Event Transcript (full): Multilateral Development Banks ... · 9/30/2015  · the world’s needs are, but also the role of multilateral development banks in meeting those needs.

Unedited Event Transcript

Multilateral Development Banks and Asian Investment: Room for More?

Peterson Institute for International Economics, Washington, DC September 30, 2015

Adam Posen: Good morning everyone. Welcome back to the Peterson Institute for

International Economics and welcome to all our friends watching the webcast live. I am Adam Posen, President of the Peterson Institute. It’s my great pleasure to be bringing you here for this joint event we do with Moody’s on sovereign debt issues and related concepts.

We’ve had a series of rich discussions in today’s multilateral development banks and particularly the need for them and for infrastructure, spending in Asia I think is particularly topical for a variety of perspectives. Very grateful to have this partnership with Moody’s on substance. Anne Van Praagh, who’s my main partner in this, and all our colleagues were delighted to move that forward, but I also want to recognize my friend Domenico Lombardi and our colleagues from Centre for International Governance Innovation.

We do a number of partnerships with them, including on central banking and governance issues and Anne and I felt that on this occasion, it was great to broaden out our audience to bring in the CIGI network and some of the CIGI scholarship. So, we are reaching out to our core economists, to Moody’s market people to CIGI’s international governance and NGO community, all of which, of course, overlap, but which, I hope, will provide us with a very fruitful discussion today.

I look forward in particular at lunch to having my dear colleague and noted independent thinker Simon Johnson give us a keynote on the rules for the international economy in the 21st century, but we’re also featuring a very important new study from Moody’s from Steve Hess, basically where do MDBs spend their money. And, I think, that this is a key place for us to take off from. And, again, I’m glad we’re able to bring together multiple perspectives on these critical issues. I will turn it over to Anne in a moment.

First, I just want to make two announcements. First is just to say we traditionally do this and we also do activities with CIGI around the IMF

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World Bank meeting. This year they decided to take the IMF World Bank meetings on the road. That’s their problem, not ours. But we are going ahead and, in addition to this event, tomorrow will be our semiannual global economic prospects meeting led by David Stockton on the US and the global policy outlook featuring Nicholas Lardy, who, of course has an independent—and not to be contrarian for contrarian’s sake but at this point, contrarian to the panic view on China, as well as some issues of long-term fiscal and income developed by our new fellow, Paolo Mauro and these are things that I think will be in dialogue with Moody’s and others in the time to come.

Second announcement is just to say that we are in the midst of a very busy season here. There’s a lot of intention on think tanks and their behavior. We are very proud of our supporters and our partners, but we are also so proud of them we disclose everything. If anybody would like to know where our funding comes from or how we decide and how we quality control our publications, I refer you to www.piie.com and it’s all there. Just because of some reports in the press, I thought I’d remind people about that. But I hope it goes without saying. Anyway, not about us, by the way, just to be clear.

If I could just for a moment ask Domenico Lombardi from CIGI, who leads our Global Economy program to say a few words and then, turn it over to Anne to lead the first panel.

Domenico Lombardi: Thank you, Adam, for your kind words. I just want to reiterate that we at CIGI are very happy about our work partnership with the Peterson Institute and we are delighted to partner today with Moody’s Investors Service.

Just as a way of introduction, I would like to make just four quick points in terms of the issues that we are going to discuss today and issues that we closely follow at CIGI, the Centre for International Governance Innovation.

So, when we talk about Asian investment especially investment in infrastructure, essentially we talk about four fundamental things. The first is how to create better regional markets and how to integrate these better regional markets in Asia with the rest of the world economy. But this is an endogenous regional dynamic that we have seen at play in other regions as well.

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However, when we talk about Asian investment, we also talk about the size. And you might recall a study by the Asian Development Bank a few years ago, they were essentially estimating the need for Asian infrastructures in this decade at some 8 trillion essentially a little bit short than 1 trillion a year.

This compares and contrasts with the investments that so far have been put forward by, you know, the Bretton Woods institutions, the multilateral development banks and in fact, we are going to talk about these issues at length today. But this also speculatively also reflects, you know, huge opportunities for investors and these however, will also depend on how open the initiatives, the regional initiatives that are currently shaping up in Asia will be. And I think this is also one of the reasons why we are here today. So, I am looking forward to a very rich discussion and thanks Adam for setting this up.

Anne Van Praagh: Great. Thank you everybody and thanks to Adam and the Peterson Institute for hosting what I hope will be a very interesting and engaging event. I’d like to acknowledge my colleagues from Moody’s that are here today. Steve Hess will be presenting later today and we have Matt Kulakovskyi, who’s the contributor to the report. And hopefully, we’ll have an interesting dialogue as the day goes along.

I think that this particular topic is very interesting for a couple of reasons. So we know that the number of world leaders met this week. They have adopted what is a sustainable development agenda for 2030, outlined a plan for meeting basically society’s needs and the planet’s needs over the next decade and a half. This is a pretty groundbreaking culmination of what has been a two-year process and I think that outlines not only what the world’s needs are, but also the role of multilateral development banks in meeting those needs.

So, it is a very interesting topic. It’s one that we’re very focused on at Moody’s. We have about 35 ratings on MDBs and we’re going to tell you a little bit more about those, the characteristics of those multilateral development banks and some interesting findings that we’ve been looking at.

It’s also an interesting topic now. It’s interesting now because China. China is at a pivotal moment. It is growing slower than people expected. There are questions about this stop-go nature of its rebalancing effort. How successful will it be in managing this transition from what was a very

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government-led, heavy investment led growth paradigm to a rebalanced economy, more consumption driven and at what pace that will happen, how well managed that will be?

That’s very much a focus from our perspective from a sovereign credit risk perspective. I manage the sovereign ratings team and the supranational team at Moody’s covering the Americas, the Middle East and Asia. So, China is very much on the minds of us, many of us at Moody’s these days. You put these two things together, MDBs and China and I think you have a very interesting set of topics and that’s really the basis for our discussion today.

So, our first panel, I’ll introduce our speakers in a minute here. We are going to take a slightly different format. We’re going to take a fireside chat format. So, we’re going to have some brief introductory comments with some slides and some moderated O&A and we’ll use some of our visuals to help us along the way.

But, let me introduce my co-panelists here. We have Andrew Davison. Andrew is a Senior Vice President with Moody’s. He is in the infrastructure finance team based in London and Andrew brings, in addition to his infrastructure finance experience at Moody’s, he’s also been leader ranger and financial advisor in infrastructure financing, including project finance for many years. So welcome, Andrew.

Andrew Davison: Thank you.

Anna Van Praagh: We have Simeon Djankov. Simeon, as many of you know, was the Deputy Prime Minister as well as the Finance Minister of Bulgaria from 2009 to 2013, very pleased to have Simeon here. Simeon was one of the early thinkers on the One Belt, One Road initiative, the Silk Road initiative. That’s going to be a subject of our panel today. Simeon, some of you know also from the World Bank his role as an economist there so very pleased to have these impressive speakers with us today.

I thought I would start just by framing the issues for us a little bit and we have some prepared slides. I think it’s not a surprise to anyone in this room. You’ve heard the estimates around the infrastructure finance needs are globally. 60 trillion is the number that people have talked about. The

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McKinsey study showed 60 trillion by 2030. These are big numbers. No matter how you define it, no matter how you measure it, it’s big numbers and the large and growing requirement for infrastructure investment is very much high on the agenda of policymakers across the globe and the rationale is compelling. Advanced economies have big infrastructure needs. Anyone who’s been through New York recently knows the aging infrastructure issues that we face.

And at the same time, we have very low borrowing costs across many developed economies at this point, which should make infrastructure investment attractive. Emerging markets and frontier markets will benefit from infrastructure investment to address infrastructure bottlenecks.

So, it’s clear to us that there is a strong rationale at this point to use infrastructure to help alleviate some of the growth constraints that we’re facing around the world. As the chart shows, the quality of overall infrastructure is lower for low, middle-income countries. Those are the green dots. And the scale of infrastructure is vast.

So, if you think about 60 trillion, you know, how do you carve that up? Well, I think one interesting and large piece of that that we’ll be focused on for quite some time to come is the One Belt, One Road initiative. This is an ambitious, intraregional plan. It involves potentially more than 40 countries in Central and South Asia, the Middle East, Eastern and Western Europe. And the idea is to create an unbroken transport and infrastructure network. It’s made up of the Silk Road Economic Belt cross Western and Central Asia and the 21st century Maritime Silk Road. And one interesting statistic that Andrew always likes to remind me of is that this is an initiative that affects two-thirds of the world’s population and basically one-third of GDP. So, it is vast in scale.

The plan is designed to enhance China’s trade and financial linkages. China will gain from greater energy import diversification. Energy supplies from Russia, Central Asia will be developed as alternatives to their traditional Middle East and African suppliers. Regional integration will also create demand for Chinese capital and consumer goods exports as well as services at a time when demand from traditional markets, such as Europe and the US, remains historically weak. You see the blue line there. Those are the 40 One Belt, One Road countries that I mentioned earlier and that the growth trajectory there of Chinese exports by destination is impressive particularly relative to the US and the European Union.

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So from a sovereign credit perspective, we see the One Belt, One Road as credit positive for most sovereigns who will be beneficiaries of funding coming from this initiative. More than two-thirds of the countries that fall under the One Belt, One Road initiative are either unrated or they’re rated below investment grade. That’s probably a familiar group of countries to many of you who work at multilateral development banks and you know the challenges associated with bringing to bear projects and project finance and infrastructure finance to these areas.

But we do see that enhanced trade and investment will ease downside pressures on GDP growth so that we think the net credit impact will be positive. You can see in the pie chart on the left the grey slice and the blue slice. Those are the ratings that we consider, that we call below investment grade. And the One Belt, One Road countries, the 40 that I mentioned, are shown in the orange bar. And we’re forecasting that growth will be slower for those countries, but the average forecast for 2015 to 2019 among those 40 countries is quite high, among the highest in the world so some pretty interesting opportunities for those countries.

We do see South and Southeast Asia likely to benefit most from infrastructure investment. There is the potential to really transform the economies in these countries spurring investment and growth, especially for the smaller and poorer countries – Bangladesh, Cambodia, Pakistan, Vietnam. We think these are likely to be the biggest beneficiaries. A number of these countries have projects already under way with the One Belt, One Road initiative and Simeon’s going to address some of that in a little bit.

The other way that we think about the One Belt, One Road is how is this likely to affect sovereign debt profiles? We do see that loans extended by China, either on a concessional or on commercial basis will raise government debt burdens. We know that the Asian Infrastructure Investment Bank and the Silk Road fund will boost China’s importance as a source of external finance. China is already a very important source of finance for many countries. Commercial borrowing may raise budgetary pressures with countries that have weak fiscal policy. And government debt burdens, which are currently moderate but depend on foreign financing, will be a little bit more exposed in that respect.

So, one last comment from me before we move to our Q&A session here is that one interesting observation that we’re going to talk about later in

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our MDB discussion is that there is greater financing required for lower rated sovereigns.

Lower rated sovereigns typically rely more on foreign financing and there is a strong correlation between sovereign ratings and current account balances. So an interesting trend to watch will be to what extent the One Belt, One Road strategy initiative projects will affect the balance of funding sources for particularly the lower rated countries that are typically more vulnerable to periods like we’re in now where you have more volatile capital flows.

So with that as an introduction, I thought it would be interesting to turn to Simeon for a few comments about his involvement in the One Belt, One Road strategy. As finance minister, you were in some of these meetings with other government officials, conceiving this plan and I thought the audience would be interested in your personal experience.

Simeon Djankov: Thank you. In preparing for this panel we had several conversations by phone and actually, something I had forgotten as experience from my time in the Bulgarian government when I was, as I mentioned deputy prime minister and finance minister came up which actually is quite relevant for today’s discussion.

Late, I think it was October 2011, in the midst of the Eurozone crisis where most finance ministers were dealing not with their countries, but with Greece, I get a call from my prime minister and he says, “What you are doing?” You have two choices. To say nothing which means he’s going to give you more work or to say I’m extremely busy which is the right response. So, I say extremely busy. He says, “You immediately get on to a plane and go to Warsaw.” “Why?” “Tusk called—the prime minister then, Donald Tusk called—and he’s calling an extraordinary meeting of all heads of governments of Central and Eastern Europe, but I cannot go so, you’re going today, immediately.”

So, with this I go and I call him from the airport and say, “Well, what’s the meeting about?” And he said, “I didn’t understand. So, they were in a hurry, but they’ll brief you I’m sure when you land.” So, literally from my ministry I get on the plane, get there. And when you land you ask, “What is this about?” And the ministry officials meeting say “Well, frankly we don’t know either, but I’m sure by the evening you’d be briefed.” In the evening indeed we learned that the Chinese premier has come with a large

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delegation after being in some of Western European countries and has asked Donald Tusk to organize this extraordinary meeting. And it was extraordinary in the sense that it happened for the next day.

The next morning we meet and indeed, I think about 22 heads of governments from Central and Eastern Europe, including some of the caucuses like Georgia and Armenia were there. Expecting what the topic is going to be, we’re not really announced the topic other than the Chinese premier is there with a large delegation. And we learned this is the first time when I learned the term the New Belt Road.

The comment was that the Chinese government with some academics has been preparing for a year; it was said at the time. So 2010 was the genesis, this idea as a way to bring different countries economically together. So, this picture that I’m just showed was the first time shown there from Sri Lanka, Pakistan, all the way to Germany and create this New Silk Road and that they are very interested to have an annual event with the heads of states of Eastern and Central Europe basically to see how this will progress over time.

Naturally, there are lots of questions, but nobody was allowed to ask questions at this first meeting. Like, one question, Poland was not really part of the original Silk Road, but yet we are meeting in Poland. But the more interesting part of the meeting is that in the afternoon we’re again at lunch told every one of you has 45 minutes with the Chinese premier to talk specifically about his country’s plans on the new Silk Road. Imagine, we’ve just heard of this initiative, 45 minutes, one-on-one with the Chinese premier. And indeed one-by-one we went and talked about our own country’s perspective on this possible at the time initiative. None of what we know today was known then and the conversation, at least in my case, was, well, my first question which, I think, is a natural question is why is China interested in some of these countries?

Bulgaria is a mid-sized country in Europe, but frankly, a relatively small country, 7.5 million population. Some of our neighbors are you know, less than a million people. So, it’s not like large, large investment projects can happen there. So, I ask this question to the Chinese premier. Why are you interested in this region? And he said, basically we want to know more about these countries. We don’t know much, we haven’t been investors in the past, not just in infrastructure because the conversation from the very beginning was infrastructure. Hopefully later we’ll talk about the fact that at least the investment that is so far happening are not only in

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infrastructure, they are broader on that. But, he said we want to know about this region more so that economically we can develop in the future.

And in closing, just one point I want to make, so they want to know more. I thought about it then and I think increasingly about it now. At the time, Chinese companies were trying to penetrate the infrastructure market, particularly in the new EU countries, like Bulgaria, Romania, Poland and so on and they were quite unsuccessful. So, there were many projects funded by Brussels mostly. So, money was not an issue, but you’d see Chinese companies applying for such projects, having the lowest prices, but somehow objectively or subjectively, we can discuss this more, they were consistently rejected for quality reasons, for other reasons.

So, there was one, as of 2011, there was one project, one large infrastructure project in all of eastern Europe and this happened to be in Poland. So, I think that was perhaps why Donald Tusk was the host of this meeting. They had not penetrated any of the other countries. So perhaps in closing, the rationale for this initial meeting, and it has happened since, I have been to two other meetings, 2012, 2013, like that was to indeed see whether there is some room for investment opportunities for Chinese companies in the region. As we’ve learned, it’s not just investment. They since have invested in some other projects as well.

Anne Van Praagh: Yeah. So, Simeon, give us a little bit of a sit rep on what’s happened since those early days. What projects have been done, which ones are ripe for being done now?

Simeon Djankov: So, since then as I mentioned, every year there has been this annual meeting. It’s hosted in different countries. It was in Romania, in the Czech Republic, in Serbia this year and all the heads of state by now are visiting and are showing a number of projects. So, there is certainly a lot of interest in our region, in how to work with the New Silk Road initiative.

Initially, a big road block was that in order to invest in such projects, the various Chinese institutions involved were asking essentially for sovereign guarantees, but those who have done public finances know that with sovereign guarantees you’re basically increasing your [inaudible 00:24:40] debt level, but important at this time in Europe also your deficit.

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So, from the very beginning 2011/2012, we started having a discussion can this be done on a project finance basis, something that perhaps Andrew will tell us about. Otherwise, as long as it is sovereign guarantees, the majority of countries would not be that interested and the countries that would be interested as Anne mentioned, are countries that are lower ranked, have lower ratings and as a result, this is a way for them essentially to get to the international markets.

So, if you look where projects now either completed or near completion, in Eastern Europe we have Serbia having basically a completed project which is a bridge over the Danube. Macedonia having a nearly completed project which is basically an extension of an idea to go from Budapest in Hungary through Serbia from Macedonia to the Greek ports and in this way basically have a transport corridor of cargo trade coming not just from China, but primarily from China and getting to the heart of Europe so several countries.

Hungary has announced that they have just signed a contract for their part of this transport corridor, but Serbia, Macedonia, there is a project that is signed in Montenegro. So, basically the smaller former Yugoslav countries have some projects.

One rationale as I have mentioned is that they have lower credit rating. So, this is a way for them to get cheaper financing and importantly by now, no sovereign guarantees. Another rationale which I think later in the discussion would come up is that individually these countries are quite small and their infrastructure projects also are quite small.

But if you combine them, something that frankly other international institutions have not been good at—I was for many, many years at the World Bank as you mentioned. We’ve tried many times to do cross country projects and it doesn’t quite work in the World Bank framework while the New Silk Road initiative is very good at that. So several countries basically line up, present together a project like the Budapest to Athens transport corridor and this happens.

There is a project signed by Russia—we’ll talk about Russia later—hopefully on an another part of type of rail project that basically connects Moscow to Kazan which is a city in the south and from there it would go to another section which is already built in Kazakhstan that connects Kazakhstan to the Russian border. So, this is another part of the new Silk Road to get from China towards Russia and then from there to Germany.

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And then there are some projects, maybe Andrew will mention that are done in Sri Lanka, that are done in Pakistan, but here and there we already have infrastructure projects. I’ll finish with this.

In the case of Russia at least, I know of projects that have nothing to do with infrastructure. Well, we can argue that everything is infrastructure, but as part of the New Silk Road initiative, for example a Russian state-owned company has gotten about $2, $2.5 billion equivalent for nanotechnology projects.

So, in closing, I’d like to say that in my view, the new Silk Road will be mostly on infrastructure, but over time, it would expand to some related industries depending not just on economic rationale, but I would say also on political rationale.

Anne Van Praagh: Great. Thanks. Okay. We’re going to shift gears a little bit. We’re going to take a look at where this funding is going to come from. And with that, I’m going to ask Andrew to give us his thoughts on exactly how this new infrastructure is contemplated, how is it going to be funded?

Andrew Davison: Anne, thank you, and pleasure to be here everybody. So, we heard from the introductory comments that the size of investment required is significant. Recently with specific reference, the One Belt, One Road initiative however, the China Development Bank has pointed out that over $1 trillion of projects are currently under development associated with the One Belt, One Road initiative.

Now, when we compare that with the available resources by the time you look at the aggregate assets, the aggregate debt which is outstanding from multilaterals—my collage Steve Hess will comment on this later—but essentially we’re talking about a similar order of magnitude, $1 trillion plus of outstanding debt from all multilaterals today.

Yes, the Asian Infrastructure Investment Bank and policy banks will contribute significant funding resources, the Silk Road fund, a state-owned development fund seated with $40 billion, but these contributions really just start to scratch the surface and some of the themes that we’d like to develop in this panel are the need to catalyze and mobilize private sector

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finance to be able to deliver these very significant quantities of infrastructure assets. That’s the very simplistic answer.

However, in the infrastructure sector as ever, the issues are a little bit more complex and in fact, Simeon touched on some of these issues. What is infrastructure? What isn’t infrastructure? We might conceptualize core infrastructure. For example, roads, yes, Bridges, yes. Power transmission, power distribution, clean water, waste water, airports, sea ports. Okay, core infrastructure.

What about motorway service stations? What about shopping facilities in airports? What about the nanotechnology facilities which are related and which have or carry industrial growth potential. Now in our view, these are not core infrastructure, but some investors might look at those characteristics and say, okay, there is still resilience in revenue streams associated with these investments.

So, from a Moody’s perspective, when we look at this universe of infrastructure, what we’re looking at, in fact, within that infrastructure word it carries the connotation discrete subsectors with homogenous risk characteristics, but the uniting characteristic of infrastructure is a fundamental need or service which those assets are providing to society which then creates a resilient or inelastic revenue stream. And it is that characteristic which turns an asset into infrastructure as opposed to something else.

So, to come back to some of the other themes then well, how these infrastructure assets within the One Belt, One Road space are going to be delivered? Well, actually it gets more complex yet. There are different procurement approaches. Is it going to be procured by the public sector entity or a private sector entity and for what reason? Are those reasons commercial drivers, public policy drivers? What’s the business model going to be of that infrastructure service provider? And once you’ve got that business model established, what’s the funding strategy? And there are a range of different funding financial models. So, the picture becomes more nuanced, more complex.

Trying to keep it simple, there are two sources of funds. Either user pay or public sector resources contribute. And the user pay element is illustrated by the willingness of users. For example, to pay money to cross an estuarial crossing, a new bridge between two centers of population, the

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value of which is an economic saving in time and cost to move from A to B direct over that bridge as opposed to circumnavigate the estuary.

And that illustrates real value that infrastructure can provide to users, but contrast that with a social accommodation facility, might be a hospital. Would users be willing to pay for that facility and where markets have been established, typically transportation, the answer is often yes. Where markets are unlikely to be established in the public sector, for example, social accommodation, the answer is likely to be no.

So, coming back to these procurement approaches, you know, we identify within the infrastructure sector procurement directly by the sovereign, by sub-sovereign entities or indeed guarantees which allow those assets to be procured. That’s a key and very important source of procurement particularly important in the One Belt, One Road context. More generally, particularly in the developed markets, regulated utilities or businesses will also develop an infrastructure to meet their regulatory requirements.

Within the US, we’ve seen the advent of P3s, public-private partnerships more generally and a growing global sector of asset procurements. But those public-private partnerships are associated with concession or single asset project facilities. And then we can add a fourth type of procurement associated with businesses competing in open markets particularly in developed countries, perhaps less relevant to developing and emerging countries along the One Belt, One Route.

Moody’s rates some $3.3 trillion worth of debt obligations in the infrastructure space. We segment that conceptually between utilities, infrastructure corporate, so the roads, the airports, the sea ports entities. And then, project finance special purpose vehicles to which we then add municipal infrastructure entities – four different building blocks within that in aggregate representing over $3 trillion worth of debt obligations.

Throwing some other ideas into the pot, the availability in terms of financing will reflect investment risks. That’s a very simplistic statement, but essentially investor risk appetite is also a function of exposure to country risk, exposure traffic risk, currency risk, commodity price risk and these develop from and are shaped by the different procurement approaches and delivery mechanisms that we mentioned.

So, coming back to the questions around the One Belt, One Road initiative and the key sources of funding for infrastructure so, yes, policy banks such as the China Development Bank are clearly going to be important. On-

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shore and off-shore corporate bonds and we know, we observed that the Chinese government is indeed encouraging Chinese financial institutions and companies such as infrastructure state-owned entities to issue bonds in renminbi and foreign currencies outside China to that end. So, we know that those corporate sources of funding are being mobilized, encouraged by China. The Asian Infrastructure Investment Bank, clearly the Silk Road fund that I mentioned earlier and then, other development finance institutions, bilateral regional development banks, et cetera.

So, those are key, but coming back to the overall message which is that scale of financing is so vast that it creates the imperative to mobilize and leverage private sector resources. These are some of the other issues that should also be on the table for policymakers to consider how to leverage public sector risk capital in such a way to catalyze private sector capital.

In that instance, multilateral banks have a key role to play in achieving that catalyzation. In particular, multilaterals have unique ability to manage risk, particularly risks associated with developing markets and sovereign entities. And that appetite and ability has the potential to provide a platform for the innovation of risk mitigants, new products in the space which will allow private sector capital both debt and equity to flow once those investable parameters are attractive for the private sector.

Anne Van Praagh: Great. Thank you.

Andrew Davison: Thank you.

Anne Van Praagh: All right, Simeon. Back to. We’ve talked about the role of the publics, the private sector, where the sources of funding are going to come from. In your view, what’s the role of the public sector here and which governments do you see as being actively embracing these projects going forward, which ones will be taking liabilities on balance sheets, which ones will be more actively engaging the private sector? What’s the role of the public sector here?

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Simeon Djankov: The two sets of governments that so far have shown quite a lot of interest are some of the Central Asian countries – Kazakhstan in particular and some of the smaller, not yet European Union member countries in East Asia or the Caucuses. Georgia is an example, Macedonia. I mentioned Montenegro, Serbia. Basically, countries that cannot yet rely on EU structural funds or at least not all of the EU structural funds which has a big infrastructure component and which for reasons of history have transport corridors that do not well serve their trade and finance.

So, what do I mean by that? So, if you imagine Macedonia or Montenegro, part of former Yugoslavia, they have good infrastructure going to Belgrade because that was the capital 20 years ago, in some cases ten years ago, but they don’t have good infrastructure capitals, good infrastructure corridors linking them either to ports as Andrew mentioned, for example, the Greek ports or towards Central and Western Europe, towards Austria, Germany and so on. To build these transport corridors they need money that is significantly more of what they can get from, at least so far, from most of the existing multinational institutions.

That’s why a new player like the New Silk Road initiative or however you can call. This is very interesting for these countries, particularly as I mentioned earlier, if they manage to avoid the sovereign guarantee issue. And the sovereign guarantee issue, I mentioned one feature which is important that it gets on your public accounts and counts as debt and deficit, but the other issue is that if you have a project that involves several countries, then it becomes a big issue which sovereign guarantee are you going to use to basically to build this project.

At the World Bank certainly, where I’ve worked on such projects, this is a big issue especially if countries are not otherwise friendly to each other for political or other reasons. At least in Eastern Europe, in the last two, two and a half years, the New Silk Road initiative has managed to get around the sovereign guarantee issue by basically saying this is project financing and we are fine if different parts of the projects are signed by different governments, in some cases even large municipalities. The bridge that I mentioned is essentially a municipal project, at least the way that it was done. So, there is certainly interest in it.

These countries, there is potential interest as I mentioned in Georgia; even Azerbaijan now is getting interested in this, Kazakhstan for the same reason. The infrastructure, the transport infrastructure of Kazakhstan basically goes to the extent that the [inaudible 0:41:04] goes towards

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Russia. They’d like to expand and have some transport corridors going to other parts of the world, including by going to the far east of Russia to get to the ports that exist there and towards China.

Russia is a relatively a new player in this market. Until about a year ago, Russia not only was not interested in this initiative, but it was through its both economic and political levers was actively trying to undermine it in part because it has its own economic initiative in the broader region which is the Eurasian Economic Union that involves from Belarus to Armenia to the Kyrgyz Republic, Kazakhstan, potentially Turkmenistan and Tajikistan as well. So, it was not particularly happy to see China basically getting into its backyard with large infrastructure projects.

This rapidly changed last year basically when the west imposed sanctions on the financial sector primarily, but also through the financial sector on some of the large infrastructure project financing that large state-owned Russian companies have been promised to build infrastructure in the region. And suddenly about a year ago, we saw a lot of initiative from the First Deputy Prime Minister Igor Shuvalov of the Russian Federation going several times to China, inviting Chinese officials to Russia. And we have several projects, I mentioned railroad that links Moscow to Kazan which is already signed. That same project has to continue from Moscow to St. Petersburg. That part is nearly negotiated and I expect to be signed maybe early next year.

And then some projects that, at least on the face of it, like I mentioned the nanotechnology project don’t really link to the New Silk Road as an infrastructure project, but they are valuable for two reasons. One that I already mentioned, it’s a good way to substitute absent, at least now Western financing because of sanctions with basically Chinese financing. So, Russia is interested in that, but also, unlike some of the smaller countries that I’ve mentioned in Eastern Europe that are basically happy to find an alternative source of financing, Russia takes the view of that okay, so we’ll have this infrastructure build up and then what’s going to happen? We’re going to have even more Chinese cargo and Chinese goods. So, when we build it, we want also to be able to have exports if it can go the other way. So, it’s not a one-way road. And this is how nanotechnology links.

So, the discussions and the negotiations on some projects have been like this, okay, let’s build this, but let’s at the same time think, in this case trains when they go from Russia to China what are they going to carry?

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And nanotechnology seems a bit let’s say overly optimistic at this stage, but around this type of projects. There are some agricultural projects incidentally that are under consideration, both in Kazakhstan and in Russia to be financed by the New Silk Road initiative.

So, Russia’s turnaround so to speak mostly dictated by the Western sanctions as I mentioned means that suddenly the whole region is in play, not just in the infrastructure projects themselves, but to say well, this is an initiative. Andrew made this, the point where we can create markets along the way. So, we can create industry that currently either does not exist or is not linked with the rest of the world, getting financing alongside the New Silk Road initiative and in this way having a two way trade.

Anne Van Praagh: Okay. We’re going to shift gears and before we open it up to the audience for questions, I want to ask about implementation risks. Obviously, with a network of projects this vast and the ambitious nature of this kind of undertaking integrating Eurasia, constructing the belt and road will be challenging. It will be challenging from a diplomatic perspective. It will be challenging from the standpoint of recipient governments may not have the policy framework or the project implementation capacity to handle projects of this magnitude. That could lengthen project execution.

There are other political hurdles, political risk we’ve talked a little bit about, the stability of governments, the capacity of government balance sheets. So, maybe Andrew, I can ask you to share your thoughts on implementation risks and you’ve looked a lot at infrastructure projects over many years through different economic cycles, what are the ingredients that make for successful or unsuccessful projects?

Andrew Davison: Sure. I think the fundamental ingredient is, is there a need that that asset is going to provide or meet? And you know, a rhetorical question is what is the benefit of a road that does not link meaningfully to populations or does not meaningfully create an economic story? What is the benefit of painting all buildings in a city green which could be an infrastructure investment, but actually has no value?

So, if that story really does create value, if it creates a resilient product or service which then catalyzes economic growth, then that is a key ingredient in creating a revenue stream or use of that asset which can then

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create the benefits which create the resilient revenue which give rise to a number of these financing strategies that I mentioned.

In terms of the ability and willingness of new sources of finance to come into market, the slide on the screen here illustrates some of the depth that currently sits within the institutional investor space which is attracting significant interest in terms of how policymakers might tap into that depth.

So, what that chart shows essentially is there’s over $93 trillion worth of assets held by institutional investors across the OECD country and that’s split into three particular sectors – pension funds, insurance companies, investment funds represent about a third each and then there is public pension reserve funds which is that little line slightly lower down so $93 trillion worth of assets of which a relatively modest proportion today is invested or associated with infrastructure.

So, the execution risks that Anne referred to, if those are managed and manageable and within the risk return appetites for this type of investor, it is possible to attract and mobilize sources of capital for those particular investment opportunities. But more specifically, what are the key risks that any infrastructure project may be exposed to? Well, the political risks and country-specific risks that Anne referred to. These are issues that would create some degree of correlation with stresses affecting host governments or public sector entities within those host governments and those could have significant and adverse impact on the ability of infrastructure project to deliver on its base case economic plan and associated revenues.

Currency mismatch risk, a mismatch, fundamental mismatch between revenues and the debt currency create headaches for projects. Projects exposed to legal and regulatory risks are a challenge within that host country. These are different aspects of sovereign and country risk.

And then when we come back to thinking about the project itself, we can conceptualize risks that can adversely impact the revenue stream such as traffic volume risk or indeed toll price risk on new build toll roads. And then, we might also conceptualize the underlying risks, the fundamental risk associated with construction or indeed the operation of a new facility.

For example, there is very little experience today of carbon capture and storage, but that type of project might be rather more important in the future in order to meet some of the sustainable development goal ambitions in reducing and managing climate change in due course.

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So, there are a range of different risks which in due course might lead a project to fail or underperform.

Anne Van Praagh: Great. Okay. Well, let’s see what questions the audience has at this point. We’ve got one here.

Ravi Vish: Thank you. Ravi Vish from the Multilateral Investment Guarantee Agency.

So, we provide political risk cover for projects in emerging markets, in particular infrastructure and Andrew, you talked about a number of risks in these projects. Obviously, we see all of them, but the biggest risk we see quite often is the traffic forecast risk as well as the amount of toll that’s provided and those obviously are not easy to quantify upfront and those are quite important just because you obviously want to also minimize the toll in the government in terms of the minimum revenue guarantee.

So, in a project like this where we have number of countries involved, I’m interested in understanding how those are being sequenced so that you have a network effect and that, you know, these risks are minimized to the extent possible. And on this point, a comment I want to add is obviously the political risk cover that we provide includes bits of contract which does not involve a government account and guarantee. So, just like OPEC, we provide the same cover, but those can be very useful in mitigating the risk for investors. But the key question is how do you sequence these different projects to have the maximum benefits? Thank you.

Anne Van Praagh: Thank you. That’s a key challenge. Anyone want to take a stab at that? I would say that we have our own history of looking at toll roads and having fairly mixed results in terms of, you know, actually meeting forecasts. So, toll roads themselves and maybe Andrew can talk a little bit about the history of toll road debt performance relative to other asset classes, but I think the forecasting is a key issue and I don’t know if the others want to chime in there?

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Simeon Djankov: Maybe I can make first a slightly more general comment and get to the toll road. I think as one of perhaps the challenges of this project going forward is so far the projects that I have seen being signed, worked on and in a few cases finalized under the New Silk Road initiative without exception have been projects that the project preparation and evaluation was started with a different either development agency or commercial bank and basically for one reason or another, they didn’t get to the end.

In the case of Russia as I mentioned, for example, the Moscow-Kazan high-speed railway was basically a project where the World Bank was involved, EBRD was involved, two large global commercial banks were involved. When sanctions hit basically, these financiers withdrew, but the project preparation and evaluation was fully done. So, it was essentially given for consideration and then signed on. Exactly the same happened with the nanotechnology project. Exactly the same happened with the idea of having Athens to Budapest highway and rail.

So, in other words another multinational or commercial global financier did a lot of the work together with the governments, municipalities and so on. And for one reason or another when it was not possible to finance it in this particular way, the Chinese investors/partners came in and took these projects.

Why is this a challenge? Because you know, there are only so many finalized evaluated and prepared projects. So, for this initiative to really get to the large numbers that had been presented today, the institution, the Asian Infrastructure Investment Bank, the New Silk Road fund, they rapidly have to build up project preparation and evaluation facilities something that they frankly don’t have now.

So I think this is a potential challenge and it goes then to the question of how do you evaluate which country or which even section within the country to build. In my mind, at this point, there isn’t a particularly rigorous way that this has been looked at. It really has been looked at where do we feel that the preparation and evaluation has been completed by somebody else. Thank you, we take their project and then we finance it, but you cannot really develop a serious business model based on the prior work of others.

Just in conclusion, these projects that I mentioned, Budapest to Athens, it started, perhaps not coincidentally with Belgrade and then with Macedonia because 2009 or so China invested in the Port of Piraeus. So, a Chinese

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state-owned company became the majority owner of the Port of Piraeus so, they already have several years of experience in that region and they have done as part of this preparation basically studies of how much cargo, which way and so on. So, that’s why they started building it that way.

The moment you go however Serbia to Belgrade to Budapest, there are no studies how much this is going to be used. There are some alternative railroads that can be used from Belgrade and not coincidentally, I think that project is behind everything else even though it was signed at the same time.

So, in conclusion I think this evaluation, preparation both on new projects in general and particularly how to stage an existing project is very much missing. We are very much at the beginning which means to me it would take some years before we can say now this is financing projects to the tune of several hundred billion dollars, not to talk about trillions. I think this is seven, ten years in the future.

Andrew Davison: I’d probably highlight three issues. Firstly, Simeon has talked about the establishment of integrated networks across the One Belt, One Road initiative countries. So potentially, we’re talking up to 40 separate sovereigns coordinating in a strategic visionary way an integrated transport network. And if there is a bottleneck at any point, it doesn’t really matter if you’ve got a six-lane highway to your border if there isn’t a road then connecting on the other side. That asset has no value. It only becomes valuable when people can actually use it.

So, I think the first point I’d make is that it comes down to the political will and vision to actually create these integrated transport and economic corridors.

The second point I’d make is the attraction of user-paid toll roads or user-paid facilities as a procurement mechanism. So, from a country’s perspective, if aggregate resources for that country are constrained and rationed, it’s very attractive to be able to pass a concession law to grant a concession to auction a concession to the private sector and say you, private sector entity have the right to build a road and charge users. So, essentially for very little money upfront, you can leverage or a country can leverage its ability to create and develop assets.

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But then the private sector response is well, okay, what is the traffic going to be on that road and I think this is where you’re question really focused. And I think this a third element which is there is a fundamental uncertainty about traffic forecasts, particularly in developing markets where those traffic routes have not been established. The science of traffic forecasting works well where there is an established traffic pattern or there is a limited opportunity for traffic to move in different ways, different pathways. Where it doesn’t work well is where there is essentially no established traffic pattern which is essentially part of the problem with where we are today in terms of the ambition of the One Belt, One Road initiative.

One way which could work is that it may be an appropriate use of public sector resources and risk appetite to establish a road and then to perhaps sell that asset once that traffic establish has been created or it might be an appropriate use of private sector risk appetite to underwrite a certain minimum level of traffic or committed revenue which then allows a private sector financing solution to evolve in a way in which you had suggested. But fundamentally these issues around traffic demand risk forecast, it’s essentially educated guess work and there are many precedents where that balance has just been completely misjudged by so-called experts.

Anne Van Praagh: Okay. Let’s see what other questions—yes.

Shahid Yusuf: Shahid Yusuf from The Growth Dialogue at George Washington.

My question is regarding growth inducing and multiplier effects of the sorts of investments you’re talking about.

If I look at the kind of countries, Kazakhstan, Macedonia and others, most of them have very little industry. So, if there is going to be Chinese investment, there is a high probability that the Chinese would bring some of their own workers, some of their own machinery, a lot of the intermediate inputs that will be needed for the construction of this kind of infrastructure.

In which case, what would be the short- and long-term multiplier effects of this for these countries and what do you see is the likely growth effect?

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Will it be 0.1% to their growth, will it be 0.5%? I mean, what sort of growth effects are we looking at because in looking from the countries’ perspective that’s what really counts. It isn’t you know, that can I get some tolls out of this road; it is how much growth do I get out of this activity.

Anne Van Praagh: Yeah, that’s a great question. I’m not sure we have a good answer for that. I know I’ve heard being on the receiving end of different government meetings, ranges from 0.1% to well over one full percentage point of growth, annual growth.

And so, I think that that’s a question that we don’t have a good answer to. It probably depends on which country we’re talking about, what kinds of investments, the scale of those investments and timing of them. I don’t know if panelists want to make a brief comment on that topic.

Simeon Djankov: First, you brought an interesting point that we have not discussed so far which is that indeed, at least in the contracts that we’ve seen parts of, there is always a part that says that such and such percentage should be basically performed by Chinese companies. So in the case of Moscow-Kazan railway, I think it’s about 30%. In the case of the Athens to Budapest, it’s in some sections 25%, in some 13%, not sure exactly how the negotiations were done, but there is a component where as you mentioned Chinese workers, Chinese companies will actually execute the project which over time is one I think of China’s interest to basically bring its know-how, to increase its know-how in these new countries and regions.

I still think in this part of the world, there are a number of infrastructure projects that I can at least see that have a very high return. Basically, because of what Andrew said which is that—let’s take Georgia. So, it’s a small country, it doesn’t have too much exporting ability, but certainly its exporting ability will be greatly increased if there is a good transport connection between the capital Tbilisi and the port, let’s say of Poti or the Port of Batumi. Currently, it’s very difficult to get from basically the main industrialized area of the country to the port so that from there you can somehow export.

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Similar is the case with as I mentioned, with some of the former Yugoslav countries. Some of them are landlocked, some of them don’t have large ports so they very much would benefit from being linked to the Greek ports and then, from there to be able to export.

And even in Russia, a country that invests very heavily in infrastructure because so much of the investment is let’s say wasted, there are many projects. You know, there isn’t for example, a good railway connection between St. Petersburg and Moscow. The return to such an investment is probably huge both in terms of the actual utilization of this road as well as improvement to the economy.

So, my guess is that if we take a specific project which is not yet financed, the Georgian government hopes to have it negotiated soon, Tbilisi to Poti let’s say highway, my guess is that this is going to add two to three percentage points to the GDP of the country for several years. Simply the need for such basic infrastructure is very high in some parts of the region.

Anne Van Praagh: Okay, let’s see if we have time for one more question then we’ll go to our break.

Sunil Sharma: Sunil Sharma from the IMF.

Given what I’ve just heard, given that we’re looking at not just country-specific investments, but multi-country investments, in terms of the funding, given the multiplicity of risks, how would the assets be created? Will these be ill-equipped investments? Are there specific issues involved in trying to securitize some of these investments? Is there a need for long-term patient investors?

And, this issue came up recently in the discussion we had with Martin Wolf at the IMF and there was a sense that maybe there’s a market failure and a sense that long-term patient finance is not available cross border as easily it may be available in country-specific investments. So, when I think about the framework that we have in mind, are there specific issues that arise in these sorts of multi-country investments?

Anne Van Praagh: Great question. Okay. Who wants to take a stab at that one?

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Andrew Davison: Well, thanks for your question. Simeon has mentioned this concept of project financing several times now but essentially, we’re talking about asset-specific financing, the revenue stream for which is created from the use of the underlying asset. This has been a very successful technique to finance projects in emerging markets.

To give you a sense of scale of project finance industry, it didn’t really exist 30 years ago but as quantitative and analysis techniques have matured, this industry has delivered over $3 trillion worth of long-term funding over 30 years. And that’s split essentially 40% power, about 30% social and transportation infrastructure and about 15% oil and gas so three big categories of project finance. So, there’s about 70% of that $3 trillion sum has been deployed to support long-term investment in infrastructure and related assets. Most of that investment has been undertaken by banks, however and, I think, where you started from which is what are the constraints which are preventing institutional money from flowing.

Well, I think we see green shoots of interest from institutional investors who are particularly interested in infrastructure debt for three reasons. It provides an asset liability matching, long-term assets and cash flows with long-term liabilities. The risk return parameters are attractive and it provides portfolio diversification.

So, the pull factors are there, but actually, this industry has been started and really established bedded down in the banking sector and that technology hasn’t really transferred yet to the institution investor base.

So, the attraction is clear. With $93 trillion worth of institutional money and a relatively small proportion today invested in the infrastructure sector then, that is the prize, which many parties are seeking to mobilize.

Anne Van Praagh: Okay. Thank you everyone. I’d like to ask you to join me in thanking our panelists Andrew and Simeon. Great job, everyone.

Adam Posen: Good morning ladies and gentleman. If I could, I’d like to reconvene our

session. Again, this is the joint conference on sovereign risk panel

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between Moody’s and PIE. On this occasion joined by our usual partner CIGI to talk about multilateral banks and the role in Asia and infrastructure spending. We already had a pretty lively and I think usefully fact filled discussion of the One Belt, One Road initiative in this context, including its European dimension, which is, and Russian dimension from our Russian colleague Simeon Djankov which of course is a very important, often overlooked dimension. And we’re grateful that Anne Van Praagh and Moody’s for putting that together. I’m now going to turn to my colleague Domenico Lombardi handling Global Economy Program at the Center for International Governance Innovation to introduce and chair the session. Please.

Domenico Lombardi: Okay. So, thanks Adam. So, in the first session we have spoken about

infrastructure needs, infrastructure projects. In this second session we’re going to focus more squarely on the multilateral development banks and I think it’s important talk about their role for at least two reasons.

First, because generally whenever we talk about international financial architecture, we tend to focus on the IMF or the World Bank, but clearly there is a broader universe out there and the potential role of the MDBs is not always audibly spelled out. The second reason is that I think, depending on how well the multilateral development banks will be able to enhance their financial and lending policies to a scale comparable with infrastructure needs we have just seen, I think this is going to have an impact in terms of how open the emerging regional architecture that is being shaped in Asia, in emerging Asia will be. In other words, I think the issue of whether this emerging regional architecture will be open, will be complementary or will be alternative to the existing international order is somehow still an open question and I think much will depend on how effective the current international architecture will be in trying to address, at least some of the infrastructure needs and the issues that have been already highlighted. So, to discuss these issues we have a panel composed of Steve Hess. He’s going to be the lead off panelist; he’s a senior vice president at Moody’s. And then, after his lead off presentation, we’re going to have two more panelists. Michael Leauge, Hongying Wang, senior fellow at the Center for International Governance Innovation. And then, of course Adam Posen, the host and the president of the Peterson Institute. Then, after their presentations we’ll have, of course, a chance to do Q&A and have a debate afterwards. So without any further ado, let me call on Steve Hess, senior vice president of Moody’s. Thank you, Steve. The floor is all yours.

Steve Hess: In addition to being senior vice president, I was given a few years ago the

role of what’s called multilateral or supranational ratings coordinator at Moody’s, which was a new responsibility which hadn’t existed before and

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that’s because this particular sector or group of ratings at our institution was growing very fast and it was felt that position was needed. In addition, about the same time we, for the first time ever, published a methodology for how to rate supranational organizations, most supranationals are MDBs. So, this sector has been growing so, and therefore we at Moody’s have had to recognize that because of course, they have wanted more ratings and we are a rating agency, but I thought I might start, before we get into the presentation, just with some very basics, in other words what do we mean by multilateral development bank and of course, it’s an international organization owned by governments, two or more governments. We have a couple that only have two shareholders, but, of course, then there’s the World Bank that has 180 roughly. The thing about them that distinguishes them from a lot of other organizations is that they have a public policy mandate, and the mandate can vary. In general, it’s economic development, hence the name development bank. But, there are other mandates that I’ll get into a little bit later. One thing that this means, of course, is that, unlike commercial organizations, these are not profit maximizing organizations. They make profits in general, but they’re not profit maximizing. Also, they’re not regulated by national authorities and they don’t have access to central bank financing, except for one or two of them. And they’re generally exempt from foreign exchange controls and other national regulations in the countries where they exist. So, for example, and at Moody’s we have for every country that we rate, we have what we call a country ceiling and the country ceiling is supposed to be the highest rating that you’ll give to any entity in that country. Well, we have for example, the Asian Development Bank is in the Philippines, but it’s rated triple A which is way about the Philippine’s country’s ceiling so, they are not considered to be located, if you want to put it that way, located in the country where they actually they are located. So, we now have 35 rated supranationals, we only had 15, 10 years ago so, these organizations are playing a much bigger in global financial markets than they used to. A lot of them existed before, but didn’t want ratings because they weren’t issuing debt or they just issued debt in the local capital markets and they didn’t need ratings, but over the last 10 years we’ve seen a huge increase in the number of institutions that are rated and the debt issuance in the capital markets that has been rate by us, that’s an indication that, of course they are growing in their lending because they only borrow to lend. And on average they are highly rated institutions, they are financially strong, there’s never been a default by a multilateral development bank and they have—another characteristic they have that I didn’t mention earlier is

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something called callable capital where if they run into a debt problem, that they can call on their shareholders for an amount that’s already decided. There’s never been an incidence of a call on capital. Well, there was one, only one a few years ago. They also receive, from time to time, capital increases from their shareholders, indicating the member support that’s there. That’s part of the consideration when we rate these institutions. Also, as I said earlier they have very diverse mandates. In general, economic development is the most important, but they have also, there are some institutions that are very specialized. I’m not going to talk about every single institution, but here’s a list of the institutions that we rate and they vary quite a lot in size, going all the way from the European Development Bank which has 600 billion or so in total assets and then, down to banks like Shelter Afrique, which you might not even know of, but a very small—the North American Development Bank is also quite small. So, there’s a whole range of size in these institutions and most of them are in between. As I said, they are very highly rated. Triple A ratings and double A ratings dominate the rating scale and in the comparative sense, compared to other, if you want to call them asset classes, they have a very high proportion of highly rated institutions and triple A’s in particular. You can see here we just compared the distribution of the ratings of these institutions to the distribution of our sovereign ratings and you’ll see that in the very highly rated categories all the way down to A2 there are, the MDBs are rated more highly than the sovereigns or in the proportion of MDBs that are rated more highly then the sovereigns is quite high actually. Of course, the sovereign universe is much larger with about 130 countries rated and only 35 MDBs, but still the rating scale shows that they are very highly rated and I would say that it’s even a bigger divergence if you were to look at commercial banks or corporate ratings. So, the supranationals are, or MDBs rather are one of the most highly rated categories of issuers that we look at. As I mentioned, they’re becoming important in global capital markets, more so then ever before and they’ve been getting capital increases. The left hand graph here shows their leverage ratios, meaning their debt to equity ratio basically and the capital increases that they’ve been receiving are the red dots there and you can see that in the last few years these are only the largest MDBs, the capital increases, there were quite a few of them at the time of the global financial crisis and thereafter. So, they are viewed by their shareholders, of course, as institutions that are in a way counter cyclical. When the global financial crisis came and the commercial finance was not really available, the shareholders, in other

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words the governance thought that well, we can use these institutions to help developing countries in particular and they did. The outstanding debt stock on the right hand graph is also, these are only the largest debt issuers in the capital market. You’ll note that the green bar represents the European Investment Bank and it is larger than all the others combined. It’s by far the largest multilateral development bank. And second, at the bottom of the other bar, is the World Bank. So, it’s the largest other than the European Investment Bank. And then, you have the large regional development banks are included here. Despite their growing size and actually importance in development finance, if you look at them in the context of global capital flows they’re actually rather small. This graph here on the left shows you cross border claims in the BIS. In other words, these are commercial bank claims. And even if we exclude interbank claims, which is a big part of, in fact the biggest part of commercial bank cross border claims, even if you exclude those, MDBs are still quite small. So, their role in development finance is very important and we’ll get to that in terms of particular countries and things in a while. But, in total they’re still rather small. And I would say that that’s one point you could make about well, does the world need another one? For example, do we need the Asian Infrastructure Investment Bank? I think well, there’s plenty of room for them I guess is the point I would make, because these are still rather small in terms of the total global capital markets. Also, they are only about half of official lending which is not included in the graph on the left and you can see official lending includes just bilateral lending, in other words, direct lending from one government to another usually for development purposes and national import export banks are also important, the IMF is there. So, MDBs are about half of official lending, but there are other sources of lending of course besides MDBs coming from governments and national Exim banks. So, who are they lending to? You can see in the bar that by far high-income countries get the most money in absolute terms. But, they get the lowest proportion of the MDB money in terms of the percent of their GDPs. So, the green line shows you the percent of GDP which is the right hand scale that goes to various income, well, the various levels of income countries and as I guess, this would be the ideal world is that the low income countries get the highest percent of, as a percent of GDP. In other words, the development impact will be highest, most likely in the low income and the lower middle-income countries where you have a little over 10% of GDP is represented by loans from multilateral development banks. Upper middle income is a bit less and then, high income, it’s only about 5%.

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So, that is probably the pattern you would like to see, even though the absolute amount of dollars is very large going to the high income countries, which is sort of a surprise when we—we have put together for the first time really a data base that has all of them together. And we were rather surprised to see, and you will see later why that’s the case, but we were rather surprised to see that the absolute amount of dollars going from multilateral development banks was the highest in the high income countries. I mentioned earlier that a lot of these institutions are specialized. I mean, of course there’s various areas of specialization. These are just a few examples, there are more, but EUROFIMA, for example, is a European institution that only finances railroad rolling stock. In other words, train cars. And that’s the only thing they do for the national railroads in Europe. The North American Development Bank, which a lot of people have never heard of, only finances for environmental projects along the US Mexican border, that’s their entire mission in life. APICORP, which is the Arab Petroleum Investment Corporation, owned by the members of the GCC only makes loans in the energy related petrochemical industry and that’s it, that’s their mission. Council of Europe Development Bank is another rather old, by MDB standards, institution and their mission is to lend for social projects in Europe, mainly these days in Eastern Europe. I did mention Shelter Afrique earlier. What they do is they make loans to the housing sector in Africa. So, they’re very specialized as well. Several banks do focus just on trade finance, and there’s one called PTA Bank for example in Africa which does trade finance for, PTA stands for Preferential Trade Area which is a group of African countries that, it’s not exactly a free trade zone, but they have preferential treatment of trade coming from one another and this bank just does trade finance for that group of countries. So, there’s quite a lot of specialization and even if you don’t have an industry specialization, almost all the banks except for the EBRD, the World Bank and IFC are regionally focused one way or the other. They’re not global institutions. So, there’s a regional focus and this can go in different ways. For example, the EBRD, the European Bank for Reconstruction and Development, they lend mainly to the countries of the CIS and yet, their shareholders are the advanced economies, the Western European economies, the US and Canada I think. They lend into this region. There are other regional banks that are owned by the regional shareholders and lend to the same group of countries. One good example of that is the Central American Bank for Economic Integration which is owned by the Central American governments and only lends in Central America. So, they don’t have outside shareholders to any significant degree. They’re very regionalized.

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This is not showing up, or is it? It shows up over here. Well… yeah, but what can I do about it. This isn’t connected, I don’t think. Yeah, well, I guess we have to. You’ll see on the scale on the left shows… what this is supposed to show is where the actual dollars, the absolute amount of dollars, or euros or whatever the currency is, the absolute amount of lending by MDBs, where does it go. The scale on the left, you know, it goes from very light colors, which aren’t showing up, all the way to the dark blue, I think it was originally blue and the dark blue is countries that receive $50 billion, or more in absolute terms, and you’ll note that aside from India, they’re all in Europe. So, this is because, as I said earlier, the European Investment Bank is by far the largest lender and they only lend, well, they have a few loans outside of Europe, but almost all of their lending is in Europe, and therefore in absolute terms, Western Europe receives the most dollars or money from MDBs aside from India. China, Brazil and Mexico come next really and they are the more classic recipients of MDB financing, but this map was rather surprising when we first put it together because we hadn’t really thought systematically about why would European countries be the biggest recipients of the multilateral development bank finance, but it turns out that they are in dollar terms. This just shows the regional distribution and again… if you missed what was on the map, you can see that Western Europe is again, in absolute dollars is the biggest recipient and it goes all the way down. But, one interesting point here is the blue dots which show as a percent of GDP, and you’ll see western Europe is still there, but one of the interesting points I would like to point out is that East Asia is quite low, not quite low, but one of the lowest here as a percent of GDP in terms of getting finance from multilateral development banks and I would say this is another point where you know, the Asian Infrastructure Investment Bank, the AIIB, which has just been created will fill in a void in a certain way, even though the Asian Development Bank has been there for a long time and it is an important institution. Asian countries, East Asian countries in particular, still don’t receive that much in terms of GDP, compared to other regions in the world. And I mentioned, by the way, earlier regional institutions, this would be another one of course, but up until now, in fact, although there are I don’t know how many regionally focused institutions in Africa, quite a few, you also have a number in Latin America, a number in Europe. In Asia really there aren’t any, other than the Asian Development Bank, there aren’t any others unless you count the Eurasian Development Bank which is in Kazakhstan, but for the rest of Asia there really aren’t any regionally focused institutions, except for the Asian Development Bank.

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So, once again, the Asian Infrastructure Investment Bank would be sort of the first one outside of ADB. And this map again, I’m sorry that it’s not showing up. It’s clearer. Well, yeah, I guess it’s clearer in a sense that yeah, the higher end of the scale shows up and so, it emphasizes them. And these are countries, the highest end of the scale, the dark blue is the countries that receive more than 12% of GDP in multilateral financing and this is more what you would expect, a priori, if you hadn’t thought about it in terms of which countries are going to get the most help from MDBs. And here you can see West Africa and some parts of East Africa, Mongolia, Pakistan and some of the Balkan countries and Central America also by the way, is there, it’s small, but it shows, it is there and those are the countries that receive, as a percent of GDP, and therefore you would expect that on average the development impact, although measuring the development impact is sometimes hard, you would expect that the development impact would be greatest in those countries and those are the ones that need it most. So, the absolute dollars were rather surprising to us anyway, but the actual impact, if you want to put it that way, is in the countries here that show up in the darkest colors. You might be surprised to see Finland there also showing up on this map at all. There is the Nordic Investment Bank which only lends in Scandinavian countries and it’s headquartered in Finland, by the way. So, it also shows up. And Spain as well is there, but most important ones are the blue colored ones and that’s sort of the pattern you would expect. So, that’s all I’ve got to say at this point. I guess the conclusions are that this is a growing sector and there’s still more room for it to grow. We see articles and things where it says well, does the world need the Asian, the AIIB, is that really needed? And other articles that say well, is that going to compete with the World Bank and cause the World Bank to become irrelevant because the AIIB is going to be there and it’s quite a large and well capitalized institution? Is it going to crowd out the World Bank or other—the Asian Development Bank, for example? We don’t think so, we think there is plenty of room for this new institution and of course that’s what those other institutions will tell you. Well, we’re happy to have more finance, because infrastructure finance in particular, which was discussed earlier, the need is so large that another bank is not unreasonable or it’s not a problem, in fact it’s probably a positive to contribute to global development finance in general. So, that’s it.

Domenico Lombardi: Thank you very much, Steve for sharing with us these results. I’m sure

they’re going to prompt a number of questions. Certainly, I do have a few questions, but let me call on Michael Hongying Wang and then, Adam and then, we are going to have a Q&A session to discuss these issues.

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Hongying Wang: Okay. Let me try to follow what we just heard from Steven Hess. My hope is to have a discussion with you about where the new multilateral development banks fit in the overall picture. What are the promises and potential problems?

So, we all know that in the last couple of years there’s been a tremendous new development in this area of multilateral development banks. So, the New Development Bank or BRICS bank in 2014, July of 2104. The AIIB that came along later that year, which finally passed its article of agreement this June and then, the South Asian countries have also gotten together to form their own regional development fund and then, China is now in discussion with other Shanghai Corporation Organization members to plan a development bank for that organization and so on and so forth. So, obviously this is an area where we’re seeing a lot of change. So, one of the questions that have been on the minds of policymakers here and elsewhere, but particularly here, is weather this is a threat with all these new banks coming along. The New Development Bank representing a very large share of the world’s population and also, a significant share of the world’s economy, are they more or less leaving behind the existing international institutions to set up their own parallel institutions sort of escaping the existing order to set up a new order? What about the AIIB? The worry is that the AIIB itself may come up with new rules, new practices that would be contradictory to the existing rules of multilateral lending and perhaps undermine the current system. So, as I said, the reaction was particularly strong in Washington so, we now have this very familiar statement by Larry Summers, seeing this as perhaps an indicator the US has lost its role as the chief rule maker for the international economy. Some would go even further to suggest that perhaps the establishment of the AIIB represents a new Bretton Woods moment, with China now at the center. Okay. So, what I want to talk about briefly are three questions. What do the new development banks, how do they fit in the infrastructure landscape, should we worry? And then, what should we worry about? So, to get to the point of how do they fit in the landscape of infrastructure financing, but more broadly global economic governance, it’s important to see the limitations of the traditional MDBs. So, as far as infrastructure is concerned there’s been various estimates, but widely shared is the estimate that developing countries together would need something about $2 trillion a year to fulfill its need in infrastructure financing, but the actual investment has only been lees then one trillion a year in recent years. So, there’s obviously a gap that really needs to be filled, but the traditional banks have limited capacity, in part because of

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the issue of governance reform, you know the capital that could have come from the new emerging economies has not been incorporated in their capacity. So, there has been a recent study that shows the annual flow, let’s say 2012 from the World Bank was about $24 billion, the ADB was close to $9 billion, but as we’ve heard this morning how little that is in the overall picture of infrastructure development needs. So, part of the promise of the new banks, China led or not, is to help fill this gap. So, assuming a credit leverage of 2.4, this, again, is by this recent study, the MDB and the AIIB could make a combined annual lending of about $24 billion, a total stock of 240 billion. And that would be comparable to World Bank’s lending and that would constitute a 1/3 of the total lending by established multilateral development banks. Certainly, that’s not the only way in which the new banks could contribute to the infrastructure landscape. More importantly, as we’ve already seen, is the new banks have already introduced a competitive dynamic that wasn’t there before. So, as these emerging economies are getting together talking about and even bringing to fruition some of these banks, the other actors have accelerated their own steps in filling the infrastructure gap. The G20 has launched a global infrastructure initiative with a hub in Australia. World Bank has increased its funding, plans to further increase its funding, and infrastructure projects and launched a global infrastructure facility that is hoped to serve as a platform to bringing various actors to fund infrastructure. And then, there are various regional programs that have been put in place or under planning by regional development banks. Besides that, the new banks could contribute or change the existing pattern of infrastructure financing by bringing certain kinds of reforms, so for example, new form of financing. A resource financed infrastructure which has been actively practiced by China in recent years is now a serious subject of study by the people at the World Bank and then elsewhere. Is that viable; is that something, a new model that needs to be expanded to multilateral lending as well? And then, the Chinese have been very clear about not, in their own words, meddling with internal affairs of the borrowers so, as they make their loans and provide support maybe through China led multilateral development banks, they emphasize that they would like to have these projects, you know, suit the needs of the local communities rather than follow the traditional principles of free market and privatization, deregulation and such. And then, the new banks have also emphasized that they want to be flatter with their bureaucracy, smaller staffed definitely, both the MDB and the AIIB look like they’re going to be that way and to have shorter process, more efficient process of approving projects.

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So, this had caused worry, I would say not. Most of the reform measures are really about, you know, marginal change within the current framework. There is definitely a shared consensus that the new banks share with the old banks and other major stakeholders that infrastructure is critical to global economic growth and integration and there is also a common belief that good governance is very important. So, the Chinese officials have repeatedly emphasized that those are certainly principles they would adhere to with their newly established banks. And there is also the sign that they are very likely to work with the other banks that have already existed for a long time. So, the ADB and the AIIB obviously are two potential competitors, but they have actually gone out of their way to emphasize recently that they are going to work together, maybe with joint projects and such so, that’s a reassuring sign. So, all of this worry and concern, especially heard in Washington, probably goes beyond that these banks are new, to the factor that China plays a big role, the China factor is very much part of the concern. So, these new development banks from the perspective of Washington may very well be part of China’s more aggressive diplomatic undertaking, China’s financial state craft. So, it’s not just the new multilateral development banks, but the unilateral and bilateral initiatives China has taken in recent years, recent months and as recent as Xi Jinping these last few days. These all seem to be signs that China is becoming quite eager to take over some kind of leadership role in international finance. So, is China trying to overthrow the existing order? That’s, I think, the bigger question behind the concern and the worry. So, in a different context president Obama said, if we, Americans don’t write rules, this is in the context of TPP, negotiations with Chinese will write the rules out in that in region. And I think that certainly applies to financing as well. Okay. So, one thing I guess we all need to keep in mind as we evaluate China’s intention and how much one should worry about China’s ambition, is that the Chinese leaders are always playing a two level game. They certainly have very strong diplomatic ambitions, not surprising, given China’s growing economic strength in recent years, but one shouldn’t put too much emphasis, because if you look at the details of China’s reform proposals, they’re well within the current I think general framework. They wanted to have better representation at the IMF, they wanted RMB to be part of the SDR basket and so on and so forth, but those aren’t really revolutionary ideas. And China’s diplomatic ambition tends to be limited to the region, rather than global, but I can’t say, you know, China’s, if it’s monolithic. There are certainly groups within China, factions within the Chinese decision making circles that have something else in their mind, but I would say all the signs suggest that the leaders today, the predominant voice is one of caution and cooperation and joining the world with moderate reform proposals.

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At the same time, the Chinese leaders probably wake up every day thinking much more about their domestic concerns and worries, the politics, the economics, and you can see they’ve very clearly laid out these concerns, even as they push for China’s foreign financial policy. So, access to energy, raw materials to support domestic industry, to export overcapacity of domestic industries, to earn better returns on their financial assets and so on and so on, developing the western part of China as part of One Belt, One Road initiative and so on. So, I would say that suggests that China’s main concern is what can China get out of these as a kind of a mentality of absolute gains, what can we gain rather than what can we gain over what others have. So, the goal isn’t, at least for the foreseeable future, to diminish necessarily other countries, especially US influence, that may be a slice of the story, but mostly it’s what can China get out of these initiatives. So, as long as the mentality’s about absolute gains rather than positioning yourself above somebody else relative gains, then there is plenty of room for cooperation. Which isn’t to say these banks have no problems that we can foresee. There are certainly potential problems, but I would say these problems are widely shared by old and new development banks, multilateral development banks. One issue is the financial sustainability of these efforts, these projects. We’ve heard earlier today about public private partnerships, that’s a popular concept, but its record has been quite mixed as far as development is concerned. So, there have been plenty of cases where private participation based on pursuit of profit has really not led to widely shared growth locally. Where the investment goes, who has access to the new infrastructure isn’t always decided on the basis of development, poverty alleviation and such. So, that’s something we need to be concerned about. So much dependents on private input and we can’t blame the private actors, they’re there for profit, they aren’t charities. And then, the financialization of infrastructure, which I’m sure many of you know a lot more about than I do, could pose a problem for the financial stability the recipient countries where the projects take place, but also cross nationally. So, those are things to keep in mind and alongside financial sustainability, there are also potential problems with environmental and social sustainability. A lot of the projects, especially many of the projects China likes to fund are mega projects and not necessarily what the local community needs or can afford in the near future. Of course, private investors, as I said, they’re there for a profit, so if that means sustaining a locked in old technology, so be it, that’s what’s going to generate returns for us. So, there are certainly incentives that are

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understandable form the private actor’s point of view, from China’s point of view, that may not ultimately serve the needs of the recipient countries. And then, there’s been a tremendous rush to get these bankable projects out there. So, some of which, especially these private public partnership projects circumvent the safeguards that the World Bank and other development banks have spent years trying to put in place. When you have private actors, some of these standards no longer apply. So, China playing a very big role in this new scene of infrastructure development itself has a mixed record in terms of the environmental impact of the infrastructure projects. So, that’s something that you need to keep in mind. So, just to summarize how do the new MDBs fit, they fit by filling a gap, by stimulating competition and by perhaps introducing some reform measures, which may or may not be good, depending on whose perspective you take. And should we worry? I would say not, for the reasons that maybe policymakers in Washington were worried last year, or earlier this year, expressed their concern, but we do need to worry about the environmental and social impact and sustainability of this new rush to infrastructure investment. Thank you very much.

Adam Posen: Thank you. And I hope no one feels I’m abusing host privilege by

contributing to this panel.

I think this is a very important set of issues and I want to particularly thank Steven and Hongying for getting us to here we are. Andrew I think set things up, obviously educated us a lot, but where he concluded, in a sort of gentle way, there is indeed room for more from the point of view of demand and financial sustainability and resources. And Hongying took us one step further and I’m very grateful to Hongying for coming, I’ve been wanting to get her on our podium for a while so thank you for joining us today, taking us into the political realm and the political economy of such institutions. What I’m going to try to do is build on that one step further and get into the obnoxious policy pundit realm of what should be done from here. And basically, we didn’t intentionally stack the cards this way, but I agree with the broad thrust of what’s been said in this panel, that there is room for more, there is room for more infrastructure investment, there is room for more utilization of public monies and multilateral lending in Asia, there is room for more institutions, the diversity of institutions, that Steven pointed out to us isn’t well known or recognized and if the system still functions. And there is room for an important Chinese role in these institutions. I think this is all worth saying and worth emphasizing and even recognizing that it makes economic sense.

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Now, I have to make a statement, a clear statement that a number of us, we don’t take Institute positions, but a number of us at the Peterson Institute have been on this wicket for about a year and we’re pretty openly critical of the way the US government responded to the initial AIIB. Our colleague Simon Johnson, who will be giving a luncheon address, has spoken about this. My senior colleagues Ted Truman and Fred Bergsten, who both of whom who are normally seen as very strong bulldogs for US institutions, were out there calling this a mistake, the way the US government addressed the AIIB and I’ve been out there as well. I don’t suggest that the more beneficial collaborative kinds of relations we saw on Xi-Obama summit is anyway directly attributable to our lectures, but I do want to emphasize that there’s good reason why we were out there saying this. So, the first point is that I think there’s been a misconception from the sort of IMF world to the MDB world. That we toss around terms of conditionality and lending standards in the IMF context and then we toss them around in the World Bank and MDB context, but they’re very different things. The worst thing that can happen, if the World Bank or the MDB or the AIIB makes a bad loan, is that they waste some money. Maybe the worst thing that can happen plus, is they waste some money and it goes to a corrupt official. If the IMF has a system of cascading, competing conditionality, we see a race to the bottom in potential crisis situations, the building up of large imbalances, distortions in exchange rates and potentially very severely distorted macroeconomic policies. Now, that’s not some snobbish thing that oh, IMF is more important than World Bank, not at all, or more important than MDBs, not at all. In the long run what the MDBs encourage and develop may be at least as important as crisis firefighting. But this fundamental lumping together of term conditionality in the IMF context and conditionality in the MDB context seems to me to have been a grievous recurring mistake. There is no inherent competitive problem in having “too many MDBs”. I think the second thing, which just to stipulate and our friends at Moody’s have done a very good job of this, our friends at McKenzie Global Institute, one of our other partners on the occasion, has also done previous work on capital per capita and capital of the various developing economies, there is a large shortfall, it’s not just at JFK. Now, many of the people in this room are well familiar with the long sort of tortured history of multilateral development lending, of bridges built to nowhere of Aswan dams cropping up to ill effect on the environment and ill effect on the economy. I think that’s just a lesson for us that public investment is every bit as difficult as private investment. You have to do proper project assessment, you have to learn from experience, you have to

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do cost benefit analyses that are transparent and publicly available, you have to meet some kind of market test. But, that’s not a statement that infrastructure spending is inherently bad and wasted and in fact, the evidence in economics is either largely favorable to infrastructure spending, or is completely muddled on the results, which is another way of saying we haven’t figured out how to sort out the good from the bad projects which is a serious issue, but is not the whole game. I would additionally pick up on something that Simeon gave a number of very good examples of during his presentation in the opening panel. That network effects from geography are hugely important. We know and have seen recurrently the geographic trade patterns, geographic investment patterns and I mean geography in the broad, literal proximity, but also this is why the Silk Route is not so crazy. Historical ties between countries, Simon Johnson and others have written about colonial ties and how those continue to persist in various ways. But, geography in the large remains a huge determinant of the potential growth paths and the potential trade paths for developing economies. And so, when we think about targeted infrastructure and institutions that can say, we need a railroad that goes from here to here and as was mentioned, we need stations that function on both sides of the border, that matters. And sometimes trade agreements and good markets are not enough, as our Institute has published in the past by Barbara Kotschwar and Gary Hufbauer and others, it is a crying shame that a combination of protectionist regulations and underinvestment has limited land transit between the Mexico and the US within NAFTA. And multilateral development banks are one way around those things. So, the second point I would turn to is that I would go beyond a little bit of what Hongying was saying and go even further and I think at this moment, not by any means forever and not by any means always, but at this moment, I think China’s economic leadership globally is to be praised. When we look at the way that they have responsibly tried to move their currency towards a market outcome, but at the same time not wanting to crash the economies of their neighbors or unnecessarily create strife with the US, they’ve lent against excessive market forces at the way they pretty maturely took the slings and arrows of the AIIB debate from the US and continued to press ahead with putting in good standards, or at least from what all of us can see from the outside looks like good standards there. I think most of all they’re putting their money where their mouth is and in a world where Norway continues to lead the pact on development assistance and most of us do not put up a huge amount, in a world where the US public opinion assumes that we send 10 or 15% of our federal budget abroad and it’s under, I think, 2%, this is worth correcting and worth praising. I also think, to be fair, that China as a great power, should be allowed to make some of the same mistakes that the Americans and the

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British and others, and the French have done in the past. Which is, they should be, and my colleague Colin Hendrix has written about some of these issues along with Marcus Nolan in various places, but you know, let them go do FDI in Africa, let them find out that they don’t get to take everything away with them, let them find out that people won’t necessarily love them and therefore, as a result, let them find out how they should behave. That’s just part of the learning that has to be done and I don’t think it is unreasonable that we should have an international structure that actively supports that, which I think a Chinese led multilateral development bank, but more Asian development banking in general would help. It is fair to make a distinction, and I hope the US government and the UN community will make a distinction, between China investing through these avenues in soft power and hard power. I mean, to put it crudely, helping Pakistan become a closer and closer client state through water projects is one thing, building deep water ports for Chinese aircraft carriers in Sri Lanka is something else. And I think it is fair for the US to try to draw those lines, but it is both misguided and unfair for the US to try to draw those lines a priori at the institutional level. Let it be a matter of lending principles, let it be a matter of open discussion. I do think I would completely agree with and recommend Hongying’s points about the cooperative institutions are possible and again, without wanting to get too much into specifics, I do think that President Nakao and the leadership of the ADB, the Asian Development Bank, has been surprisingly successful, not only intentional, but successful in reaching out to their future counterparts. I think that they deserve credit for that. The ADB has had a consistent record, though being repeatedly Japanese led and Japanese and American funded, of being respected in China and other parts of Asia where Japanese and American institutions have not always been held in high regard and I think this is worth pursuing. I think, two last points, I think there is a big picture economic thing we have to think about here that beyond the question of the benefits and cost of the specific loans and the specific programs of these institutions which we will depend at our friends at Moody’s, among others, to keep monitoring, there is an issue we do have, as macroeconomists keep saying, a shortage of safe assets. We have a relatively limited number of places people want to put their money and in the world in which the only place everyone wants to put their money is US treasury bills, is not a good world from a large number of purposes. If it’s the Chinese sitting on those reserves, it wastes their people’s money. It also, of course, is a distortion to world markets.

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Even if we go to a full one trillion greater lending and greater investment out of the Asian MDBs, as some of my colleagues speaking earlier said there is room to do, that will not solve the global imbalances problem, but it is a non-trivial bucket in the right direction, not just a drop. And I think that that’s worth considering. I think it’s also important when we start worrying about freighting these with too many missions, these MDBs I mean. I was very interested in Steven Andrew’s point that, you know, we have certain, very specialized multilateral development banks, including the African housing and the infrastructure one and so on. I think it is fair, as he implicitly and Hongying explicitly raised, to think about what is the role in climate change, in green technologies of these banks. I think that is something that we more generally want to look at, but again, this is a place where more is better. It’s very hard to understand why having fewer institutions in the framework and a smaller supply of lending in any way helps with that issue. Finally, let me say a word about US leadership. I think I am very pleased by what happened at the Xi-Obama summit, not so much because anything really happened, but because nothing really happened. I was very concerned that amidst the domestic pressures on the US, that the US Obama administration was going to just be a naysayer on everything, but do so in a way that was visibly standing tough against the Chinese and to their credit, the leaders of the Obama administration chose not to do that, and again, that was a win. But, I think that it is important to say that the MDB, the AIIB, all of this is, in some sense, a side show on American and European excessive role in the IFIs. This is something nice that will be helpful to see Asians and particularly China have an institution in a sense they call their own, but as the Chinese leadership themselves have repeatedly said, that is a second best. What we need is a real role in governance for China, for Asia in general, and for emerging markets. And that begins with quota reform at the IMF, which the US has failed to deliver on five years after agreeing to it. President Obama in the Xi-Obama summit press conference made glancing reference in response to a question, it should not be glancing reference, it should have been an active affirmation that that is the part of building the US China relationship, that this has to get through Congress. So, the one thing I will say about this discussion of the multilateral development banks in Asia, there is room for more, it is a good thing, but it doesn’t fix the global governance problem, we need to look at other ways to do that. Thank you very much.

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Domenico Lombardi: Thank you. Thank you, Adam. I have nothing left to do besides summarize so effectively, I think, the thrust of the discussion since early this morning. But, before actually turning to our audience, I would like to use the prerogatives of my chair to actually break the ice and start off with a couple of questions. The first question I would ask Steve from your presentation, clearly there was this apparently surprising result that the high income economies get most of the multilateral development bank aid or loans, but my question is—you did mention in your presentation that the inclusion of the EIB, the European Investment Bank, somehow drives this picture, but at the same time I wanted to ask you, to what extent controlling for the EIB, you know, we would still be able to observe the same picture or we would be getting a completely different picture? And then, a second question that I would have for the panel is, again, this is, I think that was implicit in the discussion we have been having since early this morning, but clearly when we talk about a huge infrastructure need, it’s maybe one trillion for emerging Asia, it could be two trillion for the whole of the developing countries in the world, the numbers are huge as it was pointed out and at the same time, the financing role of the multilateral development bank is pretty small, pretty limited. So, to what extent we have room for, you know, financing the financial policies of these banks, to what extent in particular the triple A requirement is still a sort of ballpark or key principle that should underpin the financial policies of these institutions creating the triple A sort of policy was important to get World Bank access the financial markets in the 50’s and no one really knew about the World Bank at the time, so no one disputes that decision at the time, but in the world we live in and Steve, you mentioned the ADB is located in Manila and still has a triple A rating, much higher than the Philippines. I think that to some extent, you could argue about the same thing, about the World Bank located in Washington and how you’re rating then the US government….

Adam Posen: No, not by us. Domenico Lombardi: But, this may also be true of a number of other multilateral organizations.

So, to what extent, I think, a greater dose of realism in assessing these financial policies might be required in order to unleash greater financial capabilities about these institutions? So, shall we go in the order of the panel? So, Steve you first, and then Hongying and Adam.

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Steve Hess: Well, yeah. We haven’t done this calculation, although I’ve been meaning

to.

If you took the EIB out of the picture, you know, what would all the things that I showed you look like? Obviously, there would be more focus on developing markets, but I still think that as a percentage, the last map which wasn’t very clear, but the last map, as a percent of GDP, which countries get the most, that wouldn’t change, because EIB is not a big player in the developing markets, they occasionally make a loan here and there, but I mean they’re not big in that sense. So, that picture would not change. But, because that’s based on the money that’s coming in. I don’t want to be US centric, and just say they’re in dollars, because they’re in euros as well, or even yen, or even renminbi in some cases. So, I don’t think that that picture would change. Obviously, the absolute one, where the absolute dollars are going and they’re concentrated in Europe, that would change considerably, bur for the percentage of GDP, which is the most important thing, I think, in terms of the development impact of these institutions, that picture would not change. And on the other question, the triple A requirement. Now, that’s quite interesting in whether, you know, if the World Bank is double A one would it still be able to operate well. The model that these institutions have is well, if we have a triple A rating, we can borrow at the lowest rates of any borrower in the world and in fact, their rates are indeed, in fact they’re proud of it, you know, how low their spread is over US treasuries or whatever. I mean, it’s almost, sometimes it’s practically zero. And we can borrow at very low rates in the markets, issue our bonds and therefore we can lend to these countries at also, what is below market rates and that has a development impact. So, that’s their reasoning on why a triple A rating is very important. If they were a double A one, they would of course be able to borrow in the market, but would probably be marginally higher in terms of the cost to them and therefore they’d have to pass that on to the developing countries that are borrowing from them and so, they would continue to operate, but perhaps be less effective in their development mission, that’s what they say. And without naming names, I can say that a number of like treasurers of these institutions have told us well, “We must remain triple A, that’s our, we would never do anything that would jeopardize our triple A rating”, but the reasoning is, because of the development impact they can have by lending at cheaper rates because they can borrow at very low cost, that’s

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the reason that they sort of insist on the triple A. We had another one of them say you know, they call us from time to time and say “Well, we’re thinking of issuing this kind of debt and what would that do in a rating sense” and if we tell them “Well, we’re not so sure”, they say, “We will never issue a bond that is not rated triple A”, you know never. So, they’re very committed to this model and for the reasons that I said. In the market I don’t think it would be a big problem, you know, in the bond market they can still sell the bonds.

Domenico Lombardi: Yeah, that’s my point. Hongying. Hongying Wang: Well, I just wanted to bring in maybe an additional factor here.

The Chinese are very concerned and very well aware of the importance of getting a good rating. In fact, Chinese officials have already said to people like Moody’s, “You better give us a good rating, otherwise we’re going to turn toward our domestic market to raise the funds for these new banks and their projects”. So, they certainly know the importance and they would like to have a good rating, even though it’s kind of early on what basis do you rate these newly established banks and the AIIB hasn’t really officially come into being yet, the MDB has. Something I wanted to bring to our attention is that the Chinese have already talked about, for quite a few years, the unfairness of western rating agencies. They said look at our Chinese bonds, even the city bonds, the corporate bonds. There have been very few cases of default and look at the US, why is it that they get all these high ratings and we’re not rated or we’re getting below, you know, whatever rating. But I assume that’s an area where China will come up with its own solution in the not too distant future. Already there is a Chinese led rating agency with cooperation from others that they perhaps, at some point, would make that an issue. Well, if you don’t rate us fairly, we’re going to maybe develop a different mechanism, taking into account local conditions, maybe compete for that part of financial governance.

Domenico Lombardi: Adam. Adam Posen: Thank you.

Before I respond to the two questions Domenico rightly set, let me just say something about what Hongying just said. I’d encourage our colleagues from Moody’s to give us something to put on the website. We always do an event report and show all the links to all the materials which everybody’s provided. Something about either in general how you rate the

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MDBs or what would be the applicable plans for eventually rating AIIB. Whatever you have publicly available. I am a little less worried about, than Hongying sounds to be, about the Chinese complaining about unfairness and going domestic. I heard Japanese complain about unfair rating agencies, I’ve heard Greeks complain about unfair rating agencies. I’m not going to say that ratings agencies always get it right. We’ve even published some stuff in the past by Bill [inaudible 01:12:03] and others suggesting they don’t, but the idea that the ratings agencies are somehow western and hugely biased is something we’ve heard repeatedly and then, we’ve seen Japanese municipal bonds and now Chinese city bonds be a little shaky. So, anyway just to say, I think, it would be useful, we’d be happy to include it in the event to just provide just some documentation about how you do this. In terms of Domenico’s two questions. Let me be blue sky even further than I was in my remarks. I think the issue of the long-term investor that was raised by Domenico and addressed by my colleagues on the triple A’s I think is really interesting. And again, let me emphasize, we live in a world where all kinds of savers and investors and long term investors, of insurance companies and various pension funds either want to or are legally required to invest into things that are triple A or close to triple A. And yet, as a result of, oh, I don’t know, things like AIG financial products, there aren’t that many triple A things out there anymore. And that seems is true for sovereigns, at least as much as we’ve discussed at previous events of this sort. And so, the idea that we can create a world, or not a world, a set of additional assets or expand the assets that meaningfully are triple A, which I think legitimately a lot of the MDBs can be and which is underscored by Domenico’s point, that unlike everybody else, they can have a rating that is better than where they happen to be setting their headquarters is I think something that would be welcomed by the world community of investors. And particularly in a world where the FSB, as I’ve said on other occasions and [inaudible 01:13:44], our colleague has also said, is creating all kinds of rules that punish long term investors and that shove them into low return US, MDB availability, MDB balance sheets, MDB bonds for sale. The second point is just about the question of, that Andrew Steven just kindly raised in his charts, Steven Andrew, that we have this weird thing, or not so weird when you think about it, but this odd looking thing of the Europeans and real money terms of providing a lot more money to their region and whereas of course, in percentage terms of local economies, the African distribution is much higher. I would just offer two points on that.

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The first is, I do have some hope that the private sector will begin to fill the gap in Africa more than it has. Tomorrow, our colleague Paolo Moro is going to be presenting some work that he’s been doing on long term income projections and he’s obviously not the only one, but that there is a real demographic in income future for Africa that is starting to attract notice and so, while there are a lot of places the private sector won’t make up for things, maybe in Africa we can see some hope of that. The second thing though is, and I’m going to offend some people here, but just as we can have new multilateral development banks, maybe some multilateral development banks can go, if new ones come, others can shut. In other words, maybe the EBRD was supposed to take seriously, it had a sunset provision of sorts when it was set up, and maybe now that Bulgaria and Romania are pretty well off, it’s one thing they can go into Kazakhstan, but of course, the Asian Development Bank and the AIIB are also going to go into Kazakhstan. Kazakhstan is oil so, pick a different -stan. Maybe their research department has a tracking of transition, it’s a very useful thing and should be maintained, but we should not be just talking about MDBs, new MDBs, additional MDBs, we should be willing to countenance, eventually the closure of MDBs, just like there really isn’t an MDB for North America at the moment.

Steve Hess: There is the North American Development Bank and that’s the only MDB

that makes loans in the United States. It’s very small, but it does make loans in the United States and it’s the only one.

I’d like to reinforce the point that you made though, about the shrinking pool of triple A assets. I’ve been the lead analyst at Moody’s for 19 years now, for the IBRD, the World Bank and I would say, for the first dozen years the phone never rang, no investors were interested, because of course, as I said, their borrowing costs are so low that the return on those bonds was not worth thinking about from the investment community. All of a sudden, at the time of the global financial crisis and thereafter, I got lots and lots of telephone calls from investors to say you know, what, “Tell us about this institution, we’ve never even looked at multilateral development banks” and they just wanted to know the basics, it wasn’t like… I mean, these are big global investment banks calling up and saying “We don’t even know the basics so, please inform us about this” because they were all of a sudden considering these as investments.

Domenico Lombardi: Thank you, Steve. So, I would open up if there are questions. Can you

please raise your hands and then state your name and affiliation please. Adam Posen: Can I suggest that everyone from sort of the mid-point back, if they’re

physically mobile go to the standing mic and back and we’ll alternate

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between the traveling mic upfront and the standing mic back. Yes, that means you, handsome physically fit person. Go.

Martin Weiss: That’s the best compliment I’ve had in a while.

My question is for Steve. You mentioned callable capital early in your presentation. I think, as you know in the past run, the last run of capital increase has relied, US and other shareholders relied very heavily on callable capital to fund our contributions. So, in your view, what impact does that have, both on the MDB’s ability to do riskier investments in the infrastructure and more broadly, is Moody’s, and as I know some other investment banks are, looking at how callable capital fits into the rating. Is that something that we should be taking less seriously than we should and if so, what impact does that have on the amount that the banks can lend?

Domenico Lombardi: If you allow me. Can we take questions in group and then the panelists

will address them? Steven Hess: Okay. Domenico Lombardi: So, that was Martin Weiss from the Congressional Research Services.

Randy Henning from American University. Randy Henning: Thanks Domenico. I wanted to kind of follow up. This has been a great

session and I appreciate the presentations that all of you have made. I wanted to kind of follow up further, both on Marty’s prompt and on Adam’s prompt and take advantage of the presence of the Moody’s team to ask Steve to elaborate further on the ratings process for the multilateral development banks and the supranationals.

In light of the debate over AIIB, there are a couple of particulars I’d ask. One is, how much importance do you place on transparency of these institutions when considering the ratings, and in particular maybe transparency with respect to the contracting process in these institutions. And secondly, do you assume that the bonds issued by these institutions are always going to be senior to bilateral official debt and junior to the International Monetary Fund? What is your assumption with respect to the seniority of these issues?

Steve Hess: [inaudible 01:20:15]. Randy Henning: Yeah. Sure.

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Steve Hess: It all seems to be MBDs. But, the callable capital question and the question of ratings methodology go together, I’ll just say very briefly, and we may want to put the ratings methodology on the website in response to what Adam was saying earlier, but it is on our website. We have the methodology, as I said earlier, published about 3 years ago and in that methodology we have 3 major areas.

First is capital adequacy, where we don’t include callable capital. So, it’s a standalone assessment. And then, we have liquidity. We put those two, in other words, holdings of liquid assets and we put those two together and come up with what we call intrinsic financial strength. So, we’re just talking about paid in capital, you know, the real equity that they possess. Then, after the intrinsic financial strength assessment, we add a third factor which is called member support. And that’s where callable capital comes into play. And we, actually they will have a nominal amount of callable capital, but we then look at the average shareholder rating, in other words what’s the probability that these guys will come up with the callable capital and so, we discount the callable capital by that amount and we scale it against their debt. So, that’s the way we include callable capital and so, a lot of these institutions will have very high intrinsic financial strength. So, member support almost doesn’t matter in that case. Some of them do get uplift however because of the strength of the members and the existence of the callable capital. So, that’s a very short summary of how we look at that. The bonds are not senior. The bonds that the institutions issue are not senior to other bonds in the market because that’s in the market. What is senior in a certain way are the loans that MDBs make to say governments, and we’ve had instances of that where, you know, a government will default on its commercial borrowings, its bonds, but it will not default to the MDBs. And that’s what we call preferential creditor status. So, there’s evidence and we’ve seen it, that there is actual preferential creditor status, but on the bonds side, you know, the World Bank issues bonds, those aren’t senior to, I mean there is no seniority because I mean they’re in the bond market. So, that doesn’t apply. Now, transparency. I would say in general. The transparency of these institutions is quite high, at least we get all the information we need and I think maybe some of the various smaller ones in Africa or whatever are a bit less transparent and we do consider that. If we don’t think we have enough information when we’re considering the rating, but in general, it’s not a big issue for these institutions because they are very well governed and transparent. Now, the question becomes of course in the case of AIIB, well, it’s brand new, and so you can say well, their articles of agreement and all of that are looking good, but we don’t know how they’re going to operate because there’s no track record. Of course, we haven’t been asked

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to rate them yet, so we don’t have experience directly, but I think a lot of commentary on this and one of the reasons that the US initially had its doubts about the AIIB was precisely well, one of the aspects was probably transparency. But, we’re neutral on that, because we don’t know yet.

Domenico Lombardi: Great. Thank you, Steve. So, we have the lady to my left. And then, we

have two questions over there. Denise Carpenter: Thank you. This is Denise Carpenter with the Commerce Department.

This has been fascinating.

My question really has to do with China and its status as a borrower and a lender. They’ve graduated from AIDA, but they still get quite a bit of money, probably $1 billion a year, plus from both the World Bank and the ADB for projects in China and I wonder if they borrow to build roads in China, but they’re doing a lot of bilateral lending and now they’ve created this new development bank in the AIIB and I wonder if there should be a call, or if there has been a call, for them to be graduated completely from these institutions, given that their role is, you know, increasing in terms of their lending capabilities, should they still be able to borrow at the levels they’re borrowing, when there is still so much need for infrastructure in other countries?

Domenico Lombardi: Thank you. We have two more questions from there and one final question

from table number two and then we have to wrap up. Shahid Yusuf: Shahid Yusuf. I was at the World Bank for a very long time and for almost

20 years what one heard repeatedly was that the bank had become irrelevant, that the private sector, the private financial markets could take care of everything and that these multilateral institutions were really on the way out. But, now all of the sudden, for the last couple of years, ever since the AIIB and the BRICs Bank have come on to the scene, this kind of concerns have seem to have evaporated. All of a sudden we see an enormous gap out there in infrastructure and so on, which needs to be financed by somebody and clearly the private sector, the private financial markets seem incapable of doing so.

So, I’m wondering why the sudden switch. Why all of a sudden we see a big gap out there which the multilateral development agencies can try and fill?

Domenico Lombardi: Thank you. So, one more question. Vikram Nehru: Thank you very much. I am Vikram Nehru from the Carnegie Endowment

for International Peace.

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My first question is that nobody on the panel so far has remarked on this initiative by Nakao [san 01:27:25] and the ADB to collapse the balance sheets of the Asian Development Fund and the OCR into one balance sheet which will allow them additional leverage and apparently they consulted with Moody’s before they finally did that, which will allow them to increase their leverage by about $100 billion I understand. It’s one of their competitive reactions to the AIIB. So, I’d like Steve to just let us know the thinking behind how this in no way affected the triple A rating of the ADB and whether this is something therefore that the World Bank could emulate, bringing together IDA and EBRD balance sheets in a way that will potentially increase the leverage of the World Bank. Secondly, the panel has not remarked on the whole guarantee process and to what extent would the panel recommend a more aggressive, or should I say less timid, approach of the MDBs towards guarantees and how would this be reflected in the analysis of Moody’s? Thank you.

Domenico Lombardi: So, one last question and then we will revert back to the panel. Gary Litman: Thank you. Gary Litman, US Chamber of Commerce.

Is there a way to asses or estimate the economic gains to China from lending through the new bank that they’re setting up, or for that matter, for other creditors who may participate there?

Domenico Lombardi: So, we’ll start with Steve and then we’ll… Steve Hess: I’ll try to be brief, because we’re running out of time here. As to the

question on China and why it’s still borrowing from these institutions, it is a good question in my mind, in the sense that they’ve got $3.5 trillion in international reserves, why should they need to borrow from these institutions. And if you ask them and you ask the institutions, and we’ve done both, they say that “Well, we just actually on lend this and we, to provincial projects, right, we’re not borrowing it for the purposes of central government financing, we’re on lending to provincial projects” and what we value from the World Bank and others is their technical assistance, in other words the advice that they give us on these projects that are on the local level. We value their technical assistance and of course, the IFC, the World Bank, they do do a lot of technical assistance to these countries and they apparently do value that.

I mean, it’s obvious that China in the macro sense doesn’t need the money, but that’s what we’ve been told about why they continue to borrow, and China is near the top of the list of the borrowers from these institutions in terms of the dollars.

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Yes, the World Bank balance sheet was actually shrinking before the global financial crisis and there was the question, you know is it now irrelevant and all of a sudden, they got a capital increase and they started lending more, because of the global financial crisis. And so, yes, the relevancy still seems to be there and Adam was saying EBRD might be irrelevant and that question has been around for years and all of a sudden, their balance sheet also has gone up and it’s not because of Bulgaria and Romania, it’s more Central Asia and you know, Georgia, Armenia, those kinds of places. And so, yes, the question should they close has been asked. ADF, moving in to the ADB, they took a different strategy. You’re asking basically about shouldn’t the World Bank do the same with AIDA. There is talk, although I have no idea what the result might be, that you know, they will actually, AIDA has rather large financial resources, convert those into capital and make AIDA more independent rather than merging it with the World Bank. Now, whether they do that or not I have no clue, but that’s the talk, they don’t seem to have the same strategy that the Asian Development Bank had.

Domenico Lombardi: Just very briefly. Steve Hess: And as on guarantees. Well, there is MIGA out there. So, there are

guarantees and MIGA’s rating is based totally, it’s guaranteed business basically. There are a few other MDBs that specialize in guarantees. The large ones give some guarantees, but it’s not a big part of their business.

Domenico Lombardi: Thank you very much, Steve. I think we are running behind schedule so… Adam Posen: Why don’t each of us make one comment that’s supposed to… Domenico Lombardi: Very briefly. Adam Posen: What’s the most important thing you want to add? Hongying Wang: Oh. Well, I would just add that the World Bank makes loans to China also

because of the good performance. The World Bank doesn’t just, I guess, run around and necessarily give the loans to those who need the most, but they’ve always been very happy with how the loans in China have performed. So, there’s a supply and demand for that.

Adam Posen: And just a response to Gary on the benefits of these kinds of lending

programs to the stakeholder countries or the lending countries.

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I know Washington and people always want a number and it would make life easier to be able to go to Congress and say there’s a number and I’m sure there’s someone out there who will give you a number. I’m not trying to make fun of you, I’m making fun of our process and Washington. We’ll tell you that precisely $252 billion in gains accrued to the US over the period such and such. I think it’s better to frame that as a deep intellectual question. What happens long term to trade patterns, to trade demand, to investment stability, to political stability, to connections between countries that are not necessarily geographically linked and to distortions, the removal of distortions with this kind of lending and then, how does that accrue back to the lending country or the investor country is a difficult question, but it starts getting into things that at least you can break down and be tangible about and then, I would additionally add, I think there is upside for savers in the original countries as few of us have suggested. You expand the balance sheets and the issuance of bonds.

Domenico Lombardi: Thank you, Adam. So, I think we are running behind schedule as I said,

but this is a sign that the discussion has been extremely interesting. There is no time for the summing up, but Adam has already done that. So, there is also no need. I want to thank you Adam, again, for setting this up. Moody’s, for partnering with all of us and for adding some [inaudible 01:34:31] to the debate this morning. So thank you again.

Adam Posen: Good afternoon, folks, and welcome back to our lunch and highlight of

our joint Moody’s, PIIE and CIGI conference on the Multilateral Development Banks: Room for More? We’ve had two very, I think informative and intense sessions with a lot of issues raised on governance, on China, on lending capacity, on specifics of ratings, on the role of the MDBs, on the potential demand for infrastructure. And rather than going back to that, we’re going to broaden it still further. I am delighted that my colleague Simon Johnson has agreed to give today’s keynote on the topic of—I want to make sure I get the wording right—Global Economic Rules for the 21st Century, is that right? I knew the content; I just couldn’t get the phrase right. Simon Johnson, as all of you know, is a senior fellow here, but also, and in some sense, primarily of course is the Ronald A. Kurtz professor of entrepreneurship at MIT Sloan School. Simon is one of the world’s most cited economists and creative, particularly on the issues of development, but also more recently on financial regulation and justice issues related to that. Simon was director of research and economic counselor at the IMF prior to joining the Institute.

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Since then he has become something of a rock star with his fantastic 13 Bankers written with James Kwak and their subsequent book White House Burning on the US fiscal issues. He and James continue to put out The Baseline Scenario, one of the world’s leading economic policy blogs and Simon remains a very influential advisor in domestic debates, including as a member of the FDIC Systemic Resolution Advisory Committee and the Private Sector Systemic Risk Council founded by former FDIC chair Sheila Bair. He and I are together on the Congressional Budget Office’s panel of economic advisers and in addition—I don’t know how he has the time to do everything, but he does—he joined the Financial Research Advisory Committee of the US Treasury’s Office of Financial Research. I know from my colleagues and our mutual friends at MIT that he’s an outstanding citizen and teacher there. He remains a very actively engaged and an outstanding member of our community here and he remains someone who is extremely articulate, forceful and farsighted in thinking about the global financial architecture and now, occasionally linking it to trade issues as seen in his recent op-ed that we are featuring today on the website about US leadership. So, Simon is going to take our discussion of multilateral development banks and embed that in the broader debate over the US role of China’s rise in international governance. I am delighted to have him with us today and then, Anne Van Praagh, our colleague from Moody’s will chair the Q&A on the record following Simon’s remarks. Simon, thank you very much.

Simon Johnson: Thanks, Adam, for the kind introduction and for the opportunity to speak

today. My topic is Global Economic Rules, the rules that govern how the global economy works today and most importantly and I think most interestingly, the rules that will affect how the global economy develops in the decades to come. Specifically, I’d like to talk with you about three relatively straightforward questions.

First of all, which global rules matter now and for the foreseeable future? I’m going to argue there are some important rules currently being formulated and hopefully we can discuss that further. Secondly, as my friends and former colleagues from the IMF like to say, who holds the pen? Who’s in charge of—who has the initiative? Who frames the issues? Who does the drafting of these new rules? And thirdly, what exactly is the process through which these rules emerge? What you should be looking for? Is it some sort of big deal, a large conference or a series of conferences? Or is it a much more subtle and incremental process?

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The main issue though, I have to say that fascinates me is the one that you’ve been grappling with directly and indirectly all morning which is US leadership in the world and the effect of the rise of China on that leadership. Does the emergence of the Asian Infrastructure Investment Bank, for example, challenge the United States? Does it mean that global leadership has perhaps already shifted away from the United States? Does the US response or lack of response to the AIIB represent a bigger shift in global power that we should be spending more time on? Now, I think it is very hard or impossible to have any discussion of global rules without going back a little bit in history and talking at least for a few minutes about 1944 and the system that emerged after World War II. Now, I know you all know a great deal of history so I’m going to be brief in this part of my discussion. But I think there are a couple of points worth making and I’m going to come back to those by way of comparison later on. So, taking my three specific questions. What were the global economic rules that mattered in 1944 as the end of World War II approached? I think we’ll agree that the most important rules were about finance and specifically about international finance, how you make payments between countries—what we now call current account convertibility and related issues. And also, of course how it would be possible for a country to finance imports larger than exports, finance the current account deficit in a way that was sustainable, in a way that was fair, in a way that over time they would not build up unsustainable debts. Now, the context for thinking of those rules of course was fairly obvious. Europe and other countries needed to be rebuilt. This would require a great deal of capital. It would also require an ability to import more than export for the foreseeable future. So, on what terms could devastated economies with uncertain prospects borrow? And of course, the backdrop to that was how could the world avoid a repeat of the debt default disasters and competitive devaluations experienced during the 1920s and 1930s? Who held the pen in 1944? Well, it was the United States, I think, to a large degree—not the United States alone and not the United States unilaterally imposing its will on other countries. If you go back and look at how the ideas that became Bretton Woods, the Bretton Woods Conference emerged, it was very much about British-US interaction. It started with a conversation about how to pay for British imports of war supplies and it became a discussion about exactly how the international payment system would be structured subsequently. I have to say that Anne has pointed out; I do still have a residual British accent. I had forgotten all about it until she told me that. But I am an

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American so, when I say we, I mean we Americans, when I say the British, I mean those other people. The British put up a good fight and Lord Keynes of course spent a number of years, the last years of his life actually fighting really hard to propose alternative arrangements in which the dollar would not be as central a feature of the payment system. But ultimately, the Americans got what they wanted – an end to privilege trading arrangements within empires or if you prefer slightly more modern language, the establishment of the principle of non-discrimination against American goods in Britain and throughout the British Empire, as well as obviously in many other countries. This was the end of the sterling as the leading world currency and the replacement of the dollar and it was also the end of Britain in its former role as a dominant financial power. What was the process through which these roles emerged? It was very big set piece negotiations culminating in the 1944 Bretton Woods Conference. A lot of things had been worked out prior to that of course. The Bretton Woods was very important and Bretton Woods was certainly at some level an attempt to be inclusive. The Soviet Union, I would remind you, was at the Bretton Woods conference and if you look at the original articles of agreement, there is an allocation of quota to the Soviet Union. They chose not to participate. They decided that they didn’t want to follow that route. And countries subsequently could participate on I would say mostly a take it or leave it basis. You could join this club or not join the club. Over time, perhaps the rules have shifted, but not that much actually. Taken as a whole, this new set of global rules codified the rise of the United States as the predominant market economy in the world through acts of deliberate design and based on its unassailable position at the world’s leading creditor, the US helped its allies back on their feet and this made a major contribution to economic recovery and growth over the decades. As this is a lunch talk and you’re all struggling to stay awake, I felt I should bring in some quotes from Yogi Berra, the great baseball player who very sadly passed away. There are a lot of Yogi Berra quotes and I’m sure you can find better one to fit this, but for the three—I have three sections of what I’m going to say today and for the first section the decisions that were made in 1944, I think Yogi Berra would have said when you come to a fork in the road, take it. So, they did. Now, the world has obviously changed a lot since 1944 and you know, perhaps looking back, you might want to say that it’s been a great success

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and perhaps an unparalleled success. But at the time and certainly in almost every decade, there have been many people who believed that the US had lost its leading position as a world economic power. The first time perhaps was in the 1950s. Remember the Soviet Union launched Sputnik in 1957. Many people thought this heralded the end of US dominance in many ways. I think the US very clearly won that competition. In 1970s, the fixed system of exchange rates broke down and that was extremely traumatic and people, I think with good reason, were convinced that this was the end of the dollar as the center of the international payment system. It wasn’t actually. Holdings of dollars today are much greater than they were in 1971. In the 1980s, Japan was widely regarded as being on the verge of overtaking the United States in part because of superior manufacturing techniques but also because they ran a persistent current account surplus and accumulated assets around the world. I was a graduate student at MIT in the 1980s and you could attend the classes—I didn’t actually attend them, I only watched them through the window—but you could attend classes where I think you held hands and learned by holding hands. I don’t know quite how that worked. Japanese manufacturing techniques, like just in time delivery and so on. These classes don’t exist anymore as far as I’m aware at MIT. And Japan is number one with no disrespect intended, including to the person who wrote the book, called Japan Is Number One. It’s not now an idea that I think you would take very seriously. In the 1990s, the launch of the euro was considered likely to propel Europe to greater global prominence. Today, the European economy is center stage—I’m reading these words carefully, I’ve thought about drafting them—the European economy is center stage, but not in a good way. I don’t mean to be obnoxious about this, but you can think about what’s happened in Ireland, Portugal, Spain, Cyprus or Greece repeatedly. And while I’m sure that Europe will recover and Europe remains a very important part of the world economy, the idea that Europe will displace the US in terms of global leadership seems like more of a stretch than it did two decades ago. In recent years of course, the discussion has been much more about China and the question of whether China can displace or take over some of the US role at the international level. Naturally, the discussion has changed a little bit in recent months away from a focus on rising Chinese economic prowess towards ways in which the potential disruptions of the Chinese stock market can affect US markets and the rest of the world. Now, China matters, don’t misunderstand me and again, I’m not at all trying to be disrespectful and I do think we should take elements of its

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economic policy seriously, including how the exchange rate of renminbi is managed. My favorite book on China’s potential for becoming a world power is Arvind Subramanian’s book Eclipse, Living in the Shadow of China’s Economic Dominance which is a bestselling Peterson Institute book published in 2011. They’ll be happy to sell you one at the front desk if you don’t already have one. The author, our very good friend, Arvind Subramanian is now chief economic advisor to the Indian government and hopefully they are listening to his well-crafted advice about how China grew through exports of manufactured goods and associated productivity improvements. China became integrated into global supply chains producing things for companies elsewhere on a scale previously unimaginable. And Chinese managers learned how to make better products. And while I’m plugging Peterson Institute books and as Nick Lardy is looking straight at me, you should also buy his book on the private sector in China. And don’t believe me, believe The Economist survey that came out in the mid of September and I think this is a fantastic and absolutely compelling story. But I don’t think, and you can push back after I’m done, but I really don’t think China is now running or likely too soon run the world economy. And I don’t think the Asian Infrastructure Investment Bank is a tool that will propel them to that dominant role. In 1944 perhaps it would have been a different discussion, but that world is long gone. The amount of private capital flowing to developing countries is much larger now obviously then it was in the 1940s. And the cloud or the sway that you get from these multilateral development banks is consequentially considerably smaller. And I thought this was a nice point that came out in the Moody’s report that the multilateral development bank lending matters a great deal for some countries that we should care about. It’s a large part of GDP for some low to middle-income countries. That’s an important point and I hadn’t fully realized those details. So, thank you for that in the report. But, at the global level, is this a large amount of capital that really moves the political debates and helps to set the rules? I don’t think so. So, with regard to the decline of US dominance and the repeated reports that the US is finished as a global leader, I think Yogi Berra would have said, “It ain’t over till it’s over.” So, you don’t seem to be very keen on baseball. Perhaps I should have brought soccer metaphors or something for a more global crowd.

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So, the third point, the third section of what I want to say is about the US and global rules today. What are the rules that matter for the world economy looking forward? And I think the interesting difference to my mind is if you look back in 1944, the US really needed other countries to get on board. Now, global rules obviously work better when they’re adopted by more countries, but the essence of the problem in 1944 was international payments. How countries would transact with each other at the sovereign level, how they would manage sovereign debts and how sovereigns, creditor countries, would at the sovereign level contribute to various ways that other countries could borrow. Hence the International Bank for Reconstruction and Development, the World Bank and all of the successor organizations that were built with a similar motivation. But, I don’t think that’s the issue today. The issues today I think are threefold. And they’re all issues that fall very much within the scope of action of the US government, the US authorities. Sometimes I have to correct my, our foreign students and visiting executives when they talk about the American government. I don’t think there is one American government; I think there is a number of them. But, the American authorities have great sway over these policies and over these rules. Before I get to that though, just one point and I think Adam had to step out, but you can tell him, Mark, that I agree with him on this point which is what’s the motivation? What do we want these rules for? How does our motivation today compare with 1944? I think it’s very similar. Adam had a piece in The Economist recently debating whether or not we still want growth at some big world level and there are arguments why you want to be careful about the nature of growth and you want to worry about the sustainability of growth. But I think we want jobs in this country; we want jobs at decent wages. There are many people who want to be lifted up and that has been a major contribution of the US to the world in the post-war decades—the ability of the US to grow and to have a market to which other people can have access and a market to which you can sell relatively easily. But here are three sets of rules that matter a great deal that are currently in flux and that could potentially go, I think, either way in terms of being pro-growth and in terms of being a helpful contribution to the nature, the inclusive nature of the world economy. The first set of rules is about financial regulation. But this is not finance as in 1944. This is not cross-border payments. This is about the rules for banks, the rules for financial intermediation. And you know, frankly, I think we got these very badly wrong in the run up to 2008 largely because we forgot the lessons from the Great Depression of the 1930s. Please, no one get defensive, I’m not trying to

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point out a particular finger at anyone, I’m not trying to play a blame game here, but after the 1930s the US adopted the principle of having equal access to markets, of having a great deal of investor protection and having a great deal of disclosure around the way firms revealed information particularly to smaller investors. Strong capital markets, strong, fair competitive capital markets were an essential part of the US post-war growth and that’s not what we had in the early 2000s. That’s not what mortgage-backed securities were about. And it’s not how consumers were treated, including people who borrowed to take out a mortgage on their home. The bigger picture there which I’ve written in the book 13 Bankers with James Kwak that Adam kindly mentioned, the bigger picture in our view is that starting in the 1930s we deregulated many parts of the American economy, some of that made a great deal of sense, but with regard to finance or financial services, deregulation went too far. There was a race to the bottom, for example, with regard to two issues I want to focus on or at least mention. One is capital and the second is consumer protection. On the side of capital, equity. How much loss absorbing equity do you have in your balance sheet, an issue that Moody’s obviously cares about a great deal when they look at borrowers? It is a matter of fact and of history that some of the largest brand name international banks ran their businesses in the 2000s with as little as 2% loss absorbing equity. So, they had on their balance sheet, they had 98% debt and 2% equity. Well, if the value of your assets takes a hit and I don’t think you have to be much of a great economic forecaster to anticipate such shocks in the future, 2% equity gets wiped out very easily. Others, much stronger international banks that are now regarded as having a prescient had 3% equity, also, not very much by way of loss absorption capacity. The system of risk weights and I know there are plenty of blame to go around and I’m not trying to point a finger, but the system of risk weights which was developed on an international basis as perhaps not quite a rule, but a guidance in an attempt to have convergence in rules across banks. The system failed completely in the past decade, not just once on mortgage-backed securities, but twice. The second time would be European sovereign debt. We got the risk rates wrong. We got them wrong in the private sector. We got them wrong in the government sector. We got them absolutely wrong in the academic sector. So, now we have new rules, now we have committees, now we have committees within committees and probably committees within those also. And according to the very careful analytical work of Tom Hoeing who’s the Vice Chairman of the FDIC who publishes this work in a private capacity, loss absorbing capital measured correctly, tangible equity

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relative to tangible assets is now up to around 4% for many international banks whose names I am protecting but you can look at them on Tom’s website. Now, has capital increased? Yes, from 3% to 4% for many of them. Is that a big increase? I don’t think so. I think that the right way to proceed though going forward is what I hope the Federal Reserve is doing which is to impose a steeper graduation of capital requirements and associated regulations so that the very large, let’s call them mega banks which pose the greatest potential systemic risk to the system face higher capital requirements, broadly construed. The regional banks in the United States, and we have a very vibrant regional banking sector which has actually done remarkably well in the past five years, they’re say between 50 billion and 500 billion in total assets or total risk exposures, they are subject to somewhat less by way of capital requirements. And community banks below 50 billion or below 10 billion in total assets are subject to even lower capital requirements. The great thing about community banks of course is that they can fail. They do fail all the time and when they fail, they do not bring down the economic system so, their shareholders and their management is very much on the line. That is of course not the case for the largest banks. So, there’s a lot of work to be done and I don’t think it’s over and I do know very well there’s enormous pushback against the system of graduated capital requirements. Many arguments have been made every day in Washington and this will be a feature of the presidential campaign, I don’t know how explicit will it be. Ask me again in 2017 what’s going to happen, but I am on some days cautiously optimistic that we’re moving that in the right direction. On consumer protection I would just say this. You know, there are many people including in industry who like to complain about the Consumer Financial Protection Bureau, the CFPB. I see it as a huge potential competitive advantage of the US economy just like the Securities and Exchange Commission was such an advantage in the 1930s. Equal protection, disclosure, a level playing field the investors was incredibly good for the development of the US capital markets. There is no way that anyone with a sensible, reasonable business model should be happy that their competitors are able to rip off, deceive, mislead consumers. That’s not what we allow in the non-financial sector. That’s not what we allow in any kind of product which is relatively more transparent and all of us as consumers see through directly, including the fruit you buy on a weekly basis at the grocery store. It’s not acceptable

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and not a good way to organize the economy with regard to financial products. Here we’ve made some progress. Now, there is a lot of push back also against the CFPB and you have to ask me again in 2017 where this is going to land, I don’t know completely, but I am again cautiously optimistic on some days that we’ve made enough progress and connected with enough consumers so, it’s relatively hard to undo that. But, know that these are American decisions about the American economy and the American consumer. You don’t need an international agreement on consumer protection and we have plenty of international agreements on capital standards. You can take them and like them or not, it doesn’t matter. There’s enough there as a basis on which the Federal Reserve and other regulators can now build. The second set of rules that matter today are about international trade. And I have to admit that when I joined the Peterson Institute for the first time in I believe 2006, I didn’t fully understand the way in which international trade negotiations worked and I, like many people, were focused on the multilateral trade negotiations and their lack of progress. But, I have become convinced in part by my colleagues and in part because many of my colleagues have been very involved in this process from the beginning that there is underway a very important set of agreements and obviously negotiations. The Trans-Pacific Partnership is the one that’s the most prominent currently, but also, the Transatlantic Trade and Investment Partnership, the TTIP, the potential free trade agreement between the United States and the European Union. These are not trade agreements of the post-war variety. They are not about reducing tariff barriers and eliminating quotas. They are about setting rules. They are about setting rules to some degree for trade, also to a great degree for investment. The US and its allies, if I can use that term, are writing the rules again and there’s definitely echoes here of 1944. But I think it’s accurate to say, I haven’t read the TTIP, I’m not allowed to read it, but I think it’s by all accounts there is a great deal still to be determined in terms of where we end up with labor rights, environmental protection and investor rights to sue government through private arbitration actions. There may also be potential changes with regards to currency manipulation. I’m a big supporter of the proposals put forward by Joe Gagnon and Fred Bergsten from the Institute, but I have to recognize these so far have got insufficient traction within the American political sphere. So, we don’t know where TPP will end up. TTIP is still at a very early stage, but this is going to have a huge impact. In 20 or perhaps 30 years,

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there will be, I think, a large free trade and investment area stretching from the European Union through the United States and into large parts of Asia. Other countries may choose to join or not join, but that will be a different economy, a different set of opportunities and I hope a different and a better set of rules for everyone involved than what we have today. That one is not a 100% in the hands of the United States but we do have a huge amount of say particularly about the terms of TPP today. And if you want a measured and I think detailed critique of where we are on that, I commend to you the views of Sandy Levin who’s the senior democrat on the House Ways and Means Committee, the ranking member. The third issue, very briefly, that matters is perhaps the one that matters most, but also the one that’s hardest to pin down and that’s rules for the adoption of new technology. See, I think what we’ve learned since 1944 is that what trumps everything in the world is innovation. That’s what drives growth. That’s what keeps you as a leader. That’s what keeps the US as a leader. The best-attended talk I ever went to when I was a graduate student in the 1980s at MIT was how to get a green card. It’s still I think the best attended talk on campus, every year. People want to stay here, they want to be innovative, they want to contribute to some degree in startups, but also in established companies. Now, when I think about rules for adoption of new technology, I don’t just think about whether or not we have a favorable environment for innovation and startups. There’s plenty people who want to complain about that. I honestly don’t see that in the data. As a place to start up a business, as a place to build a business quickly, as a place to raise capital, as a place to have an exit liquidity even if you prefer for investors, there is nowhere else comparable. Other places are trying, other places are rising. Berlin will tell you that they’re making some progress. Some parts of China are trying to get in on a similar act. But all those roads tend to lead back to the United States, to Silicon Valley, to Boston, to other places. But in terms of rules, I would want to flag for you, if I may, just I think as an example, but also as a fascinating example and one that may link up across my other themes, efforts to develop the use of blockchain technology. Blockchain technology is a distributed encrypted ledger system used for Bitcoin, the digital currency, obviously a controversial and fascinating topic by itself, but the underlying technology of the blockchain is one in which transactions are verified and shared by a global network of computers.

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Now, this may sound like a marginal issue, it may sound like something peripheral, not of great interest, but for those of you who would like to look at the news for markers around whether we should take this sort of thing seriously, I would like to point out that nine large banks just two weeks ago announced the creation of their own consortium to support the use of blockchain technology in financial markets. These are called the R3 Blockchain Consortium. And another 13 banks just joined in the last couple of days. Some banks are being quite public and moderately explicit about experiments they’re conducting. This is no just about payments and it’s not just about being able to pay people quicker or in a different way. A lot of it is about how you own and transfer the ownership of financial instruments. We use a lot of antiquated technology. It takes a long time to settle a payment, to settle a transaction. None of that is necessary if you build a new system from scratch. Now, what does that system look like? What are the rules that govern it? That’s absolutely a fascinating question. It’s completely up in the air. I think the government will have less to do with this. It’s much more a private sector issue and there’s an initiative at MIT run by the MIT Media Lab with which I’m somewhat connected that is trying to ensure that the public interest or at least some non-commercial interests are represented in that conversation. The parallel is to the Internet. Now, the Internet, you may or may not know how the Internet works, but you use it all the time. In fact, many of you are using it right now as you’re listening to me. I could see you at the back. It’s the same thing with the blockchain technology. You don’t know how that works and you’re not going to care. In five or ten years, you’re going to be making payments, buying and selling real estate, transferring assets in fundamentally different ways. Better ways? Perhaps. Faster ways? Definitely. Will they be ways that are more transparent? Will it be ways in which for example systemic risk is easier to diagnose than today’s derivative markets? Will they be ways that are highly concentrated in the hands of a relatively few players or will it be a much more dispersed technology? Well, we had these issues obviously around the Internet; we had these debates still about the Internet. We will have those debates about blockchain technology. My preference would be to have something, a relatively open, relatively equal access with relatively good protections for everyone who participates. I think, again that’s to me what the US learned from the 1930s, what the US applied after World War II and what really helped to make this economy great. But, the debate is on and the powerful vested interests are of course, want to tilt the plain field this way or that

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way. But it’s not about international. It’s not about getting other people to agree with this. This is about American politics and American policy decision. So in conclusion, does the China now challenge the United States? Well, look, some parts that China has experienced have served that country very well and served as remarkable lessons to other people and I, for one welcome the Chinese efforts to invest in other countries and to establish or comply with high standards of governance as they said that they have. We all have to care about corruption. We all have to care about weak institutions and we all know the dangers that those can bring and as Adam said these are many of the mistakes that we, the United States and those British people have made over the decades. But it’s the US that leads the push for freer trade across the Pacific and for a substantial reduction in various barriers to trade and investment between the US and Europe. The Europeans of course are an important part of that also. I see Jacob looking at me from the back. If we get these rules right, favoring ordinary citizens, this will be a major contribution to global growth and international prosperity. We absolutely can get financial regulation right and we’ve made some steps in the right direction, including I would say Dodd-Frank financial reforms. There is a powerful backlash against them and we’ll see if those reforms withstand the backlash. And we had the potential to adopt a much more open trading system for securities of all kind. That’s the blockchain if we put the right architecture on it. So all of these points matter for the global economy, they matter for the precise nature of growth and prosperity and they matter for US leadership. The US may lose all of these opportunities. There is no question that that can happen. There are many creative people in the United States and we do some good things and we do some things that are less good. And as Yogi Berra said ultimately, well, Yogi Berra saying that I hope won’t apply to us, but it may apply is we made too many wrong mistakes. But they’ll be our mistakes, our mistakes, the US’s mistakes. It’s all unforced errors at this point. The opportunities are there for us, the lesson from our experience and from our history, I think, are relatively straightforward. And there’s nobody else in the world who can take away from us or prevent us from making sensible decisions if that’s what we choose to do. Thank you very much.

Anne Van Praagh: Okay. Thanks everyone for sticking around. We are going to have an on-

the-record Q&A. So, we’ll get set up here on our stage and I think we

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have about 15 to 20 minutes for that. So, we hope you stick around and ask questions. Okay. Okay, Simon Johnson, on the fork in the road and it ain’t over till it’s over and too many wrong mistakes, thinking about US-China relationships, balance of power here. I think one interesting question. You ended your comments with kind of a scoring of how the US stacks up on these various measures. Will banks continue to behave? Will we get the trade agreements right? And this new technology that I’ve never heard of, blockchain technology, would you walk through how you see China on each of those factors and how do you see its trajectory? I think one thing that’s an interesting observation; you know China is in the midst of this rebalancing. The questions still remain about the trajectory, how quickly this rebalancing will occur, whether it will be stop-start, how bumpy it will be. The stock market interventions this summer pointed to a more bumpy ride than a smooth ride, perhaps a detour in their efforts to bring more market-oriented reforms to the economy. I think there is a certain amount of impatience that people have that today’s media-hyped world has about how much time China is sort of given to think through this transition and this rebalancing. The efforts that it’s making to shift its bond markets or reforms that took—in the US, they took decades and they are being pushed and pushed pretty quickly. Same with capital controls, loosening up of the capital account, reforms that are happening pretty quickly. So, how should we think about these items that you laid out and on what time frame should we expect China to attempt these kinds of things?

Simon Johnson: So, on finance obviously the Chinese financial sector has its own

particular issues to work out and precisely what the government ends up supporting, what it doesn’t support is going to be a key decision that they have to make.

But the point that I’m trying to make is that in terms of the strength of the global economy and the strength of the US economy and our contribution, it’s about how our financial institutions operate, it’s about the rules that govern for example, capital and consumer protection and there’s not much China can do one way or another that affects our choices there. I hope they have a more stable system. I hope that they can sort out their problems without that causing further or any disruption to their growth. But, that is a somewhat isolated decision. Now, on terms of trade, of course, a big question that my global trade strategist friends here think about a lot is whether China would at some

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point choose to join the TPP and what would that look like? And I don’t think we have any strong, you know, definitive indications on that. Those of us who think that currency manipulation or language to discourage and as much possible prevent currency manipulation should be part of the TPP and we’re not winning that argument, but those of us who still continue to argue that do so in part because we think that China, it’s not just about China, but China has in the past managed its currency in ways that were damaging to the global economy, damaging to the US in terms of the kinds of jobs that we lost. And that should be discouraged in the future and by setting those rules in TPP, you’re setting an expectation for the behavior of everyone who joins, including potentially China. So, we’ll see if China chooses to go a different route and China chooses to build its own trade block for example. I think though the TPP, particularly when you join the Dodd’s or the TTIP, becomes more compelling to more countries around the world. On the blockchain technology, it’s interesting that the Chinese do participate in that. The Chinese have some significant firms that contribute computing power which is a key part of how this distributed network runs. But in terms of the debate and discussion about the structure of blockchain and how it’s used for financial markets, this seems to be a lot about the US right now. The UK is also present in that discussion, London would like to be a center for the development of this technology. Perhaps the Europeans will get in on that. I don’t think we’ve seen any definite signs of that yet. It is a technology that can have applications in many places and it is a technology just like mobile phones that may confer some, if not advantage some possibility to leap frog. If you don’t have fixed lines and you go straight mobile phones, you can do things differently. So, blockchain has substantial potential for impact in the development sphere also. But, we don’t yet see a Chinese influence over the structure of that, of those marketplaces.

Anne Van Praagh: And how about banking regulation, how do you see things developing in

China? Or you want to comment on the state of the banking system? We have enough visibility into that.

Simon Johnson: No, I don’t want to comment on the Chinese banking system. You know,

clearly everybody who goes through any parts of economic development has to establish resilient and robust regulation and the center of that is capital and having enough loss absorbing capital and I cannot hold out the United States as an exemplary model for that in recent decades. But, the Chinese are figuring this out.

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You also have to figure out and again, the US had many problems with this and so the Europeans, you have to figure out what is supported by the government and what is not. So, if a large bank fails today in the United States, who gets what kind of protection from the Federal Reserve or from the FDIC? Who suffers what kind of loses? You obviously think about that a lot at Moody’s and you know that it’s very complex and evolving. The Chinese had figured that out too and it’s only when you have stress situations and when there is political pressures to provide bailouts that you really understand what is going to be supported and what isn’t. So, I’m optimistic. Ultimately they will make some progress on that but it’s still pretty early days.

Anne Van Praagh: Okay. Well, let’s open it up to our audience. We’ve had a lot of

interesting, thought-provoking comments here from our friend. Perhaps people have questions at this point.

Female Speaker: Thank you very much. I really liked your comparison between now and

the 1940s. So as you were reviewing the rule setting in the 1940s, one of the things you mentioned is the US was a major international creditor and that no longer is the case today with China being one of the largest international creditors in the world, certainly one of the largest to the US, if not the largest. Do you see that still being relevant at all, being a creditor in terms of exercising influence?

Simon Johnson: Well, being a creditor clearly matters for something. So, having a large

amount of net reserves for example matters. Think about how people would be discussing China today if China didn’t have very much by way of reserves. In fact, there are people who are saying that the reserves they have are not sufficiently substantial. I’m not in that camp. So, clearly it affects your individual position as a country and that then affects your role relative to the international discussion relative to the IMF and so on.

What I don’t think it does is confer the kind of advantage at the global level that the US had in the 1944 where it was all a question of to whom will the US lend and on what basis and that was what the Word Bank was about, that was what the Marshall Plan was about. The IMF was of course a little bit more an attempt to balance between the creditors and the debtors and provides some additional balance and payments lending under some relatively short-term circumstances. But, the world was very much about official credit and who was able to make a loan and who was more likely to have to borrow. I really don’t think that an official credit is a bilateral credit or the multilateral credit that’s reviewed in the Moody’s report on the discussion today or any new forms of official, sovereign lending, the sovereign as the

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creditor, that that really makes so much difference it will confer so much power. And obviously, there are many people who say that the large Chinese holding of US treasuries confers some sort of power over the US. I really don’t see that. I really do not think that that is anything like the kind of significance that it had in the 1940s or in the 1950s for example, the time of the Suez Crisis which is where Arvind Subramanian begins his book Eclipse. Back then, yes, official credit mattered a great deal; now, much less.

Domenico Lombard: Thank you, Simon. Domenico Lombardi from CIGI. I also like the way

you described the setting for the Bretton Woods Conference at the time, how the US played a uniquely proactive and inclusive role. I would also like to add that at the intellectual leadership provided by the US official Harris White was kind of unique in recent financial history.

However at that time, we were in a world essentially dominated by official

flows. Right now, as you have implicitly reminded us, we are in a world dominated by private capital flows as our friends from Moody’s know well. And clearly we have essentially no international institutions that really have the power of coordinating initiatives in this realm. Indeed, it’s only from the 2009 that the Financial Stability Board has been established and initially was a nonentity with no legal personality. Now, it has the status of a Swiss NGO, but one of the reasons for that is that you know, it’s not a treaty organization because the US Congress would never pass the treaty. Likewise, you know the US was very inclusive at the Bretton Woods conference, but at the time was the uniquely unchallenged super power. Now, it is still the leading power, but clearly the world has become more multi-polar. Indeed, this is why we have the G20 for more than the G7 or the G1. So, I would just like to have your reactions, your comments on this. It’s a little bit of a chicken and egg problem because every time we talk about the US role in global economic governance, we are then confronted by these harsh realities. And in fact, this morning Adam was reminding us of the difficulties to get the IMF governance reform package agreed by the G20 in 2010 through US Congress to date. Thank you.

Simon Johnson: So, Domenico, I think we agree on all these points. Let me just sort of

restate the thesis as a way to check that perhaps we agree fully.

The way I would put it is that there is this strange combination in American political history and political thought and it actually comes from the part of the political spectrum that’s closest to the business community.

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On the one hand they recognize, at a private sector level that the global economy has been very good for them. And while the US obviously had a lot of protections in the 19th century, that’s not the policy we pursued from the 1930s. You can’t find many people in the business sector who want any kind of protectionism today. At the same time and that same general part of the political spectrum which is incredibly influential consistently in the US, there’s a lot of isolationism. So, in 1944, which is three years after 1941, there were many people who did not want to enter World War II, that wanted to keep the US back and it was not an isolated or a single moment. There had been a lot of pressure and a belief in the US as needing to keep separate from European conflict since the beginning of the republic. So, I think that those pressures are still with us. It’s very disconcerting that Congress will not take up even these limited modest IMF reforms and I think a step in the right direction, but a small step and don’t deal with the deeper issues that you’re talking about, but they won’t do that. You know, to your point about you could say lack of political foundation, lack of legitimacy or just weaknesses of the international institutions, I would say yes, that is the territory and it’s not going to change. You’re not going to have another Bretton Woods Conference. You’re not going to have some big recapitalization of the IMF or the creation of a new institution with more powers. What you are going to have is private capital flows and those private capital flows are absolutely influenced by rules and I’m suggesting that this is not a hopeless throw-up-your-hands situation. The rules we make in the United States can have a lot of influence over how we are impacted and how that affects the rest of the world. Now, how the Chinese run their financial system is, I have to say, their business completely. And they can either you know, they’ll learn some hard lessons just like we hopefully have learned our hard lessons. So, I’m not trying to fix the world’s problems and I don’t think an international treaty or attempting in that direction is particularly promising, but getting our own rules right, at least, and maybe we could find more of those rules to go through, that is a very constructive opportunity and it’s one that private sectors should welcome too. I don’t think anything I said is at all anti-private sector. There are some particular vested interests who would not like no consumer protection for example. All right. We do have to get over that and that is a big hurdle, but despite the odds we have made some progress on that so, I don’t think I can be too pessimistic.

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Anne Van Praagh: Let me pick up on one comment that you made. So I think you were really trying to get at what are the new tools and what are the institutions and what are the factors that make the US sort of in its position today and what does the future look like there.

In terms of governance, how do you think about functioning of government, the political leadership both for the US and China and how would you compare and contrast the two? It seems like you know, this week in Washington we were almost faced with a shutdown, that seems to be behind us now. We were looking a couple of months ahead to several continuing resolutions and potentially running out of extraordinary measures to deal with the debt limit. How do you think about governance and smooth functioning of government when you’re thinking about this question of future viability and leadership for the US?

Simon Johnson: Well, I think that you’ve put your finger, Anne, on the key point which is

fiscal stability and trying to create a stable environment for private sector decisions. I think that’s a fundamental responsibility of government. We used to be good at it in this country and I think we’ve lost it. It is incredible that despite the opportunities provided for us by the role of the dollar in the world economy, despite this very impressive track record we have in terms of our fiscal performance and being able to pay our debts that we continue to engage in these games that are fundamentally destabilizing and damaging to our economy and damaging to other people’s economy too. So, I think that is really, really irresponsible and you know, I think people around the world when they look at the US as a leader potentially have many good things to say about the US and that we have many attractive features, including it’s a good place to get a job, a good place to build a career, good place to raise capital. But you know really this kind of action at the level of our government or that was my joke about we don’t have one government, we have many governments, right? That was a reference there, perhaps a little too delicate. I think it’s at best embarrassing and I think it does potentially damage leadership and damage our role in the world economy. I don’t subscribe to the view that we have paralysis in the US. Clearly, the TPP is moving ahead. That’s not about paralysis. Financial regulation has moved a lot in seven years, that’s not paralysis. And I’m not afraid of debate, I’m not afraid of back and forth. I think that’s the nature of the democracy and I welcome every attempt to bring any of these issues into the open in the candidate debates we’re having now for the nominations

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and in the presidential debates. I think that’s incredibly helpful and constructive. But I do think that we should take this global role seriously. And I think that the private sector, the business sector should be demanding of the leadership of this country not to be destabilizing. That’s not good for them and it’s not good for the people they employ and it’s not good for the world. And the Chinese, I’m sure, have similar issues, but let’s leave it at the US.

Anne Van Praagh: Leave that one for now, okay. I think you know, from our perspective our

position on the government front is that you know, as people know we have a Triple A rating a stable outlook on the US government. We’ve had periods of time where there weren’t budgets passed or there were budgets passed. If our focus tends to be on the outcomes then the irony or the paradox I guess is that the outcomes have been pretty good.

So, growth has been better than we expected. The fiscal performance is better than we expected. The debt to GDP numbers, a common metric that we look at for leverage has not risen as fast as we thought it would and it stabilized, at least for the time being. So, for this, at least next part of this decade we see things being stable. Now, as we get later into later years, into the early 2020s, we’ll start to see more pressure on social spending, partly due to demographics, but also just partly due to the structure of healthcare and social security and that will be a real test in our view about whether this divisiveness that we see today is something that can become overcome to address those longer-term issues. I don’t know if you have thoughts on that one.

Simon Johnson: I think you put those points very well. There are some longer-term issues

and decisions to be made that are difficult and we don’t know how that’s going to work through this political system. I absolutely agree with that, but I think my concern, my previous answer was about the unnecessary, potentially destabilizing short-term confrontations which may ultimately end up not damaging our credit rating, thank goodness, but certainly are not helpful to the rest of the world economy, right? Spreads go up sometimes and people can become worried about what’s going to happen in our economy or to our government finances and those highest spreads can affect the private sector and can affect sovereigns in other countries.

And the GAO, I mean, you can argue the numbers on this, but the GAO finds that at least some of the recent confrontations over debt and over government spending have the consequence of pushing up government borrowing costs, at least, you know to some degree. Why is that helpful? Why would we want that to compound or pile on top of those longer-term difficult decisions that we have to make?

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Anne Van Praagh: Yeah. Point taken. Let’s see if there are other topics people would like to

raise. Yes, go ahead. Larry Greenwood: My name is Larry Greenwood. I was formerly with MetLife and before

the Asian Development Bank. You pointed out that in these three cases that US leadership is a natural thing and we should just simply do the right thing, but there are some issues that obviously we can’t solve by ourselves and one was it falls in the third category, introduction of technology and that has to do with cyber securities, cyber theft and those kinds of issues. We just this last week saw some small progress in that area, clearly an area where without cooperation with China, we can’t solve the problem at all, right? So I just wanted to ask, is that an area where we simply need Chinese leadership?

Simon Johnson: That’s a good point. So, I think we need US leadership and it would

certainly go better if we had Chinese cooperation. If the Chinese want to lead in terms of reducing cybercrime, I’m all in favor, absolutely, please if other countries want to take the lead. My point was just that we can and should focus on making progress on our own terms and for ourselves and try to bring other people along with us to the extent that it’s possible, to the extent that they want to join in and that’s terrific.

Anne Van Praagh: Okay. Last chance for questions. All, right. Thank you, Simon. Thanks

everyone for joining today in the conference. Simon Johnson: Thank you.