Despite a huge increase in the number of sustainable development initiatives since the adoption of the 2030 Agenda in 2015, a persistent funding gap of $2.5 trillion per year is impeding the achievement of the Sustainable Development Goals (SDGs). What can and should we do about this. What is the role of governments and business?
Financiering van de SDGs in het decennium van actie
The first step in financing the SDGs is to ensure that capital is actually used effectively where it has a real impact on sustainable development. Global GDP in 2018 was estimated at $85 trillion and this means that if just 3% of global GDP were invested in sustainable development, the world could close the funding gap for the SDGs. This would allow the global community to meet its sustainability ambitions and collectively achieve the 2030 Agenda.
However, many obstacles stand in the way. The Global Future Council on Development Finance, convened by the World Economic Forum and consisting of 24 experts active in the field, is focusing on innovative ways to overcome the systemic challenges that limit the flow of development finance. The new Development Finance Transformation Map was created for the annual meeting in Davos in 2020, which provides an overview of the key dimensions that characterize the ecosystem.
The World Economic Forum brings together representatives from national governments, donors, multilateral and bilateral development finance institutions (DFIs), private investors, financial leaders and academia. The Forum believes that conventional approaches to development finance are inadequate to address the market failures that manifest themselves at the national level. Therefore, actions taken to date have not achieved the scale and speed required to mobilize the capital needed to achieve the SDGs.
With its focus on finding solutions, the Forum recognizes that integrated actions are needed from all participants – the providers of capital (supply), the users of capital (demand) and the institutions that connect the two (intermediaries).At the same time, the Forum also realizes that only limited progress will be made if these areas are explored in silos, given their interconnectedness.
There is a need for an integrated approach that takes into account the interplay between all elements. In this approach, public and private stakeholders at the global and national levels work together to bridge the funding gap of the SDGs to achieve more than they could separately. Moreover, for global leadership to be effective in practice, it must be harnessed to action at the national level so that the system can work in sync and achieve the speed and scale needed to make real progress in the decade of action.
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Supply side: aggregate investment opportunities to attract more capital
The private sector is seeking investment opportunities that match return expectations and risk appetite. Weak global economic growth expectations and the proliferation of bonds with negative returns mean that projects in developing countries and emerging economies that contribute to the realization of the SDGs should offer attractive investment opportunities. However, market failures discourage private participation in financing the SDGs. High risk perceptions, local currency volatility, information asymmetry between capital providers and project developers, and transaction size-to name a few-often turn an attractive investment opportunity into a highly complex transaction. This means that the ultimate expected return does not outweigh the risk and effort required by the investor to deploy the capital.
An example: Small Island Developing States (SIDS) are a group of 58 island states that face similar development challenges due to their vulnerability to natural disasters, their need for climate change resilience and their small size. While SIDS are in urgent need of new sources of capital to finance their plans under the 2030 Agenda, they face difficulties in attracting private sector investment given the high risk they face and the lack of projects with scalable returns.
The World Economic Forum is developing a framework to help SIDS attract capital and solve their size problem through the use of pooling tools at the national, regional or sectoral level. These tools can bundle smaller investment solutions into larger opportunities that can more easily attract private capital. This could become a viable mechanism for SIDS to find new sources of capital for the SDGs.
Demand side: a strategic approach to the use of all types of capital
Market failures also stem from the demand side. One such source of inefficiency is the lack of coherent strategic development planning: countries need to link their national allocation processes to the SDGs and develop a national financing plan for the 2030 Agenda.
Governments need to move away from a narrow project-based approach and towards a holistic financing strategy for the SDGs, involving all capital sources at different stages of the investment value chain.
During its previous mandate, the Global Future Council on Development Finance recommended that countries should focus on thee transition of “funding” to “financing”, which no longer relies on official development assistance (ODA) and other public financing, but clearly identifies the right kind of capital for each project, with a holistic consideration of all sources of capital – domestic, international, private and public – that can be leveraged at the national level.
Furthermore, the Forum believes that governments can make or break a country’s attractiveness to investors. By fostering a sense of “investable governance” and creating a conducive environment that enhances investor confidence, a country can set itself up for success. For example, implementing a regulatory framework that attracts private investors through business-friendly policies will encourage further business investment. To achieve this, multi-stakeholder collaboration is essential so that the public and private sectors can align on the right kind of measures needed to improve the governance of a country in which to invest.
The changes will only have a lasting impact if they build on the consensus of both public and private stakeholders and thereby enable the country to hold on to an overall governance framework that continues to support domestic and international investors operating in the country.
Intermediary institutions: act as catalysts in the interest of countries
The supply and demand dynamics outlined above will evolve within an existing development finance landscape, and it is critical that the relevant intermediary institutions are better able to match the supply and demand for capital for the SDGs. This will require a fundamental reassessment of the roles of different development financiers and other stakeholders.
In particular, multilateral development banks (MDBs), regional development banks (RDBs), national development banks (NDBs), and development finance institutions (DFIs) must prioritize their role as catalysts that help countries shift from “investing” to “financing,” embracing a change that some institutions have already begun.
As countries shift from a “project by project” approach to strategic efforts to establish private markets and attract diverse capital providers, intermediaries must strengthen their ability to bring investors and countries together. This requires a deeper understanding of the different types of capital needed to achieve the SDGs (ranging from standard project finance to the most impactful type of venture capital) and the ability to work well with both the public and private sectors.
The World Economic Forum considers it critical that existing intermediaries focus on catalyzing new sources of financing, including from pension funds, insurance companies, and small investors who have not traditionally been active providers of SDG financing.
This implies mobilizing private finance at various stages of the project life cycle. For example, MDBs tend to put their own capital into their own customized projects and hold that capital throughout the life of the project.
MDBs should find a way to get more private investors on their side at the start of the project and then attract more risk-averse investors by allowing refinancing of the MDB financing once the risk of the project has decreased. This would help mobilize a whole new class of SDG investors and also allow MDBs to recycle their own capital more efficiently.
MDBs could use their relative expertise to identify more projects acceptable to banks and make it easier for private financiers to get involved. There is an urgent need to attract more private investment in sustainable development in middle- and low-income countries, where MDBs and DFIs together mobilized only $69 billion around the world in 2018.
In Davos, members of the Global Future Council on Development Finance will meet with representatives from both the public and private sectors to engage them in reigniting the energy needed to meet the ambitious goals of the Decade of Action and Achievement.
Bridging the funding gap of the SDGs is not a matter of reinventing the wheel. It is about understanding and removing the barriers to the supply of and demand for capital and better aligning the two. We need only 3% of global GDP in investments to close the financing gap of the SDGs. This would bring the world one step closer to achieving the goals of the 2030 Agenda and achieving the inclusive growth and sustainable development we all desire.