China Redux

Esteemed economists Seema Jaychandran and Michael Kremer have proposed an elegant solution to the problem of funding going to rogue or illegitimate regimes (via the Washington Post). Their answer: loan sanctions, in which illegimate regimes are cut off from receiving loans or other forms of credit through an explicit increase in the likelihood that the borrowed funds will not be repaid to creditors.

Let’s take Iran. As I write this post, US diplomats are pressuring international banks and foreign governments to stop providing loans to Iran, which enables it to expand oil production (which provides the revenues to fund its nascent nuclear program). But this is an imperfect approach: it is time-intensive and taxing on US diplomatic resources, and it is unenforceable — the US has no decisive legal recourse against the banks or a country like France beyond bargaining. The bottom line is the bottom line: since loaning Iran money can be a profitable business, international banks are not likely to stop–unless everyone else does.

Jaychandran and Kremer figured out that the best way to get creditors to stop providing credit is to remove the profit motive from the equation. How? In the author’s scheme, the US and other western donor nations would discourage repayment of illegitimate debt — debt incurred by countries under the control of illegitimate regimes (such as Iran, or Burma). Legitimate successor governments–the next government of Iran (democratic, of course)–would be told not to pay back the loans, and their assets would be protected from any seizures. The authors even suggest that the US, UN, UK, etc. could threaten to withold aid to legimitate governments that pay back illegitimate debt. That would take care of that problem quickly.

Essentially, illegitimate debt would be non-transferable, so creditors who still wanted to provide loans would have to be willing to assume an extraordinary amount of risk. If the government in charge flipped, the investment would be lost.

That where China comes in — or doesn’t. The authors don’t discuss China because loan sanctions woudn’t discourage China from providing funds to illegitimate regimes. Chinese aid is already unconditional; it is provided without concern for corruption, governance, fiscal probity, human rights, macro and microeconomic policies, etc etc — all the things that tend to mark illegitimate regimes.

The problem is that China does not really care if it loses all $800 million of its investment in Zambia (which is not an illegitimate regime). Profit is secondary to China’s larger goals in Africa. China has already signaled that it will forgive major amounts of African debt in the future. For western donors, debt forgiveness is a tool to control inflation in developing countries, stabilize governments, and work towards poverty reduction. For China, it’s a way to stave off growing resentment from the citizens of the African countries who are receiving Chinese aid — and ensure unbroken access to what it really wants in Africa: export markets (legitimate or illegitimate), natural resources, and training grounds for Chinese professionals (on this, see my earlier post).

Kramer and Jayachandran have devised a brilliant tool to help cut off funding for dangerous and corrupt regimes. Just don’t expect loan sanctions to work against rising powers with money to burn.