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The Crisis of China

About the role of China as the engine of global institutional innovation, argues Erik Berglof, director of the Institute of International Relations at the LSE

The IMF has listed the yuan as a reserve currency, and China is actively involved in development projects around the world. The country is increasing its influence on the world economy and gaining experience for a qualitative leap forward.

The Crisis of China

Eric Berglof

Director of the Institute of International Relations at LSE
Crisis offensive

The Board of Directors of the European Bank for Reconstruction and Development (EBRD) approved China's application to become a shareholder of the bank. The work on the application took about 10 years. EBRD membership is just one manifestation of China's rapidly growing role in international financial institutions. The question now is, will China become the engine of change in these institutions, or vice versa?

The global financial crisis has shaken the international financial architecture, catching many institutions by surprise. For example, the International Monetary Fund seeks to seriously curtail its activity. Many of the institutions, such as the EBRD and the European Investment Bank, have demonstrated responsiveness, resulting in increased mandate and additional capital.

The crisis has also undermined the legitimacy of the G-2016, which unites countries that have become a source of problems, while at the same time giving fresh strength to the G-XNUMX. Against the backdrop of these transformations, China has received an opportunity to expand its global influence, and it is determined to use it, despite the resistance of individual countries. For example, China plans to use its G-XNUMX presidency in XNUMX to advance an ambitious agenda.

China is a member of many institutions, including some regional players such as the African Development Bank (ADB) and the Inter-American Development Bank (IDB). With their help, he deepens his external relations, in particular through joint investments in projects around the world. For example, last year, China significantly expanded its cooperation with ADB, creating a $ 2 billion fund "Africa: Growing Together".

Likewise, China's sovereign wealth funds have become important anchor investors in investment vehicles set up by both the World Bank's International Finance Corporation and the EBRD to attract long-term institutional capital to their projects. One of these funds - SAFE - is now the only investor in such a mechanism of the EBRD, despite the fact that China has not yet formally joined this organization.

Copying institutions

China is also creating new institutions. The establishment of the Asian Infrastructure Investment Bank (AIIB) made headlines this year, not only because of strong opposition from the United States, but also because countries such as the UK and Germany joined it anyway. China has also played a key role in the creation with BRICS partners of the New Development Bank (NDB), headquartered in Shanghai.

There is a $ 40 billion China Silk Road Fund to support infrastructure projects needed to implement President Xi Jinping's Belt and Road Strategy. This strategy aims to improve trade and communications across Eurasia. The Silk Road Fund - China's most ambitious project today - overshadows traditional international financial institutions in terms of both scope and breadth. The first initiative of the fund - the $ 1,65 billion dam of the Karot hydroelectric power station in Pakistan - involves not only direct financing of the project, but also equity investments in companies that are engaged in the construction of the dam and are responsible for its operation over the next 30 years.

So far, the Silk Road Fund is a unilateral initiative, and therefore belongs to the same category of institutions as the China Development Bank or the state investment conglomerate CITIC. However, the Chinese authorities say the fund is open for other countries to join, which, however, seems unlikely given the scale of the Chinese commitments.

Communist innovators

Despite the impressive size of China's investment projects, the country's leadership has so far been relatively conservative with regard to institutional innovation. Recently, however, Chinese Communist Party officials have been discussing the idea of ​​an experimental new multilateral financial institution designed to “rehabilitate the environment,” that is, to support major projects to reclaim land, purify water and improve air quality.

It will not be easy to create such an institution: it needs global coordination to attract potential shareholders, as well as large subsidies, without which investment will be impossible. However, such a major institutional innovation would help fill an important gap in the global financial architecture, as well as strengthen China's leadership in financing environmental remediation.

At the same time, Chinese institutions are innovating on a smaller scale, leading the way in developing more flexible and faster approaches to financing. For example, the first president of the AIIB, Jin Liquun, announced plans to eliminate certain elements inherent in existing institutions, such as permanently resident boards of directors, as well as migration restrictions on hiring employees.

Despite all this, China's growing role in global finance is unlikely to profoundly change how existing institutions operate. Of course, innovations that highlight flaws in existing structures can help inspire the reform process. And the EBRD can no doubt benefit from China's experience in pilot projects and in scaling them up.

For the EBRD, China's stake in the bank will be tiny, at least at first. The Chinese claim that they are here to study. Indeed, joint investments with the EBRD can provide Chinese companies with the necessary knowledge, and potentially even protection, as they penetrate new markets.

It now seems likely that increased participation in multilateral institutions will change China more than it does those institutions. China will be able to hone its own strategy of participation in projects in Africa and other parts of the world. Moreover, he will have the opportunity to improve his own development model.

However, in the long term, the development challenges that China is facing at home (primarily the rapid environmental degradation) may push it to assume a more active, transformative role as an engine of global institutional innovation.

For the first time the material was published on the website of RBC 01.12.2015
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