Chapter 2. The expansion of the financing for sustainable development system: More actors and resources

The domestic public sector’s resources affect the Sustainable Development Goals

Governments have the primary responsibility for implementation of the 2030 Agenda, through direct financing and setting the regulatory environment for foreign and domestic private investment.

Tax revenues are the largest source of finance, exceeding the volumes of any single cross-border resource. In 2016, tax revenues in developing countries amounted to USD 4.3 trillion. The share of tax revenues in the overall finance mix varied from 42.7% in least developed countries and 42.4% in low-income countries to 62.2% in lower middle-income countries and 78.2% in upper middle-income countries.

Figure 2.1. Mix of financial resources in developing countries

USD billions, 2016

Note: The estimates have been calculated for the list of developing countries eligible for ODA but do not include a number of countries and territories because of lack of data on tax revenue. Those excluded are the following low-income countries (LICs): Democratic People's Republic of Korea; Somalia, which is also a least developed country (LDC); and South Sudan (also an LDC).

Among lower middle-income countries and territories (LMICs), the following are excluded: Bhutan (LDC), Kosovo, Mongolia, Myanmar (LDC), Sri Lanka, Syrian Arab Republic, Vanuatu (LDC), West Bank and Gaza Strip. A third group excluded are upper-middle income countries (UMICs): Cuba, Fiji, Former Yugoslav Republic of Macedonia, Libya, Montenegro, Nauru and Venezuela.

Sources: IMF (2017[1]), “World Revenue Longitudinal Data”, https://data.world/imf/world-revenue-longitudinal-dat; OECD (2018[2]), “Global Revenue Statistics Database”, https://stats.oecd.org/index.aspx?DataSetCode=REV;

OECD (2018[3]), “Creditor Reporting System” (database), https://stats.oecd.org/Index.aspx?DataSetCode=crs1;

World Bank (2018[4]), “Migration and Remittances Data”, http://www.worldbank.org/en/topic/ migrationremittancesdiasporaissues/brief/migration-remittances-data; IMF (2017[5]), “Balance of Payments” (database) 2017, http://www.imf.org/external/datamapper/datasets/BOP for private investment data.

 StatLink https://doi.org/10.1787/888933852635

Greater public resources are associated with greater spending on SDGs such as health (SDG 3) and education (SDG 4).1 Domestic public resources can help tackle inequality (SDG 10) by redistributing wealth in ways that are acceptable to society as a whole. While evidence on the redistributive implications of tax systems in developing countries remains limited, recent findings confirm that fiscal systems in developing and developed countries can reduce inequality and support inclusive growth (Box 2.1).

Domestic public resources are not yet sufficient to meet global and country ambitions

Countries may choose different approaches to the financing of development that involve lower tax ratios; different dimensions of development such as fragility, economic vulnerability and human capital development may affect the ability to raise revenues.3 Without an agreed, ideal tax-to-GDP ratio, a ratio of 15% is increasingly recommended as a minimum benchmark for effective state functioning (IMF et al., 2016[11]) (Gaspar, Jaramillo and Wingender, 2016[12]). As shown in Figure 2.2 2.2, low-income and least developed countries remain some distance below this ratio, although since 2005, some progress has been made in increasing the ratios. The average ratio in middle-income countries is above 15% but this is still well below the 2016 OECD average of 34.3%,4 indicating significant room to grow tax revenues to finance sustainable development. Such growth becomes increasingly urgent if – due to rising debt levels in developing countries – opportunities to finance public spending through debt financing narrow in the future (Chapter 5).

Figure 2.2. Tax-to-GDP ratios by country classification

% of GDP

Note: The ratios are calculated for countries in the OECD list of developing countries receiving ODA.

Sources: (IMF, 2017[1]), “World Revenue Longitudinal Data”, https://data.world/imf/world-revenue-longitudinal-dat; (OECD, 2018[2]), “Global Revenue Statistics Database”, https://stats.oecd.org/index.aspx?DataSetCode=REV.

 StatLink https://doi.org/10.1787/888933852654

There are substantial differences in countries’ ability and capacity to increase tax revenues. Moreover, mobilising more tax revenues may not always be desirable given the opportunity costs it involves. Tax effort estimates gauge the ratio between revenue and potential revenue given a country’s current GDP, level of development, etc. While there is relatively little research in this area, one study by Fenochietto and Pessino (2013[13]) has found high-income countries showed a higher tax effort (77%) than did low-income countries (65%) and middle-income countries (64%). However, there is significant variation within these categories and a large number of developing countries appeared to be operating close to their potential. Regionally, Africa had the second-highest level of tax effort (71%), behind only Europe (77%) and significantly ahead of Asia Pacific (59%).

Especially where tax effort is already high, increasing revenues often depends not just on tax policy changes and administrative improvements but also on growth and structural changes in the economy. In consequence, growing the domestic private sector is vital, as is discussed further elsewhere in this chapter. Many developing countries also have very large informal sectors and underground economies where cash transactions leave no audit trails for tax purposes. Even where income is declared, it is often grossly underestimated. Many developing countries face additional challenges to growing tax revenues, among them weak revenue administrations and poor governance. But assertive policy approaches can make a difference, as shown in the essay on Indonesia’s tax reform (Box 2.2 “Tax reform and quality spending are crucial for a more sustainable and inclusive economy”).

International tax policies also have a substantive impact on tax revenues, for example by eroding multinational enterprises’ ability to shift profits offshore and avoid corporate taxes in the countries of operation. This is particularly important for developing countries, for which spillovers in international corporate taxation are especially marked and important (IMF, 2014[14]).

International efforts are needed for more domestic resource mobilisation

International partners need to consider how best to support developing countries to reach their potential to mobilise greater domestic revenue. For most countries, the most effective actions will be a combination of development co-operation and policy coherence. The Addis Tax Initiative acknowledges this: donor country signatories have committed to collectively double their spending on tax capacity development between 2015 and 2020 and to improve policy coherence for development in tax matters.

Committing resources for capacity building is important, but this must be matched with a commitment to ensuring impact. Even when doubled, ODA to domestic revenue mobilisation will only be USD 445 million and represent just around 0.3% of ODA, so ensuring maximum return is important. To do so may require new approaches to capacity building. One innovative approach is that of Tax Inspectors Without Borders, which deploys experienced tax auditors to work with countries’ revenue authorities on live cases and has mobilised USD 414 million in additional tax revenue so far. Its return on investment is thus more than 100:1.

Additionally, domestic policies in developed countries can be aligned to support domestic revenue mobilisation in other countries. The most obvious way to accomplish this is by adopting new international standards on exchange of information and taxation of multinational enterprises and by supporting their implementation. These standards commit countries to co-operation and therefore enhance the ability of all countries to raise revenues (Chapter 5). The automatic exchange of information (AEOI) will enable tax authorities to automatically receive information about their taxpayers’ offshore financial accounts. Over 100 jurisdictions are currently committed to implementing AEOI. Bringing more developing countries into this network offers huge potential, as testified by Indonesia’s experience and described in Box 2.2. The OECD/Group of Twenty (G20) Base Erosion and Profit Shifting (BEPS) project provides a range of tools to address the main methods used by multinational enterprises to shift profit offshore. Moreover, the 117 countries and jurisdictions that are members of the Inclusive Framework on BEPS are committed to meeting the four minimum standards that address cross-border challenges. Both information exchange and the BEPS Actions significantly increase the information available to and options for developing countries to effectively tax cross-border activity. To further realise this potential, it is important that the tools are designed in a way that is fit for purpose and especially that takes account of capacity constraints in developing countries. In this regard, the establishment of the Inclusive Framework on BEPS is a significant development as it brings developing countries into the international standard-setting processes on tax on an equal footing.

Efforts to grow tax revenues must be accompanied by support for strong public financial management systems. The role of governments is not only to mobilise resources but also to use those resources to advance sustainable development. Improvements in the tax system that are not accompanied by improvements in the way resources are spent are not likely to achieve the desired development outcomes. To ensure that resources are spent in an effective and sustainable way, it is important to embed domestic resource mobilisation approaches in broader fiscal governance frameworks.

Domestic investment is the main source of capital formation, but it appears to be in decline

Domestic private investment can take the form of investment by private enterprises of retained profits and/or finance from other sources and potentially through banks, private equity or the growing number of stock markets.

Domestic private investment is challenging to measure empirically because indicators are often mingled with other categories. One possible proxy to estimate the portion of capital formation financed by domestic resources is gross fixed capital formation less FDI as a percentage of GDP. Figure 2.3 shows that despite considerable variation across developing countries, total domestic investments generally make up a sizable portion of GDP. The relationship between domestic investments and GDP increases steeply at lower per capita income levels and reaches over 20% of GDP for many developing countries including low-income countries and lower middle-income countries. In comparison, total external financing on average represents less than 20% in low-income countries, less than 10% lower middle-income countries and less than 5% in upper middle-income countries.

Figure 2.3. Domestic private investment against per capita GDP

Gross fixed capital formation in the private sector less FDI, % of per capita GDP, 2014-16

Note: The graph plots domestic resources as captured by the difference between gross fixed capital formation (GFCF) in the private sector and foreign direct investment net inflows. Countries included in the graph are low to upper middle-income countries for which data on GFCF in the private sector, FDI and GDP are available. These are Angola, Bangladesh, Bolivia, Botswana, Burundi, Cameroon, Chad, Republic of the Congo, Croatia, Democratic Republic of the Congo, Egypt, El Salvador, Georgia, Ghana, Guyana, Honduras, the Islamic Republic of Iran, Lebanon, Madagascar, Malawi, Malaysia, Mauritania, Mauritius, Mexico, Nepal, Niger, Pakistan, Panama, Peru, Philippines, Russian Federation, Senegal, Sierra Leone, South Africa, Sudan, Suriname, Swaziland, Thailand, Togo, Uganda, Uzbekistan and Yemen.

Source: World Bank (2018[15]), “World Development Indicators” (database), http://databank.worldbank.org/data/reports.aspx?source=world-development-indicators.

 StatLink https://doi.org/10.1787/888933852673

Domestic private investment appears to be in decline. Excluding China, domestic mergers and acquisitions (M&A) declined by over 60% between 2010 and 2017, falling to USD 95 billion from USD 237 billion. This decline corresponds closely to the broader downward trend in foreign investment and especially cross-border M&A in developing countries, which fell by about USD 72 billion, or 30%, as discussed later in this chapter. With some notable exceptions,5 domestic M&A has fallen faster. This suggests that some of the same factors that have reversed the foreign investment trajectory, such as economic recovery in developed countries and record levels of corporate debt in developing countries, are also dampening domestic investment M&A.

To counterbalance these trends, active measures have to be taken to promote domestic investment in developing countries by addressing bottlenecks and risks. The international community can support this by providing technical as well as financial assistance for a better enabling environment including legal and regulatory frameworks.

Financial sector development is a key driver of domestic investment

In designing enabling environments, financial sector development will be key. A well-functioning financial system mobilises domestic savings, improves resource allocation, and facilitates diversification and management of risk (Levine, 2005[16]). Financial sector development is a critical enabler of the 2030 Agenda. Indeed it is included as a target in 8 of the 17 SDGs. These include SDG 1 on eradicating poverty; SDG 2 on ending hunger, achieving food security and promoting sustainable agriculture; SDG 3 on ensuring health and well-being; SDG 5 on achieving gender equality; SDG 8 on promoting economic growth and jobs; SDG 9 on supporting industry, innovation, and infrastructure; and SDG 10 on reducing inequality. SDG 17 on strengthening the means of implementation also includes an implicit role for greater financial inclusion through greater savings mobilisation for more investment and growth (UN Capital Development Fund, 2018[17]).

Globally, some progress is being made in terms of promoting financial sector development. Financial sector deepening, which can be measured by the extent of domestic credit generation and its share in GDP, has increased especially sharply for upper middle-income countries (Figure 2.4). At the same time, the ratio in low-income countries has increased by nearly 50% since 1990 but nevertheless remains very low, suggesting the need for additional deepening. Weak institutional, legal and regulatory environments and capacities are often cited as the main challenges to be overcome to deepen the financial system (IMF, 2012[18]).

Figure 2.4. Domestic credit to private sector as a share of GDP

% of GDP

Source: World Bank (2018[15]), “World Development Indicators” (database), http://databank.worldbank.org/data/reports.aspx?source=world-development-indicators.

 StatLink https://doi.org/10.1787/888933852692

In addition to depth, financial sector access, efficiency and stability are important for development outcomes (Levine, 2005[16]). Between 2011 and 2017, the proportion of the world’s adult population with an account at a financial institution grew to 69% from 51%, an increase of about 1.2 billion people (Demirgüç-Kunt et al., 2018[19]). Technological advances have led to an expansion of financial services: mobile banking services now are helping to reach large numbers of unbanked people and extend formal financial services to the poor, especially in sub-Saharan Africa. In Kenya, 73% of adults have a mobile payment account and about 50% have one in Uganda and Zimbabwe (Demirgüç-Kunt et al., 2018[19]). Nevertheless, serious concerns remain about the security of transactions that are made through mobile banking, and regulatory mechanisms are not yet in place (Reaves et al., 2017[20]).

Foreign-owned banks dominate the banking systems of many developing countries, notably in Latin America and sub-Saharan Africa. This brings competition and efficiency but also the risk of transmitting external shocks. For developing countries, the median share of assets held by foreign banks rose to 52% in 2008 from 8% in 1995. In comparison, the median share in developed countries rose to 27% from 5% over the same period.6 Foreign banks can bring competition, efficiency and a stabilising influence on domestic economies in times of crisis (Cull et al., 2017[21]). But the global financial crisis highlighted that foreign banks also can transmit external shocks and crises to the domestic economy by reducing their lending earlier and faster than domestic banks and by repatriating funds to their home countries (Anginer et al., 2014[22]).

There have been efforts since the crisis to ensure that developing country concerns are reflected in the international financial system. At the request of the G20, the Financial Stability Board, in collaboration with the International Monetary Fund (IMF) and the World Bank, has been monitoring the effects of regulatory reforms on emerging markets and developing economies, taking developing country concerns into account in the design of the international regulatory framework. With the recent finalisation of global financial regulatory reforms, international financial organisations also are preparing to step up capacity-building efforts to assist the implementation of the new standards. An example is the launch by the IMF of the Financial Sector Stability Fund in November 2017 to assist low-income and lower middle-income countries as they assess and address risks and vulnerabilities in the financial sector.

Despite significant progress, deficiencies or market failures can often hamper access to finance for segments of society. A lack of sustainable lending to small and medium-sized enterprises (SMEs) constrains growth in low-income countries. The International Financial Corporation (2013[23]) estimates that the credit financing gap for formal SMEs in developing economies is close to USD 1 trillion. A gender gap in access to finance also persists. Globally, 72% of men have a bank account compared to just 65% of women, and the gender gap is even higher – at nine percentage points – in developing countries (Demirgüç-Kunt et al., 2018[19]).

Policy makers have to ensure that the financial sector is socially and environmentally sustainable. Initiatives to build what Grameen Capital India has termed a “capital-with-a-conscience ecosystem” are examples of ongoing efforts described in Box 2.3 “Getting private resources on board for sustainable development”. Particular attention has to be given to low-income countries, as financial sector inefficiencies tend to weigh more heavily on these places than on middle-income countries, as the former tend to be more vulnerable to fluctuations in commodity prices and external financing (Eichengreen, Park and Shin, 2017[24]).

Trends over time of external flows vary depending on the type of flow:

• The rates of increase in private investment flows have declined, a trend that holds across all income groups.

• Official flows to low-income countries have declined recently in favour of a more rapid increase for middle-income countries.

• Growth in remittances has remained stable in the low-income country context while remittances are increasing at a slower pace for upper middle-income countries.

Different actors have different roles

The international community calls on all the various actors to play a part in financing for sustainable development, but this goal is complicated by the individual objectives of different actors.

• Concessional flows as well as philanthropic flows usually aim to further sustainable development.

• Commercial investments are driven by a profit motive.

• Remitters are mainly motivated to contribute to the well-being of individual recipients at the household level.

To evaluate the implications of trends in cross-border actors and their resources, it is important to understand their role in the sustainable development financing system. Private sector actors can bring productivity gains and job creation while the public sector can have a comparative advantage in targeting poverty and gender inequality. Moreover, the sectoral destination may vary according to the type of actor. While the private sector tends to invest in economic sectors such as manufacturing, official flows are well placed to target social sectors such as health and education (see Chapter 4). These roles can change at different income levels (see Chapter 6).

The destination of flows also varies by the type of actor. Low-income countries tend to have a higher reliance on official and especially concessional flows while for lower middle-income countries (LMICs), remittances are a major source of external financing. Non-concessional official flows target LMICs and upper middle-income countries (UMICs). The major share of private finance goes to UMICs but it is an important source for LMICs as well (Figure 2.6).

Figure 2.6. Destinations of external financing in 2016

Source: Authors’ calculations based on OECD (2018[3]), “Creditor Reporting System” (database), https://stats.oecd.org/Index.aspx?DataSetCode=crs1 for official bilateral and multilateral flows; World Bank (2018[4]), “Migration and Remittances Data”; IMF (2017[5]), “Balance of Payments” (database) for FDI, portfolio investments, and long-term and short-term debt.

 StatLink https://doi.org/10.1787/888933852730

Currently, USD 1.7 trillion in resources are already flowing into developing countries but not every dollar will have the same development impact, as Chapter 4 discusses further. To ensure these are spent in a way that is conducive to sustainable development, the diversity and distinct comparative advantages of actors must be exploited.

Commercial investors have become increasingly important and diverse

Over the past 30 years, multinational enterprises (MNEs) have become important actors channelling FDI8 to establish a presence in developing countries. Over the last 20 years in particular, the nature of MNE investment flows to developing countries has evolved beyond a relatively narrow focus on the extractive industries to become one of the cornerstones, along with trade, of global value chains (GVCs) Box 2.4. Many developing countries are now involved in the production of increasingly sophisticated goods and services that feed into the international production networks of MNEs. Global value chains are increasingly used as channels contributing to sustainable development, mostly through financial transfers but also through the transfer of knowledge, standards and skills.

MNEs also engage in portfolio investments, especially within the context of strategic partnerships with other MNEs and domestic firms. Multinational enterprises base their decisions to invest on a broad range of factors including market size, labour force skills, macroeconomic and institutional stability, physical infrastructure, and natural resources.

Other actors involved in portfolio investments include institutional investors such as pension funds, sovereign wealth funds, mutual funds, private equity funds, and hedge funds. Often these investors seek opportunities in developing countries to reduce the risks of their investment portfolios through diversification and higher returns. Since financial assets in developing countries have low correlation with returns in developed economies, they complement the risk-return profile of financial investors in developed countries.

Investors in developing countries themselves account for one-quarter of global FDI outflows, up from around 12-13% before the 2008-09 global financial crisis (World Bank, 2013[28]). The rapid rise of China as one of the world’s largest sources of FDI, including through Chinese state-owned enterprises, has been particularly important (Box 2.5).

The growing visibility of this relatively new kind of actor – the state-owned enterprise (SOE) – goes hand in hand with the growing significance of investments from developing countries, as these countries often channel their investment through SOEs. Although not strictly a private sector actor, state-owned enterprises often behave in ways that are similar to their private sector MNE counterparts. This may mask significant government involvement in some cases. Data on FDI do not allow for a distinction between international investments by state-owned enterprises and privately-owned MNEs, but data on cross-border M&A suggest conservatively that the former account for around 10-20% of global FDI flows.

Finally, a multitude of private actors are often involved in project finance, one of the most important forms of investment from a development perspective and a primary method for financing so-called greenfield investments. Project finance usually involves a combination of MNEs and commercial lenders as well as many of the public-sector partners discussed later in this chapter, such as bilateral and multilateral donors, regional development banks, and export credit agencies. Although project finance is smaller in volume terms than are other private flows, it is important from an SDG perspective insofar as it often directly supports specific SDGs. Among these are SDG 7 (the development of renewable sources of energy), and SDG 9 (transport infrastructure).

Box 2.5. China becomes the top source of investment in developing countries for the first time

An increasingly important source of investment in developing countries is China. A major driver of China’s outward investment has been its One Belt, One Road initiative, which has channelled billions of dollars into infrastructure projects in the Eurasian countries and beyond (OECD, forthcoming).

One indicator of China’s growing influence is the increase in merger and acquisition (M&A) investments. Chinese M&A accounted for 20% of all cross-border M&A received by developing countries, making China the top source of investment into developing countries ahead of Japan and the United States. Chinese investment in developing countries grew rapidly beginning around 2010 and has continued to grow even as the Chinese government has been reigning in outward investment more generally. Overall outward M&A from China declined by USD 115 billion, or 53%, between 2016 and 2017, but M&A to developing countries doubled to USD 25 billion (Figure 2.7).9

Figure 2.7. China’s growing importance as a source of investment in developing countries

Source: Authors based on data from Dealogic (2018[29]), https://www.dealogic.com/content/.

 StatLink https://doi.org/10.1787/888933852749

This increase in Chinese investment in developing countries would seem to represent a purposeful, policy-driven trend. Most of this investment is being undertaken by fully owned Chinese state-owned enterprises, as it has been since the Chinese investment boom in developing countries started in 2010. Over this eight-year period, fully owned state-owned enterprises undertook 63% of this investment in value terms.10 These data likely understate the extent to which the government participates in China’s outward investment flows, especially in the context of the One Belt, One Road initiative, insofar as they do not include the activities of partially state-owned firms or the role of state-owned banks in financing outward investments by privately owned firms.

Private finance can bring benefits beyond pure financing

Private investors are the single largest providers of cross-border financing to developing countries. This means that encouraging even a relatively small share of this investment to align to the SDGs has significant potential. Even without intending to, private investors and the FDI they generate are particularly relevant for the SDGs for a variety of reasons including but not limited to the following:

• They transmit new technologies

• They provide access to new international markets

• They can fill gaps that domestic investors and other investors or sources of financing cannot reach

• They can generate decent jobs and tend to pay higher wages and better uphold the principles of responsible business conduct than domestic enterprises

• They tend to create business linkages in the economy that support domestic enterprises

• They generate revenues

Private sector actors can play especially important roles in the financing of specific Sustainable Development Goals such as SDG 7 (affordable and clean energy) and SDG 9 (industry, innovation and infrastructure). Where public budgets are under strain, private investors can fill infrastructure financing gaps and bring expertise to improve project efficiency. Chapter 4 explores the specific contributions of commercial investors towards the SDGs in greater detail.

These benefits, however, are not always automatic or even guaranteed. The logic and motivations driving private investors differ from those of public actors and investment returns need to be transformed into development gains. To harness the full sustainable development potential of private investors, it is important to identify mutually beneficial opportunities that satisfy the objectives of private actors and contribute to the achievement of the SDGs at the same time. Moreover, a key challenge is to move away from a narrow focus on quantities and volumes to the quality and development impact of financing, as discussed further in Part II.

An era of foreign investment prosperity for developing countries comes to an end

Private investment including FDI, portfolio investment and long-term debt to developing economies amounted to around USD 890 billion in 2016. At their peak in the early 2000s, private investment inflows amounted to more than 8% of GDP for LICs and UMICs.11 In the period 2000-16, private investment as a share of GDP was on average 6.2% for LICs, 5.6% for UMICs and 4% for LMICs. With fluctuations from year to year, the share of private investment over GDP has generally declined compared to the early 2000s and early 2010s (Figure 2.8).

Figure 2.8. Private investment inflows as a share of GDP in developing countries are declining

% of GDP

Source: Authors’ calculations based on IMF (2017[5]), “Balance of Payments” (database), http://www.imf.org/external/datamapper/datasets/BOP; IMF (2018[30]), “World Economic Outlook” (database), https://www.imf.org/external/pubs/ft/weo/2018/01/weodata/index.aspx.

 StatLink https://doi.org/10.1787/888933852768

FDI, which makes up the largest part of these flows, has shown relatively solid growth and resilience until recently. Developing economies fared relatively better than developed countries during the financial crisis and experienced a one-year decline in FDI of around 30%, with volumes dropping to around USD 430 billion12 in 2009 compared to the 40% drop in global FDI flows. FDI flows recovered strongly in 2010, thanks in large part to a 50% increase in flows to developing economies that year. Over the following five years, flows to developing countries were relatively stable, growing to around USD 630 billion in 2015.

This period of FDI prosperity, as some have called it, came to an end in 2016, when FDI flows reversed course at the global level. Over the period 2015-16, flows to developing countries fell by USD 70 billion, or 11%, in a trend that seemed to continue into 2017. The reasons behind these declines include a mix of broad cyclical and more country-specific factors. Among the former are tighter monetary policy in developed economies and the reversal of the commodity super-cycle (OECD, 2016[31]). More country-specific factors include various sources of geopolitical instability, concerns over rising protectionism and record levels of corporate debt in emerging markets (IMF, 2016[32]). FDI outflows to developed countries followed a similarly broad reversal.

Trends in mergers and acquisitions13 in developing countries show that, in contrast to FDI inflows, M&A inflows were already beginning to decline in 2012 (Figure 2.9). Overall, M&A volumes in developing countries were USD 162 billion in 2017, down by USD 72 billion from the high of USD 234 billion that was reached in 2011. The biggest declines were in upper middle-income developing countries, with annual M&A inflows to China decline by USD 19 billion between 2011 and 2017, to Chile by USD 14 billion, to Turkey by USD 10 billion and to Brazil by USD 9 billion.

Figure 2.9. Inward M&A: middle-income and least developed countries

USD billion

Source: Authors’ calculations based on data from Dealogic (2018[29]), https://www.dealogic.com/content/.

 StatLink https://doi.org/10.1787/888933852787

The decline in cross-border M&A would not be a negative development on its own had it been offset by a rise in domestic M&A, since this is a trend generally associated with economic development. Over the past decade, developed countries received 29% of their M&A investment from foreign sources; 71% was generated domestically.

In contrast, developing countries received 44% of their M&A investment from foreign sources and generated 56% domestically. The main reason for this difference relates to domestic market weaknesses, imperfections and failures such as a weak domestic financial sector. These can hold back domestic investors but foreign investors are able to overcome them given their significant resources. However, as noted, domestic M&A in developing countries has trended downward more rapidly than cross-border M&A flows, suggesting an overall decline in private sector investment in developing countries.

This downward trend is mirrored in project finance flows. Despite showing resilience to the overall downward investment trends in 2016 and 2017, project finance in 2018 experienced its worst first half in ten years, with volumes down 30% year-on-year (Figure 2.5) and affecting all regions. The number of new transactions declined by 50% to 377 in the first half of 2018 from 725 in the same period of 2017. In addition, around 38% of project finance was for refinancing purposes, up from 24% in the first six months of 2017. In other words, just as the volume of project finance is declining, a shrinking share is going towards new projects.

Policy action is needed to counteract the decline in foreign investment

Business investment in developing countries is currently like a river whose feeder streams are drying up one after another. This process started with cross-border M&A, which started to decline around 2012. This was followed declines in FDI and domestic M&A in 2016, and most recently, in the first half of 2018, in project finance. Portfolio investment is also under pressure in developing countries as interest rates begin to rise in the developed economies and record-high levels of corporate debt have raised the spectre of financial turbulence (OECD, 2018[33]).

Whether this situation worsens depends on many variables. But the current trend is clearly not encouraging. Given data limitations, putting a precise number on the extent to which private business investments in developing countries have shrunk is not possible. However, an orders-of-magnitude calculation based upon cumulative declines in FDI against a counter-factual assumption of zero growth from the previous high in FDI in 2011 suggests that developing countries have foregone between USD 400 and USD 450 billion of FDI from 2012-2016.

Given this scenario, which is leading from billions to millions instead of billions to trillions, an urgent and challenging policy agenda suggests itself. Elements of such an agenda might be expected to address the following challenges:

• The global rules for trade and investment need to be improved and made to work better in support of an open, rules-based global economy. One of the greatest threats for developing countries would be the widespread outbreak of protectionist trade and investment wars that could accelerate what to date has been a significant but measured retreat of the private sector from developing countries.

• As private sources of financing that align with and can support achievement of the SDGs retreat, public sources will become relatively more important and will need to play a counter-cyclical role, while recognising that they cannot fill the gap left by the private sector. The author of the essay “Adapt finance and the financial system to “save the world”” calls for the strategic use of public resources to mobilise and attract private capital. This will be difficult in developing countries given that declining business investment has a knock-on negative impact on the ability of governments to maintain adequate levels of tax receipts; this could feed negative spirals as public spending on critical business infrastructure is cut back, further undermining business climates. Co-ordination among donors to maximise the development impact of official development assistance ODA and other forms of public financing becomes critical.

• Considerable scope remains for pursuing domestic policy reform agendas to improve business climates and to put in place investment promotion and facilitation strategies. Private investment has been declining but continues to play a critical role in helping countries to develop critical infrastructure, generate employment and foster innovation. Governments have an important role to play in helping to better align business interests and the SDGs, thus generating more development impact from less investment. Fostering such closer alignment can also be achieved through the promotion of responsible business conduct.

Private flows constitute the largest single source of foreign financing going to developing countries. Looking forward and beyond the looming development crisis, much more needs to be understood about private flows and the full implications of this financing for achievement of the SDGs. The AAAA created high expectations regarding the contribution of the private sector to sustainable development – expectations that stand in contrast to the current trend line of private flows. This points to an important knowledge gap that will need to be filled to inform an empirical policy-oriented agenda in the future.

Migrants from developing countries act as providers of financing for sustainable development

Recent years have seen an increase in international migration. In 2015, 3.3% of the world’s population or 244 million people were international migrants. This is a significant increase from the estimated 155 million people who were international migrants in 2000 and who then represented 2.8% of the world’s population. Many of the migrants come from developing countries and send home remittances to support their families.

Decisions to send remittances are essentially private and personal in nature. Remitters may be motivated by altruism, but they are not necessarily taking into explicit consideration the achievement of the SDGs in their home countries. As outlined in Box 2.7 migrants are influenced by a range of factors that can include a desire to support family members and the intention to prepare for a return to their home country (OECD, 2006[34]). The willingness to remit also depends on the duration of migration (the length of time a migrant intends to stay abroad and whether the stay is temporary or permanent); family situation (whether the migrant is single or married and has children); and network effects (whether the migrant moved alone or with family members and the degree of attachments to those left behind) (OECD, 2006[34]).

Remittances are also sent collectively through migrant and diaspora associations such as hometown associations or diaspora direct investments, often with an explicit development orientation. Diaspora groups form hometown associations in the country of destination to collectively support the country of origin through investments in development projects. Mexican migrants in the United States, for example, form such associations to channel funds back to Mexico’s poorest rural areas with high levels of out-migration. Another form of such financing is investment by diaspora-owned firms or firms with diaspora members in top management in productive activities (Rodriguez-Montemayor, 2012[35]).

Remittance volumes have surged to become the second largest source of external financing

The volume of remittance flows has continued to steadily climb in tandem with the movement of people. Experience has shown that remittances, constituting a steady stream of foreign exchange, can help to alleviate poverty and stimulate economic growth in migrants’ countries of origin (Singer, 2010[36]). A case in point is Korea. Remittances from Korean workers in West Germany and the Middle East and from Korean soldiers deployed to Viet Nam provided foreign exchange that contributed to jumpstarting the rapid economic development in the 1960s.

Beginning in the early 2000s, global remittance flows increased sharply, helped by technological advances in financial infrastructure that significantly reduced the costs of transmitting funds.14 The amount of global remittances rose to USD 466 billion in 2017 from USD 122 billion in 2000, making remittances the second largest type of cross-border financing to developing countries. Regional growth trends and projections suggest remittances will increase in developing countries overall, following a decline in 2015 and 2016 that is attributed to weak economic growth in the sending countries of the Gulf Cooperation Council and the Russian Federation (“Russia”) and to exchange rate movements.

Remittances make up a sizable portion, around 4%, of GDP in both lower middle-income countries and low-income countries (Figure 2.10). For lower middle-income countries, it has remained fairly constant from the early 2000s through 2016. But the share of remittances in GDP increased sharply for low-income countries, doubling during this period. Among the top receiving countries in terms of remittances as a share of GDP are small economies such as Kyrgyzstan, Tonga and Tajikistan, which each receive more than or close to 30% of GDP in remittances. In nine out of ten top receiving countries, remittances correspond to 20% of GDP or more.

Figure 2.10. Remittance inflows as a share of GDP

% of GDP

Source: Author’s calculations based on World Bank (2018[4]), “Migration and Remittances” (database), http://www.worldbank.org/en/topic/migrationremittancesdiasporaissues/brief/migration-remittances-data for remittances. IMF (2018[30]), “World Economic Outlook” (database), April 2018 Edition, http://www.imf.org/external/pubs/ft/weo/2018/01/weodata/index.aspx, for GDP data.

 StatLink https://doi.org/10.1787/888933852806

Transaction costs involved in sending remittances to developing countries, however, far exceed the SDG target (indicator 10.c) of less than 3%. The average cost of sending remittances has remained flat at 7.1% (Figure 2.11Moving towards financing for development), with the lowest average transaction costs in South Asia (5.2%) and highest in sub-Saharan Africa (9.4%). Remittance costs across many African corridors and small islands in the Pacific remain above 10% because of the low volumes of formal flows, inadequate penetration of new technologies and lack of a competitive market environment (Ratha et al., 2018[37]). Potential remedies in terms of domestic policy are discussed in the essay “How to mobilise remittances for development financing”.

Figure 2.11. Remittance costs across regions exceed the 3% SDG target

%

Source: World Bank (2018[38]), “Remittance Prices Worldwide” (database), https://remittanceprices. worldbank.org/en.

 StatLink https://doi.org/10.1787/888933852825

Remittances are the most stable form of cross-border flows and can have a positive development impact

Migrants’ remittances present the most stable form of cross-border flows to developing countries. While private capital flows tend to rise during favourable economic cycles and fall in bad times, remittances appear to react less violently and may even rise during recessions in recipient countries. For example, remittances to developing countries continued to rise steadily in 1998-2001 when private capital flows declined in the wake of the Asian financial crisis (Ratha, 2005[39]). While remittances are relatively stable at aggregate levels, inflows to individual developing countries may be quite volatile, impacting on economic stability (Jackman, 2013[40]).

These benefits of remittances enhance the creditworthiness of developing countries. The World Bank-IMF Debt Sustainability Framework allows recipient countries to carry higher levels of debt when the ratio of remittances is higher than 10% of their domestic income and 20% of exported goods and services (IMF, 2017[41]).

At the micro level, too, remittances can have a positive impact on development and poverty. They are shown to increase the income of recipient households and remove financial constraints, reinforcing a household’s ability to resist external shocks. In some countries, “households that receive remittances are more likely to engage in productive activities such as owning businesses, real estate or agricultural assets” and tend to spend more on education (OECD, 2017[42]). However, the link between remittances and higher investments is not always straightforward. In some cases, remittance income is spent on the daily consumption of basic goods rather than in investments in human and physical capital (Adams and Cuecuecha, 2010[43]).

Policies in remittance sending and recipient countries can enhance development impact

How can remittances be best harnessed to benefit sustainable development? Although an important source of cross-border financing, remittances must be considered separately from other forms of financing for development due to their essentially personal nature. Not all remittances contribute to sustainable development and measuring the portion of remittances targeting sustainable development is challenging (Chapter 4).

To strengthen the development impact of remittances and make sure that remittances can be used in the most beneficial way for the migrants and their families, policy should focus on creating an enabling environment that supports the use of remittances for long-term investments (OECD, 2017[42]). For example, policies that foster financial inclusion of migrants and remittance recipients and that promote financial literacy can help to channel remittances towards investment in human capital and productive activities.

Domestic policies in remittance-sending countries that help to ensure the effective transfer of remittances at the level of non-state intermediaries also can enhance the development impact of remitters and diaspora communities (Chapter 5). Both the Addis Ababa Action Agenda and the 2030 Agenda point to high transaction costs as a potentially productive area for policy intervention.

Foundations continue the long-standing human tradition of philanthropic giving

Philanthropy has been a part of human civilisation for thousands of years. In ancient China, clan-based lineage organisations provided allowances to widows and orphans, distributed grain to the poor and built schools for children (UNDP, 2016[44]) Philanthropy is also deeply ingrained in the Judeo-Christian tradition, evidenced by the ancient Hebrews’ gifting of one-tenth of their income to those in need, and it is also a pillar of Islam, which requires zakat giving (Andrews, 1950[45]).

In the 20th century, some of the wealthiest industrialists in the United States, such as John D. Rockefeller and Andrew Carnegie, organised their philanthropic giving at an unprecedented scale with the aim of systematically addressing the social needs of the day. These philanthropists said they considered it the duty of the rich to use their skills and fortune to benefit the wider community and poor.

A surge in entrepreneurial wealth over the last 30 years has brought with it a new class of philanthropists. By bringing a business approach to philanthropy and focusing on strategy, innovation and partnerships, these actors play a unique and pioneering role in the financing for sustainable development system.

In terms of volumes, a handful of large players based in the United States and Europe dominate philanthropic giving to developing countries. A survey conducted in connection with the recent OECD (2018[46]) report, Private Philanthropy for Development, finds that just 20 foundations provided 81% of total philanthropic giving to developing countries during 2013-15 and nearly three-quarters of all such philanthropy originated from foundations based in the United States. The Annex to this chapter provides further details. The Bill & Melinda Gates Foundation, headquartered in the United States, alone accounts for nearly half (49%) of total giving, which largely explains the finding about geographic concentration. Of the 143 foundations included in the OECD data survey sample, other top originating countries were the United Kingdom (7% of total philanthropic giving), Netherlands (5%), Switzerland (2%), Canada (2%) and the United Arab Emirates (2%).

Philanthropic giving nevertheless is relatively small in volume

Philanthropic giving to developing countries amounted to USD 23.9 billion in the 2013-15 period, or USD 7.96 billion per year on average (OECD, 2018[46]). While philanthropic giving remains relatively modest compared to financing for development more broadly, foundations have become major partners in some specific areas. For example, in the health and reproductive health sectors in 2013-15, support from philanthropic foundations constituted the third-largest source of financing for developing countries, after support from the United States and from the Global Fund to Fight AIDS, Tuberculosis and Malaria.

Almost three-quarters (74%) of foundations’ giving in 2013-15 supported activities in social infrastructure and services such as health, education, human rights and social protection (Figure 2.12). Overall, health was the main sector targeted by philanthropic giving – far ahead of other sectors – with USD 12.6 billion or 53% of the total. The Gates Foundation was the major player in this arena, accounting for 72% of total giving to health. The donations of other foundations accounted for only the remaining 28% of the sector total, although the OECD survey shows that health and reproductive health was also their main funding priority.

Figure 2.12. Philanthropic giving by sector, 2013-15

USD billion

Source: OECD (2018[46]), Private Philanthropy for Development, https://doi.org/10.1787/9789264085190-en.

 StatLink https://doi.org/10.1787/888933852844

Philanthropy also mainly targeted middle-income countries, who in total received 67% of the flows. 37% went to lower middle-income countries and 30% to upper middle-income countries. Only a third of country allocable funding went to least developed countries and other low-income countries (OECD, 2018[46]).

Some philanthropic foundations play key roles innovating and collaborating with other actors

Philanthropic foundations are increasingly influential actors in international development. The largest players in particular, and notably the Gates Foundation, are actively shaping the agenda setting and funding priorities of international organisations and governments by virtue of the size of their grant making, networking and active advocacy.

In some cases, philanthropic foundations can play a special role in financing for sustainable development because they are relatively less risk averse and relatively more are willing to invest in innovative business concepts and financing models (Marten and Witte, 2008[47]). Box 2.9 “Unlocking financial innovation to accelerate pro-poor innovation” reviews the range of possible collaborative opportunities with philanthropic foundations who can provide the seed capital for innovative solutions to development problems. Yet the vast majority of philanthropic foundations are traditional in the instruments and channels of delivery they use (OECD, 2018[46]).

Philanthropy can further be used to bridge silos in the financing for sustainable development system, as foundations generally value partnerships and strategically engage in coalitions with government, donors, social entrepreneurs and civil society organisations. Many of the foundations assessed in the “OECD Survey on Private Philanthropy for Development” systematically engage with governments (67%) and with donors (45% when designing or implementing their programmes and projects (OECD, 2018[46]).

Better data and more co-ordination can help even more to harness their potential

• Better and more data are needed to understand and guide the contributions of philanthropic giving to the global goals. Philanthropic foundations are concentrated in a few countries of origin and exhibit similarly significant heterogeneity in terms of the size and scope of their operations. As Chapter 4 discusses in detail, measurement of the global effect of philanthropy is fragmented. The limited availability and transparency of comparable data and measurement standards are additional challenges to mapping their contributions and impact. Recent efforts by the OECD, among them the Survey on Private Philanthropy for Development and the launch of the OECD Centre on Philanthropy in 2018, provide opportunities for improvement in reporting on philanthropic giving.

• There is a need for closer co-ordination with other actors in the financing for sustainable development system. Given their innovative capacities and their focus on partnerships, philanthropic foundations can make a valuable and unique contribution to sustainable development. To make better use of this potential, more institutionalised platforms of co-ordination and knowledge sharing are needed to bring together philanthropic foundations, bilateral and multilateral providers of development financing, and developing country governments. Dedicated philanthropic dialogue platforms at the sectoral, regional and local levels along with international reporting and data collection initiatives (such as the DAC statistics on development finance and the OECD Centre on Philanthropy) can enhance transparency and alignment among actors, ensuring that the flows are mutually reinforcing and complementary rather than duplicative (OECD, 2018[46]).

Bilateral providers can address pressing development needs

Bilateral providers of financing for sustainable development are governments and national development agencies that provide financing, either concessional or non-concessional, to support the economic, environmental, social and political development of developing countries.15

It is sometimes argued that geopolitical self-interest is the ultimate motivator of official development finance, e.g. the possibility to pursue concrete foreign policy interests (Alesina and Dollar, 2000[48]); (Younas, 2008[49]). Development co-operation by official providers became an institutionalised activity after the end of the Second World War and in the wake of the emerging Cold War competition. Bilateral providers deployed aid as an extension of foreign policy with the primary objective of projecting project soft power and also helping to build a vibrant post-war international economy. However, the official objectives of development co-operation, which often are clearly stated in the mission statements and mandates of the implementing agencies, are to promote the development of the recipient country. For instance, a key objective of the European Union’s policy on foreign aid is the reduction and eventual elimination of poverty, as mandated by the Lisbon Treaty of 2009.

This formal mandate of bilateral providers – to promote development – requires them to explicitly target the most pressing development needs. Thus, given the role they play, they cannot easily be replaced by alternative providers. As a guardian of development finance, the OECD Development Assistance Committee (DAC) supports members’ efforts to comply with this mandate.

Since its establishment in 1960 as part of the OECD, the DAC has institutionalised norms of donor behaviour. The DAC coined new terminology in 1961 by distinguishing concessional flows or official development assistance (ODA) from non-concessional or other official flows (OOF) as a special measure of development assistance, applying softer terms to address the urgent needs of those less developed countries with the most severe economic and debt servicing problems. Building on this definition, DAC members agreed to raise concessional finance in the form of ODA to the level of 0.7% of each donor’s national income (GNI).16

Another norm for bilateral donors is to explicitly target the most vulnerable countries and sectors with high development impact. In December 2014, DAC members agreed to allocate more ODA to the group of countries and territories that are classed as most in need: least developed countries, low-income countries, small island developing states (SIDS), landlocked developing countries, and fragile and conflict-affected contexts.

Beyond the group of DAC members, there are many bilateral actors who are providing development co-operation, which is also referred to as South-South co-operation. Its steady rise is mirrored in the substantial increase in the number of bilateral providers reporting their development finance to the DAC, which grew to nearly 50 in 2016 from fewer than 20 in 1960.

Moreover, there are many other development co-operation providers who do not report their financing to the DAC. While many of these countries have longstanding development co-operation programmes, their weight in the financing for sustainable development system has increased significantly and reflects their growing importance as drivers of global trade, investment and growth. The lack of transparent data on their activities makes it challenging to understand the full sustainable development finance system and to co-ordinate efforts across different groups of actors (Chapter 4).

As noted in this chapter, many South-South providers extend official financing through state-owned enterprises such as sovereign wealth funds, which often act like private investors. China’s development co-operation, in particular, often mixes concessional with non-concessional resources, which blurs the distinction between public and private actors.

A large portion of bilateral official flows comes from OECD countries and is concessional

Official flows from bilateral providers amounted to USD 210 billion in 2016, of which 74% (USD 155 billion) were concessional flows. In 2016, OECD DAC members provided a total of USD 167 billion, of which concessional flows constituted the majority (71%). South-South co-operation flows from ten major countries beyond the DAC are estimated to be USD 6.9 billion in 2015, up from USD 5.2 billion in 2011. The overall share of these providers in total cross-border financing in developing countries remains small compared to that of DAC members. Nonetheless, some bilateral providers, among them Saudi Arabia and the United Arab Emirates, ranked among the top ten bilateral concessional finance providers in 2015. Moreover, China’s development assistance efforts, articulated in the form of megaprojects around the One Belt, One Road initiative are quite substantial in both size and impact, and amounted to USD 3.1 billion in 2015, according to OECD estimates.17

However, data constraints mean it is difficult to accurately estimate and fully acknowledge the contribution of South-South co-operation. In the above-mentioned case of China, estimates of the amounts of concessional finance provided in a single year range from USD 3 billion to USD 7 billion. In some cases, a large portion of official finance is channelled through state-owned enterprises and resembles private investments. For example, China’s development finance extends beyond the traditional concepts of aid to include “export buyers’ credits, official loans at market rates and strategic lines of credit provided to Chinese enterprises” (Lakatos et al., 2016[50]). This can make it even more difficult to fully grasp the full picture of South-South co-operation.

Bilateral flows can target development needs

Bilateral providers are well positioned to target economic and social vulnerabilities, as confirmed by the sectoral allocation of their financing. Due to limited availability of data on the sectoral allocation of flows, the analysis is based exclusively on bilateral providers reporting to the DAC. Compared to multilateral providers, these providers allocate a greater share of flows to social sectors such as government and civil society (11.4%) and education (7.7%). The respective values for multilateral providers are 5.4% (government and civil society) and 3.2% (education). Moreover, a sizable proportion of financing (13.4%) is allocated to humanitarian aid. All of these flows are concessional in nature, as bilateral concessional finance almost exclusively targets economic sectors.

Moreover, bilateral providers have demonstrated a commitment to countries most in need. Since 2000, concessional finance by bilateral actors to countries most in need – including least developed countries, low-income countries, and fragile and conflict-affected countries and territories – increased more rapidly than did financing for other country groupings (Figure 2.13).

Figure 2.13. Bilateral concessional finance to select country groups over time

Indexed: 2000 = 100

Note: The peaks in 2005 and 2006 for UMICs and fragile and conflict-affected states and contexts are due to high levels of debt relief.

Source: OECD (2018[3]), “Creditor Reporting System” (database), https://stats.oecd.org/ index.aspx?DataSetCode=CRS1.

 StatLink https://doi.org/10.1787/888933852863

However, more recently, these trends do not seem to continue to the same extent. Figure 2.14 shows that although per capita flows to fragile and conflict-affected contexts have increased from 2010-2016, flows going to least developed countries and other low-income countries in per-capita terms have declined to USD 32 from USD 38 and to USD 37 from USD 47, respectively. This suggests that increases in financing have not been able to keep up with population growth in these countries and contexts. At the same time, concessional and non-concessional flows per capita to lower middle-income countries have increased to USD 20 from USD 15.

Figure 2.14. Concessional and non-concessional financing per capita (selected groups)

Note: The figure includes concessional and non-concessional financing provided by OECD DAC members.

Source: OECD (2018[3]), “Creditor Reporting System” (database), https://stats.oecd.org/ index.aspx?DataSetCode=CRS1.

 StatLink https://doi.org/10.1787/888933852882

Although it is difficult to make quantitative statements about the destinations and qualities of South-South co-operation, the added value of non-DAC providers often lies in their innovative approaches. South-South co-operation offers opportunities for technology transfers and knowledge sharing at low overheads and draws on the providers’ own development experiences. One example was an arrangement to transfer agricultural techniques between and among SIDS. Cuban experts “introduced the drip irrigation technique for adoption by local farmers in other SIDS countries, which proved to be cost-effective and suitable to conditions in small islands where irrigation water is particularly rare” (UNDP, 2016[51]). Enhancing dialogue with such actors is crucial so that their voices, views and lessons from their development experience are integrated in DAC and DAC members’ policies and practices.

Bilateral actors can achieve more through co-ordination among themselves and collaboration with others

• The universe of bilateral financing for sustainable development providers is becoming increasingly diverse, and non-DAC providers sometimes set alternative benchmarks for development assistance (Esteves and Assunção, 2014[52]). This leads to more choice for developing countries. But the diversity of providers also raises concerns that lack of co-ordination may lead to fragmentation. While the allocations of official resources are sovereign decisions motivated by poverty alleviation, historical ties, economic interests and/or other factors, the lack of co-ordination in allocation practices can result in gaps if providers choose to focus on the same set of countries or sectors (OECD, 2013[53]).

• Bilateral financing for development providers is well placed to target social needs and vulnerable countries, having clearly demonstrated a commitment to do so. Recent trends, however, suggest that financing to low-income countries and least developed countries, for example, has increased at a slower pace than to financing to other developing countries and lags behind population growth. The relatively high reliance of these countries on cross-border financing suggests that a decrease in the per capita level of official flows into these countries can affect them more severely than other countries.

• Official flows can be used to support the mobilisation of other financing for development resources such as domestic revenues and private sector financing. Development co-operation has the potential to mobilise tax revenues for developing countries and provide needed support to public financial management systems. Given the recent retreat of private investment flows, which has been described earlier in this chapter, official flows can also play a role in mobilising private resources. The targeted support for enabling environments can ensure that both domestic and international resources are channelled to areas with the greatest need and impact and utilised in a way that is conducive to sustainable development. Yet the need to mobilise private sector resources could clash with the commitment to countries most in need, as they are often less attractive to private investors. A careful balance must be struck, as is argued in Box 2.10 “Increasing the pie”, but in the context of clear criteria to guide the allocation of funds to conflicting priorities.

Multilateral actors are a central pillar of the financing for sustainable development system

Multilateral actors are international agencies, organisations and funds that provide financing for sustainable development. The members of these institutions are governments who are represented at the highest decision-making level by persons acting in an official and not individual capacity. Multilateral institutions are a central pillar of the international development finance framework that was founded on the two Bretton Woods institutions, the World Bank and the IMF. The establishment of the International Development Association (IDA) in 1960 was another milestone in the evolution of this framework, reflecting a general sense that a multilateral approach was needed to overcome co-ordination problems that were arising from the large number of individual development co-operation programmes. The 1960s also saw the establishment of an additional tier of multilateral development banks whose governance arrangements more reflected the rise of regional powers. Since the 1990s, vertical funds18 and trust funds19 have come on the scene and grown in number and importance. Confined to specific purposes such as regions, countries and thematic focuses, these have contributed to the specialisation and also proliferation of multilateral channels in the financing for sustainable development system (Figure 2.15).

Figure 2.15. The proliferation of multilateral providers

Source: Authors based on Faure, Prizzon and Rogerson (2015[54]), Multilateral development banks: A short guide, https://www.odi.org/sites/odi.org.uk/files/resource-documents/10650.pdf.

Multilateral actors, as discussed throughout this chapter, can be categorised as multilateral development banks (MDBs) such as the World Bank Group and regional development banks; the United Nations system;20 the IMF; and other organisations such as vertical funds. Their functions and relationships are outlined in Box 2.11Multilateral providers. These multilateral institutions are simultaneously providers of financing for development in their own right and serve as intermediate channels or agents assisting their member states to implement sustainable development policies.

A large portion of multilateral resources is non-concessional and targets middle-income countries

Depending on the type of organisation, financing flows from multilateral providers can be concessional or non-concessional. Financing from most UN entities is concessional and consists of grants for projects in developing countries. MDBs have both concessional and non-concessional financing windows. Non-concessional financing typically consists of loans extended to middle-income country governments, some creditworthy low-income country governments and in some instances to private companies. Concessional windows of MDBs provide grants and highly concessional loans to low-income country governments.

In 2016, concessional and non-concessional financing provided by multilateral actors reporting to the DAC amounted to USD 33 billion and USD 68 billion respectively.21 While non-concessional flows are more than twice as large as concessional flows, they are provided exclusively by multilateral development banks (USD 59.6 billion) and the IMF (USD 7.8 billion). Multilateral flows tend to focus on middle-income countries. This is due to the fact that non-concessional financing, which takes up a larger share of the overall financing provided, often targets countries who are able to repay financing at market terms. Regarding non-concessional flows (excluding IMF loans), 41% were allocated to lower middle-income countries and 52% to upper middle-income countries. Low-income countries received 30% of concessional flows and lower middle-income countries 50% of the total.

Multilateral providers have several comparative advantages

Multilateral providers have several advantages that give them a special place within the financing for sustainable development system. Because of their convening power, they are unique in the support they can give to collective international action to provide the global public goods needed to tackle border-transcending problems such as climate change and humanitarian and global health crises (OECD, 2015[57]). By pooling resources from multiple bilateral providers, multilateral providers can help to reduce fragmentation of development efforts and enhance policy coherence.

Multilateral providers often have specialised knowledge in policy reforms and/or specific sectors, for example in infrastructure in which 37.2% of all multilateral flows are concentrated. Multilateral organisations often have extensive country presence and political knowledge, in particular in fragile contexts. From 2010 to 2016, per capita financing from multilateral institutions for fragile and conflict-affected states increased to USD 17 in 2016 from USD 14 in 2010, indicating an increased focus on fragile contexts.

Multilateral providers, and MDBs in particular, are well equipped to leverage resources from private sources to support the shift from billions to trillions for financing the SDGs. As they generally finance only a share of a project, MDBs by design are in the business of mobilising additional investors by setting up pooled funding structures and providing advice and risk mitigation (World Bank, 2015[58]). In addition to participating in the financing of projects, MDBs also explore other means of private sector resource mobilisation, some of which are discussed in Chapter 3. One example is the IFC Asset Management Company (AMC). A wholly owned subsidiary of the IFC in the form of a private equity company, it manages funds from private investors and invests them in companies and projects in developing countries. Since its establishment in 2009, the AMC has raised USD 10 billion across 13 funds (International Finance Corporation, 2018[59]).

Partnerships are key to making the multilateral system fit for purpose

The multilateral system is expanding and becoming more complex. The arrival of new players such as the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB) reflects changing dynamics in the financing for development system. The addition of new international agencies may be a double-edged sword. The share of bilateral contributions channelled through multilateral agencies has remained stable. But the increasing number of players, in some cases with overlapping responsibilities, comes at the risk of aid fragmentation.

The best way for multilateral providers to maintain their credibility in this environment is to better co-ordinate their efforts and division of labour. Initiatives aimed at encouraging and enhancing such collaboration are underway to make full use of core comparative advantages. For example, the UN-World Bank partnership framework to build resilience and sustain peace in conflict areas, which has been in place since 2008 and was updated in 2017, provides a platform to “develop joint analyses and tools for more effective solutions; co-ordinate support to address protracted crises; and scale up impact by leveraging financing” (UN-World Bank, 2017[60]).

In order to remain relevant in an increasingly diverse sustainable development finance system, multilateral providers are also pursuing more inclusive partnerships with various financing for development actors including the private sector, civil society and countries engaging in South-South co-operation (Kharas, 2010[61]). MDBs in particular need to act on their ability to catalyse private sector financing. The forthcoming OECD report, Multilateral Development Finance 2018, focuses on efforts by MDBs to mobilise private finance (OECD, forthcoming[62]).

Subnational actors are involved in financing for sustainable development at various levels

Subnational actors contribute to financing for sustainable development through activities that are collectively termed decentralised development co-operation. The concept of decentralised development co-operation originated in the 1980s in the context of a retrenchment of central governments in favour of an increased role for local and regional governments to promote public-private partnerships. However even earlier, in 1971, the UN General Assembly recognised in a resolution the practice of municipal twinning as a tool for international co-operation. Over time, these city-to-city partnerships grew to involve other subnational public authorities and public agencies. Examples include water authorities in the case of France and in the Netherlands. In this way, decentralised development co-operation activities were expanded not only in terms of the sectoral focus but also the levels of government involved. The Addis Ababa Action Agenda reaffirmed the growing trend in decentralisation of public spending to local and regional actors across developing and developed countries alike (paragraph 34).

The actors involved in DDC range from governmental to non-governmental and across the local to the regional and provincial levels. The OECD report, Reshaping Decentralised Development Co-operation (2018[63]), identifies four tentative categories with respect to roles and responsibilities of various actors, according to whether the lead role is that of a promoter, enabler, facilitator or implementer (Figure 2.16Decentralised development co-operation contributes to the localisation of financing for sustainable development). This section on subnational providers overall is largely drawn from the analysis in this report.

Subnational governments including regions, provinces and municipalities tend to be the primary promoters of decentralised development co-operation, together with central government public agencies or sectoral ministries. Beyond central and subnational governments, decentralised development co-operation activities involve diverse partnerships with a wide range of actors. Universities and research centres are often active as enablers, facilitators and implementersDecentralised development co-operation contributes to the localisation of financing for sustainable development. They can offer support to strengthen the evidence base and evaluation of decentralised projects, leading to a strengthening of local technical capacity. NGOs, civil society organisations and youth volunteers increasingly play a significant role in decentralised development co-operation projects, specifically as implementers.

Figure 2.16. Different roles in decentralised development co-operation

Source: OECD (2018[63]), Reshaping Decentralised Development Co-operation: The Key Role of Cities and Regions for the 2030 Agenda, https://doi.org/10.1787/9789264302914-en.

Decentralised development co-operation contributes to the localisation of financing for sustainable development

Funds channelled through decentralised development co-operation are relatively small, with volumes standing at USD 1.9 billion in 2015. Variation in volumes across countries and years is quite high – much greater than variations in ODA extended by central governments. Over the 2005-15 period, decentralised development co-operation spending increased for Austria (+360%), Switzerland (+44%), Italy (+39%) and Belgium (+16%). It decreased for Greece (-100%), Portugal (-97%), Spain (-56%), Japan (-46%) and Germany (-4%).

Decentralised development co-operation owes its comparative advantage to its reliance on local know-how and expertise through local governments. Reshaping Decentralised Development Co-operation (OECD, 2018[63]) argues that this form of development co-operation contributes to improving the quality of local government services and broadens their coverage, increasing the satisfaction with and trust in local administration, and providing wider access to financing for sustainable development.

Specific challenges such as delivery of public services to informal urban settlements, action led by local governments to face climate change and migration to urban areas are key areas where subnational actors can have a significant development-enhancing role. Local government empowerment is expected to develop competences for local revenue mobilisation and to provide access to long-term financing for sustainable development mechanisms.

In line with these priorities, decentralised development co-operation targets primarily health, education, agriculture and water (Figure 2.17Systematic data collection and co-ordination can support subnational actors). In 2015, decentralised development co-operation mainly targeted multisector activities, which represented 21% of total sector-allocable resources. The sectors included were education/training, scientific research, rural development, and in-donor refugee costs. Health and agriculture sectors represent 12% and 10% of decentralised development co-operation respectively; education amounted to 8% and the water sector amounted to 6% of total sector-allocable decentralised development co-operation. However, these figures must be treated with caution, as reporting on sector-allocable decentralised development co-operation is limited due to reporting challenges faced by several DAC members.

Figure 2.17. Sectoral allocations of decentralised development co-operation in 2015

Source: OECD (2018[63]), Reshaping Decentralised Development Co-operation: The Key Role of Cities and Regions for the 2030 Agenda, https://doi.org/10.1787/9789264302914-en.

 StatLink https://doi.org/10.1787/888933852901

Systematic data collection and co-ordination can support subnational actors

• Though small in absolute volumes, financing for development by subnational actors contributes to the localisation of the SDGs. Based on a spirit of voluntarism and commitment to embed in local communities and mechanisms, these activities help to bring global agendas close to home. Further engagement through decentralised development co-operation activities can support and strengthen local governance in developing countries while empowering communities and promoting collaboration between local authorities and civil society.

• Challenges in decentralised development co-operation lie mainly in the high transaction costs associated with the small scale of the projects. National governments, global networks or platforms, and national associations of local and regional governments can play an important role to facilitate the co-ordination of decentralised development co-operation activities. Better reporting on these activities can facilitate the stock taking and information gathering that are pre-requisites for a better and more systematic co-ordination of efforts across levels of government and across sectors.