Article: Financing the Growth of Cities

By Clare Romanik, Urban Resilience Adviser, USAID

Cities of the developing world face a daunting challenge in accessing the financing required to build infrastructure and deliver services for their growing populations. The estimated global infrastructure investment required from 2013 through 2030 ranges from $57 trillion to $67 trillion (covering transport, water, and telecoms, but not schools or hospitals), with 75 percent of these investments needed in cities.[1] Expanding access to financing for sustainable urban development is becoming more critical because of three trends:

  1. Cities of the developing world are growing rapidly in population and number: By 2030, a projected 662 cities will have at least 1 million residents, 63 cities are projected to have between 5 and 10 million inhabitants, and there will be 41 megacities (with populations greater than 10 million). Between 2016 and 2030 the number of African cities with 500,000 inhabitants or more will grow by 80 percent.[2]
  2. Donor-funded international development assistance is becoming a much smaller share of developing country finance and investment.
  3. Devolution of authority and responsibility means that cities—not national governments—are often charged with service delivery, transport, and economic development and expected to find the means to pay for and carry out these new functions.

Why isn’t there enough capital to fund infrastructure in cities?

In the past, cities of the developing world depended on their national governments, who often turned to international donors for concessional financing of infrastructure and other large development projects. Since 2000, this has been changing significantly, with domestic investment and foreign direct investment overtaking overseas development assistance. As a result, development agencies like USAID now see their role as catalyzing and leveraging investment from the private sector or helping improve domestic resource mobilization by supporting improvements to tax systems, rather than directly financing investments.

Bringing private finance to the table for public investments in developing countries is tricky because of the inherent risks in long-term investing in unstable environments. In the United States, we have successfully developed instruments, such as municipal bonds, that allow a city to obtain all of the funds to build infrastructure today, while spreading the repayments out over a decade or more. This means that businesses and citizens continue contributing to paying for the infrastructure as they benefit from the services and economic development that it supports. It is a complex challenge to introduce these types of financing instruments in the countries where USAID works because they lack strong financial management systems, have poor country credit ratings, insolvent utilities, low collection rates, and underdeveloped capital markets. One good example is Kenya, where USAID and its technical implementing projects, including the Sustainable Water and Sanitation in Africa (SUWASA) program, worked across water utilities, banks, and the government to encourage lending for expanding clean drinking water services while improving financial performance through cost controls. USAID’s Development Credit Authority (DCA) provided partial risk guarantees to several banks that increased loan security, encouraging local banks to initiate lending to water utilities, which previously had not received commercial financing.

Effective fiscal decentralization—the process of devolving authority and financial responsibility from the national government to local authorities—creates a predictable fiscal transfer flow between national governments and cities and provides incentives for cities to increase their own source revenues, both of which are needed to demonstrate city creditworthiness.  The Addis Ababa Action Agenda prioritizes the need for donors and development partners to support domestic resource mobilization in developing countries at the national and subnational level. Best results for fiscally empowered cities come when work at the national level on the intergovernmental fiscal framework is paired with systems improvements at the local level to increase cities’ own source revenues. A 2014 case study on revenue mobilization of Ghanaian local government identified the main obstacles as “inadequate data on revenue sources, lack of enforcement of revenue mobilization bylaws, inadequate revenue collectors and their training.”[3] One way to address this that has worked in Ghana and Tanzania is a local revenue information system that identifies and maps taxpayers for easier billing and to confirm tax payment.

The value of land

Land is often underutilized for generating both capital and operating revenues. Citizens often resist property taxation if it is not directly related to a service received such as user fees for water, electricity or permitting and administrative services. A 2016 case study on Ghanaian local government mobilization noted significant contributions of property taxation to own source revenues, even with a low compliance rate of about 30 percent. The authors conclude that “innovative measures must therefore be adopted by local governments to make property owners appreciate the need to pay taxes. This will help improve property rate mobilization to help local governments move towards fiscal independence.”[4] As Chief of Party for a USAID project in Kyrgyzstan, I saw first hand, how important it was to get journalists on board with the introduction of a new property tax to build local awareness and support.  We organized local study tours for the journalists in which mayors explained how cities needed property tax revenues for kindergartens and public health clinics, which changed the journalists’ attitudes fundamentally.

The city of São Paulo has been innovative in creating capital revenues from city land by introducing a development concession mechanism for additional building rights. The theory is to capture some of the increased value of land when regulations change (such as allowing higher density) or when infrastructure improvements are made. The city deposits the funds received from real estate developers into an urban development fund that has paid for social housing projects, new parks, sidewalks and street improvements, drainage and sanitation, community facilities and cultural heritage restoration.[5]

Learning from what works

The complex challenges of urban finance demand a comprehensive and innovative approach to realize the potential of all resources and to draw on the comparative advantages of public and private actors. A good start in capturing relevant experience has been made by United Cities and Local Government (UCLG) which recently launched a Global Observatory of Local Finances. In 2016, UCLG jointly produced a report with OECD on “Subnational Governments around the World: Structure and Finance” that highlights the diversity of the systems in place drawing on a sample of 101 countries.

Cities drive a country’s economic development and urban finance is the key to unlocking the potential of cities in the developing world.

USAID’s E3/Urban team works in a holistic way to help cities and develop partners understand the range of challenges and solutions – from accessing private capital markets to increasing own source revenues – while ensuring transparency and not leaving out the urban poor.

To learn more about USAID’s private capital management work, visit: https://www.usaid.gov/pcm

To learn more about the Development Credit Authority visit, https://www.usaid.gov/dca

[1] McKinsey Global Institute. (2013). “Infrastructure productivity: How to save $1 trillion a year.”  Kim, Julie. (2016). Handbook on Urban Infrastructure Finance. New Cities Foundation.

[2] UNDESA. (2016). “The World’s Cities in 2016 – Data Booklet.”

[3] Ernest Adu-Gyamf. (2014). “Effective Revenue Mobilisation by Districts Assemblies: A Case Study of Upper Denkyira East Municipal Assembly of Ghana” in Public Policy and Administration Review. http://pparnet.com/journals/ppar/Vol_2_No_1_March_2014/7.pdf

[4] Roland Tundyiridam, Alhassan Yakubu Alhassan, Abdul-Rahim Abdulai. (2016). “Contribution of Property Rates to Internally Generated Fund (IGF) Mobilization in Kassena-Nankana Municipality of Ghana” in Advances in Social Sciences Resource Journal. http://scholarpublishing.org/index.php/ASSRJ/article/view/2083

[5] Paulo Sandroni. (2011). “Urban Value Capture in São Paulo Using a Two-Part Approach” Lincoln Institute of Land Policy.