Today, a former CGD Visiting Fellow, John Simon, disagrees. Before coming to CGD Simon was the US Ambassador to the African Union and the Executive Vice President of the Overseas Private Investment Corporation (OPIC), where he led efforts to finance housing markets across Sub-Saharan Africa and SMEs in Liberia. He is a founding partner of Total Impact Capital.
Thank you, Owen and Theo, for the chance to comment on the paper.
Unfortunately, I’m generally unpersuaded by your main argument. Having represented the American government as an Ambassador and at a senior level at OPIC, an American DFI, I’ve seen first hand many of the unique benefits of marrying development-focused investment with commercial discipline.
First, you assert that DFIs don’t have better information than private investors. I don’t agree. If this were true, DFIs who take risk in frontier markets that private investors are not willing to take — or take alone — would all be loss-making entities. In fact, OPIC and the IFC and almost all the other DFIs make healthy profits.
The reason is they have made the investment to understand these markets in a way private investors — unsure of the returns — do not, and hence they do have better information — some in the public domain, some in their intelligence bureaus — than the more risk averse private sector. The insider information comes partly in the form of reporting from our embassies and intelligence agencies. Since the apparatus would be there with or without OPIC, it is a costless subsidy to OPIC. Access to it gives DFIs an opportunity to avoid deals that have serious problems and de-risk deals that have minor ones. Because this information is sensitive, it cannot be made available to the broader public.
More importantly, DFIs do nothing but invest in emerging and frontier markets, allowing them to build the skills, knowledge, and networks to succeed where others fail. This includes knowing the good local lawyers and accountants who can bring a project to closure, legal templates that work in the environments in question, and an understanding of what risks really matter in these developing country contexts. For example, I have seen many experienced investors come to OPIC with a government off-take agreement they thought was rock solid based on their experience in developed countries, only to have to renegotiate it from the start once OPIC's lawyers and underwriters have a go at it.
Second, you dismiss some of DFIs unique comparative advantages, which make them better channels for private investing for social returns in many developing country environments.
DFIs are extensions of governments most developing countries — and individuals in those countries — do not want to upset. Therefore, while a government official or local businessman may not think twice about cheating a foreign investor, they will think at least twice before they do the same to the US government.
For these two reasons, DFIs can indeed perform on par with the private sector and identify deals that the private sector ignores.
This undermines your assumption that the cost of the OPIC loan and the pay for success contract are the same. That would only be true if the OPIC loan is concessional (I would dispute that point, again looking at OPIC's loss experience) and also that the transaction costs are similar. In fact, we know only too painfully, the transactions costs of setting up pay for success schemes are quite high, sometimes so high as to make the whole enterprise impractical, whereas the transactions costs for an OPIC loan are manageable.
Even if the transaction costs were the same, from a real world perspective, the pay for success mechanism will hopefully cost the Treasury something – i.e., we will have success and there will be a budgetary payout, whereas the OPIC loan, if all goes well, will actually make the Treasury money. Of course, the reverse is true in the case of failure, but if the OPIC folks have done their job right the successes will outnumber the failures by several times. Do you think 10 years from now the same will be true for PFS?
Finally, it is not a choice between private investors and DFIs. The DFIs can only operate with private investors. But I am confident very few of the billions of dollars in deals the DFIs support every year would happen without their participation. And that would be too bad, because the vast majority of those deals bring significant developmental and financial returns.
John makes some excellent points. We are certainly not arguing against the idea of DFIs in general, nor OPIC in particular. Even so, we continue to believe that pay for success is better than guarantees and loan subsidies — we explain why in our next blog post.