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How might a Global Financing Mechanism be financed?

Marcus Manuel's picture
Submitted by Marcus Manuel
on Mon, 18/04/2022 - 17:04

This blog draws on an upcoming study funded by Brot Fur die Welt “Assessment of the potential increase in domestic and external financing for social protection in low-income countries” that will be published by FES, as well as the author’s previous research at ODI.

 

Domestic fiscal space is limited in poorest countries

The starting point for any analysis of the financing needs of a Global Financing Mechanism is an assessment of what countries can afford to finance themselves, This is sometimes referred to as fiscal space. There are three main options for increasing fiscal space – increasing taxes, increasing debt and increasing the proportion of tax and debt finance that is spent on social protection.

As others have noted (Valverde et al 2019) there is considerable potential for countries to increase their own tax revenues. ODI estimates (Greenhill et al 2015, Manuel et al 2018, Manuel et al 2020) draw on IMF and World Bank research on what is the maximum level of tax (as % of GDP) that each country could sustainably and equitably raise. This research suggests that low and middle income countries could collectively increase their tax revenues by $2 trillion a year. However these additional revenues are not evenly distributed. Middle income countries (MICs) account for 99% of this potential increase. The potential for additional revenues in low income countries (LICs) is just $11 billion a year.

As for debt finance, the Covid-19 crisis has revealed the potential – at least in the short term – to increase borrowing. Most of the global response to Covid-19 was debt financed. However, as with tax potential, there is great disparity between countries’ abilities to take on more debt. Most of the Covid-19 related debt was raised by the richer countries. And while the poorest countries were able to borrow from the IMF and the multilateral development banks, many have now reached the limits of what they can sustainably borrow. Many of the poorest countries are now classified as either in debt distress or at high risk of becoming debt distressed. The potential for most LICs to borrow more is now tightly constrained.

As regards the proportion of tax and debt finance that is spent on social protection, there is no clear cut answer as to what percentage is appropriate. There are international spending targets spending for many sectors – such as agriculture, education, health and social protection. However, these have not been developed in a consistent manner. Building on earlier ODI research which factors in the needs of other sectors, including their relative SDG costs, I have attempted to develop a consistent set of spending targets. I concluded that a reasonable fair share for spending on social protection (including health) is a quarter of total government spending. As the health sector is already supported by several global funds, my presumption is that any global financing mechanism for social protection would focus on the non-health costs. I estimate that the fair share for spending on social protection (excluding health) is around 14%, equivalent to 2.2% of GDP in a typical LIC.

Bringing all these elements together suggests that all upper middle-income countries and many lower middle income countries have the potential to self-finance the costs of a minimum basic system of four social protection floors – children (0-5), maternity, disability and old age pension (65+). By contrast, hardly any LICs could self-finance the costs of such a system. Nor could six lower middle income countries. In total there are thirty-one countries that could not afford the full costs. Twenty countries could not even afford half the costs. In aggregate these thirty-one countries face a $27 billion a year funding gap. Even if these countries just focused all their resources on one limited social protection floor – children (aged 0-5) - they would still face a financing gap of $11 billion a year. It is these countries that are most in need of external support.

 

Innovative funding sources have yet to deliver significant additional financing

In the last twenty years there has been no shortage of proposed new innovative sources for financing development. All of these would be good sources for a Global Financing Mechanism for social protection. The list includes sales of IMF gold, foreign currency transaction tax, financial transaction tax, unitary taxation of multinational companies, global taxation of aviation and maritime fuel (neither of which are currently taxed), solidarity levy on global advertising spending, on air tickets or other relevant items, wealth tax, special drawing rights (SDR), reductions in illicit flows and debt relief.

An innovative financing source would be attractive option for the Global Funding Mechanism as it would help conceptualize the Mechanism not as a “north-south charity”, but as a worldwide financing mechanism based on the social policy principle of solidarity, within a global risk pool, where all people (or countries) contribute based on their economic capacity and receive payments related to specific contingencies (as in a public social health insurance).

Despite all the interest, these innovative sources have not yet resulted in a significant sustained additional source of funding beyond traditional aid (Official Development Assistance). While there have been major initiatives over the last twenty years on debt relief and climate finance, in both cases the costs were subsumed into traditional aid flows. Total aid levels – as a proportion of the gross national incomes of donor countries – have rounded to 0.3% since 2005 (and for most of the 1970s and 1980s). If all countries did reach UN target of 07% that would yield an additional $200 billion a McCord et al 2021year (compared to 2021 levels).

To date there has only been one truly additional source of funding - SDRs. And it took the global financial crisis of 2008 and the global pandemic of 2020 to trigger their issuance. Moreover, it is still not clear how much of the latest SDR 650 billion allocation will be transferred from richer countries to poorer ones. What does seem likely, is that any transfer will be mediated and disbursed by the IMF. It would therefore not be available for funding a Global Financing Mechanism.

 

There is a clear case for rebalancing traditional aid

Until the Covid-19 crisis hit, the prospect of aid being a major source of support for a global funding mechanism looked remote. For the last ten years aid for social protection (excluding health) has been modest, at around $2 billion a year. It accounted for just 1.2% of all aid in 2019 (McCord et al 2021).

However, there is a clear long-term case for rebalancing social protection’s share of total aid. In LICs the SDG costs of achieving universal education, health and social protection are similar for all three sectors. Yet social protection receives far less aid support. And compared to the funding gaps in each sector, it is clearly the most underfunded sector (Manuel et al 2020). In their own countries, donors on average spend the same on social protection as they do on education and health combined. Even in the US, where the government spends the lowest proportion on social protection, 20% of the national budget, this is more it spends on education and only slightly less than on health. Yet in their aid budgets, social protection receives seven times less the amount provided for education and health. Even a limited rebalancing of their aid, to 7%, which is half the proposed fair share for domestic spending, would enable all countries to provide a social protection floor for every child aged 0-3.

Encouragingly, the Covid-19 crisis has already started a rebalancing of aid flows. There has been an extraordinary increase in social protection programming and funding; led by the largest donor, the World Bank, which has tripled its support. The World Bank was already providing half of all social protection aid before the crisis and appears to have provided two-thirds during the crisis. In the last two years the World Bank has increased its spend on social protection to the same level that the Global Fund (to Fight AIDS, Tuberculosis and Malaria) spends on health.

While the latest aid figures show no overall increase in aid as % of gross national income, they do highlight the share of aid that is currently being spent on short term issues – 3.5% on Covid-19   vaccines and 5.2% on supporting newly arrived refugees in donor countries. While the Ukraine crisis will impact on spending on refuges in 2022, these elements will hopefully not be needed in the longer term and would free up $15 billion a year.

 

Next steps

The focus of the UN Global Accelerator is on unlocking increased domestic finance for social protection. The potential to increase domestic financing in many countries noted above underlines the case of pursuing this option. At the same time, the above analysis reinforces the case made in the first blog and second blogs in this series that the effort on the global accelerator needs to be complemented with efforts to develop an external financing mechanism. Such a mechanism is needed to support those countries that cannot afford the costs of universal social protection by themselves even if they maximise their tax revenues and the proportion of their spending that they allocate to social protection. The third blog and fourth blogs have explored how to ensure that countries that would benefit from a global financing mechanism, would fully participate as partners in how it operates and would maintain full ownership of their social protection systems that the mechanism supports.

But before such a mechanism can be created, there needs to be not just one donor, but a coalition of bilateral donors and philanthropic funders willing to commit initial funding and call on others to join them. To help build that coalition I suggest four key steps that such donors and funders could take now.

First, establish a consensus on what is a “fair” and reasonable proportion of domestic funding for lower income countries to set aside for social protection, taking due account of the needs of the sectors. The current set of inconsistent and collectively over-ambitious sectoral spending targets just sets countries up to fail and undermines trust between donors and lower income countries.

Second, review the current balance of aid allocations across the social sectors. The review would reflect on why the current balance is so different from the balance in donors’ own countries. The review could also explore the benefit that increased cash transfers would have on their investments in health and education and assess whether a better balance would have a greater impact on reducing extreme poverty. The review could also include discussions with governments and civil society in lower income countries on their desired balance of investments across the social sectors and how these might have changed because of Covid-19.

Third, map out what results could be achieved if a mechanism could be established at the size of the most successful global fund to date – the Global Fund - $4 billion a year. As the World Bank alone is now providing social protection funding close to this amount, a Global Financing Mechanism on a Global Fund scale would seem both an ambitious and feasible target that is worth exploring. Having a clearer idea of what could be achieved would help motivate other funders. My initial estimates suggest such a mechanism would be sufficient to enable 5-10 LICs to introduce a limited form of the four key non-health social protection floors – universal child grants (0-3); maternity, disability and old age (over 70) – to millions of people.

Fourth, while an agreement on a new global mechanism is being developed, start to see what could be achieved at a country level, where a LIC government has a clear vision of the elements of the social protection system they want to introduce, a group of donors is willing to be make offers of coordinated long term support and there is prospect of an effective sustained broad partnership, including with Parliament and civil society.

 

References

 

Marcus Manuel undertook this piece of research as an independent consultant. He is also a Senior Research Associate at ODI and a former regional director at UK’s Department for International Development (DfID).

 

This is the fifth and last post of the blog series “Global Financing Mechanisms for Social Protection”, which draws from different studies around the proposal for a Global Fund for Social Protection. The blogs look into different subjects, such as: learnings from earlier global fund initiatives, costing for country cases, micro-simulation on expected impacts, financing side proposals, institutional coordination, governance, among others. As of February 2022, the studies are currently being implemented by experts from United Nations University-MERIT, University of Bochum and other independent experts. The blog series is organized by Brot für die Welt and the socialprotection.org team.

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