Wednesday, 11 October 2017

SWFs for Germany: A crazy idea?

Small and medium income earners have few capital assets, have limited resources to save or smooth out income fluctuations, and are therefore unable to skim off risk premiums on assets. Political Germany has therefore recently been increasingly discussing the creation of a Sovereign Wealth Fund (SWF) as a solution to societal challenges such as increasing poverty among the elderly, increasing income and asset polarisation or intergenerational justice. Following Corneo's lead (2017)[1] and inspired by Thomas Piketty, it is now recommended that a broader diversified capital stock be built up with the creation of an SWF investing in securities and distributing the return annually to the population at equal amounts per capita without any further conditions than a minimum duration of residence in Germany.

The original motivation for the creation of SWFs was to preserve intergenerational justice in countries that exchanged their exhaustible natural resources for foreign exchange by extracting and exporting them. Without the establishment of sovereign wealth funds, such countries would have effectively used up their total assets at the expense of future generations, i. e. their total savings would have been negative[2]. But what is to be thought of sovereign wealth funds in countries such as China and Germany, which generate excess savings and export surpluses as a result of domestic investment and consumption deficits? Would the establishment of an SWF for Germany come at a favourable time in the long term? This essay tries to approach these questions.

World champion of net capital exports
Germany is not only the world champion in soccer, but also in net capital exports. The German current account surplus in 2016 amounted to 297 billion US dollars (268 billion euros) and China took second place with a surplus of 245 billion US dollars. Both China and Germany are characterized by a rapidly aging population. Rapid aging coupled with an aversion to immigration does incite to save for old age. Indeed, Germany's surpluses are structural in nature: since the turn of the century, it has not recorded a current account deficit; its domestic savings have always exceeded domestic investment. While China's current account surplus has been declining as a fraction of its GDP since the Great Financial Crisis, the German surplus has since then fluctuated between 6 and 8 per cent of its GDP.

In 2016, the German external surplus amounted to 8.5 per cent of GDP. As formerly in China, corporate savings, or rather corporate investment deficits, and the public sector budget have contributed to the high saving ratio in Germany[3]. In 2016, Germany saved 12.2 per cent of its disposable income; the savings rate of non-financial corporations was 4.3 per cent. The saving ratio of the consolidated government sector was 1.7 per cent, due to Wolfgang Schäuble´s 'Black Zero' policy. The corporate and government investment deficit and the consumer deficit corresponded to a savings surplus of 10.3 percent for Germany with the rest of the world. If Germany were a closed economy, it would suffer from a large demand deficit, low capital returns and deflation.

High returns are rarely achieved through massive net capital exports, however. Formerly known as a producer of 'cheap goods´, China has long been referred to as provider of 'cheap savings', which the country made available to the USA. As a large part of the FX reserves were invested in low interest rate US Treasury bonds and the US had (and still has) a corresponding current account deficit with China, China granted the Americans cheap vendor loans[4]. The accumulated FX reserves became a legacy burden due to the build-up of interest rate and exchange rate risks and the threat of the central bank losing monetary control.  This was followed by speculative bubbles on the real estate and equity markets. As a result, China turned part of its financial assets into tangible assets - through accelerated growth of sovereign wealth funds. According to the latest SWF Institute data, four Chinese sovereign wealth funds are among the top ten, with total assets of over USD 2 trillion at the end of September 2017, compared with Norway's Government Pension Fund Global, the world's largest single sovereign wealth fund, which has reached a total of USD 1 trillion[5].

Although Germany, as a member of the euro zone, does not hold exorbitant FX reserves, factors comparable to China have a negative impact on the economic return of its capital exports.  German banks and insurance companies have invested their savings in US subprime and Greek government bonds over the past few decades, resulting in heavy losses on these foreign investments. 2,200 billion euros have been invested abroad on a net basis since 2000, but in 2016 Germany's foreign assets amounted to only 1,600 billion euros. Germany's capital loss amounted to 600 billion euros, 7,500 euros per capita[6]. Since the outbreak of the euro crisis, German savings have no longer been transferred abroad primarily via commercial bank loans, but via public channels, as Germany´s voluntary private transfer dried up. Since then, the Deutsche Bundesbank's net foreign position has multiplied; at the end of September 2017, Target II claims amounted to around 850 billion euros. Since the beginning of 2016, the ECB has been paying interest zero percent on these balances.

In the autumn of 2017, after the German federal elections, the question arises as to how much German capital exports will collapse if the (liberal party) FDP's refusal to make the Eurozone a transfer union prevails. Would SWFs be a way out for Germany if its capital exports collapsed within the euro zone?

Dynamic inefficiency, aging and return on investment
For China and Germany, dynamic inefficiency can be diagnosed. An economy is dynamically efficient if gross investment income exceeds gross fixed capital formation on a sustained basis, whereby investment income is defined as the sum of profit, rent and interest income. If this is the case, then the financial sector will provide more resources for future consumption than it consumes. Conversely, if investments exceed investment returns, the financial sector withdraws resources from the economy. This is inefficient, because the whole purpose of investment is to increase future consumption opportunities[7].  In Germany today (as in China before) too little is being consumed. 

However, the creation and financing of SWFs from excess savings would only perpetuate the dynamic inefficiency in countries, such as Germany, where SWF financing does not derive from the export earnings of exhaustible raw materials (Arab Gulf States or Norway). SWFs that are financed from domestic demand deficits (instead of raw material revenues) do not therefore promote intergenerational justice but undermine it at the expense of today's generation.

In a closed economy where savings by definition equal investments, investment income would fall below investment expenditure as a result of excessive capital accumulation. If the return on capital falls below the growth or wage rate, a pay-as-you-go pension scheme is superior to funded pensions in a closed economy. To be sure, pay-as-you-go schemes for old-age pensions are largely influenced by changes in real wage growth and the ratio of contributors to pensioners (support ratio). The pay-as-you-go system is therefore essentially enclosed into the ageing economy and cannot escape the demographic pressure resulting from the expected drop in the support ratio, except by raising the retirement age.

However, even fully funded pension systems cannot escape demographic pressure, even if there are significant flows of capital between the ageing and younger parts of the world. Firstly, higher life expectancy will put pressure on the calculation of funded pensions. Secondly, the ageing of the population will exacerbate the pressure on returns by reducing the profitability of pension funds and insurance companies. An economic-demographic simulation model (MacKellar and Reisen, 1998) with two scenarios (relative self-sufficiency versus financial globalisation of pension schemes) predicts a decrease in the return on investment due to the fall in the labour force for both scenarios. In the autarchy scenario, the capital intensification associated with ageing will reduce investment income by 150 basis points by 2050 and by 110 basis points in the globalisation scenario[8].

Piketty (2011)[9] has postulated in his famous book, based on many years of empirical evidence, that the rate of return on capital, r, has usually been higher than the growth of production, g. If wealth is not heavily taxed or decimated by the consequences of war, the inequality r > g leads to a concentration of wealth, according to Piketty. The formula refers to the return on investment (r) to the growth rate (g), where r comprises profits, dividends, interest, rent and other investment income before taxes; g denotes the growth of disposable income or wages. Note that Piketty´s formula would preclude the formation of a middle-class, especially in fast-growing countries.

However, Piketty conceded that the tendency to higher wealth inequality was reversed between 1930 and 1975, in his judgement due to one-off circumstances. Interestingly, 1975 coincides with the beginning of the integration of 50 percent of the unskilled labour force into the world economy, triggered by the opening of China, India and the disintegration of the Soviet bloc (in my terms: Shifting Wealth Phase I).  A simple Cobb Douglas production function, in which capital contributes a third of the income (the rest is provided by unskilled labour and know-how), shows that doubling the global labour supply has reduced unskilled labour productivity by a good 16 percent[10]. This led to a corresponding reduction in equilibrium wage for basic skills. Meanwhile, the original wage effects of the integration of China, India and other emerging markets have been coming to an end.

It cannot be ruled out that "Piketty is history", as Goodhart and Pradhan predict in a recent BIS study[11], as longstanding demographic developments that caused income and wealth inequality will now change. This is supported by the fact that several trends, which have been valid for forty years since the entry of post-communist states and emerging Asian countries into the market-economy organized world economy, have ended. Goodhart and Pradhan forecast for the coming decades:
·         The ageing and shrinkage of the world's labour force (outside the Sahel Zone) and thus a higher share of wages in world income;
·         The decline in massive outsourcing to China and Eastern Europe, thus putting an end to price deflation for labour-intensive goods and hence provide scope for a more restrictive monetary policy in advanced economies, probably leading to asset price deflation; and
·         The trend reversal in the global development of factor relations with an increase in the capital ratio in production and a reduction in returns on capital[12].

Both pay-as-you-go and funded pension systems are being burdened by the ageing process (especially in Germany, China and Japan). However, the predicted improvement in real wages relative to return on capital discourages to persue wealth and generational equity by building SWFs. While pay-as-you-go systems of old-age provision will be less burdened by global wage trends, the projected reduction in the return on capital employed will put a strain on funded old-age provision and sovereign wealth funds.             

[1] Giacomo Corneo (2017): Ein Staatsfonds, der eine soziale Dividende finanziert, Freie Universität Berlin Fachbereich Wirtschaftswissenschaft, Diskussionsbeiträge 2017/13, Mai.
[2] Helmut Reisen (2008), How to Spend It: Commodity and Non-Commodity Sovereign Wealth Funds, OECD Development Centre Policy Briefs No. 38, OECD, Paris, September.
[3] OECD (2010), Perspectives on Global Development: Shifting Wealth, Figure 2.6., OECD, Paris; Statistisches Bundesamt (2017), Volkswirtschaftliche Gesamtrechnungen: Sektorkonten, Destatis, Wiesbaden.
[4] The term vendor loan needs to be handled with caution, as there is no bilateral link between current account and capital account balances in an open global economy; for example, the USA was not only indebted to China via its purchase of government bonds but also through loans provided by European banks.
[5] Chinas four SWFs listed by the SWF Institute are China Investment Corporation; Hong Kong Monetary Authority Investment Portfolio; SAFE Investment Portfolio; National Social Security Fund. See
[6] Marcel Fratzscher (2017), „Der deutsche Sparirrsinn“, Die Zeit, 17.2.2017.
[7] See A. Abel,  G. Mankiw,  L. Summers , R. Zeckhauser (1989), „Assessing Dynamic Efficiency: Theory and Evidence“, The Review of Economic Studies, 56.1, Januar, S. 1–19. 
[8] Landis Mackellar und Helmut Reisen (1998), A Simulation Model of Global Pension Fund Investment, Technical Paper No. 137, OECD Development Centre, Paris.
[9] Thomas Piketty (2013), Le capital au 21e siècle, Editions Seuil, Paris.
[10] Helmut Reisen (2006), „Globalisierung, Proletariat und Prekariat“, Internationale Politik, January 2006.
[11] Charles Goodhart and Manoj Pradhan (2017), “Demographics will reverse three multi-decade global trends“, BIS Working Paper No. 656, Bank for International Settlements, Basel.
[12] Piketty (2013) argues that the capital deepening goes is compatible with an increase in the return on capital. This, however, requires a substitution elasticity between labour and capital greater than one.

Wednesday, 30 August 2017

Europe´s ´Migration Partnership´ with the Sahel Zone

On 28 August, France's President Macron had invited the presidents of Niger, Chad and Libya to the Élysée Palace to find solutions to the refugee crisis. Also present: the leaders of Italy, Germany and Spain. The mini summit came up with a plan for the eschewal of African migrants. As it were, Macron, Merkel, Rajoy & co decided to extend the European external borders up to the Libyan coast and now even well into the Sahel zone: forefield control as a populist waste disposal instrument. No matter how cruel the reception camps. Euphemistic label: ´Migration Partnership´.
Berlin has an increased interest in Africa because it fears that immigration in the public is unpopular. In a recent survey on the Bundestag election 2017, there was no other topic (poverty, unemployment, crime) that worried the Germans as much as the immigration and integration of foreigners. Clearly more than half of the interviewees, 56 per cent, consider migration the greatest societal problem currently for Germany. In fact, the irregular migration to Germany and Europe - mainly via the Mediterranean - had increased strongly until 2015. To be sure, migration from Africa is still low compared to Africa´s total population and relative to the refugee wave from the Middle East. But African migration to Europe will rise.
Historical experience - formerly in Europe, East Asia and North America, but also in China and India - has shown a demographic transition pattern that is closely linked to economic development. In the preindustrial phase, high birth rates and high mortality rates cause weak population growth. In the first part of the demographic transition, mortality rates begin to drop while birth rates and population growth remain high. In the second part of the demographic transition, declining birth rates and declining death rates lead to a slowdown in population growth. In the (post-) industrial phase, low birth rates cause weak or even declining population growth.
In one world region, however, the demographic transition is still slow although per capita income has risen: Sub-Saharan Africa. Demographic standstill includes Africa's most populous state, Nigeria, which already has nearly 200 million inhabitants. South of the Sahara, the decline in birth rates is agonizingly slow: the figure fell from 5.1 per woman in 2000-05 to only 4.7 per cent in the period 2010-2015. By 2050, according to UN projections, Africa's population will double to 2.5 billion[1]. Medical advances and the expansion of health care systems have led to higher life expectancy but living standards remain low, not least because of the associated rise of total population. One has to fear that without birth control and vigorous educational measures for the young Africans part of the continent will stay in the first phase of the demographic transition for too long. Some African societies have been stuck in the Malthusian trap.
The migration potential of Africa, the total number of African migrants, is likely to rise from a demographic perspective as long as the population grows strongly. From an economic point of view, the willingness to emigrate will remain high due to lack of training and labor market opportunities for a growing working population. The IMF categorizes 85 per cent of African migrants as economically motivated, only 15 per cent as political refugees[2]. Politically, Africa's migration potential is fueled by government failure, instability, political persecution and human rights violations. The attractiveness of political stability, democracy, the rule of law and social policy in Europe explains part of the migration to Europe. The migration potential of Africa is also likely to increase from the ecological point of view because water scarcity and the degradation of soils will increase as a result of advancing climate change and growing population pressure. Whether the African migration potential will manifest itself in migration to Europe also depends on the absorption capacity of the African target regions (such as southern Africa and North Africa).
In fact, African migration has so far mainly remained within the continent. According to IMF data, the share of immigrant migrants in the total population in Africa is relatively low (2%) compared with the other developing countries (3%). The reason is simple: the poorest cannot afford to emigrate. It is Africa´s future migration dynamics that worries politicians most. Today, a total population of just fewer than one billion Africans translates into 20 million migrants. In 2050, it will be 50 million if Africa´s migration percentage stays at two percent and Africa's population rises to 2.5 billion. How many of them will leave Africa?
According to the cited IMF note, the proportion of African migrants who actually leave their continent has increased from a quarter in the last quarter of the 20th century to a third today. Their numbers ranged from one million in 1990 to today's six million. Population growth and the growing share of African exodus suggest that their number will rise to 20 million over the coming decades. Most Africans migrants want to go to Western Europe these days. European governments want to prevent this with all their might, at the cost of betraying their own basic humanitarian principles. “So sad.”

Sunday, 30 July 2017

G20 Africa Partnership and German Colonial History

Germany´s colonial history has been ephemeral and limited compared with many European neighbors. Former German colonies in Africa are Burundi, Cameroon, Namibia, Ruanda, Tanzania and Togo. While Otto von Bismarck disapproved the idea of Germany as a colonial power, the economic interests of Hanseatic trading and shipping companies pushed for establishing German coonies overseas. Major motives then: attenuate Germany´s population pressures via emigration; secure raw materials for the new German industries; build infrastructure by forced labor of indigenous populations via head taxes; and secure viable outlets. The latter motive was fed by Germany´s industrial crisis (1873-79) that went along with overproduction in heavy industry, very much like in today´s China. A further motive would be called ´soft power´ today, then it was ´cultural mission´ especially of the churches.

The recent G20 Africa Partnership has been criticized as ´neocolonial´. True, that reproach is over the top. But there are some hidden parallels with Germany’s colonial history – from the first flag waving 1884 until Germany´s ultimate loss of its colonies as part of the Versailles Treaty 1919. Reading the new book “Die Deutschen und ihre Kolonien” produces some insights[i].
Here is my list of parallels:

  • ·       The G20 Summit in Hamburg recalls the Berlin Conference on West Africa 1885/85, a gathering of 15 states. The Berlin Conference opened a run on yet unoccupied ´protectorates´ as a result of specifying  criteria for the recognition of colonial possession (occupancy) under international law.
  • ·         “Volk ohne Raum”, the national slogan, crystallized the thesis of a dearth of habitat for the quickly growing German population. Mass emigration to Africa and elsewhere was supposed to relieve Germany´s supposedly narrowing living and feeding room. Land grabs – occupying land for plantation agriculture – were common then. Today, it is Africa´s population that is growing quickly (the fertility rate per woman is still between 5 and 7 percent in Central and West Africa). This generates an intercontinental migration pressure that nowadays Europe tries to block by arguing that its ´living room is full´.
  • ·         Then as today, Germany has stayed largely unfamiliar with Africa. Its short colonial history and restrictive naturalization policy, compared to France and Great Britain, left it until quite recently with little immigration from the global South. Germany´s perception of Africa was thus narrowed toward charitable commitments, with a corresponding neglect of Africa´s economic potential.
  • ·         Costly prestige projects characterize the German imperialism in the late 19th and early 20th century. This corresponds to the ´Bella Figura´ that the German G20 Presidency has been trying to make with the African Partnership and those many uncoordinated plans[ii].
  • ·         Especially Bismarck, just like today´s architects of the G20 Compact With Africa, tried to resist the public financial liabilities connected with Africa. Instead, private trading companies were mandated with the administration of German protectorates as well as private investors with financing Africa´s infrastructure. That didn´t last long as ultimately public finance of the German Reich became liable for building infrastructure, administration and military.
  • ·         Especially the German finance ministry has been criticized with lazy thinking, namely to have followed the blueprint scripted by the IMF and the World Bank for its Compact With Africa, rather than to develop own concepts[iii]. Similarly, the German imperial state had neither a strategy nor a concept for developing its colonies. The Germans mimicked the British charter societies and relied on local warlords, as they were so little familiar with African matters.
Africa has suffered long-term development damage from colonialism, independent of the type of colonies (raw material extraction v settlement), as colonialism has fostered the creation of extractive institutions on the continent[iv]. However, on balance, Germany´s colonial net benefit has been negative, too: public grants v private profits. The spending on colonial administration, heavy investments into infrastructure (especially the railway in East Africa) and the large military expenditures to confront uprisings required important Reich funding. Emigration to Africa by Germans remained very small (except for today´s Namibia), export markets shallow (except for railway parts and beer!). Tsetse fly infections and Africa´s challenging topography increased infrastructure cost beyond the planned sums. Germany´s colonialism in Africa thus has turned out to be a lose-lose adventure.

[i] Horst Gründer und Hermann Hiery (Hrsg.), „ Die Deutschen und ihre Kolonien“, be.bra verlag GmbH, Berlin 2017.
[ii] Robert Kappel, “The many plans of Germany´s Africa Policy. Is it moving forwards?”, Weltneuvermessung, 29th June, 2017.
[iii] Helmut Reisen, “Die ideologische Schieflage des Compact with Africa“, Makronom, 14. Juni 2017.
[iv] Leander Helding and James Robinson, “Colonialism and development in Africa”, Voxeu, 10. Januar 2013.

Thursday, 8 June 2017

The G20 ´Compact with Africa´ is Not for Africa´s Poor: The Finance Framework

A key pillar of the G20 Africa Partnership is the ´Compact with Africa´ (CwA), an initiative within the G20’s finance track, coordinated by the German Federal Ministry of Finance. In its resolution adopted by G20 finance ministers and central bank governors in Baden-Baden, the G20 has acknowledged “its special responsibility to join forces in tackling the challenges facing the poorest countries, especially in Africa”[1]. The ´Compact with Africa´ initiative aims to boost private investment and investment in infrastructure in Africa. To this end, the World Bank, the International Monetary Fund and the African Development Bank have produced a joint report (“The G20 Compact with Africa: A Joint AfDB, IMF, and WBG Report”), which proposes a catalogue of instruments and measures designed to improve macroeconomic, business and financing frameworks as a way to boost investment [2]. The document is a dense, well-argued and documented text, albeit written in fairly technocratic language.
The CwA Financing Framework aims at increasing the availability of financing at reduced costs and risks, with a focus on long-gestation infrastructure projects. It targets in particular pension funds and life insurers. These institutional investors are characterized by the long-term nature of their balance-sheet liabilities, which enables them to invest in infrastructure projects with long gestation periods. They would indeed make a very good fit for funding Africa’s infrastructure. Projected to reach $100 trillion by 2020, institutional investors (pension, funds, life insurers and sovereign wealth funds) would need to invest one percent of their annual new inflows to fund Africa’s infrastructure gap, estimated at $ 50 billion per year [3].
The CwA makes some important ideological presumptions. First, it is solely driven by the Anglo-Saxon financing model with a focus on direct securities (equity and bond) markets rather than bank-based financial intermediation, which has underpinned (Continental) European and East Asian economic and social development.  Second, the CwA Financing Framework is silent on the important role that the public and semi-public sectors may have played in early stages of development via mandatory public pension plans (East Asia) or not-for-profit financial ccoperatives (such as agricultural credit unions).  Third, it is silent on the “financing gap” (also known as the MacMillan gap), which has come to indicate that a sizeable proportion of economically significant SMEs cannot obtain financing from banks, capital markets or other suppliers of finance. The MacMillan gap requires an important role of public development institutions and public policies in tackling underlying market imperfections. Lastly, it seems that the German Ministry of Finance that commissioned the CwA report in the first place has missed a unique chance to bring in the specific German history of bank-based intermediation, of rural credit unions and of public infrastructure push in the context of late industrialization. This would indeed be relevant for the African context.
Instead, the CwA Financing Framework consists of three linked components to tap the global pool of private finance: The first peddles blending instruments and facilities - the use of public or philanthropic funds to attract additional investments from private sector actors into development projects - to lower African country risk to private investors (the new Private Sector Window under the IDA18 replenishment is mentioned explicitely); the second aims at support of domestic debt markets and at a more supportive global regulatory environment; the third aims to promote new public infrastructure investment funds, such as Managed Co-Lending Portfolio Program (MCPP) initiated by The International Finance Corporation (IFC), part of the World Bank Group.
Because most African countries remain poor, they are not considered creditworthy. Even though the African Development Bank (AfDB) has 54 member countries, of which only 17 are not eligible to African Development Fund (AfDF ) funding, most countries have a per capita income below an operational cut off (fiscal year 2015-2016: $1,215). Recent Brookings forecasts project that the number of people living in extreme poverty (the headcount of those falling below $1.90) will rise in 19 African countries by 2030.

Table 1:               Eligibility to access AfDF funding (Number of countries (out of 54 total))
Creditworthiness to sustain AfDB financing
Per capita income
above the AfDF/IDA
operational cut-off

30 AfDF-only
3 blend-eligible
4 AfDF-Gap
3 AfDB-only

Apart from general investment barriers, common project risks for infrastructure investments need to be considered in the African context. These include: completion risks (failure to complete the project on time and on budget); performance risks (the risk that the project fails to perform as expected on completion, maybe due to poor design or adoption of inadequate technology); operation and maintenance risks (relates costs, management and technical components and obligation to provide a specific level of service); financing risk (which may arise from an increase in inflation, interest rate changes etc.); and revenue risks (which relates to the possibility of the project not earning sufficient revenues to service its operating costs and debt and leave adequate return for investors).
Legal, regulatory and institutional challenges of Private-Public Partnerships (PPPs) should not be underestimated in the context of Africa’s low-income countries. Long-term commitments in the infrastructure sector depend on a set of legal, regulatory and institutional frameworks. From the time of project preparation, to bidding and finally operation, the regulation of PPPs requires an independent regulator and the handling of disputes by an independent judiciary. Other institutional prerequisites are property and collateral registries, reliable accounting and reporting procedures, tested and reliable foreclosure mechanisms. The longer the term of contracts and the larger the funding commitments, the more important such ‘basic’ institutional and legal infra­structure becomes. Moreover, fiscal contingencies of PPPs could burden weak public finances in countries where debt tolerance has proven low. In particular when privately financing large infrastructure projects in immature markets, there is a risk that private returns come at the expense of long-term fiscal costs (contingent liabilities).

Table 2: The infrastructure funding escalator
Step 1
Step 2
Step 3
Step 4
Step 5
Major funding source
Step 1 + Aid
 Grants +
Step 2 + Banks loans + leveraged private funds
Step 3 + Private Equity + Project Bonds
Growing role institutional investors
Source: based on Della Croce, Fuchs, & Witte (2016); see text.

To a large extent long-term funding of infrastructure in Africa is provided circumventing the intermediation process altogether, including via foreign direct investment. As for low-income Africa, the CwA’s focus on an important role for private institutional investors to fund the infrastructure gap lacks realism: Most African countries are at the first two steps of the Infrastructure Funding Escalator, where public investment and concessionary aid remain the major funding sources.
The first component of the CwA Financing Framework pins high hopes on blended finance and leveraged finance via development finance institutions (DFIs). Table 3, however, shows that private funds mobilized by DFIs seem to have shied away from the ‘Bottom Billion’ (to paraphrase Paul Collier). Within the group of countries attracting blended finance investments, LICs generally (not just in Africa) receive much less on a per country basis compared with other developing countries [4]. LICs obtained, on average, US$60 million of private investment per country between 2012 and 2014; the equivalent figures for other developing countries were six times higher – US$352 million for LMICs and US$404 million for UMICs. Little of blended finance and of foreign direct investment (FDI) goes to low-income countries compared to ODA, as both categories of private-sector flows seem to favour middle-income countries. Despite policy efforts to mobilize private finance through official DFIs, they so far have represented a small fraction of the flows directed to low-income Africa.

Table 3:               Allocation of FDI, ODA and DFI mobilized funds per income group in Africa                                (mean percentage shares during 2012-2014 )
Income Group
DFI mobilized
Low Income
Lower MIC
Upper MIC
Data for country-allocable investments only; residual went to high-income group

Three commitments addressed to partner countries are derived from the first component: support ongoing de-risking initiatives; support various de-risking instruments (IDA18 Private Sector Window, AfDB´s PSF; support the further refinement of a commonly accepted set of principles for ´blended finance´. This is more of a self-promotion of the World Bank and the AfDB than a helpful commitment for low-income Africa. In reality, new AfDB initiatives have had a low uptake, especially in low-income Africa. A study finds that the growing complexity and fragmentation of private-sector mobilization initiatives created my multilateral development banks seems confronted with “little awareness or understanding of these private sector mechanisms and initiatives” on the ground [5].
The second component of the CwA Financing Framework calls for domestic debt market development, as already exist in Egypt, Nigeria and South Africa. The CwA document is well aware (in some paragraphs, at least) of capacity constraints that impede Africa´s securities market development. To be sure, there has been limited progress in developing markets for long-term finance on the continent. Except for South Africa the depth of equity and bond markets falls far short of the capitalization and liquidity of financial markets in other developing regions, despite recent issuance of Eurobonds and local currency bonds in some places. The largest and most important segment across financial sectors in Africa is the banking system, not an ideal source of intermediation for long-term finance, given the maturity transformation of banks’ short-term liabilities and consequent risks.
To avoid currency mismatches in private and public balance sheets, local currency bond market development is primordial. Most poor countries do not borrow in their own currency, which has time and again triggered debt crises as a result of strong currency depreciation (as currently observed in African commodity exporting countries).  Substituting external, foreign currency debt with domestic, local currency debt may increase rollover and interest rate risks because of shorter maturities of the latter; this implies it will have to be refinanced more frequently and possibly at a higher rate. Ghana is an example of the risks involved: In the recent decade, Ghana had issued three Eurobonds with tenors between 10 and 12 years, whereas the average tenor of its local currency bonds at issuance was about two years only; moreover, their yields stood at no less than 23% in 2014.
Four commitments addressed to partner countries are derived from the second component: introduce an appropriate regulatory and supervisory framework; establish over-the-counter trading as well as custody and settlement mechanisms to minimise costs and risks for debt securities; support the development of pensions funds, life insurance companies and mutual funds to develop a domestic institutional investor base; implement ´sound´ debt management policies. I have major doubts whether scarce African government resources are really best employed by facilitating an Anglo-Saxon system of direct securities markets, and what the risks are in terms of fraud and gambling.
The CwA finance framework tries to put the cart before the horse, especially for LICs in Africa, by trying to appeal to institutional long-term finance. It ignores the financing model of successful development that has been largely based on public infrastructure preceding industrial development, corporate savings via retained earning, rural credit associations and bank-based finance. It also ignores the risk of debt sustainability linked to blended finance, especially as multilateral development banks are reducing the share of concessionary finance, including to African countries with a long default history.
Low domestic savings levels, weak government finances and a low debt tolerance militate against forcing foreign private debt and contingent fiscal liabilities upon countries where infrastructure deficits are most blatant. The risk of lasting current account deficits, which are mostly financed privately, is that they tend to end with balance-of-payments crises. Many African countries have benefited from comprehensive debt restructuring and relief efforts in recent decades, but since 2010 countries have accumulated foreign debt again as raw material prices weakened, growth slowed and concessional debt was replaced.  Both investors and Africa’s governments should consult the Joint World Bank-IMF Debt Sustainability Framework for Low-Income Countries before raising the finance they need to meet the SDGs, including through grants when the ability to service debt is limited.

[2] The report benefited from contributions by Professor Paul Collier (Oxford University), Richard Manning (Oxford University), and Ulrich Bartsch (German Ministry of Finance).  
[3] Kappel, Pfeiffer & Reisen (2017), GDI Discussion Paper 13/2017.  
[4] Tew & Caio (2016), Blended finance: Understanding its potential for Agenda 2030. London: Development Initiatives. Blended-finance-Understanding-its-potential-for-Agenda-2030.pdf.
[5] Bertelsmann-Scott, Markowitz & Parshotam (2016). Mapping current trends infrastructure financing in low-income countries in Africa within the context of the African Development Fund. SAIIA, Johannesburg.