290 32839 privatesector P U B L I C P O L I C Y F O R T H E NUMBER NOTE 2005 Private Finance APRIL Tim Harford, Are Private Loans and Charitable Giving Replacing Aid? Bita Hadjimichael, and Michael Klein Private financial flows to developing countries, such as debt, equity, remittances, and private charitable giving, have increased Tim Harford (tharford@ifc.org) is dramatically over the past 20 years. One commentator has even an economist, and trumpeted "the privatization of foreign aid." Since private Bita Hadjimichael (bhadjimichael@world charitable giving remains small and developing country governments bank.org) a senior PRESIDENCY are borrowing more, not less, from official sources, this claim is economist, at the World misleading. But unprecedented sums are indeed flowing to the VICE Bank and International Finance Corporation private sector in developing countries. (IFC). Michael Klein (mklein@worldbank.org) Private financial flows are having a huge devel- Net debt and portfolio equity flows are trivial is chief economist at IFC opment impact in the countries receiving them, compared with foreign direct investment and DEVELOPMENT and joint World and the momentum seems to be picking up. gross remittances; private flows go mostly to Bank­IFC vice president, Gross unofficial flows--foreign direct invest- middle-income countries (figure 2). private sector SECTOR ment, migrant workers' remittances, portfolio Foreign direct investment flows go largely to development. equity flows, grants from nongovernmental lower-middle-income countries--notably China, This Note is part of a organizations (NGOs), and loans without a sov- with 30 percent of the developing world's popu- PRIVATE series exploring trends ereign guarantee--increased sixfold between lation and 39 percent of these flows. Remittances, in the aid industry, 1970 and 1985, and nearly tenfold between though smaller, have already outpaced official including patterns of aid 1985 and 2002, to exceed US$380 billion (fig- development assistance and would exceed for- flows, competition, and ure 1). Official flows--loans, grants, export eign direct investment flows if the data excluded GROUP the effectiveness of credits, and publicly guaranteed debt--were China. (For a skeptical discussion of the data, see different types of aid. less than half this level in 2002, at less than OECD n.d.) And while direct investment flows to BANK US$180 billion. As recently as 1985 official flows developing countries are roughly proportional to had been three times as large as private flows. the size of their economies--with lower-middle- Net flows give an alternative picture, because income countries overrepresented--remittances large repayments or profit repatriations can to low-income countries are large relative to their WORLD make gross flows huge even while net flows are economies (figure 3). small or negative. Net flows to the private sector Remittances also are important because THE in developing countries display clear patterns. they go directly to households, often for P R I V A T E F I N A N C E A R E P R I V A T E L O A N S A N D C H A R I T A B L E G I V I N G R E P L A C I N G A I D ? Figure Unofficial flows far outstrip official flows to developing countries 1 Gross unofficial flows (US$ billions) Gross official flows (US$ billions) 400 400 300 300 2 200 200 100 100 0 0 1970 1975 1980 1985 1990 1995 2002 1970 1975 1980 1985 1990 1995 2002 Private, nonguaranteed debt Portfolio equity (net) Multilateral loans and grants Export credits Foreign direct investment (net) Remittances Other publicly guaranteed debt Bilateral loans and grants NGO grants Source: World Bank, Global Development Finance database; Organisation for Economic Co-operation and Development (OECD), Development Assistance Committee. spending on essentials or investing in a new this private charitable giving is poorly measured house or business. The total flow is much more (box 1), figures on donations from the largest stable than foreign aid or foreign investment foundations (OECD 2003) suggest that annual (Ratha 2003), because the income and num- private giving from rich countries is probably ber of migrant workers change slowly. Even more than US$10 billion and less than US$25 recent money laundering laws have not damp- billion. Compare these numbers with around ened remittances, as many feared they would. US$70 billion of official development assistance Other private cross-border giving--from and US$98 billion of remittances in 2002. foundations, corporations, religious groups, and membership-based NGOs--is apparently Changing patterns of commercial finance substantial, yet far smaller than remittances and What trends have emerged in investment other sources of development finance. While flows--bonds, bank loans, and foreign direct Figure Direct investment and remittances top net private flows to developing countries 2 Low-income countries Lower-middle-income countries Upper-middle-income countries Net flows (US$ billions) Net flows (US$ billions) Net flows (US$ billions) 120 120 120 100 100 100 80 80 80 60 60 60 40 40 40 20 20 20 0 0 0 1970 1975 1980 1985 1990 1995 2003 1970 1975 1980 1985 1990 1995 2003 1970 1975 1980 1985 1990 1995 2003 Foreign direct investment Remittances (gross) Bonds Portfolio equity Bank loans Source: World Bank, Global Development Finance database. Figure Where does the money go? Box How well is private charitable giving measured? 3 1 Distribution by country income group, 2003 Data on private charitable giving reported to the Development Assistance Committee (DAC) of the Low Lower middle Upper middle Organisation for Economic Co-operation and Development (OECD) are patchy. For example, France, Percent reported by DAC to be the fifth largest source of private giving in 1992, reports no data from 1996 0 25 50 75 100 Foreign direct on. Ireland's NGOs are implausibly reported to have given US$56 million, US$0, US$5.7 million, and investment US$90 million in a series of four years in the late 1990s. Remittances Private giving also is vulnerable to double counting (Radelet 2005). NGOs receive funding from Gross national foundations and corporations and often substantial funding from governments too--all of which income might be counted once when transferred to an NGO and again when disbursed by the NGO. Population Recent estimates of U.S. private giving show big disparities. Adelman (2003) puts U.S. private giv- ing at US$17 billion annually, arguing that the OECD figure of around US$6 billion underestimates Source: World Bank, Global Development Finance database. the amount because most private donations are not reported. While Adelman has been criticized for lack of documentation, her estimate seems likely to be more accurate than the OECD figure. investment? One way of interpreting the pattern of these resource flows to developing countries is as a shift from debt to equity finance (figure 4). This shift occurred in two stages: In the early Figure The shift from debt to equity 1980s net flows of debt collapsed because out- All debt flows rose sharply and (perhaps as a result) gross 4 Foreign direct investment plus portfolio equity inflows fell. Then throughout the 1990s equity Net flows to developing countries (percentage of total) flows grew very quickly, mostly in the form of for- 100 eign direct investment. 80 Although net flows of private debt today are tiny compared with net foreign direct invest- 60 ment, gross flows of private debt remain quite large: US$247 billion in 2003, compared with 40 net foreign direct investment of US$152 billion. These gross disbursements of debt have 20 undergone big shifts in composition over the past 0 two decades. In the mid-1980s most debt flows 1970 1975 1980 1985 1990 1995 2003 from banks and bond markets to developing Source: World Bank, Global Development Finance database. countries were publicly guaranteed. Now gov- ernments prefer to borrow from multilateral debt with long maturities but presumably feel it agencies (see Note 289 in this series). Meanwhile, is too risky to do so, especially at interest rates commercial banks have found no shortage of cus- that could compete with those of official sources. tomers in the private sector (figure 5). Yet the demand for nonguaranteed private debt remains strong. The most likely explana- What explains trends in private finance? tion is the growing importance of the private So the major developments in private for-profit sector in developing countries after the privati- finance are a shift from debt to equity and a shift zation and deregulation of the 1980s and 1990s. away from private debt with a sovereign guaran- Still, equity finance, usually in the form of for- tee. What might explain these trends? eign direct investment, is much more popular As Note 289 in this series argues, the shift in than private debt finance. One important reason sovereign borrowing from private sources to is that equity finance shares risks in a way more multilaterals seems to reflect responsible debt likely to align the incentives of investor and recip- management: developing countries are seeking ient. Equity finance gives investors an upside risk longer maturities and paying off debt. This and so encourages them to transfer technology implies that the decline in private, publicly guar- and expertise. Direct investment also is less foot- anteed debt is a demand-side phenomenon. loose than portfolio capital or short-term debt Private banks and bond markets could supply and thus attractive to recipient countries. P R I V A T E F I N A N C E A R E P R I V A T E L O A N S A N D C H A R I T A B L E G I V I N G R E P L A C I N G A I D ? Figure The rise of nonsovereign debt 5 Gross disbursements (US$ billions) Gross disbursements (percentage of total) 160 100 viewpoint 120 80 60 is an open forum to 80 encourage dissemination of 40 public policy innovations for private sector­led and 40 20 market-based solutions for development. The views 0 0 published are those of the 1970 1975 1980 1985 1990 1995 2003 1970 1975 1980 1985 1990 1995 2003 authors and should not be attributed to the World Privately raised, publicly guaranteed debt Private debt without public guarantee Bank or any other affiliated Commercial bank loans Commercial bank and other loans organizations. Nor do any of Bonds Bonds the conclusions represent Source: World Bank, Global Development Finance database. official policy of the World Bank or of its Executive Directors or the countries Moreover, the risk of expropriation for for- finance, probably because direct investment has they represent. eign direct investment is arguably lower than more attractive risk-sharing properties. And the risk of repudiation for long-term debt. This while much of this investment is bypassing the To order additional copies calculation depends on the investment climate poorest countries, remittances are flowing in contact Suzanne Smith, and must be set against currency risk, which large quantities even there. managing editor, affects foreign direct investment but not dollar- Room F 4K-206, denominated debt. This tradeoff has presum- The World Bank, 1818 H Street, NW, ably swung in the direction of direct investment Washington, DC 20433. as typical (median) inflation rates have fallen in References developing countries. As long as the investment Adelman, Carol. 2003. "The Privatization of Foreign Telephone: climate in developing countries continues to Aid." Foreign Affairs 82 (6): 9­14. 001 202 458 7281 improve, large flows of direct investment can be OECD (Organisation for Economic Co-operation and Fax: expected to persist. Development). 2003. "Philanthropic Foundations and 001 202 522 3480 Development Cooperation." DAC Journal 2003 4(3). Email: Conclusion ------. n.d. "Remittances as Development Finance." ssmith7@worldbank.org Private finance is now the biggest show in town. http://www.oecd.org/dataoecd/62/17/34306846.pdf. But to speak of a privatization of foreign aid, as a Radelet, Steve. 2005. Comments in debate, U.S. Aid: Produced by Grammarians, provocative Foreign Affairs article (Adelman 2003) Generous or Stingy? Center for Global Development, Inc. recently did, is going too far: developing country Washington, D.C., January 13. (Transcript at http://www governments continue to borrow most of their .cgdev.org/docs/0113aid_debatetranscript.pdf.) Printed on recycled paper debt from official sources, and private charitable Ratha, Dilip. 2003. "Workers' Remittances." In World giving is substantially smaller than official devel- Bank, Global Development Finance 2003: Striving for Stability in opment assistance. But money from overseas is Development Finance. Washington, D.C. reaching the private sector in far greater amounts than a couple of decades ago, a large share of it remittances from migrant workers. Also very large are investment flows, which increasingly take the form of equity finance rather than debt T h i s N o t e i s a v a i l a b l e o n l i n e : h t t p : / / r r u . w o r l d b a n k . o r g / P u b l i c P o l i c y J o u r n a l