New OECD aid rules could trigger a shift away from grant giving

In a recent op-ed, Katrine Heggedal and Carsten Staur extol new rules agreed by the OECD’s Development Assistance Committee (DAC) to score private sector instruments (PSIs - loans, investments and guarantees extended at or near market terms) as Official Development Assistance (ODA). They claim the changes will encourage more and better development finance from the private sector and bring increased transparency and accountability to aid statistics.

I disagree. I see no reason to believe that these new rules will incentivise private sector involvement in development, especially in the poorest countries. On the contrary, the new rules actually undermine the integrity and robustness of ODA statistics. This agreement is, over time, likely to reduce funding to the vitally important social sectors in developing countries – including health and education, as well as adaptation projects to combat climate change – that rely on grants.

If the DAC were serious about encouraging private sector development, its members would instead focus on those areas where genuine aid would help, such as offering grants for training, advising on improvements to the legal and regulatory frameworks in developing countries, assisting governments to combat corruption, and financing enabling infrastructure. Incentivising essentially cost-free PSI is only likely to reduce these useful types of assistance.

Simon Scott responded to Heggedal and Staur, pointing out that the DAC’s decision to score ODA for PSI abandons the core principle of concessionality so that donors can now score ODA while making considerable profits. Indeed, the new rules abolish the basic concept of ODA as a net transfer of resources to developing countries. But there are several other good reasons to question this latest DAC agreement:

Firstly, Heggedal and Staur fail to explain, either in their first op-ed or in their reply to Scott how donors’ scoring ODA for PSI will incentivise more investment from the private sector. After all, these instruments already exist. To take just one example, donor governments have for decades been using guarantees to support developing countries’ purchases of goods and services through numerous agencies, most notably their export credit agencies. However, such support has never counted as ODA, since WTO rules forbid governments from subsidising it, lest such subsidies spoil markets and distort international trade.

The DAC has tried to claim that the guarantees on which it will score ODA are somehow different from export credit guarantees, because the credits’ primary purpose will be development. Yet political pressures will force donors to support their own firms, and the trade-distortion risks of providing what is in effect tied aid will be the same whatever the ostensible primary motivation. Accordingly, international subsidy rules will still apply, so DAC members will be swearing to the WTO that their guarantees have no gift element, while claiming in their ODA figures that they do have a “grant equivalent”.

And while ODA scoring might perhaps embolden donors’ development finance institutions to extend more private sector loans and investments at or close to market terms, it’s not at all clear that private firms would “rise to the challenge,” as Heggedal and Staur claim, unless they were offered a real subsidy. Moreover, even if the use of PSIs did increase, this would be unlikely to benefit the countries in most need of help. The DAC’s own statistics show that in recent years, just 4 per cent of aid through PSIs supported investments in least-developed countries.

Heggedal’s and Staur’s claims about bringing greater transparency and accountability to ODA statistics are also unfounded. In fact, the myriad ways of over-counting ODA for all transactions except pure grants will make it impossible to compare real aid efforts by donor, instrument, sector, or policy objective. The DAC even allows donors to choose among different options for reporting ODA on certain PSI instruments, with these options yielding very different results for identical investments with identical returns. It is astonishing to me that the OECD is willing to publish as “statistics” numbers so lacking in rigour and credibility.

I believe what we are really seeing here is just the latest chapter in efforts driven largely by donor finance ministries to score ODA without budgetary outlays. These efforts make a mockery of the public’s understanding of “aid” – i.e. of money being given, on their behalf, to help developing countries.

This has serious practical consequences. As I have earlier argued, allowing donors to score ODA for extending profitable loans and investments means that “real” aid will decline. Creating accounting incentives to provide loans, investments and guarantees disincentivises the provision of grants. Why should a donor spend real money to reach its ODA target, when it can do so using profitable instruments?

The United Kingdom is a case in point. Its current ODA target of 0.5% of GNI may be a legal floor, but it’s also a political ceiling. Enabling the UK to reach its target through profitable PSIs will certainly result in fewer grants.

The gradual movement away from grants – already observable, but sure to be accelerated by this new agreement – will especially impact those sectors where investments do not yield financial revenues, such as health and education. These sectors are vital for the long-term economic and social development of poorer countries: they rely necessarily on grants, and they will suffer from the switch to PSI support. In short, fewer grants and more PSIs in middle-income countries will hurt those that the DAC says it most wants to help.

Moreover, Heggedal’s and Staur’s call for more private sector investments for adaptation measures to combat the effects of climate change are highly problematic. Such projects typically do not generate any revenues that can be used to service loans or investment. Pushing loans instead of grants for climate adaptation will just saddle developing countries with additional debt, leaving them to pay the costs of a climate change that they have not created while donors claim credit for aid they have not given. This is the antithesis of climate justice and the polluter pays principle.

Every time the DAC agrees on a new reform that over-counts ODA, we hear placatory noises about a future “review.” Sure enough, Heggedal and Staur assure us that the DAC is committed “to review these rules in a few years’ time [in reality not until 2030!] to assess whether they work in practice or need adjustment.”

But what will “work in practice” mean? It certainly won’t mean ensuring that the statistics have integrity or robustness, as these are being forfeited now, and deliberately. Moreover, the review will not be by independent statistical experts, free from government influence, but once again by the DAC itself, marking their own homework.

This farce has gone on long enough. It is past time that ODA rules were placed under a robust body of statisticians with the requisite independence from political pressure to restore credibility to the accounting of development assistance and abolish the artificial incentives that damage the cause of development.

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Stephen Cutts was Deputy Head of Export Credits at the OECD, before becoming Chef de Cabinet and Deputy Executive Director there. He has also served as Assistant Secretary-General of the United Nations. Cutts founded the website ODAReform.org.