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Three principles for aid and the private sector

Added 17 Oct 2016
Originally published by Public Finance International

Using aid to mobilise trillions in private money is a hot and hugely controversial topic. Such aid is no different from any other kind: it can be well spent or badly spent and should meet basic effectiveness principles

Donor governments are currently revising rules on Official Development Assistance (ODA or ‘aid’) so that the opportunities for using aid to leverage – or more accurately, subsidise – private companies and private investment could explode. This is, of course, hugely controversial, and Eurodad has warned that more care, thought and time should be devoted to such rule changes, involve recipients and stakeholders and be preceded by a firm commitment from donors not to tie aid to the use of their own firms.

When we talk of aid to leverage or subsidise or mobilise private finance we are talking about two basic things: the use of public money to subsidise a private financier; or the use of publicly backed institutions – typically development banks or guarantees agencies – to help channel private finance towards underserved sectors or countries.

The first important point is that, unfortunately this has become a debate about western or multilateral institutions, when really national development banks are collectively more important players, though, as the World Bank noted, little research effort is directed towards understanding them.

Aid for private investment: what principles?

Over many years aid practitioners agreed, and re-agreed most recently in Busan in 2011, basic principles for what makes aid effective. These principles are important no matter the kind of aid, as they summarise our best knowledge about the how external public actors ought to behave if they want to have a positive impact in developing countries.

Principle 1: Results

We can start here because everyone can agree that results are important, right? Well no, actually: the debate here is overwhelmingly framed as being about quantity – or in the World Bank’s unhelpful catchphrase ‘from billions to trillions’ – not impact. There are so many problems with this framing, it’s hard to know where to start. First, it shows an unfortunate disregard for reality: domestic investment, largely from private sources, is already in the trillions, averaging over 30% of GDP in developing countries.

So it shows that what we are really talking about is foreign investment (typically less than 4% of GDP), where the quality is more important than the quantity. Quality is important not just because much foreign investment in low-income countries is in extractive industries, which can have huge negative (as well as positive) impacts, but also because it misses the point about why we would use public institutions or public money (like aid) to interfere in private financial markets in the first place: which is mainly to improve the way they function, not to increase their size. We may want public intervention to make finance more stable or less prone to crises, or we may want to encourage finance to go to key sectors, industries or regions. Public interventions, including the use of aid, are, in reality redirecting private finance – from unproductive to productive sectors, from some countries to others – not normally increasing the amount available overall. This is why results should be our focus, and we should drop the myopic obsession with large numbers.

Principle 2: Democratic ownership

This is important not just for democratic reasons but because all countries that have successfully developed have done so on the back of strong domestic leadership. Unfortunately, the current debate on aid and private finance starts from the perspective of the donor: it looks through the telescope the wrong way. What actually matters is examining the key constraints to private investment and growth at national level, which could range enormously, from issues that are to do with the financial sector (lack of finance, lack of investable projects) to issues outside the financial sector, such as poor infrastructure. Decisions about whether to spend more aid money subsidising private finance, versus for example, investing in infrastructure or healthcare, should be made at country level, not because of donor trends.

Principle 3: Transparency and accountability

The current level of information on publicly backed investments overseas made by donor-controlled institutions is woeful. For example, Swedfund in Sweden issues a press release about each investment, but rarely anything more. The main point here is that aid has an impact on real people’s lives – sometimes an enormous impact. Citizens of developing countries have a right to know what is happening, and a right to hold donors accountable.

Finally, none of the above should be taken to suggest that the debate about the use of aid should be the focus of donors’ efforts to support the private sector in developing countries. If donors were really serious about this agenda, they would focus, for example, on improving trade and investment rules, or closing down their tax havens that channel illicit finance of developing countries. But that is a topic for another blog.

 Jesse Griffiths will be speaking on donor-backed investments in private enterprises and development effectiveness at the ‘2016 CAPE conference: where next for development effectiveness?'