The final Element, #5 (grant / concessionality), seems like the most obvious thing to development people and business people (particularly export people), but it is only obvious because those two groups rarely have to talk. If they did, they’d realize that they have two totally different understandings of what it means. Ironically, it is the business people who understand it the best. There are three ways to finance a development project — grants, loans and investment financing.
The simplest way to explain the first option is to start by focusing first on what a “grant” is. It doesn’t mean, as many CIDAites would interpret it, as the difference between “grant”, “contributions”, and “contracts”. No, it means what it means in plain speak — I give this to you, you don’t have to pay me back. For a domestically-focused person, think of it as a gift. You are at university, you’re at the end of your third year, you are struggling to get the money together for fourth year, and your rich uncle Roger says, “No problem, here’s 10K.” All yours, no need to pay it back. That’s a grant.
Almost all development projects as CIDA does them, and most by all donors, are grants. Sure, there might be shared contributions, but it is CIDA / Canada paying. It isn’t a loan — so whether it is a contribution agreement or a grant or a contract, it’s the same — you do this, we will pay you, and you don’t “owe us” anything back. That’s 100% grant — there’s no payback.
As such, all CIDA projects (assuming they met the previous 4 criteria) are all ODA-eligible, can be counted as ODA, and therefore comes out of the Canadian aid budget. If you use the above education example, you got “10K” and your uncle (if the OECD/DAC was keeping track) would say he gave $10K in “official personal education assistance (OPEA)”.
But wait. Option 2 is for loans. What if your rich uncle says, “Well, Timmy, I’ll give you the $10K but you have to pay me some of it back.” If you only have to pay back 75% or less, then at least 25% of it was “grant”, and it is therefore OPEA-eligible. So, if you get $10K, and can keep $5K as gift/grant (50%), you would pay back $5K. But, here’s the kicker, your uncle would still be able to claim $10K in OPEA. He gave you 10K, and made sure at least 25% or more was grant, so it *all* counts as OPEA. Yep, even if he only really gave you $5K, he claims it all. Because it was an actual flow of resources, it came from an eligible “organization” (family members with too extra money), you were on the approved list of recipients, it was primarily for your benefit, the activity is allowed under the list of activities, and at least 25% or more was grant. Yep, definitely OPEA — therefore you count the whole project as OPEA. Of course, if Roger wants it all back, then there’s no real benefit to you i.e. no grant benefit at least, and he couldn’t claim squat as OPEA.
In development circles, this type of loan can happen, but they don’t occur much anymore after all the focus on HIPC and debt relief. And if they do happen, they tend to operate a lot more like a third category of project — the large-scale government-as-backer investment-like project.
Let’s pick a lovely country like, I don’t know, Japan. And let’s say they want to do a bunch of projects in, oh, I don’t know, let’s say telecoms. In Asia. And Asian countries are lining up to get their help. But suppose Japan doesn’t want to just hand over the money — after all, the recipient country is going to reap economic benefits from this and it is more like an investment than an aid project. So they say, “Okay, let’s work out an eight-year business plan whereby I give you money in years 1,2,3,4 to get things going, you’ll hire Japanese companies, and you pay me back in years 5,6,7,8”. The Philippines (picking randomly) says, “Wait, why would I borrow from you? I can do it myself and hire whoever I want.” So Japan says, “Sure, but commercial rates are 8% for this level of risk, but we’ll back the cost and the upfront stuff, and in exchange for you using Japanese companies, we’ll only charge you 4%”. (I know those aren’t the exact rates, but I’m using simple exaggerated ones to show why the Philippines might say yes). The Philippines says, “Great, let’s go!”. So project launches, etc.
But look at what Japan is doing — they are giving money to the Philippines (a flow), they are the govt (official donor), the Philippines are on the list of recipients, and infrastructure development is clearly for the primary benefit of the developing country. Four out of the five criteria are met. Can it meet the fifth? People think, “Hell no, they have to pay it back”. But wait a second, the Philippines are getting a pretty good deal. They are getting $100M a year for four years at 4% when commercially Japan could charge 8%. That looks a LOT like a 4% benefit per year being given to the Philippines, plus compounding from years 2-8. Could it amount to a 25% “grant” portion over 8 years?
An apology is due here to non-economists as this paragraph and the two that follow are not really for you, you don’t need them, but true economists right now are sputtering at me, calling me nasty names, because that’s not how the calculation really works. I know, and explaining discount rates is really painful to everyone but export credit types, but here goes. To know if the Philippines gets a 25% benefit, you have to estimate the rate of return on the spending. Not the rate that Japan gets (4%), not the rate commercially (8%), but the rate the Philippines would get from the project. What’s their “benefit” rate, essentially, but it’s called the internal rate of return in normal business parlance and the social rate of return in development circles.
You know what the Philippines actually has to pay (4%, 8 years, etc.) but you have to know the benefit to their society from the project. There’s a lot of complicated math you can do if you’re a business type, but in the end, it’ll be an estimate. If you estimate large, everything looks like a huge gift. If you estimate low, nothing does. No one really knows until the project happens. But aid budgets are set going forward, not reporting backwards. So Japan has to know if it could be an aid project or not BEFORE we know what the real rate of return will be. And way back when interest rates were high, the DAC discussed this issue and said, “Well, we don’t really know what the real social rate of return is, but we think it’s probably 10% on development projects”. They had to choose a rate, and they chose 10%.
So, the technical way is to take the payments Japan makes, find their net present value at the lending rate (4%); then you take the payments that the Philippines has to make (based on the 4%) and discount them at the social rate set by the DAC (10%) to get the Net Present Value today.
With a big welcome back to the non-economists, let’s figure out what to do with the numbers. Given that you discounted Japan at 4% and discounted the Philippines at 10%, you know that the Philippines number is going to be smaller. In other words, rich Uncle Roger isn’t getting the full $10K back from little Timmy. If the Philippines’ payback number is only 75% or less of the Japanese investment number, then Japan gave them at least a 25% grant in the project.
Guess what? Japan just met the fifth criterion.
So they can count the project as ODA. The WHOLE project.
Is that significant? Absolutely. Unbelievably significant. Because it also means they can PAY FOR IT OUT OF THEIR DEVELOPMENT BUDGET. If you’re wearing your Birkenstocks, you’re sputtering, “No, wait, go back, how did THAT happen?????”. Go back, read the five elements. You’ll see.
Does it matter to Canada? On a development side, not really, we couldn’t afford those projects ourselves. But Japan can, one of the few who can/could. And so they did things like infrastructure. But who does it matter too? Western telecoms companies who would love to bid on those projects. If the projects had been done by the Japanese government through another mechanism, they would have had to comply with the WTO and had international competitive bidding. But as part of their development program, it can be exempted from WTO rules, and hence only Japanese companies could bid. Which is how Japan could get domestic support for it in the first place.
The really fun part of the conversation though for trade types is that the 10% number the OECD uses is meaningless. It might be 2, it might be 20, it might be 200, nobody knows. It’s a theoretical construct. But it was established by consensus and it would require consensus to change. And one country, in particular, i.e. Japan has had a very strong vested interest at different times in NOT changing it.
Separately though, what would you change it to? Some argue it should be down at 5% or 3%. Something low, more akin to traditional investment rates of return (i.e. your best alternative return). Some think it should be even higher. But here’s the kicker — because 10% has such an impact on repayment compared to actual interest rates, pretty much anything with a timeline longer than three or four years is probably going to qualify as concessional. It’s just the way the compounding works.
Why all of this isn’t the big issue everybody thinks it is, not even me
I hate the pundits’ treatment of “development” as a holy grail that everyone can define and agree upon. I hate them talking about “aid levels” like everyone should understand what they mean, and implying that it is simple or obvious.
But while all the pundits are going crazy about the possible implications of “trade” on “aid”, I’m not sure this is as big as an issue as people think it will be. We already have to make decisions on which countries we’re going to help, how we’re going to fund it, and whether it counts as development at all. This discussion has been ongoing for 40+ years, it’s just most CIDA types and NGOs didn’t see it so openly referred to…But for CIDA, FAC and ITC, it’s always been present.
For some governments, it has been “we help everyone everywhere” and often with small drops in the bucket for each country. For other governments, it has been “who has the greatest need”. For others, it has been “where can we make our biggest contribution”.
But saying that “pure development” will be compromised is dancing on the head of a rhetorical pin. The projects still have to match what the OECD says is development (however wobbly that definition is), but since official development assistance can include apples, oranges and a few truck parts, I think we first need to decide what “pure development” means and which part we are talking about, and then let’s talk about whether it’s “now” compromised.
After all, if we’re going to have the conversation, can we at least talk about the same thing?