A new system of development finance

By Jeffrey D. Sachs

Governments meet in Doha this weekend to review the global system of development financing, the means by which resources flow globally to support sustainable development. The system is broken, though the conferees are unlikely to say so clearly.

Just as we need an overhaul of financial market regulation, we also need an overhaul of development finance, if we are to address problems of poverty, hunger, and climate change.

Development financing involves three main processes: development aid for the poorest countries, those which cannot attract market-based financing for necessary investments; direct and portfolio investments, mainly for emerging markets and resource-rich poor countries; and financing for global public goods, such as climate-change mitigation and adaptation.

Aid flows are far below promised levels and are unpredictable; market flows are heavily concentrated in a few countries, and are subject to panicky reversals; and global public goods are disastrously under-financed, good intentions without backing.

There is no point of accountability. When aid is promised but not delivered, nobody really cares except the poor countries themselves. And more often than not, the poor get blamed for some malfeasance or another as the reason why aid hasn’t flowed.

Development ministers piously proclaim that they will honour their commitments, such as to double aid to Africa by 2010, even as their finance ministers are cutting their aid budgets.

What’s shocking is that the rich world has not been able to organize itself to increase aid to Africa by a measly $25bn per year (less than 10 cents per hundred dollars of rich-world income), even as they’ve committed at least $2.5tr in the past month for financial-sector bailouts.

The “reformed” aid architecture has actually deprived aid of its political support in the rich countries. Aid reformers have generally argued for “budget support,” meaning money to the treasuries of the poor countries, rather than “tied aid” in the form of investment projects supplied by industrial and construction companies, or targeted support through specialized global funds for disease control, education, agriculture, and so forth.

Industrial enterprises in the US, Europe, and Japan that might have sold power plants, road construction, port facilities, and the like backed by aid funds, have lost interest and contact with development aid. And the rich-country public does not trust general budget support, since it doesn’t know how their money is being used.

The most successful aid in recent years has been for targeted purposes through global funds – to provide immunizations for children, or to fight aids, TB, and malaria. The public then clearly understands how money translates directly into lives saved. Aid can be counted in bed nets, antiretroviral treatments, doses of measles vaccine. The results can be counted in the dramatic reductions of deaths from malaria, measles, polio, and other diseases now strikingly evident. These funds have won public backing and increased financing.

The first true reform of the aid system, therefore, should reconnect aid with measurable inputs and outputs, through targeted global funds and programmes. International aid donors should pool their money into global funds for primary education, food production (supplying seed and fertilizer to peasant farmers), clean water and sanitation, family planning and contraceptives (through the United Nations Population Fund), nutrition (through UNICEF and the World Food Programme), and for infrastructure. The public would see clearly how their money is used. Projects would be monitored and audited. Successes and failures would be transparent.

The second reform should be to “re-tie” aid, in part, by encouraging national donor agencies to support infrastructure projects provided by national companies.

China is doing this by the investment of billions of dollars throughout Africa, to notable benefits on the ground throughout Africa. Japan has a history of success of this kind of aid in south-east Asia. With a deep recession in the high-income world, direct financing of companies to build vitally needed roads, power plants, port facilities, and the like in the poorest countries would be a triple win: for development, for macroeconomic stimulus, and for building a domestic political base for meeting aid commitments.

The goal, of course, should be to enable countries to graduate from development aid, and to rely on market financing. Yet market financing is heavily concentrated in a few emerging markets and resource-rich poorer countries.

To expand the range of market financing, the key step is build the infrastructure in the poorer countries so that market-based investments become profitable. And financial measures are needed to prevent dramatic reversals in private flows, as we have experienced since the collapse of Lehman Brothers in September. Perhaps the key step here is currency swap lines from the rich-country central banks to the poorer countries, so that market panics do not sweep over the emerging markets.

Traditional development aid (whether reformed or not) and market-based financing do not finance global public goods, such as the heavy investments needed for climate change mitigation and adaptation or to protect biodiversity.

We need new forms of global financing for the research, development, demonstration, and diffusion of sustainable energy technologies, such as carbon capture and sequestration, and advanced technologies in power generation. Africa has remarkable solar potential, enough for itself and for Europe, but it requires a big scientific, engineering, and public-private financing effort on a region-wide scale, yet financing is not available.

Small funds such as the Global Environmental Facility have been established for these purposes, but they are in the millions of dollars per year category rather than the tens of billions needed. Innovative financing is essential. We should adopt a global carbon levy in which each country provides a few dollars per tonne of carbon dioxide emitted to finance global investments in mitigation and adaptation. Switzerland and Norway have recently advanced such proposals.

An analogous small tax on global transport and on global financial transactions can add significant and needed international funding. A levy on airline tickets is already functioning and can be complemented by a similar levy on international shipping.

An overhaul the international finance system is now likely. The financial crisis has already triggered the process. There is much talk about Bretton Woods II. The world should remember that the first Bretton Woods agreement involved much more than financial regulation, and looked forward to post-war reconstruction, development, and trade.

This time around we need a similarly expansive vision, in which a new system of development finance addresses the great challenges of sustainable development: poverty alleviation, disease control, climate change, and well-functioning global financial markets that serve all countries, rich and poor.

Jeffrey D. Sachs is the director of the Earth Institute, Quetelet professor of sustainable development, and professor of health policy and management at Columbia University

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