Theme: The OECD recently published aid figures for 2006. Major debt relief operations in 2005 and varying trends among donors explain the first decline since 2001 in the total volume of development aid.

Summary: This paper first offers an overview of development aid figures for 2006, recently published by the OECD. The paper pinpoints the main cause of the decline in the total volume of aid compared with the previous year: namely, the completion in 2005 of major debt relief operations. It goes on to review the main advances in so-called innovative aid instruments and, in particular, in taxation on air fares, the International Finance Facility for Immunisation and research incentives for the pharmaceutical industry. The analysis concludes with some reflexions on the possibilities of extending multilateral debt relief initiatives, the scope for improving aid quality and the likely progress in new developmental financing instruments.

Analysis: A few weeks ago, the OECD (Organisation for Economic Cooperation and Development) published the 2006 Official Development Assistance (ODA) figures for the group of donors on the Development Assistance Committee (DAC). As the organisation itself projected last year, these figures revealed a year-on-year decline of more than 5% in real terms in aid to developing countries from rich countries.

This analysis aims primarily to review the main causes of this decline and to offer a general overview of the current aid situation. It then examines the so-called ‘innovative instruments for development financing’ which have received most support or made most headway in the last year.[1]

Aid is Declining, as Expected

This expected decline breaks the upward trend that started in 2001, a milestone year for ODA in the last few decades. Until then, throughout the 1990s, development aid had been shrinking steadily, partly as a result of the fall of the Berlin Wall, the end of the Cold War and the resulting shift in geo-strategic interests among the main donors. From 2001, with the renewal of donors’ commitments and also the emergence of new geopolitical challenges in the wake of 9/11, this trend made a U-turn. The consecutive increases in development aid between 2001 and 2005 brought total aid from DAC countries back to 0.33% of their combined GNI (Gross National Income), the same percentage as in 1992, when the downturn commenced.

However, as we already mentioned, these increases could not be sustained in 2006 and, according to the OECD, are also likely to be unsustainable in 2007. The reason is the nature of aid that triggered the boom in 2005. External debt relief accounted for almost US$23 billion, while total increase was more than US$26 billion. Excluding debt relief operations in 2005, the year-on-year increase in official development assistance was only around 9% in current dollar terms. These exceptional aid packages focused on debt relief (and, to a much lesser degree, on emergency aid in the wake of the Tsunami disaster), obviously rendering the pace of growth untenable.

Accordingly, the reasons behind the strong increases in 2004 and 2005 also account for the decline between 2005 and 2006. Without debt relief operations in 2005, official development aid to DAC countries increased by more than 24% in current dollar terms, rather than declining by just over 2% (see Table 1). At all events, it is significant that, behind the striking headline in the OECD press release announcing the final figure for development aid in 2006,[2] the data nevertheless still evidence that official development assistance from DAC countries was above the levels of 2004 (close to US$104 billion in 2006, vs. some US$80 billion in 2004).

By donors, the greatest increases in aid volume in 2006 were in Ireland, Australia, Spain, Sweden and the UK. The OECD highlights the increases in bilateral aid and the contributions to multilateral bodies by Ireland, as well as the international contributions from Spain –to the United Nations and other bodies– and the UK.

 Table 1. Net ODA in 2005-2006 (in billions of current dollars –unless otherwise specified–)

Source: OECD and the authors.

Accordingly, in 2006, the league table of donors was largely the same as it has been in the last few decades. While the main OECD economies rank top in terms of volume disbursements of aid in absolute terms (measured in current dollars), in relative terms (ODA as a proportion of GNI) the so-called ‘like-minded’ economies lead the field. Table 1 shows that, in 2006, the largest disbursements in absolute terms were made by the US (more than US$22.7 billion), followed at a distance by the UK (just over US$12.6 billion), Japan (some US$11.6 billion), France (just over US$10.5 billion) and Germany (around US$10.3 billion). In the same year, the highest volume of ODA in relation to GNI came from Sweden, which donated over 1%. In second place were Norway and Luxemburg (each with 0.89%), followed by the Netherlands (0.81%) and Denmark (0.80%).

Whatever Happened to the Innovative Financing Instruments for Development Aid?

Aside from the performance of ODA itself, in the last few years there have been a number of proposals for alternatives to traditional aid. There are very diverse proposals aimed at increasing the volume of funds in the short term channelled towards development in poor countries in order to maximise the possibilities of meeting the MDGs (Millennium Development Goals) by 2015. The proposals that have received most attention are global taxes (on air fares, some financial transactions, weapons sales or polluting gas emissions), the platforms for issuing new financial instruments to frontload funds for development (International Finance Facility or issuance of new development-focused Special Drawing Rights in the IMF), a world lottery and donations to public-private partnerships and global funds. They have sometimes included innovative instruments to enhance the impact of remittances, which according to the World Bank totalled close to US$200 billion in 2006, on development. These initiatives focused on making it cheaper to send the remittances and on designing incentives to foster the use of banks and investment of physical and human capital in countries receiving remittances.

The innovative instruments have received considerable media coverage and have generated debates as to their visibility and advisability. Those who support global taxes claim that these would play a dual role, since not only would they increase funding for development, but they would also reduce incentives to produce global public bads, such as pollution or speculative financial movements, and they would therefore help govern the global economy to an extent. The other instruments, although designed only to raise funds, would also be a good strategy to increase development aid beyond the amounts to which voters in a particular donor country are willing to increase traditional ODA: after all, an increase in ODA requires higher taxes or cuts in other public expenditure items. Critics of these initiatives assert that they are either unviable at the global level or that they are economically inefficient, unfair and sometimes even regressive. They also insist that if there really is consensus on the need for higher short-term funding for development it would be better to increase traditional ODA, for which purpose the debate must be opened in the DAC countries as to whether or not it is advisable to reassign public expenditure items to development cooperation projects.

Above and beyond these theoretical debates, some countries have spearheaded initiatives to implement some of these instruments, which have given them some political credit before global public opinion as the leaders of the commitment to development (something which is not necessarily true, since they could have opted to increase traditional ODA ‘quietly’, as Spain has). Furthermore, in 2005 the UN approved a declaration supporting innovative sources of development financing.

The three most advanced initiatives are the tax on air fares, the International Finance Facility for Immunisation (IIFFm) and the Advanced Market Commitments (AMCs) to encourage research into vaccines. Although there is no consensus as to the best way of financing these instruments, there has been agreement in that all new funds generated will finance health programmes, especially vaccines. This consensus is underpinned by the idea that these are investments with extremely high returns in the long term and that the cost of inaction (not vaccinating) clearly undermines the growth and development prospects of poor countries. There follows a brief outline of all three initiatives, the countries involved and the financing available to them.

(a) Tax on Air Fares (Solidarity levy)

In 2004, the French government, supported by Chile and the UK, proposed the creation of a small national, not global, tax on air fares. In February 2006, at the Paris Conference on Innovative Financing for Development, Brazil, the UK, Congo, Ivory Coast, Cyprus, Gabon, Jordan, Luxemburg, Madagascar, Mauritius and Nicaragua lent their support to the proposal and undertook to create the tax in the medium term, but they did not set a deadline. To date, in May 2007, 18 countries have supported the initiative, whose funds will be distributed by UNITAID, the body created in September 2006 under the auspices of the World Health Organisation (WHO) to cutting prices and increasing access to drugs in developing countries.[3]

The tax has been criticised both for its lack of efficiency and fairness and because of its low fund-raising capacity, since it is estimated that it would muster US$450 million per year, almost half of which would come from France. However, it has served to show that these new instruments are politically viable and have a considerable media impact.

(b) International Finance Facility and the International Finance Facility for Immunisation (IIFFm)

In 2004, the British government raised the possibility of creating an International Finance Facility to frontload the scheduled future increases in ODA to developing countries by 2015. The IFF would be a financial platform that would act like a Global Treasury to generate funds by issuing debt in international financial markets. The logic behind the system is as follows: first, donor countries would pay in their irrevocable, formal, multiyear future commitments, acting as stakeholders in the fund. Next, they would issue bonds on the financial markets, payment of which would be guaranteed by the donors’ pledges (securitisation). Fully backed, these bonds would have top credit ratings, and could therefore generate funds at lower interest rates than developing countries would pay on debt. Lastly, revenues generated from the bond issues would be distributed to the developing countries in the form of donations, never loans.

Although it is estimated that the IFF could raise as much as US$50 billion per year, the proposal has not been sufficiently fine-tuned, especially in terms of management, destination of the funds and leveraging levels; so a pilot IFF has been set up to finance a large-scale vaccine programme (IIFFm), and this has met with broad consensus. The project, which commenced operations in November 2006 and that will generate US$4 billion per year until 2015, is financed by contributions from the UK, France, Italy, Austria, Germany, Spain, Sweden and Brazil, as well as by the Bill and Melinda Gates Foundation. The IIFFm will test the viability of the IFF system, in terms of both securitisation of donors’ contributions and its governance structure. The donations will be distributed through the Global Alliance for Vaccines and Immunisation (GAVI), which encompasses UNICEF, WHO, the World Bank, the Bill and Melinda Gates Foundation, plus a number of governments from donor and beneficiary countries. The funds will be used to buy and distribute vaccines for 72 countries whose per capita income is lower than US$1,000, speeding up compliance with various MDGs in the poorest countries (reducing child mortality and improving maternal health, directly, and reducing poverty and improving education, indirectly).

(c) Advanced Market Commitments (AMCs)

The third of the new instruments, AMCs, seek to modify the structure of incentives to pharmaceutical companies so that they invest more in drugs and vaccines that are needed in the third world. They do not do this now because a huge investment is needed to develop these drugs and vaccines and there is no assurance that they will have a market in which to sell them due to the levels of poverty in the countries affected by this kind of disease. Accordingly, in February 2007, in Rome, Italy, the US, Canada, Norway, Russia and the Bill and Melinda Gates Foundation set up a fund totalling US$1.5billion, aimed at incentivating research into a vaccines targeting pneumococcal disease, which causes 11 million child deaths by pneumonia in poor countries. Although obtaining these vaccines is vital because increasing numbers of children with AIDS are becoming ill with pneumonia, the AMC has been criticised for not focusing on malaria, the effects of which are still more devastating. At all events, the pilot programme for pneumonia could be extended if it achieves its objective: which is that the pharmaceutical companies which currently see these investments as unprofitable start ploughing more funds into this kind of research since they would have a guaranteed market if a vaccine were developed.

Conclusions: Despite the end of most debt relief operations in 2005, relief was still a significant item on the total aid figure for 2006, but not so in 2007. The OECD therefore projects further declines in aid by the end of the current year.

The conclusion of debt relief operations is, in our opinion, an important and necessary step forward in relations between developed and developing countries. However, its removal from aid figures among for DAC donors evidences the still-considerable financial effort required to meet the various commitments undertaken by this group of countries since the beginning of the decade. Furthermore, the international community still has considerable scope for putting forward a more global and more definitive solution to the problem of external debt with many developing countries. In this regard, there are calls from various sectors to focus more on the problems of some non-HIPC (Heavily Indebted Poor Countries) nations -in other words, developing countries with higher per capita income, but nevertheless with critical problems (sometimes even chronic) in terms of their external debt-.

There is a need for more aid, but also better aid. Given the limitations of financial resources (limitations on public expenditure in donor countries, difficulties in raising additional funds), it is worth insisting once more on the importance of managing available aid funds correctly. The many DAC recommendations to boost aid efficiency are well-known: aid untying, or limiting ODA loans to highly indebted countries name some examples. In fact, in these years in which much of donors’ activity has focused on debt relief programmes, controlling reimbursable aid seems particularly important, so as to avoid generating vicious circles in which ODA loans are cancelled shortly after being granted.

Generally speaking, the effective reduction of poverty in aid-receiving countries also requires alignment of the various instruments of trade and financial policy of developed countries with the economic and social development goals of the receiving countries: known as coherence between development policies.

Finally, global taxes such as the ‘Tobin Tax’ or global environmental taxes do not yet have enough support and are still opposed by the US and Japan, and so are unlikely to be implemented in the short term. Although the air fare tax is already in place, its fund-raising capacity is very low. It is basically a French initiative backed by a group of sympathetic nations, with little real impact on development but with considerable political and media appeal. Furthermore, there does seem to be increasing consensus about using market mechanisms and incentives to design new instruments (such as the IIFFm and AMCs) and to plough all additional funds into health programmes, particularly vaccines. Beyond the debate about the beneficiary countries’ capacity for managing and absorbing debt, there is broad consensus that the fight against infectious diseases is a priority, and that it is a secure long-term investment whose returns are not yet diminishing.

Iliana Olivié
Senior Analyst, International Cooperation and Development, Elcano Royal Institute

Federico Steinberg
Analyst at Elcano Royal Institute and Professor at the Department of Economic Analysis in Madrid’s Universidad Autónoma