Blog: Changing the mindset on aid

This article was originally published by Overseas Development Institute

I’ve read a lot recently about ‘the future of aid’ (see here and here). The future of traditional development aid is suddenly in question it seems, as developing countries drive global economic growth and boost their capacity to mobilise domestic resources.

The UN’s High Level Panel on Post-2015 report notes that domestic revenues in developing economies totalled $7.7 trillion in 2012, having growing by 14% annually since 2000. Developing countries are now leveraging more private capital such as foreign direct investment, bank loans and bond finance. 46% of global savings are now located in the developing world and, if the World Bank is right, that share will rise to 62% by 2030.

Meanwhile, the share of aid in global transfers is shrinking, representing just 1% of financial flows to the world’s growing ranks of middle-income countries. The UK’s Department for International Development is ending aid programmes in India and South Africa, arguing that they can now develop their own economies. Indeed, some developing countries are already contributing to poverty reduction and economic development elsewhere.

Will such changes in the world economic order render traditional official development assistance (ODA) obsolete? Can the developing world now address its own challenges?

This narrative could appeal to some donors. ODA from the so-called ‘traditional’ donors is falling, together with public support in some countries as austerity programmes bite. ODA from the OECD DAC countries has declined by 6% since 2010, and there is little prospect of large increases in the near future.  There is much enthusiasm about the major role the private sector can have in the financing of sustainable development.

I feel however that this storyline misses something fundamental: the fact that there will ALWAYS be a need for international public finance.

In principle, the money to fund sustainable development is out there. Global capital markets represent around $218 trillion in financial assets and global savings are estimated at about $18 trillion. But these resources rarely fund the most critical areas for sustainable development:  financing for social services, long-term infrastructure investments, high-risk investments (such as innovation, research and new technologies and financing for small and medium-sized enterprises) and financing for global public goods (GPGs). This is why international public finance, although small in absolute terms, remains so important; it can help correct for these massive market failures.

The need for international public finance to help fund essential basic services in the developing world could dwindle, but even in a world where poverty is eliminated, the overall need for international public finance is not going to fall. Its focus, however, will shift and evolve over time.

This shift is already apparent as financing for climate change and GPGs draw on scarce international public funds. This trend will continue post-2015, and aid budgets are likely to supply most international public climate finance, even though this finance should be additional. Other cross-border challenges will also compete for international public finance in the post-2015 era.

It’s clear that the traditional concept of aid as a short-term ‘charitable’ donation from rich to poor that ends once the recipient ‘develops’ is outdated. Instead, there is a permanent need for international public finance in our increasingly inter-connected world. This idea is not new. In 2010, a Center for Global Development Working Paper suggested that aid should be relabeled ‘global policy finance’ to reflect its changing role over time.

If we accept this idea, we must also ask whether the tools we have to raise and mediate these resources are fit for purpose over the long-term.

The current model to raise international public resources for development is based on voluntary pledges by countries – pledges that are rarely met. Only six high-income countries have kept the promise to allocate at least 0.7% of GNI to ODA. The Green Climate Fund is largely empty, despite commitments by developed nations to mobilise $100 billion per year by 2020.

In terms of the institutional architecture that mediates international public finance, an ever-growing and bewildering spaghetti bowl of bilateral, multilateral and mixed public-private channels exist to delivers funds to recipient countries. It’s incredibly inefficient.

If we agree that we will need international public finance for the forseeable future, such voluntary ‘aid’ commitments should be replaced, over time, with statutory assessed contributions. Here, all countries contribute international public finance according to their capacities to do so, and in line with the principle of common but differentiated responsibilities. All countries are also eligible to receive funds, regardless of income level, and grants and loans are an essential part of the mix.

There are precedents. The UN and the IMF receive some funds through core-assessed contributions with additional funds supplied on a voluntary (and more unstable) basis. The European Union operates fiscal transfers to support more disadvantaged member countries and regions.

How individual countries choose to fund their differentiated contributions will be up to them. But there may be a role for innovative sources of finance, particularly financial transaction taxes. Such taxes could raise stable and predictable resources for domestic and international objectives. Twelve countries of the European Union have already come together voluntarily to agree on such taxes, with France committing 10% of the revenues raised to international development. If a critical mass of other countries – developed and developing alike – were to do the same, this could raise crucial and additional international public finance in the post-2015 period.

This proposal for a universal system for compulsory assessed contributions to international public finance does raise difficult questions. How could it be reconciled with the failure by most developed nations to reach 0.7%? What would be the best institutional architecture to manage such funds? How can it be enforced? A system under which ‘everyone contributes’ would need to factor-in differentiated responsibilities for climate change, but last week’s Climate Change Conference in Warsaw saw continued fights over who should pay when climate-related disasters strike.

Even so, the post-2015 debate is a chance to re-think the long-term role of aid and international public finance in a more interdependent world. We need to change our mindset, shifting from ‘aid’ as a temporary charitable measure to ‘help the poor’ to an understanding that international public finance is a permanent need that is, in turn, in our national and collective interests.

Meanwhile, the achievement of the 0.7% target is still  important. The eradication of human poverty has not been met, but is within our grasp if there is sufficient political will.