and food production was one-half of the country’s 1938 levels. Nearly one-fifth of the country’s housing had been destroyed over the course of the war. Inflation had resulted in a wave of poverty, while the country’s price controls fueled the expansion of the black market.

But today, Germany has become a formidable economic force. The reasons for the German economic miracle, or “Wirtschaftswunder,” are subject to debate among economists, but some credit the Marshall Plan.

The initial Marshall Plan and its variants worldwide are in line with economist Paul Rosenstein-Rodan’s “big push” theory that massive reforms and investments are more helpful than gradual actions in overcoming obstacles that preclude development in underdeveloped economies. In other words, a “big push” is required to undo the inertia of a stagnant economy. Such a “big push” would help the DRC get out of its rut, given the country’s numerous and multifaceted economic, social, and security challenges. But the push must address the real issues that Congolese face.

Institutions over infrastructure

Investment plans for African countries often focus on spending in areas like infrastructure and equipment—and ultimately, some costly and not terribly useful “white elephants.” A Marshall Plan for the DRC should avoid falling into those two pitfalls by taking a completely different approach: focusing on institutions rather than infrastructure.

After all, infrastructure projects in the DRC easily mobilize resources from a variety of public and private stakeholders. The Emirati company DP World, for example, is investing hundreds of millions of dollars over decades in the construction and management of the DRC’s first deep-sea port in Banana due to the economic potential there. Beyond that case, the country’s infrastructure potential and needs are so immense that all that the government would have to do is to design bankable projects and abide to the conditions set by international private or public partners.

Conversely, commitment to lasting and in-depth institutional reform is far below what the DRC and other poor nations need because a reformed institution is less immediately visible than a bridge or a school. In addition, reforming or even creating an institution is more time-consuming, more complex, and dependent on combining success factors such as overcoming vested interests and tailoring institutions to sociological realities. It involves mapping and optimizing processes, investing in training, and paying civil servants better—but also limiting abuses vis-à-vis users of public services, who are often not considered as customers but rather as sheep that can be sheared mercilessly.

Overcoming the DRC’s development obstacles will require a substantial investment in the country’s institutions. Strong institutions are the key to turning the DRC’s immense potential into tangible results, enabling the country to fish for itself instead of being offered fish by other countries.

A DRC with strong institutions would see civil servants better paid, unbiased decisions from the courts, vulnerable groups protected by the police, natural resources and projects managed without corruption, better-equipped schools, and a social safety net that protects the most vulnerable.

Preparing for the push

Initial work in designing the Marshall Plan should start with an in-depth inclusive discussion among Congolese and between Congo and its partners about the governance mechanisms of such an initiative.

This initial discussion is essential because of the colossal sums at stake and also the controversies that have plagued Congolese infrastructure projects: In order to avoid problems associated with the DRC’s poor public finance management and to increase the likelihood that the plan succeeds, this discussion should be structured around strengthening its absorptive capacity—the amount of foreign aid that the DRC can use productively. The DRC has faced difficulties in quickly implementing quality investment projects and ensuring that every dollar invested reaches its intended beneficiary. Shaping a new normal will require improvements in three areas.

1. Preparations for the Marshall Plan should include the recruitment and training of motivated and skilled people who can effectively design and manage reform projects in the long term.
2. The DRC must establish a stronger and more efficient control mechanism to ensure good fiduciary management of the plan’s projects in order to avoid misappropriation, collusion, and corruption. Such practices have long bedeviled public contract tenders and public funds management.
3. It will be necessary to meticulously prepare the various projects and investment plans in order to avoid mistakes of the past, including some famous white elephants, and to guarantee adequate social impact. To do this, leaders taking part in the plan should adopt an experimental approach in which they run small-scale test projects to better understand and correct their shortcomings before deploying them throughout the country.

Institution building is a serious matter. It requires time and stability. Besides, institutional quality is sensitive to policy changes that follow shifts in political leadership. Hence the need, as a foundation to the Marshall Plan, to build a clear, accountable, and trans-partisan consensus around institutional reform. If a platform for reform has buy-in from political parties and stakeholders across Congolese society, it would be immune to the negative side effects of changes in government. With new elections slated for 2023, now is an opportune political moment to start that dialogue. Presidential candidates, in particular, should explain how their pledges will contribute to the much-needed institutional transformation. The country’s burgeoning civil society could seize the opportunity to mobilize Congolese across party lines and identify priority sectors for institution building in preparation for the plan.

Such a process would empower the Congolese people, who have often been marginalized in designing development policies even though they’re meant to be the beneficiaries. It would foster crucial local commitment to institutional transformation. Plus, the preparation effort could help establish an equal relationship between the DRC and its financial partners in their mission to propel the country into the twenty-first century.

Doing the Marshall Plan math

How much should an institutional Marshall Plan for the DRC cost? Let’s start with a linear method to evaluate the original.  

From 1948 to 1952, sixteen countries received a total of $13.3 billion, representing roughly $159 billion in 2022. Distributing that among the total 1948 population (approximately 270 million) of the countries that received this aid yields a per capita endowment of $588 in today’s dollars to match the original Marshall Plan.

That would add up to approximately $55 billion for the DRC and its estimated 95.2 million people. The amount is practically the size of the DRC’s GDP and more than ten times what it receives in annual Official Development Assistance. It may seem enormous—but that is not the case considering the scale of the DRC’s weak social indicators and immense needs. The sum is about one-third more than the $40 billion the US Congress committed this year to aid Ukraine in its fight against Russia, and represents roughly three to four years of expenditures for Washington, DC, or Chicago.

The spillovers from the Marshall Plan would also be transformative; those resources would help provide the “big push” that the country needs to fight against the rise of the ADF in eastern DRC, meet its development challenge, rebuild, and, above all, consolidate its governance and move from a cyclical, natural-resource-led growth to a more balanced and sustainable momentum supported by strong institutions.

A Marshall Plan-style investment could quickly transform the DRC, which is projected to become the world’s eighth most populous country by 2050, into one of the globe’s most dynamic markets. The DRC, with its connections to world cobalt battery supply chains, could also become a home for green industries, with jobs available for youth in all sectors of a radically transformed economy.

Ultimately, an institution-centered Marshall Plan would dramatically transform the DRC over the next decades, helping new generations of Congolese achieve Lumumba’s vision of a bright future for the country, the region, and for Africa.

Jean-Paul Mvogo is a nonresident senior fellow at the Atlantic Council Africa Center.

The post Here’s what a Marshall Plan for the DRC could look like appeared first on Atlantic Council.

What did Gorbachev believe?

Following Gorbachev’s passing, Senior Fellow Ben Judah spoke with Vladislav Zubok, Professor of International History at LSE and author of Collapse, on how Gorbachev saw Lenin, Europe and Ukraine. Did Gorbachev look to Lenin for inspiration? Was the Soviet collapse inevitable because Gorbachev was simply too naïve about economic management? What did Gorbachev feel about Ukraine and Putin’s foreign policy towards Kyiv?

You can watch #BritainDebrief on YouTube and as a podcast on Apple Podcasts and Spotify.

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Ben Judah

Director

Europe Center Transform Europe Initiative

Economy & Business European Union

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The post #BritainDebrief – What did Gorbachev believe? | A Debrief from Dr. Vladislav Zubok appeared first on Atlantic Council.

What are the origins of Europe’s energy crisis?

As concerns continue to grow over Europe’s capacity to endure a winter with less Russian natural gas, Senior Fellow Ben Judah spoke with Dr. Helen Thompson, Professor of Political Economy at Cambridge University, on Europe’s energy, climate and geopolitical reckoning. What are the historical origins of Europe’s predicament? Is the current crisis only caused by war in Ukraine? Why have Western Europe politicians become more “energy illiterate” when describing policy objectives? Is this a geopolitical and climate-related reckoning for Europe, in addition to it being an energy security-related reckoning?

You can watch #BritainDebrief on YouTube and as a podcast on Apple Podcasts and Spotify.

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Small and medium-sized enterprise (SME) development is critical for broad-based and sustained economic growth as Latin America and the Caribbean (LAC) grapple with ongoing global shocks following two years of pandemic-related fiscal challenges. SMEs are a primary source of job creation, comprising 99.5 percent of firms in the region, and accounting for 60 percent of employment.¹ Yet, these same firms represent only 20 percent of gross domestic product (GDP), due to constraints spanning financial to productivity issues.

Helping SMEs both overcome growth constraints and provide higher-quality jobs is important in the context of today’s disparate and fragile economic recovery. SMEs are particularly vulnerable to inflation and labor-market weaknesses from scarcity to informality.² With risks of lasting consequences still present, returning to pre-pandemic levels of output is insufficient for the economy in general, and for SMEs.³

Many LAC governments provided extraordinary support for SMEs throughout the COVID-19 pandemic. Now is the time to look beyond the pandemic and consider actions to enhance SME access to financing, technical assistance, and digital literacy—three drivers for unlocking the potential of LAC SMEs.

The following pages help to unpack three questions for these three drivers: How can LAC create a financial system more in line with the needs of SMEs to achieve greater development and growth? What capacity-building and technical assistance do SMEs need to increase productivity? What new opportunities does digitalization present for SMEs? A sneak peek: the answers highlight the importance of a multisectoral, holistic approach to empowering SMEs.

This spotlight built upon findings from private, nonpartisan strategy sessions as part of the Adrienne Arsht Latin America Center’s #ProactiveLAC Series, which aims to provide insight and foresight to LAC countries on how to advance economic reactivation and long-term prosperity.

View the full issue brief below

The Adrienne Arsht Latin America Center broadens understanding of regional transformations and delivers constructive, results-oriented solutions to inform how the public and private sectors can advance hemispheric prosperity.

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The post Unlocking SME potential in Latin America and the Caribbean appeared first on Atlantic Council.

The public sector external debt to be restructured amounts to $17.3 billion, more than half of the total Zambian public debt. According to the Zambian Ministry of Finance (MOF), official bilateral creditors account for 15 percent of public debt, multilateral and plurilateral financial institutions for 11.5 percent, Eurobond investors for 11.7 percent, and non-bonded commercial lenders for 11.4 percent. About $6 billion is owed to Chinese commercial and state-owned lenders alone—constituting the largest creditor group by nationality and giving China significant leverage in Zambia’s ability to restructure its debt. The classification of this amount of debt between official bilateral and private sector lenders has been a contentious issue, contributing to the uncertainty in restructuring process. For example, there had been contention about how to classify debt owed to China Development Bank, as bilateral or private sector debt. Now the Zambian MOF has classified it as debt to private creditors.

Zambia was one of the first countries to apply to restructure its sovereign external debt under the Common Framework for Debt Treatment in early 2021. The Common Framework (CF) was launched by the Group of Twenty (G20) Summit in November 2020, to provide a mechanism for low income countries to seek debt restructuring when unavoidable. Under the CF, an Official Creditor Committee for Zambia was formed, co-chaired by China and France. The Zambian OCC pledged to negotiate with Zambia to restructure its public external debt. Its commitment cleared the way for the IMF Board to consider and approve the assistance package for Zambia. These steps taken to restructure Zambia’s debt could form a template for future instances of sovereign debt restructuring under the Common Framework.

In addition to the progress made so far, according to the IMF, Zambia and the OCC aim to sign a legally non-binding memorandum of understanding (MOU) by the end of 2022. The MOU will set out the key parameters of Zambia’s debt restructuring terms regarding: the changes in nominal debt service over the IMF program period, the debt reduction in net present value (NPV) terms, and the extension of the duration of Zambia’s debt.

Zambia will then negotiate bilaterally with each official creditor for a restructuring deal, consistent with the key parameters set out in the MOU. Concurrently, Zambia will negotiate with private sector creditors, seeking comparable treatment as mandated under the Common Framework. The Zambia External Bondholder Committee has been formed, representing 45 percent of the outstanding value of Zambia Eurobonds, and presumably will engage in the negotiations.

The progress so far suggests that the OCC has found a compromise which is acceptable to China—which until now has insisted on bilateral negotiations with debtor countries instead of participating in multilateral restructuring efforts. The MOU will be legally non-binding, and the key parameters on NPV reduction and duration extension are consistent with many solutions containing various scenarios of interest rate cuts and maturity extensions that do not require a nominal reduction of the face value of the debt. Nominal haircut is something China has avoided in its previous bilateral debt restructuring agreements with debtor countries. As well, the actual restructuring deal will be negotiated bilaterally with each official creditor—something China has long insisted on. These features will presumably allow China to move forward with the other two cases under the Common Framework, Chad and Ethiopia. The Zambian case may therefore serve as the template for debt restructuring under the Common Framework.

However, even with such a promising , the current approach to sovereign debt restructuring is still plagued with many deficiencies. The process remains time-consuming and inefficient for the following reasons.

Firstly, the Common Framework is only open to 73 low-income countries. Middle-income countries also in debt distress, such as Sri Lanka, are excluded. Sri Lanka has reached staff-level agreement with the IMF for a $2.9 billion package, not yet approved by the Board. Aporoval of  the package  is contingent on progress in debt restructuring negotiations with Sri Lanka’s creditors. With more than $50 billion of external debt, about 47 percent with private sector creditors and bondholders, and 10 percent each with bilateral creditor China and Japan, Sri Lanka can benefit from the steps set out in the Common Framework to better manage its debt restructuring task. Therefore, the G20 should extend the Common Framework to middle-income emerging countries in debt distress.

Secondly, a way needs to be found to encourage countries in debt difficulties to use the Common Framework. Currently, countries fear being downgraded by credit rating agencies and losing capital market access if they take advantage of it. If the stigma around the Common Framework remains, many countries will avoid it; only three have applied so far (Zambia, Chad, and Ethiopia).

Thirdly, convincing private creditors to participate in debt restructuring on comparable terms with official bilateral creditors will remain difficult. Private creditors complain that the restructuring terms are reached in the OCC without their inputs, and their concerns are not taken into consideration. They do not receive the IMF and World Bank Debt Sustainability Analysis, which is the basis for restructuring negotiations in the OCC until it is too late to contribute to the assessment. These concerns must be addressed before one can hope for more participation by private creditors in the debt restructuring process under the Common Framework.

Zambia shows that progress can be made to render the Common Framework more workable to restructure low-income countries’ sovereign debt. However, more needs to be done to refine a comprehensive, efficient, and effective sovereign debt restructuring procedure. The international community  needs change now, with many low income and emerging market countries close to or already in distress, especially following the Covid-19 pandemic and the war in Ukraine.

Hung Tran is a nonresident senior fellow at the Atlantic Council, former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Zambia: A template for debt restructuring? appeared first on Atlantic Council.

This progress will be in the spotlight on August 24 when Ukrainians celebrate thirty-one years of independence while also marking six months since the beginning of the war. As someone who has been lucky enough to witness Ukraine’s nation-building journey first-hand since the final years of the USSR, I can testify to the remarkable transformation that has taken place.  

The first time I visited Kyiv was in June 1985 when I attended an economic conference at the Institute of Economic Planning of the State Planning Commission. It was led by Academician Alexander Emelianov, the most Marxist-Leninist economist I ever met in the Soviet Union, and I met quite a few. Even then, Ukraine was evidently cleaner and better organized than Moscow. I was also struck by the fact that it was a much greener city.

The week before the Moscow August coup in 1991, George Soros asked my late friend Professor Oleh Havrylyshyn and me to spend a week in Kyiv and meet all the economic policymakers. I was shocked by what I heard. We met with Emelianov again, who was now chief economic advisor of Soviet Ukrainian leader Leonid Kravchuk and coyly claiming to support the transition to a market economy. I was not convinced, largely because he did not appear to understand what a market economy was.

We talked to many other people in Kyiv. Their dominant view was that Ukraine’s only real economic problem was Russia. If Ukraine could just cut its links with Russia, the country’s economic problems would be solved. Nobody seemed to care about the details of marketization, liberalization and privatization, with the sole exception of a junior economist from the democratic Rukh political party who had a decent economic understanding and even spoke English. Depressed, I passed through Russia to Sweden the day before the Moscow coup. Oleh Havrylyshyn, who was a highly patriotic Ukrainian, wanted to do what he could and remained in Ukraine to serve as deputy minister of finance.

In the summer of 1993, I went to a World Economic Forum event in Kyiv with some hesitation. Ukraine had no economic policy. Shortages were devastating and the country was experiencing devastating hyperinflation of 10,000 percent. The government ministers of the time clearly knew that they were lost, so most of them did not even appear at the event as announced. The few foreigners present were just astounded, though I was not. This was the low point. Something clearly had to change.

In July 1994, Leonid Kuchma was elected president. I liked what I saw. Kuchma talked straight and seemed radical. I got in touch with Soros and told him that I would be happy to work with Kuchma. A few days later, Soros called me and said that he had got an appointment with Kuchma. Would I like to come along? Of course, I told him. We met with Kuchma in Kyiv. Soros offered our services. Kuchma replied, “I am ready.” Afterwards, Soros told me, “You do what you think is necessary. I pay.”

I had expected this answer and had prepared a team who flew in three days later. After eight weeks of hard work, the new Ukrainian government concluded its first IMF program which swiftly killed the problem of hyperinflation. Apart from Kuchma himself, our greatest collaborators in the Ukrainian government were Economy Minister Roman Shpek and NBU Governor Viktor Yushchenko. Our group expanded to 27 people, predominantly wonderful young Ukrainians. Unfortunately, fall 1994 was the high point. By the end of 1997, we quietly departed.

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In December 2004, I danced in the streets of Kyiv with a million Ukrainians during the Orange Revolution as the country experienced a watershed moment in its modern history. In the aftermath of this momentous geopolitical turning point for Ukraine and the wider post-Soviet region, I co-chaired a UN-sponsored commission on reform proposals together with Professor Oleksandr Paskhaver.

Looking back, I am still proud of the report we produced. We promoted it by all means, but the only member of the new post-Orange Revolution government who was really engaged was Finance Minister Viktor Pynzenyk. The other senior politicians were only interested in becoming prime minister, it seemed. Future Kyiv Mayor Leonid Chernovetskiy told me, “Don’t you understand? They are all victors. Why should they listen to anybody?” How right he was.

The main problem after the Orange Revolution was chaos at the highest level, but there were many other issues. The European Union played no real role and offered no sense of direction. The number of senior Ukrainians who spoke English and had international experience remained tiny. Economic ideology was largely absent. The few at the top wanted to prosper personally. Also, it all seemed too easy. The Orange Revolution had proceeded peacefully like a fairytale. Ukraine’s economic growth in 2003 was 12 percent. Why worry?

Despite the political disappointments that followed the 2004 uprising, it remains a hugely significant event in Ukraine’s national story. The most important long-term benefit of the Orange Revolution was to be a strong and vibrant civil society. This has had a profound impact on Ukraine’s subsequent nation-building progress.

The Orange Revolution also marked the end of Kremlin-style central government censorship and ushered in a new era of media freedoms. The Ukrainian media landscape is still far from ideal and continues to suffer from excessive oligarch influence, but no subsequent Ukrainian government has been able to reassert the kind of control exercised by the authorities before the Orange Revolution.  

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Ten years later, millions of Ukrainians once more took to the streets to defend their democratic future. Although the 2014 Revolution of Dignity might superficially appear similar to the Orange Revolution, it was to prove a far graver confrontation that ultimately sparked direct Russian military intervention.

The Russian invasion caused a severe economic crisis in the first half of 2014. Fortunately, by now Ukraine had ample human capital with many young people who had received an excellent education abroad. This was strikingly different to the situation in the early 1990s or even in 2004, when an absence of internationally experienced Ukrainians had hindered the country’s efforts to reform and advance.

Ukraine was also able to sign an Association Agreement with the EU, which offered both access to the vast European market and a detailed roadmap for further reforms. Skillful and forceful reformers were invited to join the government and many good reform laws were adopted. This process abated prematurely in 2016 before reviving briefly in 2019. Despite many setbacks, the overall direction toward greater transparency and Euro-Atlantic integration remained clear.

The past eight years of Russian aggression against Ukraine have helped define the Ukrainian nation. This was already evident in 2014 following the seizure of Crimea and Russia’s military intervention in eastern Ukraine. The consolidation of Ukrainian national identity has become even more pronounced over the past six months since the onset of Russia’s full-scale invasion in February 2022.

Today, the Ukrainian nation knows that it is part of Europe. An overwhelming majority of Ukrainians want to join both the European Union and NATO. This also means that Ukrainian society is ready to carry out the vital judicial reforms that have been missing all along.

Existential challenges remain. Ukraine must still overcome Russian aggression and win the war. This is far from certain. Nevertheless, Ukraine approaches this month’s thirty-first anniversary of independence stronger and more united than many in the early 1990s would have dared to believe and ready for economic takeoff if a sustainable peace can be secured.

Anders Åslund is the author of “Russia’s Crony Capitalism: The Path from Market Economy to Kleptocracy.”

Further reading

UkraineAlert Aug 9, 2022

Flawed Amnesty report risks enabling more Russian war crimes in Ukraine

By Lillian Posner

Amnesty International’s recent report accusing Ukraine of endangering civilian lives has sparked a wave of international criticism and is being actively used by the Kremlin to justify Russian bombing of civilian targets.

Civil Society Conflict

UkraineAlert Aug 10, 2022

Putin is running out of excuses as Ukraine expands the war to Crimea

By Peter Dickinson

Russian officials have denied that Ukraine was behind an audacious August 9 attack on an airbase in occupied Crimea but Moscow’s excuses are beginning to wear thin as Vladimir Putin’s invasion continues to unravel.

Conflict Disinformation

UkraineAlert Jun 27, 2022

Odesa rejects Russia: Putin’s Ukraine War turns old allies into bitter enemies

By Oleksiy Goncharenko

Putin has long claimed to be the champion of pro-Russian Ukrainians. However, the Ukrainian regions most closely associated with pro-Kremlin sentiment have also been hardest hit by the current invasion.

Conflict Disinformation

The views expressed in UkraineAlert are solely those of the authors and do not necessarily reflect the views of the Atlantic Council, its staff, or its supporters.

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UkraineAlert is a comprehensive online publication that provides regular news and analysis on developments in Ukraine’s politics, economy, civil society, and culture.

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The post Russia’s invasion has highlighted Ukraine’s nation-building progress appeared first on Atlantic Council.

China’s economic growth slowed to 0.4 percent year-on-year in the second quarter of 2022, despite aggressive steps by authorities to support struggling companies, boost consumption, and address the spike in youth unemployment. These measures amounted to short-term firefighting. There were few signs of the fundamental structural reforms needed to put the Chinese economy on a sustainable long-term growth path. Beijing’s aversion to relinquishing economic control to market actors has laid the groundwork for more financial instability in the second half of 2022, including in the struggling property sector.

With the 20th Party Congress looming, we see little chance of a change in approach, even if the Chinese economy veers toward a hard landing. Some analysts point to episodic Q2 endorsements of market reform and the end of “campaign style” regulation as evidence of correction. Until more definitive policy reversals are evident, however, the outlook for liberal policy reform in China to address deep-seated structural flaws in the economy remains dim. 

The bottom-line assessment for Q2 2022 shows that Chinese authorities were active in two of the six economic clusters that make up the China Pathfinder analytical framework: financial system development and competition policy. There were fewer developments in the innovation, trade, direct investment, and portfolio investment clusters. In assessing whether China’s economic system moved toward or away from market economy norms in this quarter, our analysis shows a mixed picture.

This issue of the China Pathfinder Quarterly Update highlights China’s youth unemployment problem and the dynamics between private and public sector employment trends. Absorbing a record 10.7 million new university graduates into the labor market was always going to be challenging during the pandemic, but in Q2, the effects of a shrinking economy, unending regulatory crackdown, and zero-COVID lockdowns in major Chinese cities pushed unemployment to new highs. The report dives into new hiring data for sectors targeted by the crackdown, statistics on recent graduates taking the civil servant exam, and survey data on expected salaries to assess the severity of China’s unemployment problem.

View the full issue brief below

The China Pathfinder Project

China is a global economic powerhouse, but its system remains opaque. Policymakers and financial experts disagree on basic facts about what is happening inside the country. To create a shared language for understanding the Chinese economy, the China Pathfinder project scores China and other open market economies across six key areas and presents an objective picture of China relative to the world.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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Report Oct 5, 2021

China Pathfinder: Annual Scorecard

By GeoEconomics Center and Rhodium Group

Over the past eight months, teams from the Atlantic Council and Rhodium Group have taken a dive into China’s economy to address a fundamental question: Is China becoming more or less like other open-market economies? 

China European Union

Issue Brief May 11, 2022

China Pathfinder: Q1 2022 Update

By GeoEconomics Center and Rhodium Group

Over the past ten months, teams from the Atlantic Council and Rhodium Group have taken a dive into China’s economy to address a fundamental question: Is China becoming more or less like other open-market economies? 

China Fiscal and Structural Reform

The post China Pathfinder: Q2 2022 Update appeared first on Atlantic Council.

More importantly, visible growth slowdown has spread losses in the real estate property sector to the banking sector, mostly among small and medium-sized provincial banks. For now, the magnitude of damages is manageable, but a sustained period of slow growth would generate greater losses in more economic sectors, banks, and companies. This pattern raises the risk of a financial crisis and economic recession, unless authorities act now to resolve, recapitalize, and consolidate weak, small banks and highly indebted developers. China’s government should also establish a robust resolution and recapitalization framework for banks and companies to replace the current ad hoc approach.

Weak spots in China’s banking sector

China has a large banking sector with assets amounting to 336 trillion yuan ($50 trillion), or almost 300% of its GDP, compared with a bank asset-to-GDP ratio of 75% in the US. Four large state-owned banks dominate China’s banking scene: Industrial and Commercial Bank of China (ICBC), Construction Bank of China (CBC), Agricultural Bank of China (ABC), and Bank of China (BOC). At the end of 2021, by international standards these banks were adequately capitalized (with Tier 1 capital ratios averaging above 12%) and profitable (with returns on equity ROE more than 9%). Both measures are comparable to those of US banks, while European banks are better capitalized but have a lower ROE of 4%. China has a non-performing loan (NPL) ratio of 1.72%, in between the US, with 0.84%, and the Euro Area, with 2.32%. In short, the dominant players in the Chinese banking system look healthy at present.

However, the Achilles’ heel of China’s banking system is its 4,000 small and medium-sized provincial banks. All together, they have about 77 trillion yuan ($11.5 trillion) in assets, slightly less than a quarter of total assets of the Chinese banking system. The weaknesses stem from their flawed business model, in which small banks are often thinly capitalized, rely on costly and volatile interbank markets for funding, and lend to small and medium-sized enterprises (SMEs) – which tend to have high credit risks and high non-performing loan ratios. Moreover, small banks have been plagued with corruption and other wrongdoing.

This was typified by the case of Baoshang Bank. The bank grew 30-fold from its founding in 1998 to 2019 thanks to a policy-driven lending boost to SMEs and was seized by the authorities in May 2019 due to “serious credit risks”. Baoshang Bank was then declared to be bankrupt and was liquidated a year later (the first Chinese bank to have been liquidated two decades) after it was uncovered that the bank made 150 billion yuan of related loans, which became non-performing, to billionaire Xiao Jianhua’s Tomorrow Group Holdings—Tomorrow had a 89% stake in the bank and Xiao is now on trial. This episode created a hiccup in China’s interbank repo market when even some short-term AAA bank debts were refused as collateral due to market participants’ fears of counterparty risks. The People’s Bank of China (PBOC) had to inject a net 250 billion yuan to the financial system to restore market liquidity.

Since then, many small banks have gotten into trouble and had their problems resolved by Chinese authorities. The process is non-transparent, by which an ad hoc group of provincial and local governments, state-owned banks, and companies is put together to buy out the failing banks. The practice is referred to as the “one bank, one policy” approach, associated with Guo Shuqing, the Chairman of China Banking and Insurance Regulatory Commission (CBIRC). More recently, several small banks in the provinces of Henan, Anhui and Liaoning ran into severe cashflow problems and in mid-April had to significantly limit, or to freeze, withdrawals by depositors. Those banks have suffered from the practice of offering high interest rates to attract depositors from afar through digital channels, some operated by China’s big social media platform companies; and then invest the proceeds in Wealth Management Products (WMPs) in the hope of generating high returns to pay back depositors—something the authorities have tried to discourage. The slowing economy since the beginning of this year has caused many WMPs to underperform expectations, rendering many small banks (like those mentioned above) unable to generate sufficient income to meet withdrawal demands—hence the need to limit withdrawals.

Small banks have also been hit by the refusal of a growing number of home buyers to pay interest on mortgages taken from banks to buy unfinished housing units, which have remained incomplete due to the construction slowdown and many developers being embroiled in debt crises. At present, 28 of the top 100 developers have negotiated a debt restructuring with their creditors or have defaulted outright on both onshore and offshore obligations. These developers have left about 100 projects in 50 cities identified so far as unfinished. Mortgage loans on these projects are estimated to be about 1.5 trillion yuan ($222 billion)—a miniscule amount in terms of China’s total bank assets. However, the amount of high-risk credit can grow quickly amid speculation about which banks are going to be hit next—fostering a sense of crisis and undermining public confidence in the Chinese banking system, especially its small banks. Deterioration of the property sector—which accounts for almost one-third of China’s GDP and a quarter of all bank loans—could snowball into a banking and economic crisis.

Spreading fallout of the property sector debt crisis

Declining property sales and values have also hurt municipal and local governments, which have relied on property sales for 42% of their revenues. As revenue from land sales dropped by more than 30% in the first half of 2022 from levels one year ago, the central government eased its campaign to curb local governments from borrowing and issuing bonds through Local Government Financing Vehicles (LGFVs) to limit their financial stability risks. Specifically, the Ministry of Finance is considering allowing local governments to issue 1.5 trillion yuan ($220 billion) of special bonds in the second half of this year to speed up infrastructure investments in support of the faltering economy. These measures are being taken even though LGFV debt climbed to 53 trillion yuan ($8.2 trillion), or 52% of GDP, at the end of 2021 and LGFV credit risks have increased significantly. In the past year, incidences of default by LGFVs have risen—42 LGFVs defaulted on non-standard debt (such as trust loans, accounts receivable, and bills of exchange, which are not traded on exchanges or in the interbank markets).

Corporate debt default in China has also been on the rise. So far this year, China’s bond defaults hit $20 billion compared with $9 billion for the whole of last year—with developers accounting for the bulk of defaults. Slow growth means more bond defaults can be expected. However, these levels of default imply a very low default rate on the outstanding volume of non-financial debt.

Despite struggling to manage financial risks across many sectors, the government has succeeded at times in curtailing shadow banking activities—those using funding and investment instruments which are poorly regulated and harbor obscure risks. The size of this sector has been reduced by 40% since 2017 to stand at 57 trillion yuan ($8.9 trillion) or 49.8% of GDP in 2021—the lowest in 13 years. However, the practice of raising funds through and investing in WMPs, entrusted loans, and other similar vehicles by making use of digital channels is still prevalent, presenting another source of financial stability risks.

Finally, on top of domestic weaknesses in the property and small bank sectors, China must manage its first overseas debt crisis as a creditor. Chinese state-owned banks (SOBs) have lent a total of $838 billion to countries participating in the Belt and Road Initiative (BRI) since its inception in 2018 until 2021. While many projects have been useful for participating countries, many have not generated adequate commercial returns. The pandemic and fallout from the war in Ukraine have led several countries to default on their external debt (like Sri Lanka) or suffer acute debt distress (like Pakistan). From 2018-2021, China has had to renegotiate terms of $70 billion of BRI loans, with the pace accelerating in recent years. Though Chinese SOBs often offer “rescue loans” to help debtors service their borrowings and avoid default, once they are in default, China must negotiate a restructuring of the loans. This process reduces their present values by extending maturities and cutting interest rates or principal amounts. While BRI loans are small relative to total assets of SOBs, sharply rising credit risks and costs related to these loans will burden Chinese banks’ earnings outlook in the foreseeable future—something China can ill-afford given its domestic problems.

Slow reactions by Chinese authorities

Given the significant risks mentioned above, it is difficult to understand the complacent attitude of Chinese authorities responding to the plight of depositors at small banks. Their attitude may give some indications about the quality of supervision of small banks in China, which often acts counterproductively. For example, withdrawal restrictions caused long lines of depositors at affected banks waiting to get their money out and led to demonstrations in Zhengzhou, Henan’s capital. Local authorities reacted by directing plainclothes policemen to beat up demonstrators and turn on the “Code Red” on their cellphone COVID-19 apps to prevent them from appearing at public places.

Their actions triggered widespread indignation and protests on social media. After several months of inaction, the CBIRC and PBOC stepped in. They conducted an investigation, blaming the irregularities on a gang of criminals which controls those banks, using them to engage in illegal activities. The PBOC has also begun to facilitate payments to small depositors of up to 50,000 yuan, telling all depositors to be patient. Since China’s deposit insurance scheme is supposed to protect deposits up to 500,000 yuan, the decision to pay only 50,000 yuan has raised further questions instead of reassuring depositors. Authorities have also urged banks to cooperate with local governments to help fund developers finish their residential projects.

Actions to resolve, recapitalize, and consolidate weak banks and indebted developers

China’s authorities need to urgently deal with slow growth and its related problems. Firstly, they should use their strong sovereign balance sheet to resolve, recapitalize, or liquidate ailing property developers and weak small banks. China has been cautious in using public resources to support its economy during the pandemic. As a result, China’s general government debt to GDP ratio of 77.8% compares favorably with that of the developed countries averaging 115.5%. China’s fiscal and central bank balance sheet space needs to be utilized now to stop the rot among small banks and indebted developers from spreading to the rest of the economy.

Secondly, they must promulgate a clear and robust resolution, recapitalization, and liquidation legal regime to avoid the inefficiency and uncertainty of the current ad hoc “one bank, one policy” approach. They also need to beef up China’s deposit insurance fund with a modest balance of 96 billion yuan ($15.1 billion) at the end of 2021, compared with the US Federal Deposit Insurance Corporation’s $119.4 billion.

Finally, China should make its operations more transparent and predictable to restore public confidence in the banking system. Failure to quickly implement these measures will not only threaten China’s financial and economic stability, but its political stability as well.

Hung Tran is a nonresident senior fellow at the Atlantic Council, former executive managing director at the International Institute of Finance and former deputy director at the International Monetary Fund.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Slow growth exacerbates China’s financial stability risks appeared first on Atlantic Council.

But more importantly, the G7 has finally flexed its muscles after watching its relevance being called into question for a decade. Now that it has brought down a heavy financial hammer against Russian President Vladimir Putin following his invasion of Ukraine, the question facing the leaders of this group—which represents around half the global economy—will be: What do they do next?

Our GeoEconomics team brings you seven data points they’ll be thinking about as they search for a path forward.

1. Core consumer price index

The leaders of the G7 economies meet precisely as their independent central bankers are beginning to take ownership of inflation. The bankers are raising interest rates with some dread: Most have spent the past eighteen months arguing that inflation is mainly being driven by supply-side shocks—the kind monetary policy is meant to ignore. Now, high energy prices and constraints on Chinese growth have led policymakers to increase the odds of a global recession. Record-high inflation in the eurozone, the United States, and the United Kingdom will feed expectations of further price increases, and central banks recognize they need to intervene to break the cycle.

Coordination is the purpose of the G7. While rates will be hiked at slightly different intervals, leaders can discuss the fiscal side. All are tempted to support households that are facing higher bills, but the countries are coming out of the pandemic with higher debt burdens. Fiscally conservative members, such as Germany and the United Kingdom, will also argue that profligate spending will cause inflation to last longer. 

Will the rate hikes do enough? They are significant for economies that have become used to cheap credit over the past decade. And while the eurozone has seen negative interest rates for about that long, with inflation this high—over 8 percent in the United States and the eurozone— it’s unclear whether rates between 1.5 and 2 percent will alter expectations. 

—Charles Lichfield is the deputy director of the Atlantic Council’s GeoEconomics Center.

2. GDP revisions

G7 economic growth has slowed by more than 2 percent compared to projections from last year. With the group now collectively forecasted to grow around 3.25 percent in 2022, a range of factors—particularly Russia’s invasion of Ukraine—are responsible for the slowdown. But even before the war, the advanced-economy recovery was in a precarious place: Inflation throughout the G7 was already rising due to imbalances in supply and demand, and exacerbated by the fiscal support governments provided during the pandemic. New lockdowns in China also played a role by worsening inflation and causing additional bottlenecks in global supply chains. The war added an additional series of supply shocks as it restricted access to Russian oil, gas, and metals, as well as Ukrainian wheat and corn. This surge in fuel and food prices has been most acutely felt in European economies. Look for coordinated action from the G7 on unblocking ports and relieving some of the pressure on food supply. 

—Niels Graham is an assistant director in the GeoEconomics Center.

3. Sanctions against Russia

G7 countries have imposed unprecedented coordinated sanctions and export controls against Russia with the goal of turning the country into a global economic pariah and increasing the cost of waging its war in Ukraine. While the original G7 agenda does not mention Russia or Ukraine by name, there’s no doubt that one of its goals is to safeguard global economic recovery and financial stability—both of which are currently undermined by Russia’s invasion of Ukraine. Addressing the challenges of supply-chain disruptions and global food shortages will require G7 partners to reintegrate Ukraine into the world economy and provide financial assistance to Kyiv. 

Fortunately, the seven countries are on the same page when it comes to funding Ukraine, having pledged twenty billion dollars to prop up Ukraine’s budget. But as Ukraine’s finance minister said during an event at the Atlantic Council last month, not all that money has reached its bank account. Kyiv will have the chance to make the case in person: President Volodymyr Zelenskyy has accepted the German chancellor’s invitation to take part in this year’s G7 summit. 

—Maia Nikoladze is a program assistant in the Economic Statecraft Initiative within the GeoEconomics Center.

4. Guidance on interest rates

Hindsight is 20/20—and for the G7, it might indeed be a good idea to look back. Forecasting is always a precarious business, which is why many international organizations temporarily suspended economic prognostication in the thick of the pandemic. But the US Federal Reserve and European Central Bank didn’t have that luxury; they had to do their best to estimate gross domestic product (GDP) growth, inflation, and interest rates over multiple years despite the fog of an unprecedented supply chain crisis and mutating virus. 

It didn’t work out as they had hoped: The forecasts varied so widely over the past year that it called into question whether they were even worth doing in the first place. So should the G7 nations keep trying to forecast to markets what’s coming, or simply deal with what’s right in front of them? Expect some humility from the leaders this week as they work to address the immediate inflation crisis—while recognizing that neither they nor the brilliant economists in their governments can predict the next global pandemic, or how the war in Ukraine will end.

—Josh Lipsky is the director of the GeoEconomics Center

5. G7 debt vs. emerging-market debt

Germany’s emphasis during its G7 presidency on financial stability and inclusive growth means debt will be a key theme at this year’s summit. In response to the pandemic, countries worldwide pushed through massive fiscal-stimulus packages to provide economic relief. While debt-to-GDP ratios are elevated for all countries compared to pre-pandemic levels, they are slowly beginning to subside for G7 economies—but still have yet to peak for emerging markets and developing economies. Tighter US and European monetary policy, surging commodity prices, and a drastic decline in global-trade growth will hamper their ability to retain dollars and service their unprecedented levels of debt. 

As the risk of debt default increases for those countries, G7 members should take steps to ensure that the G20 Common Framework for Debt Treatments is implemented effectively. This means China, as the world’s largest bilateral creditor, needs to step up and help renegotiate with countries to avoid default. Look for how the G7 coordinates this week ahead of next month’s G20 finance ministers meeting in Indonesia—and watch whether it takes up US Treasury Secretary Janet Yellen’s call at the Atlantic Council in April for a reform of the Bretton Woods system. 

—Mrugank Bhusari is a program assistant in the GeoEconomics Center.

6. CBDC and Cryptocurrencies

All of the G7 economies are in the process of developing a Central Bank Digital Currency (CBDC) to promote digital transformation and provide more efficient payment systems. Canada, France, Germany, Italy, and Japan are in the more advanced stage of development and have been testing both retail and wholesale CBDCs since April 2021. The first three, in particular, are helping create the digital euro. The United States and United Kingdom are the farthest behind on CBDC development, as both are currently in the process of establishing research partnerships. In the former, President Joe Biden’s executive order on digital assets initiated further research and interagency coordination for the digital dollar. The G7 has shared concerns regarding privacy and cybersecurity of the different CBDC models.

When it comes to cross-border testing, the focus of the G7 should be on interoperability across the various domestic CBDC models, legacy payments infrastructure, as well as regulated, private digital currencies. This is not just an abstract problem: When the G7 cut Russia off from SWIFT, it increased incentives for countries like China to find new ways to send money across borders. Meanwhile, the collapse of cryptocurrency markets is reminding regulators why they need to step in and help protect consumers. 

CBDC Tracker

The new Central Bank Digital Currency (CBDC) Tracker & interactive database takes you inside the rapid evolution of money all over the world.

—Ananya Kumar is the assistant director of digital currencies at the Atlantic Council.

7. Vaccination rates

At last year’s G7 summit, the first item on the agenda was to end the pandemic by vaccinating the world. Leaders adopted the World Health Organization’s goal of vaccinating 70 percent of every country’s population by mid-2022 and committed to sharing at least 870 million doses within a year. Unfortunately, only 17.8 percent of people in low-income countries have now received at least one dose. Resolving this crisis requires equitable distribution.

A successful global vaccination push by the G7 will contribute to global immunity, reduce the risk of new variants emerging, and enable the resurgence of the global economy. The pharmaceutical industry has produced more than thirteen billion doses, but low-income countries still face obstacles due to supply-chain bottlenecks and intellectual-property protections. These are challenges that the World Trade Organization’s recent decision to ease intellectual-property restrictions on vaccines fails to address. This year, G7 commitments toward both vaccine supply and global distribution strategies will be a deciding factor in resolving the COVID-19 pandemic and resulting economic blight.

—Sophia Busch is a project assistant in the GeoEconomics Center.

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Of course, the agreements concerning e-commerce, fisheries subsidies, and COVID-19 vaccines deserve to be celebrated.  But most of the agreements are temporary in nature.  Deep divisions among WTO members remain, as evidenced by various silences across the official documents released as of this morning. The most notable of silences involve Russia and China.

The E-Commerce Moratorium Decision

It is true that the moratorium regarding customs duties on electronic transmissions has been extended. But the extension is temporary, lasting only 18 months. The short-term nature of the extension suggests just how hard it was to reach agreement.

While the agreement provides “Ministers or the General Council” at the WTO the ability to extend the moratorium, the agreement itself sets March 31, 2024 as a clear expiration deadline. If the WTO Ministerial Council has not met by this date, the moratorium expires, and a new waiver or extension will be required.

The Fisheries Subsidies Agreement

The WTO also officially required its Members to cease subsidizing fishing activities that are “illegal, unreported, and unregulated.” It also required them to cease subsidizing fishing activities regarding overfished stocks and fishing operations outside their own jurisdictions. Yet, Members remain responsible for determining what constitutes “overfishing.”  Implementation, if it occurs, will be slow. The agreement only becomes effective two years after the decision has been become a formal amendment to the WTO Treaty.

In other words: fishing subsidies have not been eliminated except with respect to activities that domestic law already declared as illegal. Moreover, the implementation period extends well into the future. While the WTO Secretary General declared that the Fisheries Agreement constitutes the first WTO agreement “with sustainability at its heart,” the preamble was more modest. The formally agreed text only identifies the elimination of “overcapacity” as its core objective and the word “sustainability” is markedly absent.

Finally, Act. 12 of the decision may be the most important part of the Fisheries Agreement. It indicates that today’s agreement “shall stand immediately terminated” if the decision has not been implemented through “comprehensive disciplines within four years of the entry into force of this Agreement.”

The COVID-19 Vaccine Decision

The intersection of intellectual property rights, biotech manufacturing, trade rules, and public health ironically highlighted the fissures in the post-war multilateral system. Today was no exception. Indeed, no intellectual property waivers have been granted regarding COVID-19 vaccines. 

As U.S. Trade Representative Ambassador Katherine Tai noted, the agreement merely “produced accommodations to the intellectual property rules for COVID-19 vaccines that can facilitate a global health recovery.” UK International Trade Secretary Anne-Marie Trevelyan was more direct: “…this is not about waiving intellectual property rights.  This decision should make it easier for developing countries to export the vaccines they produce within existing guidelines.”

Intensifying Pressure Points

Official sector statements communicate with negative space (silence) at least as much as they do with their words. These silences provide clues about the scope and scale of disagreements. The silence emanating from Geneva speaks eloquently about the fragility of the multilateral trading system and indirectly illustrates why today’s announced agreements are so tentative, temporary, and limited.

The formal press statement from the WTO makes clear that no consensus on the WTO’s future agenda exists. It specifically highlights four familiar areas that block progress: food stockpiling, subsidies, cotton, and market access. The impasses surrounding market access and food stockpiling should sound alarm bells for those seeking assurances that the WTO will survive the decade as a functioning institution.

Market Access and Subsides (China): China’s well-known policies regarding market access have been generating tension within the WTO for over a decade in addition to Beijing’s controversial push for “market economy” status. A number of economies continue to object to granting China market economy status in large part due to its extensive subsidy and state-owned enterprise economic structure.

None of these issues was resolved during the marathon negotiating sessions in Geneva this week. This is not a situation in which the issues are unclear or technically difficult to address. Rather, the inability to resolve these differences reflects a deep disagreement on whether (or not) the multilateral trading system and its members will retain their commitment to market economy principles.

Food Stockpiling (Russia): The WTO issued a long Declaration on food insecurity which largely “reaffirms” its commitment to existing standards that permit Members to implement export restrictions to address food insecurity and urges Members  “with available surplus stocks to release them on international markets consistent with WTO rules.” The Declaration is silent on the cause for an intensifying food crisis globally: the war in Ukraine.

The WTO documents do not highlight that the Russian Federation was present at the Geneva meetings. The long list of concerns and causes concerning the intensifying food crisis mention rising prices three times and trade disruptions, but never note (much less condemn) the blockade of Ukraine’s Black Sea ports by Russia – through which Ukraine’s considerable exports of wheat and sunflower oil and other agricultural commodities flow to the global economy. Nor does the statement call out the considerable disruptions in supply chains associated with Russia’s illegal invasion of Ukraine. Strikingly, the European Union has not yet released a statement supporting or discussing the WTO outcomes.

Conclusion

The Bretton Woods structure of economic interdependence sought to make war too expensive to wage.  To that end, it sought to create positive economic incentives for peaceful dispute resolution (alongside the United Nations). The end of the Cold War made it possible to pursue a fully integrated global economy, ushering in WTO memberships for Russia and China. But the WTO’s silence regarding the key issues of the day strongly suggest that the multilateral system is far more fragile than the headline-making (but very temporary) agreements on fisheries and e-commerce announced today.

Barbara C. Matthews is a non-resident Senior Fellow with the Atlantic Council’s Geoeconomics Program.  She is also Founder and CEO of BCMstrategy, Inc., a data company that quantifies public policy risks using patented technology.  She has had a distinguished career in global financial and economic policy, including government service as the first U.S. Treasury Department Attaché to the European Union with the Senate-confirmed diplomatic rank of Minister-Counselor and as Senior Counsel to the House Financial Services Committee.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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Introduction

China’s flagship Belt and Road Initiative (BRI) is often directly compared to the United States’ postwar Marshall Plan. The comparison is made due to the BRI’s scale, global infrastructure investment ambitions, and geopolitical and security ramifications. But how accurate is this analogy, and what do the similarities and differences between the two infrastructure programs tell us about the economic and political anxieties of our time? While there are far more differences than agreements between the BRI and the Marshall Plan, the impetus behind both initiatives reveals important parallels between the postwar reality and post-financial crisis global posture. Through the analysis of several examples, this issue brief provides crucial insights as international political and business leaders once again call for a “new Marshall Plan”—this time to rebuild Ukraine should Russian aggression end.

Comparing the Marshall Plan and the BRI

There are more differences than similarities between the Marshall Plan and the BRI.

First, the method of financing for the two programs are polar opposites. The Marshall Plan was mostly financed through concessions, where countries received funds through grants or in-kind subsidies. The BRI instead relies on loans and liquidity support from the People’s Bank of China.

Second, the two programs were perceived differently. The Marshall Plan was largely celebrated, particularly in Europe. The European Recovery Program train, funded by the Plan, supplied goods and food to millions of European citizens. The Plan ultimately lowered trade barriers and catalyzed economic and industrial advancements. On the other hand, the BRI has received mixed reactions: in areas where it was successful, locals supported the program; but where infrastructure projects failed, delayed, or became more expensive than anticipated, locals blamed the BRI for increasing debt and the withdrawal of public services.

Conclusions

As the United States and the European Union jointly embark upon the G7’s Build Back Better World Initiative (B3W) and as the EU expands its Global Gateway infrastructure program, the successes and failures of the Marshall Plan and BRI provide a few caveats and helpful tips for regional infrastructure and development programs:

1. Local and national leaders should be heavily involved in project development, and an independent third party should monitor public tender. Programs should also work to stimulate and engage local labor markets. 
2. Sources used to fund the proposed infrastructure projects should be made publicly available. A higher grants to loans ratio will likely be more successful.
3. International actors should prioritize investing in sustainable, future-oriented, renewable energy infrastructure. Officials should consider the long-term economic and environmental benefits of each project before implementation.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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By the Freedom and Prosperity Center

The Freedom and Prosperity Center aims to increase the prosperity of the poor and marginalized in developing countries and to explore the nature of the relationship between freedom and prosperity in both developing and developed nations.

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See how scores have changed over time

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Executive Summary

The Atlantic Council’s Freedom and Prosperity Center aims to increase the prosperity of the poor and marginalized in developing countries—and to explore the nature
of the relationship between freedom and prosperity in both developing and developed nations.

To aid in this task, this report introduces the new Atlantic Council Freedom and Prosperity Indexes.

The Freedom Index measures economic, political, and legal freedoms for nearly every country in the world, using the latest available data when the index was constructed at the end of 2021. The Prosperity Index measures economic wellbeing and human flourishing for the same countries and time period. In addition, we collected historical data to allow us to track and analyze change over time. We constructed the same indexes going back in five-year increments for the years 2006, 2011, and 2016; 2006 is the earliest date for which data on our indicators are available.

To be sure, there are limits to any data-collection effort. The world changes quickly, and the data we collected at the end of 2021 may not still represent current realities in every case. Russia, for example, is less free today than when we collected the data, due to Vladimir Putin’s invasion of Ukraine and his related crackdowns at home. In addition, we needed to choose indicators that could be applied across all countries and over time, but these generalized measures may not always fit neatly with the unique circumstances in every country. Still, despite these limitations, we believe that these indexes provide new and valuable information on global freedom and prosperity.

Going forward, we plan to update the indexes annually. The methodology to produce the indexes is straightforward and transparent, and is described in detail in the appendix.

We have built on the work of several comparable country indexes. Many of these measure one aspect or another of freedom or prosperity. Some combine freedom and prosperity indicators and produce a single index. Our approach in designing the Atlantic Council Freedom and Prosperity Indexes was different in a few ways.

• We defined freedom comprehensively. Many existing indexes measure economic, political, and legal freedoms separately, whereas we combine all three in our Freedom Index.
• We defined prosperity comprehensively. We also take a broad view of what constitutes a prosperous country. We go beyond material measurements like income per capita and healthcare. We argue that a truly prosperous country should also score well on the quality of the environment, its treatment of minorities, and the general happiness of the population.
• We constructed separate indexes for freedom and prosperity. By creating two distinct indexes, we hope to give researchers a better opportunity to analyze the relationship between freedom and prosperity. We also offer policymakers and other thought leaders clearer benchmarks for reforms and tracking results over time.

The indexes demonstrate that there is a strong relationship between freedom and prosperity. This report draws on the trajectory of the results over time, and other historical evidence, to argue that freedom tends to result in prosperity. In other words, freer countries tend to be more prosperous, and we have reason to believe that improvements in freedom will, over time, lead to greater and more durable prosperity.

The report also shows that autocracies generally do not deliver prosperity for their people. All countries rated Prosperous in our index (except for Singapore and Israel) also rank as Free. All countries in our Free category fall in either the Prosperous category or in the upper half of the Mostly Prosperous category. Both China and Russia rank lower in the Prosperity Index than Free countries do.

These findings lead us to recommend that governments, international organizations, private-sector companies, philanthropic organizations, and others concerned with prosperity promote economic, political, and legal freedoms.

The center will use the indexes and supporting data for its own research, and will also make them available for other researchers. All the research and resources used to produce the indexes and this report are publicly available. The Freedom and Prosperity datasets are accessible on the center’s website. The indexes will be updated annually, allowing thinkers and doers to track progress over time. Through our work and the work of others, we hope to make the world freer and more prosperous.

Summary and key takeaways

We hope that scholars and practitioners can use these data to conduct a wide range of analyses and to forge practical recommendations. In this section, we present some of our own preliminary analysis to explore the central question of this project: what is the relationship between freedom and prosperity? To be sure, this has been the subject of enormous scholarly debate, and we will not be able to resolve this question in a single report. Still, this analysis brings new data to bear on this question. The data and analysis in this report indicate that freedom and prosperity are correlated, and provide further support for the thesis that freedom contributes to prosperity.

Prosperity is highly correlated with freedom

A central finding of this report is that prosperity and freedom are highly correlated. The correlation coefficient between the indexes is 0.81. High values of Freedom are associated with high values of Prosperity, and low values of Freedom are associated with low values of Prosperity. The R² statistic shows that 66 percent of the variation in prosperity around the world can be explained by freedom (Table 5).

The strong relationship between freedom and prosperity can also be seen in simple descriptive statistics. With the exception of Israel and Singapore, every country in the Prosperous category is also in the Free category. Israel and Singapore (due to the latter’s high levels of economic freedom) occupy the two highest positions in the Mostly Free category (Table 4).

Moreover, no Free countries in 2021 are Mostly Unprosperous or Unprosperous; they are either Prosperous or Mostly Prosperous. The forty-one countries that comprise the top category of the Freedom Index also all rank in the top fifty for the Prosperity Index, except for Romania (fifty-one in the Prosperity Index) and Cabo Verde (eighty-one).

In addition, all Unfree countries in our Freedom Index rank in the Mostly Unprosperous or Unprosperous categories in our Prosperity Index—except for Cuba, which scores above fifty on Minority Rights and Health.

Continuing with the descriptive statistics, we find that citizens in Free countries are five times richer in per capita income ($36,142) than citizens in Mostly Free countries ($7,246) (Table 3). They are six times richer than citizens in Mostly Unfree societies ($5,791).

Table 3: Descriptive statistics across Freedom Index categories

Category	Country counts	Freedom Index		Population covered		GNI per Capita (US$)		Health Score
		Mean	Median	Mean	Median	Mean	Median	Mean	Median
Global	174	56.7	55.7	7,686	100%	13,312	5,070	62.2	67.2
Free	41	83.2	82.3	1,131	15%	36.142	32,290	87.5	89.9
Mostly free	67	60.8	59.7	2,824	37%	7,246	7,246	60.6	65.9
Mostly unfree	55	39.7	40.5	3,570	46%	5,791	5,791	49.1	47.1
Unfree	11	18.3	18.9	157	2%	2,775	2,775	43.7	42

Table 3 Continued: Simple statistics across Freedom Index categories

Category	Country counts	Environment Score		Happiness Score		Minority Rights Score		Prosperity Index
		Mean	Median	Mean	Median	Mean	Median	Mean	Median
Global	174	45.4	46.1	62.2	56.1	79.1	87.6	51.2	49
Free	41	80.7	89.2	79.4	78.4	94.6	95.9	76.9	79.1
Mostly free	67	38.7	41.6	52.1	52.4	85.3	88.9	48.2	47.7
Mostly unfree	55	30.4	27.1	47.0	45.3	66.7	70.0	40.0	38.3
Unfree	11	29.4	29.5	27.5	22.6	47.6	45.6	30.5	31.3

The quality of life is also different in Free and Unfree societies. As can be seen in Table 3, Health, Environment, Happiness, and Minority Rights improve as a country moves toward greater freedom. The average Health score jumps from 60.6 to 87.5 when moving from the Mostly Free to the Free category. The average Environment score drops by more than 50 percent when moving from the Free group to the Mostly Free group. People in Free countries are almost three times happier than people in Unfree countries. For Minority Rights, the gap is smaller between the Mostly Free and Free groups (nine points), but the score drops significantly as freedom decreases, with gaps of almost twenty points between Mostly Free and Mostly Unfree, and again between Mostly Unfree and Unfree. These results suggest that more freedom is associated with a better life for the average person.

Table 4: Overlap between freedom and prosperity categories 

Evidence suggests that freedom contributes to prosperity

In this section, we examine whether freer countries tend to become more prosperous over time. Scholars have long debated the direction of the relationship between freedom and prosperity. The insight that freedom promotes prosperity goes back at least to Adam Smith’s The Wealth of Nations, which argues that laws and institutions that protect the liberty of individuals to pursue their own interests result in greater prosperity for the larger society.

Others argue the relationship goes in the opposite direction. Barrington Moore, for example, argues that a country cannot sustain democracy without a thriving middle class. People acquire property and material wealth first, and then demand a voice in government, including the freedoms to protect their wealth. This hypothesis goes all the way back to Aristotle, who posited that a large, prosperous middle class may mediate between rich and poor, creating the legal foundation upon which political freedom may function. A century ago, Max Weber extended this line of thought, proposing that the middle class defends its economic power by enshrining it in laws and institutions.

A third possibility is that there is a positive feedback loop; freedom begets prosperity, which, in turn, begets more freedom.

The idea that institutions are the key to long-run economic growth is well established in contemporary economic theory. Institutions provide the rules of the game. Rules that incentivize entrepreneurship, hard work, long-term planning, and broad access to economic opportunities tend to produce wealthier societies. Rules that stifle innovation, discriminate against certain segments of society, and do not guarantee that individuals will be able to enjoy the fruits of their labors and creations tend to produce poorer societies.

In theory, both democratic and autocratic countries could put in place sound economic institutions to produce long-run growth. But, in practice, democracies are much more likely to do so. Dictators often establish rules that maximize their political control and benefit themselves and their supporters, to the detriment of broader segments of society. On the other hand, because democratic leaders are drawn from, and represent, broader cross sections of society, they tend to put in place institutions that benefit wider swaths of that society.

We will not be able to definitively resolve this complex debate in a single report, but we do bring new data to bear on these questions. We believe that our data and associated analysis provide evidence that freer countries tend to become more prosperous.

In an effort to disentangle this relationship, we examined the strength of the correlations between freedom and prosperity over time. Using the same methodology, we re-created the 2021 Freedom and Prosperity Indexes for 2016, 2011, and 2006. We examined whether measures for freedom in prior years are associated with levels of prosperity in subsequent years. After all, changes in prosperity do not happen overnight. If freedom drives subsequent prosperity, then we should see the correlations between freedom in prior years more strongly associated with levels of prosperity in subsequent years.

This is what we found. Indeed, as one can see in Table 5 and Figure 6, the longer the time lapses between our measures of Freedom and Prosperity, the stronger the association. A country’s level of Prosperity today is better explained by its level of Freedom in 2006 than by its current Freedom. In this analysis we are concerned with the general trend over time, not the absolute differences from year to year. The correlation and R2 statistics are higher the further one goes back in time, indicating a stronger fit between past Freedom and future Prosperity. The 2006 Freedom Index, the earliest measure of Freedom calculated for this report, is most strongly associated with levels of Prosperity in 2021. While the relative differences may seem small, they are in a consistent direction. This rough test does not provide definitive proof that advances in freedom produce subsequent prosperity, but it is suggestive of such a dynamic and worthy of further investigation.

Table 5: Historical correlations

Prosperity 2021
Freedom Index Year	R2	Slope	Simple Correlation
2021	0.656	0.762	0.810
2016	0.662	0.771	0.814
2011	0.673	0.809	0.821
2006	0.677	0.834	0.823

Note: The table is based on the results of simple ordinary least squares regression, in which Prosperity Index 2021 is the dependent variable and time series of the Freedom Index are the explanatory variables.

We also tested the alternative hypothesis. Are past levels of Prosperity more strongly associated with current levels of Freedom? While there is a relationship, it is weaker than the link between Freedom and subsequent Prosperity. For example, the R2 statistic between Prosperity in 2006 and Freedom in 2021 is 0.613, while the same statistic for Freedom in 2006 and Prosperity in 2021 is 0.677. Freedom in a given year is more strongly associated with subsequent prosperity than the reverse. This simple test suggests that the relationship is driven more by a country’s level of freedom shaping its subsequent level of prosperity than by the reverse.

As we plan to update the data annually, we look forward to conducting further analysis on the direction and magnitude of the relationship between freedom and prosperity, and we encourage others to do the same.

We also analyzed the countries with the biggest score changes in the Freedom Index between 2006 and 2021. If our hypothesis is correct, we should expect big shifts in the independent variable (Freedom) to be associated with meaningful changes in Prosperity.

Two countries stand out for big changes in freedom over this period, and we found that their prosperity levels changed in the same direction.

Bhutan had the biggest jump in Freedom of any country between 2006 and 2021, and also showed an increase in Prosperity. In 2008, Bhutan experienced a transition from an absolute monarchy to a constitutional monarchy, including the establishment of an elected legislature. Bhutan’s Freedom Index score reflects these changes, with a 74-percent increase in Legal Freedom and a whopping 166-percent increase in Political Freedom between 2006 and 2021. Bhutan’s income score increased by 91 percent, and there was a 35-percent increase in its Environment score.

Venezuela, by contrast, is the country that lost the most freedom and prosperity between 2006 and 2021—a result with roots in Hugo Chávez’s increasing political repression and embrace of socialist and populist economic policies as he consolidated power. The country dropped more than 42 percent in its overall Freedom score. The fall in its Political Freedom score was most pronounced—a 68-percent drop. On the Prosperity Index, Venezuela’s score plummeted 24 percent from 2006 to 2021. The country was once among the wealthiest and most developed in Latin America, but now scores poorly on Health, Income, and Happiness.

Divergent development paths for formerly communist countries in Eastern Europe

As our next test, we look to the divergent paths of countries’ political and economic transitions after the end of the Cold War. The fall of communism in Central and Eastern Europe in the 1989–1990 period can be viewed as a kind of natural experiment. Before the fall, these countries had similar levels of freedom and prosperity. Some countries, like Estonia, Latvia, Lithuania, and Romania, chose democracy and free markets. Others, such as Belarus and Russia, came to be ruled by autocratic regimes over the following years. What was the result of these choices on the trajectories of their subsequent economic development?

These six countries had divergent economic paths between 1995 (the first year for which all countries had comparable data) and 2020. As we can see in Table 6, the countries that chose freedom are between seven and nine times wealthier today, while the countries that remained autocratic are only between three and five times richer.

Table 6: Increase of GDP per capita in selected former communist countries (1995–2020)

	GDP per capita (current US$)
	1995	2020	Multiplier
Estonia	3,134	23,027	7.3
Latvia	2,330	17,726	7.6
Lithuania	2,168	20,234	9.3
Romania	1,650	12,896	7.8
Belarus	1,323	6,424	4.9
Russia	2,666	10,127	3.8

The data from our Freedom and Prosperity Indexes show similar results, as can be seen in Table 7. Russia (ranked eighty-eighth) and Belarus (ranked eighty-second) underperform in the Prosperity Index relative to their freer neighbors.

Divergent development paths for people living under communist and democratic governments

Table 7: Scores of selected former communist countries

	Freedom 2021		Prosperity 2021
	Score	Rank	Score	Rank
Estonia	87.2	14	65.6	36
Latvia	81.7	25	62.6	42
Lithuania	81.8	24	63.9	39
Romania	76.3	36	59.8	51
Belarus	39.4	139	50.0	82
Russia	41.2	135	49.0	88

We can draw similar conclusions by looking at World War II as the starting point for a new development period. For decades after World War II, China, Germany, and Korea were divided. Some people lived in communist countries, while others lived in countries with free markets and with political regimes that either were democratic from the beginning (West Germany), evolved into a democracy (South Korea and Taiwan), or had a wide range of freedoms (Hong Kong).

This provides us with another natural experiment. Did people living in freedom become more prosperous over time?

We begin with Germany. According to Organisation for Economic Co-operation and Development (OECD) data, democratic West Germany’s gross domestic product (GDP) per capita in 1950 was only about 1.5 times larger than that of communist East Germany ($4,280 vs. $2,796). But, by the reunification of Germany in 1990, West Germany’s per capita income had grown to be 3.6 times larger ($19,441 vs. $5,403) than that of East Germany.

Let us now turn our attention to the Korean Peninsula. North and South Korea were both exceptionally poor in 1950. While both countries lacked political freedom from the end of the Korean War until 1980, they selected very different paths regarding economic freedom. South Korea’s dictators chose capitalism and secure property rights, while North Korea’s leaders selected a state-planned communist economy. By 1980, South Korea’s per capita income ($1,589) was more than double that of North Korea ($768).

Starting in the 1980s, South Korea transformed itself into a democracy, while North Korea remains a dictatorship. The addition of political freedoms in South Korea resulted in an even larger divergence in the economic paths of these two nations. United Nations data for 2021 show GDP per capita of $31,947 for South Korea and $639 for North Korea. Today, people living in the free South Korea are fifty times wealthier than those living in the unfree North Korea.

North Korea is not ranked in our indexes because it does not provide sufficient data. South Korea ranks thirty-fifth and Free in our Freedom Index and twenty-fifth and Prosperous in our Prosperity Index.

How does this story look when examining Chinese people living under different political and economic systems? The People’s Republic of China (PRC) has been under the control of the Chinese Communist Party (CCP) since 1949. China has never had political freedom, although it started instituting liberalizing economic reforms in the 1980s under Deng Xiaoping. Until its takeover by the PRC in 2020, Hong Kong was either under British control or an autonomous PRC region, enjoyed some democratic freedoms, and ranked among the freest markets in the world. Taiwan was established as a dictatorship at the end of World War II, but adopted free markets. It started transitioning to democracy after 1975. What were the results of these institutional choices?

The PRC, Taiwan, and Hong Kong were all poor in 1961, with GNI per capita of $76, $163, and $437, respectively. But, their different levels of freedom resulted in different levels of prosperity by 2020. Free Taiwan and Hong Kong were able to break out of the middle-income trap, while unfree China, at least to date, has not. The middle-income trap, a measure created by the World Bank in 2006, refers to a situation in which a developing country moves from the poor to the middle-income category, but gets stuck below the high-income threshold—currently calculated by the World Bank as $12,695 GNI per capita. In 2020, per capita income in China, Taiwan, and Hong Kong was $10,055, $25,055, and $46,324, respectively. These differences are also clear in our indexes. Taiwan ranks Free and Mostly Prosperous, while China ranks Mostly Unfree and Mostly Unprosperous. We have chosen not to rank Hong Kong because it is now under the control of the PRC.

Autocracies are generally not prosperous

Some might think that an autocratic ruler can guarantee stability and push through needed economic reforms. They might point to Singapore as an example of a prosperous non-democracy. But, such examples are few and far between.

Authoritarian leaders like to centralize power, and dislike strong economic institutions that may check their power. While authoritarian leaders may sometimes make good economic decisions, they frequently make catastrophically bad ones. For example, the collectivization of agriculture led to mass famine in Joseph Stalin’s Soviet Union, in Mao Zedong’s China, and in Kim Il-Sung’s North Korea. More recently, and less dramatically, bad financial decisions by Turkey’s leaders led to high inflation and currency collapse, while in Kazakhstan the long-lasting kleptocracy of former President Nursultan Nazarbayev and his family led to social unrest. Even if a country has a wise authoritarian leader who makes consistently good decisions, like Lee Kuan Yew of Singapore, there is no guarantee that his successor will be equally wise. Moreover, a model that might work for a small city-state like Singapore does not easily apply to larger countries.

Autocracies are also subject to rapid and dramatic reversals along the path toward greater prosperity. Venezuela, for example, a country rich in natural resources and with a democratic tradition, adopted authoritarian and socialist policies in the early 2000s. As a result, Venezuela lost two-thirds of its GDP from 2014 to 2019. This is comparable to the 60-percent drop in GDP Syria experienced during its civil war. Bad authoritarian leaders curtailing freedoms can devastate a country as much as a civil war.

Unfree societies do not depend on rules and institutions but, rather, on authoritarian decisions. These decisions may, at times, redirect capital and people toward more productive outlets and have a positive impact in the short term. But, over the long term, if these decisions are not accompanied by greater freedoms, these autocrats are likely to undermine any progress they achieve.

Likewise, the authoritarian tendency to accumulate power makes leaders reluctant to allow free markets, which, when properly regulated, reflect the decisions of numerous economic agents and are a sounder path to economic development than the decisions of an autocrat or central bureaucracy.

Figure 7: Comparative rankings in the components of the Prosperity Index

Note: We use the rankings of China and Russia and the average rankings of all countries included in the Free category. The five axes represent the five indicators forming the Prosperity Index. The center point represents a rank of one hundred and seventy-four, the worst possible performance. The outer line represents a rank of one, the best possible performance on each indicator.

China

China is often cited as a model of successful economic development, but our indexes do not bear this out. After seventy-three years of Communist Party leadership, China ranks one hundred and fortieth in the Freedom Index and one hundred and fourteenth in the Prosperity Index.

To be sure, China’s economic growth has been impressive in many ways, but it is still far from achieving broad-based prosperity. Looking at the components of the Prosperity Index, China ranks only fifty-seventh on the Income score, with a GNI per capita just over $10,000. This puts it squarely in the middle-income range, well below other Asian countries such as Japan, Taiwan, South Korea, and Singapore. While elites in China’s coastal cities are wealthy and there are far fewer Chinese living in poverty than in the past, the country’s interior remains largely poor.

China’s low position on the Prosperity Index is also explained by its Minority Rights rank of one hundred and sixty-seven out of one hundred and seventy-four (Figure 7). This score, part of our comprehensive view of prosperity, reflects China’s brutal policies in Tibet and genocide in Xinjiang.

There are also real questions about whether China’s state-led capitalist model can continue to deliver income growth. Xi Jinping prioritizes political control over economic growth, and has been backtracking on liberalizing reforms, as seen in his crackdowns on the Chinese tech sector. Moreover, China’s past path to growth was driven largely by exporting cheap manufactured goods and major infrastructure investments by the CCP.

To break out of the middle-income trap, however, China will need to become a true innovation leader and develop a consumer-based market. It is unclear whether it can make that transition without more freedom.

Furthermore, China has many other structural deficiencies, including high levels of pollution, massive corruption, a shrinking of the working-age population as a result of the failed one-child policy, excessively harsh yet ineffective COVID-fighting policies, and an international community that is becoming more fearful of economic dependence on China. The CCP announced in March 2022 that China’s GDP growth target for the year was “around 5.5 percent,” the lowest in thirty years. But, just a month later, the International Monetary Fund projected a 4.4 percent growth rate and some economists predict growth rates of under 4 percent. Even Xi Jinping has admitted that slow growth in China is “the new normal.”

Russia

Russia is a prototypical example of a Mostly Unfree and Mostly Unprosperous country. It ranks one hundred and thirty-fifth on the Freedom Index and eighty-eighth on the Prosperity Index. This is the result of more than seven decades of communism and two decades of authoritarianism after the fall of the Soviet Union in 1991 (with a brief period of experimentation with freer markets and political pluralism in the 1990s).

Russia enjoyed strong economic growth in the early years of the 2000s, thanks largely to high oil prices and more open markets. Russia, like China, is a middle-income country with a GNI per capita of approximately $10,000. Russia is similar to China on many metrics of Prosperity, with the exception of Minority Rights (one hundred and forty for Russia), where China ranks even worse. The data for our analysis were collected before Russia’s invasion of Ukraine. As Vladimir Putin clamps down on Russian society during the war, we expect Russia’s freedom and prosperity to decline further in the coming years.

Oil-extracting autocracies

The major exception to our finding that autocracies cannot produce prosperity comes from oil-rich states, like the Gulf monarchies. Oil revenues have allowed these autocracies to provide their citizens with some of the highest per capita incomes in the world.

Gulf monarchies

The Gulf monarchies, with the exception of the United Arab Emirates (UAE), all fall into the Mostly Unfree category.

Due to their ability to generate large revenues from oil extraction, however, these countries rank highly in one of the key prosperity indicators, GNI per capita. Their scores on our Prosperity Index, however, suffer because they rank poorly in other prosperity indicators like Environment and Minority Rights.

While Gulf monarchies have seen record income from high oil prices over the preceding decades, the world may be moving away from fossil fuels and toward cleaner forms of energy. To succeed in such an environment, oil-producing states will need to liberalize their economies and allow their people more freedoms.

Some Gulf monarchies are already taking limited steps in this direction. In Saudi Arabia, for example, the government has recently granted women greater rights and further opened to foreign investment.

United Arab Emirates

The UAE has been leading the way toward more freedom in the Gulf region. It outperforms all the other Gulf monarchies in both freedom and prosperity. While its Political Freedom measures are quite low, it does allow a wide range of Economic and Legal Freedoms. Indeed, taken together, these freedoms are sufficient to move the UAE into the Mostly Free category—the only country in the Gulf to receive this distinction. These greater freedoms have also resulted in superior economic performance. The UAE bests its neighbors to rank as the thirty-fourth most prosperous country globally in our index.

Singapore

Singapore is often mentioned as the leading example of how autocratic systems can provide economic prosperity. Our Freedom Index reveals, however, that the secret to Singapore’s success is quite straightforward. While Singapore ranks poorly on Political Freedom, it has among the highest levels of Economic and Legal Freedoms. Indeed, Singapore ranks as a Mostly Free country, and barely falls short of our threshold for fully Free.

Singapore demonstrates, therefore, that this model can work, but its example may be sui generis: Singapore is a small city-state. Indeed, there is much evidence that small countries open to international trade can prosper. But, it would not be easy to run a larger country in such a centralized manner.

In addition, Singapore has been governed, so far, by fairly wise autocrats who have continually prioritized economic and legal freedoms. Given that political power in the country is concentrated, however, there is always the risk that future leaders would choose to rein in these freedoms. While it may seem foolish to kill the goose that laid the golden egg, there are many examples of autocratic leaders doing just that if they feel that it is necessary to protect their political power. Allowing more political freedom in Singapore would provide guardrails against arbitrary changes to Singapore’s successful economic model, and better ensure its future prosperity.

Methodology and FAQ

2021 methodology

In depth Methodology

FAQs

Frequently Asked Questions

1. What are the Atlantic Council Freedom and Prosperity Indexes?
The Freedom Index measures economic, political, and legal freedoms for nearly every country in the world. The Prosperity Index measures economic wellbeing and human flourishing for the same countries. The indexes can be used to inform policymakers about real-world reform opportunities in developing countries.

2. What time period does the report cover?
The 2021 Freedom and Prosperity Indexes use the most recent data available. Most of these data are from 2021. Where data from 2021 are not available, data from the most recent year available are used instead.

In addition, we collected historical data to construct the indexes for the years 2006, 2011, and 2016. This allows us to track national trajectories over time, even in the first year of the indexes.  Going forward, we plan to update the indexes annually.

3. How are the data collected?
The Freedom Index and the Prosperity Index are constructed on a diversified data and analytical basis, comprising different databases produced by the American Economic Journal, the Center for Economic and Policy Research, the Credendo Group, the Fraser Institute, Freedom House, the Fund for Peace, the Heritage Foundation, NASA, Transparency International, the United Nations, the V-Dem Institute, the World Bank, and the World Justice Project.

4. What do the scores capture?
The Freedom Index and Prosperity Index are two separate indexes that rank 174 countries around the world according to their levels of freedom and prosperity. The Freedom Index measures Economic Freedom, Political Freedom, and Legal Freedoms. The Prosperity Index measures Income, Environment, Health, Minority Rights, and Happiness.

For more details on the construction of the indexes, please refer to the Methodology section.

5. How does the scoring system work?
All measurements in the indexes are weighted equally and the score for each index is the simple average of its parts. Scores range between zero and one-hundred, with higher values indicating more freedom or prosperity. Where appropriate, raw data are converted to a 0-100 scale.

6. What are the different scoring categories?
Countries on the Freedom Index are divided into four categories based on their overall score: those above a 75-point score (Free), those with scores between 50 and 74.9 (Mostly Free), those with scores between 25 and 49.9 (Mostly Unfree), and those with score from 0 to 24.9 (Unfree).

The same categorization is used for the Prosperity Index: those above a 75-point score (Prosperous), those with scores between 50 and 74.9 (Mostly Prosperous), those with score between 25 and 49.9 (Mostly Unprosperous), and those with scores from 0 to 24.9 (Unprosperous).

7. How is the ranking constructed?
We rank Freedom and Prosperity separately, and countries are ranked according to their score. Scores range between zero and one-hundred, with higher values indicating more freedom or prosperity.

8. Where can I view past years’ scores?
All the data are accessible on this website and can be downloaded.

9. Is there a link between Freedom and Prosperity?
We find that freedom and prosperity are highly correlated. The correlation coefficient between the indexes is 0.81. High values of Freedom are associated with high values of Prosperity, and low values of Freedom are associated with low values of Prosperity.

We find that the strength of this relationship increases the further one goes back in time. A country’s level of Prosperity today is better explained by its level of Freedom in 2006 than by its current Freedom, suggesting a relationship that is worthy of further investigation.

10. What makes the indexes different from other existing indexes?
There are several existing indexes that measure freedom and prosperity around the world, and our research built on these efforts. But the Atlantic Council Freedom and Prosperity Indexes are unique.

We define freedom comprehensively. Existing indexes measure economic freedom, political freedom, and legal freedoms separately, but no other index combines those measures to offer a comprehensive measure of freedom. It is our belief, supported by scholarship and historical evidence, that countries with all three types of freedom, working together in a manner that is mutually reinforcing, are best able to secure durable development.

We define prosperity comprehensively. We go beyond material measurements like income per capita and healthcare. We argue that a truly prosperous country should also score well on environmental performance, treatment of minorities, and the general happiness of the population.

We constructed separate indexes for freedom and prosperity. By creating two distinct indexes, we hope to give researchers a better opportunity to analyze the relationship between freedom and prosperity. We also offer policymakers and other thought leaders clearer benchmarks for implementing reforms and tracking results over time.

11. How do you prevent political bias?
The methodology used to produce the indexes is straightforward and transparent. We provide all the information to replicate them.

We did our best to collect the most reliable information available. The objective of these indexes is to provide standardized measures that can be applied to every country. One might argue that the methodology or the data collected is irrelevant to certain types of political situations or specific countries. That might be the case in some instances, but rarely so. Moreover, there is an inherent tension between generalizable and specific knowledge. We self-consciously opted for the former. We would encourage other researchers to explain how our indexes illuminate or obscure country-specific dynamics.

12. What are the limitations of the indexes?
Ensuring comparability of the data across a global set of countries was a central consideration. When selecting sources to be included in the indexes, coverage was the determining factor. In the rare case of missing data for a certain year, we have replaced the missing data with data from the closest available year. All these instances are described in the dataset.

Data were collected over the past year, using the most recent information available. They might not reflect the latest political or economic developments. These indexes should not necessarily be taken as an accurate reflection of the most recent current events. We will, however, update the indexes over time to capture real-world changes on an annual basis.

Authors

Staff

Dan Negrea

Senior Director

Freedom and Prosperity Center

China Economy & Business

Staff

Matthew Kroenig

Vice President and Senior Director, Scowcroft Center for Strategy and Security

Scowcroft Center for Strategy and Security

China Defense Policy

Technical Advisers

Staff

Joseph Lemoine

Deputy Director

Freedom and Prosperity Center

Africa Economy & Business

Former staff

Joel Kesselbrenner

Freedom and Prosperity Center

Economy & Business Inclusive Growth

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China’s leaders spent the first months of 2022 in damage-control mode, as a host of economic problems and new pandemic-related challenges piled up. With the entire city of Shanghai under a zero-COVID lockdown, the crackdown on technology firms ongoing, and the property sector deteriorating, good economic news was scarce. The lockdowns alone—not considering the less dire zero-COVID measures—have affected more than 25 percent of China’s population, hitting consumption and manufacturing across the country and triggering a broad public outcry.

On the geopolitical front, Beijing’s ambiguous positioning on Russia’s invasion of Ukraine raised the prospect of secondary sanctions, amplifying the risk calculations for foreign businesses in China. Foreign capital, meanwhile, has been flowing out of China amid a mounting debate about whether the country is becoming “uninvestable.” With the 20th Communist Party Congress scheduled for November, China’s leadership will be firmly focused on ensuring stability and growth this year, pushing reform down its list of priorities.

The bottom-line assessment for Q1 2022 shows Chinese authorities were active in three of the six economic clusters that make up the China Pathfinder analytical framework: financial system development, competition policy, and portfolio investment openness. There were fewer developments in the innovation, trade, and direct investment clusters. In assessing whether China’s economic system moved toward or away from market economy norms in this quarter, our analysis shows a distinctly negative shift.

This issue of the China Pathfinder Quarterly Update highlights China’s improbable GDP growth target for 2022. At 5.5 percent, it was seen as a stretch even before a new round of COVID-related lockdowns was imposed in the waning days of Q1. Beijing’s subsequent insistence on upholding the target suggests that political objectives will trump reform priorities in the run-up to the Communist Party Congress in late 2022. The report dives into three main factors contributing to slowing economic growth: the flagging real estate market, ongoing tech crackdown, and widespread zero-COVID lockdowns.  

View the full issue brief below

The China Pathfinder Project

China is a global economic powerhouse, but its system remains opaque. Policymakers and financial experts disagree on basic facts about what is happening inside the country. To create a shared language for understanding the Chinese economy, the China Pathfinder project scores China and other open market economies across six key areas and presents an objective picture of China relative to the world.

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The Atlantic Council’s GeoEconomics Center has teamed up with New Financial to produce an ambitious blueprint for the future of UK banking and finance. 

Clear and concise, our 62 recommendations cover all these areas while emphasizing the need for more rapid reform in three broad areas:

·      Enabling the sector to better support the UK economy

·      Improving its international competitiveness

·      Mapping the role it can play in developing global cooperation and partnerships

Our blueprint is resolute in calling for a new regulatory framework that is dynamic, outcomes-based, and data-led. Brexit provides the UK with an imperative to rethink its role as a banking and finance hub. The financial bubble should move on from debating the trade-off between divergence from the EU rule book and access to the Single Market. 

Specific recommendations on prudential and market policy should help the industry better support the wider UK economy. We are also adamant about the “digital first” approach the UK should be taking, with the aim of leading global innovation in areas such as data sharing, open banking and digital IDs.

Our analysis suggests that the UK has the potential to achieve as much as 40 percent growth in its capital markets, with nearly two thousand additional companies a year could raise an additional $75 billion per year in the capital markets, an increase of around 40 percent. This will have enormous implications both for the UK and the global economy.

The launch of this report was marked by a conference held at Banqueting House in London. UK Economic Secretary to the Treasury John Glen provided keynote remarks. Following his address, the conference examined the key domestic and international implications of the report in two high-level panels.

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At the time of the first COVID-19 lockdowns there was fear in many economies of another Great Depression. However, for large parts of the world, the economic recovery has been stronger and faster than anticipated despite challenges from high inflation and, more recently, Russia’s invasion of Ukraine and its economic fallout. For example, at the start of 2022 the EA and US GDP trajectories were already approaching pre-pandemic trend levels. The recovery has been better than past ones in part due to enormous fiscal spending. Compared to the Great Recession, both the EA and US used fiscal stimulus to a much larger degree.

While both the EA and US spent more this time around, how they went about fiscal stimulus was notably different. In the EA, much of the income support for workers was funneled through their employers. Most EA countries paid employers to keep furloughed workers on their payroll while not working, and paid them a high but less than equal percentage of their working wages (on average ~75 percent). In the US, UI was expanded to include more types of workers than previously accepted, the length of time workers could be on UI was extended, and the amount of income support provided was greatly elevated. In some cases, US workers were receiving more than 100 percent of their working income. In addition, multiple rounds of stimulus checks were sent to US households.

Structural differences in EA and US labor markets, differences in spending magnitude, and differences in public health management make policy impact comparisons inexact. However, it is clear both policy regimes were effective and present tradeoffs.

As a result of EA furlough programs, employment levels were affected very little, and much less than in the US. Employment is also back to pre-pandemic levels, unlike in the US. Relatedly, these policies were very successful at keeping workers in the labor force. In many EA countries the labor force participation rate has been higher for most of the pandemic recovery than the US’. Labor market stability is one reason inflation in the EA has been lower than in the US.

On the flip side, real wages for US workers grew faster for much of the recovery because they have been less attached to pre-pandemic employers (though recently both have been struggling with surging inflation). Job switching and competition for labor are driving forces behind rising wages as employers try to attract employees. In addition, self-employed workers likely fared better in the US from direct income support. Lastly, unlike the EA there has been a burst of new business formation in the US, which could have long-run impacts as economies evolve after the pandemic.

From a public finance perspective, it appears the EA was more efficient than the US as the EA has had higher GDP growth per unit of public debt issued. This reflects political choices in terms of how much to spend, policy effectiveness, and differences in administrative capabilities. For example, the US struggled to effectively implement enhanced UI. As a result, a crude measure emerged where one dollar amount was instituted instead of a given percentage level of lost wage income. This led to a larger percentage of Americans receiving more money from UI than they did while working than policymakers necessarily intended. Other areas of inefficiency in the US fiscal response include employee-retention tax credit processing and the primary attempt at a large-scale furlough style policy, the Paycheck Protection Program (PPP). PPP had positive impacts but also helped lots of employers that likely did not need assistance.

The EA and US fiscal policy responses to the COVID-19 pandemic have led to stronger economic recoveries than many imagined. However, there is always room for improvement and lessons to be learned. Moving forward EA and US policymakers should assess the strengths and weaknesses of both approaches while improving components of their respective fiscal policy apparatuses as needed. Both furloughed job and income support methods may be needed when responding to future crises. Policymakers should have a complete toolkit available to respond in the most effective and efficient manner.

Jeff Goldstein is a contributor to the Atlantic Council’s GeoEconomics Center. During the Obama administration he served as the Deputy Chief of Staff and Special Assistant to the Chairman of the White House Council of Economic Advisers. He also worked at the Peterson Institute for International Economics. Views and opinions expressed are strictly his own.

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Introduction – Prospects and trajectories for the Chinese economy

After several decades of spectacular growth, a variety of structural problems have become more challenging for China. Growth based on investment and export has slowed in recent years. Importantly, China’s population is aging rapidly with the labor force having already shrunk.  As a consequence, total factor productivity growth has been slowing—to 1.1% per year in the past decade and a half, less than a third of the rate in the previous three decades.  In addition, China is engaging in a strategic competition with the US and Europe, making for a difficult, and at times hostile, world environment for its economy compared with the previous period. Against this backdrop, Chinese leaders especially President Xi Jinping have tried to transform the Chinese economy from the old investment and export-based model to one driven by innovation—basically to improve productivity and compensate for the declining labor force.

A three-stage framework

This paper examines the factors that could support or hinder China’s efforts to transform its economy to one driven by innovation; using a three stage framework to analyze the process of producing and using innovations. The three stages are:

• input mobilization stage
• R&D stage
• output implementation stage.

This framework can help assess the relative strengths and weaknesses of China’s governance model combining party/state political control with market mechanism. Such a governance model, and until recently together with favorable global conditions and China’s demographic tailwind, delivered spectacular economic growth in the past four decades. The key question now is whether it can turn China into an autonomous innovation powerhouse, driving growth in the future.

By and large, many if not most observers in the West are skeptical of China’s ability to do so, mainly based on their negative view of Xi Jinping’s increasingly autocratic rule, tightening central control over society and the economy. While such a negative assessment of Xi’s concentration of power has merits, to summarily conclude that China’s technology push is destined to fail—no matter how intuitively appealing this conclusion is—risks underestimating China. This is not a wise thing to do while engaging in a strategic geopolitical struggle against the world’s largest economy (in purchasing power parity terms). It is better to strive for deeper insights into China’s strengths and weaknesses—to better evaluate the prospects of the Chinese economy and of the technological rivalry which forms a key part of the US-China geopolitical and strategic competition.

Conclusions

On balance, China can be said to have relatively more strengths in the input mobilization and output implementation stages; and more weaknesses in the R&D stage. In other words, China has been a good innovation sponge, but yet to show that it can be an innovation leader. Specifically, in the next 10-20 years, there are still many benefits in fully rolling out cutting edged but known technologies such as 5G/6G telecommunication, the Internet of Things (IoT), EV/ batteries/charging stations, smart cities and homes, automation and robotics etc. Doing so quickly at scale will give China first mover benefits as well as the ecosystem with which to foster further developments of the digital economy and society.

Beyond this foreseeable future, however, China may encounter difficulties in fostering major transformative innovations due to its authoritarian regime which restricts the free flow of ideas and information. As such, its ability to establish an autonomous innovation leadership position in the world and use it to drive economic growth remains an open question.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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The 2018 loan was negotiated when I was heading the department responsible for the IMF’s overall strategy and policies. Since then, the fund’s staff has produced a hard-hitting assessment of the factors that contributed to the loan’s failure. With Argentina unable to meet its debt-service obligations this year, the board had to decide between providing the country with fresh funds or accepting its largest borrower going into default.

The board’s reasons for choosing the former were many. First, a default on the IMF loan would have brought suffering for ordinary citizens, if market access for Argentine borrowers was sharply curtailed. Second, it would have left Argentina unable to borrow from the fund again until its arrears were cleared with bridge loans from friendly countries. Third, it could have fueled already strong anti-IMF sentiment in the country, undermining chances to resume negotiations at a later stage. And fourth, it would have hit the IMF’s financial reputation, even though its balance sheet could absorb an arrears resolution process over a few years.

With the world economy suffering from a multitude of shocks since 2020, the geopolitical rationale for tiding Argentina over its repayment hump has grown even stronger. Financial exposures to Argentina have been reduced in recent years, but global debt markets are strained and more vulnerable than usual. A possible debt default by Russia still hangs in the air and higher interest rates threaten borrowers, with global credit at an all-time peak. Inflation and commodity price shocks are likely to reverberate through global markets once lenders fail to get repaid. Against this backdrop, deteriorating economic sentiment in Latin America—a relatively stable region in recent years—could create yet another front that nervous investors would watch anxiously.

Moreover, the world should not have to focus on a crisis in Argentina when every effort must be centered on helping the Global South withstand an impending food crisis, caused by the projected drop in grain exports from Ukraine. Buenos Aires has also played its geopolitical cards smartly in recent weeks. While finalizing a staff-level agreement with the IMF, President Alberto Fernández joined China’s Belt and Road Initiative during his visit to Beijing (with a stop in Moscow), sending a strong signal to Washington and its Western allies.

However, the terms of the fresh loan could create the impression that IMF money is now freely available to cure the financial ills of any country demanding it loudly enough. Unlike the countries receiving emergency financing at the outset of the COVID-19 crisis, Argentina’s problems are largely homemade. Although a member of the Group of Twenty (G20), its economy has been badly mismanaged over several decades. Previous governments were either unwilling or lacked bipartisan support to undertake critical reforms to lift the country onto a sustainable growth trajectory.

With the just-approved loan, Argentina missed an opportunity to signal that it is willing to deviate from the past. Compared to an average IMF program, Argentina’s loan has come with hardly any strings attached, including a slow fiscal adjustment path that will surely be discarded by policymakers once campaigning for the next election begins in a few months. Although IMF directors emphasized the need for “gradually removing economic distortions and providing a more predictable regulatory framework,” the government refused to consider productivity-enhancing reforms over the thirty-month loan period, favoring “a model of greater state involvement and protection,” according to the IMF staff report.

As is often the case with IMF programs, growth and inflation projections look overly optimistic. Yet, IMF staff concede that the test for debt sustainability is not met with high probability, as would be required in cases that exceed normal lending limits. The program can go forward on a technicality as there is sufficient private-sector debt that Argentina has “the option to implement a more definitive debt restructuring,” according to IMF policy, in case downside risks jeopardize its capacity to repay the IMF after the end of the program. However, in these circumstances and after two major haircuts on private bond holders during the past twenty years, obtaining market financing at affordable rates will remain an uphill battle for years to come.

In effect, the program seems to be little more than a refinancing of the previous IMF loan that the Fernández administration has loudly demanded, but that has long been a taboo for the fund’s shareholders. It is not unusual for successor arrangements to follow IMF programs. However, these have traditionally served to complete unfinished reforms, not to perpetuate the fund’s own exposures.

With its approach in Argentina, the IMF has now compromised its capacity to deal with future crises. The fund’s leverage to convince hesitant governments to undertake necessary reforms will be diminished by this program. Private-sector creditors will find it even harder to accept debt write-downs if the largest multilateral lender keeps itself whole without increasing a borrower’s ability to fulfill its obligations to other lenders. The IMF’s preferred creditor status may come under scrutiny, and solving the growing problem of excessive sovereign debt around the world will become more complex as a result.

The decision is partly the responsibility of the IMF’s leaders who seem to have acquiesced to intense pressure, believing that the program outcome this time will be different. Even so, political ownership even for this minimalist program is badly missing in Buenos Aires. The ratification bill faced opposition even among the ruling coalition, and lawmakers weakened language on Argentina’s commitments to ensure passage in the lower house. It would have required strong support from key IMF shareholders to convince Argentina’s body politic of a different approach.

It is still not too late for the IMF’s board to regain the initiative. During the coming reviews, a determined Group of Seven (G7) could press for a modicum of reforms to improve the program’s chances of success. This is not only about Argentina, but also about fixing a bad precedent before the world faces a fresh economic downturn that will require the IMF to be at the top of its game. The fund’s major shareholders would be well advised to exercise their geopolitical unity when it comes to stiffening the backbone of the world’s lender of last resort.

Martin Mühleisen served as the IMF’s director for strategy, policy, and review from 2017 to 2020.

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Climate change hazards, from rising sea levels to forest fires, are set to asymmetrically impact the Mediterranean’s coastal ecosystems. In addition to increased natural disasters, climate change also will exacerbate the region’s economic vulnerabilities stemming from resource scarcity, heat stress, and impacts on tourism. With increased stress on populations in the region, climate pressures have the potential to indirectly exacerbate violent conflict.

The potential for future threats from climate change necessitates that nations consider not only national climate plans, but strategies to mitigate global pressures on supply chains, food systems, and economic interdependencies to manage cross-border risks. The United Nations Environment Programme’s Mediterranean Action Plan serves as a starting point by assessing these risks. Building on it, the European Union can direct development assistance towards strengthening countries’ abilities to adapt, further strengthened by transatlantic cooperation. In anticipation of the security ramifications of climate change, NATO should set climate adaptation as a priority.

The transition to renewable energy will result in both economic and geopolitical benefits through the creation of jobs and development of advanced technologies. Tourism, which makes up a fifth of Greece’s GDP, is likely to be adversely impacted by higher temperatures and natural disasters. This could generate additional risk for Greece’s financial credibility. The EU should consider this as a threat to the institution as a whole, with Greece and Cyprus the member states most vulnerable to climate change. Fortunately, Greece has a solid foundation from which to build up its climate resiliency, as strategies to this end are part of the Greece 2.0 plan and the country is already one of the top producers of wind and solar energy globally. 

The Mediterranean should not be making these efforts alone as economic and geopolitical stressors cause cross-border instability, a strong motivator for the region and partners to deliberately address climate adaptation in tandem.

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Introduction                                     

The United States’ aging infrastructure is currently unable to support the kind of economic growth and productivity it needs to successfully compete with other advanced and emerging economies. This includes the present state of nontraditional infrastructure, such as the semiconductor industry; and recent shortages have highlighted US dependency on foreign producers. Inbound FDI stock in the United States has grown over the past decade, but the rate of FDI inflows has slowed down over the last five years: a decline of 71 percent between 2015 and 2020—while annual FDI inflows into competitors such as China have increased by 20 percent. 

Targeting key areas 

Infrastructure spending should not only mean investing in roads, ports, and electricity grids. Rather, it should also incentivize inbound FDI in sectors that are critical for the US economy: large capacity batteries, semiconductors, and smart and green infrastructure. The global competition for FDI is increasing, and the United States needs to adapt swiftly to the changing FDI marketplace if it is to remain the largest recipient of FDI in the world. This includes encouraging US outbound FDI in sectors and countries that are of strategic importance for the United States. They provide metals and materials essential for ensuring the efficiency of US manufacturing and supply chain resilience.

The solution 

The well-being of the US economy depends heavily on immediate and massive investments in the US infrastructure. Therefore, promoting FDI both domestically and internationally must play a key role in the United States’ infrastructure and supply chain resilience strategy. It would in turn increase the productivity, efficiency, and competitiveness of the US economy, contributing to its sustained appeal as a leading FDI destination in the second quarter of the twenty-first century. The recent $1 trillion infrastructure law is a step in the right direction, but the government should also spur private investments in US infrastructure, both domestic and FDI, through various incentive programs. 

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On March 29, Forward Defense nonresident senior fellow Peter J. Dean wrote an article in the the Conversation titled “Budget 2022: the government spends big on its ‘khaki election’ strategy, but neglects diplomacy and other ‘soft power.'” Dean breaks down Australia’s latest budget which increases spending on defense and cybersecurity while neglecting veterans and diplomacy.

While Morrison and Defence Minister Peter Dutton were happy to splash money on defence capabilities, over in veterans’ affairs things were not so rosy.

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The post Tran quoted in South China Morning Post on the impact of western sanctions imposed on Russia and how countries might attempt to circumvent them appeared first on Atlantic Council.

The message was delivered by Vice Premier Liu He and the Financial Stability and Development Committee under the State Council (FSDC), which is one of the strongest mouthpieces for economic policy support available to Beijing, short of a speech by Li Keqiang or Xi Jinping. But fundamentally, the statement was reactive to the selloff that had taken place earlier in the week, which saw Chinese equities and bonds drop by margins unseen since 2008 and reflected numerous economic threats metastasizing at once.  These included renewed pressure on China’s economy because of the emerging Omicron outbreak, multiple defaults by Chinese property developers, the threat of delisting Chinese stocks in the United States, further regulatory crackdowns against Chinese platform and technology firms, and rising political risk associated with China’s perceived political alignment with Russia.

The sudden need for a statement from Liu He’s office highlights how the Russian invasion of Ukraine has created a massive wedge between political leadership in China and technocratic officials managing financial markets.  Political leaders are concerned primarily with how China can use its relationship with Russia to advance China’s interests in a longer-term competition with the United States and US-led alliances, and are willing to incur economic costs to do so.  Technocratic China, in the voice of Liu He’s FSDC, seems to have reminded political leaders this week that China remains highly reliant upon stable financial market conditions, needs significant inflows from foreign investors, and requires at least the perception of well-executed domestic economic policies consistent with liberalizing markets. China’s perceived alignment with Russia, along with problems in policy messaging and coordination over the past year, were damaging all of those objectives.

Foreign investors have been reducing their exposure to China and there is a growing contingent who think China is becoming “uninvestable.” Financial technocrats have spent years establishing channels like the Stock and Bond Connect programs to invite foreign investors into Chinese markets. China faces inevitable pressure from capital outflows. It sits on top of the world’s largest money supply: over $38 trillion, expanding at a pace of around $3 trillion per year. This creates incentives for Chinese households and corporates to continuously diversify into foreign assets.  This week, the promise of long-term counterbalancing inflows back into Chinese markets came under attack from multiple channels, and Beijing felt compelled to respond, or at least try to reassure financial markets. Whether or not this message succeeds will become clear over the coming months. 

The substance of the FSDC announcement was less significant than the statement itself, which refuted growing market fears that Beijing was either asleep at the wheel, indifferent to market contagion, or actively contributing to some of the selloffs in technology and platform companies. The FSDC statement contains five key messages, all corresponding to some specific market concern in recent weeks.  In order, those concerned the state of China’s economy, pressure on property developers, delisting of Chinese stocks, regulation of technology and platform companies, and specific concerns about the Hong Kong market. The order probably does indicate a relative ranking of priorities for Beijing.

On March 15, the NBS announced surprisingly upbeat growth numbers for the first two months of the year. But instead of boosting market confidence, investors questioned the quality of data and rushed to exit their positions, fearful that Beijing would not actually take concrete steps to boost the economy this year, and would merely massage the economic data. The FSDC statement pledged to “concretely improve the economy in Q1 and monetary policy will be more proactive.” This is a clear message that at least financial technocrats do not see a solid foundation in the recovery so far in Q1 and monetary easing remains on course.  Technically, the PBOC could cut interest rates on medium-term lending (MLF) rates at any time, but the most likely window remains the next regular MLF operation on April 15. The FSDC statement may even generate momentum to take a more dramatic step and cut benchmark deposit rates. This has not occurred since October 2015.

The second message involved property developers and did not break much new ground, merely pledging to study and unveil forceful measures to prevent and address risks. Local governments have already unveiled several initiatives to boost demand, and Beijing has helped them encourage asset management companies and state-owned developers to take over projects from distressed firms and keep construction going.  But the problem in China’s property sector right now is that no one is buying houses, with 30-city sales down 48% y/y in the first 14 days of March, deepening declines from earlier in the year. Supply in recent years has run far ahead of fundamental demand from owner-occupiers. Speculators filled in that gap in the past but those investors are now staying on the sidelines, particularly as the Omicron outbreak gains momentum. It is possible Beijing will push hard on property tycoons themselves to use their own money to alleviate financial pressures and repay debt, but ultimately, the recovery of the sector depends on a recovery in sales.

In terms of the potential delisting of Chinese stocks from US markets, the FSDC said China and US are making positive progress and working on detailed plans, and that the Chinese government continues to support all firms listing overseas. The CSRC has pretty much said the same thing in recent days but clearly, a message from the FSDC is much stronger and may suggest that concrete concessions to US regulators will soon be on offer.  Given the rapidly approaching delisting timelines, significant progress is likely to be necessary to maintain investor confidence that the delisting threat is being delayed or eliminated. Talk here is cheap, even from Liu He’s office, as these issues have remained unresolved for years.

The message regarding platform and technology firms should probably be interpreted far more cautiously than the immediate optimism from equity markets over the past two days. The statement only says that regulatory work will make progress while maintaining stability (regulators will not stop their campaign, but they will try to make it less destructive to the market). Regulatory work needs to be transparent and anticipated (in our interpretation, this means the FSDC needs to know what the rest of the bureaucracy is doing). The statement also says that government ministries need to coordinate with financial regulators before issuing policies that will have a major impact on capital markets. This could mean more coordination behind policies and less immediate political risk of events such as the crackdown on education technology firms last July, which wiped out valuations in the sector.

The FSDC statement addresses a real concern for financial markets, as policymaking has become far less coordinated under the State Council and individual ministries have taken their own initiatives to respond to leadership priorities such as “common prosperity,” without much concern for the potential collateral damage. But this problem persists, even if the FSDC is aware of the costs. After the FSDC meeting, all relevant financial regulators issued their own version of a statement echoing the FSDC’s priorities, but there was nothing from the Cyberspace Administration of China (CAC), from the Ministry of Education, or even from the State Administration for Market Regulation (SAMR). All of these agencies generated their own forms of market risks over the past year. Bureaucratic conflicts in the service of leadership priorities can still easily break down policy coordination and effective messaging to markets.

In response to the statement, optimistic sentiment surged in financial markets.  There was a low threshold for good news to clear after the concatenation of factors that had produced the selloff earlier in the week.  The credit impulse should finally turn positive in April or May, and equity market performance has historically improved under these circumstances.

Beijing has clearly demonstrated their awareness of the problematic narratives that have been developing around the Chinese economy, and in a politically important year, an escalating financial market rout is one of the last things political authorities want to see.  But Beijing’s concern should now be focused on the effectiveness of policy support, not the tone of leadership statements.  And there are still many hills to climb to address the real concerns of investors that produced the selloff in the first place.

Daniel H. Rosen is a Senior Fellow with the Atlantic Council GeoEconomics Center

Logan Wright is a Contributor to the Atlantic Council and partner at Rhodium Group

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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The post Beijing’s message to financial markets: We’re listening appeared first on Atlantic Council.

Yet, although the announcements showed a policy reorientation that will help a number of listed companies, they indicate the reorientation by only one of many bureaucracies which influence listed companies in China. In addition, top-down dictatorial leadership in China, as well as the leadership’s evolving policy preferences, will continue to give rise to higher volatility for Chinese companies—especially in the tech sector.  

The March 16^th FSDC meeting does represent a clear policy reorientation by the financial bureaucracy in China. For overseas listed stocks, especially, the financial technocrats in China had threatened to force Chinese companies that had listed in the United States to delist over differences in auditing standards between the United States and China. The FSDC assuaged investors’ concerns by stating that the United States and China “are working hard to formulate a specific proposal for cooperation. The Chinese government continues to support all kinds of companies (in China) to list overseas.” For internet companies, the FSDC called for “stable and healthy development of (internet) platforms…through standardized, transparent, and well expected regulations….” After a year of unrelenting regulatory actions against the internet industry, this provided a bright ray of sunshine.

Perhaps most important after a year of regulatory actions against some of China’s largest listed companies, the FSDC urged that “for policies that have major impact on the capital market, (the issuing agency) should coordinate with financial regulators ahead of time in order to maintain the unity and stability of policy expectations.” This statement clearly sought to assure investors surprised by an unrelenting stream of policies which affected revenue, or even the basic business models of a wide range of Chinese companies in the past year and half. 

Despite these assurances, FSDC statements must be taken with a large pinch of salt. For one, agencies under the control of FSDC, especially the power trio of the People’s Bank of China, the China Banking and Insurance Regulatory Commission, and the China Securities Regulatory Commission, traditionally held important sway over listed companies. However, the Cyberspace Administration of China (CAC), which is outside of FSDC control, has emerged as an impactful agency for tech companies listed in China and overseas. The CAC is the administrative arm of the Central Commission on Internet Security and Informationization (CCISI), which is chaired by Xi Jinping himself. Since the commission is directly under the Central Committee, CCISI and CAC by extension are entirely outside of FSDC jurisdiction. As a State Council organ, FSDC only has jurisdiction over financial regulatory agencies in the State Council.

Although relatively restrained in its first few years of its existence, the CAC engaged in a series of regulatory actions in the past year and half, including placing a daily gaming limit on young people, banning thousands of live streamers and online fan clubs for music and movie stars, and limiting or even proscribing recommendation algorithms, in-app pop ups, and push notifications.  Although some regulatory measures such as data protection requirements and limits on push notifications were likely welcomed by consumers, other measures eradicated or severely undermined basic business models for thousands of Chinese tech companies generating hundreds of billions in revenue per year. Moreover, the CAC enacted a new cybersecurity vetting procedure for any tech company wishing to list in China or abroad, thereby making itself a de facto securities regulator for China’s fledgling tech industry. 

Gaming, live-streaming, online fan clubs, and online tutoring were all multi-billion dollar industries where consumers in China and beyond sought entertainment and ways to improve their lives. Measures enacted by CAC and other regulatory bodies in China resulted in catastrophic losses for some of these companies, while others have scrambled to revise their business models at great costs. This has led to enormous losses in Chinese wealth. Just Tencent, Alibaba, Pinduoduo, and Didi alone had lost close to 1 trillion dollars in market value since the beginning of 2021, only recovering about 20% of the lost value in the recent rally. Although a policy reorientation by FSDC is welcoming, it does little to reassure investors in the technology sector if a similar reorientation does not happen at CAC and other regulatory bodies, such as the State Administration of Market Regulation (SAMR).  

More importantly for the future development of the technology sector in China, the Chinese regulatory system continues to be top-down. A change in the top leadership’s preferences or attention would lead to dramatic policy changes impacting listed companies and their investors. As generations of China scholars have noted, the power of China’s authoritarian government is “fragmented” into several major bureaucratic groupings. With dictatorial power at the top determining nearly all senior level promotions, leaders of these various bureaucracies vie with each other to gain the attention and favors of the top leadership. This power dynamic will continue to create incentives for mid-level ministers to respond immediately to the wishes of the top leadership without too much reflection on the impact of resulting policies on firms and individuals in China. Officials may even be incentivized to enact policies leading to underperformance by bureaucratic or political rivals. But in the process of doing so, companies face potentially catastrophic new regulatory requirements.

Despite recent setbacks, the great wealth of human capital, strong entrepreneurial spirit, and world-class infrastructure in China continue to make it a promising hub for the tech industry. However, in a system governed by the dictates of powerful party organs and individual officials, firms and investors will continue to engage the Chinese tech sector under the shadow of unexpected and potentially devastating state interventions.     

Victor Shih is a contributor for the Atlantic Council’s GeoEconomics Center. He is an Associate Professor and the Ho Miu Lam Chair in China and Pacific Relations at UC San Diego.

Report Oct 5, 2021

China Pathfinder: Annual Scorecard

By GeoEconomics Center and Rhodium Group

Over the past eight months, teams from the Atlantic Council and Rhodium Group have taken a dive into China’s economy to address a fundamental question: Is China becoming more or less like other open-market economies? 

China European Union

Issue Brief Jan 31, 2022

China Pathfinder: Q4 2021 Update

By GeoEconomics Center and Rhodium Group

Over the past ten months, teams from the Atlantic Council and Rhodium Group have taken a dive into China’s economy to address a fundamental question: Is China becoming more or less like other open-market economies? 

China Fiscal and Structural Reform

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The post Can one statement fundamentally calm market volatility in China? appeared first on Atlantic Council.

How can Britain fix its corruption problem?

With the passing of the Economic Crime Bill in the UK, Senior Fellow Ben Judah interviews Margaret Hodge MP, Chair of the All-Party Parliamentary Group on Anti-Corruption and Responsible Tax, to discuss what Britain’s next steps are in tackling Russian corruption overseas. What exactly does the Economic Crime Bill do? What reforms are needed for British law enforcement to go after economic crime?

You can watch #BritainDebrief on YouTube and as a podcast on Apple Podcasts and Spotify.

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The post #BritainDebrief – How can Britain fix its corruption problem? A Debrief from Margaret Hodge MP appeared first on Atlantic Council.

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It is critical that US policymakers fully appreciate the broader context in which these decisions will be made. The US–China technology competition is not confined to the economy.  Its outcome will directly influence US national security, and could even impact our enjoyment of the freedoms we take for granted today.

Simply put, the US and Chinese government have widely divergent views on how to use technology and the winner of the competition will be well positioned to proliferate their view worldwide. On the whole, US policymakers protect and nurture a system that promotes free markets, the free flow of information, and freedom of expression, even if specific policies pursued vary over time. By contrast, China’s government focuses on enhancing control of its citizens’ economic and personal decisions, monitoring everyday communications and movements, and does not hesitate to promote propaganda or censorship. 

The ongoing Olympic Games vividly illustrate this difference in worldviews. The United States Olympic and Paralympic Committee felt the need to instruct its athletes to use “burner phones” to avoid monitoring by state officials while in China and the downloading of malicious software that would follow them home.

In 2022, China will host a watershed meeting of the Party Congress to decide whether to extend Xi Jinping’s leadership and double down on its current policies. Most analysts expect President Xi’s reign and the State’s crackdown on technology to continue. By increasingly regulating China’s domestic technology sector, President Xi seeks to eliminate diffuse power centers that could challenge the CCP, and harness greater control over major technology companies and the data they possess. At the same time, China is continuing to support indigenous innovation and attempting to give its companies a leg up on their rivals through more confident forms of diplomatic force projection.

2022 will also be a key inflection point for US trade and technology policy. In the coming months Congress will decide how to proceed with China competitiveness legislation, the Administration will be finalizing the details of its Indo-Pacific trade agenda, and both will assess concerns about the size and activity of large US technology platforms. Democrats and Republicans alike should depoliticize these issues and consider their policy choices through the lens of strengthening US economic and technological competitiveness with China.

Pass Bipartisan China Competitiveness Legislation

In recent months, the US House of Representatives and Senate both passed versions of China competitiveness legislation. This legislation centers on increasing government incentives to promote innovation in key technology areas such as semiconductors, quantum computing, 5G, and synthetic biology, among others. Both versions of the legislation also seek to improve supply chain resilience and reliability through partnerships with key allies around the world. 

Finalizing the legislation should be an easy decision, but prospects for a swift conclusion appear increasingly unlikely due to actions by both parties. House Democrats pursued a partisan process to design key elements of the bill, such as its trade components. Their strategy exacerbated partisan tensions and yielded poorly designed proposals that could undermine US competitiveness, such as an unwieldy outbound investment mechanism or the effort to raise tariffs on low-cost goods. As for the Republicans, many appear focused on scoring political points rather than legislating by calling the legislation “weak on China” without offering a viable alternative. 

To move forward, Democrats should abandon the House’s partisan elements in favor of the Senate’s bipartisan approach. The Senate bill would lower costs for US businesses with targeted tariff relief, provide new tools to counter China’s censorship, and advance a much-needed digital trade agenda. For their part, Republicans should be willing to support many of the same kinds of trade and supply chain policies they have been advocating for over the past few years, even if some also happen to be supported by the current Democratic President.

Promote a Real Indo-Pacific Trade Strategy

An effective China strategy also requires an active trade policy, especially in the Indo-Pacific region. Domestic investment is important, but policymakers cannot ignore the growth opportunities afforded US companies and workers by consumers living outside American borders. Additional access to these opportunities is crucial to long-term US economic health, and setting the norms of economic engagement in China’s neighborhood is crucial to support American values. 

China’s recent assertion of itself in the Indo-Pacific region further increased the imperative for US action. China’s longstanding efforts to promote the Regional Comprehensive Economic Partnership (RCEP), a regional trading block that will further link its supply chains with Australia, India, Japan, and eleven other countries, successfully concluded with the agreement’s entry into force earlier this year. Adding insult to injury, China is also seeking to join the Comprehensive and Progressive Trade Agreement for Trans-Pacific Partnership (CPTPP), a trade agreement that the United States originally championed under the Obama Administration but has since abandoned.

In the absence of a robust US alternative, China’s efforts to join these agreements threatens to lock US businesses and workers out of the region and undermine our ability to promote our economic model and values by tying other countries’ economies closer to China. 

The Biden Administration’s Indo-Pacific Economic Framework (IPEF) has potential, but as currently conceived is unlikely to provide a real alternative to China. The Framework is constrained by trade provisions limited in scope to digital, labor, environment and competition, instead of the much broader range of provisions covering market access, intellectual property, and services, just to name a few.  The lack of market access is particularly troubling, and if left unchanged, could ultimately doom the initiative. Countries vulnerable to Chinese influence may be reluctant to face China’s wrath by joining a US alternative that is far narrower and less substantial than what China is offering.  To address this problem, the United States should either make the IPEF more ambitious, or revisit the ill-conceived idea to walk away from CP-TPP and instead seek to renegotiate its terms.

Avoid Punitive Action Against US Technology

Both Democrats and Republicans raise legitimate issues with US technology firms, including their size, perceived political bias, and outsized role in policing disinformation. However, many policy responses under consideration appear punitive in nature rather than designed to solve real issues. Worse yet, some responses would put the US technology industry at a structural disadvantage compared with China’s national champion firms. 

A problematic bill currently working its way through Congress is the American Innovation and Choice Online Act. It would impose one-way data-sharing mandates on US companies while granting Chinese companies preferential access to US technology and systems. This is not rhetoric: the bill would require US companies to grant foreign rivals the ability to “access or interoperate with…operating systems, hardware or software” owned by US companies. At the same time, vague language on “self-preferencing” would compel US firms to favor content and apps from foreign rivals. It would lead firms to discourage platforms from providing vertically integrated security services necessary to safeguard US infrastructure from foreign cyber-threats. Many politicians have suggested going further and “breaking up” Big Tech.  

As an alternative to this “anti-competition” agenda, policymakers should pursue targeted tools designed to solve actual problems.  If consumers are harmed by the size of these companies, states should continue pursuing antitrust cases using existing laws to address the problem. When it comes to content, Congress should advance an “anti-censorship” agenda that ensures conservative voices are not unduly silenced. A good starting point would be legislation (1) requiring technology platforms to provide complete transparency about their standards for banning content; (2) requiring regular reporting on the implementation of these policies; and (3) imposing penalties for significant deviations from these standards.      

2022 will be a critical year for the US–China competition. It is essential that US policymakers develop working solutions to develop effective China competitiveness legislation, a successful trade agenda in the Indo-Pacific, and to manage the challenges Big Tech presents. Ultimately, US economic vitality, national security, and values depend on it.

Clete Willems is a nonresident senior fellow with the Atlantic Council’s GeoEconomics Center and is a a partner at Akin Gump Strauss Hauer & Feld. Mr. Willems previously served as Deputy Director of the National Economic Council.

Econographics Dec 3, 2021

The RCEP ratification and its implications

By Niels Graham

On January 1, 2022 the Regional Comprehensive Economic Partnership (RCEP) trade agreement will go into effect. When it enters into force, the partnership will be doubly historic: it will be both China’s first multilateral trade agreement and the world’s largest free trade agreement.

China Economy & Business

Issue Brief Jan 31, 2022

China Pathfinder: Q4 2021 Update

By GeoEconomics Center and Rhodium Group

Over the past ten months, teams from the Atlantic Council and Rhodium Group have taken a dive into China’s economy to address a fundamental question: Is China becoming more or less like other open-market economies? 

China Fiscal and Structural Reform

Report Nov 30, 2021

Transatlantic tools: Harmonizing US and EU approaches to China

By Noah Barkin and Agatha Kratz

Cooperation between the US and the EU is essential if they are to develop effective responses to the challenges presented by China. However, there has been a lack of coordination in recent years. Nevertheless, this paper argues there is now an opportunity under the Biden Administration for the United States and Europe to learn from each other and harmonize some of their China-related efforts. 

China Economic Sanctions

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The post The path forward on the US-China technology competition appeared first on Atlantic Council.

Over the past decade former Secretary of the Treasury Larry Summers revitalized the term secular stagnation to describe persistent economic conditions in the United States and other advanced economies. The expression was first used to explain the economic environment the United States faced in the 1930s following the Great Depression. The term describes economies enduring chronic shortfalls in private demand and investment, excess savings, and an imbalanced market equilibrium for capital that lowers interest rates, growth, and inflation. Consistently low rates driven by low demand also contribute to supply side contractions that reduce economic growth and productivity.

A key question for US fiscal policy in the decade ahead is if the current inflationary bout will fundamentally alter the secular stagnation paradigm the US economy was in, or if this episode will be a shorter-term event. To answer this question, it is important to unpack the rise of secular stagnation in recent decades and current inflationary pressures.

Since the late 1970’s savings in the United States and globally from households, firms, and governments accumulating foreign-reserves have increased, leading to a global savings glut as former Fed chairman Ben Bernanke phrased it. In turn, real interest rates across advanced economies have steadily declined, even in instances when they should theoretically rise such as a tight labor market or significant government spending. For example, the 10-year yield for Treasury Inflation-Protected Securities, introduced in 1997, has lurched downward for much of the past two decades. The rate is currently negative, which means the United States can pay back less than it borrowed in real terms in ten years.

There is no single cause of secular stagnation, but several variables appear to contribute. A major factor is shifting demographics. Population growth in the United States and other advanced economies has slowed for decades. With fewer prime-age workers, there is less consumption and motivation for businesses to invest in expanding capacity. Longer life expectancy means people spend more of their time retired and need to save more. Increased economic inequality also played a role. Wealthier households have a lower marginal propensity to consume and tend to save more, and their share of total capital has grown. Some prominent economists also point out the rise of digital technology advancement, noting that digital technologies are less capital intensive and generate less investment demand compared to prior technological revolutions.

Regardless of the precise causes of secular stagnation, it has important implications for fiscal policy. First, frequently low interest rates give policymakers more fiscal space, or the flexibility to make budgetary decisions without sacrificing financial sustainability, to operate in. When the real interest rate on safe financial assets, such as US treasuries, is less than real GDP growth, a government can run deficits while maintaining stable debt to GDP ratios because the economy is growing faster than the interest accruing on its debt. During the pandemic the United States ran its largest fiscal deficits since World War II. However, the increase in GDP growth combined with low interest rates led to faster debt stabilization than previously predicted.

Secular stagnation also requires more expansive fiscal policy. Increased government investment boosts demand to consistent and sufficient levels, such that private investment is crowded in as businesses accelerate their spending to expand supply capacity. This reinforcing cycle alleviates ongoing demand and investment shortfalls and leads to higher GDP growth.

While this premise holds under certain economic parameters, it doesn’t mean that governments have infinite fiscal space without generating inflation or higher interest rates, or that spending is always worthwhile. For instance, some emerging markets with different macroeconomic circumstances are experiencing faster interest rate increases following government stimulus. Some economists suggest using real debt servicing costs compared to GDP to guide fiscal space. Others argue governments should focus on making budgetary changes more automatic, based on distress indicators and interest rate conditions. Many experts do agree that extending debt maturities to lock in low rates, and investing in areas such as climate change, infrastructure, and education — where the benefits to growth outweigh the low servicing costs — makes sense.

High inflation, and its potential duration, must also be a part of the fiscal policy calculus. Data suggest an unusual mix of pandemic-initiated factors is increasing inflation. These include elevated demand driven by short-term fiscal stimulus and loose monetary policy, skewed demand composition towards goods and away from services, supply chain disruptions, and a hot but still recovering labor market. At the same time, the pandemic has accelerated some underlying longer-term structural trends behind secular stagnation. These trends will likely continue after pandemic disruptions fade.

Considering these factors, and the Fed’s crucial commitment to tame inflation, relevant experts and stakeholders do not seem to expect above target inflation beyond the next few years. Consumer expectations, economic forecasters, and bond market data points indicate the anticipation of a return to the low-rate and low-growth characteristics of secular stagnation in the coming years.

Experts concerned about inflation over the past year, including Larry Summers — who warned about the risk of inflation well before most — have also predicted that the return of secular stagnation and low growth is probable in the next few years. Thus, many also recommend growth inducing fiscal investments. For example, the Biden administration’s Build Back Better agenda received support from a wide array of economists despite the present inflation burst. The proposals are appealing because they are spread out over ten years, real interest rates are negative, and they make crucial investments in areas evidenced to show increased US growth potential, productivity, and well-being.

In the years ahead the United States will likely move past current inflation challenges and will once again be battling secular stagnation. Although today’s inflation caught many by surprise and poses risks, it is important for policymakers to keep perspective on the economy’s long-term needs. If the United States is to overcome the difficult challenges ahead, its fiscal space must be recognized and used in a sustained, efficient, and thoughtful manner.

Jeff Goldstein is a contributor to the Atlantic Council’s GeoEconomics Center. During the Obama administration he served as the Deputy Chief of Staff and Special Assistant to the Chairman of the White House Council of Economic Advisers. He also worked at the Peterson Institute for International Economics. Views and opinions expressed are strictly his own.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

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China Inside Out Dec 16, 2021

Global Sanctions Dashboard: Holiday edition

By Julia Friedlander, Michael Albanese, Maia Nikoladze and Castellum.AI

Coordinated actions against Belarus and global human rights abusers, sanctions on African states, and anti-kleptocracy reform.

Africa Belarus

Report Nov 30, 2021

Economic statecraft: Finance and money

By Dr. Carla Norrlöf

Using economics to achieve non-economic foreign policy objectives has become a dominant strategy for great powers in the post 9/11 world. The economic statecraft kit now includes a wide range of practices such as financial sanctions, coercive policies and inducements to defensive policies.

Australia China

The post US fiscal policy must be ready for the return of secular stagnation appeared first on Atlantic Council.

China moved farther from market economy norms in the fourth quarter of 2021. The real estate sector continued to dominate the headlines as Evergrande, the country’s largest property developer, finally defaulted, along with peers Kaisa, Sinic Holdings, Fantasia, and Modern Land. Meanwhile, the government’s regulatory crackdown intensified, culminating in ride-hailing giant Didi’s forced delisting from the New York Stock Exchange. The move may herald a broader unwinding of foreign listings, particularly for data-heavy Chinese companies.

While VC flows to China’s tech startups showed a recovery from a low in 2020, the main targets for this investment were hardware technology sectors favored by Beijing. With expectations for a slowdown in 2022 mounting, China’s leaders dropped their fiscal restraint and promised new stimulus at their year-end Central Economic Work Conference (CEWC).

The bottom-line assessment for Q4 shows Chinese authorities were active in four of the six economic clusters that make up the China Pathfinder analytical framework: financial system development, competition policy, innovation, and portfolio investment openness. There were fewer developments in the direct investment and trade clusters. In assessing whether China’s economic system moved toward or away from market economy norms in this quarter, our analysis shows a primarily negative shift.

This issue of the China Pathfinder Quarterly Update highlights Didi’s forced delisting. Didi’s story warns private companies in data-heavy industries that running afoul with regulators will result in severe penalties, regardless of the company’s size. Beijing’s intervention in the Didi listing resets risk assumptions. It is no longer theoretical that the state might sacrifice economic dynamism in pursuit of what it perceives to be greater national security. Now, the question is how often and how far down the value-added ladder authorities will use these tactics.

View the full issue brief below

The China Pathfinder Project

China is a global economic powerhouse, but its system remains opaque. Policymakers and financial experts disagree on basic facts about what is happening inside the country. To create a shared language for understanding the Chinese economy, the China Pathfinder project scores China and other open market economies across six key areas and presents an objective picture of China relative to the world.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post China Pathfinder: Q4 2021 Update appeared first on Atlantic Council.

The post Lipsky and Aladekoba cited in Politico on the controversy surrounding the Nigerian government’s plan to remove fuel subsidies appeared first on Atlantic Council.

In the words of Secretary Yellen, not raising the debt ceiling and a subsequent U.S. government default would mean that “in a matter of days, millions of Americans could be strapped for cash…Nearly 50 million seniors could stop receiving Social Security checks for a time. Troops could go unpaid. Millions of families who rely on the monthly child tax credit could see delays. America, in short, would default on its obligations…A default could trigger a spike in interest rates, a steep drop in stock prices and other financial turmoil,” and economic chaos at the global level.

Raising the debt ceiling will undoubtedly be good news for more than 64 million recipients of Social Security payments, who will continue receiving their checks on time for another year. However, raising the debt ceiling year-after-year will not effectively address the increasing challenges facing the Social Security System. The future looks grim for retirees, disabled seniors, and their families. The Old-Age, Survivors, and Disability Insurance (OASDI) program, commonly known as Social Security, is facing financial troubles, and is estimated to run out of reserves in just 12 years.

Social Security is facing a financing crisis

The Social Security system’s cash flow has been negative since 2010. That means the program has distributed more in social security benefits than it has collected in social security taxes, as large cohorts from the baby-boom generation started to retire. As a result, the United States Treasury borrowed from financial markets to redeem Social Security trust fund securities. Estimates suggest that the program’s cash flow will remain negative for the next decade, leading to the depletion of its current $2.9 trillion reserves in the next decade.

Once the reserves run out, the benefits will be capped at the level of social security taxes received on annual basis. Without significant reforms, in just 10 years, the eligible beneficiaries — more than 80 million retirees, survivors of deceased workers, and disabled workers and their dependents — will receive less than 79 percent of the scheduled social security benefits they were promised. The longer-term outlook is even grimmer: the 75-year present value of the fiscal projection of Social Security and Medicare shows a $26.7 trillion and $54.9 trillion deficit.

The financial troubles of the Social Security and Medicare systems primarily stem from an aging population and declining employment to population ratio in the United States. In the past two decades, the share of population ages 65 and above increased from 12 to 17 percent, while the share of people ages 0-14 — future workers — declined from 22 percent to 18 percent (Figure 1). During the same period, the employment-to-population ratio declined from 65 to 59 percent — 61 percent before the onset of the COVID-19 pandemic (Figure 2). 

Delaying substantive reforms will only exacerbate the crisis and increase the cost of future reforms

The cost of inaction will only rise the longer Congress waits to reform the Social Security systems. In 2010, the Trustees of the Social Security trust funds estimated that the reserves would be depleted by 2037 and the 75-year shortfall was equivalent to 1.92 percent of payroll. Only ten years later, in 2020, the depletion date was reduced to 2034 and the 75-year shortfall was equal to 3.21 percent of the payroll (Figure 3).

Considering the aging population, longer lives and retirements, fertility rates lower than the replacement rate, and the shrinking labor force participation rate in the United States, substantive reforms must be implemented immediately. A combination of the following reforms would make the Social Security system sustainable:

• Increasing social security tax rates: The Social Security tax rate is currently set at 12.4 percent and divided equally between the employee and employer. Fiscal Year 2020 estimates suggest that an increase of three percentage points in payroll tax would cover the fund’s shortfall over the next 75 years.
• Increasing or removing the income cap for social security tax: Currently, social security taxes are paid for incomes up to $142,800. In other words, in 2021, only 84.5 percent of all earnings will be subject to social security tax, while in 1982 this figure was around 90 percent of all earnings. Collecting social security tax on 90 percent of all earnings would reduce the 75-year financing shortfall of social security by around 20 percent. Moreover, if all earnings were subjected to social security tax, the program would remain solvent for over 40 years.
• Raising the retirement age: Currently, the full retirement age (FRA) is between 66 and 67 years old depending on the birth year of a worker. However, current social security rules allow workers to receive retirement benefits starting at age 62 (early eligibility age or EEA). Increasing the FRA and EEA by three months per year until it reaches 69 years old would eliminate 26% of the system’s projected shortfall in the next 75 years.
• Increasing the number of workers: With a current worker-beneficiary ratio of 2.6, the Social Security system is facing a negative cash flow — a worker-beneficiary ratio of 2.8 is needed to keep the system solvent. It is expected that this ratio will decline further, to 2:0 by 2060, pushing the system into severe crises. Therefore, any effective Social Security reform agenda must reverse this trend or, at minimum, reduce the downward pressure on the worker-beneficiary ratio. While immigration can help to some extent, there are other options. Attracting more workers into the labor force through introducing worker and family-oriented policies — such as high quality and affordable early education and child-care programs — is a more effective way to reverse the downward trajectory in the worker-beneficiary ratio.

Public opinion varies significantly around Social Security reform, making any changes to the system a challenging and politically charged topic in Washington. However, lawmakers on Capitol Hill only have a few years to restore balance and longevity to the system. Let’s not forget that the current estimates for the shortfalls are based on normal scenarios and do not take into account the negative shocks of future recessions, natural disasters, and crises such as the current pandemic, which is estimated to have reduced the Social Security exhaustion date by four years. Congress must act now.

The post How secure is Social Security? appeared first on Atlantic Council.

The post Tran’s piece on China’s debt reduction campaign was featured in a Formiche article appeared first on Atlantic Council.

In the third quarter of 2021, a Chinese economy already straining under COVID-19 was rocked by energy shortages, while Evergrande, the country’s largest real estate developer, inched toward a full-blown debt crisis. At the same time, the government broadened the ongoing crackdown on technology giants, delivering another hit to investor sentiment. These disruptions are not the result of policies launched this quarter; rather, they reflect the consequences of the government’s failure to introduce much-needed market discipline, including in the real estate and energy sectors.

Framing the outlook on China’s economic health is a broader uncertainty surrounding the future of the country’s development path under the slogan of “common prosperity” championed by Xi Jinping. Beijing’s moves in response to the challenges this quarter prioritized political objectives over market-oriented policy reform—not an encouraging signal.

The bottom-line assessment for Q3 shows that Chinese authorities were active in four of six economic clusters that make up the China Pathfinder analytical framework—financial system development, competition policy, innovation, and portfolio investment openness—with fewer developments in the trade and direct investment openness clusters. In evaluating whether China’s economic system moved toward or away from market economy norms in this quarter, our analysis shows a mixed-to-negative trendline.

This issue of the China Pathfinder Quarterly Update highlights the Evergrande crisis, which has become a litmus test for how the Chinese government will balance financial stability against market discipline. China’s systemic debt problem has left only undesirable policy options, with implications for the Chinese consumer and economy at large.

View the full issue brief below

The China Pathfinder Project

China is a global economic powerhouse, but its system remains opaque. Policymakers and financial experts disagree on basic facts about what is happening inside the country. To create a shared language for understanding the Chinese economy, the China Pathfinder project scores China and other open market economies across six key areas and presents an objective picture of China relative to the world.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post China Pathfinder: Q3 2021 Update appeared first on Atlantic Council.

Below, South Asia Center experts share their analysis. 

Welcome help to move towards macroeconomic stability and better investor confidence

After months of painful negotiations, and Pakistan on track to enforce required legislative reforms, the IMF finally announced today that it reached an agreement with the Pakistani government for the $1 billion tranche of the $6 billion loan. This is welcome news for the international business community and global investors given turbulent domestic politics, rising inflation, and a rocky US-Pakistan relationship. Given that the United States holds the largest share of votes in the IMF, the revival of the loan, and the likely stabilization of the Pakistani rupee sends the right message to international investors that the international community—and the United States in particular—believes Pakistan is ready to make the necessary reforms and abide by commitments made to the IMF.

The World Bank is expected to release funds that were held since the IMF paused the loan program, and the IMF nod will help move forward the recently announced $4.2 billion promised to Pakistan by Saudi Arabia. The IMF funds, along with the central bank reforms Pakistan agreed to, should help in improving macroeconomic stability and boost investor confidence in Pakistan’s ability to execute their reform agenda and stabilize the economy. All eyes are on Pakistan to see if this time will be any different than the prior bailouts.

Safiya Ghori-Ahmad, Nonresident senior fellow, Atlantic Council’s South Asia Center

Coming months will be critical

If you look at the IMF programs over the years, you’ll see the policy actions required by the government remain largely the same. This statement is no different. That said, this does settle the wave of uncertainty that had taken over considering the long process of coming to a staff level agreement. The impact is generally positive for investors which will start to show in equities and of course the currency.

However, it is important to note that the leeway given to the government and the central government during COVID-19 is now coming to an end. Over the next few months, the “accommodative” monetary policy will be reversed gradually, leading to a double digit policy rate, more taxes on fuel and electricity, and a less expansionary fiscal and monetary environment. The next few months will reveal how serious the government is on execution and one hopes to see quicker action on things that improve the debt management outlook for the country.

Ariba Shahid, Economic and Business Journalist, Profit Magazine

Not much has changed

The IMF agreement text has barely evolved over the last decade. The latest announcement has the usual commentary on increasing interest rates, reforming state-owned enterprises, making the central bank more independent, and reducing the fiscal deficit. If we look at all statements over the last decade, we may see that not much has changed.

A major sticking point has been the autonomy of the central bank. Before the current governor, the last few governors were either bureaucrats or commercial bankers, often handpicked to follow a certain line as required by the incumbent government. In such a scenario, central bank independence was hampered which often led to reactive policy prescriptions and pursuit of a disastrous fixed exchange rate regime. Legislative changes that bolster the autonomy of the central bank are sorely needed before the onset of the 2023 election cycle.

Having said that, the fact of the matter is that Pakistan has historically failed to implement all suggested reforms in their true spirit, and the IMF has at times been complicit in ignoring the lack of progress.

The result is like groundhog day, where the same symptoms, the same problems, and the same solutions are repeated every few years.

Ammar Khan, Independent Macroeconomist

A positive shift for Pakistan

In my view, the IMF agreement is positive and will bolster investor confidence in Pakistan’s economy. The defined timeline for milestones and reforms is expected to ensure that the government keeps moving in the right direction. In addition, the performance and indicative criteria set out in the agreement will mean that the government remains disciplined in its spending in the coming months. Given Pakistan’s political economy, governments need backing from the fund to make painful decisions, and this agreement is likely to do just that.

Samiullah Tariq, Head of Research, Pakistan Kuwait Investment Company

The South Asia Center serves as the Atlantic Council’s focal point for work on the region as well as relations between these countries, neighboring regions, Europe, and the United States.

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Issue Brief Aug 4, 2021

Beyond Pakistan’s 2021-22 budget: The economy and growth

By Uzair Younus

Recently appointed to his position, Shaukat Tarin has positioned the budget as being growth oriented in focus, with significant increases to subsidies, public-sector development, and salaries of government employees.

Economy & Business Fiscal and Structural Reform

Bretton Woods 2.0 Oct 21, 2019

A Conversation with the Governor of the State Bank of Pakistan H.E. Reza Baqir

On October 16th, the Atlantic Council’s Global Business and Economics (GBE) Program hosted a roundtable conversation with Dr. Reza Baqir, Governor of the State Bank of Pakistan.

Economy & Business Fiscal and Structural Reform

New Atlanticist Aug 19, 2021

A strategic assessment from India: Kabul’s chaos makes Pakistan look more dangerous

By Vappala Balachandran

As has been the case for millennia, India’s ambitions in Afghanistan are cultural in nature, not military. The same cannot be said for Pakistan.

Afghanistan Conflict

The post Experts react: A renewed Pakistan-IMF agreement appeared first on Atlantic Council.

China’s non-financial-sector debt—incurred by the government, corporate, and household sectors—reached a record level of 272 percent of China’s gross domestic product (GDP) in 2020. But since then, Chinese companies have deleveraged noticeably under pressure from both the government and the pandemic economy. Even despite a small increase in the debt from the central and local governments (accounting for 45.6 percent of GDP) and local government financing vehicles which borrow to raise additional money for local governments (accounting for another 36.4 percent), corporate deleveraging has reduced China’s debt by 7 percentage points to 265 percent of GDP in the third quarter of 2021.

At the center of the corporate deleveraging campaign is the August 2020 “three red lines” policy which states that a property company cannot borrow new debt unless its debt-to-asset ratio is less than 70 percent, its net debt-to-equity ratio is less than 100 percent, and its cash-to-short-term-debt ratio is more than 100 percent.

Many property developers have not met those “red lines” requirements and therefore have not been able to borrow new debt to refinance old debt or carry out normal operations. As a result, they’ve fallen into debt distress—all together, they have about 33.5 trillion yuan ($5.24 trillion) in debt, which is equivalent to nearly a third of China’s GDP. The most visible case has been Evergrande which has about $300 billion of liabilities; it has been restructuring its domestic liabilities including bank loans and onshore bonds while managing to pay interest on offshore dollar bonds at the end of the grace period. Other developers such as Fantasia Holdings Group, Modern Land China, R&F Properties, Sinic Holdings Group, and China Properties Group are likely to follow Evergrande’s footsteps.

This approach appears to be consistent with China’s go-to strategy to manage a recent spike in corporate debt crises: China prefers pre-default restructuring if possible, especially vis-à-vis international creditors, while encouraging state-owned companies to buy assets from the stricken developers to help them deal with their financial obligations. Moreover, Chinese authorities stand ready to ease their policies enough to prevent the distresses of those developers from spreading to the whole real estate sector, or to other sectors, causing systemic financial instability. This strategy is China’s attempt to instill discipline in its financial markets but in a controlled environment.

China has also tried to rein in speculative investment in property by making it more difficult to purchase real estate for investment purposes. Some 96 percent of urban households in China have purchased one house (the US homeownership rate is now 65.4 percent), 31 percent have purchased two properties, and 10.5 percent have purchased three or more, according to a 2019 central bank survey. China plans to impose a property tax in some regions in pursuit of its “common prosperity” goal to more evenly distribute wealth across the population. This tax has been discussed for twenty years, but resistance at various levels of government has held it back. So far the national government has instituted trial programs only in Shanghai (at 0.4 percent to 0.6 percent of the value of second homes) and Chongqing (at 0.5 percent to 1.2 percent of the value of existing stand-alone houses and high-end properties). When rolled out nationwide, the property tax may also reduce local governments’ dependence on land sales and borrowing through local government financing vehicles—helping to promote the goal of deleveraging.

China’s deleveraging effort also includes its crackdown on lending and borrowing that takes place outside of banking regulations through instruments such as entrusted loans, trust loans, and undiscounted bankers’ acceptances. These transactions are not transparent and lack supervision. China has made good progress in this area as well; it has reduced the outstanding amount of these “shadow banking” loans by about 18 percent since 2018 to just more than 20 trillion yuan ($3.1 trillion) in 2020. China has also cracked down on the use of wealth management products (WMPs) as a poorly supervised way to raise funds. The country’s latest regulation, issued in June, prohibits banks and wealth management companies from using the cash raised by WMPs to invest in the stock and low-rated bond markets. The regulation also restricts WMPs to a maximum leverage ratio of 120 percent. At present, WMPs amount to about 25 trillion yuan ($3.9 trillion) in value and are still growing, albeit at a slower pace.

So far, Chinese authorities seem to be intent on staying the course in bringing corporate debt down to more sustainable levels—at least to the global average ratio of less than 100 percent of GDP. But doing so will require slowing the debt-fueled economy at least for the foreseeable future. In particular, the real estate sector accounts for up to 25 percent of China’s GDP. The resulting slowdown from deleveraging real estate could reduce China’s GDP growth by 1 percentage point per year until 2025, bringing growth down to the 4 percent to 5 percent range in the next few years.

China certainly is capable of creating the fiscal and monetary policies needed to stimulate a higher pace of growth. After all, its total government debt is quite modest at around 68 percent of GDP compared to a global average of 104 percent of GDP; and the People’s Bank of China has never done any quantitative easing or purchasing of assets to ease financial conditions to support economic growth. But China has been very cautious in its macroeconomic policy stance throughout the pandemic, and this approach is unlikely to change. On the other hand, Chinese authorities are in a good position to ensure that growth will not collapse or that financial stability is not threatened.

China under Xi Jinping seems intent on deleveraging its economy, in particular the corporate sector, accepting slower growth in the foreseeable future while reserving its policy ammunition to intervene if things get out of control. The outcome would be slower but more sustainable growth that is less prone to financial instability—not a bad prospect for the Chinese economy. But for the rest of the world, the implications would be less benign. Since the 2008 crash and the resulting Great Recession, China’s growth has been a strong tailwind for the global economy and especially the commodity markets, benefiting many developing countries. Going forward, such tailwinds will be much weaker, and in specific cases where declining exports to China can not be diverted elsewhere, they may transform into headwinds.

As China’s debt-fueled growth winds down, many economies may encounter a tough external economic environment. Perhaps it’s time for them to row their own boats.

Hung Tran is a nonresident senior fellow at the Atlantic Council, former executive managing director at the International Institute of Finance, and former deputy director at the International Monetary Fund.

The post China’s debt-reduction campaign is making progress, but at a cost appeared first on Atlantic Council.

Ukraine’s tax authorities have traditionally been viewed as an obstacle by the country’s business community. A range of complex and often ambiguous laws have consistently created opportunies for different supervisory bodies and law enforcement agencies to pressure legitimate businesses. This has led to widespread corruption and exploitation by politicians and oligarchs, who have frequently been accused of using the tax authorities as leverage against their competitors and opponents.

Another major issue is the wide range of different government agencies with authority to interfere in business matters. For many years, it has been common for business people to win their battle with the tax police only to be confronted by the economic department of the Ukrainian Security Service or the National Police. Needless to say, this has done little to boost economic growth or improve the investment climate.

With these problems in mind, the Bureau of Economic Security was conceived as an umbrella body to investigate all manner of economic crimes and serve as a platform for constructive dialog between the state and the business community. If implemented effectively, this reform has the potential to dramatically improve Ukraine’s business environment.

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