European Report on Development 2014 Financing and Other Means of Implementation

in the Post-2015 Context

Insights from the Country Illustrations

Debapriya Bhattacharya

Table of Contents

1. Introduction Research methodology Selection of countries Outline of the paper

2. Country-level Transformative Experiences 2.1 Economic transformation 2.2 Social transformation 2.3 Environmental transformation 2.4 Some key insights

3. Finance Options 3.1 Domestic finance 3.2 International finance

4. Enablers for Transformative Changes 4.1 National enablers

4.2 Global enablers

5. Complementary Policies 5.1 Global linkages

Preferential treatments in export markets 5.2 Domestic policies

Fiscal policies/tax reforms Trade policy and investment promotion Other government interventions

5.3 Country-specific complementary policies

6. Future Scenarios and the Way Forward 6.1 Current and expected flows of finance 6.2 Needs and recommendations

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1. Introduction This paper synthesises the main messages of the Country Illustrations (CIs) commissioned for the European Report on Development 2014 (ERD 2014), which focuses on ‘financing and other means of implementation in the post-2015 context’. The Report explores issues related to financing, enabling policies, and other means of implementation for achieving sustainable development transformations that are critical to the post-2015 agenda. The purpose of the CIs was to produce national-level insights to inform the Report. This paper provides an overview of the CI papers, teases out insights and consolidates the policy implications.

Research methodology The CIs were guided by the ERD methodological approach. First, the analytical framework recognised that sustainable development (the core of the post-2015 agenda) entails economic, social and environmental transformations. Second, that in pursuing sustainable development it is useful to focus on the enablers of change. A literature review and empirical evidence indicated the importance of four types of critical enabler:

Institutions (e.g. political and economic, financial and informal) Revenues (e.g. physical, human, natural) Technology Networks (e.g. local, regional, global)

In this connection, it was underscored that finance contributes to the development of the enablers, and also that the development of the enablers leads to generation of more finance. Third, the methodology emphasised that transformative changes are context-dependent, implying that complementary policies are important for promoting the effective mobilisation and use of finance and other means of implementation (MOI) for the post-2015 agenda. Within this analytical framework, it is possible to identify country-level needs and policy priorities as well as prospects for the mobilisation and use of finance and non-financial MOI. The main research question addressed by ERD 2014 is ‘How can financial resources be most effectively mobilised and channelled, and how can they be combined with selected enabling policies and other means of implementation, to achieve a transformative post-2015 agenda?’ Simply put, the ERD 2014 explores the effectiveness of finance in conjunction with enabling policies and other MOI for achieving specific policy objectives in specific contexts. The commissioned CIs identified development solutions in the interface of three elements – the country context (benchmark), the transformative agenda related to national development objectives, and the suitability of specific MOI including financing, enabling policies/institutions and other supportive instruments. While it may not be possible to observe a unique or clear-cut solution for a particular interface, it is more important to locate the distinguishing ‘triangulation’ at a particular moment for a particular country. Selection of countries

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The countries profiled in the CIs were selected according to the following criteria: a. Diversity in terms of geographical location and physical attributes, size

(population and economy) and level of development (per capita income); b. Countries readily identifiable with a certain type of transformative change in the

economic, social and environmental spheres; and c. Growth dynamics underpinned by significant experience regarding the use of

certain financing modes or other MOI, including domestic and international instruments.

Accordingly, the following countries were selected. a. Bangladesh (South Asia): A least developed country (LDC) whose key

transformations include the growth of the export-oriented textiles and ready-made garment (RMG) industry and access to overseas remittances. Bangladesh has also achieved commendable human development.

b. Indonesia (South-East Asia): A lower-middle-income country (LMIC) and a large emerging economy, Indonesia is rich in natural resources and has achieved an extensive reduction in poverty.

c. Tanzania (sub-Saharan Africa): An LDC that is rich in natural resources, Tanzania has notable potential to produce energy.

d. Mauritius (African Island): A Small Island Developing State (SIDS) and upper-middle-income country (UMIC), Mauritius has undergone distinctive structural transformation (from sugar to textiles to services).

e. Ecuador (Latin America): A UMIC that is rich in natural resources, Ecuador is moving towards green financing initiatives.

f. Moldova (Eastern Europe): A LMIC and Europe’s poorest country, Moldova is highly dependent on aid, and is moving towards deeper trade integration with the European Union (EU).

Table 1 lists the six commissioned CIs. Outline of paper Following this introduction, Section 2 assesses the transformative experience in the six countries, Section 3 looks at their varying financing options. The role of different enablers is discussed in Section 4. Section 5 reviews the complementary national and international policies that have promoted the generation and use of financial resources. The concluding section looks at the horizons and sketches the evolving scenarios for the sample countries in terms of the prospects of obtaining finance and other MOI. Table 1: Country Illustration Reports Country Author Institution Bangladesh Fahmida Khatun Centre for Policy Dialogue Ecuador Ivan Borja and Andrea Ordonez University San Francisco de Quito Indonesia Bagus Santoso and Yose Rizal

Damuri DEFINIT and CSIS

Mauritius Nikhil Treebhoohun Global Finance Moldova Olesea Ghedrovici European Business Association Tanzania Hosena Lunogelo Economic and Social Research Foundation

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2. Country-level Transformative Experiences It is a challenge to capture the multi-dimensional transformative experiences of a country in a given period of time. The six commissioned CIs clearly show that each country has followed a very different development path and experienced different challenges in its growth trajectory determined by its economic, environmental and social context. It is maintained that economic transformation is propelled by dynamic growth that involves structural changes by moving employment and resources from less productive to more productive sectors and activities (within firms, and within and between sectors). Social transformation envisages a shift towards an inclusive society that pursues growth with equity, reduces poverty, and is guided by a redistributive social vision that is grounded in the principles of non-discrimination, transparency, and accountability. Finally, environmental transformation implies moving the economy from high- to low-carbon energy consumption, associated with access to modern and efficient energy systems, greening of production and consumption, and adjusting to new climatic conditions, while safeguarding biodiversity. Table 2.1 summarises the main transformations highlighted in the CIs. It shows that they have all undergone significant shifts in their economy, social indicators and environmental status. In the economic sectors, Table 2.1 highlights the growth of the export-oriented industry (Bangladesh), rise of small and medium-size enterprises (SMEs) (Indonesia) and fast expansion of mining sector (Tanzania). Another set of countries has witnessed faster growth of the service sectors, i.e. Ecuador (financial services), Mauritius (tourism) and Moldova (ICT products). It seems that the growth of the service sector is prominent in the countries with relatively higher income. The relevant question in this regard is whether the observed economic shifts will lead to sustainable development. The social transformation process appears to be more similar across the sample countries. The common features include a drop in poverty (headcount ratio), improved maternal and child mortality rates and enhanced school enrolment. Interestingly, improved sanitation (and water supply) was highlighted by all the CIs as an important example of environmental transformation. Many of the six countries suffer a significant deficit of access to commercial energy (e.g. Tanzania) as well as the negative impact of the climate change (e.g. Bangladesh and Mauritius). Table 2.1: Leading transformative experiences (2000–2012)

Country Type of Transformation

Economic Environmental Social

Bangladesh

Growing ready-made garment (RMG) sector, Bangladesh is a world leader in textiles exports.

Improved electricity, water supply and sanitation.

Significant decreases in maternal mortality and under-5 mortality rates with improved life expectancy.

Ecuador Striking increase in per Significant improvement Poverty decreased by a

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capita GDP as a result of a growing services sector

in access to water and sanitation.

large margin. Major decrease in maternal and under-5 mortality rates.

Indonesia

Rise of SMEs, which make a significant contribution to GDP.

Improved access to water and sanitation.

Significant drop in under-5 mortality rate and poverty.

Mauritius

Flourishing tourism, financial service and textile sectors.

Improved sanitation.

Gradual increase of women’s participation in the labour force. Impressive enhancement of average household disposable income.

Moldova

Massive growth in the services sector – ICT being a major contributor.

Improvements in forest area and sanitation. GDP per unit of energy generation increased.

Pre-school enrolment almost doubled and 10% decline in poverty, i.e. poverty gap decreased substantially.

Tanzania

Mining sector, tourism, and construction contributed heavily. Mining sector growing at an average annual rate of 10%. GDP per unit of energy use is following an exponential trend.

Improved sanitation.

Under-5 mortality rate fell to 33% and maternal mortality rate almost halved.

2.1 Economic transformation Growth dynamics and structural changes. Between 2000 and 2012, all six countries experienced significant economic growth – in most cases (except Moldova, where the GDP growth rate became negative due to systemic shocks) – the GDP growth rate was higher in the final year of the period. As a result, per capita GDP increased by two to five times, even when economic growth rate decelerated over the period. Did the robust economic growth in these countries lead to structural economic changes? No country has ever transitioned from low-income to middle-income to high-income status without undergoing a process of industrialisation. The profiled countries are broadly following the sequence taken by today’s developed economies after the Industrial Revolution: decreasing reliance on the agricultural sector, increased share of industry (e.g. manufacturing, extractive industries and construction), and an expansion of the service sector when the share of manufacturing sector stagnates or declines. Interestingly, only in Bangladesh and Tanzania – two LDCs – was an increased share of industry in the GDP coupled with incremental growth in the share of manufacturing. In other cases, it was mostly construction, although the middle-income economies – upper (Mauritius and Ecuador) and lower (Moldova and Indonesia) – had been witnessing greater growth of the service sector.1 These structural economic trends led to a decline in the share of agriculture in the GDP. As Table 2.2 depicts, this is common to all the countries, although this was not

1 The Asian Development Bank concludes from its research on a worldwide sample of 109 countries that almost no economy has become high income without manufacturing output and employment shares reaching at last 18% of GDP. The two UMICs, Ecuador and Moldova, were all below this threshold in 2012, with manufacturing employment comprising 13% and 14% of the workforce respectively.

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accompanied by commensurate fall in the share of agricultural labour, which remains high. As may be expected, the share of agricultural labour is lowest in the countries with higher per capita income (i.e. Mauritius and Ecuador). For this structural change to be sustainable, the productivity of labour and land has to increase faster in the countries with a higher share agricultural employment. Table 2.2: Key indicators for economic transformations (2000 and 2012)

Bangladesh Ecuador Indonesia Mauritius Moldova Tanzania 2000 2012 2000 2012 2000 2012 2000 2012 2000 2012 2000 2012

GDP growth (annual %) 5.9 6.2 1.1 5.1

4.9 6.3 9.0 3.2

2.1

-0.7 4.9 6.9

Per capita GDP (at current prices, in USD)

356 750 1462 5425

790

3551

3861

8862

354

2047 308 609

FDI, net inflows (% of GDP)

0.6 1.1 -0.1 0.7

-2.8

2.2

5.8

3.2

9.9

2.5

4.5

6.0

Exports of goods and services (% of GDP) 14.0 23.2 32.1 30.9

41.0

24.3

61.4

54.8

49.8

43.5

13.4

29.5

Imports (% of GDP)

19.2

32.1

27.0

33.0

30.5

25.9

61.9

66.7

75.4

83.9

20.1

47.3

Personal remittances (% of GDP)

4.2

12.2

7.2

2.9

0.7

0.8

3.9

0.0

13.9

24.5

0.1

0.2

Net ODA received (% of GNI)

2.4 1.7

0.9

0.2

1.1

0.0 0.4

1.5

9.4

5.8

10.5

10.2

Tax revenue (% of GDP)

6.8 10.5 10.32 12.7 15.53 11.44 18.45 19.0 14.7 18.6 7.66 16.1

Agriculture, value-added (% of GDP)

25.5

17.7 16.3 9.8 15.6 14.5 7.0 3.5 29.0 13.4 33.5 27.6

Employment in agriculture (% of total employment)

62.1 48.17 29.3 27.8 45.3 35.1 12.1 7.8 50.9 26.4 82.18 76.59

Manufacturing, value added (% of GDP)10

15 18 28 24

19 13 23 17 9 10 16 14

Industry, value added (% of GDP)

25.3 28.5 35.7 40.1 45.9 46.8 31.0 24.7 21.7 16.7 19.2 25.0

Services, etc., value added (% of GDP)

49.2 53.9

48.0 50.1 38.5 38.7 62.1 71.9 49.2 69.9 47.3 47.4

Domestic credit to private sector (% of GDP)

4.09 17.9 26.0 27.4 19.9 35.0 57.5 100.8 12.7 37.9 4.1 17.9

2 2005.

3 1999. 4 2009. 5 FY2007–08. 6 2007. 7 2005. 8 2001. 9 2006. 10 Data available only for manufacturing and industry, and not for the contribution of construction to GDP.

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Bangladesh Ecuador Indonesia Mauritius Moldova Tanzania 2000 2012 2000 2012 2000 2012 2000 2012 2000 2012 2000 2012

Market capitalisation of listed companies (% of GDP)

2.3 6.4 3.8 7.0 16.3 45.3 29.1 62.0 n/a n/a 2.3 6.4

Source: World Bank Development Indicators (WDI)

Foreign Trade. The degree of openness of the economy (i.e. exports plus imports/GDP) increased in all six countries from 2000 to 2012. In most cases, however, this was predicated on a greater share of imports than exports in GDP (apart from Bangladesh and Tanzania). In other words, the LDCs experienced faster export growth (low-cost textiles and minerals). The lack of common trends in import and export dynamics reflects the varying endowments and comparative advantages of the economies. Falling world commodity prices and the global financial crisis of 2007–2009 disproportionately affected Indonesia, Mauritius, and Moldova. These countries are highly connected to the global financial and capital markets and their exports declined in response to reduced global demand. Indonesia is a major exporter of fuel and edible oils, whereas Mauritius is heavily dependent on its luxury tourism sector. Mauritius is also notable for its high investment and capital freedom, and it sharply felt the effects of the overheated global financial markets. Furthermore, Indonesia, Moldova and Mauritius trade more heavily with developed nations than the other countries. Developed nations were the source of the financial crisis and these countries were the unwitting victims. In contrast, Bangladesh, Ecuador and Tanzania have underdeveloped financial markets and low international financial integration. Bangladesh and Tanzania have had rising exports, the volume of which approximately doubled in the 2000–2012 period. Bangladesh is a world leader in exports of low-value RMGs and textiles and was less affected by the changes in global demand. In contrast, Mauritius also exports large quantities of textiles and RMGs, but these exports declined since they are high-end products. Tanzania is a heavy exporter of precious metal ores (such as gold) as well as minerals that are important for manufacturing. The global demand for these did not decline in the aftermath of the global financial crisis. These diverse export performances point to the fact that the extent of the effects of the global market on an economy depends not only on its degree of openness, but also on the composition of its exports and the nature of its integration into the international market. Domestic resources and public expenditure. With the exception of Mauritius, the CIs show an increasing tax-to-GDP ratio during the 2000–2012 period. Expanded tax bases, improved governance and administration as well as policy reforms contributed to this positive trend. Only Indonesia had a lower share of tax revenues in GDP in 2012 than in 2000 as it struggled to recover from effects of global financial crisis. A slow recovery of global international trade and a current account deficit contributed to Indonesia’s low economic growth and fall in tax revenue.11 Greater availability of domestic resources improved the fiscal position of these countries and fuelled the growth of public expenditure, particularly in the social sectors. With the

11 For example, around 40% of Indonesia’s VAT revenue is from imports, which also fell during the 2000–2012 period.

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adoption of the Millennium Development Goals (MDGs), there was greater policy inspiration to do so. Although public expenditure (as a share of GDP) increased in all six countries, improved governance and policy reforms protected them from negative feedback loops that can create structural imbalances in the economy. Reforms were critical for Moldova, which experienced a sharp rise in public expenditure in 2009. Foreign Direct Investment (FDI). Increasing FDI in four countries (the exceptions being Mauritius and Moldova) also possibly brought positive spillovers such as increased productivity alongside the transfer of knowledge, technology, and management skills. Indonesia and Tanzania had the most notable increase in FDI inflow. Although Moldova undertook legal reforms, visa liberalisation etc. to attract FDI, results are yet to follow. This indicates that an enabling regulatory framework may not automatically be rewarded with increased FDI, but such inflows are expected to play a critical role in a country’s graduation from LMIC to UMIC or LIC to LMIC status. Remittances. Migrants’ remittances played a significant role in economic transformation in Bangladesh and Moldova. In Bangladesh, the share of remittances in the GDP grew from about 4% (2000) to around 11% (2012), and Moldova experienced an increase from about 14% to 24.5% of GDP during the same period. Unlike FDI inflows, remittances were relatively unaffected by the financial crisis because the sector is less directly linked to the global financial network. When remittances contribute significantly to the GDP, they have an important multiplier effect (a positive feedback loop), and, by financing household-level consumption, contribute to reducing poverty.12 Remittances also have critical importance in stabilising macroeconomic factors, including the foreign exchange rate. Official Development Assistance (ODA). Over the 2000–2012 period, all countries but Mauritius have reduced their dependence on aid as ODA as a percentage of their Gross National Income (GNI) decreased. This may imply faster economic expansion in the face of stagnating or reduced ODA. Even Bangladesh and Tanzania are transforming from being dependent on aid to depending on trade. 2.2. Social transformations The country-level diversity in economic progress is not readily evident in relation to the changes in the social sectors. As Table 2.3 reveals, all six countries made improvements in the five selected indicators of social development, i.e. life expectancy at birth, literacy rate, maternal mortality ratio, under-5 mortality rate and poverty ratio. Curiously, Mauritius saw an increase in the maternal mortality ratio. Higher public expenditure, targeted ODA, and prudent governance contributed to improvements in the social sectors in all six countries. Healthcare, education, and agriculture (which is critical for nutrition) are key recipients of the government budget in most of these countries. ODA has been used mainly to fund projects that were critical for improving literacy rates and safety-net programmes for the most vulnerable.

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According to the ILO, for Bangladesh in 2004, remittances had a multiplier effect of 3.3 on gross national product (GNP), 2.8 on consumption and 0.4 on investment.

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Regarding poverty reduction, Moldova and Ecuador have achieved the most spectacular success, largely thanks to their high level of public financing for social-protection schemes, including cash-transfer programmes. As expected, despite some success, the two LDCs continued to have the highest level (headcount ratio) of poverty in 2012. Table 2.3: Key indicators for social transformations (2000 and 2012) Bangladesh Ecuador Indonesia Mauritius Moldova Tanzania

2000 2012 2000 2012 2000 2012 2000 2012 2000 2012 2000 2012

Life expectancy at birth, total (years)

65.3 70.3 73.4 76.2 67.3 70.6 71.7 73.6 66.9 68.7 50.0 60.8

Literacy rate, adult total (% of people aged 15 and above)

52.8 58.8 91.0

91.59

90.413

92.814

84.3 88.815

96.7 99.016

69.417

67.818

Maternal mortality ratio (national estimate, per 100,000 live births)

340 17019 120 8720 310 19021 28

7322 39 2123 770 41024

Under-5 mortality rate (per 1,000 live births)

87.7 40.9

34 23 52 31 19 15 30 18 132 54

Poverty headcount ratio at $1.25 a day (PPP) (% of population)

58.6

43.325

20.7 4.626 47.727

16.228

n/a n/a 39.029

0.430 84.6 67.931

Source: WDI

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2004. 14 2011. 15 2011. 16 2011. 17 2002. 18 2010. 19 2013. 20 2013. 21 2013. 22 2013. 23 2013. 24 2013. 25 2010. 26 2010. 27 1999. 28 2011. 29 1999. 30 2010. 31 2007.

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2.3 Environmental transformations Most of the observed environment-related changes seem to be spillovers of the economic transformations (see Table 2.4). Some of these ‘transformations’, such as declining forest area and increased CO2 emissions, are perhaps better referred to as ‘changes’ as their nature does not fit the positive definition used in the ERD framework. Table 2.4: Key indicators for environmental transformations (2000 and 2012)

Bangladesh Ecuador Indonesia Mauritius

Moldova Tanzania

20

00

20

12

20

00

20

12

20

00

20

12

20

00

20

12

20

00

20

12

20

00

20

12

Forest area (as % of land area)

11.3

11.1 32 47.7 38.933 54.9 51.734 19.1 17.335 9.9 11.936 42.3 37.337

CO2 emissions (metric tons per capita)

0.2 0.438 1.7 2.239 1.3 1.840 2.3 3.241

1.0 1.442 0.1 0.243

Improved water source (% of population with access)

76.0 84.8 79.6 86.4 77.7 84.9 99.2 99.8 93.4 96.5 54.3 53.2

Improved sanitation facilities (% of population with access)

44.5 57.0 69.6 83.1 47.1 58.8 89.1 90.8 78.6 86.7 8.8 12.2

Access to electricity (% of population)44

46.5

59.6

92.2 95.5 73.0 72.9 99.4 99.4 No data for 2000–2014

14.8 15.0

Total natural resource rents (as % of GDP)

3.4 4.2 20.0 20.00 14.6 7.1 0.0 0.0 0.5 0.5 3.8 11.6

Source: WDI

Forestry and natural resource rents. Given the drive to undergo economic transformation, it is not surprising that deforestation appears to be common to all six countries. Rapid urbanisation and higher demand for agricultural land (e.g. in Bangladesh, Moldova and Tanzania) and a dependence on biomass-based fuel (especially in Tanzania) have led to problematic trends of declining forest area, land degradation, and habitat destruction.

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2011. 33 2011. 34 2011. 35 2011. 36 2011. 37 2011. 38 2010. 39 2010. 40 2010. 41 2010. 42 2010. 43 2010. 44 The figures in the 2000 column are for 2010, and in the 2012 column for 2011, the only years for which there are WDI data.

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Timber is a valuable building material, fuel, and a lucrative export. Tanzania and Ecuador (home to part of the Amazonian rainforest and highly prized timber such as mahogany) have experienced the greatest deforestation. Despite this, all six countries (except Indonesia) have received constant or increasing natural resource rents because of increasing extraction of petroleum, natural gases, and minerals. CO2 emissions. Due to industrialisation, CO2 emissions have increased in all the six countries, albeit they remain very low in global terms. Mauritius, the heaviest emitter, released 3.2 metric tons per capita in 2010. By way of contrast, Trinidad and Tobago (a high-income country with 2.5 times the land area of Mauritius) released 38.2, while Japan (one of the world’s most developed economies) released 9.19 metric tons per capita. Although green technology and emissions control will be important in the future (given the economic growth and population dynamics of these countries), these investments are likely to pose an unsustainable economic burden (except perhaps for Indonesia and Mauritius) and will certainly be ineffective without commensurate efforts in developed countries (the world’s heaviest polluters). Electricity access. Improved access to and production of electricity is both the result of economic development and an enabler. Dependable and widespread access allows industries and services to grow, while attracting FDI and infrastructural development partnerships. Electricity access is high in the more industrialised LMICs and UMICs (Ecuador and Mauritius have 90% coverage), and lowest in the two agriculture-dependent LDCs (Bangladesh and Tanzania). This will soon change for Tanzania, as its telecommunications sector grows rapidly and investments in TANESCO (the energy monopoly) yield dividends in two to five years. Water and sanitation. With the exception of Tanzania, the CIs show that there is greater access to improved water and sanitation, primarily funded by public expenditure and ODA. Tanzania’s poor performance can perhaps be explained by the fact that its budget has been more focused on improving infrastructure and education than on healthcare and water and sanitation. Tanzania is by far the poorest of the six countries in terms of GDP per capita. It may be concluded that even though social and environmental goals in all the six countries are similar (unlike their economic goals), when the government has very limited resources, establishing budgetary priorities creates stark trade-offs. 2.4 Some key insights The CIs paint an overall picture of dynamism underpinned by growth of the non-agricultural sector, more open economies, enhanced domestic resource mobilisation, and a rise in remittances or FDI in the face of stagnating (if not declining) ODA. Notwithstanding these positive economic trends, each of the countries faces specific structural, institutional and policy challenges. Accordingly they are making unique choices in mitigating the risks to development, while at the same time the CIs show that six distinct nations can follow similar trends in social and environmental transformations. While each embarked on a different economic journey, the CIs show that rapid economic growth need not be a prerequisite for social transformation. Countries with very different per capita income showed quite similar social indicators. This has to do largely

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with policy priorities underwritten by public resources – domestic and international. It points to the fact that education and health programmes, funded by tax revenues and ODA, can enable countries to build human capital that is critical for accelerating sustained economic transformation. The CIs show that environmental transformations have arisen either as an offshoot of economic transformations (e.g. deforestation and CO2 emissions) or thanks to greater public expenditure on the social sector (e.g. access to electricity, water and sanitation). Of the three, however, the process of environmental transformation is possibly most dependent on global interventions, particularly in relation to the adverse impact of climate change. When countries are particularly rich in petroleum, energy resources, and minerals (e.g. Tanzania and the oil-rich countries in the Middle East), environmental transformation and the associated natural resource rents can jump-start economic transformations. However, such rents from non-renewable resources are unable to ensure sustained growth in the medium term. As an inevitable step towards economic transformation, the countries have opened up their economies (through trade and investment) to the rest of the world. At the same time, this has made their economies more vulnerable to the vagaries of the global market. The shocks of the global financial and commodity markets are most strongly transmitted to the most globally connected economies, and Indonesia, Mauritius and Moldova are still struggling to recover from the global financial crisis. The CIs thus underline the need for global systemic changes in order to safeguard the achievements of developing countries. 3. Finance Options The transformative experiences discussed in the preceding section suggested that the six countries are undergoing changes in the composition of financial flows. These flows can be categorised by source, i.e. domestic and international, and by nature, i.e. public and private (see Table 3.1). ‘Blended finance’ mixes public and private finance from both sources. ‘Innovative development finance’ is another set of emerging financial flows that may be separately considered.45 Table 3.1: Types of Financial Flow Source Type Blended Finance

Public Private Domestic Tax revenue Bank credit to private

sector Public–Private Partnerships (PPPs) (with foreign loans) International ODA, Other Official

Flows (OOF), foreign debt,

Remittances, borrowing from credit market, FDI, international philanthropy

innovative finance, climate finance

45 There is no internationally agreed definition of Innovative Development Finance, but it is widely accepted that non-traditional finance needs to be raised at the global level in addition to the traditional sources.

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The pertinent question is what factors prompt a country to choose one or another option for financing productive investment, social programmes or environmental needs. Is the choice dictated by the country’s level of development (i.e. per capita income) or the nature of activity or sector (i.e. economic, social or environmental) or both? It is also relevant to explore whether access to a particular form of finance changes as the country undergoes transformation. Figure 3.1, based on the CIs, shows the changing direction of different forms of finance and their magnitude. The role of traditional international public finance is declining (second quadrant) while other financial flows are on the rise: domestic public and private finance are increasingly prominent, and international private finance is also sizeable. In the absence of a breakthrough in the area of innovative (international) development finance, a combination of domestic public and private finance or domestic public finance and international private finance is emerging as the dominant mix. Figure 3.1: Changes in Direction of Financial Flows

Public

International

Tax revenue

Domestic

Domestic credit to

private sector

FDI inflow

Export of goods

Net ODA

External debt stock

Personal remittances

Blue – Bangladesh Red – Ecuador Yellow – Indonesia Green – Mauritius Black – Moldova Orange – Tanzania Market capitalisation

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* The length of the arrows indicates the intensity of change in the value of the indicator Source: Developed from WDI 2014 database 3.1 Domestic finance Tax revenue. Tax revenue, as the critical domestic public finance instrument, comes across in all the CIs. Mauritius has the highest tax-to-GDP ratio at around 19% (2012), and Moldova achieved 18.6% in the comparable period. Tanzania had a much higher tax-to-GDP ratio (over 16%) than Bangladesh (10.5%). This may suggest that while a country’s income level may define the potential for domestic resource mobilisation, much depends on the tax efforts of the relevant institutions. This indicates the critical need to undertake institutional and policy reforms in this area. It is important to examine the changing composition of tax revenue. For example, the difference between Bangladesh and Tanzania has much to do with the natural resource rent received by the latter. Another aspect r relates to the move away (following trade liberalisation) from external trade taxes (i.e. import duties) to domestic taxes (e.g. value-added tax (VAT)). The third change is brought about by the growing importance of direct taxes levied on income and property. For example, in case of Bangladesh, the share of income tax in government’s total tax revenue increased from 18% in 2000 to 25% in 2012 (see Box 1).

Private

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Export revenue. Mauritius receives the highest export revenue (as a share of GDP) of the six countries, standing at about 55% (2012), although this was lower than in 2000 as exports declined in the face of the global financial crisis – as they did in Ecuador, Indonesia and Moldova, although Bangladesh and Tanzania were successful in retaining their export share. However, given high product concentration in these two countries’ export baskets, they also remain potentially vulnerable to external shocks. What is important in this connection is to explore what kind of financial instrument can support not only the expansion of productive capacity of existing exports in these countries, but also their diversification. Aid for Trade (AfT) could be one such instrument (but although much-hyped, it is yet to show desirable results). The other would be financial and policy reforms to enable these countries to engage dynamically in global value chains (GVCs) and increase the retained value. Domestic credit to the private sector. Mauritius held the biggest share of domestic credit to the private sector at more than 100% of GDP in 2012. Obviously, as Mauritius seeks to become an international financial centre, such a degree of financial deepening is to be expected. However, domestic credit to the private sector also comes across as one of the most dominant sources of finance in the other countries. Despite being defined as an LDC, Bangladesh had the second highest share of domestic credit to the private sector – about 50% of GDP in 2012. Its commercial banks (state-owned and private) not only financed private investments but also the governments’ large infrastructure projects – often though syndicated loans. However, the high cost of credit underpinned by the large proportion of non-performing loans and large spread has prompted them to seek access from the global markets in foreign currency denominated loans. The ability of the

Box 1: Flow of finance: stylised trends

Tax revenue (as a percentage of GDP) increased between 2000 and 2012 (with the exception of Indonesia)

Receipt of net ODA (as a percentage of GNI) decreased for each of the sample countries, except for Mauritius. Moldova has had the sharpest decrease, reaching 5.82% in 2012 from 9.35% in 2000.

Net inflow of FDI (as a percentage of GDP) increased for Bangladesh, Ecuador, Indonesia and Tanzania between 2000 and 2012. FDI and ODA in Mauritius followed the opposite trend, and both declined for Moldova.

Remittances (as a percentage of GDP) increased substantially in Bangladesh and Moldova between 2000 and 2012, while they declined sharply in Ecuador and Mauritius. Tanzania and Indonesia’s ratio increased only very slightly.

Domestic credit to the private sector (as a percentage of GDP) performed robustly in all six countries. Tanzania experienced a four-fold increase in this domain, followed closely by the other countries.

Exports of goods and services (as a percentage of GDP) increased for Tanzania and Bangladesh, but decreased for the other countries. Among those experiencing a drop in exports between 2000 and 2012, Indonesia’s was the most dramatic, with the export-to-GDP ratio falling from 40.98% in 2000 to 24.29% in 2012.

Agricultural value addition (as a percentage of GDP) decreased for all six countries, which is not surprising, but at the same time the share of service sector’s value addition (as a percentage of GDP) increased.

While manufacturing and industries’ value addition (as a percentage of GDP) increased for both of the LDCs, the LMICs and UMICs experienced a decrease.

Market capitalisation of listed companies (as a percentage of GDP) increased for all six countries, but Bangladesh performed exceedingly well in this regard.

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financial sector to support private investment and trade was demonstrated in Bangladesh when the banks began to extend trade finance through back-to-back letters of credit rather than export orders. A further innovation in Bangladesh remains the supply of micro-credit for small-scale and cottage-level production. The general trend is that the share of credit to the private sector (as a percentage of GDP) increases with the rise of per capita income, but that much depends on the maturity and sophistication of the financial market. Thus, in Ecuador, like Mauritius, the share was only 27% of GDP. Market capitalisation. It is believed that with the rise in income level and private investment, equity financing becomes more important than debt financing. Thus, Mauritius had the highest share of market capitalisation of listed companies (61% of GDP in 2012), whereas the comparable figure for Ecuador was only 7% of GDP. Market capitalisation derives the highest share of development finance for Indonesia, which has significantly increased since 2004, followed by a drop during the global financial crisis in 2008. Indonesian state-owned enterprises (SOEs) also play a major part in the country’s capital market. In 2010, listed SOEs contributed about 30% of the total market capitalisation on Indonesia’s stock exchange. 3.2 International finance As noted earlier, the role of ODA (as a percentage of GDP) in all six countries is on the decline. ODA and external debt. Tanzania had the highest share of ODA among the six countries at 10.2% in 2012. Net ODA and other official aid received by the country had been increasing over the previous 20 years (except during the period of multiple crises 2007–2010), which also affected the donor countries. Tanzania is one of only a few African countries to have benefitted from increased donor support due to its relatively solid public governance. However, due to the rapid expansion of the economy, net ODA as a proportion of GNI has been on the decline, despite some increase in absolute terms. Moldova has the second largest share of ODA – 5.8% of GDP in 2012, down from 9.4% in 2000. The EU is the major source of ODA in Moldova. Despite having policies and strategies to increase domestic resource mobilisation (DRM), the country has been a net recipient of ODA, usually in the form of loans, grants, and contributions (which do not require repayment). Much of the ODA received by these countries is allocated to poverty-reduction and development interventions, as well as government development expenditure, accounting for around 40% of the national and 80% of the development budget, respectively. ODA can still play an important role in financing large public infrastructure projects (particularly through international financial institutions including regional banks) and social programmes including safety nets (particularly through bilateral donors, which provide mostly grants). The ‘moral hazard’ inherent in the aid relationship is that it rewards the non-performing (failing) countries rather than those which have successfully achieved MIC status. Indeed, there is also a ‘missing middle’ in the development finance regime.

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A large part of ODA to developing countries takes the form of concessional loans. This results for many countries in a high level of debt-servicing liabilities, diminishing the value of net flow of ODA. For example, Tanzania has to allocate about 10% of its annual budget (2012–13) to service the foreign debt. Foreign Direct Investment. Tanzania had the highest share of FDI at 6%, followed by Mauritius at 3.2%; Ecuador had the lowest at 0.7% (based on WDI data). In the past decade, Tanzania has had an overall increase, although fluctuating, in foreign investment. The net inflows reached 8% of GDP in 2010, or about USD 18 billion. These investments have been directed to the mining (and natural gas exploration and extraction) and the service industry (especially in finance and tourism) and although they have led to sustained GDP growth of above 6.5%, this has been termed ‘jobless growth’. Thus, the challenge remains to reorient FDI in favour of the manufacturing sector and modernisation of agriculture. Moreover, if FDI inflow is not sustained at a relatively high level, the recipient country may soon become a net capital exporter due to outward remittances of profits and royalties by the foreign investors. Remittances. Remittances are the most significant source of development finance for Moldova, equivalent to about 25% of its economy in 2012. However, personal remittances will decline in importance in the medium term, as many Moldovans move abroad to join their families. In 2013 alone, officially more than 2,500 Moldovans moved to settle abroad. The majority of migrants are below 40 years of age and as more of them settle permanently abroad, the remittances will decline. Bangladesh had the second highest share of remittances at 12.2% of GDP in 2012, although most of its migrant workers live in their host countries temporarily (only in connection with their employment). The challenge here is to keep up a steady outflow of workers to neutralise the impact of returnee workers on remittances. 4. Enablers for Transformative Changes Transformation is a ‘process by which an economy upgrades and productivity grows works through a series of enablers, which also serve as intermediate indicators of competitiveness’. This section looks at the economic, social and environmental transformative experiences described in the CIs. In addition, a distinction between national and global enablers has been made in order to examine their ‘enabling responsibilities’. Further, the enablers have been distinguished in terms of their direct or indirect impact. Table 4.1 presents the consolidated picture. As mentioned earlier, a country’s transformation takes diverse forms and routes, but tends to be based on an operational interaction between different enablers.46 Table 4.1: Economic, Social and Environmental Enablers Global National

Economic transformation

Direct Enhanced global linkages Rejection of nationalism and inward-looking

Physical infrastructure Rural development Transport

46 Chapters 6–8 of the ERD 2014 discuss a range of enablers for economic, environmental and social transformation. This section relates diverse enablers within a specific country context.

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Global National policies Technical assistance Remittances FDI

Power Water and sanitation Social infrastructure Health and nutrition Education Penetration of technology Agriculture Rural livelihoods Legal rights Private and commercial use of computers Remittances National governance, regulatory reforms and policy coherence Political stability Privatisation Deregulation Establishment of Export Processing Zones (EPZs) Reform of the judiciary Convertibility of current account Adoption of floating exchange rate Less reliance on ODA and more on DRM over the last decade

Indirect

Technology as a tool to provide health services to the poor Technology contributing to empowerment of women Social projects

Interesting example

Jamuna Multipurpose Bridge Microcredit Impressive performance by the RMG sector

Social transformation

Direct

FDI Investments for climate improvements Remittances (although varying in degree of impact) ODA Support of consumption Development of services and demand for services and/or goods

Health, education, water and sanitation, social protection and technology were prioritised Changes in government policies Dollarisation Changes of laws and contracts as regards oil exports (for oil-exporting countries) Strengthening of the government’s fiscal priorities Tax policy reforms Increase in tax base and compliance Restructuring of national debt Re-establishment of public finance priorities Limitations of private international flows Enhancement of productivity and technology Institutional development and reshuffling of government spending Decentralisation reform Ensuring local government autonomy Capacity building of local public administration Infrastructure development in this regard

Indirect

Export (as a source of private finance and investment) Infrastructure

Macroeconomic and political stability

Interesting example

The concept of ‘sumak kawsay’ (a new model of development, where the constitution highlights social rights such as access to health, education and decent employment) or ‘living well’

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Global National Creation of Free Economic Zones (FEZ)

Environmental transformation

Direct

ODA Exports Enhanced global linkages Direct trade flows Competition of FDI in third markets Bank lending FDI

Physical infrastructure Significant improvement in telecommunications Initiation and implementation of PPPs Reliance on non-concessional loans Social infrastructure development Increase in labour productivity Pursuit of educational policies, with improved educational indicators Policy modification to support sustainable development Existence of sustainable access to improved water and basic sanitation Education for sustainable development aiming to educate youth Land as an enabler Transforming agriculture from subsistence to commercial farming Inclusion of the private sector (also PPP arrangements) Provision of donor funds (also catering to technology) Establishment of SEZs Governance Control of corruption Voice and accountability Political stability and rule of law Government effectiveness and regulatory quality

Indirect FDI policies coupled with other economic and social policy reforms

Interesting example

Strong policy reforms (on a positive marker)

Source: Compiled from CIs

4.1 National enablers Infrastructure Infrastructure has been a prime enabler of transformation in each of the CIs. Infrastructure, social and physical, is imperative for economic transformation. While roads and ports are necessary to make domestic and international linkages together with power, technology and other infrastructure, human development is equally essential. There are weak implementation capacities relating to the quality and type of infrastructure in developing countries, although there have been gradual improvements. Physical infrastructure features in all of the CIs, in particular in relation to significant and observable improvements in rural development, transport, power, water and telecommunications. Specifically, Indonesia initiated and implemented PPPs together with the reliance on non-concessional loans to further its economic transformation. Health, sanitation and educational facilities feature prominently in economic and social transformations, while enhancement of labour productivity, modification of educational policies to support sustainable development and other environmental measures were highlighted in the countries that underwent

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environmental transformation. Specifically, social protection has been prioritised in Bangladesh and Ecuador and environmental carrying capacity (existence of sustainable access to improved access to water and basic sanitation and sustainable development education) by Indonesia. Interestingly, Indonesia has stressed environmental capacity development, an aspect that does not feature in other CIs. An interesting example is that of the concept of ‘sumak kawsay’ or ‘living well’, a new model of development pioneered in Ecuador, whose constitution highlights social rights such as access to health, education and decent employment. Creation of Free Economic Zones (FEZ) is a distinctive feature of the Moldovan government. Governance Governance has been identified as one of the essential enablers of transformation. Economic transformation incorporates regulatory reforms and policy coherence. The fact that governance, together with improvements in the rule of law and judicial fairness, plays a vital role in the transformation of a country is well known. Specifically, the attainment of political stability, privatisation, deregulation, establishment of EPZs, reform of the judiciary, convertibility of the current account and adoption of a floating exchange rate are identified as the governance-related enablers for the countries that underwent economic transformation. For social transformation, changes in government policies can be identified as the major enabler. Ecuador, the only oil-exporting country among the CIs, took specific measures to change laws and contracts regarding mineral and oil exports and dollarisation. The government of Ecuador regained power of fiscal policy by recentralising resources of the oil industry, reorganised public finances and spending priorities, strengthened fiscal priorities by increasing tax policy reforms and increasing the tax base and compliance and most importantly, restructured the country’s national debt. Moldova, the other economy undergoing social transformation, undertook institutional and decentralisation reform, local government autonomy and building the capacity of local public administration as the prime enablers. Control of corruption, political stability and the rule of law, government effectiveness and regulatory quality and voice and accountability, together with the enablers of other transformations, led environmental transformation in Tanzania. Technology Technology plays a catalytic role in harnessing different aspects of transformation. Previously neglected, technology has become a prerequisite of development, shaping a country’s ideas, practices, standards and other global benchmarks, allowing it to aim higher and not to stagnate. The CIs rightly point to the importance of technology as an enabler, particularly in the areas of agriculture, rural livelihoods, legal rights, sending of remittances, personal and commercial use of computers, and of course productivity. With improved equipment and machinery, technological advances enable health services to be provided to the poor and can contribute to the empowerment of women.

Scope of governance reforms: Regulatory reforms Policy coherence Rule of law Reform of the judiciary Attainment of political stability Privatisation Deregulation Tax policy reforms Decentralisation Institutional reforms Local government autonomy Capacity building Corruption Government effectiveness Regulatory quality Voice and accountability

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4.2 Global enablers Global linkages The intensification of global linkages is identified as another fundamental enabler in most of the CIs. Trade promotion, financial linkages and FDI are key constituents of global linkages. Exports have been a source of private finance and investment for each of the countries. Bangladesh and Mauritius have taken advantage of global linkages in extending their exports in the field of textiles and garments (Bangladesh is currently the second largest exporter of RMGs after China). These countries flourished in this arena as a result of outward-oriented economic strategies, rejection of nationalism and inward-looking policies and successful collaboration with donors (which also contributed technical assistance). All of the other CIs stress the expansion of global linkages. The Tanzania CI specifically pointed to competition in developing country markets, direct trade flows and trade in non-conventional markets, competition for FDI and bank lending as the components of ‘enabling’ global linkages. FDI and remittances FDI is identified as an enabler or complementary enabler in all of the CIs. Some of the countries have attracted FDI because of their political stability and attractive policies, others have constructed SEZs or FEZs to attract investment. Remittances, likewise, have benefitted the transformative process in several cases. For example, Bangladesh and Moldova benefitted tremendously from remittances. Remittances might not have contributed to infrastructure development in Bangladesh, but they have helped to increase disposable household income especially in the rural areas. Remittances play an appreciable role in the Moldovan economy, complementing its social and economic transformation. Remittances have had little or no impact on poverty in Ecuador since most of the recipients are high-income individuals. Global issues Global economic or macroeconomic stability will significantly determine the transformative capacity of individual countries. This is because of global integration involving trade, finance and a range of other determinants. Hence, many of the CIs suggest that global stability would be both an enabler and a prerequisite of transformation. Moreover, tax regimes should be reviewed and reinforced to curb illicit financial flows and retain capital for investment in the local economy. This would lead to greater investment in the local economy to complement the enablers, both national and global. Illicit financial flows concerning developing countries (Kar and Freitas 2013) shows the intensity of the problem. Furthermore, multilateral trading systems should be given more importance as there are already examples of countries benefitting from these (e.g. Bangladesh and Mauritius benefit from preferential access in the EU and the USA), and they would complement the global linkage enabler. Hence, individual countries should address this issue and build appropriate networks. Selective country-specific enablers Certain enablers are country-specific rather than global in nature. For example, microcredit programmes in Bangladesh have been very important in empowering women (rural women in particular) and providing finance for small-scale businesses. The policy to restrict private international flows in Ecuador is another example of a country-specific policy. Funding of social projects is a dominant strategy for Mauritius,

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while Moldova has preferred foreign investment and capital as a development strategy. The Tanzania CI highlights exceptional topography as an enabler, and the transformation of the agricultural sector from subsistence to commercial farming, ODA (with technology spillovers) and inclusion of the private sector (in relation to PPPs) is its preferred approach to transformation. 5. Complementary Policies Policies in different areas interact with the chosen financial options. Preferential treatment in the main export markets (i.e. RMG sector in Bangladesh), duty-free-quota free (DFQF) market access, quota facilities provided by the importing countries under the Multi-Fibre Arrangement (MFA) and zero-tariff market access are global policies that interact with exports. Fiscal and exchange-rate reforms, securing access for local products and services through treaties (e.g. Yaounde, Lomé, AGOA, DTAs in Mauritius) and joining regional groupings (e.g. COMESA, SADC, IOC, IORA) provide complementary support to trade and FDI. Global funds under the AfT package and technical assistance provided by UN agencies, the Commonwealth Secretariat, AFD, the EU and others help to mobilise ODA. These are some of the supporting global policies that have enabled economic transformation towards a higher growth trajectory.

5.1 Global linkages A number of complementary global policies have enabled the Bangladeshi economy to transform towards a higher growth trajectory. The quota facilities provided by the importing countries under the MFA and zero-tariff access to a number of developed country markets have helped to boost RMG exports from Bangladesh. The country’s entrepreneurs were able to take the advantage of favourable global policies and increased market access for their RMGs. In sum, greater financial resources generated by the export-oriented RMG sector and migrant workers’ remittances have helped to sustain higher growth. Bangladesh is eligible for the AfT package, which is part of ODA. Under AfT both financial and technical support is provided to improve export diversification in LDCs and enhance the quality of their exports so that the countries can increase trade. Such support is expected to help LDCs overcome their supply-side constraints so that they can take advantage of DFQF access to markets in developed countries. Although Bangladesh achieved impressive export performance, mainly through RMG exports, the country is unable to take advantage of the market access facilities due to various domestic constraints. Owing to lack of resources, poor infrastructure, weak productive capacity and technological base, low competitiveness, weak institutions, bureaucratic complexities and lack of trade-related professional expertise, Bangladesh remains less competitive than other countries in the Global Growth Competitiveness Index. Global linkages in terms of collaboration with donors was an important enabler of structural transformation in Mauritius, both at the national level and in the restructuring of the sugar industry. Mauritius used ODA and multilateral assistance relatively well, thanks to the combination of complementary factors such as government interventions, fiscal and exchange-rate reform, institutions set up for trade promotions and attracting FDI. The government was instrumental in securing access for Mauritian products and services in treaty negotiations (Yaounde, Lomé, AGOA, DTAs) and joining regional groupings (COMESA, SADC, IOC, IORA). Technical assistance has been provided by UN agencies, the Commonwealth Secretariat, AFD and the EU, among others. Many of the programmes were successful thanks to consultation with local

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stakeholders on the conception and design. Without such technical assistance (often provided on a grant basis) it is doubtful whether Mauritius, with its limited human resource base, would have moved so fast. The flexible attitude of foreign institutions also helped. FDI helps to promote economic development in Indonesia, especially poverty reduction job creation, spillover effects on technology, innovation, and knowledge, and increased tax revenues. Moldova made great adjustments to its foreign relations, policy and general framework in 2014. There is a widespread opinion that this was accepted by EU officials because of the complicated situation in Ukraine. Thus, adverse conditions across Moldova’s borders and the EU’s willingness to protect Moldova from these negative influences, contributed to faster moves towards EU accession. ODA influenced these linkages via strengthening institutions, developing infrastructure and skills, all necessary for being a solid partner for the EU and globally. At the same time, these global linkages also will affect ODA. Moldova will obtain more assistance in order to become an EU association partner. At the same time, controls on ODA efficiency are likely to become more intensive so that it is focused on sustainable development, and probably more for economic infrastructure and transformation and less for social programmes. In terms of global linkages, migration is more significant than remittances per se. Diaspora networks are providing potential benefits for trade, investment and skills development. The government set up a Diaspora Relations Bureau, which is responsible for the cultural, economic and social activities of various institutions to support the diaspora. The government and political forces are interested in the diaspora for many reasons, one of which is that Moldovans living abroad can vote and the elections are in November 2014. In Tanzania, the total accumulated value of foreign assets accrued through FDI has followed a positive trend. Following the liberalisation and economic and social reforms over the past two decades the FDI stock has tripled. Policies adopted in the early 1990s to undo the social orientation that the economy had pursued for over 20 years resulted in positive trends which, along with regulations to enable privatisation and free-market mechanisms had played a critical role in encouraging FDI and improving global trade linkages. Trade in FDI stock has risen significantly over the past decade and remains favourable. This may be in part attributed to the country’s establishment of SEZs in the hope of fostering rapid economic development through promotion of exports, attracting local and foreign investment, and generating employment. International trade has been improving and the balance of payment is deemed favourable. Preferential treatment in export markets Preferential market access is one of the most significant complementary factors for Bangladesh, particularly in the RMG sector. Within 20 years Bangladesh has transformed from being aid- to trade-dependent, owing to a number of policies that have been adopted by successive governments since the 1980s. These policies include market-oriented reforms, tariff liberalisation and pursuit of an export-oriented growth strategy. Significant reductions of various customs duties and tariff waivers were introduced, along with the removal of trade-related quantitative restrictions, the elimination of import-licensing procedures, and the unification of exchange-rate regimes in the early 1990s. At present there are various incentives and policies to boost the export performance of identified sectors and products. In Ecuador the government has prioritised expanding country’s geopolitical relations and accelerating regional

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integration processes. During the global financial crisis, Ecuador injected resources to the economy and created an active trade policy by supporting certain production sectors and by applying import safeguards. This policy was successful in favouring certain sectors of Ecuador’s industries, slowed imports, and held back the foreign currency drain, as well as helping to regulate imports flow and confront trade balance issues. Indonesia’s shift from import substitution to export promotion facilitates finance mobilisation. The outward-looking strategy believes in each country’s comparative advantages to decide what goods and services to be produced and exported. They are also open to FDI. However, due to being more open and therefore exposed to global influences, Indonesia was hard hit by the 1997 Asian Financial Crisis. 5.2 Domestic policies National governance, policy coherence and technological advancement National governance, policy coherence, global linkages and technological advancement are identified as some of the most significant enablers. These enablers coincide with certain complementary factors. For example, Mauritian political stability is manifested in terms of broadly shared beliefs of the political class and consensual adherence to an outward-oriented economic strategy, market-driven development, and the rejection of nationalisation and inward-looking policies. These factors have reinforced policy coherence. For instance, unlike the case in other countries, the Export Processing Zones (EPZ) Act did not refer to a specific geographical area. It was instead a legal entity that provided the holder of an export enterprise certificate with generous incentives such as tax holidays, duty-free import of raw materials and equipment, free repatriation of capital, and flexible labour regulations. The importance of an appropriate meso-micro incentive structure, consistent with macroeconomic objectives of stability, prudence and balance, cannot be over-emphasised. Even so, the Mauritian economy did not really take off before the mid-1980s. The main reason was the failure to get prices right, i.e. exchange rate, interest rates, tariffs and tax policies, all of which have to be geared towards a clear-cut goal – development through the adoption of an outward-looking strategy. Furthermore, complementary polices have added to technological enhancements, e.g. a strategy for the consolidation and modernisation of existing industries through technology and productivity development was defined and institutions were set up, such as the Export Processing Zones Development Authority to provide support to export-oriented enterprises to restructure, the Mauritius Offshore Business Activities Authority to promote the development of financial services, the Mauritius Freeport Authority to promote transshipment from Mauritius. In Bangladesh, the replacement of ‘planned economic growth’ by the private sector-led growth was mainly due to donor conditionalities. Such policy shifts contributed to the stabilisation of the macroeconomic situation and bringing greater discipline in the fiscal and monetary sectors. The reform process that began in the 1980s in terms of withdrawing agricultural subsidies, privatisation of SOEs, liberalisation of the financial sector and withdrawal of quantitative restrictions were further consolidated in the 1990s. The open economic policy has also facilitated the inflow of finance in various sectors that had been the exclusive domain of the public sector during the initial years. Both domestic and external private investment was allowed in the areas such as power generation and distribution, telecommunications, aviation, healthcare and education. Donors provided support for improving a number of macroeconomic and sectoral targets, and also focused on decentralising public administration and reforming the judiciary as a means to improve their governance. Liberalisation policies received

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further momentum in the 2000s. The country made its currency convertible on the current account, adopted a floating exchange rate, reduced import duties further and removed control on the movement of foreign capital. The financial sector adopted various reforms in the 2000s including deregulation of interest rates, which allowed competition among banks. Thus the reform measures continue as the country strives to improve its economic performance. Despite the acceptance of donor conditionalities, however, the flow of ODA has been declining. This is not only because of the overall shortage of ODA, but also due to the increased capacity of the domestic economy to mobilise resources attained through successful implementation of various policies. The creation of an enabling environment also helped the country to be integrated with the global economy. One of the positive outcomes of various reform measures was the improvement in domestic revenue mobilisation effort since the 1990s. While the flow of ODA declined to 2.2% of GDP in FY2013, investment and savings rates started to increase, which resulted in higher economic growth. Due to various reforms and incentives in trade and finance there has been greater private investment during the 1990s and 2000s. Conducive policies also attracted FDI, including tax incentives and profit repatriation facilities. The challenges for increasing tax ratio in Indonesia come from many aspects, in particular governance. In Tanzania too, good governance is a key criterion in enabling the recipient country to access prospective and/or existing grant(s), loan(s) or development funds. As an aid-dependent country, Bangladesh has had to address key governance issues, in particular: voice and accountability, political stability and the absence of violence, government effectiveness, regulatory quality (macroeconomic stability); control of corruption and the rule of law. Adherence to good governance practices will be key to the ability to attract private-sector investment and financial-sector confidence to expand services in the country. Tackling corruption has been one of the most pressing challenges for Tanzania, where high-profile scandals have seriously damaged its standing with donors, and the proposed budget cuts jeopardise national development and poverty-reduction goals. There is widespread public dissatisfaction with government efforts to combat corruption overall and the performance of the Prevention and Control of Corruption Bureau (PCCB) in particular. The main reason for dissatisfaction relates to low conviction rates in cases of grand corruption. The central plank in the government’s anti-corruption platform is Public Procurement Regulatory Authority, which evaluates the procurement accounts in public entities. Public entities account for a substantial portion of national expenditure. In an effort to enhance the transparency of its agencies to comply with the agency’s auditing, this has over time resulted in an impressive improvement. In committing to international definitions of openness, Tanzania is a member of the global initiative for reinforcing transparency in transactions in the extractive industry, and is among few countries to adopt the open government global initiative launched by the G8. Fiscal policies/tax reforms In Ecuador, fiscal policy is considered both as a means to control the market and also to achieve development goals. The previous constitution lacked a strong focus on planning and programming which is present in the current public policies. Since 2007, the National Secretariat of Planning has developed three versions of the National Development Plan, which includes goals related to social transformation. Although the government has regained power of its fiscal policy by recentralising the resources of the oil industry, which it is intended to use to meet the specific needs of the surrounding

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communities. The government therefore created a National Enterprise in 2011 to carry out key projects in provinces were oil, mining or hydroelectric currently operate or will operate in the future. In Mauritius, prior to the structural adjustment programmes (SAPs), fiscal policy was characterised by high government expenditure, financed by high taxes and external borrowing. The fiscal and exchange rate-reforms undertaken in the context of the SAPs ensured more efficient fiscal governance. In Indonesia part of the public revenue comes from corporate taxes, while at the same time most of government budget has been allocated to routine spending, leaving limited fiscal space for development. Indonesia needs to diversify the sources of public revenue and reduce the fiscal burden. Since 1991, the government has made two key changes to the tax system in Tanzania: simplification of the customs tariff structure in 1992, from over 50 to just five rates, designed to reduce tax evasion, and the introduction of VAT in 1998 that aimed to replace ‘the highly distortionary sales tax’, the hotel levy, and receipt-based stamp duty. Since 2000, the government made further policy changes to the VAT regime. Trade policy and investment promotion In Mauritius, FDI was actively encouraged, and there was a general consensus that this was in the country’s interest. Mauritian nationality was offered to Hong Kong investors when the future of the former British colony was being discussed in preparation for the handover to China in 1997. This second surge of investment from Hong Kong propelled the remarkable growth of the textile and clothing sector in the 1980s. Institutions were set up specifically to promote trade and attract investment and their boards of directors comprised more representatives from the private than the public sector. Ecuador’s exchange-rate policy was instrumental in maintaining the competitiveness of the economy. The government has prioritised expanding geopolitical relations and accelerating the process of regional integration. During the global financial crisis, Ecuador injected resources to the economy and created an active trade policy by supporting certain production sectors and applying import safeguards. This policy was successful in favouring certain industrial sectors, slowing imports, and holding back the foreign currency drain as well as helping to regulate imports flow and confront trade balance issues. Other government interventions Ecuador’s 2008 constitution re-affirms the role of state in promoting development. Domestic capital and savings became a driver of development, while monetary reserves and social security funds have been used to fund productive investments and public banking across different sectors of the Ecuadoran economy. The Lomé Convention provided Mauritius with sufficient market openings for its growing textile industry. In addition it guaranteed a substantial sugar market at a price usually higher than the world price. The government played a key role in building institutions, developing infrastructure and creating a growth-friendly economic environment. While this does not imply that all the policies it followed were necessarily correct, they have successfully fostered economic growth – securing guaranteed prices and markets for sugar, adhering to international conventions which gave Mauritian

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goods access to the then EEC and to quotas for its textile exports to the USA; providing free primary and secondary education to support a literate and adaptable labour force; and investing heavily in physical infrastructure without neglecting social needs. The government of Tanzania has launched various initiatives aimed at promoting productivity and raising value addition in the manufacturing, mining, tourism, and agricultural sectors. The products include gemstones and minerals, fish and fish products, horticultural produce, spices, cotton and textiles, handicrafts and tourist services. The government also has policies to foster development and investment in the mining, oil and gas sub-sectors. This is especially true of the FDI policies and incentives to attract investors in the mining sector, including guarantees against expropriation, nationalisation and other commercial risks; tax holidays; 100% ownership and expatriation of profits; duty exemption for project capital goods; investment allowances and deductions, for example, 100% capital allowance on industrial plant, buildings and machinery and on agricultural expenditure. Inputs for mining, agriculture, tourism and goods manufactured for export are all VAT-exempt, and businesses can carry over losses for five years against future profits. Under the import duty drawback scheme, businesses are entitled to a refund of duty charged on imported inputs for goods destined for export or to be sold to international institutions such as United Nations (UN) agencies. With these efforts, the Tanzanian Revenue Authority reports show that between 2008 and 2010 three groups have gained most of the exemptions: companies with certificates of incentives provided under the Tanzanian Investment Act and Zanzibar Investment Promotion Act, recipients of VAT exemptions and mining companies under the Mining Act. 5.3 Country-specific complementary policies Public planning. Ecuador’s 2008 constitution states planning functions as the base of the model of development and good living. The National Development Plan sets the overall guidelines for development and priorities for public budgeting and investment (mobilising financial flows to social sectors), emphasising social transformation and economic reform. Measures for SME development. Domestic tax revenues come mainly from SMEs in developing countries. In Moldova the strategy to develop the SME sector from 2012 to 2020 was approved in 2012. According to the Ministry of Economy, this strategy and the plan for its implementation provide the mid- and long-term policy framework for the development of micro, small and medium enterprises in Moldova in the transition from a consumption-based economy to one oriented towards export, investment and innovation, and the political goal of European integration. A number of national programmes to support the SME sector are underway or have been implemented, e.g. the Credit Guarantee Fund (FGC), the Programme to Attract Remittances to the Economy - PARE 1+1, the National Programme of Youth Economic Empowerment (PNAET), the ‘Supporting the Implementation of the Migration and Development Component of the EU-Moldova Partnership for Mobility’, the ‘Effective Business Management’ Continuous Training Programme (GEA), and the programme to support the SME sector, funded by the Government of Japan. Increasing budget revenues from privatisation. In Moldova, a series of laws on PPPs, including the PPP for the Concession of the S.E. ‘Chisinau International Airport’,

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government approval of state assets and works and services of national public interest that are eligible for PPPs, as well as the government decisions on the National Council for Public–Private Partnership, and the PPP for building homes and buildings for social-cultural activities. International policy context. Moldova is part of the European Neighbourhood Policy (ENP), within which the EU–Republic of Moldova Action Plan (EUMAP) was signed in 2005, a political document setting out the strategic objectives of cooperation, with the main purpose being to bring Moldova closer to the EU. EUMAP was signed for a three-year term and was based on the Partnership and Cooperation Agreement (PCA). In 2010, Moldova and the EU pledged to negotiate an ambitious Association Agreement to replace the PCA. In parallel, EU authorities negotiated and completed in late 2010 with the Moldovan government the Visa Liberalisation Action Plan, which covered security of documents, illegal immigration, the rule of law and security and foreign relations and fundamental rights. In 2014 the visa regime for Moldovan citizens was liberalised and the EU initialled the Association Agreement on 29 November 2013. Moldova was expected to sign in June 2014. The Tanzanian National Energy Policy (2003). The broad objective of the policy is to ensure the availability of reliable and affordable energy supplies and use them in a rational and sustainable manner in support of national development goals. Its objectives mirror the Energy master plan, MKUKUTA and the country’s Vision 2025. This policy statement set out the national commitment to sustainable energy production and use. Industrial policy in Tanzania. In the latter 1990s, the government developed ‘The Sustainable Industrial Development Policy (SIDP) 1996–2020’, which aimed to shift the economy’s engine of growth from the public to the private sector. The idea was to consolidate the existing national industrial capabilities in the short run; and in the medium term to build up new capacities in activities with competitive advantages for export markets. To achieve this, the policy aimed to create an enabling environment, including fiscal incentives, transparency, a stable and simple regulatory framework and macroeconomic stability. Consequently, the industrial sector started to grow steadily and achieved a high growth rate.

Public–private dialogue. Close public–private collaboration forms part of good governance as it shows willingness on the part of political leaders to enter into dialogue and a sense of responsibility on the part of the industrial sector to participate constructively in the process of policy-making (e.g. in Mauritius). A precondition for effective dialogue is the existence of a structured private sector. Conscious of this, the private sector in Mauritius organised itself to speak with one voice in its dealings with government and established the Joint Economic Committee which comprised all the private-sector bodies. Thus, the relationship was built on trust, on the understanding that the government had social responsibilities and that the profitability of the private sector was not its sole concern. There are inevitably tensions but the existence of mechanisms for dialogue ensured that solutions were found. Ecuador’s economic regulation. A legal framework has been put in place to regulate and control finance and banking in order to lower interest rates, retrieve reserves from deposits abroad, make the productive system more dynamic, and bolster public banks

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and cooperatives. An anti-monopoly law penalises abuse by large firms. Ecuador’s labour and salary policy. The 2008 constitution made it illegal to outsource jobs and proposed the public oversight of companies to eliminate such labour flexibilisation. The universal social security policy was redesigned to affirm the mandatory nature of employees’ affiliation and avoid all forms of precarious working relations. From 2007 to 2012, the percentage of full-time employees affiliated to the social security system rose from 39% to over 62%. Between 2009 and 2012, the government has increased the minimum wage several times. Such policies have helped maintain and even increase households’ purchasing power. Whereas in 2007, the average household income covered 67.1% of the basic commodity basket, by 2012 this had risen to 91.5%. The constitution differentiates between productive as opposed to domestic and reproductive work. It also recognises unpaid work for the self-employed and carers and guarantees progressive social security for unsalaried labour, overwhelmingly performed by women. There remains a need to reorganise regulatory frameworks since they not only fail to encourage but often impede the collective organisation of labour. Ecuador’s production factors. The distribution of production factors is also covered by the constitution. The government has made progress in transferring and granting titles of ownership to government-owned land not under production, and has sold stock in various seized companies to their workers. Nevertheless, most agrarian reform has yet to be completed. The Water Resources Law facilitates the distribution of water. Ecuador’s redistribution policies. To create a new social inclusion structure (protection of purchasing power, continued subsidies, a combination of universal coverage and targeted social protection, and greater rights) based on reducing poverty and striving for greater equality has been established. Social wealth benefits a broad array of sectors and social classes. Ecuador’s oil contracts. Ecuador has moved from production-sharing to service-type contracts as part of the government policy to regulate the oil sector, and as an important source of funds to implement its social policy. 6. Future Scenarios and the Way Forward Section 6.1 summarises the key options for financing development in the short and medium term and Section 6.2 suggests guidelines for the proper development, management and coordination of finance flows. These recommendations are critical for ensuring that economic, environmental, and social transformations are sustainable in the post-2015 context. Table 6.1: Financial Flows FINANCIAL FLOWS Public domestic Tax revenues Public international ODA Private domestic Domestic credit to the private sector

Exports and Imports Private international Remittances

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FDI Blended PPPs COMPLEMENTARY MOI Financial innovation Developing financial institutions and capital markets

Innovative financial instruments Trade finance

Social and environmental innovations

Climate Health Energy

Other South–South Cooperation (SSC) Land acquisition

6.1 Current and expected flows of finance Short- and medium-term projections for each financial flow and complementary MOI are based on current trends and future expectations for infrastructure, policies, legal and political reforms, diplomatic relations, and economic structural changes, summarised in the following key points:

Tax revenues are the driving force behind infrastructural, social, and environmental transformations. All six countries have an infrastructural gap.

ODA is of declining importance and contributes only a minor part of GDP in the six countries but supports government budgets in implementing small, strategic projects. The precise uses vary according to each country context, although most ODA is focused on the social and environmental sectors.

The positive trends in domestic credit to the private sector, seen in all six countries, are encouraging. Domestic credit is the key source of finance for the private sector, and healthy credit flows are a good marker of economic development.

FDI inflows have declined and become more volatile since the global financial crisis. Infrastructure gaps, low investment security, and political volatility are among the key deterrents to FDI. Declining trends are discouraging, as FDI is an important indicator for economic growth. The world’s highest recipients (e.g. USA, China, Hong Kong, Brazil, Belgium) are either developed economies or experiencing rapid growth.

All six countries show a lack of financial innovation and underdeveloped financial markets. This can be attributed to low demand (for example, these countries’ industrial and service sectors – which generate much of the demand for domestic credit – have begun expanding relatively recently) and difficulties with monitoring and regulation.

Revenues from energy sources and natural resources depend on whether a country has such endowments (e.g. fossil fuels, hydroelectric opportunities, minerals and ores). Such revenues can contribute to the economy and provide a buffer against world price shocks (e.g. Mauritius is an energy importer and would be susceptible to fuel price hikes). However, these endowments are not a prerequisite for economic transformation, as service-oriented economies such as Singapore, Hong Kong, and Mauritius have demonstrated.

The lack of common trends in exports and imports, and the differences in each country’s foreign trade status since the global financial crisis, illustrate that these flows depend on each country’s unique comparative advantages.

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6.2 Needs and recommendations This section identifies the feasible and necessary post-2015 transformations, and the critical actions that each country needs to make. Although recommendations are country-specific, the common points are as follows:

For the two LDCs and LMICs, there is opportunity to increase tax revenues. This will be the most sustainable form of finance for critical infrastructural, climate, and social transformations.

Pursuing PPPs is a promising option for meeting infrastructural financing needs that cannot be fulfilled by the government budget. Developing countries like India have had much success with such initiatives, although they need to be transparently and carefully monitored. As the global financial crisis has illustrated, the ‘off-balance sheet’ privileges of PPPs can create serious economic vulnerabilities (such as with the cases of Freddie Mac and Fannie Mae in the USA).

There is still some need for ODA in all six countries. Funds should be used in small, strategic projects pertaining to climate resilience, trade finance, healthcare, education, and infrastructure.

Financial innovation and the development of financial institutions are critical. At the same time, these developments can be double-edged swords if incorrectly pursued. Development countries that pursue heterodox and innovative policies, tailored to local conditions, are more successful than those pursuing a ‘one size fits all’ framework or purely finance-driven globalisation.

Sustaining remittance flows is a priority for Moldova and Bangladesh. These countries need to better support their aspirant, current, and returnee migrant workers. Potential policies include: creating training programmes for aspiring migrant workers, helping returnee workers reintegrate, and improving credit availability for both groups.

Improving and supporting FDI inflows is a priority for all six countries. The current trends of weak inflows indicate that the countries must create infrastructure, improve accountability and transparency, and ensure investor security and political stability.

Green growth and resilience against climate change is a common priority. Urbanisation, industrialisation, and population growth mean that habitat destruction, climate change, GHG emissions, and pollution are ever-increasing dangers. Developed and rapidly growing economies like Brazil, China, and India are by far the world’s biggest polluters and emitters.

Renewable energy (e.g. solar or hydroelectric generation) is essential. Globalisation and foreign trade are the way to achieve rapid development

and reap the benefits of comparative advantage and spillovers associated with technology, capital, and knowledge transfers. Yet as the exogenous shock created by the global financial crisis has shown, this interconnectedness can also expose countries to lasting economic vulnerabilities. To prevent shocks of the nature and magnitude of the global financial crisis and Asian Financial Crisis calls for: a. Improved monitoring and regulation of global financial markets and

shadow-banking systems

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b. Increased regulation of Special Purpose Vehicles (SPVs) and PPPs, and greater transparency of their financial statements (such as ‘off-balance-sheet’ activities).

c. Diversification of exports to prevent over-reliance on too few commodities. This will create a buffer against shocks to any particular exports, and especially applies to countries with large export sectors.

d. Ensuring some local generation of necessities like food and energy, as this protects countries that are heavily dependent on importing them. For example, 90% of Mauritius’ energy supply is derived from imports because of a lack of carbon-based fuel endowments.

To summarise, while there are common trends in financing options and goals, each country needs to pursue heterodox policies that are tailored to its unique context. Although there is a need for global-level policy-making and cooperation, countries also need the policy space to formulate their own priorities and development paths. Domestic and international forces will shape how this space is – and can be – used. The post-2015 framework thus needs to be sufficiently flexible to respect this need for country diversity and domestic policy space. At the same time, the agenda must be sufficiently wide-ranging across a diversity of internal and external drivers and yet specific enough in each case. Only then can we expect the post-2015 agenda to be successful in guiding local and international actions, and thus ensure sustainable, supportive, and inclusive development across the world.

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Annex BOX 1: COMPOSITION OF GDP BY PRODUCTION SECTOR Figure 2.1: Composition in 2000

Figure 2.2: Composition in 2012

With the exception of Indonesia, the countries are dominated by the service sector. In 2012, Mauritius and Moldova had the largest service sectors, in part because of their low agricultural and natural resource endowments (including sustainable fuel sources).

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Bangladesh Ecuador Indonesia Mauritius Moldova Tanzania

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