When heads of state, ministers of finance and leaders of the international development community gather in Addis Ababa this July for the Third Conference on Financing for Development, I hope that the discussion will be grounded in the hard realities facing the least-developed countries struggling to provide basic services to their growing populations.
I also hope that conference participants rise above the popular but misleading narrative that the private sector is the panacea.
Looking to the private sector as the primary source of financing for development is particularly seductive for two reasons: statistical evidence seems to support the argument, and it provides a rationale for reducing official development assistance at a time when donor nations are struggling with debt and budget crises.
However, placing unrealistic expectations on the private sector to meet basic needs in health, education and public administration clouds a critical debate.
Part of the problem is definition. “Private sector financing” is one of those catch-all terms. It encompasses business spending (foreign and domestic direct investment), remittances from migration in a globalized world, user fees to private providers of public services, and large-scale private philanthropy that has exploded out of the technology revolution.
Private sector financing has been an engine of economic growth in countries that have moved out of lower-income status. Tens of millions of people have worked their way out of poverty as countries adopt business-friendly policies that attract private investment. Growing prosperity has, in turn, increased domestic revenue mobilization, providing countries the means to finance their own development. As governance improves, countries are able to access international equity and credit markets as well as attract innovative instruments such as social investment bonds. For many countries that have “graduated” to lower-middle- or upper-middle-income status, ODA is no longer a major source of development finance. A number of countries including Brazil, China, India, South Africa and South Korea have even joined the ranks of donor nations.
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Because these transformations are occurring in some of the most populous countries, they have a huge impact on reducing global poverty. Living standards have risen faster in the last 50 years than ever before. Taken together, the private sector makes a compelling case for financing development, one that we’re likely to hear a lot about in July.
But there is a problem.
National wealth, with few exceptions, depends on a population’s capacity to produce. And a population’s productive capacity is largely nursed by public institutions that assure a healthy, nourished and educated population. As we in the United States know, modern health care and education systems are expensive. The uncomfortable reality is that most LDCs do not produce enough national wealth to finance these institutions. For example, the average expenditure on primary education in the United States is about $10,390 per child per year, or 70 times greater than the average primary education expenditure in LDCs of approximately $148 per year. Even after adjusting for purchasing power parity, $148 will not buy a modern education no matter how innovative we are. The same is true for health and for less popular but essential expenditures on competent public administration. You get what you pay for and for most LDCs, this is what is politely referred to as “weak governance.”
There are many inspiring examples of businesses investing in the communities where they work. Corporate philanthropy and new models of shared value, where businesses advance core commercial interests by investing in socially beneficial activities such as supply chain and workforce development, can play an important role in building prosperity. But these investments should not be seen as a substitute for essential public investments in health, education and good governance.
Looking to private financing to cover public costs risks widening gaps in countries already struggling with huge income inequality.
Here is the crux of the challenge in financing for development: Without external finance, LDCs can’t afford the modern institutions and infrastructure necessary to increase productive capacity and attract private capital. Brain drain, corruption, patronage and self-interested elites are both a cause and a consequence and in many countries act as binding constraints to the reforms necessary for the private sector to become the engine of development finance.
Stunning progress in a few growth economies is in marked contrast to the slow headway among the majority of LDCs. This can confuse discussions about development finance because, at a macro level, the data on private financial flows show a marked shift away from ODA to private financing. However, the graph below demonstrates the limited influence of private financing among the poorest countries.
The Addis conference provides an opportunity to strengthen our commitment and approach to sustainable development. Let’s take a hard look at the dilemma of how to pay for modern institutions in poor countries and recognize the critical need for ODA to build public institutions and encourage difficult reforms.
What role do you think the private sector plays in financing global development? Chime in by leaving a comment below, and check back for more news and analysis ahead of the Third Conference on Financing for Development in Addis Ababa, Ethiopia.
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