The gulf between economic data and official pronouncements grew through the second quarter of 2024. Property markets, stock prices and consumer sentiment all indicated weakness while China showcased engagement with foreign investors and private Chinese firms to signal intent to boost activity. But new policy actions were not market friendly in the period before the July 2024 Third Plenum economic planning meetings. There were a few encouraging signs for foreign investors, including pledges to discipline local protectionism and arbitrary regulations, but these have been heard before, and “promise fatigue” is a serious problem. Most of the clusters we track showed limited progress or further divergence from OECD norms. On trade, China refused to acknowledge the legitimacy of the overcapacity concerns the world was alarmed about.

The second quarter generally reflected the takeaway from the July plenum meetings: China will leverage whatever it can to drive technological advancement, and national security will override efficiency at home and engagement abroad. New rules to address excess local regulation contain expansive national security carveouts, as do pilot measures to allow foreign investment in data centers and telecom. Beijing’s commitment to direct state support to vast swaths of the economy was reinforced this quarter, with the state planning plenum manifesto as a capstone.

Read the full issue brief below

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Sinographs Jul 23, 2024

Key takeaways from China’s Third Plenum 2024

By Hung Tran

The communiqué of the Third Plenum of the CCP Central Committee lacks major policy initiatives to address the country’s near-term growth challenges.

China Economy & Business

Issue Brief May 15, 2024

China Pathfinder: Q1 2024 update

By GeoEconomics Center and Rhodium Group

In the first quarter of 2024, Beijing pushed forward with a flurry of efforts to support a faltering stock market, ramp up exports to make up for domestic demand, and double-down on high-tech sectors with subsidies and other innovation funding.

China Fiscal and Structural Reform

Report Oct 4, 2023

Running out of road: China Pathfinder 2023 annual scorecard

By Atlantic Council GeoEconomics Center and Rhodium Group

The China Pathfinder project examines whether China’s economy is converging or diverging with the world’s leading open market economies.

China Digital Policy

The post China Pathfinder: Q2 2024 update appeared first on Atlantic Council.

With EU countries now facing greater fiscal constraints, the bloc needs to either further amend them or find a way to have more common European debt. Only then will EU member states be able to make the increases in defense spending that are necessary to bolster security on the continent and deter further aggression from Moscow.

The EU’s fiscal rules

The EU is a partial monetary union (not every state uses the euro) and is not a fiscal union. Twenty of its twenty-seven member states use the euro, but they maintain their own public accounts. The EU’s budget amounts to just 1 percent of the bloc’s entire gross domestic product (GDP). Brussels levies few taxes and spends little for the bloc, and that relatively small budget is the sum of the EU’s fiscal union. The real power of the EU resides in the supervision of the member states’ fiscal policies.

This is why some countries with high levels of debt or deficit—France, Italy, Poland (which spends 4.1 percent of its GDP on the military), and several others—might be under special supervision by the European Commission under the Excessive Debt Procedure (EDP). The EDP requires the country in question to provide a plan of fiscal consolidation that it will follow, as well as deadlines for its achievement. Countries that do not follow up on the recommendations may be fined. Of course, many EU countries are in debt, and most of them run a deficit even in good times; in bad times, they just run even bigger deficits. The European Commission will take into account additional military expenditures in the assessment, but only on military equipment, not on increasing the number of soldiers.

In 2023, the average debt-to-GDP ratio in the EU reached 82 percent, and it was even higher in the eurozone, at 89 percent (with France exceeding 110 percent and Italy going beyond 137 percent). The highest deficits were recorded in Italy (7.4 percent of GDP), Hungary (6.7 percent), and Romania (6.6 percent). Eleven EU member states had deficits higher than 3 percent of GDP. In comparison, the United States has a debt of around 123 percent of GDP and ran a deficit of 6.3 percent in 2023.

The original EU fiscal rules implemented thresholds for each country’s deficit and debt at 3 percent and 60 percent of GDP, respectively, and they required cutting national excess debt-to-GDP ratios by one-twentieth each year. These restrictive rules contributed to the eurozone’s prolonged recession from 2011 to 2013, and some rules have since been relaxed. In response to the COVID-19 pandemic, for example, the bloc activated its general escape clause, which allows for deviations from the EU’s Stability and Growth Pact in times of crisis. Moving forward, however, the rules will likely turn restrictive again, though less so than the old ones. In April 2024, EU institutions agreed on a consensual change to the fiscal framework, making the path back to a debt of 60 percent GDP and a deficit below 3 percent of GDP a matter of negotiations between each member state’s government and the European Commission.

Treat military spending differently

Some EU countries, such as France and Poland, argue for military expenditures to be treated differently, as some member states have different needs in the current geopolitical climate. Not all EU member states are in NATO; for example, Austria is neutral. But under the current EU rules, the fiscal space for military expenditures is one-size-fits-all. After Russia’s full-scale invasion of Ukraine in 2022, defense expenditures incurred that year were within the escape clause, but this does not address the underfunding of the military within the EU.

In 2024, the average military expenditures of NATO and EU members is expected to reach 2.2 percent of GDP, with a group of countries far below the threshold of 2 percent. More importantly, these are big economies with relatively large armies, such as Italy (1.49 percent of GDP), Belgium (1.3 percent), and Spain (1.28 percent). All of these countries have high levels of debt and issues with deficits. Germany is set to reach 2.12 percent of GDP on defense spending this year, but it is held back by its constitutional debt brake, which does not allow for an annual deficit higher than 0.35 percent of GDP. This has created tensions within Germany’s coalition government, since spending more on weapons might mean having to spend less on climate change mitigation and social services.

Meanwhile, the United States spends 3.38 percent of its GDP on defense. To put that into perspective, the total expenditure of all European NATO members is $380 billion, almost three times lower than that of the United States (nearly $968 billion). At the same time, Russian military spending this year is estimated to reach $140 billion, or 7.1 percent of its GDP.

Common debt

European capitals need to treat the need for a stronger military in Europe as urgent and serious, but their accountants in the finance departments are not going to make it easy. Unless Brussels changes its fiscal rules to allow for greater defense spending, common EU debt might be the only solution.

The bloc can issue EU debt outside of national fiscal rules, which it did for the first time in response to the COVID-19 pandemic. Some analysts argue for common debt for a European air defense system, which is a good starting point. EU debt funding could include spending on the further development of European defense industrial capacities. EU leaders such as former Estonian Prime Minister and future EU High Representative Kaja Kallas, French President Emmanuel Macron, and European Commissioner for Internal Market Thierry Breton have supported some version of common debt for defense purposes.

Utilizing common debt should not aim solely to expand the power of the European Commission, as some critics in various capitals fear. Instead, it should transform this measure from a temporary crisis-management tool into a standard policy instrument, enabling Europe to develop a meaningful defense industrial strategy, which has been lacking since the EU’s inception. After the failed attempt to establish a European Defence Community in the 1950s, the European project has primarily focused on economic issues. Unfortunately, it’s time to revisit that discussion.

Europeans must now prepare for a challenging geopolitical environment by investing in European defense, whether through changes in fiscal rules or by taking on more European debt.

Whichever path forward the EU chooses, it must do so quickly. There’s no time to waste.

Piotr Arak is the chief economist at VeloBank Poland.

The post The EU needs to adapt its fiscal framework to the threat of war appeared first on Atlantic Council.

Mere moments after the announcement, Macron declared that he would not name a prime minister until after the conclusion of the Olympic Games in August. Until then, a caretaker government under Prime Minister Gabriel Attal will remain in place. Still, the potential of an NFP prime minister spooked the markets, as the party’s economic policies would trigger even more deficit spending. The spread of France’s ten-year bond yield against Germany’s increased by five basis points, reflecting a loss in confidence in the French government’s finances. 

But even after the Olympics, Castets is unlikely to be tapped to form a government. Instead, the parties of the center, center right, and center left will have to endure a tedious drill from which France’s constitution has spared them for decades: negotiations. 

The moderate “Republican Right” (DR) appears ready to play ball and recently put forward a set of policy proposals complete with two red lines that will inform the negotiations. But a deal including the Republicans would not be enough: The centrists would need the more moderate forces from the NFP (read: excluding the far left) to support—or at least not oppose—a government for the time being.

The negotiations behind an arrangement that would bring Communists, Gaullist Republicans, Greens, and centrists under the same banner is likely to be every bit as complicated as one would imagine. But in the likely case that the NFP fails to clear the bar for government formation, this would become the only option. The question then becomes: What could this political hodgepodge compromise on? 

Synchronized steering

Despite having lost the legislative election, the Macron-supporting center block will not concede much on any of its policy laurels. Reversing the controversial and hard-won increase of the retirement age from sixty-two to sixty-four, for example, will be off the table. 

The center right has also set explicit red lines: that there be no tax increases and that fiscal reform not hurt pensioners. 

Taking into account these constraints and the need to manage France’s strained fiscal situation, there is not much negotiating flexibility left. Nevertheless, the centrist coalition must consider some concessions and secure certain inducements if they hope to bring the Republicans, Socialists, and Greens onside. 

1. Green reindustrialization

The adoption of the Inflation Reduction Act (IRA) in the United States prompted pushback from many European states. French Finance Minister Bruno Le Maire and his German counterpart Robert Habeck claimed the legislation was not compatible with World Trade Organization principles and called for the “defense” and green reindustrialization of the European Union (EU). 

In July 2023 the French National Assembly unanimously agreed on the creation of a “national strategy” for green industry, which lays out a plan for the 2023-2030 period. One week later, a Green Industry Law was approved at first reading and later adopted in October 2023. Like the IRA, France’s Green Industry Law seeks to meet environmental objectives (reducing forty-one million tons of CO2 by 2030, or 1 percent of France’s total footprint) and economic ones (positioning France as a leader in green and strategic technologies, while reindustrializing the country). As part of the law, the Green Industry Investment Tax Credit (C31V) was established to encourage companies to carry out industrial projects involving batteries, wind power, solar panels, and heat pumps. The C31V is expected to generate €23 billion in investment and directly create forty thousand jobs by 2030. 

While in opposition, the Socialists and Greens voted against the law and other left parties abstained. All cited the lack of specificity and actual green commitments in the industrialization-centered bill. However, if the centrist bloc offered to revisit the bill or introduce new, more targeted standards and legislation, it could serve as a powerful inducement to win the Greens and Socialists’ support. Given that this French counter to the IRA involves private-sector mobilization and promises reindustrialization, it has the added benefit of being (just about) fiscally feasible and acceptable to the right. 

2. Rewarding effort

The thirty-five-hour work week was first introduced into French law by Lionel Jospin’s Socialist-led government in 2000, and it has since become a cornerstone of the left’s platform. However, the fact that most employees still work above the legal thirty-five-hour limit has led to a system where they can take half days or full days off to compensate for extra hours. 

In August of 2022, Macron’s government successfully passed an amendment that allowed firms to buy these hours back from their employees, essentially transforming them into paid overtime. 

As part of the center right’s current proposal, the group is seeking additional flexibility in the thirty-five-hour work week by reducing taxation on overtime, on top of cutting overall social charges paid by employees. The center right has been fairly nonspecific about how much these would be cut, most likely to avoid alienating the left. However, the main way the Republicans propose to fund this—a cap on unemployment benefits at 70 percent of the minimum wage—would be a red flag for the parties which could otherwise be lured out of the NFP.

3. Balancing budgets

France’s large budget deficit, which in 2023 soared to 5.5 percent of gross domestic product (GDP), raises the stakes. In May, S&P Global Ratings downgraded the country’s long-term credit rating from “AA” to “AA-” and the European Commission reprimanded France for exceeding the EU’s deficit cap of 3 percent of GDP. Today, the Commission formally opened proceedings against France and six other violating countries, directing them to immediately take corrective measures to rectify their fiscal deficits or else face financial sanctions from Brussels. 

Both S&P and the Commission forecast positive economic growth, but emphasize the urgent need for France to address its public finances. Growth alone will not be enough to overcome the fiscal hurdles ahead. 

Reconciling the center right’s rejection of any tax hikes and the need to provide parties of the left with guarantees on social spending for them to abandon the NFP will be very challenging indeed. But there is some room for compromise. 

Shortly after Macron’s arrival at the Élysée Palace for his first mandate in 2017, he moved to slash France’s contentious wealth tax, replacing it with a real estate tax. A flat tax of 30 percent on capital gains was also introduced. The decision came as part of Macron’s pro-business platform in a bid to curb the flight of French millionaires from the country, and it drew sharp criticism from political opponents who labeled him “president of the rich.”

The centrist bloc could offer to reintroduce a progressive taxation scheme on capital gains. In the spirit of France’s goal of green reindustrialization, the centrists could move to keep the favorable 30 percent flat tax for green technologies to encourage investment, while introducing a progressive scheme in other sectors. If they do decide to favor green industrial investment, the tax benefit would have to apply to capital gains accrued throughout the EU—not only France—so as to not violate single market rules. 

Sticking the landing

Negotiations will be more of a marathon than a sprint. Macron is unable to call for new elections for at least the next twelve months, so until then, this parliament will have to find a way to work together. 

After the formation of a government—which Macron has indicated will not begin until after the Olympics—the next major challenge facing French policymakers is to pass the yearly budget by December. This grueling event will be made all the more difficult by today’s unprecedentedly divided National Assembly.

Whichever government emerges from current negotiations will risk having its spending plan voted down immediately. Fortunately for France, the constitution contains a proviso that would allow the state to carry on. Essentially, if the Assembly cannot agree on a new budget, the plan approved for the previous fiscal year will roll over. 

However, recycling this year’s budget would still create a projected deficit of 4.4 percent. This would again violate the EU’s 3 percent cap and fall well short of the deficit reduction the markets—the ultimate referees of how France is faring—are hoping to see. 

Charles Lichfield is the deputy director and C. Boyden Gray senior fellow of the Atlantic Council’s GeoEconomics Center

Gustavo Romero is an intern with the Atlantic Council’s GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post What French economic policy may look like after the Olympics appeared first on Atlantic Council.

Since their inception in July 1944, they have played central roles in global finance and built the world’s economic architecture as the norm-setters, knowledge-producers, convenors, and actors in the international development and finance landscape.

In 2024, the BWIs are facing multi-faceted existential challenges, posing serious risks for their relevance and effectiveness. The rapidly changing nature of the global economy, commerce, and finance and the increasing challenges triggered by the emergence of new players, technologies, and crises—especially in the past two decades—are forcing these institutions to take a renewed look at their governance structure and mandates. This is not the first time they have had to do so.

A reformed Bretton Woods system already emerged nearly five decades ago in 1976 through the Jamaica Accords. In 1971, the Nixon administration created a shock when it canceled the direct convertibility of the US dollar to gold and rendered the old Bretton Woods system inoperative as currency exchange rates became more volatile. The new rules stabilized the international monetary system by permitting floating exchange rates and formally abolishing the gold standard, which the United States was already no longer underpinning.

This time, meaningful reform for the BWIs will require a genuine acknowledgment of the following developments in the global political economy:

1. Economies that are not part of the high-income club are playing an increasingly large role in global trade and finance. However, the BWIs’ voting, leadership, and governance structures do not reflect this shift in the global economy and the IMF and WBG remain US-, Group of Seven (G7)-, and European Union (EU)-centric institutions. Together, the EU and the United States still maintain about 40 percent of votes in the World Bank and the IMF even as their relative prominence in the global economy has eroded.
   
   
   
   
2. The global economy is facing a growing number of challenges that have stretched the resources of BWIs and tested their effectiveness in bringing together the right stakeholders. One can point to unsustainable levels of sovereign debt, weather-related extreme events, increasing risk of pandemics, and aging populations as only some of these multifaceted challenges. Moreover, tariffs, subsidies, currency wars, protectionism, industrial policies, sanctions, geoeconomic fragmentation, and decoupling have become commonplace hurdles to globalized trade. The emergence of heightened geopolitical tensions between some of the world’s largest economies has undermined global financial stability and has also introduced significant difficulties for the BWIs to adhere effectively to their mandates of effective global governance, shared prosperity, and international monetary cooperation. This is eroding gains made through globalization in the past few decades.
3. The emergence of state-led development finance institutions and the growing number and influence of regional multilateral development banks and financial institutions, sovereign wealth funds, and pension funds have drastically altered the global landscape of development finance, calling for a more active collaboration between BWIs and the following parallel institutions:
   • Nearly 160 countries are signatories to China’s Belt and Road Initiative (BRI) and/or the G7’s Partnership for Global Infrastructure and Investment.
   • More than forty multilateral development banks and financial institutions—such as the Asian Development Bank, the Inter-American Development Bank, the African Development Bank, the Islamic Development Bank, and the Asian Infrastructure Investment Bank—are active in the global development finance landscape.
   • More than fifty national development banks such as Qatar Development Bank, Korea Development Bank, and Development Bank of Nigeria are offering a wide range of financing products to international public and private entities.
   • More than 130 sovereign wealth funds boast around $12 trillion in assets globally.
   • Public and private pension funds have over $24 trillion and $42 trillion in global assets, respectively.
4. Several multinational corporations (MNCs) command economic and technological might larger than many countries and are increasingly shaping the future of global economy through innovation and by influencing policy debates. MNCs are estimated to account for nearly one-third of global gross domestic product (GDP) and a quarter of global employment, and the revenue of Walmart alone was larger than the GDP of more than 170 countries in 2023. Environmental, social, and governance standards have been put in place to create a framework where MNC activities are not detrimental to environmental and social objectives but are based on best governance practices. However, the BWIs have played too minor a role and influence in these conversations. 
5. The emergence of digital currencies and assets and the increasing role of technology (artificial intelligence, machine learning, and fintech) in economic and monetary policy offers challenges and opportunities for the efficiency and stability of the global economy. Alternative finance championed by non-state actors has moved faster than international and domestic supervisory and regulatory bodies, including the BWIs, which have not kept up with the rapid pace of change. For example, the IMF in collaboration with the Bank for International Settlements could play a significant role in coordinating the global efforts in standard-setting for central bank digital currencies and new cross-border payment systems.
6. New debates and policies are altering global economic, monetary, and trade policies. Modern monetary theory, universal basic income, quantitative easing and tightening, modern central banking, global minimum taxation, fair trade, and human rights considerations in global supply chains are some of the issues BWIs need to be more proactive about.

Acknowledging the gravity of the risks facing effectiveness and relevance of BWIs, our Bretton Woods 2.0 Project has conducted in-depth policy research on the rising challenges facing BWIs’ governance and operations and has put forth feasible policy recommendations for their consideration in their reform journey. Substantive reforms are never easy, especially for multilateral organizations with such long and complex histories and intractable geopolitical rifts between their members. Difficult decisions, especially regarding the governance and leadership structure of these institutions, must be made, however. As Axel van Trotsenburg, senior managing director at the WBG recently acknowledged, for the IMF and WBG to remain true to their mandates and still relevant at their one hundredth anniversary in twenty years, they must embark on reforms that heed the issues highlighted above.  

Amin Mohseni-Cheraghlou is a macroeconomist with the GeoEconomics Center and leads the Atlantic Council’s Bretton Woods 2.0 Project. He is also a senior lecturer of economics at American University in Washington, DC. Follow him on X (formerly known as Twitter) at @AMohseniC.

The post The Bretton Woods institutions need revitalizing. Luckily, they are no strangers to reform. appeared first on Atlantic Council.

This surge in defense spending follows Russia’s full-scale invasion of Ukraine in February 2022. The war in Ukraine has prompted an unprecedented 18 percent increase in defense spending this year among NATO allies across Europe and Canada. In total, NATO countries now meet the 2 percent target, together spending 2.71 percent of their GDP on defense. This creates positive momentum and success to build on for the Washington summit, which is expected to highlight the Alliance’s collective strength and focus on deeper integration with Ukraine. 

Poland stands out as the biggest spender, allocating 4.12 percent of its GDP to defense. Sweden has also increased its defense spending dramatically since the 2022 Russian invasion of Ukraine. The Washington summit will witness Sweden’s first participation in a NATO summit as an official NATO member, following its accession in March.  

As NATO celebrates its seventy-fifth anniversary, the large increase in defense spending can help renew the Alliance’s unity and strength to continue supporting Ukraine and be prepared for the future. 

Clara Falkenek is an intern with the GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Who’s at 2 percent? Look how NATO allies have increased their defense spending since Russia’s invasion of Ukraine. appeared first on Atlantic Council.

One of the IMF’s tasks is indeed to deflect some of the political blame from a government that has committed to fiscal adjustment measures and faces public opposition. Even after the bill was withdrawn, however, public anger has yet to subside, fueled by killings of demonstrators and accusations of corruption and misuse of public money.

The truth is, of course, that Kenya’s decline into fiscal trouble has been entirely predictable, led by the ambitions of past leaders who followed the path of easy money. Especially during the mid-2010s, under President Uhuru Kenyatta, Kenya was looking for ways to leverage its “frontier market” status into higher growth via debt-financed investments and infrastructure projects. As a result, within a decade, Kenya’s public debt ratio almost doubled from 41 percent of gross domestic product (GDP) in 2014 to a projected 78 percent of GDP in 2024.

One prominent creditor has been China’s Export-Import Bank, which provided Kenya with $3.2 billion to build a Standard Gauge Railway (SGR) between Nairobi and the port of Mombasa—a project that has been criticized because of its weak governance and high cost but, according to recent reports, will be extended to Kenya’s western border with Uganda.

Although public investment does have an important role in raising a country’s economic fortunes, Kenyans are still waiting to see the social returns of the debt-financed investment spree. GDP growth has hovered around 5 percent since the mid-2000s, real GDP per capita has stagnated in recent years, and the poverty rate (at just below 40 percent) remains above pre-COVID-19 levels. It is no wonder that the fiscal belt-tightening now required to arrest a further run-up of public debt has met with resistance, amid legitimate questions about who benefited from the loans that ordinary Kenyans now have to repay.

Ruto, in office since 2022, carries his share of responsibility for the fiscal sins of the past, having been vice president in the previous administration and a proponent of the Chinese railway loan. His government is also dealing with droughts and the aftermath of the COVID-19 crisis, which hit Kenya and other frontier markets particularly hard, including through spillover effects from global inflation and higher interest rates. Being caught out in a weak fiscal position and facing eventual default, Kenya turned to the IMF in 2021 to help stabilize its finances, including a “multi-year fiscal consolidation effort centered on raising tax revenues and tightly controlling spending.”

The government did reasonably well under this program, which originally foresaw a steady pace of fiscal adjustment (at about 1 percentage point of GDP per year over five years) and allowed for measures to absorb its social impact. Both the primary fiscal deficit and the trade balance improved, and the shilling unwound much of its decline vis-à-vis the US dollar as Kenya surprised markets by repaying a two-billion-dollar Eurobond last month. Moreover, the program unlocked a considerable amount of concessional multilateral financing, including from the World Bank.

But the country remains in a financial hole from which it will be very difficult to climb out. One problem is that higher interest rates keep adding to Kenya’s debt dynamics, as illustrated by the hefty 10 percent interest rate on a smaller Eurobond that Kenya issued in February to meet its June payment. Therefore, despite an improvement of the primary deficit broadly in line with program targets, Kenya’s public debt is still projected to increase this year.

While the government planned to continue on its programmed adjustment path, the latest package of measures—including tax measures to offset gradual revenue slippages over the years—appears to have been the political straw that broke the camel’s back. So, what are the alternatives available to the government now?

• First, “keep calm and carry on” may be the motto of the day. The government appears to be looking for spending measures to substitute for lost revenues, but this will not be viable in the long term. Expenditure compression has its own distributional (and political) consequences, and the overall fiscal adjustment strategy will need to be balanced across revenue and spending items.
• Second, with interest payments accounting for more than a quarter of total revenue, the Kenyan government may decide to seek a debt restructuring. This is not something the IMF could impose on Kenya, unless it judged that public debt was unsustainable. However, the government went to great lengths in the past to service its debt and retain access to financial markets. It would have been cynical on the part of IMF shareholders, who routinely call for strong ownership from program countries, to force Kenya into an unwanted debt operation—as long as there was still a realistic chance of avoiding it. This now looks less assured, and it may be the only avenue left for the government.
• Third, however, the Export-Import Bank of China is the biggest bilateral lender to Kenya, holding claims worth $6.5 billion, close to two thirds of all bilateral debt. China has a special responsibility to provide debt relief, given the history of corruption and questionable economic value of the SGR project it helped finance. Kenya would have to request a debt treatment under the Group of Twenty (G20) Common Framework, which has recently become more efficient in dealing with problem cases. However, bilateral debt negotiations could still take a long time to resolve, and Kenya would risk being cut off from external financing for a considerable period.

As the government needs to chart a fresh course in this difficult environment, it is also very likely that supporters in the West will call for more money and fewer fiscal adjustment as the solution to Kenya’s problems. The Nairobi-Washington Vision, formulated during Ruto’s state visit to the United States in May, has also called for increased financial support for developing countries. The question is, where should this money come from?

• First, anyone who has looked at a financing needs table of an IMF program (for example, see Table Six here) understands that spending can either be financed by revenues, grants, or borrowing. Since grants don’t carry any interest or repayment burden, they would be ideal for a country in Kenya’s situation. But taxpayers in rich countries have shown less and less inclination to finance development aid, let alone through direct transfers or outright debt relief for poorer countries.
• Second, the IMF and other multilateral institutions have raised funds and mobilized special drawing rights (SDRs) in recent years to subsidize interest rates paid by poorer member countries, and Kenya is already benefiting from this effort. However, there are limits to this approach. Subsidies have to be either financed from donor countries’ budgets (with less and less political support) or they are generated from richer countries’ SDR holdings.
• Third, SDR-based lending works only to a limited extent. SDRs derive their value from their status as foreign exchange reserves and being exchangeable for dollars and other hard currencies held by central banks in wealthy countries. Any overuse or exposure to default risk (for example, from rising public debt in recipient countries) could compromise their reserve-asset status, which would impact both the IMF’s financing model and its capacity to lend to countries in distress.
• Fourth, could the IMF and World Bank provide larger loans? The two institutions regularly review the amounts that countries can access under various conditions. Ceilings have gone up over time, but shareholders (who carry the ultimate risk) generally require that larger loans come with stricter macroeconomic conditionality, an approach that would presumably have triggered a similar outcome for Kenya. Moreover, multilateral loans already account for more than a quarter of Kenya’s public debt. Since these loans cannot be restructured, private creditors might be more hesitant to invest in the country, because any future debt operation might need to be deeper than in similar countries with a smaller share of multilateral debt.

To sum up, Kenya’s predicament is largely homemade, albeit with help from willing external lenders. The COVID-19 crisis exacerbated a lack of fiscal discipline, eventually forcing the country to adopt a stabilization program. While meeting with some initial success, recent events have made it clear that the government’s adjustment strategy needs to change, putting a possible debt operation on the table. The IMF did its best to support an initially credible effort by the government, but it must also ask itself what could have been done to prevent the sharp increase in public debt that is at the heart of Kenya’s problems today.

Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF official with decades-long experience in economic crisis management and financial diplomacy.

The post Kenya’s fiscal troubles are largely homemade. Now the country is running out of options. appeared first on Atlantic Council.

The high rate of dropouts ahead of the second round make the number of three-way races favoring National Rally much lower and a hung parliament more likely. An absolute majority for National Rally cannot be fully ruled out yet, but an absolute majority for the New Popular Front already can. This shift in probabilities has led to diverging reactions in bond yields, which have remained slightly higher than before the first round, and stock prices, which have rallied.  

Following Macron’s announcement of the snap election on June 9, French ten-year bond yields increased more than in any other week since 2011. In other words, it was the worst week for the rate at which France borrows from markets since the heart of the eurozone crisis. 

While he was admittedly in campaign mode, French Finance Minister Bruno Le Maire’s warning of a possible “Liz Truss-style” event if National Rally wins—referring to the 2022 bond market meltdown in the United Kingdom that forced the then-prime minister to reverse course on her fiscal plans—was more than a mere talking point. Increased yields arise from falling demand for government loans, reflecting a diminished faith in a government’s finances. The market could see both the extreme right and the extreme left promising to reverse cost-saving measures taken by the incumbent government (such as pensions reform) without offsetting these with new sources of income. 

This graph shows that the “spread” with German bonds has yet to fall significantly despite the greater likelihood of a hung parliament. Why? 

France’s finances are already fragile. Two weeks ago, the European Commission named France as one of seven countries in violation of its new fiscal rules due to high debt levels and no expected reduction in spending. With no tradition of broad coalitions in France, the assumption at this point is that no government will be able to conduct more cost-cutting or efficiency measures. 

Still, France’s bond yield increases thus far remain far less severe than the UK gilt crisis in 2022. 

On the other hand, the results of the first round prompted stock market prices to rally from their initial steep drop following the announcement of the snap election. France’s private sector seems to have taken comfort from the central scenario of a hung parliament and the elimination of a New Popular Front majority scenario. The likelihood of punitive taxes and other major economic changes businesses would need to contend with is now much lower, but not gone.

While France’s CAC 40 index noticeably increased on Monday and Tuesday, it hasn’t fully recovered the losses made following Macron’s decision to dissolve parliament. Clearly, investors are still waiting to see how the second round and its aftermath play out. In a hung parliament scenario, Macron’s party would have to negotiate with all parties that reject the far right. The strongest bloc among these will be the left. This is enough for investors to remain in wait-and-see mode for now.

Charles Lichfield is the deputy director and C. Boyden Gray senior fellow of the Atlantic Council’s GeoEconomics Center

Sophia Busch is an assistant director with the Atlantic Council GeoEconomics Center.

Clara Falkenek contributed research to this piece.

This post is adapted from the GeoEconomics Center’s weekly Guide to the Global Economy newsletter. If you are interested in getting the newsletter, email
SBusch@atlanticcouncil.org.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post How are markets reacting to the French snap election? appeared first on Atlantic Council.

Compared to last year’s economic free-fall, Argentina’s situation is indeed looking up. President Javier Milei and his team have embarked on a serious fiscal adjustment initiative and are making a determined effort to bring inflation down from record levels. These policies have met with considerable early success, but the austerity measures needed to reduce the fiscal deficit have led to massive social disruption and serious street protests against the government.

Despite these early achievements, the real issues facing Argentina remain low productivity, a weak growth outlook, and large external financing needs in the foreseeable future. Together, they call into question whether Argentina will be able to crawl out from under its large debt burden and access markets to obtain fresh financing beginning in 2025, as projected by the latest IMF staff report. This forecast corresponds to an exceedingly optimistic scenario, in which continued reforms lead to an improvement in Argentina’s twin deficits, culminating in a strong pickup in capital flows in the medium term.

In reality, it is more likely that the reform momentum will be slowed by hardening opposition in the National Congress of Argentina, in particular in the Senate, where Peronist provincial governments still hold sway. Further exchange rate depreciation, the lack of a strong rebound in labor markets, and accumulating pain from continued austerity will also impair Milei’s hopes of gaining a parliamentary majority of his own during next year’s midterm elections.

A drubbing at the polls could throw Argentina back to square one. Both of the last two governments were hobbled by weak election outcomes halfway through their presidents’ terms. Despite Milei’s popularity with a large part of the Argentinian public, failure to array Congress behind his movement could again leave Argentina with a lame duck government and a half-completed reform agenda.

In such a situation, the envisaged liberalization, if not outright dollarization, of Argentina’s exchange rate regime—which still seems to be one of the president’s key objectives—is bound to fail. The country would need a strong and growing economy to sustain the kind of fiscal discipline that is required for a stable exchange rate regime, and this will not be possible without deep changes to Argentina’s economic laws and structure, starting with the government’s own footprint.

Such changes require a societal consensus toward market-friendly reforms, but also toward the appropriate distribution of incomes in case growth takes off. In Argentina, such middle ground between radical reform and government largesse has been elusive for decades, and it is unlikely to be found unless the main political camps are prepared to compromise.

Without dismissing this possibility outright, it is much more likely that the economic hardship currently experienced by ordinary Argentineans will drive voters back toward the main opposition party. The Peronist party will, without doubt, promise large handouts to core constituencies that abandoned them during the last elections, frustrated by high inflation and rising unemployment. And as the economic environment is stabilizing, many voters will have forgotten who was responsible for Argentina’s precarious situation in the first place.

The IMF should therefore remain cautious in its discussions with the current government. The institution was wrong to lower its standards for the current program, which granted Argentina a fairly easy restructuring of its repayment terms, an operation that is in principle ruled out by the IMF’s own statutes. Going forward, the fund should be leery of granting Argentina fresh money, digging itself even deeper into a hole that is already threatening to upend its own balance sheet (and possibly imposing losses on shareholders whose per-capita income is still below Argentina’s).

Instead, any new relationship with Argentina should be based on conditionality that ensures sustained growth and the eventual repayment of Argentina’s debt. As it failed to do in 2022, the IMF should insist that both political camps sign on to a meaningful reform program. Otherwise, it risks a reprise of the Macri experience, when IMF funds provided the incumbent government with a financial war chest to support its reelection which the next opposition-led government did not feel obliged to repay when it came to power.

Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF official with decades-long experience in economic crisis management and financial diplomacy.

The post Milei’s biggest challenge is to foster the societal consensus that Argentina needs to thrive appeared first on Atlantic Council.

Women and civil society are indispensable as first responders in the ongoing war. They must also be central to the planning, distribution, and oversight of funds in reconstruction efforts. As the German and Ukrainian governments recognized, the physical reconstruction of Ukraine needs to be paired with a comprehensive social, human-centered recovery. Women, who represent the majority of the highly educated and skilled workforce in Ukraine, are well-positioned to strengthen anti-corruption measures, modernize the energy sector, and drive Ukraine’s reform agenda. All of these components are essential for an effective recovery. In addition, these efforts can help Ukraine meet the conditions for its accession to the European Union (EU).

The record to date for women’s inclusion in recovery efforts has not been what it needs to be. Policymakers must continue to ensure that Ukrainian women leaders will have the opportunity to meaningfully and fully participate in Ukraine’s recovery. Ukraine can only recover if women and civil society are fully involved in its reconstruction.

Where do women fit in the Ukraine recovery agenda?

Held in Lugano, Switzerland, in July 2022, the first recovery conference resulted in the adoption of the “Lugano Declaration,” which includes guiding principles for Ukraine’s recovery process. At the 2023 conference in London, the EU announced the creation of a new Ukrainian facility that would provide a total of fifty billion euros to Ukraine over four years. From this total amount, thirty-nine billion euros will be allocated to the state budget to support macroeconomic stability. Another eight billion euros will go toward a special investment instrument that will cover risks in priority sectors. This year’s conference in Berlin aimed to attract private-sector investment in Ukraine, including in human capital. The agenda included the explicit goal of investing in women and youth. This was a positive development and should encourage international financial institutions and private donors to continue to invest in women-owned and -led businesses in Ukraine, as well as to train Ukrainian women to take on jobs in Ukraine’s critical sectors.

How to unleash Ukrainian women’s economic potential

Invest, train, and enable Ukrainian women. Women in Ukraine and elsewhere have traditionally had limited access to credit, markets, and training opportunities. They have also struggled to balance responsibilities in the workplace and their primary caregiver responsibilities. These challenges must be overcome if women are to fulfill their economic potential.

The World Economic Forum notes that one solution for improving women’s access to credit is to not necessarily demand collateral, because women often do not own private property. Moreover, many women (as well as men) in Ukraine have lost their homes and properties to the war, so providing property as collateral is not likely to be an option for them. Therefore, adopting alternative ways to determine women’s creditworthiness could encourage more women to apply for business loans.

Ukrainian women, with the support of Western companies and institutions, have already stepped up to launch their own startups. These should be scaled up. Since the start of Russia’s invasion, an increasing number of Ukrainian women have founded tech startups, benefitting from improved access to investors outside Ukraine, as well as programs sponsored by the EU, international organizations, and private companies. For example, VISA launched its “She’s Next” program in Ukraine in 2020, and it has since hosted gatherings where Ukrainian women presented their business proposals and received funding and training at business schools. More Western companies should team up with women-led Ukrainian nonprofits to create opportunities for funding female-led startups and give them access to education and training.

Train Ukrainian women to fill workforce gaps in critical sectors. Now is an important time to train Ukrainian women in two critical sectors that will play a key role in rebuilding Ukraine’s economy: finance and cybersecurity. Ukraine has consistently ranked as one of the most corrupt countries in Europe in Transparency International’s global Corruption Perceptions Index. Although Ukraine has made significant progress in the fight against corruption since 2014, it remains a problem and a concern for the United States and other foreign partners. The cost of complete reconstruction is currently estimated to be around $750 billion, but international donors are concerned about the potential misappropriation of funds put toward reconstruction.

Reform of its financial sector is essential for Ukraine to secure financial aid for reconstruction, as well as to meet the requirements for joining the EU. The urgent need for financial system reform coincides with women playing a much larger role in the financial system, both within the government and private sector. By transferring the knowledge of, for example, the best anti-money laundering (AML) practices to Ukrainian women, the West would create a generation of AML experts in Ukraine who are capable of detecting suspicious money flows and preventing corruption and money laundering within the Ukrainian financial system.

At the same time, equipping Ukrainian women with cybersecurity skills would help them defend Ukrainian banks and the financial system from Russian intrusions. Ukrainian banks were one of the primary targets of the cyberattacks that Russia initiated right before launching its full-scale invasion of Ukraine in February 2022. More recently, at the end of 2023, Monobank, one of the largest Ukrainian banks, reported a massive hacker attack. While the bank has not publicly attributed this attack to any specific threat actor, Russia has been suspected due to its history of backing cybercrime groups attacking Ukraine. The persistent threat of Russian cyberattacks against Ukrainian banks should be countered by training Ukrainian women in cybersecurity and digital forensics.

Ukraine’s partners and allies can learn from and build on existing work to train Ukrainian women in cybersecurity. For example, the United Nations Institute for Training and Research organized a project that trained Ukrainian women evacuees in Poland in cybersecurity and data analytics. The project was held from October 2023 to March 2024 and was funded by the government and people of Japan. Private companies have also launched similar initiatives. For example, Microsoft is working with nonprofit organizations in Poland to train Ukrainian women refugees to enter the workforce in cybersecurity. Such projects need to expand to include more partners and reach more Ukrainian women.

Investing in Ukrainian women is smart economics

Leveraging Ukraine recovery conferences and other global convenings to encourage Western investment in Ukrainian women corresponds with the United States’ existing strategy of providing economic incentives to allies—also known as positive economic statecraft. The EU, United Kingdom, and other Group of Seven (G7) members are already heavily invested in Ukraine’s success. Directing investment toward the female workforce will strengthen an already existing strategy of ensuring Ukraine has the resources to minimize economic dependence on Russia. Investment in Ukrainian women will create a multiplier effect for the economy. It is well-known that women often spend their income on education, healthcare, and nutrition—all of which raise the standard of living. This is a force that moves economies forward but is often sidelined.

Finally, Ukrainian women can fill in global workforce gaps, too. Training Ukrainian women in cybersecurity would help address the global cybersecurity skills crisis. Private companies and policymakers often note that the world does not have enough cybersecurity professionals. Meanwhile, Ukraine has a highly educated population, especially in technical subjects. Cyber-trained Ukrainian women could defend not only Ukrainian banks but also businesses and governments around the world.

As policymakers and private sector actors adopt strategies for Ukraine’s reconstruction, it is crucial that they fully leverage the potential of Ukrainian women and help establish the groundwork for an inclusive and sustainable recovery.

Melanne Verveer is the executive director of the Georgetown Institute for Women, Peace and Security and a former United States ambassador-at-large for global women’s issues at the US Department of State.

Kimberly Donovan is the director of the Economic Statecraft Initiative at the Atlantic Council’s GeoEconomics Center and a former senior US Treasury official.

The post Women should play a central role in rebuilding Ukraine’s economy appeared first on Atlantic Council.

The reality is that Beijing’s measures are a mere drop in an ocean of empty or unfinished apartment buildings, moribund developers who have defaulted on at least $124.5 billion of dollar debt, and hundreds of millions of homeowners who once bet on a now-collapsed property bubble. It also is bad news for an economy that over the past two decades came to rely on the property sector—and the industries like construction that it turbocharged—to provide between 20 and 30 percent of the growth that fueled China’s economic “miracle.”

Even if the Chinese government eventually comes to grips with the current crisis, it is extremely unlikely that the property engine will end up firing on more than a few cylinders. The combination of a declining population, slowing urbanization, and market changes that have made new homes less attractive than existing housing stock means that frothy property development will be a thing of the past.

None of this is good news for the global economy. The downsizing of China’s housing demand will be felt by natural resource suppliers across the developing world. But of far greater concern will be the implications of China’s growing reliance on low-priced exports to fuel growth—a surge that already is sparking trade tensions with the United States, Europe, and emerging market countries. This dependence on factory output will be a constant now that the property bubble has collapsed, taking with it a big chunk of Chinese domestic demand.

The impact of the real estate downturn has been reflected for months in China’s economic indicators. Sales of new and existing homes fell at a record pace in April, and property investment plummeted nearly 10 percent year on year. Home prices posted their sharpest decline in nearly ten years. The impact on employment in the property sector has been severe: an estimated half million real estate jobs have disappeared since 2020.

The carryover to the larger economy has been severe. Consumer spending has been hit especially hard, with many small businesses failing to recover from China’s strict Covid-19 shutdowns. Automobile sales posted their largest one-month drop in nearly two years in April, and overall retail sales rose at an anemic pace. Youth unemployment is a lingering problem, although the government’s recent recalculation of that number after it rose to an embarrassing 21 percent has masked the true extent of the problem.

The damage from the property collapse is virtually everywhere in China, with the possible exception of mega-cities like Shanghai and Beijing. Unoccupied and uncompleted buildings are ubiquitous, especially in smaller provincial cities that hosted the final stages of the building boom. Housing statistics compiled by Bloomberg and Chinese researchers estimate that the current stock of unsold housing in 100 major cities totaled 511.8 million square meters at the end of February, down from a peak of 530.6 million at the end of 2022. That is roughly ten times the total office space in Manhattan.

Goldman Sachs estimated last month that it will cost 7.7 trillion yuan to buy up enough apartments to return China’s inventory of empty homes to 2018 levels—and that assumes a 50 percent discount on current market prices. That figure is roughly 25 times the amount in the central bank’s bailout plan. The same study calculates that Chinese developers need $553 billion to complete housing that they pre-sold to buyers, and then failed to finish, in what amounted to a nationwide Ponzi scheme. Even that is far more than the $42 billion allocated in the new plan.

The core problem that China faces in dealing with the remains of its property bubble is the sector’s interlocking financial obligations of private and government developers, financial institutions ranging from state banks to shadow institutions, and local governments (many of which set up financing vehicles to buy land that the governments themselves put up for sale). With the market’s collapse, that foundation now has become profoundly unstable.

While developers have defaulted on their dollar-denominated bonds issued overseas—leaving foreign investors with little recourse but to file suit in Hong Kong courts—Beijing so far has tried to forestall defaults and restructuring of yuan debts. To mishandle the situation could have destabilizing consequences that would further damage the economy and undermine the legitimacy of Xi Jinping’s government. The result so far has been incremental steps: funding for some developers to complete pre-sold apartments, interest rate cuts to encourage buyers, and the release of funding like last week’s central bank initiative.

But buyers remain cautious, in part because prices so far are not coming down significantly. More importantly, banks are very hesitant to lend the cheaper money that’s been made available. For example, when the central bank last year made available $27 billion of interest-free funding developers to complete apartments, banks lent only a tiny proportion. They worry that they will be left holding the bag when defaulters eventually default.

On the other hand, history suggests that a bailout delayed only becomes an ever-larger bailout. The IMF, which has considerable experience helping countries address property crises has recommended that China pursue “more market-based adjustment in home prices and quickly restructur[e] insolvent developers to clear the overhang of inventories and ease fears that prices will continue to gradually decline.”

But it is not clear whether Beijing is willing to commit the trillions of yuan—and the political capital—that will be required to do this. The government has begun issuing what is slated to amount to $138 billion of ultra-long-term bonds this year and has announced plans for $539 billion of local government bonds. But it remains to be seen how much will go to relieve the property crisis. With local governments and their financing vehicles overloaded with more than 100 trillion yuan of debt, Beijing is facing many difficult decisions.

It may just end up trying to muddle through while repeating its declaration of the need “to urgently build a new model of real estate development,” as the Politburo stated on April 30. In that case, it will continue to widen the divide between weak domestic demand and expanding exports—with all the international political tensions that inevitably will result.

Jeremy Mark is a senior fellow with the Atlantic Council’s GeoEconomics Center. He previously worked for the International Monetary Fund and the Asian Wall Street Journal. Follow him on Twitter: @JedMark888.

The post There’s less to China’s housing bailout than meets the eye appeared first on Atlantic Council.

In March 2024, China’s Premier Li Qiang capped off a bumpy first quarter by cancelling a traditional annual press conference to talk about the government’s plans for the coming year. But in many ways, China’s policy measures spoke for themselves. The year-to-date story has been one of harried effort to support a faltering stock market, ramp up exports to make up for domestic demand, and double-down on high-tech sectors with subsidies and other innovation funding. The most important policy document of China’s economic year, the Government Work Report, promised state guidance and fiscal expansion but did not address the structural problems that have impaired Beijing from doing that in the past several years.

We identify some positive policy developments compatible with global market norms this quarter, including in financial system development and direct investment openness. New data security guidelines provided some reassurance to skittish foreign investors after years of uncertainty on the scope of data rules. Beijing pledged once again to ease the business environment and level the competitive playing field for foreign firms, this time through twenty-four measures and a charm offensive with foreign CEOs at the China Development Forum. And despite uncertainty, foreign portfolio investors took advantage of premium China bond returns, even as direct investment stalled.

These policy strategies were mostly familiar. In most of the areas monitored under the Pathfinder framework, there was either no market convergence or active backsliding. There was little to no public discussion of the structural and systemic factors weighing on the economic outlook, low productivity, foreign concerns over overcapacity or exchange rate risks. This paucity of needed debate fanned the flame of discussions in G7 capitals about the need to coordinate collective trade defense. While a few signs of the end of the property correction are showing up, suggesting a cyclical stabilization with the next several quarters, the longer-term headwinds to sustainable growth will mount until meaningful market reforms are implemented.

Read the full issue brief below

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Report Oct 4, 2023

Running out of road: China Pathfinder 2023 annual scorecard

By Atlantic Council GeoEconomics Center and Rhodium Group

The China Pathfinder project examines whether China’s economy is converging or diverging with the world’s leading open market economies.

China Digital Policy

Issue Brief Feb 5, 2024

China Pathfinder update: Lack of policy solutions in second half of 2023 belies official data

By GeoEconomics Center and Rhodium Group

Through the second half of 2023, the gap between China’s impressive official data and visibly underwhelming consumer demand, unresolved local government debt problems and an unprecedented drop in foreign direct investment was stark.

China Economy & Business

Econographics Dec 11, 2023

China’s manufacturing overcapacity threatens global green goods trade

By Niels Graham

Chinese lending is exacerbating a growing glut in its green manufacturing sector. Beijing is increasingly looking abroad to absorb excess capacity. This may have devastating effects for the global trading system as economies move to protect their own domestic industry.

China Economy & Business

The post China Pathfinder: Q1 2024 update appeared first on Atlantic Council.

The EU’s economic weight in the world has declined substantially in the past few decades and its strategic position has weakened seriously as the geopolitical rivalry between the United States and China intensifies. Against that backdrop, one of the report’s main recommendations is to transcend the Capital Market Union to promoting a Savings and Investments Union instead. The aim is to mobilize savings and investments in EU countries, and the report proposes launching a variety of investment vehicles to facilitate retail and institutional investments in the EU economy and especially its green energy transition efforts. These include an EU-wide auto-enrollment Long Term Savings Product leveraging tax incentives by member states; enhancing the Pan-European Personal Pension Product; a European Long-Term Fund; as well as a European Green Guarantee facility to support bank lending to green energy projects. Unfortunately, this well-meaning proposal fails to tackle the underlying causes of the EU’s fragmented capital markets.

While the proposed funds and products may be worthwhile, it is difficult to assess their contributions to reviving EU economic growth until more operational details are forthcoming. Meanwhile, by emphasizing the use of tax incentives and guarantees, the report has downplayed the unglamorous but crucial tasks of harmonizing laws, regulations, market structures, and practices in twenty-seven member countries to forge a seamless European capital market where savings can flow to the best opportunities without internal barriers. The harmonization job is far more complicated than it sounds—involving the development of common rules or at least common and consistent standards for corporate laws. That includes bankruptcy and reorganization provisions, creditors’ ease in seizing and liquidating loan collaterals, tax procedures, supervision of markets and entities, accounting standards, trading rules including for shorting, investment rules for institutional investors such as pension funds, insurance companies and mutual funds, listing requirements including the languages used for prospectuses, etc. Turning all these national rules and regulations into a common EU rules book has run into strong resistance from vested interests in various countries, explaining the slow progress to date in advancing the Capital Market Union. However, without making much more headway in these nuts-and-bolts issues, the proposed European Savings and Investments Union will likely be slow in taking shape as well.

The report also singles out practices which hinder the channeling of savings to investments in the EU but does not get to the root causes of the problems or suggest ways to overcome the impediments.

Firstly, the report bemoans the fact that while the EU is home to €33 trillion ($35.4 trillion) of private savings, annually €300 billion ($321 billion) are being diverted to overseas financial markets, primarily to the United States, due to internal fragmentation. However, it does not recognize, and does not suggest ways to rectify, the fundamental factor attracting European savings to the much larger US stock market, which accounts for 54.5 percent of world market capitalization compared to large European markets at 15.7 percent. Investment flows to the United States primarily because of superior returns on American equity markets compared to those of the EU. Specifically, for the period 1900-2020, the average annual nominal return on US equities was 9.6 percent compared to 7.2 percent for Europe. So long as this remains the case, savings from the EU and the rest of the world will continue to be attracted to the United States, where foreign investors own 40 percent of the stock market. So the EU need both reforms and investment: structural reforms to make the EU economy more productive and its corporations more profitable will create more investment opportunities to deploy European savings at home—while more investment now could help improve EU productivity and growth prospects. Thus, while it is wise to find ways to increase investment in the EU, the problem is more fundamental than just the efficiency of capital markets.

The Letta report also points out the fact that EU households keep 34.1 percent of their savings in bank deposits, not investing those in stock and bond markets. It is important to realize that this behavior of European households reflects their cultural and traditional preference for loss avoidance over capital gains with risk.  As such, a more developed Capital Market Union may encourage somewhat more allocation from bank deposits to portfolio or direct investments, but that would not substantially change the loss-avoiding investment behavior in the near term. Instead, it is more useful for policy makers in the EU to find ways to create a business environment for EU banks which receive an important part of its funding from retail depositors to invest the proceeds more productively.

Relative to US peers, EU banks have posted very low returns on assets (ROA) (of 0.4 percent vs. 1.4 percent for the United States) as well as low returns on equity (ROE) (fluctuating between 2-6 percent, about half of the US level). Consequently, market valuation of EU banks has been much lower than that of US banks: the price to book ratio of EU banks in 2014-2021 averaged 0.79x compared to 1.53x for US banks. In short, helping EU banks become more efficient and profitable—for example by launching the European Deposit Insurance Scheme (EDIS) to complete the Banking Union—would probably do more to support EU economic growth than trying to get EU households to change their investment behavior from bank deposits to market investments.

In conclusion, in highlighting the inefficiency of EU capital markets and proposing several products and policies for improvement, the Letta report has focused attention to the need to complete and upgrade the Capital Market Union, and the Single Market in general, to help the EU improve its economic performance in an era of geopolitical rivalry. However, much of the work requires attention to the detailed harmonization of economic and financial rules and regulations across the membership to promote a seamless market for savings and investments. These are unglamorous and painstaking tasks, but they need to be done.

Hung Tran is a nonresident senior fellow at the Atlantic Council GeoEconomics Center, a former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.

The post The Enrico Letta Report and the state of the EU’s Capital Market Union appeared first on Atlantic Council.

Recent economic data and projections by international institutions, including the World Bank, reveal that the country faces considerable headwinds. Several notable social indicators, too, raise concerns that the country’s success story may be unraveling. Not coincidently, these shifts are taking place under a government that is less and less accountable to its citizens.

The worsening economy: The big picture

Published on April 2, the World Bank’s Bangladesh Development Update forecasted that the country’s gross domestic product (GDP) growth in fiscal year 2024 would be 5.6 percent. Within days of the World Bank’s forecast came a report from the Bangladesh Bureau of Statistics (BBS) that GDP growth in the second quarter of the current fiscal year, between October and December 2023, was 3.78 percent. This is a dramatic decline compared to the previous quarter’s growth, which stood at 6.01 percent. The numbers were far higher in previous years’ second quarters; in fiscal year 2022 it was 9.3 percent and in fiscal year 2023 it was 7.08 percent. The overall GDP growth projection of the World Bank sharply contrasts with the government’s initial projection for fiscal year 2024, which the Bangladeshi government revised down in January from 7.5 percent to 6.5 percent.

Analysts have described the government’s growth target as unachievable. Those who have been following Bangladesh’s economy were not surprised that the World Bank projected a rate below last fiscal year’s growth of 5.8 percent and well below fiscal year 2022’s growth of 7.1 percent. The country’s average GDP growth over the past decade, according to government statistics, was around 6.6 percent. The World Bank forecast suggests that Bangladesh’s economic growth has been on a downward trend for two consecutive years and that the projection for next year is not much different from this year.

The economic crisis in Bangladesh, which has been evident since the middle of 2022, didn’t appear suddenly due to external shocks. It was in the making for quite some time. Two years ago, Bangladesh reached out to the International Monetary Fund (IMF) and other international lenders to avert a meltdown. The government did secure new loans, but these have added to existing external loans. For the first time, external debt surpassed one hundred billion dollars in late 2023. As a result, the cost of servicing the debt is increasing at an unprecedented rate. In the first eight months of the current fiscal year, the country spent $2.03 billion making payments on this debt. The debt servicing, not only the foreign but domestic sources, is forcing the government to borrow to “repay a large part of its PPG [public and publicly guaranteed] debt obligations,” according to economist Mustafizur Rahman.

This is putting a serious dent in Bangladesh’s foreign exchange reserves, which have continued to slip. As of early April 2024, they stood below the IMF’s suggested $19.26 billion. Concurrently, nonperforming bank loans, which are about 10 percent of total outstanding loans, according to the central bank’s statement, are increasing. In the past fifteen years, the amount has increased six and a half fold. In a single year, it increased by more than 20 percent. Faced with pressure from the IMF to reduce the defaulting loans, the Bangladesh Bank has devised a stealthy way to do so—essentially, by cooking the books. The Bangladesh Bank has decided to relax the write-off policy that will wipe out a large amount of loans from the books but will hold nobody accountable—neither those banks which have allowed this to happen nor the businesses which have defaulted.

Instead, a recent amendment to the Bank Company Act will allow the sister companies of the defaulters to continue to borrow. In another controversial move, the Bangladesh Bank has decided to merge “weak banks” with “strong banks”  as part of its banking sector reform program. In April, the World Bank described this move as “counterproductive,” and experts have questioned its prudence. It will force the liabilities of weak banks onto the depositors of stronger banks. Many of the banks identified by the central bank as weak were approved in the past fifteen years for political considerations. The benefits enjoyed by those who established these banks and borrowed from various banks are now being paid by the public at large.

Economic woes of citizens

The broad economic crisis is having serious consequences for Bangladeshis, especially those in the middle class and poorer segments of society. While official statistics from February claim that inflation is below 10 percent, the prices of food and essentials in the market indicate a far greater number. Although food and fuel prices have fallen in the global market, Bangladeshis have not enjoyed the benefits of this. Instead, the government in March once again raised the price of electricity. In 2023 alone, the government raised the price of electricity and gas three times.

The plight of the common people can be gleaned from the data provided by a BBS survey conducted in the middle of 2023, “Food Security Statistics 2023.” The survey revealed that around 37.7 million people experienced moderate to severe food insecurity in the country. The report also noted that more than a quarter of families were taking out loans to cover the cost of daily necessities, including food. A survey by the South Asia Network on Economic Modeling, a think tank, shows that 28 percent of households resorted to borrowing money between April and November of 2023. The share of households borrowing money, largely from informal sources, has been on the rise for the past decade. According to a 2022 BBS survey, the average amount of loans per household in the country nearly doubled between 2016 to 2022, whereas the amount increased just 34 percent in the six-year period between 2010 and 2016. These numbers point to a difficult, perhaps even deteriorating, economic situation for many Bangladeshis.

Social indicators are showing strains

While the economic indicators alone are concerning, there are also disturbing developments in several social development indicators.

Bangladesh had been registering increases in life expectancy for decades. In 2020, it reached 72.8 years, the highest to date. But since then, the pattern of growth has been broken. In 2021, there was a decline, to 72.3 years. In 2022, a modest increase to 72.4 was reported by the BBS. But the Bangladesh Sample Vital Statistics-2023 (BSVS-2023), published by the BBS in March 2024, shows a reversal, to 72.3 years. Combined with the information that food insecurity has increased in the past year, it is worth asking what might be causing this decline.

The decline in life expectancy is in part a result of the increase of the death rate in children. The BSVS-2023 shows that the mortality rate for children under five years of age, newborns, and children under one year has increased. Nor was the increase a one-off incident. Take, for example, the mortality rate for children under one year of age. The number was 21 per 1,000 five years ago, while in 2022 it increased to 25 and in 2023 it reached 27. The death of children below one month has reached 20 per 1,000 live births, up from 16 in 2022. Five years ago, the death rate of this age group was 15. The death rate of children under five years was 33 per 1,000 in the past year, an increase from 31 in 2022 and 28 five years ago. The BVS-2023 identified other troubling trends in social indicators as well. For instance, child marriage has increased significantly in recent years—from 31.3 percent in 2020 to 41.6 percent in 2023.

Two aspects of education and employment are noticeable in the statistics provided in the BSVS-2023 and a survey conducted by the Bangladesh Bureau of Educational Information and Statistics (BANBEIS). First, there has been a drop in students at the secondary-school level and an increase of NETT (not in employment, education, or training) among the youth population. Over the past four years, the number of students at the secondary school level in Bangladesh has decreased by one million, according to the BANBEIS.

According to the BSVS-2023, the share of children between five and twenty-four years not in educational institutions has risen since the COVID-19 pandemic. In 2020, at the onset of the pandemic, 28.46 percent were out of educational institutions, while in 2023, the share reached 40.72 percent. On the other hand, BSVS reveals that 39.88 percent of youth between the age of fifteen and twenty-nine are neither in school nor in employment. The percentage was a little better than 2022, when it was 40.67 percent, but according to the labor force survey of 2016-2017, the NETT was around 30 percent. As such, this increase by almost ten percent in eight years reflects a pattern.

How did it happen?

These economic and societal shifts are happening neither abruptly nor in a vacuum of policy decisions. Instead, they are taking place incrementally and under a system of governance that has repeatedly claimed its legitimacy based on “development,” even at the expense of democracy and an inclusive political system.

The absence of accountable governance is allowing a crony system to flourish, even as it is holding back the economy. The government has created a clientelist network upon which it relies for survival and stability. Recent elections have been neither free nor fair, and they have resulted in an economy that is increasingly beholden to a small group of people who facilitate the victory of the incumbent.

This is not unexpected. The dire warnings that authoritarianism can burst the bubble of growth appear to be coming to pass. As the country’s system of governance has transformed from a hybrid regime to an autocratic system, especially after the 2018 election, social development has received less attention from the government, which relies less and less on a mandate from citizens. Regime survival is not contingent on public support, which tends to judge the incumbent based on performance. If these trends continue, then the optimism that accompanied the fiftieth anniversary of Bangladesh’s independence may soon seem like a distant memory.

Ali Riaz is a nonresident senior fellow at the Atlantic Council South Asia Center and a distinguished professor at Illinois State University.

The post Is the Bangladesh success story unraveling? appeared first on Atlantic Council.

It starts with Draghi’s forthcoming report on EU competitiveness, at the request of European Commission President Ursula von der Leyen, to be published after the June 6-9 elections for the European Parliament. According to a source close to Draghi, who shared early details on condition of anonymity, the report will likely include a frank appraisal of Europe’s weaknesses. Brussels should pay close attention, and lawmakers should elevate Draghi to be the next European Council president to help make his report’s prescriptions for a more integrated and competitive EU a reality.

Time to compete

The most important things that happen in the world don’t happen in Europe; this is especially true regarding the economy and technological innovation. Draghi is strongly convinced of this, and the competitiveness report will likely dive into Europe’s limited creative and productive capacities.

Draghi is set to deliver a cold, hard dose of reality: Right now, Europe lacks both the resources and the will to compete with the rest of the world, especially considering the capacity of the United States and China to stimulate the economy through government spending. But the report will also likely highlight the fact that Europe has tremendous opportunities to correct for these shortcomings.

One reform that the document will promote is the establishment of interconnections between national production systems, with a view toward creating a single European system of integrated continental supply chains—an ambitious aim, to say the least. “The geopolitical, economic model upon which Europe has rested since the end of the second world war is gone. The European Union has to become a state,” Draghi said at the end of November. His vision for Europe entails the establishment of public debt, fiscal policy, and defense as the pillars of the new EU. He is also convinced that the EU needs five hundred billion euros per year to lead environmental and digital transitions and to provide social protection to its citizens.

As Draghi said in Washington in February, European countries will require “more investment even at the cost of higher public deficits to stimulate growth and fight inequality without forgetting the importance of raising productivity and to assign a new role of budgetary policy that reaches where monetary policy alone cannot reach.”

Draghi is widely regarded as, above all, a defender of European interests and an Atlanticist. As Italian prime minister, he was a key player in aligning Europe with Ukraine. Moreover, he personally developed the system of sanctions placed on Russia’s central bank. This demonstrates a strong track record for defending the EU’s freedom and democracy against any threats.

Draghi’s vision could be the source of inspiration for a government program for the EU for the next five years. And Europe needs his engagement to realize these aims.

The next Council president?

How might Draghi engage with the European institutions? Many observers in Brussels and across the continent think that he could be the next president of the European Council. Even though this institutional office is often criticized for being largely symbolic and lacking a cabinet, it’s the person that makes the office. The president sets the agenda of the Council and could be more than an honest broker between national leaders. A president with Draghi’s vision could truly lead. For example, as European Council president, Draghi would be able to start the process of reforming the EU’s founding treaties by proposing items in formal and informal discussions, as well as crafting plans to realize the policies he will suggest in his report. As he said in Brussels at the High-level Conference on the European Pillar of Social Rights on April 16, “we will need a renewed partnership among member states—a re-defining of our union that is no less ambitious than what the founding fathers did seventy years ago with the creation of the European Coal and Steel Community.”

The problem is that, for now, Draghi has said publicly that he is not interested in assuming any European office, and no political leaders are asking him to get involved.

The campaign for European Council president will start after the elections in June. The new balance of power between the European parties will be determined, together with their agreement on who will hold the main European offices. Three parties that are likely to contend for a leading role in the EU institutions are the European People’s Party (EPP), the Socialists and Democrats (S&D), and Renew Europe (Liberals).

The EPP is expected to be the largest group in the European Parliament. Draghi has a strong influence on the EPP’s leader, von der Leyen, who could ask him at the very least to go on with his work on competitiveness. However, the EPP—mainly the northern European members—are not too keen on the idea of “good debt” that Draghi proposes.

S&D is likely to nominate former Portuguese Prime Minister Antonio Costa as president of the European Council, but he might not be proposed by his country, in which case the nomination would not move forward. During the Socialist Congress in Rome, one of the main leaders, secretary of the Italian Democratic Party Elly Schlein, publicly supported Draghi’s plan to spend five hundred billion euros per year for environmental and digital transitions. And the former Italian prime minister is highly respected by two other influential S&D members: Spanish Prime Minister Pedro Sánchez and German Chancellor Olaf Scholz.

In addition, Draghi has a strong relationship with French President Emmanuel Macron, the leading voice of the Renew Europe group. According to a source close to Macron, his support for Draghi will depend on the outcome of French president’s talks with other European leaders after June 9. The sense is that Macron considers von der Leyen a good choice for a second term as commission president, despite the two campaigning against one another and having disagreements on specific issues. And if von der Leyen backs Draghi, that will bring Macron along, too.

Concerning the other parties, it looks like it will be difficult for the Conservatives and Reformists Party (ECR) to enter into a coalition together with the Socialists. But ECR leader and Italian Prime Minister Giorgia Meloni already has a strong relationship with von der Leyen, and proposing the pro-European Draghi for president of the European Council might be a way to strengthen her accountability with EU partners. Whatever happens after June 9, Europe will need, to paraphrase a quote often attributed to Henry Kissinger, a leader able to carry the European Union from where it is to where it has not been. Draghi could provide that kind of leadership as president of the European Council.

Mario De Pizzo is a nonresident senior fellow at the Atlantic Council’s Europe Center. He is currently a journalist at TG1, Italy’s flagship television newscast program produced by RAI, Italy’s national public broadcasting company.

The post The case for Mario Draghi as the next European Council president appeared first on Atlantic Council.

Times are changing and the IMF’s Fiscal Monitor released earlier this month documented this in detail. Policymakers are increasingly turning to subsidies to achieve a variety of objectives. The Fiscal Monitor documented the proliferation of industrial policy and, notably, offered a partial endorsement. The report also illustrates how economists’ views of industrial policy are evolving and where there is still disagreement.

What’s the IMF-approved version of industrial policy? In short, the IMF cautiously endorsed sector-specific interventions as a way to promote innovation, but remains skeptical of measures that get in the way of free trade.

The IMF’s case for industrial policy starts with the acknowledgement that innovation doesn’t happen under ideal market conditions. New ideas and inventions have positive spillovers (externalities) which means that the market, left to its own devices, won’t provide sufficient innovation.

That opens the door to policies like research grants or R&D tax credits that subsidize new research and inventions. Those economy-wide measures are known as “sector neutral” or “horizontal” industrial policy, and they tend to have more buy-in from economists. But the IMF’s Fiscal Monitor went further, outlining when and why “vertical” or sector-specific industrial policies can be worthwhile, too. The key, according to the IMF’s researchers, is to target sectors that either have especially high spillovers—where a breakthrough would improve productivity in lots of other arenas—or where there are other unresolved market failures at work. They cite clean energy and health care as examples.

“This Fiscal Monitor shows that well-designed fiscal policies to stimulate innovation and the diffusion of technology can deliver faster productivity and economic growth across countries,” the report concludes.

The IMF’s endorsement comes with a lot of caveats, which the researchers summarize:

They also note that larger, less open economies like the United States benefit more from such policies—because they capture more of the benefits of innovation subsidies.

The IMF is not the only international organization recognizing the case for industrial policy. The OECD’s researchers published an extensive and largely positive evaluation in 2022.

However, the IMF’s version of industrial policy isn’t necessarily the one most in vogue. Most notably, the Fiscal Monitor warns that “policies discriminating against foreign firms can prove self-defeating and trigger costly retaliation.” In a paper published in January, IMF researchers found that two-thirds of industrial policies enacted in 2023 distorted trade. So while the IMF may be warming to industrial policy in theory, it remains skeptical in practice.

Walter Frick is chief editor of the Atlantic Council’s GeoEconomics Center

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post The IMF warms to industrial policy—but with caveats appeared first on Atlantic Council.

The post Mühleisen quoted in Bloomberg on IMF debt restructuring reform appeared first on Atlantic Council.

Below are his prepared remarks.

The Middle East – North Africa (MENA) has emerged as an important strategic region for the People’s Republic of China (PRC), with a significant expansion of its interests and presence across the region. However, at this stage China remains primarily an economic actor there, with growing political and diplomatic engagement and little in the way of a security role. This economics-first approach has contributed to improved public perceptions of China across MENA; public polling data from the Arab Barometer consistently shows positive views of China as an external actor, with respondents from 8 out of 9 countries perceiving China more favorably than the US. At the same time, its modest involvement in regional political and security affairs, evident in its minimal response to Houthi strikes on maritime shipping, underscores its reluctance to play a more meaningful role in MENA, which has no doubt been recognized by governments that expected a more robust response given Beijing’s outsized economic presence.

This highlights an important point about how MENA features in the PRC’s broader strategic objectives. It is first and foremost a region where China buys energy, sells goods, and wins construction infrastructure contracts. These economic interests have not required a corresponding political or security role, and Chinese leaders have not indicated that they will do so; they benefit significantly from the US security architecture that underpins the region’s fragile status quo. China works closely with US allies and partners in MENA, especially the Gulf Cooperation Council states and Egypt, and in many regards Beijing’s interests in the Middle East have been consistent with those of the US.

At the same time, MENA has to be considered as part of a larger global strategy under which US- China interests diverge substantially. China’s more assertive foreign policy since the global financial crisis started under the leadership of Hu Jintao and has intensified under Xi Jinping. The 2017 US National Security Strategy identified China as a great power competitor, and the rivalry is playing out in MENA as elsewhere. Beijing has rolled out new global initiatives – the Global Development Initiative (GDI), Global Security Initiative (GSI), and Global Civilization Initiative (GCI), discussed below – to present itself as a leader of the Global South, using a state-centered alternative to Western liberalism.

In this effort, the MENA is a region where China aims to establish a normative consensus consistent with Beijing’s preferences. As a result, we see several examples of PRC leaders promoting narratives that the US is unreliable, or that its presence in the region exacerbates tensions and conflict. After a January 2022 meeting with MENA officials, for example, Chinese Foreign Minister Wang Yi said the Middle East “is suffering from long-existing unrest and conflicts due to foreign interventions…We believe the people of the Middle East are the masters of the Middle East. There is no ‘power vacuum,’ and there is no need of ‘patriarchy from outside.’” Whereas in the preceding two decades the PRC rarely overtly challenged the US position in MENA, it has become a regular feature as Chinese leaders exploit pressure points between the US and regional actors in order to differentiate itself from the US and to create friction between Washington and its MENA partners and allies. This has been especially present in Chinese messaging since the October 7, 2023 Hamas attack on Israel, as PRC leaders have consistently used the crisis to undermine the US and present itself as a more reliable partner to the Arab world.

China’s diplomatic activities in the Middle East

While it has not been widely recognized, China has developed a deep, broad and systematic approach to diplomatic engagement across MENA. It uses a range of bilateral and multilateral diplomatic tools, and these have been complemented in recent years with international organizations where Beijing has significant influence. It also has appointed special envoys for region-specific issues.

At the bilateral level, China has diplomatic relations with all regional countries. Several of these are enhanced by strategic partnerships, which are mechanisms to coordinate on regional and international affairs. Five MENA countries – Algeria, Egypt, Iran, Saudi Arabia, and the UAE – have been elevated to comprehensive strategic partners, the top level in China’s hierarchy of diplomatic relations. This results in the “full pursuit of cooperation and development on regional and international affairs.” To be considered for this level of partnership a country has to be seen as a major regional actor that also provides added value, such as Egypt’s control of Suez, or Saudi’s leadership role in global Islam and energy markets. Therefore, when assessing China’s diplomatic efforts in MENA, these countries (Algeria to a lesser extent) are the load-bearing pillars of Beijing’s approach. They see more official visits, attract more investment, do more contracting, and generally support a wider range of China’s interests in the region. That China has comprehensive strategic partnerships with both Saudi Arabia and Iran means there are more frequent bilateral high-level meetings, no doubt contributing to China’s role in the Saudi-Iran rapprochement.

At the multilateral level, China uses the China Arab States Cooperation Forum, which includes all Arab League members, and the Forum on China Africa Cooperation, which includes nine Arab League members. These forums present China with regular ministerial-level meetings where they map out cooperation priorities. They also have several sub-ministerial level issue-specific working groups. The result is a relatively deep level of diplomatic engagement.

China has appointed special envoys for the Middle East, the Horn of African Affairs, and the Syrian Issue, all of which were designed to present the PRC as an actor with influence and interest in these issues, although the impact of each has been marginal.

Finally, two international organizations where China plays an influential role, BRICS and the Shanghai Cooperation Organization Forum, have admitted Middle Eastern states as members in recent years. BRICS expanded for the first time in 2023 to include Saudi Arabia, Egypt, Iran, the UAE, and Ethiopia, giving the organization a presence in MENA and the Horn. The SCO admitted Iran as a full member in 2023, a position it has coveted since 2005. Other MENA participants in the SCO are Bahrain, Egypt, Kuwait, Qatar, Saudi Arabia, and the UAE, all of which are dialogue partners. This does not make them SCO members; it is a position for countries that wish to participate in discussions with SCO members on specific issues that they have applied to join as dialogue partners. It could eventually result in full membership but that does not appear to be on the horizon for any Middle Eastern dialogue partners for now.

All in all, Chinese diplomacy has been highly active and quite successful laying the groundwork for a deeper presence in the Middle East.

China’s involvement in MENA conflict mediation

China’s efforts to position itself as a conflict mediator is part of a larger strategy, embedded in the GSI, to present the PRC as a leading global actor. As a 2023 report from MERICS cautioned, “China’s current mediation push seems to be largely a reflection of its geopolitical competition with the United States and its ambition to expand its global influence at the expense of the West.” In MENA as elsewhere, the results have been mixed. The Saudi-Iran rapprochement is an example of a low cost ‘win’ for China. It has been well documented that much of the negotiation that led to the March 2023 announcements in Beijing had been done through Iraqi and Omani efforts. China’s involvement appears to be as a great power sponsor that was broached during Xi Jinping’s December 2022 summit in Riyadh and further discussed during President Ebrahim Raisi’s visit to Beijing in February 2023. Given China’s comprehensive strategic partnerships with the Saudis and Iranians, it has significant diplomatic relations with both countries and was therefore the only major power that could play such a role. However, it has to be stressed that most of the groundwork had been laid before China’s involvement, and that the rapprochement itself was the result of domestic political and economic pressures within Saudi and Iran.

Given this highly publicized diplomatic ‘win’, Chinese analysis promoted a narrative of a “wave of reconciliation” in the Middle East as a result of Beijing’s efforts. Ding Long, a Middle East expert at Shanghai International Studies University, described China’s mediation diplomacy, guided by the GSI, as driving events in the Middle East in the wake or the Saudi-Iran deal:

Within a month since then, the Saudi-Iran rapprochement is like a key that opens the door to peace in this region. The warring parties in Yemen took a critical step toward a political solution; Bahrain and other Arab countries have restored diplomatic relations with Iran; Saudi Arabia and other Arab powers are interacting more frequently with Syria. A wave of reconciliation is also encouraging more joint efforts between China and the Middle East in pursuing peace.

Shortly after the Saudi-Iran deal, the PRC announced that it was willing to wade into the Israel- Palestine conflict during a June 2023 visit from Palestinian President Mahmoud Abbas. Immediately following this, Israeli Prime Minister Benjamin Netanyahu announced that he had accepted an invitation to Beijing for October; for obvious reasons the visit did not happen. China’s response to the Hamas attack, discussed below, has negated any prior work towards being a mediator on the issue; its relationship with Israel has been deeply damaged at this point and it is hard to see how Beijing could play a constructive role negotiating between the two. The March 2024 meeting in Doha between Chinese ambassador Wang Kejian and Hamas official Ismail Haniyeh further cements this. Any role China can play would be in support of Palestine and highly partisan.

In any case, just over a year after Beijing’s first successful foray into Middle East diplomacy, the region is less stable that it has been in recent memory, and China’s efforts at mediation have had little tangible impact. It has little influence on Iran or its non-state partners of Hamas, the Houthis, or Hezbollah, and is not seen as credible by Israel. Generally, its response to events since the Hamas attack have made China look very transactional and self-interested in the region, rather than a responsible extra- regional power with substantial Middle East interests.

A point worth considering on this topic is that China is a relative newcomer to Middle East political diplomacy. As described above, it is primarily an economic actor in the region, and despite its special envoys, cooperation forums, and strategic partnerships, it does not have the depth of regional specialization that the US or European countries do, given their longstanding involvement in MENA. As China develops a deeper pool of MENA talent this will change, but it is early days. Its area studies programs in universities and think tanks are not nearly as developed as their US counterparts, making for a much shallower pool of expertise.

China’s response to the Hamas attack on Israel

The Hamas attack on Israel had significant repercussions for China’s approach to the MENA and resulted in a more blatantly realpolitik approach to the Israel-Palestine conflict. China’s ambition to play a role in resolving this conflict was based largely on the ‘peace-through-development’ framework of the GDI/GSI. The attack demonstrated the need for a more robust response, but in the wake of the attack the limits of Beijing’s normative approach were evident. Since then, China has not pursued a mediator role, siding firmly with Palestine while frequently condemning Israel and the US. Pointedly, it did not blame Hamas for the attack and has seemingly made the ‘one man’s terrorist is another man’s freedom fighter’ argument; during International Court of Justice hearings Ma Xinmin, a legal advisor for the Chinese Ministry of Foreign Affairs, argued that Palestinian acts of violence against Israelis are legitimate “use of force to resist foreign oppression and to complete the establishment of the Palestinian state.”

A point worth considering is that within China, the Israel-Palestine conflict resonates differently than it does in the US and other Western liberal democracies. The demographic composition of the West with large immigrant populations means that there are significant Jewish, Muslim, Christian and Arab communities for whom the Israel – Palestine conflict is a major issue that animates voters, NGOs, and lobbyists. Democratic leaders are expected to have positions that represent their constituents, and Middle East policy has to try to thread the needle of interests and values in a manner that balances citizens’ often deeply held convictions. In China, religious minorities – especially of the Abrahamic faiths – are comparatively insignificant in the demography, and the immigrant population from the Middle East is virtually non-existent. The Party has increased repression against Muslims, Jews, and Christians during the Xi Jinping era, making overt political action from them incredibly costly. This, combined with the fact that China has an authoritarian government, means the issue if Israel and Palestine does not mobilize Chinese citizens like it does in the US, and the government is less concerned with being responsive to citizens’ concerns. It is, therefore, a purely geopolitical issue. The CCP can use its policy in the region to advance its own interests while challenging the US and its Western allies without the additional consideration of managing domestic pressures. Its messaging on the war in Gaza is therefore more about China presenting itself as an alternative to the US as a global leader than it is about the war itself.

China’s global initiatives and international order

At this point China’s three global initiatives (GDI, GSI, GCI) are following the same early-stage trajectory of the Belt and Road Initiative (BRI). When it was announced in 2013 there was little understanding or awareness of it outside of China, and within China ministries, agencies and municipalities spent most of 2014 and 2015 incorporating the BRI into their missions. The 2015 white paper on the BRI and the 2017 Belt and Road Forum enhanced its global profile. The GDI, GSI, and GCI have been appearing in joint communiques across MENA and are cited by local actors as useful contributions from China, but they do not appear to be widely understood yet, nor do many local governments seem to be aware of them. It is likely that the GSI first came to a wider audience when then-Foreign Minister Qin Gang described the Saudi -Iran rapprochement as “a case of best practice for promoting the Global Security Initiative.”

However, the normative framework of these initiatives has appeal for regional governments. Whereas liberal norms of global governance focus on democracy, free markets, human rights, and international institutions, China’s trio of initiatives promote sovereignty, territorial integrity, self-determination, and noninterference in the domestic affairs of states. Essentially, it rejects the universalism of liberal norms and promotes a statist vision instead. For governments and societies long frustrated by the inconsistent promotion of liberal values from the west, or by those that reject liberalism altogether, China’s model is attractive.

The impact of China’s global initiative and the BRI should also be considered as a consequence of a global order transition. During the Cold War, bipolarity meant governments in need of development assistance could turn either to the West or the Soviets. The end of the Cold War meant the developing world was limited to Western institutions underpinned by liberal values that imposed conditions, often inconsistent with local norms. The emergence of China and its global initiatives provides alternatives, and that Beijing presents these initiatives in contrast to liberal institutions is appealing to many governments in the Middle East.

The issue of Xinjiang

The CCP identified its ‘core interests’ in a 2011 white paper, “China’s Peaceful Development”. These core interests are state sovereignty, national security, territorial integrity, national reunification, maintenance of its political system and social stability, and maintaining safeguards for sustainable economic and social development. Importantly, all of these are domestic concerns. In practical terms, anything another country does to undermine these – especially including support for independence movements in Xinjiang, Tibet, Hong Kong and Taiwan – will damage the relationship. The CCP faces numerous challenges from issues of domestic governance, and pressure from within is the most significant threat to its continued rule. When foreign governments apply pressure on Beijing on domestic issues there is pushback, typically in the form of coercive economic statecraft.

All of this is to say that Middle Eastern governments have shown no inclination to speak or act on the issue of repression of Uyghurs or other Muslim minorities in China. No regional government wants to jeopardize a bilateral relationship with one of its most important trading partners on an issue that few feel is relevant to their own core interests of building sustainable economies and improving governance in the face of significant domestic pressures. Engagement with China is largely seen as an opportunity for regional governments to address these challenges, and China’s own experience of development since the Reform Era began in 1978 is perceived as a model for this.

Another consideration here is that Beijing frames its repression of Uyghurs as a response to a conservative religious ideology that promotes separatism and has used terrorism in an attempt to establish an independent state. In doing so, it addresses a concern for many Middle Eastern governments, most of which are deeply concerned about the spread of political Islam in their own countries. As such, the issue is less about any notion of pan-Islamic solidarity than it is about challenges to the state from an ideology seen with deep hostility from regional governments.

Policy Recommendations

• Provide explicit support for MENA countries in their development programs.
• Encourage more investment into MENA from private US companies.
• Improved messaging on what the US does in the region beyond the realm of security.
• Improved messaging on how MENA features in US interests and policy.
• Enhance public diplomacy – bring more MENA students to US on training and education programs.
• Draw upon the narratives of other extra-regional allies and partners that have interests in MENA and have also had challenges in dealing with China. They can help with the messaging – what have their experiences with China been? What issues should MENA countries be considering?
• Where possible, align approaches to MENA with US allies to provide a greater range of investment, development, and trade options.

Jonathan Fulton is a nonresident senior fellow with the Atlantic Council. He is also an associate professor of political science at Zayed University in Abu Dhabi. Follow him on Twitter: @jonathandfulton.

The post China’s Strategic Objectives in the Middle East appeared first on Atlantic Council.

The post Mühleisen quoted in Axios on IMF debt restructuring reform appeared first on Atlantic Council.

But central bank governors and finance ministers who met in Washington this week grappled with more than the question of when their countries will be “landing” after a period of high inflation: They also looked to manage how their countries recover, aiming for a soft landing that avoids recession.

With so much at stake, we dispatched our experts to IMF and World Bank headquarters in Foggy Bottom to decode the institutions’ plans to navigate the turbulence of the global economy.

• Dispatch from IMF-World Bank Week: Your cheat sheet on progress made

• This week in one word: Clarity

• Côte d’Ivoire’s Nialé Kaba on the future of World Bank leadership: Why not an African?

• The Polish finance minister on his country’s “U-turn” toward European values

• See day five analysis

Watch all our conversations with central bank governors, finance ministers, and experts

IMF-World Bank Week at the Atlantic Council

WASHINGTON, DC APRIL 15–19

The Atlantic Council hosted a series of special events with finance ministers and central bank governors from around the globe during the 2024 Spring Meetings of the World Bank and International Monetary Fund (IMF).

Dispatch from IMF-World Bank Week: Your cheat sheet on progress made

This week, the world’s finance ministers and central bankers came together in force for the first time since the “Marrakesh miracle,” that was the annual meetings last year—at least in the words of former IMF Managing Director Christine Lagarde—which finally resulted in progress on quota reform and a debt restructuring deal for Zambia.

But I doubt this week will go down in history as the “Washington wonder.” Tepid global growth, difficulty recovering from the pandemic (among developing countries), US-China competition (with Washington’s threat of new tariffs), and war cast a long shadow. Still, the officials were able to make real progress on both sides of 19th Street.

Yesterday, my colleague Martin outlined the IMF’s successes: The Fund adjusted its lending policy, allowing it to step in to support countries in debt distress, and called attention to the risks of large fiscal deficits.

But there are, after all, two sides to 19th Street. And on the World Bank side, countries including the United States, Japan, and the United Kingdom pledged $11 billion for some of the Bank’s guarantee instruments, which make its programs less risky—and more attractive—for private investors. The added firepower complements restructuring within the Bank to streamline the guarantee system. Hopefully, these changes will encourage private investors to fill countries’ funding needs for the green and digital transitions.

The G20 finance ministers and central bank governors also met this week, with Brazil’s Fernando Haddad giving the group homework: Find agreement on a wealth tax by the time the ministers meet again in Rio de Janeiro in July (the Atlantic Council will be there too).

Later today, as officials and their delegations start heading home, the security barriers will come down and 19th Street will open again. For the ministers, the hard work begins when they get home—and we will be watching closely to analyze whether the financial leaders make meaningful progress before the annual meetings in the fall.

This week in one word: Clarity

As the spring meetings drew to a close and leaders made their final statements, a few points became clearer.

Even though the global economy can feel hyper-interdependent at times, it is now becoming clearer just how muddled the economy is by divergence, inequality, and fragmentation. “Winners” and “losers” are seeing the economic gaps between them widen. There’s a heightened sense of uncertainty, with the threat of another political, economic, or natural shock looming.

What some may have seen as mission creep in finance—addressing energy transition challenges, the inclusion of gender and youth, and fragility—has become mission critical as macroeconomic stability and growth have become more dependent on, or disrupted by, these factors.

As a result, the timeframe for analysis—and more importantly action—has shrunk as spillovers, impacts, and risks from debt, inflation, conflict, and climate change have brought more urgency. On top of that, fiscal space has tightened, and capital flows stream away from where they are needed most. New research shows that countries in the Global South are paying out more in debt service than they are bringing in grants or loans—to the tune of fifty billion dollars. The United Nations’ annual Financing for Development report, released just before the spring meetings, reveals a more than four-trillion-dollar annual shortfall in funding to meet the Sustainable Development Goals, as I discussed this week with Assistant Secretary General Navid Hanif. 

While the World Bank and IMF have introduced reforms to optimize balance sheets, quotas, and capital adequacy to increase available financing, those changes are necessary but insufficient; that makes the World Bank announcement on Friday (that eleven countries have pledged eleven billion dollars to support the Bank’s hybrid capital and guarantee instruments) a welcome step.

Another thing that is clear after this week: the role regional multilateral development banks and international financial institutions (beyond the Bretton Woods institutions) play in addressing today’s challenges. This role isn’t new; I wrote about their role in COVID-19 response and recovery a few years ago. But there is again a need for private capital and philanthropic funding in a revamped international architecture that meets the moment.

And while more resources are key, it has become even clearer that more consideration needs to be paid to how funds are actually disbursed and delivered. As UN Undersecretary General and UNOPS Executive Director Jorge Moreira da Silva noted in our conversation, more than half of existing IDA funds have yet to be allocated. Furthermore, while analysis and policies are important, implementation matters and warrants additional attention.

Leaders across the global economy must ensure that even as they drive supply, they don’t forget about demand—from bankable projects to business environments, and from building capacity to domestic resource mobilization. This is the macro- and micro-challenge of the road ahead.

Côte d’Ivoire’s Nialé Kaba on the future of World Bank leadership: Why not an African?

On Thursday, Côte d’Ivoire’s Minister of Economy, Planning, and Development Nialé Kaba sat down with Rama Yade, senior director of the Atlantic Council’s Africa Center, to discuss the country’s economic priorities—among them, fostering sustainable growth. The two, conversing in French, spoke at an event that took place at the Atlantic Council’s IMF broadcast studio.

Côte d’Ivoire’s economy is predicted to rank fifth this year among the fastest-growing economies in Africa. Kaba said that the country would continue to make economic reforms to “enhance competitiveness, attractiveness, and economic performance.”

Kaba touched upon the IMF’s support to Côte d’Ivoire, which includes $3.5 billion under the Extended Fund Facility and Extended Credit Facility, in addition to a newly agreed upon 1.3 billion through the Resilience and Sustainability Facility. The minister also noted the importance of reform efforts at the Bretton Woods institutions, pointing to changes in how the IMF and World Bank select their leaders. “Perhaps one day the World Bank could be led by an African. After all, why not?”

Kaba also discussed topics closer to home. On Côte d’Ivoire’s agricultural sector, the minister said she’ll be looking to focus on the “local transformation of our raw materials.” Côte d’Ivoire is the world’s leading producer of cocoa, and Kaba said there is a need for investors to “settle and employ local labor.”

Touching on more global matters, Yade asked about the relationship between Côte d’Ivoire and China—specifically how a decrease in Chinese investments in Africa would affect the economy. Kaba was clear in her position that while China has been a primary investor, Côte d’Ivoire remains “strongly connected to Europe and also to the United States.”

Watch the event

The Polish finance minister on his country’s “U-turn” toward European values

“Poland is back to Europe… we’ve made a ‘U-turn’ from what I call a ‘Hungarian path,’ which is out of the European values,” Andrzej Domański, minister of finance for Poland, argued at an Atlantic Council event on Friday.

Domański gave his remarks in discussing how Poland’s economy—which has proven resilient after avoiding recession in periods of mounting global economic challenges—fits within the greater European economy.

When analyzing the reasons why Poland’s economy recovered relatively quickly after the pandemic and after the initial wave of impacts from Russia’s full-scale invasion of Ukraine, Domański pointed to Poland’s economic diversification. “We don’t have one sector that would be overwhelming the whole economy. I believe this is one of the factors that is behind our resilience.”

Following that, when discussing Poland’s plan for the energy transition, Domański said that Poland can take “two obvious directions: one of them is renewables, and the second one is nuclear energy.”

Domański also discussed the ongoing priorities of the Polish government in further bolstering the economy. On the topic of security, Domański vowed that Poland “will not cut spending on defense” and that it will “will not stop helping [its] Ukrainian friends.”

Watch the event

• Dispatch from IMF-World Bank Week: What will this week’s legacy be?

• Paolo Gentiloni on how the war in Ukraine is impacting Europe—and how the EU can help fill Kyiv’s “financial gap”

• Is the global financial system fit for climate change?

• The South African finance minister’s plans to champion an African perspective during its 2025 G20 presidency

• “Congo is open for business,” argues DRC Minister of Finance Nicolas Kazadi

• See day four analysis

Dispatch from IMF-World Bank Week: What will this week’s legacy be?

There were plenty of reasons for a dour mood to spread across the spring meetings this week.

One such reason is that higher-than-expected inflation readings in the United States dampened expectations of Federal Reserve rate cuts, driving up long-term rates around the world. The Financial Times even spoke of relegating the low-interest period of the 2010s to the dustbin of history. Countries are beginning to realize that they may not have the means to service their debt, support their aging populations, pay for the green transition, help Ukraine, and finance military rearmament all at the same time.

The dour mood was reinforced by the Israel-Iran exchange of direct attacks and Russia’s destructive air campaign in Ukraine. Higher oil prices and further supply-chain disruptions consequently topped the IMF’s downside risks to the forecast. Calls from the Biden administration to triple aluminum and steel tariffs provided a reminder of the risk of future trade conflicts and increasing economic fragmentation.

Less discussed, but similarly mood-souring, was the topic of the stronger dollar, which might have negative consequences for emerging and developing countries with growing fiscal deficits.

The International Monetary and Financial Committee chair released a statement today that was among the most bland in recent history, repeating well-known positions about the IMF’s role in the global economy and committing to the implementation of recent decisions, but falling well short of new initiatives.

But when determining this week’s legacy, there are reasons for a better mood to prevail. The IMF did propose a tweak to its debt policies, allowing the Fund to lend to countries even if they’re still in debt restructuring negotiations with big bilateral creditors (think China). The IMF also, in its World Economic Outlook, finally zeroed in on the “significant risks” that large countries’ fiscal deficits pose to the global economy. And there are signs of momentum ahead: Liechtenstein is on track to join the IMF as member number 191, in a year marking the eightieth anniversary of the Bretton Woods institutions. Whatever mood the delegates are in when they depart Washington, their work will carry on.

Paolo Gentiloni on how the war in Ukraine is impacting Europe—and how the EU can help fill Kyiv’s “financial gap”

In a discussion at the Atlantic Council on Thursday, Paolo Gentiloni, the European Commissioner for Economy, expressed a surprisingly positive outlook about the European economy, as the European Union (EU) continues to face post-pandemic and security challenges. 

In discussing the IMF’s latest World Economic Outlook, which slightly downgraded forecasts for the eurozone, the former Italian prime minister said he sees “the conditions for an acceleration of the economic activity for the second part of this year, and probably more in 2025.” His conviction rests, he said, on “better-than-expected” declining inflation, shared “strong labor markets” across the Atlantic, and an increase in purchasing power in several European countries “not impacting inflation, but consumption, which would trigger a better level of growth.” The EU’s goal was ultimately to “avoid a recession and major energy crises.”  

When assessing Europe’s economic-rebound prospects, Gentiloni urged to not “compare the impact of the Russian invasion in Ukraine, in Europe, with other parts of the world,” highlighting its disproportionate impact on “Europe and the Global South.” Russia’s invasion “disrupted part of the European business model” reliant on “cheap gas” and exports, which particularly affects Europe’s largest economy, Germany. The geopolitical risk remains “the largest risk” threatening Europe, he said, while there is no “substantial risk from a financial stability point of view” or “divergences in level of growth among different European countries.” Gentiloni said he is “quite optimistic that [Europe is] out of the most difficult part” of its “economic situation.” 

Amid the growing debate about Europe’s future competitiveness, Gentiloni said that the topic fits into wider discussions on “how the model we built the European Union [on] in the last decades should be probably transformed.” To achieve its ambitions, Europe must “find common funding” beyond the NextGenerationEU (which is expiring in 2026) to further attract private investments and complete the green transition, “avoiding the idea that slowing down or taking a different direction will solve our problems, because the global competition on clean tech is there,” Gentiloni said.  

Drawing on a quote from former European Commissioner Pascal Lamy, Gentiloni remarked how “the EU cannot be the only herbivore in a world of carnivores” and argued that the “solution is to compensate economically, socially those that are most affected and to win the battle of the cultural narratives.”

Watch the event

Is the global financial system fit for climate change?

We know what the future is set to look like: By 2040, according to the Intergovernmental Panel on Climate Change, we will be living in a 1.5 degrees warmer world, with consequences that are already being predicted by science. That’ll be the case unless extraordinary action is taken.

The private sector is now waking up to this reality. Industry is beginning to recognize that climate risks raise financial risks. Homeowners are finding it harder to insure their houses. Water levels are rising, disrupting ports that play a large role in the global economy. Outdoor workers cannot work safely in heat waves, which are striking with alarming frequency.

The economic costs of inaction cannot be postponed and passed on to future generations.

There must be a new ambition for adaptation and resilience finance. Currently, progress on catalyzing investments in climate solutions is often slow and scattered, and it also often lacks scale. The solution: Redefining the economic and financial order.

To begin imagining what that new order should look like, we sat down with climate finance experts, who helped us spread our Call for Collaboration between the public and private sectors that we launched at COP28 last year. Catch up on that conversation, held on the sidelines of the IMF-World Bank Spring Meetings, below.

Watch the event

The South African finance minister’s plans to champion an African perspective during its 2025 G20 presidency

South African Minister of Finance Enoch Godongwana joined the Atlantic Council’s IMF Broadcast studios on Wednesday to outline his country’s economic priorities, including its vision for the Group of Twenty (G20) agenda during its presidency in 2025.

In the conversation with Atlantic Council Africa Center Senior Director Rama Yade, Godongwana said that South Africa is focused on being not the biggest economy but the strongest. “What we must focus on is that we are the most industrialized economy on the African continent, and to what extent we can build on that, to build competencies, that makes us the strongest economy on the African continent,” he said. Sharing his optimism about economic growth on the African continent, Godongwana cautioned that a slowdown in growth in South Africa’s trade partners, such as China, may lead to a spillover effect not only on South Africa’s economy but that of the South African Development Community region.

Regarding South Africa’s upcoming presidency of the G20, the minister said that South Africa is developing an agenda that will include some of Brazil’s current priorities—and others from previous presidencies—and that South Africa “will inject an African perspective into that agenda” after consultation with countries on the African continent.

Turning to South Africa’s membership and ambition within the BRICS group, the G20, and the IMF and World Bank, the minister argued that there is no tension for South Africa within these groupings, but that they have been helpful in addressing challenges that the country faces. Responding to a question about a possible BRICS currency, the minister stated that there “is no document from the BRICS that talks about a BRICS currency in our declarations.” Godongwana stated that there is a push, regionally in Southern Africa and within the BRICS, to accept local currencies and to use alternative payment systems beyond the dollar when conducting international trade. But BRICS, he said, is not about undermining the current system—but changes in the current system are needed.

Speaking during the IMF-World Bank Spring Meetings, Godongwana discussed reforms he’d like to see the Bretton Woods institutions make, including governance and funding changes at the IMF and the World Bank. The minister argued for a change in the selection of heads of the IMF and World Bank and called for non-American and non-European candidates to be considered for the top leadership positions of the organizations. Speaking to investors, Godongwana stated that he welcomed investment into South Africa and the African continent that respected countries’ sovereignty and geopolitical strategies.

Watch the event

“Congo is open for business,” argues DRC Minister of Finance Nicolas Kazadi

DRC Finance Minister Nicolas Kazadi joined the Atlantic Council’s IMF broadcast studios on Wednesday to outline his country’s economic priorities, including its intent to create more opportunities for investment.

Kazadi argued that “Congo is open for business” and “the mining sector specifically is driven by foreign investment.” In March this year, the Congolese government began to implement a 2017 law requiring all subcontracting companies to be majority Congolese-owned. The minister explained that while Congo encourages investment, the country wants to ensure that private investors share the prosperity with local partners and build local capacity. “We don’t even need a law for that, it is a matter of principle” to help local Congolese businesses grow, argued Kazadi.

In the mining sector, the finance minister said that Congo is looking for investments along the full energy value chain, “trying to raise awareness in our youth, support them as they invest in the ecosystem that we are trying to build in partnership with the big private sector,” he said. Kazadi said that “Congo is trying to bring more transparency along the value chain to raise the standards” to avoid situations in which products do not meet international environmental, social, or governance standards that can impact the image and business environment of the country. He said that he hoped companies working in the Congo would help charge a “local transformation of critical minerals” that would change the economy “completely,” bringing the gross domestic product “from billions to trillions,” he said.

Speaking during the IMF-World Bank Spring Meetings, Kazadi discussed Congo’s upcoming sixth review of its Extended Credit Facility program and reforms he’d like to see the Bretton Woods Institutions make, including changes to the channeling of Special Drawing Rights. He expressed a readiness to work with international financial institutions on addressing the development challenges facing his country.

Watch the event

• Dispatch from IMF-World Bank Week: The issues we haven’t heard about—yet

• European Investment Bank president urges multilateral cooperation on Ukraine’s reconstruction and climate financing

• “The role that digitalization plays for Ukraine, especially now, is critical,” says Olga Zykova

• The Global South’s reform agenda for the IMF and World Bank

• See day three analysis

Dispatch from IMF-World Bank Week: The issues we haven’t heard about—yet

IMF headquarters was abuzz today following the announcement of Managing Director KristaIina Georgieva’s new global policy agenda, outlining the economic challenges of the day and what the IMF plans to do about them.

The three priorities she chose for the Fund to tackle: rebuilding fiscal buffers, after public debt edged upward to 93 percent of GDP; reviving medium-term growth, which has deteriorated since the global financial crisis; and renewing its commitment to its members, with more quota resources to go around.

All of the above are worthwhile things to do. But, at least from where I was watching in the IMF HQ1 Atrium, Georgieva didn’t seem to mention anything about two of the most pressing issues of the day when she presented the global policy agenda this morning.

The first issue is China’s industrial overcapacity and its global impacts. The EU has launched or is expected to soon launch anti-subsidy investigations looking into Chinese electric vehicles, wind turbines, and medical devices. But the news that really spread like wildfire at the spring meetings was that, just a couple blocks away, the White House announced an investigation into China’s shipbuilding practices. President Joe Biden also called for tripling tariffs on Chinese steel and aluminum products, the starting gun for more protectionist measures to come—and a major risk to global growth.

The second issue is the divergent monetary policies being put forth by the US Federal Reserve and the European Central Bank, pushing up the dollar’s value in foreign-exchange markets. The topic did come up during the G20 press conference following the group’s meeting of finance ministers and central bank governors today. A strong dollar will undermine low-income countries’ growth prospects—something the IMF must pay attention to.

The silence on these risks to global growth shows the Fund should pay more attention to the issues at the core of its mandate to coordinate members’ economic policies as they are being shaped and implemented. Doing so early—rather than reactively helping countries deal with the fallout of poor international cooperation—would avoid negative spillovers on the global economy.

European Investment Bank president urges multilateral cooperation on Ukraine’s reconstruction and climate financing

On Thursday, Nadia Calviño—who this year took over as president of the European Investment Bank (EIB)—spoke to the Atlantic Council at the IMF-World Bank Spring Meetings, where she talked about the EIB’s priorities, including encouraging investment in Ukraine for reconstruction, rallying climate financing, and helping the European Union achieve its strategic priorities.

Calviño explained that the EIB is working with other multilateral institutions and with local Ukrainian partners to identify Kyiv’s rebuilding priorities—including infrastructure projects and support to small and medium-sized enterprises—to “make the most of Europe’s money.” She added that the EIB is working with the European Bank for Reconstruction and Development, the World Bank, and the United Nations Development Programme to ensure that “the experts that are on the ground are providing the most efficient service… to all of us.”

Calviño said that the EIB is proud to have garnered a reputation as “the climate bank,” with over 50 percent of its investments being in green projects and having supported the development of innovative technologies. “The green agenda is really ingrained in everything we do, inside and outside the EU,” she said. She argued that the investments being made in less-developed countries were strategic in nature and critical for Europe’s future priorities.

Calviño additionally said that there’s a sense of a “shared responsibility” across the Global North in addressing climate financing needs and deconflicting those efforts. She added that a North-South dialogue is “very important” and “needs to be accompanied by facts, not just words.”

Watch the event

“The role that digitalization plays for Ukraine, especially now, is critical,” says Olga Zykova

In the bustling IMF headquarters on Tuesday, I sat down with Ukrainian Deputy Finance Minister Olga Zykova to talk about the role of digital development in post-war reconstruction.

Ukraine had been busy taking many of its public services digital, even before the outbreak of the war in 2022. Zykova, who became deputy finance minister a few months into the war, told me that Ukrainian citizens have used technologies, such as the Diia app, to do everything from travel to access healthcare to buy war bonds for financing. She told me (and also Candace Kelly from the Stellar Development Foundation and Kay McGowan from Digital Impact Alliance, who also joined the expert panel) that she believes Ukraine’s efforts can be a successful example for other war-torn economies looking to rebuild their digital infrastructure.

The conversation then turned to the importance of open-source infrastructure, as the panelists discussed the collaborative advantages of open-source technological solutions which can provide developers the flexibility to adapt technologies to fit their needs across countries and situations.

We also discussed the need for a robust evaluation and impact assessment of the funding of these programs and the technologies themselves, to ensure that they reach their full potential. This call for robust impact metrics has been a consistent theme of this week, echoed by multilateral development banks, the private sector, and civil society.

Zykova also outlined Ukraine’s priorities for the IMF-World Bank Spring Meetings, calling for the creation of a sustained plan to equip Ukraine with the means to meet its reconstruction demands. She encouraged countries to not lose focus, even with lingering uncertainties about funding in Ukraine, and reiterated the importance of building resilient networks as the EU approaches its elections.

Reconstruction in Ukraine represents many of the existential questions ahead for the World Bank and IMF this decade—how to shore up democratic resilience, build consensus across an increasingly fracturing global order, and use technology to reduce inequality and achieve lasting prosperity.

Watch the event

The Global South’s reform agenda for the IMF and World Bank

International media has until now paid little attention to statements of the Group of Twenty-Four (G24). The committee represents developing countries within the IMF and World Bank, playing a similar role to the Group of Seventy-Seven, a coalition of developing countries that comes together at UN gatherings. As Global South countries have become more vocal in their demand for reforms of the Bretton Woods institutions, the G24’s statements have become more important. The group should be considered counterparts to the Group of Seven (G7) in discussions about changes, especially in the context of the International Monetary and Financial Committee (IMFC)—an important body in the governance of the IMF.

On April 16, the G24 met and issued a communiqué summarizing the positions of developing countries on many issues on the reform agenda.

Regarding the IMF:

• The G24 welcomed the equi-proportional increase in quota but stressed the need for a quota realignment to reflect involving realities of members. (Developing countries in aggregate have increased their weight in the global economy but feel underrepresented in the Fund’s quota and voting-share distribution.)
• It urged the Fund to eliminate the surcharge on its base lending rate which has resulted in high borrowing costs to members in need of substantial IMF support.
• It proposed considering sales of IMF gold to increase the financial resources of concessional lending facilities such as the Poverty Reduction and Growth Facility.

Regarding the World Bank:

• The G24 acknowledged the Bank’s efforts in implementing the Evolution Roadmap, sponsored by the Group of Twenty to optimize its balance sheets and increase its financing capability and efficiency.
• However, the G24 cautioned that the commitment to allocate 45 percent of annual financing to climate-related projects should not be at the expense of financing for basic development challenges like combating poverty and hunger.
• It called for a capital increase for the World Bank and multilateral development banks in general—especially a strong replenishment of the resources of the International Development Association (providing grants and low-interest loans to low-income countries) in its twenty-first round of funding, which is currently underway.

In the view of many in developed countries, the demands articulated by the G24 may resemble a wish list containing many items difficult to command sufficient agreement to be adopted—for example, the quota reform. Nevertheless, developed countries should take these demands seriously and engage constructively with developing countries to find a reasonable way forward. Failure to do so would undermine the legitimacy and effectiveness of the IMF and World Bank—institutions that should play important roles in sustaining global growth and supporting less-developed countries.

• Dispatch from IMF-World Bank Week: A tale of two headquarters

• Mixed developments on sovereign debt restructuring

• The Spanish minister for economy outlines his country’s economic trajectory—including a predicted 20 percent drop in its debt-to-GDP ratio

• Despite the IMF’s revised growth forecast for Russia, the Russian economy is not doing well

• Finance Minister Muhammad Aurangzeb outlines Pakistan’s path to economic reform and stability

• Back to the basics: High turnover rates for central bank governors do not help with inflation

• Spooking the spirit of Bretton Woods

• See day two analysis

Dispatch from IMF-World Bank Week: A tale of two headquarters

In many ways, the story on day three of these spring meetings feels like a tale of two headquarters: Both style and substance differ between the boisterous World Bank on one side of 19th Street and the more buttoned-up IMF on the other.

The Bank’s atrium has been decorated with hundreds of colorful drawings by staff members’ children, depicting a “livable planet”—the newly added objective to the Bank’s vision statement. The Fund’s atrium, on the other hand, hosts an interactive “let’s grow together” board where delegates can affix stickers to the types of training and institutional strengthening they need. Both spaces strive to inspire and provoke thought, but the vibes are quite different.

Substantively, the Bank is abuzz with chatter about its “evolution,” touting progress such as a new guarantee platform, the corporate scorecard, and the series of reforms initiated last year to improve its impact. People at World Bank HQ are also energetically making the case that the Bank’s “money and knowledge” are vitally needed now, as a “great reversal” in development—explained in a new report—has resulted in one in three low-income countries becoming poorer than they were on the eve of the pandemic.

At the Fund, it’s about “resilience amid divergence” (as I discussed this afternoon with my fellow World Economic Outlook ‘decoders’ from the Atlantic Council): cautiously celebrating the fact that better-than-expected resilience in the US economy, coupled with stronger labor markets and cooling inflation in many places, is driving steady global growth. But that celebration doesn’t paper over the fact that debt, higher-for-longer interest rates, and conflict are undermining growth and impeding recovery in many developing countries.

Where Bankers, Funders, delegates, and guests seem to be speaking the same language is around “leverage” (the need to use the Bretton Woods institutions’ funding to crowd in additional financing) and “demographics” (with certain population trends raising macroeconomic and social-development pressures and opportunities, which I’ll be talking about at the IMF on Friday).

PS: If you’re wondering which of the headquarters has the better store for some spring meetings swag, it’s the World Bank’s.

Mixed developments on sovereign debt restructuring

This was a big week for those working to help vulnerable middle- and low-income countries overcome debt crises. For years now, there has been a slow-moving discussion about how to improve the framework for sovereign debt restructuring. And on that front, there has been both good news and bad news in recent days.

First, the good news: Three years or so since Zambia defaulted on its international bonds, it has just reached a restructuring deal with its bondholders which has been accepted by the official bilateral creditors. However, Zambia is not out of the woods yet. It still has to negotiate debt deals with its commercial creditors—basically international banks including many Chinese stated-owned banks such as the China Development Bank, Industrial and Commercial Bank of China, etc. It is not clear if this problem will hold up the actual implementation of the agreed debt restructuring measures—highlighting the complexity of the sovereign debt restructuring process.

The second piece of good news is that the IMF Executive Board has just approved some adjustments to the Fund’s Lending into Official Arrears (LIOA) policy—basically allowing the Fund to lend to a member in distress even though that member is in arrear in servicing its debt to an official bilateral creditor. The just-approved adjustments would give the Fund more flexibility in making use of the LIOA policy when a creditor country (i.e. China) has not been forthcoming in the restructuring process, delaying its timely conclusion. The key outstanding question is whether a low-income debtor country would be prepared to go along with the idea of activating the LIOA vis-à-vis China—especially those who have relied on China for trade and investment via the Belt and Road Initiative.

Then there’s the bad news. A piece of proposed legislation is moving through the New York State Legislature that would amend the state’s creditor and debtor law. Basically, the amendments would unilaterally impose a restructuring regime, for example compelling bondholders to accept a restructuring deal managed by an overseer appointed by the governor of the state of New York. As about half of international sovereign bonds have been issued under New York law, and the other half under English law, this legislation would, if passed and implemented, introduce a huge element of uncertainty to the sovereign bond market. It could potentially disrupt its smooth functioning and raise borrowing costs for emerging market and developing countries. And it could short circuit international efforts, such as the G20-sponsored Common Framework and the Sovereign Debt Roundtable, which are trying to develop international agreements to improve the sovereign debt restructuring framework.

All three stories highlight the complexity of debt restructuring negotiations. But the summary of the week’s news on that front: two steps forward, one step back.

The Spanish minister for economy outlines his country’s economic trajectory—including a predicted 20 percent drop in its debt-to-GDP ratio

Spain is positioning itself as a “growth engine” in the eurozone, argued Spanish Minister of Economy, Trade, and Business Carlos Cuerpo.

He said that in 2023, Spain “grew five times the euro area average.” That, coupled with his prediction of a 20 percent drop in the country’s debt-to-GDP ratio (with respect to the peak post-pandemic), “[configures] a good way forward” for Spain, Cuerpo said, with sustainable growth likely ahead in the medium term.

Cuerpo said that Spain is hopeful about its economic prospects, as foreign direct investment has grown, indicating “confidence of world investors in the Spanish economy.”

Cuerpo spoke with GeoEconomics Center Senior Director Josh Lipsky at Atlantic Council headquarters during the IMF-World Bank Spring Meetings. They discussed Spain’s path forward utilizing NextGenerationEU funds and its role in the conceptualization of new EU fiscal rules. Cuerpo reflected on the transformation of primary themes of discussion over the EU’s fiscal rules, beginning with the green transition, pivoting to strategic autonomy, and now focusing on economic security. “There is a common denominator [within] those discussions, which is the need for investment,” he said.

Cuerpo pointed to Spanish investment in green hydrogen, semiconductors, and battery-related initiatives through the NextGenEU funds. A midterm evaluation from the European Commission found that the Spanish GDP level increased by 1.9 percentage points in 2022, when compared with a hypothetical Spanish economy without the NextGenEU funds present. “It’s not just an opportunity for the Spanish economy,” Cuerpo said. “The impact of the plan is already a reality.”

Watch the event

Despite the IMF’s revised growth forecast for Russia, the Russian economy is not doing well

You’ve heard it before. Gross domestic product, or GDP, is not the best indicator to understand Russia’s economic performance under sanctions. Nor is the exchange rate. Yet, the IMF’s decision this week to revise Russia’s growth forecast for this year upwards to 3.2 percent after another upward revision in January is one of the most talked-about findings of the World Economic Outlook. And while the widening fiscal deficit and rapid inflation remind us that the Russian economy is still under strain, it’s important to acknowledge that, at the start of Russia’s full-scale invasion, sanctions policymakers thought they could reasonably hope to plunge Russia into a prolonged recession. And in April last year, when the IMF predicted the Russian economy would grow in 2023, most thought this was wrong, but it did indeed grow by 3 percent.

How are they pulling this off? It’s not just about oil and gas export income, though higher oil prices help. Combined disclosed and undisclosed military and domestic security spending exceeds 30 percent of GDP—and therefore represents a major boon for overall GDP figures. The Ministry of Finance had to reach into its savings more than expected at the end of 2023, taking the liquid part of the National Wealth Fund down from $150 billion to $130 billion. The weak exchange rate and labor shortages are also working together to keep inflation very high, at almost 8 percent.

It’s wrong to say the Russian economy is doing well. The problem is that it has enough resources to keep funding the war.

Finance Minister Muhammad Aurangzeb outlines Pakistan’s path to economic reform and stability

On Monday, Pakistani Finance Minister Muhammad Aurangzeb emphasized the country’s need for structural reforms over a span of two to three years. In an Atlantic Council conversation with the South Asia Center’s Kapil Sharma, Aurangzeb outlined Pakistan’s strategy, arguing that efforts shouldn’t merely focus on financial stabilization: They should also lend focus to sustainable growth and inclusivity. 

“The crux of our strategy with the IMF involves not just temporary relief but laying the groundwork for enduring stability and economic resilience,” Aurangzeb said. He underlined the importance of understanding and implementing long-term policies that have been on the nation’s agenda for decades. The minister argued that the time for action on these reforms is now, especially with the looming end of Pakistan’s three-billion-dollar Stand-By Arrangement with the IMF, currently set for late April. 

Pakistan reportedly intends to ask for a larger and extended program from the IMF to support its economic reforms. To that end, Aurangzeb argued that when it comes to these economic reforms, Pakistan doesn’t need more policy prescriptions: It needs implementation. 

“Ensuring macroeconomic stability is not merely about stabilization; it’s fundamentally about inclusive growth and addressing climate impacts,” said Aurangzeb. He noted that the financial and structural reforms would help Pakistan mitigate the adverse effects of climate change and promote financial inclusivity, especially among vulnerable groups, including women. 

Watch the full event 

Back to the basics: High turnover rates for central bank governors do not help with inflation

Inflation is front and center at the spring meetings. Reducing it is crucial for any inclusive growth and development strategy because, after all, inflation is a regressive tax on the poor, who lack the real assets to effectively hedge against inflation.  

While the global median headline inflation has declined to 2.8 percent in 2024 and many central banks have been successful in their fight against inflation—particularly the Federal Reserve (known as the Fed), Bank of England (BoE), and European Central Bank (ECB)—many developing and emerging economies are still suffering from high inflation rates, sometimes with rates higher than 20 percent. Several factors continue to contribute to these rates: rising energy and food prices; increasing sovereign debts; higher policy rates in the ECB, UK, and Fed (and thus larger capital inflows to these economies); and growing budget deficits—partly because of the higher cost of energy and of servicing debt due to higher interest rates.

An often ignored but equally or even more important factor is the independence and reputation of central banks. While the majority of countries suffering from inflation rates higher than 20 percent claim that their central banks are independent and their policies are not influenced or dictated by their central governments, in practice the so-called “independence” of these central banks is severely undermined by the high turnover rates of their top bosses.

Available data suggests that over the past decade, the median tenure of a central bank governor or president in the twenty economies with the highest inflation rates has been a mere two years. Over the past ten years, a number of central bank governors have come and gone: Seven in Argentina, eight in Turkey, six in Venezuela, and five in Iran. Just to put this in perspective, during the same period, the median tenure of the leadership in the Fed, ECB, BoE, and Bank of Japan has been five years, and these institutions have each changed leadership only once in the past decade.  

Such a high turnover rate for the central bank leadership is a clear sign of its lack of independence. It also severely undermines the most important asset of a central bank: its reputation and credibility. Economic actors, markets, and consumers in an economy look to the central bank and its leadership for direction on the future of the economy and directly equate high turnover in a central bank leadership to policy uncertainty, demolishing the reputation and policy credibility of a central bank. A central bank lacking reputation and credibility is like a chef without a kitchen.

In fighting inflation, it’ll be important to go back to the basics: religiously protecting the reputation and independence of central banks and aggressively rebuilding any losses on these fronts. After all, reputation is extremely hard to build but very easy to lose. And that is the most important tool a central bank has to fight inflation.

Spooking the spirit of Bretton Woods

It was supposed to be a week of multilateralism, breaking down barriers between borders, and preventing “fragmentation” (as the IMF often likes to say). But the United States had different ideas.

Following US Treasury Secretary Janet Yellen’s recent trip to China where she hammered home the risk of Chinese manufacturing overcapacity, the Biden administration today called for a tripling of tariffs on Chinese steel and aluminum. As if that wasn’t enough, the Office of the United States Trade Representative is beginning an investigation into Chinese unfair trade practices on shipbuilding and maritime logistics, per a White House announcement this morning.

Couple this with the European Union’s ongoing anti-dumping investigation on Chinese electric vehicles (as we’ll discuss with EU Commissioner for the Economy Paolo Gentiloni tomorrow), and suddenly the spirit of Bretton Woods is looking a little spooked. That’s one reason why the understated warning in the IMF’s World Economic Outlook yesterday about downside risks may already feel out of date.

• What the World Economic Outlook left out

• What should be done with Russia’s blocked reserves?

• Dispatch from IMF-World Bank Week: IMF report launches keep it dull

• The IMF warns the United States to get its fiscal house in order

• How much can multilateral development banks crowd in private capital? It’s not looking like much—so far.

• When it comes to trade relationships, North America comes first, argues Mexico’s secretary of finance

• Read day one analysis

What the World Economic Outlook left out

The just-released World Economic Outlook (WEO) has a nice subtitle that sums up very well its key messages—”steady but slow: resilience and divergence.” Resilient because economic activity in advanced countries has been solid and precipitated a 0.2 percentage point upgrade in the IMF’s growth forecast, to 1.7 percent this year. Divergent because low-income countries (LICs) have had their growth estimates cut by 0.2 percentage points to 4.7 percent this year. They have absorbed most of the $3.3 trillion loss in global economic output relative to the pre-COVID trend. They’ve also built up onerous levels of debt so that many are in debt distress and now have to use more than 14 percent of their government budget to pay interest, crowding out other important and necessary expenditures.

Unfortunately, the outlook for the LICs looks to be even worse than the WEO’s forecast, thanks to the Iranian attack on Israel over the weekend, as well as recent upticks in US inflation data.

Going forward, the heightened risk of war following Iran’s direct attack on Israel will likely keep oil prices elevated, having risen by some 12 percent since the beginning of the year. Meanwhile, higher-than-expected inflation will delay any easing by the Federal Reserve. That has caused a renewed uptick for the dollar. The combination of elevated oil prices and a strong dollar is bad for many countries, but it is particularly devastating for LICs because most LICs have to import oil—so high oil prices coupled with a depreciating currency against the dollar represent a double whammy, undermining growth. Also hurting LICs is the fact that a strong dollar increases their debt and debt servicing burdens, and it also tends to trigger capital outflow exacerbating the stress.

These two news events will push LICs even further behind in the convergence process. In short, global economic disparities will likely increase with unfavorable social implications for the world. The WEO has not paid sufficient attention to this risk.

Watch more

What should be done with Russia’s blocked reserves?

Since February 2022, Western sanctions have blocked roughly $300 billion in Russian reserves. Thanks to high interest rates, these reserves have been generating income for their custodians, the largest of which is Belgium-based company Euroclear. The question Group of Seven (G7) members will be discussing this week is how to use that interest income.

Bloomberg’s Viktoria Dendrinou and the Council on Foreign Relations’ Brad Setser joined the Atlantic Council GeoEconomics Center’s Charles Lichfield to compare the two primary proposals: 1) Tax almost all the interest income and use the windfall as a funding source for Ukraine or 2) pull forward some of the interest income stream to provide funding more quickly, maximizing its value through financial engineering.

Although the United States wants to come to an agreement by June, Dendrinou explained that things are moving more slowly on the European side due to the greater risks posed by Russian retaliation, as Europe has more assets in Russia. This adds to fears of knock-on effects on the euro’s role as a reserve currency.

Still, Setser came back with ambitious plans to generate even more interest income by actively managing the funds. “If you put this in deposit accounts and you had access to the full $300 billion,” he said, a reasonable estimate “is nine to ten billion dollars per year.”

Dendrinou and Lichfield expressed skepticism about the feasibility of doing this from a legal perspective, as it may require changing the ownership of the assets. Looking to the future, Dendrinou tentatively suggested that there’s “probably going to be some kind of financial engineering in place” by next year’s spring meetings.

Setser, on the other hand, boldly predicted that by June, the G7 will “agree to a facility that pulls forward some, not all, future interest income so that the current sum that flows to Ukraine this year is more than the three to four billion that is currently being discussed.” G7 outcomes from this week may provide some early signs about a realistic timeline for using the interest income.

Watch the event

Dispatch from IMF-World Bank Week: IMF report launches keep it dull

Each year at the spring and annual meetings, participants like me count down to the launch of the IMF’s most important flagship publications—the World Economic Outlook (WEO) and Global Financial Stability Report (GFSR). The launches are typically the high point of the week, often receiving more media attention than pronouncements from the finance ministers and central bank governors that come later on.

The GFSR unveiling has always been a jargon-laden affair. While the WEO press conferences have become increasingly staid over the years, they were once known for public debate and even sarcasm.

The most memorable launch happened in the aftermath of the 1997 Asian financial crisis, when the IMF came under fire for its tough policy prescriptions. Then IMF Chief Economist Michael Mussa had firmly defended the Fund against the attacks—which especially rankled when they came from then World Bank Chief Economist Joseph Stiglitz. At the September 1998 WEO launch, Mussa declared that “those who argue that monetary policy should have been eased rather than tightened in those economies are smoking something that is not entirely legal.”

But today’s launch events at IMF headquarters hewed to the new status quo. IMF Economic Counsellor Pierre-Olivier Gourinchas, who heads the Fund’s Research Department, offered the WEO’s case for optimism—with global growth forecast at 3.2 percent in 2024 and 2025—arguing that “the global economy remains remarkably resilient” although progress to reduce inflation has “stalled.” Notably, he called on China to address its property downturn and “lackluster” consumer demand. IMF Financial Counsellor Tobias Adrian then elaborated on the financial sector risks hanging over China at the GFSR press conference.

Mentioned only in passing were global geopolitical fragmentation, the divergence of fortune between advanced and low-income countries—the latter an important theme of this WEO—and the stalled progress in restructuring developing country debt. These uncomfortable issues were left to another day.

The IMF warns the United States to get its fiscal house in order

Unlike last year, the IMF’s World Economic Outlook (WEO) and Global Financial Stability Report (GFSR) were not derailed by events happening a few days before publication. Last October, the Hamas terrorist attack on Israel the weekend before the Marrakesh meetings rendered the Fund’s forecasts outdated by the time they appeared.

Iran’s large-scale attack on Israel, by contrast, has not yet led markets to a fundamental reassessment of geopolitical developments, although the situation remains extremely fragile. The IMF’s spring reports therefore deliver a timely message about the factors behind a more somber medium-term outlook. With the inflation shock gradually diminishing, the Fund’s forecasters are on more solid ground assessing the challenges facing the IMF’s member countries, with fiscal pressures front and center in this year’s reports.

These are also depicted in an excellent article by Pierre-Olivier Gourinchas, the IMF’s chief economist. The degree of fiscal adjustment needed to stabilize medium-term debt ratios for many countries is striking, including the United States. The US fiscal stance is raising “short-term risks to the disinflation process, as well as longer-term fiscal and financial stability risks for the global economy,” as Gourinchas put it. In other words, US fiscal policy poses a risk both to US disinflation and to global long-term interest rates unless the United States gets its fiscal house in order.

“Something will have to give,” concludes Gourinchas, an ominous reference to a long list of downside risks that are listed in the two reports. However, the good news is that the GFSR is less alarmist about financial sector developments this time, focusing instead on how to manage the “last mile of disinflation,” a considerable change in tone compared to the discussions only a year ago when the United States was on the verge of a major banking crisis.

As always, the IMF as a multilateral institution needs to be careful how it depicts geopolitical events, and there are well-calibrated references to commodity price developments and supply chain disruptions caused by ongoing conflicts. The reports, however, cannot elaborate on the precarious situation caused by Russia’s war in Ukraine and the ongoing conflict in the Middle East.

But these conflicts may increase pressures on government finances, including from rearmament needs, fiscal spending during an election cycle, and lower tax revenues due to mediocre growth rates. As a result, the advocated fiscal adjustment may remain elusive. Still, the IMF’s staff has done its duty by pointing out the underlying risks.

How much can multilateral development banks crowd in private capital? It’s not looking like much—so far.

In redefining its mission as striving for a world without poverty on a livable planet, the World Bank—under President Ajay Banga—has drawn attention to the need to mobilize capital resources to help developing countries close the climate action funding gap: A gap that currently amounts to the difference between the $100 billion committed annually by donor countries and the over $2.4 trillion needed per year by 2030.

It is clear that developed countries and multilateral development banks don’t have the capital resources to meet much of the investment gap. As a consequence, the Bank has put much effort into finding ways to catalyze, or crowd in, private capital by providing risk-sharing and guarantee facilities. With private institutional investors and asset managers holding more than $400 trillion of assets under management, the Bank hopes to draw in multiples of private capital to stretch its project dollars.

However, research by the Institute of International Finance has found that in recent years, multilateral development banks collectively managed to mobilize just fifteen dollars for every one hundred dollars committed—or one-fifteenth, decidedly not significantly multiplying the amount it has put up in its commitments.

While it is truly important and laudable for the Bank to find ways to catalyze private capital, it is better to be realistic about the potential outcome and impact of such efforts, so as not to set the stage for later disappointment. By presenting realizable targets—at least for the foreseeable future—the Bank can focus on the tremendous climate action investment gap that needs to be filled, continuously urging the international community to rise to the occasion to help meet the challenge before it is too late.

Of course, developing countries can help themselves by implementing structural reforms, especially in governance, to make themselves increasingly investable in the eyes of both domestic and international investors, attracting the needed investment flows.

When it comes to trade relationships, North America comes first, argues Mexico’s secretary of finance

Mexico’s Secretary of Finance Rogelio Ramírez de la O joined the Atlantic Council’s studios on Monday to outline his country’s economic priorities, including its relationship with the United States.

Ramírez de la O argued that Mexico is “one of the most open economies in the world for both trade and capital,” thanks in part to the country’s exports, which are reported at over 35 percent of gross domestic product. The secretary of finance said that the country benefits from its level of openness, which he stated is comparable to certain European countries—but it’s also one that “fewer economies in Latin America have.”

Last year, Mexico surpassed China as the biggest exporter of goods to the United States. Mexico is committed to North American integration because “it’s where the core of our exports activities [lie],” Ramírez de la O argued. “This doesn’t mean that anything else comes secondary, but it comes next.” Looking ahead toward the USMCA renewal in 2026, the secretary of finance reassured members about product traceability—a demand rising from concerns over Chinese products. “We’re trading mainly and foremost North American content,” he said.

Speaking on the first day of the IMF-World Bank Spring Meetings, Ramírez de la O discussed reforms he’d like to see the Bretton Woods Institutions make, including correcting current account imbalances to revisit the world trade rules architecture and advocated for revisiting financial assistance for Latin America. He expressed readiness to engage with the Group of Twenty and multilateral development fora to define a global tax framework.

Watch the event

• What’s the strategy behind this year’s smaller-scale spring meetings?

• Dispatch from IMF-World Bank Week: Climate change is the writing on the wall

• Geopolitics is eroding the IMF’s relevance

• COVID-19’s economic impact on the poorest countries has just become clearer

• Financial markets may be calm after Iran’s attack, but watch how countries react to pressure from elevated oil prices and dollar pressure
• Read preview analysis

What’s the strategy behind this year’s smaller-scale spring meetings?

The spring meetings have just gotten underway, but thus far the official events around 19th Street feel somewhat scaled down. The registration and security lines today were certainly shorter than last year. And there are notably fewer headline events, at least as far as the official World Bank side convenings are concerned.  

Perhaps it’s reflective of the Bank’s intent to bring more focus to its work—as President Ajay Banga discussed in his preview press conference. The Bank consolidated its public schedule into three days with just two “flagship events”—one on the energy transition in Africa and one on strengthening health systems. Both are decidedly linked to the International Development Association (the Bank’s concessional fund for low-income countries) whose twenty-first replenishment campaign seems to have more urgency and ambition as debt and other macroeconomic, microeconomic, and geopolitical challenges stymie recovery and growth in deeper ways.

Or perhaps it reflects an interest in putting more time into one-on-one, closed-door, dealmaking meetings—including with the private sector. Leveraging resources and mobilizing private capital is a priority for the Bank, as Anna Bjerde, managing director for operations, reiterated in our conversation this afternoon: “In a world where resources are scarce, ‘leverage’ is the name of the game,” she said.

Or perhaps it reflects the pace and impact of the “unofficial” spring meetings: The increasing number of side events with a broader array of actors around and beyond 19th Street, including our robust dual-sited slate at the Atlantic Council. These convenings are as well, if not better, placed to unpack—and discuss critically—the global geoeconomic, financial, development, and sustainability challenges and opportunities we collectively face, as well as navigate how (after eighty years) the Bretton Woods Institutions and the larger multilateral system should evolve and respond.

Dispatch from IMF-World Bank Week: Climate change is the writing on the wall

With the IMF-World Bank Spring Meetings taking place again in Washington this year, the setting is familiar—but there’s also something strikingly new. As I walked into the World Bank’s headquarters today alongside many of the world’s finance leaders and experts, I was pleasantly surprised to see that the Bank’s mission statement, posted by the entrance, had changed: “Our dream is a world free of poverty,” had smartly been amended to add “on a livable planet.”

The new statement reflects the World Bank’s goal to evolve and to equip itself fully to deliver on its mission, which I discussed today with the Bank’s managing director of operations, Anna Bjerde.

The statement also exposes a hard truth: A world free of poverty cannot be attained or sustained in a world where carbon dioxide (CO2) emissions keep rising and climate challenges keep growing at the expense of the poorest—even as low-income populations contribute a mere 0.5 percent of global CO2 emissions, according to World Bank data.

Addressing global poverty and climate change requires more cooperation among the world’s largest economies and emitters; but the recent rise of geopolitical tensions and geoeconomic fragmentation, as our Bretton Woods 2.0 Project has pointed out, has made such cooperation much harder. This year’s spring meetings are a golden opportunity to make the case for more cooperation on addressing global challenges and reducing the rising temperature—both of the planet and its geopolitics.

This July, the Bretton Woods institutions will celebrate their eightieth anniversary, amid multifaceted perils facing the global economy and the world order. The countries present at the spring meetings must face these threats head on, so that by the time the IMF and World Bank turn one hundred, their member countries can look back with pride at the hard decisions they made to secure a livable and peaceful planet for all.

Geopolitics is eroding the IMF’s relevance

Expectations for this week’s Group of Twenty (G20) and IMF-World Bank Spring Meetings have hit a floor as the geopolitical environment continues to deteriorate. Russia and Iran are intensifying their pressure on Ukraine and Israel respectively, and political divisions in the West on the conflicts are becoming more acute. China is about to trigger another trade scuffle by throwing the (financial) weight of the state behind key industries that compete for global market share. The United States and Europe are on the defensive, fiscally stretched and riven by societal polarization that is also shaped by geopolitical adversaries.

There will be ample diplomatic squabbling over communiqué language concerning the wars in Ukraine and Gaza and the usual appeals to the spirit of multilateral cooperation—but there will also be complaints over excessive subsidies, trade restrictions, and financial sanctions. Discussions over quota reallocations will be doomed by irreconcilable geopolitical differences, and progress toward a more workable global debt architecture is likely to remain gradual, even if important work is proceeding on a technical level.

The one area where some consensus may exist is in raising funds for climate and development finance. Again, Western countries are on the defensive here, given that national development budgets have generally shrunk. Leveraging the funds of multilateral lenders, which the Western countries still dominate, remains an important way to at least partly match the financial resources that China, the Gulf countries, and increasingly India channel into building diplomatic ties with the developing world.

This also explains the selection of Kristalina Georgieva from Bulgaria to serve another term as IMF managing director. Under her leadership, the fund has expanded its toolkit to lend to developing countries, generally with fewer questions asked of loan recipients than under her predecessors, likely spelling financial trouble in the future. Already, there are demands for further reductions in the IMF’s lending rates as well as additional Special Drawing Rights (SDR) issuances.

By contrast, the Fund’s core economic work has generally received less attention. During her first tenure, the institution’s work was tailored to Georgieva’s personal areas of expertise, most of which lie in the mandate of the World Bank. The Fund was largely silent on the run-up in inflation, and its global economic messages have lacked clarity as it generally shies away from calling out countries for bad economic management.

Kenneth Rogoff, a former IMF chief economist, asked in a 2022 article why the IMF has turned into an aid agency. This question has now been answered by the majority of the IMF’s shareholders, who simply seem to prefer it that way. Whatever may be achieved during this year’s spring meetings, the mandate of the once proud institution seems to have shifted from safeguarding global financial stability to becoming a source of cheap funding for climate and development purposes.

COVID-19’s economic impact on the poorest countries has just become clearer

Four years after COVID-19 shook the global economy, the World Bank has released a report that lays out in the starkest possible terms just how devastating the pandemic was for the world’s poorest economies. In a report entitled “The Great Reversal,” the Bank details how much ground many of the world’s seventy-five least-developed countries have lost: One-half of that group is seeing its income gap with advanced economies widening, and one-third is poorer today than on the eve of the pandemic.

A key reason for the failure to regain growth momentum after COVID-19 has been sharply rising debt. In a separate report on developing country debt issued late last year, the World Bank estimated that eleven of the low-income countries were in “debt distress,” and twenty-eight were at “high risk” of distress. In 2022, the year the report analyzed, low- and middle-income countries paid $443.5 billion in debt service and $185 billion in principal repayments.

The countries assessed in “The Great Reversal” are eligible for World Bank low-interest loans and grant aid from the Bank’s International Development Association. They account for 92 percent of the world’s population living without access to affordable, nutritious food and over 70 percent of the world’s extreme poor. At the same time, their economies collectively account for only 3 percent of global output.

As central bank governors and finance ministers gather this week, the question—which they have faced at every spring and annual meeting since early 2020—will be whether they are prepared to work together to address this crisis of deepening poverty and debt. Or, will they leave town having only issued more communiqués expressing their “deep concern”?

Financial markets may be calm after Iran’s attack, but watch how countries react to pressure from elevated oil prices and dollar pressure

The IMF-World Bank Spring Meetings have officially kicked off, and international financial markets have maintained fragile stability in the immediate aftermath of Iran’s large-scale attack on Israel, which included the launch of more than three hundred missiles and drones. The United States, along with several European and Middle Eastern countries, has emphasized the need to prevent further escalation. Due to the fact that Iran’s attack was less damaging than some anticipated, but with the still lingering risk of war, oil prices have given back some of the risk premiums built up last week in anticipation of Iran’s attacks, with Brent Crude sinking to just below ninety dollars a barrel—after having gained some 12 percent since the beginning of this year. In case of all-out war between Israel and Iran and disruptions of the oil flow through the Strait of Hormuz, oil prices can well exceed one hundred dollars a barrel. About a fifth of the volume of the globe’s oil consumption ships through the strait, with very few alternative routes.

Meanwhile, persistently strong inflation data in the United States has pushed market expectations for the first Fed cut later in the year, keeping the dollar strong—the greenback has appreciated by about 14 percent since the recent low in 2021. The dollar is also underpinned by safe haven flows given heightened geopolitical tension.

The combination of elevated oil prices and a strong dollar has put pressure on many countries, especially low-income countries. In particular, nearly all Group of Twenty (G20) members have seen their currencies weaken against the dollar—led by the Turkish lira and the Japanese yen, which each lost more than 8 percent since the beginning of the year. This has prevented many countries from easing monetary policies to support their economic recoveries. Watch this topic closely: The dollar’s strength, and the potential negative impact of it, could be a main topic of discussion in the G20 meeting of finance ministers and central bank governors scheduled for April 17 and 18.

• Dispatch from IMF-World Bank Week: The era of separating geopolitics and economics is over

• IMF head Kristalina Georgieva on how to avoid ‘the Tepid Twenties’ for the global economy

• What to expect from the 2024 IMF-World Bank Spring Meetings

Dispatch from IMF-World Bank Week: The era of separating geopolitics and economics is over

As the world’s finance ministers and central bank governors descend on Washington this week—and snarl the city’s traffic—they seem to just want to be able to stick to the script.

It’s an understandable sentiment. The agenda is daunting, with issues such as sticky inflation, China’s struggling economy, and a rising risk of debt defaults. And, as IMF Managing Director Kristalina Georgieva made clear in her curtain-raiser speech at the Atlantic Council on Thursday, those are just the immediate problems. The medium-term challenges of job disruptions from artificial intelligence and the green energy transition can’t be ignored.

But as Iran’s large-scale attack on Israel this weekend reminded us, the ministers and governors will need to first address something else—the reality that geopolitical tensions and conflict have, as Georgieva said, “changed the playbook for global economic relations.”

Six months ago, on the eve of the IMF-World Bank annual meetings in Marrakesh, Hamas unleashed its brutal terrorist attack on Israel. The ministers spent the next five days being asked about the possible impacts on the regional and global economy, and nearly all of them demurred. As we at the Atlantic Council pointed out at the time, that was a mistake. It was clear from the start that war between Israel and Hamas would have economic repercussions. Sure enough, two months later, Houthi attacks linked to the war began disrupting major shipping routes in the Red Sea.

Now, Iran’s attack has cast a dark shadow over the spring meetings. Once again, many of the ministers will surely try to avoid addressing the potential fallout. Even if geopolitics is the last thing the ministers want to be discussing, they may not have a choice. It’s worth remembering that the Bretton Woods Institutions were created during a war to address the devastating economic toll of conflict. For the last several decades, it was often possible to keep geopolitics and economics separate—but that time is over. The sooner the ministers recognize the new reality, the more effective they can be.

IMF head Kristalina Georgieva on how to avoid ‘the Tepid Twenties’ for the global economy

With global growth predicted to remain “well below” its historical average—at slightly above 3 percent—“making the right policy choices will define the future of the world economy,” International Monetary Fund (IMF) Managing Director Kristalina Georgieva said Thursday.

“The sobering reality is global economic activity is weak by historical standards,” inflation is “not fully defeated,” and fiscal buffers “have been depleted,” she explained at an Atlantic Council Front Page event ahead of the 2024 IMF-World Bank Spring Meetings. “Without a course correction, we are indeed heading for ‘the Tepid Twenties’—a sluggish and disappointing decade.”

Yet, there is reason for optimism, Georgieva argued while previewing an upgrade to global growth forecasts the IMF will release next week: Growth is “marginally stronger” thanks to “robust activity” in the United States and in many emerging-market economies, including an increase in household consumption and business investment and the easing of supply-chain problems.

Inflation is dropping “somewhat faster than previously expected”—a trend Georgieva expects to continue in 2024. While inflation is down in the United States, new data this week show that it may be creeping back up; “that is a concern,” Georgieva said, “but I think the [Federal Reserve] is acting prudently.” In response to some predictions that inflation would come down, propelling the Fed to cut interest rates this year, Georgieva cautioned “not so fast.” If the Fed has to then reverse course and raise rates, she said, that would undermine public confidence in monetary policy.

Yet on the other hand, high interest rates in the United States are “not great news” for the rest of the world. “High interest rates mean the dollar is also stronger,” which for other countries means that their currencies “are weaker,” she explained. “It could become a bit of a worry in terms of financial stability.”

Below, read more highlights from Georgieva’s curtain-raiser speech and conversation with Atlantic Council President and Chief Executive Officer Frederick Kempe, which touched upon the “good policies” needed to achieve a soft landing across the world and concerning economic trends in China.

New Atlanticist

Apr 11, 2024

IMF head Kristalina Georgieva on how to avoid ‘the Tepid Twenties’ for the global economy

By Katherine Walla

“Making the right policy choices will define the future of the world economy,” International Monetary Fund Managing Director Kristalina Georgieva said at the Atlantic Council.

China Financial Regulation

What to expect from the 2024 IMF-World Bank Spring Meetings

Josh Lipsky, senior director of the Atlantic Council GeoEconomics Center, breaks down the issues at the top of the agenda for the spring meetings.

The post Our experts decode policymakers’ plans for the global economy at the IMF-World Bank Spring Meetings appeared first on Atlantic Council.

Online Event Thu, April 11, 2024 • 9:00 am ET

IMF Managing Director Kristalina Georgieva on the state of the global economy

AN #ACFRONTPAGE EVENT– IMF Managing Director Kristalina Georgieva previews the latest findings on the economic outlook and financial stability.

Digital Policy Economy & Business Fiscal and Structural Reform Future of Work

With global growth predicted to remain “well below” its historical average—at slightly above 3 percent—“making the right policy choices will define the future of the world economy,” International Monetary Fund (IMF) Managing Director Kristalina Georgieva said Thursday.

“The sobering reality is global economic activity is weak by historical standards,” inflation is “not fully defeated,” and fiscal buffers “have been depleted,” she explained at an Atlantic Council Front Page event ahead of the 2024 IMF-World Bank Spring Meetings. “Without a course correction, we are indeed heading for ‘the Tepid Twenties’—a sluggish and disappointing decade.”

Yet, there is reason for optimism, Georgieva argued while previewing an upgrade to global growth forecasts the IMF will release next week: Growth is “marginally stronger” thanks to “robust activity” in the United States and in many emerging-market economies, including an increase in household consumption and business investment and the easing of supply-chain problems.

Inflation is dropping “somewhat faster than previously expected”—a trend Georgieva expects to continue in 2024. While inflation is down in the United States, new data this week show that it may be creeping back up; “that is a concern,” Georgieva said, “but I think the [Federal Reserve] is acting prudently.” In response to some predictions that inflation would come down, propelling the Fed to cut interest rates this year, Georgieva cautioned “not so fast.” If the Fed has to then reverse course and raise rates, she said, that would undermine public confidence in monetary policy.

Yet on the other hand, high interest rates in the United States are “not great news” for the rest of the world. “High interest rates mean the dollar is also stronger,” which for other countries means that their currencies “are weaker,” she explained. “It could become a bit of a worry in terms of financial stability.”

Below are more highlights from Georgieva’s curtain-raiser speech and conversation with Atlantic Council President and Chief Executive Officer Frederick Kempe, touching upon the “good policies” needed to achieve a soft landing across the world and concerning economic trends in China.

IMF-World Bank Week at the Atlantic Council

WASHINGTON, DC APRIL 15–19

The Atlantic Council hosted a series of special events with finance ministers and central bank governors from around the globe during the 2024 Spring Meetings of the World Bank and International Monetary Fund (IMF).

Time for reform in China

• The IMF forecasts that China will see 4.6 percent gross domestic product (GDP) growth, just below Beijing’s target of 5 percent. But its productivity remains low, and it has an aging population. “China has to take on a new policy course,” Georgieva said. “What has worked in the past cannot be sustained for the future—and the Chinese leadership is aware of that.”
• Georgieva said that the IMF is slated to have consultations with China soon, where it will discuss what the managing director called three “solvable problems” for China: Low domestic demand, a need to reform its state-owned enterprises, and its real-estate crisis.
• On China’s challenges in the property sector, Georgieva said that while Beijing has taken some measures, it could “be more forceful” to let the market “decide on price,” and that it could also help support construction and “be more decisive” in dealing with failing companies.
• During a recent visit to China, US Treasury Secretary Janet Yellen stated that China is using unfair trade practices, a consequence of overcapacity, that hurt US businesses and workers. Georgieva said that China continues to face overcapacity problems in some sectors, making it “critical to develop domestic demand and shift the economy more towards services.”
• Georgieva estimated that when China drops 1 percentage point in growth, the rest of Asia drops about 0.3 percentage points. “China making good choices would be good for everybody,” she said.

“Expect the unexpected”

• “It is tempting to breathe a [sigh] of relief. We have avoided a global recession and a period of stagflation… but there are still plenty of things to worry about,” Georgieva said.
• She said to expect inflation to decline, albeit with “ups and downs,” and only some countries—mainly advanced economies—will be ready to begin cutting interest rates in the second half of the year. “This monetary pivot will differ from country to country,” she cautioned, as premature easing could lead to new inflation and monetary tightening. “No more [are we] in the place of 2020 when everybody went in the same direction,” she said.
• She added that policymakers will need to “deal decisively” with debt, as fiscal buffers “are exhausted,” and debt levels in many countries are “simply too high.” “For most countries, the prospect of a soft landing and strong labor markets mean there is no better time to act, to reach sustainable debt levels and build stronger buffers to cope with the shocks that will come in the future,” she said. “Delay is simply not an option: Consolidation must start now.”
• Georgieva also urged countries to adopt policies that reinvigorate growth and improve productivity, including policies that speed up the green and digital transformation. “How well we handle them will define the legacy of this decade,” she said.
• And with artificial intelligence (AI) poised to affect almost 40 percent of jobs globally, according to the IMF’s estimates, investing in digital infrastructure and introducing strong social safety nets could determine whether AI will enhance the economy, she said.
• “The pandemic, wars, geopolitical tensions: They have already changed the playbook for global economic relations,” the managing director said. “In a fast-changing and more turbulent world, bringing countries together to tackle challenges and pursue opportunities is more important than it has ever been.”

Watch the full event

The post IMF head Kristalina Georgieva on how to avoid ‘the Tepid Twenties’ for the global economy appeared first on Atlantic Council.

The issues Yellen raised reflect real concerns in the United States and Europe—in particular about hi-tech and clean energy sectors like electric vehicles (EVs), lithium batteries, and solar panels. However, it is not a straightforward matter pushing back against China on grounds of overcapacity. The EU has initiated anti-dumping investigation of Chinese EVs—imports of which have surged in many European countries threatening domestic producers—but evidence of overcapacity in that sector is weaker than in solar panels and batteries. Measures to restrict import of these products would simply raise their prices, as Western companies are not in a position to replace Chinese products.

More importantly, the West needs to recognize that overcapacity is intrinsic to China’s economic model—and therefore that calls to end it amount to wishful thinking. In other words, while the complaints about overcapacity are justified  from a Western perspective, they will not change the situation any time soon—despite platitudes about US-China relationship being on a “more stable footing” expressed at Yellen’s meeting with China’s Premier Li Qiang.

Chinese EVs pose different challenges than batteries and solar panels

China does have overcapacity problems. Overcapacity is typically measured using utilization rates, the rate of industrial capacity in a sector that is being used for production—low rates imply surplus capacity. Companies with a lot of surplus capacity tend to lower prices to generate demand, hurting the profitability of the whole sector. China has low utilization rates—which have fluctuated around 75 percent, well below the 80 percent considered to be normal. At the end of 2023, China’s capacity utilization rate has recovered to almost 76 percent—a few percentage points higher than the pre-Covid low in 2016 and a few percentage points lower than those of other major countries including the United States (whose utilization rate fell below 80 percent in 2023).

However, behind the aggregate low utilization rate of 76 percent is a very wide dispersion among different sectors. EVs have a high utilization rate, whereas China has very low-capacity utilization rates in low tech sectors such as cement and glass—which are being pulled down by the property construction slump—as well as in lithium batteries and solar panels.

In automobiles, producers of internal combustion engine (ICE) vehicles have suffered from very low capacity utilization rates—in many cases well below 50 percent—as consumers have been shifting from ICE vehicles to EVs. By contrast, EV producers, especially large ones like BYD, SAIC and Li Auto, have high utilization rates, exceeding 80 percent. These companies have increased their production and export of EVs significantly in recent years, arguably because they are quite efficient in terms of prices and quality. Even Elon Musk admitted that Chinese EV companies “are extremely good…and the most competitive in the world.” The smaller and less efficient EV producers have been weeded out relentlessly from the more than 400 companies launched more than a decade ago to about fifty having some degree of recognized name brands. This consolidation process has accelerated after China ended its subsidy program for EVs at the end of 2022—putting huge pressure on less efficient producers. (While past subsidies supported Chinese EV companies, the fact that this subsidy has been ended could be used by China in its defense against the EU investigation.)

Furthermore, China is not as dependent on the export of automobiles including EVs as some other major car manufacturing countries. Specifically, its export rate is quite low, at 15 percent compared with 48 percent in Japan, 72 percent in South Korea, and 79 percent in Germany. As a result, possible EU and US tariffs may blunt China’s EV export growth in those regions but can hardly be expected to alter the overall growth trajectory of the country’s EV sector.

In the first two months of 2024, China experienced an 8 percent increase in total EV export in volume terms, having been able to shift EV sales in the EU (which has declined by 20 percent) to Asia (export to RCEP countries has increased by 36 percent). These two regions account for 30 percent each of China’s EV export. Furthermore, China can boost domestic demand by raising the target for the share of EVs in new car sales from 45 percent by 2027 (rather low relative to the target of 65 percent by 2030 in the EU). Such a move would be helped by the fact that China has rolled out 2.7 million charging stations across the country at the end of 2023–compared with only 64,187 in the United States.

In contrast to the EV sector, lithium battery and solar panel producers have suffered from very low capacity utilization rates—in many cases below 50 percent. In particular, China’s annual production of solar panels is more than twice the global demand. This huge overcapacity has significantly driven down the prices of these products, benefiting all importing countries in their green transition efforts. Raising tariffs on these products will increase their prices to users and delay many countries’ green transition targets, especially as Western companies are not in a position to replace Chinese products. It is instructive to note that President Biden has vetoed a Congressional resolution to reinstate tariffs on cheap solar panel imports from South East Asian countries—for fear of delaying the pace of solar installations necessary to meet his administration’s target of 100 percent clean electricity by 2035.

Overcapacity is intrinsic to China’s economic system

The West should focus its complaints on the sectors where Chinese overcapacity is most egregious—for example in wind power turbines on which the European Commission has just launched an anti-subsidy probe. As it does so, it must also recognize that the long cycle of overcapacity build-up and correction is generic to China’s economic system of state capitalism. Strategic decisions by leaders the Communist Party of China (CCP) will mobilize resources to invest in chosen sectors. That leads to overcapacity, which comes with unfavorable side effects, which eventually cause the leadership to undertake corrections. This process usually takes far longer than the prompt market-driven resolution of inefficient and unprofitable companies in the West. In China, grossly inefficient companies have been liquidated or absorbed by more efficient units, but in a managed and gradual consolidation process to minimize undesirable social impacts such as rising unemployment or hollowing out manufacturing communities.

A clear example of China’s overcapacity cycle can be found in the huge stimulus program unleashed by Beijing in response to the 2008 Global Financial Crisis—offering abundant and cheap credit to spur construction in infrastructure and housing. The resulting overcapacity in coal, steel, and other construction materials was quite severe, depressing producer price inflation, keeping it in negative territory for more than fifty consecutive months. In addition, overcapacity in the steel industry caused bitter complaints by other steel producing countries. By 2015, China launched a wide-ranging Supply Side Structural Reform to reduce overcapacity  by encouraging a consolidation process in those sectors, cushioned by measures to boost demand. China’s Belt and Road Initiative (BRI), launched in 2013, could have been designed partly with the goal of exporting the country’s surplus capacity in construction in mind. These measures were able to bring the overcapacity problem under some degree of control.

In another example, China has had significant overcapacity in the shipbuilding sector, which is 232 times greater than that of the United States, posing a threat to competitors like South Korea and Japan. China has addressed that problem in a strategic way by using its abundant capacity to build modern warships to catch up with the US Navy.

At present, CCP leadership seems to be aware of the industrial overcapacity problem which has caused producer price inflation to be negative continuously since late 2022. In presenting the government work program at the National People’s Congress meeting last month, Premier Li Qiang said that “China wanted to reduce industrial overcapacity” but flagged more resources for tech innovation and advanced manufacturing to develop “new productive forces.” It appears that, like in the 2015 episode, China will spur the consolidation of the sectors having significant surplus capacity. However, the result could be more efficient and competitive enterprises, continuing to pose a challenge to producers in the West and a few developing countries aspiring to develop their manufacturing industry.

A realistic path forward

The United States and EU, together with other manufacturing nations, have wrestled for some time with the overcapacity problem in various industries, caused by China’s economic system of state support to its enterprises. So far, the major remedy to this challenge has been countervailing duties on China, either sanctioned by the World Trade Organization (WTO) after a lengthy and difficult process or imposed unilaterally by former President Trump and maintained by President Biden. However, raising tariffs has not been a totally satisfactory solution. It has given some protection to impacted sectors in importing countries at the cost of higher prices to consumers. But it has not been a game changer in terms of ensuring a level playing field for all countries.

Based on historical experience, it’s safe to say the current phase of China’s overcapacity in hi-tech and green industries like lithium batteries and solar panels will be impacting the rest of the world for some time to come. It is reasonable to criticize and complain to China, but policymakers should remember that an end to overcapacity would mean a major shift in China’s economic model, which is exceedingly unlikely. They must therefore be prepared for a sustained period of heightened trade tension during which Beijing will eventually take some measures to reduce industrial overcapacity when its domestic impact becomes unacceptably negative—but in China’s own way and on its own timeline.

Hung Tran is a nonresident senior fellow at the Atlantic Council GeoEconomics Center, a former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.

The post Breaking down Janet Yellen’s comments on Chinese overcapacity appeared first on Atlantic Council.

The post Lipsky quoted by The Japan Times on Yellen China visit and debt restructuring appeared first on Atlantic Council.

The post China Pathfinder cited by South China Morning Post on China’s progress toward a market-based economy appeared first on Atlantic Council.

The post Lipsky quoted by Bloomberg on Yellen China visit and developing country debt restructuring appeared first on Atlantic Council.

Africa’s growth potential

Over the past four decades, extreme poverty rates in the world, measured as share of population living with less than $2.15 a day (2017 PPP), declined from around 44 percent to less than 10 percent. However, as of 2019, the share in Sub-Saharan Africa was around 35 percent—and is expected to have risen to 45-50 percent in the past five years because of the back-to-back shocks of the pandemic, debt and inflation crises, and increasing food and energy prices caused in part by the Russia-Ukraine war. Clearly, Sub-Saharan Africa has missed the benefits of globalization in the past four decades which lifted billions out of poverty around the world through trade and an integrated global supply chain.

At the same time, Africa has tremendous potential which, if unleashed, can lead to rapid growth in the continent and higher aggregate demand for globally produced goods and services. Africa’s growth could revitalize global growth, which has been decelerating for various structural reasons over the past two decades. With deeper engagement of BWIs and other Multilateral Development Banks (MDBs) and International Financial Institutions (IFIs), African economies can seize the moment and become the engine of global growth.

Promoting public-private partnerships

As the World Bank’s and other MDBs’ financial and technical resources are becoming increasingly limited, they need to shift their focus from merely providing loans and various forms of financial assistance to actively catalyzing the flow of other quasi-public and private resources into the development of Africa’s human capital and social and physical infrastructure. Therefore, BWIs and other MDBs should prioritize strengthening financial governance and legal structures of African economies which would encourage private investment in the continent. The establishment of the Global Infrastructure Facility (GIF) by the World Bank marks a significant stride in this direction. However, much more needs to be done to establish infrastructure as a new asset class in global capital markets and the BWIs, engaging with more than forty other MDBs and IFIs, have a unique position to lead the global discussion on this front. The case of quasi-state institutional investors is of particular importance. With more than $70 trillion of assets under management (AuM) and long-term investment horizons, SWFs, public and private pension funds, and various retirement saving vehicles are uniquely positioned to bridge Africa’s growing infrastructure financing gap.

Accelerating Africa’s regional integration

BWIs including the World Trade Organization (WTO) can play crucial roles in promoting regional integration in Africa through various mechanisms and initiatives. First and foremost, the MDBs, with the World Bank leading the efforts, can provide financial support for regional infrastructure projects, such as transportation networks, energy grids, and communication systems. These projects can facilitate the movement of goods, services, and workers between countries in the region, promoting economic cooperation and development. Trans-Saharan Highway and Trans-African Railway are two examples of such projects that could facilitate intra-continental trade in Africa. Second, the IMF can help countries in the region manage their monetary and exchange rate policies to facilitate cross-border financial flows and reduce currency volatility. This can enhance economic stability and create a conducive and fairer environment for regional trade and investment. Third, the MDBs with WTO leading the efforts, can support the negotiation and implementation of regional trade agreements or customs unions, which aim to reduce trade barriers and increase market access among participating countries. Efforts such as African Continental Free Trade Area (AfCFTA) must be enhanced and supported with relevant regulatory and infrastructure development project.

Prioritizing Africa’s integration into global supply chains

Given its triple advantages—vast natural resources, growing and young population, and its geo-strategic location and access to open seas—Africa can play a central role in the global economy and supply chain. However, Africa is currently responsible for only about 5 percent of global trade. BWIs, and other MDBs and IFIs should therefore prioritize programs and projects that would leverage Africa’s triple advantages in the global economy, making Africa an essential and indispensable part of the global supply chains, energy, and labor and consumer markets for decades to come.

Programs that could speed Africa’s inclusion in global supply chains include:

• Vocational training programs would provide African youth with the skills in highest demand in today’s globalized economy.
• Construction of ports and linking them via railways and roads would reduce the cost of trade with and inside Africa and help accelerate Africa’s integration.
• Development of solar, wind, and green hydrogen energy production could make Africa the global hub of renewable energy with massive export potential, especially to Europe and Middle East.
• Agricultural development would help Africa benefit from its massive agricultural potential and potentially allow it to become the world’s major supplier of food and agricultural products.
• Developing Africa’s tourism industry should be a priority since Africa is home to some of the world’s magnificent natural and historical attractions. Given that tourism industry makes up more than 10 percent of global GDP, MDBs should prioritize developing Africa’s tourism industry, which can contribute significantly to the continent’s development and long-term employment.

Multilateralism is the key

Africa’s needs go beyond debt restructuring. The continent has tremendous potential and a “big push” from BWIs, other MDBs and IFIs, and global private sector and institutional investors, mixed with meaningful steps by Africa’s leaders to improve their governance structure, can unleash an economic renaissance in Africa. The revival of multilateralism, with Africa having more voice and representation in BWIs and other institutions of global economic governance, is a necessary first step.

Amin Mohseni-Cheraghlou  is a macroeconomist with the GeoEconomics Center and leads the Atlantic Council’s Bretton Woods 2.0 Project. He is also a senior lecturer of economics at American University in Washington DC. Follow him on X at @AMohseniC.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Making Africa a top priority for Bretton Woods Institutions appeared first on Atlantic Council.

In the sixty-four years since, those three major economies have never all faced a recession at the same time (outside of the Global Financial Crisis). But as of last week all three were in technical recessions—until updated GDP numbers on Monday showed Japan very narrowly avoiding one.

What’s particularly concerning is that nearly half of the G7 experienced stalled growth at the end of 2023 and none of these slowdowns are alike. In Germany, the manufacturing sector is going through a painful transition as weak demand, competition on electric vehicles, and the aftershocks of Putin’s invasion have slowed growth to a standstill.

In the UK, the post-Brexit labor shortage and sluggish productivity growth have created an economic cycle that still hasn’t curbed high prices. In fact, the government has signaled that this recession might be the only way to break the back of inflation. 

Then there’s the most interesting case, Japan, where an aging population is consuming less and less. In fact, Japan is on pace for a 15 percent contraction in its population between now and 2050. With an average age of forty-nine, Japan has one of the highest proportions of elderly citizens in the world. When the disappointing GDP data came out last month, Japan lost its spot as the third-largest economy in the world.

The good news is that each of these recessions is expected to be short-lived. The latest data out of Japan on Monday shows 0.4 percent GDP growth in Q4, (meaning it avoided two straight negative quarters of growth). Even before the new data, the Nikkei has been surging due to expectations that the Bank of Japan (BOJ) may finally be ending the era of negative interest rates. In the UK, Bank of England Governor Andrew Bailey may finally be able to start cutting rates this summer. And in Germany, new manufacturing orders unexpectedly jumped 10 percent at the end of year—prompting hope that the spring will truly be a season of revival.

But here’s the key difference between now and then. When the United States turned the corner in 1961, the import demands from its booming middle class helped pull up countries around the world. But in 2023, the United States was already the fastest growing G7 country. In 2024, US GDP growth will likely slow, not surge.

Combine the US situation with China’s deepening economic problems and the picture becomes clear. The world’s two largest economies won’t be able to generate enough growth for the UK, Germany, and Japan—it is going to have to happen from within.  

And that’s a scenario unlike 2008, unlike the 1960s, and in some ways, different from nearly any time since World War II. 

Josh Lipsky is the senior director of the Atlantic Council GeoEconomics Center and a former adviser to the International Monetary Fund.

Alisha Chhangani is a program assistant for the Atlantic Council GeoEconomics Center where she supports the center’s future of money work

This post is adapted from the GeoEconomics Center’s weekly Guide to the Global Economy newsletter. If you are interested in getting the newsletter, email SBusch@atlanticcouncil.org

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Stalled growth in the UK, Germany, and Japan darken global economic outlook appeared first on Atlantic Council.

The government did announce economic targets for the coming year and expounded upon its lofty pursuit of high-tech industrialization. But the week of meetings offered no real insight into how Chinese leader Xi Jinping intends to deal with a deepening property crisis, trillions of dollars of local government debt, falling prices, soaring youth unemployment, the loss of business and consumer confidence, and a rapidly aging society.

For a government that takes pride in announcing reams of policy blueprints and diktats, the absence of any detail on how it plans to take on these interlocking issues left the inevitable conclusion that Beijing simply doesn’t know how to proceed. In contrast with some past sessions, the nominal legislature failed even to raise polite questions about the road ahead, and journalists were denied a customary post-Congress news conference with the premier.

Beijing’s silence sends a message to China’s citizens that they are on their own in an anemic economy. All they got was a vague promise in Premier Li Qiang’s work report to the Congress to “see that no large-scale return to poverty occurs.”

That will be small consolation for Chinese from all walks of life who have tasted prosperity over the past two decades but now are struggling to make ends meet. As the Bloomberg columnist Shuli Ren wrote after the premier’s speech, “it is now clearer than ever that the Communist Party is walking further away from its own people.”

Inevitably, Li’s report contained an optimistic forecast of economic growth “around 5 percent” of gross domestic product (GDP) in 2024, following the government’s claimed 5.2 percent gain last year. (By contrast the Rhodium Group estimates that China’s economy grew only 1.5 percent in 2023, the difference at least partially explained by the frequent fungibility of Chinese government statistics.)

As my Atlantic Council GeoEconomics Center colleague Hung Tran outlined at the beginning of the Congress, the government’s growth forecast is based on a fiscal deficit of about 3.8 percent of GDP. Government spending will be augmented by nearly five trillion yuan of bond issues and most of the proceeds of a one trillion yuan bond issue from late 2023.

Much of that spending is expected to go to infrastructure—which China already has built so much of that new investments are unlikely to have significant economic returns. It is also expected to go toward developing higher value-added industries, such as green technology and semiconductors. However, there was no sign that the government was prepared to channel resources to boost household spending, which is necessary if growth is to revive. Without higher levels of consumer spending, Beijing’s efforts to stimulate the economy increasingly will be akin to pushing on a string.

Similarly, while the premier’s work report called for the government to “foster a new development model for real estate” and to “make concerted efforts to defuse local government debt risks while ensuring stable development,” there was no discussion of devoting serious resources to either challenge. With local government debt totaling more than thirteen trillion dollars and nearly three dozen real estate companies defaulting on bonds and loans, the government’s silence on these issues did little to reassure domestic or foreign investors. Over the weekend, China’s housing minister received attention for saying that insolvent property developers should go bankrupt or be restructured, a statement that did not indicate a significant policy shift.

Moreover, there was no explanation of how the money flowing to state-owned enterprises in the government’s drive for “high-quality development,” led by what Xi calls “growth poles” of new productive forces, will offset the government’s sharp turn in recent years away from private sector innovators who have helped drive the economy. A regulatory crackdown on leading private companies in the e-commerce and online services sectors has sapped the economy of vitality: Total investments by corporate giants such as Alibaba, Tencent, and Baidu plummeted 40 percent in 2023, and employment in the sector has been hit by layoffs, depriving millions of recent college graduates of job opportunities.

Nor was there any discussion of how Beijing intends to fund its touted “silver economy” that would reorient domestic demand toward supporting senior citizens, who are estimated to reach 30 percent of the population by 2035. The only concrete commitment in the work report was an increase in the monthly benefit for the rural and “non-working” urban senior citizens of a paltry twenty yuan ($2.78).

Xi appears focused on pushing an outmoded approach to state-led modernization—a twenty-first-century version of the Maoist drive in the 1950s to build heavy industry. The Chinese leader, speaking to a provincial delegation at the Congress, appeared to go out of his way to declare that “we must not declare a model” and “establish [new industries] first and then break” the old ones. But there can be no doubt that he is intent upon breaking the mold of private sector-led growth.

The problem is that he is placing his expectations on a government that is ill-equipped to take on this task. China is not only saddled with debt and facing the need for belt-tightening. As the premier’s work report acknowledged, the bureaucracy is riddled with inefficiency, waste (especially involving priority government projects), and corruption. This, combined with all the country’s deep-seated economic problems, suggests that the “modern industrial system with advanced manufacturing as the backbone” that Xi seeks is being built on a fractured foundation.

Jeremy Mark is a senior fellow with the Atlantic Council’s GeoEconomics Center. He previously worked for the International Monetary Fund and the Asian Wall Street Journal. Follow him on Twitter: @JedMark888.

The post China is failing to address its economic challenges appeared first on Atlantic Council.

In July, the United States formally released its proposal on how to implement the final elements of an international regulatory framework for banks. The proposal immediately generated criticism and has created a semblance of bipartisanship in the House Financial Services Committee. Republicans unanimously called for the proposal to be scrapped as Fed Chair Powell testified this week, while Democrats worried about a lending squeeze. But the effect the rules might have on US banks’ central role in the global financial system also deserves scrutiny. 

Since the Global Financial Crisis (GFC), the Basel Committee on Banking Supervision has been working to establish a newly agreed set of measures to strengthen the regulation, supervision, and risk management of banks globally. Built on two previous accords, many of the “Basel III” additions to the Basel Framework are already in effect. The recent controversy concerns the final set of rules, known as the “Basel III Endgame” (or B3E), which focuses on the capital and leverage ratios banks will need to implement to cover the risk that their assets lose value in another market downturn.

Why are they needed in the first place? The B3E framework is a response to the large government bailouts of “too big to fail” banks during the GFC. It expects clear domestic rules on how banks calculate the capital they are meant to hold. Capital is what is left over when a bank subtracts its liabilities from its assets. In case too many of a bank’s assets lose value, its capital—and therefore future profits and shareholders—is meant to take the hit before depositors do. But during the GFC, low capital ratios meant governments had to step in to protect deposits.

The new proposed rules, released in July by the Fed, Office of The Comptroller of The Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) have been heavily criticized by the financial industry. The argument is that this is a classic example of “gold plating,” whereby the US rules as currently proposed would create regulatory burdens beyond what the international framework requires and put eight Global Systemically Important Banks (G-SIBs) based in the United States and over thirty-five banks with assets worth over $100 billion at a competitive disadvantage.

It’s true the new rules venture into new territory. The risk-weighted approach brought in by previous Basel Frameworks focused on assets like loans and mortgages. However, the new rules expand the range of items on a bank’s balance sheet that factor into capital adequacy ratios.  Now, derivatives covering interest rate risk and counterparty credit risk (among others) will be included. B3E also introduces leverage ratios preventing banks from borrowing more than a certain ratio to their earnings.

So, what’s the problem? The rules could prevent US banks from using their own internal models to work out how much capital they need to hold against their loan books. Instead, banks will have to rely on standardized measurements of risk using credit ratings from agencies, even if derivatives carry little to no risk to a bank acting in an agent capacity. They also lay on additional capital requirements to account for the complexity and interconnectedness of G-SIBs, in addition to their size.

By the Fed’s own estimation, the overall capital increase required by the new rules is 16 percent but it readily acknowledges this will be higher for the largest and most complex banks as a larger share of their assets will become risk-weighted assets requiring capital buffers. Contrary to what Europe-watchers may expect, the EU’s interpretation of B3E is less stringent. Its version is estimated to increase RWA by less than the Fed’s 16 percent estimation, because the EU will allow for the use of internal models and include other opt-outs from assets being included in capital ratio calculations when the risks to banks are small to non-existent.

Yes, the technical side is daunting, but B3E matters for everyone in the United States. The foreign policy community should care whether these rules improve or hinder the GeoEconomic position of the United States by potentially creating a combination of higher lending rates and due to banks exiting markets associated with higher risk weighting. That could be a problem if it leaves these markets open to rivals and adversaries.

US regulators including US Federal Reserve Vice Chair Michael Barr argue the rules are appropriate given that government has had to shoulder risks taken by banks in the past. Moreover, supporters argue better-capitalized banks tend to lend more in downturns—providing a much-needed stimulus—and avoid lending irresponsibly when times are good. This domestic reasoning needs to be squared with the geopolitical challenges the United States faces at the moment.

If US banks do exit certain derivatives markets, to be unevenly replaced by Non-Bank Financial Institutions (NBFIs) and foreign, mainly European, competitors, will the US financial system remain as central to providing dollar liquidity to corporations? Currently, the depth and reach of US capital markets is connected to the world by globally active US banks. This is one of the factors which has kept the dollar as the pre-eminent currency for trade invoicing but alternatives like the Euro and the Yuan have been rising. A retreat by US banks from their global role could also make it more challenging for the US government to implement sanctions and other economic statecraft policies against adversaries. Washington should consider if the new rules could eventually hamper the implementation of financial sanctions.

These are the tests which the foreign policy community should apply to the B3E rules. There’s no need for alarmist scenarios. The rules proposed last July would not challenge the dollar’s dominant position in international finance. Treasury bills are considered risk-free under the framework and owning them will not force banks to hold any additional capital. And there is no doubt following the GFC, and more recently the collapse of Silicon Valley Bank, the Basel process and other regulatory changes are needed and useful.

But the challenge going forward is to think about B3E beyond the impact on the banks and into the realm of foreign policy and geoeconomics. In the hearings this week Chair Powell recognized the rules need to be looked at and even revised before they are final. Hopefully the Fed will consider the foreign policy implications of their decision, too.

Charles Lichfield is the deputy director and C. Boyden Gray senior fellow, of the Atlantic Council’s GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post How banking regulations affect US foreign policy appeared first on Atlantic Council.

Economic targets for 2024

The 2024 Government Work Report sets this year’s economic targets, which are virtually identical to those made in 2023. GDP growth is planned to be “around 5 percent”, with a central government budget deficit of 3 percent of GDP in continuation of a proactive fiscal policy and a prudent monetary policy. In particular, China plans to issue one trillion yuan of ultra-long special government bonds to support the budget; and to raise the special local government bond quota to 3.9 trillion yuan from 3.8 trillion yuan in 2023. The urban unemployment rate is set at around 5.5 percent with twelve million new jobs to be created.

More interesting than the targets are the government‘s priorities as reflected in the increases in spending. Total central government expenditure is projected to increase by 3.8 percent to 28.5 trillion yuan (almost $4 trillion), with debt interest payments topping the list rising by 11.9 percent; followed by science and technology at 10 percent; stockpiling of grains, edible oils, and other necessities at 8.1 percent; national defense at 7.2 percent (same as last year); diplomatic activities at 6.6 percent; and education at 5 percent.

The planned fiscal deficit at 3 percent of GDP—declining from the realized deficit of 3.8 percent in 2023—along side the commitment to“prudent” monetary policy have disappointed many analysts and financial market participants who had hoped for a “big bazooka” stimulus plan to kick start the lackluster economy. Furthermore, they point out that this year will not benefit from the base effect resulting from earlier slow growth due to Covid-19. As a consequence, most analysts are keeping their estimates for 2024 growth below 5 percent, with the IMF expecting 4.6 percent.

The key factor in this year’s growth prospects is whether the property sector starts to stabilize, having been in a sharp decline over the past three years. In particular, after suffering the worst price fall in nine years—a drop in investment of 9.6 percent and in new construction starts of 20.4 percent in 2023—home sales and prices have increased modestly in recent months. If this trend gains traction, it would set the stage for the series of moderate support measures implemented so far to show some positive results. In this context, it is interesting to note that Rhodium Group, which had estimated actual 2023 growth to be 1.5 percent instead of the official 5.2 percent, has expected a cyclical recovery to 3.5 percent in 2024.

Developing the “New Three” for high-quality growth

In any event, more important than the exact GDP growth estimates is the NPC’s endorsement of the decisions made earlier by the CCP Politburo. These decisions reflect Xi Jinping’s emphasis on developing new quality productive forces, through strengthening capability in science and technology to form the foundation for high-quality growth. This has emerged as Xi’s main strategy to develop a new engine of growth for China. It is also a way to stay competitive with the West in science and technology, not the least to sustain the modernization of the Chinese military.

New quality productive forces refer to new clean energy technologies and products—dubbed the “New Three” by the Energy Intelligence Group. These include electric vehicles (EVs), lithium ion batteries, and renewable energy products such as solar panels, wind turbines, storage facilities and other infrastructures—all together accounting for 11 percent of China’s GDP. These sectors were targeted in the 2015 “Made in China” plan as well as the 14th Five Year Plan adopted in 2021. Last year, with state guidance and support, the New Three sectors have experienced a surge in investment of 6.3 trillion yuan ($890 billion)—40 percent higher year-on-year. According to Finland’s Center for Research on Energy and Clean Air (CREA), without that investment, China’s growth in 2023 might have been 3 percent instead of 5.2 percent. The Energy Intelligence Group has estimated that the new clean energy sectors will continue to grow, accounting for 18 percent of China’s GDP by 2027—in contrast to the property sector shrinking to a smaller but more sustainable 15 percent from its former peak of 25 percent of GDP.

Overcapacity problems

The problem with this approach is that it has created substantial overcapacity in those sectors, leading to a surge in export at low prices to Europe, the United States, and the rest of the world.

For example, China accounts for 75 to 96 percent of the global production of various components of solar panels but demands only 36.4 percent of the output. The rest has to be exported. And China’s export of EVs has increased by 1,500 percent in the past three years, helping China replace Japan as the largest exporter of automobiles. All together, exports of New Three products increased by almost 30 percent in 2023, exceeding one trillion yuan ($139 billion) for the first time.

Alarmed at the prospects of their markets being swamped with Chinese green energy products enjoying state support, the EU has started an anti-dumping investigation into EV imports with a possibility of imposing countervailing duties. The United States has opened an investigation into the data security risks of Chinese vehicles using “connected car technology”. China has reacted strongly to such moves, threatening retaliation. And China will try to export those products to countries in the Global South, many of which having no domestic manufacturing and would welcome competitively priced goods for their climate transition efforts.

In short, one of the biggest implications of the Government Work Report is that the development of clean energy industries has been identified as a strategic focus to promote high-quality growth—a new Xi catchword. The chosen strategy serves China’s strategic and economic interests but has created serious overcapacity problems, distorting world markets and raising trade tensions with the West. This adds another dimension to the geopolitical rivalry between China and the United States, making it more intractable and difficult to diffuse.

Hung Tran is a nonresident senior at the Atlantic Council’s Geoeconomics Center; a former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Unpacking China’s 2024 growth target and economic agenda appeared first on Atlantic Council.

The post China Pathfinder cited in Radio Free Asia on 2024 China GDP target appeared first on Atlantic Council.

Table of contents

Evolution of freedom

The evolution of the aggregate Freedom Index in Brazil is clearly hump-shaped. During the first half of the period of analysis, from 1995 to 2013, the freedom score either increased or was relatively stable, driven mainly by improvements in just two indicators of the economic freedom subindex.

The first of these is the women’s economic freedom, which shows a clear step-change in 2002, although the reasons for this are not clear. During that year, there was a change in government, and the Worker’s Party (Partido dos Trabalhadores) took office. They were very much committed, at least in rhetoric, to increasing women’s economic freedom. In 2003, some parts of the civil code were reformed, which did lead to an improvement in women’s rights. However, it seems unlikely that this one legislative change can explain the 17-point increase in this indicator. Around the same time though, married women’s property rights improved, and punishments for sexual harassment—especially in the workplace—increased.

The second positive trend began in 1996, an important year for the stabilization of the economy. The liberalizing reforms introduced by the government of President Fernando Henrique Cardoso led to significant improvements on the trade freedom indicator. Sectors such as telecommunications and energy were opened to competition. There were also proposals for trade liberalization, even if some of these did not pass into law. Even the early years of Lula’s (Luiz Inácio Lula da Silva’s) government were very favorable to trade freedom, and the data seem to suggest that trade freedom did not decrease until after 2018, with the election of President Jair Bolsonaro. Bolsonaro did not create any barriers to trade, but very soon it became apparent that European countries did not want to continue negotiations on a trade deal with Bolsonaro.

In terms of political freedom, elections in Brazil are superb, and this is well captured by the elections indicator. They are fast, efficient, transparent, and the system is very secure. Even in locations where the electoral process is computerized, it is completely offline, decreasing the security risk. There is a slight fall on this indicator, starting in 2015, which is possibly attributable to polarization: when society is very politically polarized, you will always hear claims about the “unclean” electoral process. This is something we have seen recently in the United States and other countries.

Similarly, the political rights indicator shows a decline in recent years that is hard to identify in reality. It may be that, when the level of polarization is high, there are always segments of the population that can feel disenfranchised. And perhaps the indicator is capturing the repression of protests against President Dilma Rousseff’s government in 2015–16, or President Bolsonaro’s rhetoric regarding the Supreme Court, both of which may have caused anxiety about political freedoms. But there has been no obvious objective fall in political rights. The same applies to civil liberties. For example, when President Bolsonaro was elected, he publicly attacked journalists and other groups, but he took no concrete action against them. So, the feeling that political and civil rights have been reduced is understandable, but there have been no substantive changes that would allow us to say that people in Brazil were less free—and certainly not enough to justify a 33-point fall in the score.

Legislative constraints on the executive increased in the last few years, and here the indicator score is an accurate reflection of reality. However, while progress on this indicator is generally intended to be read as a positive shift, in Brazil’s case there are reasons to see greater legislative power as problematic. In 2016, President Rousseff was impeached. People connected to the Worker’s Party would say it was a “legislative coup,” a common accusation in many Latin American countries when similar situations arise. I am not of that opinion, but it is clear that a nontrivial share of the population is. During the President Bolsonaro years, a group of legislators, mostly interested in pork-barrel projects, gained a lot of power, to the point that the Supreme Court had to intervene to shut down their “secret budget”—effectively a slush fund for paying off supporters. The same group of legislators has continued to hold power after Lula’s election. This situation may have increased the impression that political rights were deteriorating, because presidents elected by the people seem, in reality, to be constrained by Congress.

The evolution of legal freedom, especially concerning judicial independence, is easier to agree with. The judicial system has been affected by executive interventions, justifying a deterioration of judicial independence scores. Moreover, the same indicator also measures judicial effectiveness, and here too the worsening situation has been very evident since 2014. Even before this, Brazil’s scores—of between 85 and 90—seem unjustifiably high because the country has long suffered from an ineffective judicial system. Only 10 percent of murders in Rio de Janeiro end up with a trial, and the numbers have been bad since at least the 1990s, when I was looking at crime and social interactions in the city. The fact that the accused do not receive any punishment until the appeals process has been exhausted means that some court decisions are only implemented ten years (or more) after they are handed down.

On top of this structural problem, in the last decade the judicial system in Brazil has become very influenced by politics. As a result, we see the Supreme Court making a decision, only to completely reverse it two or three years later, with essentially the same set of judges. This appears to be captured by the clarity of the law indicator. Laws in Brazil are very badly written—a lawyer’s dream. To give just one statistic, the value of all the unresolved tax claims in Brazil’s judicial system equates to 75 percent of Brazil’s gross domestic product (GDP). The macroeconomic impact of the low level of clarity in the law is serious, but there are always those interested in the obscurity of the law.

From freedom to prosperity

The evolution of the Prosperity Index, and in particular the fall in Brazil’s score in the last decade, seems to be driven by the minority rights indicator, which is proxied by religious freedom. Brazil has been experiencing fast growth in the percentage of its population identifying as evangelicals and, in particular, neo-Pentecostals. This has created at least two sources of friction. Neo-Pentecostals complain about persecution from the Catholic establishment, liberal legislators, mainstream media, and tax authorities. For example, even though there is no income tax on the profits of religious organizations in Brazil, nonprofit organizations are not exempt from paying social security or taxes imposed on purchases. Neo-Pentecostals feel they should enjoy full exemption from tax and regulations such as city codes. Second, Catholicism and Afro-Brazilian religions are often thought to be connected to “progressive” politics in Brazil, while evangelicals are usually more right wing, so the increase in political polarization may also partly explain the evolution of this indicator. As evidence of this tension, there have been attacks on followers of African-rooted religions by some neo-Pentecostal groups, occasionally allied to local drug gangs.

There is no question that income in Brazil stagnated in the last decade. But Brazil’s economic performance has been mediocre for the last fifty years. In the early 1980s, labor productivity was around 55 percent of the US rate. Now it is less than 25 percent. An exception is the agricultural sector, which has experienced remarkable productivity growth. Development means catching up with the technology frontier, and that is something Brazil has been unable to do. Japan, South Korea, Spain, and many others were able to do so. India and China are doing it now. But not Brazil; we can say the country is, in fact, un-developing.

President Cardoso’s government (1994–98) implemented programs to help the poorest in the country. The effort was amplified during President Lula’s administration (2002–06), which explains the overall positive trend in equality. The problem is that Brazil started from a very high initial level of inequality. Short-run fluctuations are likely to be explained by the fact that inequality is counter-
cyclical: when the economy goes down, inequality goes up. Since the COVID-19 crisis, there has been some temporary expansion of social programs, which has helped decrease inequality, but the long-run fiscal sustainability of these programs is by no means clear.

There has been an improvement in health in Brazil since 1995, mainly due to programs aimed at ensuring that the very poorest have access to regular check-ups and vaccinations. These efforts bore obvious fruit during the rollout of COVID-19 vaccines, because the whole system was already in place, so the vaccine program was relatively effective and fast. Health often requires a small marginal investment to generate large benefits, as was the case here.

Finally, it is undeniable that there have been some improvement in terms of years of education and enrollment in Brazil, and these are the metrics captured by the education indicator in the Prosperity Index. However, with the exception of very few states, there has been very little improvement in educational achievement—something that is not captured in the indicator. Progress is even lower in terms of preparing youth for the labor market. This explains why labor productivity is falling despite years of schooling increasing, which may otherwise seem a puzzle. It is worth highlighting one state in particular, Ceará, which clearly outperforms all the others in terms of educational spending effectiveness, despite its relative poverty. My advice to everyone involved in education in Brazil would be to simply copy whatever Ceará is doing, because the results are encouraging. The current minister of education was the governor of Ceará, so we may see some improvements across the country. However, there is reason to remain skeptical because education leaders usually prefer to reinvent the wheel instead of just replicating whatever is working in other places. This seems to be a universal law of decentralized public systems of education.

The future ahead

Labor productivity in Brazil is a clear signal of the economic prospects for the country—though I think it is a symptom of those prospects rather than a cause. Businesses in Brazil face a huge number of hurdles: We have very high and inefficient taxes. Firms are more worried about paying less tax than producing in a more efficient way. Regulations in Brazil are also especially inefficient, and there are important difficulties regarding long-term financing, related to the legal risks and fiscal deficits in the country. The labor market is very rigid, and even if President Temer and President Bolsonaro tried to remove some of these frictions, President Lula has announced plans to impose more labor regulations. These regulations would hurt firms and the overall economic prospects for Brazil.

A second important challenge for Brazil is security. A special concern is the relatively new route for drug trafficking from producers in Colombia, Peru, or Bolivia to Europe, which goes through Brazil. It is similar to a negative technological shock. Gangs fight with each other for control of the new routes, and this increases crime. Some paramilitary groups are also gaining strength, and these are more organized than the gangs and often affect legal businesses. For example, Rio de Janeiro’s largest electricity company, Light SA, may go bankrupt due to the amount of electric supply that is stolen and then resold to consumers and firms. These groups also control the transportation and construction sectors in some urban areas. All these things have large economic effects. And many states in Brazil lack an efficient police force. The police in the states of Rio de Janeiro and Bahia are particularly violent and inefficient. Unless the security situation improves, it is hard to foresee improvements in other dimensions.

What is going to happen with Brazil? Well, some things will help, like the proposed tax reform, which hopefully will simplify the tax code and curb exceptions, loopholes, and litigation. The finance minister is also committed to tackling the fiscal deficit. It is not clear how he will do it, but an improvement of the fiscal situation inherited from President Bolsonaro would greatly help the country.

Top firms in Brazil are excellent and, if the cost of doing business in the country was smaller, they could truly contribute to growth. Brazil has the cleanest energy mix of any country, and should be able to deal effectively with the illegal deforestation in the Amazon. Reforestation of the Amazon forest could be a source of cheap carbon capture at scale. This could make Brazil a big exporter of goods that have an excellent climate footprint—an exceptional opportunity for the country. Brazil missed an opportunity in the 1980s, when they could have educated their growing labor force, and now it is presented with a similar opportunity again. But the country needs to deal with all of the challenges discussed here.

José A. Scheinkman is Charles and Lynn Zhang Professor of Economics at Columbia, professor of economics (emeritus) at Princeton, and research associate at NBER. Scheinkman is a member of the National Academy of Sciences, recipient of a Guggenheim Fellowship, docteur honoris causa from Université Paris-Dauphine, and board member of Cosan S.A. Scheinkman’s current research focuses on the economics of forest preservation in the Amazon.

Trackers and Data Visualizations

Jun 15, 2023

Freedom and Prosperity Indexes

The indexes rank 164 countries around the world according to their levels of freedom and prosperity. Use our site to explore twenty-eight years of data, compare countries and regions, and examine the sub-indexes and indicators that comprise our indexes.

The post Economic reform is crucial for growth in Brazil appeared first on Atlantic Council.

Table of contents

Evolution of freedom

The evolution of political freedom is conceptually the simplest issue in the Indian context. In big-picture terms, the trends shown in the political freedom subindex are very accurate. The graph clearly shows a significant fall in India’s performance in the last ten years. This trend could be termed “democracy capture,” rather than “democracy backsliding,” for a reason that will become apparent below. Looking at the scores on the four indicators of political freedom (elections, political rights, civil rights, and legislative constraints on the executive), India’s score has reduced in every dimension.

Nonetheless, the election score, as reflected in this data, seems to show a steeper fall than most people working in India, or most political scientists, would endorse. And this is the paradox of Indian democracy at this moment. In a narrow interpretation of the electoral core of democracy—which mainly captures elements such as peaceful transitions of power, contestability, and the fairness of the process itself (i.e., Robert Dahl’s polyarchy)—India still does quite well. In fact, no opposition party in India is questioning the legitimacy of elections, which in itself tells you something. Elections are deeply contested, and India performs well on measures of participation, political contestation, or freedom to form political parties. If we look at state or local elections, the degree of contestation is even higher. The dominant Bharatiya Janata Party (BJP) rules only 15 of 28 states currently. In the electoral indicator, India may even be performing better than is reflected in the Index. However, there are some concerns over the degradation of some aspects that make elections fair. For example, the BJP receives three times more funding from electoral bonds than all other national parties combined.¹ The Enforcement Directorate, which investigates corruption, typically focuses its efforts more on opposition politicians: about 90 percent of current investigations involve opposition politicians. While this has not yet led to opposition politicians withdrawing from electoral contests, it does seem to place additional burdens on them. But all things considered, the political system does not question the legitimacy of the electoral process.

It is between elections that a decline in civil liberties and political rights for civil society is evident. There is a palpable sense of a decline in freedom in these areas. There is a greater criminalization of dissent. Several political activists, including students, are being held under India’s draconian preventive detention laws. The whole “information order,” (which includes mass media and social media), particularly media in vernacular languages such as Hindi and most television channels, is tightly controlled. There has been a massive decline in academic freedom. It is harder for many groups to obtain permission to protest. The checks and balances of a constitutional democracy are eroding. There is more open dissemination of hate speech that targets minorities.

It is important to underscore the fact that you can have pretty good elections and institutional machinery and yet produce outcomes that are not as protective of our freedoms as we would like. It also points to the fact that the way in which this BJP government regulates or suppresses political rights and civil liberties is somewhat artful. Unlike previous episodes of backsliding in India (e.g., 1975, when a formal state of emergency was declared), there have been no mass arrests or major changes in the law. The government is very selectively targeting particular individuals or institutions, using the formal administrative and legal machinery at its disposal. It uses tax laws, administrative law, and informal threats to target institutions or individuals that dissent from the government. This is artful for three reasons: First, there is plausible deniability. Each of these instances of targeting is presented as simply the normal operation of law, rather than what they are: a form of repression. Second, it allows for a form of statistical reassurance. The numbers of individuals or groups being targeted may not be, as a proportion of the population, very large, and so large sections of society are convinced that these attacks on freedom of expression are not going to really affect them. Third, as a consequence, this selective, exemplary targeting multiplies in effectiveness because it also leads to self-censorship—a more efficient way for the government to achieve its aims. It also makes the issue seem less politically urgent, and divides opposition parties, for whom some targets are more salient than others.

Such strategies are in line with how a lot of modern authoritarianism works. This is a crucial paradox to understand: you can have vigorously contested elections by almost all measurable criteria, and yet that can be accompanied by a dramatic decline in political and civil rights in particular, as well as legislative constraints on the executive. Some might be tempted to say that this makes India closer to an illiberal democracy. This term is an oxymoron though, since some of the basic liberal freedoms—like free expression, equality before the law, freedom of association, and a fair information order—are constitutive of both liberalism and democracy. So an attack on liberal values is, inevitably, an attack on democracy. It also raises the specter of whether those who begin by attacking liberal freedoms may not, at some point, also attack electoral processes. But at the moment one cannot deny the fact that the government of Narendra Modi is popular and that it won power through legitimate means.

What are the drivers of this process? The proximate explanation is simply that Indian democracy is electing to power an explicitly majoritarian government. The BJP’s stated ideology is to make Hindus a self-conscious political force and consolidate Hindu political and cultural power. It seeks to reclaim India as a Hindu nation and rescue it from what it regards as a thousand years of Hindu subjugation in three phases: first subjugation by Islamic rulers, then by the British, and after independence by a secular elite. It also seeks to reclaim a more authentically Indian idiom of discourse and politics. This involves a massive project of cultural engineering: rewriting history, renaming public spaces, marking more sharply the boundaries between the Western and the Indian, or between Muslim and Hindu. It is important to keep this ideological background in mind because a significant explanation for the decline in India’s freedom scores has to do with the domination of this ideology. Wherever you have a project that converts a pluralist society into an ethno-nationalist state, minorities will be targeted. The clampdown on civil liberties is justified in the name of nationalism: almost all dissenters from this ideology are marked as anti-national, which licenses their persecution. The political support for the abridgment of individual rights is mobilized in the name of nationalism.

You can ask a deeper question: Why is it succeeding? The standard story in most democracies that experience this kind of backsliding is that the center and the left, or anybody who is not aligned with the autocratic right, is fragmented, which allows for nationalist political strategies to succeed much more easily. In India today, there is no opposition leader even remotely able to match Narendra Modi in terms of individual charisma. Narendra Modi’s personal biography, as a leader who did not come from either economic or social privilege, allowed sections of marginalized groups to identify with him in a way that would have been impossible a decade ago. Political strategies and political communication do matter, and Modi’s ability to identify with the poor and the lower-middle classes is really quite remarkable. He has been able to construct the argument that most of the opposition represents a kind of corrupt, privileged, ancient regime that for seventy years kept India backward, with low ambitions, and prevented the majority from realizing its full political destiny. We always used to assume that, in India, the natural check on right-wing authoritarianism was the fact that India has lots of cross-cutting divisions (language, region, caste, and so on), which provided a natural distribution of social power. The joke in India used to be that people do not cast their vote, they vote their caste. But if you look at caste voting patterns now, they are much more evenly distributed across parties. One of the interesting things that has happened over the last fifteen or twenty years is that these social groups—that once were assumed to be “natural” checks and balances on Hindu consolidation and majoritarianism—are themselves becoming more strategic in orientation. This is partly a consequence of economic growth and greater political freedom. The dynamics of growth have created inequalities not only among caste groups but also within caste groups. So for example, the interest of different subgroups among the Dalits now diverges, based on their situation in the economy. This has made the relationship between caste and voting a lot more fluid, and has led to a greater individualization of decisions.

Additionally, Mr. Modi, unlike many of his right-wing colleagues across the world (e.g., Erdoğan or Bolsonaro), is actually competent in economic management. We are nowhere near the 10 percent gross domestic product (GDP) growth the government claims, nor in an environmental paradise, nor are we seeing significantly reduced inequality. But the Modi government is a reasonably competent steward of the economy. India still enjoys relative macroeconomic stability, with inflation under control. A growth rate of close to 6 percent provides enough revenue—and political capital—to build a coalition that will support welfare reform.

The legal freedom subindex highlights two important stories. First, on bureaucracy quality and corruption, the massive expansion in state capacity in India in the last fifteen years has produced a movement from retail corruption to wholesale corruption. A lot of ordinary Indians now experience the state as being less corrupt. Previously, a large number of public services would be subject to corruption by bureaucrats. In part, this was allowed to continue because these bureaucrats contributed to systems of political corruption—the bottom-up networks created by political actors. One of the interesting results of economic growth has been that politicians have realized that you can easily make money and extract rents from just two or three sectors of the economy, like construction or defense. And you can now do it in a way that is much less inefficient than used to be the case. It also means that political parties have become more centralized, because now they do not have to rely on diffuse networks of patronage across the system. They can rely instead on particular relationships between state and capital to extract all the rents they want. So, in that sense, the corruption story is relatively good news. But this is accompanied by greater concentration of capital at the top, which may pose long-term challenges for small businesses.

Second, the judicial independence score reflects the real bad news story in the area of legal freedom. The Indian Supreme Court used to be considered one of the most independent supreme courts in the world, particularly over the last twenty years. But it has more or less abdicated its function as a custodian of political values. It has consistently delayed hearings on a range of constitutional cases that would have preserved the checks and balances of the current system. Here are just some of the cases in question: the electoral bond case, which has so far failed to improve the transparency of party donations; a range of federalism petitions relating to the status of Kashmir; and the constitutional validity of the government’s use of “money bills” as a legislative device, allowing it to bypass the upper house, even in nonmoney legislation. The Supreme Court is allowing Hindus to reclaim disputed shrines, the centerpiece of Hindu nationalism. The Supreme Court has more or less subordinated itself to government, going along with the administration’s ideological agenda, even if it puts minority rights at risk. The government’s attack on political freedoms and civil liberties could not happen without the cooperation of the judiciary, and again the way in which they cooperate is very artful. The Supreme Court basically does not hear politically sensitive cases. One example is the situation with a number of students from Jawaharlal Nehru University, imprisoned awaiting trial in connection with the 2020 Delhi riots. The Supreme Court has not heard even the case for bail for three years. The judiciary has improved on things like contracts, contract law, economic disputes, and so on. But on issues where the government’s ideological agenda or power is at stake, the judiciary has, in essence, ceded its authority. The decline in judicial independence is likely to be even more severe in reality than is captured by the indicator.

In terms of economic freedom, it is surprising that the score on the investment freedom indicator is not higher because, at least for domestic businesses, further domestic liberalization is generating a great deal of optimism. Two things might explain the data: First, we are at a juncture where the frameworks for both investment and trade are relatively uncertain. There is an ongoing discussion around the development model that India should follow. The uncertainty around India’s orientation to the global economy makes for domestic regulatory uncertainty. Second (and with more on this below), the current government has been successful in publicly producing some private goods such as roads or sanitation, but it has been unable to enforce other kinds of economic regulations that could sustain economic growth in the long run.

Finally, the overall evolution of the women’s economic freedom indicator is a fair reflection of the real picture, as this is an area that has improved significantly in the last decade in India. However, the drivers of this change are probably not those captured by the Index. The data shown in the figure mainly reflects the legal changes made in terms of working hours flexibility and maternity leave. But these legal reforms apply to a very limited number of firms, and thus cannot explain the significant improvement in women’s economic freedom. Instead, the real improvement in this area seems to come from the increase in access to basic goods such as sanitation, cooking gas, or drinking water, as captured by the progress of India on the Multidimensional Poverty Index. Progress in these areas truly impacts women’s economic freedom and produces a massive expansion of their economic potential.

From freedom to prosperity

India had a remarkable period of growth until 2009, with eight years of almost 8 percent GDP growth. From 2009 to around 2014, the economic situation is hard to assess because India experienced multiple shocks. Dealing with the financial crisis of 2009, the previous government left a remarkably broken financial system. Then the process of de-monetization significantly pulled income growth down. Another remarkable economic reform was the introduction of a single nationwide goods and services tax. In the long run it is likely to be very beneficial, as it raises government revenue more efficiently and cuts down on tax evasion, but in the short run it imposes severe costs on small businesses that are still struggling in some ways. Finally, we had the COVID-19 crisis. Despite all these events, GDP growth has not fallen below 5 percent in the last ten years. This is why there is some optimism about Indian growth.

Nonetheless, there are two noteworthy potential constraints on Indian economic development in the near future. The first is reflected in the recent decrease of the legal freedom subindex, as the tax and regulatory environment is still a lot more uncertain than investors would like. This is not because of a legislative desire to suppress legal freedom in these areas. It is more a function of the state’s inability to create regulatory clarity. The second has to do with the distribution of the growth dividend. The top 20 percent of India’s income distribution has probably done very well lately, as in most countries in the world. The bottom 20 percent has actually not done too badly, because of several welfare measures, as reflected in an improvement in the Multidimensional Poverty Index. It is actually the middle 40 percent that is struggling. India’s workforce is moving away from agriculture at a rate that might be expected. But the transition from low-productivity and low-paid work to high-productivity and better-paid jobs is proving elusive for the middle 40 to 60 percent. There are two reasons for this: First, the Indian economy is still very informal. The government has made attempts to bring more of the economy into the formal sector to increase scale, productivity, and access to credit. But the process of doing it, in the short run at least, raises the costs for very small informal businesses. Many of them are struggling. There is greater concentration of capital. Second, the employment elasticity of capital is rising. It takes more capital investment to create jobs. India’s growth path is still quite capital intensive. The result is high underemployment.

Progress on education is slower than it should be. The improvements in the quality of human capital will take eight to ten years to show up. There is considerable reason for optimism regarding the human capital issue, as it is less of a binding constraint in India than it used to be. The evolution of the health indicator in the Prosperity Index is an accurate reflection of reality, but again, there is a paradox here. One of the big successes of the Modi government has been to make health insurance available to large numbers of Indians. It is one of his flagship schemes and is quite remarkable. But the investment in public health is still clearly insufficient, and this is reflected in the dramatic drop in the indicator due to the COVID-19 crisis. Similarly, Mr. Modi has done very well on sanitation. More people have toilets and fewer Indians practice open defecation. That is a huge success. But in terms of building systems that can transport that sewage and reprocess it, we are not doing so well.

In terms of environmental regulations, there is again an interesting paradox. India is doing better than many peer countries on creation of renewable energy. Progress on solar, wind, and renewables has been remarkable. Yet, the government is at the same time enabling greater investment in coal. Also, the government is still unwilling to enforce some of the key environmental regulations that are already in place. Therefore, India has one of the most polluted environments in the world. All in all, on both environment and health, and despite progress, this government is unsuccessful at creating systems and processes that can account for market failures.

The future ahead

The evolution of political freedom in India is worrisome. In the next two or three years, there is a very high probability that political freedoms will decline even more. The way in which this government has empowered hate speech against minorities and co-opted the judiciary is very concerning.

We are at a big crossroads. It is the first time since 1975 that we must ask this question: Will there be a smooth transition of power? If it looks like this government is struggling and could lose the election, will it accept transition of power as smoothly as India has been used to? And here’s the catch-22: if this government wins, the majoritarian consolidation will be a continued threat to political freedom. But if it looks like it could lose, then the chances of resorting to extra-legal means to either hold on to power or ensure that its successor is not able to function will rise considerably. We can see evidence of this course of action in state elections which the BJP has been losing. In many of them, the BJP is deploying the central government’s power to break up the state governments that have been elected.

On the economic prosperity front, I think there are reasons to be cautiously optimistic. Yet, there is a politically problematic take on the situation: I do not think the harm to political freedoms is going to translate into an economic penalty for India. Large parts of Indian capital and foreign investors may not care. If they can make money, they will come. This has always been the case; it is the blunt truth.

Whether improvements on prosperity will be enough to overcome the structural problem of the middle 40 to 60 percent remains an open question. This group cannot be satiated by welfare expenditure. But nor does it fully participate in the gains of growth. It is also worth remembering that India is a highly diverse federal country. Peninsular states of south India have historically done much better and have per capita incomes 50 percent higher than the rest of the country. North Indian states like Uttar Pradesh and Bihar are still lagging in growth, and that is where most of the poverty is now concentrated. Most of these states present no real challenge to Hindu nationalism as an ideology, but they may resent moves towards greater economic centralization. So India will have to manage the political challenge of a geographically unequal society. This could work for democracy in two opposing ways. On the one hand, federalism can check the centralizing tendencies of Indian democracy. On the other hand, it could exacerbate political conflict and deepen the yearning for authoritarianism.

Pratap Bhanu Mehta is senior fellow and a former president of the Centre for Policy Research, New Delhi and Laurence Rockefeller Visiting Professor for Distinguished Teaching at Princeton University. He was previously vice chancellor of Ashoka University. He is the author of The Burden of Democracy (2003), co-editor of The Oxford Handbook to the Indian Constitution; India’s Public Institutions; and The Oxford Companion to Indian Politics. He was convenor of the Prime Minister of India’s Knowledge Commission (2005–07) and member of India’s National Security Advisory Board. He is also editorial consultant to the Indian Express and a fellow of the British Academy.

Trackers and Data Visualizations

Jun 15, 2023

Freedom and Prosperity Indexes

The indexes rank 164 countries around the world according to their levels of freedom and prosperity. Use our site to explore twenty-eight years of data, compare countries and regions, and examine the sub-indexes and indicators that comprise our indexes.

The post India’s political freedom is at risk appeared first on Atlantic Council.

Table of contents

Evolution of freedom

Aggregate freedom in Kenya has increased substantially and constantly since 1995, but the data correctly show a marked structural change in 2010. This was a crucial year in the recent politico-economic history of the country as it marked the inauguration of the new constitution, which has been the driving force behind many of the trends shown in the Freedom Index and subindexes. The 2010 Constitution reformed Kenya’s highly centralized institutional architecture, creating a devolved and highly decentralized system. This ensured that lower levels of government (regions and counties) receive much higher levels of funding, that can be better allocated according to the needs of local populations.

The economic freedom subindex clearly presents a jump around 2010, mainly attributable to a significant increase in women’s economic freedom. Legal changes that accompanied the constitutional reform had important effects on women’s empowerment and freedom. The endorsement of the 2010 Constitution established vital rights and encouraged additional reforms towards greater legal gender equality, including reserving seats for women’s political participation and encouraging nondiscrimination and equality. For example, the constitution outlined new principles relating to land policy, including the elimination of gender discrimination in law, customs, and practices related to land. Financial inclusion of women is an important area of improvement, and the Central Bank data—based on various FinAccess Surveys—clearly show that women are becoming much more economically included and empowered. Also, when you look at the disaggregated data for different regions of the country, you find that the gender gap in financial access is actually declining in many counties in Kenya. The growing economic empowerment of women is also evidenced by increasing employment rates of women and a reduction in the gender wage gap in many professions. Legislative changes have allowed women to hold and manage property, and placed them on a more equal legal footing with men in matters relating to property. For example, the passage of the Land Act and Land Registration Act in 2012 increased women’s rights over marital property. Regarding access to education, the gender gap is closing very fast. For example, in many university courses, the proportion of women and men enrolling is now much more equal than was the case a decade ago. The new decentralized constitutional framework has been crucial in creating the conditions in which women’s freedoms can improve. The situation of women is significantly worse in rural areas, but now local and regional governments have the autonomy and resources to provide and generate economic opportunities for women at a devolved level.

The economic freedom subindex also shows a sustained increase in property rights protection, which seems to reflect the judicial reforms that have been introduced since the 1990s. In the last three decades, there has been a significant improvement in the speed of judicial processes, and in the reliability of the guarantees given to domestic and foreign owners. For example, since the inauguration of the new constitution in 2010, parliament has enacted four major land laws aimed at improving land property rights: the Land Act of 2012, the Land Registration Act of 2012, the National Land Commission Act of 2012, and the Community Land Act of 2016. The World Bank’s Ease of Doing Business Index also undoubtedly incentivized Kenyan governments in this period to improve the institutional architecture of the country in order to facilitate economic activity. For example, the move towards “e-government”—the myriad reforms aimed at digitalizing interactions between citizens and government agencies—received a big push in order to improve Kenya’s position in the Doing Business ranking. This was, in fact, achieved in several successive years. The recent digitization of land records in Kenya is a means to improving security, by requiring a landowner to approve all applications relating to a specific property. Digitized records will also reduce the cost and time of land transactions. Section 9 of the Land Registration Act of 2012 facilitated the coming wave of digitalization and e-government by providing the Registrar of Lands with the right to maintain relevant documents in a secure and accessible format, including in electronic files.

Political freedom shows a substantial increase during the 1990s, which captures the movement from a one-party political system to a multiparty system. This was a generalized change in Sub-Saharan Africa, with levels of political freedom increasing in several countries. But such changes are always complicated, because it is easy to introduce political competition on paper, but always difficult in practice. This was a period of great political agitation in Kenya, reflecting broader political liberalization across Africa, with a very intense push for constitutional reform from civil society, resulting in significant achievements. External pressures to liberalize the political space were also crucial.

Kenya is probably one of the countries in Africa with the highest levels of civil and political liberties. However, the data show a significantly lower score for civil liberties than for the rest of the indicators of political freedom. It is likely that this relates to the protests, campaigning, and activism before and after electoral periods, which reached a peak with the serious electoral violence of 2007–08. But in general, Kenya is a society in which civil and political freedom is high, where citizens can express freely their political views, with a vibrant opposition in evidence. Electoral results have been challenged various times in recent years, accompanied by judicial reviews of the electoral results after several recent elections.

The large increase in legal freedom observed in 2010 is single-handedly driven by improved judicial independence and effectiveness, and this again is a product of the new constitution. The judicial system has proven to be very independent from political pressures; the challenges to—and judicial reviews of—the electoral results are a clear sign of this. The clarity of the law also improved significantly during the constitutional reform discussions that crystalized in 2010, and that is also evident in the data. In 2015, the judiciary adopted a nationwide case-tracking tool which enhanced the level of judicial accountability. There has been an attempt to standardize and speed up the handling of cases.

But the decentralization of power brought about by the new constitution has also had a negative side, at least in the short term. This is because now there is an additional level of government, the regional level, which necessarily increases the bureaucracy in the country. Moreover, three levels of government means a significant effort of coordination is required in order to efficiently provide the public services that were concentrated in the central government. These difficulties explain why bureaucracy quality does not show a significant change after 2010. Also, more bureaucracy opens the door for more corruption, especially with such a large structural change in the institutional framework. In recent years, there has been a clear aim to improve bureaucratic quality—for example, with the push for e-government—but Kenya has still a lot of room for progress.

From freedom to prosperity

The rapid growth in income in Kenya starts in 2002, a critical year for the country. In 2002 the country experienced a major political transition when the president, who had run the country for twenty-five years, stepped down. The new leadership was very keen on detailed government planning. They introduced a long-term development plan, called Vision 2030, with the objective of making Kenya an upper middle-income country by the year 2030. It was based on some crucial pillars, one of them being innovation. Kenya has led the region in some critical sectors thanks to this forward-thinking approach. Today, approximately 54 percent of Kenya’s gross domestic product (GDP) is generated by the services sector, parts of which are particularly vibrant and innovative, like tourism and financial services. The latter is a great example. Thanks to the innovative tool of mobile money, financial inclusion increased from 25 percent of the population in 2006 to about 84 percent in 2021, according to the 2021 FinAccess Survey, one of the highest levels in the whole Sub-Saharan Africa region. Mobile money in Kenya, which gained local popularity through the M-PESA application, allows users to deposit, withdraw, transfer money, make payments for goods and services, and access credit through cell phones. Mobile money products have evolved considerably since their introduction to Kenya in 2007, with a considerable range of innovative products and mobile service providers emerging. The agricultural sector, even though it is still very important in terms of employment, has been declining in terms of its contribution to GDP in Kenya and in several Sub-Saharan African countries. For several decades it represented about 30 percent of GDP in Kenya, but this has declined to about 20 percent—a fact reflected in the country’s debasing of GDP, which was carried out in 2021. Kenya is also trying to diversify its exporting industries towards nontraditional sectors. Today, 40 percent of Kenya’s exports are within the region, and these are mostly manufactured goods. With a strong base in manufacturing, Kenya is uniquely placed to benefit from the recently launched African Continental Free Trade Area.

Regarding inequality, the country clearly benefited from the constitutional change of 2010, because the devolved system of government significantly reduced regional disparities. Historically, the northern part of the country, for example, has lagged behind in terms of development because of its severe (semi-desert) climatic conditions. With the new system, funds are more easily transferred and more effectively administered by the regional and local governments, and inequality between rural and urban areas has clearly been reduced. The process of financial inclusion mentioned above, which was given major impetus by the introduction of mobile money in 2007, has been a second driver of reduced inequality. Segments of the population at the lower end of the income distribution have benefited most from this process, because it has opened the door to financing opportunities to start businesses, increase human capital, and so on.

Minority rights are also better protected with the decentralized system of government. The 2010 Constitution enables the state to put in place affirmative action programs to protect minorities and marginalized groups. Communities and ethnic groups that were somewhat marginalized before have been empowered in different regions. Even at a political level, it is clear that there is an effort to include previously silenced communities. The work carried out by civil society organizations has also been crucial on this point, in terms of creating an awareness about minority rights and demands in different parts of the country. This was demonstrated by the broad-based civic education carried out during the constitutional review process that culminated in the 2010 Constitution.

One of the primary goals of the political leadership that took power after 2002 was to improve the level and quality of education in the country. The aim was to reach 100 percent enrollment in primary education, and to increase significantly the enrollment levels in secondary and university education. However, the starting point was very low, so there is still a long way to go, particularly in secondary and tertiary enrollment. According to UNICEF, before the COVID-19 pandemic, nationwide enrollment in primary education in Kenya was at 93 percent while secondary school enrollment was only at 53 percent. Another important aspect is that increasing enrollment at a very fast pace requires vast resources to ensure that the quality of the education pupils receive is high. And this is not always the case in Kenya, even though education forms a very large part of the government budget. Some educational indicators, like the number of teachers, have not kept up with the levels of enrollment. The pupil-to-teacher ratio remains very high in some Kenyan counties. For example, in Turkana County in northern Kenya, it is at 77:1 according to UNICEF. So, the big challenge for the country at present is to improve both quality and quantity.

Once again, the 2010 Constitution will have major effects on life expectancy, and health more generally, but these are probably going to take longer to materialize in the data. Moreover, the slowing of progress on the health indicator in the decade before the COVID-19 pandemic may be explained by the same reason. The implementation of healthcare is now decentralized and run by the regional governments, even though healthcare policy is still in the hands of the central government. It is not easy to start running a regional health service from scratch, and there is obviously a learning period when indicators may even deteriorate. Inadequate resources provided by the national government to the counties and understaffed health facilities in many areas remain critical challenges. But in the medium and long run, once the implementation constraints begin to ease, it seems likely that healthcare services will be delivered more efficiently, and health statistics will show the results.

The future ahead

One of the critical issues that Kenya faces now is how to keep improving productivity. I see manufacturing as an obvious area for improvement, and this should include growing its share of GDP. Today, it is slightly below 10 percent, and Kenya should almost double that. I think we have a big opportunity in Africa with the implementation of the African Continental Free Trade Area. It would create tremendous opportunities for countries like Kenya that have some manufacturing base. Kenya is competing with manufactured goods from Asia and other places that have major cost advantages. Bigger markets, such as those that will become available through the African Continental Free Trade Area, can generate productivity improvements through export competition and also provide economies of scale benefits.

An important challenge for Kenya relates to the large share of informal employment. Moving part of these workers and firms towards formalization will ensure that economic opportunity and development are more stable. And, obviously, higher levels of formal employment and production generate larger and more stable sources of government revenue, as tax compliance is easier with formal sector firms. This will help the already firm path of fiscal consolidation that Kenya has followed in recent years. The current account deficit has also been declining, partly because of reduced imports, but also due to stronger and more competitive exports. This is a very promising path for Kenya, and the country now needs to take advantage not only of regional value chains, but also global value chains, particularly in areas like tourism where Kenya has long-standing experience and a diversity of tourist attractions.

But economic reform and development needs to be accompanied by continued institutional reform and transformation. Further pushing the inclusivity of institutions is the only way to ensure that increasing prosperity in Kenya is based on solid foundations and is therefore sustainable in the long run.

Robert Mudida is currently the director of the Research Department of the Central Bank of Kenya. He was a full-time academic for seventeen years, having taught and carried out extensive research at two leading universities in Africa: the University of Nairobi and Strathmore University. At Strathmore University he was full professor of political economy. He has published four books and numerous articles in top international peer-reviewed journals in the areas of political economy, financial economics, macroeconomics, and industrial organization.

Trackers and Data Visualizations

Jun 15, 2023

Freedom and Prosperity Indexes

The indexes rank 164 countries around the world according to their levels of freedom and prosperity. Use our site to explore twenty-eight years of data, compare countries and regions, and examine the sub-indexes and indicators that comprise our indexes.

The post Stabilizing revenue will lead Kenya to greater prosperity appeared first on Atlantic Council.

Table of contents

Evolution of freedom

The gradual deterioration of freedom in South Africa, which started in the early 2000s and is reflected in the Freedom Index, encapsulates the evolution of the country. Regarding economic freedom, the severe drop in investment freedom is very likely due to the introduction of legislation requiring foreign investors to have local partners, and to give away equity on a large scale. The application of such requirements to more and more sectors explains the continuing erosion of investment freedom up until today.

The ability to move capital in and out of the country has been static or has slightly improved. Similarly, trade freedom has not suffered big changes during the period of analysis, and that is well captured by the flat trend of this indicator. The short-run fluctuations are probably due to the changing trade agreements with the European Union (EU), but these are modest. The slide in property rights protection that started around 2012 is explained by the introduction of efforts to amend the constitution to allow for “expropriation without compensation” of agricultural land. While a strong majority favored the amendment, parties could not agree on the specific way such a policy would be carried out, and it was finally left aside. Nonetheless, it obviously continues to be a major threat in the near future, as the African National Congress (ANC) is likely to lose its majority and may revert to a populist alliance that would raise the issue again.

The significant increase in women’s economic rights, up to an almost perfect score, may be correct at a legislative level. Nonetheless, the real situation may be worse for at least two reasons: First, the levels of criminality, and particularly gender-based violence, are today at an all-time high, which clearly reduces women’s actual freedom. Second, even if there are no legal restrictions on women’s participation in economic affairs, social and traditional norms may still severely limit their opportunities in some areas of the country. Consequently, the positive push that this indicator gives to the aggregate economic freedom subindex may be somewhat artificial, implying that the real trend in overall economic freedom is probably worse than currently shown.

The political freedom subindex shows a very flat trend, but with a mild deterioration apparent in the last few years. The evolution of the indicators in this subindex can shed some light on what is going on. Elections and political rights scores are very high in South Africa, and the slight negative trend may be attributed to political polarization, but overall, the electoral process and its guarantees are not severely affected. The “legislative constraints on the executive” indicator has a clear upward bump in the 2013–19 period, which probably reflects the failure of parliament to act on allegations of state capture during the presidency of Jacob Zuma. The publication of the State of Capture report in 2016 resulted in a national scandal, and the rejection of its conclusions by Zuma, who was later chastised by the Constitutional Court, and this may explain the initial increase on this indicator. The establishment of the Zondo Commission in 2018 can account for the additional increase up until 2020. The post-2020 fall can be explained by the failure of the state to take action against the many individuals exposed for corruption before the Commission, and the impunity with which COVID-19 funds were looted by senior officials. Hence, the fall after 2020 is capturing the failure of the government to implement the recommendations of the Commission in any meaningful way. Nonetheless, the very marked upward bump shown in the data, between 2015 and 2019, seems rather unrealistic as no specific legislative changes were introduced on this front.

A second clear fact highlighted in the political freedom data is the significant worsening of civil liberties since 2019. Government actions during the COVID-19 pandemic are surely behind the initial drop. The empowerment of the army to stop and search individuals as a means of restricting the spread of the disease generated many abuses, and even deaths in some encounters. The health restrictions imposed in South Africa—such as the prohibition on buying certain goods, and the severe lockdowns and limitations on free movement—were probably among the strictest in the world. It is not surprising that, even after lifting the COVID-related restrictions, South Africa’s score on civil liberties protection has not rebounded and has actually worsened. This is because, in recent years, there has been a strong move against civil society in proposed legislation. For example, legislation is planned that would require nongovernmental organizations to apply for state security clearance to prove that they are not acting in favor of foreign powers.

The visible deterioration of legal freedom in South Africa since 2008 is notable. In 2009 Jacob Zuma acceded to the presidency and, very early in his mandate, he started to appoint close collaborators to senior positions across the criminal justice system in an effort to protect himself and his cronies against prosecution. The indicator on bureaucracy quality and corruption adequately shows the erosion and capture of the state apparatus. Judicial independence being relatively high and constant throughout the period of analysis may be faithfully reflecting the fact that the High Court and the higher levels of the judicial system have been able to prevent their capture by the executive. But it is also very true that the judicial system in South Africa is not as efficient for the average citizen, and this fact may not be fully captured by this indicator. It could be that the decline in the clarity of the law since 2010 is picking up the overall uncertainty and opacity of the judicial process in regular cases, due to inefficient and very slow courts.

From freedom to prosperity

The Prosperity Index seems to portray a picture that is the complete opposite of my reading of South Africa’s recent development trajectory. The Index shows a fall in prosperity between 1995 and the global financial crisis of 2007–08, followed by a recovery in the last fifteen years. Instead, I believe that the first half of the period of analysis was relatively positive for the country, while the last ten to fifteen years saw a clear deterioration. A closer look at the indicators that make up the Prosperity Index shows that it is mainly the evolution of the health indicator that is shaping overall prosperity. Therefore, it is probably more enlightening to analyze each indicator separately than to rely on the aggregate score.

The evolution of income per capita somewhat vindicates my argument. Gross domestic product (GDP) growth was strong and stable up until 2007, thanks to a substantial reordering of the public sector budget. On the one hand, there was some fiscal tightening and consolidation through reduced overspends. On the other, President Mandela (in power 1994–99) introduced several social programs that had an important redistributive effect. President Mbeki (1999–2008) continued this policy path and South Africa achieved positive GDP growth rates for several years in the early 2000s. Another crucial factor that fueled South Africa’s economic success in this period was a substantial decline in the cost of borrowing. With the election of Nelson Mandela in 1994 and the transition to a fully democratic system, South Africa’s credit rating was upgraded from close to junk to AAA. The increased borrowing capacity of the South African government helped create a quite substantial movement into the middle class, especially among black South Africans, who gained access to public sector jobs with rising wages. The resignation of Mbeki and the accession to power of Jacob Zuma, together with the worsening international environment during the 2007–08 financial crisis, halted abruptly the positive economic growth rates of the previous decade, and started a period of stagnation. The rating of South African debt deteriorated again and made further pay increases for public servants and other redistributive policies unsustainable.

The drastic dynamics of the health indicator are driven by the extremely different approaches to AIDS of Thabo Mbeki and Jacob Zuma. The former was a denialist and refused to deal with AIDS for most of his term, relenting only once the courts ruled against him near the end of his presidency. When Zuma took office, the government finally accepted that AIDS was a major problem, and a comprehensive health policy was instituted to begin fighting the disease. This shift—combined with the United States President’s Emergency Plan for AIDS Relief (PEPFAR), which began in 2003—played an important role as well in the dramatic increase in life expectancy from 2006. The severe impact of COVID-19 in South Africa, clearly greater than the average for Sub-Saharan Africa, does not necessarily imply a worse handling of the pandemic in the country. This is because COVID-19 disproportionately affected individuals with preexisting conditions, who represent a much greater share of South Africa’s population than is the case for the rest of the region. South Africa has a relatively higher cohort with so-called “first-world diseases” like diabetes, heart disease, hypertension, and so on, all of which contributed to higher mortality rates during the pandemic.

South Africa is a very unequal country, and the significant deterioration in terms of inequality during the first half of the period of analysis is very plausible. The main reason for such poor numbers is the dysfunctional labor market, including high levels of unemployment. There is a great divide in South Africa between those with a job and those without one. The expansionary policies of Mandela and Mbeki were intended to reduce inequality; they succeeded in expanding middle-class wealth but failed to deal with the growing number of people “outside” the labor market. Today South Africa has roughly three million civil servants, which represent close to half of the total number of taxpayers in the country. This somewhat artificial middle class that emerged since 1994 pulled away from those with limited job opportunities, worsening inequality. There were also some cases of incredible wealth creation among a very tiny elite, which widened the distribution even further.

The improvement in environmental quality is not impressive, clearly slower than the rest of the region. This is probably due to the fact that fossil fuels and solid fuels are still heavily used, especially among poorer households with no access to cleaner energy sources, as electricity generation has foundered. South Africa still operates a large fleet of coal-fired power stations and a fleet of carbon-intensive diesel generators, as the country has been unable to effectively transition to renewable sources of energy. So, the rise in this indicator may be more attributable to the fall in large industrial operations in the country than to a comprehensive policy focus towards a cleaner environment.

The important increase in the education indicator, of more than 20 points in the last twenty-five years, captures the massive push to increase enrollment rates at all levels of the educational system. Preschool has been an important policy focus, but also there has been a very substantial increase in fee subsidies for university students, so years of schooling are increasing at the intensive and extensive margins. Nonetheless, when we look at the quality of education, the assessment is not so positive. The standards required to pass to the next grade have been dramatically lowered. The deterioration in the quality of the education received by pupils is evidenced by the scores in global benchmarking tests, which paint a very different picture to the steady rise shown when measuring years of schooling.

The future ahead

The near future for South Africa will be determined by the evolution of the political situation. It is all about getting the politics right. The upcoming election in 2024 is going to be crucial for the country. It is very likely that we are going to see a change from a dominant party system to a coalition system. This may lead to some political instability in formal politics and parliament, but it will also lead to greater accountability and more political competitiveness. The direction the country will take is not obvious and will depend on which party or parties enter into coalition with the ANC, which is likely to remain the single largest party. The risk of the radical left party entering government is clear, with its support for arming Russia with South African weaponry, expropriation of whole sectors of the economy, and so on. If the ANC continues looking to the Communist Party and the trade unions for support, and builds a coalition with the populist left, there is a substantial risk of heading towards a downward political spiral, a rise of populism, and a sharp fall into a situation similar to that of Venezuela. Instead, if the political center is able to hold its electoral territory and becomes a suitable partner for the ANC, it would offer a completely different trajectory for South Africa. There is, for the first time, a serious effort to build a pre-­election pact between opposition parties, which may change the overall political calculation in favor of the center. Therefore, the electoral results of 2024, and the coalition outcomes, will be the key determinant of where South Africa will be in ten years.

South Africa’s fiscal situation is also a pressing problem that needs to be addressed if we are to avoid a major crisis. We are now on the verge of a fiscal cliff, with rising debt that will soon further constrain government spending. This will likely lead to a deterioration of the social climate, with worsening outcomes in areas like health and education. Again, a sensible government that can introduce structural reforms in the public sector and stabilize the fiscal situation, is of fundamental importance for South Africa.

Finally, South Africa’s global alignment will play a crucial role in its evolution in terms of freedom and prosperity. The importance given to being part of the BRICS group (Brazil, Russia, India, China, and South Africa) is not helping South Africa as it weakens the country’s standing with other nations with whom it has a more favorable trade balance and to which it exports more finished products. The expansion of the BRICS group to include Iran, Saudi Arabia, the United Arab Emirates, Argentina, and Ethiopia reinforces this negative trend. Moreover, China’s economic slowdown is leading to falling external demand for South African goods, especially minerals, threatening foreign exchange earnings. And being close to Russia and China is negatively impacting South Africa’s relations with other democracies—in the West and elsewhere—and making it more difficult to develop an exporting sector that is not so heavily dependent on China.

Greg Mills heads the Johannesburg-based Brenthurst Foundation, a think tank that seeks to strengthen African economic performance. He has directed numerous reform projects with African heads of state across the length and breadth of Africa. His latest books include Rich State, Poor State (2023), The Ledger: Accounting for Failure in Afghanistan (2022), and Expensive Poverty (2021), as well as a volume on South African scenarios, The Good, the Bad and the Ugly (2023).

Trackers and Data Visualizations

Jun 15, 2023

Freedom and Prosperity Indexes

The indexes rank 164 countries around the world according to their levels of freedom and prosperity. Use our site to explore twenty-eight years of data, compare countries and regions, and examine the sub-indexes and indicators that comprise our indexes.

The post South Africa needs political change to meet economic demands appeared first on Atlantic Council.

Table of contents

Evolution of freedom

The evolution of the Freedom Index for Sub-Saharan Africa closely resembles that of the global average since 1995, with a very mild convergence. The same is also true for the subindexes of economic, political, and legal freedom. This is already good news for the region, as the trends are positive, but this does not capture the full story of freedom development in Africa. This is because the big movement towards liberalization, especially in terms of economic freedom, took place during the 1980–2000 period, so largely before the starting point of the Freedom and Prosperity Indexes data set.

In 1970, all dimensions of economic freedom were extremely low in most of the countries of Sub-Saharan Africa. Figure 1 below shows the evolution of trade freedom back to 1970, obtained from the same source used in the Freedom and Prosperity Indexes (the Fraser Institute’s Economic Freedom of the World index). The average score for the region at the beginning of the period was around 3.8 out of 10, significantly lower than the rest of the world (5.5). In the 1970s, governments were following counterproductive policies such as overvalued exchange rates or quantitative restrictions on trade. These policies were destroying any possibilities to develop an exporting sector because, with an overvalued exchange rate, exports were simply uncompetitive. Exporters would have to turn in their dollar earnings at an artificially low rate and, in many cases, they would have to resort to the black market to buy their imports. The number of countries in Sub-Saharan Africa with a black market premium above 40 percent was very substantial.

A big wave of economic liberalization took place in the 1980–2000 period, with governments correcting the artificial distortions in their exchange rates and opening trade and financial flows. So, this first dramatic movement towards a more economically free environment is not captured by the economic freedom subindex, which mainly shows what we could call a second wave of liberalization after the year 2000. This has been mainly driven by increasing women’s economic rights, which have clearly improved in some countries of the region, but certainly not all. Investment freedom has also improved in the last ten years, making capital movements more efficient. This is evident when you observe that there are no countries today in Sub-Saharan Africa with black market premiums above 20 percent.

Figure 1. Trade freedom in Sub-Saharan Africa, 1970–2022

Property rights also show a mild improvement in recent decades, but the weak institutional environment portrayed by the legal freedom subindex probably represents the biggest constraint to further improvement nowadays. The very low and stagnant levels of all indicators of legal freedom, especially that of bureaucracy and corruption, impose a significant drag on Sub-Saharan Africa’s development. A critical aspect of legal freedom is security, a very unstable area in Africa. Religious and ethnic conflicts are always a risk in the region, and this generates a high level of uncertainty, which can have negative effects on investment and economic development.

The development of political freedom in Sub-Saharan Africa was not so great as economic liberalization, and the democratic institutional framework is rather weak in those places that transitioned to more inclusive political regimes. This is well captured by the fact that legislative constraints on the executive are significantly lower than the rest of the indicators of the political freedom subindex, and judicial independence is also low, suggesting that proper systems of democratic checks and balances are still not fully developed in most countries.

Overall, the story of the development of freedom in Sub-Saharan Africa has so far been very uneven, in two senses: First, there is large variability across countries in the region. Second, there is large variability among dimensions of freedom. Economic freedom really took off after 1980, but legal and political institutions have not really improved. And this situation imposes a constraint on development because there is complementarity among different areas, so reforms in one aspect need supporting reform in others if they are to be successful in the long run. Moreover, further progress in legal and political freedoms are not just means to achieving higher levels of material prosperity, but are in themselves a measure of well-being, which emphasizes the need for continuing liberalization in these areas.

From freedom to prosperity

The Prosperity Index shows a parallel evolution of the Sub-Saharan African region and the global average. Even if we would hope to see a stronger process of convergence, so that Sub-Saharan Africa would catch up with the rest of the world, parallel trends are already good news for the region. Compared to the situation before the 1980s, where Africa was significantly falling behind the global average, the fact that, in the last three decades, the region has been able to develop at a similar pace to other regions is a clear sign that the economic liberalization of the 1980–2000 period has paid off.

An extreme example of the trends of both freedom and prosperity is Ghana. Figure 2 shows what was happening with exchange rates and black market premiums over the last sixty-two years. By 1982, the real exchange rate had appreciated to a level that was more than one thousand percent higher than it is today. The black market premium on foreign exchange was also above a thousand percent. The consequences were disastrous. Ghana used to dominate the world market for cocoa. By 1982, Ghanaian cocoa growers were receiving only 6 percent of the world price, and cocoa exports had collapsed. Facing famine, Ghanaian leader Jerry Rawlins began reforms in 1984. The government devalued sharply the nominal exchange rate and thereby reduced the black market premium.

Figure 2. Black market premium and real exchange rate index in Ghana, 1960–2022

The economic liberalization coincided with a turning point for Ghana’s economy. As shown in Figure 3, Ghana experienced a sharp decline in per capita income from 1960 to 1983. After the reforms, Ghana registered a steady rate of economic growth that has continued ever since.

Ghana also undertook some political liberalization in 2000, and since then Ghana has had an unbroken series of competitive elections. This may also have contributed to Ghana’s steady growth in the new millennium.

Getting back to Sub-Saharan Africa as a whole, indicators like health and environment show a very rapid improvement throughout the period of analysis. It is true that the starting point was really low, and thus there remains ample room for improvement in the future. Foreign aid, which has clearly been ineffective in other areas, may have helped improve health and sanitation conditions, especially in rural areas. For example, early life mortality has significantly decreased in recent times, which accounts for an important share of the progress in overall life expectancy.

Figure 3. Cumulative logarithmic growth in per capital income in Ghana since 1960

Some progress has also been occurring in education, in terms of convergence with global averages in primary and secondary school enrollment. However, the education indicator of the Prosperity Index, which measures average years of education, does not fully show the region’s convergence towards the rest of the world. This may be due to faster expansions in college enrollment in other regions like Asia and Latin America compared to Sub-Saharan Africa. But the growth in the number of people enrolled in early levels of education in Africa is substantial. Nonetheless, another aspect of education not captured by the Prosperity Index is quality, and this is obviously an issue in Sub-Saharan Africa. When you consider quantity and quality, it is clear that there is still a lot of progress to be made.

The future ahead

The different dimensions of the Freedom Index very well identify the constraints and challenges of Sub-Saharan Africa’s development in the medium and long term. Economic liberalization has borne fruit lately, although further financial and trade integration of the region with the rest of the world should continue. But today the big challenge is to strengthen the process of democratization and institution building, and the necessary reforms in these areas are much harder to accomplish. The recent wave of military coups is not a promising sign, and there is ongoing conflict associated with Islamic movements in some areas. So, the situation regarding security and the maintenance of peace is a necessary condition for Sub-Saharan African development.

I think there is probably not going to be as much support for African development from international institutions and foreign countries as there was in the past (particularly in the 2000s), because there is a shift of focus towards other regions, like Ukraine and Eastern Europe. Also, I assume that the Israel-Hamas War will continue to focus attention towards the Middle East. Usually, things tend to go in cycles. I do not think that foreign support was all that successful in achieving economic growth, but aid probably deserves some of the credit for the progress on health and education, especially.

In relation to foreign influences in the region, I do not think that China’s Belt and Road Initiative will have very different results than the significant amounts of funds received by Sub-Saharan African countries from Western nations during the 1980–2010 period. Moreover, I think the same problems of debt repayment and default are likely to be repeated, this time with China’s investments. At the end of the day, for foreign investment and aid to successfully affect Africa’s economic development, it has to be directed to some productive uses. And this is not usually the case with this kind of heavily politicized financing.

Finally, the efforts to deepen economic and financial integration within the region are probably a good idea, as within-region trade is unusually low for neighboring countries in Sub-Saharan Africa. But it is certainly not an easy task, as the several unsuccessful attempts to promote free trade areas or common currencies in the region in the last several decades prove. This failure may be due to Africa’s burden of having too many countries, some of them very small states. This generates great difficulties in reaching agreements because there are multiple strong political interests. Institutional development and democratic reform may help in this sense, as deeper integration among African nations would probably benefit the majority of the population.

William Easterly is professor of economics at New York University. He is the author of The Tyranny of Experts: Economists, Dictators, and the Forgotten Rights of the Poor (2014), The White Man’s Burden: Why the West’s Efforts to Aid the Rest Have Done So Much Ill and So Little Good (2006), and The Elusive Quest for Growth (2001). He has published more than 70 peer-reviewed academic articles.

Trackers and Data Visualizations

Jun 15, 2023

Freedom and Prosperity Indexes

The indexes rank 164 countries around the world according to their levels of freedom and prosperity. Use our site to explore twenty-eight years of data, compare countries and regions, and examine the sub-indexes and indicators that comprise our indexes.

The post Sub-Saharan Africa grapples with development imperatives appeared first on Atlantic Council.

While the United States is well on its way to building the next generation of facilities to produce the integrated circuits, solar panels, and batteries needed to supply its digital and green transitions, the EU is struggling to connect its companies with state financing. In theory, the EU’s 27 members have matched US efforts through the European Commission with the NextGen EU recovery fund, a debt-funded program worth around $880 billion. However, because the commission lacks a permanent fiscal union with centralized taxation and borrowing powers, it has had to rely on member states to design and implement plans for NextGen funds. This decentralized approach, in conjunction with stipulations attached to its disbursements, have made it far harder for EU companies to access funding. 

NextGen EU funds are contingent on governments meeting performance targets set by the Commission. As of early 2024 just 18 percent of the Commission’s targets have been met, meaning that only about 30 percent of available grants and loans have been released to member states. Some member states, such as Poland and Hungary, have been blocked from accessing a bulk of their allocation because of the Commission’s rule-of-law concerns. Others, like Germany, have been stopped by their own constitutional court from releasing the funds to industry. These funding lags and uncertainties have stymied EU manufacturers’ investment at home. In contrast, the scale and accessibility of funding in the United States has meant that some major European manufacturers such as Volkswagen, BMW, Enel, and Norwegian battery group Freyr, are opting to instead prioritize investments in the United States.

What’s driving the US manufacturing construction boom

In line with IRA and CHIPS and Science Act priorities, construction is overwhelmingly concentrated in the computer, electronics, and electrical manufacturing sectors. This broad sector covers manufacturers producing computers, communications equipment, similar electronic products, as well as products that generate, distribute, and use electrical power. In other words, the goods needed to facilitate the green and digital transitions. Since the start of 2022, spending on construction for this sector has approximately quadrupled.

This surge in spending has transformed the computer and electronic segment into the dominant driver of US manufacturing construction. In 2023, the sector contributed some 64 percent of all construction manufacturing spending. Just five years earlier, its share stood at a meager 11 percent. The growth in computer and electronic manufacturing has not come at the expense of other sectors. Chemical and transportation manufacturing construction spending is also up 4 and 21 percent respectively from 2022 to 2023, and food and beverage manufacturing construction spending has remained steady.

While this historic expansion in US manufacturing construction is the first step to the reshoring of domestic production, concerns remain over whether the framework will be able to deliver the manufactured products. Labor force bottlenecks remain as the most immediate risk to the Biden Administration’s success. The US Bureau of Labor Statistics’s Job Openings and Labor Turnover Survey (JOLTS) notes that there were 601K open manufacturing jobs and 449K open construction jobs in December 2023. With US unemployment currently sitting at 3.7 percent, well below the average rate of 5.8 percent of the past two decades, the Biden administration’s main challenge will be to find workers to build and staff these new manufacturing facilities. One way to do this will be to support the transition of workers away from declining industries through the upskilling domestic workers. However, this alone will likely be insufficient. The US will also need to bring in skilled workers from abroad through reforms of its immigration system. 

With US industrial policy implementation well underway, the White House should now shift attention toward how it can best bring along the US’ allies and partners. Delays around NextGen EU, the elevated energy costs and economic uncertainty stemming from Russia’s invasion of Ukraine, and structural differences between the the US and EU’s governance structure mean that the Commission will not be able to galvanize investments in manufacturing production facilities at the same scale or speed as the United States. This is further complicated by the EU’s surging green goods imports originating from China as Beijing attempts to export its production overcapacity abroad. If Washington wants to ensure the European green and digital transition is built by friendly manufacturers, it should aim to do more to directly support its partners in Brussels, Berlin, and beyond. 

Niels Graham is an associate director for the Atlantic Council GeoEconomics Center where he supports the center’s work on China’s economy and US economic policy.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post The IRA and CHIPS Act are supercharging US manufacturing construction appeared first on Atlantic Council.

The post Mark quoted by Business Insider on China stock market crash appeared first on Atlantic Council.

Through the second half of 2023, the gap between China’s impressive official data and visibly underwhelming consumer demand, unresolved local government debt problems, and an unprecedented drop in foreign direct investment was stark. The China Pathfinder framework scans for evidence of market policy reorientation to fix these problems. But in this coverage period (July through December 2023), Beijing’s response was limited. Officials redoubled efforts and incentives to encourage foreign investment and trade, pledged to loosen cross-border data transfer rules, and increased deficit spending limits to stoke anemic demand. Beijing also simultaneously threatened economists with consequences for even talking about bearish signals and discontinued unflattering economic data, severely aggravating credibility concerns. Policymakers did next to nothing to tackle the real structural problems. Though we expect the severity of 2022–23 declines to set China up for a modest cyclical rebound in 2024, long-term growth potential will disappoint until fundamentals are addressed.

Here are five things to watch for in 2024:

1. In the quarters to come, property will shift from a massive drag to a modest boost to GDP growth—though from a much lower base.
2. There is a reasonable likelihood that policymakers will try to use this breathing room to get more reforms on track, rather than defer them further as in recent years.
3. While cyclical conditions will stabilize this year, Beijing must soon acknowledge that slower growth, in the 3 percent or 4 percent range, is here to stay. This may lead to more modest geoeconomic ambitions, but will also bring spillovers to trading partners due to lower domestic demand.
4. China will continue to face weak exchange rate conditions, and capital outflows are expected to continue.
5. Beijing’s capacity to influence growth via government spending will remain constrained by local fiscal stress and an already burdened monetary policy.

View the full issue brief below

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Related content

Report Oct 4, 2023

Running out of road: China Pathfinder 2023 annual scorecard

By Atlantic Council GeoEconomics Center and Rhodium Group

The China Pathfinder project examines whether China’s economy is converging or diverging with the world’s leading open market economies.

China Digital Policy

Econographics Dec 11, 2023

China’s manufacturing overcapacity threatens global green goods trade

By Niels Graham

Chinese lending is exacerbating a growing glut in its green manufacturing sector. Beijing is increasingly looking abroad to absorb excess capacity. This may have devastating effects for the global trading system as economies move to protect their own domestic industry.

China Economy & Business

Econographics Jan 10, 2024

China’s local government debts are coming due

By Jeremy Mark

China’s economic slowdown brings local government debts into sharp focus, threatening infrastructure and social services.

China Economy & Business

The post China Pathfinder update: Lack of policy solutions in second half of 2023 belies official data appeared first on Atlantic Council.

PES was central to the agenda in principle if not in name at last month’s World Economic Forum in Davos, featuring in both official and unofficial conversations and convenings. New announcements and commitments echo this sentiment and especially illustrate how the private sector, in partnership with governments, can and should play a role in advancing PES. For example, more than twenty Ministers and CEOs came together in a WEF alliance to mobilize financing for the clean energy transition in the Global South. The Network to Mobilize Clean Energy Investment for the Global South will amplify the investment needs of developing nations and advance actionable solutions to increase green energy capital flows globally. Comprising Ministers from Colombia, Egypt, India, Japan, Malaysia, Morocco, Namibia, Nigeria, Norway, Kenya, South Africa, and ten other countries, the Network to Mobilize Clean Energy Investment for the Global South “will provide a collaborative space for its members to accelerate clean energy capital solutions in emerging market contexts—through innovative policies, new business models, de-risking tools and finance mechanisms—and exchange best practices for attracting sustainable flows of clean energy capital.”

Also this month, the US Millennium Challenge Corporation marked the 20th anniversary of its founding, bringing to light its two decades of economic growth and poverty alleviation investments whose model and eligibility requirements—including democratic rights and control of corruption ‘hard hurdles’—have unlocked policy reforms, unleashing the “MCC effect” in numerous countries. To date, MCC has invested over $17 billion in infrastructure and policy reforms in health, education, power, agriculture, and transport in forty-seven countries, benefiting over 300 million individuals worldwide. This year, Cabo Verde was selected for development of a new regional compact “as a result of its strong commitment to democracy, its economic development needs and lingering poverty, and the potential opportunities to strengthen regional economic integration and trade in West Africa with a committed and engaged former MCC partner”; while Tanzania and Philippines can begin developing threshold programs to advance the rule of law in support of compact eligibility after selection by the Board in December 2023.

A third illustration, the European Commission and the Africa Development Bank signing of a Financial Framework Partnership Agreement on January 29 to boost energy, digital, transport infrastructure investments across the continent with co-financing. The agreement falls under the EU’s values-driven Global Gateway initiative which prioritizes advancing rule of law, human rights, and international norms and standards alongside inclusive economic growth, health and education in its cooperating countries: its 2021-2027 package with Africa will support investments worth €150 billion.

Where else might we see PES this year? Here’s a few things worth watching.

While PES has been more complicated to enact in multilateral contexts, this year’s G20 has potential beyond the strength in numbers alone. The members of the G20 represent around 85 percent of the world’s GDP, and more than 75 percent of world trade. Brazil took the reins of the G20 Presidency in November 2023, and has put development front and center on the agenda, opening the door to a robust PES orientation: its three key priorities comprise combating hunger, poverty, and inequality; advancing the three dimensions of sustainable development (economic, social, and environmental); and reforming global governance. Indeed, in the run up to the Leader’s summit in November, the Sherpa’s Development Working Group will convene again in March and May to further public policies to reduce inequality, trilateral development cooperation (grants, technical assistance, lending) and more specifically investments in water and sanitation. At the same time, PES will take center stage as the work of the Finance track gets underway next month when Ministers and central Bankers will convene and deliberate how preferential trade and fiscal incentives might be deployed to address fragmentation and debt challenges of lower middle-income countries.

As it relates to conflict response, we see PES as a frame for continued and specific bilateral and multilateral support to Ukraine’s economic recovery as well as EU expansion—with aid and membership contingent on and related to reforms which capacity building, technical, and financial assistance will be targeted to advance. A €50 billion ‘Facility’ from the EU has just gained unanimous approval, and we could see other moves such as extending Ukraine access to the Single Euro Payments Area (SEPA). The United States Agency for international Development (USAID) Ukraine Mission has forecast awarding this year a new flagship trade and competitiveness project to encourage business enabling reforms, support industries and firms, further job creation, and increase exports.

Similarly, as war rages in Israel and Gaza, fomenting humanitarian crisis, we are likely to see PES incentives. Those could include development grants and economic aid to encourage neighboring countries Egypt and Jordan to increase their intake of refugees and facilitate logistical humanitarian support, as well as to Gaza and the West Bank themselves for economic recovery and reconstruction alongside promotion of rule of law and peacebuilding.

On trade, as fragmentation threatens supply chains, including for critical minerals, new and improved preferential trade and finance mechanisms that reduce dependence on China or bolster regional ties will be on the table. The US African Growth and Opportunity Act is up for reauthorization. First passed in 2000, The African Growth and Opportunity Act (AGOA), which makes preferential terms of trade and investment support dependent upon favorable annual reviews of a country’s economic policies, governance, worker rights, human rights, and other conditions, was last reauthorized in 2020 and is set to expire in 2025. With US Senator Coons releasing a discussion draft of reauthorizing legislation in November 2023, that in part incorporates AGOA with the nascent African Continental Free Trade Agreement, we can expect to see robust, and perhaps unusually bipartisan, discussion this year.

Finally, this year marks the 80th anniversary of the Bretton Woods Conference that launched the World Bank (then IBRD) and International Monetary Fund (IMF) as the nature and direction of global economic governance continues to evolve, creating an important entrée for PES. Over the past decade, developing countries’ options for financing have increased as China and others have increased their global footprint giving way to more strategic competition. At the same time, as their fiscal space tightens and liquidity constrained, the case for using positive economic statecraft tools is clear and all signs point toward seeing more of it than before in 2024. It will be important to monitor impact and learn from effectiveness (or not) of these solutions in real time as well as over time as resulting policy reforms and investments take hold and bear fruit.

Nicole Goldin is a nonresident senior fellow with the Atlantic Council’s GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Why 2024 will be a big year for positive economic statecraft appeared first on Atlantic Council.

Given how far from credibility China’s 2023 statistics were, closer attention will be paid this year. Institutions which previously took China’s official numbers at face value, including the IMF and OECD, know that individuals, firms and countries with fewer analytical resources depend on them to check the math. Updated IMF WEO projections released January 30 upgraded China’s 2024 forecast by 0.4 percentage points, to 4.6 percent. Meanwhile, the Fund’s Article IV report on China, with its franker Staff Report section, should come out soon. Together these will clarify how international organizations assess the health of China’s economy.

Rhodium Group’s growth outlook for China in 2024 is again lower than consensus, as it was last year, but because our 2023 estimation was so much lower than the official figures (a mere 1.5 percent GDP growth at best) we see 2024 as a modest recovery rather than the continued deceleration reflected in consensus numbers. This is a cyclical stabilization resulting from property hitting rock bottom.

Still more secular stagnation will come—until Beijing gets back to long-deferred structural reform work that President Xi Jinping started in 2013 only to pause in the face of challenges. But a cyclical breath may be what Beijing needs, and explains People’s Bank of China (PBOC) Governor Pan Gongsheng’s remark last week, “now that China’s economy is recovering, we have greater room for maneuver in terms of macro policy”. Greater room, yes; but not a great amount of room. Even the 3-3.5 percent GDP growth we imagine possible for 2024 will require Governor Pan and peers to regain credibility by doing what is necessary to sustain economic growth even when it requires political sacrifices.

Daniel H. Rosen is a nonresident senior fellow with the Atlantic Council’s GeoEconomics Center and a founding partner of Rhodium Group where he leads the firm’s work on China, India and Asia.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Is China decelerating or recovering? appeared first on Atlantic Council.

Europe faced a perfect storm in 2022, with the invasion of Ukraine upsetting the post war security order, massive disruption in energy supplies especially coming from Russia undermining the backbone of Europe’s energy system and growing geopolitical rivalry, in particular between the US and China that crippled further the world trading system on which Europe relies for its economic growth. This is but the latest episode of Europe’s failure to insulate itself from the geopolitics of energy, a position of great vulnerability akin to a “Permanent Suez” crisis. The European response to double down on the energy transition and accelerate the decarbonization of its economies is sensible and necessary. It is also the only response that leads to a more secure and prosperous Europe.

Devoid of large fossil fuel and mineral resources, the continent is dependent on an arc of authoritarian energy powers, across central Asia, Africa and the Middle East. These toxic relationships, necessary to fuel the European economy, have repeatedly threatened European domestic politics, international security and wealth, culminating with the Russian war in Ukraine. In that light, Europe’s decarbonization policies can serve as more than climate policy, but also a security and foreign policy. Europe’s strategy in this energy transition will hinge on its ability to overcome five internal problems:

• The Fiscal problem: The European Union’s fiscal rules and limited budget limit the necessary financing Europe’s energy transition requires.
• The Hostage problem: Anti-transition interest groups continue to hold national politics hostage.
• The Collective Action problem: National veto players at the European level can hold the entire Bloc back.
• The Just Transition problem: The energy transition creates winners and losers, and the latter need to be compensated fairly, as exemplified by the “Gilets Jaunes” protests.
• The Industrial problem: Europe’s industrial base, green or otherwise, is increasingly challenged outside its borders.
• The Multilateral problem: Europe will need to support decarbonization outside its own borders, and in particular in less-developed countries.

Europe will need to completely overhaul its economic, trade and fiscal policies if it is to find a sustainable place in this new order. The race for critical minerals, of which Europe is once again bereft, will force European policymakers to redefine their relationships with mining states, while learning from the mistakes of the past. Further down the value chain, Europe risks massive deindustrialization if it fails to compete with Chinese and American firms. Finally, the Bretton Woods institutions that have governed global financial markets need to be reformed to unlock climate financing for less-developed States. This is a tall challenge that will require leaning on the US as much as possible.

Europe has entered the race to “net zero” from a position of weakness, and will need to reform internally and chart a path between the United States and China so as to avoid confrontation. Europeans should find an arm-length relationship that allows creating a Critical Minerals Club with the United States, reassure China about the scope of its economic de-risking and push hard for reforms international financial institutions, and push for a global “green” spending target as a percentage of GDP. This is an arduous path, but the only one which ensures Europeans a secure and prosperous place in the new world order.

About the authors

Ben Judah is director of the Transform Europe Initiative and a senior fellow at the Atlantic Council’s Europe Center. His current research focus is on the European consequences of Russia’s invasion of Ukraine, transnational kleptocracy, European energy and decarbonization politics, and Britain’s attempts to reset its diplomatic posture after Brexit.

Shahin Vallée is a senior research fellow in DGAP´s Center for Geopolitics, Geoeconomics, and Technology. Prior to that, he was a senior fellow in DGAP’s Alfred von Oppenheim Center for the Future of Europe.

Tim Sahay is a nonresident senior fellow at the Atlantic Council’s Europe Center and the senior policy manager at the Green New Deal Network, a coalition of labor, climate, and environmental justice organizations growing a movement to pass national and international green policies.

The Europe Center promotes leadership, strategies, and analysis to ensure a strong, ambitious, and forward-looking transatlantic relationship.

Learn more

Related content

Report Oct 16, 2023

How to strike a grand bargain on EU nuclear energy policy

By Ben Judah, Rachel Rizzo, Théophile Pouget-Abadie, Jonah Allen, Francis Shin

The EU currently faces an internal dispute over nuclear energy. To resolve this, the EU must commit to allowing each member to pursue its own energy mix, recognize nuclear energy as a crucial part of Europe’s existing energy mix, and adopting a technology-neutral approach to the implementation of the GDIP and NZIA.

Energy Markets & Governance European Union

In-Depth Research & Reports Sep 6, 2023

Policy memo: A NATO-style spending target could fund long-term decarbonization

By Ben Judah, Francis Shin, Rachel Rizzo, Théophile Pouget-Abadie

EU member states and like-minded allies should set national-level spending targets, each based on a percentage of their respective annual GDPs, for decarbonization-related purposes. This would provide the basis of an international coalition that would ramp up global climate spending and set a useful benchmark to anchor high-level diplomatic discussions on the subject.

Climate Change & Climate Action European Union

The post How Europe can escape its structural energy weakness amid great power competition appeared first on Atlantic Council.

This paper addresses the need for governance reform in the Bretton Woods Institutions (BWIs), namely the International Monetary Fund (IMF) and the World Bank. The report, informed by interviews with former officials, consultants, and think tank experts, provides an analysis of the challenges these institutions face in a rapidly evolving geopolitical climate.

The authors highlight that the most recent reforms in the BWIs, including the IMF’s General Reviews of Quotas and the World Bank’s selective capital increases, have been insufficient in adapting to significant economic and geopolitical shifts. The paper emphasizes the need for a governance reform roadmap, focusing on quota reallocation, diplomatic efforts, and a commitment to diversity and democratic principles.

Key points include the stagnation in quota shares and Special Drawing Rights (SDR) allocations in the IMF, with the Fifteenth General Review of Quotas concluding in 2020 without any alterations. The anticipatedIMF outcomes of the Sixteenth and Seventeenth General Reviews of Quotas suggest a potential shift in the representation of major economies like China and India, but concerns remain about the slow pace of substantial reforms.

The report examines geopolitical challenges, especially the reluctance of the United States and Japan to significantly increase China’s role and influence in the BWIs. This has led to the underrepresentation of certain regions like Southeast Asia and Africa, both in terms of quota shares and on a nominal GDP and per capita basis. The paper underscores the persistent inequalities in representation since the founding of the BWIs in 1944, with fluctuations in power generating grievances for underrepresented states.

The authors propose a four-point approach to governance reforms in the BWIs, emphasizing rules-based, automatic quota reallocation, transparency, and gradual changes. They suggest introducing weighted voting on the executive boards for specific issues, like climate change; creating a joint committee for governance reforms, and addressing the overrepresentation of European nations. They also highlight the critical role of Executive Directors (EDs) in governance reform, advocating for more diverse representation in leadership and staff, and suggesting policy changes to enhance transparency and inclusivity. The authors also advocate for doubling the number of deputy directors and vice presidents at the IMF and World Bank, respectively, and instituting a rotational system for Executive Board leadership to ensure more geographic diversity in the BWIs.

In conclusion, the paper calls for a democratized governance structure in the BWIs, emphasizing the need for reevaluating quota allocations and diversifying leadership roles. By addressing these foundational challenges, the BWIs can navigate the complexities of today’s global economic landscape more effectively, fostering trust, representation, and robust leadership. The authors also argue persuasively that BWI reform can not only reinforce the legitimacy of the IMF and World Bank but also indirectly help the soft and hard power of the states most hesitant to reform the international monetary system.

Sienna Nordquist is a Bretton Woods 2.0 Fellow with the GeoEconomics Center. She is also a PhD student in Social and Political Science at Bocconi University (Milan, Italy).

Joel Christoph is a Bretton Woods 2.0 Fellow with the GeoEconomics Center. He is also a Ph.D. researcher in Economics at the European University Institute (EUI) in Italy.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

Related content

Issue Brief Jan 16, 2024

Navigating subsidy reform at the WTO

By Sona Muzikarova and Sophia Busch

The legitimacy of the World Trade Organization is in question. The United States and its allies, and leaders in the organization, can better wield its potential to address global issues, specifically to reduce inefficiencies from fragmentation caused by subsidies.

Economy & Business Fiscal and Structural Reform

Issue Brief Jan 16, 2024

Developing an agenda for international financial institutions and central bank digital currency

By Greg Brownstein and Utsav Saksena

Is the emerging architecture appropriate, effective, and sufficient to manage the global transition to digital money? This report focuses on three domains: financial stability, development and financial inclusion, and global payment systems.

Digital Currencies Economy & Business

The post Governance reform of the Bretton Woods Institutions appeared first on Atlantic Council.

The World Trade Organization (WTO), founded in 1948, and regulating trade among its 164 member countries, has been a powerful engine for overall economic expansion, at the forefront of the international rules-based system. It has generated economic gains by promoting freer and fairer trade; increasing competition, efficiencies, and innovation; protecting consumers; and providing a platform for rules enforcement and dispute resolution to enhance stability and predictability in the global trading system. It also has supported the integration of developing countries into the world economy by fostering growth, development, and poverty reduction. Since its founding, the global economy has evolved largely in line with the ideals the WTO prescribed, as exports in 2019 were 250 times the level of 1948, reflecting widespread economic growth and interconnected trade.¹

However, the WTO has now become almost infamously ineffective at settling disputes and holding countries accountable for unfair trade practices. Global trade has grown increasingly fragmented since the global financial crisis of 2007–2009, the COVID-19 pandemic, and Russia’s 2022 invasion of Ukraine, all of which accelerated the trend against free trade and globalization. In all major economies, trade policy is increasingly used as a strategic instrument to address geopolitical competition. While US policymakers fixate on China’s unfair trade practices, US export controls against China and the US Inflation Reduction Act are prime examples of trade-distorting policies. The legitimacy and relevance of the WTO is in question, and it faces many challenges. However, the WTO retains unique characteristics that grant it an important role in international trade policy problem-solving: a set of core principles, a forum for negotiating and monitoring, and membership representing 96.7 percent of global gross domestic product (GDP).²

This report aims to provide recommendations for how the United States and its allies, and leaders in the organization, can better wield its potential to address global issues, specifically to reduce inefficiencies from fragmentation caused by subsidies. By first outlining and explaining the obstacles preventing an effective WTO, this report will ultimately provide recommendations for how the organization can provide guidance on subsidies for global public goods by facilitating discussions within multilateral trade agreements. It also provides suggestions for how the WTO can work with other Bretton Woods institutions to ensure that less-developed countries (LDCs) gain access to green financing, technology, and resources.

About the authors

Sona Muzikarova is a political economist, author and policy consultant, with over a decade of experience delivering forward-looking insights on the region of Central and Eastern Europe.

Sophia Busch is an assistant director at the Atlantic Council’s GeoEconomics Center.

Related content

Issue Brief Jan 16, 2024

Governance reform of the Bretton Woods Institutions

By Sienna Nordquist and Joel Christoph

The paper emphasizes the need for a governance reform roadmap at the IMF and World Bank focusing on quota reallocation, diplomatic efforts, and a commitment to diversity and democratic principles.

Economy & Business European Union

Issue Brief Jan 16, 2024

Developing an agenda for international financial institutions and central bank digital currency

By Greg Brownstein and Utsav Saksena

Is the emerging architecture appropriate, effective, and sufficient to manage the global transition to digital money? This report focuses on three domains: financial stability, development and financial inclusion, and global payment systems.

Digital Currencies Economy & Business

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Navigating subsidy reform at the WTO appeared first on Atlantic Council.

Following global trend lines, significant shifts in Latin America and the Caribbean—including presidential elections in Ecuador, Guatemala, and Argentina, unprecedented agreements with the Venezuelan government, a worsening security situation in many countries, and a pressing focus on climate change—set the stage for even more change to come in 2024.

Join the Adrienne Arsht Latin America Center as we explore top questions that may shape this upcoming year in the hemisphere.

What will the region’s newest presidents accomplish? How might Latin America’s ties with countries such as China and Russia evolve? What might be the role of the United States in an election year? Will the Caribbean see new, international attention to the specific threats faced by major climatic events?

Take our quiz to find out if you agree with what we’re predicting!

Related content

New Atlanticist Jan 10, 2024

Ecuador has declared ‘internal armed conflict’ against criminal gangs. What’s next?

By Isabel Chiriboga

Ecuadorian President Daniel Noboa has mobilized the military to fight criminal groups in his country, following two notorious criminal leaders’ escape from prison.

Civil Society Conflict

Report Nov 30, 2023

Advancing US-Colombia cooperation on drug policy and law enforcement

By Atlantic Council US-Colombia Advisory Group

Consumption and price of the drug has remained stable in the United States in recent years. However, the current trend of falling coca leaf and cocaine prices in Colombia present a natural incentive for coca growers to find alternative forms of income, which could mean a higher rate of success for alternative development programs.

Civil Society Colombia

Issue Brief Sep 26, 2023

A roadmap for the Caribbean’s energy transition

By David Goldwyn, Eugene Tiah, and Wazim Mowla

Caribbean countries are in desperate need of an energy transition. Disproportionately high electricity costs impede economic development, stress public finance budgets, and harm the competitiveness of tourism and other industries.

Americas Caribbean

The post 2024 predictions: How ten issues could shape the year in Latin America and the Caribbean appeared first on Atlantic Council.

This, of course, was the story of President Mauricio Macri’s government, which began in late 2015. The ending is well known: The economic turnaround fell short, in part because there was no congressional majority for significant reforms, and the country’s scarce foreign exchange reserves were spent in an unsuccessful attempt to prevent the exchange rate from crashing.

After returning to power in late 2019, the Peronists under President Alberto Fernández put pressure on the IMF to agree to a debt rollover—without even a hint of economic reform. Unfortunately, the institution’s management and shareholders went along, fearing a default on Argentina’s IMF obligations that would have dented the IMF’s financial standing. They ended up merely pushing the problem down the road and facilitating yet another episode of fiscal overspending that ended in hyperinflation, rising poverty, and empty state coffers.

The clean-up task has now fallen to the government of President Javier Milei, which has been off to an impressive start, lifting economic restrictions and taming the fiscal deficit. Given the lack of reserves to repay external creditors, one of its first steps was to ask for the resumption of the existing IMF program, which had been on hold due to unrealistic pre-election spending promises.

Agreement on the next IMF tranche of funds, announced on January 10, was reached fairly quickly, even as some of the policy priorities of the new government are still being formulated. However, it would have been highly irrational for the IMF to resist, given the excessive leniency extended to the last administration. It makes sense for now to continue with the loan, helping the government with its unprecedented steps to stabilize the Argentinian economy.

After the program ends in September, Argentina’s external financing needs will recede for several years, mainly because the repayment of the earlier IMF program is complete. Although Milei has been careful not to commit to a new program request yet, it seems likely that his administration will need to return to the negotiation table in the near future, given the Herculean task in front of it.

The IMF should not rush into a new program, either. Another failed program would not help long-suffering Argentinians, and there are at least three important concerns that need to be addressed:

1. There are still fundamental questions about Argentina’s economic future. Notwithstanding the government’s ambitious plans, it is not clear that the economy’s growth potential can be marshalled quickly enough, even under an ideal reform scenario. The large adjustment underway could deepen the recession, and there is not much debt left that could be restructured to ease public financing constraints. Moreover, it is highly doubtful that market investors, often burned in the past, will be eager to rush in with new money quickly.
2. The success of the Milei administration in pushing major reforms through congress is highly uncertain. Without a majority on its own, and with a large Peronist opposition in Argentina’s Congress and in the provinces, Milei’s Freedom Advances party may not be able to pass important labor market and pension reforms that would be fundamental to attract foreign direct investment and boost productivity over the long run. But unless the country breaks with the worst excesses of its Peronist past, any major program appears doomed from the beginning.
3. Except for its economic agenda, the policy program of the new administration has not yet moved into focus. There was an authoritarian streak to many of candidate Milei’s pronouncements, and the current minister of security, Patricia Bullrich, also campaigned on a tough law-and-order platform. It remains to be seen whether their domestic policies will remain conducive to an economic recovery, an issue that may flare up around a potential major strike called for by the trade unions to begin on January 24.

Argentina is not the first country to find itself (again) in such a dire situation. However, in countries that were able to overcome deep-seated structural problems, reforms eventually stuck beyond the tenure of any single government. That required a societal consensus to discard the old ways of doing business that were no longer viable. For example, Greece, Brazil, and Jamaica were finally able to achieve turnarounds, either by way of consensus or by ditching extremist views at the ballot box. Argentina’s divided political landscape offers little hope in this regard, even if its recent elections have hinted at a shift toward market-oriented politics.

It would therefore be unwise for the IMF and its major shareholders to work exclusively with the Milei government to negotiate a new program. Argentina’s opposition needs to share the responsibility for cleaning up the mess it left behind, agreeing to an economic strategy that has a realistic chance of success. IMF shareholders should present Argentina with a stark choice: take a sustained path of reform that will be supported with fresh money and investment incentives, or face an uncertain future with prolonged misery, social hardship, and continued decline. Even to die-hard Peronists, the right choice should by now be obvious.

Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF official with decades-long experience in economic crisis management and financial diplomacy.

The post Argentina needs reforms even more than the IMF’s money appeared first on Atlantic Council.

Those shaky finances have come into focus as the Chinese economy slows amid a property crisis, depressed business and consumer confidence, and soaring youth unemployment. Governments from modern mega-cities like Tianjin and Chongqing to the backwater provinces of Guangxi and Guizhou have saddled themselves with debt obligations that an International Monetary Fund (IMF) research paper last year called China’s “Achilles heel.” Small wonder then that Moody’s Investors Service cut its credit rating for China last month to negative from stable.

The pain is already being felt across China as local governments struggle to repay those debts and Beijing accelerates an effort begun last year to restructure them. As one Chinese hedge fund advisor writes, “the depletion of local governments’ credit capacity has not only crowded out the rising demand for social security, but also undermined the financial health and confidence of Chinese households.”

That suggests little relief in the coming year for businesses and families whom Chinese leader Xi Jinping, in his New Year’s message to the country, uncharacteristically acknowledged are facing a “tough time” and “remain at the forefront of my mind.”

The fixed-income investment giant PIMCO wrote in September that uncertainty about China’s local government debt is unlikely to pose “systemic risk” to China’s financial institutions, but so-called “idiosyncratic credit events could occur over the next six to twelve months.” Translation: fasten your seatbelts. The Rhodium Group has estimated that four-fifths of more than 2,000 corporate entities called “local government financing vehicles” (LGFVs), which local authorities have set up to borrow from banks and issue bonds, are unable to cover the cost of interest payments. A big chunk of that borrowing was incurred after COVID-19 hit in 2020 and local authorities were required to implement strict “zero Covid” measures. One Chinese academic calculates that the resulting  “Covid-induced deficit” totaled approximately 4.2 trillion yuan ($600 billion)!

Chinese banks and other government-linked institutions are the primary purchasers—and often the underwriters—of the LGFV bonds. But some private Chinese institutional investors and individual investors also have them in their portfolios because of the high yields, which have averaged 5-8 percent per year until recent restructurings. According to Fidelity International, LGFVs represent between 40 and 50 percent of China’s corporate bond market, while PIMCO estimates that Chinese banks’ loan exposure to the local government entities represents about 24 percent of corporate loans and 15 percent of total bank loans. Foreigners have largely steered clear of LGFV bonds, as their issuers are justifiably regarded as too risky.

The repercussions of all that borrowing are about to hit full force: LGFVs must repay (or refinance) $651 billion of renminbi-denominated bonds in 2024 alone. Yet that is only 7 percent of the total 66 trillion yuan ($9.292 trillion) of debt that the LGFVs were projected to have accumulated by the end of 2023, according to the IMF. And that does not include an additional 40 trillion yuan of debt that the IMF says is directly owed by the local governments.

However, Professor David Daokui Li of Tsinghua University insists that IMF estimates have underestimated debt because there is a need to include LGFVs practice using borrowed money as paid-in capital to fund subsidiaries, which then repeat the same practice with their own subsidiaries. This “pyramid structure,” he says, ends up disguising the true extent of LGFV obligations.

Nonetheless, the combination of the IMF’s estimate of LGFV and local government debt in 2022 (94 trillion yuan, or $13.429 trillion) equaled about three-quarters of China’s GDP ($17.96 trillion). That was far larger than the combined GDP that year of Japan ($4.23 trillion), Germany ($4.08 trillion), and France ($2.78 trillion).

Of course, debt in and of itself is not a sign of weakness. For example, US government debt in September 2023 was about 120 percent of GDP. The real issue is the ability to repay obligations, and China’s have become increasingly unsustainable at the local level.

Much of the LGFV borrowing has gone to fund infrastructure and other projects that cannot generate adequate revenue flows to service the debt. The Rhodium Group estimates that the median return on LGFV assets in 2022 was 1 percent, but the average interest rate on the associated debt was 5.36 percent. Of course, there are many reports of waste and corruption involving local investments.

To make matters worse, as China’s property market fell into crisis in 2021, local governments lost a major source of revenue from sales of land rights to developers. As developers collapsed under the weight of their own debts, local governments turned to LGFVs to buy the land. More than one-half of residential land purchased at auctions in 2022 went to LGFVs in transactions that totaled more than $324 billion. With residential and commercial construction unlikely to return to the record levels and prices of recent years, these purchases may prove unprofitable and the loans behind them unpayable.

The looming debt debacle places Beijing in a complicated policy bind. The central government relies on local governments—especially the country’s 2,850 counties—to provide a level of services unmatched by any other country, according to a 2018 IMF study. In the pre-COVID-19 period, local governments accounted for 85 percent of general government spending (89 percent with LGFV spending). That includes public pensions, unemployment benefits, and health programs. While Beijing transfers funds to local governments for these programs, local governments have been loaded down with considerable unfunded mandates over the years. David Daokui Li’s breakdown of 2020 local government debt shows that about 14 percent of obligations were incurred because of social spending.

In addition, Rhodium calculates that local government subsidies and tax incentives account for two-thirds of government funding for research and investment in science and technology at universities, research institutes, and state-owned and private companies.

Beijing is loath to see local governments default on their debts, but it also has shown no inclination to shift those vast sums en masse onto the central government’s books. Instead, over the past year it has announced programs to refinance, roll over, restructure, and reshuffle the local debt. Some bank loans have been extended for twenty-five years at lower interest rates, and provincial governments are accessing nearly 2.5 trillion yuan of unused central government funding for bonds to reduce funding pressures in cities and counties under their authority (with more bond financing expected to be announced when the National Peoples Congress meets in March). While the new bond issues have proved popular with some investors, the refinancings have faced some resistance from holders of the older, higher-yielding issues that are being replaced; only 59 percent of 2023 “redemptions” were approved by investors.

The government’s efforts to relieve the pressures building on LGFV debt so far pale in comparison with the total obligations that have built up in recent years across China, and however Beijing kicks the repayment can down the road, grassroots governments will remain on the hook for massive debts.

This could not come at a worse time for an economy shifting into lower gear and a population—more than 950 million of whom, by one recent estimate, live on less than $300 a month—already tightening its belts. With Xi Jinping’s government giving top priority to building a “modern industrial system” at the expense of spurring domestic demand, increasingly cash-strapped local governments will be hard pressed to meet the needs of their citizens.

Jeremy Mark is a senior fellow with the Atlantic Council’s Geoeconomics Center. He previously worked for the IMF and the Asian Wall Street Journal. Follow him on Twitter: @JedMark888.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post China’s local government debts are coming due appeared first on Atlantic Council.

The post Goldin quoted by Axios on higher interest rates and global debt costs appeared first on Atlantic Council.

Africa is home to considerable reserves of critical minerals, which are essential for the production of electric batteries and other sectors that will be at the heart of the transition to a low-carbon economy. In order to succeed in this transition to a green and inclusive economy, Africa must ramp up its green banking ecosystems and mobilize resources needed to finance climate mitigation and adaptation while also addressing deforestation, pollution and biodiversity loss. Concessional financing and rapid reforms are critical to create green banking ecosystems which are capable of channeling private investment to Africa.

In this report, Jean-Paul Mvogo explains how green banking ecosystems can better finance green development. Stakeholders must prioritize three pillars: increasing green public financial resources, mobilizing more private financing, and creating buoyant green banking ecosystems. 

About the author

Jean-Paul Mvogo is a nonresident senior fellow with the Atlantic Council’s Africa Center. He has been working as an economist for almost twenty years for major development partners (IMF, UNDP) or private actors on projects aimed at promoting the emergence of strong financial, Tech and entrepreneurial ecosystems in Africa.

The Africa Center works to promote dynamic geopolitical partnerships with African states and to redirect US and European policy priorities toward strengthening security and bolstering economic growth and prosperity on the continent.

Learn more

Related content

Online Event Tue, December 5, 2023 • 8:00 am ET

Green banking and a renewed climate finance architecture for Africa

On the ground at COP28 in Dubai, the Africa Center launches a new report on how green banking ecosystems can better finance green development and assembles an expert panel on how to better finance green development.

Africa Climate Change & Climate Action Energy & Environment International Financial Institutions

The post How green banking can unlock climate solutions in Africa appeared first on Atlantic Council.

These initial steps have provided reassurance to investors and signal the welcome transition of a maverick candidate into a more responsible, even if not mainstream, future head of government. They are also a sign that, now that the fate of his country will soon rest on his shoulders, Milei has realized that there are few realistic policy options for him to pursue. Foreign exchange reserves are exhausted, financial markets remain all but closed to Argentina, and an International Monetary Fund (IMF) program has run badly off track due to the actions of the outgoing administration. Moreover, China will remain a critical trade partner and possibly the only major source of bilateral financial assistance for the foreseeable future.

In this situation, adopting the US dollar as Argentina’s official currency could have pushed the country into a severe depression that could have resulted in more people out of work and increased poverty. Since the country has far from enough dollars to replace its monetary base at the current exchange rate, dollarization would have implied another major depreciation of the peso. The resulting loss of purchasing power for peso holders, combined with deep cuts in subsidies and other public expenditure that would be needed to bring the budget into balance, would have been a serious hit to those without access to dollar income or foreign remittances.

Milei has said that dollarization still remains a consideration over the medium term. One could indeed imagine that, for a country with a long history of regular bouts of hyperinflation, abandoning the peso could finally bring about monetary stability and impose much-needed fiscal discipline. However, a strong currency whose exchange rate is influenced by factors entirely unrelated to the domestic cycle would bring its own set of problems, primarily for the competitiveness of exports, on which Argentina remains heavily dependent.

Most importantly, dollarization would not provide insurance against fiscal recklessness down the road once Argentina could again borrow in financial markets. The experience of dollarized economies such as Ecuador and El Salvador shows that the adoption of the US dollar is no panacea in the absence of sustained growth and responsible macroeconomic policies.

The question therefore remains how the Milei administration intends to reduce inflation and lower the fiscal deficit once in office. A rational course of action would be to reduce the public deficit, cease direct monetary financing, and raise real interest rates over the first half of the new president’s first term, leaving some measures in place to protect the poorest segment of the population. However, monetary and fiscal consolidation would only be a necessary, but not sufficient, condition to generate a sustainable uptick in long-term growth that would be needed to eventually raise Argentinean living standards.

The key to economic success indeed lies in removing the thicket of obstacles that have curbed the productive capacity of Argentina’s economy over the past decades. It is for this reason, no doubt, that the new president-elect promised to send a package of reforms to the national congress, which would be recalled on December 11, the new administration’s first day in office. 

Alas, the chances of a strong reform package being passed into law appear low at first sight. The Peronist opposition would hardly agree to turn Argentina into a wholly free-market economy overnight, and Milei and his conservative allies have no legislative majority on their own. Moreover, most of Argentina’s provinces are still governed by the opposition, leaving Milei with only a small political power base. In fact, having thrown in his lot with the conservative alliance, Milei could find himself in a similar situation as former President Mauricio Macri, whose economic reform plans were largely dependent on winning a legislative majority for his second term.

It is therefore necessary to draw the right lessons from the failed 2015-2019 reform experiment. First, it would be a mistake for Milei to squander his large popular appeal in a rerun of the Macri experience. The outcome would be disastrous for Argentina, which has moved closer to a full-blown economic collapse in the meantime. Milei would instead need to make his case for economic reform directly to the Argentinean people, raising the cost for the opposition to refuse support for critical legislative steps.

Second, the IMF has a key role to play in forging a bipartisan reform consensus. Unlike the simple loan rollover during the Fernandez administration, the resumption of IMF lending this time would need to depend on the legislative implementation of growth-enhancing reforms. Given the multi-year time frame for such reforms, it would not be unusual for the IMF to engage with both the ruling and opposition parties.

Third, the United States and Europe, as the largest IMF shareholders, have a special responsibility in this regard, and they should lean on the IMF leadership and Argentina’s body politic to work toward an ambitious program outcome. Moreover, by identifying ways to directly support the Argentinean economy, they could increase the chances for program success, providing much-needed relief for the long-suffering Argentinean population.

Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF official with decades-long experience in economic crisis management and financial diplomacy.

The post Milei is backing away from his radical dollarization idea. What options does Argentina have?  appeared first on Atlantic Council.

The fragmentation of the global economy has been on display at two international conferences in recent weeks—and it doesn’t bode well for deeply indebted developing countries beset by inflation and lost access to capital markets.

The fault lines, centered on the divide between the United States and China, are adding new difficulties to efforts to restructure defaulted loans, and that will produce more pain for countries whose limited resources go to creditors instead of their own people. The recent sharp rise of global interest rates will only exacerbate the problem.

The debt issue loomed over ministers from 190 countries at the annual meetings of the International Monetary Fund (IMF) and World Bank in Marrakesh, Morocco, earlier this month. There was one breakthrough: an agreement on restructuring Zambia’s debt to government lenders, of which China is the largest creditor. But that came nearly three years after the country defaulted and then only after nine months of hard negotiations with a creditor committee headed by China and France. Those talks followed a Group of 20 (G20) Common Framework agreement in 2020 to establish a mechanism for restructuring the debt of the world’s poorest nations. The Marrakech meetings also announced progress at a roundtable on “processes and practices” related to restructuring—euphemisms for technical issues (mostly raised by China) that have slowed the provision of debt relief.

Perhaps the most significant development on debt during Marrakech was bad news: Sri Lanka announced an agreement with the Export-Import Bank of China to restructure $4.2 billion of debt. Sri Lanka, a more developed country whose 2020 default is not covered by the G20 framework, has been conducting what one IMF official described at an Atlantic Council panel as “ten parallel discussions.” The agreement underlined China’s willingness to undercut a multilateral workout in pursuit of its own interests. In this case, Beijing cut its deal even as it sat in as an “observer” in talks between Sri Lanka and a creditor committee led by India and Japan. The Ex-Im Bank deal, whose terms have not been released, also got out ahead of Sri Lanka’s negotiations with private sector creditors.

China’s approach took on more meaning when representatives from more than 100 countries, including twenty-two heads of state, gathered last week in Beijing under the patronizing gaze of Chinese leader Xi Jinping to celebrate the 10^th anniversary of the Belt and Road Initiative (BRI). That vast effort has built infrastructure throughout the developing world, but also has saddled countries with over $1 trillion of debt. Unlike Marrakech, discussion of debt was largely absent from the proceedings, outside of remarks from Vice Premier He Lifeng at a side event and a paragraph in the forum’s 16,500 word “white paper.” Xi Jinping’s speech to the forum focused on the BRI’s achievements and criticized “ideological confrontation, geopolitical rivalry, and bloc politics,” a pointed reference to US policies toward China.

The divergence between the two international gatherings underlined the increasing difficulty of sustaining international cooperation on debt issues. In the pre-COVID era, restructurings normally proceeded quickly after a country defaulted, with the defaulter reaching an agreement with the IMF on a loan and reform program, creditor governments providing financing assurances to support restructuring, and subsequent debt talks normally taking about two months.

While the Zambia negotiations were an improvement over the first Common Framework process with Chad, which took eleven months, each restructuring is essentially terra incognita. These days, debtor countries face a complicated creditor landscape—a largely Western group of government lenders called the Paris Club; multilateral financial institutions like the IMF and World Bank; China and other new sovereign lenders like India, which works closely with the Paris Club; and the private sector, which accounts for the largest amount of lending in many countries and has its own conflicting stakeholders (traditional banks vs bondholders).

The Common Framework has sought to incentivize the various creditor groups to act in relative concert and reduce the negative economic impact on low-income countries. But distrust has made this much more difficult to achieve, especially as Beijing and private-sector lenders jostle for the best terms. The disorder is more pronounced in non-Common Framework countries, where there is no agreement on an orderly process. For example, the IMF now lends to Suriname while its government has stopped repaying Chinese loans—a process called lending into arrears—because Beijing has not provided assurances of continued financing during restructuring. Meanwhile, private bondholders forged ahead with a deal that will involve a 25 percent “haircut”—or reduction in principal owed—on two bond issues, with repayment to be funded by future oil revenues.

While it is useful that creditors and debtors meet under the aegis of the IMF and World Bank roundtable to discuss outstanding issues, this is no substitute for real progress. There are still many issues even for Zambia, which still must reach separate agreements with each individual creditor government. While it has reached an agreement in principle with Eurobond holders—with an 18 percent haircut—there is still a long way to go with other private-sector bondholders and banks, which include Chinese state banks that Beijing insisted be excluded from the sovereign portion of the Zambia agreement. There are many issues still to resolve before a final restructuring accord is in place, as Brad Setser and Théo Maret enumerated in September.

Private sector lenders will inevitably insist on similar terms to the sovereign creditors. But this emphasis on “comparability of treatment” may compound future problems because creditors in both Zambia and Sri Lanka are requiring higher interest rates on restructured debt if economic growth recovers. One problem this poses for debtor countries is that the burden of higher interest payments—which will only become heavier with global rates rising—will fall on already strained fiscal resources. An IMF study on debt in sub-Saharan Africa released during the Marrakech meeting detailed the sharp rise in the share of government revenue going to interest payments. It warned about the “difficult policy choices” countries will confront “to remain current on debt.” Those policy choices will hit the most vulnerable citizens hardest in the form of less money for health, education, and economic development.

The principle that a country should repay its obligations when economic conditions have recovered makes sense, at least in theory. However, if creditors insist that borrowers facing severe economic challenges continue to tighten their belts when conditions improve—which is what the growth-linked repayment schedules would entail—there will still be serious social costs. That will be part and parcel of an increasingly unmanageable restructuring process that likely will increase global inequality and fragmentation.

Vasuki Shastry, formerly with the IMF, Monetary Authority of Singapore, and Standard Chartered Bank, is the author of the recently published The Notorious ESG: Business, Climate, and the Race to Save the Planet.

Jeremy Mark is a senior fellow with the Atlantic Council’s Geoeconomics Center. He previously worked for the IMF, CNBC Asia, and The Asian Wall Street Journal.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Creditors are still not doing enough to relieve developing country debt: A tale of two confabs appeared first on Atlantic Council.

Executive summary
Introduction
The war in Ukraine: A new dimension to the nuclear debate in Europe
What does a peace pact on nuclear energy look like?
Conclusion

Executive summary

Nuclear energy was once a source of European integration beginning with the creation of Euratom, the European Atomic Energy Community, in 1958. However, it has become in the contemporary European Union a source of division, with France and Germany leading rival blocs regarding its future. As a result the EU does not meaningfully fund nuclear energy and member states have engaged in political interference trying to block other member states’ attempts to launch nuclear projects. Nuclear energy is today a source of European disunion. This acrimony has come at a terrible time for the EU, when it urgently needs to decouple from weaponized Russian energy supplies and decarbonize due to the worsening climate emergency. This paper proposes that the EU reduce Russia’s presence in European nuclear markets and sign a “peace pact” allowing each country to pursue its own energy mix without political interference as part of a grand bargain. This bargain would recognize that nuclear energy is a crucial part of Europe’s energy mix, ensure the EU adoptsa technology-neutral approach in the Green Deal Industrial Plan and Net Zero Industrial Act while ramping up support for nuclear skills, research, and development, in exchange for further integration of electricity markets and agreement on its reform, higher renewable targets and renewed work and research on the management of nuclear waste. Only such a peace pact recapturing the spirit of technological optimism and geopolitical commitment behind the launch of Euratom can help Europe overcome the deep nuclear divisions which are holding it back. 

Introduction

The history of European nuclear energy: From integrative to divisive force

Once upon a time, nuclear energy united postwar Europe in excitement. About eight kilometers from the center of Brussels, Belgium, sits an eye-catching tourist attraction that garners almost 600,000 visitors per year. The 335-foot tall Atomium, described on the eponymous website as “a monumental structure halfway between sculpture and architecture and where the cube flirts with the sphere,” is a sight to see. Unveiled as the flagship construction for the 1958 Brussels World Fair, the Atomium was meant to represent the faith people put in science—especially nuclear science—and what that could mean for human progress. To this day, the nine glimmering spherical atoms that make up the Atomium are a physical representation that nuclear energy has not always been seen as a source of European division.

Today, political Brussels faces an unprecedented energy puzzle. European policymakers, still grappling with the consequences of the energy crisis caused by Russia’s invasion of Ukraine, have scrambled to reaffirm the continent’s position as a global climate leader. The bloc must adapt to the Russian gas supply shock, all while accelerating an energy transition that provides sufficient and cost-competitive energy in a way that does not transfer Europe’s dependency from Russian gas to Chinese-controlled critical raw materials. At the same time, the US Inflation Reduction Act (IRA), which provides generous incentives for green industries to localize production in the United States, could threaten the viability of industries in Europe, all while the transatlantic community pushes to move green supply chains away from China. In this context, European policymakers are fiercely deliberating the future of nuclear energy: is it a critical enabler of Europe’s energy transformation, as a stable source of low-carbon energy, or a dangerous blocking point that diverts funding from renewable energy deployment? This has drawn sharp divisions between France and Germany. And in stark contrast to the optimistic days of the Atomium, nuclear energy is now far from being at the center of European integration: when the European Commission first presented the RePowerEU plan in March 2022 with the aim of reducing EU reliance on Russian gas, nuclear power was not even mentioned. It has become a source of European disunion. 

France-Germany divide: From pro-nuclear geopolitics to anti-nuclear protests

The Atomium is testament to the fact nuclear energy was not always a toxic subject in Brussels. To understand the nuclear debate in Europe today, one must go back almost seventy years to see how Europe approached energy access and economic integration in parallel with post-WWII reconstruction. Nuclear energy, now the most divisive topic in Europe’s energy transition, was once a central pillar of European integration. That is not to say the path there was clear cut or simple. After World War II, European leaders knew that successful reconstruction would require secure and reliable access to electricity and that overdependence on foreign energy sources could create major problems with reconstruction efforts.¹ This is why the bloc began, essentially, with energy. In 1951, Belgium, France, Italy, Luxembourg, the Netherlands, and West Germany signed the Treaty of Paris, which created the European Coal and Steel Community (ECSC), the precursor to the European Economic Community (ECC) and eventually the European Union. The primary role of the ECSC was to develop a common market of coal and steel within Western Europe, ensuring that Western Europe would have guaranteed access to these materials.“² According to Robert Schuman, one of the fathers of European integration, the point of this common market was to make another war between France and Germany “materially impossible,” as coal and steel were the primary resources required to build armaments at an industrial scale up until the Second World War.“³

Looking to further deepen cooperation, the Foreign Ministers of the ECSC states gathered for the Messina Conference in 1955. Among other developments, the ministers agreed upon both the need to further develop the technology for nuclear energy generation and the establishment of a common European institution that would oversee this development. This decision eventually led to the creation of the European Atomic Energy Community—Euratom. The Suez Crisis in 1956 starkly highlighted Europe’s problem with importing most of its energy sources, and the ECSC’s foreign ministers decided to appoint “three wise men”⁴ to set targets for European nuclear energy. At the height of the Suez Crisis, it was decided that European coal, water, and natural gas would be unlikely to meet more than a third of projected increase in electricity demand: another major argument in favor of nuclear energy.

It was in this spirit that the idea of pan-European nuclear energy efforts really began to gain traction. And finally, in 1958—the year the Atomium opened in Brussels—the six original members of the ECSC signed the Euratom Treaty. The treaty pooled core aspects of the nuclear industries of member states, ensured standards for nuclear safety and security, and promoted cooperation in research and development into nuclear energy. R&D was critical: at the time, American players dominated nuclear technology, which they licensed out to European energy providers. Building out European nuclear capacity was, beyond a project to work together toward the peaceful use of nuclear energy, also seen as an instrument for Europe to eventually achieve energy independence. Nuclear energy was seen as key to European integration—not division. 

During this time, a set of narratives predominated in Europe that helped leaders gain support and acceptance from the public to develop nuclear energy capabilities: there were huge reconstruction needs, notably in steel (and correspondingly in coal); a desire for peaceful cooperation with neighbors; a recognition that Europe was still excessively dependent on nonindigenous energy sources, especially oil from the Middle East; concerns that coal would eventually run out; and the threat that high energy prices would pose to economic recovery and growth. This brought the six together into Euratom in a spirit of geopolitical purpose and technological optimism symbolized by the Atomium at the 1958 World’s Fair.

Nuclear power continued to gain traction over the following decade. After France’s failure to maintain control over colonial Algeria, there was a deep desire in Paris to reduce reliance on energy imports from the Arab League. However, it was the 1973 energy crisis that again highlighted Europe’s collective continued vulnerability on foreign sources of energy and propelled Europe into becoming the most nuclearized region in the world. That year, Arab members of the Organization of the Petroleum Exporting Countries (OPEC) placed an embargo on the United States and allies that supported Israel in the 1973 Yom Kippur War. At the time, Western Europe and Japan relied on OPEC states for between 45 percent and 50 percent of their oil, and when market prices climbed by 300 percent as a result of the embargo, import-dependent countries became acutely aware of their vulnerability.⁵ Could nuclear power potentially reduce those vulnerabilities? Given its longstanding geopolitical concerns—post-Algerian independence in 1962—and concerns about Arab-energy supplies, France led the charge across Europe, via the “Messmer Plan,” to invest in nuclear and to affirm the power source as it is relied upon today.⁶ In fact, plants built or planned immediately following the 1973 oil shock still represent 40 percent of today’s nuclear capacity worldwide.⁷

Political suspicions and ambitions shaped this first nuclear age. France has always been the most advanced country in Europe when it comes to nuclear energy. It created the CEA (national atomic agency) in 1945, which had 1 percent of the total government budget by 1955 and dwarfed all other European nuclear energy budgets at the time. This meant seeking technological alliances overseas. Framatome, a French-led nuclear company, was formed in 1958, under President de Gaulle to acquire the license of the US company Westinghouse’s pressurized water reactor designs for use in France. This acute dependence meant France was nervous about US domination of the nuclear energy space and was in favor of deeper European integration from the get-go to counterbalance it. This spirit was summed up by the French National Assembly in 1956 by Louis Armand, one of the “wise men” and first president of Euratom: “Everything moves so fast that if we do not speed things up, we will never catch up. Without Euratom, it’s simple: all European countries will have to turn to the [nuclear] giants,” referring primarily to the United States and Russia. Armand was indeed worried about European states building century-long dependencies on the two superpowers for nuclear material and technology.

However, over the Rhine, there was as much suspicion of France as with the United States. Initially, West Germany lacked nuclear expertise, but had expertise in chemical and other industrial sectors, and wanted to import cheap supplies of enriched uranium from the United States to underpin a reviving and export-led national industry. In short, many in Germany viewed France’s offer of cooperation as a ploy to control this new industry. These differences also played out when trying to negotiate the Euratom Treaty: France wanted a strong dirigiste framework, whereas West Germany’s approach was more business-friendly.

However, these early optimistic narratives surrounding nuclear energy soon flipped. Excitement for secure and reliable nuclear power gave way to disenchantment and concern for the potential immense destruction caused by disaster and improper waste management. Following the 1979 Three Mile Island incident, the 1986 Chernobyl nuclear power plant disaster, and social justice impacts of improper waste management and uranium mining, public perception of nuclear energy quickly deteriorated throughout Europe.⁸ Through public pressure campaigns, governments soon scaled back investment in new reactors. Crucially for the future of Europe’s collective approach to nuclear energy, France’s first nuclear reactor at Fessenheim on the Rhine, the country’s border with Germany, proved a catalyst for the emergence of the anti-nuclear protest movements in that country and a deep sore in relations between both partners, despite it being at the onset a Franco-German project.⁹ These accidents, crises, and protests built up the fault lines between Germany and France on nuclear energy that continue to this day.

These eventually stark differences between Germany and France over their respective nuclear energy policies can be traced to the late 1970s. The rise of the Green Party in Germany became synonymous with the push for environmental protections, and, alongside it, the desire to phase out nuclear energy.¹⁰

This led to very different political contexts in France and Germany by the early twenty-first century. Across the Rhine, the Greens succeeded in their anti-nuclear pressure so dramatically that no new nuclear reactors have been built in the country since 1989. This was just the beginning. Furthermore, following the Fukushima accident in 2011, Angela Merkel’s government (a coalition between the Christian Democratic Union/Christian Social Union and the Free Democratic Party) introduced the Energiewende policy, which aimed to shut down Germany’s seventeen nuclear power stations by 2022 and phase out coal power by 2038 (now 2030) through aggressive renewable energy expansion, industrial decarbonization, and efficiency targets. France, as a gesture to Germany following the Fukushima disaster, agreed to close the plant in Fessenheim on the Rhine.¹¹ This is the political environment that led to Germany shutting down its last three nuclear plants in April 2023—despite widespread international criticism given Europe’s energy needs in the wake of Russia’s invasion of Ukraine.

However, it is crucial to understand Europe’s current predicament that Germany’s Energiewende should not be mistaken for leading to uniquely green results. As a result of pushing for denuclearization, Germany and other EU states became increasingly reliant on cheap imported fossil fuels from Russia—especially natural gas. These fundamental differences between France and Germany form the heart of the divided approach that Europe takes to nuclear energy today. What is more important: a nonnuclear approach to energy tomorrow or a decarbonized approach to energy today?  

Nuclear energy today: A critical but divisive source of energy for Europe

Notwithstanding these political differences, nuclear energy is critically important to Europe. Today, more than one hundred nuclear power plants produce about a quarter of electricity generation in the European Union and nearly half of all carbon-free electricity in the EU.¹² Nuclear electricity generation almost perfectly splits the European Union in two. France’s fifty-six reactors (the second largest fleet in the world, behind the United States) produce almost half of Europe’s nuclear electricity. Spain, Sweden, Belgium, and eight other EU countries (Czechia, Finland, Bulgaria, Slovakia, Romania, Hungary, Slovenia, and the Netherlands) make up the rest. 

While some member states, such as Belgium, have sharply decreased their nuclear production over the past few years, others have progressively ramped up, as in Romania, whose nuclear power plants came online as recently as 1996, or Hungary, which is expanding its Paks nuclear power plant. At least twenty-five new nuclear reactors are planned in other member states, including six in Poland and two in the Netherlands. Italy, which shut its nuclear reactors down after Chernobyl, making it the only G8 country without its own nuclear power plants up until Germany’s own closures, has now launched a new government initiative to contemplate reintroducing nuclear power.¹³

Figure 1. Stances on nuclear energy in the EU

The European Union can therefore be divided into six groups: decommissioners, expanders, extenders, entrants, status-quo players, and nonnuclear energy players. Decommissioners, such as Spain, currently operate reactors but have active plans to phase them out. Expanders, like France and Slovakia, currently have existing power plants and plans to build new ones. Extenders, like Hungary, Slovenia, Bulgaria, Belgium, and the Netherlands, have plans to build new reactors or other measures to extend the operational lifespan of existing reactors. Entrants, like Poland, are countries that have never developed nuclear energy before but wish to do so. Those at a standstill, like Sweden, are countries that have operational power plants but lack official plans to either build more plants and/or units, or decommission existing plants. Finally, nonnuclear members, such as Germany, Denmark, and Austria, are states that have either fully decommissioned or never adopted the use of nuclear energy.¹⁴ Prior to Brexit, the United Kingdom and its nine nuclear reactors tipped the political balance in favor of the pro-nuclear camp. With the British exit from the European Union, the pro-nuclear camp lost one critical ally. This sense of flux and indeterminacy has been a driver of such bitter disputes over the EU nuclear future.

Figure 2. Share of nuclear in domestic electricity production (Europe, 2021)

Not only the question of nuclear power per se but also the question of Russia and the uranium that enables it divides Europeans. To power its nuclear power plants, the EU sources uranium from a limited set of partners, notably Russia, but also Niger, Kazakhstan, Australia and Canada. But the ties between Europe’s nuclear industry and Russia extend beyond uranium. Rosatom, a Russian state-owned nuclear power company, has built reactors in five European countries (Bulgaria, Czechia, Finland, Hungary, and Slovakia), and is currently building two in Slovakia and two in Hungary. What’s more, Rosatom has deep ties with the French nuclear industry, both as a client and as a partner: as late as 2021, EDF (a French state-owned electric utility company) and Rosatom signed a strategic cooperation agreement and a joint declaration on research.¹⁵ This is not simply a French matter as Germany’s Siemens also remains a partner of Rosatom.¹⁶ Unsurprisingly, France has come under increasing pressure, especially from Ukraine, to cut ties with Rosatom. As of yet, the European Union has not sanctioned Rosatom or any associated personnel and companies, unlike the United Kingdom and United States.¹⁷ However, the latter still receives imports of Russian uranium.¹⁸ In fact, Ukraine wants every European country with ties to Russia’s nuclear industry to cut them. The pressure seems to be working: efforts are underway in various European capitals to wean European nuclear industries from Russian dependence: Poland, Slovakia, and Bulgaria have all recently signed agreements with Western players (notably Westinghouse and EDF). 

Uranium imports free of Kremlin-influence pose a challenge for all Western countries. Meanwhile, France in particular has concerns given the recent coup d’état in Niger, which may lead to the state falling under Russian influence; as of 2020, 34.7 percent of French uranium imports came from the country. This is alongside 28.9 percent from Kazakhstan and 26.4 percent from Uzbekistan, two other states where Russia has limited influence.¹⁹ The United States, meanwhile, imported 35 percent of its uranium from Kazakhstan and 15 percent from Russia directly as of 2021.²⁰ This is a collective problem for Western allies, though not an unsolvable one, should the situation degrade, given the extensive uranium deposits in allies such as Australia and Canada. So far, uranium, unlike oil and gas, has not been weaponized by Russia. Again, European countries are divided on what is more important: decoupling from Russian resources totally, as the first priority, or only decoupling from weaponized Russian hydrocarbons.  

Nuclear as part of the Green Energy Transition

Many of Europe’s green politicians may suggest otherwise, but any fair analysis of the continent’s energy situation and trajectory shows that Europe will not be able to achieve its net-zero goals without nuclear energy being part of the mix. Long before the urgency injected by the Russian invasion of Ukraine, it was already evident that nuclear energy in Europe is critical when it comes to providing the three-pronged benefits of energy security, sovereignty, and a reduction in emissions as part of a wider net-zero strategy. With EU member states now needing to find alternate energy sources even faster, nuclear energy will have to continue to play a critical role, albeit one that might look very different than in the past.  

Nuclear energy as a key enabler of Europe’s decarbonization goals

Nuclear energy is crucial in helping to meet ambitious emissions targets that are likely out of reach at the current pace of transition.²¹ This is especially true in Eastern Europe, which is still overly reliant on coal, and lacks coastlines for offshore wind and appropriate solar resources.²²Nuclear reactors already provide about half of the low-carbon electricity generation in the EU, and the countries with the lowest carbon intensity of total electricity production in 2021—Sweden and France—achieved this by utilizing both nuclear and renewable energy production.²³

Beyond the low-carbon electricity that nuclear technology already provides, this energy source can accompany and enable the deployment of renewable energy. Rather than being seen as antagonistic, the two should be seen as complementary. The ability of nuclear energy to supply secure and reliable low-carbon power—that can be ramped up and down to meet needs—at a competitive price provides solutions to a suite of shortcomings that result from large-scale renewable energy deployment. 

Renewable energy generation is uncertain across hours, days, and seasons and balancing supply and demand becomes increasingly difficult as the grid is characterized by a larger share of renewables. Solutions like battery storage and demand management can help grid operators balance supply and demand across hours or days, but variation across weeks or months requires different solutions. For example, multiweek periods of almost no wind and limited solar power can occur in the winter in Germany—stretches of time that are nicknamed Dunkelflaute, or dark doldrums.²⁴The lull in generation is currently met by burning fossil fuels, but meeting gaps like these in Germany or elsewhere with nuclear power would be emissions-free. Nuclear energy is already seen as a “baseload” supply (the minimum amount of electricity needed to meet the constant and essential demand) that can be relied upon in the face of variable generation, and is largely used for this purpose.²⁵

Nuclear energy can also help maintain grid stability, a service that can be even more valuable than power generation. Healthy electric grids must balance supply and demand, but also maintain safe frequency to avoid failures or accidents. This becomes more complex with renewable energy generation, in which renewables utilize inverters instead of turbines to convert energy into electricity; turbines maintain frequency free of charge.²⁶ Nuclear electricity utilizes turbines and can thus deliver “ancillary services,” (balance frequency) across a renewable-dominant grid. For example, an analysis of a carbon neutral power system in China projected that in 2060, nuclear energy would supply only 10 percent of total electricity production, but almost half of the ancillary services.²⁷

Finally, an effective energy transition may simply be unrealistic without nuclear energy. The International Energy Agency (IEA) projects that the EU will fall short of its ambitious renewable energy targets, and recent research makes it clear that the coal phaseout is not happening fast enough.²⁸ In Austria, an outspoken nuclear opponent in the European Union, a recent internal government report highlights that the country is not currently on track to reach its climate targets.²⁹ Additionally, the 2022 energy crisis has caused Germany, Poland, and a handful of other European countries to consider delaying plans for coal phaseouts. 

It’s worth digging a bit deeper into Germany specifically: combined with gas shortages, the decision to follow through with its plans to phaseout nuclear power has actually increased reliance on coal and other fossil fuels in the short term.³⁰ Unsurprisingly, the decision to follow through with these phaseout plans has drawn increasing controversy and shows that the Greens’ vision for the energy future may no longer be a shared one.³¹ A recent survey by YouGov in Germany revealed that only 26 percent of Germans fully support a complete phaseout of nuclear power today, with clear divisions across political and regional lines.³²  In Bavaria, Minister-President Marcus Söder recently appealed to keep regional nuclear plants on despite the federal phaseout plans.³³ His pleas were ultimately rejected—despite the clear climatic and security benefits of keeping the plants running. 

A cost-competitive solution to the energy transition

Economic necessity means nuclear energy is not something that Europe can continue to remain divided over. Simply put, including nuclear power in the EU energy supply will bring down the costs of the green energy transition. It will continue to be the least costly low-carbon technology that is dispatchable (meaning readily adjustable to meet fluctuating demand) after hydropower through at least 2025, according to the IEA.³⁴ Achieving net-zero targets globally without investing in nuclear energy would require $500 billion more investment and raise consumer electricity bills on average by $20 billion a year by 2050, the IEA found.³⁵

That storyline exists within France. RTE’s landmark study, Energy Pathways to 2050, found that the most cost-effective pathways to a carbon-neutral French grid by 2050 require both extending existing reactor life and investing in new reactors alongside renewable energy development.³⁶ Crucially, the IEA has found that the ability to invest in and extend nuclear reactor life well past initial lifetimes, or long-term operation (LTO), is even competitive with renewable energy generation, which now enjoys famously low costs.³⁷ Ambitious targets for emissions reduction in 2030 and carbon-neutral electricity generation in 2050 may already be unrealistic.³⁸ Phasing out nuclear and meeting those targets will be prohibitively expensive, if not impossible, in nuclear-dependent member states. The evidence is clear: there is no path to net-zero for the European Union without a prominent role for nuclear energy. 

Advanced reactor designs show potential for new applications

Given the push to renewable sources of energy and the benefits nuclear power plants provide, nuclear energy is likely to be an important component of the net-zero transitions in Europe and abroad. But nuclear in the net-zero age could look somewhat different from the late twentieth century. This gives reason to think that its politics—characterized by division—can change too. 

While some countries are hesitant to invest in conventional large-scale reactors for the transition, they are enthusiastic about the potential of advanced reactor designs to enable decarbonization. Belgium and Italy have joined the pro-nuclear alliance as observers due to their intent to only pursue advanced reactor designs, and the Netherlands’ new climate budget pushes for the construction of smaller nuclear reactors.³⁹

There are, however, reasons for skepticism. This is not an approach shared by all: Poland, for instance, currently plans to build large reactors, while other countries (e.g., Romania) are refurbishing and investing in existing reactors. Further, countries that are investing in large-scale nuclear, including France and the United States, have made sure to earmark funds for advanced reactor designs, such as evolutions of existing designs of small modular reactors (SMRs).⁴⁰

Despite the many benefits of such SMRs, they have not yet been commercialized to replace large reactors in the power mix. For one, designs are in various stages of development and license applications, and commercial viability remains uncertain. And while they address cost concerns, commercial SMRs as conceived of today might, according to one study, end up producing twofold to thirtyfold more waste than conventional atomic power plants in operation.⁴¹ Additionally, existing infrastructure and regulation has been designed for large reactors and adapting for SMRs will require grid investments and policy changes. 

Overall, SMRs and advanced reactor designs have potential and require additional research and development. Investment should continue to address shortcomings, and designers/policymakers should think critically about how to take advantage of the benefits of nuclear power in the decarbonized energy mix. We should expect such reactors to play a different but important role in the energy transition, as there will be specific applications where the use case for large reactors is less clear. This might be the case for industrial sectors with hard-to-abate emissions, including hydrogen production, mineral extraction necessary for the clean transition, and other industrial processes. These reactors will not, however, replace the need for large-scale reactors—and they won’t short-circuit the politics and long-standing opposition to nuclear power. 

The war in Ukraine: A new dimension to the nuclear debate in Europe

Nuclear has divided Europe at a time when unity is required

Just as in the crises of 1956 and 1973, Russia’s invasion of Ukraine in February 2022 once again exposed Europe’s heavy reliance on imported fossil fuel supplies. It also forced policymakers to reassess their understanding of both energy security and energy independence. In the span of a decade, Europe witnessed Libya, a key oil supplier to its south, engulfed in a devastating civil war, and more recently, Russia, once perceived as a reliable gas supplier to the East, invading Ukraine and shutting down gas supplies. Whereas the nuclear-versus-renewables debate hinged on its environmental impacts, the war in Europe has placed energy sovereignty as the number one priority, shifting the terms of the debate.

Figure 3. Share of gas supply from Russia in Europe (2021)

For member states that first invested in nuclear energy to provide energy security, the war in Ukraine has validated the need to invest in a new age of nuclear energy. Proponents argue that nuclear power has clear benefits to deliver security and independence, along with the decarbonization benefits described above. Nuclear energy can provide locally produced electricity and heat, with relatively few inputs, anywhere in Europe.⁴⁴ Nuclear fuel is extremely energy dense—one uranium pellet, which is around one inch tall, is equivalent to one ton of coal or 120 gallons of oil.⁴⁵ As a result, reactors have a relatively small geographic footprint and waste is minimal relative to power output. Uranium—the most common fuel used for nuclear power—is abundant and geographically diverse, even though Russia remains one of Europe’s largest suppliers of enriched uranium.⁴⁶ Operating costs remain low once reactors are built and the levelized costs of energy (LCOE) are consistently lower than fossil fuel alternatives—especially where supply is scarce.⁴⁷

Instead of a joint European approach, a new division has embedded itself between pro- and anti- nuclear camps: the question becomes, does Europe leave nuclear behind and seek other options for secure, low-carbon dispatchable energy, or reinvest in established and new nuclear technologies and fully recognize the role they can play in the green energy transition?

Figure 4. EU electricity generation by fuel (2021)

Europe’s politics surrounding nuclear energy are now so acrimonious that there was no mention of nuclear energy in the bloc’s RePowerEU plan to decouple from Russian energy sources, as previously mentioned. Germany has also been engaging in political interference to block other member states from developing nuclear energy. In February 2022, Germany’s energy minister, Steffi Lemke, of the Green Party, visited Poland and claimed that Germany would use “the appropriate legal instruments at the European level” to prevent Poland from launching a nuclear program.⁴⁸ Political acrimony between France and Germany over Berlin’s refusal to allow meaningful EU funds to be allowed to support nuclear energy has led to a suspicion in the French cabinet that Germany’s policy may not in fact be ideological but commercial, with a desire to undercut a French energy advantage.⁴⁹

Divisions have calcified. At a meeting in Stockholm in February 2023, eleven member states agreed to deepen cooperation on nuclear energy. This pro-nuclear alliance, with France at its helm, includes Bulgaria, Croatia, Czechia, Finland, Hungary, the Netherlands, Poland, Romania, Slovakia, and Slovenia, with Belgium and Italy joining as observers. At the core, these member states envision the electricity source as central to the energy transition and want it placed “on an equal footing” with renewables as a low-carbon source of energy. In October, they submitted a proposal to the European Commission to ensure plans for electricity market reforms do no harm to their existing nuclear fleet. ⁵⁰  On the other side of the table, a group dubbed the Friends of Renewables was formed in response to oppose measures to accommodate nuclear power and is “ready to fight” against future concessions. Austria has formed the opposition with Estonia, Spain, Denmark, Ireland, Luxembourg, Portugal, Latvia, Lithuania, and Germany.⁵¹

The formation of these two blocs impedes consensus building in Europe on crucial energy policy initiatives now and in the future. The two increasingly entrenched sides lobby hard to gain allies for their cause, and the consequences of this extend beyond the legislatives efforts themselves. The nuclear debate has, in the words of an attendee of the Atlantic Council’s decarbonization Paris policy workshop in March, escalated the energy crisis into “a political crisis, a crisis of trust” that has “wasted political capital” and threatens the conventional consensus-building process for EU energy policy“⁵² In this vein, the French National Assembly recently published a report on “the loss of French sovereignty in energy,”⁵³ pointing to European energy rules and its impacts on the French nuclear industry over the past twenty years as the main culprit. Nuclear energy has become—at the worst possible time—a source of European disunion. 

Making matters worse is the poor state of the French nuclear industry. The French Senate recently published a report on French nuclear energy, noting that, “due to a lack of coherent policy and investment this energy is in structural decline.”⁵⁴ By late 2022, a record twenty-six of its fifty-six reactors were offline for maintenance or repairs after the worrying discovery of cracks and corrosion in some pipes used to cool reactor cores.⁵⁵ This crisis sent French nuclear generation to a thirty year low turning the country into a net energy importer for 2022, importing even from Germany. Lack of skills and capacity domestically meant France was required to bring in American and Canadian experts and contractors. This is part of a series of deep problems that have faced EDF, which the French government fully nationalized in 2022. Therefore, despite strategic and climatic vitality, European nuclear power faces a double bind: that of supranational German-led political opposition and French-led domestic underperformance. To truly unlock nuclear energy’s potential, both will have to eventually be overcome at the EU level: removing German hostility to countries wishing to develop their own industries and providing support to overcome French failures.

Nuclear divisions hinder Europe’s efforts to build a truly climate-neutral economy

This row is impacting core EU policymaking. The nuclear debate inevitably emerges in every energy-related discussion in Brussels, including the negotiations for the Renewable Energy Directive and related emissions reductions targets, discussions around standards for hydrogen production, decisions surrounding funding guidelines for that production, and plans for electricity market reforms. Ongoing clashes between EU member states therefore significantly delay agreements at a time when Europe needs to present a unified agenda and accelerate its efforts if it is to meet its climate neutrality goals. The worse the Franco-German “motor,” the worse the functioning of the EU.

Disagreements on nuclear energy also bog down efforts to invest in the infrastructure required for a net-zero European economy. France, Spain, and Germany are unable to find consensus on how to allocate EU financial resources toward the integration of European energy infrastructure like hydrogen pipelines. This dispute has already had political consequences, such as when President Emmanuel  Macron threatened to delay the construction of BarMar, a hydrogen pipeline that would run from Spain through France to Germany.

The nuclear dispute also impacts Europe’s green industrial strategy. Ambiguous language in the recent Net Zero Industry Act (NZIA) proposal from the Commission is aimed more at quieting both factions than bridging the gaps between them.⁵⁶. The NZIA, the bloc’s response to the US IRA, is part of the EU’s broader Green Industrial Plan, which European Commission President Ursula von der Leyen declared is meant to “to scale up manufacturing of clean technologies in the EU and make sure the Union is well-equipped for the clean-energy transition.”⁵⁷ It defines which net-zero technologies are strategic for both Europe’s industry and decarbonization, which, in turn, determines which technologies will get access to a wide range of benefits, potentially including fast-tracked permitting, simplified regulatory oversight, and European funding. The main body of the act includes “advanced technologies to produce energy from nuclear processes with minimal waste from the fuel cycle” and “small modular reactors” as two of the technologies that will benefit from the policy initiatives—but this excludes the current reactors essential to Europe’s energy mix and technologies such as the second-generation pressurized water reactors that France plans to develop.⁵⁸

Additionally, the annex to the policy defining those technologies, which “will receive particular support” and are subject to the “40 percent domestic production benchmark,” does not mention any type of nuclear technology, nor does a separate document identifying investment needs and funding availability.⁵⁹President von der Leyen has said that “nuclear can play a role in our decarbonization effort,” but is not deemed “strategic for the future.”⁶⁰ Similarly, the Commission working paper on “strategic” green industries does not once mention nuclear power.⁶¹

The European Union does not meaningfully fund nuclear energy 

The EU does not meaningfully fund nuclear energy despite its strategic and climatic importance and core importance to multiple member states. While there are already funding initiatives for nuclear energy in the EU, the majority of these relatively small resources are set aside for safety and decommissioning programs aimed at “improving the safety standards of nuclear power stations and ensuring that nuclear waste is safely handled and disposed of,” while leaving it up to member states to “choose whether to include nuclear power in their energy mix.”⁶² This leaves a gap in the securing of resources needed for nuclear fuel (primarily uranium), as well as deficits in vital investments in technical skills training for the development and operation of nuclear energy equipment and encouraging technological innovation in the field. 

The current energy crisis, political disputes, and the new wave of industrial economic initiatives further prove that this approach needs updating. For perspective, the €132 million package announced in March that directs funding from Horizon Europe (see Table 1) for research in small modular reactors is a drop in the ocean compared to recent measures in the United States.⁶³ The $6.85 billion in direct funding and additional generous US tax credits are clearly aimed at continuing and enhancing the domestic nuclear industry through support to existing reactors, supply chain enhancement, and technology-agnostic funding for research and development. There is a clear opportunity to reframe the NZIA and additional EU policy initiatives in a way that finds a reasonable middle ground for nuclear energy’s role in the transition. 

Nuclear disputes stand in the way of deepening European electricity markets via infrastructure and reform

There is a further issue holding back Europe. The EU is already the world’s largest interconnected electricity market, ensuring that power flows from where it is produced to where it is needed. But the energy crisis and the challenges posed by increasing shares of renewables calls for more integration, an objective that Europe has so far failed to meet. In January 2023, the European Court of Auditor released a report pointing to the lack of progress made in recent years, notably on interconnectors.⁶⁴ In 2002, the European Council had set a target of 10 percent of electricity interconnection as a proportion of generation capacity for each member state. The target has yet to be reached, three years past the 2020 deadline. 

France’s geography places it at the heart of European energy systems—between Northern wind and southern sunshine. And yet, French policymakers have been slow to build out interconnectors, to the dismay of their Spanish neighbor.⁶⁵The last high voltage interconnector to come online across the Pyrenees was in 2015, despite the rapid deployment of renewable generation capacity in Spain.⁶⁶ More recently, the BarMar spat was the latest iteration of French obstruction.  

Many factors could explain France’s reluctance to become a European energy platform: the pressure it would place on France’s domestic grid,⁶⁷ or shielding its nuclear electricity exports to Germany and Italy from Spanish competition.⁶⁸ But France also heavily subsidizes its nuclear industry, making French nuclear electricity historically among the cheapest sources of energy across the EU.⁶⁹ These subsidies led EDF to the brink of default and subsequent nationalization by the French government last year.⁷⁰  In this context, this reason explains French policymakers’ reluctance to build out more connections: France cannot afford to subsidize nuclear-derived electricity for Europe at large. This is how France and not only Germany contributes to the blockage at the heart of European nuclear energy politics. 

No wonder then, that Europeans have struggled to agree on electricity market reforms this year. In March 2023, the European Commission proposed various revisions to regulations governing Europe’s electricity market design. While leaving market fundamentals unchanged, the Commission’s proposals included consumer protection measures, supporting long-term power purchase agreements and, more controversially, two way contracts for differences (CfDs), whereby governments top up energy producers when prices drop below a minimum threshold, and vice versa when a maximum threshold is reached.⁷¹

This last point sparked intense debate between the pro and anti-nuclear camps.⁷² France wants CfDs to cover existing assets, namely its nuclear fleet, while Germany views this as unfair support that would distort markets. In late July and ahead of summer recess, the European Parliament voted on a watered-down version of the Commission’s proposal, making only newly-built plants eligible for CfD funding.⁷³ Negotiations between the European Council, the European Parliament and the European Commission will accelerate towards the end of the year, under the supervision of the Spanish Council presidency. 

Sven Giegold, German state secretary for economy and climate, recently told the Financial Times that France and Germany needed a “grand bargain” on energy.⁷⁴ Indeed, the need for a political grand bargain on nuclear energy in the EU is clear: to resolve divisive disputes and reestablish trust in the consensus-building process, to streamline broader energy policy that depends on nuclear strategy, and to meet the objective of supporting low-carbon technology essential to the European economy. Given the centrality of energy it remains—as it was in 1958 with the launch of Euroatom—a geopolitical necessity. Otherwise, a deep source of disunion will continue to drive European member states apart. Above all else, ambitious targets for EU-wide decarbonization are simply unrealistic without nuclear energy—but its use must be defined by a new strategy that would guarantee Europe’s energy security and resilience against energy-based extortion from foreign producers.

What does a peace pact on nuclear energy look like? 

 It is time to resolve divisive disputes on nuclear energy and find a compromise that defines the role of the power source in the energy transition. This will require a political—not a technocratic or a technical —decision. As a quarter of all electricity supply and about half of the low-carbon generation in the EU, nuclear energy is essential, strategic, and will complement the deployment of renewables and ensure energy security and independence.⁷⁵ Member states, principally Germany, should respect individual decisions to develop their energy mix as they see fit, as long as emission reductions are reached. Member states, principally France, also need to drop their hostility to the deeper integration of European electricity markets. Together they should look to a long-term solution on electricity pricing that can square the various circles holding Europe back. The EU should do this in ways which can help the strategically important sector overcome the politics of both German-led supranational opposition and French-led domestic underperformance. 

First, European member states, in particular France and Germany, should sign a peace pact on nuclear energy. This should take the form of a political neutrality agreement on the topic of nuclear energy that affirms that each state is free to choose its own energy mix, as is defined by the treaties, stops interference in these policies, and affirms there is no right to block member states wishing to launch, expand, or simply conserve their nuclear capacity. Both sides should acknowledge that nuclear and renewable energy will both play a vital role in reaching emission reduction targets. As a continent facing a rapid rise in temperatures, Europe has no time to lose to decarbonize its energy mix. But as a compromise this pact would recognize that nuclear energy generation is a complement, not a substitute, to renewable energy targets. Therefore, nuclear generating countries should commit—in exchange for the peace pact—to deeper integration of European electricity markets, new targets for the deployment of renewables, while supporting reforms to simplify and accelerate permitting, and investing in additional cross-border grid connections, with the support of EU money, via existing funding instruments and the European Investment Bank, whilst looking for a long term solution on electricity pricing. In practice, this means that France must abandon plans to subsidize all of its nuclear electricity production, including its requirement that CfDs cover existing assets. Not only would this contribute to a subsidies race on both sides of the Rhine, it would fundamentally undermine the workings of an integrated European electricity market, notably by making it impossible for France to agree to build the interconnectors Europe needs. Indeed, France would then be subsidizing electricity prices for all of its neighbors. 

Second, the Green Deal Industrial Plan (GDIP) and the Net Zero Industrial Act must be revamped.   The European Commission should adopt a technology-neutral approach, focusing on emission reduction targets rather than defining a list of strategic sectors. This approach would include placing renewable energy and nuclear energy on the same footing. This method, recently pushed by the Bruegel think tank, is more in line with the treaties enshrining the right of member states to design their energy mix.⁷⁶ This means that the nuclear industry should not be discriminated against, whether in access to European funding for research & development, nuclear waste treatment, or for nuclear-derived hydrogen.

Third, the benefits of nuclear energy are only fully reaped when strong supply chains exist, supported by skilled workers. The European Commission should ramp up efforts to support nuclear skill development, as well as research and development efforts. Europe, as recent problems in the French nuclear sector show, lacks crucial skills. Pursuing nuclear energy independence only works if a strong domestic industry can support and share markets for labor and materials that are not overly reliant on Russia. A critical policy objective should be to improve access to training and enhancing existing skills for operating nuclear energy equipment. Investing in skilled labor and materials across the nuclear supply chains will reduce capital and operating costs, address construction delays, and reestablish efficiency across the value chain. Fostering technological innovation should be another goal of EU energy policy. The majority of large European nuclear power plants are regarded as nearing the end of their operational lives, need better fuel efficiency, and face issues with water shortages. Member states will need to identify opportunities to address these deficiencies as part of their overall decarbonization strategies. Currently, there is an acute lack of resources across the board, as France’s problems illustrate. 

Fourth, the concerns of the anti-nuclear camp must be addressed with a focus on nuclear waste. While the benefits are clear, critiques against nuclear energy use—as voiced by Germany and its anti-nuclear allies—must be addressed. Even though safety precautions with nuclear power plants have dramatically increased since the Chernobyl disaster, the more-recent Fukushima incident convinced many—including the Green Party, which holds the crucial economic affairs and climate action portfolios in Germany’s cabinet—that the risks of nuclear power are too high. This must be addressed with a new focus on research into waste, safety, and nuclear management in any grand bargain.

Finally, in the same way that Europe has made drastic (and successful) efforts to reduce Russian gas dependencies, the European Union should be reducing the Russian presence in European nuclear markets, notably for Russian uranium.⁷⁷ This will require the continued authorization of new fuel sources to replace Russia’s supply, which has already begun. One recent case: Orano Mining, which is partially owned by the French state, concluded a memorandum of understanding with Kazakhstan to help the EU recognize the potential of the world’s largest uranium exporter.⁷⁸ On this point, France will need to pay heed to other member states’ concerns on the outsized influence that Rosatom has, especially in terms of enrichment capacities. This is an area where deepened cooperation between Europe and its Western allies can bring significant benefits. Indeed, spare capacity exists, notably in France, Canada, and the United States, across the different steps of the nuclear fuel value chain: from mining to conversion, enrichment, and fuel fabrication.⁷⁹

Conclusion 

The February 2022 invasion of Ukraine exposed the fragility of Europe’s dependence on Russian hydrocarbons for its energy needs. EU policymakers have acted impressively to mitigate the effects of short-term energy shocks, but measures for long-term resilience are losing momentum and are threatened by unresolved conflict around the role of nuclear energy in the energy transition, as demonstrated by the failure to even mention nuclear energy in the RePowerEU response plan. Failing to reach a European consensus on nuclear energy will further degrade political capital and trust, and additionally jeopardize ambitious targets for decarbonization that already seem out of sight. Nuclear energy, with its low-carbon and reliable electricity generation, can play a significant role in ensuring energy security and meeting decarbonization targets. However, it is currently stymied by both the politics of German-led supranational obstruction and French-led domestic underperformance. A “peace pact” on nuclear energy in Europe and a package to allow the nuclear energy sector to compete has the potential to accelerate broader energy transition policies, restore trust in consensus building, and reestablish the EU as a climate leader. This will be a political—not a technocratic or a technical—decision and requires European leaders to recapture the spirit of technological optimism and geopolitical purpose that first birthed Euroatom. In short, the spirit of the Atomium.  

Policy recommendations

• To resolve deep divisions, EU members should sign a peace pact on nuclear energy. This should take the form of a political neutrality agreement on the topic of nuclear energy that affirms that each state is free to choose its own energy mix, stops interference in these policies, and also affirms there is no right to block member states wishing to launch, expand, or simply conserve their nuclear capacity.
• To do so, subsidy schemes targeted at existing nuclear assets should be dropped, as they undermine the functioning of European electricity markets and its further integration via interconnectors.  
• To make this viable,EU members should agree to place renewable and nuclear sources of power on the same footing under the GDIP and NZIA. This would implement a technology-neutral approach to lowering carbon emissions.
• In exchange, nuclear generating EU members should commit to deeper integration of European electricity markets, new targets for the deployment of renewables, while supporting reforms to simplify and accelerate permitting, and investing in additional cross-border grid connections, with the support of EU money, via existing funding instruments and the European Investment Bank, whilst looking for a long term solution on electricity pricing.
• To strengthen such an effort, the European Commission should support nuclear engineering skills development, along with research and development capabilities.
• To address concerns, EU members should redouble efforts to research, address, and manage nuclear waste disposal. 
• Finally, EU members with Western allies should reduce their reliance on Russian sources of uranium. While fully decoupling from Russian uranium imports will likely be infeasible in the short to medium term, the EU should diversify its sources of uranium to avoid having the Kremlin keep its existing advantageous position in the EU uranium supply.

Related content

In-Depth Research & Reports Sep 6, 2023

Policy memo: A NATO-style spending target could fund long-term decarbonization

By Ben Judah, Francis Shin, Rachel Rizzo, Théophile Pouget-Abadie

EU member states and like-minded allies should set national-level spending targets, each based on a percentage of their respective annual GDPs, for decarbonization-related purposes. This would provide the basis of an international coalition that would ramp up global climate spending and set a useful benchmark to anchor high-level diplomatic discussions on the subject.

Climate Change & Climate Action European Union

Event Recap Apr 18, 2023

Decarbonization solutions for addressing Europe’s green industrial policy challenge 

By Transform Europe Initiative

The Atlantic Council co-hosted a high-level workshop on “Decarbonization solutions for addressing Europe’s green industrial policy challenge” in Paris with the German Council on Foreign Relations (DGAP) and Groupe d’études geopolitiques (GEG).

Energy Markets & Governance European Union

New Atlanticist Jun 1, 2023

The G7 can take NATO-EU climate cooperation to the next level

By Francis Shin, Rachel Rizzo

There is a strong opportunity for meaningful NATO-EU cooperation by using the Group of Seven as a convening platform for climate change-related discussions.

Climate Change & Climate Action Energy & Environment

About the authors

Ben Judah is director of the Transform Europe Initiative and a senior fellow at the Atlantic Council’s Europe Center. He is the author most recently of This Is Europe and his research interests focus on the geopolitics of decarbonization, Britain and the European Union.

Rachel Rizzo is a nonresident senior fellow at the Atlantic Council’s Europe Center. Her research focuses on European security and the transatlantic relationship.

Théophile Pouget-Abadie is a nonresident fellow at the Atlantic Council’s Transform Europe Initiative and policy fellow at the Jain Family Institute.

Jonah Allen is a nonresident fellow with the Atlantic Council’s Europe Center and a research fellow at the Jain Family Institute.

Francis Shin is a research assistant at the Atlantic Council’s Europe Center.

Acknowledgements

The authors would like to thank Dr. Jennifer Gordon, Dr. Matthew Bowen, Shahin Vallée and Cécile Maisonneuve for their invaluable insights and feedback in the writing of this report.

The post How to strike a grand bargain on EU nuclear energy policy appeared first on Atlantic Council.

It therefore came as a surprise to see the US Treasury Department’s undersecretary for international affairs, Jay Shambaugh, give a tough appraisal of the IMF and its leadership in a September 7 speech at the Center for Global Development. Shambaugh urged the institution to use its economic surveillance mandates to “speak truth to power,” and he urged the IMF to insist on stronger economic reforms in its programs intended to help countries out of financial difficulties. In addition, he argued for restoring the traditional division of labor between the IMF and the World Bank by letting the Bank focus on “structural” policies—such as climate change adaptation and mitigation—and keeping the IMF concentrated on macroeconomic developments.

Although couched in careful language, his critique no doubt caught the attention of the IMF’s management team. Shambaugh argued that the IMF was deficient in some core areas. And he called for the IMF to pull back from its climate-related work, which has been a major area of focus in recent years. 

Shambaugh’s speech did have a larger aim, however. By reminding his audience of the IMF’s true purpose, the speech sought to prepare the ground for a capital increase (also known as a quota increase) that could boost the institution’s lending capacity. Unlike the World Bank and other multilateral development banks (MDBs), which use their capital to borrow private money through bond issuances in global markets, the resources for IMF loans are directly provided by its largest shareholders, especially those whose currencies are globally traded. A capital increase for the IMF could therefore signal larger loan volumes, providing additional financial relief to borrowing countries if deployed properly.

Shambaugh’s remarks should be seen as part of the Biden administration’s strategy to employ multilateral lenders for geopolitical advantage. In pushing for an IMF quota increase, the United States is trying to deflect criticism that the Western world is failing to help low-income and developing countries reduce poverty and mitigate the effects of climate change. By itself, this is a laudable effort, and leveraging loans by multilateral institutions is a realistic strategy, given tight public budget constraints in the face of rising debt levels and high interest rates.

To make this strategy work, however, the United States needs to step up its engagement at the IMF. That’s because capital is not the biggest constraint on IMF lending.

Issue Brief

Oct 9, 2023

The Bretton Woods institutions under geopolitical fragmentation

By Martin Mühleisen

Given China’s current resource advantage, Western countries need to make better use of the IMF and World Bank where doing so is in their interest. If applied more broadly, this approach could provide incentives for other governments to return to multilateral institutions, instead of China, for support.

China Economy & Business

The IMF’s outstanding credit volume is currently around $150 billion, which is equivalent to only 24 percent of its capital or 15 percent of its total lending capacity (which includes funds that the IMF could borrow from large member countries in addition to its capital). Increasing the IMF’s capital would likely occur against a reduction in borrowing agreements (in part because the United States would be unlikely to get fresh funds appropriated by Congress), with the result being that the IMF’s overall lending capacity would likely remain unchanged at around one trillion dollars.

Therefore, a decision to increase loan limits for individual countries does not depend on a capital increase. Underpinning IMF lending with a larger capital base would of course be beneficial, but the IMF still has ample resources to lend, and its preferred creditor status provides a strong protection against potential loan losses.

This gets to the real issue facing the IMF: whether its policies and lending practices can ensure that higher loan volumes will be put to good use and eventually repaid. Shambaugh’s remarks do not reflect much confidence in the IMF’s current ability to do so, given the problems it has encountered with large borrowers that are grateful for the money but reluctant to live by the conditions that are attached. Argentina, which reneged on its fiscal targets right after the last loan tranche was received, is the most brazen example, but there are other countries that have come back time and again for more loans without addressing their underlying structural problems.

It is here where the United States and other large shareholders need to primarily engage. With their majority in the IMF Executive Board and geopolitical clout, the Group of Seven (G7) and associated countries need to find ways to hold IMF management responsible for bad lending decisions, while incentivizing borrowing countries to uphold their end of the bargain.

This may not be the arms-length arrangement that the IMF’s founding members intended when they set up the Bretton Woods institutions. However, in today’s geopolitical environment, in which China and other countries are actively undermining the existing global order, Western countries don’t have much of a choice unless they are prepared to see the IMF lose more of its already diminished effectiveness.

Unlike in 2005, the United States needs to engage forcefully to keep the IMF fit for purpose. Shambaugh’s speech was smart politics, putting China on the spot to support a capital increase without providing for an overdue increase in its voting share. But this is not the end of it. The United States needs to ensure that the IMF’s fundamental business model remains valid: Loans should only be provided in exchange for economic reforms. Anything else would undermine confidence in the world’s official lender of last resort and deprive Western democracies of a critical asset in their fight to maintain a rules-based global economic order.

Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF official with decades-long experience in economic crisis management and financial diplomacy.

The post The United States just sent a strong message to the IMF appeared first on Atlantic Council.

Introduction

The economic and military rise of China presents Western democracies with a challenge unlike any they have faced since the inception of the Bretton Woods system.¹ The Warsaw Pact was too weak to question the West’s economic dominance during the Cold War, but China—with its successful brand of state capitalism—has turned into a formidable competitor. It has become the largest trade partner for many countries, and the Belt and Road Initiative (BRI), despite its shortcomings, has made geopolitical inroads into the Global South that the West has struggled to match.

As the West has begun to respond to the challenge, concerns about economic fragmentation have intensified after Russia’s attack on Ukraine and increasing military tensions in the Taiwan Strait. Both China and Western countries are considering means to shore up critical supply chains and reduce strategic dependencies on each other. Global trade volumes have not yet been affected in a significant way, but a growing web of trade and investment restrictions has had a chilling effect on economic sentiment.

This dynamic also throws a shadow over the work of the International Monetary Fund (IMF) and World Bank, as well as other institutions created to support free markets and open trade. Nations that were once dependent on multilateral institutions for development funding, investment projects, and emergency aid now have the opportunity to secure economic and financial assistance from other creditors with less benign interests. Moreover, a shift toward protectionist trade policies, and the sanctioning of foreign exchange reserves by the United States and its allies, has diminished the West’s standing in many capitals around the world.

On the other hand, the US dollar’s central role in the international monetary system, of which the Bretton Woods institutions are an integral part, still provides the West with a significant advantage. The renminbi may challenge the dollar’s dominance at some point, but China’s efforts to internationalize its currency have so far been met with only modest success.

Nevertheless, the Bretton Woods institutions clearly lost influence in recent years. With many emerging markets enjoying stable market access even during the COVID-19 pandemic, the IMF and World Bank have been left to work mostly with low-income countries and a few larger countries with chronic economic problems. Many of those countries require debt restructuring to allow multilateral loans to resume, but China’s long-delayed debt workouts are effectively blocking the Bretton Woods institutions from fulfilling their mandate. Moreover, program countries question why they should subject themselves to the advice or conditionality of institutions in which they have little say, given that governance arrangements remain strongly in favor of the United States and other Group of Seven (G7) countries.

As a result, both institutions have been in search of a new role for themselves. The World Bank (along with other multilateral development banks) is looking to leverage its capital base to step up climate and development loans, and the IMF has repurposed dormant Special Drawing Rights (SDR) reserves provided by its richer members to increase its concessional loan volume, a model that could be also adopted by other multilateral lenders. Both approaches contain elements of financial engineering, reflecting tighter budgets in member countries and diminishing political support for development aid, even among traditional donor countries.

These efforts are intended to help meet large climate and development financing needs in the Global South. Moreover, multilateral institutions can be instrumental in attracting private capital to the climate fight, provided that loans fulfill their objectives and are being repaid with sufficient return. Recipient countries will, therefore, need to put any additional funding to good use, an issue that has so far attracted less attention than the intricacies of leveraging development banks’ capital base. Bretton Woods shareholders should encourage an effective division of labor among the institutions, insist on sensible loan conditionality, and, where necessary, actively support governments in meeting program targets.

However, stepped-up climate lending will not be enough to win the struggle for hearts and minds in the Global South. Given China’s current resource advantage, Western countries also need to make better use of the IMF and World Bank where doing so is in their interest. For example, to incentivize critical reforms and boost growth prospects in partner countries, multilateral financing should be flanked by co-financing, investment finance, specific trade preferences, or other forms of geopolitical support that increase the chances of program success. Unlike previous efforts, this attempt has to be meaningful and better coordinated between Western shareholders for maximum effect and burden sharing.

The example of Ukraine has set a precedent for how the institutions can be part of a strong allied effort to support a partner country within their multilateral setting. If applied more broadly, this approach could provide incentives for other governments to return to multilateral institutions, instead of China, for support. However, Western shareholders must be careful to stay within the institutions’ rules-based framework and operate on a consensual basis, where possible. The multilateral character of the IMF and World Bank is an international public good that the West would be well advised to preserve.

If and when the political climate were to turn back toward multilateral collaboration, the Bretton Woods institutions could play an important role in helping the global economy to defragment, just as they did in the years after World War II. At that point, voting shares in the institutions should be adjusted to correct the significant underrepresentation of China and other emerging markets. In the meantime, the West should identify other ways to raise the influence of the Global South, including on the two boards and in the selection of management positions.

I. China’s rise and the mulitlateral order

China rose to become the world’s second-largest economy on the back of a mercantilist economic policy that exploited Western countries’ commitment to free trade and open markets. Although a member of the World Trade Organization (WTO) since 2001, it successfully leveraged a comparative advantage in labor-intensive manufacturing through unfair trade practices to become the world’s major exporter.

While benefiting from the existing multilateral international order over several decades, China has also been turning inward for some time to replace its dependence on net exports with domestic sources of growth. Aggressive trade measures by the United States may also have prompted China to double down on domestic demand and support for domestic innovation. In 2021, China’s Communist Party embraced a strategy of “independence and self-reliance” that seeks to both establish global leadership in key technologies and secure access to the raw materials needed to reach this objective. As part of thisstrategy, China has been developing partnerships with countries in the Global South and is building up military strength, challenging US naval dominance in the Western Pacific and elsewhere.

The Belt and Road Initiative

International finance is one area where political tensions between the two camps are playing out. China has turned its BRI into a major strategic initiative to expand its presence and deepen diplomatic relations with a range of countries around the globe, predominantly in Africa. Besides generating diplomatic goodwill and deepening political relations, the initiative has helped China invest parts of its large dollar-denominated reserve holdings, estimated at up to $6 trillion, as well as promote the use of the renminbi abroad.

Although the BRI is nominally a tool to assist global development, China itself has benefited from it in major ways. It has been able to generate employment by exporting construction services to build large-scale infrastructure—including railways, highways, ports, and airports—financed by Chinese financial institutions. In many cases, this infrastructure facilitates the transport of goods destined for Chinese markets, such as oil or raw materials. Indeed, with China being a major energy importer, some analysts have seen the BRI predominantly through the lens of China’s economic and military security benefits.

From the perspective of recipient countries, the BRI has been more controversial. It has been criticized over shoddy project implementation, lack of transparency, onerous financial terms, and a growing debt burden for recipient countries. In some cases, Chinese lenders have financed prestige projects of local political leaders that had few tangible benefits, fostering corruption and debt dependence. In cases where countries encountered difficulties in repaying their loans, China has insisted on having first recourse to export revenues and was slow to restructure excessive debt burdens, which has generated considerable hardship for countries such as Angola, Ethiopia, and Zambia.

More recently, China’s state lenders have reduced their BRI loans, facing increasing pushback, but China’s commercial banks appear to have taken up the slack. China, therefore, remains a key lender for emerging markets and developing economies, rivaling the activities of the Bretton Woods institutions and multilateral development banks in the Global South.

The battle for influence in global institutions

China is using its growing economic and geopolitical clout with the Global South to actively reshape international relations in its favor. On the one hand, China has been seeking greater influence in existing multilateral institutions. While stepping up its donor engagement in the Bretton Woods institutions, it has gained more influence in the United Nations (UN), where it benefits from the “one county, one vote” principle. For example, China currently holds the leadership of four of the UN’s eighteen specialized organizations and agencies. These include agencies that would provide China with platforms to advance its own standards in several key technologies and economic sectors, potentially securing competitive advantages over Western countries. On the other hand, when facing opposition within multilateral institutions, China has sought to use multilateral or bilateral mechanisms to either bypass existing institutions or create new ones, such as the New Development Bank (NDB) or the Asian Infrastructure Investment Bank (AIIB), to increase China’s influence in developing global rules and standards.

China is not the first country to use economic leverage to gain global influence, of course. The United States, as well as the United Kingdom (UK) and France with their historical colonial ties, have followed similar strategies in the past. In principle, the governance arrangements of the Bretton Woods institutions are flexible enough to accommodate shifts in countries’ global economic and financial relevance. However, China’s approach to human rights and political and individual freedoms, and the degree of state control its one-party system exerts on the economy, are fundamentally incompatible with the liberal economic foundation that underlies the Bretton Woods institutions. This incompatibility has become a major stumbling block for governance reform, a major point of contention in the two institutions.

The “fence sitters”

In the shadow of geopolitical tensions between China, Russia, and the West, a number of larger (and mostly wealthier) emerging markets have begun to chart a more independent political course in recent years. As countries like Brazil, India, and Indonesia, along with Saudi Arabia and the Gulf states, have gained in economic weight in recent years, they also became more successful in maintaining macroeconomic stability and reducing the need for official and multilateral assistance. Despite limited room for fiscal policy, most of these countries successfully withstood the COVID crisis and a sharp rise in US interest rates that might have warranted programs with the IMF in earlier years.

Reflecting their economic strength, as well as newfound confidence, these countries have been quietly assuming a larger role in several multilateral organizations. They have also been careful not to become entangled in the battle between major powers, instead keeping their policy options open and making decisions on a case-by-case basis. This independence become strikingly evident in the voting outcome of several UN resolutions that condemned Russia’s invasion of Ukraine in early 2022 (see chart). Although the resolutions were passed with the votes of around 80 percent of UN member countries, the majority was much smaller when measured in terms of global economic weight (between 64 and 72 percent) or world population (43 percent), owing particularly to the abstentions of India and China.

This outcome does not imply that all of these countries share autocratic tendencies or seek to curb relations with the West. Rather, the willingness to deviate from the West stems from long-standing economic and geopolitical relationships with China and Russia that countries are careful not to jeopardize, echoing the Non-Aligned Movement from Cold War days. Moreover, countries now have more room for opportunistic policies that enhance their national interests, as well as their governments’ domestic standing. Some leaders play on what Daron Acemoglu has called the “new nationalism,” building their careers on historical grievances against Western powers and the erosion of long-standing traditions and social norms as a result of globalization.

So far, the rise of these “middle powers” or “fence sitters” has played out largely within the existing UN and Bretton Woods architecture. This could be about to change, however, given the reported interest of more than forty countries in joining the BRICS (Brazil, Russia, India, China, and South Africa) bloc and its affiliated financial institution, the NDB, headquartered in Shanghai. There has also been speculation that the BRICS countries might discuss the potential establishment of a common currency to enable member countries to circumvent US sanctions in their dealings with Russia and China.

Figure 1. UN Resolution ES-11/L.5 Supporting Ukraine’s Territorial Integrity (By share in global GDP and world population)

II. The slow decline of the Bretton Woods Institutions

What do these changing geopolitical circumstances imply for the Bretton Woods institutions? To answer this question, it is best to start from where the institutions stand today, less than two years after the end of the COVID pandemic.

The Bretton Woods twins’ original mandate was to help with reconstruction after World War II and to prevent a repeat of the Great Depression. The IMF, in particular, was to address economic and financial imbalances to preserve the efficient functioning of a gold-based fixed exchange-rate system, enabling the expansion of free trade and higher long-term growth. The system hardly worked as intended, however, and the United States moved the dollar off gold in 1971. Most importantly, the United States and other members were not prepared to subsume sovereign interests under the authority of international institutions, even when they had a controlling influence on their boards.

The IMF and World Bank nevertheless played an important role during the rapid phase of globalization after the collapse of communism. Acting as firefighters during major crises, their programs provided important liquidity support during the Latin American debt and peso crises, the Asian crisis, the global financial and European crises, and, more recently, the COVID crisis.

Retreat from multilateralism

The institutions have not been without controversy, of course. Opposition parties of all colors have always accused the Bretton Woods institutions of pushing for excessive austerity, and the policies of the “Washington Consensus” became synonymous with pictures of street protests and abject poverty in developing countries. Its loans still carry a stigma that countries are trying to avoid at all costs, and calls for market reforms and tight fiscal budgets are undermined by nationalism and protectionist policies moving back on the agenda in industrial countries, too. The World Bank has been subjected to criticism for the environmental consequences of its lending programs, and for not doing enough to help the fight against climate change and bring poverty down on a global scale.

Moreover, the Bretton Woods twins have long ceased to be the towering giants in their respective fields of work. Their staff is still composed of excellent economists, valued as technical advisers to central banks and governments, and their training courses and technical assistance are a global public good that remains in high demand. Nevertheless, compared to even a decade ago, hands-on macroeconomic and development expertise is now in much larger supply, including in central banks, academia, think tanks, and global financial institutions. There have also been concerns about the IMF’s repeated failure to detect and prevent the buildup of large economic imbalances, including the crises in the 1990s and 2000s, as well as the sharp increase in post-COVID inflation.

Many countries did benefit from the work of the two institutions, of course. In fact, most lending programs achieve at least a modicum of success, especially when they are based on a strong societal consensus (as in Jamaica, for example). On the other hand, because emerging markets already knew since the 1997 Asian crisis that they needed larger reserve cushions to protect themselves against capital outflows, Bretton Woods loan volumes have come down significantly in terms of gross domestic product (GDP) in recent decades (see chart).

Figure 2. World Bank and IMF lending (% world GDP)

More broadly, major shareholders’ political support for multilateral institutions and their policy advice has been steadily on the decline. This has been most visible in the area of free trade, especially after the United States shut down the WTO’s Appellate Body in late 2019. As for the IMF, the task of coordinating economic and financial policies for the world economy shifted first to the Group of Seven (G7) and then to the Group of Twenty (G20). In these forums, the world’s largest economies discuss their agendas under the spotlight of a global audience that has long lost interest in the minutiae of board discussions at the Bretton Woods institutions.

Outdated governance arrangements

The rise of the G20 reflects, among other things, that the governance arrangements of the Bretton Woods institutions are fundamentally out of touch with economic reality. Using the IMF as an example, the last agreement to adjust capital and voting shares dates to 2010, aimed at achieving a shift of five percentage points from industrial to emerging markets. This agreement took more than five years to implement, due to a lengthy ratification process in the US Congress, and no further adjustment has taken place since.

The IMF regularly calculates how much current voting arrangements are out of line compared to a formula that has long served as a yardstick for each country’s quota, or capital share. This “calculated quota share” is a weighted average of nominal GDP (50 percent), the sum of receipts and payments in the external current account (30 percent), the variability of current account receipts and net capital flows (15 percent), and official reserve holdings (5 percent).²

The aggregate misalignment between actual and calculated quota shares was about fourteen percentage points in 2020, half of which were accounted for by China (Chart X). As a group, member countries of the Association of Southeast Asian Nations (ASEAN) are also undervalued, reflecting their strong growth in recent years. On the other side, many more countries are overrepresented on the IMF board, with the United States, Japan, and France, along with other European countries, accounting for around 40 percent of the overvaluation.³

Figure 3. IMF quota out-of-lineness (In percentage points)

The difference between quota shares and their formula-derived values is only half the story, however. Historically, the prime beneficiaries of the current quota formula have been small European countries with open economies. They are benefiting from the fact that GDP only accounts for half of the calculated share, with the other half reflecting a country’s participation in international trade and reserve holdings, including intra-European Union (EU) commerce.

This discrepancy becomes evident when comparing the UK and EU countries’ combined voting share (about 30 percent) with that of the United States (17 percent)—although both economies are broadly of the same size and have a similar degree of economic openness. The large influence of Europe is further enshrined by the fact that smaller European countries have formed constituencies with countries in the European periphery that guarantee them a seat on the executive board on a fairly regular basis.

The current stasis of the quota debate can be roughly described as follows.

• First, as long as the United States remains the issuer of the world’s major reserve currency (and, thus, the main backer of the IMF’s Special Drawing Rights), it will be unlikely to give up its veto power. It would otherwise risk ceding control over at least some aspects of its money supply to the IMF, given that most borrowers use their programs to gain access to US dollars. The United States would, therefore, maintain a voting share above 15 percent.⁴
  Second, a major block of votes would need to shift from industrial countries to emerging-market countries. This would involve a substantial decline in the share of European countries and Japan, which would be subject to enormous political obstacles.
• Third, China is unlikely to agree to any outcome that will not see its voting share increase. This prospect looks remote, however, given the increase in geopolitical tensions. One formidable obstacle in this regard is the need to secure US congressional approval, but ratification would also be an uphill political battle in other countries.
• Fourth, the negotiations are complicated by the fact that many industrial countries, large and small, contribute considerable resources to various borrowing agreements and trust funds that allow the IMF and World Bank to operate as they currently do. These contributions might be politically at risk once countries have a decreasing influence over the institutions.

A related debate concerns the voice of low-income countries at the two institutions—in particular, those in Africa. At the IMF, there are currently two executive directors from the region, broadly representing French- and English-speaking countries. At the World Bank, Angola, Nigeria, and South Africa jointly hold an additional seat. However, African countries have long argued for additional seats at the two boards, which would increase their voice and reduce constituency sizes to a more manageable level.

III. Benign neglect? The role of major shareholders

Debates about the governance of the Bretton Woods institutions would presumably be less intense and bitter if the institutions were seen as fully delivering on their mandate of helping member countries achieve stronger and stable growth, reduce poverty, and promote sustainable development. It is hard to deny, however, that the IMF had some key responsibilities taken out of its remit by the G20, that the World Bank has been left underfunded relative to what it has been expected to achieve, and that China has been blocking lending activities by interfering with orderly debt-restructuring processes. In that sense, major shareholders bear a key responsibility for the gradual decline of the institutions. It was in particular the 2008 global financial crisis that exposed a major shortcoming in the IMF’s role as global lender of last resort. At its core, the crisis originated in the US and European (shadow) banking systems that catalyzed unsustainable booms in the US and European periphery.⁵ As an institution lending to sovereign nations, the IMF had neither the funds nor the tools to provide liquidity injections of sufficient magnitude into the global financial system. Instead, it fell to the US Federal Reserve to keep financial institutions afloat during the crisis, both by increasing money supply in the United States and by extending swap lines to other central banks with large dollar needs. The IMF and World Bank were left to deal with the aftermath, helping countries that had neither access to the major central banks’ swap network nor the reserves to weather the shocks by themselves.

Figure 4. Financial firepower (trillions of USD)

The 2008 crisis also provided a boost to regional initiatives aimed at mitigating the impact of global shocks. Led by the European Stability Mechanism and the Chiang Mai Initiative Multilateralization (CMIM), regional financing arrangements (RFAs) have become an important part of the global financial safety net, relegating the IMF to third place in the hierarchy of global emergency financing (see chart).

This development reflects individual policy choices of large IMF shareholders. Central bank swap lines were set up to meet major central banks’ domestic policy objectives, and large members of the euro area  as well as Japan, China, and South Korea were instrumental in the establishment of their regional safety nets. This was done partly for want of adequate global alternatives, and partly in response to political pressure for larger independence from the United States, which had until then been at the center of global rescue efforts. One could regard this as an early sign of geoeconomic fragmentation, caused not by geopolitical tensions but, rather, by a growing sense of regional identity in the wake of crisis seen as originating in the United States.

Weak oversight of large programs

A similar pattern could also be observed during the COVID crisis. While RFAs on the whole were not activated during the pandemic, the number of central bank swap lines increased, including on the part of the People’s Bank of China, which has increasingly become a lender of last resort in its own right. The IMF and multilateral development banks were called upon to help countries that did not have large-scale access to either source of financing.

Figure 5. IMF credit outstanding by borrower, May 2023

A few of those countries benefited from the IMF’s Flexible Credit Line, receiving sizeable precautionary arrangements that involve no explicit conditionality, but most other countries had to apply for standard IMF and World Bank programs. While many of those have been successful, the lenders are also dealing with a significant number of problem loans.

Troubled programs include several emerging markets that have received fairly sizeable loans, both in absolute terms and relative to their IMF quotas, which is the common yardstick used to ensure equitable access to the IMF’s resources (see chart). These countries have repeatedly asked the IMF for support in recent years, given their lack of durable market access. IMF conditionality should, in principle, have helped countries overcome their political and structural obstacles, but this has demonstrably not been the case.

Argentina, for example, has done little to reform its economy over the years, keeping a large share of its citizens dependent on favorable commodity prices and public handouts. Egypt’s programs have similarly failed to produce the hoped-for impulse to export-led growth, not having reduced the military’s large role in the economy. Pakistan has been caught in a cycle of on-and-off programs with the IMF for decades, but the underlying fiscal and structural problems remain unchanged, with the army frequently interfering in the political process. Ecuador will likely need another IMF program as the repayments from the previous program fall due, with the political future of economic reforms much in doubt.
These developments suggest that support for the principle of “financing against reforms,” supposed to be the bedrock underlying the IMF’s lending operations, is crumbling among IMF’s shareholders. This complicates program negotiations with other countries, who would insist on evenhanded treatment; it creates financial risks for the institution; and, most importantly, it does not help the citizens of program countries who fail to see an improvement in their economic situation. Without the support of major shareholders—both inside the board room and on a bilateral level—IMF staff simply do not have the political heft to convince reluctant authorities of the need for major reforms. This is especially true where political pressures or management interests favor loan disbursements being paid out in time.

Lack of development finance

The Bretton Woods institutions appear similarly unable to help the developing world escape an endless cycle of underinvestment in human and physical capital, trade shocks, rising debt, political instability, and violence. Apart from a few countries—including Nigeria and other so-called “frontier markets”—prospects for other countries continue to look bleak. Out of thirty-nine countries now classified by the IMF and World Bank as “in debt distress” or at a “high risk of overall debt distress,” twenty had received significant debt relief through the Heavily Indebted Poor Countries (HIPC) initiative around the turn of the millennium, indicating the sustained presence of macroeconomic difficulties (see Table 1).

Table 1. LIDCs eligible for concessional Bretton Woods loans, July 2023

This outcome certainly reflects idiosyncratic problems in each country, but a lack of concessional financing has also contributed. According to the Organisation for Economic Co-operation and Development (OECD), official development assistance (ODA) in real terms reached an all-time high in 2022, but humanitarian aid and the domestic cost of absorbing growing numbers of migrants and refugees accounted for much of the increase in recent years. By contrast, bilateral ODA to low-income and developing countries fell slightly in real terms, and for sub-Saharan Africa it declined by 8 percent last year. During COVID, the Bretton Woods institutions’ emergency loans (free of explicit loan conditions) and a $650-billion SDR issuance in 2021 provided some relief, but the small amounts per country demonstrated yet again how far the poorest countries have been left behind by the rest of the world.

Finally, while multilateral institutions have long been the largest source of financing to low-income and developing countries, they are now facing three problems in stepping up their lending volumes. First, the lack of donor financing to pay for interest-rate subsidies has constrained their concessional lending capacity. Second, African countries have also become more reluctant to accept outside policy prescriptions—unsurprising in light of the example set by larger countries—which reinforces concerns about the effective use of financial assistance and hurts fundraising prospects. And third, the high indebtedness of poor countries has placed limits on the amounts of financing that multilateral institutions can provide without more fundamental debt restructuring.

China’s block on debt workouts

The last point puts the spotlight squarely on China’s ambivalentrole as the largest official lender to developing countries. To highlight how much the sovereign debt landscape has shifted, Chart X shows that multilateral institutions and Western countries (organized in the Paris Club of official creditors) accounted for about 85 percent of all loans to low-income countries in 1996.⁶ That share had fallen to 62 percent by 2020, replaced by non-Paris Club creditors (mostly China), bondholders, and other private creditors.

These changes diminish the leverage that multilateral lenders have in promoting sound policies and good governance. First, governments now have the possibility to receive sizable bilateral loans without major policy conditions (even if Chinese lending terms overall are much less concessional and may include unrelated political conditions). Second, once China is a major official creditor, the process of debt restructuring tends to be much slower than under the Paris Club framework.

This is because, by statute, the Bretton Woods institutions are unable to lend if a country’s debt is viewed as unsustainable. Any subsequent debt restructuring used to be a well-defined process under Paris Club rules. With China and other non-Paris Club members involved, however, the process is defined by the 2020 G20 Common Framework, a much less structured exercise that is not binding on participants and leaves significant room for bilateral discussions. After the first cases took several years to move forward, the pace of restructuring may accelerate after creditors reached agreement on Zambia in June 2023. However, China still retains considerable leverage as a key creditor and trade partner to many countries. While the Common Framework may provide some reprieve, there is reason to expect further challenges to the Bretton Woods system. China and Russia already tried to increase their global influence by expanding the BRICS group, and China may step up lending though the NDB, which recently doubled its loan capacity from $50 million to $100 billion.⁷

Even so, there is no evidence that China will be more successful in helping creditor countries achieve higher sustainable growth paths than those under the existing multilateral system. On the contrary, experience with the BRI suggests that advantages accrue mainly to China in the form of exports of construction services, access to raw materials, and deepening security and military ties, often with corrupt government elites at the expense of the broader population.

Figure 6. Creditor base for the PRGT-eligible countries: 1996 vs. 2020 (Percent of total external debt)

A wake-up call

Taken together, these trends do not bode well for the future of the multilateral system. Outdated governance arrangements and underperforming programs with large politically connected member countries are not a recipe for success in a competitive geopolitical environment. Moreover, as China has begun to set up a parallel financial universe with countries in the Global South, the Bretton Woods institutions’ influence on policy decisions has been declining.

The IMF and World Bank, therefore, need to find a new modus operandi if they are to remain relevant in today’s geopolitical environment. It is possible that the G7 and the Western allies may have taken the institutions for granted for too long, deluding themselves that a hands-off approach to problems outside the advanced- and emerging-market universe could be left to technocratic institutions with little oversight. If so, the experience of the past few years should have served as a major wake-up call.

IV. Climate finance as an opportunity

The declining relevance of the Bretton Woods institutions has not gone unnoticed inside the institutions, or by civil society. Under pressure from many corners, they recognized early on that they needed to become more active in the fight against inequality, and—most of all—support global efforts to combat climate change.

The latter has now become a major focus for the institutions to redefine themselves. It starts from the observation that financing needs in the Global South are extraordinarily high. According to World Bank President Ajay Banga, trillions of dollars annually would be needed to meet climate and development goals in the developing world. As this imperative has not yet translated into major funding increases, given tight budgets everywhere, the institutions and their major shareholders are now looking for additional sources of money.

In particular, the G20 has embarked on a discussion to allow multilateral development banks to extend more loans on their existing capital base, subject to preserving high credit ratings that allow loans to be extended at concessional interest rates. Several countries have also donated parts of their SDR holdings to increase the amount of concessional loans that multilateral organizations can provide, while the World Bank is exploring ways to attract private capital to fund additional climate loans.

…But climate finance needs to be sustainable, too

Amid the newfound momentum, however, it must be kept in mind that the IMF and World Bank are financial institutions. This means that they will only be able to serve as effective facilitators, let alone catalysts for attracting private capital, if loans are being repaid and they are able to preserve their own financial standing. This aspect is often neglected in discussions of ever-growing financing envelopes, and one should guard against unrealistic expectations. Ajay Banga, the newly elected World Bank President, summed it up well by saying that it would be important to achieve “a better bank” before asking for a bigger bank.

Some activists might hope that loans could eventually be forgiven or “cancelled,” implicitly transforming official loans into climate or development grants. However, setting up recipient countries for a repeat of the HIPC experience of the late 1990s and early 2000s would be highly detrimental to their development objectives. Instead, shareholders of multilateral institutions should hold their management responsible for proper program design, while asking recipient countries to spend funds appropriately and live up to their policy commitments.

What should be the role of the Bretton Woods Institutions?

Meeting and managing the demand for climate and development finance should, in principle, play to the strengths of the Bretton Woods institutions. They should be able to intermediate additional climate funds by applying their-time tested model of cooperation.

• The project-based nature of climate finance implies that multilateral development banks should be on the frontline assisting countries in project selection, design, and implementation. Funds should be spent in a way that generates the largest possible return for the country’s citizens. This requires a realistic assessment of a country’s implementation capacity and the long-term costs and benefits of projects that could be financed.
• Using its newly developed analytical toolkits, the IMF should help countries manage the macroeconomic effects of a significant pickup in borrowing and project spending (including possible exchange-rate appreciation, wage and price pressures, or a pick-up in rent seeking and corruption). The IMF would also signal to lenders that their funds are well spent and debt remains sustainable even under new climate challenges, helping to unlock more financing. This would be mostly in the context of IMF surveillance, but traditional loans would also remain available.

Governments should have powerful incentives to ask for climate funds. For many countries, mitigating the effects of climate change is of an existential nature, which should help concentrate political support behind any measures that may be needed to qualify for additional loans. And improvements in public expenditure management, governance, or debt transparency, for example, would enhance a country’s capacity to attract private-sector capital as well, possibly kickstarting a virtuous circle that could lift growth prospects and help countries make progress toward their Sustainable Development Goals.

The IMF’s climate facility: Put it back where it belongs

As shareholders of the two institutions contemplate a way forward, however, they would be well advised to correct an earlier decision that conflicts with the optimal division of labor. The first institution to introduce an SDR-backed lending facility for climate purposes was the IMF, an institution normally not engaged in project finance. The fund crossed that line in 2022 by setting up its Resilience and Sustainability Trust (RST) to provide long-term concessional financing with a twenty-year maturity for climate purposes.⁸ The RST gives access to 143 countries, including China and Russia, for example, but also a group of highly indebted small island economies not otherwise eligible for concessional loans. There have been ten recipients so far, with a total loan volume of about $4 billion.

Unfortunately, the setup of the RST is too complex for its own good. RST recipients are required to negotiate a regular IMF program in parallel, which is intended as a financial safeguard for donor countries. This creates an important conflict of interest. On the one hand, there are strong expectations for the RST to be quickly channeled to intended recipients. On the other hand, countries would probably not apply if they were faced with hard policy demands, given relatively modest loan amounts. Especially when tied to a moral cause such as climate reparations, this raises questions about program quality and makes it hard for lenders to halt loan tranches if borrowing countries fail to comply with the terms of a loan.

One important motivation for creating the RST at the IMF came from shareholders’ dissatisfaction with the World Bank’s climate work under its previous president. However, the bank is already heavily involved in defining the scope and conditionality of RST climate objectives, and it is now again under competent leadership. It would, therefore, be sensible to disentangle the link to full-fledged IMF programs and transfer the remaining trust fund resources to the World Bank when the facility is up for a full review in 2025. This would not change the ultimate use of those funds, but it would allow each institution to refocus on its respective strengths, eliminate a bureaucratic nightmare caused by the RST’s dual-program structure, and permit climate-specific project skills to again be concentrated in one institution for maximum synergy.

Good geopolitics, but not enough

Western countries are not only morally obliged to help the Global South advance on its climate transition; it is also a geopolitical necessity. Following the delayed provision of vaccines and other medical supplies during the pandemic, a failure for the West to provide urgently needed climate assistance could badly backfire. On the other hand, hopes for a meteoric increase in available climate funds (and their potential to quickly deliver large-scale climate victories) are likely to be disappointed. Developing countries are also likely to argue that any funds being provided reflect only a small share of the cost their countries have suffered from climate change as a result of historic carbon-dioxide (CO₂) emissions.

Climate finance will, therefore, not solve the Global South’s resentment of overbearing Western countries—but not pursuing it would make things worse. The only option for multilateral development banks is to increase their funding capacity and serve as a catalyst for private investment, based on well-designed programs. Alternative means, such as raiding the capital base of the institutions, liquidating the IMF’s hidden gold reserves, creating an oversupply of SDRs, or watering down lending standards would not be sustainable, and should be firmly resisted. It would compromise the long-term ability of multilateral lenders to both help the global climate effort and fulfill other important tasks under their mandates.

V. The need for plurilateral action

The West has a strategic interest in keeping the Bretton Woods institutions strong, having invested so much financial and intellectual capital in them over the past eight decades. As the global economy is undergoing massive structural change from political, demographic, and technological factors, there is no shortage of areas to analyze, and new crises will continue to lead to requests for financial support. But if advice is not being followed and programs do not succeed, the institutions will continue to shrink in relevance, which would play into the hands of the West’s geopolitical rivals.

A first step would be to reflect on how the institutions could better fulfill their core mandate, from economic truth telling to project financing and macroeconomic adjustment programs. There is considerable room to streamline the work agenda of the institutions, which both suffer from mission creep and procedural requirements that dilute staff resources and affect output quality.

To be useful in a fragmented global environment, policy advice would have to become more pragmatic and flexible, requiring new analytical work to obtain a better understanding of the impact of industrial policies and fragmentation on individual countries and the global economy. Moreover, the two institutions could explore the role of technological and market solutions for the green transition, as well as the growth and distributional consequences of the race for critical minerals. They should also regularly remind their member countries that open markets and a level playing field remain in the long-term interest of all.

Stronger incentives for better programs

Even more important from a geopolitical perspective, Western shareholders need to help the IMF and World Bank make their lending programs work better. This will require a new approach, given the diminishing incentives for governments to heed policy prescriptions as part of their lending programs.

A major problem in programs has been that incentives to adjust are time inconsistent: there is a short-term downside from fiscal and structural reforms, but gratification from higher growth is often delayed until a program has concluded. A game-theoretic view suggests that, once a program has gotten under way, the most stable outcome is for governments to underperform and for lenders to continue to pay out nevertheless. The result can be a series of failed programs that perpetuate high debt and low growth.

To change this vicious cycle, countries require additional support measures (beyond program financing) to have a better chance at using their programs to achieve higher growth. For many low-income countries that already undergo adjustment programs, the availability of significant climate funds could play such a role, as discussed above.

When the geopolitical case for additional support may be particularly strong, the West should consider more far-reaching options. For example, to enhance a country’s growth prospects, the United States or Europe could grant countries preferential access to their domestic markets, large-scale investment financing, or enhanced access to important technologies. Other countries might ask for geopolitical support of some kind—all of which should be tied to the successful program implementation. The point is not to leave the Bretton Woods institutions alone in working with these countries, but to supplement programs with bilateral or plurilateral measures that could have a tangible economic impact.

This approach had some precedents in the euro area crisis, where the IMF played an important role in program design but was supported by the common effort of euro area member countries, involving both financing and peer pressure to move the negotiations forward. In the end, even a reluctant Greek government was convinced that staying inside the euro area was in the best interest of the country, which eventually put the Greece on a sustainable track.

More recently, this approach has been applied in Ukraine, where a G7-centered coalition provided the IMF with assurances that the country would be able to repay its loans to the institution. The program could not have proceeded otherwise because IMF conditionality, focused on economic policies, is not able to mitigate the extraordinary risks from an ongoing military conflict. With these assurances, the IMF has been able to work out a regular macroeconomic program—focused on budget implementation, inflation, and governance—even with significant uncertainty around Ukraine’s macroeconomic parameters.

The Ukraine program led to some complaints about a lack of evenhanded treatment for less connected borrowers because it was preceded by a minor change in the IMF’s lending rules.⁹ This is a sign that Western shareholders need to be careful to stay within the consensual character of the institutions, making it attractive for emerging markets and low-income countries to remain in the multilateral fold. In other words, to support their allies, Western countries need to pursue their geopolitical objectives in a plurilateral way that is compatible with the IMF and World Bank’s multilateral architecture.¹⁰

Tying into the New Washington Consensus

Convincing governments and parliamentarians in Western capitals to step up support for countries or grant preferences of the kind just described will, of course, be difficult. However, if the West is serious about living up to the challenge posed by China, it will need to back up its determination with sufficient resources. Previous G7 initiatives, such as the Blue Dot Network or the Partnership for Global Infrastructure and Investment (PGII), have been fairly ineffective so far, and integrating the Bretton Woods institutions in this strategy will be critical.

As far as the United States is concerned, the seeds for such an approach have already been planted. In recent speeches, Treasury Secretary Janet Yellen called for a friend-shoring approach to secure key supply chains and raw materials from global partners, and National Security Advisor Jake Sullivan outlined the New Washington Consensus, a strategy to form innovative international economic partnerships by “a different brand of US diplomacy” (Box 1).

While not focusing on specific countries, these speeches made clear that the United States, in principle, is willing to extend preferences to countries in which it takes a special geostrategic interest. The EU, Japan, and other large economies should follow the US example, creating a rich pool of resources that could potentially be used to attract and support geopolitical partners.

Even if these efforts would not fully match the speed and volume of Chinese investment lending and project implementation, the West could become a more attractive partner for strategically important countries—based on more favorable lending terms, better governance, a larger push for program quality, and a genuine desire to help countries move to a higher and sustainable growth path. This could have a galvanizing impact on other countries that are accessing China for want of other alternatives. For countries held up in debt-restructuring negotiations with China, targeted support from Western countries may help them to forgo future Chinese lending, opening up an avenue to apply the IMF’s Lending into Official Arrears (LIOA) policy in selected cases.¹¹

Back to the roots of multilateralism

In case of increasing geoeconomic frictions, a more systemic government response to coordinate economic and financial policies may be needed. Meeting Chinese (and Russian) challenges to the West’s liberal economic order could well exceed the capacity of existing ad hoc structures (mainly those run by G7 ministerial staff) to deliver. A broader approach to agree and implement Western policies may be needed, whether in the form of a coalition around the G7 or a Group of Twelve consisting of the United States and its leading allies in Asia, Europe, and North America. In such a case, a small intergovernmental council or secretariat could be set up to coordinate specific elements of Western policies and function as a clearinghouse for allocating common resources, collaborating closely with the staff of the Bretton Woods organizations. Such an approach would not be unique. The current multilateral system has its roots in World War I, when an Allied Maritime Transport Council began to coordinate scarce transportation capacity to both provide war material to the Western front and feed the British population.¹² The idea to overcome sovereign prerogatives through multilateral cooperation was revolutionary at the time, but it eventually led to the creation of the United Nations and the Bretton Woods system.¹³

A century after its creation, a similar approach might again be necessary to coordinate a joint effort against powerful opponents undermining the international order.

Figure 7. UN Resolution ES-11/L.5 supporting Ukraine’s territorial integrity (By financial contribution to the IMF)

Governance shortfalls need to be mitigated

Finally, the lack of adequate governance arrangements will continue to raise questions about the legitimacy of the Bretton Woods institutions. However, in light of China’s attempts to dominate other international bodies, as discussed above, it would be unwise to provide it with a significantly larger voting share as long as its policies are in clear opposition to the ideals under which the institutions were founded. The reason is that it would place China in a position to form coalitions with other countries to block strategic decisions at the two institutions.

As shown in Chart X, the group of countries not supporting last year’s UN resolutions on Ukraine would, in principle, already be able to veto key strategic decisions at the IMF. There is no indication that the UN coalition would carry over to the IMF Board of Governors, of course, but the trend is clear: the next reallocation of votes would likely give a blocking minority to countries not firmly allied with Western countries, which still provide the bulk of IMF resources.

Once China was ready to accept its obligations as a major shareholder, and in the context of reduced geopolitical tensions, discussions about serious quota adjustments will, of course, need to resume. In the meantime, should there be no completion of future quota rounds, it would still be possible to raise the IMF’s lending capacity through multilateral and bilateral borrowing arrangements, if needed. The technical work to prepare for an eventual resumption of quota discussions could, in any case, proceed.

As long as quota discussions are on hold, however, the Bretton Woods institutions should provide emerging-market countries with other avenues to increase their voice.

• The United States and Europe should agree to appoint the World Bank president and IMF managing director on the basis of merit, rather than nationality.
• The number of board chairs for emerging markets should be increased, along with the provision of a third African chair at the IMF board.
• The annual IMF-World Bank meetings could be held in an emerging-market or low-income country every other year.

Lastly, it behooves the institutions to spend more of their intellectual capital on policy questions that are of particular interest to countries in low-income and developing economies. In addition to climate policies, this includes topics such as the Integrated Policy Framework, dealing with unorthodox exchange-rate policies and capital controls, or the subject of Islamic Finance. Policy challenges outside advanced economies tend to be more difficult to understand analytically, given political, institutional, or structural idiosyncrasies, and the institutions should further expand their toolkit to serve all member countries in the best possible way.

Conclusion

This paper argues that the United States and its allies need to adopt a robust approach to marshal sufficient resources in their geoeconomic competition with China. By stepping up climate funding, as well as other financial and institutional support, to incentivize good policies in partner countries, the West can provide the Global South with a viable alternative to Chinese loans and their pernicious political influence.

Making this strategy work would require major Western shareholders to work more closely with the Bretton Woods institutions, ensuring that programs with geopolitical allies reach their intended objectives. In doing so, it will be critical to stay within the existing framework of the current multilateral system, which in itself remains a major strategic asset for the West.

Related content

Issue Brief Oct 9, 2023

Reimagining Africa’s role in revitalizing the global economy

By Amin Mohseni-Cheraghlou

The African continent potential to revitalize the world economy and reverse the downward trend in global growth. However, for this to materialize, it needs substantial investments in its physical and social infrastructure.

Africa China

Issue Brief Oct 9, 2023

How the IMF can navigate great power rivalry

By Hung Tran

Fragmentation resulting from geopolitical competition between large economies is posing a serious challenge to the fulfillment of IMF’s core missions. Here’s how it can respond.

China Economy & Business

About the author

Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former International Monetary Fund (IMF) official with decades-long experience in economic crisis management and financial diplomacy.

Acknowledgements

The author thanks Josh Lipsky, Charles Lichfield, Jeff Fleischer, and Tam Bayoumi, as well as participants of an informal seminar, for inspiration and insightful comments. All errors remain his own responsibility.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post The Bretton Woods institutions under geopolitical fragmentation appeared first on Atlantic Council.

Introduction

The International Monetary Fund (IMF) was launched in 1944, charged by its forty-four founding members with “monitoring the international monetary system (IMS) and global economic developments to identify risks and recommend policies for growth and financial stability,” among other things. As key features of the world economy and its monetary system have changed over time, the IMF has responded and adjusted its functions as well as its analytical and policy framework to remain relevant and useful to its membership, now 190 countries.

There have been several fundamental changes in the IMS, posing different challenges for the IMF. In the first three decades of its existence, the IMF served as an overseer of an international fixed exchange-rate regime—with most other currencies pegged to the US dollar (USD), which in turn was linked to gold (at $35/ounce). The IMF mission was to ensure that exchange rates were fixed at appropriate levels and to identify the need to adjust currency parities from time to time to rectify underlying imbalances—basically to countenance such adjustments and not allow them to be used to gain unfair competitive advantages. After the United States suspended the convertibility of the USD to gold in 1971 and the oil shock of the mid-1970s, the IMF supported a freely floating exchange-rate system, arguing that this would enable countries to absorb shocks to their trade balances and economies caused by external factors—and in the process, expanding the range of policy issues it deals with. In particular, the IMF encouraged a free movement of capital to help developing countries augment their insufficient domestic savings with imported capital to grow their economies. In this context, the IMF advocated liberalization, deregulation, and other structural reforms to reduce rigidities in the economy, enabling markets to function more efficiently, thus attracting capital inflows. As capital flows have increased, debt has accumulated, leading to a series of sovereign debt crises beginning in the 1980s. The IMF has had to require debt restructuring as a condition for restoring financial sustainability before an IMF program can be approved. This task has become more difficult as the composition of creditors to developing countries has become complex and numerous. With the start of the new millennium, climate change has been recognized as posing increasingly tangible threats to financial and economic sustainability, prompting the IMF to adjust its mission to help mitigate climate change risks and support the green transition and sustainable development.

More recently, geopolitical competition and conflict between China and the United States, especially after Russia’s invasion of Ukraine, have fragmented the world on political, economic, trade, and financial fronts. These fragmentations, including of the monetary and financial system, have posed a serious challenge to the fulfillment of IMF core missions in three important dimensions. First, heightened mistrust and even hostility between key countries have undermined their willingness and ability to cooperate to forge common responses to global challenges. This has interfered with the functioning of many international organizations, transforming fora for cooperation into venues of competition. This could eventually threaten the still-normal operation of the IMF—as well as the World Bank.

Second and more concretely, the policies adopted by key countries to promote a broad concept of national security that includes economic security and environmental and social protection—in particular trade/investment controls and industrial policy—have significantly deviated from the IMF’s theoretical model of essentially open market economies and free trade. Such a model has served as a normative template for IMF assessment and recommendations to all members as well as policy conditionality for its assistance programs for members in need. The IMF now faces the challenge of reconciling its free market model with the new concerns of its important members—either by persuading them to refrain from or minimize deviations from its traditional model, or internalizing those concerns in its model and, in the process, changing the orientation of its policy advice.

Finally, given the geopolitically driven fragmentation of the world economy, the IMF has to discharge its core mission of finding ways to promote economic growth and financial stability—now being constrained by loss of economic efficiency.

The rest of the report will analyze each of these three dimensions in details, sketch out the challenges they pose to the IMF, and suggest some ways to deal with them.

I. Great power competition raises mistrust and undermines cooperation

The US-China strategic competition has been in the making for the past decade but accelerated in 2017 when newly elected President Donald Trump criticized China’s unfair trade practices as causing substantial and persistent US trade deficits and hollowing out its manufacturing base. The criticism was followed by the United States unilaterally imposing tariffs on imports from China in an attempt to rectify the trade imbalances. A dispute ensued that has quickly deepened and widened to other fronts of the US-China relationship and relations with their respective allies.

Essentially, the strategic competition is rooted in resentment as China—a growing economic and political power—continues to grapple with the post-World War II global order and institutions essentially established by Washington and its Western allies, and seeks to overturn that world order in favor of a new one aligning with its vision and interests. This overriding goal has been articulated by successive generations of Chinese leaders, most recently by Xi Jinping in October 2022 as “fostering a new type of international relations.” More importantly, many other countries share the desire to replace the US-led order with a multipolar system, in which large emerging market (EM) countries have more of a voice in shaping the rules and decisions in international affairs. Specifically, it has been proclaimed as the common goal of the China-Russia “partnership without limits,” the BRICS grouping (Argentina, Brazil, China, Egypt, Ethiopia, India, Russia, Saudi Arabia, South Africa, and the United Arab Emriates), and other major EM organizations and fora.

Understandably, the United States has declared that it is in its national security interests to defend and preserve the post-WWII order that has helped to engender peace and prosperity in most of the world for many decades, and to push back against China’s efforts to weaken and change that order. This objective has been articulated in US and (more recently) German national security strategies. It also was reflected in the messaging from the latest Group of Seven (G7) summit meeting in Japan—pointing at China as the rival power pushing for change in the status quo.

The two camps’ competition for influence in shaping the global order has impacted the functioning of existing international institutions set up after WWII to facilitate international interactions. Instead of being fora for cooperation as originally intended, these institutions—including the United Nations and its affiliated organizations like the Human Rights Council and Commission, the World Health Organization (WHO), the International Civil Aviation Organization (ICAO), the International Telecommunications Union (ITU), etc.—have become venues for competition. So far at the expense of the United States and Europe—specifically by pulling together a majority of member countries that vote in support of China’s positions. This has been clear in cases of defending China against Western charges of: human rights violations against the Uyghurs in Xinjiang, lack of transparency and cooperation in investigating the origins of COVID-19, and blocking Taiwan from participating in some of these agencies’ work (i.e., the WHO or ICAO).

At the same time, China has launched alternative institutions to provide venues for cooperation among like-minded countries while excluding the United States. In addition to participating and hosting a series of government-to-government groups like BRICS and the Shanghai Cooperation Organization (SCO), China has regular summit meetings between China and the Association of Southeast Asian Nations (ASEAN) and Central Asia, Africa, Middle East, and Latin America groupings. In addition, China created international development banks such as the Asian Infrastructure Investment Bank (AIIB) and, as a BRICS member, is a founding member of the New Development Bank (NDB). The aim is to build up alternative international institutions to facilitate cooperation between China and other countries on China’s terms and not under the tutelage of the United States and Europe—which has contributed to the fragmentation and weakening of the current global order and its institutions.

Specifically, the strategic competition has weakened the UN and many of its affiliated agencies as well as the World Trade Organization (WTO), but so far has not impacted much the functioning of the IMF (or the World Bank). During the coronavirus-related global economic shock, the IMF has made available $250 billion, or 25 percent, of its lending capacity to member countries; initiated and mobilized support for a special drawing right (SDR) to allocate an equivalent of $650 billion to all members. These IMF actions helped many members in need of liquidity support and assisted the G20 to launch the Debt Service Suspension Initiative and then the Common Framework for Debt Treatment to assist low-income countries (LICs) in or near sovereign debt crises. After Russia’s invasion of Ukraine, the IMF was quick to give Ukraine two emergency loans valued at $1.4 billion and $1.3 billion, respectively; and last April, the IMF approved a $15.6 billion four-year program catalyzing $115 billion of financial support for Ukraine from Western donor countries. The IMF also launched a Food Shock Window to help poor members suffering from the war-related shortage and high prices of grains, and a Resilience and Sustainability Trust to provide long-term, affordable financing to low-income and vulnerable middle-income countries to deal with the impact of climate change and invest in a green transition.

Despite those worthy achievements, it is nevertheless reasonable to suggest that without the strategic competition and heightened mistrust among major countries in the background, more could have been done to help LICs and other vulnerable countries during the crises caused by the coronavirus pandemic and Russia’s invasion of Ukraine—amid struggles in dealing with climate change and reducing poverty. It is sobering to look at the gap between what has been done and what is needed for LICs to achieve sustainable development—estimated to be $2.5 trillion per year. With stronger international cooperation and support, the IMF and World Bank could have provided more financial assistance, including risk-sharing facilities to help catalyze private investment as well as facilitating more debt relief to LICs. It also is important to note that the IMF’s ability to continue functioning and responding to crises may owe a lot to its current governance structure: voting power is weighted by members’ capital contributions, as reflected in their quotas and voting shares. Accordingly, the United States commands 16.5 percent of the total votes,¹

and the G7 has 41.25 percent of the voting shares—comfortably putting the West in general in the driver’s seat for most IMF activities and projects: a simple majority is required, but approval by consensus is typical. In other words, the IMF is still essentially a Western-driven institution, which can explain why it has functioned relatively smoothly, including approving potentially controversial programs such as that for Ukraine; the IMF usually carries out programs with countries after a conflict, rather than during a war.

However, it remains an open question how well the IMF can carry out its missions and how long its current governance structure can last if the existing geopolitical conflicts continue to escalate. Going forward, the deepening of the strategic contention could begin to hamper the functioning of the IMF. Fundamentally, the rising level of mistrust and at times hostility between the United States and China would make it very difficult to develop international consensus to reform the governance structure of the IMF to give more voice and representation to emerging markets and developing countries (EMDCs)—so as to be more commensurate with their growing weight in the global economy.

An ongoing reform effort has been negotiated as part of the IMF’s sixteenth quota review, scheduled to be concluded by December 15, 2023. The quota review includes the task of revising the quota formula to support an increase of quotas to augment the permanent financial resources of the IMF. Currently, permanent resources account for less than half of the IMF total lending capacity of SDR 713 billion ($950 billion), with the remainder funded by the New Arrangement to Borrow of SDR 361 billion, which is scheduled to expire in December 2025, and the bilateral Borrowing Agreements for SDR 139 billion, expiring at the end of this year but extendable to year-end 2024 if creditor countries agree to do so. In the past, the borrowing arrangements were extended routinely without much fanfare; in the current global tension, that should not be taken for granted. While the probability of not extending the borrowing arrangements is low, the failure to do so would have a significant impact in sharply curtailing the IMF’s lending capacity and its ability to help countries in need.

More importantly, the quota review will try to reach agreement to distribute quotas in a way that would raise the voting power of the EMDCs. In the current environment of tension and mistrust, it is highly unlikely that a redistribution of voting power in favor of EMDCs—especially China—will be supported by the United States and other Western countries. Consequently, the sixteenth IMF quota review is destined to expire without producing any results. As such, the underlying unequal voting power will continue to fester as a source of discontent in the Global South, posing a threat to the legitimacy of the IMF.

In addition, weakened cooperation has made it more difficult to come up with new and necessary initiatives requiring strong international consensus. For example, it would be difficult to get support for another round of SDR allocation, as has been suggested by countries and civil society organizations. The IMF has recognized the difficulty in building international consensus in multilateral efforts, suggesting that a plurilateral approach involving smaller groups of like-minded countries can be a practical way forward. However, there are limitations to the plurilateral approach, as evident in the recent Paris Summit for a New Global Financing Pact.

More pressing for developing and low-income countries (DLICs) has been the lack of progress in the IMF’s (and World Bank’s) efforts to promote the Common Framework for Debt Treatment to deal with the growing sovereign debt crisis of DLICs. In their latest initiative, the Global Sovereign Debt Roundtable, these institutions have promised information sharing to all creditors including private ones and concessional loans or grants to the LICs in debt crises—hoping to speed up several debt restructuring operations under the Common Framework. Since its launch in 2020 by the G20, only four countries (Zambia, Chad, Ethiopia, and Ghana) have applied to restructure their sovereign debt under this framework, and most have languished in the process without much progress (except for Zambia, which just got its debt restructuring deal). Meanwhile, DLICs have incurred more than $9 trillion of debt, of which a $3.6 trillion portion represents long-term public external debt with 61 percent owed to private creditors. In particular, seventy-five LICs eligible for International Development Association concessional loans are being burdened with almost $1 trillion in debt; with more than half of them already in, or at high risk of being in, debt distress.

One particular policy tool, Lending into Official Arrears (LIOA), has been developed to deal with situations where a debtor country has accepted the conditionality for an IMF program, but cannot get all of its official bilateral creditors to agree to a restructuring deal to help the country meet the Fund’s financial sustainability requirement. In that case, the IMF can lend to the country in question while allowing it to stop servicing its debt to the bilateral creditor which has refused to participate in a restructuring deal. This situation applies to China in several LIC cases, such as Zambia, where the country had reached IMF staff agreement for a program at the end of 2021, but progress toward board approval was held up until late August 2022 and disbursement delayed until late June 2023—by a failure of bilateral creditors to reach a debt restructuring deal. Western countries attributed this failure to China’s reluctance to accept a reduction in the principal amount of debt and its preference to conclude a bilateral deal with debtor countries. Eventually, a restructuring deal for Zambia’s $6.3 billion debt to bilateral creditors was reached consistent with China’s preferences—extending maturities of the debt to 2043 at lower interest rates, with no cut in face value to reduce the present value of the debt by 40 percent. This deal is useful but insufficient to meaningfully reduce Zambia’s debt load, which is estimated to exceed $18 billion. In any event, the IMF has not been able to use the LIOA tool to deliver needed support to Zambia—probably fearing opposition from China as well as facing reluctance by the debtor country to be unfriendly to China.

In short, escalating geopolitical conflicts would make it more difficult for the IMF and World Bank to continue functioning normally in the future.

II. Policies to promote derisking have deviated from the IMF template

The strategic competition so far has taken place mainly in the economic, financial, and high-tech areas—driven by efforts from both sides to reduce the risk of exposure and vulnerability to each other. As reflected in the latest G7 summit communique, the West appears to coalesce around the concept of derisking (rather than decoupling) vis-à-vis China— realizing that it is impractical and quite costly to economically decouple completely from China. The concept of derisking—coming after a string of notions such as reshoring, near-shoring and friend-shoring—is vaguely defined to encompass controlling trade and investment transactions with China concerning high-tech products and know-how in advanced semiconductors, artificial intelligence (AI), quantum computing and other areas, especially those with military applications. It also includes reducing reliance on China for strategic industrial inputs such as critical minerals like rare earths, which are essential for high-capacity batteries and the world’s effort to transition to green energy. 

The motivation behind derisking, however, seems to differ between the United States (wanting to preserve or even widen its lead over China in high-tech and related military capacities) and the European Union (aiming to reduce its dependency on China in a few specific areas). The US approach is more offensive in nature and has been perceived by China as hostile efforts to contain its rise—deepening mistrust and prompting retaliation. The difference in motives has also tempted China to try to prevent Europe from being fully aligned with the United States, giving Beijing more room for maneuver.

Western derisking efforts have been implemented via trade and investment controls and industrial policy to promote national champions in high-tech and other critical areas. The United States—under both President Trump and President Biden—has increasingly controlled the export of advanced chips, along with the hardware and software needed to produce them, to an increasing number of Chinese entities. It’s likely that the range of high-tech items under export control will be expanded in the future, with an aim to delay Chinese progress in critical and dual-use technologies such as AI, quantum computing, and biotech, among many others. The United States has also strengthened its Committee on Foreign Investment in the United States (CFIUS) and significantly increased its screening to restrict Chinese investment in a broad range of US companies. The Biden administration and Congress are finalizing rules to impose outward screening of investment to China, in particular in advanced semiconductors, quantum computing, and AI. Specifically, the US government has invoked national security to ban Huawei’s equipment from being used in the US telecom infrastructure and is in the process of banning ByteDance’s TikTok.

The United States also has embraced industrial policy by passing a series of laws including the Infrastructure Investment and Jobs Act (aka Bipartisan Infrastructure Law), the CHIP and Science Act, and the Inflation Reduction Act—all designed to incentivize high-tech investment and manufacturing in the United States through the use of subsidies, tax incentives, and other favorable regulatory treatments. This, however, has unleashed a subsidies race between the United States and EU countries.

Many US allies in Europe and Japan have adopted similar but milder measures including the screening of inward foreign investment and possible outward investment, and restricting sales of advanced chips and chip-making technologies to China while promoting chip production in the EU (via the European Chips Act). The EU also has launched the Critical Raw Materials Act to reduce its dependencies on countries that are not union members. Some European countries have restricted the use of Huawei equipment in their telecom infrastructures. More generally, trade protectionist measures have been on the rise: as of 2020, the G20 countries—instead of setting examples in trade liberalization—had adopted them.

At the same time, China and its allies have also tried to derisk by reducing their vulnerability to the G7 use of economic and financial sanctions—especially after the unprecedented sanctions on Russia after its 2022 invasion of Ukraine. Of particular concern: the G7’s decision to freeze the foreign reserve assets that the Bank of Russia held in the G7 economies. China and its allies’ derisking mainly involves increasing bilateral trade and investment activities, and developing alternative—essentially bilateral—means of settlement for cross-border transactions to avoid use of the US dollar.

The measures highlighted above, done in the name of protecting national security on both sides, have significantly deviated from the IMF model and norms of an open, rules-based market economy with free trade, and where the role of government is limited to ensuring a free, well-regulated, and competitive marketplace where private firms and consumers determine the supply and demand of goods and services, resulting in an optimal allocation of resources in the economy, both domestically and globally. The essentially open and free market model has been used by the IMF as the normative template to assess the economic performance of member countries and give them advice in its regular Article IV consultations. More importantly the model underpins the conditionality required for IMF assistance programs to countries in crises.

In addition to the national security concerns and subsequent protectionism measures highlighted above, the EU has increasingly used regulatory and tax measures to promote compliance with its strict environmental protection standards (such as the Carbon Border Adjustment Mechanism), while the US government has strengthened its trade regulations to promote labor standards (such as the wage requirements for auto workers in Mexico in the United States-Mexico-Canada Trade Agreement).

To be fair, this “orthodox” model has been tweaked at the margin by the IMF’s evolving policy of maintaining a decent level of social safety net (also to help build public support for IMF programs), and acquiescing to countries imposing temporary capital controls to dampen disorderly capital flows. However, these measures basically involve setting priorities in fiscal policy and using temporary capital control measures, and not fundamentally moving away from the IMF’s model.
As a consequence, the IMF has to find ways to reconcile its free market model with the reality of trade/investment controls and industrial policy practiced by an increasing number of important member countries—contradicting key IMF advice and lending conditions  pushing for deregulation and liberalization of economic and trade activities. In fact, the IMF needs to  rethink its model anyway as more and more members of the economic profession have conducted new research using rigorous empirical methods, finding that industrial policy has been more ubiquitous than thought and can bring economic benefits if implemented properly. As a consequence, the IMF has to either specify well-defined exceptions to its model, where such control measures can be used with minimum distorting and disruptive effects, or modify its model to internalize national security and environmental and social concerns, with more accurate measurements of the costs and benefits of such interventions in the market. Doing so would change the orientation of its policy advice.

Practically, the IMF needs to develop a new economic model, in which the objective function contains multiple goals, not only maximizing output and employment at stable prices, but also securing national security, achieving net zero CO₂ emissions by 2050, and reducing economic and social inequality. Some of these objectives are at odds with each other, making the assessment of tradeoffs very important. The constraints also have increased to reflect all the negative consequences of fragmentation, beyond the traditional financial and technological limits.

Given the difficult challenges of coming up with such a new model, the IMF, at the very least, has to analyze and estimate/quantify the potential benefits of enhanced national security and environmental and social protection, compared with the costs in terms of losses in economic efficiency resulting from those measures. This analytical work can provide some help to member countries in navigating the geopolitically fragmented world—especially in finding ways to limit the downside impacts of derisking policies.

III. Coping with the consequences of fragmentation

The fragmentation of global trade, payment, monetary, and financial systems as well as declining international cooperation for scientific and technological research and development has already had a negative impact on the global economy. The negative effects will accumulate and become more tangible over time. The IMF will need to find ways to help members mitigate against such poor development prospects.

The breakdown of the open rule-based trading system

The geopolitical contention between key countries has weakened the open rules-based trading system anchored by the WTO. Basically, the WTO has not been able to facilitate any multilateral rounds of trade liberalization since its inception in 1995. Instead it has had to settle for several plurilateral agreements among smaller sets of willing countries for specific trade issues. These may be second-best solutions in the absence of multilateral agreements, but they have splintered the global trading system into a growing number of regional and plurilateral trade agreements. As of now, there are more than 350 regional trade agreements (RTAs) between various countries around the world, making it more complex and costly to trade across borders, especially for EMDCs.

Importantly, the US refusal to agree to the appointment of members of the Appellate Body has rendered the appeal process in the important WTO trade dispute-resolution mechanism inoperable—undermining a key function of the WTO.

Partly reflecting geopolitical tension, the annual growth rate of world trade has slowed to 1.9 percent this year, relative to global economic growth of 2 percent; the volume of trade in goods has fallen while that of services (accounting for 22 percent of total trade) has risen. Going forward, world trade is estimated to grow by 2.3 percent per year through 2031, while the global economy is expected to grow by 2.5 percent—a reversal of the traditionally faster growth of world trade stimulating economic growth in most of the postwar decades. The geopolitical pattern of trade has also changed, with China’s exports having clearly shifted from the West to the Global South (including BRICS countries)—reaching $1.6 trillion a year to the Global South, compared with $1.4 trillion to the United States, Europe, and Japan combined.

Fragmented payment system

To reduce the vulnerability to US sanctions that deny banks and financial institutions of targeted countries access to SWIFT and clearing and settlement of USD transactions through the US banking system, other countries have tried to develop ways to settle trade and investment transactions among themselves without using the dollar. So far these efforts have resulted in a network of bilateral deals, mainly between China and another country, making use of bilateral currency swap lines (CSLs) between the renminbi (RMB) and another domestic currency. Since 2009, the People’s Bank of China has arranged CSLs with about forty-one countries, for a combined valuation of $554 billion. The CSLs have been increasingly used to settle cross-border transactions as well as for China to provide emergency liquidity lending and balance of payment support to developing and low-income countries (DLICs) in crisis—estimated to have reached $240 billion, or over 20 percent of total IMF lending over the past decade. The CSLs have been complemented by the various offshore RMB deposit markets, the most important of which is Hong Kong—reported to amount to RMB 833 billion ($115 billion) at the end of April 2023. The cross-border RMB transactions have been facilitated by the maturity of China’s Cross-border Interbank Payment System (CIPS), which was launched in 2015 and cleared transactions valued at $14.1 trillion in 2022 with 1,420 financial institutions in 109 countries.

Those efforts are not really aiming to replace the dollar in the global payment system, which is very difficult to do given the breadth and depth of the well-regulated US financial markets serving the largest economy in the world; they are mainly intended to reduce—or derisk— those countries’ vulnerability to US sanctions to some extent. The fact that the Russian economy has managed to function in the face of US/Western sanctions, including the exclusion of many Russian banks from the SWIFT and CHIPS systems, has motivated other countries vulnerable to Western sanctions to further develop these alternative settlement mechanisms. Those efforts to use local currencies in cross-border payments can be observed in a broad range of countries and regions; from Russia to India, ASEAN to the African Union and BRICS member countries.

As a consequence, the global payment system has been fragmented: the dollar still enjoys the key role in the system, but more and more cross-border transactions are being conducted without using it, and on a bilateral basis using local currencies. This will make global cross-border payment transactions—already cumbersome and costly—even less efficient and transparent, imposing a growing risk and cost on the global economy. This environment also will make it harder for the IMF to meet its mandate and improve the working of the global payment system, as suggested by the G20 roadmap released in 2020.

Moreover, different countries have adopted different approaches to the development of a central bank digital currency (CBDC). China is quite far ahead of other countries in terms of prototyping and testing its digital yuan, or eCNY, while the United States has shown a growing degree of skepticism toward a CBDC, which many conservative US politicians oppose. When CBDCs begin to be rolled out in other countries, that would likely add another dimension of fragmentation in the global payment landscape as the lack of communicability and interoperability among different CBDCs will create serious challenges for global payment system and financial stability.

Fragmented financial system

According to recent IMF reports, fragmentation can be observed in international financial activities. Specifically, foreign direct investment (FDI) and banking and portfolio investment flows have tended to focus on recipient countries perceived to be politically more friendly to originating countries than otherwise. As a result, the IMF has estimated a reduction of about 15 percent in bilateral banking and portfolio flows. This differentiation in investment transactions has reduced the efficiency of capital flows to EM countries, undermining growth rates in many EMDCs.

Moreover, the fact that China has made use of its extensive bilateral currency swap lines to provide emergency liquidity to friendly countries has complicated the IMF’s premier role in coordinating the timely activation of the multitiered global financial safety net.

Recent IMF research has estimated that the cumulative potential losses of output could be substantial—up to 7 percent for the global economy and up to 8 to 10 percent for some countries, given the addition of technological decoupling. Such losses would reinforce the effects of worsening demographics—the aging of society and decline in the labor force—by lowering potential growth rates in the future, which are estimated to slow to 2 percent per year in the next twenty years, compared to growth rates of 2.7 percent per year in the previous two decades. This anticipated slowdown would compound the various headwinds confronting many countries. Furthermore, financial fragmentation could increase the risks to global financial stability by triggering volatile capital flows in reaction to geopolitical tensions, while weakening the global financial safety net.

In this challenging scenario, the IMF would need to find ways to mitigate the negative impacts of financial fragmentation: advising members on how to sustain economic growth and financial stability while the global geopolitical situation continues to deteriorate, reducing potential economic growth rates and limiting available resources including FDI that governments can mobilize to address the challenges facing them. Against this backdrop, the IMF can continue to add value to members by identifying reforms and especially by providing technical assistance to implement changes in administrative processes, including the focused digitalization of government services, which could improve transparency and reduce corruption. These measures may not require significant budgetary resources and can help improve business performance, thereby supporting growth. In any event, the task of finding ways to sustain growth is intellectually challenging since simple economic efficiency is no longer necessarily the shared goal among members, as many now want to pursue multiple objectives through economic policymaking. Several of those objectives may be at cross-purposes and are likely to produce unexpected and unwanted side effects—which the IMF should monitor closely and report promptly.

Conclusion

The IMF and other international organizations are products of international cooperation. The IMF’s mandate, resources, and ability to assist members depends on the willingness and ability of key countries to work together for common solutions to shared global challenges. In that sense, the future of the IMF is not in the institution’s hands, but those of its members. Against that reality, the IMF can still find ways to leverage its practically universal membership to support necessary measures to the extent possible. It can also depend on its formidable institutional strength, especially its staff’s analytical prowess, to be helpful to members. In particular, the IMF should focus on analyzing the cost and benefits of geopolitical contention, and the resulting fragmentation of the world economy and financial system—like it began to do around the time of the spring 2023 meetings. This may not be sufficient to persuade major countries to reverse their geopolitical contention, but the IMF should be able to help those countries adopt the policies that are the least damaging to the global economy, with particular focus on limiting the negative spillovers of their policies on low-income and vulnerable middle-income countries.

Related content

Issue Brief Oct 9, 2023

The Bretton Woods institutions under geopolitical fragmentation

By Martin Mühleisen

Given China’s current resource advantage, Western countries need to make better use of the IMF and World Bank where doing so is in their interest. If applied more broadly, this approach could provide incentives for other governments to return to multilateral institutions, instead of China, for support.

China Economy & Business

Issue Brief Oct 9, 2023

Reimagining Africa’s role in revitalizing the global economy

By Amin Mohseni-Cheraghlou

The African continent potential to revitalize the world economy and reverse the downward trend in global growth. However, for this to materialize, it needs substantial investments in its physical and social infrastructure.

Africa China

About the author

Hung Tran is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, a former executive managing director at the Institute of International Finance, and former deputy director at the International Monetary Fund.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post How the IMF can navigate great power rivalry appeared first on Atlantic Council.

Introduction

The world economy now finds itself at a critical juncture, facing a series of extraordinary setbacks that have pushed down growth. Reigniting growth requires a unique combination of targeted policies, robust international cooperation, and a renewed look at the global economy, with a particular focus on Africa. Due to its burgeoning and youthful population, abundant natural resources, and a strategic geographical location that can facilitate global trade, Africa can play a major role in—and should be front and center of—any renewed efforts for revitalizing the global economy. A decade-long robust, inclusive, and green growth in Africa will not only move hundreds of millions living in the continent out of poverty but will also accelerate a global rebound and recovery. However, for this to materialize, Africa needs substantial investments in its failing and inadequate physical and social infrastructure. With access to basic infrastructure, alongside efficient institutions as well as its young population, massive natural endowments, and strategic location Africa can seize its economic potential and act as an engine of growth for the global economy for decades to come. Therefore, it is crucial to support Africa to unleash its immense economic potential, through massive and focused investments in the continent’s human capital and its physical and social infrastructure.

I. The global slowdown: An overview

The global economy has entered a prolonged period of slowdown. According to a 2023 World Bank report, “Nearly all the forces that have powered growth and prosperity since the early 1990s have weakened.” Even before the COVID-19 pandemic, an aging population, slowing productivity, and growing barriers to trade and the free movement of people were slowing global growth. Then came the triple back-to-back shocks: the pandemic, the Ukraine war, and persistently high inflation along with subsequent rapid rate hikes to fight it. Those shocks, combined with preexisting structural factors, have introduced strong headwinds for the global economy and its growth prospects in the next decade. If there is no significant policy intervention to revitalize the global economy, the potential result is a lost decade—not only for certain countries or regions, but for the entire world. According to the World Bank, the global potential gross domestic product (GDP) growth rate is expected to decline to its lowest level in three decades, i.e., 2.2 percent per year between now and 2030.

Figures 1A and 1B demonstrate that the current global slowdown, which has become more pronounced following the pandemic, has been gradually developing over the past two decades. The five-year moving average of the world’s real GDP growth rate has decreased from 3.7 percent in 2000 to 2.4 percent in 2021, as depicted in Figure 1A. Similarly, growth has also decelerated in terms of GDP per capita, as shown in Figure 1B. The five-year moving average of the world’s real GDP per capita growth rate has declined from 2.2 percent in 2000 to 1.4 percent in 2021.

Figure 1. World GDP growthrate (Five-year moving average, 2000-2021)

Figure 2. World GDP per capita growth rate (Five-year moving average, 2000-2021)

The global slowdown can be attributed to various factors, many of which can be reversed through targeted and coordinated policies, including

• Aging labor forces and consumer markets, especially in advanced economies, but also in many emerging markets and developing economies (EMDEs) (Figure 2A);
• declining global productivity;
• the mounting debt burdens that have accumulated over the past decade (Figure 2B);
• the rising energy and food prices over the past three decades, which rose long before the Ukraine war (Figures 2C and 2D);
• the increasing geopolitical fragmentation, protectionism, and friend-shoring, and declining levels of international trade (Figure 2E); and
• the growing frequency and severity of natural disasters with ripple effects of security issues (Figure 2F).

Figure 3. Population 65+ as percentage of total population

Figure 4. Average public debt-to-GDP ratio

Figure 5. Food price index

Figure 6. Energy price index

Figure 7. Growth rate of share of trade in global GDP (Five-year moving average, 1990-2021)

Figure 8. Frequency of climate-related disasters (Annual recorded events in the Emergency Events Databse)

II. Revitalizing global growth: Some coordinated policy responses

Reversing the above trends calls for a globally coordinated and targeted set of policies that would contribute to improvements in labor productivity and mobility, increasing aggregate demand, and promoting sustainable and inclusive growth at the global level. Some of these include the following.

Increasing labor-force participation and facilitating the movement of labor: Globally, only 59 percent of the population above fifteen years of age is in the labor force. This is mainly driven by the lower participation of females and youths in the labor force. As seen in Figure 3A, globally, the female labor-force participation rate (47 percent) is less than two-thirds that for males (72 percent), with some regions—such as the Middle East and South Asia—having very large gender gaps in labor-force participation rates. Moreover, only 40 percent of the world’s youth (those aged 15–24) is in the labor force, with the Middle East again lagging behind the rest of the world—especially in terms of the female youth in the region (Figure 3B). Estimates show that increasing female and youth labor-force participation rates closer to the level of prime-age male workers (around 70 percent) could, on average, raise global potential growth by 0.2 percentage points by 2030.

Figure 9. Labor force participation rate

Figure 10. Youth labor force participation rate

One way to increase the world’s youth labor-force participation rate is to facilitate an easier movement of labor from regions of the world with a growing young labor force to regions where the population and the labor force are aging. This would require governments in aging economies (with the support of international organizations such as the World Bank, International Labor Organization (ILO), and United Nations (UN)), to reform immigration policies and promote certain types of visas to attract the needed skills for various sectors. Enabling greater labor mobility would support the global economy for two main reasons. First, it will allow richer countries with aging populations to capitalize on the demographic advantage of those regions that have a significant youth population. Second, the regions of the world with younger labor forces—Africa, South Asia, and the Middle East—will benefit from the remittances.

Expanding infrastructure investment: As seen in Figure 4, the current trends in infrastructure investments and needs will result in an $11.9-trillion shortage in infrastructure investment by 2040. The bulk of this gap will be in the transportation industry ($7.7 trillion), followed by the energy industry ($2.4 trillion). Moreover, adding the investments needed to achieve the Sustainable Development Goals (SDGs) by 2030, the world’s infrastructure investment gap would increase to $14 trillion by 2040. In other words, over the course of the next seven years, $2.1 trillion of additional infrastructural investment is needed to achieve the SDGs. Boosting global investment to about 2–3 percent of the world’s GDP over this decade, especially in the infrastructure sector, can increase potential growth by about 0.3 percentage points per year.  

Figure 11. Global infrastructure investment gap (Amount needed to achieve SDGs, 2023-2040)

With growing debt levels, the governments in many economies—especially EMDEs—have been facing increasingly limited capacity to invest in physical and social infrastructure. Hence, there is a need for a global push to strengthen and optimize the frameworks of private-public partnerships (PPPs) to foster increased engagement of the private sector in infrastructure initiatives. Moreover, quasi-state actors, such as sovereign wealth funds (SWFs) and public pension funds (PPFs) can also play a crucial role in infrastructure investment. With more than $33 trillion in assets under management (AuM), these institutional investors possess a distinct advantage in bridging the global infrastructure financing gap. This advantage stems mainly from the long-term investment horizons of institutional investors, which align with the secure, yet moderate, return expectations typically associated with large-scale infrastructure projects.

Re-globalization and reducing the costs of and barriers to trade: The ratio of world trade to GDP grew from 25.3 percent in 1972 to 61 percent in 2008, an average annual rate of 2.5 percent (see Figure 5). With the onset of the 2008–2009 global financial crisis (GFC), world trade-to-GDP ratio dropped by more than 8 percentage points and has not yet recovered to the levels seen in 2008. Looking at the five-year moving average of the growth rate of the trade-to-GDP ratio (as seen earlier in Figure 2E), while the decade preceding the GFC was characterized by the rise of global trade and globalization, the post-GFC decade can mainly be seen as one of declining global trade and rising protectionism, especially after 2014.

Figure 12. Trade as share of world GDP

According to the International Monetary Fund (IMF), trade barriers have increased from less than four hundred in 2009 to about 2,500 in 2022. Recent policy decisions, such as reshoring and friend-shoring, could expose individual countries and the global economy to greater fragmentation and vulnerability to shocks. Moreover, according to the World Bank, the expenses related to shipping, logistics, and regulations significantly contribute to trade costs, often resulting in the doubling of prices for internationally traded goods.

Reversing these global protectionism and geoeconomic fragmentation trends could add 0.2 to 7 percent to the global output, depending on how severe the protectionism and geoeconomic fragmentation could get. However, reversing these trends, which have been in the making for more than a decade, will require a momentous effort by all economies around the world—especially the members of the Group of Twenty (G20), among whom geoeconomic fragmentation has been rapidly rising. At the same time, enhancing the trade regulatory and physical infrastructure is another area that needs to be addressed. This is where investment in physical infrastructure (discussed in some detail above) can help reverse declining trends in global trade.

The process of strengthening the role of trade in the global economy necessitates robust reform of the World Trade Organization (WTO). However, reaching a consensus on intricate trade issues remains a challenge due to the WTO’s diverse membership, the growing complexity of trade policies, and heightened geopolitical and geoeconomic tensions. Plurilateral agreements, and creating several regional mini-WTOs among select groups of WTO members, can provide a viable way forward in certain areas.

Reversing climate change and reducing global emissions: As seen earlier in Figure 2F, the severity and frequency of climate-related natural disasters have risen substantially over the past three decades, and experts link this trend to climate change and global warming. The economic cost of these disasters is also on the rise. According to the World Meteorological Organization, out of more than twenty-three thousand recorded disasters since 1970, more than eleven thousand can be directly linked to weather, climate, and water hazards. These devastating events led to a staggering 2.06 million fatalities, and incurred financial losses amounting to $3.64 trillion. Certain countries, particularly smaller states, have experienced significantly greater devastation than what is indicated by the average impact, amounting to approximately 5 percent of their annual GDP.

Reducing the detrimental impacts from climate change calls for a coordinated global response, with the world’s major emitters and the largest emitters per capita in high-income economies taking the lead. As seen in Figures 6 and 7 carbon-dioxide (CO2) emissions per capita in high-income economies are thirty-two  times larger than those in low-income economies.

Figure 13. CO² emissions per capita (Metric tons (2019))

Figure 14. CO² emissions per capita by income level (Metric tons (2019))

According to a report from the World Bank Group, if developing countries invest an average of 1.4 percent of their GDP annually toward adaptation and mitigation strategies, they could potentially achieve a remarkable 70-percent reduction in emissions by the year 2050. Such investments would also enhance their resilience to climate change impacts. The report estimates that, within lower-income countries, the financing requirements can surpass 5 percent of their GDPs, necessitating additional assistance from high-income countries and multilateral development banks (MDBs).

III. Revitalizing global growth: Why Africa matters

Through unlocking its economic potential, Africa can address its developmental needs, contribute significantly to global economic growth, and create a more prosperous and economically stable future for its people and the world. Africa’s role in reversing the global economic slowdown lies in leveraging its young and growing population, natural resources, and strategic location.

Population, consumer markets, and labor forces: As seen in Figure 8, while all regions of the world have been aging—albeit at widely different paces—the share of population sixty-five and above in Africa has remained at a mere 3 percent over the past four decades. With nearly two-thirds of its population under the age of thirty, and 40 percent under the age of fourteen, the continent enjoys having the youngest population structure in the world (see Figure 9). This means that Africa will benefit from a growing young-consumer market (with a high marginal propensity to consume) and an ample supply of young workers for at least the next three to four decades. Nigeria is a case in point, as it will be the third most-populous country in the world in 2050 after India and China.

Figure 15. Population 65+ as percentage of total population

Figure 16. Age breakdown of population

With Africa’s population expected to double by 2050—from its current 1.4 billion to 2.8 billion—Africa’s growing and young consumer market will be the main driver of global demand for consumer, education, health, technological, and infrastructural products and services. For example, the doubling of population will translate to a 50-percent increase in demand for housing and all that is needed to have a modern household, from electricity and water connections to basic appliances and furniture to municipality services. As of 2018, the continent had an estimated housing shortage of fifty-one million units and, at the current lackluster housing-construction rates, this gap is expected to increase to seventy-five million by 2050. Hence, the continent boasts an already enormous demand for housing and consumer goods and services, which is only expected to grow for decades to come. Additionally, the housing sector is well known for its job-creation potential.

According to the International Finance Corporation (IFC), each housing unit will create five full-time jobs in Africa. This means that closing the housing gap by 2050 will lead to the creation of 375 million jobs in Africa, practically absorbing all the informal-sector employment—which currently represents 83 percent of employment in Africa—and the unemployed population, and increasing the number of employed African adults age fifteen and up by more than 80 percent. This, in turn, will boost household income and aggregate demand in the region, igniting a positive loop of higher income and higher aggregate demand and imports into the continent, translating to higher aggregate demand for global consumer and technological goods and services. In other words, closing the housing gap in Africa can contribute significantly to global growth in the next three decades, while also providing the growing young population of the continent with housing and job opportunities.

Considering that the youth labor-force participation rate (LFPR) is around 38 percent in Africa (see Figure 3B above), the continent needs to create  about ten million jobs per year for the next 20–30 years in order to employ every new youth entrant into the labor force. Clearly, jobs created from closing the housing gap will address this growing demand and more. Given this capacity, supportive policies can be devised to increase Africa’s youth LFPR to level to that of North America (51 percent). Such policies will increase the needed volume of new jobs to 13–14 million per year, which can all be absorbed by efforts to close the housing gap on the continent. Moreover, increasing youth LFPR in the world’s youngest continent and creating jobs for them will only add to higher LFPR at the global level, increasing the world’s workforce productivity and employment-to-population ratio. As highlighted earlier, such policies would contribute to global growth.

The same sorts of reasoning and statistics presented above for the housing sector can also be applied to the increasing demand for energy, basic infrastructure, education, entertainment, and healthcare services in Africa over the next few decades. In short, as the continent’s middle class grows and disposable incomes increase, African consumers will play a vital role in driving demand for basic infrastructure and goods and services, both domestically and internationally. This could be a major component of a robust global rebound because, on average, household consumption is responsible for about 60 percent of the world’s GDP.

Natural resources: Africa is home to an incredible amount of diverse natural capital. Nearly 30 percent of the world’s mineral reserves, 12 percent of its oil reserves, and 8 percent of its natural gas are located in Africa. The continent is also home to 40 percent of the world’s gold reserves. Moreover, the continent boasts the largest reserves of cobalt, diamonds, uranium, and platinum in the world. In other words, 30 percent of world’s rare-earth deposits are in Africa. These elements are central to the global economy, and their importance is rising rapidly—especially in various strategic high-tech industries such as semiconductors, batteries, and green energy. Finally, the continent also possesses 65 percent of the world’s arable land, making it central to long-term food production and security.

Given its natural resources, Africa has the potential to play a significant role in the global energy transition and climate mitigation for three main reasons. First, Africa—especially Northern Africa—possesses abundant renewable energy resources. By tapping into these resources, Africa can contribute significantly to global green-energy production and reduce reliance on fossil fuels. For example, equipping a mere 1 percent of the Sahara Desert area with concentrated solar power plants would be more than sufficient to meet the electricity demand of all of Europe, the Middle East, and Africa. Moreover, the Sahara’s strong solar radiation makes it ideal for the generation of green hydrogen (for example, in Morocco) that can be transported to Europe using the current oil and gas pipeline between the two continents. Hence, Africa has the potential to become a major global exporter of green energy.

Second, Africa is home to abundant mineral reserves, including key resources used in battery technologies, such as lithium, cobalt, and nickel. These minerals are essential for the production of batteries for electric vehicles (EVs) and energy-storage systems. Africa’s role in global battery technology lies in responsibly extracting and processing these minerals, potentially becoming a significant supplier to the growing EV and green-energy storage markets.

Third, considering that Africa’s population is expected to double by 2050, meeting this rapidly rising energy demand from renewable sources is crucial in addressing global climate challenges. Many parts of Africa still lack access to electricity. As seen in Figure 10, electricity access is nearly universal in all regions of the world, only 56 percent of Africans have some sort of access to electricity. This means that about 600 million Africans lack access; in other words, 80 percent of the total 750 million people who don’t have access to electricity in the world are in Africa. Africa has the great opportunity to leapfrog the technology in electricity generation and distribution—just as it leapfrogged landlines in many parts of the continent and embraced mobile/digital communication—and tap into its immense potential for renewable electricity generation, alongside off-grid and mini-grid solutions, as the path forward for expanding access to electricity for its rapidly growing population. The same is true for Africa’s transportation industry, as the continent can address its growing demand for private and public transportation through EVs. These will drastically reduce Africa’s greenhouse-gas emissions in the growing electricity and transportation industries, making Africa a global leader in providing its population with access to affordable and renewable energy, which is articulated as Goal 7 of the SDGs. Although Africa’s share of global emissions is projected to increase from around 4 percent in 2023 to 11 percent in 2050, any African contributions to reducing global emissions without significantly harming its growth projections will be welcomed by the global community. Ivory Coast, Senegal, Uganda, Togo, and Cameroon, as well as six cities in South Africa, have already made great strides on this front.

Figure 17. Access to electricity (Share of population by continent)

It is important to highlight here that while Africa is only a small contributor to global emissions, the continent has started taking important initiatives for the green transition. Starting with the 1997 Kyoto Protocol and extending to the 2016 Paris Agreement (COP21), a significant number of African nations have embraced and ratified environmental pacts. The proliferation of consciousness-raising campaigns is evident, and exemplified by initiatives like the African Union’s Agenda 2063, conservation funds such as the Blue Fund, the Desert to Power project by the African Development Bank, and the Great Green Wall endeavor aimed at cultivating vegetation across the Sahel region.

Various countries are actively engaged in this movement. Burkina Faso, for instance, is home to the largest solar-power facility in West Africa, while President Macky Sall’s Green Emerging Senegal Plan is driving eco-friendly strategies in Senegal. In Ethiopia, nearly 100 percent of the nation’s electricity is sourced from renewable resources (96 percent from hydropower).

In short, by leveraging its renewable energy resources, promoting local manufacturing and innovation, and actively participating in global collaborations, Africa can contribute to the advancement of green energy and battery technology worldwide, and position itself as a key player in the global shift toward clean, and renewable energy sources. This will contribute significantly to the global sustainable-development agenda, enhance energy access, and reduce carbon emissions—all of which are key ingredients for a global recovery.

Trade and connectivity: Africa is surrounded by seas and oceans on all sides, making it easy to trade with most of its economies. Of the fifty-four countries in the continent, thirty-eight have access to open waters. The remaining landlocked economies can access open waters through at least one neighboring country. Given Africa’s geographical position and its potential as a trading hub, leveraging its strategic location can enhance its participation in global trade, strengthen economic ties with other regions, and drive overall economic growth and development. Africa’s location holds strategic importance in global trade for several reasons. First, the continent is geographically positioned as a gateway between the Atlantic and Indian Oceans, linking multiple regions, such as the Middle East and Europe. This location allows for efficient trade routes and connectivity between Africa, Europe, the Americas, Asia, and the Middle East.

Second, Africa is home to important maritime trade routes. Its coastal regions, including the Gulf of Guinea, the Red Sea, and the Cape of Good Hope, serve as critical maritime trade routes. These routes are crucial for shipping goods between continents, facilitating international trade and commerce. Also, Africa’s proximity to the Suez Canal is of significant advantage. Annually, 12 percent of the world’s trade is carried through this canal. The Suez Canal, located in Egypt, connects the Mediterranean Sea to the Red Sea, providing a vital shortcut for maritime trade between Europe, Asia, and Africa. This access greatly reduces shipping distances and the cost for goods passing through the region.

Third, and related to the above, is Africa’s abundant natural wealth. As highlighted earlier, Africa is immensely rich in natural resources, and its strategic location facilitates the export of these resources to various markets worldwide, driving economic activities and trade partnerships.

Efforts are under way to establish and expand trade corridors within Africa. Projects like the Trans-Saharan Highway, Trans-African Railway, African Integrated High-Speed Railway Network, Niger-Benin crude pipeline, and other infrastructure developments aim to enhance intra-African trade and improve connectivity, fostering regional integration and expanding Africa’s role in global trade. On the policy front, too, venues for regional integration are being explored. For example, efforts toward regional integration, such as the African Continental Free Trade Area (AfCFTA), aim to establish a single market across the continent. This initiative can enhance intra-African trade, increase investment flows, and create a more favorable business environment, positioning Africa as a key player in global trade.

Conclusion

Vietnam, despite its limited access to natural and energy resources compared to Africa, has experienced an impressive sevenfold increase in its GDP over the past thirty years (from $45 billion in 1990 to $332 billion in 2021). If Africa can achieve similar growth rates in the next three decades, it has the potential to contribute a staggering $20 trillion to the global economy in 2050.

This is not unrealistic. Africa managed to triple its GDP, from $900 billion to $2.7 trillion, between 1990 and 2021. Moreover, during the same period, Ethiopia’s GDP increased by 7.6 times—more than the increase in Vietnam—while the economies of Ghana, Tanzania, and Egypt grew by five, 4.6, and 3.7 times, respectively. By leveraging the heterogeneity among its fifty-four economies,

Africa can build upon this performance through fostering greater regional trade and labor-market integration, increasing climate resilience, and better integrating its labor and commodity markets in the global supply chain. Through such coordinated policies, Africa has the potential to grow at an average annual rate of 5–7 percent in the next three decades—resulting in an African economy that is 4–7 times larger by 2050. This could result in a global economic boom led by a generation of ambitious young Africans ready to innovate, produce, and consume. No other region in the world possesses the same potential for growth. To achieve its potential and contribute to a robust global rebound, Africa needs a concentrated “Big Push” financial and technical investment in its physical and social infrastructure and labor markets. The case of physical infrastructure is of particular importance. Over the past two decades, Africa stands out as the sole region where road density has experienced a notable decline. Approximately 43 percent of the continent’s roads have been paved, but South Africa accounts for 30 percent of the total. Also, as seen in Table 1, 44 percent of Africans lack access to electricity, 73 percent lack access to safely managed drinking water and sanitation services, 58 percent do not use the internet, and 98 percent don’t have access to broadband services.

Table 1. Lack of access to basic infrastructure (2021)

Hence, Africa’s existing infrastructure gap is the main bottleneck for unlocking its immense economic potential. Massive investments in transportation, electricity, water, sanitation, and communication infrastructure are needed for the continent to seize its position in the global economy and act as its engine of growth. According to the African Development Bank, the annual investment gap in Africa’s infrastructure is around $100 billion. Moreover, many African countries need help with developing their governance, financial, and legal institutions. The Bretton Woods Institutions (BWIs) can play a crucial role in supporting Africa to get the “Big Push” it needs. A more active, focused, and multifaceted long-term engagement of the World Bank, IMF, and yes, WTO in Africa’s development will help crowd inthe much-needed institutional and private-sector investment in the region’s physical, social, financial, and legal infrastructure.

Some critically important areas for BWIs to revisit are debt relief/restructuring, assisting with climate adaptation and resilience efforts, supporting overall governance capacity of African economies, promoting private-public-partnerships in physical and social infrastructure investment, accelerating African regional integration, prioritizing Africa’s integration into the global economy and supply chains, and reinforcing multilateralism and international cooperation. It is through such coordinated programs and policies that BWIs can support African economies seize the opportunity to jumpstart their economies and contribute to a sustained economic growth in the continent for decades to come, with of course significant ripple effects on revitalizing global growth.

Related content

Issue Brief Oct 9, 2023

How the IMF can navigate great power rivalry

By Hung Tran

Fragmentation resulting from geopolitical competition between large economies is posing a serious challenge to the fulfillment of IMF’s core missions. Here’s how it can respond.

China Economy & Business

Issue Brief Oct 9, 2023

The Bretton Woods institutions under geopolitical fragmentation

By Martin Mühleisen

Given China’s current resource advantage, Western countries need to make better use of the IMF and World Bank where doing so is in their interest. If applied more broadly, this approach could provide incentives for other governments to return to multilateral institutions, instead of China, for support.

China Economy & Business

About the author

Amin Mohseni-Cheraghlou is the macroeconomist with the GeoEconomics Center and an assistant professor of Economics at the American University in Washington, DC. He leads GeoEconomics Center’s Bretton Woods 2.0 Project.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post Reimagining Africa’s role in revitalizing the global economy appeared first on Atlantic Council.

Introduction

Background: The changing face of macroeconomics

Assessing the IMF’s recent surveillance

How successful was IMF surveillance?

Too many reports

Introduction

Mike Mussa, the chief economist of the International Monetary Fund (IMF) from 1991 to 2001 once said to me, “the job of the IMF is to manage crises and we have managed to have a lot of them.” Mike loved quips but this one also said a great deal about his views on the IMF. To most people, the IMF’s major role is lending to countries, which constitutes managing crises. Mike focused more on the evolution and risks to the global economy and advising policy makers how avoid bad outcomes, or managing to not have a lot of crises. In IMF parlance, this is surveillance.¹

The IMF’s work on global surveillance has steadily increased as globalization has made the world economy more interlinked. During Mussa’s tenure the IMF’s global surveillance was contained in one publication, the World Economic Outlook (WEO) run by the IMF Research Department.² In response to the 1997 Asia crisis the IMF decided to beef up its financial analysis and started publishing the Global Financial Stability Report (GFSR) produced in another department, Monetary and Capital Markets.³ Subsequently, the IMF also added the Fiscal Monitor and External Stability Report, written in other departments. The logic of producing many reports is that it allows the IMF to communicate its views on the current conjuncture better with specialized audiences—macroeconomists, financial analysts, budgetary specialists, and those who focus on international trade and finance. While these reports attract different audiences, their length, the result of augmenting surveillance with background research, likely deters certain readers.

This fracturing of IMF’s global surveillance message also works against its unique width and breadth. No other institution combines the IMF’s diversity and reach of both membership and expertise in macroeconomic, financial, and external issues. Its unique role is ever more important as the global economy has become increasingly interconnected—a process that current geopolitical tensions may slow but are unlikely to fundamentally reverse. Forecasting and its associated policy advice are difficult under the best of conditions. Producing separate reports on macroeconomic developments, financial stability, fiscal positions, and external developments only makes things tougher. To improve its global analysis, the IMF should consolidate its conjunctural analysis into a single, shorter, and more pointed report.

Background: The changing face of macroeconomics

In the early 2000s macroeconomists had reason to be pleased. The great moderation—the fall in output volatility that occurred in the 1980s—suggested that skillful policies could moderate the business cycle. There was also broad acceptance that the policies prescribed by the “Washington Consensus” would bring future growth and prosperity. These policies included greater globalization through further opening and integrating of international trade and capital markets, technocratic monetary policy run by independent central banks using inflation targeting combined with relatively conservative fiscal policies that would keep government debt in check, and moderate tax rates and government spending to create incentives to work while providing for a decent social safety net. Strikingly, these policies seemed to be endorsed across a broad swathe of the world, including Russia and China, the west’s former cold war adversaries.

Macroeconomics still had issues. The business cycle remained a source of instability; greater international capital mobility had led to debilitating financial crises, especially in emerging markets; rising inequality in advanced countries was also a concern; and fast-growing China flouted the implicit rules of the trade game by limiting domestic market access and imports while boosting exports through an undervalued exchange rate. However, these were perceived as relatively minor concerns. The focus was on further improving the existing arrangements (including by persuading China to adopt better trade and exchange rate policies), harvesting the benefits of open markets (including through more globalization), and determining the best monetary regime (including by assessing if central banks should target inflation or the price level). To quote a leader in the field, the state of macro was “good.”

The 2008 North Atlantic financial crisis and subsequent global recession dented macro’s confidence in many directions. Most obviously, it was a massive bolt from the blue. Slightly surprisingly, one of the very few to warn about growing financial risks in advanced economies and their consequences was Raghuram Rajan, chief economist of the IMF. However, his speech at the prestigious Jackson Hole conference was heavily criticized by several prominent economists and had no discernable impact on the IMFs general views on financial stability. The Fund continued to support the “originate to distribute” model in which banks bundled loans into securities that were sold in the market. When the originate to distribute model imploded in 2008 the unanticipated financial crisis created a deep global recession.⁴

During the subsequent scramble to avoid a new great depression, governments and central banks spent huge amounts of money propping up their financial sectors. As policy rates fell to zero, constraining more conventional responses, the major central banks were also forced to support activity by adopting unconventional policies of uncertain efficacy. One policy involved quantitative easing in which the central bank bought large amounts of government bonds to reduce long-term interest rates.⁵ While these vigorous responses succeeded in avoiding a new great depression, the recovery was painfully slow, as is often the case after financial crises. In addition, inflation remained stubbornly below central bank targets. As a result, quantitative easing, introduced as an emergency measure in response to a crisis, lasted for well over a decade.

The 2008 financial crisis also dented the intellectual underpinning of macroeconomics. The deployment of new policies led to greater uncertainty and debate as to the appropriate policy mix. In addition, the profession faced the problem of integrating the financial system into a framework that had largely ignored such concerns. The IMF was an important part of this effort, reflecting its broad involvement in macroeconomic and financial issues.⁶ Much has been learned from this work both inside and outside of the IMF, including on the links between the business and financial cycles. Despite these efforts, however, a new consensus on a macroeconomic model that incorporates financial risks has yet to emerge.

Most importantly, the unexpected crisis and slow recovery undermined public confidence in economic expertise. Slow growth brought issues of inequality to the fore resulting in a rise in populism. The massive renumeration of investment bankers was already an issue in many people’s minds even when the financial system seemed to be doing a good job of moving savings into productive investment. The financial crisis reinforced these doubts by underlining the inability of bankers, and the people who regulated them, to understand or control the risks they created. In addition, the decision to bail out the financial sector to avoid worse economic disruption, however technocratically correct, further undermined popular confidence in policy makers and their advisers. The leaching of confidence in experts led to the rise in support for unconventional economic solutions. In short, the 2008 financial crisis increased economic uncertainty by underlining the risks coming from financial shocks, by forcing central banks to deploy untested economic policies, and by reducing public trust in economic orthodoxy.

IMF global surveillance responded to the more complex and interconnected macroeconomic environment by emphasizing greater cooperation across teams with only limited changes in structure. On the former, there was more focus on integrating the macroeconomic and financial perspectives,⁷ analyzing international spillovers, and identifying unexpected shocks.⁸ On the latter, as occurred in the wake of the Asia crisis, the Fund widened its coverage by adding publications, but the new additions were, and remain, less prominent than the GFSR. The biannual Fiscal Monitor, first published in 2009, tracks underlying fiscal positions and policies while leaving the WEO as the primary arbiter of short-term fiscal advice. In addition, in 2014 the IMF introduced an annual External Stability Report to track current account surpluses, deficits, and their likely evolution over time. Both publications adopted the same basic format as the two main flagship reports combining current analysis with background research. These additions succeeded in widening the IMF’s coverage of legitimate macroeconomic issues. Indeed, in many ways the External Stability Report took the IMF back to its original purpose of monitoring external imbalances and the appropriateness of exchange rates, albeit in quite a different environment.⁹

While widening coverage, the addition of these publications further fractured the IMF’s messaging. The Fiscal Monitor is produced by one team in one IMF department, both of which are different from the teams and departments producing the WEO and the GFSR. The External Stability Report is written by yet another set of authors under the overall direction of the chief economist and a cross-department group. Despite encompassing four publications, the global surveillance portfolio and the resources applied to this work remain relatively modest. Further, the groups writing the reports are quite small, and a significant part of their work comprises research rather than directly assessing the current situation and its risks. Therefore, the question is whether these limited resources are well deployed.

Proponents of the current system argue that there is extensive consultation between the groups and consequently the publications provide a single view of the global economy from different angles. From this perspective, the existing “cubist” approach encompassing various points of view allows the IMF to speak more directly to the concerns of differing audiences. While the WEO appeals to macroeconomists interested in the evolution of the overall economy, the other publications speak to more specialized readers such as financial commentators (GFSR), budgetary types (Fiscal Monitor), or those more interested in international trade and finance (External Stability Report).

It is certainly correct that these publications tend to attract different types of readers coming from different areas of expertise. On the other hand, having several teams write the same underlying narrative from different points of view inevitably creates repetition that eats into the resources devoted to global surveillance at a time when the IMF’s resources are limited. In addition, if catering to specific audiences is an important objective one might legitimately wonder if it is enhanced by mixing current analysis with background research. It seems unlikely that most readers are equally interested in the opening chapter, devoted to the current conjuncture and risks, and the research served up in the rest of the text. The fact that the research chapters are launched separately at the biannual IMF-World Bank meetings and that the online versions of the reports allow readers to choose which chapters to download suggests this is not the case, and that this research could be published separately.

The more fundamental issue, however, is whether discussion across these varied groups of authors is the best way to assess the current conjuncture. Clearly, the teams consult each other extensively since the texts of the conjunctural chapters are replete with references to the other reports and the issues contained therein. The WEO discusses the risks to financial stability, fiscal positions, and external imbalances while the GFSR, Fiscal Monitor, and External Stability Reports provide outlines of the global macroeconomic environment. However, discussion and consultation are different from decision and resolution. Indeed, it would be surprising if the differences in perspectives across the various publications were fully resolved. The logic of putting forth various publications is to account for the varying perspectives of readers, and these differences in perspectives will surely inform the various texts and create a certain level of constructive ambiguity. The key question is not whether such ambiguity exists, but how well such an approach illuminates the current conjuncture and risks.

From this perspective, the last few years provide a useful test. The world has been hit by two unexpected, non-economic shocks with profound economic spillovers: the COVID pandemic and the war in Ukraine. The COVID pandemic was a global shock with numerous macroeconomic, financial, fiscal, and external ramifications, a wide imprint that plays to the IMF’s strengths given its near-universal membership and broad expertise. In addition, while the war in Ukraine was clearly a more localized event, much of its economic fallout has come through disruptions of commodity markets, most notably in energy and cereals. Since commodity markets are highly integrated at the global level, the impact on the availability and prices of energy and food have had global effects. The impacts appear most evidently in terms of trade, external deficits, and fiscal revenues, all of which are areas where the IMF’s width and breadth are major advantages.

In addition, a flawed policy response to these shocks in developed economies has led to a destabilizing burst of inflation as well as several bank failures that have undermined macroeconomic stability. Inflation, which had been quiescent since the 2008 financial crisis, rose to levels not seen since the 1980s and is proving much harder to quell than had been expected. Caught behind the curve and with inflation rising well above target, the major central banks rapidly hiked policy rates—most notably the Federal Reserve in the United States, European Central Bank in the euro zone, and the Bank of England in the United Kingdom.¹⁰ These hikes uncovered unexpected financial weaknesses as three medium-sized US commercial banks and Credit Suisse, a major European investment bank, had to be rescued. Further deepening the sense of uncertainty about the current policy stance, inflation has fallen slowly and activity has remained relatively robust despite rapid rate hikes and banking hiccups.

Given the size of these shocks, the flawed policy response, and the difficulty in restoring inflation to target it is instructive to review the IMF’s assessment of risks and what policy advice was provided to counter any anticipated adverse effects.

Assessing the IMF’s recent surveillance

In assessing the IMF’s surveillance over recent years, it is useful to start by emphasizing the size and unusual nature of the COVID pandemic and the war in Ukraine. The last pandemic of a similar scale to COVID was the great influenza of 1918. While the influenza death toll appears to have been greater, it struck a global economy that was significantly less intertwined. It also occurred immediately after the first World War, a shock that had already disrupted international commerce. Clearly, the COVID pandemic created exceptional uncertainties for the global economy.

The Russian war in Ukraine involved two significant economies that are major producers of important commodities—Russia supplies energy while Ukraine supplies food to global markets. This makes the war relatively economically disruptive compared to most other conflicts since 1945. The most obvious comparator is the Yom Kippur war in 1973 which led to a quadrupling of oil prices that helped to spark the great inflation of the 1970s. While the Yom Kippur war was short and the belligerents were less economically important, the disruption to the global economy came through non-military responses, as in Ukraine. It was the reduction in supply of oil from the Arab oil producers that led to the oil price hikes of 1973, just as the main economic impact of the Ukraine war is the result of the lower supply of oil and gas because of sanctions imposed on Russia and the disruption to Ukrainian cereal exports from the Russian decision to limit exports through the Black Sea. More generally, the world has faced many commodity price spikes over the years. As a result, while the Ukraine war was unexpected, its economic spillovers were relatively familiar.

Given these considerations, the analysis below focuses on the IMF’s assessment of risks and policy advice since mid-2021. This excludes the initial effects of the COVID pandemic with its myriad of uncertainties that the IMF could not reasonably be expected to assess with any accuracy. By mid-2021, however, forecasters were on firmer ground. The outlook situation had stabilized insofar as it was clear that the world was starting to recover from the pandemic. Further, the economic effects of the pandemic were better understood since policy makers had observed the impact of COVID-related lockdowns and vaccines. Hence, while the situation remained uncertain, by mid-2021 it was much more feasible to make educated guesses about the future path of the world economy. Admittedly, forecasters faced new shocks in 2022, most notably the war in Ukraine and the severe lockdowns in China. However, the economic spillovers of these shocks were more familiar and better understood than the fallout from the initial wave of COVID in 2020.

In sum, while conditions in the world remained unusual, by mid-2021 the global recovery was on more familiar territory than the landscape presented during the initial stages of the pandemic. Indicative of this return to something closer to normalcy, for the first time since the start of the pandemic, the forecast for inflation ticked up significantly in the July 2021 World Economic Outlook Update.¹¹ It was to become a pattern. The next section of this paper deals with the IMF’s assessment of inflation and the appropriate policy responses.

The July 2021 WEO Update was relatively sanguine about price pressures. To quote from the report:

“Recent price pressures [in advanced economies] for the most part reflect unusual pandemic-related developments and transitory supply-demand mismatches. Inflation is expected to return to its pre-pandemic ranges in most countries in 2022 once these disturbances work their way through prices, though uncertainty remains high. Elevated inflation is also expected in some emerging market and developing economies, related in part to high food prices. Central banks should generally look through transitory inflation pressures and avoid tightening until there is more clarity on underlying price dynamics. Clear communication from central banks on the outlook for monetary policy will be key to shaping inflation expectations and safeguarding against premature tightening of financial conditions. There is, however, a risk that transitory pressures could become more persistent and central banks may need to take preemptive action.”

The October 2021 WEO repeated the above prediction that price pressures were likely transitory. It also echoed the advice to maintain clear communication to keep inflation expectations anchored and financial conditions stable, and avoid tightening monetary policy that would risk disrupting a still fragile recovery.

This does not mean that the authors of the October 2021 WEO ignored the risk of a rise in inflation. Perspicaciously, chapter 2 reported research on the historical experience of higher inflation. The analysis used a conventional Phillips curve approach and standard measures of labor market conditions and expected inflation. The policy message from the chapter was relatively clear: if inflation expectations remained anchored, then headline inflation was unlikely to become a major problem. While the text of the chapter mentioned that rises in inflation could be triggered by prolonged supply disturbances, commodity or housing price shocks, and long-term (government) expenditure commitments, the analysis gave pride of place to the impact of a de-anchoring of inflation expectations. This is clear from simulations of future inflation paths reported in the chapter. In addition to a baseline scenario, the chapter produced two fan charts of future inflation in a tail risk scenario involving commodity price hikes together with continuing supply disruptions with and without a de-anchoring of inflation expectations. If expectations remained anchored the authors calculated that there was less than a 10 percent chance of headline inflation across advanced economies rising above 5 percent during 2022 even in the tail risk scenario (which the authors assessed had less than a 0.1 percent likelihood but can be argued to be close to what happened because of the Ukraine war and China lockdowns). Only when the authors assumed that inflation expectations de-anchored did the projections anticipate a major burst of inflation of the type that actually occurred.

The April 2002 WEO, published after the start of the Ukraine war and severe lockdowns in China, contained further rises in the forecast for inflation. Despite these increases, the advice continued to assess that policy makers should focus on the stability of inflation expectations. It says: “Provided medium-term [inflation] expectations continue to remain well anchored during the unfolding of the current conflict, price- and wage-setting should adjust to the developments in commodity prices, supply-demand imbalances, and labor supply described in this chapter.”

However, when the expected date of inflation returning to target receded into 2024, the advice on combatting inflation changed in the July 2022 WEO Update. The most detailed articulation of this new approach is contained in the October 2022 WEO. While observing the acceleration of tightening monetary policy and acknowledging concerns that central banks could tighten too fast, the WEO argued that the risks from under- and over-tightening were not symmetric. “Misjudging yet again the stubborn persistence of inflation could prove much more detrimental to future macroeconomic stability by gravely undermining the hard-won credibility of central banks.” Importantly, instead of looking at whether inflation expectations had de-anchored, the focus switched to the impact on macroeconomic stability if inflation expectations were to de-anchor. Belatedly, the balance of concerns shifted from the danger that over-tightening could derail the global recovery to worries over the mistake that ultimately occurred. Under-tightening created an inflationary spiral that could be difficult and costly to end even as medium-term inflation expectations appeared anchored.

It is useful at this juncture to go back and examine the advice given on financial stability since mid-2021 in light of the three medium-sized US banks and one major European bank that failed in early 2023. The April 2022 GFSR highlighted the risk that higher inflation and a rapid tightening of monetary policy could lead to financial instability. In addition to “tightening macroprudential tools to tackle pockets of vulnerabilities” the text advised that, “authorities should determine whether financial institutions have a comprehensive risk management process, with a special focus on credit, market, and counterparty risks.” These concerns, however, were not focused on banks as was made clear in the October 2022 GFSR, which observed that “financial vulnerabilities are elevated in the sovereign and nonbank financial institution sectors, where rising interest rates have brought on additional stress. A bright light comes from our global bank stress tests which show relative resilience for advanced economy banks.” To be fair, in a later section the text advised supervisors to ensure that “banks have risk management systems commensurate with their risk profile, including strengthening the capacity and adequacy of stress tests” which was clearly not the case for Silicon Valley Bank or Credit Suisse. However, in the light of the subsequent problems in the US and European banking systems and its impact on the provision of credit, the judgement that advanced country banks were a “bright spot” was clearly unfortunate.

It is also striking that while the IMF made numerous references to the potential for losses in assets, the risks from losses on bond holdings—the factor that felled Silicon Valley Bank—was never explicitly mentioned. This is striking as falling bond prices were an obvious conduit for asset losses since the policy of quantitative easing. As a result of this policy, central banks bought large quantities of long-term bonds aimed at boosting the economy by lowering bond yields or, equivalently, raising bond prices.¹² Given that quantitative easing was aimed at artificially raising bond prices, its reversal (dubbed quantitative tightening) was always likely to create atypically large losses in bond markets.

How successful was IMF surveillance?

How successful was the IMF in warning the world about these risks to the global economy and how to avoid them? The answer depends upon the way that the question is framed. The IMF did a good job of warning about the risks. The possibility that inflation could prove more resilient than expected was persistently identified as a major risk as early as the July 2021 WEO Update. Furthermore, the WEO published an extremely timely chapter on the experience with rising inflation in October 2021. The IMF clearly identified the risk that inflation could overshoot and become entrenched, as indeed has occurred.

On the other hand, the policy advice that accompanied these warnings—the more complex part of the assessment—was less useful. The IMF emphasized the importance of ensuring that macroeconomic stability could be maintained if inflation expectations remained anchored around the inflation target through the spring of 2022. This reflected an understandable concern that excess monetary tightening in response to a temporary rise in inflation could damage a recovery that remained susceptible to many risks, such as a more virulent strain of COVID. However, inflation became a major problem even as conventional measures of inflation expectations remained anchored. Inflation consistently exceeded forecasts because the IMF consistently underestimated the persistence of price pressures. Fear of going too far led to insufficient action in the early stages of the recovery when nascent inflationary pressures could have been nipped in the bud. A faster response would also have allowed more time to assess the impact of rate hikes on growth and inflation, reducing uncertainties about the monetary transmission mechanism. It was only after it became apparent that inflation was unlikely to return to the targets set by the central banks in developed economies within a reasonable time frame that the IMF’s policy advice shifted from worrying about a premature tightening of monetary policy to concern about the risk that tight labor markets could lead to a rise in inflation expectations in the future.

With the benefits of hindsight, the October 2021 research chapter analyzing past experiences of rising inflation may have contributed to this faulty advice. The Phillips curve framework used in the chapter relied on measures of economic slack and inflation expectations. The authors chose to focus on the results that measured slack by the unemployment rate and expected inflation using the prediction of inflation over the next 3 years from Consensus Economics, both entirely standard measures. One of the peculiarities of the post-COVID recovery, however, was that there were an unusually large number of vacancies compared to unemployment as COVID led workers to reconsider the value of their jobs—leading to the so-called “great resignation.” Two prominent macroeconomists have concluded that the reason that inflation proved more persistent than expected is that the high numbers of vacancies meant that the labor market was tighter than the unemployment rate suggested. In addition, professional forecasts of inflation largely reflected the conventional view in the profession that central bank credibility implied low inflation risks, replicating the flawed analysis of the central banks as well as the IMF. In short, specific choices made by this in-house research may have contributed to the conjunctural analysis underestimating the tightness of the labor market and overestimating of the degree to which inflation expectations remained anchored.

The IMF’s advice regarding risks to financial stability shows a similar pattern—early identification of the underlying risk but less helpful policy advice. The concern that a rapid monetary policy tightening because of higher-than-anticipated inflation could undermine financial stability was clearly flagged in the April 2022 GFSR, and subsequently repeated. However, the policy advice concentrated on the risks to emerging markets or to peripheral institutions in advanced economies such as nonbanks, in part because of the relatively rosy assessment of the state of the international banking system provided by a global stress test in the October 2022 GFSR. In fact, the main unexpected financial tremors were rooted in the banking systems of the United States and Europe and reflected either long-standing management problems (Credit Suisse in Switzerland) or losses on large investments in treasury bonds (Silicon Valley Bank and other US banks). Furthermore, the losses on bonds that felled the US banks partly reflected the rapid switch of the Federal Reserve from accumulating bonds (quantitative easing) to reducing such holdings (quantitative tightening). This specific link between macroeconomic policy and financial frailty was not discussed by the IMF.

Of course, the IMF was not unique in misdiagnosing the shocks of the last three years. Central banks and finance ministries around the world struggled to forecast in such an unprecedented environment. The fact that others made the same mistakes, however, is hardly a strong defense. The IMF was relatively well placed to analyze the situation as it reflected global shocks, similar developments across a range of countries, and a mixture of macroeconomic, financial, and fiscal concerns.

Too many reports

Given the mixed record of IMF global surveillance on the impact of recent shocks, it is important to ask how its performance can be improved. The last major change in the structure of global surveillance was the introduction of the GFSR in the aftermath of the Asia crisis of the late 1990s, with the aim of sharpening the IMF’s focus on financial risks. The decision to add a new publication was driven, at least in part, by the conventional view at the time that macroeconomic developments and financial stability risks could be largely separated, and that financial instability was mainly limited to emerging markets. However, the combination of research conducted over the last two decades and problems in advanced country banks have made it clear that such a dichotomy is artificial. Indeed, the close relationship between macroeconomics and financial stability is evident from the frequent cross-referencing between WEOs and GFSRs (as well as cross-references to Fiscal Monitors and External Stability Reports). In addition, experience shows that better decisions are made when diverse views are aired and debated. In this case, that means IMF surveillance would benefit from greater deliberation, especially between its macroeconomists and its financial experts.

Another interesting and somewhat surprising conclusion from the analysis in this paper is that nestling research with surveillance is not necessarily helpful. As discussed above, the WEO chapter looking at experiences with rising inflation and the GFSR’s global bank stress test may have led to an excessively benign assessment of risks. Research inevitably looks mainly to the past, but the past does not always predict the future. Indeed, part of the art of surveillance may involve assessing the particulars of the present as well as similarities with the past. This implies that it may be useful to consider assigning surveillance to a dedicated team that is not also involved in producing research. To be clear, assessing new research is a vital input in surveillance, but too close a link to the authors may result in too much weight put on specific results.

These insights suggest that IMF global surveillance could be improved by switching from the current arrangement involving many publications combining conjunctural analysis with research to a single, short, focused, and more easily readable paper that concentrates on the forecast, risks, and possible policy options. This could improve surveillance in several ways. First, a single narrative would play to the IMF’s strengths in terms of the width of its analytic reach. Consultation across groups can be valuable, but still makes it possible to leave differences in underlying analysis and emphasis unresolved. The IMF would do better to ensure that diverse views are fully articulated and then harmonized by creating a single narrative. This would allow the Fund to speak with a clear, authoritative voice rather than sending tailored messages on different aspects of the global environment, however well-orchestrated. Closer collaboration could, for example, have pinpointed losses on bonds as a key conduit between monetary tightening and financial stability.

Second, the switch to a single group solely dedicated to surveillance would allow for a greater emphasis on policy advice. As noted above, the risks to the forecast were identified early. It was the policy advice that was less insightful. A dedicated group that is not distracted by producing research may be more focused on providing tangible policy advice. Such a group may also be better placed to assess the specifics of a current environment when faced with unexpected economic developments. A single group might also find it easier to devote more resources to assessing different policy options compared to the present arrangement involving several separate groups crafting similar underlying assessments for different audiences.

In keeping with its deserved reputation as the world’s premier macroeconomic institution, the IMF should use its global reach and expertise to improve the quality of its analysis of current risks and policy recommendations. One important step to achieving this goal would involve consolidating the current range of reports into a single, much more focused narrative covering the state of the world economy with a harmonized discussion of economic and financial risks, their linkages, and the policy options. Such a change will not be trivial, particularly given the existence of differing departments producing distinct products. In addition to setting up a new team to write the new surveillance report and developing new procedures to assess and integrate diverse views, it will require a major restructuring of the groups that produce the WEO, GFSR, the Fiscal Monitor, and External Stability Reports. Such a change will require the full attention and leadership of the management team and the support of major shareholders. It would also ensure the continued relevance of an institution whose advice—and allegiance—will increasingly be questioned while increasingly needed in a fragmenting geoeconomic landscape.

Tamim Bayoumi is a contributor to the Atlantic Council’s GeoEconomics Center and Visiting Professor at King’s College, London.

The author thanks Martin Mühleisen and Charles Collyns for providing useful comments on an earlier draft.

Related content

Issue Brief Oct 9, 2023

The Bretton Woods institutions under geopolitical fragmentation

By Martin Mühleisen

Given China’s current resource advantage, Western countries need to make better use of the IMF and World Bank where doing so is in their interest. If applied more broadly, this approach could provide incentives for other governments to return to multilateral institutions, instead of China, for support.

China Economy & Business

Issue Brief Oct 9, 2023

Reimagining Africa’s role in revitalizing the global economy

By Amin Mohseni-Cheraghlou

The African continent potential to revitalize the world economy and reverse the downward trend in global growth. However, for this to materialize, it needs substantial investments in its physical and social infrastructure.

Africa China

Issue Brief Oct 9, 2023

How the IMF can navigate great power rivalry

By Hung Tran

Fragmentation resulting from geopolitical competition between large economies is posing a serious challenge to the fulfillment of IMF’s core missions. Here’s how it can respond.

China Economy & Business

The post Less is more: Fewer reports would improve the IMF’s global surveillance appeared first on Atlantic Council.

Foreword

2023 was never going to be the year of China’s economic resurgence. While some analysts anticipated the end of zero-COVID policies would unleash pent-up consumer demand and revive corporate animal spirits, those who understood the deep structural nature of China’s economic malaise have been bracing for impact.

Now, many around the world are finally coming to terms with reality—the Chinese economy is suffering in part because the Party continues to prioritize ideology over economic dynamism.

In 2023, China’s GDP will likely grow at less than 4 percent for only the third time in the past twenty years. And this raises two fundamental questions: How will Xi Jinping, now in his third term, respond? And how will the other major economies around the world handle these tectonic shifts?

In leading market economies, the increasing emphasis on national security in economic decision making has been perhaps the most significant development in international economics.

For the past several years, the US and Europe have demonstrated an increasing willingness to use the tools of economic statecraft to begin the so-called process of “de-risking.” This includes export controls and outbound investment screening for certain national security technologies. While the moves are not surprising from a US perspective, the fact that counties like Germany—long dependent on China for its export market—has been willing to engage in these conversations represents a significant shift.

China has responded in kind—including accelerating work on its own semiconductor capacity and introducing controls on the export of critical minerals gallium and germanium.

Missing amid this escalation is a proper look at the broader implications. What does it mean if the world’s second-largest economy can’t recover from its economic malaise? How high are the risks of the tools of statecraft being perceived as crossing a line from competitive action to national security threat?

These questions become more pressing as elections approach in Taiwan and the US in 2024.

This where the China Pathfinder framework offers valuable insights. Now in its third year, China Pathfinder gives policymakers a way to distinguish the signal from the noise of Chinese economic policy decision-making. With the benefit of tracking changes in China’s performance along more than 25 economic indicators across multiple years, we can move beyond instant reactions to identify where China is actually making strides toward market reform. We can also identify the areas where China is backsliding.

The goal of Pathfinder has always been to create a shared language on China’s economy for policymakers around the world. The reaction to Pathfinder in its first two years has affirmed that mission. In our meetings with US, European, and Chinese officials, the data we provide in these pages is recognized as useful and revealing, even if these officials disagree on how to act in response. The analysis has been cited around the world and is required reading in many Chinese econ syllabi.

One of the reasons that the project has resonated is that the findings in Pathfinder are not limited to China. Because the purpose of the China Pathfinder study is to compare China to the top ten OECD economies over the same period, one of the most rewarding and surprising parts of this work has been discovering the trajectory of market economies. One of the most significant shifts captured by Pathfinder has been the inclination of some countries to lean on a new form of industrial policy in the last several years.

So, what comes next? While it’s tempting to assume that China’s current trajectory will persist, recent events such as US Commerce Secretary Gina Raimondo’s trip to Beijing and the return of a US-China economic dialogue suggest the story is more complicated. We should not overlook positive signs that come amidst the gloom of political rhetoric. Could China’s domestic economic pressures, including youth unemployment and a floundering property sector, shock Chinese leaders into reversing the statist course they’ve been on since Xi came to power? However unlikely, the possibility remains.

Our hope is that Pathfinder sheds some light on the various paths China may take—and shows that while Beijing has run out of the easy options, opportunities for adjusting the economic model remain viable. The course it chooses will determine its fate—and impact the rest of the world—for years to come.

We thank the dedicated teams from Rhodium Group and the Atlantic Council who have worked tirelessly to make this report a reality. And we thank each of you for taking the time to engage with this critical work.

Josh Lipsky
Senior Director, Atlantic Council GeoEconomics Center

Executive summary

With hopes of a rapid recovery following the dissolution of China’s zero-COVID policy dashed, structural threats to the country’s economic stability have never been greater. Although draconian lockdowns certainly soured the mood of businesses and consumers in China, the economic malaise that policymakers in Beijing are staring down now is not caused by cyclical factors like COVID, but by a failure to reform the country’s economic system. Chinese leadership is aware it needs to undertake significant reforms to shake off the shackles of the current structural slowdown, but previous efforts have fallen far short of the big bang changes that the moment demands.

To track Beijing’s reform efforts, China Pathfinder compares China’s economic system to those of market economies. Using six components of the market model—financial system development, market competition, modern innovation system, trade openness, direct investment openness, and portfolio investment openness—we establish a quantitative framework for understanding China’s progress or regression on reform. China’s outsize role in the global economy and the necessity of reform in maintaining the country’s growth make this work a key to understanding China’s future trajectory.

Key findings

• The economic effects of the pandemic obscured the underlying problems, but developments in 2022 underlined the structural nature of China’s slowdown. Although political expediency led Chinese policymakers to blame the effects of COVID for economic malaise, the implosion of the property sector, cratering market confidence, and rising tensions with Western countries forced an admission of a downturn.
• China has made some reform progress, with trade openness a standout improvement. China’s trade openness is within the range of market norms, and its goods trade practices are likely to remain a point of progress. Despite still being well behind OECD norms, China has also made progress over the past decade in the openness of its financial system, with the score for pricing of credit entering the range of market norms for the first time.
• In the past year, China strayed further from market norms in the areas of market competition and its innovation system. Amid widening global competition over high-tech industries, Beijing has seen a sizeable increase in the presence of stateowned firms in its top companies, tightening of cross-border data rules, and the staying power of industrial policy as a key tool. China’s restriction of academic database access and crackdown on how companies use algorithms has made its innovation system less open.
• Open market economies in some cases moved away from market norms in 2022 due to the state of the global economy. OECD economies saw movement away from market norms in financial system development and portfolio investment, mostly as a result of a decline in market capitalization and falling non-financial corporate debt compared to GDP. These drifts say more about structural changes in the global economy than they do about particular regulatory changes.
• In its current trajectory, China’s economic growth will continue to grind ever slower. This slowdown will impact Beijing’s ambitions for indigenous high-tech development, exacerbate local fiscal crunches, and have spillover effects for other countries who depend on China as an export or import market. The slowdown will also begin to diminish perceptions of China’s state-led economic system, with implications for the competition between Beijing and market economies.
• If Beijing is going to dig its way out of its current economic hole, it needs to allow robust debate and enact concrete reforms. To make positive changes, China should retire its GDP target, rebalance the fiscal burdens that are unequally shared by local and central governments, privatize some of its state-owned assets, and reform its pension system.

Figure 1: 2022 annual economic benchmarks

Chapter 1: The past explains the present

In 2023, China’s troubled economic performance caught the world by surprise. With COVID behind us, expectations were set for a strong Chinese recovery. Though it paid an awful cost for the abrupt end of zero-COVID, China was assumed by many to be poised for a powerful economic revival as lockdowns ended, freeing businesses and consumers to spend. But instead of a boom, the world has watched China falter. The handful of whispers about growth risks in early 2023 turned into a shouting match among prominent foreign economists by mid-year, jostling to talk about what was wrong with China but focusing largely on cyclical reverberations from the pandemic rather than the longer arc of economic policy ambitions and shortfalls over the Xi Jinping era.

The thesis of China Pathfinder is that China’s leaders explained the structural risks to their economy clearly, a decade ago, and demonstrated seriousness about dealing with them, only to pull back in the face of challenges. Progress toward market economy norms is the key to China’s GDP growth today, as it was in past decades, and the dearth of market convergence since 2015 correlates with the end of high growth. That change to potential growth, and to Beijing’s ability to manage perceptions about it, not only reshapes expectations about China’s domestic performance, but also influences China’s geoeconomic power, resilience in global competition, and relations with the United States.

In this report, we update data indicators on China’s systemic alignment with leading market economies through the end of 2022, and relate those statistics to this year’s macroeconomic malaise. To set the scene for that, we briefly review China’s policy trajectory over the past decade, which makes clear why the China Pathfinder framework is designed to gauge alignment with advanced market economy systems.

Xi’s first Third Plenum, a decade later

In November 2013, Xi Jinping—then in his first year at China’s helm—set his economic policy course, at the Third Plenary Session of the 18th Central Committee of the Communist Party of China. With the laissez-faire missteps of the global financial crisis still stinging, the Third Plenum communiqué was surprising for its pro-market orientation. A signature instruction was to “make the market decisive.” More than two hundred specific reforms grouped into “60 Decisions” included pruning the role of state enterprises, completing center-local fiscal reform, reforming corporate governance, and promoting competition.

Taken together, this extensive plan was a genuine commitment to economic reform in alignment with market economy principles and not merely an aspiration formulated abroad. The terms of China’s WTO accession in December 2001 provided the same evidence a decade earlier, but it is important to establish that this was the intended course in the Xi era as well—at the beginning. Over the following years, Beijing made significant efforts to implement the plan. Premier Li Keqiang endorsed the premise that his government should be judged, even by foreign press.

The motivations for serious reform were clear: if they were not achieved, President Xi himself penned, China would find itself in a blind alley. As we wrote in the precursor study¹ to China Pathfinder in 2014, one year after the Third Plenum (edited for brevity):

“We project that China’s potential GDP growth in 2020 will be 6 percent. Half through investment, the other half [from] more efficient use of resources (what economists call total factor productivity). Such growth depends on new rules and institutions that let markets steer resources—people, money, and materials—to where they can generate the highest growth. Without this marketization— which depends on both re-regulation and a new mindset about the roles of the Party and the government—the gains from productivity would all but evaporate. Growth driven only by investment would mean a hard landing: no better than 3 percent annual GDP growth. Falling productivity could easily pull private investment down with it, leaving GDP growth even lower at 1 percent, surely a crisis.”

Going into 2020, growth was indeed 6 percent. After the COVID interlude, the question is whether China can return to that growth rate, or will slow to the 1-3 percent range we projected. Present indications suggest the latter, due to prioritization of political control over efficiency that has characterized the Xi era since the start. While officials explicitly recognized the risk of low-productivity statist lethargy in 2013, they judged the allure of foreign political and social ideas even greater, as shown by other policies. The same year as the 60 Decisions plan, an ideological communique was issued painting Western constitutional democracy as “an attempt to undermine the current leadership and the socialism with Chinese characteristics system of governance.”

The 2013–2020 period was essentially a test of whether Beijing could find a way to achieve market economic goals without embracing a more liberal political system. As of 2023 it would appear the result was negative: economic reforms were not completed, while political priorities took precedence.²

For Xi, who started an unprecedented third term as leader in 2022, the set of systemic challenges laid out in 2013 remains unchanged, but the magnitude of these economic problems (such as the debt load, fiscal shortfalls, innovation gaps, and dependence on investment-led growth and exports) have only increased. The 60 Decisions list of necessary policy reform work remains the best benchmark for China’s ability to realize its potential GDP growth potential. President Xi was correct, as Deng Xiaoping had been before him, in saying that “if we do not implement reform and opening to the outside world, do not develop the economy and raise the people’s living standards, we will find ourselves in a blind alley.”

2022 and 2023: Pandemic obscures problems

The inability of China’s largest property developers to cover debt payments in mid-2021 marked the end of an era. The property sec-tor, responsible for as much as a quarter of GDP growth and almost half of investment, could no longer serve as the anchor of economic expansion expectations. Other risks were evident in 2021 as well, as discussed in previous China Pathfinder reports, including (among other things) falling household incomes, declining productivity, elevated tensions with major trading partners, and unclear signaling to private entrepreneurs and foreign investors.

The market-oriented prescription for these challenges would be a frank and urgent reform agenda for 2022. Instead, the Communist Party took a political approach centered on controlling the public narrative to project stability and administrative control. The 20th National Congress of the Chinese Communist Party was looming in October 2022, and it was clear, after years of crackdown on dissent, that spinning a positive message celebrating the CCP’s success in steering the economy through challenging times at that political event was paramount. The Party intensified zero-COVID policies in the run-up to the Congress, downplayed structural concerns, and attributed economic challenges such as weak property demand and investment to the pandemic, rather than structural issues.

Behind the COVID veil, three realities forced Beijing to admit missing its GDP growth target in 2022 for the first time. The first and foremost was, as noted above, the property sector. China’s annual housing starts peaked at 1.71 billion square meters in early 2021, enough for around 18 to 19 million houses. With the revelation that those property developers didn’t have the money to service their debt or finish construction, that number fell 52 percent to only 881 million sqm at the end of 2022—a huge bite out of business investment. Second, 2022 market confidence continued to suffer from contradictory policies on data handling that cast uncertainty over the operation of promising sunrise sectors including social media and artificial intelligence. Third, and crucially, the outlook for China’s commercial interactions with major western nations starting with the United States continued to sour, with Beijing maintaining an uncompromising posture as export controls, investment controls, and other China de-risking policies were developed abroad. Contrary to rosy official statistics, US and EU foreign direct investment to China as measured by independent researchers displayed a steep downturn. We relate these economic headwinds to specific policy reform areas in Chapter 2.

Insistence on blaming the 2022 growth shortfall on the pandemic rather than structural realities led to misguided expectations for 2023. After the November abandonment of zero-COVID restrictions, authorities started messaging a return to high, pre-pandemic 5-6 percent GDP growth as the anchor for this year. As discussed in our Q2 2023 quarterly report,³ this was completely unrealistic, but at the start of 2023 it was taken as reliable by the vast majority of observers in finance, manufacturing, government, and international organizations. By midyear, that confidence had evaporated and debates about “the end of the Chinese economic miracle” were in full swing.

Views on China’s current economic situation can be grouped into five camps, starting with the perspective taken in the China Pathfinder framework and its precursor program (China Dashboard and Avoiding the Blind Alley) since 2014. The assessment in this body of work is as presented above: that China is a transition economy, its potential growth rate is contingent on carrying through on incomplete structural reform, that Xi Jinping and the CCP have stated as much, and that years of delayed structural reform to foster market economy incentives has left China with nothing to replace property and infrastructure debt bubbles after they were exhausted in 2021. We are not alone in this view although we have stood by it most consistently.⁴ Beyond this structural view, we see four other distinct camps presently.

First, some observers argue that China is experiencing a cyclical slowdown, and that it is caused by faltering household consumption triggered by their leaders’ extreme responses to COVID.⁵ While those policies were unceremoniously jettisoned almost a year ago, the argument goes, they left a long economic malaise. Seen through this lens, if authorities provide sufficient assurance that they’ll leave individuals alone, households will start spending money they’ve been saving. Consumer confidence is definitely lacking, but this likely has as much to do with weak income and employment growth as a buildup of precautionary savings. Some of the household savings buildup in recent years is also related to paying down mortgage debt. In considering this hypothesis it is also important to consider the declining capacity of fiscal policy and credit expansion to generate investment growth to offset household slack, particularly among local governments.

Second, the authors of the World Economic Outlook (WEO) series at the IMF are the most authoritative source for comparative forecasts of national growth.⁶ The summer 2023 WEO update takes the view that China’s GDP is unchanged at midyear from where it was forecast earlier in the year—at 5.2 percent—but that the composition underlying it has shifted. In a mirror image of the COVID consumer disorder above, the IMF argued that China’s consumption growth has been strong enough to hold GDP growth constant despite COVID restrictions, rising unemployment, plummeting property investment, and a negative contribution of net exports to overall growth. Given that household consumption is only 38 percent of China’s economy, it is hard to accept that its growth alone has been enough to drive 5 percent economic growth in China this year.

Third, a few observers argue that conditions in China aren’t bad, and that we are already seeing a V-shaped recovery back to pre-pandemic growth rates. In this view, neither consumption nor investment is a structural drag on growth. In volume terms, imports are recovering and household savings are declining—these indicators support a strong recovery story and that growth will recover its strength in short order.⁷ This argument is difficult to square with even the official data, given that almost all indicators show a deceleration of sequential growth from earlier in the year to the summer, and a continued slowdown so far in Q3.

Finally, a growing body of research is focused on the negative spillovers of decoupling policies on China and other emerging markets. World Bank work on the negative spillovers through the innovation channel,⁸ and IMF work on the trade channel,⁹ for instance, show significant shocks from these trends. Hawkish policymakers in the US explicitly talk about the need to cease enabling China’s fast growth, so it is no surprise to see connections drawn between de-risking policies and the falloff in China’s growth. However, while rising political risk in the US-China relationship is definitely affecting businesses and investors’ China strategies, overall US-China trade reached a record high in 2022, and in any case the nature of China’s economic problems has little to do with external shocks.

In our Pathfinder Q2 2023 report, we described a modest opening in domestic discussion of economic problems among Chinese economists.¹⁰ While most of the discussion of the nature of the slowdown described above has taken place among non-Chinese analysts, the conversation has broadened inside China as well. Numerous retired government officials and Party-affiliated economists, such as Liu Shijin, Yin Yanlin, Xu Lin, and Jiang Xiaojuan, have published speeches or commentaries about the need for serious market reform since May 2023. It is a positive sign that Chinese economists are discussing the state of progress on macroeconomic reforms, but there is a long path between an academic discussion among economists and formal officials and the actual implementation of difficult structural reforms by China’s top leadership.

The Pathfinder framework & updates to research design and methodology

The China Pathfinder framework analyzes China in comparison to advanced economies in our sample across six dimensions that reflect an economy’s market orientation, with three clusters focusing on the domestic economic system (financial system development, market competition, and a modern innovation system) and three clusters covering the external openness dimension (trade openness, direct investment openness, and portfolio investment openness).

The research design is quantitative in nature, including three sets of datapoints for each of these economic dimensions: a composite score, annual benchmark indicators, and supplemental indicators.

China Pathfinder selects a set of four to six annual cross-country comparable indicators for each economic dimension. The data for each indicator are normalized using the Min-Max methodology, and rescaled from 0 to 10. Higher scores indicate more alignment with market economy norms. The composite score for each economic cluster is a simple average of the indicator scores for each country.

Starting with this year’s annual report, the composite score methodology has been revised to better reflect countries’ progress or regression across time. Previous editions have focused on countries’ performance in a particular year, compared to each other. The Min-Max methodology has been updated to calculate one minimum and one maximum across all countries and all years of the sample, for each indicator. The methodology previously would conduct normalization separately for each year, where the minimum and maximum were calculated for only one given year (instead of across all years). This meant that if a country’s performance ranking among its comparison countries did not change, then a country could receive the same score across years. This would be true even if its performance in the raw data had changed across years. The new methodology corrects for this, so that we can assess not only relative distance between countries’ performance, but also distance between one country’s improvement upon its past performance. More information on the stress-testing process that took place to update the methodology, potential impacts on the data results, and literature supporting this revision can be found in the Appendix.

Figure 2: Summary of China Pathfinder clusters and indicators, 2023

The annual indicators that contribute to each economic area’s composite score are outlined in Table 1, and are explained in more detail in Chapter 2.

The China Pathfinder framework also uses supplemental indicators, though these datapoints do not contribute to composite scoring. Supplemental indicators zero in on unique aspects of China’s economy that are not comparable across countries, such as the role of stock connects in opening up Chinese investment avenues. These indicators are updated annually and are featured at the end of the cluster analyses in Chapter 2.

Numbers alone are not sufficient to capture the complexity of a country’s economic system or how the domestic dimensions of economic policy interact with the external dimensions. Therefore, we supplement our quantitative analysis with qualitative assessments. In Chapter 2, the analysis of each cluster discusses composite scores, but also unpacks the developments that shaped policies— and outcomes—in 2022. Chapter 3 highlights the most significant data findings and draws conclusions about their potential impact on China and other economies. As this is the third report in a series of four annual reports, we outline the main signposts we expect to see in H2 2023 and 2024 that would indicate China is moving in a market reform direction.

Chapter 2: Historical baseline and 2022 stocktaking

In this chapter, we review each of our six clusters in detail. For each of the six economic pillars, we begin with a discussion of how to define the cluster and its relevance to a market-oriented economy. This provides a framework for how we selected indicators and why they are a fair proxy of that particular area of economic performance. The next section outlines each indicator and its corresponding methodology, followed by an analysis of the 2022 data findings for China and open-market economies. The individual indicator stocktaking leads to our overall composite score results, where we assess countries’ relative performance and interesting trends for 2010, 2020, 2021, and 2022. The six sections of this chapter each conclude with a review of the major policies and other relevant developments that were enacted or occurred in China in 2022.

2.1 Financial system development

Figure 3: Composite index: Financial system development, 2022

Definition and relevance

Open market economies rely on modern financial systems for the efficient pricing of risk and allocation of capital.¹¹ Key pillars of modern financial systems are generally market-driven credit pricing, availability of a broad range of financial instruments, the absence of distortive administrative controls on credit price and quantity, and access for foreign firms to financial services and foreign exchange markets.

How does China stack up in 2022?

We chose the following annual indicators to benchmark China’s financial system development against that of open market economies.

Efficient pricing of credit

As a proxy for efficient pricing of credit we use the absolute value difference between the average borrowing rates for non-financial corporations and projected GDP growth. In an efficient financial system, the cost of capital (the average interest rate) should roughly mirror the expected return (for which we use the projected GDP growth rate). Countries with efficient pricing of credit will be close to zero in this calculation.

In 2010, China’s projected growth rate far exceeded the real interest rate for corporate borrowers, effectively subsidizing producers and punishing savers. While 2021 was characterized by high bounce-back growth rates associated with China’s pandemic recovery, China’s pricing of credit improved in 2022 because of rising real interest rates and slowing GDP growth. Meanwhile, in many open economies, high inflation rates far surpassed average borrowing rates in 2022, leading to large differences between the proxied cost of capital and expected return. China’s score for this indicator, 6.1 percent, has now entered the market economy range, which had not been the case in previous sampled years.

Direct financing

The extent of direct financing in an economy reflects the ability of firms to borrow directly from the market instead of going through banks and other intermediaries. We include two measures of direct financing: stock market capitalization as a share of GDP and outstanding non-financial corporation debt securities as a share of GDP. China’s stock market capitalization relative to its GDP is still far lower than most other major economies. The stock market capitalization for all countries in our sample declined between 2021 and 2022, reflecting rising inflation and deteriorating global stock market conditions. Though China’s direct debt financing increased from 8.4 percent in 2010, its nonfinancial corporate bonds as a share of GDP has decreased marginally each year since 2020. However, its 2022 value of 24.5 percent still exceeds the market economy average of 17.6 percent. China’s direct debt financing has far surpassed the bank-dominated financial systems in the EU.

State ownership in top ten financial institutions

In previous years we relied on survey data from the World Bank’s Bank Regulation and Supervision Survey (BRSS) for information on state ownership in the financial sector. However, these surveys are not frequently updated, and were missing data for some of our sample countries. For this reason, we created our own indicator that captures the influence of the state in this area. Our indicator measures the degree of state ownership in the country’s top ten financial institutions by market capitalization. For each country, we look at the proportion of each institution’s public stock owned by the government. We then weigh the results according to each institution’s market capitalization. For this measure we relied on market capitalization and government ownership data provided by Bloomberg.

We see a sizable gap between China and OECD economies for this indicator. In 2022, China’s weighted average government ownership proportion reached 39 percent compared to the open-economy average of 4 percent. The government ownership proportion for China dropped from 47 percent in 2010 but has not changed much since 2020. South Korea is the only OECD economy with a relatively high percentage of state ownership in financial institutions, at 19 percent in 2022. The high degree of state involvement in finance has been, and remains, one of the core systemic differences between China’s system and that of open economies.

Financial institutions depth

The financial institutions depth indicator captures bank credit to the private sector, the assets of the mutual fund and pension fund industries, and the size of life and non-life insurance premiums to GDP. This indicator is a useful proxy for the sophistication of the financial system in terms of financial offerings available beyond the banking system, whereas other indicators of institutional depth often have bank credit as the only driver of the results. In 2022, China had the lowest score in the sample (0.49) but is close to Italy and Spain’s scores (0.54 and 0.56, respectively). However, China is still well behind the open economy average of 0.77.

Financial markets access

The financial markets access indicator illustrates the difficulties faced by smaller companies in accessing the stock market and captures the number of issuers in the bond market. It combines two variables: the percentage of market capitalization outside of the top ten largest companies as a proxy for access to stock markets and the number of financial and nonfinancial corporate issuers on the domestic and external debt market in a given year per 100,000 adults to estimate bond market access.

China is far behind the market economy average in this area, with access declining from 0.37 in 2021 to 0.19 in 2022. Its 2022 level of financial market access now is barely higher than it was in 2010, at 0.18. This could mean smaller Chinese firms faced rising difficulties accessing finance in 2022, or that large firms could borrow more easily. One contributing factor remains the financial institutions’ bias in favor of state-owned enterprises (SOEs), local government financing vehicles (LGFVs), and other state-affiliated actors. Because they enjoy the implicit backing of the Chinese government, they are assumed to be safer borrowers than small, private enterprises. Market economies’ financial market access has generally remained steady since 2020.

Composite score

Blending our annual indicators, our Financial System Development Composite Index puts China at 2.9 in 2022, against an average of 6.2 within our sample of the ten largest open market economies (Figure 3). This shows some improvement from China’s score of 2.8 in 2021. In 2010, China’s score was only 0.5, reflecting progress toward more depth and diversity in China’s financial system, as well as deleveraging efforts since 2018. However, China still has the lowest composite score among the countries in our sample for 2010, 2020, 2021, and 2022. For all indicators, China remains behind open economies. This is not necessarily surprising. China’s financial system is still largely driven by state-owned banks and has only recently moved towards more advanced forms of financing characteristic of market economies. While there has been some progress in ensuring that financing is available to a broader and more representative group of firms within the economy, the overall state-driven character of the country’s financial system remains unchanged.

Our indicator set has good coverage of the institutional dimensions of financial system development, but external factors have impacted the results for some indicators. For example, China’s pandemic recovery in 2022 affected GDP data, which is a component of some output-driven indicators. This contributes to the decline in market capitalization and nongovernment debt securities as a share of GDP for most countries in 2022.

A year in review: China’s 2022 financial system policies and developments

We update our benchmark indicators yearly to track the pace and direction of change. On a quarterly basis, we track policy developments that could push China either closer or further from the average of market economies in terms of its financial system. From this exercise, we have selected a few of the most significant events that took place in 2022.

China’s property sector troubles continued through 2022, prompting Beijing to take a series of temporary steps, such as the PBOC and CBIRC’s 16 measures to support the property market, that were more focused on stability than market liberalization. Instead of getting at the root of the problem, this policy package offered extensions for property developers to repay their outstanding bank loans and eased restrictions on bank lending to developers. This reinforces Beijing’s efforts to prop up the old growth model.

In April 2022, the PBOC revised the way it guides bank deposit rates, pricing deposits according to market interest rates instead of the central bank’s own benchmark rates. This change can reduce corporate lending rates and boost credit demand in the sluggish economy, representing an important step toward interest rate liberalization. China has attempted to initiate this reform numerous times since 2004, but has reversed its efforts each time to maintain the dominance of state banks. In 2012, the deposit rate was allowed to be set higher than the benchmark rate and by 2015, in theory, there was no ceiling on the deposit rate. In reality, the PBOC still managed deposit rates through an interest rate self-discipline committee to impose an implicit ceiling. During this time, the fastpaced development of wealth management products was a step toward market reform to allow unregulated competition on rates offered, replacing deposits. We will watch carefully to see further signals of interest rate liberalization.

Though in 2022, China’s government tuned down the rhetoric on the common prosperity campaign—which includes income inequality reduction as one of its pillars—it took aim at the perceived elitism and flashy lifestyles of financial sector employees. Chinese regulators aimed to restrict financial sector salaries, intervening in internal business decisions. In Q2 2022, the Securities Association of China warned companies in the sector against granting excessive short-term incentives for employees, citing compliance risks. In the same quarter, the Asset Management Association of China mandated that over 40 percent of senior staff bonuses be deferred for three years or more. The various interventions fall within a larger campaign to prioritize “social responsibility,” which signals increased government involvement in financial sector companies. The scrutiny on financial sector “extravagance” has intensified in 2023, with the Central Commission for Discipline and Inspection taking aim at high wages and bonuses.

In addition to tracking policy signals in these areas, we are also monitoring several higher-frequency indicators to gauge progress on market-oriented, liberal economic reforms. Figure 3.2 includes a selected number of these supplemental charts, including the pace of credit growth in the Chinese economy; the distribution of credit to consumers, the private sector, and SOEs; the distribution of Chinese bond ratings; interest rates for savers; and exchange rate dynamics.

Figure 3.1: Annual indicators: Financial system development (2022*)

2.2 Market competition

Figure 4: Composite index: Market competition, 2022

Definition and relevance

face low entry and exit barriers, market power abuses are disciplined, consumer interests are prioritized, and government participation in the marketplace is limited and governed by clear principles. Competitive markets are important to the overall development of an economy because firms with competitors have greater incentive to innovate and improve productivity. This adds diversity to the market and higher quality growth.

How does China stack up in 2022?

We chose the following annual indicators to benchmark China’s market competition against open market economies.

Market concentration

We measure overall market concentration across all industries using the top five listed companies’ revenue as a share of total industry revenue. The higher the proportion of total revenue that the five firms make up, the more concentrated the industry. The indicator is a simple average of the calculated proportions from 11 industries: communications, consumer discretionary, consumer staples, energy, financials, healthcare, industrials, materials, real estate, technology, and utilities. The industry categorization is consistent across all countries in the sample. For countries with industries comprising less than 50 listed companies, we use the top 10 percent of the total firms in the industry instead of the top five. The indicator was constructed in-house, based on manual data collection from Bloomberg, to replace the Herfindahl-Hirschman Index data published by the World Bank, which had a one-year lag.¹²

This measure shows that China’s markets were less concentrated than most major open economies in 2022. China’s top firms across 11 industries represented only 38 percent of the industries’ total revenue in 2022, compared to 48 percent in 2021. By comparison, the OECD average was 61 percent. Most of the sample market economies in Europe saw an increase in market concentration from 2021 to 2022, with Italy as the exception. US markets, meanwhile, saw rising competitiveness, with top firms constituting 36 percent of industry revenue in 2022, down from 42 percent in 2021.

China’s size and large number of provinces likely contribute to its lower market concentration, as provincial monopolies competing with each other can produce an overall less-concentrated market. Economies of scale, which lead to lower production costs for larger companies, contribute to increasing market concentration for both capitalist and state-led systems.

This aggregate measure does not provide a fully nuanced perspective on the discrepancy between highly competitive sectors (mostly in manufacturing) and oligopolistic sectors with heavy state dominance in China (transportation and energy, among others). In some sectors, low market concentration scores indicate too much competition or, in other words, fragmentation. In instances where there are too many competing companies, inadequate capital discipline and government interference to prevent company failures lead to overcapacity that requires firms to cut corners on necessary investments or export aggressively to use idle capital assets.¹³

SOE presence in the top ten firms

One important determinant of market competition is the role of SOEs in the economy. We identify the top ten companies (based on market capitalization) in each of 11 industries. Companies for which the government holds at least a 50 percent share are considered state-owned. The market capitalization of SOEs’ in the top ten firms are added together, then divided by the industry top ten’s total market capitalization. This allows the results to proportionately account for SOEs that rank higher in the top ten by market capitalization, instead of simply counting how many SOEs are in the top ten list (which would treat each SOE as equally influential). The process is repeated for each of 11 industries listed in the market concentration indicator description.

Bloomberg data on government ownership share for companies in market economies accurately capture the extent of state ownership. For these countries, a company was considered an SOE if the government owned 50 percent or more of its shares. However, many Chinese SOEs’ largest shareholders are not clear-cut government entities such as the State-owned Assets Supervision and Administration Commission (SASAC) of the State Council or Ministry of Finance. The team used Chinese sources to conduct outside research on Chinese companies, determining whether companies had key shareholders that were other SOEs, the Central Huijin Investment Co. (a state-owned investment company), or Hong Kong Securities Clearing Company (of which the Hong Kong government is the largest shareholder). This supplemented the results that the Bloomberg ticker offered.

SOEs’ role in China’s economy is one of the key differences between the Chinese system and market economies. For China, SOEs made up 57.1 percent of top ten firms’ market capitalization across industries in 2022, an over 30 percent increase since 2021. In fact, the presence of SOEs in China in 2022 was even higher than in 2010, when they accounted for 53.6 percent. For 2022, in the financial, materials, and technology sectors, the number of SOEs within the top ten firms increased the most. In contrast, the open-economy average was only 3.9 percent. For all EU market economies in our sample, state ownership in top firms increased since 2021. Italy was the most notable example: Only 6.4 percent of its top ten firms were SOEs in 2021, increasing to 14.3 percent in 2022. For South Korea, the share of SOES’ market capitalization in the top ten firms’ market capitalization increased by more than 3 percentage points between 2021 and 2022, with the current proportion already exceeding 2010’s levels. By comparison, the US had no state ownership in the top ten firms across for all surveyed years, and the UK’s low proportion of 0.9 percent showed a further decline since 2021.

Foreign direct investment restrictiveness

Openness to competition from foreign companies is a characteristic of open market economies. The OECD’s FDI Regulatory Restrictiveness Index is an established indicator to measure the permissiveness of an economy to foreign competition.¹⁴ The index methodology is being revamped this year, so 2022 data are not available as of this publication. We use the OECD’s 2021 data as a basis to build our indicator after reviewing foreign equity restrictions, screening requirements, and other restrictions on the operation of foreign enterprises that were publicized in 2022. China scores 0.73 on an inverted scale from 0 (most restrictive) to 1 (least restrictive), compared to the open market-economy average of 0.92. In 2022, China showed further progress from its 2010 benchmark score of 0.53, although much of this progress was driven by changes in particular industries rather than by wholesale improvements across the economy. Its negative list for foreign investment remains extensive, as do the number of other measures handicapping foreign participants, including procurement and tech transfers. China’s FDI restrictions have worsened marginally since 2020. Market economies’ FDI restrictions have stayed largely the same since 2010. Compared to 2010 FDI restrictions levels, only Australia has increased restrictions in 2020 and then once again in 2021.

Rule of law

Another key ingredient for a competitive marketplace is fair and impartial enforcement of rules. The World Bank’s Rule of Law Index captures the extent to which agents have confidence in the rules of society, including elements such as the quality of contract enforcement, property rights, and the courts. Our adjusted index ranges from 0 to 5, with lower values representing less rule-of-law-based governance. Here China is behind all market economies, with a score of 2.5 compared to the open economy average of 3.8. There has been relatively little improvement for China since 2010 compared to other indicators.

Composite score

Our Market Competition Composite Index, which represents a normalized average of these annual indicators, puts China at 3.76 in 2022, against an open-economy average of 6.9 (Figure 4). This is a small decrease from its 2021 score of 3.83, though still well above the 2010 score of 1.4. China has competitive markets in many industries and oligopoly dominance in others, including via state ownership. Contestability of markets and fairness are diminished through limitations on rule of law. The goal of “competitive neutrality” in regulation of private and public-sector firms competing in the same segments—an aspiration at the heart of China’s 2001 World Trade Organization (WTO) accession—is still a distant one.

The composite scores show China’s market competitiveness still outside of the OECD economy range, but some of these economies slipped in a non-market direction in 2022 as well. Regression on the market competition metrics from 2010 to 2022 was notable for Italy and Spain, followed by Germany and France.

While our methodology captures many aspects of market competition, our data coverage does have some limitations. Cross-country data on the value and variety of subsidies is poor, especially in the case of China where the role of the state and non-market forces is murky and nearly impossible to research today. Measuring informal barriers to market competition—for example, discrimination against foreign and private companies, asymmetries in access to industrial policy, and the special role of Communist Party committees in firms—is notoriously difficult in China today.

A year in review: China’s 2022 market competition policies and developments

We update the abovementioned benchmark indicators yearly to track the pace and direction of change. On a quarterly basis, we track policy developments that could push China either closer or further from the average of market economies in terms of its competition policy. From this exercise, we have selected the three most significant developments that took place in 2022:

While Beijing promoted foreign investment in public announcements throughout 2022, Chinese regulators sent the opposite message by tightening rules surrounding cross-border data transfers when the information could pose a national security risk. Frustratingly for companies, China’s government has not defined what “national security” means. In May 2022, the Ministry of Commerce (MOFCOM) proposed draft regulations on dual-use¹⁵ “Methodologies to Measure Market Competition,” OECD. item export control, prohibiting exports that pose national security risks. Effective September 2022, the Cyberspace Administration of China (CAC) mandates security assessments for companies exporting sensitive or critical data. Definitions for data categories, including what exactly constitutes “important data,” remain unclear. These evolving regulations increase compliance challenges for foreign firms operating in China, particularly in reconciling these requirements with their home governments’ standards.

Our data shows that state presence in top companies across industries increased significantly in 2022. This does not account for the less clear-cut mechanisms for the Chinese government to intervene in business operations. In 2022, the China Securities Regulatory Commission (CSRC) updated regulations for publicly offered investment funds, mandating Communist Party cells be established in the Chinese subsidiaries of foreign fund managers and foreign Chinese joint ventures. While the influence of Party cells is unclear, their existence for foreign firms implies potential consultation with Party members for decisions, increasing the risk of government involvement.

Beijing’s strategy in reaction to economic troubles has not changed much, with industrial policy being a common tactic used to selectively boost consumption in certain sectors. In 2022, purchase tax exemptions on new energy vehicles (NEVs) were extended for the third time, now slated to end in 2023. Though the intervention was effective in doubling domestic NEV sales compared to 2021, it came at the expense of the broader auto industry, where traditional car sales contracted by 13 percent in 2022. Favoring specific industries remains a pillar of China’s industrial policy, warping outcomes and creating perverse incentives.

In addition to a preference for state guidance in setting economic outcomes, it also shows a continued supply-side bias, whereas direct support to China’s consumers would be more helpful to rebalance the economy. In addition to tracking policy developments, we are also watching higher-frequency indicators to gauge real-time progress on market- oriented and liberal economic reforms. These include more granular measures of state ownership in the Chinese economy (such as monthly profits and employment by ownership type and SOE return on assets), and FDI restrictions by sector (Figure 4.2).15

2.3 Modern innovation system

Figure 5: Composite index: Modern innovation system, 2022

Definition and relevance

Market economies rely on innovation to drive competition, increase productivity, and create wealth. Innovation system designs vary across countries, but market economies generally employ systems that rely on government funding for basic research but emphasize private sector investment; encourage the commercial application of knowledge through the strong protection of intellectual property rights; and encourage collaboration with and participation of foreign firms and researchers, except in defense-relevant technologies

How does China stack up in 2022?

In 2023, questions about the reliability of China’s R&D statistics prompted the OECD to put a handful of their Main Science and Technology Indicators on hold.¹⁶ This means that one of the annual indicators—the ratio of private enterprise to government expenditure on R&D—was excised from the China Pathfinder framework to preserve the integrity of the analysis. As a result, for each year in the sample we recalculated all countries’ composite scores without this indicator and stress-tested the results to ensure changes in scores were marginal.

We chose the following annual indicators (also used in previous China Pathfinder reports) to benchmark China’s track record against open market economies in terms of a modern innovation system.

National spending on research and development

R&D expenditures as a percentage share of GDP is an indicator to measure R&D spending relative to comprehensive economic activity across the economies in our sample. Our data show that China has modestly increased its relative R&D spending each year since 2020, from 2.2 percent to 2.4 percent in 2021, and to 2.55 percent in 2022. China is now approaching the open-economy average of 2.64 percent. However, its spending on R&D as a share of GDP remains significantly below high-tech powerhouses such as South Korea, the United States, Japan, and Germany. Notably, these market economies also experienced the highest increases in R&D spending as a share of their GDPs since 2010. For instance, South Korea’s R&D spending had increased nearly 50 percent, from 3.3 percent in 2010 to 4.9 percent in 2022. Most of this increase happened between 2020 and 2021, amidst increasing competition in high-tech sectors globally. This year South Korea’s government announced it would allocate 70 percent of its R&D budget to core tech, including secondary batteries and semiconductors. High R&D spending does not always lead to innovation: modest commercial aviation headway in China, despite huge development spending over the past twenty years, is an example of that.

Venture capital attractiveness

Venture capital investment as a share of GDP is our second reflection of system innovativeness. Venture capital plays a key role in innovation-driven entrepreneurship and shows the confidence of private sector investors in start-ups’ ability to grow in an economy’s ability.¹⁷

The United States has long dominated global venture capital, but its VC as a share of GDP dropped from 1.5 percent in 2021 to under 1 percent in 2022. The United Kingdom took the lead with 1.24 percent in 2022. While China has been one of the most important new recipients of global venture financing, its VC as a share of GDP in 2022 dropped lower than its 2020 and 2021 levels, coming in at 0.4 percent. In our 2022 annual report, we anticipated that the crackdown on technology firms—which has continued in the financial sector—and overseas IPOs would reduce enthusiasm of private and foreign investors for Chinese startups. The disappointing 2022 data has captured these impacts. While state investment remains a major driver of VC in China through government guidance funds and similar vehicles, US pressure related to semiconductors and other national security-linked industries contributes to the waning enthusiasm.

Triadic patent families

Filed As an indicator for the quality of innovation output, we use the number of triadic patent families filed, controlled for GDP. Triadic patent families are corresponding patents filed at the European Patent Office, the United States Patent and Trademark Office, and the Japan Patent Office. They are generally considered higher quality patents and, thus, offer a better perspective than purely looking at the number of patents. China filed roughly 300 more triadic patent families in 2022 compared to 2021, but the progress is incremental compared to South Korea, which filed nearly 700 more patents in 2022 relative to 2021. China’s innovative quality, as measured by this indicator, falls below the open-economy average of 4,400 patents, which contrasts sharply with China’s top global position in the count of overall patents filed.¹⁸

International attractiveness of a nation’s intellectual property

Another proxy for a country’s innovation output quality and global relevance is receipts for payments from abroad for the use of intellectual property (IP). Controlled for GDP, this indicator offers perspective on the relative attractiveness of national IP to other nations.¹⁹ China ranked last in this indicator for 2010, 2020, and 2021, but saw an incremental improvement in 2022. At 0.074 percent of GDP, China’s receipts for IP surpassed Australia’s (0.073 percent of GDP). The open economy average was 0.6 percent, indicating Chinese companies have some catching up to do. While Germany still led in receipts for IP as a share of GDP in 2022, Japan is catching up, seeing a 12.3 percent increase from 2021. Receipts for the United States’ IP decreased 9 percent in 2022 compared to 2021.

Strength of IP protection regime

To measure the protection of intellectual property, we use the International Intellectual Property Index provided by the US Chamber of Commerce’s Global Innovation Policy Center. The index is composed of fifty individual indicator scores that look at both existing regulations and standards, as well as their enforcement. Because the index was not launched until 2012, we use that year as our baseline. China has a score of 58 in 2022, a 2-point improvement since 2021, but well below the open-economy average of 87.8. However, China has shown considerable improvement from its 2012 baseline, when it had a score of 37. This long-run improvement reflects China’s efforts to strengthen de jure protections and establish more reliable legal enforcement mechanisms. Since 2020, all market economies have seen little change in scores.

Composite score

Combining the above indicators, our Modern Innovation System Composite Index puts China at 2.18 in 2022, against an average of 4.5 within our sample of the ten largest open market economies (Figure 5). China has made progress toward a modern innovation system since 2010, when it scored 0.38, but it still suffers from substantial institutional shortcomings (from heavy state intervention to lagging IP protection) and shows a substantial gap in innovation quality. China’s 2022 composite score also declined from the 2.38 that it received in 2021. While some market economies have seen falling scores from 2021 to 2022, all of them have still improved compared to 2020.

Countries’ drop in venture capital as a share of GDP accounted for most of the composite score decreases between 2021 and 2022. The wide range of composite scores even among market economies from 2010 to 2022 indicates that a market-driven “modern innovation system” can take many shapes and forms. Market economies have generally opened their innovation systems more in recent years compared to 2010, as well as upgrading innovation regimes on the basic research side, through R&D expenditures, triadic patents, and IP protections.

Our analysis has some limitations. For example, it does not include certain unique aspects of China’s economy, like the presence of SOEs in leading sectors relevant to innovation including telecommunications, airspace, biotech, and semiconductors. Data constraints also restrict our insight into specific components of China’s innovation ecosystem, such as subsidies or government guidance funds.

A year in review: China’s 2022 innovation policies and developments

We update these benchmark indicators yearly to track the pace and direction of change. On a quarterly basis, we track policy developments that could push China either closer or further from the average of market economies in terms of its innovation system. From this exercise, we have selected the most significant developments that took place in 2022, all of which are steps to regulate or centralize data:

In 2022, CAC announced rules governing how tech companies use algorithms, to prevent the spread of harmful or illegal information online. The policy created a registration system, where companies or individuals developing algorithms must submit paperwork to CAC for each creation. The regulator could opt to conduct security checks on the algorithms if deemed necessary. While the rules help to establish standards and can put a stop to companies’ algorithm abuses that have facilitated unfair competition or monopoly behavior, they also give the government leeway in defining “fake news” or “harmful information.” This can further enable the state to integrate ideological guidance into how online information or app content is generated.

CAC is scrambling to set up guardrails in this rapidly developing digital space, with the algorithm rules being followed by 2023 draft regulations on AI-generated content (AIGC). Efforts to regulate harmful content are not exclusive to China, but there, regulation extends to censoring government criticism. These rules could hinder sector growth and disadvantage Chinese AIGC providers against competitors like OpenAI’s ChatGPT. CAC-mandated registration and security reviews would apply not just to algorithms but also to GPT training content. China’s data opacity, exemplified by unreliable R&D expenditure reports, complicates foreign economic analysis. Actions in 2022, like CAC’s cybersecurity probe into academic database CNKI, further restricted foreign access to key information. The cybersecurity review focused on CNKI’s management of data on Chinese key industries, research projects, and S&T development. This growing data sensitivity could undermine China’s basic R&D efforts including by making foreign companies or academics fearful of inadvertently violating the cross-border data rules or being unable to transfer their own data out of the country.

In addition to tracking policy developments, we are also watching several higher-frequency, and often China-specific, indicators to gauge progress on market-oriented and liberal economic reforms. Figure 5.2 shows a selection of these indicators including the number of researchers per one thousand people employed, the share of foreign investors in venture funding rounds for Chinese companies, payments for the use of intellectual property, and the innovative industry share in industrial value added.

Figure 5.1: Annual indicators: Modern innovation system (2022*)

2.4 Trade openness

Figure 6: Composite index: Trade openness, 2022

Definition and relevance

Free trade is a key feature of open market economies to facilitate specialization based on comparative advantage. We define trade openness as cross-border flow of market-priced goods and services free from discriminatory, excessively burdensome, or restrictive measures.²⁰

How does China stack up in 2022?

We apply the following annual indicators to benchmark China against open market economies in terms of trade openness.

Goods and services trade intensity

Our primary de facto trade openness indicators are gross two-way goods trade as a share of global two-way goods trade and gross two-way services trade as a share of global two-way services trade. This metric is often referred to as the trade openness ratio, although a low ratio doesn’t necessarily imply restrictive policies (it can also derive from the size of a country’s economy or a non-trade-friendly geographic location). Both indicators show that China is an economy heavily integrated in global trade flows. China has the highest ratio when it comes to goods trade and a ratio above the open-economy average when it comes to services trade. China’s goods trade intensity increased from 12.5 percent in 2021 to 13.1 percent in 2022. The United States’ goods trade intensity increased from 9.8 percent to 11.6 percent—an 18 percent jump— over the same period. Other market economies saw only marginal improvement.

In 2022, global services trade rebounded across most market economies, following a decline in 2020-2021. The US leapt even further ahead in services than goods trade compared to the previous couple of years. Its 2022 share of global two-way services trade increased 26 percent from 9.8 percent in 2021, now making up 12.4 percent of the world’s two-way services trade. In 2022, China’s services trade intensity increased to 6.4 percent, up from 5.8 in 2021. Germany’s services trade intensity recovered since 2021, surpassing China’s to hold the second-largest share, at 6.8 percent.

Trade Barriers: Tariff Rates

On the de jure side, the standard metric for assessing a country’s trade openness is tariff rates. We chose the simple mean of most favored nation (MFN) tariff rates across all product categories. We use a simple mean instead of an average that applies weight by the product import shares corresponding to each partner country. The simple mean can diminish the common issue of weighted MFN tariff rates being skewed downward, as goods subjected to steep tariffs would likely see lower quantities imported and, thus, a lower weight in the calculation.²¹ In 2022, China’s tariff rate was still higher than that of market economies, but it dropped by 2.26 percentage points since 2021. All sampled countries reduced their tariff rates over the same period.

Restrictions on services trade

For a de jure measure for services trade openness, we rely on the OECD’s Services Trade Restrictiveness Index (STRI), which measures policy restrictions on traded services across four major sectoral categories.²² These are logistics, physical, digital, and professional services, and we weight them equally. Each sectoral category also contains several specific industry subindices. A lower score on the index indicates a more open policy to services trade, with scores ranging from 0 to 1. This index only started to provide data in 2014, so this is the earliest year for benchmark comparison. In 2022, China’s score was 0.35, more restrictive to services trade than the open-economy average of 0.20.²³ While China eased some restrictions compared to 2021, sectors such as accounting, media, and telecom remain highly restricted. Meanwhile, OECD economies have maintained consistent services trade openness since 2014.

Restrictions on digital services trade

In recent years, China has become an even greater outlier in digital services trade, a crucial subcategory of global services trade. This research adapts the OECD’s Digital Services Trade Restrictiveness Index (DSTRI), which measures barriers that affect trade in digitally enabled services across fifty countries.²⁴ This includes infrastructure and connectivity, electronic transactions, payment systems, and IP rights. The index ranges from 0 to 1, with higher scores indicating a greater degree of restrictiveness. This index only started to provide data in 2014, so this is the earliest year for all countries in our sample. In 2022, China’s DSTRI score was 0.31, the same as in 2021, but still above the open-economy average of 0.10. China’s DSTRI score was 0.19 in 2010, showing that restrictions have increased since. The lowest-ranked market economy in our sample, South Korea, had a score of 0.2, and China’s restrictions were within open-economy range in 2010, though ramping up since then. The scores for most market economies have remained consistent since the index’s inception in 2014, offering a reliable benchmark for comparison.

Composite score

In 2022, China’s Trade Openness Composite Index score—which reflects a blended average of the above indicators—was 4.12, up from 3.55 in 2021 and significantly higher than its 2010 score of 2.88. This improvement primarily stems from de facto indicators and brings China closer to the open-economy average of 5.7 (Figure 6). In fact, this is China’s best overall score in the six clusters we measure. Composite scores for market economies also increased over the same period for the same reason. While China has reduced tariffs to a level nearly comparable with OECD economies and has become the world’s largest trading nation in goods, it remains less open in services trade and faces criticism for unreported nontariff barriers.

While we have good access to basic trade-related data, our coverage faces several shortcomings. For instance, the services trade data have flaws, including significant distortions through tourism spending and hot money flows. The pandemic years’ impact on tourism can produce skewed results for services trade data. Many aspects of China’s trade environment that are not unique to China— including nontariff barriers, informal discrimination, and exchange rate interventions—are especially difficult to research in China due to restrictions on research, data access limitations and other problems.

A year in review: China’s 2022 trade policies and developments

We update these benchmark indicators yearly to track the pace and direction of change. On a quarterly basis, we track policy developments that could push China either closer or further from the average of market economies in terms of its trade openness. From this exercise, we have selected the two most significant developments that took place in 2022:

In August 2022, Beijing imposed retaliatory trade measures against Taiwan in response to a visit by Nancy Pelosi, then-US House Speaker. China’s General Administration of Customs banned imports of Taiwanese foods, including biscuits and fruits, while MOFCOM suspended exports to Taiwan of natural sand, an input in semiconductor manufacturing. However, these actions had limited strategic or economic impact on bilateral trade due to the minor role these sectors play in Taiwan’s exports and China’s exports to Taiwan.

In late 2022, China’s State Council announced a marginal tariff reduction for 2023, lowering the general tariff rate from 7.4 to 7.3 percent. The policy temporarily reduced tariffs on over one thousand products and signaled further cuts for some IT products starting in July 2023. While framed as a trade liberalization move, the tariff adjustments primarily aim to boost lagging growth. The State Council pointed to supporting consumption and the manufacturing sector as the main reasons for lowering tariff rates, which should push down the prices of certain medical supplies and drugs, food items, small household appliances, and inputs in advanced manufacturing. At the same time, this policy increased import and export tariffs on specific commodities to bolster the security of domestic industrial chains.

In addition to tracking policy developments, we are also watching higher-frequency, often China-specific, indicators to gauge real-time progress on market-oriented and liberal economic reforms. Figure 6.2 shows these indicators, including China’s current account balance as a share of GDP, RMB exchange rates compared to major currencies, China’s trade balances, role in processing trade, and trade policy interventions.

Figure 6.1: Annual indicators: Trade openness (2022*)

2.5 Direct investment openness

Figure 7: Composite index: Direct investment openness, 2022

Definition and relevance

Direct investment openness refers to fair, nondiscriminatory access for foreign firms to domestic markets and freedom for local companies to invest abroad without restrictions or political mandates. Direct investment openness is a key feature of open market economies that encourages competitive markets and facilitates the global division of labor based on comparative advantage.

How does China stack up in 2022?

We use the following annual indicators to benchmark China against open market economies in terms of direct investment openness.

FDI intensity

Our main de facto indicator for inbound direct investment is the inbound FDI intensity of the economy, which is calculated by dividing the total inbound FDI stock of an economy by its GDP. In 2022, China’s inbound FDI intensity stood at 19.1 percent of GDP, below the market economy average of 40 percent but higher than South Korea’s or Japan’s (14.1 percent and 4.8 percent, respectively). This score marks a decline for China since 2021, and places it even further below its 2010 level (which was 25.8 percent). For most open market economies, inbound FDI intensity has increased over the same duration. The market economy average increased more than ten percentage points since 2010.

For outflows, we measure outbound FDI intensity, which is calculated by dividing outward FDI stock by GDP. China’s outbound FDI intensity has improved from a very low base in 2010 but, with a score of 15.26 percent in 2022, it remains lower than any other country in our sample and the open economy average of 47 percent. China’s outbound FDI stock as a share of GDP decreased slightly from 2021’s 15.3 percentage. Most open market economies’ outbound FDI intensity either stagnated or declined since 2021. For the United States, the nearly 25 percent drop from 2021 to 2022 has brought its outbound FDI intensity to approximately match 2010 levels (equivalent to 32.1 percent of GDP). This indicator uses market value for FDI stock, which is subject to fluctuation. In 2020 and 2021, high equity valuations increased the market value for both inbound and outbound FDI stock, and the subsequent correction in 2022 pushed the values down. This contributed to the large drop in US inbound and outbound FDI intensity from 2021 to 2022.

Direct investment restrictiveness

To measure de jure restrictiveness for FDI, we built our own indicator for direct investment restrictiveness. While there is a solid body of academic work on the topic of cross-border capital controls, we found existing research insufficient for our purposes due to lackof a magnitude metric,²⁵ coverage gaps, and significant time lags.²⁶ Our indicator is compiled for outflows and inflows and covers three types of restrictions: national security reviews, sectoral and operational restrictions, and repatriation requirements and other foreign exchange restrictions. The scoring is based on a proprietary framework derived from information contained in the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) as well as proprietary research on national security review mechanisms and sectoral restrictions.²⁷

China had a relatively high level of inward FDI restrictiveness in 2010 and has successfully implemented reforms to reduce some of these barriers by 2022. Its restrictiveness score has therefore decreased from 7.3 in 2010 to 5 in 2022. However, China maintains not just national security reviews, but an expansive negative list of restricted sectors as well as foreign exchange restrictions for foreign companies. Its restrictiveness score is still far higher than the open-economy average of 1.8. Key improvements in 2022 include the National Development and Reform Commission (NDRC) and MOFCOM removing two sectors from the negative list, while the NDRC and State Council also issued measures to encourage foreign investment in manufacturing and certain services sectors.

At the same time, open economies have become more restrictive when compared to 2010. For instance, multiple market economies rolled out sanctions or other restrictions on Russia due to the war in Ukraine. Others, such as Canada and Spain, also increased the scope of their investment screening regimes for strategic and national security reasons. Noteworthy 2022 restrictions were implemented by the United Kingdom—the National Security and Investment Act that significantly amended the foreign investment screening mechanism—and the United States—the Inflation Reduction Act (IRA) that excluded Chinese investors from certain government subsidies to the electric vehicle industry²⁸ and a new executive order that strengthened the screening mechanism for inbound foreign investments.

China’s score on outward FDI restrictiveness was very high in 2010, reflecting a regime requiring approvals for every single outbound investment. Beijing made a significant push over the following decade to give firms more autonomy to invest abroad, especially in 2014 when China moved to a system that required firms to register their investments instead of obtaining approval. However, Beijing retracted these liberal policies in 2017 after large capital outflows. At 6.3, China’s 2022 outbound FDI restrictiveness score remains the same as in 2020 and 2021, and only slightly lower than in 2010. By comparison, the open market economy average was 0.6, relatively stable across all sampled years. In 2022, the United States’ outbound FDI restrictiveness score increased slightly with the rollout of the CHIPS Act that limited company transactions that would boost the semiconductor capacity of China or other foreign “countries of concern” for a decade.

Composite score

On aggregate, our Direct Investment Openness Composite Index puts China at 2.18 in 2022, against an open-economy average of 6.3 (Figure 7). Based on the same criteria, China scored 2.13 in 2021, 2.14 in 2020, and 0.65 in 2010. China’s composite score lags in both the de facto and de jure indicators, ranking last across all four measured years. China still maintains strict capital controls which limit its de jure scores; it also punches well below its weight when it comes to de facto measures of FDI intensity. Despite the conventional narrative about the growing impact of China’s FDI flows abroad—such as in FDI in the EU’s EV sector—and its historical ability to attract FDI, China’s performance is modest when scaled to its economic size.

As with other indicators, our de facto measures for direct investment openness are imperfect because they are influenced by a host of non-policy variables, such as market size, economic growth, and business cycles. Our measures for de jure restrictiveness reflect scoring judgments that are subject to a certain degree of subjectivity.

A year in review: china’s 2022 direct investment policies and developments

track the pace and direction of change. On a quarterly basis, we track policy developments that could push China either closer or further from the average of market economies in terms of its direct investment openness. From this exercise, we conclude that China’s policies toward FDI have not changed significantly in the last year. We take note of de facto developments and incremental policy changes that took place in 2022 below:

According to official data, in 2022, China saw a 9 percent year-over year increase in inbound FDI. However, this contrasts starkly with alternative measures of inward FDI, such as the announced greenfield FDI deal value reported by fDi Markets and total completed mergers and acquisitions (M&A) value from Bloomberg. Compared to MOFCOM’s reported $189 billion in direct investment that flowed into China in 2022, the other comparison sources only reported $16 billion in greenfield FDI and $25 billion in M&A transactions for the year. MOFCOM data is dominated by “round tripping” flows from Hong Kong, a common loophole to avoid China’s capital controls. China’s official data on inbound FDI has become increasingly different from micro-level transaction data since 2019. In 2022, the announced foreign greenfield deal value in China fell by 50 percent compared to 2021. The same year saw a 44 percent decrease in announced M&A deal value from the previous year. The alternative inbound data show China’s domestic investment environment has become less attractive to foreign investors, which aligns with foreign business survey results.

In H1 2022, China’s policy on managing FDI remained stable. Only in the second half of the year did China roll out policies aimed at promoting FDI inflows, likely in response to an unprecedented drop in both greenfield investment and M&A during the first seven months of the year. The State Council, NDRC, MOFCOM, and other ministries implemented partial-opening policies—encouraging foreign investment in manufacturing, opening the services sector in certain cities, and supporting foreign enterprises to invest in high-tech equipment and components—along with high-level statements. However, the impact of these measures remains to be seen.

In addition to tracking policy developments, we are also watching higher-frequency to gauge progress. Figure 7.2 presents these indicators, including measures of China’s outbound and inbound FDI flows; the inward and outward FDI stock for the top ten market economies; and China’s role in global M&A transactions.

Figure 7.1: Annual indicators: Direct investment openness (2022*)

2.6 Portfolio investment openness

Figure 8: Composite index: Portfolio investment openness, 2022

Definition and relevance

Portfolio investment openness refers to limited controls on twoway cross-border investment into equities, debt, and other financial instruments. Portfolio investment openness is a key ingredient for financial market efficiency and market-driven exchange rate adjustments in open market economies.

How does china stack up in 2022?

We apply the following annual indicators to benchmark China against open market economies in terms of portfolio investment openness.

Internationalization of debt and equity markets

To measure de facto openness to portfolio investment, we calculate the sum of cross-border debt (government and corporate bonds) assets and liabilities relative to the size of the economy as well as the sum of cross-border equity (stocks) assets and liabilities relative to the size of the economy. Assets are holdings of foreign securities by residents, and liabilities represent foreign holdings of securities issued by residents. China significantly lags behind the open-economy average in both categories. In 2022, China’s cross-border debt assets and liabilities as a share of GDP were 6.1 percent, compared to the open-economy average of 80 percent. Its cross-border equity assets and liabilities were equivalent to 9.5 percent of GDP, a nearly 15 percent drop from their 2021 share, and well short of the open-economy average of 86 percent. While China has made some progress since 2010, particularly in debt assets and liabilities, its previous years’ gains in equity internationalization were largely erased in 2022. In 2022, nearly all economies’ scores dropped, likely as a result of faster GDP growth associated with the pandemic recovery.

Portfolio investment restrictiveness

For a de jure perspective, we created our own Portfolio Investment Restrictiveness Indicator that captures regulatory restrictions on portfolio investment flows based on the IMF’s AREAER database and our own research. We calculate separate indices for portfolio outflow and inflow restrictiveness, assigning numerical scores based on the implementation of opening or closing measures during a given year. The inward portfolio restrictiveness indicator captures restrictions on the purchase of bonds and equity securities locally by nonresidents as well as on the sale and issuance of bonds and equity securities abroad by residents. The outward portfolio restrictiveness indicator captures restrictions on the purchase of foreign securities by residents as well as restrictions on the sale and issuance of bonds and equity securities locally by nonresidents.

On inward portfolio restrictiveness, China has historically tightly limited the inflow of foreign short-term capital, except through narrow programs such as the Qualified Foreign Institutional Investor (QFII) Scheme. While access has expanded through stock and bond connect schemes over the past decade, foreign investors still face quotas and inadequate cross-border settlement infrastructure. China’s 2022 restrictiveness score of 6.3 remains well above the market economy average of 0.6, despite marginal loosening of restrictions in 2021–2022, including allowing certain foreign institutional investors to access the interbank bond market directly rather through the bond market connect.

On outward portfolio restrictiveness, China has been cautious to liberalize due to concerns about large-scale capital outflows and implications for financial system and exchange rate stability. There was limited easing in 2021, with the expansion of the Shanghai– London Stock Connect to Swiss and German markets. However, households remain generally unable to invest in overseas securities and institutional investors remain constrained to special programs and quotas, keeping China’s 2022 restrictiveness score of 7.5 far higher than the advanced economy average of 0.5.

Composite score

Our Portfolio Investment Openness Composite Index puts China at 1.2 in 2022, against an open-economy average of 6.9 within our sample of the ten largest open market economies (Figure 8). This is an improvement from a score of 1.1 in 2021, and 0 in 2010. In previous editions of the China Pathfinder report, China’s score in portfolio openness was 0 for all surveyed years, since it had the lowest level of openness among sampled countries across all indicators. The updated normalization method captures countries’ progress or regression compared to their performance in prior years. This is possible because each indicator’s minimum and maximum is calculated across all years of data. China’s portfolio investment openness was lowest in 2010, but it has improved marginally since then and is no longer the absolute minimum. We therefore can show its improvement even if it still ranks behind other countries. Relative to 2010, we have seen improvements in the ability of foreigners to access and participate in China’s markets, which is reflected in the new scoring system. The revised methodology still shows a large gap between China and the OECD economies, which is not surprising given that China exercises a level of control over its capital account that is distinct from open market economies.

Particularly in the de jure measures of portfolio openness we have seen large improvements in the ability of foreigners to access and participate in China’s markets relative to 2010. For instance, the RMB Qualified Foreign Institutional Investor (QFII) program that allows foreigners to invest in China’s capital markets increased its quota numerous times since 2010. China has also created the stock and bond connects—launched in 2014 and 2017, respectively—that give foreign investors access to Chinese A-shares and bonds.

Portfolio investment is highly mobile and volatile, so our de facto measures are susceptible to fluctuations caused by market sentiment, macroeconomic dynamics, and other factors. We noticed this particularly to be the case for 2022 portfolio volume as a share of GDP data, with sizable declines for both China and OECD economies compared to 2021. Portfolio investment data are also heavily impacted by tax optimization and financial system designs. Finally, our measures for de jure restrictiveness are based on human judgment and, thus, reflect a certain degree of subjectivity.

A year in review: China’s 2022 portfolio investment policies and developments

We update the abovementioned benchmark indicators yearly to track the pace and direction of change. On a quarterly basis, we track policy developments that could push China either closer or further from the average of market economies in terms of its portfolio investment openness. From this exercise, only one development from 2022 was a definitive market reform signal:

After a more than decade-long dispute between the US Public Company Accounting Oversight Board (PCAOB) and China’s CSRC over access to Chinese audit work papers, in August 2022 Chinese authorities agreed to the inspection of accounting documents. This defused the risk that US-listed Chinese firms (that use Chinabased auditors) would be forced to delist due to noncompliance. The PCAOB confirmed that it secured “complete access to inspect and investigate” Chinese audit firms in 2022. This marks a positive shift in China’s approach to accounting transparency since developments assessed in our last year’s report.²⁹

In addition to tracking policy developments, we are also watching higher-frequency, often China-specific, indicators to gauge progress. Figure 8.2 presents these indicators, including the change in foreign holdings of Chinese bonds and equities; foreign holdings of Chinese portfolio securities by investor country; total foreign holdings of RMB assets; the share of China’s currency in international payments; and net movement through the Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connects.

Figure 8.1: Annual indicators: Portfolio investment openness (2022*)

Chapter 3: Conclusions and implications

China’s economic slowdown in 2023 is largely attributable to its persistent structural reform gap, lagging behind top OECD economies in most market dimensions except for trade and innovation. While there is a global drift away from market norms among OECD countries, China faces regression in its financial system development and growing state ownership in key industries. Trade, although a bright spot, faces constraints due to changing pandemic conditions and trade defense measures by trading partners. Domestic business sentiment is suffering due to unpredictable regulatory developments, reflected in lower venture capital investment and weaker private business investment. Foreign investor confidence is also waning, as indicated by declining inbound FDI, posing a threat to an economy that still heavily relies on foreign capital and technology.

• Among the various explanations for China’s 2023 slowdown, the persistent structural reform gap through last year is the prime candidate: As China approaches the 10th anniversary of the 2013 Third Plenum, it remains far behind the top ten OECD economies in most dimensions of a market economy except for trade and innovation. In fact, its score has declined for market competition.
• There is some backsliding by market economies, but causes vary: In financial system development, the OECD economies in our sample drifted away from market norms in 2022 for the second year in a row. The main factors driving this backsliding were a decline in market capitalization (direct financing of firms relative to GDP size) and outstanding non-financial corporation debt as a share of GDP. This reflects the state of the global economy, rather than governments closing off market access or implementing new restrictions. Market economy scores also took a hit in portfolio investment, and largely for the same reason. In terms of market competitiveness, EU economies saw their 2022 scores decline compared to 2021, due to growing state ownership among top ten firms and higher industry concentration. And where China’s restrictions on inbound FDI were marginally lowered in 2022, such barriers were elevated in several other countries.
• Trade is under pressure: China is within the OECD range in trade openness, and its position in goods trade continues to rise. However, the pandemic conditions that fostered China’s trade advancement have abated, and in the more advanced area of services trade, China remains a laggard. The environment for China’s exporters is also under pressure, as pandemic-era deficits, dependence on China for strategic inputs, and growth in electric vehicle exports provoke heightened trade defense measures by China’s trading partners. In fact, most OECD countries in our sample have seen their scores in trade openness decline compared to the 2010 baseline (though all improved between 2021 and 2022).
• The private sector is in need of a boost: From 2021 to 2022, the share of SOEs in China’s top ten firms across 11 industries increased from 44 percent to 57 percent. The growth in state ownership was even more apparent in the high-growth, high-salary financial and tech sectors. The rising state role and unpredictable regulatory developments have badly damaged China’s domestic business environment. Venture capital (VC) investment as a share of GDP in 2022 dropped below 2020 and 2021 levels. While officials nominally declare the crackdown on tech companies over, and new Premier Li Qiang announced new measures to support private sector development in summer 2023, business sentiment continues to be severely depressed as reflected in weak private business fixed-asset investment.
• Foreign investors are staying home: China’s inbound FDI stock as a share of GDP has been declining, falling from 21.5 percent in 2021 to 19.1 percent in 2022. In fact, China’s inbound FDI intensity has been falling since 2010, when it was at its highest at 25.8 percent. This decrease is a warning sign for an economy that continues to rely on foreign capital, know-how, and technology. Meanwhile, surveys of major business associations for US, EU, and Japanese businesses all show falling confidence in China as a favorable investment destination.
• While China’s financial system score improved slightly in our framework for technical reasons, vulnerabilities have come to a head: Market forces tend to converge GDP growth rates and interest rates, whereas in China borrowing costs tend to be well below headline economic growth. China’s historic 2022 GDP growth shortfall narrowed this indicator gap for China, giving it a better financial system score. But underlying financial conditions and the risk of a debt crisis got worse last year and are still more concerning in 2023, forcing authorities to intervene heavily.

Implications

We attribute China’s 2022 GDP growth shortfall to a lack of structural reform, rather than COVID or cyclical policies, and explain the current economic slowdown the same way. The implication of this analysis is that 2023 growth will also fall well below the 5-6 percent target, whether or not the official data acknowledge it. Given the lack of major reform announcements year-to-date, similar weakness in 2024 should be expected. If Beijing does announce meaningful big bang reforms, growth would be even lower in 2024 as a result of adjustment pains. Not long ago many observers assumed China would surpass the US in absolute GDP size by the end of the 2020s. In light of current performance in China and the US, that will not happen in this century, let alone this decade. This change in expectations has global implications. For developing countries, the relative allure of liberal markets versus China’s “state capitalism” approach will shift, in ways that require policymaker and business leader attention.

• Tech ambitions at risk: China’s difficulty in reforming its economic structure is a threat to growth prospects. This is evident in numerous sectors, notably in the technology industry. The government’s crackdowns on tech companies have aggravated youth unemployment concerns and impeded high-tech aspirations. In 2022, Beijing prioritized lockdowns and security for political messaging over tech-sector recovery, leading the most important firms in the industry to threaten to abandon China. Beijing is now scrambling to reestablish domestic and foreign private sector confidence. In 2023, it rolled out a package of 31 initiatives aimed at bolstering the private sector, and held numerous sessions on boosting China’s innovation capabilities. Most recently, Beijing announced it will create a new bureau to support the private sector. But credibility is impaired, and Beijing will need to match actions to words before companies feel more confident.
• Fiscal challenges are structural and need fixing if confidence in China’s future is to be restored: Sub-national governments in China are grappling with massive debt loads, while they are responsible for providing most social services. An aging population requires healthcare and pension payouts, while poverty alleviation remains a major challenge. Industrial policy, military and public security spending, education, decarbonization, overseas assistance and myriad other promises are not yet funded: the implication of the growth outlook is that many of these activities will need to be moderated.
• Global spillovers: For many countries and firms, globalization has increased dependency on China’s economic success. As recently as April 2023, the IMF was projecting China to be the primary driver of global growth through 2028. A slower-growing China means negative spillovers for many around the world, including nations dependent on exports to China to generate earning to repay Chinese debt. From German car manufacturers to Australian iron ore, this is not just a concern for the global south.
• Geopolitics and geoeconomics: The persistence of Chinese GDP growth at rates a multiple of OECD growth has been the foundation of China’s external power and influence, both economic and political. With or without reform, China’s future growth average will be lower, in absolute terms and relative to the United States and other OECD economies. This will reshape expectations for great power competition. Sometimes countries undergoing a slowdown behave more moderately, other times they react belligerently. But in any case, China’s behavior over the last 10 years—assertive external policies without regard for economic consequences—is likely to change.

Looking ahead

2023 has already been a tumultuous year in China, and this is more to come. At the third plenary session of the Central Committee this fall, Party leaders will set economic priorities for the coming five years. Structural threats to economic stability have never been greater. The State Council has explicitly promised a comprehensive reform plan to deal with these existential risks, including the property sector and, especially, local government debt levels that are spiraling out of control. In the past, Beijing was able to kick the policy can down the road; today, they are at the end of that road and need to address the present problems. The question is what policy moves would be credible enough to restore confidence. Here are five moves that could instill optimism for 2024:

• Robust debate about the structural slowdown and reform: Chinese government signals in 2023 have been mixed. On the one hand, Beijing suppressed datasets at odds with an optimistic view (for instance youth unemployment numbers) and forbade discussion of disinflation. On the other hand, retired officials and respected economists were permitted to speak publicly about the structural nature of China’s slowdown by mid-year, calling for overdue reforms. Wider room for public debate about the economy would be a positive signal.
• Retire the GDP growth rate target: Few indicators have been as emblematic of China’s relentless pursuit of growth as the GDP growth target. With the exception of 2020, Beijing set a growth target every year, and always met or exceeded it, until 2022. But prioritizing growth-at-all-cost, even when that means tolerating frequent manipulation of data to achieve the desired results, has damaged long-term economic potential. The GDP growth target is a political imperative for the Party, tied to the goal of doubling GDP by 2035. Shifting to market economy type targets— employment and inflation—is one of the best things Beijing can do to improve the quality of growth and policymaking.
• Central-local fiscal rebalancing: For Beijing to provide a social safety net and foster prosperity for the Chinese people, local governments must be bailed out and put on a firm fiscal footing. The current system, which sees local governments on the hook for most expenses but retaining only a small portion of the tax revenues they collect, left local governments reliant on land sales or LGFVs to raise funds. The consequences—ballooning local debts and financial instability—are undermining China’s prospects. The central government must absorb local expenditure responsibilities or identify responsible resourcing strategies.
• Privatizing some state assets: In 2023, China’s government rolled out reforms that transition its IPO system to a completely registration-based one rather than an approval-based one. This could lay the groundwork for a gradual privatization of state assets. While no big bang is anticipated in 2024, local governments should move toward listing their SOEs, inviting private capital and, in the process, filling up their depleted assets. For this to become a full-throated pro-market reform, the government should also allow private investors to have a say in how the companies are run, rather than merely providing silent capital.
• Reforming the pension system: China’s slowdown, coupled with its rapidly aging population and shrinking workforce, is bad news for local governments facing growing fiscal constraints. Beijing must do something to place the pension system on a more stable financial footing. This likely involves more direct central government control and responsibility for shortfalls in local pensions, as well as enabling new sources of local revenues such as property taxes and broadening the tax base. It also likely involves reforms such as raising the retirement age, which is relatively low by global standards (60 for men, 50-55 for women).

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

About China Pathfinder

Mission

China Pathfinder is a joint initiative from the Atlantic Council’s GeoEconomics Center and Rhodium Group that measures China’s economic system relative to advanced market economy systems. Few people, even within the circle of China experts, seem to agree about the country’s economic system, where it is headed, or what that means for the world. The goal of this initiative is to shed light on whether the Chinese economic system is converging with, or diverging from, open market economies. Over the course of two short decades, China has risen from the world’s sixth-largest economy, with a gross domestic product (GDP) of $1.2 trillion in 2000, to the second largest, boasting a GDP of $17.95 trillion in 2022. China now intersects with the interests of most nations, businesses, and individuals. With China’s past and future systemic choices impacting the world in both positive and negative ways, it is essential to understand its global footprint. The hope is that China Pathfinder’s approach and findings can fill in some of the missing puzzle pieces in this ongoing debate—and, in turn, inform policymakers and business leaders seeking to understand China.

Partners

The Atlantic Council is a nonpartisan organization that galvanizes US leadership and engagement in the world, in partnership with allies and partners, to shape solutions to global challenges. The Atlantic Council provides an essential forum for navigating the economic and political changes defining the twenty-first century by informing its network of global leaders. Through the papers it publishes and the ideas it generates, the Atlantic Council shapes policy choices and strategies to create a more free, secure, and prosperous world.

Rhodium Group is a leading independent research provider. Rhodium has one of the largest China research teams in the private sector, with a consistent track record of producing insightful and path-breaking analysis. Rhodium China provides research, data, and analytics to the private and public sectors that help clients understand and anticipate changes in China’s macroeconomy, politics, financial and investment environment, and international interactions.

Authors

This report was produced by Rhodium Group’s China team in collaboration with the Atlantic Council’s GeoEconomics Center. The principal contributors on Rhodium’s team were Daniel H. Rosen, Nargiza Salidjanova, and Rachel Lietzow. The principal contributors from the Atlantic Council’s GeoEconomics Center were Josh Lipsky, Jeremy Mark, and Niels Graham.

Acknowledgments

The authors wish to acknowledge a superb set of colleagues and fellow analysts from the public sector, international organizations, think tanks, business associations, and universities who helped us strengthen the study in group review sessions and individual consultations. These individuals took the time, in their private capacity, to critique the indicators and analysis in draft form; offer suggestions, warnings, and advice; and help us to ensure that this initiative makes a meaningful contribution to public debate.

The authors also wish to acknowledge the members of the China Pathfinder Advisory Council: Steven Denning, Gary Rieschel, and Jack Wadsworth, whose partnership has made this project possible.

This report is written and published in accordance with the Atlantic Council’s intellectual independence policy. The authors are solely responsible for its analysis and recommendations. The Atlantic Council, Rhodium Group, and its donors do not determine, nor do they necessarily endorse or advocate for, any of this report’s conclusions. This report is published in conjunction with an interactive data visualization toolkit, at http://chinapathfinder.org/. Future quarterly and annual updates to the China Pathfinder Project will be published on the website listed.

The post Running out of road: China Pathfinder 2023 annual scorecard appeared first on Atlantic Council.

In the aftermath of the global financial crisis, a combination of low interest rates and abundant liquidity caused public debt in emerging market economies to almost triple from $215 billion in 2010 to $627 billion in 2021. But the Covid-19 pandemic dealt a heavy blow to sovereign financing. A sharp drop in investors’ risk appetite sucked capital from emerging markets, particularly from low-income countries, raising the “rollover” costs for governments carrying already high levels of debt. On top of soaring interest costs, governments issued more short-term debt as they needed additional cash to pay for vaccines and fiscal stimulus, which heightened refinancing risks. As low-income countries’ credit ratings were cut into junk territory, the G20 suspended their debt repayment for over a year and introduced the Common Framework to speed up restructurings. But a lasting solution to debt sustainability in low-income countries requires more dramatic action, in which the IMF will play a critical role.

Sovereign debt restructuring is essentially a zero-sum game of allocating the burden of a haircut among different creditor groups. Under the Common Framework, a debtor country would first request debt relief from official bilateral lenders before seeking treatment at least as favorable from its private creditors. While the Common Framework has looped non-Paris club countries like China (which has been resisting multilateral debt negotiations) into debt relief talks, it fails to help different creditors agree on what a fair burden sharing looks like.

One point of contention is the preferred creditor status of multilateral lenders. Notably, China has insisted that multilateral development banks (MDBs) take losses alongside bilateral and commercial creditors. Since the IMF cannot sign off on bail-outs unless all official creditors commit to writing down loans, China has tried to extract concessions from MDBs by delaying the installment of IMF financing. At the Global Sovereign Debt Roundtable in April, the IMF agreed to provide more grants to indebted countries in exchange for China softening its demand, although there was no guarantee from China that it would provide debt relief in line with other official creditors.

Then there is the matter of coordinating between official and private creditors. The Common Framework delays restructuring by forcing private creditors to wait for and follow the terms set by the official creditors’ committee. This would have worked in the days when official creditors dominated the lending market. But as the number of private creditors multiplied, official and private creditors often clashed over the terms of restructuring. For example, official creditors tend to prefer maturity extensions while private creditors favor haircuts in exchange for early cash flows. Moreover, credit rating agencies duly downgraded countries seeking debt rescheduling and debt relief, even though such treatments would improve countries’ debt sustainability from a development perspective. Consequently, many countries are reluctant to join the Common Framework for fear of losing access to private markets.

As lenders remain in a gridlock, the IMF can play a bigger role in accelerating restructurings and staving off future debt crises. To start, the uncertainty about borrowing countries’ true ability to repay and private creditors’ willingness to grant comparable relief have held up agreement on restructuring terms. Although the IMF does not directly take part in debt negotiations itself, it is the only organization with the political legitimacy to act as a neutral advisor to both debtors and creditors. It can, for example, build on top of the IIF-OECD Debt Transparency Initiative by reconciling the debt data it receives from sovereigns with information reported by private creditors. Collaboration with the World Bank, its sister institution, is equally important as the latter produces long-term growth forecasts that inform debt sustainability analyses. As the world’s crisis lender, the IMF can also design financial incentives that would encourage greater transparency, such as the disbursement of grants or concessional loans that are conditional on borrowing countries meeting a set of disclosure requirements. Greater debt transparency has two benefits. One is that it would encourage private creditor participation in granting debt relief by reducing official creditors’ monopoly on assessing compliance with the “comparability of treatment” principle. The second is that if sovereigns can make public the terms and arrangements that were previously hidden, this would hopefully restore investor confidence and improve their credit ratings.

Moreover, the IMF should make good use of its financial firepower. As a welcome first step, it has advocated the reallocation of covid-era discretionary special drawing rights (SDRs), which amounts to almost $650 billion, to low-income countries. Cash-strapped governments could then swap SDRs with currencies to shore up their reserves and support their economic recovery. At the Summit for a New Global Financing Pact in June, the IMF’s managing director announced that the IMF has successfully rechanneled 20 percent ($100 billion) of the SDRs into trusts that would issue concessional loans to low-income countries. But to achieve a more ambitious 40 percent reallocation, the IMF must convince non-participating countries that the global public goods that arise from more foreign assistance outweigh the domestic budgetary costs. Moreover, the IMF can mobilize external sources of financing. It should work with the OECD to earmark a portion of the revenue from the global minimum corporate tax for development purposes. 

Lastly, the IMF should take advantage of the ongoing restructurings to introduce new financial instruments that better serve the needs of poor countries. Take state-contingent debt instruments, which reduce interest payment during recessions and increase payout in good times. Their popularization would not only help weak economies absorb commodity shocks but also avoid unnecessary credit downgrades due to short-term liquidity problems. Innovations often emerge out of crises. The IMF, with its extraordinary convening power, must take advantage of this opportunity to set up contractual standards that befit today’s increasingly complex debt landscape.

Bruce Shen is a former Next Gen Fellow with the GeoEconomics Center’s Bretton Woods 2.0 Project.

Euel Kebebew is a former Next Gen Fellow with the GeoEconomics Center’s Bretton Woods 2.0 Project.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Learn more

The post How the IMF can make sovereign debt restructuring more effective appeared first on Atlantic Council.

Introduction
What drives financial de-risking in the Caribbean?
Why correspondent banking relationships are a public good
Policy recommendations
Benefits for the Caribbean and its partners
Conclusion
Acknowledgments
About the author

Introduction

Economic development and prosperity in Caribbean countries¹ require a stable and secure financial sector. The ability to access international finance and credit, trade with other countries, and secure foreign investment are all actions that underpin this stability, especially for the small and open markets in the Caribbean. Vital to performing these actions are correspondent banking relationships, which financial institutions, governments, and citizens use to conduct cross-border financial transactions. Correspondent banking relationships are a public good, given how crucial they are to the proper functioning of economies and financial systems, especially for small countries in the Caribbean.

However, over the past decade, Caribbean countries have seen a significant withdrawal of these relationships (also known as financial de-risking), which is when a financial institution severs, rejects, or puts limits on transactions with a particular group and/or individual customer. The Caribbean is frequently cited as the region of the world most affected by this phenomenon.²

Stabilizing correspondent banking relationships in the Caribbean requires imparting on the international financial system an appropriate and equitable understanding of the challenges small markets face from financial de-risking, and the important role they play in the health of the global economy. One way to achieve this is to conceptualize and categorize correspondent banking relationships as a type of critical financial market infrastructure (CFMI), which would help highlight the fact that if the financial sectors of one region (in this case, the Caribbean) are significantly affected by financial de-risking, the economic consequences could be felt globally. Global governments, regulators, and central banks work to ensure CFMIs’ viability and sustainability since financial systems and economies would find it difficult to function without them.³

This issue brief builds on the 2022 Atlantic Council report Financial De-risking in the Caribbean: The US Implications and What Needs to Be Done,⁴ which was produced after a series of roundtables held among members of the Financial Inclusion Task Force (FITF) organized by the Atlantic Council’s Caribbean Initiative. In that first report, the FITF explained that categorizing correspondent banking relationships as CFMI “would provide global recognition to the importance that correspondent banking services provide to the health and ability for growth of Caribbean economies and citizens.”⁵ In 2023, the Caribbean Initiative convened several members of the FITF along with other financial experts to provide a practical and actionable recommendation to US, Caribbean, and multilateral stakeholders on the necessity of categorizing correspondent banking relationships as CFMI.

What drives financial de-risking in the Caribbean?

There are two main drivers of financial de-risking in the Caribbean: 1) limited profitability for correspondent banks due to the relatively small size and volume of transactions; and 2) countries’ classification as “high-risk jurisdictions,” and their perceived weak regulatory frameworks to address money laundering and terrorism financing. Both drivers have contributed to a broad decline in correspondent banking relationships.⁶ The Caribbean Association of Banks survey in 2017 noted that twenty-one of its twenty-three member countries had lost at least one correspondent banking relationship. Further, an analysis of Society for Worldwide Interbank Financial Telecommunication (SWIFT) data (contained in our 2022 report) confirmed these lost correspondent banking relationships, with some countries faring worse than others, such as Belize, Saint Vincent and the Grenadines, Dominica, The Bahamas, and Jamaica, which all saw a more than 40 percent reduction in correspondent banking relationship counterparties between 2011 and 2020.⁷

It is worth noting that while all Caribbean countries analyzed for this report saw a reduction in correspondent banking relationships over the period, not all saw a reduction in transaction volumes or values. However, in all cases, fewer correspondents saw an increase in the concentration of flows through fewer counterparties, which ultimately increases potential risks. Should the consolidation trend continue, this means entire financial systems will become more reliant on fewer institutions, increasing the possible impact on the system should more banks decide to cease doing business in or with the region.

Table 1. Change in correspondent banking relationships, transaction volumes, and transaction values across Caribbean countries, 2011-2020

Profitability limits identified by correspondent banks are based on a risk versus reward calculus. First, correspondent banking is a fee-based service, and given the small populations of Caribbean countries, there are inherently small volumes of transactions occurring between correspondent and respondent banks. As a result, correspondent banks weigh those potential profits against stringent US regulations that threaten heavy fines and sanctions if a Caribbean financial institution that has a relationship with a US correspondent bank is unable to mitigate risks, such as financial crimes. In many cases, the risk of the relationship with the Caribbean counterparty outweighs the potential reward.

Factoring into the perceived risks of engaging with Caribbean jurisdictions are concerns from US banks about the region’s ability to manage and mitigate illicit finance. Correspondent banks perceive that despite increased capacity to adhere to anti-money laundering/countering the financing of terrorism (AML/CFT) standards, Caribbean governments have weak regulatory frameworks that do not sufficiently address concerns over financial crimes. Further, many Caribbean countries that face financial de-risking are continually classified by the US Department of State’s annual International Narcotics Control Strategy Report as jurisdictions with high rates of money laundering and drug trafficking. The report is one of the factors correspondent banks account for when determining whether to maintain or begin a correspondent banking relationship in the Caribbean. During the 2022 financial de-risking roundtable held in Barbados and co-chaired by then-Chair of the House Financial Services Committee Maxine Waters and Prime Minister of Barbados Mia Mottley, several Caribbean heads of government shared that their ministries lack the capacity to provide sufficient responses to the report’s contents. For US correspondent banks, particularly mid-tier ones, this poses a significant challenge as they fear inheriting the reputational risk of Caribbean jurisdictions, which influences their own relationships with correspondent banks at home.

Financial de-risking and its drivers have many possible economic implications for Caribbean countries, impacting a wide range of stakeholders, including governments, financial institutions, and citizens. The potential impact on remittances is one example. In this case, financial de-risking and lost correspondent banking relationships increase costs and risks for money transfer operators (companies moving currencies from one financial institution to the other). Citizens themselves, particularly those most vulnerable and dependent on remittances for subsistence, bear the brunt of this burden. As an example, Jamaica—where remittances are equal to a fifth of overall gross domestic product—has placed limits on the amount of money that can be transferred due to a stricter regulatory regime. Outside of remittances, financial de-risking can limit access to international capital needed to facilitate investment, trade, and access to credit—all critical for commerce and development, especially in the Caribbean.

Why correspondent banking relationships are a public good

The economic and investment activity that correspondent banking relationships support makes them a crucial public good. Essentially, public goods are those that benefit all citizens by providing positive outcomes for individuals and institutions. Most often, governments play an important role in ensuring access to public goods. The same should be true for correspondent banking relationships, and both Caribbean governments and their advanced economy partners have a role to play in protecting them. Of course, this does not obviate the need for appropriately sound and rigorous regulatory frameworks, which must continue to be enforced and bolstered to mitigate money laundering and terrorism financing concerns. These two objectives can certainly reinforce one another.

This is precisely the reason why the SWIFT payments system is deemed a critical financial market infrastructure. SWIFT is an intermediary and executor of financial transactions among banks globally, including sending payment orders that are then settled by correspondent accounts among financial institutions.⁸ As of 2018, half of all high-value cross-border payments used SWIFT payments in more than two hundred countries and territories.⁹ The effects of restricted access to the SWIFT network—and by implication, correspondent banking—was evident in the aftermath of the Russian invasion of Ukraine, where multiple Russian banks’ access was limited. This was a form of economic sanction, which led to significant operating delays and increased financial costs for counterparties across the globe. Although an extreme example, this highlights the importance of correspondent banking flows and related risks that restricted access to correspondent banking flows implies, which are particularly acute for small open economies such as those of the Caribbean.

Policy recommendations

Categorizing correspondent banking relationships as CFMI or a public good can help underscore their importance to long-term economic development for Caribbean economies and catalyze resources and reforms needed to address related challenges. While more work is needed to comprehensively diagnose capacity, institutional deficits, and policy reforms—for both regional and correspondent bank host countries—the following preliminary options would support progress in this effort and are discussed below.

First, the members of the House Financial Services Committee should consider taking action that encourages the US Treasury and MDBs to redouble efforts to provide technical assistance and capacity building aimed at improving regulation, supervision, and reporting requirements for Caribbean financial institutions. As discussed, driving financial de-risking in the Caribbean are the perceived reputational risks for banks due to increasingly strenuous AML/CFT regulations and compliance standards. MDBs and other development partners have provided support to individual countries, but this can be scaled and regionalized to facilitate dialogue and needs assessments, maximize resources and effectiveness, and avoid duplication of efforts. The potential benefits of such an initiative would extend well beyond the issue of financial de-risking and support financial sector stability, development, and inclusion more broadly. Streamlined assistance that is underpinned by legitimate institutions such as MDBs and the US Treasury can help instill confidence in correspondent banks, bringing new relationships to the region or protecting those that already exist.

Second, the House Financial Services Committee could work with the US Treasury and MDBs to create a regional facility with a mandate to provide services to customers and jurisdictions where costs and risks are challenging for conventional financial institutions. Modalities should include bundling smaller transactions to generate greater economies of scale and providing financial incentives that would help address challenges posed by the increasing costs of counterparty risk assessments. The facility could also serve as a bridge of information among governments, regulatory bodies, and MDBs to help fill information gaps and ensure that financial institutions are in the best position to keep up with rapidly evolving international compliance standards.

Benefits for the Caribbean and its partners

US and MDB support for categorizing correspondent banking relationships as CFMI would benefit broader Caribbean economic development goals. Steady access to correspondent banking relationships creates and maintains a strong financial sector. This helps encourage local banks to lend to the local private sector, thus stimulating economic growth among micro, small, and medium-sized enterprises—the backbone of Caribbean economies. This is even more important since the Caribbean is import-dependent on petroleum products, medical services and equipment, food supplies, and foreign investment to build infrastructure projects such as roads and critical facilities. While the region is making strides to reduce import dependence, the nature of its open and small economies ensures that there will always be some reliance on the global financial system. For example, given the accumulating effects of climate change in the region, climate and development finance from MDBs and organizations such as the Green Climate Fund will be essential to adaptation and mitigation efforts. However, these groups are unlikely to lend in local currencies and, even if they do, the goods needed to purchase equipment and services will primarily come from abroad and require payment in the form of international currencies.

But the United States and MDBs also benefit from correspondent banking relationships categorized as CFMI. In recent years, the United States and MDBs have used their global platforms to advocate for Caribbean priorities. Some reform has come of this, such as debt pauses announced by MDBs and new policy frameworks such as PACC 2030, but little has been done in the area of financial de-risking. Addressing this issue through a first step with CFMI categorization would help build additional goodwill and help MDBs support their own development agendas in the Caribbean and other Small Island Developing States. Financial de-risking is not just a Caribbean problem with other countries such as those on the African continent affected as well. Therefore, both the United States and MDBs have an opportunity to address a significant development challenge at a global level.

Conclusion

Correspondent banking relationships are crucial conduits for foreign exchange and finance, which are the lifeblood of Caribbean economies. Given the importance of correspondent banking relationships, they fit the criteria first as a public good, and second as CFMI. This categorization is not just important, but feasible and justifiable. It is in the interest of all actors to maintain a functioning and healthy global system and categorizing correspondent banking relationships as CFMI is the first step to ensuring that all countries and citizens have access to it.

Acknowledgments

At the Atlantic Council, we thank board member and founder of the Caribbean Initiative Melanie Chen for her support of this publication and our previous work on financial de-risking. We would also like to thank the experts and policymakers who joined the private roundtables and one-on-one consultations that informed this publication, including Nigel Baptiste, Henry Mooney, Wendy Delmar, Dawne Spicer, Stephen Thomas, and Deepa Sinha. A special thank you goes to Jason Marczak, senior director of the Atlantic Council’s Adrienne Arsht Latin America Center, for his guidance, leadership, and comments during this publication’s process and to Charlene Aguilera for her help and support in coordinating this publication.

About the author

Staff

Wazim Mowla

Associate Director & Fellow, Caribbean Initiative

Adrienne Arsht Latin America Center

Caribbean China

Wazim Mowla is the associate director of the Caribbean Initiative at the Adrienne Arsht Latin America Center. He leads the development and execution of the initiative’s programming, including the Financial Inclusion Task Force, the US-Caribbean Consultative Group, the PACC 2030 Working Group, and the Caribbean Energy Working Group. Since joining the Atlantic Council, Mowla has co-authored major publications on the strategic importance of sending US COVID-19 vaccines to the Caribbean, strategies to address financial de-risking, and how the United States can advance new policies to support climate and energy resilience. As part of his work on the Caribbean, Mowla was called to provide congressional testimony to the US House Financial Services Committee on financial de-risking. Mowla holds bachelor’s degrees in international relations and history and a master’s degree in public history from Florida International University, and a master’s degree in comparative regional studies from American University.

Related content

Issue briefs and reports May 12, 2021

COVID-19 vaccine tracker: Latin America and the Caribbean

Our interactive maps track the percentage of the population of each Latin American and Caribbean country covered by current vaccine agreements; the total number of doses secured by each country and breakdown by supplier/vaccine; where each vaccine is being used across the region; and how many vaccines flow from each major producing country to regional destinations.

Caribbean Coronavirus

Report Mar 1, 2022

Financial de-risking in the Caribbean: The US implications and what needs to be done

By Jason Marczak, Wazim Mowla

This report identifies how the withdrawal of correspondent banking relations, otherwise known as de-risking, affects Caribbean economies, people, and US-Caribbean relations.

Americas Caribbean

Issue Brief Sep 20, 2022

PACC2030: Quick wins for a US-Caribbean partnership on climate and energy resilience

By Wazim Mowla, Riyad Insanally

PACC2030’s success is crucial for CARICOM countries and the United States, and it needs to deliver in the short term to generate confidence that the United States is committed to a sustainable partnership.

Caribbean Economy & Business

The Adrienne Arsht Latin America Center broadens understanding of regional transformations and delivers constructive, results-oriented solutions to inform how the public and private sectors can advance hemispheric prosperity.

Learn more

The post Strengthening financial inclusion in the Caribbean: Treating correspondent banking relationships as a public good appeared first on Atlantic Council.

In 2026, Indonesia is expected to surpass Russia to become the world’s sixth largest economy (in PPP terms)—about two years earlier than if Putin’s invasion of Ukraine had never happened. (We reached that estimate by comparing the IMF’s growth projections pre- and post-invasion.)

This is not directly a sanctions story. Yes, financial sanctions and lack of access to advanced technology through export controls have significant negative long-run effects on the Russian economy. But Russia’s slide and Indonesia’s ascent are both driven in large part by the same thing: people. Russia is suffering from acute brain drain while Indonesia’s labor force is growing. In particular, Indonesia’s educated professional class is growing while Russia’s is shrinking. That contrast is what makes their soon-to-be swap on the list of the world’s largest economies notable. The world’s center of economic gravity is shifting.

In Russia, working citizens under the age of 35 now comprise less than 30 percent of the labor force, the lowest share since Russia started collecting that data twenty years ago. And here’s a statistic which should scare all Russian policymakers: from the start of the invasion to spring 2023, 86 percent of Russian emigrants are under the age of 45 and 80 percent are college educated. In the coming years, Russia’s labor supply will shrink as potential migrants view the country less favorably and as its living standards converge with other former Soviet republics, Moscow’s traditional source of migration. This, coupled with declining birth rates, means that by 2040 a declining workforce could reduce GDP growth by as much as 0.5 percent, according to projections like those by Bloomberg Economics. 

Meanwhile Indonesia’s labor force is growing, its commodity exports are booming, and its new capital is under construction. There is a reason why Xi Jinping reportedly tried so hard to bring Indonesia into the BRICS expansion this week. He knows very well where the future is heading: it’s to China’s south, not its north. 

While Russia’s workforce ages and its education levels decline, Indonesia’s continue to improve as new workers enter the labor force with strong educational backgrounds and important skills, albeit at a slower rate than the two decades prior to COVID. A growing and more prosperous labor force has also provided a strong foundation for increases in Indonesian private consumption. This is particularly important for China as it searches for new consumer markets to absorb its exports. Although Russia may be an important export market for Chinese producers for the moment, as it rushes to fill the gaps left as western companies pull out, its long-term growth prospects are stagnant at best and more likely negative. The opposite is true for Indonesia, which is still mostly on track to achieve its goal of becoming a High-Income Country by 2045.

Indonesia can see its brighter economic future ahead and its refusal so far to join the BRICS expansion speaks to its own growing confidence—and was one of the most significant and overlooked developments of last week. 

The data shows that Russia will increasingly need benefactors like China to prop up its economy while rising powers like Indonesia will have many more friends eager to do business across the islands. 

Josh Lipsky is the senior director of the Atlantic Council GeoEconomics Center and a former adviser to the International Monetary Fund.

Niels Graham is an associate director for the Atlantic Council GeoEconomics Center where he supports the center’s work on China’s economics and trade.

This post is adapted from the GeoEconomics Center’s weekly Guide to the Global Economy newsletter. If you are interested in getting the newsletter, email SBusch@atlanticcouncil.org

The post Indonesia’s economy will surpass Russia’s sooner than expected. Here’s what that says about the global economy. appeared first on Atlantic Council.

Distinguished speakers at the workshop included H.E. Peter Dovhun, minister of economy of the Slovak Republic; Ms. Ditte Juul Jørgensen, director-general for energy of the European Commission; and Dr. Julije Domac, special advisor on energy and climate of the Republic of Croatia, among others.

Participants acknowledged the importance of solidarity and cooperation in the success of the REPowerEU plan, which aims to reduce reliance on Russian energy sources—especially gas—and has been credited with lowering Europe’s Russian gas dependence by cutting imports from Russia by two-thirds by the end of 2022. The European gas supply needs to be diversified. In this context, tripling the LNG supplies from the US is a positive development.

Similarities and differences between IRA and the Green Deal were discussed. Both the EU and the US have common objectives – to invest more in clean energy supply chains, technologies, and innovation. At the same time, a positive development is that the differences are being addressed not by retaliatory measures but through direct dialogue to find solutions.

Like much of Central Europe, Slovakia is heavily reliant on Russian oil and gas for its energy supply and has faced difficulties with diversification following Russia’s invasion of Ukraine. To that end, as it continues to support Ukraine with military and humanitarian aid, Slovakia and other Central European member states are key contributors to EU efforts to reduce reliance on Russian fossil fuels and reduce carbon emissions.  

Slovakia is seeking to rapidly electrify its economy to address its dependence on Russian fossil fuels. The government describes its efforts as focused on solving the “energy trilemma” – maintaining the balance between the security of supply, sustainability, and affordability. Another priority of the current government is addressing energy security and affordability ahead of the 2023 election.

Panelists praised Slovakia’s move towards building a gas interconnector with Poland, in addition to prioritizing ongoing gas supply talks with Lithuania, Germany, and Italy.

While Russia has weaponized the European Union’s dependence on Russian energy, the EU showed that its systems are more resilient than the Kremlin expected. However, the EU needs to avoid creating new dependencies while cutting the old ones. Panelists argued that EU member states need to seriously engage in implementing the REPowerEU plan’s objectives to reinforce Europe’s energy sovereignty in addition to ensuring decarbonization occurs at an expedited rate. The participants agreed that outlining EU aid plans to states previously more reliant on Russian hydrocarbons would be vital to get the implementation of REPowerEU objectives back on track.

Participants also discussed how nuclear power could help in reducing Europe’s dependence on Russian oil and gas while lowering emissions. Discussants emphasized the need to consolidate and harmonize the regulatory frameworks and safety standards needed to support the use of nuclear energy. The consensus that emerged among participants was that, in addition to Europe’s ongoing search to secure critical minerals abroad, Europe needs to reduce its dependence on Russian uranium if nuclear energy is to play a role in Europe’s decarbonization and diversification. The potential for small modular reactors (SMRs) and the high capital costs associated with nuclear energy were also a subject of the debate. The overall conclusion was that bringing SMRs to market at scale needs to be a central part of a transatlantic energy and climate partnership.

Nevertheless, participants noted the potential importance of nuclear energy as a long-term measure towards decarbonization. Some senior policymakers present argued that nuclear energy should be seen as a carbon neutral and sustainable form of electricity production, and that EU member states that have prioritized nuclear energy technology development should consider developing partnerships with likeminded EU countries on the matter as well. 

Therefore, the overall picture that emerged from the workshop was of enduring European solidarity on achieving decarbonization. EU member states have largely retained their commitment towards decarbonization despite pressure from the Kremlin, albeit not on track to reach the targets set by REPowerEU. Participants further emphasized that US and European policymakers should be less concerned about the impact of “Ukraine fatigue,” the alleged decline in support for aiding Ukraine, and more on ensuring that EU members accelerate their efforts towards diversifying their energy supplies away from Russia. Finally, while nuclear energy remains a hotly debated topic among European policymakers, disagreements were more on the lack of construction, manufacturing, design, and operational expertise capabilities present in Europe as a whole.

Transform Europe Initiative

The Atlantic Council’s Transform Europe Initiative (TEI) is a critical element of the Europe Center’s drive towards structural reforms in Europe.

TEI leverages a robust body of work in strategic decarbonization.

Explore the program

The Europe Center promotes leadership, strategies, and analysis to ensure a strong, ambitious, and forward-looking transatlantic relationship.

Learn more

The Global Energy Center develops and promotes pragmatic and nonpartisan policy solutions designed to advance global energy security, enhance economic opportunity, and accelerate pathways to net-zero emissions.

learn more

The post Workshop on the role of Central and Eastern Europe in European decarbonization  appeared first on Atlantic Council.

Together, the BRICS countries have already overtaken the Group of Seven (G7) advanced economies in terms of their contribution to global gross domestic product, with the group now accounting for almost a third of worldwide economic activity measured by purchasing power parity. The consequences of this economic rise have reverberated through a number of areas, including trade. While trade between Russia and the G7 has fallen by more than 36 percent since 2014 under the weight of economic and financial sanctions, trade between it and the other BRICS nations has soared, increasing by more than 121 percent over the same period. China and India have become the largest importers of Russian oil following bans imposed by the European Union. China’s trade with Russia hit a record of $188.5 billion dollars last year, a 97 percent increase from 2014 and around 30 percent greater than in 2021. The surge occurred as Russia more than doubled its rail exports of liquefied petroleum gas as part of a drive to diversify its exports under the harsh sanctions regime.

By opting not to comply with western-led economic and financial sanctions, the solidarity of BRICS has been a balm for Russia. The bloc has offered trade diversion and other relief to one of its founding members and, in the process, weakened the effectiveness of US-led sanctions as a tool for advancing economic and geopolitical interests.

Online Event Wed, August 23, 2023 • 1:30 pm ET

The 2023 BRICS Summit: Africa in Action

With South Africa hosting the BRICS Summit and the 2023 AGOA Forum, the Africa Center brings together leading experts examining Africa’s growing role on the geopolitical landscape.

Africa Economy & Business International Financial Institutions International Markets

A multipolar magnet

Thwarting the sanctions regime has had consequences that reach far beyond the impact of the crisis in Ukraine. Bolstered by their success on the economic and geopolitical fronts, the BRICS group is increasingly viewed by a growing number of countries in the Global South as an attractive agent of multilateralism. More than forty nations—including Algeria, Egypt, Thailand, and the United Arab Emirates, but also key Group of Twenty (G20) countries such as Argentina, Indonesia, Mexico, and Saudi Arabia—have formally expressed their interest in joining the BRICS in the lead-up to this week’s summit.

If the effectiveness of trade diversion by BRICS nations in weakening the impact of western sanctions against Russia is any indication, sanctions could become less effective as a tool for advancing the economic and geopolitical interests of the G7 after the admission of new BRICS members. In a zero-sum global trading environment, the bloc’s expansion would also accelerate the diversification of demand away from G7 countries and reduce members’ exposure to future geopolitical risks.

The focus in Johannesburg will certainly be on the admission of new members, as well as trade and investment facilitation in a challenging global environment where the escalation of trade and tech wars—along with the “friendshoring” of supply chains—has increased the risk of global growth deceleration and a hard landing in China. BRICS members are likely to discuss sustainable development in the climate change era, global governance reform, and an orderly process of increasing trade in local currencies. On the latter point, more and more emerging economies are exploring ways to conduct trade in non-dollar currencies following the imposition of sanctions against Russia.

The dollar remains the global reserve currency, and the pace at which other currencies have chipped away at its dominance has been incremental. But a growing number of experts, including senior US government officials, recognize that the aggressive use of economic and financial sanctions to advance US foreign policy could threaten the dollar’s hegemony in the years ahead. US Treasury Secretary Janet Yellen recently emphasized this point: “There is a risk when we use financial sanctions that are linked to the role of the dollar that over time it could undermine the hegemony of the dollar.”

A new reserve currency?

The significance of dedollarization takes on greater importance in light of rumors that the bloc might attempt to develop a BRICS-issued reserve currency to be used by members in cross-border trade. While the BRICS nations—which collectively enjoy a comfortable balance of payment surplus—have the financial wherewithal to establish such a currency or unit of account, they lack the institutional architecture and the scale to sustainably achieve this end.

Even assuming that its members are fully aligned geopolitically and more inclined to co-operate than to compete, adopting a common currency presents several challenges. As the creation of the euro, now the world’s second largest reserve currency, illustrated, hurdles will include: achieving macroeconomic convergence, agreeing on an exchange rate mechanism, establishing an efficient payment and multilateral clearing system, and creating regulated, stable, and liquid financial markets.

The United States was able to persuade other countries to use the dollar owing to its hegemonic position as the world’s industrial powerhouse and single-largest trading nation following the end of World War II, reinforced in the decades since by the size of the market for US treasuries, which are often considered to be the world’s leading reserve asset. If they wish to provide a competitive alternative, the BRICS countries would need to agree upon a state-of-the-art bond market. It would need to be big enough to absorb global savings and provide assets with low risk of default where surplus funds could be parked when not used for trade.

Reflecting on these challenges, Anil Sooklal, South Africa’s ambassador-at-large to BRICS, reiterated in July that a BRICS currency will not be on the agenda during the summit, though expanding trade and settlement in local currencies will be. In fact, BRICS countries are already making strides in the use of local currencies in cross-border transactions. Their use is helping to sustain and boost cross-border trade between members, even amid a challenging operating environment of heightened geopolitical risks. It is also loosening the balance of payments constraints associated with dollar funding, bolstering local economies.

Although China and India may have diverging security interests, they each stand to benefit from the increased use of local currencies. BRICS nations are already using their own currencies for some bilateral trade payment settlement, and Saudi Arabia is considering signing a deal with China to settle oil transactions in renminbi. Meanwhile India is expanding the use of local currencies for bilateral trade payment and settlement beyond the BRICS group, inviting more than twenty countries to open special vostro bank accounts to settle trade in rupees. In a history-making move, India made its first oil payment to the United Arab Emirates in rupees earlier this month.