Making policies work

GREAT insights Magazine

Development Finance – Upside Down

11-09-2014

Koskelo, J. 2014. Development finance – Upside down. GREAT insights Magazine, Volume 3, Issue 8. September 2014.

Though Africa is still often portrayed as a continent full of misery, Africa now contains 7 or 8 (depending on the source) of the world’s 10 fastest growing countries— a figure which we often forget. Another stunning statistic also comes from the continent: over 40% of Kenya’s GDP passes through MPesa, Kenya’s popular mobile payment platform. Indeed, over half of all mobile payments globally take place in Kenya. These are only a few of the statistics illustrating the rapidly changing environment for development today.

Yet, both the general public and the broad development community are still stuck with a largely outdated image of developing countries as inhospitable places where famine and various other disasters, natural and man-made, prevail. Though these continue to be important themes in certain fragile or war-torn countries, such humanitarian emergencies are not nearly as frequent as they were a few decades ago. 

Rather than focus on famines, the development community should embrace the fact that emerging markets are increasingly becoming co-drivers in a global community, and in fostering economic growth.

Changing mentalities in development finance

I often ask various decision-makers in the development community on their views on the most important factors in helping hundreds of millions of people escape poverty during the last decade. What sources generated sufficient funding for making such investments feasible? The typical responses rarely, if ever, bring the private sector to the forefront.

Yet recent statistics tell a compelling story of a mega-shift from largely public sector funding to a situation where the private sector acts as the main engine for growth and change.  Whereas a decade ago, the amount of funding from public and private sector sources was still about the same, the latter now outpaces the former many times over in developing markets. Private-sector funds not only finance private enterprises, but are increasingly playing a role in providing long-term capital to governments in Africa and other developing markets, as well as supplementing traditional donors by helping meet needs for grant-based funding.  Developing countries have become “emerging economies,” or “frontier markets”. Acronyms like BRICs or “the next 15” have become commonplace. More broadly, private sector-driven growth has helped hundreds of millions of people worldwide to escape poverty during the last decade alone. 

The development community needs to embrace this mega-shift, which has already taken place.  People working on development issues in relevant ministries need to stop living in the development architecture of yesterday and adopt that of present – or even that of the future. We need to recognise the fact that traditional donors, that is, Western, mostly European countries, will be battling high public debt levels for years to come. Hence, even if they wanted to, they would not have resources to directly match current funding needs through grants alone.  Rather, the scarce money that is available must be used to achieve the optimal development impact, rather than simply ‘more of the same.’ This also means ending allocation of scarce development money simply on the basis of historical needs or historical donor architecture.

New models for development finance

The private sector, to be sure, is not the answer to all development challenges.  But, it is an important part of the solution and, when combined with appropriate public interventions, can significantly accelerate positive development results. 

The public sector’s primary role in policy-making remains key to success.  It is crucial to create a policy framework that encourages and facilitates productive private sector investments. The much-debated ‘Doing Business Report’ by the World Bank(1) has triggered welcome competition among governments on improving their rankings. While not perfect, the focus it has generated more than offsets its potential deficiencies. Indeed, the important role of public sector in setting the ‘right’ regulations is becoming ever better understood.

The public and private sectors are working together much more than before, and in more creative ways. Public Private Partnerships (PPPs), for example, have become well established in projects where the private sector can only take part of the risk, and needs public sector funding or guarantees to make a project or investment financially feasible, or in countries that have reached their debt ceiling and need to find innovative methods to provide public services. PPPs are, furthermore, becoming a dominant model in infrastructure investments, where annual funding needs run to hundreds of billions of dollars annually just to maintain the current level of infrastructure.

Blended funding, meanwhile, mixes pure commercial money with grants or first loss guarantees to encourage the private sector to venture into an industry segment or geographical area where return expectations are not otherwise commensurate with risks. Examples of success in blended funding can be found in health care, education, smallholder farming, renewable energy and micro enterprises.

Though blending public and private money has been, and continues to be, controversial, bringing the private sector in has brought numerous benefits.  Not only does the private sector have deeper pockets, and is hence able to provide more funding; rather, private-sector efficiency has also led to a drive to measure the impact of development funding and of individual projects much more accurately than before, resulting in the birth of a whole new industry. The official amount of development assistance alone is not, and should not, be used as the key criteria; rather, focus has shifted to the actual impact on beneficiaries per dollar spent.

Private sector’s emerging role in community development

Though the private sector has historically faced criticism for not doing enough to address externalities, much has changed in recent years in this area as well. For example, if you compare a mining investment a decade ago with one from today, the difference is striking: there has been a huge shift in how to deal with environmental issues, as well as the impact on the local community. Extractive industries have adopted voluntary standards and guidelines on tackling difficult issues, which has not only improved community relations but has also lowered risk, and hence increased adjusted long-term returns for investors. 

Similar voluntary norms dealing with environment, local communities, and social issues have been adopted by banks on project finance. Private-sector funding with appropriate safeguards has helped all industries recognise the benefits of sustainable finance.

Embracing the changes

The development community needs to embrace change, rather than remain fixated with the ineffective use of ODA money. Poverty on a massive scale in developing countries is projected to nearly disappear within the next 50 years. This current positive trend, pushed by private sector-driven growth, can be accelerated and be made more ‘fair’ and sustainable through new models of public private funding and partnership. We should not stand in the way of this promising trend but need to embrace the changes it brings, not least within the broader development and donor community itself.

Jyrki

Jyrki Koskelo is Managing Director of High Growth Emerging Markets at Atlas Mara Co-Nvest Ltd.

Footnote

[1] See http://www.doingbusiness.org/

 

This article was published in GREAT insights Volume 3, Issue 8 (September 2014).

Share Button
Economic Transformation and TradeBusiness and DevelopmentDevelopment Finance and TaxationDevelopment FinancePrivate sectorPublic Private Partnerships (PPPs)AfricaKenya

External authors

Jyrki Koskelo