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CGD Publication: The Politics of German Finance for REDD+ - Working Paper 390

The Politics of German Finance for REDD+ - Working Paper 39012/4/14

The concept of Reducing Emissions from Deforestation and Forest Degradation (REDD+) and its framing of forest protection as a climate mitigation approach mark a clear paradigm shift – after decades of up-front financing of traditional ODA projects REDD+ follows the logic of ex-post payments for measured and verified performance within much larger jurisdictions. 


Development blog: Norway’s “Rainforest Billions”: How Did the Stars Align?

Seven years ago at the 2007 climate talks in Bali, then Norwegian Prime Minister Jens Stoltenberg shocked the world by pledging $2.5 billion over the next five years to reduce tropical deforestation. Since then, as described in a recent CGD Working Paper, “The State of REDD+ Finance,” Norway has remained the 10 billion kroner gorilla when it comes to putting money on the table for REDD+. As illustrated in the figure below, Norway’s pledges surpass those of the next five countries combined.

The 10 billion kroner gorilla: Norway pledges more for REDD+ than next five countries combined
Pledges for REDD+ 2006 – March 2014

Last month, we released a paper and accompanying blog detailing the challenges of climate politics, budget austerity, and aid rules that constrain REDD+ finance from the United States. How has Norway avoided such constraints? We also released a paper and blog reviewing the political opposition generated by a proposal to include international forests offsets in California’s cap-and-trade program. By contrast, why has Norway’s finance of REDD+ provoked so little controversy in the domestic political arena?

A new CGD Working Paper, “Climate Policy Constraints and NGO Entrepreneurship: The Story of Norway’s Leadership in REDD+ Financing,” by Erlend A. T. Hermansen of the CICERO Center for International Climate and Environmental Research–Oslo and Sjur Kasa of Hedmark University College, answers these questions and many more.

Lack of political, financial, and bureaucratic constraints

Hermansen and Kasa illuminate how the stars aligned to support Norway’s initial “rainforest billions” commitment, and to maintain that support over the last seven years, through a change in government last year. In short:

  • There was (and is) overall consensus across the political spectrum on the importance of taking action on climate change.
  • The limited options for low-cost domestic emission reductions made investment in reducing emissions from tropical deforestation attractive to a range of constituencies.
  • A growing economy, combined with a target of 1 percent of Gross National Income (GNI) for overseas development assistance (ODA), allowed the new rainforest commitment to be incorporated into the aid budget, thus circumventing the fiscal conservatism of the largest political party and the Ministry of Finance. Framing the commitment as performance-based finance also increased its palatability across the political spectrum.
  • The initiative was championed by Erik Solheim, who from 2007 was simultaneously playing the roles of Minister of Environment and Minister of International Development. By creating a new Climate and Forests Secretariat under the Ministry of Environment, the Norwegian International Forests and Climate Initiative (NICFI) was able to bypass the “cautiousness”(and many of the norms) of the Norwegian Agency for Development Cooperation (Norad).
NGOs as policy entrepreneurs

But the stars did not align all by themselves. As tipped in the title of their paper, Hermansen and Kasa emphasize the role of NGOs as policy entrepreneurs in generating and sustaining the rainforest billions commitment.

In 2007, the leadership of Friends of the Earth–Norway and the Rainforest Foundation Norway saw a window of opportunity as climate change rose on the domestic and international political agendas. Friends of the Earth–Norway proposed a crosspolitical “climate settlement,” leveraging the desires of the ruling parties and the opposition to show leadership on the climate issue.

The NGOs also linked their proposal to international developments, mobilizing support from the Brazilian Minister of Environment Marina Silva and civil society leaders from Brazil for prospective Norwegian funding for reduced deforestation. (For more on parallel developments in Brazil during this period and the country’s remarkable success in reducing deforestation, see the background paper by Sergio Abranches and associated blog.)

And by providing legitimacy, NGO support for the initiative might also help explain the relative absence of domestic controversy over NICFI, even in the face of concerns about corruption and safeguards in the context of REDD+ implementation described in the paper. The authors speculate that NICFI’s “very generous funding for civil society projects” channeled through Norad—from which CGD as well as Norwegian NGOs have benefited—might also have dampened criticism.

Looking ahead

Hermansen and Kasa conclude that domestic political support is sufficiently robust that NICFI is likely to be a “centerpiece” of Norwegian climate policy for the foreseeable future. Ironically (and appropriately), the continuation of NICFI will be more dependent on political developments in partner countries than at home in Norway. Setbacks in the fight against deforestation in Brazil and Indonesia in particular could “undermine NICFI, and certainly make the planned future spending of Norway’s rainforest initiative difficult to achieve.”

Let’s hope that the stars remain aligned in the heavens above Norway as well as across the skies of forest-rich countries in the tropics for effective partnerships to reduce deforestation.

Authors: Frances Seymour View Profile

Development blog: The ADB Says Poverty Is Rising in Asia: I Have My Doubts

Would you believe that half of Asia lives in poverty and the absolute number is rising? That’s what the new Key Indicators report by the Asian Development Bank (ADB) would have you believe—49.5 percent in 2010, to be precise, with a poverty count of 1.8 billion, up from 1.6 billion in 2005.

This is surprising. Indeed, it runs counter to every other assessment I have seen.  Absolute approaches to measuring poverty over a very wide range of poverty lines (including $1.25 a day) have shown a decline in Asia’s poverty measures. And (weakly) relative poverty measures also show declining poverty rates, as is shown here. It takes a marked upward revision in the real value of the poverty line over time to deliver rising poverty in Asia. This calls for a closer inspection.

At the heart of the ADB’s new poverty counts is a set of three “adjustments” they make to the international line of $1.25 a day in 2005 prices. Taken separately, none of the three is enough to give rising poverty in Asia, but together they manage it. However, when I look more closely at the three adjustments, I have concerns about two of them.

The first adjustment is to switch to a regional line of $1.51 a day. To get this, the ADB has applied essentially the same method used to set the global $1.25 a day line, but solely on data for Asia. (The $1.25 line is the mean of the national lines found in the poorest 20 or so countries in the world; the ADB did roughly the same for the poorest countries in Asia.)  The $1.25 line was never meant to be the only line, and higher lines are defensible. Switching to $1.51 adds 10 percentage points to the poverty rate for Asia in 2010.

The second adjustment is to use the rate of food price inflation for adjusting over time whenever this is greater than the overall rate of inflation. This is odd. The authors acknowledge that people living around the median do not just consume food. In Asia, close to half of their expenditures go to nonfood goods. It can be granted that the official Consumer Price Indices for some countries put too low a weight on food for the purposes of poverty measurement. But the standard corrective is to reweight the index appropriately, not to simply switch to the food CPI when it rises more than the ordinary CPI.  This second adjustment adds 4 percentage points to the poverty rate for Asia.   

The third adjustment is for “vulnerability.” The aim here is to find the increment to the poverty line in a risky world that gives the same level of welfare as a risk-free line. This third adjustment adds 12 percentage points to the 2010 poverty rate.

There are a number of issues here. While this type of “welfare-consistency” is conceptually appealing for setting poverty lines, the report is not internally consistent. It argues for welfare consistency in dealing with risk, but implicitly rejects that principle for relative poverty lines, at different levels of development. Welfare consistency almost certainly requires setting a higher line in richer countries to compensate for the welfare loss from relative deprivation and the higher costs of social inclusion (as argued here).

It’s also not clear why the base poverty line ($1.25 or $1.51) should be treated as risk free; the underlying national lines were clearly not developed in a riskless world. As the report acknowledges, national poverty lines reflect the prevailing view of what it means to be “poor” in a given country. Such assessments are unlikely to ignore country-specific risk.  

I have other concerns about the report’s assumptions, and the problems will not be evident to many readers. Using some math, and numerous assumptions buried in quite technical boxes, the report derives a formula for the risk-adjusted poverty line corresponding to any given risk-free absolute line. Let me try to explain what all those equations in the report’s boxes mean.

“Risk” is assumed to take a rather special form, namely that it rescales personal income levels (it is “multiplicative”) and in a way that it is uncorrelated with the long-run income levels. The latter appear to be measured by overall regional averages. A single parameter reflecting relative risk aversion is assumed.

Are the assumptions plausible? Some observers will think that the ADB’s assumed parameter for the extent of risk aversion is on the high side. But for me the more worrying feature is that any rise over time in the overall interpersonal variance of incomes is taken to reflect an increase in their riskiness. Rising variance is passed onto their risk-adjusted lines. 

That is hard to accept. Plainly the rising income dispersion that we see in Asia and elsewhere stems in no small measure from rising inequality of wealth. Rising risk is no doubt a contributing factor, but it is not the whole story. To put it another way, the risk-free long-run interpersonal variance of incomes in Asia is almost certainly rising. Thus the ADB’s upward revisions to poverty lines overcompensate for rising vulnerability.

The ADB’s researchers have made a valiant, even heroic, effort to deal with what they see as the shortcomings of standard absolute poverty lines. In the end, however, I am not convinced by their calculations, or their implication that poverty is rising in Asia. 


Authors: Martin Ravallion View Profile

CGD Publication: Climate Policy Constraints and NGO Entrepreneurship: The Story of Norway’s Leadership in REDD+ Financing - Working Paper 389

Climate Policy Constraints and NGO Entrepreneurship: The Story of Norway’s Leadership in REDD+ Financing - Working Paper 38912/3/14

Norway – a small northern country with only 5 million inhabitants – is at present a global leader in REDD+ financing. In this paper, we explain why and how this happened by telling the story about the emergence of Norway’s International Climate and Forest Initiative (NICFI) in 2007 and its institutionalization in the following years. 


Development blog: Why Aren’t Forests More Prominent on the Agenda for COP20 Climate Talks in Lima?

Conserving the world’s tropical forests is a critical element of any global strategy to protect against climate change—and promote development, for that matter—but we haven’t heard much about it being on the agenda for the COP20  climate talks in Lima starting this week. One reason for that: negotiations on forests were largely completed at COP19 with agreement on the Warsaw Framework on REDD+, and a new CGD Working Paper explains how.

But the stakes for forests in Lima remain high – see below for more on why.  First, let’s understand how the forest-related negotiations got out in front of the others.

Why were negotiators able to reach agreement on forests more quickly?

Why Forests, Why Now?

In “Two Global Challenges, One solution: International Cooperation to Combat Climate Change and Tropical Deforestation,” Antonio G.M. La Viña and Alaya de Leon of the Ateneo School of Government in Manila explain that the achievement of agreement on REDD+ was the culmination of an unusually constructive strand of negotiations.  The authors are particularly well-placed to tell the story, having both played key roles in REDD+ negotiations as members of the delegation from the Philippines.

La Viña and de Leon start by summarizing the history of previous attempts to reach international agreements on conserving tropical forests, including the failure to conclude a convention on forests among the outcomes of the Rio Earth Summit in 1992.  In the context of the resulting policy vacuum, the linkage of forests to climate change provided a timely opportunity to address two global challenges with one solution: REDD+.

La Viña and de Leon analyze how the politics of REDD+ were unique, with the national interests of various countries not splitting along the usual North-South divide.  Indeed, the relative absence of the G-77 and China as leading protagonists in REDD+ negotiations is notable.  Overall, the interests of industrialized countries in low-cost mitigation options lined up with the interests of forest-rich countries in generating a new source of development finance, although the positions of individual countries evolved over time.

A model for other areas of negotiation?

Despite an alignment of interests in reaching agreement on forests, doing so was not easy.  Negotiators had to address a long list of technical issues, such as guidance on setting reference emission levels (RELs) and rules for the measurement, reporting, and verification (MRV) of forest-based emission reductions.  Technological advances in remote sensing over the previous decade facilitated agreement on the inclusion of emission reductions from “avoided deforestation” that were not possible at the time of the Kyoto Protocol.  

Two particularly contentious issues had to do with finance and safeguards. Brazil, Bolivia, and many nongovernment stakeholders opposed finance of REDD+ through carbon markets, out of concern that offsets would enable industrialized countries to avoid reducing their own emissions.  Many countries and other stakeholders were also worried that market-driven finance would create perverse incentives to harm vulnerable communities and ecosystems, for example, through displacement of indigenous peoples or conversion of natural forests to plantations. Ultimately, “appropriate market-based approaches” were accepted as a financing option linked to compliance with a set of safeguards agreed at COP16 in Cancun in 2010.  Those safeguards would also of course apply to non-market-based sources of finance.

La Viña and de Leon describe how these challenges were addressed through an approach to negotiations that combined a number of features designed to nurture and build on incremental progress.  Technical issues were resolved before tackling political issues, and nongovernment stakeholders were giving an unusual degree of access to the discussions in order to secure their support for negotiated outcomes.  La Viña and de Leon see lessons learned from this approach as applicable to other areas of negotiation. 

What are the stakes for forests in Lima?

This week’s negotiations are a critical milestone on the road to COP21 in Paris next year, where a new global climate agreement is expected to be reached.

First, many observers are hopeful that the momentum created by forest-related commitments announced at the UN Secretary General’s Climate Summit in September via the New York Declaration on Forests will carry through to Lima, influencing the size and composition of national commitments being formulated for inclusion in the Paris agreement.  Indeed, the host of COP20, the Government of Peru, announced a REDD+ partnership with Norway and Germany in New York, so its own efforts to reduce emissions from deforestation will be in the spotlight.

Second, a few issues related to REDD+ are still on the negotiating table for methodological guidance, as La Viña and de Leon describe in their working paper, including non-carbon benefits, non-market-based approaches, and safeguard information systems.  An issue that could prove tricky is how to craft a comprehensive approach to account for land-based emissions, linking REDD+ to reductions in agricultural and other terrestrial sources of emissions.  While everyone agrees that such linkage is in principle desirable, doing so without unraveling the painstakingly achieved agreements specific to REDD+ would be a challenge.

Third, and most important, countries participating in REDD+ will be looking for signals in Lima that the international community is serious about providing finance commensurate with the task of reducing forest-based emissions.  With the REDD+ rulebook essentially complete, implementation is now effectively held hostage by the lack of broader agreement on a global emissions reduction strategy that would liberate large-scale finance for forests.  Recent (Brazil) and prospective (Indonesia) submissions of Reference Emissions Levels on the part of the two largest REDD+ countries increase the pressure on industrialized countries to be prepared to reward performance in reducing deforestation with results-based funding.

As detailed in a previous CGD Working Paper and associated blog, REDD+ finance so far has been too small, too slow, too public-sector dependent, too concentrated, and not sufficiently performance-based.  Recently announced contributions to the Green Climate Fund are promising, but there’s still a long way to go before reaching the $100 billion of climate finance per year by 2020 envisioned at COP15 in Copenhagen.  

La Viña and de Leon conclude from the experience of REDD+ negotiations that “international cooperation [on climate change] is not certain but it is certainly possible.”  Here’s hoping that negotiators reach the cooperation possibility frontier in Lima!

Authors: Frances Seymour View Profile

CGD Publication: Two Global Challenges, One Solution: International Cooperation to Combat Climate Change and Tropical Deforestation - Working Paper 388

Two Global Challenges, One Solution: International Cooperation to Combat Climate Change and Tropical Deforestation - Working Paper 38812/2/14

This paper provides an analysis of the international political dynamics around the reduction of tropical deforestation and forest degradation as a climate mitigation strategy, emphasizing the necessity of an enabling environment and sustainable financing to support the scaling up of these efforts globally.


CGD Event: Why Forests? Why Now? Events at the 20th UNFCCC Conference of Parties

Why Forests? Why Now? Events at the 20th UNFCCC Conference of Parties12/8/14

The Center for Global Development will host a reception on Monday, December 8 at the 20th UNFCCC Conference of Parties in Lima, Peru for a discussion and celebration of CGD’s forthcoming book Why Forests? Why Now? and the research of our Working Group on Performance-Based Payments to Reduce Tropical Deforestation.

Why Forests? Why Now? draws on scientific, economic, and political evidence to show that tropical forests are essential for both climate stability and sustainable development, that now is the time for action on tropical forests, and that payment-for-performance finance for reducing emissions from deforestation and forest degradation (REDD+) is a course of action with great potential for success.

The working group aims to understand the political, financial, and practical obstacles that are holding back what should be large flows of funds to forest-rich countries to reward them for measured reductions in deforestation. We seek to identify practical ways to accelerate performance-based finance for tropical forests in the lead-up to COP 21 in Paris.

The reception will take place on Monday, December 8, 2014 at 8:00 p.m. at the Casa Andina Miraflores (Av. La Paz 463, Miraflores). Frances Seymour and Jonah Busch will present a brief overview of the book and will join fellow CGD expert Michele de Nevers to give remarks on the working group. The discussion will be followed by a cocktail reception to conclude around 10:00 p.m.

CGD Publication: Predicting Partnerships: Which Countries Will MCC Select for FY2015 Eligibility?

Predicting Partnerships: Which Countries Will MCC Select for FY2015 Eligibility?12/1/14

The Millennium Challenge Corporation’s (MCC) board of directors is scheduled to meet on December 10. As usual, they will use this end-of-year meeting to vote on which countries will be eligible for MCC assistance for FY2015.


Global Health blog: Major Progress at the Global Fund: A One-Year ‘More Health for the Money’ Update for World AIDS Day

Last September, we released a report on how the Global Fund could get more health for its money. In it, we offered concrete suggestions for improvements in several different value-for-money domains, all with an eye toward maximizing the health impact of every dollar spent.

A lot can change in a year. And during a recent reread of our own report, I was pleasantly surprised by how much the Global Fund has changed for the better, particularly in how it does business. So what’s been done, and what challenges remain? 

More Data-Driven Allocation

Under its old system, the Global Fund allocated its funding through a series of proposal rounds. During each round, countries could submit their requests for funding; good proposals would be approved and bad proposals rejected by an expert technical review panel  until all available funds were committed. 

While well-intentioned, this system was rife with problems. As we wrote in our report, “by failing to provide countries with a clear budget constraint, predictable funding windows, or rewards for efficiency, the Global Fund created strong incentives for countries to maximize their funding requests—often without considering actual need and other funding sources, or assessing their most pressing priorities given scarce resources.” Funding went to countries with the best proposals—not necessarily the countries that had the greatest need or capacity to deliver results. As a result, major differences (up to 5,000-fold!) were seen in per-case spending on HIV across countries, with no obvious justification for the discrepancies.

Fast-forward to today and the Global Fund now deploys an explicit, data-driven allocation formula to split scarce funds across countries on the basis of their disease burdens and ability to fund their own disease programs (the board originally voted to enact a formula-driven allocation approach in 2012; exact allocations for the 2014–2016 window were announced in March). As a result, funding is better aligned with countries’ respective disease burdens, and more predictable funding empowers countries to plan ahead with a clear understanding of the available resource envelope. In a new paper with Victoria Fan and Amanda Glassman, we conclude that this new “methodology is expected, but not guaranteed, to improve the efficiency of Global Fund allocations in comparison to historical practice.”

Still, the fund has experienced some growing pains during its ongoing transition to the new approach. The split of funding across the Global Fund’s three target diseases is based on historical practice rather than objective criteria, and the relatively low allocations for malaria and tuberculosis (32 percent and 18 percent, respectively) remain controversial. Within each disease area, the sources to inform cross-country allocation are inconsistent. In particular, the use of malaria data from 2000 was intended to protect countries where continued funding is required to sustain recent gains; in practice, the fund’s own technical review panel  worries that “allocation amounts … may no longer reflect the most strategic investment of resources.” Finally, during the first wave of New Funding Model proposals, confusion about the role of “incentive funding” and competition for its allocation proved a major distraction. But the Global Fund has absolutely taken a step forward toward a strategic, evidence-based approach, and we look forward to watching further refinements over the next few years.

More Results-Based Contracts

In our report and a related paper, we recommended that the Global Fund restructure its contracts to incentivize better results. One year later, we’re pleased to see the fund embrace piloting of results-based contracting mechanisms with open arms, and we’re even more excited to be part of the action.

Here are some highlights: In Rwanda, the Global Fund has signed on to a pilot project where payments are tied to performance against specific HIV outcome indicators. In Mesoamerica (countries of Central America and southern states of Mexico), the fund is supporting a Cash-on-Delivery model to reward countries for progress toward malaria elimination. In Benin, the Global Fund is partnering with the World Bank’s Health Results Innovation Trust Fund to support results-based financing for providers at local health facilities. And many more projects are currently under discussion as the Global Fund explores how results-based financing can become a core component of its overall business model. 

Looking Ahead

One more exciting development: this month, with support from the Bill and Melinda Gates Foundation, and in partnership with both the Global Fund and the Clinton Health Access Initiative, we’re launching a new working group to explore how the Global Fund can best put innovative contracting designs to work across its portfolio—all while striving to maximize the health impact of each dollar and mitigating the attendant risks. The working group will be co-chaired by a high-ranking member of the Global Fund’s secretariat, and we expect that the output will help inform the Fund’s strategy for the next replenishment cycle.

Though the finish line is still far away, the Global Fund deserves kudos for what’s already been done. We’ll continue to check in on movement – but for now we’re happy to see momentum in the right direction.

Authors: Rachel Silverman View Profile

Development blog: Alex Cobham’s Off to the Tax Justice Network

It is with bitter-sweet excitement that we share our news that Alex Cobham is taking up a new post from the beginning of next year as Director of Research at the Tax Justice Network.

This feels like a coming of age. Since we began CGD in Europe in 2011, we’ve focused on three main priorities: development impact bonds, Europe Beyond Aid and Alex’s area: illicit financial flows (IFF). In our work on illicit flows, we’ve been lucky enough to have had a little input to the 2013 G8 process; to have written the zero draft for the Mbeki panel on IFF out of Africa which will report in January 2015; the background paper for the 2014 Tana High Level Forum on Peace and Security in Africa; and a study published by the Copenhagen Consensus on the potential costs and benefits of our proposed new IFF targets for post-2015.  Along the way, Alex Cobham and Andy Sumner proposed a new inequality measure, the Palma; and their current work combines these areas, looking at the possibility of adjusting global income distributions for undeclared (illicit) incomes. And the first major academic paper on the Financial Secrecy Index is forthcoming.

Now Alex is off to take the research and policy agenda forward with the Tax Justice Network, who began, a little over ten years ago, to produce the dangerous ideas that have risen from nowhere to the top of the G8, G20 and OECD agenda; and CGD is bringing together a new team to take the work forward here, with Vijaya Ramachandran and Matt Collin in London, and Washington visiting fellow Peter Reuter.

We’re looking forward to continuing to work together, confident that the net effect will be an expansion of policy-focused research into this important set of issues. And we are seriously considering getting a fußball machine for our new office in the hope that this will entice Alex to fulfil his promise to be a regular visitor.

Authors: Owen Barder View Profile Alex Cobham View Profile

Global Health blog: Realizing the Vision of Swasth Bharat through Fiscal Federalism in India

Related Research

In his early days as India’s new prime minister, Narendra Modi has shown remarkable leadership in all sectors, including health, for which he’s articulated his vision to create a Swasth Bharat, a Healthy India. Combined with two major policy windows—the proposed restructuring of the Planning Commission and the report of the 14th Finance Commission expected by the end of the year—the policy reforms under the ruling National Democratic Alliance (NDA)’s mandate of “Universal Health Assurance for All” have the potential to be a game-changer for India’s neglected public health system.

India’s health system has many problems but perhaps the most obvious is its persistently low levels of public financing for health, with often limited health outcomes. With only 1.7 percent of its GDP being spent on health expenditures (including sanitation and nutrition), India spends roughly $15 per person for health each year. As a result, up to 75 percent of health care expenses are borne out of pocket by patients. And given the lack of any mechanism to insure against health risks, much of India’s low-income population has to forego necessary healthcare or is forced into bankruptcy because of the inability to pay when confronted with a severe medical condition.

One critical policy lever that could have an impact on Indian public health expenditure and its effects on health outcomes is the financial flows and incentives from central government to states. India’s center-to-state fiscal transfers have occurred through three channels—Finance Commission; Planning Commission; and Centrally Sponsored Schemes—with at least three crucial characteristics (see figure 1):

  1. Are the allocations based on a formula and objective criteria or not?
  2. Are there conditionalities associated with those transfers?
  3. Who does the money go to?

While health is a ‘state’ subject, the central government has exerted significant influence on health financing through the flagship scheme known as the National Rural Health Mission (NRHM) from 2006–07 onwards. NRHM has now been extended to cover urban areas under the National Health Mission (NHM) umbrella. However, a systematic assessment of the impact of the three channels of transfers at the state level has not been attempted until now.

Over the past year, the Center for Global Development and the Center for Policy Research’s Accountability Initiative (in Delhi) have conducted research on intergovernmental fiscal transfers to improve health in India. As an early step we commissioned a background paper that describes and analyzes the myriad of channels and mechanisms of center-to-state fiscal transfers that could affect health outcomes. See a draft of the background paper here.

Source: Budget Documents, Government of India, 2014–15

Building on this background paper, Accountability Initiative and CGD have jointly pursued several areas of research to better assess the consequences and effectiveness of these different channels of funding—between Planning Commission and Finance Commission, within the Finance Commission, and the ‘Centrally Sponsored Schemes’ for health. In December, we are convening a working group to discuss some of our early findings and policy recommendations.

Authors: Victoria Fan View Profile Anit Mukherjee View Profile Rifaiyat Mahbub View Profile

Development blog: Should Sovereign Wealth Funds Finance Domestic Investment?

Countries have traditionally invested their sovereign wealth in securities of major markets able to provide dependable returns and macroeconomic stability, but some are now investing more sovereign wealth domestically because of diminished returns in major markets and new investment opportunities at home. This opens up some potential opportunities but also a number of serious risks, including undermining hard-earned efforts to sustain macroeconomic stability and providing a vehicle for politically driven “investments” that fail to add to national wealth.  Resource-rich countries are prone to this; the quality of their public investment management is substantially lower than that of non-resource countries.

Related Research

In a policy paper, my co-authors (Silvana Tordo, Havard Halland, Noora Arfaa, and Gregory Smith) and I propose a set of checks and balances to mitigate the risks of putting sovereign wealth into domestic investments.  Here I present a summary of that work.

Why the Trend toward Domestic Investments?

Sovereign wealth funds amount to more than $6 trillion in assets, and about half of that belongs to resource-exporting countries.  Several resource-rich developing countries have established or are establishing sovereign wealth finds with an expanded role as a national investor, including in “strategic” projects. Angola, Nigeria, Papua New Guinea, and Mongolia are among the most recent examples. More are in the making, including Colombia, Morocco, Tanzania, Uganda, Mozambique, and Sierra Leone.

With needs in such countries high, popular sentiment may push governments to spend part of their accumulated financial wealth at home. And given constrained access to finance since the global financial crisis and the significant management and governance challenges facing public investment in resource-rich countries, governments may see the sovereign wealth fund as a means to improve the quality of public spending and attract private investors to strengthen investment discipline.  

A Risky Proposition

If a sovereign wealth fund has, or engages, the necessary expertise it could act as a specialized investor, helping to attract private investors through well-designed private-public partnerships, but opening the door to domestic investment introduces very serious risks. With domestic investments, the investor—the government, on behalf of the nation—is also the promoter of the investments. The quality of the fund’s portfolio can then be undermined by politically driven decisions, with “investments” contributing neither to growth nor to increasing the wealth of the nation. Since the fund could be used to bypass parliamentary scrutiny of spending, the result could be even more inefficient and fragmented public investment programs. Sovereign wealth funds are particularly vulnerable to these risks because, unlike pension funds or development banks, they have no creditors able to exert due diligence in an independent manner.

How to Mitigate the Risks?

The basic conflict of interest posed by state ownership cannot be eliminated, but it can be mitigated by good policies. 

Coordinate strategic investments. Domestic investments by sovereign wealth funds need to be considered part of a public investment program and the implementation of macroeconomic policy.  As such, especially if large they should be considered in the context of overall investment levels to avoid damaging “boom-bust” cycles. 

Finance the right investments.  An infrastructure project, for example, may provide indirect benefits such as the stimulation of private investments and jobs that are not fully captured by its financial return. While such social and economic returns should be high, wealth fund investments must also yield “acceptable” financial returns.

Invest for competitive returns. Allocations to domestic investment should not be in the form of a mandated share but determined on the basis of competition with the returns on foreign assets.  When domestic returns are low or there are indications of asset bubbles, investment should be channeled abroad. 

Pool investments.   Investing with private investors, pooling with other funds, and co-financing with the regional development banks could help sovereign wealth funds reduce risk, bring in additional expertise, and enhance the credibility of the investment decision. Some funds, such as Nigeria’s, have signed cooperation agreements with major international investors. Limiting investments to minority shares would serve to reduce risks of politically motivated allocations.

Strengthen corporate governance.   There is a large body of knowledge on effective external governance (between the state and sovereign wealth funds) and internal governance (the composition and functioning of the board of directors or trustees and the management processes of the fund). It is especially important that sovereign wealth funds mandated to invest domestically have independent boards, professional staffing, independent auditing, and transparent reporting, especially on strategic investments. 

What Lies Ahead?

Sovereign wealth funds as strategic domestic investors can inject a degree of discipline into the use of natural resource revenue and help countries avoid the “resource curse.”  However, they also have the potential to exacerbate the mismanagement of resources that has plagued so many oil and mineral-exporting countries.  Although domestic investment by sovereign wealth funds is a new issue, some funds such as Temasek (Singapore) have been active investors in large projects, including in developing countries.  We see no sign that the trend will go away, except possibly in the event that a commodity price collapse creates a financing crisis in the resource countries that causes the funds to be tapped to provide massive assistance to budgets.  A second stage of this research is looking in more detail at the practices of a number of funds that could provide useful lessons.   

Authors: Alan Gelb View Profile

Global Health blog: World AIDS Day 2014: UNAIDS Shifts Its Emphasis toward Reducing New Infections

On World AIDS Day in 2003, WHO and UNAIDS launched a campaign called the “3 by 5 initiative,” with the objective to “treat three million people with HIV by 2005.” At that time, AIDS treatment was still prohibitively expensive for poor countries, where only a few thousand people had access to treatment. Thanks to President Bush’s creation of the President's Emergency Plan for AIDS Relief (PEPFAR) program that same year, the number of people on antiretroviral therapy (ART) began to rise dramatically. While the total number of people on ART reached only one million in 2005, the objective to reach three million people was attained in 2007, and the numbers have continued to climb. The numbers have now surpassed 11 million in low- and middle-income countries and 13 million worldwide. (See bottom trend line in figure 1.)

Figure 1. Impressive growth in the number of people on antiretroviral treatment has not yet led to a decrease in the total number of people living with HIV/AIDS

Because treatment extends lives and new infections have persistently outpaced AIDS-related deaths, the number of people living with HIV/AIDS has consequently continued to grow (top line in figure 1). I argued in my 2011 book, Achieving an AIDS Transition, that a unique focus on expanding access to treatment would make recipient countries increasingly dependent on rich ones and would generate unsustainably growing demands for donor resources. The alternative, I proposed, was to focus even more attention and effort on reducing the rate of new infections to below the mortality rate so that the number of people living with AIDS, and eventually the number needing treatment, would begin to decline.

This year, in their annual World AIDS Day plea for more resources, UNAIDS is for the first time focusing more on the need to reduce new infections than on treatment expansion. In figure 2 below, we have assembled into one chart the projections UNAIDS shows in figures 6a and 6b of their new “Fast Track” report. Under their “constant coverage” scenario, new HIV infections will exceed AIDS-related deaths by about half a million persons a year through 2030, causing the number of people living with HIV/AIDS to increase by about 8 million, or to a total of about 43 million (not shown; imagine the top line in figure 1 continuing to climb).

This scenario is a dismal one for the AIDS epidemic. With the need for treatment continually climbing and donor commitments for AIDS remaining flat or declining since 2008, AIDS advocates are concerned that the days of unlimited budgets are over.

But UNAIDS is urging the world to make one last push. Instead of hoping only for constant coverage, or perhaps failing to sustain even that modest goal, UNAIDS is proposing instead that the world adopt “ambitious targets” by aiming for “zero,” which they define as reducing new HIV infections and AIDS deaths by at least 90 percent by 2030. As figure 2 shows, the ambitious targets would bend both the new infections and the annual deaths dramatically downwards. The “AIDS transition,” a key milestone defined in my book, is passed in 2019 when new infections will for the first time be fewer than deaths and the total number of persons living with HIV/AIDS will begin to decline.

Figure 2. With UNAIDS ambitious targets, the world will reach an AIDS transition after 2019

Source: UNAIDS, Fast-Track, November, 2014

Of course, it’s one thing to find a set of assumptions that predict new infections and deaths to go down instead of up (the Futures Institute helped UNAIDS with this meticulous and heroic task). It’s another thing to achieve these ambitious targets. UNAIDS is depending on increased funding of existing interventions to get us to the AIDS transition and beyond. Suppressing mortality to this degree requires greatly expanding treatment to 81% of all infected people, and suppressing new infections requires that 90 percent of people on treatment have suppressed viral load.  So increased funding will certainly be necessary to reach the AIDS transition. However, as I argue in my book, countries that have been receiving aid to finance their AIDS epidemic will also have to dramatically change their attitudes towards HIV prevention. In addition to deploying the array of available preventive medical technology, including treatment-as-prevention, male circumcision, and needle sharing, affected countries must find new ways to incentivize their citizens to assiduously adhere to AIDS treatment guidelines and to adopt safer sexual practices. Cash transfers to schoolgirls and their families show promise but have not yet been widely adopted. More important might be regional and district-level cash-on-delivery rewards for verified evidence of reductions in new HIV infections.

Bravo to UNAIDS for setting a course towards a future when it will no longer be needed—a future without AIDS. Now it must convince donors and recipient countries that this future is realistic and attainable. And that allocating resources towards achieving the AIDS transition is consistent with other sustainable development goals, like universal health coverage and protection from Ebola and other disease outbreaks. The hard work is still ahead.

Authors: Mead Over View Profile

CGD Event: Winners and Losers of Globalization: Political Implications of Inequality

Winners and Losers of Globalization: Political Implications of Inequality12/9/14

The last quarter century of globalization has witnessed the largest reshuffle of global incomes since the Industrial Revolution. Branko Milanovic finds that the main factor behind the reshuffle was the rise of China and, to a slightly lesser extent, all of Asia. By tracking the evolution of individual country-deciles through a new panel database of 100 country-deciles and deriving the global Growth Incidence Curve, Milanovic and co-authors are able to show the underlying elements that drove the changes.

They find that three changes stand out, and those changes open up discussion on the following political issues: how to manage rising expectations of political participations in emerging countries like China, how to “placate” rich countries’ globalization losers so that they do not begin supporting populist anti-immigrant policies, and how to constrain the rising economic and political power of the global top 1 percent.

*The CIRF series is an academic research seminar that brings some of the world's leading development scholars to discuss their new research and ideas. The presentations are at times technical, but retain a focus on a mixed audience of researchers and policymakers. There’s more about the series here.

Development blog: All Technology Leapfrogging Is Not the Same (Why Phones ≠ Energy)

In the debates over how best to bring electricity to the billion-plus poor people who live every day without it, a common refrain is that we can replicate the telecommunications leapfrog with energy too. It’s an attractive notion. Instead of building telephone landlines, billions of poor people jumped right to mobile phones. Why not just do the same with electricity and, instead of building a grid and big dirty power plants, just go right to off-grid solar? 

Yet “the supposed analogy between cell phones and distributed solar is misplaced” argues UC Berkeley’s Catherine Wolfram because of (1) cost, (2) benefits of centralized networks, (3) actual development goals, and (4) quality. She concludes:

I worry that the idea of energy leapfrogging lulls us into ignoring the difficult development versus environment tradeoffs involved with bringing electricity and other improved energy services, like motorized vehicles, to people who do not currently have them... .

Modern energy can transform people’s lives, so it’s unfair to insist that households who do not currently have electricity use the high cost, zero-carbon alternative...let’s stop talking about energy leapfrogging and keep our eyes on the goal of achieving cost-effective, low-carbon solutions.

Read the full post here

Authors: Todd Moss View Profile

Development blog: ‘Taxing across Borders’: An Academic Milestone

Originally posted on Richard Murphy's Tax Research blog on November 21st. 

A new paper from Gabriel Zucman (of London School of Economics, and erstwhile co-author of Thomas Piketty) in the (free-to-view) Journal of Economic Perspectives represents a milestone in the academic economics literature. As far as I’m aware, it is the first major journal paper that aims to put a specific scale to both corporate tax distortions via ‘tax havens’, and the evasion of individual income and wealth taxes through offshore ownership. This post sets out the main findings of the paper and briefly discusses its policy proposals.

Cross-border corporate tax avoidance

The bulk of the paper deals with corporate tax avoidance, and contains substantial new analysis of profit-shifting by US-headquartered multinationals. The story is built up in five figures. First, Zucman shows that the share of all US corporate profits declared as earned outside the US has risen steadily in the post-war period.

Second, Zucman shows that the share of those foreign-earned profits declared as earned in a group of jurisdictions he labels ‘tax havens’ has grown especially sharply – to over half by 2013 (or from around 2% of all US corporate profits in the mid-1980s, to over 20% at its 2008 peak).

The share of US MNE profits retained in’ ‘tax havens’ has also risen: nearly four-fold since the 1980s, towards 40%.

Zucman then shows that the effective tax rates on US corporate profits has fallen consistently in the post-war period, but with an important change.

From the 1960s to the 1990s, the nominal tax rate was also falling – so a falling effective rate may be broadly consistent with the policy intention. From the 1990s onwards the nominal rate has been stable, but the effective rate paid has continued to drop steadily – so this is less obviously a deliberate policy choice.

Offshore tax evasion

The other element of the analysis deals with tax evasion through offshore wealth holdings, and draws on earlier work. There are two main points here. First, Zucman shows that the share of US equities held by individuals or through firms based in a group of ‘tax haven’ jurisdictions has risen from 2% or less in the 1980s, to exceed 8% now (with no discernible change due to the financial crisis).

The second part of the analysis is a global estimate of the total offshore holding of wealth (in this case, not in a particular group of ‘tax havens’, but in all jurisdictions other than the home country). [Of course, holding assets ‘onshore’ also allows in many cases – not least the US – for great opacity and tax manipulation too. See e.g. this new paper from Jason Sharman and co-authors that continues his great work of showing the extent to which OECD economies lag the ‘usual suspect’ havens in, for example, the risk attitude of company formation agents when unknown parties seek to breach beneficial ownership identity requirements.]

The identified offshore wealth holdings are estimated at $7.6 trillion. Data from the Swiss authorities, as presented in earlier work by Zucman and Niels Johannesen (see Fig.7 here), is then used as the basis for an assumption that 80% of offshore assets are undeclared, which in turn gives rise to an estimated tax loss of c.$190bn.

Policy proposals

Zucman makes two main policy proposals: corporate tax reform, and a world financial register. On the former, he considers and dismisses OECD BEPS attempts to fix current system, along with formulary apportionment options. Instead, Zucman argues for (re)integration of corporate and individual income taxation, within the more complex reality of globalisation – even although attempts at integration were largely dropped over time as this complexity developed.

The way that Zucman proposes to make this work is through a major shift in information provision and use, through the creation of a world financial register – Piketty’s major proposal in Capital (which I’ve enthused about before, for its spirit of democratic and financial transparency). Zucman here calls it “a transparent way to enforce a fair distribution of corporate tax revenue globally and thus make an imputation system work in a globalized world.” He then considers and dismisses counter-arguments around cost, complexity and obstructive financial secrecy. (On cost, by the way, my limited cost-benefit analysis of national registers established globally may be of interest.)

Each of these proposals deserve – and I hope, will receive – substantial attention.

Last word, not the last word

The paper itself is a great contribution, pulling together elements of Zucman’s work into a single, powerful argument. In doing so, it also confirms the difficulties of attributing anything more than approximate scale on the basis of current data. By that I mean that the approaches taken are either somewhat partial (what of other jurisdictions’ multinationals?), and/or rely necessarily on extrapolations (for example from Swiss data on asset declarations to the global level); and in addition, inevitably, on assumptions about returns and implicitly about counterfactuals. To be clear, these points are not meant as criticisms; rather, they are additional confirmation that this kind of work requires such steps – as various recent pieces have argued. Researchers simply need to be clear, and open to criticism (as Zucman is), about the steps being taken.

So while it certainly isn’t the last word about the scale of either corporate tax avoidance or offshore tax evasion (and I may write a more critical review of some technical points later), Zucman’s paper marks an important milestone in the development of rigorous academic research in these areas.

Authors: Alex Cobham View Profile

Development blog: Trade Growth Is Slowing; Is Protectionism to Blame?

When the financial crisis hit in 2008, many people feared that countries would respond as they had during the Great Depression and restrict imports. And as shown in the chart below, trade plunged even more deeply than economic output, but then it rebounded just as quickly. It seemed the system built after World War II to avoid beggar-thy-neighbor trade policies had worked pretty well. Certainly there was nothing like the Smoot-Hawley tariff bill of 1930 that raised the average US tariff by a third — to almost 60 percent! But more recently, trade growth slowed dramatically again and the question is why?

Protectionist measures are creeping up…

Simon Evenett, founder and coordinator of the Global Trade Alert (GTA) project, thinks we should not be too sanguine that the world avoided broad, new across-the-board trade barriers. The project monitors and reports on trade measures around the world, classifying them into those that are liberalizing and those that are discriminatory (and likely to harm other countries). In the project’s latest report, titled “The Global Trade Disorder,” Evenett points to disturbing trends in the data. He concludes that there have been three phases since the early days of the economic crisis. There was an initial upsurge in protectionist measures during the crisis, followed by a modest decline as economies recovered in 2010-11. But more recently, as economic growth has slowed in many parts of the world, the number of new protectionist measures ticked up again. 

And, because many of the previous measures have not gone away, the cumulative number of beggar-thy-neighbor measures in place is higher now than at the peak of the crisis. The European Union and India have imposed the most measures affecting the greatest number of trading partners, while China is the most frequent target (pp. 4, 66 of the report). The most recent data indicate that metals and chemicals are the sectors most frequently hit, surpassing agriculture. 

Most of the measures identified in the GTA are ad hoc duties imposed against allegedly unfair (dumped or subsidized) imports, or bailouts and other financial incentives for domestic industries, and not increases in old-fashioned tariffs. In that sense, the international trade rules are working; it’s just that the rules have weak spots. And trade growth, which was outpacing output growth before the crisis, slowed dramatically during Evenett’s third phase of crisis-era protectionism.

But how much do these protectionist policies really matter for trade?

Of course, some of the decline in trade growth is due to the lack of growth in key parts of the world. A recent VoxEU article concluded that about half the slowdown was due to cyclical factors, particularly economic stagnation in the European Union. The other half they concluded was due to structural factors, including modest increases in protection around the world. However, the article suggests this is only a small part of the problem, citing data from the World Trade Organization which shows that just over 1 percent of global imports are covered by restrictive measures:

Figure 8. Trade covered by new import restrictive measures

Source: WTO.

While Chapter 4 of the new Global Trade Alert report argues that the WTO count of new restrictive measures is too low, it is hard to believe that the “murky” protection measures captured by the GTA would change the order of magnitude of trade affected.

What are other explanations for slower trade growth?

Paul Krugman argued on his New York Times blog last year that the rapid growth of trade in the post-World War II era was due to sharply declining costs of trade. In his story, both sources of declining trade costs—post-war trade policy liberalization and the spread of shipping container technology—have largely run their course and a slowdown in trade growth is not surprising.

In an intriguing new analysis, Cristina Constantinescu and Michele Ruta, and Aaditya Mattoo, economists at the IMF and World Bank, respectively, argue that changes in supply chain trade in China and the United States are the key factors explaining the slowdown in trade growth. Notably, as China’s industrial sector matured, the share of imported inputs in China’s total exports was nearly halved from its peak of 60 percent in the mid-1990s. And in the United States, the authors conclude that the pace of offshoring and supply chain fragmentation by US companies seems to be declining.

Should developing countries be concerned?

Even if the pace of supply chain fragmentation is slowing, we are unlikely to see it reverse. So, if the slowdown in China’s trade is paired with economic reforms that shift the focus in China to domestic consumption and public goods, such as clean air, and improved health and other services, new trade opportunities could open up for other developing countries. But the growth in discriminatory trade measures documented in the Global Trade Alert is worrying. Even if the trade impact is not yet large, it comes in addition to the proliferation of regional trade arrangements that contribute to erosion in the international rules-based trade system.

So, having read the latest GTA report, I’m even more grateful that US and Indian negotiators were able to work out a compromise on food security that will let the WTO get back to work. It should never have gotten to this point, and the road ahead is by no means smooth, but willingness to reach a deal at least indicates that these two major players still do value the multilateral system. 

Authors: Kimberly Ann Elliott View Profile

Development blog: Giddy Optimism on 2015

Three big conferences next year could affect the next two decades of global development.  The first will bring world leaders to Addis Ababa in July for the Third International Conference on Financing for Development.  Next up, presidents and other assorted potentates will gather in New York at the United Nations to agree on Sustainable Development Goals for 2015–2030.  Finally, the UN Framework Convention on Climate Change will meet in Paris in December to negotiate what will follow the Kyoto treaty.  I’m increasingly optimistic about two out of three of these events, to the extent that the rather grim prospects for the third are beginning to appear a little less apocalyptic.

Going in reverse chronological order, I share the excitement over the recent US-China climate deal and what it might mean for the UNFCCC in Paris.  In my Business Week blog this week I suggest the deal gives hope that the conference could line up ambitious national targets into a global target on the year that greenhouse gas emissions will start to decline (Nigel Purvis believes it could be 2025).

When it comes to the post-2015 development agenda, I still hope the secretary-general pulls a rabbit out of the hat with his upcoming report and that it provides a compelling narrative of what the Sustainable Development Goals are meant to be for.  If he manages that, and it provokes member countries to edit and sharpen goals, there’s still the chance that the New York meetings could celebrate a powerful and useful outcome document.  But at this point, I’m not terribly optimistic.  According to this report, the UN permanent representatives from Ireland and Kenya, who are the co-facilitators of the plenary on the organization and modalities of intergovernmental negotiations and remaining issues related to the summit for the adoption of the post-2015 development agenda (a job title that is 55 characters too long to tweet) suggest that, from governments’ point of view, “the targets—but not goals—proposed by [the Open Working Group] may require ‘tweaking’” before they are adopted.  It would be nice to think that the goals are to be excluded from the tweaking because they need more than tweaking, which is itself diplomat-speak for “hacking mercilessly.” But I’m not sure that’s what they meant.

That leaves Addis.  Perhaps it will prove fortuitous that it comes before New York and won’t be infected by a sense of disappointment if the SDGs remain a bit of a mess.  There are a lot of ideas on the table at the moment, including better aid targeting; building up nonconcessional financial flows and guarantees to invest in infrastructure; using the momentum out of the G-20 on issues like tax, transparency, and illicit financial flows; getting rid of harmful subsidies and redeploying the money to more development-friendly uses; perhaps even dealing with bits of the international elements of a range of nonfinancial issues from technology though trade and the environment.  If just some of these ideas come to fruition, the Addis event will be well worth the cost of the business class airfares and conference canapés.

Overall, the US-China climate agreement and the news that the United States and India appear to have reached a compromise on customs streamlining and agricultural subsidies, meaning a WTO deal might be in the cards, suggest the environment for global deal-making going into 2015 is markedly improved.  The US administration deserves credit for its considerable part in taking poison out of the well.  Next year is a big opportunity to improve long-term global development prospects. It is nice to think world leaders might actually grasp it—or, at least, most of it.

Authors: Charles Kenny View Profile
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