1 Challenges of Sustainable Shelter Development in Macroeconomic Context – Financing Urban Shelter

CHAPTER

1

CHALLENGES OF SUSTAINABLE
SHELTER DEVELOPMENT IN
MACROECONOMIC CONTEXT1

During recent years, there has been a growing recognition of the importance of urbanization in the economic and social futures of nations by the international community, member states of the United Nations and a wide range of civil society organizations. This recognition is based on country experiences, development policies, studies and projects since the first United Nations Conference on Human Settlements held in Vancouver, Canada, during 1976.

Urbanization – and its many dimensions – has been important in all countries. The first and most evident dimension is demographic, as most developing countries have urbanized considerably since the 1950s and are projected to continue this process through the middle of the 21st century (see Figure 1.1). This increasing share of total population living in cities is similar to the historic patterns of Europe and North America, with increasing urbanization accompanying rising levels of gross domestic product (GDP). The key differences lie in the faster pace of urban growth in developing countries during this period and the absolute levels of urban population as represented both in the concentration of people living in mega-cities (urban agglomerations of over 10 million residents) and the increasing numbers of medium-sized cities of up to 3 million.

These facts of contemporary life in the 21st century have themselves transformed the world, with higher levels of individual and household incomes resulting from unparalleled levels of economic productivity benefiting from economies of agglomeration and scale. The concentration of economic activity and power in cities has, in turn, attracted footloose capital from the global economy, transforming the world itself in what is now understood as a process of ‘globalization’.

These processes, however, have also created many problems and contributed to growing patterns of difference within countries and people. Urbanization, for example, has been accompanied by continued out-migration from rural areas in many countries. The mechanization of agriculture and the globalization of agricultural production have reduced both the local control of the rural sector and the demand for rural labour. When placed into a national and international context, what might be called ‘a geography of difference’ can be easily seen.

Together, these processes set the stage for the fundamental issue that this Global Report addresses: how can housing and infrastructure services be financed for growing numbers of urban residents during the 21st century? The first part of this chapter presents the building blocks of a conceptual framework for answering this question, while the second part presents, as a background, the macroeconomic context of financing urban shelter development.

The fundamental issue is: how can housing and infrastructure services be financed for growing numbers of urban residents during the 21st century?

UNDERSTANDING URBAN
SHELTER DEVELOPMENT
CHALLENGES

As mentioned in the preceding section, this first part of the chapter presents the building blocks of a conceptual framework for understanding the global challenge of financing the development of urban shelter, as well as related infrastructure and services. Individually, these building blocks are not controversial. They reflect the current knowledge and the collective thinking of observers and participants in the world's urbanization experience. However, when linked together, they demonstrate that the world is facing an urgent and dramatic problem, with significant consequences for individual cities, countries, regions and the world itself.

Demographic framework

The starting point of this analysis is the process of demographic transformation. United Nations projections and recent assessments of expected demographic growth in developing countries (see Statistical Annex, Tables B.1 and B.2) indicate that the developing countries will add approximately 2 billion new urban residents during the next 25 years.2 This robust finding, added to the existing numbers of 1 billion people currently living in slums, frames the ‘demand side’ for the need for housing and infrastructure services in developing countries.

Table 1.1

Demographic highlights (China and India)

China India
Urbanization level in 2000, estimate (%) 35.8 27.7
Urbanization level in 2030, projection (%) 60.5 41.4
Urban population in 2000, estimate (000) 456,247 281,255
Urban population in 2030, projection (000) 877,623 586,052
Increase in urban population, 2000–2030 (000) 421,376 304,797
Increase in number of total households, 2000–2030 (000) 284,040 129,358
Average quinquennial increment, 2000–2030 (000) 47,840 21,560
Average annual increment, 2000–2030 (000) 9.568 4,311
Source: UN Population Division, 2004. UN-Habitat, 2003a.
Developing countries will add approximately 2 billion new urban residents during the next 25 years

Looking more closely, approximately 90 per cent of this demand will occur in 48 countries, with most of the growth occurring in East and South Asia. The concentration of this demand reflects both the overall population sizes of China and India, but also other large Asian countries such as Bangladesh and Pakistan in South Asia, and Indonesia, the Philippines and Viet Nam in East Asia. During 1950, these countries were largely rural; today they continue to experience rapid urban growth, with many of their urban concentrations reaching over the 1 million population level. Much of this growth has been fuelled by economic growth itself, with higher urban incomes attracting rural migrants. The enormous growth of urban populations of China and India are shown in Table 1.1, demonstrating that these countries have both experienced large-scale shifts in their populations towards urban centres while continuing to grow at aggregate levels.

It is predicted that the scenario of a decreasing rural population and increasing urban population, with the only possible exception of the African continent, will be exacerbated by expected universal reductions in fertility levels. Indeed, the prediction is that by 2020, the rural population growth rate will turn negative for the first time.3

Africa will also continue to experience rapid urban demographic growth, reflecting continued rural-to-urban migration, with push factors from the lack of productivity of agriculture and the inability to feed and provide incomes for rural populations. The slow growth of rural productivity in African countries has many causes: environmental pressures in the Sahel and East Africa, with severe water shortages, loss of topsoil and lack of rural infrastructure; overpopulation in some parts of the Great Lakes Region of Central Africa; or armed conflicts destabilizing cultivation patterns. These internal problems have been exacerbated by the global trading system, with subsidies by developed countries – for example for cotton – which displace cotton produced in Burkina Faso or Mali from world markets.

Even though Africa's cities have not generated the jobs needed to sustain growing urban populations, they have, nonetheless, attracted large numbers of people fleeing rural poverty. While studies during the 1970s showed that these migrants were largely attracted by the prospects of higher wages from urban employment,4 this motivation has been strengthened by the lack of food security in rural areas, as well as by the need for physical security from armed conflict and environmental risks. This ‘urbanization of rural poverty’ is reflected in the increasingly large urban slums in most African countries.

In contrast, the Latin American countries experienced urbanization at an earlier period in which economic growth generated the financial resources needed for the construction of housing and urban infrastructure. Cities such as Buenos Aires, São Paulo or Mexico City demonstrated spectacular growth during the mid 20th century. Even during these periods of economic boom, however, this growth did not keep up with the growing demand for housing and urban infrastructure, such as water supply, sanitation and electricity. Public-sector institutions were unable to provide these services at a rate faster than the proliferation of favelas in Rio de Janeiro, barriadas in Lima or tugurios in Quito.

Nevertheless, Latin American cities have become the loci of economic productivity and employment growth. At the same time, they are also the loci of growing urban poverty and inequality between the rich and poor. How to bridge this gap will be discussed in later chapters of this Global Report.

In contrast to the developing countries, transition economies and developed countries face different challenges in the financing of urban development. Previous public patterns of provision of housing and infrastructure in the transition countries have been disrupted by the political and economic changes following the collapse of the Soviet Union. These systems had provided a very minimum quality of housing and infrastructure in most countries, with long waiting periods for new households. Whether these cities will become productive engines for the growth of their new reformed economies remains to be seen.

Cities in developed countries have occupied an increasingly important place in their respective national economies. As economies shift towards financial services and the knowledge economy, these activities tend to be located in large cities. How well the cities perform with these functions depends upon the reliability of their infrastructure and the quality of urban life as factors in attracting new investment.

Each of these regions and individual countries have always had their own set of characteristics that determine their patterns of urban growth and specific development challenges to be faced by their governments and societies at large.5

Translating demographic growth into the
demand for housing and infrastructure

Recent data and analyses indicate that the current global backlog of slum dwellers is about 925 million people.6 As shown in Table 1.2, when this figure is combined with the projected 1.9 billion additional urban population, approximately 2.825 billion people will require housing and urban services by 2030. This projection is the starting point for this Global Report.

In considering this number, precision is not really very important. What is critical, however, is the order of magnitude. Close to 3 billion people, or about 40 per cent of the world's population by 2030, will need to have housing and basic infrastructure services. Table 1.3 demonstrates that in order to accommodate the increments in the number of households over the next 25 years, 35.1 million housing units per year will be required. This estimate, in turn, translates into completing 96,150 housing units per day or 4000 per hour. These figures do not include replacements of deteriorated and substandard housing stocks.

Socio-behavioural framework

The challenges raised are not, however, exclusively about the quantity of population, but also about its composition. A recent publication argued that the processes of social differentiation in cities are also accelerating7 because they are interacting with the scale and rate of demographic change. There are not only more people in cities, but they eat, work, play, educate, dress and express themselves differently. The richness and, indeed, the tolerance of the culture and diversity of urban behaviour is a major factor in explaining why there is not more violence and conflict than exists in cities. One could easily make the argument that Mumbai and Bangkok are surprisingly peaceful, given their scale and complexity. These processes of urban social and cultural differentiation require much more documentation and research because they are an important factor in what would actually be ‘sustained’ in sustainable cities.

Processes of differentiation also have financial implications as diverse populations express their special needs, with more elderly populations requiring special services at the same time that there are school-age children require more schools and teachers. A wider diversity and range of social needs implies a wider and more diverse set of services, whether provided by government or nongovernmental organizations (NGOs). Growing ethnically diverse cities can also create the need for ethnically sensitive policies and programmes, as well as the necessity to maintain peaceful relations between communities. For example, one can imagine that ethnically homogeneous neighbourhoods and communities may exclude other people not sharing their particular identity. These conflicts can have direct impacts upon the quality of life in neighbourhoods and on access to infrastructure services.8

Economic framework

The capacity of developing countries to finance their needs depends largely upon their level of future economic growth and development. If countries are productive and able to generate employment and incomes for growing populations at an accelerated rate, they will be able to generate and mobilize the savings and investment to finance basic needs, such as housing and infrastructure services. Then, with realistic policies supported by effective institutions, they can have a chance at meeting growing needs. If, however, they remain at current growth rates or, as in some cases, are unable to grow economically, there will be little likelihood that these resources will be available. In this sense, macroeconomic growth is a necessary but not sufficient condition for addressing this problem.

Table 1.2

People requiring housing and urban services by 2030

Urban population (2003) 3,043,934,680
Estimated urban population (2030) 4,944,679,063
Additional urban population 2003–2030 1,900,744,383
Population living in slums (2001) 923,986,000
People requiring housing and urban services by 2030 2,824,730,383
Source: Statistical Annex of this report

This Global Report will examine that relationship and identify each of the possible sources of finance for urban development in order to determine which policies and programmes are likely to assist in this process. The following sections present the differences between the macroeconomic conditions of countries, as well as the various sources of macroeconomic growth needed to provide the foundation for urban development, while also demonstrating that this is a two-way process: cities and towns are also important contributors to macroeconomic performance.

Urban development requires the support of urbanbased economic activities, including manufacturing, services and construction, among others. It must also alleviate existing constraints to those economic activities, such as reducing infrastructure deficiencies by improving the reliability of water supply, electricity and telecommunications, as well as by addressing the negative health and environmental impacts of human and solid waste, as well as pollution from transportation.

The capacity of developing countries to finance their needs depends largely upon their level of future economic growth and development

Public authorities will also need to strengthen the institutional framework within which private economic activity occurs – for example, the regulatory framework determining how many steps are required to obtain a building permit or a licence to open a small business. Studies during the 1990s showed that some countries required extraordinary numbers of steps to obtain construction permits, such as 55 in Malaysia and 27 in South Africa.9 These excessive regulatory steps sharply increased the cost of housing through the delays involved, even reaching 3 per cent of GDP in Malaysia, as well as the transaction costs for individual builders and construction enterprises. Local government institutions have a large role to play in reducing the costs of economic activity in cities. Similarly, local financial institutions that provide credit for construction or loans for small enterprises also play a pivotal role in stimulating the local urban economy.10

The economic paradox of this situation is that while cities are the loci of productivity, they are also the loci of increasing poverty. This poverty has many causes. Some of it is a result of the overall level of national income of countries: Burkina Faso is poorer than Brazil, which means that, on average, people in Burkina Faso consume less in absolute amounts of goods and services than do their Brazilian counterparts, and also that there is a narrower range of goods and services than are available in Brazil. It can also mean that the social indicators of health and welfare are lower in terms of longevity, health status, literacy and infant mortality, as well as gender equality.

Table 1.3

Housing requirements to accommodate increments in the number of households over the next 25 years

Increments in the number of households over a 25-year period 877,364,000
Average size of annual increments 35,094,000
Per day 96,150
Per hour 4,000
Source: Statistical Annex of this report

In urban areas, however, much of this poverty is a result of the lack of housing and infrastructure services that are necessary for people's and enterprises’ basic needs, consumption and production. It is clear that the lack of these services has an impact upon the productivity of urban economic activities and, therefore, on the city and the nation as a whole. A study of infrastructure services in Lagos, Bangkok and Jakarta during the 1990s demonstrated that enterprises which had to provide their own water supply, electricity and other infrastructure services had lower profits and were therefore constrained in their growth. Infrastructure deficiencies had a direct impact upon how many jobs were being created. These companies in Lagos actually spent up to 35 per cent of their fixed investment in providing their own infrastructure; as a result, they had lower profits and were thus unable to grow.11

Varying types of deprivation, such as health, malnutrition and a lack of clean water supply, also have both short- and long-term impacts upon the health status and, thus, the productivity of men, women, and children.12 Poverty, therefore, becomes intergenerational, as is observed in many large city slums in developing countries, such as the Dharavi slum in Mumbai, which now houses almost 2 million people, or the slum in Mathare Valley, Nairobi.13

Cities will have to increase their productivity in order to generate jobs, incomes and financial resources as well as to provide urban services

The key issue, however, is that increased urban population growth – increasing the denominator in the per capita calculation of gross domestic product – will necessarily mean that urban areas will become poorer if they are unable to augment jobs and incomes faster than their populations grow. Because rapid and large-scale urban population growth is expected between 2005 and 2030, cities will have to dramatically increase their productivity in order to, first, generate jobs and incomes and, second, generate the financial resources for housing and urban services. In this sense, the issue of urban employment generation cannot be easily separated from the options for financing future urban development in developing countries.

Employment and income generation will also have a major impact upon what kinds of housing and infrastructure will be affordable to growing urban populations. These issues are both quantitative and qualitative: quantitative because absolute levels of income will be needed to finance specific types of housing and infrastructure, and qualitative because the stability and growth of income over time will permit certain financing options – for example, mortgages – while lower levels of income will not qualify for financing.

The economic condition of cities – how fast job opportunities and incomes increase – is further complicated by the growing impact of exogenous economic factors upon cities. Processes of economic globalization and trade have changed patterns of production in cities, leading to deindustrialization in many cities. This means that footloose industries close in cities with higher relative costs and move to new locations with lower costs – for example, from the US to Mexico or, later, from Mexico to China. The pursuit of profit-maximizing locations by private enterprises has led to major economic and social disruption in many countries over the last two decades.

Today, this disruptive behaviour by firms is compounded by new factors in the global economy, including global interest rates, whereby change in one large economy affects the price of money in the global economy as a whole. The Asian financial crisis of 1997–1998, followed by crises in the Russian Federation, Brazil and, later, Argentina, all demonstrated the volatility of the global economy. Changes in the supply and demand for specific products led to changes in the demand for their inputs, as well. In some cases, the analyses of the distribution of risk for foreign investors at a global level increased the cost of borrowing by individual countries, precipitating new crises, as in the case of Argentina during late 2001. The oil price increases of late 2004 have added to the feeling, in many developing countries, that global market forces are beyond the control of individual countries. These processes have even intensified as competition has grown between countries in providing various factors of production. Overall, the impact of the volatility of global economic and financial forces upon cities is manifested in dramatic and socially harmful impacts upon employment and labour markets, more generally, with the frequent flight of investment and jobs to new locations.14

Within this new global economic context, the economic roles of cities have become increasingly important for individual countries. If São Paulo is not productive, the economy of Brazil will suffer; similarly, if India is unable to efficiently move its exports through the port of Mumbai, the costs of those exports will be higher and India's overall economic performance will be hurt. Long journeys to work through the traffic congestion of Bangkok reduce worker efficiency. During the mid 1990s, Mexicans working in the maquiladora factories in Ciudad Juarez had to spend 29 per cent of their incomes on transportation to work, thereby reducing the possibility of meeting other household needs.15 In contrast, the modal integration of transportation in the Netherlands facilitates the access of workers to a wide range of employment opportunities.

The key point here is that housing and urban infrastructure is a critical part of the economic production function of cities. Without housing and public services, workers cannot be productive, and whole urban and national economies will feel the impact. Basic services such as water and sanitation have immediate impacts upon the health of the population.

In this context, meeting the financial needs of cities in developing countries, and particularly the financing of infrastructure and housing, should be high national priorities. Yet, too often, national budgets for investment in urban infrastructure are very low, if existent at all. It is interesting to note that official development assistance also contributes few resources for these investment needs.

Because the economic performance of cities is critical to national economic performance and, indeed, to the functioning of the global economy itself, these financial needs should be considered essential international priorities as well. Housing and infrastructure are essential for both production and human welfare. It will be impossible to reduce urban poverty if slum conditions are not improved in many cities throughout the developing world. In this regard, the Millennium Development Goal (MDG) of significantly improving the living conditions of at least 100 million slum dwellers by 2020 is important in bringing some international attention to this problem. It is equally important, however, to note that this MDG only represents about 4 per cent of the projected demand for slum improvement by 2030.

Environmental framework

An additional and important dimension of this problem is the management of natural resources required by the urban population, such as clean water and clean air. Growing demand for infrastructure services places immediate pressures on these natural resources. It is also apparent from most environmental studies that cities have important impacts upon the natural environments in which they are located. Studies during the 1990s demonstrate that the ecological footprint of cities is having enormous consequences for the sustainability of natural resources.16 Consumption of natural resources by urban residents is frequently growing faster than the environment's ability to reproduce those resources. A clear example of this situation is the deforestation of areas near African cities. Urban residents collect firewood for use in cooking and heating, cutting down trees and scrub bushes, thereby contributing to the erosion of topsoil and the sustainability of local ground cover.

One of the most important environmental issues to be addressed is the increasing cost of potable water in almost every city in the world. High levels of water consumption, with little attention to conservation or conserving behaviour, has had the effect of increasing the distance that cities must go to find potable water. Beijing now collects its water from sources 1290 kilometres from the city. Indeed, there are over 30 Chinese cities that currently have severe water shortages. This problem affects cities in both rich and poor countries: Los Angeles also goes 1290 kilometres for its water and New York is dependent upon distant water resources in New York State. Yet, efforts to conserve and improve the efficiency of water use are minimal in most cities. Some cities have used higher water charges as incentives for conservation and in order to improve the efficiency of water use. Bogotá has worked on this problem by educating its population.17

Another critical area is the management of human and solid waste. This problem also becomes increasingly significant as urban populations grow. Water-borne sewerage systems are prohibitively expensive for most cities in developing countries. On-site methods of sanitation and waste treatment are, in some cities, necessary alternatives to so-called conventional solutions. These issues also apply to non-human solid waste, where the quantities of waste quickly outstrip landfill capacity in many cities. The need for collection and recycling programmes to avoid the complete waste of reusable materials is of high priority.

If these urban problems have important local and regional consequences, they also have global impacts. A recent study from China demonstrates how urbanization is contributing to global warming, with carbon dioxide emissions largely coming from cities.18 Another study also notes that global warming is reducing rice yields in Asia, suggesting that food may prove to be one of the most serious constraints to urban population growth over time.19 The systemic character of the impacts of urban settlements upon the environment and, in turn, the impact of global climate change and other forms of environmental change need to be better understood. However, it should be noted that cities can also provide positive impacts upon the environment – for example, in concentrating all of the waste in specific locations rather than dispersing it.

One of the most important environmental issues to be addressed is the increasing cost of potable water in almost every city in the world

These environmental externalities, and particularly the likelihood of severe shortages of natural resources and increasing costs of infrastructure services, must be included in any financial and economic framework for cities in developing countries. The notion of ‘sustainable development’ needs to be made operational, rather than just a normative and rhetorical objective of governments and visionaries. As a result, this is an important component of the challenge posed by this Global Report. The task of mobilizing finance should not simply be intended to have more resources to extend current housing and infrastructure services, but rather to change the production and consumption of those services in the direction of methods, costs and impacts that can enhance the sustainability of cities and their surrounding regions.20

Financial framework

The most fundamental financial issue in this Global Report is that cities will require very large investments in order to create infrastructure and services with long-life benefits – yet, they lack the systems to finance these services. For example, it is almost impossible in most developing country cities to obtain mortgages to finance the purchase of housing. And yet it is difficult to imagine that the great majority of cities and their residents can afford to use disposable cash to finance long-life investments.

The following chapters in this Global Report undertake an in-depth examination of potential sources of finance at the international, national and local levels. A preliminary review of these sources suggests, however, that it is unrealistic to expect major additional financing from international donors, the global financial sector, the national level (where most governments are facing serious fiscal deficits) or the municipal level (where local budgets are also severely constrained).

The problem is both an issue of what is actually financed and whether sufficient levels of finance are being mobilized for this sector

International development aid

Current levels of foreign investment, international aid and government financing are clearly not meeting the current demand for housing, as Box 1.1 illustrates. Furthermore, official development assistance (ODA) to Africa and South Asia does not seem to have had any major impact upon the incidence of slums (see Figure 1.1). Individual projects in specific cities may have been successful, such as Jakarta, Madras or Nairobi; but their national and even citywide impacts have been limited.

Box 1.1 Demonstrating the foreign direct investment and
official development assistance paradox: The case of Mali

Mali has one of the highest amounts of foreign direct investment (FDI) as a percentage of gross domestic product (GDP) and a significant amount of official development assistance (ODA); yet, 93.2 per cent of Mali's urban population live in slums. During 2002, FDI in Mali totalled US$102.2 million and ODA was over US$472 million.

However, if US$574.2 million from the combined FDI and ODA were devoted solely to housing the 3.4 million people in slums, it would not suffice. Estimating 7 persons per household and US$5000 to build each housing unit, it would cost US$2.4 billion to house the current population, not taking into account the projected population growth of over 11 million by 2030.

Source: World Bank, 2004d.

Figure 1.1

Official development assistance (percentage of GNI), 2002

Source: World Bank, 2004e.

Foreign direct investment

As shown in Figure 1.2, sub-Saharan Africa has the highest levels of foreign direct investment (FDI) as a share of GDP; yet, in absolute terms, this level of FDI is only approximately US$191,329,892, compared to US$535,569,231, which South Asia receives. It is apparent from the data in Figure 1.2 that FDI, even if it were addressed to improving slums, cannot make (and has not made) any appreciable difference. In any case, only infrequently do private foreign investors place their investment funds in slums, even though there would probably be a high rate of economic return, if not financial return. Exceptions include the Community-led Infrastructure Financing Facility (CLIFF) initiative in India (see Chapter 6, Box 6.9).

Figure 1.2

Gross foreign direct investment (percentage of GDP), 2001

Source: World Bank 2004e.

National public investment in shelter

A third source of finance for housing and urban infrastructure would be national public investment – that is, publicly allocated funds from national budgets or special funds. With the exception of China and India, very few developing countries have allocated large absolute amounts of financial resources to housing and urban development.

The problem, therefore, is both an issue of what is actually financed: whether public investment in housing and urban infrastructure has been directed towards the needs of the poor and whether sufficient levels of finance are being mobilized for this sector. Both issues are important and are addressed in subsequent chapters of this Global Report.

The question of what is financed, however, must be broadened to include a wider range of infrastructure and housing solutions than normally included in international discussions. For example, in lieu of extending the network of urban water supply, it may be necessary to drill boreholes in un-served areas on the urban periphery. This approach would tap aquifers whose water is then distributed by aboveground tubing or pipes. Such a solution is a fraction of the cost of extending the existing water supply network – although, admittedly, it may present other problems, such as the need for later aquifer recharge. This suggests that how housing and urban infrastructure are considered in terms of technology, standards and costs can have very important implications for their financing.

Valuing urban assets

Another related issue to estimating the finance needed for cities is the fact that existing cities have enormous present asset value. A rough exercise in the World Bank during the early 1990s attempted to determine the ‘financial value of cities’.21 It concluded that the infrastructure stock of cities in developing countries was worth about US$3 trillion. This compared to an annual investment flow of approximately US$150 billion each year, or 5 per cent of the stock. More than 95 per cent of this annual flow came from domestic resources in countries, both public and private. This is a substantial figure, but woefully inadequate when one observes the large numbers of households worldwide without adequate water supply or sanitation.

Nevertheless, it points to a critical policy problem: it is known that most urban infrastructure in developing countries does not last as long as that in developed countries. Maintenance is neglected, both for financial and technical reasons. If, however, cities were able to obtain, say conservatively, another 5 per cent of benefits from improved maintenance of the stock, this would amount to US$150 billion or roughly current annual investment. Better operations and maintenance could reduce the need for some, though certainly not all, of the new annual investment, thereby reducing environmental and social impacts and avoiding additional debt.22 Improved initial design of infrastructure will also reduce maintenance costs in the long term.

A key policy conclusion, therefore, is that cities must obtain more benefits from their existing assets, in a financial and economic sense, and that increase can allow their networks to be sustained longer, at lower costs.23

This conclusion is of enormous strategic value in assessing the current balance of new investment versus improving the management of current stock. It suggests that a first step in a strategy for sustainable cities would be an intensive examination of maintenance programmes to improve infrastructure performance. This might include, for example, various ways of improving information systems about the condition of infrastructure (smart infrastructure), which would alert city managers about the need for maintenance.

When these issues are discussed together, it raises questions about what, indeed, is to be financed. For example, rather than assume that it will be possible to finance large-scale extensions of conventional urban infrastructure, with their heavy upfront investment costs and high maintenance requirements, perhaps an alternative strategy is needed to complement ongoing infrastructure finance. This might involve developing smaller decentralized clusters of infrastructure services that lead to the growth of multi-nucleated urban centres, thus avoiding high downtown densities and mass transit to central points of employment. This spatial alternative is also an engineering and financial alternative.24

Governance framework

Such a spatial approach also implies the need for a decentralized approach to urban governance. It connects well to the principle of ‘subsidiarity’, which the European Union (EU) has urged on its members, whereby problems are best resolved at the jurisdictional level at which they occur rather than being referred to high administrative and political levels.

It should also be noted that the participation and voice of urban populations in formulating policy and programmes by the public sector is a critical dimension of urban management. One aspect of participation is the need to shift from the top-down administrative formulation of strategy to including the full range of civil society interests and organizations in governmental processes.25 This includes thinking about the future and adding broad-based citizen involvement to conventional urban plans. The recent 2050 initiatives in Buenos Aires, New York and, now, Barcelona demonstrate the importance of this issue.26

Using these elements of an analytic framework as points of departure, it is important to recognize the value of making virtue from necessity, or rather of using the lack of finance for conventional solutions as an opportunity to refocus the discussion of urban policy towards urban forms and processes that may be able to enhance sustainability. Finance is therefore a critical lever to orient policy and to recognize the growing role of community-based urban processes.

Mobilizing finance: removing constraints
and reducing risks

As noted earlier, the conventional forms of finance – national public investment funds; ODA; FDI; national and local private-sector finance; and municipal finance – either do not seem to place high priority on investment in housing and urban infrastructure, or they simply do not have the requisite resources.

While these various forms of finance will be analysed in greater detail in Chapters 4 to 7 of this Global Report, there are three important issues that deserve to be highlighted at the beginning. These are:

  1. 1     What forms of housing and urban infrastructure investment are legitimate and deserving of public- or private-sector investment?
  2. 2     What are the constraints to mobilizing these types of resources for housing and urban development?
  3. 3     What are the risks to providers of finance for these purposes?
Public opinion has now recognized that the bulldozer and evictions are not effective answers in meeting the demand for shelter

Addressing shelter and infrastructure
standards

One of the serious issues to be addressed in considering the financing of housing and urban infrastructure is the view that housing and settlements which do not conform to building codes and land-use regulations should necessarily be excluded from consideration. This view, commonly heard during the 1970s, has evolved over recent years; many governments now recognize that millions of people, mostly the poor, are unable to find reasonably priced land for settlement and construction. The drive to evict squatters from land legislated for other purposes, while continuing in some cities, has been reduced substantially as public officials and public opinion have now recognized that the bulldozer and evictions are not effective answers in meeting the demand for shelter. The result of evictions has simply been to move the poor to even more distant locations, increasing their transport costs to places of work. There is now greater willingness for public authorities to upgrade, in situ, the settlements of the poor, allowing them at least occupancy permits, if not full ownership of the land.

These upgrading projects have been very successful in many countries, ranging from large-scale efforts such as the Kampung Improvement Programme in Indonesia, begun during the late 1960s and expanded with World Bank support during the 1970s and 1980s, to the Bustee Improvement Programme in Calcutta, to smaller-scale upgrading programmes in African and Latin American cities. These programmes have several key features (see Box 1.2), discussed in more detail in subsequent chapters of this report.27

A second aspect of determining what is legitimate for financing is the role of building codes. In many countries, building codes require standards of construction that are prohibitively expensive for the majority of the population. A sharply declining percentage of the population in many cities in developing countries is actually able to afford living in ‘legal buildings’ – that is, those buildings which conform to existing codes. This problem, originally a legacy of former colonial rule in many countries in Anglophone or Francophone Africa, or in South Asia, can no longer be simply attributed to the past. Codes which insist on high standards in the name of ‘being modern’ or ensuring public health standards are very much a product of post-independence governments as well.

Box 1.2 Key features of slum upgrading projects

Among the more than 200 donor-assisted projects for slum upgrading, the following features are found in most of them:

  • •     in situ introduction of infrastructure services, such as water supply, sanitation and electricity;
  • •     minimal demolition of existing housing structures;
  • •     provision of minimal guarantee of legal occupancy, if not tenure;
  • •     provision of accompanying social services, such as education and public health;
  • •     expectation of community participation in the design, construction and/or maintenance of new community services; and
  • •     some degree of cost recovery through periodic household payments to the implementing public authority.
During 2004, the global GDP grew by 4 per cent

Constraints to mobilizing resources

This Global Report will demonstrate that the constraints to mobilizing financial resources are both financial and non-financial. The second part of this chapter explains how macroeconomic circumstances affect national and sub-national systems of public finance and limit the availability of financial resources. However, there are also important non-financial constraints, such as building codes. These include national and local regulatory frameworks governing land use, land occupancy and landownership. In many cities, low-income people are caught in a cycle in which they lack formal permission to occupy land and therefore are not eligible to receive essential infrastructure services, such as water supply or public transport. As a result, they remain without services, which undermines their health and access to employment. This keeps them poor and unable to rent shelter in so-called ‘legal’ land subdivisions.

For example, pavement dwellers in India, who have been frequently subjected to evictions and the demolition of their self-constructed homes, become accustomed to rebuilding using temporary materials that must be replaced annually. It is estimated that over a 20-year period, these investments are equal to those of a household making annual instalments on a 40,000 rupee house.28 The difference is that one household will have secure tenure and improved access to services and the other will still face periodic demolition and no infrastructure. While one household must use scarce funds to go further and will often pay more for water and cooking fuel, the household with legal tenure frequently has access to these resources more efficiently and cheaply and can use freed-up funds to invest in a better business or better education.

Risks to providers of finance for low-income
households

The factors mentioned above also contribute to the risks perceived by lending institutions in providing finance to low-income households. If potential clients live on land without the legal recognition of municipal authorities, these clients are potentially subject to eviction from their homes, regardless of the level of financial investment which has been made. Providing finance for these households is therefore risky business from the lender's perspective. Similarly, if the major assets of these families, their house and the land they occupy are not recognized as collateral, it is unlikely that other smaller and less fixed assets will be more secure forms of collateral.

These issues form part of a vicious circle which millions of poor households have faced for generations. The circle has begun to break down in some countries where its obvious negative results do not benefit anyone – neither governments, nor lending institutions, nor infrastructure providers, nor households. However, this process is slow and filled with institutional impediments, reflecting different perspectives and interests.

What is needed is an acceptance of new categories of risk by the providers of finance, and an understanding that these clients form a majority and growing share of potential consumers for the future. The issues around this risk will be discussed in Parts II and III of this Global Report.

THE MACROECONOMIC
CONTEXT OF URBAN
SHELTER DEVELOPMENT

The second part of this chapter presents the macroeconomic context that influences many of the issues discussed in this report. While much has been written about the global economy and the impacts of globalization, this picture needs to be disaggregated into data and analyses at the regional level in order to distinguish the specific challenges facing particular regions and countries. This section addresses the following factors: patterns of economic growth; sectoral performance and productivity; income distribution and inequality; poverty and employment; savings; external debt; patterns of investment (public, private and foreign); impacts of external factors upon macroeconomic performance; and the urbanization of national economies.

Patterns of economic growth

The publication of this Global Report coincides with a period of unprecedented economic growth at the global level. During 2004, the global GDP grew by 4 per cent. All developing regions grew at a pace faster than their growth rates during the 1980s and 1990s.29 This is surprising, given the combination of the downturn following 11 September 2001 and the large increase in oil prices during 2004, reaching over US$50 a barrel. Global trade also expanded considerably, with China's demand for imported raw materials and food spurring exports from other developing countries, particularly in Latin America where Brazil exported steel and Argentina provided soy beans and meat to the growing Chinese market. The continued high demand for imports by the US economy supported the growth of global trade.

The most striking feature of economic growth has been the high rate of growth for developing countries, exceeding 6 per cent for the first time. This was heavily fuelled by China at 8.8 per cent. Table 1.4 presents the regional breakdown of economic growth, showing the sharp contrasts between regions.30 While East Asia and the developing countries in Europe and Central Asia were above 7 per cent, sub-Saharan Africa was below half of that rate, at 3.2 per cent. Latin America and the Middle East grew at 4.7 per cent each, certainly a respectable rate for Latin America after the stagnation of 2002–2003.

From a distribution perspective, these patterns are worrying because they continue the trend towards greater disparity in income levels between the regions, as well as between developing and developed countries. Global inequality between rich and poor countries, therefore, continues to worsen, even when there have been extraordinarily high rates of economic growth.

The most questionable aspect of this growth in 2004, however, is whether it is likely to be sustained in the future. This depends upon many factors, including the changing position of the US dollar in global currencies and, hence, the power of the US economy; how China will cope with the danger of inflation; and whether global interest rates will affect debt payments by developing countries and their ability to finance needed investments for growth. These exogenous factors are clearly important influences on national macro-economic performance.

As Table 1.4 demonstrates, robust growth is expected in all regions, even though the high growth rate in China is expected to decline during 2005–2006, thereby reducing the demand for goods and services from East Asian and other developing economies. In contrast, South Asian countries are expected to sustain their growth through the liberalization of their economies, generating more trade. Latin America is expected to continue to benefit from higher commodity prices and strong trade performance. Africa is expected to improve its performance, but barely, so that its extreme poverty is unlikely to be improved by macroeconomic growth in the coming decade.

Sectoral performance and productivity

One of the most startling aspects of the macroeconomic performance of the past few years – and most visible in 2004 – is the growing importance of world trade.31 This means that ‘tradeables’, whether manufacturing products or commodities, have become increasingly central to the economic growth of all countries, whether developed or developing. The growth in commodity prices in 2004 suggests that demand has grown, particularly in China and the East Asian countries, for raw materials and specific items such as steel – for example, for automobile and machinery production. While this places great emphasis on agriculture and the production of raw materials, it also requires improvements in the efficiency of infrastructure in telecommunications, transport and key services such as electricity and water supply necessary for manufacturing and other industries.

Table 1.4

The global outlook in summary

Another sector demonstrating continued growth is the financial sector, which has benefited from the absence of major crises during 2003 and 2004. Even cases such as the economic collapse and debt default of Argentina in late 2001 proved to have had little impact, or ‘contagion’, on other than its closest neighbours, thereby reflecting the increased stability of financial markets since that time. While the decline of the US dollar and the growing strength of the Euro are likely to produce some adjustments in 2005 and 2006, there is little likelihood of major changes in the sectoral composition of growth in most countries. Information technology continues to contribute to notable increased efficiencies in industry and services in most countries. Indeed, high returns to industries, such as the financial sector, which rely upon information technologies have contributed to growing inequalities in earnings between sectors within countries.

Global inequality between rich and poor countries continues to worsen, even when there have been extraordinarily high rates of economic growth

Income distribution and inequality

One of the consequences of the pattern of economic growth described above is growing inequality. Figure 1.3 depicts the share of income earned by the poorest 10 per cent and richest 10 per cent across the regions. Latin America continues to have the highest rate of inequality, with South Asia the lowest. This extreme inequality in Latin America has been analysed in some depth and has its roots in many historical patterns of landownership, political and institutional development and, more recently, economic policy.32

Inequality has become increasingly recognized not just as a problem to be addressed in its own right, but also because of its substantial impacts upon economic growth, poverty reduction and productive investment strategies for the development of human capital. Studies over the past decade have demonstrated the high correlation between inequality and poor performance in other aspects of development.33

While some forms of inequality have been attributed to differences in the level of education between people,34 and yet others associated with higher returns to capital in sectors favoured by the global economy, there are also many forms of inequality that can be attributed to the policies of national and local governments in urban areas. A study of public investment in infrastructure among the various neighbourhoods of Buenos Aires from 1991 to 1997 demonstrated that 11.5 per cent of the population received 68 per cent of total investment.35 Inequality through skewed local public investment can therefore be a local product and cannot always be blamed upon external forces outside the country.

Figure 1.3

Regional income/consumption inequality patterns

Source: UNDP, 2004.

The most direct and important factor contributing to urban poverty is the shortage of wellpaid employment in cities

Poverty and employment

Despite the impressive economic growth of the past few years, the enduring problem of massive poverty in the developing countries remains the top priority problem facing the world today. Figure 1.4 depicts the share of the population in the six regions below their respective national poverty lines during the period of 1990–2001, below US$1 per day and below US$2 per day for the period of 1990–2002. These figures are daunting, with approximately 64 per cent of the populations in Africa and South Asia living below the US$2 a day threshold for the period of 1990–2002.

Figure 1.4

Population below income poverty lines in five developing regions

Source: World Bank, 2004e.

The incidence of poverty at the national level is highly correlated with low levels of education and poor health status, lack of access to basic infrastructure services (such as clean water supply), sanitation and electricity. This vicious circle of poverty is also intergenerational, with families caught in a poverty trap in which income-earning opportunities are frequently tied to educational attainment, location or access to credit.

The poverty problem is also characterized by strong differences between urban and rural residents. If the urban poor lack services and education, they have at least found some ‘space’ or land to occupy, albeit in squatter settlements in the less desirable areas of the city. In contrast, the rural poor are often landless, working as contract labour and continuously facing the threat of food insecurity. As noted earlier, the rural poor face two major and contradictory threats. High agricultural productivity is most likely to come from increased mechanization of agriculture, thereby reducing the demand for labour. Alternatively, low productivity will keep incomes low for everyone and also push people off the land. Both threats will lead to the same result: rural-to-urban migration. These growing tensions are very much evident in both China and India, but less so in Latin America where the largest share of the population has already moved into urban centres.

The most direct and important factor contributing to urban poverty is the shortage of well-paid employment in cities. The challenge here is both the creation of jobs and the level of wages. The generation of employment depends generally upon savings and investment within the macroeconomy and local economies, as well. As noted earlier, much of the growth of economies over the past decade has been in technology industries and financial services, neither of which requires large labour forces to be productive. While many argue that improving education in cities will be sufficient to help young people find jobs, this argument is not always true empirically, especially in the short to medium term because there are growing levels of urban unemployment in cities despite increasing investments in education. Having secondary or even university education may be a necessary, but not a sufficient, condition to find work in environments with growing numbers of job seekers.

With growing global pressures towards profits in manufacturing and service industries, there has also been little incentive for medium- and large-scale enterprises to pay ‘living wages’ to those lucky people who do find jobs. If cheaper labour is available elsewhere, investors urge the managers of these enterprises to move to sites with lower labour costs. This pattern is found in both developing and developed countries where the so-called ‘fast food jobs’ pay notoriously low wages. Again, with increasing supplies of labour in local markets, it is not surprising that wage rates are very low.

Savings

A strong consequence of high levels of poverty is a lack of domestic savings within national economies. As shown in Table 1.5, national savings rates are closely correlated with levels of GDP, with rates in Africa (14 per cent) and South Asia (13 per cent) less than half of the rate in East Asia (35 per cent). Low levels of domestic savings – both public and private – contribute to low levels of capitalization of the financial institutions in poor countries, including housing finance institutions. They are also reflected in low levels of tax revenue collection and therefore place great limitations on public expenditures and public budgets. Households and families at low incomes are able to find ways to survive, albeit marginally in many cases, with minimal expenditures for food, water and shelter. But paying taxes to institutions that appear to offer little in return is a much lower priority.

The issue of savings is particularly important when considering how to finance urban infrastructure and housing, as is discussed in Part II of this report. As noted earlier, both infrastructure and housing are durables – they are expected to have a long life, at least 50 years in the case of infrastructure; but they require large upfront investments in the expectation that they will provide a long stream of benefits well into the future. Savings is the foundation of investment. Without some surplus, investment in these future benefits is impossible. Therefore, patterns of income generation are critical factors in determining whether households will be able to invest at all in their future.

External debt

Another factor that heavily conditions the macroeconomic environment of developing countries is the significance of external debt for specific countries. Built up over time and frequently connected to the volatility in the world economy during the oil shocks of the 1970s, many national governments borrowed heavily in order to finance increased energy costs during the 1970s, as well as to finance projects in all sectors. Even where these projects were well conceived and ‘successful’ in meeting their objectives, including contributing important support for economic development such as roads, schools, factories and irrigation canals, the legacy of external borrowing has left many countries with unsustainable levels of external debt service. In some countries, particularly in Africa, the debt service to GDP ratio has reached over 400 per cent.36 Figure 1.5 depicts the total levels of debt service in various regions.

Box 1.3 Poverty reduction strategy papers

While the dire shortage of affordable housing has been recognized internationally as a deep and pervasive problem, strategies to address this have not been thoroughly addressed in existing mechanisms, such as poverty reduction strategy papers (PRSPs). These are documents that the International Monetary Fund (IMF) and the World Bank require from national governments detailing their plans to reduce poverty in order to qualify for debt relief under the Heavily Indebted Poor Countries (HIPC) initiative. Out of the 54 countries with PRSPs or interim PRSPs, many of them address housing, but with varying degrees of commitment or specificity with regard to resource requirements. Many of the PRSPs discuss housing as a problem and some have conducted surveys to identify housing needs more exactly. Some countries propose building a few hundred or few thousand units, while others propose public–private partnerships and land reform measures. However, it is disappointing that many do not include clear measurable goals or budget information.

Source: www.poverty.worldbank.org/prsp/.

Table 1.5

Gross domestic savings, 2003

Percentage of GDP Current US$
Sub-Saharan Africa 14 1,783,690,767
Middle East 24.5 27,261,325,959
Southeast and East Asia 35 321,936,208,750
South Asia 13 37,536,526,160
Latin America 16 38,121,260,000
North America 19 817,705,450,000
Europe 21 305,467,000,000
Source: World Bank, 2004e.

One of the consequences of these levels of debt is that it immediately reduces available domestic capital for investment. The net transfer out of developing countries to both public and private institutions in the developed countries, as well as to multilateral institutions, underlines the fact that the external community in some countries is not only a source of funds for domestic investment, but is a net drain on available surpluses which individual countries can generate. This negative net transfer has occurred in many countries in Latin America, as well as in Africa. However, external debt swaps have begun to be used to finance poverty reduction programmes related to the HIPC initiative, including at the city level, as is shown by the example of Bolivia in Chapter 3.

Figure 1.5

Debt service, 2002

Source: World Bank, 2004e.

Table 1.6

Size of public budgets relative to GDP (%), selected countries

Low levels of domestic savings – both public and private – contribute to low levels of capitalization of the financial institutions

Patterns of investment

Foreign investment

Given the above, the patterns of investment in developing countries have changed markedly over the past decade. Whereas, during the 1970s and 1980s, many countries relied upon the international institutions to provide needed capital, the transaction costs and conditions of those lenders have reduced their attractiveness for those countries able to enter global financial markets to raise investment capital. Countries such as the Republic of Korea and Thailand have sharply reduced their borrowing from the World Bank and the regional development banks because they are able to obtain necessary funds from private lenders. Other countries, such as Brazil and Mexico, have been able to raise funds from global markets, but by paying a premium to lenders. In contrast, most of the African countries have been unable to enter these markets, despite their offering tax holidays and other benefits, because their economic environments are unable to offer the short- and medium-term financial returns to private capital available elsewhere.

Not surprisingly, there has been an important segmentation in the global financial markets whereby some countries – particularly the East Asian countries and, notably, China – have been able to attract high levels of foreign direct investment.

The reason for this segmentation is, of course, that FDI is now private investment, with no particular public obligation to provide funds to countries where the conditions are not perceived to exist for maximum private financial returns. This logic can be perverse as well, with ‘country risk’ – the premium that countries must pay to lenders – determined by market perception of the risks of investing in specific countries. This leads to anomalies where risk is not associated with the income levels of countries, or with their levels of education and institutional development, or even with natural resources. Rather, it is determined by a narrow financial and political judgement about whether countries will be able and willing to honour their financial obligations in the short to medium term. This has led, for example, to the declaration that the country risk for Argentina was higher in 2002 than for Nigeria, even though the former has considerably higher social indicators than the latter. These financial market-driven realities have enormous consequences for individual countries, determining both their possible access to the markets themselves as well as the costs of borrowing.

The patterns of FDI also affect the allocation of finance across sectors. A study of FDI in Indonesia from the 1970s to the 1990s found that FDI ‘encouraged the growth of a network of large cities but generally neglected rural areas and smaller cities’.37 In general, there are few cases where FDI was actually devoted to housing projects in developing countries, unless this housing was for upper-class communities. FDI has supported large shopping malls in Latin American and Asian urban and suburban areas, but these investments have not contributed much to financing basic infrastructure for the poor in these communities.

Public investment

Given that there is a paucity of foreign investment in most countries, and that domestic savings rates are low, it should be no surprise that public investment as a share of GDP is low in most developing countries. Developing countries generally have relatively large deficits in their public budgets, straining to meet their recurrent expenditures, such as the salaries of civil servants or operational expenditures in school and health services. Maintaining infrastructure should be a priority in most countries; however, deferred maintenance is often not the exception but the rule. Table 1.6 shows the size of public budgets relative to GDP in selected countries.

The lack of resources for public investment in the poorest countries poses a serious dilemma. If these countries do not qualify for FDI, they are dependent upon official development assistance as the major source of financial support for economic development. Yet, ODA is also severely limited. Even with promises of additional aid from the developed countries at the International Conference on Financing for Development (Financing for Development Summit) held at Monterrey, Mexico, in 2003, the actual levels of official finance for development are constrained by lack of domestic political support in the developed countries, or by the restrictions of macroeconomic agreements with the international financial institutions (IFIs).38

It is important to note that the poorest countries have been heavily dependent upon ODA as a source of government revenue. Rwanda, for example, received ODA equivalent to more than 300 per cent of government revenue during the period of 1995–2000. Figure 1.6 shows that a large number of African countries, as well as Central Asian countries such as Tajikistan, Georgia and Kyrgyzstan, are all extremely dependent upon ODA.

It is important to acknowledge that urban development must compete with other priorities in the allocation of ODA for specific countries. The difficulties experienced in raising funds for the Global Fund for HIV-AIDS suggests that it would not be prudent to expect that the international community will be a major source of funds for urban development.

The issue of the composition of public investment also applies within countries. There are two issues here. The first is the sectoral allocation of aid (that is, for housing versus education or urban water supply). These allocations are clearly politically determined within individual governments. Second, there is an issue of the institutional level from which allocations are made. For example, many governments increasingly assign responsibility for housing and urban development to the provincial, state and local levels, rather than to national government. This means that patterns of intergovernmental financial relations and, specifically, financial transfers have a large impact upon what level and type of funds find their way to cities and towns (see Chapter 3).39

Public investment as a share of GDP is low in most developing countries

In many cases, the transfer of funds from national to sub-national units is used to cover recurrent priority expenditures. They are often not intended to cover new public investment projects. This process of decentralization has increasingly been both political – in terms of the authority for local issues being transferred to local institutions – and technical, with local officials authorized to make the important design and financial decisions regarding individual projects. What has been missing is authorizing local bodies to be able to enter local, national and global financial markets in pursuit of the funds needed to implement those projects. While there are notable cases of local governments entering financial markets – for example, the Ahmedbad Municipal Corporation during the mid 1990s – this trend has not made as much progress as originally hoped. Financial institutions have tended to be hesitant in buying the municipal bonds of local authorities without clear sources of revenue other than local taxes.

Private investment

The weaknesses of the public sector and its inability to mobilize substantial resources for urban development therefore point to the need to give greater attention to private sources of finance. Here, there is a major policy paradox: on the one hand, it is possible to readily identify the constraints facing private financiers – for example, why should they provide scarce capital to investments with medium- to long-term pay-offs, or why should they orient capital to the urban poor or even to municipalities, who, for different reasons, are equally risky even if they are deserving beneficiaries? Yet, while these questions are posed, it is true that private finance is the foundation for most investment in cities (the private sector finances precisely those infrastructure services and types of shelter for which there is such a large demand). This paradox is clearer when it is acknowledged that in no countries other than China and those of the former Soviet bloc have more than 15 per cent of the demand for housing been financed by the public sector.40

While there are notable cases of local governments entering financial markets, this trend has not made as much progress as originally hoped

The answer, therefore, is that the private sector is financing urban development: witness the shopping centre along the highway, the corner store near the market or the houses on the vacant plot across the street. The problem is that this is not keeping up with the pace and magnitude of demographic growth. There are important examples of this finance, as is illustrated in Box 1.4. The promise and limitations of this experience are presented in Chapters 4 and 5 of this Global Report.

Figure 1.6

Official development assistance, selected countries, average during 1995–2000 (percentage of total government revenue, excluding grants)

Source: IMF and IDA, 2004, p8.

One controversial aspect of private investment was also the trend, during the 1990s, to privatize public services on the grounds that private management was more efficient and cost conscious, and frequently could be counted upon to help mobilize needed capital for investment in the rehabilitation or expansion of infrastructure networks. While some of these privatization experiments resulted in such benefits, many were sharply criticized because private managers often increased the tariffs of previous public services, thereby excluding the poor from needed infrastructure, such as water supply. In addition, many privatized firms were unable to attract new capital for network expansions. This created political problems for public authorities who had justified their decisions to privatize, in part, on the expectation that unserved populations would receive services. While an overall assessment of the privatization experiment remains to be done, it is clear that effective privatization requires effective public regulation, and this factor was often missing (see Chapter 3).

Other dimensions of macroeconomic performance that have affected the availability of private finance for urban development have been the level of interest rates and inflation in the respective developing country economies. While, in general, global interest rates have been low and money has been available for investment in developed countries, this pattern has served to discourage greater exploration of so-called ‘emerging markets’, where risks are higher and the potential for inflation greater due to uncertainties in macroeconomic management and the impact of the global economy upon local markets and specific investments. The concentration of capital in European and North American markets has tended to attract new investment as well because there are more opportunities to diversify within these markets.

The impact of external factors on
macroeconomic performance

As noted earlier, the macroeconomic performance of countries is highly conditioned by the global economic environment. Relative prices of goods and services are determined both by real-sector production costs (land, labour, technology and capital) and by currency values. They are also affected by interest rates, which fluctuate at the global level in relation to the large aggregates of finance – mostly in the US, Japan and Europe – and not very much in relation to regional factors. Countries which have begun to produce specific products for trade – for example, tea in Kenya – find themselves in serious competition with producers in other countries. Countries which followed import substitution strategies during the 1950s and 1960s found themselves at a serious disadvantage during the 1970s as trade expanded and energy prices increased.41

These patterns of competition and risk have dramatically increased with the globalization of the economy. Footloose industries which left the US for Mexico under the North American Free Trade Agreement (NAFTA) have, in some cases, moved on to new locations where labour costs are lower, such as China. The notion of ‘outsourcing’, where parts of industrial and commercial processes are assigned to enterprises in other countries with lower labour costs, has become more than a frequent subject of conversation – it has also become a real threat to the stability of employment in all countries.

While this issue has been largely understood in relation to labour costs, it can also be expected that footloose industries will move some of their production and service functions to locations with more efficient infrastructure services, particularly telecommunications and transport. The most notable example of this process was described in a 2001 book by a leading author on the subject of cities and globalization, which focused on the management functions in the financial sector and how they were located in New York, London and Tokyo.42 This need for reliable infrastructure has spread well beyond the financial sector in many countries to the creation of industrial or office parks, where special services for particular economic functions are available.43 Indeed, these spaces are linked within the global economy, creating integrated economic activities through space.44 While these higher levels of integration have been heralded as offering new levels of productivity and efficiency, they can also lead to new levels of vulnerability to external shocks, where a shock to one economy or activity can affect others.45

The urbanization of national economies

A final characteristic of the macroeconomic context for urban development is the urbanization of national economies themselves. Abundant evidence exists to demonstrate the growing importance of cities in the overall productivity of countries. The increasing share of national GDP produced in cities has been well documented.

This is very much related to the ‘agglomeration economies’ found in urban areas, which results in very large cities having a substantial share of national productivity. For example, São Paulo has 8.6 per cent of Brazil's population, but produces 36.1 per cent of GDP, while Mexico City has 15 per cent of the national population and produces 34 per cent of GDP.46 These patterns do not only apply to very large metropolitan areas. For example, the five largest cities in Mexico accounted for 53 per cent of national value added in industry, commerce and services, even though they contain only 28 per cent of the Mexican population.47 A study of 13 industries in India shows that firm output is greater in larger cities.48

Box 1.4 Housing Development and Finance Corporation (HDFC) in India

Based in India, the Housing Development and Finance Corporation (HDFC) was incorporated in 1977 to provide the long-term finance that was lacking for housing needs. With offices in over 130 cities in India and abroad, HDFC's loan approvals for 2004 were 152.16 billion rupees while disbursements amounted to 126.87 billion rupees.

While it is common for housing banks to lend to middle- and upper-income households, which are perceived to be less risky, HDFC has made a concerted effort to address the dire shortage of affordable housing for low-income people in India. During 2004, with funds from the German state-owned bank Kreditanstalt für Wideraufbau, HDFC disbursed 1250 million rupees in loans to over 140,000 poor families. It also approved 303 million rupees towards 49 low-income housing projects and 282 million rupees to cover 58 loans under its microfinance facility. HDFC has also released 366 million rupees in grants towards the construction of 10,058 houses for low-income people.

Source: www.hdfc.com, www.kfw.de

The phenomenon of increasing concentration of productivity within national economies in cities and towns reflects the absolute advantages of cities resulting from agglomeration economies and localization economies. However, it also reflects the relative advantages of cities visà-vis rural areas. This is evident through an examination of the wages earned by workers in cities, even when they are working within the informal sector. A study of labour markets in São Paulo from 1989 to 1999 shows a growth of informalsector employment from 2.4 million to 3.7 million during this period. There is a noticeable ‘casualization of work’.49 Even if workers do not have the legislated benefits of formal employment, there is, nevertheless, a large increase in informal-sector employment in many cities in developing countries, thereby demonstrating the ‘pull’ of urban wages.

Patterns of competition and risk have dramatically increased with the globalization of the economy

CONCLUDING REMARKS

This chapter has presented data suggesting that, despite historically rapid rates of economic growth, there is little likelihood that conventional sources of funds will be available for investment on the scale needed to meet the projected demand for urban infrastructure and housing. Many countries continue to face the combination of significant external debt burdens, deficits in public budgets and weak financial sectors. Local governments have begun to seek finance in national and global markets; but this is only in its initial phase. Countries and cities, therefore, will have to rely upon the savings of their citizens. How those savings are mobilized through diverse mechanisms will be the subject of subsequent chapters of this Global Report.

Key underlying questions that have been addressed in this chapter are summarized and answered as follows:

  •       How have macroeconomic trends affected the living conditions of urban households during the last two decades? With the exception of East Asian countries, most developing country regions have not experienced sustained positive growth over the past two decades. Africa has continued to suffer the most, with at best uneven growth in a few countries; but most sub-Saharan states have continued to deteriorate in providing needed urban employment and incomes. Latin America has also been quite disappointing as the promised neo-liberal reforms have failed to deliver the anticipated patterns of sustained growth. In general, the upper end of the income distribution has benefited from the new patterns of economic growth in the age of globalization. While in some countries there is evidence of a new middle class, particularly in China and India, the middle class has actually disappeared in other countries, joining the poor in the absence of ‘living wages’.
  •       Have macroeconomic trends and national development policies of the last two decades improved urban- and housing-sector operations? The answer here is mostly negative. With exceptions in some countries, again in parts of India and China, and in richer developing countries such as the Republic of Korea, Thailand or Mexico, national economic authorities have generally been preoccupied with macrostability, debt and trade, and have tended to neglect implementation of the needed policy and institutional reforms in the urban sector.
  •       Has international financial assistance to the municipal and housing sectors made a significant contribution to improving urban infrastructure services and housing within cities in developing countries and countries in transition? It must be recognized that, despite considerable effort to encourage urban and infrastructure policy reform and capacity-building in the developing countries, there is little evidence of any sustained large-scale impact. One senior government official in a large developing country once replied to this question by suggesting that the question itself was presumptuous in that the level of financial resources and the applicability of the policy advice were both considerably short of what was required.

NOTES

  1   This chapter is based on two background papers prepared by Michael Cohen, New School University, New York, US, with assistance from Deanna Fowler.

  2    UN Population Division, 2004; National Research Council, 2003.

  3    UN Millennium Project, 2003, p4.

  4   Harris and Todaro, 1970.

  5   George Beier, Anthony Churchill, Michael Cohen and Bertrand Renaud developed this typology of urban growth and the range of challenges facing individual countries. See Beier et al, 1976.

  6   UN-Habitat, 2003a.

  7   Montgomery et al, 2004. See also UN-Habitat, 2004.

  8   Sharma, 2005.

  9   Angel, 2002.

10   World Bank, 1991.

11   Lee et al, 1999.

12   National Research Council, 2003.

13   Sharma, 2005.

14   UN-Habitat, 2004.

15   Dillinger et al, 1994.

16   Rees, 1992.

17   Mockus, Antanas,‘Camino a la Igualdad’, included in Memorias Encuentro Internacional de Competitividad, 2002.

18   National Academy of Science, 2004.

19   National Academy of Science, 2004.

20   Roberts and Cohen, 2002.

21   World Bank, 1992.

22   According to 1990 World Bank estimates.

23   Cohen, 1998.

24   See Graham and Marvin, 2001.

25   National Research Council, 2003.

26   Margarita Gutman, Presentation on the 2050 Initiatives at the World Urban Forum, Barcelona, September 2004.

27   UN-Habitat, 2003a.

28   Homeless International Dialogue,‘Risk and investment in urban communities around the world’, September 2002.

29   World Bank, 2005, p1.

30   World Bank, 2005, p2.

31   UNCTAD, 2004.

32   IADB, 1998.

33   Birdsall, 2001.

34   UNHCS, 2001.

35   Cohen and Debowicz, 2004.

36   For detail see: IMF and IDA, 2004.

37   Douglass, 1997, cited in National Research Council, 2003, p345.

38   United Nations,‘Building on Monterrey’ Financing for Development, 2002.

39   See, for example, Bird and Slack, 2003.

40   World Bank, 1993.

41   UNCTAD, 2003.

42   Sassen, 2001.

43   See for example, Graham and Marvin, 2001.

44   Sassen, 2002; UN-Habitat, 2004.

45   Pettis, 2001.

46   Freire and Polese, 2003, p6.

47   National Research Council, 2003, p303.

48   Cited in National Research Council, 2003, p309; see also Shukla, 1996.

49   Buechler, 2000.