Hard Financial Questions about Soft Development Money

Achieving the Millennium Development Goals (MDG’s) by 2015 is a tremendous challenge facing the international community, and there is widespread agreement that additional external aid is required to meet it. So the question now is not whether to increase aid, but how best to finance it.

The search for additional and more stable funding to meet the MDG’s has led to various proposals for innovative financing mechanisms and debt relief, in particular by British Chancellor of the Exchequer Gordon Brown. But the broad range of proposed schemes to bolster resources for development assistance raises hard questions about the appropriate balance between objective needs and sound and effective financing.

Donors as well as recipients must ensure consistency between financing and absorptive capacity. They must also ensure that additional official financing and debt relief will not distort incentives or create moral hazard. New money should go to good performers, not just to those who are experiencing debt distress.

In addition to these issues, financing proposals to achieve the MDG’s should be discussed from a central banker’s perspective. The best solutions include sufficient increases in rich countries’ foreign aid allocations and more ambitious trade liberalization. But such policies seem politically untenable in the short term, even though – according to the World Bank’s estimation – an appropriate conclusion of the current trade round under the auspices of the World Trade Organization could contribute $350 billion a year to developing countries by 2015.