Is the EU making an argument to transform aid? And is it right?

Recent EU documents suggest that a careful argument is being prepared to change aid, and perhaps end it. Read to the end for the five steps in the argument, my comments, and a big question about the game-changers that should shape future finance. The conclusion? A serious discussion about future finance for development must start by modelling country-level financing needs, in steady state and in response to shocks.

Aid is falling. Why?

The 2013 Accountability Report on EU development spending, published in July, makes for initially grim reading. It is a document in four volumes, but I can save you time: read Section 4.2.3.2. on Pg 56 of Volume 1, and you will discover that 

• ODA from the EU-28 fell again in 2012, by 4% or €2.2 bn; 
• As a result, oda is back to the same level in real terms as in 2005; 
• And amounts to only 0.39% of GNI, far below the target the EU set for itself for 2010 (0.56%), never mind the 0.7% promised for 2015; 
• Reaching the 2015 target would mean increasing oda over currently projected levels for that year by €36bn or 60%.

The report contains a wealth of country-level data and fingers the main culprits. France, Germany and Italy all stand firmly in the frame, alongside smaller countries and new members of the EU. Belgium, Malta and the UK are the only countries to show no financial gap by 2015. There are some great graphs, by the way, but they do not fit easily on a website page. I recommend Figures 4.2.3b and 4.2.3c. You might need a stiff drink before studying them.

It seems to me quite obvious that the EU, having failed to meet its 2010 target, is not going to meet its 2015 target. It is therefore disappointing to read repeatedly that the target remains unchanged. Most recently, the Foreign Affairs Council, meeting in May, said that

‘A key priority for Member States is to respect the EU’s formal undertaking to collectively commit 0.7% of GNI to official development assistance by 2015, thus making a decisive step towards achieving the Millennium Development Goals. The EU and its Member States reaffirm all their individual and collective ODA commitments, taking into account the exceptional budgetary circumstances.’

I don’t think they mean this, and think it misleading to say that they do. More than misleading, it is cruel if developing countries are led to believe that more money will be available than is likely to be the case.

An evident reason for the shortfall is the economic crisis in Europe. The Accountability Report puts this graphically, noting that

‘Through the first three years of the crisis, the EU’s aggregate ODA spending continued to increase, but eventually succumbed to the pressure in 2011 and 2012, resulting in a reversal in the slow trajectory of scaling up to meet 2015 targets.’

Actually, though, I think there is a different reason, which is that the case for aid is seen as being undermined by the rapid growth of GDP and tax revenue in developing countries, and by the rapidly falling number of low income countries. This logic is evident in the Accountability report, but even more so in a Commission Communication, also published in July. This is entitled ‘Beyond 2015: towards a comprehensive and integrated approach to financing poverty eradication and sustainable development’. The document lays special emphasis on domestic tax revenue and concludes as follows:

‘The tax take of developing countries varies, accounting on average for 13% of GDP in LICs and 22% of GDP in MICs. UNDP has suggested that an MDG-consistent government revenue share may be over 20% of GDP, showing that most MICs should be able to reach these goals solely using domestic public resources. Furthermore, according to the IMF, raising government revenues by about 3% of GDP would be feasible relatively quickly, even without considering the potential of increased natural resource revenues and new green taxes. This shows that ending dependency on aid is, in a longer-term perspective, also possible in LICs’.

In the short term, there may be a case for aid to LICs. The Communication says that

‘ODA remains a major source of finance for the 36 LICs which are also more affected by global challenges; it accounts for 12% of their GDP, already below LICs’ domestic revenues.. In the 108 MICs, ODA represents on average only 0.2% of GDP, confirming that aid should be focussed on the countries that need it most.’

In this analysis, the Commission justifies its policy of ‘differentiation’, reducing aid to middle income countries. Indeed, middle income countries are encouraged to become aid donors: ‘emerging economies and countries that have reached upper MIC status should provide their fair share of international public finance, in line with the financial resources they command’.

I’ve checked, by the way. The World Bank revises its country list on 1 July each year. There were indeed 36 low income countries last year and there are 36 this, but Mauritania has graduated and South Sudan has slipped back. The cut off is GNI per capita of $US 1035. The press release is here.

Neither the Accountability Report nor the Communication estimate how much oda would be available for each poor country or poor person, from the EU or from other donors with this degree of concentration. However, the World Bank data set tells us that there are ‘only’ 400m poor people in the 36 low income countries. Taking the EU 2015 target for oda of €96bn, that would amount to €240 per person per year, from the EU alone. The total GDP of the 36 low income countries is $US 238 bn, so this aid would amount to over 50% of GDP. It seems to me that if all aid were to be focused on low income countries, it would be beyond absorptive capacity. I know, I know, it’s complicated . . . arbitrary cut-offs . . . fragile states which are not low income  . . humanitarian emergencies . . . climate finance. But still, don’t you think the Commission might be softening up the ground for a reduction of aid in the medium term? The death of oda has long been foretold, not least by Severino and Ray in 2009. Perhaps it is now approaching.

What will replace traditional oda?

That impression is confirmed by other elements of the two reports. It is not trivial that the Communication puts domestic finance first, with an emphasis on reform of tax systems, anti-corruption, and extractives transparency. It also criticises the ODA ‘concept’ and notes with approval DAC work on ‘reforming’ ODA. The ‘principles’ at the end emphasise the need for a unified framework at country level. The Communication also calls for unification of international processes, specifically UN Financing for Development, and the UN Expert Committee on financing for sustainable development.

The Accountability Report, a Commission Staff Working Document, elaborates. It contains an extended section on remittances, and another on trade, both non-aid sources of finance (though aid can help to make them more effective). It also discusses private investment. In the public finance sphere, it summarises aid data and reviews climate and biodiversity funding.

There is an especially interesting section in the Accountability report on innovative finance (Pgs 82ff). This begins by saying that

‘There is no universally accepted definition of Innovative Financing Mechanisms (IFM). While the term initially referred to new sources of development financing that could complement traditional ODA  in a stable and predictable way, it has progressively been expanded to include innovative financial instruments aiming at enhancing the impact, effectiveness and efficiency of development finance.

The main characteristic of these mechanisms is not intrinsic financial novelty, but the fact that they differ from traditional approaches to mobilising and/or delivering development finance. Traditional sources of funding ODA typically include budget outlays from established sovereign donors, or bonds issued by multilateral and national development banks, while traditional approaches to delivering development finance include grants and loans to beneficiaries, directly or through a variety of implementing agencies. Innovative financing sources and mechanisms are essentially a way to fill the financing gap between what is needed to address developmental challenges and what donors can provide, often addressing a specific externality or market failure.

IFM are thus mechanisms that (i) support fund-raising by tapping new sources and engaging investors beyond the financial dimension of transactions, as partners and stakeholders in development; and/or (ii) deliver development finance in new ways, enhancing its impact on development problems on the ground. They can therefore be considered ‘innovative’ either because of the nature of sources or the way they are collected, implemented and used to catalyse additional financing.

Broadly speaking, IFM can be divided into innovations in fund-raising and innovative financial instruments for development:

(1) Mechanisms that generate additional Financing for Development by tapping into new and innovative finance (or funding) sources (non-traditional or non-conventional ODA resources, emerging donors and the private sector). For example, global solidarity levies  (such as the airline ticket tax or the Adaptation Fund) or national lotteries, or front loading mechanisms like the International Finance Facility for Immunisation (IFFIm), or copayment schemes such as the Advance Market Commitment (AMC) mechanism.

(2) Mechanisms that offer innovative financial instruments in the way existing aid resources are pooled, blended and delivered. For example, the EU regional blending facilities, structured investment funds like GEEREF, Special Purpose Funds like TCX, or Guarantee Mechanisms like GIIF’.

The former category, of additional funding, is shown to be growing fast, reaching over €1bn p.a., nearly half of this through the sale of emission permits, and the rest through a combination of lottery funding, solidarity taxes, debt swaps and front-loading mechanisms. Germany, France, Belgium, the UK and Italy are the major providers. Not all this funding is yet counted formally as oda – hence perhaps the interest in revisiting the definition.

The second category, of new instruments, currently exceeds €2bn p.a. , mainly by means of blending loans and grants (bilateral and multilateral) and structured investment funds. Usually, these are designed to leverage private sector finance, with ratios, the report says (Pg 89) of up to 30:1. Grants can be used to provide direct investment grants, interest rate subsidies, technical assistance, risk capital, and risk sharing mechanisms such as guarantees.

Reading between the lines: an argument on aid

Put all this together, with only decorous reading between the lines, and an argument can be discerned. Roughly speaking, and remember I am extrapolating from a reading of the text,

1. Most countries do not need aid, and will not, especially if they can tackle tax evasion, corruption and capital flight. Indeed, many current recipients of aid ought to be aid donors.
2. The small number of remaining low income countries will need aid, but probably do not need and certainly cannot absorb 0.7% of rich country GNP.
3. To the extent that aid is needed, it should catalyse and support other finance flows, with a strong (though not exclusive) emphasis on innovative instruments which leverage private sector finance.
4. Budgets are tight, so the best way to provide aid will be via new mechanisms, like the sale of emissions permits or a financial transactions tax. 
5. International frameworks need to recognise this new reality, whether in the DAC, including in its work on re-defining oda, or the UN, including in its work on Financing for Development, and financing for sustainable development, but also in the context of the post-2015 settlement.

What are we to make of the argument? Of course, there is quite a debate on these issues: for recent contributions, see Kharas/Rogerson on Horizon 2025 , Greenhill et al on The Age of Choice, or my own piece on The Future of (UK) ODA.

First, my take is that planks (i) and (ii) are defensible in narrow terms (that is, before we come to climate change). I don’t personally think that an arbitrary income cut-off is helpful, even if there is gradual tapering, and believe that decisions about aid need to take account of foreign exchange reserves and vulnerability to shocks. Nevertheless, I am not of the view that any country with poor people deserves financial aid, no matter its level of income. Non-financial aid may be a different matter. There is definite scope for technical assistance and civil society support in middle income countries.

Second, plank (iii) is probably stated too strongly, in the sense that even the harshest critics of aid would concede that the poorest and most fragile countries need untrammelled support to their budgets and public expenditure programmes. Nevertheless, complementarity looks like a good principle for many countries.

Third, on new mechanisms, plank (iv), the main point to make is that they remain small for the time being, and cannot hope to substitute for straightforward budget decisions by developed countries. The EU is not about to reach its 2015 oda target by implementing a solidarity tax on airline travel, or by taxing carbon. Whether such instruments should play a bigger part in the future is worth debate. In the end, these are hypothecated taxes, so the argument needs to be about the principle of hypothecation as well as the advantages and disadvantages of particular taxes. I’m not, I don’t think, a particular fan of hypothecation.

Fourth, on recognising the new reality, plank (v), well, yes, but it will be interesting to see how the post-2015 negotiations play out if there is not a substantial cheque on the table. Ditto the climate change talks.

Fifth, and this is really the big point, there is very little reference in the EU documents, or in my summary of the argument, to the big ‘game-changers’ that may require new thinking on development finance. To be fair, there is mention of the need for precautionary reserves and shock facilities, and of the need to think about debt sustainability. However, it would have been useful to include a systematic analysis of the impact on financing need of (a) climate change, (b) global financial crises, (c) food price shocks and (d) volatility associated with resource scarcity. Surely, each of these would have suggested that needs were greater and, importantly, more widely spread among countries than the ‘argument’ seems to assume.

Conclusion: start with scenario planning at country level

I suppose, though, that this is not an argument for the status quo. What it does suggest is careful analysis, country by country, of future financing scenarios. Perhaps we can assume action on tax systems, anti-corruption and transparency, certainly if momentum is sustained on the G8 and G20 initiatives. But has anyone modelled systematically what the requirements of different countries might be, in steady state and in response to shocks? And has there then been an analysis of what the responsibilities and responses of rich countries might be? Probably. This is where the analysis should start.

Image: http://www.drfranklipman.com/disease-transformation/