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Yet Another Agenda

Raising the Quantity and Quality of Development Financing Beyond 2015

April 2013

Dafe, F., Hartwig, R., and Janus, H. 2013.Yet another agenda: Raising the quantity and quality of development financing beyondf 2015. GREAT Insights, Volume 2, Issue 3. April 2013. Maastricht: ECDPM

Putting a potentially ambitious post-2015 development agenda on a financially sustainable footing will require the international community to move beyond aid by exploring the full range of development finance sources and reforming international policies (1).

Development financing needs beyond 2015 will be substantial. Any new post-Millennium Development Goals (MDGs) framework that seeks to move beyond its current focus on social sectors and give greater weight to concerns such as environmental sustainability productive sector development or persisting income inequality in developing countries will be costly. For instance, the OECD estimates (2) that each year around US$ 120 billion will be needed until 2015 and still US$ 60 billion annually in the following years to achieve the poverty, education and health-related MDGs. The World Bank suggests that the cost of adaptation to climate change in developing countries alone will be between US$ 70 and 100 billion a year between 2010 and 2050(3). In comparison, official development assistance (ODA) reached about US$ 133.5 billion in 2011, whereby ODA figures include administrative costs, debt relief etc. – country programmable aid was only US$ 93.1 billion in 2011. Clearly such estimates are methodologically problematic because they assume a simplistic link between inputs and development outcomes, neglecting for instance absorption challenges in developing countries, decreasing returns on aid, and spillovers between goals. However, the figures do bear the important message that additional efforts are required in order to achieve any new development agenda based on inclusive and sustainable development.

A challenging environment to raise development finance

While the financial flows to developing countries increased and became more diversified since the adoption of the MDGs, the global financial crisis has created a difficult economic and political environment to raise additional financial resources for development. For instance, foreign direct investment (FDI) and portfolio investment, which both had increased over the past decade, slumped during the global financial crisis showing now weak signs of recovery. This especially hit upper middle-income countries (UMICs) hard, since they have been attracting comparatively more investment than lower middle-income countries (LMICs) and low-income countries (LICs). Remittances to developing countries, which had also been rising since 2000, particularly in middle-income countries (MICs), less in LICs, also dropped in response to the crisis. Yet they seem to be more stable than other private flows, quickly regaining pre-crisis levels in 2010. ODA to LMICs and LICs also rose over the past decade, while ODA to upper middle-income countries almost remained stable. However, 2010 marked a turning point. In 2011, ODA disbursements dropped by around 2.7% in real terms.

These trends suggest that private flows like remittances and FDI are likely to play an important role in financing development beyond 2015. They will be complemented by domestically mobilized resources which were boosted when many developing countries across the world experienced remarkable economic growth between 2000 and 2008. Nevertheless, ODA, measured in volume a much smaller flow than the others, remains important for LMICs and is still a primary source of revenue for LICs. The near stagnation and volatility of other external flows in these countries suggest that ODA will continue to be important, at least in the medium term. However, the failure of all but a handful of OECD countries to reach the commitment to provide 0.7% of gross national income (GNI) as ODA illustrate the existing difficulties in raising aid. In view of the austerity measures in donor countries, ODA is even less likely to increase. The global financial crisis has thus intensified the challenge to mobilise more and more stable development finance. Discussions on financing development post-2015 therefore need to focus as much on how to make more effective use of existing resources as on ways to increase their volume.

Sources of development finance and their potential

Developing countries should use the full range of development financing sources, but different types of funds should be used for different purposes as they vary with respect to their costs and benefits.

Take the example of domestic resource mobilization through taxation. Taxation has been highlighted in recent policy discussions about financing a post-2015 development agenda as a source for development finance for two main reasons. First, equitable tax systems underpin national development and may have positive effects on governance (4)Second, taxation provides substantial policy space (i.e. the room for decision-making) to developing countries because using tax revenues as opposed to other external sources of finance makes a country less dependent on the interests of external contributors, be they donors or investors. Both governance effects and policy space may positively affect the effectiveness with which funds are used. However, the volume of funds that can be raised, though it had been increasing over the past decade, is limited because many LICs and LMICs still have little potential to raise additional taxes given their structural characteristics (5).

Another example is aid provided through South-South-Cooperation (SSC). Rough estimates suggest that emerging economies currently provide about US$ 15 billion in aid each year. But this figure may potentially rise to over US$ 50 billion by 2025 and thus become a larger source of development finance (6). Clear estimates are difficult to obtain because aid is only one component of SSC, which often combines loans, grants, investments, trade and technical cooperation. Despite concerns by traditional donors about weak social, environmental or governance standards of individual SSC projects for instance, developing countries still show a high demand for SSC. Many developing countries perceive the policy space associated with financial assistance received through SSC as wider than with traditional ODA. Following the principle of ‘non-interference’, SSC tends not to be conditional on the adoption of policies regarding governance, or economic and institutional reform. Moreover, many developing countries appreciate SSC for its investments in infrastructure and productive sector development because it complements the activities of traditional donors, who have tended to focus on social sectors such as health and education since the adoption of the MDGs.

Both taxation and financial assistance provided through SSC can make significant contributions to financing development. Still, the costs of development, including the costs of addressing global challenges, such as climate change and global financial instability, exceed what developing countries – including providers of SSC are still classified – can meet on their own. Traditional ODA is thus likely to maintain an important role. Therefore efforts to improve aid effectiveness through innovative approaches like results-based aid (7) and to increase ODA or at least maintain it at current levels through innovative financing instruments like blending (8) remain important. Yet the expansion of ODA has lost some of its appeal due in part to the failure to reach longstanding targets, the increase in other financial flows and the importance of national and international policies to enhance the contribution that finance makes to development. The international community therefore needs to look at additional steps it can take to finance development.

Beyond borders and funds: The role of international cooperation

International policies have important effects on the contribution any financial flow can make to development. The scope for taxation, for instance, is also determined by international tax regimes. The level and effectiveness of development cooperation depends on the form of institutional engagement between donors and developing countries. The size and volatility of external capital flows to developing countries such as aid or private investment is also determined by international financial regulation. As globalization has increased the impacts of international policies on developing countries, development cooperation post-2015 must focus as much on reforming international policies as on financing and improving the policy environment in developing countries.

For developing countries to benefit from larger and more diversified sources of development finance, it is particularly important that the international community becomes active in two areas: First, international cooperation for a development-friendly international financial system. Reforming the global financial system with a view to enhance financial stability would help to reduce the volatility of external financial flows, which – both public and private – had experienced a sharp drop in response to the global financial crisis. Reforming the global financial system with a view to curbing illicit financial flows, would also support development by increasing the scope to mobilize domestic resources in developing countries. Second, it is important that the international community becomes active in reforming development cooperation by enhancing the coordination of aid and other policies. In this area, advancing the international aid and development effectiveness agenda in a way that engages both traditional donors and providers of SSC is a priority. In addition, better international cooperation and coordination in global public goods provision (9) is important. In the area of climate finance, for instance, enhanced coordination and cooperation between development and other external policies is crucial to ensure that any new climate finance architecture supports inclusive and sustainable development, and that climate finance complements and does not replace aid.

Action at the international level is both appealing – because the international community can make a difference by changing its own policies – and politically challenging – because it may involve confronting interests of powerful countries or interest groups in powerful countries. However, if the international community genuinely seeks to put a potentially ambitious post-2015 development agenda on a financially sustainable footing, moving beyond aid by exploring the full range of financial resources and reforming international policies is the price they will have to pay.

Florence Dafe and Heiner Janus are researchers at the German Development Institute (DIE). Renate Hartwig is a researcher at the University of Passau.

Footnotes
1. European Report on Development (2013). Chapter 7. Money: Development Finance, European Report on Development 2013, Post-2105: Global Action for an inclusive and Sustainable Future
2. OECD (2012) ‘Can we still Achieve the Millennium Development Goals? From Costs to Policies’, Paris: Development Centre Studies, OECD Publishing.
3. World Bank 2010. The Economics of Adaptation to Climate Change. Washington, DC: World Bank.
4. Bräutigam, D., Fjeldstad, O. H. & Moore, M. 2008. Taxation and State-Building in Developing Countries: Capacity and Consent, Cambridge and New York: Cambridge University Press.
5. OECD (2012) ‘Can we still Achieve the Millennium Development Goals? From Costs to Policies’, Paris: Development Centre Studies, OECD Publishing.
6. Kharas, H. & Rogerson, A. 2012. Horizon 2025. Creative destruction in the aid industry. London: Overseas Development Institute. 
7. Results-based aid involves government-to-government aid whose provision is conditional upon the achievement of result agreed upon in government negotiations.
8. Blending involves the complementary use of grants and non-grant sources such as loans or risk capital to finance investment projects in developing countries.
9. Contrary to private goods, public goods are goods that are non-rival in consumption and non-excludable. The concept of global public goods applies these criteria of ‘publicness’ to the global level, referring to goods such as international financial stability or international security. Global public goods tend to be undersupplied due to free-riding since positive externalities can be enjoyed even without contributing to the good. Collective action failures in global public goods provision results in global public ‘bads’ such as climate change.

This article was published in Great Insights Volume 2, Issue 3 (April 2013)

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Economic Transformation and TradeStrengthening European External ActionEU Development Policy and PracticePost-2015 Global Development AgendaMillennium Development Goals (MDGs)Post 2015Africa

External authors

Florence Dafe

Renate Hartwig

Heiner Janus