Why does the world need another development bank?

The Obama Administration has advertised that by using “smart power,” it would enhance U.S. influence around the world. So it’s worth noting an episode in which China is routing the U.S. in economic diplomacy.

Beijing has never made a secret of its belief in chequebook politics, and in recent years, it has spent vast sums in pursuit of its regional ambitions: US$40 billion for a Silk Road Fund to develop trade through Central Asia, US$41 billion to lead a development bank with Brazil, Russia, India and South Africa, billions more in soft loans to countries in Southeast Asia, a “Maritime Silk Road” of ports across the Indian Ocean.

China’s latest venture is the US$50 billion Asian Infrastructure Investment Bank, which is supposed to provide financing for some of the US$8 trillion in projects that the Asian Development Bank estimated the region needs this decade. The Obama Administration has rightly opposed the AIIB, but its entreaties have been ignored.

Since the AIIB came into being last October, it has picked up 26 Asian members, from Bangladesh to Vietnam. Over the past week, Britain, France, Germany, Italy, Luxembourg and New Zealand also signed on, over emphatic objections from Washington.

“We are wary about a trend toward constant accommodation of China, which is not the best way to engage a rising power,” a senior administration official told the Financial Times. The official also complained that Britain had signed up for the AIIB after “virtually no consultation with the U.S.,” though British officials insist they consulted for over a month through the G7, including with Treasury Secretary Jack Lew.

The U.S. is right to worry about Britain’s habit of appeasing China for commercial purposes, especially since London has also abandoned its historic responsibility to speak up for the freedom of its former colony, Hong Kong. But this affair is also a telling indicator of how much diplomatic influence the U.S. has lost, not least with its European allies.

As for the AIIB, it’s worth asking why the world needs another development bank. The World Bank has a long history of mismanagement and tolerance for corruption, and Europeans ousted bank president Paul Wolfowitz because he withheld financing from corrupt regimes. The smaller development banks have been even more problematic.

The AIIB is likely to enhance China’s influence far more than it will help its supposed beneficiaries. Poor regimes willing to stay on Beijing’s good side will earn cheap loans on lax terms, but the bank will promote a version of China’s state capitalism, not transparent markets.

Gresham’s Law applies to economic development: Bad money drives out good. Ports, bridges and other public works funded by artificially cheap capital, with poor or corrupt oversight, become boondoggles that burden states with debt, raise default risks and often stifle productive private investment. The trillions of dollars Asia needs for public works will never materialize unless private investors see reliable, non-corrupt opportunities for returns. Easy public loans that perpetuate cronyism don’t help.

This “smart power” trouncing makes the completion of the pending Pacific trade pact all the more crucial, lest the U.S. cede even more economic leadership to China. Six years into the Obama Administration, the disheartening truth is that the U.S. has lost clout across the world — with its friends as much as with adversaries.

The bank will promote a version of China’s state capitalism, not transparent markets