Emulation or differentiation? China s development finance and traditional donor aid in developing countries *

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1 Emulation or differentiation? China s development finance and traditional donor aid in developing countries * Alexandra O. Zeitz University of Oxford alexandra.zeitz@politics.ox.ac.uk Foreign aid relationships are valuable to donors as a means of improving development outcomes and influencing recipient country policy. The emergence of new donors can lead to competition as donors vie for recipient governments attention. How does such competition affect the behavior of traditional donors toward developing countries? Emerging county donors, led by China, have distinguished themselves from traditional donors in a number of ways, including in the lack of policy conditions attached to loans and aid, but also in the types of development projects they finance, with an emphasis on large infrastructure projects. I investigate how this focus of Chinese development finance affects the behavior of traditional donors in developing countries, and whether this has a bottom-up effect on the development models supported by donor financing. I suggest that traditional donors can either emulate China s approach to development projects or differentiate themselves to remain relevant to recipient countries. Further, I identify conditions under which competition may be more likely to affect traditional donor behavior, namely if recipients are highly strategically significant or if governments in recipient countries are very politically secure. I test this using a global dataset of the terms of World Bank and Chinese lending in 131 countries, and find the World Bank responds to competitive pressure from China by differentiating its approach, decreasing the size of its projects, though I find no effect of competition on the sectors the World Bank allocates projects to. * I thank Ben Ansell, Gerda Asmus, Daniela Campello de Costa Ribeiro, Peter Knaack, Silvia Marchesi, Sam Rowan, and Folashadé Soulé-Kohndou for helpful comments on earlier drafts of this paper. Participants at the workshop Tracking International Aid and Investment from Developing and Emerging Economies at Heidelberg University provided valuable feedback. Any errors are my own. 1

2 1. Introduction Since the Cold War, advanced economies have been largely alone in providing development finance to developing countries, whether bilaterally or through multilateral institutions. The relationships created through this provision of development finance are valuable for donors and recipients beyond just the resources they provide. For donors, they offer a means of improving development outcomes as well as influencing recipient country policies. However, the rise of emerging donors, especially China, has disrupted the virtual monopoly previously enjoyed by traditional donors. 1 Given that recipient governments have a finite capacity to absorb external financing, alternative sources of development finance can place competitive pressure on traditional donors. In this paper I investigate how traditional donors respond to the arrival of China as a donor, contributing to a growing literature on competition among donors as the landscape of development finance becomes more crowded. 2 I suggest that traditional donors can respond to China s growing role by either emulating China s approach to development finance or differentiating the development assistance they offer, establishing a distinct market niche for themselves. The paper contributes a new way of thinking about donor competition, as well as highlighting a previously unexplored mechanism by which China may be shaping global practices in development. It asks: is competition with China changing the type of development that traditional donors pay for? In 2015, the World Bank announced it would be providing a $700 million guarantee to the Sankofa natural gas plant in Ghana. The guarantee was the largest ever of its kind for the World Bank, and was heralded by the Bank as a transformational project for Ghana s energy sector. 3 Years in the planning, the enormous project was motivated by Ghana s desire to reduce its reliance on imported oil. However, competition with China was also a likely factor. The World Bank s unprecedented $700 million guarantee followed on the heels of an earlier gas project financed by China, the Atuabo gas processing plant. Ghana had initially planned to develop this earlier gas project with the World Bank. A few years into preparations with the Bank, and 2

3 Bank s environmental safeguard requirements too onerous, and instead chose Chinese financing for its ease. The unprecedented guarantee later offered by the World Bank is an example of how competitive pressure from Chinese financing may lead traditional donors to emulate their Chinese counterparts, taking on projects that 3

4 Alexandra O. Zeitz Emulation or Differentiation? Furthermore, both developing country governments and Chinese rhetoric about its development assistance have drawn contrasts between China s demand-led financing and the alleged supply-driven approach of traditional donors.8 China s approach to financing development thus places traditional donors under competitive pressure by offering alternative development financing that is attractive to recipients. Given that recipients have finite time to dedicate to meeting with donors, and finite capacity to take on external finance, China s growing role has the potential to reduce the relevance of traditional donors.9 I suggest it is conceivable for traditional donors to respond in two ways, and test which is in fact taking place. Traditional donors can either emulate the approach of Chinese finance in order to meet recipients preferences for this type of funding, or they can differentiate themselves from the Chinese approach, developing a niche for themselves that is complementary to Chinese finance by providing smaller projects with a social sector focus. There are incentives for both possible responses: emulation may be the most rapid means of responding to the competitive threat of China, but differentiation may make use of traditional donors comparative advantage in capacity building and projects in social sectors. I use two measures to ascertain which approach traditional donors take in response to China s growing role as provider of development finance: the average size of individual projects and the share of projects in infrastructure-intensive sectors, including energy, transport and industry. Furthermore, I consider under which conditions such competition is likely to be more pronounced, testing whether recipient countries that are strategically significant to donors and those whose governing regimes have a strong hold on power are more likely to provoke competition. I study these dynamics with a specific focus on the World Bank because, as a multilateral development bank with the majority of voting power held by the United States and European countries, the World Bank is roughly representative of the perspectives of traditional or Western donors. Though the World Bank as a bureaucracy may be fairly immune to geopolitical competition, previous research has highlighted the extent to which influential shareholders can affect the behavior of international financial institutions and I therefore expect that competition will manifest itself in the World Bank s behavior even if it is driven by geopolitical motivations.10 Furthermore, as the largest multilateral donor, the World Bank is likely to have its own strategic reasons to experience competitive pressure from China s growing role, which has the potential to undercut the World Bank s access to borrowing governments and therefore ability to pass on policy advice. Finally, the World Bank is among the most transparent of large donors, making available the Six, C. (2009). "The Rise of Postcolonial States as Donors: a challenge to the development paradigm?" Third World Quarterly 30(6): Though the constraints in taking on debt might be most obvious, there is also a limit in the amount of concessional finance or grants a tnidhck99:taf??cs?:ta ivttid tt iid ttntanidca ii?:ta iaikte oaf??cs1. 8 4

5 project-level data necessary for this analysis. To investigate these claims I therefore use data on World Bank operations in 131 countries over the period My key explanatory variable is Chinese official financing commitments, taken from the AidData Global Chinese Official Finance dataset. 11 My analysis indicates the World Bank is responding to the competitive threat of China by in fact differentiating its approach to that of China. I find a negative relationship between commitments of Chinese development finance and the average size of World Bank projects, all else equal. This finding is robust to the inclusion of year- and country-fixed effects. Rather than mimicking the Chinese approach and increasing the size of its development projects, the World Bank appears to react to competition by shifting into smaller development projects. This effect is more pronounced in countries were the governing regime enjoys a high degree of political consolidation. However, I find no effect of Chinese development finance on sectors that World Bank projects are allocated to. What this combination of results suggests, perhaps, is that the World Bank is shifting its resources into less expensive advisory and governance projects in infrastructure-intensive sectors, rather than moving out of these sectors in response to Chinese competition. This paper proceeds as follows: Section 2 briefly discusses the rise of Chinese development finance, and compares key attributes of Chinese and World Bank financing. Section 3 argues that competition from China can directly affect the types of projects traditional donors finance in developing countries, and that competition is likely to be more pronounced in countries that are strategically significant to lenders and where governing regimes enjoy a secure grasp on political power. Section 4 introduces the data and the methods employed. Section 5 analyzes the results. 2. Introducing competitive pressure? Patterns and traits of Chinese financing China has substantially increased its official financing to developing countries over the past decade, increasing the likelihood of competition with traditional donors. Data from AidData s Global Chinese Official Finance dataset shows the steady increase of overseas Chinese financing commitments from a low base in the early 2000s. It stood at $2.6 billion in 2000 and increased to over $36 billion in Over the past decade, Chinese official financing commitments have been catching up to the World Bank s global portfolio, even surpassing the Bank in some of the recent years (Figure 1). The potential competitive threat to traditional donors has also increased over this time. 11 Dreher, A., A. Fuchs, B. Parks, A. M. Strange and M. J. Tierney (2017). Aid, China, and Growth: Evidence from a New Global Development FInance Dataset. AidData Working Paper. 12 In both the descriptive statistics that follow and the analysis reported in section 5, I use data on donors financing commitments, rather than disbursements In part, this is due to data availability. The AidData Global Chinese Official Finance dataset uses the Tracking Underreported Financial Flows (TUFF) methodology, which provides data only on commitments, not disbursements of Chinese finance. For direct comparison, I therefore use data on World Bank commitments, rather than disbursements, though these can differ. However, given my interest in competition, commitments are an appropriate measure. While studies on the effects of aid and finance require data on the amount of finance actually received, commitments data is suitable for studying the intentions of donors. Disbursements can sometimes vary for reasons that are out of the control of donors, while commitments are fully determined by donors. 5

6 Figure 1: Chinese official financing commitments and World Bank commitments, Chinese official financing has a wide regional scope, though Asia and Africa have received the bulk of grants and credits (Figure 2). Over the period , African countries received $118 billion in official financing from Chinese sources, while the total in Asian countries amounted to $116 billion. In Latin America and the Caribbean, financing commitments over the period totaled $56 billion, and in Central and Eastern Europe the total came to $53 billion, though the majority of this consists of one very large loan to Russian oil company Rosneft and a number of large loans to the Ukraine, Belarus and Turkey. Figure 2: Regional breakdown of total Chinese official finance commitments, Note: Russia has been dropped from Chinese financing commitments, since a $25 billion China Development Bank loan in 2009 significantly skews the data. 6

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8 economic return, leading to a greater emphasis on infrastructure and productive sectors over health or education. Furthermore, China stresses that its development finance is demand-led and responds to recipient countries particular interest in infrastructure projects. This combines with China s emphasis on infrastructure-led growth in its own development. The Chinese discourse on its development assistance stresses the potential for infrastructure projects to have a transformative effect on the economy. This differs from the approach of many of the traditional donors, whose portfolio tended towards social sectors and smaller projects over the course of the 2000s, as aid budget shrank and the Millennium Development Goals emphasized achieving social sector objectives. While this trend was less pronounced for the World Bank and other multilateral development banks, they too shifted funds into social sector programmes in education and health. In particular, the increased sensitivity to environmental and social impacts of large-scale infrastructure projects has meant that funding such projects with the World Bank now requires extensive and lengthy environmental and social impact reviews. 18 By contrast, Chinese funders are reputed to move much more quickly, without formalized and time-consuming environmental review procedures. Figure 3 shows the average size of World Bank and Chinese development projects over the period While World Bank projects are, on average, larger at the beginning of the period, the increasing number of Chinese megaprojects leads to a larger average size of Chinese projects over the course of the decade, in some years vastly outstripping the average size of World Bank projects. Chinese projects are also distinct in their sector focus. Figure 4 shows the proportion of annual financing allocated to projects in hard sectors such as energy, transport or industry, where infrastructure projects are more likely. 19 The chart shows that a greater portion of Chinese that World Bank finance is consistently allocated to such hard or heavy sectors. In ten out of the 15 years for which there is data, such hard sector projects made up 60% or more of financing commitments. By contrast, that is only the case for six out of the fifteen years for the World Bank. 18 Park, S. (2007). "The World Bank Group: Championing Sustainable Development Norms?" Global Governance 13(4): The World Bank and AidData Global Chinese Official Finance use different sector classifications, but I have endeavored to make these as comparable as possible. The Bank s internal classification structure comprises eleven sectors, while the AidData Global Chinese Official Finance Dataset had coders categorize Chinese projects using the 24 sector categories of the OECD s Creditor Reporting System. World Bank projects are associated with multiple sectors, while Chinese projects in the AidData Global Dataset are only associated with a single sector. I coded World Bank projects as being in hard sectors if any of the following are listed as a major sector : (1) energy and extractives, (2) industry, trade and services, and (3) transport. I coded Chinese projects being in hard sectors if they are classified as being in (1) water and sanitation, (2) transport, (3) communications, (4) energy, (5) agriculture, (6) industry, mining and construction. 8

9 Figure 3: Average size of World Bank and Chinese development projects, Figure 4: Share of World Bank and Chinese development projects in hard sectors, : Emulation or differentiation: Traditional donor responses to China s finance The entrance of China as a new donor with different practices to those of traditional donors can introduce competition and disrupt the relationship between recipient governments and traditional donors. I suggest the entry of China has the potential to shape the type of development that traditional donors choose to support with their funding, as donors respond to competitive pressure by either emulating 9

10 the Chinese approach to development finance and funding large projects in infrastructure-intensive sectors or differentiating themselves by specializing in alternative niches. Competition for recipients The claim that the entrance of a new donor can lead to competition implies that donors are contending for access to a scarce resource. Following others, I suggest donors are competing for the recipient government s attention in order to have an influence on government policy, and relatedly for a share of the total external finance that a country receives. There is a considerable literature on donors motivations in giving aid. 20 Something that emerges from this literature is that donors are motivated by wanting to influence recipient policy. 21 Donors may value their influence over recipients for self-interested reasons or because they believe that their research and experience across developing countries allow them to be effective in achieving development outcomes. The latter is more relevant to multilateral donors, who are seeking to maximize their access to recipients to translate their expertise into positive development outcomes. 22 To have such influence, donors need access to the recipient government, access that they receive in connection with development projects. In donor circles, this is referred to as the policy dialogue that accompanies projects. Competition arises when the recipient country allocates its time to meeting with other donors, thereby reducing the access another donor has to encourage the government to pursue its desired policies. This is particularly pronounced with China, since China does not coordinate its efforts with other donors. 23 While a recipient government s time spent with an OECD donor or the African Development Bank likely reinforces the policy messages of the World Bank, this is not the case with China. Thus, when recipient governments choose to dedicate time to meeting with China because they consider Chinese financing attractive, this reduces the access that the World Bank has to engage the government on its desired policy outcomes. In Ghana, for example, one donor representative explained that the Ghanaian government was slow to respond to donor requests because they were busy with Chinese loan negotiations: One document was missing to allow [us] to disburse, and in spite of several requests to sign these papers the government didn t feel it was important because they were negotiating the Chinese loan See, for example: Alesina, A. and D. Dollar (2000). "Who gives foreign aid to whom and why?" Journal of Economic Growth 5(1): 33-63, Dreher, A., S. Klasen, J. R. Vreeland and E. Werker (2013). "The Costs of Favoritism: Is Politically Driven Aid Less Effective?" Economic Development and Cultural Change 62(1): , Fuchs, A., A. Dreher and P. Nunnenkamp (2014). "Determinants of Donor Generosity: A Survey of the Aid Budget Literature." World Development 56: Bueno de Mesquita, B. and A. Smith (2009). "A Political Economy of Aid." International Organization 63(2): Milner, H. V. (2006). Why multilateralism? Foreign aid and domestic principal-agent problems.. Delegation and Agency in International Organizations. D. G. Hawkins, D. A. Lake, D. L. Nielson and M. J. Tierney, Cambridge University Press. 23 Bigsten, A. and S. Tengstam (2015). "International Coordination and the Effectiveness of Aid." World Development 69: Interview, Donor representative. Accra, Ghana, October 7,

11 A similar drive to compete is modeled by Bueno de Mesquita and Smith (2016), who focus explicitly on the competition arising from aid-for-policy deals. They assume donors provide aid in exchange for the recipient adopting policy desired by the donor. Competition arises when a rival donor offers aid in exchange for the recipient adopting a different policy. Since the recipient can only adopt one of these two policies, the outcome is necessarily zero-sum, and competition occurs. They find that donors are driven to provide increasing amounts of aid in order to secure their desired policy outcome. Using data spanning the periods before, during and after the Cold War period, they find that US aid allocation increases during periods of global competition with the Soviet Union. These assumptions can be relaxed somewhat with respect to competition between China and the World Bank. It is not always the case that China and the World Bank are pursuing diverging objectives in recipient countries. In fact, there are several projects that are co-financed through the World Bank and China ExIm Bank or the China Development Bank. However, since China mostly does not coordinate its projects with the World Bank, the more time that recipients choose to dedicate to Chinese development projects, the fewer opportunities there are for the World Bank to pursue its policy agenda with the recipient government. Thus, in order to retain their access to the government, the World Bank is incentivized to compete either by emulating the approach of Chinese development projects or by specializing to develop a complementary niche for themselves that attracts recipients. In addition to the motivation to retain access to the government for policy dialogue, there are bureaucratic drivers of competition, as donors compete for a share of the total development finance a country receives. As other work has highlighted, World Bank staff are under pressure to disburse funds. 25 Yanguas and Hulme (2015) cite one World Bank practitioner who refers to the overwhelming pressure to get money out of the door and that task teams are paid to ensure that the money is disbursed. 26 Given this incentive to disburse, competition arises when recipients choose to accept development finance from other sources and thus are inclined to reduce the amount they take from the World Bank. This is most obvious with development finance that comes in the form of loans, such as those offered by the China ExIm Bank or the World Bank s International Bank for Reconstruction and Development (IBRD). Recipient governments are constrained in the amount of debt financing they can take on by the need to keep their total debt below a sustainable threshold. With loan finance, therefore, competition arises because recipients can only borrow so much, and the choice of one lender therefore reduces the amount that another lender can lend. Combined with bureaucratic incentives to disburse, this can lead to competition for the share of total external finance that a recipient takes on. 25 This is often discussed as an impediment to conditionality, since the Bank cannot credibly threaten to withhold funds in the case of non-compliance with conditions. Svensson, J. (2003). "Why conditional aid does not work and what can be done about it?" Journal of Development Economics 70(2): , Collier, P. (2006). "Is Aid Oil? An Analysis Of Whether Africa Can Absorb More Aid." World Development 34(9): Yanguas, P. and D. Hulme (2015). "Barriers to Political Analysis in Aid Bureaucracies: From Principle to Practice in DFID and the World Bank." Ibid. 74:

12 It may appear that competition is less likely with grant aid and concessional finance, since recipients are not constrained by debt sustainability concerns in their decision of how much aid to receive. However, there are also limits to the total amount of development aid a recipient can take on. These limits arise not from debt sustainability, but rather from the transaction costs associated with development projects and the absorptive capacity of the recipient s economy. Aid projects pose significant administrative costs for the recipient government, including the design of the project, monitoring of funds and reporting to donors. In some cases, recipients are asked to provide a financial contribution, referred to as counterpart funding, 12

13 not attach policy conditions to its development finance, instead often imposing only the requirement that development projects be carried out with Chinese contractors. 28 Competition for access to recipient governments can therefore manifest as a race to the bottom in aid conditionality. Indeed, Hernandez (2017) finds that Chinese financing commitments lead to the World Bank attaching fewer loan conditions in the subsequent year. 29 I add to the emerging literature on donor competition by highlighting a further preference of recipient governments that is important in this context. In addition to this inclination toward greater volumes of finance and fewer conditions, I argue that recipients also care about the type of development intervention supported by outside finance, with a preference for projects that are larger and focused on productive sectors, especially infrastructure. Chinese development finance tends to satisfy these preferences, placing pressure on traditional donors. Recipient appreciation of large, infrastructure-focused projects derives from political incentives to publicly demonstrate development achievements. Governments in most developing countries derive their legitimacy from being able to deliver gains in development, which are easiest to demonstrate with highly visible interventions, such as investments in public infrastructure. Development finance that allows recipient governments to make such investments is particularly prized. Interviews I conducted in Ethiopia, Kenya and Ghana reveal that recipients regard the willingness of Chinese official lenders to fund large projects as a considerable advantage, especially when compared to bilateral traditional donors, who often pose substantial reporting requirements for even comparatively small projects. For example, one senior National Treasury official in Kenya spoke approvingly of the high conversion to benefit ratio of Chinese finance that provides large volumes for projects likely to have a rapid impact on economic growth. 30 This type of financing is also attractive to recipient countries for the development model that it supports. China s own success following an infrastructure-led growth trajectory has inspired many governments in developing countries to pursue similar models. Furthermore, as numerous studies on infrastructure gaps attest, financing for infrastructure is scarce, making China s provision of infrastructure-focused development finance particularly attractive. 31 Economics 70(2): , Dreher, A. (2004). "A public choice perspective of IMF and World Bank lending and conditionality." Public Choice 119(3/4): , Kilby, C. (2009). "The political economy of conditionality: An empirical analysis of World Bank loan disbursements." Journal of Development Economics 89(1): Mawdsley, E. (2012). From recipients to donors: emerging powers and the changing development landscape. London ; New York, Zed Books. The fact that Chinese development assistance is not conditioned on political institutions has led to the critique of Chinese finance as rogue aid. See Naím, M. (2007). Rogue Aid. Foreign Policy. 29 Some emerging work also suggests that recipient governments may become less compliant with World Bank conditionality as they gain access to new sources of financing. See Watkins, J. M. (2017). Undermining Conditionality? Effect of Chinese Development Assistance on Compliance with Western Aid Conditionality. 30 Interview, Senior National Treasury Official, Nairobi, Kenya. January 25, African Development Bank (2010). Infrastructure Deficit and Opportunities in Africa, Serebrisky, T., A. Suárez-Alemán, D. Margot and M. C. Ramirez (2015). Financing Infrastructure in Latin America and 13

14 Recipient preference for large, infrastructure-focused development finance thus also reflects, for some countries, an interest in a certain kind of development model. While recipients tend, on average, to prefer development finance that supports large-scale infrastructure investments, it may not be the case that developing countries wish all of their development finance to be of this type. In fact, it is conceivable that the optimum outcome for recipient countries is a specialization among donors with respect to the types of development interventions the support, with traditional donors supporting projects in social sectors, including health, education and governance, and infrastructure projects financed with Chinese support. Thus, when it comes to the type of development interventions supported, recipient preferences are more complex than with conditionality. While recipient governments have a linear utility function over the extent of conditionality of development finance fewer conditions are always preferred to more recipient governments may have more complicated preferences as to the type of development interventions that are supported. Larger and infrastructure-focused projects are preferred, but not all development interventions need be of this type. Knowing this, there are two possible approaches that traditional donors can take when confronted with the competition of Chinese development finance: they can emulate the Chinese approach to development finance and offer the same type of development projects to retain their attractiveness to recipients and thus access to the government, or they can choose to differentiate themselves by specializing in a complementary niche with their development projects, hoping that this is sufficient to retain their share of the recipient s external finance. Incentives to emulate Though it is a simplification, it is analytically helpful to think of the World Bank s incentives in responding to China s growing role as analogous to a firm facing a new market entrant. In order to retain market share (which, as discussed above, refers here to the portion of a recipient s external finance that a donor provides and thus the access the donor gains to the recipient government), the existing firm can endeavor to outcompete the new entrant by offering a more desirable version of the same product. Alternatively, it can choose to distinguish itself from the competitor by establishing a distinctive market niche for itself. There are a number of reasons the World Bank may choose to emulate the approach of Chinese development finance. First, it may be the most direct means to ensure it remains attractive to developing countries that are signaling their preferences by taking up increasing amounts of Chinese finance. Second, the World Bank may be well placed among traditional donors to respond by emulating the Chinese approach. At the same time as China s role as a provider of development finance has been increasing, many traditional donor countries have reduced their aid budgets and required their development agencies to specialize to achieve the development impact with fewer resources. 32 Though the World Bank is not immune the Caribbean: How, How much and by Whom, McKinsey Global Institute (2016). Bridging Global Infrastructure Gaps. 32 Gulrajani, N. (2015). "Dilemmas in Donor Design: Organisational Reform and the Future of Foreign Aid Agencies." Public Administration and Development 35(2):

15 to reductions in aid budgets and donor fatigue since it relies on contributions from shareholders for its concessional financing, it has a larger pool of resources from which to draw, and its IBRD borrowing window is able to rely on funds raised in international capital markets for its financing operations. Third, there has been an increasing emphasis in development on policy circles on the important of financing for infrastructure investment and economic transformation, in part driven by the example of China s development experience. 33 This shift in policy thinking, including within the World Bank, may provide a technical justification for increasing such financing in response to competitive pressure. Indeed, interviews with representatives of recipient governments indicated that several observed or anticipated precisely such a convergence, with traditional donors emulating Chinese development finance in order to remain competitive. Incentives to differentiate Yet, there are also a number of reasons the World Bank may prefer to respond to the competitive threat of Chinese financing by instead specializing in sectors that are distinct from the Chinese approach. First, emulating China s approach to development projects may not always be possible with the resources available to the Bank. As one donor representative in Nairobi noted, referring to the large railway project that China had recently funding in Kenya: unless you re bringing in $4 billion for the SGR [standard gauge railway], there s no competing [with China]. 34 Without the resources to offer the same type of projects, a better strategy may be to specialize. Second, the World Bank has developed a comparative advantage relative to China in less resource-intensive policy advice and development projects targeted at softer sectors. Since at least the mid-1990s when James Wolfensohn defined the identity of the Bank as the Knowledge Bank, the World Bank has seen its value for recipient countries in the technical expertise it offers. 35 Therefore, smaller projects focused on advisory services and social sectors may be exactly where the World Bank has the potential to outcompete China, offering recipient countries a development service they cannot fund with China and thereby ensuring their continued access to recipient governments. Given both of these conceivable sets of incentives, to emulate and to differentiate, it is not self-evident which strategy the World Bank will adopt in response to China s growing role in development finance. The tests below are therefore intended to establish which is occurring in practice. Heterogeneity across recipients As an extension to this argument, I consider in which countries such competition is most likely to have an impact on World Bank behavior. If the underlying driver of traditional donor behavior in response to Chinese development finance is a concern about lost influence with recipient governments, then such 33 UNCTAD (2014). The LDC Report Growth with structural transformation: A post-2015 development agenda, Lin, J. Y. and Y. Wang (2017). Going beyond aid : development cooperation for structural transformation. Cambridge, Cambridge University Press. 34 Interview, Donor Representative, African Development Bank. Nairobi, Kenya. February 2, Kramarz, T. and B. Momani (2013). "The World Bank as Knowledge Bank: Analyzing the Limits of a Legitimate Global Knowledge Actor." Review of Policy Research 30(4):

16 concerns are unlikely to be constant across recipient countries; influence is more prized in some countries than in others. I suggest that competition among donors is likely to be more pronounced in recipient countries that are considered strategically important by donors, especially for security reasons. Furthermore, if the change in traditional donor behavior arises out of recipient bargaining, i.e. out of the ability of recipient governments to leverage their access to alternative financing sources to reach preferred outcomes in negotiation with traditional donors, then recipient negotiating ability ought to mediate the effect of new donor aid on traditional donor behavior. Turning first to variation in donor competition by the strategic significance of recipients, there is a considerable literature demonstrating that recipients that are in some way important to donors receive favorable treatment. For example, Vreeland and Dreher (2014) show that the IMF and World Bank behavior are responsive to countries temporary presence on the UN Security Council, offering favorable treatment in response to influential shareholder pressure. Kilby (2009) demonstrates that macroeconomic conditions are less important for disbursement of World Bank loans in countries that are politically aligned with the United States. Strategic significance also increases the likelihood of competition among donors, since the motivation to gain access to recipient governments is greater in such countries. Barthel, Neumayer et al. (2014) and Fuchs, Nunnenkamp et al. (2015) find that the effects of competition among donors are more acute in countries that are important export markets, with Fuchs et al. also finding an effect of political competition on donor behavior. These different types of recipient significance thus condition donor reactions to each other even among fellow members of the OECD DAC, who are likely to see each other as less of a competitive threat than they regard China, a rising power that is not a member of this international aid coordinating body. I expect that a recipient country s strategic significance to shape the extent to which Chinese finance is seen as a competitive threat. The role of recipient governments themselves in any potential competition among new and traditional donors is not clear from the existing literature. Anecdotally, there is a sense that some governments are doing more to play different donors off each other, or may be doing so more skillfully and successfully. 36 I suggest that the degree to which a government has consolidated its political authority domestically is likely to be influential in its ability to leverage the outside option of new donors to secure preferred outcomes from traditional donors. Governments that face considerable opposition are hampered in their ability to use donor competition to reach preferred outcomes with donors. First, the opposition is likely to politicize engagement with donors and the regime must therefore be careful about how much they publicize their choices across donors. For example, in Ghana, opposition critique about close relations between the government and China in light of alleged widespread Chinese participation in illegal gold mining was an important factor in the Ghanaian government s decision to reduce its reliance on Chinese aid. In Zambia, ties between the MMD regime and 36 For example, the African Center for Economic Transformation s report on Resource Mobilization and Management highlights that Rwanda has been particularly successful in managing its donor relations to secure preferred outcomes. 16

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18 from China to a given country in a given year. 40 In all models, I lag Chinese financing commitments by one year to account for the delay in World Bank behavior responding to knowledge of Chinese financing commitments. I use two dependent variables to measure the size and focus of World Bank projects. The first of these, project size, measures the dollar amount committed per World Bank project on average in a given country in a given year (logged). It captures whether the size of World Bank projects is changing in response to new donor commitments. The second dependent variable measures the share of World Bank projects in a given year that in hard sectors, i.e. infrastructure-intensive sectors. The World Bank classifies its lending operations into eleven sectors, three of which include are more infrastructure-intensive: energy and extractives, industry, trade and services, and transport. I identify what share of projects in a given country in a given year had at least one of these three sectors listed as a major sector. 41 To investigate the extensions on the variation in competitive effects by country type, I use two indicators. The first measures whether a country is considered strategically significant to donors. I use US military aid as a proxy, drawing on data from the Security Assistance Monitor, which publishes military assistance provided by the US annually. 42 I classify countries as strategically significant if in a given year they receive above the mean amount of US military aid for the whole sample. 43 Several studies have used US military aid, or occasionally all US aid, as a proxy for a country s strategic relevance. 44 Allocations of military aid reflect the US strategic prioritization of countries, and those countries on whose behalf the US is likely advocate at the World Bank. Secondly, as a measure for whether traditional donor response is affected by the extent of a government s domestic political strength, I use a common measure of electoral competitiveness, namely the margin between the first and second largest party in the last legislative election. Countries are classified as having governments with high political consolidation if the winning party s margin of victory in the most recent election was higher than the average for the whole sample. 45 This measure helps me to get at the likely political security of the ruling government, and therefore the demand for aid resources for redistribution. The data is taken from Version 6 of the V-Dem dataset Dreher, A., A. Fuchs, B. Parks, A. M. Strange and M. J. Tierney (2017). Aid, China, and Growth: Evidence from a New Global Development FInance Dataset. AidData Working Paper. 41 The eleven categories are: 1. Agriculture, 2. Education, 3. Energy and Extractives, 4. Financial Sector, 5. Health, 6. Industry and Trade/Services, 7. Information and Communications, 8. Public Administration, 9. Social Protection, 10. Transportation, 11. Water, Sanitation and Waste. These categories were last confirmed in 2016, but have been retroactively applied in the World Bank s database to most projects from the 1990s onwards. 42 The Security Assistance Monitor aggregates data from various sources on US military aid, including the Congressional Budget Justification on Foreign Operations for State Department-funded programs and the Section 1209 report for Defense Department-funded programs. 43 The mean of US military assistance per year for countries in the sample is $128 million. 44 Including the following: Stone, R. W. (2004). "The Political Economy of IMF Lending in Africa." American Political Science Review 98(4): , Scott, J. M. and C. A. Steele (2011). "Sponsoring Democracy: The United States and Democracy Aid to the Developing World, " International Studies Quarterly 55(1): 47-69, Bermeo, S. B. (2015). "Aid Is Not Oil: Donor Utility, Heterogeneous Aid, and the Aid-Democratization Relationship." International Organization 70(01): The average margin of legislative victory in the sample is 20.15%

19 I include a number of controls that are standard in models of World Bank lending. I begin with a model using the same specification as Dreher et al. (2009), including controls for external debt (in percent of GDP), investment (in percent of GDP), GDP per capita (logged), population (logged), as well as whether a country has a temporary seat on the UN Security Council, an active IMF program, and has held an election in the previous year. I estimate a series of OLS regressions, with country- and year-fixed effects included in some models. Standard errors are clustered by recipient country. In addition, to account for potential endogeneity in the relationship between Chinese financing and World Bank projects I report models in which I adopt an instrumental variable approach that has been applied in other studies of aid, and Chinese finance in particular. 47 I instrument for Chinese finance with the interaction of Chinese steel production (logged, and lagged three years), which varies over time, and a country s probability of receiving Chinese finance, calculated as the share of years in the sample ( ) in which a country receives Chinese financing, which varies across countries. The interaction of the two thus yields an instrument that varies over time and across countries. Since the probability of receiving Chinese aid is likely to have a direct effect on World Bank projects that does not operate through Chinese financing, I include country- and year-fixed effects in model where Chinese finance is instrumented to account for the independent effect of the probability of receiving Chinese financing and steel production. 5. Results Table 1 shows the relationship between Chinese finance and the average size of World Bank projects. The results point to the World Bank adopting a strategy of differentiation in response to competitive pressure from China. Across almost all model specifications, there is a statistically significant negative association between Chinese financing commitments and the size of World Bank projects in the subsequent year. In column 1 I report the results of the full model, including all controls from Dreher et al. s (2009) model of World Bank lending. In subsequent models I include only the statistically significant controls for population size and whether a country has a current IMF program, adding country-fixed effects in column 3 and both country- and year-fixed effects in column 4. Column 5 shows the results when instrumenting for Chinese finance using the interaction of Chinese steel production and a country s probability of receiving Chinese finance. The negative and significant relationship between Chinese financing commitments and the average size of World Bank projects holds across the fixed effects estimations, though not in the final model in which Chinese finance is instrumented. Since both the Chinese finance and the size of World Bank projects have been log transformed, the effect can be interpreted as a percentage-on-percentage change. In the most robust specification, with both country- and year-fixed effects, a 10% 47 Nunn, N. and N. Qian (2014). "US Food Aid and Civil Conflict." American Economic Review 104(6): , Ahmed, F. Z. (2016). "Does Foreign Aid Harm Political Rights? Evidence from US Aid." Quarterly Journal of Political Science 11(2): , Dreher, A., A. Fuchs, B. Parks, A. M. Strange and M. J. Tierney (2017). Aid, China, and Growth: Evidence from a New Global Development FInance Dataset. AidData Working Paper, Dreher, A. and S. Langlotz (2017). Aid and Growth: New evidence using an excludable instrument. Heidelberg University Discussion Paper. 19

20 increase in Chinese financing commitments is associated with a 3.4% decrease in the average size of World Bank projects. Though this is a only a moderately sized effect, it indicates the World Bank is choosing to fund fewer large projects when China becomes a more significant source of development finance. I next investigate the relationship between Chinese financing commitments and the share of World Bank projects in hard sectors. Table 2 reports these results. I find no evidence of a statistically significant relationship between Chinese financing and the sectoral allocation of World Bank projects in any of the specifications.. While not all large projects are infrastructure projects, almost all infrastructure projects are large. Therefore, if the sectoral allocation of projects remains the same while the size of projects decreases, this suggests the World Bank may be shifting into less expensive advisory projects in the same sectors. This could be a means of shoring up governance structures and social and environmental safeguards in infrastructureintensive sectors precisely as China becomes a bigger source of finance in these sectors, and is reputed to undermined environmental and social standards in these sectors. However, it is also possible that the measure of hard sector allocations is not sufficiently precise to capture a relationship. In the World Bank s records, a project can be associated with a number of sectors, and it is not possible to identify which is the main sector focus of a project. It is possible that the indicator is not fully capturing movements in sectoral allocation due to noise from projects being assigned to multiple sectors. In Tables 3 and 4 I report results associated with the expectation that Chinese financing has a stronger effect on World Bank behavior in some countries than others. Overall, I find little evidence that the effect of Chinese finance on World Bank behavior is stronger in strategically significant countries or countries where governments have a high degree of political security. Table 3 shows the results for the size of World Bank projects, with interaction terms for countries strategic significance and their political consolidation. I find no evidence that the World Bank s response to Chinese financing is more pronounced in countries that are strategically significant. Columns 1-3 show that the interaction effect of Chinese financing commitments and strategic significance is not statistically significant across different specifications. However, strategic significance on its own does have a positive and significant effect on the size of World Bank projects: countries that are strategically significant receive larger World Bank projects, all else equal. Turning to political consolidation, the effect of Chinese financing commitments on the size of World Bank projects does appear to be moderated by the degree of political consolidation of the governing regime, increasing the negative effect of Chinese finance on World Bank project size. In column 6, with country- and year-fixed effects included, the interaction between Chinese finance and political consolidation is negative and statistically significant. This implies that Chinese financing commitments lead to smaller World Bank projects in countries with highly politically secure governments. Figure 5 below shows the marginal effects of Chinese finance by low and high political consolidation Though the confidence intervals for point estimates for high and low political consolidation overlap, and the point estimates are thus not statistically significant, the difference between the slopes is statistically significant. 20