An Innovative Perspective on Financing Development

September 3rd, 2010

What if there is a way to directly fund development that doesn’t involve foreign aid or philanthropy?  A recent article in the Christian Science Monitor, written by the finance ministers of France, Japan, and Belgium, proposes just this.  The authors suggest using innovative financing—which uses small taxes on large financial transactions, like purchases of airline tickets—to mobilize resources for development initiatives.

Just how small can these taxes be? Recently, the Taskforce on Financial Transaction for Development reported that a levy of 5 cents on every $1,000 traded on the foreign exchange market could bring in more than $30 billion per year.  The ministers hope these figures show international organizations, like the United Nations, could use innovative financing alongside traditional foreign aid to fund safe drinking water, food, treatment for pandemics, and education for children.

I admire the courage it must take to propose such funding techniques in an environment when even maintaining existing tax rates elicits heated reactions.  But if we examine the economics behind this proposal, I think we’ll find it satisfies economic guidelines.

Economists who work in natural resources often think about existence value, which is when people value the knowledge that part of the environment is in better condition, though they do not use it (also called non-use value).  For example, a resident of Canada might value preservation of Brazilian rain forests, even though the Canadian has no intention of ever visiting the rainforest and does not think the forests directly enrich his life.  We can also apply this concept to development economics.  For example, a resident of Germany might value a reduction of malaria amongst children in Mali, though the German never plans to visit Mali and no one he knows will benefit from the immunizations.

In order to monetize non-use values, environmental economists use the contingent valuations method (CVM), which involves asking people in a variety of methods how much they would be willing to pay (or give up) for environmental or other services.

Few papers have conducted contingent valuation studies on development services, since the literature generally applies the concept to the environment.  But from anecdotal evidence, we see consumers already show a significant propensity to pay additional premiums for development services.  Think about “rounding up” at the cash register of your grocery store for the local food bank.  Or expensive bottled water that promises to donate a percent of profits to helping children gain access to clean water.  One recent study showed the average consumer is willing to pay 11% more for fair-trade label coffee.

Of course, the taxes proposed by innovative financing would likely be mandatory.  While economists could conduct surveys to design appropriate rates based on a general willingness-to-pay, they would not be able to evaluate these taxes on an individual basis.

But then again, from a moral perspective—as opposed to an economist’s view—maybe a .005% tax on massive financial transactions, in the name of saving millions of lives, isn’t such a bad thing.

Written by Ann Hollingshead

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