Counting investment profits as aid risks undermining development efforts

When aid is delivered effectively, it results in breathtaking successes.

Aid has contributed to primary school enrolment now being almost universal, with as many girls enrolling as boys. Since 1990, the number of children dying before their fifth birthday has halved. Aid has been vital to curbing the spread of communicable diseases – which know no borders – in more than a fifth of the world’s countries, where aid remains a vital flow of concessional public finance.

The UK should be proud that its aid has been instrumental in achieving this progress. Aid spending is not and will never be a silver bullet. It is rather a shrewd investment in our shared future. It would be wrong to pretend that all aid is perfect, particularly when some of it is tied to the national interest of the donor rather than to the needs of those it is supposed to help.

So it was disappointing to see leaked comments last week by Penny Mordaunt, secretary of state for international development, that the 0.7% foreign aid commitment is “unsustainable”, that foreign aid obligations should be “less reliant” on the public purse, and that “returns from profits made from private aid contracts should count towards 0.7%”.

The scarcity of public finance is not an issue for aid being unsustainable. Last week, the HMRC published figures showing that the total cost of Britain’s system of tax relief had risen to a record £164bn annually. This is more about how public money is spent.

How is private investment counted as aid?

The rules on what counts as aid (or Official Development Assistance (ODA)) are agreed at the OECD’s Development Assistance Committee (DAC). The DAC’s interim rules on the measurement of aid invested in the private sector under the so-called Private Sector Instruments (PSIs) allow aid to be counted either when a transfer is made to a Development Finance Institution (DFI) (the “institutional approach”), or when those institutions make investments (the “instrumental approach”).

The UK currently adopts the former approach, allowing it to count its investments in its main private investment vehicle (the CDC Group) as ODA when it makes them, rather than when the money is actually invested in developing countries. Using this approach, the UK is planning to count all of its proposed £3.1bn-£3.5bn investment in CDC Group between 2017 and 2022 as ODA (on top of its earlier investments in CDC announced in 2015). This capital investment in CDC enables the UK to meet its 0.7% commitment. The latest leak implies that the secretary of state wants to change the current rules so donors can count as ODA not only the full amount of capital invested in DFIs making private investments, but also any reinvested profits from those investments.

New rules are risky

This current messy stop-gap arrangement on measuring aid to the private sector does little to ensure these investments benefit poor communities. It is a fudge agreed by the DAC because they have so far failed to agree new rules for aid invested in the private sector using PSIs.

Donors want to use aid to incentivise the private sector to engage in developing countries far more, and find ways to count aid invested in the private sector towards their aid budget. Their challenge is how to measure this as ODA that is kept free from any commercial distortion.

Fortunately, there is a reluctance at the DAC in Paris, and among some of its donor members, to overturn the DAC agreement confirming that capital or dividends paid back to donor governments from private sector instruments should count as negative ODA, and that reinvested profits can only be counted as ODA via the instrumental approach on a grant-equivalent basis. This is because they would represent a benefit to the donor, not the recipient – the distinctive quality of ODA is that it is devoted to development assistance for the benefit of developing countries.

Private investments need better evidence and more scrutiny

But, one of the key challenges with counting private sector investments – and returns – as ODA is that donors appear to make assumptions that aid spent by the private sector will lead inherently to positive development outcomes, without the supporting evidence.

For many donor private sector programme portfolios, donors and DFIs do not have effective systems for public scrutiny of their spending and there is poor accountability to the country governments where DFIs or private partners operate. They often don’t work with governments, or civil society organisations, or closely align their operations to support national development priorities. The Independent Commission for Aid Impact (ICAI) highlighted some of these concerns, for example, in its review of DfID’s work with the private sector.

Sometimes it’s difficult to prove that the investor would have invested regardless of the incentive of aid money. It’s also difficult to prove whether the private partner’s programme is the best for delivering development impacts at scale. In these cases, the aid transfer amounts to no more than a public-private subsidy, which is not allowed under WTO rules.

Aid is for poverty eradication, not profit

Any changes to the rules that would allow for profits to be counted as ODA present a real risk of donor aid quality deteriorating. Taxpayer-funded aid has the advantage of being subject to high levels of public scrutiny, helping ensure it helps the poorest and most marginalised escape poverty.

Most critically, aid must be concessional, i.e. a government giving away something of value, without reciprocity. Without this feature, ODA would no longer be what we understand to be “foreign aid”. This is why previous high-ranking officials serving as chairs to the DAC have raised their concerns about some proposals under the PSI negotiations undermining the integrity of ODA.

We must avoid reversing the decades of progress we can celebrate today with the help of aid that creates opportunities for people to escape poverty. Donor governments, including the UK, must work with developing countries and civil society organisations to establish the strongest safeguards for aid that mobilises private investment for development that really works in the interests of the world’s poorest.

Can private finance ever really work for the world’s poorest? We explore this debate on our podcast with experts from Christian Aid, Traidcraft Exchange and the Overseas Development Institute.