Development finance — the public and quasi-public capital deployed to accelerate economic development in low-income countries — has produced less development than its volume would suggest.
The Development Finance Gap
The volume of development finance — the official development assistance, the multilateral development bank lending, the development finance institution investment, and the concessional bilateral lending that governments and international institutions deploy to accelerate development in low-income countries — is enormous. The development outcomes that this volume of finance has produced are real but substantially below what the volume would suggest if development finance were efficiently converting financial resources into development impact.
The gap between development finance volume and development outcome is explained by several structural failures that are well-identified in the development finance literature. The transactions costs of development finance — the due diligence, the conditionality negotiations, the reporting requirements, and the procurement restrictions that accompany most development finance — absorb a significant share of the nominal finance in overhead rather than in productive activity. The allocation of development finance is shaped by the political and strategic interests of the providing governments as much as by the development priorities of the receiving countries.
What Better Development Finance Looks Like
Better development finance is development finance that is aligned with recipient country priorities rather than donor country interests, that imposes transaction costs proportionate to the developmental risk it is managing rather than the accountability comfort it provides to donors, and that measures its success in development outcomes rather than in the volume of finance deployed. Each of these requirements challenges the institutional interests of the development finance system itself — the bilateral aid agencies, the multilateral development banks, and the development finance institutions that deploy the finance and that have their own interests in the systems through which they deploy it.
Development finance that is not producing development is not development finance — it is aid to the development finance system's own institutional interests, dressed in the vocabulary of development. Measuring it against development outcomes rather than finance volumes is the first step toward making it do what it claims to do.
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