Paths for development finance

Mahmoud Mohieldin

WASHINGTON, D.C. - 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 unfinished business of the MDGs, while adding objectives related to inclusion, sustainability, employment, growth, governance and cooperation. Success will depend on the ability of world leaders 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 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 percent annually since 2000, average tax revenues in the poorest countries stand at only 10 percent to 14 percent of GDP, compared to 16 percent to 20 percent in middle-income countries and 20 percent to 30 percent 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 percent of some $400 billion in fossil-fuel subsidies reached the poorest 20 percent of the population.

But this does not relieve major economies of their responsibility to support 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 percent 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 percent 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.

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.

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.

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 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.

Copyright: Project Syndicate, 2014.

*The author is the World Bank president’s special envoy.

By Mahmoud Mohieldin