Aid must change in order to tackle inequality: the OECD responds to Angus Deaton

May 14, 2014

     By Duncan Green     

Guest post from Jon Lomøy, Director of the OECD Development Co-operation Directorate (DCD)Jon Lomoy OECD

Official development assistance – or aid – is under fire. In The Great Escape, Angus Deaton argues that, “far from being a prescription for eliminating poverty, the aid illusion is actually an obstacle to improving the lives of the poor.”

Yet used properly, “smart aid” can be very effective in improving lives and confronting the very issue that Deaton’s book focuses on, and which US President Obama has called the “defining challenge of our time”: rising inequalities.

As a recent UNDP report shows, more than three-quarters of the global population lives in countries where household income inequality has increased since the 1990s. In fact, today many countries face the highest inequality levels since the end of World War II.

There is clearly moral ground for arguing that it is unjust for the bottom half of the world’s population to own only as much as the world’s richest 85 people. Above and beyond this, however, academics, think tanks, and international organizations such as the OECD have found that rising inequalities threaten political stability, erode social cohesion and curb economic growth.

It is not surprising, then, that reduction of socio-economic inequality has moved to the centre of global discussions on the post-2015 goals. The OECD, responsible for monitoring official development assistance (ODA) and other financial flows for development, is complementing these discussions by exploring ways to better use existing financial resources – and mobilise additional ones – to promote inclusive and sustainable development. This includes redefining what we mean by ODA, as well as looking at the ways it can best be used to complement other forms of finance.

While the relative share of concessional public finance – what we traditionally refer to as “aid” – is shrinking compared to new sources of finance for development, this is still a particularly important instrument to address poverty and inequality in many countries – especially those affected by conflict and fragility, where it is difficult and risky to invest.

But to do this effectively, what we know as aid must change and adapt to the needs and priorities set by the countries themselves. Traditional aid must work in untraditional ways.

Africa tax doodleSmart aid can, for example, help countries finance their own development using domestic resources. Colombia used official development assistance to the tune of just US$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 US$3.3million to US$5.83million in just one year. Rather than eroding the social contract between citizens and states – as Deaton argues that it does – aid used in this way is likely to increase citizen’s confidence in the state by seriously bolstering the social benefits the government is able to provide them.

A recently published OECD report shows that providers of development co-operation can also help developing countries confront the challenges of illicit financial flows. Large sums of money – likely to exceed the annual volume of total official development assistance – are illegally transferred out of developing countries every year, depriving the host country of essential revenues. Multinational companies, for instance, use so-called transfer pricing to reduce their tax burden by positioning their profits in countries with low corporate taxes.

A US$10,000 project in Kenya (the cost of two workshops in Kenya that provided advice to the Kenyan Revenue Authority – KRA – on transfer pricing audits) enabled the tax authorities to negotiate a transfer pricing adjustment, contributing to an increase in tax revenues of US$12.9million. Subsequent transfer pricing adjustments by the KRA led to additional tax revenues: from US$52million for the year ending 30 June 2012 to US$85million in 2013. The KRA states that the assistance and advice provided by the workshops has been a major contributor to achieving these increases.

What’s more, development co-operation can be used to mobilise additional financial resources by providing the conditions needed to attract private investment through mechanisms that reduce risk. For example, government-provided ODA can be used to offer guarantees for private investors; or different sources of finance can be “blended” to spread the risk over a group of lenders (the syndicate), one of which is often a multilateral development bank.

These are just some of the ways in which resources can be mobilised through the smart use of development co-operation to help states reduce socio-economic inequalities, finance policies that enable more people to benefit from inclusive economic growth, and provide public services such as education.

Later this year, the OECD will publish its Development Cooperation Report 2014: Mobilising Resources for Sustainable Development. This provides an overview of existing sources of finance for sustainable development, as well as a number of financial and policy instruments that can be used to mobilise additional resources.

Critics are not wrong in questioning how aid is used. We at the OECD – and our member countries – are also doing so to ensure that we learn from the better aidpast to build better and more fit-for-purpose assistance. Times have changed, and so must public development finance. But it would be wrong, as Duncan Green says in his review of Deaton’s book, to throw the baby out with the bathwater and simply stop providing this assistance. One may argue that aid is actually one of the better instruments we have available for redistributing a share –albeit an admittedly small share – of our enormous global wealth to countries and people where it can make a great difference, thus reducing global inequalities.

Part of the “aid illusion” is thinking that aid can’t change.

May 14, 2014
Duncan Green