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Owen Barder is a Vice President at the Center for Global Development, Director for Europe and a senior fellow. He is also a Visiting Professor in Practice at the London School of Economics and a Specialist Adviser to the UK House of Commons International Development Committee. Barder was a British civil servant from 1988 to 2010, during which time he worked in No.10 Downing Street, as Private Secretary (Economic Affairs) to the Prime Minister; in the UK Treasury, including as Private Secretary to the Chancellor of the Exchequer; and in the Department for International Development, where he was variously Director of International Finance and Global Development Effectiveness, Director of Communications and Information, and head of Africa Policy & Economics Department. As a young Treasury economist, Barder set up the first UK government website, to put details of the 1994 budget online.
Kudos to Finland in 2016 for ascending to the top spot in CGD’s annual Commitment to Development Index, our ranking of how a country’s policies help or hinder development. Other countries of note this year include France, New Zealand and Austria. We just published the latest rankings, and I discuss them, their implications, and the political landscape that could affect them in our latest CGD Podcast with Owen Barder, senior fellow and director of CGD Europe, which produces the Index.
Now in its 14th year, we derive the CDI rankings by crunching the numbers from millions of data points across seven policy areas: aid, trade, migration, finance, security, technology and environment. The result is a measure of which country has the most development-friendly policies. It shows where countries do well and how they can learn from each other to do better.
We want to show how development can be a race to the top. Most of the policies that score well on the index require some sort of international cooperation—so what does the CDI tell us about the apparent retreat of globalism across the political landscape? Take a listen to the podcast to find out! And please also check out the interactive CDI rankings to see where each country stands and how they could improve.
Kudos to Finland for ascending to the top spot in CGD’s 2016 Commitment to Development Index, our ranking of how a country’s policies help or hinder development. Most of the policies that score well on the index require some sort of international cooperation—so what does the CDI tell us about the apparent retreat of globalism across the political landscape? I discuss the latest rankings, their implications, and the politics that could affect them with Owen Barder, senior fellow and director of CGD Europe, which produces the Index.
Global policymaking is at risk, threatening the international liberal order which has, for all its faults and lacunae, served the world well since the second world war. There has never been a period of such rapid progress in the human condition. Most of humanity has benefited from unprecedented increases in life expectancy, reductions in violent deaths, progress on equality and rights, and improvements in the standard of living.
This progress has been, in part, the happy consequence of better global policies. This prosperity is the result of the spread of market economies, open trade, investments in science and evidence, wider availability technologies, the establishment of norms and standards, the movement of people and capital to where the opportunities are greatest, and, though we have sadly not eliminated war, a significant reduction in violent interstate conflict.
The policies and international cooperation that have brought all this about are not always easy. Our Commitment to Development Index, the 14th annual edition of which is published today, measures the progress of the world’s industrialised economies towards policies that contribute to make this world better for everyone. We use literally millions of pieces of data to calculate each country’s performance in seven categories: trade, environment, security, technology, finance, migration and aid. This short video explains.
How Countries Ranked in the 2016 CDI
Not surprisingly, Scandinavian countries top the list again this year, with Finland, Denmark and Sweden, respectively, in the first three slots. They tend to have open and transparent financial systems and support sustainable investments in developing countries, while doing the most, relative to their size, to contribute to the global system. Such a functioning system protects the environment and improves standards of living for everyone through international security regimes and shared technology to enhance global progress. Lagging countries like Switzerland (last) and Japan (second last) demonstrate how much potential for contribution to global progress even rich countries have. While the Swiss still have room for improvement regarding financial transparency, Japan could increase its contribution to fighting climate change. But as both countries perform well in some other components, their case illustrates that the CDI is an instrument for a race to the top, inspiring the public and policy makers on how we all can do more to fight global poverty.
The US is 20th out of 27 in the latest rankings, with performances above average in aid and trade but lagging especially on its environmental policies. Although they get credit for signing the Paris agreement on climate change, the US still has by far the lowest gasoline taxes and could do much more to fight global climate change. The UK ranks 9th out of 27, and also does well on aid and trade. Though they are among the leading nations for science and research, neither country does enough to help spread that knowledge to developing countries. Together with Sweden, they have the most stringent intellectual property rights in place, which restricts access to innovation for poorer countries.
In the last 14 years, there has been considerable progress—the CDI shows that rich countries can do more to fight global poverty and have done so. 24 CDI countries have improved their overall score since our first edition in 2003, thereby demonstrating that more equal international policies are possible. No countries have gotten worse overall. The case of Austria, which shows the biggest improvement and now tops the index on security, demonstrates that even small and landlocked countries can pursue policies which have a significant impact on the wellbeing of millions of people in developing countries.
Have we now seen the highpoint of this international cooperation? Obviously we hope not. There is a huge amount to do—if all countries raised their standards up to just the current average in each dimension of the CDI, that would transform the quality of life for hundreds of millions of people.
What holds us back, and indeed threatens the progress the world has made, is our apparent inability to manage change.
Economists will tell you that it is "win-win" to have free trade, to end agricultural subsidies, to let workers move to where they can earn more money, and to spread technologies faster. But while it might be good for every country on average, there are always individual winners and losers. In theory the losers can be compensated, but in practice we don’t seem to be able, or willing, to do that. The consequence of their resistance, and justifiable anger, is that all this progress is now under threat.
We are unrepentant globalists: there is no doubt that better international cooperation has brought about, and can continue to bring about, unprecedented sustainable prosperity. The right response to the present political challenge to this agenda is to do a far, far better job of making sure that we properly manage the negative effects for people who have lost out, and work much, much harder to share the gains more widely.
The Commitment to Development Index ranks 27 of the richest countries on their dedication to policies that benefit poorer nations. Finland takes first in 2016. The UK moves down three places to 9th while the United States moves up one to 20th. Switzerland takes last of 27.
HLM2 at Nairobi’s Kenyatta International Conference Center
The panel is part of CGD’s on-going Payouts for Perils working group, focused on pinning down technically specific, politically saleable, and financially scalable innovations that we can invest in to respond better to expensive but predictable perils. That includes events like storms (think Haiti), earthquakes (think Nepal), or droughts (think the ongoing risks across the Sahel, including Kenya and Ethiopia).
Our panel in Nairobi brought together two critical skills to improving emergency aid: development expertise and risk management nous. We left it with four strong takeaways.
1. Perils - planning = tradeoffs
Our panel benefited from a stellar cast. Sitting in for the UK’s delegation to the meetings was Pete Vowles, the head of DFID’s programme in Kenya, ultimately responsible for delivering more than £150 million in UK aid. Pete told the audience how DFID is investing in new approaches to aid, including supporting a national safety net—Kenya’s Hunger Safety Net Programme—capable of reaching households affected by natural disasters instead of requiring a full-scale mobilisation by donors.
From left: Ginger Turner, Alex Palacios, Pete Vowles, and Rowan Douglas (CGD friend Rupert Simons sneaks into the frame at bottom right)
But in an environment like the horn of Africa, the budgets of DFID and other donors face a host of threats. Let’s say we allocate $100 to deliver vaccines. If a drought arrives, we’re faced with stark choices: tackle it by taking some money from our immunization campaign, or use some flexible funding we’ve held back. We either diminish one programme to subsidise another, reduce our pot of savings to respond to a later crisis, or fail to respond to the drought. That’s a list of bad choices.
2. Donors can’t, don’t, and shouldn’t “invest and forget”
Success in these difficult circumstances depends on the ability to mobilise the right amount of money at the right times. But that means either holding funds back against unknown future risks—and not being able to spend them to tackle poverty here and now—or facing the risk of being underfunded when rare-but-expensive perils arrive (or both).
That was the risk raised by Alex Palacios, who joined Pete on our panel. Alex is a senior official with the Global Partnership for Education, which raises international financing from donors to invest alongside more than 60 national governments in education systems around the world.
Those investments are now worth more than $4 billion globally. In Alex’s words, this is a portfolio that blends education inputs—like teachers’ salaries and line ministries’ capacity—with a policy shift toward spending more, over longer horizons, to educate future generations. Left intact, that portfolio delivers social and economic returns from schooling.
But that success, as Alex succinctly put it, requires resilience. When storms destroy schools, entire cohorts are set back—in some cases permanently. So delivering on goal 4 of the SDGs means both building education systems, as GPE does, but also making sure we can get kids back into school quickly after disasters strike.
3. There’s an industry that provides capital on call
Pete and Alex were joined by two professionals from an industry that we think might help donors solve some of these thorny problems.
Ginger Turner, a senior economist at the (re)insurance firm Swiss Re, pointed out that many of the problems we think of as “budgeting” are actually precisely the problems the insurance sector has native expertise to help solve.
One approach for DFID to manage its commitment to the HSNP, for example, would be to <deep breath> estimate the chance of drought, guess at the additional cost that implies, hold all that money on its books, and take the chance of either underfunding its response by guessing wrong or having more money left at the end of the year (which, in turn, means underspending on other urgent challenges).
The alternative is to set up a contract that pays out in case drought is on the horizon, for example by crunching average surface temperature and rainfall through a simple equation. As Pete pointed out, that’s precisely what the African Risk Capacity—a mutual insurance scheme across several African governments that the UK helped to set up—does.
Insurance, in other words, is an entire sector devoted to charging the rest of us a bit of money at regular intervals to keep money on call for when things go wrong. For frontline agencies and vulnerable countries, using insurance thinking and contracts could unlock a cascade of benefits. They don’t need to stock up on money that leaves them over- or under-funded. They know how much they’ll get if things go wrong, enabling planning. And they can match the payout in the insurance contract to the set of risks they face. That can catalyse faster, better-organised response—and avoid waiting for things to go wrong, hoping that donors will step in adequately and quickly.
4. (And it’s a pretty competitive one)
There’s a healthy dose of skepticism and distrust when we in the public sector contemplate shaking hands with our colleagues in the private sector. How can NGOs and donor agencies be sure to get a good deal?
Certainly this matters both for politics and for prices. This week’s biggest development story in the UK isn’t that the Multilateral Aid Review showed that the vast majority of British development dollars go the highest performing agencies. It’s about bad behaviour by Adam Smith International, a deep-pocketed aid contractor that submitted fake testimonials about its performance to MPs and took advantage of private government business plans when organising supposedly-competitive bids.
Rowan Douglas joined Ginger as an insurance sector voice on our panel. In addition to working his role as a senior executive at London’s Willis Towers Watson, he co-Chairs the Insurance Development Forum, an initiative to help more aid agencies and governments take advantage of insurance tools.
Rowan had two pithy answers to Owen’s question about getting a fair deal. First, donors should absolutely invest in technical capacity that would help agencies and governments be informed buyers of insurance. There are already growing teams in agencies like USAID and DFID (not to mention first responders like Mercy Corps) with backgrounds in actuarial science and an understanding of the insurance industry.
Second, competition is one of the best guarantors of fair prices. An annual review for ARC notes, for example, that it was able to get extremely competitive quotes for its insurance contract, ultimately receiving $55 million worth of coverage from 12 different reinsurers for just over $5 million in premiums. Insurance, in other words, is like any other industry: more transparency about procurement and more competition amongst providers translates into a fairer shake for all of us.
* * *
As Pete noted in his own smart blog post after the event, “risk thinking” and (where appropriate) insurance contracts aren’t silver bullets. But that’s okay: we aren’t hunting werewolves. Smarter financing won’t solve the humanitarian funding challenge, but it seems like a good way to free up more money for emergency response, make our assistance cheaper and more predictable, and leverage the skill and expertise of a competitive and capital-rich industry into the bargain.
Officials hard at work during the HLM2’s opening ceremony
Put simply, how we spend our aid dollars affects the quality of the help we deliver. But this is a piece of our humanitarian spending runs on legacy software: we wait until things go wrong before soliciting funding from donors to meet their costs. As Stefan Dercon, co-chair of CGD’s working group on this topic, has put it, that’s a 12th century financing solution to 21st century problems.
We’re confronted with refugee crises and tragic and continuing conflict in the Middle East and Africa. Our front pages are filled with evidence of our creaking emergency aid system. In a world where predictable, insurable risks contribute to instability, drive poverty and cause displacement, rich countries don’t need to appeal to humanitarian principles to inspire change. Simple self-interest should also do the trick.
Today we present a slightly unusual edition of the CGD Podcast. We are bringing you highlights of an excellent discussion held at CGD's offices in London which involved, among others, CGD’s Owen Barder. It was a special edition of the Radio 4 program The World Tonight, organized and broadcast by my former colleagues at BBC Radio. The discussion focused on the UK's aid budget.
Today we present a slightly unusual edition of the CGD Podcast. We are bringing you highlights of an excellent discussion held at CGD's offices in London which involved, among others, CGD’s Owen Barder. It was a special edition of the Radio 4 program The World Tonight, organized and broadcast by my former colleagues at BBC Radio.
The discussion focused on the UK's aid budget. The panel considered whether it was right for the UK legislated to spend 0.7% of gross national income on development. They also discussed attempts to make aid more transparent, ways to tackle corruption, and how to think of international development in a political landscape where major countries seem to be turning inward.
Official Side Event to the Global Partnership for Effective Development Cooperation 2nd High Level Meetings. This high-level panel will present new research conclusions and practical policy actions generated by a high-level working group convened by the Center for Global Development to deliver long-term progress on the Sustainable Development Goals by making emergency aid for disasters faster, more effective, and more fair.
The priority for policymakers concerned about the Ebola epidemic in West Africa should be to respond to the existing outbreak, treat the victims, and contain its spread.
But many have begun thinking about the medium- and long-term implications of Ebola. For example, the Vaccine Alliance (GAVI) has been asked to think about how it can help speed up the development of an Ebola vaccine.
There are two things we need to do. First, set sensible cost-effectiveness thresholds for investments in global health, and so increase our willingness to invest. Second, make an Advance Market Commitment to accelerate the development of new vaccines, for Ebola and for other neglected diseases. Here’s why.
Why Is There No Vaccine?
The normal rule of thumb is that it costs about $1 billion on average to develop a new drug or vaccine. Even if we succeeded in developing an Ebola vaccine, it might not be included in routine vaccination programmes because the disease is so uncommon, which means the costs and potential side effects of routine vaccination are unlikely to be justified by the benefits. So we would probably stockpile an Ebola vaccine to limit an outbreak instead. No company is going to make a purely commercial decision to invest a lot of money in developing a vaccine for which there would be such a small and uncertain market.
So if we want to develop an Ebola vaccine, governments and donors have to either finance the R&D directly or create a viable market for the vaccine if it is developed, or some combination of the two.
Why Don't Donors Pay for Vaccines for Diseases like Ebola?
Researching, developing, and providing access to medicines that prevent and treat infectious diseases is a very effective form of development cooperation. (This is why Angus Deaton suggests that donors should spend money for developing countries, but not in developing countries.) So why haven’t donors paid enough to develop vaccines against diseases like Ebola?
Donors use cost-effectiveness thresholds to decide which health investments to support. Following the 1993 World Development Report a health investment for developing countries used to be regarded as cost effective if it costs less than $150 per disability-adjusted life year (DALY) averted. More recently, the World Health Organization’s rule of thumb has been that interventions are highly cost effective if the cost per DALY averted is less than average annual income (measured as GDP/capita) in the country concerned and cost effective if the cost per DALY is less than three times average annual income. For Sierra Leone, one of the countries currently affected by Ebola, this rule of thumb implies that an intervention is regarded highly cost effective if it costs less than $800 per DALY, and cost effective if it costs less than $2,500 per DALY.
This rule of thumb puts a very low value on the lives of poor people, far below the value we place on the lives of citizens in wealthy countries. For example, the National Health Service considers an investment in the health of British citizens worthwhile if the cost is less than $50,000 per DALY averted. Even this much more expensive threshold is regarded as too low: there are frequent campaigns in the British press for the NHS to be allowed to pay for more expensive treatments. So donors value the life of someone in Britain twenty times more than the life of someone in Sierra Leone.
Because Ebola is relatively rare, donors will only invest in a vaccine if they place a relatively high value on the lives of people in developing countries. At $150 per DALY averted they would spend only about $20 million for an Ebola vaccine, which is not nearly enough. At a higher threshold of $2,500 per DALY averted, donors should be willing to spend about $300 million. Even if you think that the estimated $1 billion cost of developing a new drug or vaccine is an exaggeration, an investment of $300 million is unlikely to be sufficient to finance the development, approval, production, and distribution of a new vaccine.
So the reason we don’t have a vaccine against Ebola is that the likely victims of the disease are not wealthy enough to pay for the full cost of these medicines; and donors don’t invest enough in developing drugs and vaccines for relatively rare diseases like Ebola because the value they place on the lives of people in developing countries is too low.
The Cost-Effectiveness Thresholds Are Too Low
The Ebola outbreak reminds us that there are very substantial direct costs of dealing with an outbreak of disease: the WHO estimated in August that the current Ebola outbreak will require about $490 million. On top of this, there are indirect economic costs to the countries affected: the World Bank estimates suggest that Ebola will reduce economic output by something like $1 billion (though these estimates are very uncertain). This does not include the economic impact on developed countries, for which no estimates have been published. We cannot insulate ourselves and our citizens from the risks of infectious disease, nor the wider economic effects of restrictions in trade, investment, and the movement of people, nor the need for a humanitarian response.
This means there are three reasons why we have to put a higher value on the lives of people in developing countries when deciding whether to invest in prevention. First, it is plainly immoral to value other people so little relative to ourselves. Second, when outbreaks do happen, donor countries in practice have to meet substantial direct costs of treating people and containing the spread of the disease. Third, there are real and growing economic costs.
For these three reasons, it is neither moral nor practical to continue to value the lives of people in developing countries at $150-$5000 per DALY, when we value our own lives at $50,000 per DALY. (My own preference would be to value all lives everywhere equally.) But there are also significant direct and economic costs of disease, over and above the impacts on people’s health, which should also be taken into account when donors consider the cost effectiveness of investments in global health. These costs can either be taken into account in the calculations separately, or by increasing the cost-effectiveness thresholds. Whether you share my view that we should value all people equally, or whether you merely take a pragmatic view about the long-term costs to industrialized countries of a failure to invest in prevention of global health problems, it is clear that industrialized countries should be spending more on global health, and that the existing cost-effectiveness thresholds are too low.
A cost-effectiveness threshold of $10,000 per DALY would justify a substantial increase in global health investment. For example, a cost-effectiveness threshold of $10,000 per DALY averted would justify spending at least $1.25 billion on preventing Ebola.
Increasing the cost-effectiveness thresholds would have to be accompanied by (and would justify) an increase overall spending on global health. Increasing cost-effectiveness thresholds but leaving the budget unchanged could cause a deterioration in overall resource allocation and so lead to a reduction in value for money from the limited budget available.
How to Spend $1.25 Billion on Preventing Diseases
It would obviously have been far better to have prevented Ebola, or kept it from spreading, than to be obliged to spend as much money as we are now to contain the epidemic. As well as developing new medicines, that investment could have taken the form of strengthening health systems to cope with outbreaks of infectious disease, increasing capacity in the WHO, and improved disease surveillance and international rapid response mechanisms, all of which would increase resilience against a wide range of diseases.
A very good way to fund the development of new vaccines and drugs would be through an Advance Market Commitment, which harnesses the finance, innovation, and inventiveness of the private sector to tackle diseases.
The pneumococcal Advance Market Commitment introduced in June 2009 was intended to be a pilot of the AMC mechanism. As a result of this AMC, children in over 25 countries are now being immunized against the main cause of pneumonia. The mechanism has been shown to work: it should now be used for other diseases.
Using an Advance Market Commitment has the advantage that if a vaccine or treatment cannot be found, it will not cost the donors anything. And if it works, the costs of paying for a vaccine under an AMC are far lower than the human and economic costs of treating the disease.
The prospects for an Ebola medicine seem more promising than for some other diseases, which suggests that a relatively small AMC could be effective.
Fight the Next War, Not the Last One
At a threshold of $10,000 per DALY, it would also be cost effective to invest in solutions to many other neglected tropical diseases and health conditions in the developing world. We should be spending much more on widespread diseases such as malaria, HIV, and tuberculosis. So adopting a higher cost-effectiveness threshold should mean a substantial increase in spending on global health research and development and spending more on health systems.
The root of our failure to invest in new pharmaceuticals, health systems, and disease surveillance is that donors put too little value on the lives of people of developing countries and spend too little on global health.
At the values they conventionally use in cost-benefit analysis, donors are not willing to spend enough on health prevention to justify the development of new medicines.
But this is neither moral nor practical. We spend much more on treatment, and generate avoidable economic costs, because we underinvest in prevention.
Changing the cost-effectiveness threshold to $10,000 per DALY — which is a fifth of what the UK spends on itself — would transform the arithmetic of investment in health prevention.
It would justify a series of new Advance Market Commitments for neglected diseases at a level which would be likely to have a substantial effect on the incentives facing commercial pharmaceutical companies. Many exaggerated claims are made about the unique opportunities of our age: but we really could, if we decided to, create sufficient incentives for innovation and research and develop drugs and vaccines which will enable us to control these awful diseases.
If you could choose how to curb greenhouse gas emissions, would you choose a carbon tax or cap-and-trade? Environmental economists have long debated this question, and it will be on many people’s minds in the run up to the climate meetings at which world leaders will attempt to reach agreement on how to limit global warming to 2°C in Lima (December 2014) and Paris (November–December 2015).
In this post, we’ll recap what the economics tells us about this choice, and we’ll offer a challenge to the general consensus in favour of a carbon tax. Next week, we’ll depart from idealized economic theory and consider the practical questions which we think tip the balance towards cap-and-trade.
What does economics tell us?
Credit: Alastair Oloo
The basic economic question between carbon tax and cap-and-trade is about whether you should use a tax to set the price of carbon and let the quantity emitted adjust, or cap the quantity by auctioning tradable permits and let the price adjust.
Either way, you would be putting a price on carbon to reflect the true environmental and social costs of emitting a ton of carbon dioxide. And either way you would generate revenues for the government (either tax revenue or income from auctioning permits) that you could use to cut other taxes or invest in clean technologies.
So which is better? This question is particularly salient in the wake of new regulations from the US Environmental Protection Agency (EPA) giving states the flexibility to chart their own customized path to meeting their reduction targets.
Economists have been thinking about the respective merits of price controls and quantity limits for some time. Conventional economic analysis (including a ground-breaking paper by Martin Weitzman in 1974) has usually favoured price-based instruments like taxes. We argue that the potential for irreversible damage from climate change strengthens the case for cap-and-trade instead. Here’s why.
Fixing a price or fixing a quantity are notionally equivalent
Carbon taxes and cap-and-trade programs represent two different market-based approaches to environmental regulation. If the authorities set a tax, then the price of emissions is certain, but there is uncertainty about the ensuing level of emissions. If the authorities instead auction emission permits then there is certainty about the volume of emissions, but uncertainty about the price. The crux of the debate is this: which is worse, uncertainty about price or uncertainty about the volume of emissions?
You can make the case either way. If your goal is to set clear, predictable, long-term incentives for people to switch to clean energy and to invest in clean technologies, then you want to set a predictable long-term price. That is the simplified case for a carbon tax.
But there is a contrary view: we don’t necessarily know the right price to set on carbon. Setting it too high could have large economic costs and setting it too low would lead to potentially irreversible climate change. Given that our key underlying objective is to limit the volume of carbon emissions, then we should set the quantity and let the market take care of setting the price. That is the simplified case for cap-and-trade.
Theoretically, if we knew with certainty how much would be emitted for any given price, then these two approaches would be perfectly equivalent. You could set the price and be certain how much emissions would decrease, or you could set the level of emissions and be certain about the price on which the market would settle. Think of this as a graph of price and emissions: if you know exactly where the line is, it doesn’t matter whether you pick your point along the curve using the price on one axis or the level of emissions on the other, since picking one mechanically fixes the other.
But in real life, quantity and price controls differ because costs are uncertain
In the real world we don’t exactly know how much it will cost to reduce emissions, nor do we know what the environmental damage will be from a given level of emissions. That means that whether we set a price or we set a quantity, we are almost certain to be a little bit wrong, and this will impose a cost on society. In an uncertain world we can’t entirely avoid these costs, but as Martin Weitzman showed, we can keep them to a minimum by choosing the right instrument. Whether we prefer price or quantity controls depends on a combination of where the uncertainty lies, and how much of a difference it makes if we get things little bit wrong.
The more we try to reduce carbon emissions, the higher the marginal cost of doing so and the lower the marginal benefit to the environment of doing so. If we are uncertain about both the marginal cost and the marginal benefit, then it is the relationship between these that determines whether we should favour taxes or quotas.
The diagram below, from William Pizer (pdf), shows two scenarios. On the left is the scenario which many economists think is realistic. In this scenario we would have to make a big change in the quantity of emissions to increase the marginal benefit to the environment (that is, a flat marginal benefits curve) but the marginal cost of reducing emissions rises quickly as the amount of abatement needed goes up (a steep marginal cost curve). In this case we know in advance roughly what price is needed to produce environmental benefits, and the deadweight loss from setting the price at the wrong level (shown in yellow) is small. But because the marginal cost curve is in this scenario is relatively steep, setting a quota and letting the price adjust could lead to substantial inefficiency and welfare losses (shown in blue) because of uncertainty about the position of this curve.
Source: William A. Pizer, “Prices vs. Quantities Revisited: The Case of Climate Change”, Discussion Paper 98-02, Resources for the Future, October 1997, page 5. Available here (ungated).
On the right hand side is the opposite case, in which the marginal benefit curve is steeper than the marginal cost curve. In this case, the potential cost of uncertainty is greater if policymakers set the price (the cost is shown in yellow) than if they set the quantity (shown in blue). In this case, we should prefer to set the quantity of allowed emissions, and let the market find the right price.
The conventional wisdom is that we are probably in the position depicted on the left. Since it is the stock of pollutants (such as carbon dioxide) in the atmosphere which affects climate change, it might not make a huge difference to the climate and natural ecosystems if the flow of new pollutants in any given year is a little bit too high. This suggests that the marginal benefit for the environment of reducing the flow of emissions is low and would not rise very fast as emissions come down. Conversely, the marginal cost of reducing emissions might rise quite quickly (the cost of high-hanging fruit for emissions reductions could be a lot more expensive than tackling low hanging fruit).
So with a flat marginal benefits curve and a steep marginal cost curve, it is likely to be less expensive to society as a whole to set the price of emissions, using a tax, and accept that the effect on the volume of emissions is a bit uncertain, than to set a quantity cap on emissions and risk the economic costs of forcing up the price of carbon to unnecessarily high levels.
But this widely-held view depends on whether the effect of emissions on climate change, and the ensuing damage to natural ecosystems and to human society is, in the words of Rick van der Ploeg, ‘big potatoes’ or ‘small potatoes’. If there are non-linear system dynamics, perhaps involving irreversible regime shifts, then the marginal cost of being a little bit wrong about the quantity of emissions may be very substantial.
The potential for tipping points and irreversible damage points to cap-and-trade
The relationship between carbon emissions and the climate system is not likely to be a smooth, continuous function. Nor is the relationship between global warming and the impact on the economy and human wellbeing. A general property of non-linear systems is that they can exhibit “regime shifts”: changes that are large, discontinuous, and difficult, expensive, or even impossible to reverse.
The realm of possible climate-induced damage includes events that are unlikely, but cataclysmic or irreversible, such as the release of vast amounts of carbon and methane from the permafrost and ocean floor.
Tipping points such as the widespread dieback of rainforests, the bleaching of coral reefs, and the collapse of the ice sheets may kick in as the climate warms. In the jargon, the probability distribution of harm is fat-tailed. The potential for climatic tipping points, such as the weakening of the Atlantic thermohaline circulation, apart from providing sensationalist fodder for mediocre Hollywood blockbusters, suggest both that that the damage curve is likely to be non-linear, and — since it is the stock of pollutants that matter— we may not be able to remedy the effects of under-pricing carbon today just by adjusting the price later.
Source: Figure 19.5. Chapter 19, Working Group II: Impacts, Adaptation and Vulnerability. Third Assessment Report, 2001. Note: the most recent IPCC report on this topic is from 2013. The graph used here is for stylized purposes.
This point about the shape of the curve may sound esoteric, but it reflects an important common-sense idea about the asymmetry of risks. If we set the carbon price too high, we risk unnecessary economic costs, reducing the well-being of many people. But if the carbon price is too low and emissions are too high, then we risk large and possibly irreversible interference with the climate system. If the human costs of unexpectedly high emissions are sufficiently large, then capping the quantity of emissions directly would be better than setting the price because the costs of uncertainty are lower under cap-and-trade (the right hand diagram above).
If we believe that the marginal benefits curve is steeper, and the marginal cost curve shallower than conventional wisdom suggests, then given the likely costs of these uncertainties we should conclude that it is better to set a cap on the quantity of emissions, and let the market determine the price, rather than the other way round.
If we were very concerned about the economic costs of price uncertainty and volatility, we could mitigate these risks that by incorporating price-like features into a cap-and-trade scheme, such as allowing for banking and borrowing of allowances. Emitters could choose to save and use up allowances in the future or to borrow them from future allocations. That would have the effect of helping to smooth out the price over time and reducing the negative impact of cost shocks. Economists such as Roberts and Spence (1976) and Pizer (2002) have suggested hybrid systems which combine both price and quantity-control features could offer the best of both worlds, provided they are done well.
Although simple theory is sometimes characterized as favouring a carbon tax over cap-and-trade, we think the economic case is less clear-cut when we account for the asymmetry of risks in a complex, non-linear system like our climate. Our follow-up post considers the messier, real-life arguments that we believe tip the balance more decisively towards cap and trade. In the meantime, we’d love to hear what you think in the comments.
Nathaniel O. Keohane, “Cap and Trade, Rehabilitated: Using Tradable Permits to Control U.S. Greenhouse Gases”, Review of Environmental Economics and Policy, 2009, 3:1, pp. 42-62. Available here (gated).
William A. Pizer, “Prices vs. Quantities Revisited: The Case of Climate Change”, Discussion Paper 98-02, Resources for the Future, October 1997, pp. 1-52. Available here (ungated).
William A. Pizer, “Combining price and quantity controls to mitigate global climate change”, Journal of Public Economics, 2002, 85, pp. 409-434. Available here (ungated).
Marc J. Roberts and Michael Spence, “Effluent charges and licenses under uncertainty”, Journal of Public Economics, 1976, 5:3-4, pp. 193-208. Available here (gated).
Martin L. Weitzman, “Price vs. Quantities”, Review of Economic Studies, 1974, 41:4, pp. 477-491. Available here (gated).
New York City: Social impact investors, leaders of non-governmental organizations, and development specialists gathered at the Rockefeller Foundation in New York City this week to learn about Development Impact Bonds (DIBs), a new financial instrument that aims to tap private sector innovation to help improve the lives of poor people in the developing world.
Zia Khan, Rockefeller Foundation vice president for strategy and evaluation, told the audience that DIBs hold promise as “the next evolution” of innovative finance for meeting global development goals.
"What excites me most about the report are the specific case studies ranging from HIV prevention in Swaziland to scaling up low-cost schools in Pakistan. There's enormous appetite for this kind of innovation at a global level," Khan said.
Although the first DIB deal has yet to be signed, the idea is more than wishful thinking. Presenters explained how DIB pilots in various stages of development would bring the private sector’s drive for success to such problems as reducing sleeping sickness in Uganda, improving education in Pakistan, avoiding teen pregnancy in Colombia, and fighting malaria in Mozambique. (See event page for full video and photos.)
“There’s growing interest in doing good while doing well but changing the world requires more than good intentions,” said Toby Eccles, the founder of Social Finance UK, an organization that works to inject market-principles into social sector funding. “DIBs provide an opportunity for the private sector to invest in the world’s most pressing development challenges in a meaningful way.”
Eccles, CGD senior fellow and director for Europe Owen Barder, and Elizabeth Littlefield, CEO of the US Overseas Private Investment Corp., a US government agency that turns a profit, served as co-chairs of the CGD-Social Finance Working Group that prepared the report.
Eccles explained how Social Finance UK pioneered a new instrument for involving private investors in financing socially desired outcomes starting with a project to reduce high rates of UK recidivism—when former prisoners commit fresh crimes after release and wind up behind bars again.
Barder told how he was living in Ethiopia when he first learned about the new approach, dubbed Social Impact Bonds, or SIBs, and contacted Social Finance to explore how the approach could be applied to development challenges. That led to a partnership between CGD and Social Finance, which jointly convened a working group to adapt the new approach as Development Impact Bonds, or DIBs.
SIBs and DIBs work in a similar fashion: Private investors provide up-front capital to service providers who work to achieve a specific, measurable goal, such as fewer teenage pregnancies or reduced recidivism. If an independent third party verifies the goal has been met, funders (such as national governments for SIBs or donors for DIBs) repay the investors their initial investment plus a return linked to performance—the better the outcome, the greater the return.
Unlike traditional aid projects, which tend to focus on implementation of specific solutions identified before a project is funded, the DIBs approach links payments to outcomes and aligns the incentives for investors and the service providers to discover the quickest and most cost-effective means to achieve the desired result. Funders—aid donors, in the case of DIBS—pay only if the result is achieved.
Drawing on one of six case studies in the report that describe emerging pilot projects, Barder explained how a DIB could be used in Uganda to reduce sleeping sickness, a parasitic disease that takes a heavy toll on human health and is invariably fatal if left untreated. He encouraged investors and donors to learn about the new approach—and to consider taking the plunge.
“This is a time for leadership,” Barder said. “Traditional aid is giving way to innovative new forms of development finance that will create new opportunities for private firms and donors—and at the same time much better development outcomes. But these benefits can only be realized if some pioneering funders and investors are willing to bear the upfront costs of creating a new market. Heroes wanted!”
To help manage risk for individual investors and funders, the Working Group recommends the creation of a new DIB Outcomes Fund and DIB Investment Funds. These funds, which would pool capital and dilute risk, would facilitate launch and implementation of the first DIB projects and help catalyze market growth.
Luther Ragin, president and chief executive officer of the Global Impact Investing Nework (GIIN) kicked off the discussion at the New York event with a ringing endorsement of DIBs, .
"There is innovation at play that is very exciting to a wide range of investors. At the GIIN, we are convinced that this is a space that has lots of opportunity. We are happy to be associated with the development of these instruments, and the organizations that have pushed the development of these instruments."
But he also offered some potential concerns from investors. Success would depend crucially on the quality of the management of the NGO or other entity that serves as the intermediary, he said, and of “the quality and integrity of the data that determines whether or not investors get paid.”
The Development Impact Bond Working Group was convened by CGD and Social Finance with support from the Rockefeller Foundation and the Omidyar Network. Working Group members include thought leaders from the worlds of finance, government, civil society, foundations and official aid.
Six case studies of DIBs in various stages of feasibility, development and negotiation are included in the Working Group report. Pilot DIBs currently being explored and the groups in the lead include: Social Finance, for reducing sleeping sickness in Uganda; Lion’s Head Global Partners, a London-based merchant bank, for education in Pakistan; Instiglio, a non-profit that designs Social Impact Bonds, for avoiding teen pregnancy in Colombia; OPIC, for investment in clean energy; and Dalberg, a development advisory firm, for fighting malaria in Mozambique.
The development landscape between now and 2030 will be look completely different from the last fifteen years. The Sustainable Development Goals which look likely to be agreed in September, including a commitment to eradicate absolute poverty by 2030, will be addressed against a very different backdrop to the relatively successful period of the Millennium Development Goals. There are three challenges we are going to have to address.
Weak institutions are both a cause and a consequence of underdevelopment. Improving governance is widely regarded as critical to accelerating economic opportunities, democracy, and security. This is especially important for fragile states and countries emerging from conflict. Despite this, the United States and other donor governments have few financial tools that are demonstrably effective at stimulating and delivering improved governance.
One of the first things we all learn as development rookies is that you cannot simply transplant institutions, systems or ideas from elsewhere. We are told that solutions have to be organic, locally-developed, country-owned and relevant to the context. But why and when is this true?
Part of the answer is suggested in the writings of Matt Andrews, Michael Woolcock, Lant Pritchett, Justin Sandefur, me, and others (see the reading list at the bottom of this blog post). For at least some problems, there is something useful about the ‘the struggle’ - that is, the need for a community to identify its challenges and grapple iteratively with the solutions. If the process of adaptation and iteration is necessary, then solutions parachuted in from outside will not succeed. Furthermore, efforts to bypass the struggle might actually be unhelpful.
Yet successful institutions in different countries often look similar to each other. For example, a good postal service looks pretty much the same everywhere. Good finance ministries resemble each other. So why should each country have to reinvent the wheel? Can they not bypass the costly and time-consuming process of struggling to create these institutions, and simply import good practice from beacons of success at home, or from good examples abroad, so taking success to scale?
This issue came under the spotlight at a recent meeting at CGD’s Washington Office to discuss the planned role of Global Development Innovation Ventures (GDIV), a joint venture of USAID, DFID and Omidyar Network which aims “to spark innovation and scale successes”. Is there something inconsistent between GDIV’s mandate to help countries take proven success to scale and the need – in at least some cases – for countries to grapple with their own challenges themselves?
Perhaps if we understand why the struggle might be important, we can describe better whether and how progress can be achieved more quickly and with less pain, or at least understand which kinds of development success could plausibly be taken to scale.
With the help of big thinkers Lant Pritchett and Michael Woolcock the CGD meeting was able to explore this. We discussed four reasons why the struggle might be important:
The struggle shapes solutions to the context. Solutions might look similar but actually include subtle, perhaps barely discernible, differences which adapt those solutions to their environment and without which they cannot function properly. (This is the ‘external validity’ problem). Perhaps these subtle differences which are vital to the success of the solution are brought about by the process of local problem-solving.
People take time to learn. If Roger Federer showed you how to serve a tennis ball that would not mean you could immediately serve like a professional. Just because you have an MBA doesn’t mean you can run a company. Other than for simple tasks, most of us have to learn by doing. Establishing habits may require repetition and practice, both for individuals and for organisations.
The struggle confers legitimacy. Michael Woolcock points out that a careful lawyer could have drafted the Good Friday Agreement (which brought peace to Northern Ireland) in a few hours: so why did there have to be so much bloodshed and anguish? Why were all-night negotiations needed to get an agreement? Perhaps the process of compromising – of give and take, of testing limits and building trust – is a pre-requisite for all parties to accept the compromise as the best available.
Systems co-evolve. Individual institutions do not operate in a vacuum. Each organisation is in a process of evolution, shaped by an external environment which includes other institutions which are themselves evolving. This process of co-evolution brings about the self-organising complexity typical of a complex adaptive system. Particular organisations cannot jump ahead of this if the environment they need to authorise and support them is not also evolving.
These four reasons why the struggle could be important raise an obvious question about the role of development cooperation. Typically aid aims in some way to diminish the struggle, or ideally to bypass it altogether. But if the struggle is necessary, at least some of the time, then we should think twice about whether and when it makes sense to try to minimize it.
For what kinds of problem are such struggles likely to be necessary? Lant Pritchett and Michael Woolcock suggest a spectrum of complexity and implementation-intensiveness. Simple, purely logistical interventions might perhaps be replicable. But more complex problems, such as those which depend on the emergence of legitimate systems and institutions, or which require continuing compliance and behaviour change, probably cannot be replicated without some sort of struggle.
There might be disagreement about whether a particular intervention can be replicated without a struggle. For example, distributing bednets appears to be a logistical challenge which, though complicated, can be solved by sharing best practice and good logistical management. Does that mean a successful model in one country can be rolled out elsewhere? If so, this will at minimum require some effort to build support, finance and legitimacy for the programme in each country (this may not be strictly speaking a struggle, but it may not be straightforward). Beyond that, a bednet programme will succeed if people understand why they might want to sleep under bednets, and adapt their behaviour and habits; if the power relations are such that men allow women and children to use the nets; if systems are put in place to distribute new bednets, perhaps through some combination of state provision and private markets; and if old bednets are regularly retreated with insecticide. Now we have moved from a logistical exercise to the realm of developing legitimate and effective institutions to provide continuing services, and the need for sustained changes in behaviour, power and trust. Can these changes be brought about without some kind of struggle?
The need for a struggle, at least sometimes, may have four implications for development cooperation, including for the GDIV programme.
First, the goal of ‘taking proven interventions to scale’ or ‘replicating success’, bypassing or minimising the struggle, may be appropriate to a relatively small set of interventions.
Second, it is possible that some of what donors do to try to accelerate development may instead slow it down by crowding out the necessary struggle. For example, aid could pay for basic services in the short term, while in the long run undermining the social contract that would emerge from the struggle for control of domestic revenues. Donor financing of civil society may lead to challenge to authority in the short run, but it may also crowd out a more legitimate dialogue rooted in local concerns. Donor support for businesses – for example creating jobs by backing firms – may crowd out the innovative, hungry firms on which the long term success of the economy depends.
Third, where it is not possible to replicate success directly, it may be possible to support systems to enable them evolve more rapidly and more surely towards the desired goals. For example, providing circumstances in which people can ‘fail safe’ may encourage more innovation. Better use of data and rigorous evaluation, and greater transparency and accountability, can encourage more effective selection. Donor funding which encourages and rewards local problem-solving, without imposing solutions from outside, may accelerate the struggle and make it less painful. This is part of the rationale for CGD’s proposals for Development Impact Bonds and Cash on Delivery Aid. The Problem Driven Iterative Adaptation approach suggested by Andrews, Pritchett and Woolcock is an effort to describe how aid can support countries’ own efforts to solve problems. Can some kind of technical assistance accelerate the struggle without replacing it? (Even professional tennis players have a coach.)
Fourth, aid can help people while they are struggling. This support may not directly accelerate development – perhaps other than by giving people more space to fail safe – but it could help them live more comfortably while development is taking place. (Of course, it follows from the above that it is important to provide this help in ways that do not crowd out the struggle.)
We would welcome views and comments on this. Is there a significant set of development policies which whose demonstrated success elsewhere suggests that they could be replicated and scaled up elsewhere with little or no struggle? And for the others, where the struggle cannot be bypassed, what are the smart ways that donors can support countries to make progress without crowding out? CGD is involved with a number of suggestions along these lines, including Cash on Delivery Aid, Development Impact Bonds, and Problem Driven Iterative Adaptation: are these good answers to this problem and how else might donors go about supporting countries engaged in the struggle?
Some further reading (compiled for the meeting by Molly Kinder):
The spread of knowledge and ideas should help close the gap between rich countries and poor. That’s why technology transfer is one of the seven components of CGD’s Commitment to Development Index (CDI). You may remember that Denmark came out on top of the 2013 CDI overall, but it was edged out by South Korea on the technology component. France and Portugal were third and fourth of the 27 nations ranked; Slovakia and Poland took the last two spots.
Technology transfer holds great potential to improve the health and livelihoods of people living in poorer countries. Those of you who read Charles Kenny’s book Getting Better will know about the huge gains in health across the world because of the spread of germ theory (ideas), hand-washing (norms), and antibiotics (technology) in the 20th century. But that same century was characterized by historically high economic inequality between nations (perhaps now being reversed at last). Does this means that that the equalizing effect of the diffusion of ideas has been suppressed? Might arrangements in developed countries to reward innovation have had the unintended consequence of depriving the rest of the world of its benefits, so widening the gap between rich and poor?
Those concerns led developed countries in 1994 to commit that they would help spread technologies in developing countries, in return for global enforcement of intellectual property rules. Our draft paper with Walter Park suggests that developed countries are not living up to that promise.
What Developed Countries Agreed to
The 1994 Trade Related Intellectual Property Rights (TRIPS) Agreement obliges developed countries to support technological advancement by helping to spread technologies to developing countries. Article 66.2 states:
Developed country Members shall provide incentives to enterprises and institutions in their territories for the purpose of promoting and encouraging technology transfer to least-developed country Members in order to enable them to create a sound and viable technological base.
Under the TRIPS agreement countries are required to report on their compliance with Article 66.2, but the monitoring of these commitments has been inadequate and very probably the implementation has been, too, say the experts who attended a March 27 meeting co-hosted by the Center for Global Development in Europe and International Center for Trade and Sustainable Development (ICTSD).
Why Countries Are Not Meeting Their Commitments
The experts who attended our event with the ICTSD identified several indicators of inadequate fulfillment of rich-country commitments and some factors that make such fulfillment difficult.
There is no one widely accepted definition of technology transfer. It should be no surprise that technology transfer is hard to measure.
No indicators have been agreed, there is no shared agreement about what is meant by a “sound and viable technological base”, and there is no consensus on what constitutes an adequate set of incentives. In the circumstances it is not surprising that it is hard to assess whether developed countries have lived up to their commitment.
There are significant gaps in reporting.
Some European countries have never submitted a report, and others do so only sporadically. Whereas some reports provide detailed information about the implemented interventions, some countries only list them very briefly. Officials tasked with writing the reports complain that nobody pays any attention anyway.
There is very little feedback on the reports and no pressure to look at them.
Developing countries’ institutions often do not have the capacity to even read the reports, let alone assess whether the intervention has contributed to their technological development.
Overall the message is alarming:
We simply don’t know if countries are living up to their commitment to improve technology transfer.
We are not clear on what the commitment means, nor what we are doing to fulfil it, so we can’t assess whether it is working and what we can do to improve it.
How to Improve
Of course, it is never easy to measure a multidimensional, contested idea like technology transfer. But that’s true of lots of things which we nonetheless try to assess quantitatively, such as learning. In the same way, we could design indicators of technology transfer, based on the relatively widespread consensus about what is needed. We want modern, up-to-date technologies to spread to the developing world at affordable prices. We want indigenous firms to receive licensing contracts on reasonable terms to manufacture high-value goods. We want subsidiaries of foreign firms to hire and train employees to perform high-value production in least developed world, and their governments to provide the incentive and support those firms’ needs, such as financing and insurance. And for all these “wants”, we can set goals and targets. Our criticism with the process so far is that policymakers and institutions have come up with mandates and lofty words but no action, and no measurable targets (such as increased investments of 5 percent by year 2015, etc.)
Perhaps the most alarming part of the conversation was the reflection among policymakers that many developing countries — especially the emerging economies — are increasingly seen as competitors not partners. This perception, which is reinforced by economically illiterate talk of a “global race”, dampens the interest of policymakers in finding ways to share technologies to enable poorer countries to catch up. This entire view is nonsense, of course: global economic growth is win-win, not zero sum; and consumption of knowledge is non-rival. It would be a pity if these fears further reduced efforts to ensure that everyone, everywhere, can take advantage of technological progress.
Next steps: we’ll be updating our analysis to take account of the excellent suggestions we received from the expert participants in our seminar, and developing specific policy recommendations for publication later this year. In the meantime, we would be very glad to have suggestions and comments on our earlier draft.