Master - Thesis zur Erlangung des Grades
Master of Business Administration

Financing for Development - Challenges of development cooperation and development finance in a globalized world

vorgelegt von

Christian Herbst

vorgelegt am: 25.08.2005

Table of content

Index ... II

1. Preface ... 1

2. Executive summary ... 3

3. Basic principles ... 4
3.1 Definitions ... 4
3.1.1 The term "development" ... 4
3.1.2 Typology of the development countries ... 5
3.2 Causes of underdevelopment ... 6
3.3 Measuring underdevelopment ... 10
3.3.1 Income and economic power ... 10
3.3.2 Human Development Index ... 12
3.3.3 Human Poverty Index ... 13
3.4 Classification of developing countries ... 14
3.4.1 The UN – classification ... 14
3.4.2 The World Bank classification ... 15
3.4.3 The DAC list ... 16

4. The System of international development co-operation ... 17
4.1 Overview ... 17
4.2 The United Nations ... 17
4.2.1 Organisations ... 17
4.2.2 The Millennium Goals ... 20
4.3 The World Bank Group ... 22
4.3.1 Organizational structure ... 22
4.3.2 The World Bank development strategy ... 25
4.3.3 The World Bank loans ... 26
4.4 The International Monetary Fund ... 28
4.4.1 Organizational structure ... 29
4.4.2 The IMF development strategy ... 31
4.4.3 The IMF loans ... 32
4.5 The Organization of Economic Co-Operation and Development ... 34
4.6 The World Trade Organisation ... 36
4.7 The Multilateral Development Banks ... 39
4.8 The Kreditanstalt für Wiederaufbau ... 41

5. Financing of Development ... 43
5.1 Overview ... 43
5.2 International capital transfer ... 44
5.2.1 Introduction ... 44
5.2.2 The term “capital” ... 45
5.2.3 Reasons for the shortage of capital ... 46
5.2.4 Private equity finance ... 47
5.2.4.1 Foreign direct Investment ... 48
5.2.4.2 Foreign portfolio Investment ... 50
5.2.5 Private debt finance ... 53
5.2.5.1 Bond financing ... 53
5.2.5.2 Bank loans ... 57
5.2.6 Official aid flows ... 61
5.2.7 Foreign debt ... 64
5.2.7.1 Causes of debt accumulation ... 64
5.2.7.2 The dimensions of the developing countries′ foreign debt ... 66
5.2.7.3 Consequences for the developing countries ... 68
5.2.7.4 International measures / Methods of resolution ... 70
5.3 International trade ... 72
5.3.1 The gains from trade: Ghana and South Korea ... 72
5.3.2 International trade theory ... 73
5.3.3 The role of developing countries in global trade ... 75
5.3.4 The Fair Trade initiative ... 80
5.4 New sources of development finance ... 84
5.4.1 Currency transaction tax ... 82
5.4.2 Emission trading ... 86
5.4.3 The International Finance Facility ... 89
5.4.4 Microfinance Institutions ... 90

6. Conclusion ... 94

7. Appendix ... 99

1 Preface

The recent years have been the era of globalization with enormous growth in international trade, financial flows and foreign direct investment (FDI).

Globalization intensifies interdependence between formerly separated nations, however the world seems to be more fragmented, between the rich and the poor, between the powerful and the powerless, and between supporters and opponents of the new global economy.

Current figures reveal the contradiction between those that have managed to benefit from globalization, and those that are considered to be the losers of this period: A girl born in Japan has a 50 percent chance of seeing the chance of seeing the 22nd century, while a newborn in Afghanistan has a 25 percent chance of dying before age 5. The richest five percent of the world’s people have incomes 114 times those of the poorest five¹, and the world’s richest one percent of people receive as much income as the poorest 57 percent.²

The developing countries are currently facing two major problems: The first one is income poverty. In order to reduce the share of people living on one Dollar a day, the per capita income has to grow by 3.7 percent annually according to optimistic estimations. However, only 24 developing countries have realized these growth rates in the recent years. On the other hand, more than 127 countries with 34 percent of the world population have not grown at this rate.³ Many countries have suffered negative growth and the share of the poor people has increased, although the public focused increasingly on the poverty problem in the recent years, as it just happened at the “Live Aid Concert.” The second problem is infant mortality. 85 countries are on the track to reduce infant mortality to one third of the 1990 level, but they comprise less than one quarter of the world population. One the other hand, 81 percent of the countries with more than 60 percent of the world population will not be able to achieve this goal until 2015. Every day, more than 30,000 children die of preventable diseases.⁴ It is dramatic that many countries that will not achieve this goal are among the world’s poorest, i.e. the least – developed countries.

As economies became more integrated and as progresses in the fields of technology, innovation and science are being made, human quality of life should actually improve. Nevertheless, this has not happened in most countries. This reality is being reflected by the Anti – globalization protests, which are taking place in both industrial and developing countries. Although these protests take different forms and are driven by different goals, they all share the demand that global players and institutions, which are often dominated by the economically powerful nations, should increasingly consider the problems of the world’s poorest people.

The period of constant global peace and justice - the wishful thinking of humankind at all times - will only occur if the fruits of globalization are distributed more equally and if the least developed countries will catch up with the industrialized nations; methods how this goal could be achieved are pointed out in this thesis.

2 Executive summary

As most aspects related to development finance and development cooperation are being discussed in a controversial manner, as they are dependent on individual values and political attitudes, and as the scope of this subject is considerably large, it is impossible to handle all aspects in one thesis. Therefore, the purpose of this thesis is first of all to give a broad overview about the topic as a whole, including the causes of underdevelopment and the problems created by it, the most important development theories and classifications that exist in scientific literature and the policies and activities that the institutions within the system of global development cooperation follow to achieve their goals. Moreover, it is the author′s goal to inform about the different methods of financing development and to update the reader about the latest trends and figures of development finance.

To make the reader acquainted with the fundamentals of this complex subject, basic terms are defined at the beginning of the thesis. Furthermore, development theories and causes of underdevelopment are outlined. Finally, different approaches of measuring underdevelopment and classifying developing countries are introduced.

The structure of the international system of development cooperation is explained in the following chapter. Institutions which are part of the system, especially their tasks and relevance within the system, are described and the institutions’ development strategies are illustrated.

The second but last chapter deals with financing of development. After giving an overview of the topic, various methods of international capital transfer are described, including private equity finance, private debt finance, official aid flows and foreign debt. Finally, the contribution of international trade to development and new sources of development finance are pointed out.

The thesis ends with a conclusion of the results presented. Besides, the author describes his opinion on the effectiveness of development cooperation and gives recommendations how to improve these efforts.

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1 Source: UNDP, “Human Development Report 2002”, Oxford University Press, Oxford, 2002, Page 13

2 Source: Ibidem, Page 19

3 Source: Ibidem, Page 17

4 Source: Ibidem