Co-authored by Harpinder Collacott
The Investments to End Poverty report revealed dramatic change in the global financial landscape. It underlines the need to get beyond the sterile argument about whether developing countries need aid or private investment to promote prosperity and end poverty by 2030. The clear answer is both. A mix of resources is necessary to meet the diverse needs of development. See Using all resources available to end poverty: what you need to know.
As these charts show, domestic government spending in developing countries almost tripled to $5.9 trillion between 2000 and 2011. At the same time, international flows quadrupled to about $2 trillion.
Countries with the lowest levels of domestic resources and high levels of poverty rely particularly on international aid. It’s the largest flow to three quarters of countries where governments spend less than PPP$500 per person each year. Here, aid will continue to play a critical role investing in human capital, catalysing and leveraging external finance and mobilising domestic resources. Where foreign direct investment (FDI) or loans are more significant, changes in the international investment climate or risk ratings will have a considerable bearing.
We saw yesterday that foreign investment is playing an increasingly important role in developing countries. Many countries in sub-Saharan Africa have a high proportion of their populations living far below $1.25 a day and FDI volumes have been low. Even so, evidence suggests FDI has helped raise total domestic investment as a share of GDP by almost 4% since the late 1990s. The African Development Bank also estimates that the impact of FDI on savings and investments is 5 to 7 times larger than official development assistance (ODA).
Despite real development progress, many developing countries – particularly in sub-Saharan Africa – remain difficult for investors. Fragile states carry major political and economic risks. Some markets are protected by high barriers to entry or dominated by the state. Capital markets are often under-developed and financial infrastructure and regulatory frameworks are weak. Some markets lack a substantial middle class to afford goods. Although Africa as a whole is a significant market, it is fragmented.
So how can donors do more to support the mobilisation of new resources?
Donors are clearly committed to this end: over a fifth of donor support went to ‘economic development’ in 2012. Reforming the investment climate needs political will, drive and leadership from domestic governments, donors and the private sector. See Using data to get better results on poverty eradication: What you need to know.
There are many ways in which a mix of aid, government and private investment can be used more creatively, such as making changes in government policy, adjusting business models, coordinating international legislation and exchanging information and financing mechanisms that channel multiple resource flows.
Some options that aid agencies can consider to promote investment in development that leaves no one behind include:
- Reducing risks for businesses operating in fragile environments by providing guarantees, risk insurance and incentives such as advanced market commitments.
- Supporting and strengthening efforts to mobilise investment by lowering the costs, improving competition and developing human and institutional capacities.
- Working with governments and firms – particularly small and medium-sized enterprises (SMEs) – to build local capacity to respond to new investment opportunities by connecting with international value chains, enabling compliance with rules, and supporting innovation.
- Promoting labour-intensive investment that takes advantage of a growing pool of educated young people.
- Incentivising regulatory and financial sector officials to underpin better planning, transparency, up-skill tax, and more accountable use of resources and responsible investment.
- Supporting regional integration that creates larger harmonised markets that are attractive to private business.
Businesses also need to be ready to take on more risk for greater return in the future by developing innovative solutions to operating in challenging environments, proactively identifying investment opportunities that have social impacts, and showing willingness to work with non-traditional business partners such as associations and non-profits.
I met with partners in northern Uganda who have improved their agricultural productivity through access to information programmes Development Initiatives has been running in their district. As a result the community have pooled their resources and knowledge and set up a dairy factory. Now they’re looking for business partners to help them scale-up their production and take it to market. The investment risks are high for a business or investor to partner with this community association. The determination of the community and success in the face of adversity gives me confidence to say the returns could be high too. Is there a venture capitalist willing to take on this challenge?
 Gross Official Development Assistance from the 23 DAC countries and multilateral organisations to ‘economic development’ in 2012 was US$31 billion, from a US$150 billion total. Economic development covers three sectors: ‘banking & business’, ‘industry & trade’ and infrastructure. Source: OECD DAC CRS