Principal Challenges to Financing the Sustainable Development Goals

By Kingsley Eze

One in nine people on earth is starving due to world hunger(United Nations, 2020). Ten percent of the world’s population live in extreme poverty - below $1.90 US per day(World Bank, 2020). All further currency reference in this document is in US dollars. Coupled with the burgeoning effects of climate change, these conditions led to the creation of Sustainable Development Goals (SDGs) with the mission of realigning the global development track with the current realities of the world. SDGs were formed by the United Nations to replace the Millennium Development Goals (MDGs) 15 years after its creation in the year 2000. The MDGs consisted mostly of economic growth goals(Mawdsley, 2018).  The SDGs grouped in economic, social, and environmental aspects of development with a 15-year timeline, making the SDGs more holistic and representative of development than the MDGs. The SDGs consist of 17 goals and 169 targets that are to be achieved by 2030 (United Nations, 2016). The SDGs utilized a bottom-up goal-setting approach with the countries’ representatives reaching a consensus in 2012 in Rio de Janeiro (UNDP, 2015). The SDGs cover development pillars such as education, health, economic growth, reducing inequality, hunger, and gender. It is challenging to achieve one SDG without improving another because of how interlinked the goals are. However, one of the major challenges with the SDGs is how to fund them. The need to address and highlight the funding required for the SDGs has led to creating the slogan “from billions to trillions”(Mawdsley, 2018). Five years after the commitment to SDGs, the question of financing remains, and so do its challenges. In this document, sources of the SDGs financing are analyzed, and the role of private capital is highlighted, alongside a presentation of the challenges facing the flow of private capital into SDGs.

 Background

Traditionally, development projects have been financed through Official Development Assistance (ODA) or “foreign aid” including debt relief. The ODA which comes from the OECD Development Assistance Committee is an agreement in which donors pledge to give 0.7% of their gross national income. However, in 2018, only five of the donors reached the 0.7% threshold pledged while 18 out of 29 members reduced their contributions in 2017.  Hypothetically even if the donors had all met their pledges, the 230 billion that would have been would still not be enough to fund the more expansive and inclusive SDGs (Gaspar et al., 2019). An annual global investment of about 5 to 7 trillion is required to fund the SDGs (UNCTAD, 2014).  According to experts, about 1.4 trillion dollars annually is currently being spent on the 17 goals and 169 targets by developing countries – 360 billion in low-income countries and about 940 billion in middle lower-income countries  (Schmidt-Traub, 2015). To put the gap in these numbers into perspective, to achieve SDG 13 which addresses climate action, which benefits the world, 100 billion dollars is required annually by 2020 for adaption and mitigation of the effects of climate change alone. This target is not being met because the ‘Green Climate Fund’ which is a partner for developing countries and would have assisted in meeting the climate action, is underfunded itself (Morris, 2018).  According to UNCTAD, developing countries need between 3.3 trillion and 4.5 trillion annually, however, currently, there is about a 2.5 trillion gap annually between current funding levels and what is required for financing the SDGs (UNCTAD, 2014). The differences between current spending and the amount required have created the SDG financing gap. In addition, there is also a financing gap within sectors. Economic and social infrastructures have the most significant financing gaps. For example, power infrastructure has the greatest financing need of about 950 billion, while health and education require a combined 390 billion but investments fell short in these sectors (Doumbia & Lauridsen, 2019). To resolve these gaps, significant investment and resources are required from both private and public sources. At the Third International Conference on Financing for Development in Addis Ababa in 2015, financing for development, financing was categorized into private and public, which were further broken down into domestic and foreign categories. Domestic sources of financing comprised of tax revenues and private savings while foreign sources consisted of private inflows and public inflows. Private inflows included foreign direct investment, portfolio investments and remittances. Public inflow consisted of ODA, debt and other official flows (Doumbia & Lauridsen, 2019).  

Sources of Investments

The challenge with financing the SDGs is that most of the onus falls on national governments. In most cases, the need for development and the lack of resources required to meet the SDGs are located in emerging countries that are already disadvantaged economically. For example, to attain the infrastructure-related SDGs and stay on track to limit climate change to 2 degrees Celsius according to the 2015 Paris Climate Accord, lower- and middle-income countries must spend about 4.5% of their GDP (Fay, 2019). However, it has been proven that the lowest income countries tend to have the largest financing gap. This is in addition to the finding that most of the spending so far has been carried out in the developed countries, although developing countries have a greater need for SDG financing and spending. It is also projected that future growth of SDG spending is likely to occur in fast-growing upper-middle-income countries, which will leave developing countries behind (Kharas Homi, 2019). There has been an increased focus on Domestic Revenue Mobilization (DRM) by the IMF. This was a viable option before the economic crisis caused by the COVID-19 pandemic. Due to the relationship between GDP per capita and SDGs spending, there has been a decrease in finances due to a drop in tax revenue and ODA, which is a function of GDP especially in 2020 due to the COVID-19 pandemic. According to the IMF, real GDP growth for the world is about -4.4%; when broken down, -3.3% and -4.4% for emerging and advanced economies, respectively (International Monetary Fund, 2020). Unfortunately, as the GDP output of countries decreases, it means that the percentage of their GDPs that is spent on the SDGs must increase to maintain the required investment. However, this is not happening and is not likely attainable by most countries in the current economic environment.  Prior to the pandemic, although emerging countries were experiencing an increase in tax revenue, their tax revenue mobilization rates were below that of the median high-income countries. Tax revenue grew from 11% of GDP in 2000 to 15% in 2017, which is 11 percentage points behind advanced economies (Gaspar et al., 2019). DRM is also a function of an economy's size, which favours lower and upper-middle-income countries more than low-income countries. As the IMF recommended developing countries can raise 3 to 5% of  GDP by improving DRM, however, this amounts to 5 billion for low incomes countries (LICs), 95 billion for low-and-middle-income countries (LMICs) and 60 billion for upper middle-income-countries (UMICs), which highlights the disparity in resources and need (Kharas Homi, 2019).  The cross-border flow remains another means for the public sector to raise investments, however, despite the increase in cross border flow to low-income regions like Sub-Saharan Africa, there tends to be an outflow of foreign direct investment (FDI) when there is a microeconomic shock like the decrease in commodities prices (UNCTAD, 2019). A culmination of these situations means that no country is on track to meet all the SDGs' goals by 2030 and a cooperative initiative is needed (Runde et al., 2020).

 Private Sector

Collective action is required to meet the SDG indicators by 2030. Specifically required is the mobilization of private capital which should benefit the world, especially developing countries. Some private capital sources include pension funds, sovereign wealth funds, private savings, FDI, insurance companies and other investments. The numerous sources make the private sector an essential stakeholder in the financing and attainment of the SDGs due to its resources and the SDGs' effect on global outcomes. There are about 17 trillion of annual global savings, in addition to 218 trillion in global capital markets that could finance the SDGs. When evaluated, this amount is more than 4.5 trillion needed annually (UNTT, 2015).  However, the successful implementation of the SDGs depends on the quality of financing as much as the quantity. Currently, the amount of private capital financing SDGs is low compared to the total amount available. According to the OECD, between 2012 and 2018, 205.2 billion was mobilized by the development finance intervention, with 2018 being the highest individual year with 48.4 billion raised. In addition to insufficient private capital, there is an uneven distribution of private finance with only 5.3% going to least developed countries (LDCs) and other low-income countries (LICs), despite evenly distributed mobilizations across regions(OECD, 2018a). This thereby proves that inadequate financing is not a result of insufficient finances (Walker Julia, Pekmezovic Alma, 2019). To achieve the SDGs, private sector financing must be targeted to reduce the sectorial gaps. In low to middle-income countries, the private sector accounts for 9 to 13% of total infrastructure investment (Fay, 2019). This low presence shows the significant role private capital can play, especially in countries like Burundi and South Sudan, where the SDG gap per capita is higher than the GDP per capita  (Doumbia & Lauridsen, 2019).

 Challenges Faced by the Private Sector

In addition to the challenges posed in the private financing of the SDGs, such as the under-leveraging of resources and the inequality in resource allocation, there is also an inefficient allocation of private capital among the SDG sectors. In 2018, 61.6% of private capital raised went to economic infrastructure and services while only 5.6% went towards social infrastructure such as health, education, water and sanitation (OECD, 2018a). Some of the challenges of private finance can be resolved by crowding in and improving the quality and quantity of private capital being attracted. For instance, in Asia and the Pacific region, which contains many emerging countries, private finance can provide around 10 trillion annually  (Asian Development Bank, 2015).  To realign and attract the efficient allocation of resources, there needs to be a better partnership between the public, international agency partners, and the private sector. Organizations like International Financial Corporation (IFC) have taken the role of attracting private investment and helping viable projects get started, but this effort is not enough; it must be scaled up to bridge the needs of the  SDG financing gap(Doumbia & Lauridsen, 2019). Through partnerships like this and the support of the local government, investments will flow into sectors such as health, which are often considered public sector domain and in return support the attainment of SDG 3 – Good health and well being. There is also a positive economic argument to be made that by achieving the SDG goals in agriculture, sustainable cities, energy and health, about 12 trillion can be unlocked in business savings and revenue by 2030 while creating 380 million jobs (Runde et al., 2020). Some of the challenges preventing the private sectors’ investment in the SDGs are systemic, ranging across developing countries and in some cases developed countries where private capital is situated. Examples of some of these issues include risk assessment/perception, corruption, inadequate data, misalignment of incentives, and technology absence.  These issues are each further discussed below:

 Risk Assessment/Perception

Perception of risk is a significant limitation in the financing of the SDGs. Although there has been an increase in private capital flows to developing countries recently, a substantial amount is not being invested in sustainable development (OECD, 2016). This is attributed to private investors not understanding and identifying investment opportunities due to the perceived risks, which leads them to pursue investments that do not meet the SDGs mandate (UNCTAD, 2014). The misunderstanding of risk creates competition for SDGs projects. Another perception of risk occurs when the investment framework is not fully developed. The absence of the rule of law, transparency and investment regulations to protect capital in a contractual disagreement is regarded as high risk in most emerging countries. Developing countries will have to improve their institutions to attract and maintain investor confidence. The governments of developing countries can use strategies such as public-private partnership agreements to encourage private capital investments. However, they have to be wary of cost while maintaining the balance of providing a public good and overcharging the recipient of the services. Private sectors operate on the evaluation of risk and understanding the return needed to bear that risk. However, it is challenging to fully assess risk in SDG investment because projects are difficult to compare due to their uniqueness. Also, some of the projects have never been implemented before, which makes their feasibility complicated, creating uncertainty(UNCTAD, 2014). Developing countries will have to provide expert leadership by providing local institutions that will help navigate these risks for foreign investors and private capital owners.  Project ownership is equally a risk in financing SDGs projects. SDG projects thrive when there is clear ownership and leadership.  To achieve clear ownership, SDG projects should be conceived by national governments with the support of International Financial Institutions (IFIs). Risk is never going to vanish; however, processes can be put in place to help mitigate the risks.

Corruption

Tackling corruption will increase SDG financing, especially in developing countries. According to the IMF, reducing corruption will increase total global revenues by 1 trillion in developing countries (IMF, 2019). Corruption affects foreign direct investment and equally affects investments in the SDGs. Also, private capital is wary about leakages in capital, which increases the cost of doing business and affects their investment outcomes. According to a UN ESCAP-ADB-UNDP report, 40% of electricity, water, and sanitation investments are lost due to corruption (Walker Julia, Pekmezovic Alma, 2019).  Corruption in developing countries happens mostly in public procurement and public enterprises. These reduce public spending efficiency, resulting in more significant waste and less investment in SDGs such as education and health care.  To reduce corruption, countries need to take the lead by reforming institutions, investing in transparency and using technology.  International Financial Institutions (IFIs) need to partner with countries, especially emerging countries, to place frameworks that will reduce corruption and improve private sector confidence if the post-2015 development is to be met. The presence of corruption and leakages of development funds hurts every party, the countries, private sector investors and most importantly, the people who need development to attain a better quality of life.  Partnerships with IFIs and other countries help reduce corruption by sharing information and best practices. For example, about 40 countries have made it a crime to gain business abroad under the OECD anti-corruption convention. When developing countries make these efforts and commitments, they are bound to increase investments and improve tax revenue. Georgia and Rwanda reduced corruption and experienced an increase in tax revenue of 13% and 6%, respectively, over different periods (IMF, 2019).  In addition to corruption, illicit activities such as money laundering and tax evasion combined with corruption have cost the world between 800 billion and 2 trillion annually (ADB, 2017). Thus, to reduce the investment barrier and accomplish their SDGs, developing countries must tackle corruption.

Insufficient Data

The SDGs have indicators that will help with operationalization, and the 169 targets represent a way to break down the goals. However, the SDGs did not have a definitive monitoring and evaluation scheme in place when it was signed. This compromise is a double-edged sword because it helped middle- and low-income countries account for national variation and expose the absence of reliable data. Lack of data has made it difficult for countries to design, implement and monitor policies and track progress. According to the World Bank, 77 of the 155 countries in which they monitor poverty do not report poverty data (SERAJUDDIN, 2015). The disparity in data makes it difficult for the private sector to understand where and how to allocate capital. In some countries with data, the data's quality is either lacking or not comprehensive enough to be used for investment decisions. The absence of data makes it very difficult to measure progress towards the SDGs. In order to make SDGs SMART – (specific, measurable, attainable, relevant, and timely), accountability is needed, not just by donors but by a partnership of countries that signed the agreement, international organizations and civil society (Walker et al. 2019).  During this research, documenting capital flow and attempting to understand where capital is being deployed proved difficult. This challenge is part of the reason why the insufficient capital allocated to the SDGs has gone towards developed countries. For countries, especially the developing ones, to attract private capital and compete against other investment interests, a data revolution is needed. An investment might be worth being funded, but it is challenging to convince already skeptical risk-averse investors without evidence of data supporting it. Without quality data, not only would private capital be scarce, the SDGs will not be met(Espey, 2019).

Misalignment of Incentives

There is a misalignment between private capital and the SDGs. One of the misalignments is the difference in time horizon(UNTT, 2015). The SDGs require a longer time horizon - even though the allocated time is 15 years with an end date of 2030, investments in education, infrastructure, and efforts to reduce gender inequality will certainly have to exceed 15 years. This difference in timeline is also seen in the setup of financial institutions in developing countries. For example, in Africa, short-term credit accounts for 90% of bank financing, which constrains long-term investment in sustainable development. Although the Welcome Economic Forum promotes a shift to long term investment, more still needs to be done. Furthermore, private capital needs to be aligned with targeted sector financing to meet the SDGs especially for sectors that struggle to attract investment such as agriculture (OECD, 2018b).  Most developing countries lack properly developed financial and bond markets, which means that those countries' private capital departs the country, leading to capital flight, which hinders SDG financing efforts. Other misalignments of incentives between private finance and SDGs attainment are found in the returns expected. However, efforts have been made to create financial instruments such as blended finance, where philanthropic funds act as a top-up for returns to meet market returns. Efforts have to be made using ODA to realign the incentives of the private sectors. Having mandatory reporting of how private sector efforts contribute to the SDGs will be of benefit.  In addition to having private capital owners understand their assets' investment and convincing financial intermediaries that the SDGs are not only worth investing in but are profitable (Bendersky, 2020).  According to Thomson Reuters, the world's top 38 Sovereign Wealth Funds globally have about 383 billion invested in emerging markets (Waki, 2013). However, impact investing makes up 20% of these investments, which means that over 300 billion is not funding development efforts. With these alignments of incentives, there will be more private financing flowing into sustainable development.

Absence of Technology

Digitalization is a tool capable of increasing investment in the SDGs while reducing the obstacles in private financing. Through digitalization, technologies such as big data and artificial intelligence can be applied towards tracking the effectiveness of investment, banking the unbanked in emerging countries and carrying out risk analyses. ANT Financial became the world's largest lender to Small and Medium Enterprises (SMEs) in China, using technology to access and deliver loans in 3 minutes without collateral(OECD, 2020). Innovations such as this will reduce some of the challenges, such as accessibility faced by private capital.  Another example of digitalization playing a huge role in the SDGs is ANT Financial, the UNEP and the sustainable Digital Finance Alliance efforts to engage Chinese users of Alipay in carbon-saving activities based on financial transactions. Principles of these projects can be deployed globally towards sustainable investment. Currently, an obstacle is that only 55 percent of people in developing countries have access to a bank account(UNTT, 2015).  Lack of inclusive banking makes aid delivery and economic relief required to meet a goal like SDG 8 – economic growth and meaningful work challenging. Innovations like Kenya's M-PESA will have to be delivered to more emerging countries to drive financing towards SDG outcomes(KPMG, 2016). With technology and digitalization, some of the challenging issues facing SDG financing can be addressed, such as real-time financial performance on investments, reduced transaction costs, and direct engagement with recipients (Kaboré et al., 2018). As continuously observed, a challenge like this requires stakeholders' partnership as recommended by SDG 17 but with developing countries leading the charge.  

Blended Finance as a Solution

Blended finance is a strategy used to leverage, impact, and return private capital for development (OECD, 2015). For every dollar of public money invested, blended capital can attract an additional 1 – 20 dollars for emerging countries. Blended finance is a preferred tool in attracting capital because, it also helps with stakeholder relationships (public, philanthropic, and private sector), ensuring the needs of different parties are balanced and that the funds are allocated towards sustainable development and the SDGs. Blended finance funds have pooled in about 25.4 billion in committed assets, but that is a drop in the bucket compared to the SDG gap. More needs to be done, though this is not without potential risks (e.g. misallocation of risk or shifting profits towards the private sector). Blended finance is the ideal mediator for attracting private capital using already existing financial tools such as loans, equity, loan guarantees and grants for SDG (Mawdsley, 2018).

 The financing of the SDGs is very complicated. The challenges for financing are not a matter of the scarcity of resources but rather a maldistribution of resources. With 360.6 trillion available in global financial assets as of 2019, the resources to finance the SDGs are available (Credit Suisse, 2019).  There are structural and systemic issues found in institutions and capacity building, global co-operation and a realignment of incentives that need to be addressed for the SDGs to be fully financed and attained. However, as the UN General Assembly (UNGA) Declaration on the Right to Development of 4 Dec 1986 (Art 1) states, it is an inalienable right that everyone is entitled to participate in, contribute to and enjoy economic, social, cultural and political development, in which all human rights and fundamental freedoms can be fully realized (OHCR, 1986). If the UNGA declaration's vision is to be attained, difficult challenges must be resolved, including SDGs' financing. When SDGs are funded and met, the world benefits through shared prosperity especially in the face of a pandemic.

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