New Paths for Development Finance

WASHINGTON, DC – When the Millennium Development Goals (MDGs) expire next year, the world will be able to count many achievements. The number of people lacking access to safe drinking water has been halved, improving the lives of over 100 million slum dwellers; gender equality in education has been strengthened; and health care has become more accessible for millions of people. But there is still much to be done; many countries are lagging behind, and there is a great deal of discrepancy within countries.

The post-2015 development agenda promises to take on the MDGs’ unfinished business, while adding objectives related to inclusion, sustainability, employment, growth, governance, and cooperation. Success will depend on the world leaders’ ability to apply past experience not only to developing effective policies and programs, but also to finding innovative ways to finance them.

A recent World Bank Group (WBG) report – Financing for Development Post-2015 – identifies three major considerations that should inform the next development agenda. First, most of the world’s poor now live in middle-income countries, and many live in high-income countries. Second, the focus of debate about development financing has broadened from the quantity of aid to its quality – including its power to leverage other sources of finance. Finally, emerging economies have become important engines of global economic growth, with increasingly close ties to developing countries.

In this changing economic landscape, financing a transformative development agenda will require an unprecedented level of cooperation among governments, donors, and the private sector, as well as policies and institutions that facilitate more efficient use of existing resources and attract new and diverse sources of funding. The WBG report points to four foundational pillars of development financing: domestic resource mobilization; better and smarter aid; domestic private finance; and external private finance.

Domestic resources constitute the largest pool of funds available to developing countries, which mobilized $7.7 trillion in 2012, largely through taxes, duties, and natural-resource concessions. But, while developing-country revenues have grown 14% annually since 2000, average tax revenues in the poorest countries stand at only 10-14% of GDP, compared to 16-20% in middle-income countries and 20-30% in high-income countries.

Improved domestic resource mobilization and management – for example, through better tax administration, greater capacity to negotiate and manage natural-resource contracts, and stronger mechanisms for limiting capital flight and illicit financial flows – would improve the situation considerably. Subsidy reform also offers significant scope for revenue gains. In 2010, only 8% of some $400 billion in fossil-fuel subsidies reached the poorest 20% of the population. But this does not relieve major economies of their responsibility to support the development. On the contrary, better and smarter aid is critical to financing the post-2015 development agenda.

While developing countries’ resources dwarf official development assistance (ODA), which amounted to $128 billion in 2012, they constitute upward of 40% of government budgets in fragile and conflict-affected states. As a result, over the last few decades, ODA has played a central role in lifting people from extreme poverty, financing investments in human and physical infrastructure, and smoothing the path of economic reform.

But fiscal pressures in many of the wealthiest countries have resulted in a 6% decline in ODA since 2010 (in real terms), despite the emergence of new government donors and large private foundations. In this context, world leaders must identify mechanisms for improving ODA’s effectiveness. For example, they can channel aid toward sectors like health care and education, where private finance is unlikely to materialize, while using ODA to attract more private-sector financing, such as through public-private partnerships or mitigation of investment risk.

This brings us to the third crucial source of development funding: domestic private finance. Building a robust private sector capable of fostering inclusive growth, creating jobs, and broadening the domestic revenue base demands improved access to finance for micro, small, and medium-size enterprises. Financial inclusion, supported by a strong regulatory framework, encourages responsible lending and promotes innovation. It is up to governments to create an environment that enables businesses to take root, compete, and grow. In exchange, firms must go beyond minimum corporate social-responsibility standards to help advance human well-being and environmental sustainability.

The final piece of the development-financing puzzle is external private funding, delivered via foreign direct investment, international bank loans, bond and equity markets, and private remittances. Although global savings amount to $17 trillion and liquidity is at an all-time high, a relatively small share of these resources is being channeled toward investments that support development objectives, such as closing the massive infrastructure gap.

Higher-quality projects and innovations aimed at mitigating risk can clear the way for private-sector participation, while well-designed public-private partnerships and developed domestic capital markets can help “crowd in” investors in critical areas. Local-currency bond markets, vertical funds for global public goods, carbon markets, and new mechanisms to attract institutional investors and sovereign wealth funds would also help. Finally, with remittances exceeding $400 billion annually, there is scope to develop financial instruments that would facilitate diaspora communities’ investment in development projects.

This approach to development financing is not entirely new. In 2002, the United Nations International Conference on Financing for Development produced the Monterrey Consensus, which emphasized the importance of domestic resource mobilization, aid, investment, trade, institutions, and policy coherence in financing development.

As a recent UN resolution points out, what is needed now is a follow-up conference, where world leaders examine the lessons learned since 2002 to determine how to advance the post-2015 development goals in the context of a changing global economic landscape. A “Monterrey II” meeting would help countries to obtain a clearer and more realistic picture of the financing sources available, enabling them to prioritize the needed investments – and thus contribute to the successful launch of the post-2015 development agenda.

Mahmoud Mohieldin is the World Bank President’s Special Envoy.

Copyright: Project Syndicate, 2014.

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