STATE ACTORS, MARKET GAMES

Policy Banks, Public Financial Agencies, and State-Market Relations

To understand China’s development finance, the book looks particularly into its two national policy banks (zhengcexing yinhang)—the China Development Bank (CDB) and the Export-Import Bank of China (China Exim). The CDB is mandated to finance infrastructure and industrial projects, and the China Exim is mandated to support the export and overseas investment of Chinese firms.

There are two main reasons for focusing on the policy banks. The first is their size. As the following chapters will illustrate, loans from the policy banks, not the Chinese government’s revenue or commercial banks’ investments, have capitalized the majority of China’s global development finance. The two banks’ overseas lending has made China the world’s largest provider of bilateral development finance. China has also provided finance through multilateral channels, making contributions to the World Bank and creating new multilateral institutions—the Asian Infrastructure Investment Bank headquartered in Beijing and the New Development Bank headquartered in Shanghai. Yet the volume of capital funneled through these means has been much smaller than that offered by the policy banks (as discussed in chapter 4). While acknowledging China’s important contribution to multilateral development finance, this book focuses on the bilateral side of Chinese lending.

The second reason is the policy banks’ dual identity. As their name suggests, policy banks were created to serve policy goals, on the one hand, and pursue commercial interests as banks, on the other. A scrutiny of these agencies reveals the state-market boundary and demonstrates how political and economic factors interplay in a Chinese context. Particularly important is the CDB’s operating rationale in understanding China’s development, as it is the main bank that has facilitated the country’s domestic infrastructure and industrial development and created a Chinese means of development finance—kaifaxing jinrong.³ Chapters 1 and 2, which explain the domestic origin of the Chinese pathway to development, will therefore focus primarily on the CDB. China’s state-owned commercial banks, which are increasingly playing significant roles in financing overseas projects, also lie at the state-market intersection, and yet their overseas lending volumes are still much smaller than policy-bank loans, and most importantly, they are not mandated to serve policy objectives and therefore undertake projects driven mostly by business incentives. While discussing commercial banks’ interaction with the policy banks (chapters 3 and 5), the focus of this book will be the policy banks.

Nonetheless, the dual identity of the policy banks makes a comparative analysis between China and advanced industrial economies challenging, because it is difficult to find a proper Western benchmark to which the policy banks could possibly be compared. The banks’ pursuit of business interests in international markets suggests that they should be compared with profit-seeking Western investors, which are generally privately owned. Their policy-serving responsibilities, on the contrary, suggest that they should be compared with Western-led development finance institutions with similar public mandates. The banks’ dual identity not only confounds researchers that seek to make sense of China’s development finance through a comparative lens but also perplexes decision makers within them. Ever since their establishment, the policy banks have been struggling to define themselves as either a state organ or a financial agency, or something in between, and consequently, they have been struggling to define how China’s development finance should be designed.

In fact, policy banks are not a type of financial agencies peculiar to China. Throughout history and across countries, public financial agencies (PFAs) such as national development banks, aid agencies, export credit agencies, and multilateral development finance institutions have played crucial roles in capitalizing industrialization, facilitating export, and fostering economic development, and yet they have been largely underexamined in academic literature, either in terms of empirical studies or theoretical discussions. The reason is straightforward—given their dual nature, neither political scientists nor economists treat them as typical focal points for analysis. Like policy banks, most of the PFAs had historically faced or are currently facing the challenge of balancing public mandates and financial sustainability.⁴ In other words, the Chinese policy banks are not alone in struggling with the state-or-market dilemma.

Using PFAs of advanced industrial economies as a benchmark, this book characterizes state-market relations in China’s development finance through a comparative lens. The benchmark serves two purposes. First, much of existing analyses seeking to conceptualize Chinese capital use either “global private capital” or “Western foreign assistance” as a benchmark.⁵ Indeed, policy banks and the private banks of advanced industrial economies are comparable in certain respects—for instance, they both undertake commercially oriented businesses in the developing world. Yet, choosing such a benchmark would unquestionably highlight the statist aspect of Chinese capital, yielding a conclusion that China’s development finance is more state-led than its Western counterparts. Policy banks and aid agencies are also comparable, as they are both major financiers of underdeveloped regions. Yet, choosing such a benchmark neglects the fact that policy banks are rather business-driven and serve the interests of firms, and China in fact has other government organs responsible for disbursing foreign aid. To better understand the dual identity of policy banks, it makes more sense to compare them with financial agencies that are more alike.

Second, the Chinese policy banks are latecomers to the PFA family worldwide and have thus been borrowing the experiences of their foreign predecessors to build up their own operating models. As the book will show, the CDB and the China Exim were founded in 1994, whereas the main PFAs that they have been emulating—namely, Germany’s Kreditanstalt für Wiederaufbau (KfW) Group, Japan’s national development bank and export-import bank, and the World Bank—were established in the 1940s and 1950s. Examining how the policy banks resemble and differ from their foreign counterparts therefore sheds light on how China’s development finance comes into shape. By demonstrating both the peculiar and the general features of the Chinese PFAs with reference to PFAs of advanced industrial economies, this book is the first that has examined China’s policy banking from a comparative perspective.

Nevertheless, an empirical study focusing on the policy banks is a challenging task. Compared with PFAs in other countries, these Chinese banks reveal very limited official data with regard to the volumes, destinations, and terms and conditions of their loans. They do not even report their total annual disbursements consistently. Their data disclosure procedure has become even more restrained in recent years, as non-Chinese media has cast both banks in a negative light, accusing them of “debt trapping” developing countries; well-known cases have included the CDB’s oil-backed lending in Venezuela and the China Exim’s financing for Sri Lanka’s Hambantota Port.⁶ As a result, quantitative depictions of the banks’ overseas business have thus far primarily relied on secondary data collected by research institutes.⁷ To tackle this challenge and illustrate how these banks actually function on the ground, this book triangulates various sources of primary data, including quantitative data from published historical and recent official documents that capture the amount, composition, and cost of policy-bank bonds and loans, as well as qualitative data collected from interviewing people working in policy banking and related fields. I conducted in-depth field research with both banks from 2015 to 2021, interviewing people who are working or used to work in the policy banks, other financial agencies that are also engaged in China’s overseas financing, enterprises that are clients of the policy banks, and government organs that are involved in the coordination of development financing. Interviews with the policy banks were conducted with bankers of various ages, administrative levels, and departments in both the Beijing headquarters and provincial branches. Because both banks have been extremely cautious in sharing their operating details in public, the majority of interviews were off the record. When an interviewee refused to be quoted, I fact-checked their statements with sources that are openly accessible, such as media reports, memoirs and autobiographies, and officially documented speeches, and cited the latter. In addition, I conducted field research in Germany (Frankfurt and Berlin) in 2016 and in Japan (Tokyo) in 2017 and 2019, collecting firsthand quantitative data and interviewing public bank officials working at the two countries’ PFAs—namely, Germany’s KfW, the Japan International Cooperation Agency, and the Japan Bank for International Cooperation.

Grounded in empirical evidence, this book presents three stories about China’s development finance. One story is about how China has financed its own infrastructure and industrial development rapidly over the past decades; a second story tells how China, by supporting the overseas business expansion of national firms, globalizes its peculiar means of late development, especially in the developing world; and a third story is about how the globalization of China’s late development affects existing international orders and global governance led by advanced industrial economies, especially the United States.

China’s Development Finance: The State-versus-Market Debate

Scholars and policymakers generally perceive China’s global development finance as being state-led. Indeed, the state has initiated national strategies, mobilizing and coordinating various economic actors to explore business opportunities overseas and facilitate international development. From the Going Global (zou chu qu) strategy launched in the early 2000s to the BRI announced in 2013, the state has played a leading and guiding role in the business expansion of national firms and banks. Another reason China’s global development finance is seen as state-led is that the main agencies responsible for implementing the initiatives are state-owned. The largest financiers of China’s overseas projects are state banks, primarily national policy banks and increasingly state-owned commercial banks. Although state banks offer loans to private enterprises, their major clients are state-owned enterprises (SOEs), primarily the fewer than a hundred central SOEs (yangqi) regulated directly by China’s State-Owned Assets Supervision and Administration Commission that cover the industries most vital to China’s national economy.⁸

It is common for scholars and others to assume that Chinese loans, as a result of their stateness, follow an anti-market logic—that they are not necessarily driven by business incentives of profit maximization but serve the state’s policy objectives and distort market mechanisms. In academic writings, policy discussions, and media reports, China’s overseas lending is frequently portrayed as an instrument of “economic statecraft,” fulfilling the state’s foreign-policy and geopolitical agendas.⁹ News headlines and policy statements have increasingly cited China-financed projects as evidence that China is engaging in “debt trap diplomacy.” That is, it is intentionally trapping borrower countries (usually developing countries) by offering loans that these countries cannot possibly repay, thereby gaining political leverage over borrowers.¹⁰

Yet, empirical findings have shown that China’s development finance cannot be fully explained through a statist lens for several reasons. First, it remains unclear who “the state” is. Emergent research points out that China’s economic development functions in a rather fragmented manner.¹¹ Different executive agencies have distinctive priorities. For example, the Ministry of Foreign Affairs prioritizes the mission of advancing diplomatic relations with partner countries whereas the Ministry of Commerce prioritizes the mission of trade expansion of Chinese firms. Both missions fall under the broad BRI agenda of advocating “mutual connectivity” between China and countries along the Belt and Road. A monolithic “state” that represents concerted interests of various actors and dominates the entire process of overseas development finance does not seem to exist. Furthermore, the state-owned economic actors—namely, state banks and SOEs—are not just instruments that pursue national strategies. Their state ownership does not constrain them from seeking profits like private investors do. Quite the contrary, the state as a shareholder incentivizes the banks and firms to pursue profits in order to increase the value of state assets.¹² As a result, these economic actors do not follow the state’s top-down command to undertake designated projects; rather, they leverage the BRI to brand their projects and pursue their commercial interests. The market-oriented characteristics of the state banks and SOEs and their nuanced relationship with the “state” therefore require further examination.

This book takes as a departure point that the Chinese loans are not necessarily targeting projects that favor the state’s foreign-policy or geopolitical objectives. They are “profit-seeking” in their peculiar way. Stephen Kaplan conceptualizes Chinese capital in Latin America as a form of patient capital that has a long-term maturity horizon and high-risk tolerance. Rather than exiting the overseas market in cyclical downturns, China’s state investors would acquire cheap assets to exploit long-run business opportunities.¹³ Along the same line, when explaining Chinese state capital in Africa, Ching Kwan Lee expands the definition of “profits,” arguing that the utility function of Chinese investors not only includes commercial gains but also political influence and access to resources.¹⁴ These empirical analyses and characterization of Chinese capital underscore the complexity of China’s development finance: though significantly distinctive from profit-seeking global private capital, it is not entirely state-led. A market logic is obviously functioning, despite strong state presence, and figuring out how the state and the market interplay requires further scrutiny.

A main objective of this book is to highlight and explain the “marketness” of China’s development finance. This is not to say that China’s development finance is free of state participation; it has been and continues to be strongly state-led. Yet the Chinese state, as the following chapters will illustrate with empirical evidence, has created and empowered the market to serve public goals, facilitating a mutually reinforcing state-market relationship for development. Without understanding how the market plays a role in this context, it would be impossible to understand the state’s role, either.

The market logic of China’s overseas development finance has a domestic origin. It is reflected not only in the financing of infrastructure or industrial projects but in various aspects of China’s economic development since the country’s Reform and Opening Up (gaige kaifang) starting from 1978. The economic transition started with a Soviet-style, centrally planned economy, where there was no “market.” The state coordinated almost all economic activities and was the sole allocator of capital. China’s fiscal system and financial system at that time were essentially identical, as the state controlled the financing for public projects and for projects that would have been commercial in a laissez-faire market economy. The economic and financial history of China since the late 1970s, therefore, was primarily a history of rounds and rounds of “marketization” (shichanghua), a term that has frequently appeared in China’s policy documents, even to date.

Scholars of Chinese political economy have attempted to make sense of the Chinese “market” that has grown out of its centrally planned economy. They characterize the various means through which the Chinese state interacts with the market—penetrating, permeating, regulating, shareholding, investing—and highlight the fact that the state has become a component conducive to the market.¹⁵ Scholars have also detailed the process of marketization, which involves the creation of markets from scratch and the transformation of state actors that serve public goals into market actors that pursue commercial interests. For example, in the post-1978 decades, government ministries that used to coordinate industrial activities of the most strategically important sectors were corporatized and transformed into state-owned enterprises. The state has withdrawn from the role of operating these SOEs and yet holds shares and appoints top officials to manage them.¹⁶ In order to capitalize industrial development, the state created or revitalized different types of financial institutions, including the central bank, commercial banks, policy banks, asset management companies, venture capitals, and sovereign wealth funds, which were nonexistent in the central planning era.¹⁷ The goal of creating these state-owned economic actors and empowering them to pursue commercial interests was not to impair the power of the state but rather to strengthen it. Since the late 1970s, central planning was no longer believed to be the most efficient way of allocating resources and enabling urban and industrial development, and marketization was perceived as a solution. By establishing banks and firms and holding shares, the state incentivized these “market actors” to pursue profits and generate revenue, thereby enhancing the shareholder’s (the state’s) capacity in financing and supporting development projects in a rapid and massive fashion.

Understanding this market-oriented logic is crucial to understanding China’s domestic development finance. Policy banks, the primary creditors of China-financed infrastructure projects worldwide, were products of state-led marketization, created to remedy the state’s inefficiency in financing public projects. In the 1990s, the CDB facilitated the creation of China’s interbank bond market, from which it could raise funds and become a financially independent bank without the state’s fiscal safeguard. It also helped China’s subnational governments to establish financial vehicles so that they could mortgage their state-owned assets and revenues to borrow from banks and spend more than their budgetary revenue allowed. In this way, the CDB transformed subnational governments into market borrowers and created a nationwide infrastructure-financing market.

The state’s creation of financial actors, crafting of financial markets, and employment of financial instruments are not practices peculiar to China.¹⁸ Across countries, governments have been using financial approaches—issuing bonds, securitizing state assets, and creating sovereign investment funds, just to name a few—to reduce fiscal burden and capitalize economic activities. Academic literature conceptualizes this process as the “financialization of the state.”¹⁹ The process has accelerated since the 2008 global financial crisis, as governments of both developed and developing countries needed capital to boost economic vitality and chose to employ market instruments to achieve public goals.

Yet, the financialization of the state has a unique connotation in the Chinese context, as the process has been associated with China’s peculiar history transitioning from a centrally planned economy. The transformation has not been easy. As the following chapters will detail, it took China’s pro-reform policymakers decades of effort to subvert incumbent authorities, alter the institutional legacy of central planning, and advance market-oriented reforms. Following this experience, Chinese government organs, state banks, and SOEs have become reluctant to revitalize practices associated with central planning and thus avoid having the state using fiscal revenue to capitalize economic activities. This market orientation explains why China’s state-owned banks and enterprises have strong incentives to pursue business interests and hesitate to take projects that might undermine their financial performances. It explains why the Chinese government is reluctant to channel cheap capital (that is, budgetary funding raised through taxation) to support Chinese banks’ overseas industrial and infrastructure lending or to bail out their failed projects. This market orientation also explains why policy banks offer loans that carry relatively higher interest rates than their PFA peers, why they collateralized host countries’ future revenues to finance projects, and why they have been reluctant to write down debts owed by borrowing countries. While conventional wisdom describes these practices from a geopolitical or foreign-policy perspective, this book offers an alternative explanation. Through the lens of the policy banks, receiving fiscal subsidy from the government to lower interest rates or using government funds to bail out loans would mean having to reverse their endeavors advancing market-oriented reforms and, more fundamentally, to operate against the logic of China’s economic development since the advent of Reform and Opening Up. Therefore, instead of relying on the state’s fiscal assistance, policy banks employ various market instruments—guarantees, securities, collaterals, equities, among others—to resolve problems.

The Role of the State in Late Development: Competing Prescriptions

The conceptualization of China’s development finance, which entails a mutually reinforcing state-market relationship, contributes to a broader discussion on the role of the state in late development. Developing countries face trillions of dollars of infrastructure gap.²⁰ Against this backdrop, it becomes rather important on a policy level to explore how far China’s state-supported, market-based means of development finance, which has facilitated the country’s own growth over the past decades, can travel across borders and serve other late-developed economies. In fact, the rise of China as a major development finance provider in the twenty-first century has generated a new round of debate on which great power offers better prescriptions for developing countries. The United States, for example, created a national development bank in 2019 and called on other countries to form an alliance and offer development finance in a way that is based on “free-market principles,” presenting an alternative approach to the “state-led” Chinese initiative.²¹

This is not the first time in history that great powers have competed for the role of supporting “development.” In the 1930s, the United States employed its export-import bank to provide bilateral development finance to Latin America in the context of increasing geoeconomics and geopolitical rivalry vis-à-vis other powers such as Germany.²² In the early Cold War decades, the United States and the Soviet Union competed to spread their development prescriptions, offering aid, loans, and technical assistance to emerging Third World countries, many of which just gained independence from former colonizers. Justified by social science theories such as modernization theories and neo-Marxist theories, the two superpowers’ policy recommendations presented distinctive pathways toward development of “underdeveloped” economies, including China.²³ As a leading Asian growth engine in the 1970s, Japan similarly exported its development approach, especially to Southeast Asia, by offering development assistance tied to Japan’s national firms. According to the flying geese model, the industrial upgrading of the leading “goose,” in this case Japan, would yield industrial development in the late-developed recipient countries.²⁴

There is no doubt that the policy diffusion and international promotion of the development prescriptions of the big powers was largely self-interest driven: the United States employed development finance to address market failures and national security concerns in the 1930s; the two Cold War superpowers both sought to secure allies and prevent developing countries from joining the other’s camp; Japan aimed to build a regional industrial chain by relocating some of its production network to other Asian countries.²⁵ Yet, the development prescriptions they offered were not sheer instruments of national policy. The prescriptions were grounded in and derived from the respective development experience of these economies, and illustrated their view of what worked the best for themselves and for the rest of the world. Examining the various development logics of these industrial predecessors is crucial to understanding the tension between a rising China and the incumbent powers today.

To a large extent, China’s prescription for the developing world aligns with the general rules of late development. Most existing research demonstrates a positive association between the level of state intervention and the lateness of industrial development. For example, Alexander Gerschenkron’s classic piece comparing industrialization in England, continental Europe, and Russia finds that the later industrialization occurred, the more centralized and rapid the process was. Catch-up economies such as Russia adopted a state-led means of mobilizing capital and labor and focused on nurturing the most up-to-date technology.²⁶ By the same token, the developmental state literature examining the postwar catch-up of East Asian economies—Japan, South Korea, and other newly industrialized economies in Asia—highlights the role of the state in that process: through rational planning, the state channeled preferential credits to selected industries, created an advantage for national firms in international competition, and facilitated industrial development.²⁷

The analyses of these earlier industrialized economies suggest that the state’s control over finance is an essential component of late development and a key factor conducive to the postwar economic success of East Asian economies. Historically, PFAs served as the state’s financial channels facilitating industrial catch-up. For example, Japan relied on the Fiscal Investment and Loan Program (FILP) to mobilize capital for industrial finance. The program was a government-coordinated financial system that funneled postal savings and pension reserves to a group of PFAs at low interest rates, thereby supporting the development of business sectors vital for Japan’s national economy.²⁸ Major PFAs of this program included the Japan Development Bank and the Export-Import Bank of Japan.²⁹ Likewise, the South Korean government had strong control over the commercial banking sector and employed the Korea Development Bank to allocate credits to selected sectors.³⁰ More broadly, late-developed economies such as Thailand, India, Brazil, Mexico, and Turkey have all relied on state-backed national development banks to capitalize major industries.³¹

To a large extent, China’s late development in the post-1978 decades can be understood through the lens of the “developmental state” for three reasons.³² First, the Chinese state played an important role in rational planning. Like Japan’s Ministry of International Trade and Industry, a powerful government organ that coordinated the country’s economic miracle in the early postwar decades, China’s government ministries such as the National Development and Reform Commission and the Ministry of Commerce guided and regulated firms’ industrial investments and overseas business.³³ Second, like its East Asian neighbors, China has a strong state-business nexus. Through state-owned policy banks and commercial banks, the state has channeled large-volume capital to selected sectors and nurtured globally competitive industrial champions. Moreover, China has emulated Japan in practicing a mercantilist means of overseas development finance, using development-oriented loans to support national firms’ export and international investments.³⁴

However, as the following chapters will illustrate, China’s state-led development finance has its unique features that differentiate it from a prototypical “developmental state.”³⁵ China’s development finance loans are generally not cheap, and only a very small portion of them are subsidized by government revenue. Chinese lenders often impose market-rate interest rates. Consequently, unlike firms of typical catch-up East Asian states, Chinese firms do not necessarily obtain a price advantage in the international market from borrowing from their country’s policy banks. Moreover, Chinese firms financed by state banks do not always compete to win projects from their counterparts in more advanced industrial countries. While the policy banks support industrial champions like world-class Chinese telecommunication giant Huawei in obtaining the most competitive deals, they also assist construction companies in picking up projects in underdeveloped regions, which do not necessarily attract banks and firms in advanced industrial economies. In such cases, policy banks usually employ various financial instruments to “enhance projects’ creditworthiness (zeng xin),” a term the CDB often uses in a positive way. For instance, policy banks may request that the host governments mortgage their future receivables to make their projects “bankable,” rather than offering cheap loans subsidized by the Chinese government to the host governments.

These sui generis features show that theories derived from China’s East Asian neighbors cannot fully explain China’s state-supported, market-based finance. The role of the state reflected in China’s late development and industrial catch-up, unlike what conventional wisdom would suggest, does not necessarily involve a distortion of the market; rather, the state creates and utilizes the market. By the same token, PFAs in a Chinese context are not necessarily instruments of state intervention; rather, they are financial tools the state uses as a substitute for direct government subsidization on export and overseas investments. In fact, PFAs are often considered statist because the comparison “by default” is profit-seeking commercial banks. If we use the state’s fiscal system, which finances public projects, as a benchmark, PFAs appear rather market-oriented because they incorporate a market logic, rather than a pure policy logic, to determine the credit allocation for projects.

The sui generis features also allow us to reconsider prescriptions for late development. Orthodox economic theories and policy recommendations usually presume a state-versus-market dichotomy. That is, the development of the market requires the loosening of state control, and the strengthening of state intervention hampers the functioning of a free market. Experiences of the East Asian developmental states have challenged this conventional view by showing that government intervention could be an essential contributive factor for market development and economic growth. The “Chinese pathway” gives credence to an evolving awareness that even strong states in late development do best when they are sensitive to market forces, and it further advances the discussion by presenting mutually reinforcing state-market relations.

Many developing countries, like China in the 1980s, had neither sufficient government revenue nor full-fledged markets. They have been struggling to choose between the different development prescriptions offered by big powers. The choice is usually a binary one between dirigisme and laissez-faire, protectionism and liberalization. China’s development experience and its internationalization presents to the rest of the developing world an alternative approach to late development and a third pathway to economic growth. Although China does not use the term “Chinese model” officially to describe how it practices development finance overseas, the Chinese domestic approach has traveled across borders along with the global business expansion of Chinese banks and firm. Yet successful replication of the Chinese approach, as the following chapters will illustrate, would require that the host government plays a similar role that the Chinese government has been playing in facilitating China’s own growth. Specifically, the host government has to provide strong support to allow infrastructure and industrial projects to occur in a market-based manner, using market instruments to go beyond their fiscal limits and capitalizing projects vital for economic development. This, however, may include the adoption of some very controversial practices, such as collateralizing state-coordinated revenue flows to borrow from Chinese banks.

Late-Developed China and Existing International Regimes

The emergence of China’s “third pathway” leads to questions about its global implications and outlook. First, how has China’s distinctive means of overseas development finance reshaped existing international orders led by advanced industrial economies? Second, if China’s finance is associated with its lateness of development, what happens if China becomes more developed? Will China continue to finance projects in the developing world in the way it has been, or will it converge to the means of finance practiced by its industrial precursors?

To answer these questions, it is first necessary to understand how advanced industrial economies, which have been leading the existing international orders in the postwar decades, practice development finance and make rules of development financing. An emergent body of scholarly work and policy analyses has portrayed a competitive relationship between China and the existing orders, juxtaposing a state-led challenger with a rule-based liberal international order (LIO) led by the United States. Constituted by political and economic liberalism and incorporating open market and security cooperation, the LIO has played a vital role in defending the West against the Soviet Union and supporting the spread of democracy and free trade in the postwar era.³⁶ The rise of China as a powerful “illiberal” state has led to intense debates in terms of how it may affect this existing order. Some argue that China has been adapting to the LIO, while others believe that China has been changing and undermining it.³⁷ Prevailing policy discussion on the BRI generally falls under this China-versus-LIO narrative, highlighting core LIO elements that China has been contesting—namely, democracy and laissez-faire principles. For example, policy reports justifying the establishment of the U.S. International Development Finance Cooperation underscores that an American alternative to the BRI should be grounded in free-market principles and the mobilization of private investments.³⁸ They further suggest that the United States should call for Group of Seven (G7) countries and like-minded liberal democracies more broadly to collectively practice such a market-based means of development finance to counter the growing influence of China.³⁹

However, scholarly work has also pointed out that a binary outcome of either adaptation or contestation may not accurately capture the interplay between a rising China and the existing international rulemaking, as a hybrid outcome entailing both scenarios could be possible.⁴⁰ China’s responses to U.S.-led international orders in different issue areas are quite distinctive, supportive of some and unsupportive of others. Specification of “issue area” is essential when examining the rules, norms, and practices that China has been dealing with.⁴¹

China’s bilateral lending spans two interrelated issue areas: development and trade. Yet, the existing international rules and norms of development finance and trade finance demonstrate contrasting rationales—development finance rules rely on the role of the state in financing projects whereas trade finance rules constrain the role of the state in supporting business activities.⁴² Existing comparative research therefore offers two starkly different answers with regard to how China affects Western-led international orders. The development-focused research examines how Chinese loans resemble or differ from official grants and concessional loans regulated by the Organization for Economic Cooperation and Development (OECD)–Development Assistance Committee (DAC). This strand of research finds China’s bilateral development finance—and the bilateral development finance of East Asian catch-up economies and Southern development partners more broadly—to be more business-driven than its Western counterparts. While Western DAC donors offer mostly government-to-government assistance, emergent development partners often incorporate commercially oriented business activities in development assistance.⁴³ Trade-focused research, by contrast, scrutinizes how China’s state banks challenge the way the OECD regulates export credit agencies (the official agencies that offer loans and insurances to industries that cannot easily attract private capital).⁴⁴ This body of research finds Chinese loans to be more state-supported than their Western counterparts; they rely more on state banks rather than private sources of funding. That is to say, depending on the specific issue area being examined, researchers have arrived at rather different answers to the same question. Therefore, using a general concept of LIO to understand China’s interplay with existing orders fails to provide reliable information.

This book seeks to go beyond the China-versus-LIO narrative by comparing policy banks with different types of PFAs of advanced industrial economies that are operating under different international regimes with distinctive undergirding rationales. International regimes, according to Stephen Krasner, refer to the “sets of principles, norms, rules, and decision-making procedures around which actors’ expectations converge in a given issue-area of international relations.”⁴⁵ Focusing on bilateral development finance or aid, export finance, and consequently debt relief, this book shows that the impact of China on Western-led regimes is more than just a rivalry. In the issue area of export finance, China as a catch-up latecomer is indeed challenging the laissez-faire rules established by earlier industrialized economies. But in the issue area of bilateral development finance or aid, China is generally more business-oriented than Western donors. Using development finance loans as a tool for assisting the export and industrial development of national firms, China has mobilized commercially oriented business actors to undertake projects in the developing world, filling a gap that the financial schemes of existing regimes have left and yielding a convergence between Southern and Northern development practices. Yet the disparity between Chinese and Western finance has resulted in a tension between China and the existing international sovereign debt regime. Because China offers much larger volumes of business-oriented export finance than Western PFAs do in supporting projects in developing countries, it prefers to employ different debt relief approaches than those used by traditional Western creditors in resolving debt insolvency.

Furthermore, the book points out, the fact that China is able to integrate development finance with trade finance is an advantage of backwardness. Late-developed, catch-up economies are more likely to integrate aid with trade, whereas advanced industrial economies tend to manage the two kinds of finance separately.⁴⁶ Leading OECD countries such as the United States prefer to use grants and concessional loans subsidized by government revenue to support projects in underdeveloped regions and to use export credits to serve the needs of profit-seeking firms, which favor higher-income markets. This dichotomous means of credit governance came into shape in the 1970s and 1980s, when OECD disciplines strictly demarcated the two types of bilateral finance so that countries could not employ state-backed development loans to back up their private firms.⁴⁷ The demarcation was further reinforced in the 1990s and 2000s against the backdrop of the developing-country debt crisis, when OECD countries limited their offering of new export credit loans and provided primarily development assistance to indebted countries to improve their debt sustainability.⁴⁸ Yet this means of credit management is generally unfavorable for the emerging Southern development partners because many of them are not fiscally capable of using government revenue to assist other countries’ projects in a charitable manner, and their firms rely on state-backed credits to expand overseas markets.

China is not the first country that practices bilateral development finance in a business-oriented way. In the early postwar decades, Japan as a catch-up economy (vis-à-vis Western industrial economies) used official development assistance to support Japanese firms’ global expansion, challenging the U.S.-led international regimes that demarcated development aid from export finance.⁴⁹ Nonetheless, Japan has gradually lost this advantage of backwardness and converged toward the Western means of credit governance since around the 1980s, primarily for three reasons. First, external pressure from the United States and some European countries forced Japan to stop using its aid to finance its own firms—or, to use the OECD’s terminology, to “untie” Japan’s official development assistance.⁵⁰ Second, as production cost in Japan increased, Japanese firms began to outsource some of their infrastructure work to other countries, including some of the projects financed by the government’s official development assistance, leading to a natural untying.⁵¹ Third, commercially driven Japanese firms began to rely more on private investors instead of PFAs to finance their projects, and therefore they were less likely to be mobilized by PFAs to support the government’s international development policy.⁵² As a result, Japan’s management of its overseas finance was to a large extent “Westernized” by the end of the 1990s in that it distinguished state-led aid from business-led investments.

What Japan experienced decades ago is what China is experiencing today. On the one hand, Western economies have increasingly pressured China to revise its way of development financing and, especially, to limit the use of state-backed loans to support Chinese firms’ overseas business. On the other hand, the preferences of Chinese firms have changed over time. When they had just started exploring overseas market in the early 2000s, they undertook the “leftover” projects that did not interest their industrial predecessors. Now, many of them have become internationally competitive and are able to bid for the most lucrative projects on the more advanced markets. They consequently have to face the challenge of balancing the state’s imperative to support developing countries and their own commercial pursuits for profits. These changes have led to a series of questions: What happens if China loses the advantage associated with backwardness? Will it experience the same changes that Japan experienced in the 1980s and converge to the Western means of managing development finance credits, or will China be able to continue filling the infrastructure gap that industrial economies have failed to fill? In the long run, what will be the outcome of China’s rise vis-à-vis existing regimes led by the West?

As the latter half of the book will demonstrate, China and the Western-led international regimes have altered one another. On the one hand, advanced industrial economies like the United States have collectively reversed their development finance approach, switching from a traditional, gift-giving means of bilateral development assistance to a more self-interest-driven, business-oriented approach in response to China’s rise.⁵³ Similarly, multilateral development finance institutions have advocated practices of blended finance and public-private partnership to mobilize private investors to engage in development projects and to share the burden with public financiers.⁵⁴

Some scholars see this shift as the revitalization of a “development investment” approach (as opposed to a “development assistance” approach) originated from Japan and other East Asian donors.⁵⁵ Others view it as the “Southernization” of the global development landscape, as the “new” ethos and practices highlighting reciprocity and win-win is usually associated with Southern development partners and not traditional DAC donors.⁵⁶ China’s increasing influence in the developing world is a main driving force for this transition, as a major reason Western powers adopted this “new” approach was to rival China. In addition, fiscal challenges in the post-global financial crisis and post-pandemic era have also incentivized advanced industrial economies to make development “investible,” since using government revenue to support development-oriented projects in other countries is a fiscal burden for donors.⁵⁷ In short, the United States and other Western economies have begun to reverse the ethos, narratives, and practices that they have been advocating in the postwar decades and instead adopt a “Southernized” approach that is often associated with catch-up economies.

At the same time, China is gradually losing its advantage as a latecomer and has begun to adopt the Western means of managing development financing. For example, the China International Development Cooperation Agency was created in 2018 and took over the responsibility of coordinating government foreign assistance from the country’s Ministry of Commerce. The new agency has been playing an increasingly significant role in facilitating aid in accordance with China’s foreign-policy agenda as opposed to foreign-trade agenda, making Chinese government aid less mercantilist. At the same time, Chinese firms have started to seek more profitable projects in the international market, upgrading to become equity investors to gain more profits rather than remaining as sheer contractors or suppliers. As a result, they rely less on policy banks as the projects they undertake may attract commercial banks. Chinese policy banks have been discussing how to demarcate “policy-oriented projects” from “commercially oriented projects,” taking on their Western counterparts’ practice of managing credits in a dichotomous way. These changes all imply that China is converging toward the rules of Western-led international regimes.

Major Arguments of This Book

In sum, this book challenges conventional wisdom and makes four arguments. First, China’s development finance reflects a distinctive means of late development, one that is both state-supported and market-based. While studies on China’s industrial predecessors show that the degree of state intervention is associated with lateness of development, China’s late development reflects a more nuanced state role, one that empowers and employs the market to achieve state goals. Instead of allocating budgetary revenue to fund projects, the state has transformed government organs into market entities, employed financial tools borrowed from overseas to strengthen state capacity, and established market institutions to fund rapid and massive industrialization and urbanization. In other words, the state and the market reinforce one another in China’s development finance.

Second, China’s distinctive means of development finance has its origins in the country’s domestic experience transitioning away from a centrally planned economy. In the reform era, the state’s direct allocation of budgetary revenue is considered inefficient, and “marketization” is thought to be the prescription for economic growth. The CDB, in particular, has pioneered the creation of China’s domestic interbank bond market to raise long-term funds for development and assisted Chinese subnational governments in creating financial vehicles that would allow them to mortgage their revenues and go beyond fiscal constraints. While the policy banks are criticized for encouraging developing-country governments to take on large debts supported by collateralized revenue streams, they are in fact reproducing the lending mechanisms they have practiced at home.

Third, the globalization of Chinese development finance has affected the international regimes led by advanced industrial economies. While conventional literature juxtaposes a state-led China with a U.S.-led LIO and underscores the tension between the two, this book argues that China’s rise yields more than a rivalry, and its impact varies by issue area. Examining the international rulemaking in the issue areas of bilateral development finance/aid, export finance, and sovereign debt relief, this book finds the following. In bilateral aid and export finance, China, with its advantage of backwardness, has been filling a lacuna insufficiently covered by the financial schemes of Western-led international regimes. Policy banks have indeed nurtured national champions and allowed them to compete with firms of advanced industrial economies, contesting the international export credit regime. Yet, they have also supported Chinese firms in undertaking projects that their Western counterparts have “left over” in the developing world. China’s integration of development and trade has partly incentivized traditional donors to advocate for the incorporation of firms and commercial investors in undertaking development projects, yielding a convergence rather than a contestation between China and the international aid regime. China’s state-led, market-based finance, however, has led to controversies in sovereign debt relief. To keep nonperforming loan rates low, policy banks have been reluctant to write off debts. This contests the international sovereign debt regime led by the International Monetary Fund and the Paris Club, which is more accepting of debt forgiveness practiced by official bilateral creditors.

Yet, as China becomes fiscally capable of financing more infrastructure projects with government revenue, and as Chinese firms rely less on policy banks as their primary sources of funding, the question arises as to how long China will keep practicing its peculiar means of development finance. This book’s final argument suggests it may not be long. While it has been filling the global infrastructure gap insufficiently covered by advanced industrial economies, China is also losing the advantage of backwardness and converging toward the Western means of managing bilateral finance. Much like PFAs of advanced industrial economies at earlier points in history, policy banks have inevitably arrived at a crossroads where they need to make a decision: to prioritize state imperatives or firms’ interests. In the long run, China may continue financing projects in low-income countries, but it may not necessarily finance them with the policy banks’ state-supported, market-based means of lending; rather, China is more likely to use government foreign assistance directly to support projects in underdeveloped regions and have commercial banks support Chinese firms’ competition for profitable projects.

Structure of the Book

Chapter 1 and chapter 2 illustrate the domestic origin and practice of the “Chinese pathway,” explaining how a means of state-supported, market-based development finance took shape in a particular political-economic context and how it has been practiced nationwide. Chapter 3 and chapter 4 discuss how this peculiar means of finance, associated with China’s lateness of development, has been globalized through the overseas adventure of Chinese firms and banks and how it has interplayed with existing international regimes. The outlook for the Chinese pathway, as covered in chapter 5, considers the challenges China faces when it continues practicing this means of development finance and possible future changes to China’s credit management. The book concludes with a discussion on the policy implications. The focal point of analysis of all the chapters is the degree of state involvement in development finance, reflected in the operating mechanisms of the policy banks. The chapters scrutinize how the state’s role in development finance has evolved over time, varies across regions, and resembles and differs from the state’s role observed in advanced industrial countries’ development finance practices.

Specifically, chapter 1 illustrates how policy banks, primarily the CDB, developed their unique fundraising mechanism, which is selling state-guaranteed bonds on a domestic market to other Chinese financial agencies, mainly commercial banks. While bond issuance is a common way of raising capital nowadays, a “market” where financial agencies could trade bonds barely existed in China back in the early 1990s. Integrating a government-coordinated approach reflected in Japan’s Fiscal and Investment Loan Program (FILP) and a market-based bond-issuance approach practiced by Germany’s national development bank, the CDB facilitated the creation of a domestic interbank bond market to raise capital for China’s urbanization and industrialization. By doing so, the CDB transformed a traditional means of policy-bank funding (namely, the state apportioning bonds to designated buyers) into a market-based means of funding. In this process, the state transferred the tasks of allocating and pricing bonds to the newly crafted market and empowered bond transactions by offering sovereign guarantees.

The market-oriented logic is not only reflected in the policy banks’ fundraising mechanism but also in their lending mechanism. Chapter 2 illustrates the domestic version of the Chinese prescription. It traces how the CDB has nurtured a domestic infrastructure-financing market against the backdrop of China’s public finance reforms when the Chinese government lacked sufficient tax revenue to finance projects vital for economic growth. The CDB assisted subnational governments in creating financial vehicles, collateralized their lands and fiscal revenues, empowered them to borrow large quantities of loans from policy banks as well as other financial agencies, and allowed them to capitalize infrastructure and industrial projects in their respective municipalities and provinces. Replicating this means of finance nationwide starting in the late 1990s, the CDB turned subnational governments into market borrowers, transformed China’s major means of public finance from direct government spending to state-backed project financing, and facilitated China’s rapid urban and industrial development. In this process, the state has withdrawn from a direct role in allocating fiscal revenue, instead leveraging state assets and revenues and employing financial instruments to achieve public goals. Nonetheless, the financialization of the state is Janus-faced. It has incentivized subnational governments to spend more than their fiscal revenue allowed them to, thereby driving up debt volumes. To resolve debt issues, the central government has again adopted a market-based approach, conducting succeeding rounds of reregulation and refinancing for local government financial vehicles instead of bailing them out with tax revenue.

Understanding how policy banks finance projects at home sheds light on understanding China’s development finance in a global context. Comparing policy banks with Japan’s PFAs and using three case analyses to illustrate how policy banks support Chinese firms, chapter 3 finds that in addition to supporting industrial champions’ international expansion and competition, policy banks have also helped Chinese contractors—companies that build infrastructure works—undertake financially nonviable projects in less developed regions. Through collateralizing state-owned and state-coordinated revenue flows of host countries—the same way the CDB financed domestic projects—policy banks enhanced the creditworthiness of projects and created an advantage for Chinese firms in conducting business in low-income and middle-income economies. When doing so, the state’s role is not channeling fiscal revenue to subsidize firms and distort market-pricing mechanism, because neither China nor the host countries are willing to or fiscally affluent enough to do so. Rather, the state financialized its revenue flows and allowed projects to be capitalized in a market-based manner.

Grounded in the analysis of chapter 3, chapter 4 discusses the impact of China’s overseas development finance on three Western-led international regimes: bilateral development finance/aid, export finance, and sovereign debt. The chapter identifies and examines three types of Western-regulated PFAs—aid agencies, export credit agencies, and development banks that the policy banks are comparable with—and then discusses the interaction between China and the international regimes that govern these PFAs. The chapter finds that the lending destinations of aid agencies and export credit agencies of advanced industrial economies diverge significantly, whereas China does not distinguish development finance from trade finance. Policy banks capitalize development-oriented projects with loans that support national firms’ foreign trade and overseas investment. This, as chapter 4 highlights, is an advantage of backwardness that advanced industrial economies do not have, which has allowed China to largely fund the infrastructure gap faced by the developing world. The interplay between a rising China and the existing regimes is thus more than a rivalry. In export finance, China contests the existing regime; in development assistance, it converges with it.

Nonetheless, one of the main reasons China has been able to fill this development gap, financing projects in low-income regions with commercially oriented loans, is the policy banks’ support for host governments’ financialization of state-coordinated future receivables, which has empowered the host governments to “overspend.” If not regulated cautiously, this may increase the debt level of the host countries, much as it increased that of Chinese subnational governments. In fact, developing countries have already been facing debt challenges, and foreign politicians and media have accused China of practicing “debt-trap diplomacy” while traditional creditors claim it is not transparent about its lending information. The way policy banks have been resolving the current debt issues also reflects their business-oriented logic. They have been reluctant to cancel debts directly because they are unwilling to increase their nonperforming loan rates, which would consequently worsen their financial performances. Instead, they prefer to reschedule, refinance, or restructure existing loans, much as they have done with domestic debts owed by subnational governments. This has challenged the Western-led international sovereign debt regime, which had become generally receptive to debt forgiveness since the late 1980s.

Chapter 5 explores whether policy banks are likely to continue financing projects in the way they have been. Comparing them to PFAs of advanced industrial economies, especially Japan, which has transitioned from a relatively late-developed industrial economy to one of the world’s leading economies, the chapter finds that policy banks, like their foreign precursors, cannot escape the general dilemma faced by PFAs: balancing the state’s development-oriented objectives and firms’ business-oriented objectives. PFAs of catch-up economies are able to reconcile the two objectives because firms rely on the state’s credit support for business expansion. Yet, as firms grow and attract commercial investors, PFAs are no longer financiers of last resort. Meanwhile, as the Chinese government becomes more capable of offering direct foreign assistance to developing countries, Chinese commercial banks expand their overseas markets and compete with policy banks, and Chinese firms advance their business and pursue more lucrative projects, policy banks’ business scope has been significantly squeezed. They have reached a watershed where they have to make an immediate choice between prioritizing policy imperatives and commercial goals because they cannot maintain their dual identity as easily as they once did. This implies that in the long run, China may gradually adopt the Western means of managing overseas development finance.

The concluding chapter recapitulates the main findings of the book and summarizes how these findings shed light on three intensely debated policy issues: the nature of China’s “debt-trap diplomacy,” the competition between China’s BRI and the United States’ B3W initiative, and the future of China’s global development finance. Since the twenty-first century, China has globalized its distinctive means of development finance, interacting with both developing countries where most of the China-funded projects take place and developed countries that lead global development governance. Yet despite increasing interaction between China and the world, there is a huge gap between how the world perceives China and how China sees itself. While mainstream Chinese media and policy statements highlight how China has contributed to international development through the BRI, English-language media and policy analyses increasingly describe China’s overseas lending as “debt trapping” poor countries and threatening the West. This gap, unfortunately, has been widening in the aftermath of the global pandemic. This book bridges this gap by making sense of the “Chinese pathway” in a way that could be understood by both internal and external observers.