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Grants or loans: how should the UK provide aid in the future?

Written by Kevin Watkins, Dirk Willem te Velde, Jonathan Glennie, Gideon Barnard



A new report by the IDC explores the new challenges facing UK development. Three ODI bloggers reflect on its findings – and we want your views. 

Introduction by Kevin Watkins, ODI Director

The international development landscape is changing.

With rich countries still struggling to shake off the after-effects of the financial crisis, emerging markets have become a global growth pole. Countries in Africa are posting some of the world’s highest growth rates – several have entered the ranks of middle-income countries.

The good news is poverty levels have been falling at an unprecedented rate, child survival rates are improving, and more children are getting an education.

Now for the bad news. Despite their countries getting richer, the poorest people are being left behind by rising inequality. Does it really make any difference to someone living in poverty in northern Ghana, or Bihar state in India, that their country has just crossed an arbitrary line separating ‘low-income’ and ‘lower-middle-income’ countries?

There is little evidence that the stark gaps in opportunities for health and education are closing.  Meanwhile, countries affected by conflict are falling further and further behind.

These trends matter for aid donors.

Should a country like the UK still be providing aid in the form of grants to countries that have achieved middle-income status?

Put differently, should aid money follow poor people wherever they live – or should it focus on poor countries? As countries get richer, should we be blending our aid with less concessional lending? And should we be using development assistance not just to support government budgets or projects, but to leverage private finance through equity and risk guarantees?

There are no easy answers to these questions.

Countries in Africa can raise money on Eurobond markets, but many traditional donors are hesitant about providing more commercial finance. The massive infrastructure deficits in many of the poorest countries will require increased private finance.

Yet despite a proliferation of new and innovative financing mechanism designed to leverage foreign investment, there is little evidence that the deficits are narrowing.

Last week, the International Development Committee (IDC) at the House of Commons produced an excellent report exploring the development financing challenges facing the UK.

Below, three of my ODI colleagues reflect on its findings – and I hope that you’ll share your own views.


Dirk Willem te Velde – Wanted: a finance strategy in support of a new development strategy

 The global development context is changing rapidly: the proportion of people living in poverty has halved since 1990; several low-income countries have graduated to lower-middle-income status with their development finance prospects improving considerably; new development finance flows have emerged, even for the poorest countries; and the nature of private capital flows is evolving. How do development actors need to change in order to remain effective?

The UK’s Department for International Development recently designed an excellent new development strategy that focuses on economic development and structural transformation – areas which least developed countries (LDCs) have long sought support for from development actors. Beyond-aid policies have an important role in promoting growth in poor countries, but there is also a complementary role for development finance, and aid within this.

Whilst many agencies already use a variety of instruments (loans, grants, equity, guarantees) in a wide range of low- and middle-income countries and for a wide range of purposes (social support, economic development and global public goods), the challenge is that few have a finance strategy that sets out which instruments are best in what situation and for what purpose, and how this can supported by other policies.

This is precisely what a recent report by the UK House of Commons International Development Committee (IDC) on the future of UK development co-operation points out (disclaimer: I was a specialist advisor). In addition, the report has a view on a number of important debates:

  • It strongly supports an aid-to-GNI ratio of 0.7%, with a suggestion to discuss aid definitions
  • Rather than cutting aid to India, Pakistan or Nigeria, for example, the report suggests that a range of other instruments should be provided (if the countries need it) and we should think about country classification
  • When working with the private sector, the UK Government should provide returnable capital to individual businesses instead of grants
  • Rather than closing off the option of ever starting a UK development bank (and note that even the European Bank for Reconstruction and Development has a default rate of just 3%), we should build up finance skills to examine whether it is needed. 

The development finance policy context is evolving rapidly. In the coming year there will be important debates on post-2015 financing for development, on climate finance, and on the modernisation of aid. The finance challenges have become complex, the solutions more varied. This is exciting, and we will continue to feed into the debate through the European Report on Development 2014, which will explore financing in the post-2015 context.


Jonathan Glennie – This report perpetuates the fallacy that we are reaching the end-game of aid

The IDC report on the future of development finance is a really good survey of the current dilemmas facing northern aid agencies. It prompts a number of steps in the right direction, most importantly recognising the much broader range of financing instruments DFID will require in the medium term, and suggesting more support for multilateral initiatives.

Its call for deep thinking about financing future development is welcome. But my concern is that discussion will take place in a paradigm far removed from the reality of poverty and development.

Yes, extreme poverty appears to be reducing, and health indicators in particular continue to improve (as they have been for decades). But all the evidence I have seen is that vastly more international public funds will be necessary – to complement domestic and private investment – in order to achieve something approaching convergence with western living standards in a sustainable way. Ending extreme poverty may be a main priority for international cooperation, but let’s not confuse that with the overall objective.

By calling for middle-income countries (MICs) to graduate from aid, by maintaining the unhealthy obsession with the whereabouts of the world’s very poorest, by failing to properly integrate climate finance and sustainable development finance (there will be a separate enquiry into that), this report perpetuates the fallacy that we are reaching the end-game of aid and development cooperation, when we are only just getting started.

Predictably, this messaging has been picked up in all the wrong places, but it is not just the Daily Mail that seems to think people living just above the extreme poverty line are somehow no longer deserving of help by people vastly richer than them. Half the development industry appears to buy that line (partly through lazily saying ‘poverty’ when we mean ‘extreme poverty’), which is why, to be fair, the IDC report should not be expected to seriously challenge it.

The way we define ‘need’ and ‘poverty’ is fast becoming the most pressing issue of our generation, and at the moment the battle is being won by the advocates of an unacceptably stingy approach. Without a paradigm shift in our understanding of international public responsibility, the more technical discussions (e.g. about where loans might be better than grants, or where bilateral support is more appropriate than multilateral) have little chance of reaching sensible and humane outcomes.

The IDC report contains a wealth of important thinking, and touches on the big debates as my colleague Dirk Willem te Velde points out, but ultimately it fails to set an ambitious enough tone for the next period of development finance.


Gideon Rabinowitz – We need to develop more useful country classifications, and apply them to the issue of how to allocate aid

The IDC’s recent report provides an overview of the evolving development landscape and an important reflection on the strategic challenges it poses for development finance providers such as the UK Government. Rightly so, it largely avoids attempting to prescribe responses as there are no easy answers. Instead it poses a useful set of strategic questions, including producing a White Paper on development finance to guide the UK Government’s use of different aid instruments.

The topic of aid to MICs is a minefield, which, despite a valiant effort to traverse, the IDC fails to avoid. This is largely down to the impractical and unhelpful MICs category, although the IDC’s presentation of the issues wasn’t sufficiently nuanced and consistent enough either.

To explain:

The MICs group is currently a diverse set of 103 countries (and counting) with incomes per capita ranging from $1,000 to $12,000 per annum. As my colleague Jonathan Glennie likes to say, ‘very soon this group will be virtually synonymous with that of developing countries’. Identifying an aid agenda for such a group of countries is incredibly difficult, perhaps impossible.

In addition, the IDC has also fallen foul of the arbitrary nature of the income thresholds for the MICs group. In highlighting concerns about MICs receiving an increasing share of UK aid in the last two years, it clarifies that this has largely been down to the three countries with sizeable DFID programmes that have recently graduated from the low-income to MICs category – Ghana, Nigeria and Pakistan. Have these countries changed fundamentally in the last two years? It is unlikely, so how worried should we really be about this trend?

The IDC recognises this issue by stating that the thresholds for MICs need to be reviewed and updated. However, they continue to use the term ‘MIC’ throughout the report, thereby reinforcing the problems surrounding use of this term. The IDC had the opportunity to signal a more flexible use of the MICs category – perhaps by distinguishing recently graduated countries or even lower MICs from other MICs – but did not do so.

This report serves as another reminder that we need to develop more useful and multi-faceted country classifications, and apply them more appropriately to the issue of how to allocate aid.