How to fix fragile states? The OECD reckons it’s all down to tax systems.

February 25, 2014

     By Duncan Green     

‘Over-generous tax exemptions awarded to multinational enterprises often deprive fragile states of potential revenues that could be used to fund their most pressing needs.’ Another broadside from rent-a-mob? Nope, it’s the ultra respectable OECD in its Fragile States 2014 report.

After years of growth, aid to fragile states started to fall in 2011, so the report centres around an urgent call for OECD member states tofragile state inflows help their more fragile cousins find a post-aid arrangement that funds essential state functions and builds the ‘social contract’ with citizens.

The key is a shift from aid dependence to ‘domestic resource mobilization’ (taxes and natural resource royalties), currently averaging a feeble 14% of GDP across fragile states and far too dependent on royalties from oil, gas and mineral extraction (see chart, below). Foreign direct investment (factories, farms etc) is generally low in volume and volatile. (see graph, right – CPA means ‘aid’)

The OECD advocates a nicely balanced three-pronged approach:

  • ‘Encourage a broader tax base by focussing on approaches that give citizens a voice.’ (the ‘no taxation without representation’ path to the social contract).
  • ‘Support fragile states in designing frameworks to ensure fairer deals with multinational enterprises, in particular on proceeds from their natural resources; providers of development co-operation can lead by example by being transparent about the tax exemptions that benefit them.’ The report goes further, calling on OECD countries to ‘take steps to comply with global standards on money laundering, tax evasion and bribery.’
  • ‘Boost citizens’ tax morale by establishing clear links between tax revenue and local benefits.’

Currently a truly laughable 0.07% of aid to fragile states goes to strengthening their tax systems. So the OECD wants the diminishing pool of aid to redress ‘weak technical and institutional capacity’ in fragile states, helping them introduce and collect direct taxes.

A guiding principle in all this will be ‘leadership and political will for reform by the host country – aid alone cannot ‘buy’ effective and lasting reforms’. Ah. Houston, I think we got a problem. The defining feature of fragile states is not that they are poor, but that they are, erm, fragile. Institutions are weak and/or subject to capture. This is the Achilles’ heel for any number of well-intentioned aid efforts, which ‘assume a can opener’ in the form of an effective state, when its absence is precisely the problem it is trying to address.

fragile states natural resources v the restIt’s not insoluble – fragile states are ramshackle coalitions of ministries, interest groups, factions etc, as well as lots of non-state groups, some of which can form part of a pro-DRM coalition willing to confront the blockers who benefit from the status quo. Shocks, scandals and financial meltdowns offer windows of opportunity, in which resistance to change may melt away. But how such change might happen needs to be thought through just as much as the what of standard reform shopping lists.

I suspect the OECD knows this full well, but can’t include it in supposedly ‘neutral’ policy papers. In any case, it’s great that they are addressing these crucial topics. Bring on the DRM.

The report’s other oversight is remittances, which dwarf other sources of capital (see graph again), but are dismissed rather too easily in the report as only relevant to middle income fragile states (yes, they do exist). If Tajikistan is anything to go by, remittances matter a lot for the poor ones too, and are an obvious point of contact with OECD states and their migration policies. But maybe that was a political hot potato too……