Aid for the private sector: continued controversy on ODA rules

17 October 2018
Comment
As the need for concrete in Ethiopia's construction industry grows, so too has the National Cement Share Company. Its new plant in the east of the country will increase its production by six times. Photo:Gavin Houtheusen/DFID CC BY 2.0

‘Aid’ is the amount of anti-poverty money rich countries give to poor countries, right?

As last week’s furore over the UK government’s proposed change to the definition of aid shows, the reality is more complex than this. Many people (including myself) have criticised the suggestion by international development secretary Penny Mordaunt to count profits made through DfID’s private sector investment outfit, the CDC, as aid.

So what is aid, and why was the UK proposal so controversial?

What is official development assistance (ODA)?

The standard definition of aid is ‘official development assistance’ or ODA, agreed at the Organisation for Economic Co-operation and Development (OECD) in 1969. In 1970, rich countries gave this added importance when they agreed to devote 0.7% of their gross national income as ODA, a target which has stood ever since.

The acronym expresses the basic concept well: ODA is a measure of the transfer of official resources – public funds from rich country governments – devoted to development assistance – given to support the economic development and welfare of developing countries. This basic concept has stood the test of time, but there have been continual arguments about the specifics.

The most controversial current issue is how to count ODA that is used to support private sector investments in developing countries.

Aid for the private sector: a short history

In 2016, the OECD Development Assistance Committee (DAC) – the guardian of the ODA definition – agreed to introduce a new category of ODA known as ‘private sector instruments’ (PSI). The idea was to capture the value of official support to private sector companies acting in developing countries, both domestic and foreign.

In practice this largely meant finding a way to measure the ODA value of the loans, guarantees and equity investments channelled through development finance institutions (DFIs) based in donor countries. The challenge is how to measure the ‘official’ part of the support given to the private sector when that support looks very similar to commercial operations: loans must be repaid with interest, and hence they can make money for the DFI.

A fudged definition with no resolution in sight

One obvious solution would be to adapt the rules that cover ODA for public loans to developing countries governments, agreed in 2014. These rules set a formula that estimates the ‘grant element’ of the loan – the difference between the ODA-supported loan and what the cost of the same loan would have been if raised privately.

Though a repaid loan will mean that donors make money overall, the grant element effectively puts a cost on additional financial risks that the donor is assuming beyond those that a private actor would assume. This should be thought of as a subsidy, under the World Trade Organization definition of the word – it also measures a benefit to the private company, which is getting a cheap loan.

In 2016, export credit agencies realised that, under initial proposals from the OECD, the support they give to developed country exporters could count as ODA. This would mean they could be accused of offering a subsidy, which they are not allowed to do.

Lengthy discussions followed, but the OECD DAC was unable to come up with a detailed solution so agreed in 2017 on a fudge: donors could count private sector support as ODA, and the detail of what would and would not be allowed could be sorted out afterwards.

Almost a year later, however, very little progress has been made, with the definition still a matter of dispute among donors. The length of time taken is a good indicator of how controversial the topic has become.

An alternative proposal: measuring ‘financial additionality’

One proposed alternative to measuring the ‘grant element’ is to measure the ‘financial additionality’ of the support. This means measuring the extent to which DFIs offer loans and other products that would not be offered by the private sector.

But as a recent paper by the Center for Global Development points out, putting a numerical figure on this may be impossible. And it raises the prospect of entirely commercial operations being counted as ODA, stepping away from the fundamental premise that ODA measures a public input (and, in the jargon, is a ‘concessional’ resource).

UK pushes ‘institutional approach’ – then changes tack

A different approach, pushed heavily by the UK, was to ignore these intricacies and instead just count only the base capital that governments give to their DFIs. This ‘institutional approach’ has the benefit of simplicity, as governments top up DFI capital infrequently.

However, it raises concerns about the ‘development assistance’ part of ODA – as it relies on implicit assumptions about the development impact of the DFI operations, which may or may not prove to be justified.

Having pushed hard – against the objection of many other donors – for this approach to be accepted in 2017, and used it to recapitalise the CDC to the tune of £3.5 billion over five years, it now seems that the UK has realised that this precludes counting any subsequent CDC operations as ODA. By suggesting that future CDC profits should be counted as ODA the UK is trying to reopen a door it itself closed. 

In fact, the 2016 OECD DAC agreement was very clear that profits or dividends paid back to donor governments from private sector instruments should count as negative ODA – to reflect the fact that they represent a benefit to the donor, not the recipient.

The ODA rules controversy threatens to overshadow more critical issues

The focus on what counts as ‘official’ support obscures even larger issues. How should we measure the development benefit of these operations? How can we avoid incentivising aid to flow to the best commercial opportunities rather than where the greatest need is? How do we ensure transparency and accountability? How do we prevent an increase in tied aid and debt risks? And how can we ensure that recipient countries get a say in defining aid rules?

The latest ‘controversy’ caused by the UK perfectly illustrates this muddling of priorities. Instead of getting to grips with some of these critical issues, the OECD DAC may continue to struggle to get a detailed agreement on the ODA definition. Or worse, if no agreement can be reached and the current fudge continues, they risk undermining the concept of ODA itself.