NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Tuesday, March 24, 2015

If any country knows about the risks and rewards of building infrastructure, it is China. Over the past two decades, the People’s Republic has erected countless roads, dams, power plants, bridges and airports in its pursuit of economic development. The result has been a surge in debt, waste, corruption and pollution. It’s a dubious foundation from which to construct the new Asian Infrastructure Investment Bank.

In the past few weeks, large Western countries led by the United Kingdom have rushed to join the China-led body, which was set up last autumn and already has 27 members, mostly from Asia. The eager applicants have annoyed the United States and enhanced China’s efforts to alter the architecture of global finance. Yet amid the diplomatic sniping, the new bank’s prospects have been largely overlooked.

Asia undoubtedly needs better infrastructure, as anyone who has endured a traffic jam in Indonesia or avoided tap water in India knows. These problems will only get worse as populations expand and more people move to cities. The Asian Development Bank (ADB) – the Japanese-led institution that is one of the new Chinese body’s main rivals – has estimated that the continent needs to spend $730 billion on infrastructure every year between 2010 and 2020.

China is doing its best to fill the hole. The AIIB, which will draw funds from members according to the size of their economies, will start with $50 billion in capital, though that figure will eventually double. China has also earmarked $40 billion for its Silk Road infrastructure fund, and another $10 billion for the proposed New Development Bank, whose other members include Brazil, India, Russia and South Africa. All these ventures are supposed to stimulate development and growth in poorer countries.

China is not simply being altruistic. As its economy slows and evolves, the country needs to find new markets for its capital goods. Better transport links will make nearby countries more attractive as suppliers to Chinese manufacturers and as consumers of Chinese-made goods. The new financial institutions also enable the People’s Republic to diversify foreign exchange reserves still predominantly invested in U.S. Treasury bonds. China will also extend its international influence under the guise of financial aid.

Yet Asia’s infrastructure shortfall is not because of a shortage of money. With yields on government bonds at record lows, Western banks and pension funds are eager to fund long-term projects that offer a slightly better rate of return. Global project finance reached $321 billion last year, the second-highest on record, according to Standard & Poor’s. The problem is that many Asian governments are too shaky and their legal structures too uncertain to give commercial lenders any confidence that their funds will be invested responsibly and eventually returned.