The Future of Development Is Local
To achieve the Sustainable Development Goals, the world will have to shift its thinking from the national toward the urban.
In 2010, the rate of people around the world living in extreme poverty—that is, surviving on less that $1.25 a day—was officially cut in half since 1990. It was the crowning achievement of the Millennium Development Goals, the global framework developed by the United Nations and others in 2000 to catalyze transformative economic development.
This progress, however, was built on the edifice of the post-World War II economic order: the capital markets, trade and migration networks, digital infrastructure, and institutions that were designed to enable global commerce between nations and thereby encourage cooperation and peace among them. Practically every driver that facilitated this dramatic reduction in global extreme poverty—the global exchange of goods, services, and capital through transnational markets; the regional movement of production and manufacturing hubs that created global value chains; and the flow of ideas, innovation, and data that undergirded the digital economy—stemmed from an order designed to serve and support nation-states.
But the post-World War II architecture is reaching its structural limits. In particular, it is incompatible with the achievement of the Sustainable Development Goals, the successor to the Millennium Development Goals, which are 17 objectives designed to bring sustainable development to every part of the world—notably the world’s developing nations and, in particular, the world’s least-developed countries. The new goals include completely eliminating global extreme poverty, managing sustainable production and consumption cycles, ending all forms of discrimination against women and girls, and strengthening resilience and adaptivity to hazards tied to climate change.
These challenges mostly reside in the cities and communities in developing countries, including the least-developed countries, which comprise the poorest and most underserved markets in the world. But the current global financial architecture centers on sovereign states, with international credit and the benefits of such credit—notably the ability to raise capital in order to fund projects, including infrastructure—tending to flow to countries rather than to the neediest local communities themselves.
At a macro level, the problem with this nation-centric approach is that such financing is not going to those most incentivized or equipped to support the projects that advance sustainable development. Cities and local governments have the proximity necessary to better provide social and public services that meet their community’s needs, including those that define sustainable development—ending hunger; providing quality education, clean water, and sanitation; and making sure residents have access to affordable clean energy, decent work, and economic growth, to name a few.
When local governments have to make funding decisions, they will typically prioritize funding one service or project more than, or rather than, another. But when funding flows to the national government, the opportunity cost calculations are different. And even if international donors and investors encourage better national governance, and they should, funding for local projects still competes, often unfavorably, with national government priorities—such as national defense, foreign affairs operations, government salaries, and national budget deficits.
In the era of the Sustainable Development Goals, local communities are almost always the lead development actor. In fact, a deeper examination of the goals’ underlying targets shows that almost 65 percent of them are supposed to be implemented by local governments. And yet the global financial architecture does not operate on that basis.
A nation-centric architecture made sense when nations were the only geographic center of economic development and financial power. But that view needs to be expanded to include municipalities, local governments, and cities as emerging centers of economic power all over the world. Around 80 percent of global GDP is already being generated in cities, while 68 percent of the total global population will be made up of urban residents by 2050, according to World Bank data. A 2013 joint report by the International Monetary Fund and the World Bank stated that of the 1.4 billion-person increase in population projected to occur within developing countries by 2030, 96 percent are expected to live in urban areas. And 30 of the world’s 35 most rapidly growing cities are in the least-developed countries.
These shifts in financial and demographic power have implications for accessing the international credit that can fund the projects supporting sustainable development, which can be seen in the context of individual development challenges. Relative to national governments, local governments are singularly positioned to advance projects to address climate change, including infrastructure projects for climate adaptation and resilience: They have the clearest understanding of local needs, they are able to convene local stakeholders to democratize the creation of a climate action plan, for example, and they can pass appropriate policies in much easier fashion than central governments.
Yet, a nation-state-centric system can prevent climate finance from reaching those who can best enact the necessary projects. Look to the sinking of Jakarta, Indonesia, the flooding of Venice, Italy, or New Orleans before Hurricane Katrina and consider how much worse the challenge is for the developing and least-developed countries. The same capabilities that make local governments irreplaceable actors in response to climate change apply when it comes to sustainable development, too.
Take access to funding for development, for example. First, cities in poorer countries often suffer a lack of domestic financing. Savings pools in most of the least-developed nations are low and hardly adequate to finance the infrastructure needed to deliver on the Sustainable Development Goals. Many developing countries also lack the regulatory and policy frameworks that give cities the legal authority to collect taxes, issue bonds, or be sued for their debts. In such cases, cities are stuck between hoping that more money trickles down from the central government or accessing international credit. But in a nation-centric system, the second is often impossible.
Municipalities in poorer, developing nations are effectively frozen out of credit markets because they are subject to the debt limits of their national governments. Under this nation-centric architecture, national debt determines whether cities can access international credit almost regardless of that city’s own debt profile. By contrast, cities in wealthier nations can easily attract investment through the issuance of their own bonds based on their own financial health. Additionally, in various developing countries and least-developed countries, municipalities looking to borrow in local currency, as opposed to hard currencies, require permission from central governments before they can access this credit. As for the central governments in developing countries that deny their municipalities the authority to tax or issue debt, they become the borrowers of choice for international creditors, because they monopolize the power of taxation. Consider that international capital will easily flow to Los Angeles, a city of 4 million people, if it issues debt to fund an infrastructure project, while such capital could easily avoid the city of Nairobi, a city of nearly 4.5 million people that is the largest GDP contributor to Kenya—one of the fastest-growing economies in the world over the past decade despite being a developing country. The country of Benin will have an easier time accessing capital than the city of Cotonou, which holds the lion’s share of Benin’s national GDP.
To be clear, there are legitimate structural reasons for why international capital routinely avoids developing and least-developed country markets. For starters, according to the World Bank, less than 20 percent of the 500 largest cities in developing countries are considered investment grade by an international or local rating agency—though the inability to access credit is a contributing factor in the case of many municipalities. Separate from the fact that these markets are not as mature as those in other geographies, the businesses within these markets may not have access to the advisory services that would make them investable. And these markets are more likely to lack the institutional resources that would make them palatable to investors—such as rule of law and physical and digital infrastructure.
But there are also many municipalities that should be able to attract investment yet have not been able to do so due to the structure of the financial architecture. In Bangladesh, when cities were graded for credit at the local level, over a third of them attained a rating that was above investment grade. Yet those ratings make no difference, because Bangladeshi capital markets are not accessible by municipalities. The same is true for many cities in developing and least-developed countries, such as Kenya, Morocco, Botswana, and Indonesia.
To fully understand the implications, consider that between now and 2050, the urban population in sub-Saharan Africa is expected to more than triple, reaching approximately 1.3 billion people. Yet, barring fundamental changes, the region will likely lack the levels of capital investment necessary to finance development to support this population growth—including investment in infrastructure and urban planning, as well as commercial and residential real estate. If financing is not able to reach the local level, this will practically assure that the rise in urbanization in this part of the world, as well as others, will coincide with a rise in poverty—especially urban poverty and the growth of slums and unplanned communities—and its attendant consequences.
Realistically speaking, the nation will always be the main public actor in the global financial architecture. But that does not mean that this architecture cannot be more flexible. A flexible architecture that enables access for municipalities in developing and least-developed nations is the best way to ensure that sustainable development reaches the world’s poorest and most underserved people. One solution involves disaggregating national from subnational debt. It is far past time for municipalities to be able to borrow on their own terms, based on their own capabilities. Los Angeles is able to borrow in capital markets on the basis of its own creditworthiness. Nairobi should be able to do the same.
Such efforts have to be complemented with the right policy and regulatory environment at the central government level. National governments should enable the legal framework that allow cities and municipalities to borrow in capital markets, notably through the authority to issue bonds and other forms of financing, and to be subject to liability for debts. Ghana, South Africa, and Indonesia have taken the lead in such efforts. After a lot of hard work of reforms, India has also started to enable cities to access capital markets. And these policies do not have to leave behind rural areas when it comes to sustainable development. Urban areas can leverage their new capability and financial strength to help rural areas access international credit, whether by creating a pooled fund where urban and rural areas can issue a single bond or by collectively accessing thematic funds that focus on specific interests like climate change, women’s economic empowerment, or financial inclusion.
The right policy and regulatory environment would have to minimize the role of central governments as gatekeepers to international capital for municipalities. One way to achieve this is by enabling municipalities to access international credit in local currency as opposed to U.S. dollars, euros, and other hard currencies. Borrowing in local currency would insulate them from foreign exchange risks and allow investors to include the cost of risk management of such investments at the time of buying. Central banks and national governments would also be able to focus more on their traditional roles of managing monetary and fiscal policies at the macro level. These kind of innovative financial tools are starting to emerge in different global capital markets. The London Stock Exchange’s issuance of Masala bonds for local Indian infrastructure financing is one good example.
Finally, the world needs financial tools and products that can drive international investments to local infrastructure projects. Luckily, the area of innovative finance continues to produce tools and products focused on such investments, including those in poorer countries. Among those is an independent municipal investment fund that will exclusively focus on delivering investment to local projects, notably in developing countries and particularly in the least-developed countries—the creation of which was supported by the United Nations Capital Development Fund, United Cities and Local Governments (an umbrella organization for local and regional governments around the world), and the Global Fund for Cities Development (their technical partner). The hope is that the successful investments will create demonstration effects that will incentivize public and private lenders to expand financing of the municipal finance space.
It is impossible to avoid the truth that our 20th-century global financial architecture does not fully serve a 21st-century global economy and its development aspirations. Reforming the global financial system to focus more on cities can help mitigate the problems. Getting this wrong means more than missing the goal of eliminating extreme poverty. It means failing on the signal promise of the Sustainable Development Goals: to leave no one behind.
Xavier Michon is the deputy executive secretary with the United Nations Capital Development Fund.