China's growth model the envy of Africa

China has succeeded in generating abundant local and foreign capital rather than foreign aid.

As China's leaders follow the debate initiated by Britain's Tony Blair of how best to reverse sub-Saharan Africa's slide into wretchedness, they must be feeling quietly pleased with the contrast to their own country. Some 30 years ago, average per capita incomes in sub-Saharan Africa were twice that of South and East Asia - today they are half that level.

While Africa and its donors focus on aid - how much of it, to whom, from whom - the question has never had much resonance in China. In contrast to Africa, and indeed to many other Asian nations, the mainland achieved economic takeoff without being the recipient of vast amounts of foreign aid.

Japan, Taiwan and South Korea received generous infusions of US aid in the aftermath of the second world war. As US allies they also benefited from the boost to domestic demand provided by the Korean and the Vietnam wars.

China, as an avowed enemy of the West for much of the post war period, received nothing from the Western alliance. The country did receive aid from Japan from the 1978 treaty friendship onward. The treaty followed a joint communiqué in 1972 whereby Japan acknowledged the Beijing government over the Taipei government.

The loans and grants flowing into China from then on were contingent on China abandoning claims to war reparations. Giving up the right to reparations was politically tricky, because it meant giving up the chance to use Japan's war guilt for political and economic leverage.

But economically, the policy of reconciliation was far sighted and highly successful. Although China became the biggest recipient of Japanese aid, totaling $22 billion by 1997, and amounting to $1 to $1.5 billion per year until recently, of far greater import was the China-Japan trade the agreement unleashed, predicted to exceed $130 billion this year.

China has also managed to attract levels of foreign direct investments which dwarf aid inflows. At $60 billion last year, China was the biggest recipient of FDI in the world, following years of strong growth.

In contrast to China, Africa is still mired in the aid debate. There are two schools of thought for looking at aid. One is that aid encourages a beggar mentality and corruption.

This school wants aid to Africa to cease, to be replaced by responsible polices by African leaders. The other is that despite appearances, aid represents a tiny component of Africa's GDP and needs to be increased.

The second school of thought breaks down the headline total and shows they have little bearing on how much the recipient country receives in terms of wealth generating capital. Jeffrey Sachs, an economist and special adviser to the UN on poverty issues, estimates that only $12 of the $30 dollars per person sub-Saharan Africa received in 2004 went to projects with a real chance of generating wealth.

The rest went to foreign consultants, emergency food aid, debt servicing and debt relief. That is not sufficient to provide the basis on which wealth creation can flourish: A disease-free environment, clean water, the ability to feed and clothe oneself, and basic infrastructure.

Sachs adds that many corrupt Asian countries, such as Bangladesh, Pakistan and Indonesia have seen strong growth, while relatively well governed countries such as Ghana, Malawi and Senegal have struggled, essentially for lack of funds, he believes.

Still, it would seem that good governance, as the first, anti-aid school suggests, does pay dividends. China offers a relatively save investment destination.

Apart from in 1989, no shot had been fired in anger by the People's Liberation Army since the Vietnam war of 1979. That encourages people to save and entrust their funds to financial intermediaries in the hope of boosting their returns.

China has a 40% savings rate, compared to just 15% in sub-Saharan Africa. Investment also reveals a different picture.

Government, banks and businesses feel sufficiently secure to invest that abundant local capital in local projects and infrastructure investment. Local investment and sound infrastructure in turn attracts foreign investment.

In Africa, investors prefer to keep their funds highly liquid for safety reason, for example in stocks. That is why some local African stock markets are buoyant despite poor national growth rates.

About 40% of African wealth is stashed abroad instead of being deployed domestically. In contrast, China has the second biggest forex reserves on the planet.

These factors mean capital in Africa is not cheap. A low savings rate means a higher cost of capital - indeed, that why Africa needs foreign loans.

In some countries, the interest they pay on the loans now exceeds the income from the loans. But debt forgiveness, of the sort imposed on the World Bank and the International Monetary Fund by the Blair initiative will simply add to the risk premium required by foreign lenders.

And because lenders will need to provision the debt forgiveness from their profits, instead of using the profits to capitalize further lending, other third world countries will see their cost of capital rise. Aid also relieves pressure on Africa countries to develop their own bank lending and debt capital markets, meaning that even the small amount of domestic capital that does exist is not effectively deployed.

Chinese banks are only too ready to lend. Non-performing loans have been one downside of the Chinese model, but overall that is a problem of (relative) affluence rather than a feature of poverty.