Facing the Development Challenges of the 21st Century: What Role for Budget Support?

Budget support offers direct financing to a country’s treasury to create more “fiscal space” for public programs. It has constituted some 14 percent of ODA on average, increasing to over 20 percent in times of crisis. No aid modality is more controversial. Critics argue that, without earmarking funds to individual projects, they can be stolen or diverted to unproductive uses, and that, unlike investment projects, budget support produces no “tangible” results.  Proponents argue that the financing modality offers notable advantages, that it promotes government ownership and the use of country systems, provides a central focus for policy dialogue between donors and recipient governments, and is more efficient, dollar for dollar, than project financing, avoiding costly (and often multiple) donor procurement, contracting, and accounting overheads. 

The tide of consensus has risen and fallen with political trends and changing views on the drivers of aid efficiency. In the early 2000s, propelled by studies suggesting that aid effectiveness rested heavily on ‘good governance’, advocacy for budget support was captured in the 2005 Paris Declaration signed by over one hundred countries and calling for aid ‘harmonization and alignment’, mutual accountability built on a solid development dialogue, country ownership of reforms, and use of country systems.  A decade later this enthusiasm had waned and many European bilateral agencies had withdrawn from active promotion of budget support. The US, with especially high concern over the possibility of diversion, has never been an advocate. Today, MDBs provide 80 percent of budget support; the EU, with its distinctive instrument, much of the remainder.

What can we learn from studying the evidence? Two new books review the evolution of budget support and its effectiveness  since its start in the early 1980s after the second oil crisis. “Retooling Development Finance for the 21^st Century: The Importance of Budget Support” (OUP, 2023) presents the conclusions of a number of development practitioners. A second book, “Policy-Based Lending in Support of Reforms and Structural Transformation in Developing Countries”, being published with open access online by the Evaluation Cooperation Group (ecgnet.org), provides a synthesis of results from independent evaluations of the MDBs and the European Union. In addition, an expert panel was convened by CGD to provide diverse perspectives on the findings.

Securing direct evidence on the effectiveness of budget support is demanding, due to the difficulties of attribution and the construction of a counterfactual. Moreover, evaluation methodology does not always focus in an appropriately differentiated way between project-type outputs and the policy and institutional improvements that generally motivate the use of budget support. Nevertheless, a comparison of independent evaluation scores concludes that, on average, budget support operations perform as well as, if not slightly better than, investment projects. In addition, there is no evidence to suggest systematic diversion of budget support from developmental uses. Budget support has also been countercyclical, playing a critical role in easing crises where the counterfactual could be economic or political collapse. While small as a fraction of total financial inflows to developing countries, it has played an outsized role to support institutional reforms, including improved debt management, strengthening the business environment, and resource mobilization.    

Averages conceal variations, and there is no doubt that budget support – like all development funding  is subject to risks. But it is notable that these (generally positive) results have been sustained despite the fact that, over time, budget support has been extended to a wider spectrum of countries, including some fragile and conflict-affected states, with lower scores on the World Bank’s Country Policy and Assessment ratings.

This is not to say that the instrument can be offered indiscriminately, and without sound management on the donor side. The evaluations indicate several necessary ingredients for effective budget support: i) active policy dialogue based on strong analytics; ii) country ownership of reforms, including support by a powerful elite constituency; iii) a robust learning agenda and high-quality and relevant technical assistance; iv) agility by development institutions in response to changing circumstances and shocks; and v) a common framework for private and public sector collaboration and coordination.

Why then the retreat from budget support, at least among bilaterals?  One reason has been overly high aspirations – expectations that assistance provided along the lines of the Paris Declaration would spur rapid improvements in governance, despite the recognized fact that the latter reflects deep-seated societal and political underpinnings. Indeed, evidence shows greater success for budget support in more “technical” areas such as strengthening economic management and systems of public financial management than in more “political” areas such as civil service reform and reducing corruption. Another factor has been the accession of more conservative, and skeptical, governments, with lower political appetite for risks to the productive use of taxpayer money and disillusion with grander, longer-term schemes. This has led to a more granular focus on specific deliverables and results, as in the World Bank’s new Program for Results (PforR) instrument introduced in 2012.    

The evaluation results offer ideas that can help enhance the relevance and development effectiveness of budget support as developing countries strive to meet the development challenges of the 21 ^st century. They also point to the role that the instrument may play in advancing regional and global challenges beyond country borders:  advancing global and regional public goods; helping to combat climate change and adapting to its ravages; preventing future pandemics; and limiting damage from global financial contagion. All these challenges require collaboration on joint analytic work, frank policy dialogue, and resource transfers to be effective and sustainable. Combined with constructive policy dialogue on investment policy, business regulations, and the rule of law, budget support may also contribute to mobilizing private capital in the interest of sustainable development. Addressing the challenges of the 21^st century requires dialog and a range of complementary financing instruments. But at the same time, without strong ownership of the reform agenda, neither budget support nor project support will deliver. Leadership of the IMF and World Bank, meeting in Marrakech October 9-15 for their annual meetings, would do well to reflect on the opportunity to enhance design and use of budget support. 

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Mark Sundberg- Senior Fellow Emeritus, Center for Global Development, and Deputy Vice President and Chief Economist, Millennium Challenge Corporation.  This blog does not necessarily reflect the institutional view of the Millennium Challenge Corporation.