The lexicon of sustainable development includes an oft-used term: market failure. The term has been attributed to, and popularized by, a Hungarian-born economist who would eventually serve under United States President Lyndon Johnson before teaching at Harvard University—Francis Michel Bator.

Bator would unveil the concept of market failure in an August 1958 article in The Quarterly Journal of Economics, wherein he described it as “the failure of a more or less idealized system of price-market institutions to sustain ‘desirable’ activities or to estop ‘undesirable’ activities.”1

There is a very simple reason for why the market failure concept has found new relevance in the context of sustainable development generally and the Sustainable Development Goals (SDGs) in particular. In order to achieve the SDGs, we need to fundamentally reform the existing global financial architecture that currently deploys capital towards sustaining undesirable activities, such as dramatically increasing our carbon footprint, exacerbating inequalities on the basis of gender or denying individuals and communities the opportunity for decent work and inclusive economic growth, just to name a few. Sustainable development demands a new financial architecture that incentivizes capital providers to invest in the desirable activities that unite all of us as a global community—the set of activities that represent the very definition of the SDGs.

One of the most overlooked drivers of sustainable development is local finance, particularly in the context of developing countries and least developed countries (LDCs).

One of the most overlooked drivers of sustainable development is local finance, particularly in the context of developing countries and least developed countries (LDCs). When you consider the actual practice or mechanics behind the achievement of sustainable development, it becomes immediately clear that local governance is essential. Local governments are singularly aware of the sustainable development needs on the ground. They are capable of convening local stakeholders to make the process of sustainable development a democratic practice. They are also more likely to adopt the appropriate policies and regulations than national Governments.

And yet, local governments are often unable to access and accumulate the necessary capital—called capital formation—to finance sustainable development. There are myriad reasons for which municipalities in developing countries and LDCs experience low levels of capital formation. These include national Governments denying municipalities the regulatory power to tax as well as the power to issue debt to access domestic and international capital markets; and municipalities having their creditworthiness determined in significant part by the debt ratio of their national Government.

But the individual reasons do not reflect the power of the collective reality. Today’s global financial architecture does an excellent job of funneling capital to national Governments generally, local governments in developed countries and, of course, large businesses. It does a less-than-optimal job of funneling capital to municipalities in the areas of the world that need sustainable development the most. By definition, this architecture is creating market failures that will ensure that the areas facing the greatest challenges with sustainable development—parts of the world where the cities, human settlements and localities are least likely to be inclusive, safe, resilient and sustainable—are also least likely to access the financing necessary to support sustainable development.

Let us take this one step further. Probably the dominant global demographic trend taking place over the next decade is urbanization. According to World Urbanization Prospects: the 2018 Revision, around 80 per cent of global gross domestic product is already being generated in cities, while 68 per cent of the total global population will be made up of urban residents by 2050.2  A 2013 joint report by the International Monetary Fund and the World Bank stated that of the 1.4 billion-person increase in population projected to occur within developing countries by 2030, 96 per cent are expected to live in urban areas.3  Today, 30 of the world’s 35 most rapidly growing cities are located in LDCs.4

So, correcting these market failures means more than ensuring that municipalities in developing countries are not resigned to a long-term future of underdevelopment. Achieving SDG 11, on sustainable cities and communities, in developing countries is the only way to ensure that we achieve the global management of urbanization, given how much of this trend will take place in those countries. That means municipalities need access to capital.

One of the critical ways we are looking to change the financial architecture seems simple at first glance. If municipalities in developing countries and LDCs are unable to access capital, then one of the ways to reform this architecture to reduce and eliminate market failure is by ensuring that they can, indeed, access capital. But how? A pilot project that the UN Capital Development Fund (UNCDF) is running in Bangladesh offers a solution that has the potential to be scalable, replicable and impactful.

Nepalese family gather to watch television, which is possible due to a micro-hydropower plant. 7 November 2013. ©UNCDF

First, we test municipalities to prove their creditworthiness and incentivize experimenting with new regulations. There is a fundamental, self-fulfilling prophecy at work: municipalities are seemingly bad credit risks because they lack access to capital markets; national Governments are then further incentivized to deny municipalities the regulatory tools to access those markets because they are such bad bets. The reality, however, is that there are municipalities that are creditworthy and investment grade yet are still unable to access capital. In Bangladesh and Nepal, we conducted credit tests of several municipalities and found that seven (three in Bangladesh and four in Nepal) were investment grade. Once we were able to present this to the Government of Bangladesh, we were able to agree on piloting a credit programme with those municipalities.

Next, we identified a pipeline of sustainable projects that this credit would finance. In Bangladesh, we have outlined two streams within the pipeline. One stream involves commercial markets, including a bus terminal to facilitate access and transportation, a town hall and eight commercial centres. The other stream involves waste-to-energy projects in six separate municipalities. In all cases, we are working with national and local government partners to earn their buy-in and leverage their resources. Finally, as we look to the future, there is innovation. Working with partners, we innovate the right financial tool for municipalities to attract investment capital and make it work for the sustainable projects that have already been identified. As we are in the piloting phase in terms of Bangladesh municipalities accessing capital markets, they can now issue bonds that can support long-term loans that will direct capital precisely to local sustainable development projects. Just as importantly, we can identify a guarantor—either the national Government or a multilateral development agency, for example—that will guarantee the bond issuance in order to catalyse capital from sources that would otherwise not look to these investments.

Perhaps the most important aspect to consider is that this process can be applied well beyond Bangladesh and Nepal. The success we achieve with the project can provide a model for how local governments can serve as drivers of sustainable development in the world’s toughest geographies. Furthermore, rural areas do not have to be left behind; they can benefit from pooled funds with better capitalized urban centres that can collectively access thematic funds that focus on issues like climate change and the economic empowerment of women.

The SDGs represent more than an agenda. They represent a referendum. Every choice we make as individuals, communities and societies determines whether we will be engines of sustainable development or inhibitors of it.

The SDGs represent more than an agenda. They represent a referendum. Every choice we make as individuals, communities and societies determines whether we will be engines of sustainable development or inhibitors of it. It is the same in the context of the global financial architecture and the actors within it. Our decisions will determine whether sustainable development will occur because of the architecture or, if we are lucky, in spite of it.

Most importantly, this referendum is taking place within an undeniable reality. Urbanization is happening. The economic and political centres of gravity of the future are migrating towards the local. SDG 11 represents a fundamental reality—that local communities will be the crucible where the success or failure of the SDGs will be determined. It is time that we had a global financial architecture commensurate with this reality.

Notes

1. Francis M. Bator, “The anatomy of market failure”, The Quarterly Journal of Economics, vol. 72, No. 3  (August 1958), 351.

2. United Nations, Department of Economic and Social Affairs, Population Division, World Urbanization Prospects: The 2018 Revision (ST/ESA/SER.A/420) (United Nations, New York, 2019), p. p. 3, xix. Available at https://population.un.org/wup/Publications/Files/WUP2018-Report.pdf.

3. World Bank, Global Monitoring Report 2013: Rural-Urban Dynamics and the Millennium Development Goals (Washington, D.C., 2013) p.1. Available at http://pubdocs.worldbank.org/en/961951442415876455/GMR-2013-Full-Report.pdf.

4. United Nations Capital Development Fund, Report on results achieved by the United Nations Capital Development Fund in 2018. DP/2019/18. Annual session 2019, 30 May, 3-4 June 2019 (New York, 2019), p. 8. Available at https://digitallibrary.un.org/record/3800865#record-files-collapse-header.

 

18 February 2020

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