Money Makes the World Go Round – and Development Succeed

The key to economic development and ending poverty is investment.

Nations achieve prosperity by investing in four priorities. Most important is investing in people, through quality education and health care.

The next is infrastructure, such as electricity, safe water, digital networks, and public transport.

Third is natural capital, protecting nature. Fourth is business investment.

The key is finance: Mobilising 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 poor countries, which must urgently build up their human, infrastructure, natural, and business capital. 

Money should flow from rich to poor countries.

As emerging market countries became richer, profits and interest would flow back to rich countries as returns on their investments.  

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

WHY NOT?

Strangely, international finance doesn’t work that way.

Rich countries invest mainly in rich economies. Poorer countries get only a trickle of funds, not enough to lift them out of poverty.

The poorest half of the world currently produces around US$10 trillion a year, while the richest half produces around US$90 trillion.

Financing from the richer half to the poorer half should be perhaps US$2-3 trillion a year. It’s a small fraction of that.

The problem is that investing in poorer countries seems too risky. This is true if we look at the short run.

Suppose a low income country wants to borrow to fund public education.

The economic returns are very high, but need 20-30 years to realise, as today’s children progress through 12-16 years of schooling and only then enter the labour market.

Yet loans are often for only five years, and denominated in US dollars rather than the national currency.

Suppose a country borrows US$2 billion, due in five years. That’s OK if in five years the government can refinance the US$2 billion with another five-year loan.

With five refinance loans, each for five years, debt repayments are delayed for 30 years, by when the economy will have grown sufficiently to repay the debt without another loan.

’TRAGIC ADVICE’

At some point, the country will likely find it difficult to refinance the debt.

Perhaps a pandemic, or Wall Street banking crisis, or election uncertainty will scare investors.

When the country tries to refinance the US$2 billion, it finds itself shut out of the financial market. Without enough dollars, and no new loan, it defaults, and lands in the IMF emergency room.

What ensues is not pleasant to behold. The government slashes public spending and faces prolonged negotiations with foreign creditors.

In short, the country is plunged into a financial, economic, and social crisis.  

Knowing this in advance, credit rating agencies like Moody’s and S&P Global give the countries a low credit score, below “investment grade”.

As a result, poorer countries are unable to borrow long term.

Governments need to invest for the long term, but short-term loans push governments to short-term thinking and investing.  

Poor countries also pay very high interest rates. While the US pays less than 4% a year on 30-year borrowing, a poor country often pays more than 10% on five-year loans.  

The IMF, for its part, advises governments of poorer countries not to borrow very much.

In effect, it tells the government: Better to forgo education (or electricity, or safe water) to avoid a future debt crisis. 

That’s tragic advice! It results in a poverty trap.  

The situation has become intolerable. The poorer half of the world is being told by the richer half: Decarbonise your energy; guarantee universal healthcare, education and access to digital services; protect your rainforests; ensure safe water and sanitation; and more. 

And they somehow have to do all of this with a trickle of five-year loans at 10% interest!

THE FIX

The problem isn’t global goals. These are within reach, but only if investment flows are high enough.

The problem is the lack of global solidarity. Poorer nations need 30-year loans at 4%, not five-year loans at more than 10%, and they need much more financing.

Put more simply, poorer countries are demanding an end to global financial apartheid.  

There are two key ways to accomplish this.

The first is to expand roughly fivefold the financing by the World Bank and the regional development banks (such as the African Development Bank).

Those banks can borrow at 30 years and around 4%, and on-lend to poorer countries on those favourable terms. Yet their operations are too small.

For the banks to scale up, G20 countries (including the US, China, and EU) need to put a lot more capital into those multilateral banks.

The second way is to fix the credit rating system, the IMF’s debt advice, and the financial management systems of borrowing countries.

The system needs to be reoriented towards long-term sustainable development.  If poorer countries are enabled to borrow for 30 years, rather than five years, they won’t face financial crises in the meantime.

With the right long-term borrowing strategy, backed by more accurate credit ratings and better IMF advice, poorer countries will access much higher flows on much more favourable terms.  

The major countries will have four meetings on global finance this year. If they work together, they can solve this.

That’s their real job, rather than fighting endless, destructive and disastrous wars.

• Jeffrey D Sachs is professor and director of the Centre for Sustainable Development at Columbia University and president of the UN Sustainable Development Solutions Network; www.jeffsachs.org