Benign Global Economic Conditions with Risks
An outstanding feature of the world economy in recent years has been the strong performance of developing countries and, among them, of least developed countries (LDCs). The current combination of favorable terms of trade and exceptional conditions in world financial markets has indeed created the most positive growth environment for developing countries since the 1970s. To this we must add an increasing component of endogenous growth generated by the sustained high growth in China and India, which has been transmitted to other developing countries through increasing South-South trade and financial linkages.
Notwithstanding their strong performance, most developing countries remain highly vulnerable to a slowdown in the major developed economies and to volatility of international commodity and financial markets. The increased volatility in the prices of oil and some metal commodities as observed since mid-2006 should be a vivid warning for countries with a heavy dependence on primary commodity exports. A large sell-off in the equity markets of many emerging economies in mid-2006 and again in February 2007, which rippled in the latter case to developed markets as well, serves as a reminder of the risky nature of these markets, despite the swift recovery that followed in both cases.
Additionally, and even though external financing costs for emerging market economies remain low and credit premiums are at historically low levels, poor countries, as a group, continue to transfer more resources to rich countries than they receive. Net outward transfers by developing countries reached $658 billion in 2006 and those by economies in transition $125 billion. The paradox of poor countries financing rich countries has now continued for a decade, raising questions about the rationality of this pattern of resource flows. Its sustainability is also in question, for the current favourable external financing conditions may not last, as the current-account deficit of the United States may eventually induce higher benchmark interest rates.
Scaling Up of Aid and its Governance
Since the 2002 Monterrey Conference on Financing for Development, there has also been a significant recovery of ODA. Additional commitments were made in 2005 by both the European Union and the G7. It must be recognized, however, that the recent surge in ODA has stemmed from debt relief and emergency assistance. Indeed, due to the lack of large debt relief packages such as those approved in 2005, development aid from OECD countries fell by 5.1 percent in constant dollars in 2006.
With the scaling up of aid and the international awareness of the need for significant resources to meet the MDGs, there comes an urgent need for improved governance in the international aid system. The system of providing ODA is increasingly complex and fragmented and insufficiently coordinated. The international aid system now consists of a loose aggregation of more than 150 multilateral agencies, including agencies of the UN system and the global and regional financial institutions; 33 bilateral agencies that are members of the OECD Development Assistance Committee (DAC); several Governments that are not members of the OECD/DAC that provide significant sums of ODA; and a growing number of special-purpose global funds, such as the Global Fund to Fight AIDS, Tuberculosis and Malaria. To this complexity of the aid system, we should add the growing role of NGOs and the private sector in development cooperation.
Moreover, the current governance of international aid is uneven and, most importantly, recipient countries have an inadequate voice in the process. While the interests and views of the donor countries are well represented in the boards of the multilateral financial institutions—particularly in those associated with the allocation of concessional financing—and the OECD/DAC, no permanent forum exists that represents the interests of the recipient countries. The UN General Assembly has called for ECOSOC to convene a biennial Development Cooperation Forum, among other purposes, to build political oversight of aid commitments and aid effectiveness. At the country level, it is critical that institutions for measuring and monitoring aid effectiveness involve a genuine partnership between donors and recipients, which means that these processes should not be based exclusively on donor templates and indicators. Legislatures and citizens’ groups from the recipient countries should be adequately represented in these processes, which should also include an assessment of donor performance.
The Monterrey Consensus stresses that effective partnerships among donors and recipients are based on the recognition of national leadership and ownership of development plans and that, within this framework, sound policies and good governance at all levels are necessary to ensure that ODA produces the desired results. The 2005 Paris Declaration on Aid Effectiveness is a commendable effort in setting out the principles and launching a process to achieve that mandate.
A report to be issued at the end of this month by the OECD/DAC on the baseline for and progress on the Paris Declaration, will document current monitoring efforts and discussions on implementation. The report will confirm that some progress has been made in the implementation of the Declaration, as is apparent in a growing number of countries. It is clear, however, that more efforts are needed to achieve real and deep changes in aid effectiveness. Partner countries must lead in implementation of the Paris Principles at the country level. Donors are expected to harmonize their action plans, cooperate in monitoring progress, and support improvements in the quality of national public financial management and procurement systems by helping to build and strengthen country capacities and systems for monitoring results. Donors should also make their practices consistent with the principles of ownership and alignment, which will in turn require expanding the use of budget support and addressing universally understood problems, such as fragmentation.
Progress towards aid effectiveness will require political and conceptual agreement on approaches to measuring both the quantity and the quality of assistance. In this regard, there is increased interest in moving towards outcome-based conditionality, under which disbursements are based on the achievement of results, leaving recipient countries the freedom to determine for themselves the policy content of their programmes. The key advantage of this is that it enhances ownership and increases the probability of applying the proper instruments to meet agreed goals, based on the recipient country’s experience with the effectiveness of different policies. Questions have been raised about whether an outcome-based approach will permit the disbursement of funds in a timely manner. Yet, outcome-based conditionality requires timely and correct measurement of target variables and a capacity to take into account the impact of purely exogenous shocks in measuring performance. A formulaic application of outcome-based conditionality could reduce the flexibility and adaptability of the programmatic approach. Country experience suggests that outcome-based indicators are an essential tool to measure results but that caution should be used in applying them as conditions for disbursement.
Existing evidence also indicates that aid is significantly more volatile than fiscal revenue, and tends to be pro-cyclical on average. These patterns and the unpredictability of aid flows, in general, are key obstacles to macroeconomic stability and aid effectiveness in low-income countries. When there are sudden surges and reversals, central banks and ministries of finance have to respond with costly interventions to stabilize domestic liquidity and international competitiveness. When aid falls, it leads to costly fiscal adjustments in the form of increased taxation and spending cuts that transmit and even reinforce the cyclical impact of declining aid flows. This has a detrimental impact on output and poverty reduction.
Fiscal Space as a Key Element of Policy Space
The Monterrey Consensus calls for a “holistic approach to the interconnected national, international and systemic challenges of financing for development”. While improvements in the governance of scaled-up aid are a positive step, only the application of appropriate development policies can guarantee success. The Monterrey Consensus recognized that developing countries should take primary responsibility for their development and therefore need to have the “policy space” to design, implement, and finance national development efforts. A critical measure of improved governance in the aid system is whether the way aid is delivered enhances or restricts such policy space.
We thus welcome the debate that has been taking place in the Development Committee on fiscal policy for growth and development. The rediscovery of complementarity, rather than a trade-off, between stability and growth objectives; the emphasis on case-by-case analysis of the role of fiscal policy for growth and development; and the recommendation for efficiency of taxation and government expenditure are all commendable. We can add that higher and more stable growth itself could play a role in expanding fiscal space.
As expressed in the UN’s 2006 World Economic and Social Survey (WESS), policies that manage to reduce inflation and restore fiscal balances in developing countries have not succeeded in avoiding large swings in economic activity and employment. Quite often such policies induced a ‘pro-cyclical’ pattern which affects investment and hurts long-term growth. Thus, the UN document calls for a broader view of macroeconomic stability, as does the Development Committee, with an emphasis on the particular constraints that affect growth in developing countries, such as public infrastructure, skilled labor and health investment. We can add that inadequate tax receipts to finance necessary public sector social and infrastructure spending is probably a more common phenomenon than excessive tax burdens.
Historically, economic development has gone hand-in-hand with the advance in the capacities of social institutions concerned with participation, transparency, and accountability. As societies succeed in transforming their economies, so too do governance institutions progress—as an indispensable ingredient to further development and as the outcome of increased demand from domestic constituencies for such improvements. In fact, in countries that have succeeded, the state has played a key transformative role both in the economic and the socio-political spheres, and any efforts to constrict this transformative role, such as limiting the scope for public regulation of markets to improve their stable operation, slows down progress in good governance. Effective and efficient state regulation and supervision are a necessary underpinning for a larger private sector role in the economy.
There is no justification for the fatalistic belief that certain countries will remain mired in low growth and shackled with institutions that preclude growth. Sustained growth is possible with initially imperfect institutions. The 2006 WESS suggests that what is important is that the Government itself is credible in its commitment to making the changes that will remove institutional obstacles to growth. A necessary condition, therefore, for progress in good governance is the resumption of sustained economic activity that generates the space to improve institutions.
Developing countries need to determine how much of their limited resources should be spent on the governance agenda. It would be unrealistic to assume that all governance weaknesses in a developing country are of equal significance or can be tackled simultaneously. Sustained progress towards more effective, transparent, and equitable governance at the national level can most readily be assured when particular attention is given to those governance capacities that are crucial for accelerating and sustaining growth. Given the limited administrative capacities of developing countries, it is important for each country to identify and address those governance failures that are the most detrimental to their growth and structural development.
Corruption should be recognized as only a part of a complex set of governance challenges. This means that anti-corruption efforts must be understood as a component of longer-term efforts to advance practices of good governance at all levels and as a component of the overall development effort in building a variety of other capabilities. Because there are two parties to any bribe—the recipient and the giver—efforts in combating corruption should pay attention to shutting down the supply side of corruption from international sources. The United Nations Convention against Corruption is the only internationally agreed framework in this area. It is thus unfortunate that developed countries have been slower in ratifying the Convention than developing countries.
Energy for Sustainable Development
We welcome the attention given by the World Bank to energy for sustainable development through its Clean Energy Investment Framework (CEIF), which was formulated at the request of the Development Committee. We welcome, first, the attention given to improving access to modern energy services by the poor. Indeed, access to energy underpins a nation’s ability to eradicate poverty and, in fact, to achieve all of the MDGs. Capacity building for effective public sector policy development in developing countries plays a crucial role in this regard.
The CEIF also includes a focus on mitigation of greenhouse gas (GHG) emissions and adaptation to climate change impacts. Facilitating the transfer of new and cleaner technologies, including by technological cooperation initiatives and public-private partnerships, can have a profound impact on the ability of developing countries to mitigate GHG as they experience rapid socio-economic development. The impacts of climate change are expected to affect least developing countries in a number of ways, and adaptation measures may be expensive for many of them.
A coherent approach to donor aid is a feature of the CEIF. Coordinated approaches for improving access to energy and promoting clean energy investments are central to the Framework. The proposed shift outlined in the CEIF from project-by-project to programmatic and sectoral finance for carbon mitigation is welcome, as this is consistent with both a broader shift in emphasis towards budgetary support and greater flexibility in donor resource allocation. It is also in line with the recognition that, in order to scale up carbon finance significantly, such a programmatic and sectoral approach will be crucial. Plans detailed in the CEIF to provide incentives for transitioning to low-carbon economies in World Bank client countries can be part of a broad, inter-agency effort to assist countries in their mitigation efforts.
The emphasis in the CEIF on adaptation is especially timely in light of the newly released IPCC Summary for Policy Makers of its report on the impacts of climate change, which stresses the urgency of investment in adaptation, especially in developing countries, and the importance of mainstreaming climate change adaptation into infrastructure and other development investment portfolios. Further development of tools and additional resources to effectively assist developing countries in their efforts to adapt to climate change impacts are urgently needed.
The new carbon finance facility proposed by the World Bank, within the context of the CEIF, would contribute to a better policy dialogue among industrialized and developing countries to help develop programmes and introduce measures to mitigate emissions.
The growing interdependence of the global energy markets, especially oil and gas, makes continued dialogue important for long-term market stability. Predictability in terms of energy supply and demand is important to stimulate investment in the energy sector and energy efficiency technologies, as well as wide implementation of energy efficiency measures.
Many of these issues will be dealt with in the15th session of the United Nations Commission on Sustainable Development (CSD), which will take place in lateApril/early May. The Commission, which will consider the issues of energy and climate change, along with industrial development and air pollution/atmosphere, is the premier forum for dialogue on these issues with the broadest representation of industrialized and developing countries, as well as of countries with economies in transition. Preparatory work by governments has highlighted their concern with improving energy access, improving dialogue among energy producers and consumers, as well as the need for more research, development, and transfer of cleaner technology and other measures for the mitigation of GHG emissions and adaptation to climate change. The World Bank and other UN agencies, funds, and programmes have contributed actively to preparations for the CSD deliberations this year. Decisions taken by the CSD may provide guidance on these issues and also on aid disbursement for climate change mitigation and adaptation, including the carbon finance activities outlined in the CEIF.