Let the Private Sector be a Catalyst for Sustainable Development
It may come as news to some, but multilateral and bilateral development banks have increased their financing of the private sector fourfold over the last decade, boosting their annual combined investment from $10 billion to over $40 billion. This has been welcomed by most of the development community, although the debate on the balance between traditional development assistance to the public sector and donor support of the private sector continues.
At the International Finance Corporation (IFC), the largest multilateral development bank focusing on the private sector, we have been at the center of this discussion, promoting the important role of the private sector in sustainable development. In 2011 we coordinated with 30 other multilateral and bilateral development finance institutions a study on International Finance Institutions and Development through the Private Sector(1).The study notably highlights the “virtuous circle” of public and private sector cooperation for development. As experts gathered in Busan, Korea for the Fourth High Level Forum on Aid Effectiveness from November 29 – December 1 2011, the private sector had a seat at the table for the first time. This could be a turning-point, where we move from aid effectiveness to development effectiveness, while recognizing the mutually supportive roles of the private and public sectors.
There is no question that governments continue to be essential for development. They provide critical services for their populations, such as health care, education, infrastructure, and social safety nets. They also create the enabling environment for the private sector by ensuring property rights and contract enforcement, security, and macro-economic stability, as well as the proper regulatory framework. Governments’ role is to provide leadership for economic development and to ensure that it is shared by all segments of society. Grants, multilateral and bilateral finance, and technical assistance can help those countries that do not have adequate resources or expertise in this critical task. But governments can’t do the job alone—they are only part of the recipe for development and poverty reduction.
The private sector is and must be a source of economic growth and opportunity that will allow people to improve their lives. While the public sector can create a sound basis for development and a good environment for investment, the private sector will generate the vast majority of jobs, help improve public services, and ultimately provide most of the tax revenues that the public sector needs.
So where do development institutions come in? As the report points out, IFIs can play a critical role in supporting the private sector. Firms in developing countries need financing to expand their operations, as well as better infrastructure, improved business regulations, and skilled employees. Without these, they are not able to grow, especially in the more difficult environments where poor people live and work. Development institutions have experience working in these environments and are willing to provide capital where private markets may be risk averse. They provide advice to improve markets and make projects bankable and sustainable, attracting other investors by providing comfort and risk assurance. Indeed, this “additionality” is a key aspect of the IFIs’ mission – if commercial players can finance projects directly, then the IFIs should not get involved, saving their resources for more challenging environments. In addition, IFIs can help make private sector development more inclusive, and promote the high environmental, social, and corporate governance standards that allow projects to be sustainable.
To name just a few examples, development institution funding has extended mobile phones to rural areas of Papua New Guinea, with all the benefits that improved communications can provide. In Senegal, public-private partnerships are putting in place the essential infrastructure for growth, and in India they are providing improved housing for slum dwellers. Similarly, at a crucial time in Egypt, equity investments have helped create jobs, while in Brazil, microloans and training have improved the lives of street vendors.
Of course, at a time of scarce resources, some may ask whether donor governments can afford to support both the private sector as well as the public sector? The answer is yes, since in large part development institutions are self-funded, using repayments from their investments to support new projects. In fact, as a result of their success, they have had limited capital needs. While substantially increasing their investments, most IFIs have not had significant capital contributions for decades. By contrast, aid to governments usually needs to be funded every year. Furthermore, since the enterprises supported by development institutions provide substantial tax revenues to their host countries, the need for development assistance to the public sector is reduced.
In addition, IFI investments have a strong demonstration effect, showing others what is possible in difficult environments. For every dollar they invest in a project, they mobilize multiples thereof from other investors who might be too risk averse to step in alone.
All this is not to say that IFIs don’t face substantial challenges in their mission of catalyzing sustainable private sector development in emerging markets. Most have the mandate to focus on the very poorest, most difficult countries that may not have a welcoming investment climate or adequate infrastructure, nor a stable political system. This can make finding investment partners and structuring investments difficult.
While corporate social responsibility is important to many firms, their investments must be profitable, and they are loathe to risk their capital in unknown waters. Convincing them that higher risk may also bring higher return and that IFIs can help mitigate that risk is important. In addition, creative ways must be found to reach the small, job creating firms that predominate in developing countries, be it through intermediary financial institutions or through business advisory programs. These are just some of the hurdles IFIs need to overcome, but after many years of experience and sharing of best practices, they are well on their way.
In summary, supporting the private sector with judicious investment is a win-win proposition for donor governments and developing countries. A small amount of initial capital, with some well targeted advisory services, can marshal the talents and finance of private sector investors to create economic activity that ultimately is self-financing. This should not be surprising--it is one of the historic paths to development.
1. International Finance Institutions and Development through the Private Sector
This article was published in Great Insights Volume 1, Issue 8 (October 2012)