UNCTAD highlights flaws in development-financing policy

Geneva, 12 Oct (TWN) - A new approach to international development cooperation is emerging which has been prompted by the failure of previous debt-aid systems to deliver on their promises, but, points out a new report by the United Nations Conference on Trade and Development, it rests on a number of misguided precepts which could hinder its effectiveness in improving the lot of the world’s poorest countries.

Focusing on the question of financing development in the least developed countries (LDCs), UNCTAD’s Least Developed Countries 2000 Report assesses the rethink that is taking place in the areas of aid and debt relief. While the new development policies that have arisen are not business as usual, it says, they also do not constitute a constructive new beginning.

The rethink has been spurred by the “aid-and-debt trap” in which the LDCs find themselves enmeshed. Aid inflows have been animated by the desire to maintain positive net transfers to the LDCs, to ensure continued servicing of old loans and to avoid embarrassing arrears and development failure. This in effect means official creditor-donors have been taking away with one hand what they have been giving with the other.

Thus, according to the UNCTAD report, the developmental impact of aid in the more indebted LDCs has been reduced as urgently needed investments in the economic and social infrastructure are sacrificed in order to devote scarce resources to debt-servicing. At the same time, aid is diverted away from the less indebted LDCs.

This in turn discourages an effective resolution of the debt problem as countries find that progress in reducing their external debt is greeted by diminished aid inflows. Furthermore, the problem of moral hazard crops up since official creditors are insulated from bearing the full brunt of their lending mistakes.

In this vicious circle of the “debt-tail wagging the aid-dog”, therefore, high debt levels impede effective aid, and ineffective aid prevents a solution to the debt problem, laments the LDC 2000 Report.

The need for LDCs to extricate themselves from this “aid-and-debt trap” which has retarded their development prospects has sparked an overhaul of aid policies undertaken by the donor community.

Unfortunately, says UNCTAD in the report, key principles underpinning the new approach to development financing are based on a flawed diagnosis of weaknesses in international development cooperation in the past.

Contrary to conventional thinking, aid remains essential to LDCs’ development due to inadequate domestic resources and foreign private capital inflows. The UNCTAD report outlines how slow growth and low incomes limit domestic savings and loanable funds within the LDCs; this in turn limits increases in investment and economic growth.

Neither can the international capital markets sufficiently provide the development funds required by these impoverished countries. According to the report, the share of long-term private capital inflows to LDCs has dropped by at least 30% since 1990. Today LDCs benefit from only 4% of long-term capital flows to developing countries, and in the 1990s they attracted only 1.4% of the foreign direct investment going to the developing countries as a whole.

There is also, in the new approach to development financing, an emphasis on targeting aid at countries where the right policies are in place. While the right national policy environment is necessary for aid to work, such an approach, contends UNCTAD in its report, ignores the fact that aid effectiveness is also influenced by developments and measures undertaken in the realms of international trade, debt relief and private finance, not to mention by the nature of the aid delivery system itself.

Lack of coordination on the part of donors of their aid projects in individual countries will undermine the sustainability of aid programmes and negatively affect resource allocation and growth. Moreover, the volatility of aid flows can result in financial instability and hinder stable macroeconomic development.

Referring to the importance placed by donors on national ownership of policy, the UNCTAD report asserts that the issue of ownership extends beyond the preparation by countries of their own poverty reduction strategy papers, which are then endorsed and monitored by the donors. Indeed, the strict monitoring of the LDCs, combined with the threat of withdrawing concessional flows based on the principle of selectivity, is not likely to perform better than old-style policy conditionality.

Rather, UNCTAD contends that genuine ownership is a meaningless concept without effective state capacities to control the allocation of aid funds and have a say in formulating the policy agenda and monitoring the outcomes. In this regard, poor integration of the aid delivery system into national economic and administrative structures, the fiscal squeeze of previous policy conditionality and a domestic brain drain from the government sector to donor projects have all eroded state capacities over time.

The report punctures another ‘myth’ that has come to characterize the new thinking on development financing, namely, that the relatively weak response to policy reforms is the result of poor implementation. It shows that the LDCs have certainly not been laggards when it comes to implementing pro-liberalization policies prescribed by the likes of the IMF.

According to the report, the LDCs have kept up with other developing countries in all areas of the structural reform process except the financial sector and public enterprises. And they have outpaced others in the area of pricing and marketing reform. IMF data reveal that trade liberalization has also advanced further in the LDCs than in other developing countries. This was complemented by financial sector reforms. Of 45 LDCs for which data are available on the late 1990s, 27 adopted a free regime guaranteeing capital transfers.

The question then arises as to the efficacy of market-opening policy prescriptions counselled by donors and international financial institutions.  Recent financing policies have stressed the need for structural reforms to be accompanied by social and poverty reduction policies.

However, the LDC 2000 Report maintains that the shortcomings of existing policies go beyond the insufficient attention they pay to social issues and poverty reduction. Policy reforms have suffered from serious design weaknesses in relation to LDC-type economies because they neglected the impact of structural constraints, lack of economic and social infrastructure, weakness of market development, thinness of the entrepreneurial class, and low private-sector production capabilities. As a result, the new policy environment does not deliver high growth rates.

To overcome the serious development problems plaguing the LDCs, therefore, UNCTAD advocates a “New Deal” in international development cooperation. The elements of such an approach would include:

·        Reorienting national policies towards developing productive capacities (through a virtuous circle of rising investment, savings and exports) and international competitiveness, while addressing the shortcomings of markets, institutions and infrastructure in the LDCs.

·        Ensuring adequate aid flows - to fill the financing gaps in LDCs caught in the vicious circle of low incomes, low savings and inadequate levels and efficiency of investment, and bypassed by private capital inflows. For the immediate future, says the report, most LDCs have no choice but to rely on official development assistance as their major source of external finance.

·        Implementing partnership based on genuine national ownership: In view of the importance of developing effective state capacities to enable true national ownership, LDCs must work towards establishing comprehensive and coherent budgets and medium-term expenditure plans that are realistic, transparent and accountable. Without these changes, the broader forms of political accountability vis-a-vis domestic constituents and international donors cannot be achieved.

On their part, donors must ensure that sufficient funds are allocated to the LDCs to enable the creation of a more effective public sector administration.

. Undertaking adequate debt relief: The insidious “aid-and-debt trap” has highlighted the need for deeper, faster and broader debt relief. The UNCTAD report argues that the relief being provided under the Heavily Indebted Poor Countries (HIPC) Initiative, even in its enhanced form, is not only coming too late and too slowly but also arriving in amounts that are inadequate for a durable exit from the debt problem, for a transition to greater aid effectiveness and for significant poverty reduction.

According to UNCTAD, the medium-term forecasts under the HIPC Initiative of a durable exit from the debt millstone are over-optimistic. They are based on high rates of economic and export growth sustained over a long period - often over and above the rates achieved in the 1990s - and slower import growth. If the export growth rate is just 10% less than projected, major financing gaps will open by 2005, claims the report.

·        Increasing systemic policy coherence: Aid and debt relief policies must be made more complementary, avoiding the pitfalls of the negative synergies manifested in the “aid-and-debt trap.” Especially important in this context, asserts the UNCTAD report, are the promotion of private capital flows to LDCs and an international trading regime which better serves their development. Such a regime would ensure better market access for LDC exports, significant reductions in agricultural domestic support and export subsidies in developed countries, and more remunerative and stable primary commodity prices.

The new approach to international development cooperation, “which has moved so rapidly in the last three years in the areas of aid and debt policies”, should incorporate the trade dimension, urges UNCTAD Secretary-General Rubens Ricupero in his overview of the LDC 2000 Report, for “[i]t is through international trade that the LDCs will make their way in the world.” .

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