Global Outlook on closing the SDG Financing Gap

People, prosperity, planet, partnerships, and peace – the five critical elements defined by the UN as the pillars of the 2030 Agenda. On the quest of addressing the collective challenge to transition from a carbon-fueled past to a cleaner, more sustainable future, the 5Ps marked the inception of 17 Sustainable Development Goals (SDGs) in 2015. As the core of the 2030 Agenda, the SDGs were intended as guidelines for all global, regional and national development endeavors to follow for the next 15 years. Achieving these ambitious goals is highly dependent on the resources needed to fund the grand mission. The concept of finance for development has birthed the idea of financing for the SDGs. As a roadmap to follow, the Addis Ababa Action Agenda (AAAA) defined the global framework for development finance.

However, since the roadmap for sustainable development was established, there has been a breach between financial resources devoted to the cause of the 2030 Agenda and the actual amounts needed to deliver the defined SDGs. The chasm, referred to as the SDG financing gap, has been estimated at $2.5 trillion by the International Finance Corporation (IFC). The COVID-19 pandemic has only further amplified this financing rift. Mainly due to the consecutive effect of decrease in resources against the increasing needs, the OECD revised the annual financing gap to have expanded by $1.7 trillion. Overall, the social and economic shocks of the pandemic emphasized the urgent nature of SDGs, as the crises pointed towards the global interdependencies and disproportions. The phenomenon responsible for the issues that particularly impact the emerging economies, including the insufficient portion of financial commitments made towards developing countries.

The urgency sparked by the economic and social crisis, along with the previously existing financing gap raise an inevitable question – how to refine the methods of addressing the finance breach and unlock the sufficient resources for long-term SDG funding and alignment? Most research findings claim the answer lies within the financial sector, as it plays the key role in offering innovative financing instruments. Mobilizing capital and leveraging private sector funding for sustainable development are necessary steps on the way to fostering a multi-stakeholder approach that addresses the interconnectedness of global issues.

It has been almost a decade since the UN held a Sustainable Development Summit where they defined its 17 SDGs as part of the Agenda 2030. While the goals of that pledge appear to be highly ambitious with a total of 169 defined targets ought to be reached by 2030, the implementation of this global commitment has been obstructed by insufficient sources of financing. Overly aspiring goals represent only one of many issues underlying ineffective efforts towards SDG alignment. Besides high-level objectives of the Agenda 2030, lack of clear interpretation and failure to define proper metrics reflecting on the actual relevance of the SDGs to investors prevent the flow of SDG-compatible finance even further.

The current decade, referred to by the UN as the “Decade of Action”, has unfortunately started off with the global pandemic, resulting in hindered future actions as well as reversed progress towards achievement of Agenda 2030 objectives. Even before the strains of the pandemic, assessment of the finances needed for meeting SDGs has shown a significant gap between estimated goals and actual funding. As early as in 2014, the total funding requirement was estimated to amount for $5-$7 trillion, with an annual shortage of $2.5 trillion. That original estimate, however, did not include a wider set of critical SDG-related items, such as financial inclusion, operating expenditure for health and education or social security, which were further defined as part of the 2015 Paris Agreement. In 2019, the International Monetary Fund (IMF) revised that estimate to reach $2.6 trillion annually. The updated estimate for the annual funding shortfall still only reflected on partial coverage of SDGs. The calculations did not include costs related to climate change and mitigation, as well as food security and agriculture, solely focusing on human, social and physical infrastructure. Nevertheless, keeping in mind the initial estimate provided by UNCTAD which stood at $2.5 trillion, combined with a $2.6 trillion shortfall calculated by IMF for only a subset of all the SDGs, the funding gap appears to be drastic. As a result of that observation, the revised assessment for 2020 reflected on a $4.2 trillion amount that would be needed to be correctly invested every year. This estimation comes from the Organization for Economic Co-operation and Development (OECD) after they had reevaluated previous IMF’s estimates, factoring in the unfolding impact of COVID-19 outbreak.

The global outlook on the damage caused by the pandemic in respect to the SDG financing and alignment not only reflects on short-term collapse in funding resources, but emphasizes bigger concerns. The coronavirus outbreak became a turning point in addressing the challenges of the global sustainable development agenda, as it reinforces the very basis which SDGs are based on. The interrelated nature of these goals essentially conveys the fundamental truth of the world being an interconnected system, creating a threat of systematic failure as a result of uncoordinated alignment in addressing the sustainability agenda. The issue of international cooperation has been clearly highlighted by the pandemic, as the 2020 record showed a decline of $700 billion in external financing sourced to developing countries, reflecting that most countries turned inward to protect their citizens and economies in response to the global crisis.

The Force of Good Report estimated that 10% of the global GDP would be required annually to close the current financing gap which now amounts to a total of $116-$142 trillion. With another $80 trillion that would have to be added on top of an already insurmountable financial obstacle, if counting the costs for energy transition needed for climate change. With the transition funding added to the overall costs of SDGs through 2050, the calculations comprise a total of $200-220 trillion in required finance. As these total numbers are extremely hard to grasp, with the next graphic we want to take a step back and take it to the annual level. Currently, there is only around $4 billion annually invested into the SDGs. Considering the new development of the pandemic’s impact, we split the newest annual funding gap into four big drivers and highlight the overall funding requirements to achieve the SDGs.

Although the global pandemic has accentuated the financing gap and compromised previously achieved progress within the SDG scope, a significant lag in financing existed before the COVID-19 outbreak. That raises a question as to why SDG finance has not been advancing at the speed and scale required to meet the targets.

The slow progress on fulfilling the financing needs for the Sustainable Development Agenda has been framed by several constraints. Namely, intensified geopolitical tensions surrounding trade and technology, increasing external debt amidst unresolved systemic issues, misalignment in collaboration for development finance between public and private sectors.

International trade has moved away from the sustainable development agenda, as lately the world has witnessed solitary interest-centered actions, trade tensions and gate-keeping measures. Under the circumstances of continuous technological war between China and US, as well as the Brexit agreement that fully came into effect in 2020, previously existing commitments to SDG–friendly international trade were impeded. Amidst the trade war, persistent inequalities and disproportionate benefits of globalization are stripping developing countries of a chance to equally participate in the global trading scenery. Despite the initial bid on favorable development results related to technology transfer and shared industrial policies, the notion of international trade has been heavily weaponized. The rising US-China tariffs amidst the ongoing tensions puts at risk the industries in developing countries that are closely integrated into Chinese and American supply chains. At the same time, the departure of the UK from the EU and the consequent adjustment of their trade policy changed the trajectory of many emerging markets, as well as the global economy overall. The reduction in EU exports as a result of lost preferential access to the UK market was estimated at $35 billion per year, according to UNCTAD. The collateral damage also affects the competitiveness of many non-EU developing countries, measured in their exports to the UK market. Those countries include Cambodia (-12%), Madagascar (-14%), Mozambique (-32%), Myanmar (-12%) and Nepal (-20%).

A poorly defined framework creates risks of SDG washing, as even ESG criteria that are more widely recognized among investors have been heavily criticized. One of the recent studies analyzed the records of U.S. companies listed in both ESG and non-ESG fund portfolios. The comparative research found the companies added in the ESG portfolios to have showcased worse compliance with both labor and environmental criteria. The results of the study also stated that the ESG portfolio-listed companies did not subsequently improve their performance regarding any of the mentioned regulations. This shows that the equities and bonds of the companies claiming their place in the ESG fund portfolios might not be going through such stringent testing after all. At the same time, the European Corporate Governance Institute took a look at 684 U.S. institutional investors that signed the UN’s Principles of Responsible Investment (PRI) and the respective ESG scores of the companies they have invested in. That research showed no improvement in the scores of companies supported by PRI signatories compared to those held by the institutional investors that had not signed the PRI.Why do ESG funds perform so badly? The answer might appear quite expected, as the misalignment between public and private sectors’ approach towards achievement of SDGs results in lack of proper regulations and accountability surrounding the business. The evidence suggests that companies cover up their poor business performance by publicly embracing their ESG focus. When the earnings expectations turn out underperformed, the ESG comes in as a convenient excuse for the managers to shift the attention from their insufficient results. As a result of this phenomenon, many sustainable fund managers fall for the trap of allocating their investments into underperforming companies that proclaim misleading commitment to ESG.Other more complete frameworks, such as the EU taxonomy, ensure a contribution to environmental objectives, yet still fail to cover all the aspects of sustainable development. When applying sustainable taxonomies, asset managers frequently encounter challenges such as taxonomy fragmentation and lack of transition taxonomies. As national taxonomies develop, multinational asset managers face discrepancies between expectations and requirements when applying those frameworks to operations in different jurisdictions. With the risk that the “green” criteria met by one taxonomy does not necessarily suffice the same criteria for another, there is a need for more broadly applicable frameworks. The improved framework would have to be appropriately tailored to the circumstances and regulations of the local standard.

To further analyze the interconnectedness of the impact ecosystem shown by the figure above, it makes sense to take a look at some interdependencies between the sectors within it. When considering the public sector, governments and municipalities are viewed as the primary source of demand for impact. By definition, this sector should be concerned about the environmental, social and economic wellbeing of the population. Now let’s see how this sector could influence the business. As seen previously, more and more new businesses now discover the relevance of impact-based approaches. Impact is incorporated as the main growth strategy, given the ability of the evolving business-models to adapt to fast technological changes, customer demands and the potential of emerging markets. This unlocked potential creates a stake for the public sector to get involved, as the authorities have the power to stimulate the emergence and application of such business models. In return, the private sector can help the impact at a cheaper cost. Apart from being challenged to deliver solutions with the best cost-to-impact ratios, businesses will stimulate competition on impact which consequently could drive the emergence of companies focused on the integrated approaches to issues, such as energy efficiency and mobility.

Another issue that the impact ecosystem addresses is significant information and data gaps. Majority of the data related to the impact and SDGs is currently scattered across various documents, sites, and databases. International organizations and standard-setters can play an important role in collecting and managing data, all while pursuing their work in research and stakeholder convening. Once this data is aggregated and properly organized, it could effectively support the needs of various users within the public and private sectors. Moreover, as a proactive force in developing the collective understanding of impact, academia could contribute by compiling impact definitions, indicators and predictive models.

The final emphasis of the impact ecosystem falls on the civil society and NGOs. Human needs being at the heart of SDGs, individuals, and their communities represent a strong agent of impact in their demand for positive impact goods and services. As their part is mainly concerned with advocating for the emergence of the impact ecosystem, civil society’s engagement with the public and private providers also makes it the ultimate guarantor of the delivery of impacts and the integrity of business models.

As many pieces of the introduced ecosystem are being built, the rise of impact as an organizing concept for the multi-stakeholder alignment is the biggest opportunity on the road to achieving SDGs. Impact frameworks for the finance sector, public sector programs, RFPs, and impact-based models as part of refined demand and supply, as well as the improved impact metrics are all part of connecting the dots. Pandemics should be taken as a lesson showing that global challenges cannot be solved isolated, and therefore require a collective approach and commitment. Current setbacks in achieving the 17 SDGs serve as a test of the world population’s dedication to addressing those challenges and the systematic, interrelated risks that they imply. Bringing all the components together is the matter of urgency that lies at the core of the 2030 Agenda. In the following article of this series, we will focus on the innovative financial instruments and disruptive solutions that each respective sector contributes to financing sustainable development and determining whether the world can rise to the challenge of the SDGs.