Money makes the world go round, and development projects succeed

The key to economic development and poverty eradication is investment. Nations prosper by investing in four priority areas. The most important is people, through quality education and healthcare.

The second is infrastructure, such as electricity, safe water, digital networks and public transport. The third is natural capital, like protecting nature. The last is business. The key is finance: Mobilising the funds to invest at the scale and speed required. 

In principle, the world should operate as an interconnected system. The rich countries, with high levels of education, healthcare, infrastructure and business capital, should supply ample finance to the poor ones. As the emerging market countries became richer, profits and interest would flow back to the rich ones as returns on their investments.

That’s a win-win proposition. Both countries benefit. Poor countries become richer; rich countries earn higher returns than if they invested only in their own economies.

Strangely, international finance doesn’t work that way. Rich countries invest mainly in rich economies. Poor countries get only a trickle of funds, not enough to lift them out of poverty.

The problem is, investing in poorer countries seems too risky. Look at the short run: Suppose the government of a low-income country wants to borrow to fund public education. The economic returns to education are very high but take 20-30 years to reap. Yet loans are often for only five years.

Suppose a country borrows $2 billion due in five years. That’s okay if it can refinance that with yet another five-year loan. With five refinance loans, each for five years, debt repayments are delayed for 30 years, by which time the economy will have grown sufficiently to repay the debt without a loan.

Yet, the country may find it difficult to refinance the debt. Perhaps a pandemic, Wall Street banking crisis or election uncertainty will scare investors. Then it is shut out of the financial market. Without enough dollars, and no new loan, the country defaults, and lands in the IMF emergency room, followed by cuts in public spending, social unrest and prolonged negotiations with creditors.

Give low credit score

Knowing this, credit-rating agencies like Moody’s and S&P Global give the countries a low credit score, below “investment grade”. So poorer countries are unable to borrow long-term and pay punishingly high-interest rates. While the US pays less than four per cent per annum on 30-year borrowing, they often pay 10 per cent on five-year borrowing.

The IMF advises poorer countries not to borrow much—in effect, telling them it is better to forgo education (or electricity, or safe water, or paved roads) to avoid a debt crisis. That’s tragic advice! It results in a poverty trap rather than an escape from poverty.

The situation is intolerable. The poorer half of the world is being told by the richer half: Decarbonise the energy system; guarantee universal healthcare, education and digital services; protect rainforests; ensure safe water and sanitation and more. All for a trickle of five-year loans at 10 per cent interest!

The problem isn’t the goals. They are within reach, only if the investment flows are high enough. Poorer nations need 30-year loans at four per cent, and much more financing.

There are two main solutions. One, expand roughly five-fold the financing by the World Bank and regional development banks (such as the African Development Bank). Those banks can borrow at 30 years and four per cent and on-lend to poorer countries on highly favourable terms. Yet their operations are far too small. To scale up, the G20 (including the US, China and EU) should put more capital into the multilateral banks.

Two, reorient the global financing system towards long-term sustainable development, with better advice, planning and accurate ratings. The big countries will have four meetings on global finance this year: In Paris in June, in Delhi in September, the United Nations in September and in Dubai in November. If they work together, they can solve this. That’s their real job, not fighting endless wars.

Prof Sachs is professor and director of the Center for Sustainable Development at Columbia University and president of the UN Sustainable Development Solutions Network. www.jeffsachs.org.