# **<u>B. Rethinking Innovative Development Finance</u>**

1.5 **Since the term “innovative finance” made its way into the development lexicon in the early 2000s, it has come to mean many things to many people.** It has been used to describe a wide array of advancements in how economic development is supported by external actors— from financing technological and scientific advancements in a particular sector and improving the business processes of development agencies to actual financial innovations in the way development funds are raised and deployed. As the international community seeks more concrete financial solutions to operational challenges on the ground, there is a need to clearly bound the term “innovative finance.”

_An Emerging Framework_

1.6 **The primary interest for the international community is not financial innovation for its own sake, but the achievement of development objectives and results.** To understand the ways in which innovative finance can further development objectives, it is important to look at the uses and sources of development finance and also at how the resources mobilized can be transformed—through mechanisms employing financial engineering—to meet the needs of developing countries.

1.7 **<u>Uses: Development finance supports both public and private uses—that is, core</u> public functions of government as well as private initiatives in markets and civil society.**<sup>3</sup> The traditional economic rationale for government action is to _correct market failures_ through the provision of public goods (for example, basic social and infrastructure services) and regulation of markets. In carrying out these public functions, governments are also responsible for mitigating _governance failures_ or weaknesses in policymaking, resource allocation, program implementation, and enforcement of rules and regulations governing economic production and exchange. Private uses of development finance relate to private investment and related initiatives between economic agents. In pursuing private initiatives in the market and civil society, economic agents have to manage myriad risks and costs associated with information asymmetries, agency problems, and arbitrary state actions.

1.8 **<u>Sources: Over the past 60 years, the sources of development finance have continued</u> to expand in number and diversity.** _Public sources_ originate from the national tax bases of donor countries that contribute to development assistance through budget outlays. These countries include traditional sovereign donors whose contributions are monitored by the Organization for Economic Cooperation and Development-Development Assistance Committee (OECD-DAC) as well as emerging, non-DAC donors. In recent years, countries have identified global or regional taxes as a new source of public finance. Ultimately, domestic revenue in lower- and middleincome countries themselves should be the most stable, long-term source of development finance. Private sources include private firms that enter into development country markets, for example, to make investment decisions, after assessing profit-making opportunities. They also include private giving by individuals and organizations involved in philanthropy, as well as extended family and community networks that provide remittances.

> 3 World Bank, _World Development Reports_ 1997, 2004, and 2005.

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