Despite all the statements and rhetoric to the contrary, there is little doubt that foreign aid from rich countries will contract as a consequence of the global financial crisis. OECD countries, pressed domestically to tackle stagnation, rising unemployment and the collapse of the financial sector, see little alternative to backtracking on their previous commitments to rapidly increase aid flows to poor countries. Already, the sum of national fiscal stimulus packages, estimated at US$ 2.74 trillion by the International Labour Organisation, is ten times bigger than what OECD member states have committed to in terms of foreign aid, and a hundred times bigger than the aid they provided to Sub-Saharan Africa in 2007 (see this APP newsletter).
For poor countries who depend on aid flows to provide basic services, the crisis is a triple whammy. Not only they do not have the policy space to put in place counter-cyclical measures such as the fiscal stimulus packages being adopted by rich countries, but they are also being affected by reductions in international trade, foreign direct investment and remittances (take a look at Ngaire Woods’ recent BBC programme). In such an environment, the pro-cyclical nature of aid flows can only make matters worse, further squeezing budgets and potentially reversing recent gains in economic growth and poverty reduction.
Averting such further impact of the global crisis calls for urgent and innovative solutions to both the quantity and quality of foreign aid. With rich country budgets under huge stress, maintaining, increasing or improving aid flows can only be achieved from two sources: international institutions or innovative financing mechanisms. As already argued by Nancy Birdsall, both the International Monetary Fund and the World Bank could make additional resources available to help poor countries weather the global storm, though this goes hand in hand with the need to reform these institutions’ governance model, to ensure that additional resources really respond to poor countries’ needs and priorities.
More interestingly, Dani Rodrik has urged developing countries to
“push for a Tobin tax – a tax on global foreign currency transactions. Set at a small enough level – say 0.25% – such a tax would have little adverse effect on the global economy while raising considerable amount of revenue. At worst the efficiency costs would be minor; at best the tax would discourage excessive short-term speculation. The revenues collected – which would easily amount to hundreds of billions of US dollars annually – could be spent on global public goods such as development assistance, vaccines for tropical diseases, and the greening of technologies in use in the developing world”.
The Tobin tax is not a new proposal as an innovative financing mechanism for development assistance, but the crisis could be used to push for a concerted initiative in this direction, mustering the necessary political support among developed and developing nations alike. There are a number of reasons for reviving and strengthening a Tobin tax proposal. Firstly, the tax could be used to correct some of the extreme gambling and risk-taking in financial markets that has been at the source of the current crisis. While the original Tobin tax proposal focused on currency transactions, other financial instruments such as derivatives could be brought into the tax net.
Secondly, a source of financing like the Tobin tax, that is decoupled from rich countries’ budget and political cycles, would not only ensure a steady flow of revenues to finance development projects and programmes, but could help address a number of issues related to aid quality. For example, it would make it easier to allocate resources according to clear criteria based on need, rather than political or geo-strategic priorities. It would also allow for greater predictability of resource flows, a constant ask put forward by aid recipient countries, and could be deployed counter-cyclically. It could also address some of the underlying perverse incentives that have undermined the implementation of the aid effectiveness principles contained in the Paris Declaration, and promote more ownership and alignment of development efforts.
Both of these proposals to increase aid in times of crisis, based either on existing international institutions or on innovative financing mechanisms such as the Tobin tax, require important institutional reforms aimed at addressing the shortcomings of the existing aid system. While political appetite for such reforms may not be high at the moment, extraordinary times require extraordinary solutions. The G20 and other development actors need to step up to the plate.
