In my view: Development depends on realising the potential of taxation

Nigeria govtToday’s post from Ngozi Okonjo-Iweala, Co-ordinating Minister for the Economy and Minister of Finance, Nigeria, concludes a series of ‘In my view’ pieces written by prominent authors on issues covered in the Development Co-operation Report 2014: Mobilising resources for sustainable development. The Report is being launched today in London with the Overseas Development Institution, and you can watch the event by registering here.

Developing country governments would do well to strengthen their tax systems so they can mobilise the domestic resources they need to finance their own development. This is particularly true for African countries, where the recent trend of decreasing ODA shows no sign of reversing.

In developing countries in general, revenue administration is often hampered by weak organisational structures, low capacity of tax officials and a lack of modern, computerised, risk-management techniques. The value-added tax “gap” alone is estimated at around 50-60% in developing countries, compared with only 13% in developed countries. The International Monetary Fund (IMF) estimates that for many low-income countries, an increase in tax revenues of about 4% of GDP is attainable.

Since the 1990s, many African countries have made progress in improving their domestic tax capacities and receipts. Despite these improvements, however, there are still many revenue leaks that need to be plugged.

In Nigeria, we are making concerted efforts. Following the recent revision of our GDP to USD 510 billion, our tax-to-GDP ratio declined from 20% to about 12%, several points below the 15% tax-to-GDP threshold recommended by the IMF for satisfactory tax performance. Yet with our increasingly diversified economy, there is room to greatly improve our tax administration capacity and increase our tax revenues.

A recent diagnostic exercise to examine the bottlenecks in our tax collection processes revealed some interesting findings. For example, about 75% of our “registered” firms were not in the tax system! Moreover, about 65% of Nigeria’s registered taxpayers had not filed their tax returns over the past two years. With the support of external consultants, we are introducing remedial measures to improve tax performance and estimate that we can raise an additional USD 500 million in non-oil tax revenues in 2014.

The international community has an important role to play in supporting such efforts by developing countries, and evidence shows that this can yield impressive returns (see also Chapter 14). The OECD has found that every USD 1 of official development assistance (ODA) spent on building tax administrative capacity can generate as much as USD 1 650 in incremental tax revenues (Chapter 14). Yet to date, only limited funds have been targeted at improving tax institutions and tax policies.

To support the broader goal of mobilizing financing for the post-2015 development agenda, ODA can also be used in many other creative ways, for instance to leverage private financial resources (Chapter 11).

In my view, realising the full potential of domestic resource mobilisation in developing countries – and in Africa in particular – is central to discussions on financing the post-2015 development agenda. It will be particularly important to deploy a greater proportion of ODA in low-income countries to support their tax administration efforts. Realising this potential will require strong commitment and leadership from developing country policy makers, as well as the support of the international community.

Useful links

Find out more about the Development Co-operation Report 2014: Mobilising resources for sustainable development here and follow #DCR2014 for live coverage of the launch events on Twitter.

In my view: Any developing country can undergo dynamic structural transformation, starting now

Peking UniversityToday’s post from Justin Yifu Lin, Honorary Dean at the National School of Development (NSD), Peking University, and former Chief Economist of The World Bank, is one in a series of ‘In my view’ pieces written by prominent authors on issues covered in the Development Co-operation Report 2014: Mobilising resources for sustainable development.

Any developing country – even those with poor infrastructure and a weak business environment – can start on a path to dynamic structural transformation and growth today. How? By facilitating technological innovation and development in industries where it has a comparative advantage.

Take China. At the time of its transition to a market economy in 1979, the business environment was poor, infrastructure was very bad and China lacked the capacity to take advantage of its cheap labour market to produce goods for export. To overcome these obstacles, the Chinese government – at all levels and in all regions – encouraged foreign investment in special economic zones and industrial parks. This enabled China to rapidly develop labour-intensive light manufacturing and become the world’s factory.

The same approach can work in other developing countries. For instance, in August 2011 the late Ethiopian Prime Minister Meles Zenawi visited China. Aware of Ethiopia’s labour cost advantages and China’s plans to relocate its shoe industry because of rising wages, he invited Chinese shoe manufacturers to invest in Ethiopia. Managers of Huajian, a designer shoe manufacturer, visited Addis Ababa in October 2011 and – convinced of the opportunity – opened a shoe factory near Addis in January 2012, employing 550 Ethiopians. Huajian more than doubled Ethiopia’s shoe exports by the end of 2012 and by December 2013, the workforce had expanded to 3 500 (by 2016 it is expected to reach 30 000).

Before this, like almost all other African countries, Ethiopia had found it difficult to attract export-oriented foreign direct investment in light manufacturing. The immediate success of the Huajian shoe factory transformed foreign investors’ impression of Ethiopia, helping them to see it as a potential manufacturing base for exports to global markets. Over just three months in 2013, 22 factory compounds in the new industrial park of Bole Lamin were leased to export-oriented factories.

As long as it is carefully embedded within the broader economy so as to avoid creating isolated ‘enclaves’ of productivity and growth, this type of investment can help to fuel modern economic growth, funding improvements in infrastructure and institutions as well as structural changes in technology and industries to reduce costs of production and increase output values. In any country, these enhancements in labour productivity can fuel a continuing increase in per capita income.

In my view, development finance can have the largest possible impact on accelerating a developing country’s structural transformation, job generation and poverty reduction when the country uses these flows to remove infrastructure bottlenecks and develop industries that draw on the country’s comparative advantages. This pragmatic approach will allow these countries to capture China’s relocation of 85 million labour-intensive manufacturing jobs, allowing them too to grow as dynamically as the East Asian economies.

Useful links

Getting Globalization Right: China Marches to its Own Beat by Dani Rodrik, Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University, on OECD Insights.

In my view: The OECD must take charge of promoting long-term investment in developing country infrastructure

LogoReDefine3Today’s post from Sony Kapoor, Managing Director, Re-Define International Think Tank, is one in a series of ‘In my view’ pieces written by prominent authors on issues covered in the Development Co-operation Report 2014: Mobilising resources for sustainable development.

The world of investment faces two major problems.

Problem one is the scarcity – in large swathes of the developing world – of capital in general, and of money for infrastructure investments in particular. Poor infrastructure holds back development, reduces growth potential and imposes additional costs, in particular for the poor who lack access to energy, water, sanitation and transport.

Problem two is the sclerotic, even negative rate of return on listed bonds and equities in many OECD economies. The concentration of the portfolios of many long-term investors in such listed securities also exposes them to high levels of systemic – often hidden – risk.

Most long-term investors would readily buy up chunks of portfolios of infrastructure assets in non-OECD countries to benefit from the significantly higher rate of return over the long term, and to diversify their investments. At the same time, developing economies, where neither governments nor private domestic markets have the capacity and depth to fill the long-term funding gap, are hungry for such capital.

So what’s stopping these investments?

Financial risks in developing countries are well known and often assumed to be much higher than in OECD economies. Also, investing in infrastructure means that investors will find it hard to pull their money out on short notice, and therefore such investments pose liquidity risks.

Despite these easy answers, however, there are three significant caveats:

First, the events of the past few years have demonstrated that on average, political risk and policy uncertainty in developing countries as a whole have fallen, especially in the emerging economies.

Second, OECD economies are also exposed to serious risk factors, such as high levels of indebtedness and demographic decline. As the financial crisis demonstrated, they are also likely to face other “hidden” systemic risks not captured by commonly used risk models and measures.

Third, the kind of risks that dominate in developing countries, such as liquidity risks, may not be real risks for long-term investors (e.g. insurers or sovereign wealth funds). Given that the present portfolios of these investors are dominated by OECD-country investments, any new investments in the developing world may look more attractive and may actually offer a reduction of risk at the portfolio level.

So I ask again: Why aren’t long-term investors investing in developing country infrastructure in a big way?

The biggest constraint is the absence of well-diversified portfolios of infrastructure projects and the fact that no single investor has the financial or operational capacity to develop these. Direct infrastructure investment, particularly in developing countries, is a resource-intensive process.

The G20, together with the OECD and other multilateral institutions such as the World Bank, can facilitate the development of a diversified project pipeline on the one hand, together with mechanisms to ease the participation of long-term investors on the other. This work will involve challenges of co-ordination, more than commitments of scarce public funds.

In my view, the OECD – which uniquely houses financial, development, infrastructure and environmental expertise under one roof – must take charge.

Useful links

OECD work on institutional investors and long-term investment

OECD work on financial markets

In my view: The Structural Gap approach offers a new model for co-operation with middle-income countries

ECLACToday’s post from Alicia Bárcena, Executive Secretary of the Economic Commission for Latin America and the Caribbean (ECLAC), is one in a series of ‘In my view’ pieces written by prominent authors on issues covered in the Development Co-operation Report 2014: Mobilising resources for sustainable development.

Middle-income countries differ widely in their reliance on official development assistance (ODA). While for some, ODA represents less than 1% of their gross national income, for others it is more than 30%. This divergence reflects countries’ differing capacity to access financial resources and capital markets.

The DAC List of ODA Recipients shows all countries and territories eligible to receive official development assistance. The list includes low and middle-income countries, as well as the least developed countries, defined according to their gross national income (GNI) per capita. As we review the future of ODA, we need to ask: Is per capita income the best criterion for allocating official development assistance? And how can we deal with the heterogeneity of middle-income countries?

The use of income per capita as an allocation criterion relies on two assumptions: that as countries increase their income per capita they will be able to mobilise a larger pool of international and domestic resources to finance their development needs and become less dependent on ODA; and that income levels reflect a given stage of social and economic development.

Evidence shows that a country’s capacity to access external resources depends on many factors besides income per capita. These include conditions outside their control, such as country risk ratings and perceptions, external demand for the products from that country and country size (i.e. population). Similarly, domestic resource mobilisation depends on numerous factors, including levels of savings, development and strength of financial markets, and the capacity and willingness of the government to levy taxes and collect duties (Chapter 7 and 14). Evidence also shows that despite similar income levels, countries may have different development realities. For example, people may vary widely in their access to social protection mechanisms, formal financial institutions and quality education, as well as in their resilience to economic and social shocks.

Far from being a homogeneous category, middle-income countries are a widely heterogeneous social and economic grouping with a large diversity of needs. For example, in 2012 income per capita in these countries ranged from $1006 to $12,275.

As a way forward, ECLAC proposes the Structural Gap approach as an alternative criterion to that of per capita income. This approach is based on the premise that there is no single classification criterion applicable to all countries and underscores the fact that income level cannot be equated with development level. It identifies key areas where there are obstacles to sustained, equitable and inclusive growth in middle-income countries (or “gaps”): equality and livelihoods, investment and savings, productivity and innovation, infrastructure, education, health, taxation, gender and the environment. Countries themselves are responsible for identifying the main gaps that hamper their social and economic development.

In my view, the debate on the future of ODA can benefit from the Structural Gap approach, which offers a basis for inclusive and egalitarian co-operation. It should be part of the post-2015 framework, helping to reorient co-operation away from the “donor-recipient” dichotomy towards a new model of co-operation among equals, following the principle of common-but-differentiated responsibilities.

Useful links

OECD work on external financing for development

Productivity and development: Competitive services can help, but can’t do everything

Cover-PGD_2014To mark the start of OECD Development Week, today we’re publishing an article by Martin Wermelinger of the OECD Development Centre

Strong growth over much of the past decade, particularly in China, has substantially boosted developing countries’ share of the global economy. In 2010, the share of global GDP of non-OECD countries overtook that of OECD countries, when measured in terms of purchasing power parity. But will this process of “shifting wealth” allow these countries to eventually converge with advanced country per capita incomes?

The 2014 edition of OECD Development Centre’s Perspectives on Global Development shows that, at their average growth rates over 2000-12, several middle-income countries will fail to reach the average OECD income level by 2050.Their challenge is deepened by the slowdown in China, where rapid growth has up to now benefited its suppliers, in particular natural-resource exporters. Boosting productivity growth will be the key for middle-income countries to stem this trend and help them sustain the transition towards high income levels.

During the transition away from being a low-income economy, productivity is boosted by shifting labour from lower to higher productivity sectors. This shift can continue to be an important factor even in middle-income countries, for example India and Indonesia. But once this process slows down, the focus needs to turn increasingly to productivity gains within sectors. This shift is evident in overall productivity growth in OECD countries. It is also evident in China, which has raised productivity in many manufacturing industries by tapping global knowledge through foreign direct investment and by importing capital goods and components.

For sustained convergence, productivity growth needs to accelerate. Over the past decade, productivity growth made only a marginal contribution to economic growth in many middle-income countries. The report shows that it was also insufficient to significantly reduce the very large gap in productivity with advanced countries. In Brazil, Mexico and Turkey, the gap even widened. By contrast, China recorded impressive growth in productivity: around 10% annually in labour productivity in manufacturing and services. Nonetheless, China’s labour productivity remains below one tenth of the levels of the United States.

Productivity slowdowns in middle-income countries can be associated with difficulties to move up the value chain, away from a low labour cost-driven to an innovation-driven growth path. The report argues that countries need to make greater efforts to diversify their economic structure towards higher value activities. To do this they have to increase the levels of educational attainment and skills of their labour force and improve their capability to innovate – to produce goods and services that are new to the economy. They can do the latter by importing new ways of producing and distributing goods and services, as well as by developing their own which can better suit their specific conditions or give them a competitive edge in the international market. There are also opportunities to boost growth and productivity in the economy by advancing better regulation and competition policies, improving capital and labour markets, and facilitating a more effective integration into global value chains.

The report devotes special attention to the services sector that has great potential to boost overall productivity and so support middle-income countries to converge to advanced-country income levels. First, rapid progress in ICT has allowed economies of scale in the production of most services and spillover effects to be realised. For example, countries where manufacturing sectors use outsourced business services are shown to be more productive. Second, the ICT revolution means that services can now be traded across borders, with India being the classic success example of this. And finally, as poor workers swell the ranks of a growing middle-class society, consumption of and demand for variety in products and particularly services will increase. Thus, identifying the emerging demands of domestic consumers and producing the goods and services to meet those new demands can boost growth in middle-income countries.

In fact, services contributed more than half of overall growth over much of the last decade in the BRIICS. Nonetheless, bypassing industrialisation and focusing directly on boosting services is not – or not yet – a proven success strategy for upgrading to middle-income, let alone to high-income, status. Even small, rich service economies like Singapore first industrialised comprehensively.

Although not exclusively, services can also help create jobs and – with their relatively low resource intensity – drive inclusive, sustainable development. Ultimately, however, the most effective combination of policies to reach the target of convergence through inclusive and sustainable growth will depend on the specifics of each country and, importantly, the capability of its governments not only to develop but also to implement their strategies. Governments need to obtain support for necessary reforms through consultation processes where key stakeholders – including private businesses, local communities and civil society – can voice their opinion and help formulate and implement strategies.

Useful links

Global Forum on Development

International Economic Forum on Latin American and the Caribbean

Aid only for the neediest? Official development assistance after 2015

Click to read the book
Click to read the book

Today’s post is from Jon Lomøy, Director of the OECD Development Co-operation Directorate (DCD-DAC)

According to the most recent OECD aid statistics, in 2013 official development assistance (ODA) reached a record high of USD 134.8 billion, representing a rise of 6.1% compared to 2012. While this is good news, more detailed analysis shows worrying trends. The growth was largely (about 33%) in non-grant ODA – mostly loans – which tends to go to middle-income countries. On the other hand, grants, which typically flow to less developed countries, lagged behind, increasing by only 3.5% (excluding debt forgiveness). What’s more, bilateral aid to sub-Saharan Africa fell by 4% in real terms. So while ODA is on the rise in overall terms, the countries with the greatest need are being left behind.

It is important to put these figures in context when we consider the future of ODA. Traditionally seen as the mainstay of development, in recent times ODA’s volumes and growth rates have been outstripped by foreign direct investment, market-based instruments such as non-concessional loans, and remittances. In addition, many developing countries now have solid domestic resource mobilisation capabilities that are helping them to finance their own development.

Nonetheless, a recent OECD study of external financing options available to developing countries shows that ODA is still a vital resource for the least developed countries, where it represents 75% of financial flows from external sources and the equivalent of 59% of domestic tax revenues. In the upper middle income countries, on the other hand, it accounts for only 6% of external financial flows and is the equivalent of just 0.8% of domestic tax revenues.

Another study takes a look at economic growth forecasts to 2030, estimating which developing countries will no longer qualify for ODA because their average per capita income, measured as average share of Gross National Income (GNI), is too high. At present, the threshold is just over USD 12,000. The projections show that 28 of the 148 countries currently on the OECD Development Assistance Committee’s (DAC) List of ODA Recipients could move above the threshold – but that still leaves many others for whom ODA will continue to be critical.

Does this mean that post-2015, ODA should be targeted only to the least developed countries? While in many ways this is – and should be – the future of ODA, the issue is not so simple.

It is, of course, important to continue to provide support to the neediest countries to ensure that they are not left behind. The OECD Development Assistance Committee is considering building on the current United Nations target, which calls on providers of development assistance to give 0.15-0.2% of their country’s gross national income (GNI) to the least developed countries, to create an even more ambitious target.

Yet it is not only a question of where we use development co-operation, but how.

Providers of development co-operation can help upper-middle income countries overcome stubborn development challenges, for instance, by sharing knowledge and providing technical assistance. Colombia used official development assistance to the tune of just USD 15,000 (two technical missions to Colombia in 2012) to fund a capacity development programme for tax administrators. Tax revenues collected by local authorities jumped from USD 3.3million to USD 5.83million in just one year.

We also need to get smarter about using ODA to leverage private flows for development. Mechanisms like government guarantees can take some of the risk out of investment, encouraging private investors to become active in places they would not usually go. This can help to bridge large funding gaps and bring down some countries’ dependency on ODA. At the same time, it can be particularly useful in many of the least developed countries and fragile states, where large amounts of money are essential to put in place the infrastructure they need to power economic growth, create jobs and reduce poverty.

Finally, the targets that will replace the Millennium Development Goals (MDGs) in 2015 will encompass environmental, economic and social sustainability challenges for all countries that are much broader than today’s MDGs. Funding these new goals will require inputs from across the board – from public and private sources and from all communities and countries. Development co-operation will have a major role to play in helping to bridge the development–environment divide.

Making ODA fit-for-purpose in the post-2015 world is a major challenge – and a major focus of the OECD in 2014. If we make it work, all countries will benefit.

You can read more about this work programme here.

Useful links

Can we randomize development evaluation?

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Click to see the book

Jon Lomoy, Director of the OECD Development Co-operation Directorate (DCD-DAC) presents the first of two contributions to the debate on the use of randomised control trials in development economics. Diana Coyle will reply.

In her post Is economics leaving Wonderland?, Diane Coyle justly notes that development economics is ahead of the curve when it comes to “shedding the belief, at least on the part of many economists, that a single conceptual approach will deliver a ‘silver bullet’ solution or method that can be applied everywhere.”

Yet I still think we need to ask whether academic innovations in the multidisciplinary approach to economics, particularly development economics, have had an on-the-ground impact on the practice of development co-operation.

There has been a lot of discussion in academic circles, for example, about the use of randomised control trials to improve the outcome of development co-operation. While I welcome the emphasis this implies on results – and this is why evaluation has such a valuable role to play in development – like many, I wonder about the approach.

Randomised control trials in medicine make sense to me. To find out if a medication works well, you give it to one group of patients and a placebo to another. Then you see if the group taking the medication improves significantly over the group taking the placebo. Simple.

But can we take it from there to assume, as does the OECD colleague Diana Coyle quotes, that in a few years’ time randomised control trials will “turn out to have transformed the field” of development economics? Naturally, we want development that works – we want to see obvious, visible progress in poverty reduction and development. We want to validate the investment of time, money, and mental and physical energy. And where success is elusive, we want to understand quickly why we failed and learn how to do things better.

Yet the narrow, medical approach of randomised trials can, I believe, tell us very little when we need to provide information that is useful to decision makers. When it comes to understanding whether higher-level policies and programmes are working, or whether micro-successes are adding up to real progress, we need a different kind of evaluation. For example,  randomised control trials can tell us whether or not an individual project for reintegrating ex-combatants worked well, but will give us little insight into the overall politics and dynamics of peacebuilding – and into how international partners can best help in settings of violent conflict. Will they help donors decide whether they can best support education by channelling money through national budgets or by financing local NGOs? Furthermore, given what we know about the diversity of development contexts, problems like this are multiplied when we try replicate positive experiences in different countries.

Evaluating development impact is not simple. The simple approach of randomised control trials can help to treat specific symptoms, but may leave larger questions of how to end “the ailment” unanswered.

Dr Coyle does well to point out “the crucial importance of the specific context.” I have seen providers of development assistance struggle to understand how their support makes a difference. How do they use findings from treating mosquito nets with insecticide to lower the rate of malaria worldwide, or from using mobile phones to improve the livelihoods of rural farmers to generate knowledge that will make development co-operation more effective at the global policy level?  It’s not easy – especially when thinking about ‘global public goods’ like the environment, education, gender equality, or fair trade. With so many factors to consider, a host of different evaluation methods are needed to tackle them.

So while I very much endorse Dr Coyle’s hope that development economics has left Wonderland, I also hope that academic theory is heading for the real world – aiming to turn its incredible range of knowledge into practical insights and tools that can be used to treat the ailment rather than the just the symptoms.

There is, indeed, no “silver bullet” to cure a global problem like poverty. It is great that we recognise this – as long as it doesn’t discourage us in our quest to end poverty. And it is great that we celebrate leaving Wonderland – as long as we realize that understanding all the pieces of the puzzle, and how they fit together to guide effective action, requires a much broader approach to evaluation.

Useful links

OECD work on evaluation of development programmes