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Will China’s Infrastructure Bank Work?

CAMBRIDGE – With China set to lead a new $50 billion international financial institution, the Asian Infrastructure Investment Bank (AIIB), most of the debate has centered on the United States’ futile efforts to discourage other advanced economies from joining. Far too little attention has been devoted to understanding why multilateral development lending has so often failed, and what might be done to make it work better.

Multilateral development institutions have probably had their most consistent success when they serve as “knowledge” banks, helping to share experience, best practices, and technical knowledge across regions. By contrast, their greatest failures have come from funding grandiose projects that benefit the current elite, but do not properly balance environmental, social, and development priorities.

Dam construction is a leading historical example. In general, there is a tendency to overestimate the economic benefits of big infrastructure projects in countries riddled by poor governance and corruption, and to underestimate the long-run social costs of having to repay loans whether or not promised revenues materialize. Obviously, the AIIB runs this risk.

That said, there are huge infrastructure needs across developing Asia, and it is high time for China to play a greater role in international lending institutions. Moreover, the official US argument – that China should invest its money in existing institutions, such as the World Bank and the Asian Development Bank, because a Chinese-led bank would likely have governance problems – smacks of hypocrisy. Good governance? Is the US prepared to relinquish its historical prerogative to choose the World Bank president?