Making policies work

GREAT insights Magazine

More and Better Financing for Development

11-09-2014

Solheim, E. 2014. More and better financing for development. GREAT insights Magazine, Volume 3, Issue 8. September 2014.

There is plenty of money in the world that could be used for development. Just stopping the enormous sums illegally flowing out of developing countries could provide billions of dollars for poverty reduction. Redirecting fossil fuel subsidies to renewable sources of energy would reduce the pace of climate change and more than double investments in green energy. Every child would be enrolled in school and teachers celebrated as heroes if peace entrepreneurs were able to mobilise as much money as war entrepreneurs. Money can be allocated and used much more effectively if we choose to do so.

Poverty has been cut by half and millions of lives have been saved since the world mobilised around the Millennium Development Goals. As these goals expire in 2015, world leaders will gather at the United Nations (UN) to agree on a new set of sustainable development goals covering areas such as poverty reduction, education, health, equality and the environment. Whatever the goals, political leadership, policies that work and financial resources will be needed to implement them.

Making the right political decisions is of utmost importance. All the amazing success stories of recent decades have emerged from countries making the right political decisions. The Asian economic miracles did not happen because of a great new invention, discoveries of valuable natural resources or conquests. They were made possible by leaders who made good political decisions. Deng Xiaoping took the People’s Republic of China in a new direction, which eventually brought 600 million people out of poverty. Korea made smart choices that took it from being one of the poorest countries in the world to one of the richest. Brazil would have continued down the road of ever worsening inequalities had President Lula and the reformists not demanded equality through minimum wages, cash transfer programmes for the poor and better public services. Indonesia, Malaysia and Singapore provide other inspiring examples of leadership.

Implementing policies that work in various sectors and learning from each other are keys to success. Take the cases of Vietnam and Ethiopia. In Vietnam, high school students do better than the average student in much richer OECD countries. How has Vietnam achieved this? By prioritising teachers. Ethiopia has reduced child mortality by two-thirds over two decades. How? By training thousands of health workers and deploying them across the country. We should all learn from these successes and do more of what works.

But it is not only a question of making the right political decisions. Reducing extreme poverty – and poverty at large – and driving economic growth in an inclusive and planet-friendly way will require a great deal of money. How to mobilise the necessary resources to tackle the challenges of the post-2015 sustainable development goals?

The world is changing and so must development co-operation

Official development assistance (ODA) has been a tremendous success. We need more of it! A new world record of US$135 billion in development assistance was reached in 2013, debunking the myth that development will be put on the backburner because of economic stress. The next time you hear a minister, ambassador, development worker or journalist say that development assistance is decreasing, please tell them that this is not true. ODA is increasing, and it has never been higher. The United Kingdom fulfilled, for the first time, the international target of giving 0.7% of national income as development assistance. Turkey managed the biggest jump in foreign development co-operation spending in all of Europe – a 30% increase. Japan’s development co-operation also increased substantially. The United Arab Emirates set a new world record in generosity by spending 1.25% of its national income on development assistance.

Yet the geography of poverty is changing. Poor people used to live in poor countries, but today there are 1 billion extremely poor people living in middle-income countries such as India and Nigeria. While the relative importance of ODA compared to private investments is decreasing in these countries, by becoming smarter – mobilising greater private flows by mitigating risk, leveraging private investment and facilitating trade – it can continue to contribute to reducing poverty, wherever it exists.

Despite this changing geography of poverty, however, it is in many of the poorest and most fragile states that least progress is made. Within five years, most extremely poor people will be living in fragile states. ODA remains of vital importance to the least developed countries and fragile states because they have limited capacity to access other forms of financing, for instance to fund infrastructure, basic health services and education. Yet many of these countries still do not receive enough external support, and are even faced with declining assistance. Providers of development co-operation must find a way to increase assistance to these countries. The existing UN target of providing 0.15-0.20% of national income to the least developed countries is difficult to reach for providers whose total ODA budgets are less than this. A different target, for example of 50% of ODA directed to the poorest and most fragile countries, might make more sense.

In addition, there are many more resources available beyond ODA that can finance the sustainable development goals. Southern providers of development co-operation are increasingly important. China is now an important provider of development assistance and accounts for 20% of all foreign direct investment in developing countries. Turkey’s development programme is ambitious and expanding – it has the greatest presence on the ground in Somalia and has been incredibly generous to Syrian refugees. Arab nations are becoming world leaders in generosity towards others. Brazil and Mexico use their resources and their own development experience to assist Latin American neighbours. Foundations are also important players – the Bill & Melinda Gates Foundation now provides more money for development than many large European countries.

The way we measure and define development co-operation in the future should reflect the changing world in which we live (see Box). ODA as a metric has served us well, but we need a measure that will take account of the broader financial flows for development and encourage smarter development co-operation – one that supports closer co-operation between new and old providers of development finance. This new metric will complement the ODA measure, not replace it.

The OECD DAC’s work on new measures of development finance

The main objective of modernising the DAC’s development finance framework is to adapt to today’s realities of global development finance. This includes capturing new financial instruments and providers, better valuing donor effort and recipient perspectives, and ensuring that incentives promote the most efficient uses of financial resources. Another objective is to strengthen the credibility of the system by addressing growing criticism of the ODA measure over the past decade, including members’ differing reporting practices on how to calculate the subsidy component of ODA loans, which have cast doubt on ODA as a reliable indicator of donor effort.

Work up to now has focused on:

  • investigating a shift from recording net financial flows as ODA to scoring only the grant element (concessional or subsidy component) of loans and other financial instruments as ODA, as opposed to their full face value;
  • using a more appropriate discount rate for calculating the grant element (as opposed to the current 10% rate); this would align with prevailing financial market conditions;
  • examining how to standardise the reporting of “in-donor” components of ODA (i.e. expenditures in the providers’ own countries, such as first-year refugee costs, administrative costs, student costs) to improve their legitimacy, transparency and comparability, thereby addressing criticisms of “phantom ODA” (i.e. ODA that does not flow to developing countries);
  • looking at how to channel an increased share of ODA to the countries most in need, to counter the trend of declining ODA levels to least developed countries.

Countries are in charge of their own development

Countries must be in charge of their own development priorities. Used “smartly”, development assistance can help them maximise the available public and private sources of development finance. Countries’ own domestic resources, such as taxes, are the most important source of revenue, even in the poorest countries. The OECD has rolled out two programmes – Tax for Development and Tax Inspectors without Borders – to improve tax revenue generation. A project assisting Kenya’s tax administration returned an incredible US$1,650 for every US dollar invested. Foreign direct investments are much needed to build roads, ports and railways, and to create jobs. Development assistance can help unleash private investment and improve the investment climate. At US$351 billion in 2012, the flow of remittances sent home to developing countries by migrant workers was higher than development assistance and foreign direct investment combined. In fact, this is by far the largest source of external finance for many countries. Yet charges for sending remittances home are as much as 10%, adding up to US$35 billion a year in transaction fees. Work is in progress at the World Bank to halve these transfer costs – which would mobilise billions and make a huge difference in people’s lives.

Developing countries are also losing billions of dollars every year to corruption, money laundering and tax evasion. These billions fund crime and lavish lifestyles rather than schools and hospitals. Outward or lost flows like these can be stopped by sharing information, streamlining regulations and improving the capacity to investigate and prosecute financial criminals in developed and developing countries alike.

Green finance is development finance

All green investments are good for development. There are 1.3 billion people in the world without access to electricity. Any investment in renewable energy in a developing country would add to existing electricity production capacity while also stimulating development. Climate adaptation measures make sense for development too. Managing rivers and controlling floods saves lives and money. The right decisions can mean that the human and economic costs of floods, cyclones and other extreme weather events can be reduced, even as climate change exacerbates the frequency and size of these events. For example, the monsoon floods that killed hundreds of thousands in Bangladesh a few decades ago would have caused much fewer casualties today, as the government’s ability to evacuate people and control infectious diseases has improved.

It is indeed possible to protect the environment while reducing poverty and developing strong economies. Brazil has reduced deforestation in the Amazon by 80% alongside rapid economic growth. Ethiopia aims to become a middle-income country without increasing its greenhouse gas emissions. If they can do it, others can too.

There are many sources of financing available to eradicate poverty and spur sustainable growth. All we have to do is grab them.

This article will feature as the DAC Chair’s Editorial for the OECD Development Co-operation Report 2014: Mobilising Resources for Sustainable Development. For more information on the report, please visit: www.oecd.org/dac/dcr2014

Solheim_GREAT_Insights_Sept_2014

Erik Solheim is Chair of the OECD Development Assistance Committee (DAC).

This article was published in GREAT insights Volume 3, Issue 8 (September 2014).

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Economic Transformation and TradeDevelopment Finance and TaxationPost-2015 Global Development AgendaDevelopment FinanceOfficial Development Assistance (ODA)Post 2015EthiopiaVietnam

External authors

Erik Solheim