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Innovating Development Cooperation for Structural Transformation

By Jiajun Xu, Assistant Professor & Executive Deputy Dean, Institute for New Structural Economics, Peking University

By establishing structural transformation as the China International Development Cooperation Agency’s core objective, Beijing will have an opportunity to take a leadership role in advancing the international development agenda.

Nearly a year ago, in March 2018, the Chinese government announced that it would establish the China International Development Cooperation Agency (CIDCA) under the leadership of the State Council. The CIDCA is designed to play a central role in coordinating China’s foreign aid policies and practices, which used to be dispersed across multiple state organs including the Ministry of Commerce and the Ministry of Foreign Affairs. Apart from solving the government’s aid coordination problem, the CIDCA may help China recalibrate its international development strategy in support of the Belt and Road Initiative (BRI).

Will this new agency simply follow the so-called international best practices of aid giving, as espoused by the Organization for Economic Co-operation and Development (OECD)? Or will it build on China’s own development experience and employ innovative methods of development cooperation? How will the CIDCA enable China’s foreign aid to better serve the BRI, as explicitly proposed in its official mandate? The academic discipline of new structural economics (NSE) offers insights into how the new agency can make innovative contributions to development cooperation.

NSE is a theoretical framework proposed by economist Justin Yifu Lin as a way to rethink development policy. The starting point of NSE analysis is factor endowment, or what assets an economy possesses at a given time. The next step is to analyze the economy’s latent comparative advantages and whether the country’s hard and soft infrastructure are sufficient for its industrial needs. NSE is termed new to distinguish it from the old form of structuralism, which overemphasized methods focused on state intervention such as import substitution industrialization.

Compared with mainstream development thinking, NSE is new in at least two respects. First, it goes beyond the basic needs approach and places a higher priority on structural transformation to help developing countries overcome low- or middle-income traps. Second, NSE critiques free market doctrine and proposes that governments need to act as facilitators to mitigate binding constraints their countries face on the path to economic structural transformation. This fresh perspective may shed new light on two fundamental development questions: what aid is for, and how to better achieve development goals.

The Centrality of Structural Transformation

First, economic structural transformation is at the heart of the UN’s Sustainable Development Goals (SDGs), the successor to the Millennium Development Goals. The eighth goal states that countries should “promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all.” The ninth goal goes a step further to propose that countries “build resilient infrastructure, promote inclusive and sustainable industrialization and foster innovation.” By funneling development aid to projects that promote these goals, China can better coordinate its aid with that of other countries that are aligning their efforts with the SDGs.

Second, China’s own development experience shows that economic structural transformation was the underlying driving force that has lifted more than 600 million people out of extreme poverty. Although the prevailing basic needs approach was an antidote to the problems of economic structural adjustments in the 1980s, in recent years the pendulum has swung back too far, shying away from the fundamental challenges of improving productivity, diversifying industrial structures, and moving up global value chains. Economic growth alone may not have automatically led to welfare improvement for all, but economic transformation has been a necessary (albeit insufficient) condition for large-scale, self-sustaining poverty reduction.

Third, fostering structural transformation in BRI partner countries and in other developing countries can help to ensure that China’s rise is not seen as a threat but rather as a window of opportunity for countries to move up the global value chain together. Many developing countries are suffering from premature deindustrialization or the resource curse. The key challenge for many BRI participants and other developing countries is to spur inclusive, equitable structural transformation that can provide job opportunities for their ever-growing populations. As the average wages of Chinese workers rise and as the country’s industrial structures advance, light manufacturing firms are losing their comparative advantage and may relocate to low-wage developing countries.

Naturally, prioritizing structural transformation does not mean abandoning development projects in support of people’s basic needs or humanitarian aid at the operational level. Yet, by establishing structural transformation as the CIDCA’s core objective, China will have an opportunity to take a leadership role in advancing the international development agenda.

Public Entrepreneurship and Long-Term Development Capital

If structural transformation is a desired goal, what roles can development agencies play in achieving this objective? From the perspective of NSE, governments need to play a facilitating role by identifying and mitigating binding constraints. One salient constraint that many developing countries face as they pursue economic transformation is a lack of long-term finance for basic infrastructure. The infrastructure deficit stems in part from an overemphasis on the basic needs approach, which downplays the importance of economic growth as the engine for sustainable, large-scale poverty alleviation. This emphasis on social sectors was accompanied by shrinking infrastructure financing. The assumption that the free market would automatically channel capital to where it was needed turned out to be a false hope. In reality, capital markets have focused almost exclusively on short-term performance and have been unable to overcome their concerns about the high risks inherent in providing long-term finance. Consequently, developing countries have faced a daunting infrastructure gap that has severely constrained their potential for economic transformation.

At the same time, aid agencies in many developed countries failed to play a role in providing the potential capital for structural transformation. These agencies frequently sought to quickly achieve highly visible accomplishments—such as improving enrollment rates in elementary schools or eliminating infectious diseases—that could easily garner support from domestic constituencies in donor countries. Even though these efforts to support education and healthcare have their merits and help to lay the foundation for structural transformation by enhancing human capital in developing countries, they fall short by not providing much-needed long-term financing for infrastructure development.

To overcome the dangers of short-termism, the CIDCA needs to act as a public entrepreneur with two defining features: a comprehensive long-term vision and decisive action in the face of uncertainty and risk.

First, it is important to take a long-term view of international development. Even though the process of transforming from a largely traditional economy with low productivity into a largely modern economy with high productivity is happening at a historically fast pace, the whole process will take at least a generation. Planning under a grand vision is crucial to marshalling public resources (in concert with private resources) for fulfilling that vision.

Second, it is crucial to conquer the risks that are beyond the capacity of the private sector. To advance up the value chain, first movers have to take risks, overcome misperceptions (or even disillusionment), and bear the losses of failed experimentation. The large-scale transformation envisioned in this agenda is marked by unprecedented complexity and magnitude over a long period of time. At the initial incubation or take-off stage, this far-sighted vision is often beyond the reach of private players, whose range of action is usually constrained by short- or medium-term performance criteria. Public entrepreneurs are crucial to overcoming diffidence and inaction by creating enabling conditions for launching and scaling up value creation.

In terms of implementation, being under the direct leadership of the State Council, the CIDCA should have the authority to coordinate a diverse set of financial instruments— including grants, concessional loans, equity investment guarantees, and insurance—across ministries and financial institutions. This new agency may be able to create synergies across China’s development financing institutions, such as the China Development Bank, the Export-Import Bank of China, and recently established development funds including the Silk Road Fund and the China-Africa Industrial Capacity Cooperation Fund, whose collective portfolios are much larger than the aid budget.1 Furthermore, foreign aid can be a catalyst for mobilizing the participation of holders of private capital and institutional investors by incubating bankable projects.

In a nutshell, the tenets of NSE suggest that the CIDCA may help enhance China’s international leadership role and promote structural transformation in BRI partner countries and other developing states.

Jiajun Xu is an assistant professor and the executive deputy dean of the Institute for New Structural Economics at Peking University. Xu has worked for the United Nations and World Bank and currently acts as the general secretary for the Global Research Consortium on Economic Structural Transformation.

This article is part of a series resulting from a workshop on Chinese international development aid hosted by the Carnegie–Tsinghua Center. The center is grateful to The Rockefeller Foundation for the support that made this series possible.

This article uses separate research that the author conducted as part of research projects with the Foundation of China–Peking University Management Science Data Center (2017KEY06) and the National Social Science Foundation (17BJL124). These research projects are not affiliated with the Carnegie Endowment for International Peace.

Notes
[1] For reference, please see the 2017 annual reports of the China Development Bank and the Ex-Im Bank of China, as well as the Chinese government’s 2014 white paper on aid. China Development Bank, 2017 Annual Report, 2017, http://www.cdb.com.cn/English/bgxz/ndbg/ndbg2017/; and Export-Import Bank of China, 2017 Annual Report, 2017, http://english.eximbank.gov.cn/upload/accessory/201812/201812415543010122.pdf.

 

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