Financing Development in Africa

A comprehensive study on this topic was commissioned by the Danish Ministry of Foreign Affairs from DIIS at the beginning of 2007. The motivation behind the redegørelse was the emergence of a series of new or renewed sources of finance for development in Sub-Saharan Africa, against the background of a probable secular decline in DAC-coordinated ODA. This led to the question being framed of the extent to which these different new sources of finance might replace DAC-coordinated ODA in the medium-long term. The new or renewed sources of finance considered relevant included FDI and other private capital flows; remittances; ODA from non-DAC donors such as India and China; private philanthropic funds; as well as new financing vehicles to which DAC donors are one contributor amongst others, aimed at the financing of social services provision or infrastructure. In the light of the conclusions of the main phase of the study, the activity was extended in 2010 to include an international conference and final report on ‘Impacts, Responses to and Initial Lessons of the Financial Crisis in LICs’, held at DIIS in October 2010.

The outputs of the main phase of the study mainly takes the form of papers aimed at scoping each of the new or renewed financing mechanisms in terms of their magnitude and level of growth over time, their principal targets by country and sector, their political economy, their relationship (where relevant) with DAC-coordinated ODA, and their impacts and potential impacts. In addition, one papers was commissioned to reflect on the interactions between each of these financing mechanisms (including DAC-coordinated ODA) at country level, using the example of Mozambique; and one paper was commissioned to consider African governments’ policy options in relation to FDI directed at natural resource extraction – which accounts for easily the greatest part of the increment in FDI to Africa since 1990.

The main conclusions of this main phase are as follows. Firstly, there have indeed been a number of important changes in the development finance landscape. The most important of these are the growth in all kinds of private capital flow, the return of non-DAC donors, and the emergence of new structured products in the areas of infrastructure and social services. In many cases, these flows improve the overall incentive compatibility between financing instruments and development challenges. On the other hand their reliability over time remains to be established and their contribution in many Sub-Sahara African countries and to some sectors such as agriculture remain negligible. Furthermore they add to the complexity and costs of managing external financing, especially for the poorest countries.

This, taken together with the relatively modest magnitude of at least some of the flows involved means that their net contribution to resolving development finance problems is modest. They do not represent comprehensive solutions to the most familiar problems pointed out in regard to DAC-coordinated ODA and thus cannot be seen as substitutes for it. Where used selectively they may complement DAC-coordinated ODA, but the extent to which occurs in practice depends upon the development commitment and administrative and governance capacities of Sub-Sahara African governments. Where the latter are weak or absent then classic Dutch Disease and institutional distortion effects are likely.

By 2009 there were signs that, in the context of the financial crisis, many of the new types of flow discussed are slowing down or drying up. Although this coincided in the medium term with a further contraction and/or increased diversion of official aid budgets, a central short term impact was be to underline the centrality of DAC-coordinated ODA - especially for poorer countries lacking major natural resource endowments. A possible silver lining envisaged at the time was that, if the financial crisis can catalyze DAC donors to reduce aid fragmentation and overlaps in aid delivery, the productivity of some alternative financing mechanisms might also improve and with it the overall incentive compatibility between instruments and challenges. Understanding these compatibilities and designing appropriate products therefore remained an important goal.

In October 2010 an international conference on ‘The Financial Crisis and Low Income Countries’ was held at DIIS to conclude the programme. Over 20 papers were presented. A synthesis of these contributions written by Sam Jones, and a selection of the papers themselves, are published as DIIS Working Papers and can be downloaded from this homepage. The papers identified a surprising variety of impacts and responses in Africa, made more complex by the coincidence of the global financial prices with radical increases in commodity prices. A number of African governments pursued rather pro-active macroeconomic as well as fiscal policies in the wake of these developments. Besides reconsidering the content of the public policy toolbox in the light of the outcomes of these interventions, other policy lessons drawn by a number of contributors was the need to re-examine orthodox approaches to financial liberalization and particularly governance of capital flows. This project has now ended.

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