Finance and Development

Sustainable development is the Holy Grail of the international community, and the potential roles played by trade and finance lie at the heart of the search effort.  The extremely robust positive correlation between various measures of trade and financial development on the one hand, and economic growth, on the other, is the bread and butter of thriving sub-disciplines within economics.

Financial services, foreign investment and international aid are essential for trade growth and long-term development in low-income and emerging countries. Improving access to these, and boosting their efficiency, will be crucial for implementation of the sustainable development goals. In traditional development economics, the importance of trade and finance was reflected in savings and foreign exchange gaps. However, the underlying concepts and operational frameworks need to be updated to reflect changing links between trade and investment, use of innovative financial instruments and services, and the evolution of development experiences and aspirations.

The closer integration of global value chains has strengthened the links between trade, finance and sustainable development. Increased emphasis on the role of services and SMEs drives further change. The evolution of regulatory regimes, particularly possible fragmentation through mega-regionals, raises concerns in developing countries about potential difficulties to access markets and their capacity to attract financial resources.

Improvement of local financial services, capital markets, and institutional financial capacity are fundamental to development. Project finance is needed to build the hard infrastructure and skills base required to serve global markets. A large proportion of trade is financed by letters of credit, guarantees, and other instruments of trade finance, the availability and cost of which is central to the functioning of trade networks. To avoid dramatic reductions during the financial crisis, additional facilities such as the IFC’s Global Trade Liquidity Program and temporary trade finance windows were rolled out by regional development banks. A Global Trade Finance Facility, working closely with the WTO has been proposed as a potentially more permanent solution, together with an easing of regulatory conditions.

Official Development Assistance (ODA) remains a major source of revenue for Least Developed Countries (LDCs). Encouraged by the WTO-led Aid for Trade (AfT) initiative to mobilise resources to address trade-related constraints, ODA agencies increasingly focus and coordinate their support to local trade and finance reform programmes. Reporting burdens to receive ODA from multiple funders can be significant. AfT has helped build compliance infrastructure, reduce trade costs, connect developing countries (and in particular LDCs) through value chains and increase poor countries participation in trade. Furthermore, the latest trends in AfT flows are not very encouraging and recommendations are needed for boosting its effectiveness.

Preferential agreements do provide both procedural and substantive benefits to developing countries, including increased market access, lesser obligations, facilitated processes and technical and financial assistance. However, experiences with this framework are mixed. Trade preferences often do not extend to the commodities which matter most to LDCs, inflexible rules of origin reduce their value, and expiration dates discourage investment. Some argue that different forms of differentiation beyond the traditional categories are necessary to introduce flexibility to preferential trade agreements. Meanwhile negotiations over reducing margins of preference slow down broader liberalisation efforts.

A step up the development ladder, developing countries rely more on private foreign investment and remittances. Bridging the gap between aid and commerce requires support in building a favourable policy environment, creating public-private partnerships, marketable investments and growing competitive businesses able to connect to global markets. Returns, in terms of economic growth per percentage point of GDP invested, are higher in Africa than elsewhere, yet formidable barriers to foreign direct investment remain. Major investment, driven notably by Chinese demand for natural resources has occurred, yet the lack of multilateral disciplines for investment reduces the spread of robust best practices necessary to encourage investment and protect both investors and citizens.

In this context, the  E15 Expert Group on Trade, Finance and Development has examined how trade and finance can be leveraged for sustainable development in poor economies; assessed the effectiveness of capacity building initiatives and trade preference systems designed for low-income countries and least developed countries; and analysed novel financing instruments enhancing the impact of trade and finance on development.