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Development Finance

Tony Addison and George Mavrotas

This has been a roller-coaster year for global capitalism. Financial markets – flush with liquidity just last year – now resemble a parched desert. What looked like an initially containable banking crisis spread across the global financial system, taking with it some of the biggest British and US banks. At the start of 2008 there was much talk of ‘decoupling’. The South, especially the big emerging market economies, would be able to motor along despite the financial shock from the North, it was said. If so, this would have been one of the first Northern recessions to leave the South untouched. The scenario looked plausible for a while, with the smaller Southern economies gaining from the rise in world commodity prices that set new records earlier in the year. Alas, we are now in the early stages of a global slowdown, affecting both the South as well as the North. This is evident in commodity markets, where prices are well off their earlier highs. Post-Olympics, China too appears to be slowing.

World economic turmoil therefore sets the scene for the UN Conference on Financing for Development in Doha (29 November to 2 December), the most important conference on this topic since the UN’s conference in Monterrey back in 2002. September saw the long-awaited High Level Forum on aid effectiveness in Accra as well as the UN’s high level event on the MDGs in New York. Our new UNU-WIDER book Development Finance in the Global Economy: The Road Ahead (Palgrave) is therefore timely. We discuss the state of play in development finance, with our team of authors covering all aspects from official development finance (ODA) to debt relief to private financial flows. This includes the intersection and interaction of official and private flows, which has become increasingly important – especially in the present crisis.

The needs of poor countries and poor people could well be forgotten amidst the present desperate need to shore up the financial system and deal with feckless bankers and their sins. So now is the time to take a look at what Doha should focus and deliver on.

Opportunities for Doha

At their 2005 summit in Gleneagles, Scotland, the G-8 committed to raise aid by US$50 billion; but are still US$31.4 billion short. Aid fell by 8.4 per cent in 2007, after a 4.7 per cent fall in 2006. Debt relief under the Heavily Indebted Poor Countries (HIPC) initiative and Multilateral Debt Relief initiative (MDRI) dominated aid over the last two years. It is questionable whether this debt relief should really count as ODA since the debts are unlikely to have been repaid (an issue discussed in our book).

The G-8 committed to raise ODA to US$130 billion by 2010 at the Hokkaido summit this year. Will it happen? Bailing out the banking system will put pressure on aid budgets, although ODA is actually tiny in comparison. Thus the US government is spending US$700 billion to help the financial system, while US aid was $22 billion in 2007. The so-called ‘new donors’ such as India and China will make their presence felt at Doha, and there is a drive to encourage them to become OECD-DAC members. The sharp rise in financial flows (not only aid but also foreign direct investment) from Asia is one of the big changes in development finance in the six years since Monterrey. The Gulf States may well announce a step up in aid at Doha; their foreign exchange reserves have grown with the high oil price. Another big change is the increasing importance of global philanthropy, in particular the Bill and Melinda Gates Foundation. Although the downturn in equity and bond markets may have reduced the income of philanthropic foundations, they will remain a growing and important presence, especially in financing innovations in health and agricultural technologies.

In aggregate, private capital flows to the developing world are far in excess of ODA. One benefit of official debt relief has been to boost the sovereign debt ratings of countries such as Ghana and Nigeria, helping them to raise funding from the international bond market. Increases in the prices of their commodity exports helped too, and generated much interest in the so-called ‘frontier’ equity markets. But that was before the present financial crisis, and the correction in commodity prices. If the global downturn is severe and persistent then foreign investors will rethink their projects, which are mostly in the mining sector of the poorer countries. A slowdown in China would add to the stalling of foreign direct investment.

With summits on finance, the focus is naturally on money. Yes, the amount of development finance, both public and private, is important. But our obsession should be with the number of poor people on this world, what to do for them, and finding where finance fits into this bigger (poverty) picture: the World Bank recently raised its global estimate of poverty to 1.4 billion. At least 400 million of those are chronically poor, a poverty that is so deep that it crosses the generations according to the just-released second Chronic Poverty Report.

So we need Doha to not only mobilize more ODA, but also to make sure that this is spent wisely on those types of infrastructure, services and social protection that provide the most benefit for the world’s most vulnerable people. Consequently, Doha should see, we hope, much discussion of aid effectiveness. The effectiveness debate must move on from its narrow focus on growth – the new obsession among some bilateral donors – towards its impact on poverty. This is especially so for chronically poor people, many of whom get left behind by growth, even if aid does help to raise the recipient’s growth rate.

The Accra High Level Forum tackled head-on the problems of the aid business: non-transparency, too many donor missions over-stretching recipient capacities, the mix of (often incoherent) donor reporting standards, and so on. Devotees of such meetings noted a more robust language in the final communiqué than in the 2005 Paris Declaration on Aid Effectiveness generated by the last High Level Forum. Yet, after Accra it is apparent that some donors intend to slack off, and do not take the process seriously enough. The bottom line: if the transactions costs of ODA do not come down further, then aid will be wasted.

Doha will therefore need to press further on aid effectiveness. There is a link to that other Doha agenda, the WTO Doha Development Round on trade, which stalled earlier this year. Aid for trade is supposed to help poorer countries adjust to trade liberalization by investments to expand their export sectors through better infrastructure, for example. But if aid is not generous, nor effective, then it will fail to deliver improved economic growth through trade openness, and an increase in openness to import competition will only expose vulnerable economies further. Similarly, rich country subsidies to biofuel crops are reducing the real value of aid provided as balance of payments support, by raising world food prices. More joined-up thinking in the aid-trade-energy nexus of rich country policy, as well as in the aid-for-security agenda, is needed. In our UNU-WIDER book, Peter Burnell discusses the shifting geo-politics of ODA.

More Innovation in Finance, Please

Doha also needs to put the debate on innovative sources of finance into the fast lane. It has puttered along since Monterrey despite the best efforts of the Action Against Hunger and Poverty Initiative of Brazil, France, Chile and Spain that was launched at the UN in 2004 (and our UNU-WIDER book assesses progress). Since there are such a wide spread of proposals on innovative finance, the best way to accelerate progress would be to focus for the moment on just one or two. The nexus between finance and climate change is one obvious focal point. At the just-concluded UN MDG summit, the EU, Mexico, Norway, and Switzerland were among those pushing on the climate change issue. Carbon taxation has come to the fore, in particular. According to a Swiss Government proposal, a $2 per ton levy on carbon dioxide would raise around $48bn per year.

Back in 2003, UNU-WIDER took a thorough look at innovative sources of finance in a project with UN-DESA and led by Tony Atkinson of Nuffield College, Oxford. The study was mandated by the General Assembly as a follow-up to Monterrey and concluded that many of the proposals were technically feasible. But it also emphasized that they differed markedly in the amount of political support they could gather, in both the North and the South.

Amongst all the innovative finance proposals, carbon taxes get the most support among economists. They not only reduce carbon emissions (a global bad) but also they generate a flow of revenues to finance a step-up in official development assistance (both multilateral and bilateral) as well as global funds to deal with the urgent challenges of climate change, conflict, and HIV/AIDS (to name but three).

All of these problems just get worse without early action. War generates more war (notably in the Congo where violence is still endemic after the supposed 'peace deal') and viruses mutate to become deadlier (as with unchecked TB). This is especially true of climate change, arguably the very biggest challenge. A stock of carbon sits in the atmosphere, warming the earth that we will have to adapt to, even as we attempt to reduce the flow of carbon from new emissions. To reduce emissions and to adapt vulnerable countries such as Bangladesh to climate change, especially in ways that protect poor people, will need innovative ideas – including innovative finance – and early action. Given the high returns to taking action now on these global bads, it would be worth accepting a much higher levy on carbon than the Swiss proposal. This would send a clear signal to the market, encouraging a faster rate of invention and adoption of clean technologies. And the extra funds raised could also be spent on peace-keeping and more research for the diseases of the poor world in addition to climate change challenges.

The UN, with financial support from Norway, has just launched a plan for countries with tropical forests to issue tradable carbon credits by saving and planting trees. Buyers would be those countries seeking to meet their own carbon emission limits. Deforestation emits 20 percent of the greenhouse gases blamed for climate change. The sums could be large, especially for Africa with its endangered tropical forests and Indonesia (which the UN estimates could receive up to US$1 billion a year). An alternative proposal, coming from the UK, is to make payments to tropical countries based on the size of their forests. Irrespective of what scheme eventually comes to pass, one trend is clear: an increased linkage between the climate change issue and flows of development finance over the next decade.

Conclusions

Two years ago it looked more likely that the next shock to the global economy would come from the South: specifically a rapid slowdown in China’s growth or some big blow up in emerging markets (see Tony Addison’s ‘International Finance and the Developing World: The Next Twenty Years’ in George Mavrotas and Anthony Shorrocks (eds) Advancing Development). As it turns out, the shock has come from the North, first. This demonstrates an iron law of globalization: expect the unexpected. How far the present financial crisis damages the poor economies of the South, and the poor of the South, remains unclear. This is certainly not a good time for countries to mobilize private capital flows via either equity or debt, and foreign direct investment (which has been on the rise) will be threatened by a prolonged global downturn.

Poor economies will therefore need more ODA not less. The G-8 has not delivered on its Gleneagles promises. This is especially disappointing given the hard work that many poor countries have put into building better institutions, especially in the area of public finance management, to absorb and effectively use aid for development and poverty reduction. With climate change now firmly on the development finance agenda, the need for innovative financing mechanisms can only grow. This is not the time to be timid. Can the policymakers of both North and South meet the challenge? Or will narrow political agendas prevail? And will the needs of the world’s poorest people – the 1.4 billion – prevail? Time will tell.

WIDER Angle newsletter, November 2008

ISSN 1238-9544