UNCTAD: Only 1% of South’s funds can finance LDCs’ development

South-South cooperation can be conducive to the emergence of an effective and stronger State in Least Developed Countries (LDCs), according to UNCTAD´s most recent report, which proposes a new type of developmental State for LDCs --one that is more appropriate to the specific vulnerabilities and the structural constraints of LDCs.

The Least Developed Countries Report 2011 --released last week and subtitled "The Potential Role of South-South Cooperation for Inclusive and Sustainable Development"— finds that South-South cooperation and State capacity-building in LDCs can be mutually reinforcing.

While cautioning that South-South cooperation should not be seen as a panacea, the report stresses that it can be a win-win strategy for LDCs and their Southern partners.

In most LDCs, the State has very limited resources available to finance governance and growth-enhancing policies, and is confronted with specific development challenges, such as the absence of economies of scale, underutilized resources in the rural economy, reliance on static comparative advantages, and sizeable technological and financial gaps.

The report argues that South-South cooperation is particularly well-placed for supporting LDCs to build developmental State capabilities through three main channels: direct support to State capacity-building efforts; sharing policy lessons; and providing alternative sources of finance.

The experiences of successful developing economies are particularly relevant for LDCs, especially in regard to their strategic type of integration into the global economy, the promotion of vibrant small and medium-sized enterprises, the development of innovative schemes to address rural poverty, and to build a broader growth consensus.

For instance, the lessons from poverty reduction measures taken by some Southern development partners --such as Brazil´s Bolsa Familia, India´s rural employment guarantee schemes, as well as the role of China´s Spark Initiative in generating rural non-farm employment within town and village enterprises-- could be valuable for LDCs.

The LDCs are a group of countries that have been classified by the United Nations as least developed in terms of their low gross domestic product (GDP) per capita, weak human assets and high degree of economic vulnerability.

The Report shows that despite strong GDP growth during the last decade, the benefits of growth were neither inclusive nor sustainable, mainly because growth was not complemented by structural transformation and employment creation. Growth and trade has not-recovered to pre-crisis levels after the global recession of 2009.

But most LDCs continue to deepen their specialization in exports of primary commodities and low-value, labour-intensive manufacturing, rather than diversifying into more sophisticated products. Growth projections also indicate that the poorest countries of the world could face a more volatile and less expansive global economic environment in the coming decade.

Further, the Report examines how South–South cooperation could support development LDCs against this background. It shows that there are intensifying economic relationships between the LDCs and other developing countries and that these helped to buffer LDCs from the downturn in advanced economies.

A major new trend in the pattern of integration over the last decade or so has been the deepening and intensification of economic and political ties with more dynamic, large developing countries, acting as growth poles for the LDCs. While intensifying South–South relations presents major new opportunities for LDCs in terms of markets, foreign direct investment, remittances and official financing, they also bring many challenges, ranging from extreme competition to de-industrialization.

Given that financing productive capacities still remains a major challenge for most LDCs, the report revisits the role of regional development banks and proposes new modalities through which a small part of the reserves that have accumulated in developing countries and that are managed by sovereign wealth funds could support the financing of development in the LDCs. South–South cooperation should be a complement to North–South cooperation.

Only 1% of sovereign funds can finance development

Channelling only a tiny part - 1% - of the $3.5 trillion of foreign exchange reserves held by developing countries in their sovereign wealth funds to LDCs can lead to a significant increase in development finance for these countries, claims the Least Developed Countries Report 2011.

This new proposal for increased South-South financial cooperation builds on the fact that using surplus financial resources from dynamic, emerging developing countries to fund development-oriented investment in LDCs can serve to build productive capacities, facilitate trade and support sustainable development.

In addition to increasing access to financing for LDCs, such investments would provide sovereign wealth funds with an opportunity to further diversify their portfolios.

Given the declining prospects for increases in official development assistance from industrial countries facing fiscal austerity and possible limits for private flows due to the crisis, access to new forms of development finance is critical for building inclusive development paths in LDCs.

Regional development banks can be significantly expanded to provide low interest loans to LDCs as an essential instrument to facilitate their development strategies.

In this context, UNCTAD is proposing that developing countries with sovereign wealth funds invest 1% of their assets in regional development banks, for example in the form of increased paid-in capital. This should be done on a voluntary basis.

Generally, regional development banks have performed very well in providing effective development financing, but they require additional resources to fund crucial investments, and this approach could prove to be an optimal vehicle for channeling resources to LDCs.

Regional development banks, such as the Asian Development Bank, for example, are already playing a key role in facilitating regional economic integration. In Latin America, some countries have also established subregional banks, such as the Inter-American Development Bank (IADB) and the Andean Development Corporation (CAF-Latin American Development Bank), which is considered to be very successful.

Greater involvement of the regional banks will enable a greater sense of regional ownership and control of development projects. Regional or subregional development banks often rely on informal peer pressure rather than imposing conditionality. This allows them to disburse resources in a more timely and flexible fashion. They also tend to better reflect the experiences of successful developing countries.

Although LDCs have very limited power to negotiate with large global institutions, their voice can be amplified by regional or subregional development banks. Good examples include financing regional infrastructure and coordinating the financing of region-wide projects in areas such as technological innovation. Another important function of regional and subregional development banks is financing small and medium-sized enterprises.

Financial sectors in most LDCs are mostly unable to fulfil these financing functions, as they remain shallow, underdeveloped and vulnerable to external shocks. In addition, the high level of indebtedness and dependence on foreign capital inflows means that LDCs are exceptionally exposed to external shocks.

Between December 2001 and the end of 2010, the value of global reserves increased from $2.05 trillion to $9.30 trillion. The bulk ($6.1 trillion, or 80%) of the increase in global reserves in 2001-2010 was due to reserves accumulated by developing countries.

A sizeable share of developing countries’ foreign exchange reserves have been accumulated in sovereign wealth funds, which are generally run independently from traditional reserve management by central banks and/or finance ministries. The total assets of these funds are estimated to be valued at $4.3 trillion, $3.5 trillion of which are held by developing economies.

South, a game-changer for the LDCs

The Least Developed Countries Report 2011 argues that dynamic Southern economies could provide LDCs with development opportunities, but an adequate policy framework is needed to harness the potential of these emerging partnerships.

The medium-term prospects for least developed countries (LDCs) are likely to be less favourable than in the previous decade, cautions the report. This is due to the downside risks surrounding the outlook for developed economies and also the uncertain dynamics underlying the rebalancing of the world economy. The forecasts for the medium-term point to average growth rates of around 5.8%, almost one and a half percentage points lower than during the boom period from 2002 to 2008.

The current unfavourable external conditions will not only affect the growth prospects of LDCs but also their export dynamism, putting into question their current development strategy, which is based on export-led growth. Indeed, recovery in terms of export performance has been slow.

For example, exports of goods from LDCs in 2010 were still below the 2008 level. In fact, the balance in merchandise trade turned negative during and after the crisis, contributing to a substantial deterioration of the current account of the balance of payments. There is also more volatility, especially in commodity prices and - most worryingly for many LDCs - fuel and food prices are high. The trends also portend somewhat weaker private external capital inflows and possibly less aid.

With a more subdued demand for their products in developed economies, LDCs would have to search for opportunities elsewhere. Large and dynamic developing countries, as well as regional partners, both within formal integration groupings and outside, could prove to be additional outlets for LDC exports.

As the LDCs have become more open and more dependent on primary commodity exports, they have also become more vulnerable to sudden swings in external conditions. The recovery from the "triple crisis" -food, fuel and financial - is partial at best in the LDCs, and the current world situation and the outlook in the mid-term are not promising either.

The report also points out that despite the resurgence of growth during the early and mid-2000s and their apparent resilience to the global recession, LDCs continue to play only a marginal role in the global economy. This is underscored by the fact that they represented one eighth of the world total population, but accounted for less than one hundredth of total world output in 2009.

Growth rates of 7.2 % recorded by LDCs during the boom period were not enough to reverse the long-standing trend of income divergence from other developing countries. Gross domestic product per capita of the LDCs fell, compared with that of other developing countries, from almost 40% in 1970 to less than 20% in the mid-1990 - and has stayed there ever since. Other indicators point in the same direction. The economies of LDCs today represent barely 1% of the world´s total merchandise exports. Likewise, their share of total foreign direct investment (FDI) is around 2.5%.

Expanding LDC-South Economic Relationships

The Report also illustrates how, in the span of a decade, economic ties with Southern partners have intensified remarkably and have become a crucial dimension of the LDCs’ integration into the world economy.

More specifically, the study indicates that developing countries contributed to nearly half of the expansion in LDCs’ total merchandise exports over the past decade, and that the importance of Southern markets has been steadily on the rise across the whole spectrum of LDCs.

In 2009, developing countries accounted for over half of LDC exports and approximately 60% of their imports. The composition of these trade flows, however, is radically different in the two directions. LDC exports to the South are dominated by primary commodities, which together account for over 90% of the total, whereas manufactured goods represent approximately two thirds of LDC imports from Southern markets.

Southern economies have also provided the LDCs with greater access to capital, particularly in the form of FDI. Between 2003 and 2010, when FDI inflows to the LDCs were growing at nearly 20% per year, the share of investment projects from Southern investors climbed from 25% to upwards of 40%.

The multifaceted economic relations of LDCs with other developing countries encompass not only trade and investment flows, but also migration, knowledge and technology transfers. Notably, two thirds of the nearly $26 billion of remittances inflows to the LDCs in 2010 originated in Southern countries.

The Report points out that the weight of these emerging partnerships is likely to become even more significant in the near future, given the dismal outlook for economic recovery in developed countries. None of this, however, is to say that the South has become a panacea for the LDCs.

The UNCTAD study argues that the key for the LDCs is the extent to which the dynamism of South-South economic relations can serve as a springboard for developing their productive capacities. In that respect, the so-called "rise of the South" is creating a broader set of opportunities for the LDCs, but also poses challenges. However, South-South cooperation should be a complement not a substitute for North-South cooperation.

More information

Least Developed Countries Report 2011: http://bit.ly/sh7ACe

Source

UNCTAD: http://bit.ly/bhyryb