Justin LIN: Patient Capital as a Comparative Advantage for Development Financing
Author:JustinLin
From:IFF
Time:2018-08-24
As countries around the world face the challenges of sustainable development and climate change, the need for substantial development financing has given birth to new development financing ideas. Some basic theories and policy provisions of neoliberal economics need to be re-examined. Only by “reflecting traditional development financing” can new financing resources be explored and utilized.
In terms of the growth or structural transformation of the funding entity, we believe that “patience capital” or ultra-long-term capital is critical. What developing countries need to attract is patient capital rather than hot money and quick money. Therefore, China's cautious attitude toward capital account liberalization makes sense. We believe that now is the time to promote the establishment of national development banks and multilateral development banks and funds, because they are an important sources of patient capital. With the establishment of the Asian Infrastructure Investment Bank, the BRICS Development Bank and the Silk Road Fund and other industrial capacity development funds, countries around the world are increasingly interested in the role of development banks and funds. Therefore, this article will further link the concept of “patient capital” to development banks and funds and proposes the establishment of new multilateral development banks and green transition funds for developing countries.
China is utilizing its comparative advantage in patient capital
Our patient capital in “Reviewing Development Finance and Development Bank: Patient Capital as Comparative Advantage” (China Finance, 18, April 2018) depends on the “long-term orientation” (LTO) of a country or region. And the development of bank and financial institution investors. We broadly define patient capital as the ultra-long-term capital invested in a “relationship”. In this relationship, investors voluntarily inject capital (including equity and debts of more than ten years) into recipient countries/development partners, and are willing to see them grow in the future and bring great returns to both parties to achieve a win-win situation. Holders of patient capital usually have better ability to share risks with development partners.
In all Chinese Value Surveys, China ranked among the top five countries consistently with long-term orientation index (Hofstede 2010). Many of the East Asian countries/regions such as Japan, South Korea, Hong Kong (China), Taiwan (China), Indonesia and Singapore are also ranked high on LTO index. Compared with countries with similar income levels, the infrastructure of these countries and regions can obtain more funds, so the construction is relatively complete. We believe that LTO is a gift based on the Confucian culture of farming society, which usually leads to higher savings rates and investment. Patient capital is a potential comparative advantage based on long-term cultural endowments and may be transformed into a dominant comparative advantage under certain conditions. The patient capital can be considered a special endowment which, under certain circumstances, can be developed from a potential advantage into a comparative one.
In the last two decades, Germany, Japan, South Korea and Singapore are good examples of building long-term relationship with developing countries in Asia as well as in Africa by investing in their infrastructure. China has been learning and trying to catch up. Here we argue that China also has just started to use its comparative advantage in patient capital to help releasing infrastructural bottlenecks to achieve win-win solutions. China is a latecomer—it is able to turn its latent comparative advantage to a revealed one in patient capital only recently, but the potential is large, as more enterprises going global.
Time to push for more development banks and funds
The role of development banks of developing countries has been neglected for nearly 30 years, in part because of neoliberalism and the pressures of the “Washington Consensus”. Many national development banks have been privatized or liquidated due to domestic problems and international pressure from international financial organizations based in Washington. According to estimates by the Inter-American Development Bank, more than 250 development banks were privatized from 1987 to 2003, and many other development banks were also reorganized and liquidated (Olloqui, 2013).
We believe that development banks and development funds are important institutions for mobilizing and utilizing patient capital and play an important role in structural transformation. Development banks can mobilize savings from the government, the private sector and the public, and use them for long-term loan/financing projects. Most of the loans provided by existing development banks are long-term loans (90%). These existing development banks are mobilizers, managers and transiters of patient capital and introduce them into long-term infrastructure and transformation projects. Surprisingly, 13% of development banks offer loans with a loan period of more than 20 years, while most development banks have a maximum loan period of less than 20 years. Evidence of increased patient capital is also accompanied by growing sovereign wealth funds (SWFs) and government-supported strategic investment funds (SIFs) established in Kazakhstan, Malaysia, Mexico, Morocco, etc. (Halland et al., 2016) . The number of multilateral strategic investment funds is also increasing, including those for the establishment of infrastructure for multilateral strategic investment funds (MSIFs). The World Bank recently used the funds of the International Development Association to establish a new private sector window,managed by the International Finance Corporation (IFC). In essence, the use of official development aids (ODA) provided by governments to incite private sector funds (in the form of equity) to support the development of the private sector in developing countries (a combination of aid and investment, similar to the development cooperation approach of the China-Africa Development Fund) .
In the current situation, more development banks/development funds are needed to achieve sustainable development goals and address climate change. Coincidentally, Wang Yan proposed the establishment of a Guangdong-Hong Kong-Macao multilateral development bank to provide funds for the development of the Greater Bay Area to overcome the problems brought about by the "one country, two systems" and the different financial regulations of the three places. Justin Lin suggested that developed countries should establish green funds to encourage developing countries to adopt green technologies to cope with climate change. These two coincident proposals are based on an urgent need to provide more patient capital to finance sustainable development in developing regions. In our view, without the increase in development financing institutions (development banks and development funds), it is impossible to mobilize more long-term financing from developing and developed countries.
As China's national income and fiscal revenue continue to grow, the number of development financing will rise sharply, which can be seen from the commitments made by China recently on China-Africa Cooperation Forum, the 21st UN Climate Change Conference and the “Belt and Road” International Cooperation Summit.
China will gradually assume more responsibility and explore its new role in global affairs. Its official development assistance (ODA) share of gross national income (GNI) is likely to increase from the current 0.1% to 0.3%. This means a significant increase in official aid – and of course depends on the definition of official development assistance (ODA) or other official flows (OOF) or development finance (DF).
However, the rate of growth depends on development institutions and global governance. China is trying to establish an appropriate platform to make its own contribution to global development, including the establishment of Asian infrastructure investment banks and other multilateral institutions such as the BRICS Development Bank, the Silk Road Fund, the China-Africa Cooperation Forum, and the African Development Fund. In the future, countries need to establish more development banks and development funds to enhance competition and improve efficiency.
Beyond “narrow frame”, green package and other projects
Richard H. Thaler, winner of the Nobel Prize in Economics in 2017, said in his book Misbehavior that economists and practitioners need to overcome the "narrow frame" problem. For example, a CEO fails to get the 23 projects he wants, only three due to the narrow frame. When the company sees 23 projects as a portfolio, it is clear that the company will find this portfolio attractive; but when the company narrowly consider the 23 investment projects one by one, the manager will be reluctant to take risks. One way to solve this problem is to gather the projects in a pool of funds in which the investment project can be viewed as a portfolio. We believe that the World Bank is being plagued by the narrow frame problem and that it bears too little risk.
The ability to overcome narrow frame and “package” public infrastructure and private services is one of the key institutional factors for success in overseas cooperation. China develops its capacity in packaging infrastructure project in a smart way since the late 1990s, starting with the China Development Bank’s Wuhu project. In the Wuhu project, the National Development Bank combined six loan projects in the Wuhu area (green and non-green, profitable and non-profit projects) to promote overall sustainable development in the region. This shows that projects in many countries and regions can be combined into a combination of different infrastructure and industrial park project clusters, making them economically profitable and financially viable. This is only possible if the development or investment bank has long-term orientation and patient capital and seeks to establish a long-term relationship with customers or partners, in order to achieve a win-win situation.
With the similar desire to help long-term development and achieve win-win solutions, China has developed series of Resource Financed Infrastructure (RFI) projects with African countries. What is the definition of RFI model? In simple words, “The RFI model is a financing model whereby government pledges its future revenues from a resource development project to repay a loan used to fund construction of infrastructure. The key advantage of the model is that a government can obtain infrastructure earlier than it would have been able to if it had to wait for a resource project to produce revenues. This new financing model resembles aspects of other financing models, and use of the model will raise issues in the same way that every other model does, whether used for a resource development project or an infrastructure project.” (Halland et al., 2014, p. 13).
Halland et al. (2014) highlighted the most important advantage of the RFI approach, and that is this approach “can bring substantial benefits to a [host] country and its citizens,... years ahead of what would have been possible under any other model.” Based on the intellectual foundation of New Structural Economics, we had discussed the pros and cons of this RFI approach by stressing the structural aspects of the RFI concept, especially focusing on its feature of “nonrecourse” or “limited recourse” loans which are favorable to the borrower; its ability of reducing transaction cost, reducing the currency mismatch and the maturity mismatch, and encouraging the spatial concentration/agglomeration; as well as the risks associated with political economy and transparency issues. We pointed explicitly that, “There are legitimate concerns over the transparency issues around past RFI packages. We are strongly supportive of the Extractive Industries Transparency Initiative (EITI) principles for moral, political as well as risk management reasons…. In our view, any “deals” negotiated in the dark—without the support of the general public—are likely to be revoked or renegotiated later if there is a change in the government. This lesson from history should be kept in mind.”
With the hindsight, here we stress that these RFI packages actually are smart ways to package public or semi-public infrastructures to make them attractive to long-term private investors with patient capital who are eyeing for a decent rate of return in the long (10 years or more) term. The special feature of RFI packages of being “nonrecourse” or “limited recourse”, favoring the borrower, indicates the lender have assumed higher risks than in the case of full-recourse secured loans. This unique “insurance” service provided by the lender in RFI loans, that would otherwise be unavailable, has yet to be fully appreciated and priced-in by the development community. Should a high rate be charged due to this insurance service? This question is worthy of future research.
Conclusion
Currently large amount of patient capital has been used to finance the country’s domestic projects. Along with the gradual opening of China’s capital account, more patient capital is going to be exported as more enterprises and banks are “going global”. Patient capital often comes with technology, management skills and implementation capacity, the export of which will have strong impact on global connectivity and development. Using NFA as an imperfect measure, China is likely to emerge in the next few years as the world’s largest net creditor”, and a proportion of these net foreign assets would be in fact patient capital, suitable for infrastructure, manufacturing and employment generation.
International development is a two-way learning process. China needs to continue to learn, as it did in the last 38 years, to become a better development partner by listening to the demand from partners, South or North, East or West, and interacting with the governments, NGOs and civil societies. China needs to be more open and transparent in providing accurate data on international development financing and activities. Also, the political economy dynamics must be taken into consideration and carry out economic feasibility studies and social environmental assessments. In addition, existing multilateral development institutions can also learn from China's experience: they need to go beyond aid, combine aid, trade and investment, to support more national and regional development banks and development funds, and to overcome narrow frame.
In recent years, the emergence of new multilateral or regional development banks and funds such as the AIIB, the New Development Bank, and the Silk Road Fund, and other unlisted infrastructure or sovereign funds, is encouraging as they are suppliers of patient capital and they bring positive energy and momentum to the world economic development arena. In a multipolar world, it seems inevitable to have multipolar development organizations and different plural-lateral and multilateral development banks and funds. China’s recent focus on New Multilateralism is good for the global economy. We are cautiously optimistic that a common ground can be found for partners from the North and the South to work together on “win-win” solutions for sustainable development and world peace.
(The author's point of view does not represent the official position of IFF. This article is an original article. If you want to repost this article, please indicate the source of the article.)