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Theo worked with Owen Barder and the CGD Europe team. His work focuses on finance for development, with an emphasis on novel contracts and financing structures that enable development actors to deliver social returns by collaborating effectively with the private sector. Theo grew up in India and Ethiopia and has a Bachelor’s in economics, finance, and politics and an MSc and PhD in economics. During his PhD, he was an Overseas Development Institute (ODI) Fellow in the Pacific, where he worked as an economist for the Government of Vanuatu. Before joining CGD, he worked at the Ministry of Planning and Investment in Hanoi.
On Monday, Grant Shapps, the UK's Minister of State at the Department for International Development, kicked off DFID’s Energy Africa campaign at an event hosted by the Shell Foundation designed to help his team figure out how the UK government can invest its political clout and an initial £30 million ($46 million) to tackle rural energy poverty in Africa.
Energy Africa’s inspiration came from the Minister’s trip to Tanzania. There he saw a range of off-grid small-scale solar panels targeted at poor homes like ones set up by Off Grid Electric, a slick social enterprise delivering basic energy access — enough to power LED lights and a phone charger — to poor homes with rooftop solar panels and pre-paid metering. Minister Shapps wants solar power to be a big part of how we get energy access to “millions” of homes.
As my colleagues Todd Moss and Madeleine Gleave eloquently argue in seven persuasive infographics, we know that small-scale solar might meet a few basic needs but won’t catalyse economic growth. And there’s an inglorious history of private interests capturing our aid budgets to secure subsidies.
Given solar’s limitations and these risks, how can we make sure that Energy Africa fulfils Minister Shapps’s ambitious brief?
Three fast facts
Small-scale, off-grid solar is actually pretty expensive
The numbers for the Off Grid Electric installation that impressed Minister Shapps tell an interesting story.
A day’s access to OGE’s most basic service costs $0.19. This beats the $0.25 a day poor Tanzanian homes spend on kerosene (other sources put this at about $0.16 a day), but if all a household does is run a couple of lights and charge a phone, small-scale solar power is actually more expensive than electricity from Tanzania’s grid . Many communities simply can’t access that grid because of obscenely high connection charges. In some places, then, the catalytic investments are “under the grid”, connecting communities to modern levels of energy access. And off-grid solutions do not scale up — better energy access creates wealth, and wealthier people need better energy access.
Small-scale solar works for small-scale problems
About 600 million Africans are energy poor– a stranglehold on development. Poor homes, for example, rely on biomass (coal, dung, or wood) for cooking. The WHO estimates that exposure to the resulting smoke causes 4.3 million premature deaths a year in developing countries — more than malaria, TB, or HIV/AIDS. Replacing these cooking technologies would be a public health victory, but a simple electric stovetop usesover 500 kWh a year for a household cooking twice a day, which is far out of household solar’s range. Other transformational interventions suffer under the same constraint: for example,60% of refrigerators used in African health clinics suffer from unreliable electricity connections, breaking the cold chains that keep vaccines safe and effective.
Building a modern economy means building modern levels of energy access
Energy poverty chokes off whole economies because businesses struggle to grow when they can’t get access to reliable, reasonably-priced electricity. According to CGD’s analysis of the World Bank’s enterprise surveys, energy access is amongst the most serious problems facing developing Africa’s private sector, where firms estimate that losses from outages alone eat up 10% of their sales. As Aleem Walji of the World Bank put it: "Today, countries like Uganda are still 90% unserved by electricity. Can you imagine not having power in 90% of any country and still trying to grow the economy?"
A bad idea
With £30 million of funding on the table and an impressive guest list that was heavy on impact investors like Sunfunder and innovators looking to expand access to their products, it’s little surprise that the most popular breakout session during Monday’s event was the one on financing.
Many of the smart ideas in the room came down to directly supporting businesses. For example, DFID could use the money to lend to firms, guarantee their debt, help them manage local currency risks, or invest directly.
Though this makes for a compelling narrative, spending aid money directly on firms is risky. If we try to spend £30 million across a landscape of “innovative” financial instruments, we’ll be left with a mishmash of small-scale equity stakes and various loans or contracts to reduce risks, ultimately giving a vanishingly small leg up to a small coterie of (handpicked) favourites. Worse yet, issuing loans or making investments means picking winners. One of the toughest lessons from the aid industry’s love affair with microcredit has been that handpicking firms for our attention and resources risks creating flabby incumbents that stifle competition — not so much the healthy commercial ecosystem that Minster Shapps envisages as a toxic monoculture.
We can look at the paucity of early-stage financing for solar energy start-ups in frontier markets and believe that either (a) other investors have gotten it wrong, or (b) that the risk-adjusted returns are too low . It’s unlikely that DFID will find deals that investors, including impact funds and philanthropies willing to suffer low returns, have ignored. And it's not surprising that investors and innovators would tell us that it’s a great idea for us to use taxpayers’ money to do exactly that.
One way forward…
Let’s agree that small-scale, off-grid solar is just a small part of the energy poverty puzzle. And let’s agree that it’s a band-aid-not-a-cure that belongs in communities that are the least likely access the grid any time soon. How could we spend £30 million in a way that builds, rather than distorts, this market?
For many rural solar firms, a key problem seems to be access to the working capital to scale up, pay suppliers, or invest in new products. For low-income consumers, the problem is the fixed cost: solar panel prices have tumbled, but the upfront and installation costs of a setup like the one in Tanzania are still too high.
Some firms have responded by opting for a pay-as-you-go business model, installing panels at a loss and recouping their costs (and generating a profit) by selling daily access to the electricity they produce. This effectively turns firms like Off Grid Electric into creditors with sidelines in solar hardware. But though demand is high, it takes operators a long time to turn these tiny cash flows into sizable chunks of retained earnings they can use to, for example, expand into new markets.
What could DFID do? It could use its financial clout to bring this financing forward, capitalising a small fund dedicated to buying packages of a share of future payments from firms supplying customers in specific markets. This gives rural solar providers working capital today in exchange for payments over time. This is hardly original: it’s basically how our mortgages work, and has been used successfully to finance firms like SolarCity in the US.
Set out like this, the small cash flows are a feature, not a bug: even a £10 million fund could buy many more of those receivables, spreading our impact much farther. By only buying a share of the receivables from each firm for given market, DFID doesn’t accept all of the risk, keeping private firms’ shoulders to the wheel to pick good projects in areas with healthy, long term consumer demand — precisely the places the grid is least likely to be viable soon and so where solar solutions are most needed.
Most importantly, the offer could be made open to any solar operator that passes a minimum hurdle for accounting and labour standards, obviating a need to pick winners.
* * *
It’s tempting to think that putting solar panels in the hands of poor consumers will deliver fast gains in welfare and prosperity. In reality, we can’t leapfrog the dull but important longer-term infrastructure investments in better, more reliable, cheaper, and cleaner utility-scale grid connections like those that Power Africa is building out.
Minister Shapps brings impressive momentum and enthusiasm to the Energy Africa campaign. More than once during Monday’s event, attendees like Christine Eibs-Singer who have worked on rural electrification for decades said how exciting it is to get buy-in from someone of his stature. Energy Africa’s ambition should be lauded. The challenge is to harness this momentum, our aid financing, and the Minister’s political insight to scale up rural solar in places that the grid cannot reach without distorting the market or subsidizing inefficient incumbents.
What do you picture when you hear ‘humanitarian aid’?
Most of us imagine temporary shelter to help people get back on their feet after a natural disaster, or food supplies and clothing to help refugees for a few weeks after they’ve fled a conflict. Those images are increasingly out of touch with what’s happening on the ground.
Emergencies are more protracted: a girl born in Kenya’s Dadaab refugee camp the year it was founded would be well over 20 years old today and could still be living there. Last year, two-thirds of official humanitarian assistance went to long-term recipients. That’s putting humanitarian budgets under strain. According to the UN, the number of people in need of help has doubled in the last decade; humanitarian aid grew by less than half.
There’s a growing consensus that humanitarian cash transfers can help to bridge the widening gap between needs and resources, empowering people affected by disaster and using local markets to deliver the goods and services we previously thought only aid agencies could provide.
What we know about humanitarian cash transfers
The Cash Atlas, a platform to help track how and where cash transfers are being deployed, can add some context to our understanding of the current state of cash transfers. The data are self-reported by agencies and so not a comprehensive record. Nevertheless, focusing on the years 2005 to 2014, the Cash Atlas includes nearly 800 programs implemented by 49 different organisations.
We combine information about transfers with financing data from OCHA’s financial tracking service, convert figures to today’s prices, and allocate budgets equally over each project’s duration to estimate spending per year. The resulting data represents $2.8 billion worth of cash transfer programming. (Click here to download the data appendix, .do file, and a note on methodology).
What did we learn?
1. Humanitarian needs are outstripping funding
Humanitarian agencies set out the financing they need to tackle crises using the humanitarian programme cycle (previously called the consolidated appeals process). Adding what agencies asserted they needed and comparing it to what donors funded paints a stark picture of a growing deficit between needs and resources. (Click off ‘Funding’ and ‘Requirements’ to zoom in on this growing shortfall).
It’s plausible that agencies overstate their needs. But with a deficit of over $7.3 billion last year, dissembling by humanitarians, if present, probably isn’t the main story.
2. Agencies are scaling up ‘cash-type’ transfers, but most come with conditions
Cash transfers are the Rorschach test of humanitarian aid— agencies see what they want in it. It can mean putting $60 a month on a debit card so that a family can decide what to buy (and where to get it cheaply), but is also used to describe everything from vouchers for work to cash for training.
We translate the Cash Atlas’ tags into something more intuitive by calling a transfer conditional if it requires the recipient to do something (‘cash for training’, ‘cash for work’, and ‘conditional grants’), unconditional if it’s described as such (‘unconditional grant’), and a voucher if people can only spend it in specific ways (‘vouchers’, or ‘vouchers for work’).
Breaking the data down like this shows that organisations have mainly used programs that come with strings attached for beneficiaries. However, this buries an interesting lead: unconditional transfers are growing quickly, reaching about one-fifth of the total estimated budget for cash programs last year.
3. Cash is still a tiny share of humanitarian aid
What does this rise in cash programming look like in context? A reasonable comparator is how much donors spend on humanitarian aid more broadly (appeals, together with various kinds of emergency funding and bilateral aid).
OCHA’s data indicate that donors spent $23 billion on humanitarian aid last year. On a purely fiscal basis, then, cash-type interventions remain the unloved country cousins of humanitarian response, accounting for less than $1 billion of this. (Zoom in by clicking on the legend to see how cash programming has grown over time but remains a very small share humanitarian spending).
4. Most programs haven’t been (only) about transferring cash.
Our data show very few examples of ‘pure form’ programs: a budget line that only pays for beneficiaries to receive modest payments and lets them decide how to spend them. Leaving out reports that don’t flag which of these types of budget it was or which ‘modality’ was used leaves 368 programs. Of these, just 22 — less than six in every hundred — fit this description.
Type of transferUnconditional ConditionalVoucherType of programCash only225154Cash / in-kind889657
A more inclusive definition could include programs that gave unconditional grants irrespective of whether their budgets included in-kind aid. That brings the total up to 110, just under one-third of the total.
5. Most budgets haven’t been (only) about transferring cash.
A head count of programs based only on whether they include in-kind aid is instructive, but isn’t weighted by how much agencies actually spend. It might be, for example, that a small number of unrestricted transfers actually represents a very large share of humanitarian cash programming.
The 368 programs about which we know both the type of budget and how the cash transfer was made represent $750 million (of the $2.8 billion) worth of programs included in the Cash Atlas. Of this, less than 5 percent, nearly $37 million, is for ‘cash only’ programs that delivered unconditional transfers.
However restrictive the definition, and regardless of whether we’re looking at the number of programs or weighting them by spending on each, it seems that agencies haven’t comprehensively moved to large-scale, unconditional programs, or separated those programs from traditional, in-kind aid.
6. Most beneficiaries don’t (only) experience cash.
Though it’s easy to focus on top-line budgets, what ultimately matters is the number of people a program benefits. Combining information about the total budgets with the number of ‘beneficiaries’ that agencies purport to reach picks up some interesting trends.
Most importantly, this shows that larger budgets aren’t coupled to coverage. The size of the spheres indicates that voucher-based programs reach the most people, but have consistently received a smaller share of total budgets. Similarly, in the last few years fewer people benefited from conditional than unconditional programs (1.48 million vs. 1.54 million), but the graph shows that conditional transfers had larger budgets: $234 million more in 2014.
What we don’t know, but should
7. Budgets per person vary a lot, and we don’t really know what that means.
Comparing budgets to the number of beneficiaries begs the question of what this looks like on a per-person basis. Since our data are in current (2015) terms, we get a ‘budget per capita’ by adding up cash programming budgets over the last decade and dividing by the number of beneficiaries that aid agencies report assisting.
The concept of ‘budgets per capita’ highlights a fundamental gap in what we know about HCTs.
People who are skeptical about ‘cash for training’ can point out how expensive those programs are. But organizations delivering training programs might point to the same number and argue that, no, this actually shows much value they transfer to beneficiaries. In short, budgets aren’t the same as costs. If these different modes of transfer cost the same to make, ‘cash for training’ might well pass on the most to those we’re focused on helping.
But even if we took these numbers at face value, and even if we assumed (without basis) that they cost the same, we still couldn’t make a value judgment about what donors should focus on. Transferring $60 dollars to a family, for example, might help them get what they most need by making tough choices between heating, school fees, or clothing. That could ultimately be much more ‘valuable’ than other interventions that cost as much, or much more
* * *
CGD has been working with the Overseas Development Institute to look into humanitarian cash transfers, supporting a High-Level Panel on Humanitarian Cash Transfers chaired by my colleague Owen Barder. The panel will launch its report on September 14. Its findings reflect decades of hard-won, front-line experience, opportunities arising from new ways to transfer money safely and securely, and insights from a fast-growing evidence base.
Data-driven initiatives like the Cash Atlas are an important start to understanding the role that HCTs can play. But we won’t be able to get a fix on the value added by different kinds of aid without better information, not only about budgets but also on costs and, more importantly, what those we have a duty to assist actually need, want, and can use.
This, ultimately, is why the high-level panel has been convened: to help us weigh the evidence that we have on cash transfers, and to chart a path forward for humanitarian aid that strikes an informed balance between the thorny yet critical issues of cost, value, and growing need.
Approximately 15 million people are displaced outside of their home countries. Most refugees are not able to return home for many years, often more than a decade. But just 8% of these refugees are resettled safely to third countries. So without focused actions, today’s internationally displaced people are likely to be part of the growing “refugee caseload” for many years, neither able to return home nor able to settle permanently elsewhere. That not only deprives refugees of the ability to live full, productive lives, but is also overwhelming the world’s humanitarian aid budgets. Although the real value of global aid has grown 9% in the last five years, all of that increase (and then some) has been eaten up by the rising costs of humanitarian aid and refugees.
Instead of condemning more and more people to a long-term future as aid-dependent refugees, what if we turned the support they would receive from donors over many years into an endowment that would enable them to start a new life in a new country? By capitalising future humanitarian aid spending and borrowing on capital markets, we could invest in these people. This could simultaneously make it more politically palatable for countries to take in people fleeing violence, radically improve those refugees’ lives, and reduce long-run humanitarian costs for donors. That’s the basic thinking behind the Humanitarian Investment Fund, an idea that could perhaps help Kenya, for example, which this week threatened to close the Dadaab refugee camp, to see the 300,000 Somalis living there as an opportunity rather than a threat.
In the long run, refugees can make significant economic and social contributions to countries that choose to resettle them. But in the short run, facilitating their arrival and integration involves a cost to the government – resources like housing and language classes come with a price tag. Although costs decline as refugees integrate into labour markets, the issue remains one of the most politically challenging today. Newspaper coverage focuses on the (usually exaggerated) short-term fiscal effects and while ignoring the longer-term benefits that young, entrepreneurial workers can bring to aging workforces. This mismatch between short-run costs and long-term benefits creates an opportunity for financial innovation that can leave everyone better off.
Consider a Syrian living in Jordan. Like many professionals forced to flee their homes, she is probably relatively well-educated, but struggles to find formal employment. She can't go back: the risks are too great, and there may be precious little of her old life left to return to. The humanitarian response plan to accommodate Syrians in Jordan indicates that donors pay an average of $1,210 a year to support her. Instead of paying her that money year after year to maintain a (bad) status quo, we could invest in her up front by allowing her to resettle in a safe third country. This might result in a short-run cost for that country – but it would also generate long-term benefits.
Imagine a framework under which she is endowed with a sum of money to offset the (temporary) costs she and her future host government incur for her resettlement. Potential host countries anywhere in the world – perhaps those with labor market or demographic needs – can offer to accept her and receive the associated endowment.
This scheme might be particularly attractive to developing countries, which could especially benefit from both the voucher payment and the skills that refugees could contribute to their labor markets. For every refugee currently living overseas and supported by humanitarian aid, a fund could pay this one-off "voucher" to any country able and willing to accept them. By accepting the payment, the receiving country would be obliged to grant the refugee the same status it accords other migrants for whom it doesn't receive any payment. At a minimum, this would mean granting the right to work and access to public services (not currently guaranteed in all potential host countries). So returning to the example of the Kenyan government, which cites security concerns as its reason to close the Dadaab refugee camp, viewing the 300,000 Somali refugees as representing a potential investment in Kenya might change the political and fiscal algebra, or at least have better options for relocation.
We call this framework the "Humanitarian Investment Fund." What might it cost? We can get an idea by comparing the amount countries pay to support refugees overseas and the costs they report incurring when they resettle them. Looking at those differences in today’s money (net present value terms) and considering a scheme that would work for 100,000 refugees gives us a rough idea of the range of capitalisations we’re discussing. (We do this for OECD countries that report the first year costs for refugee resettlement, and leave out countries that don’t report this figure, like Australia, or reported an implausibly low figure).
For the median case, we estimate that 100,000 refugees could be resettled for about $4 billion dollars, or $40,000 per refugee. That’s squarely in the ballpark of problems that the global public sector can get its arms around. For example, if we were able to capitalise a $4 billion fund with a bond paying 2.5% a year, the nominal interest cost of permanently moving people off the global refugee caseload would be just $1,000 per person per year. And borrowing $4 billion dollars is not a high hurdle: in 2014, global aid commitments were just over $135 billion; the UN High Commissioner for Refugees’ 2014 budget was $3.6 billion (and that was only half funded).
More generally, these are conservative estimates for three reasons:
Quantity: Assuming 100,000 potential beneficiaries is an overstatement, at least to start. In reality, less than a tenth of refugees are designated eligible for resettlement. In 2014 in Jordan, only eight-tenths of one percent of the total Syrian refugee population was resettled overseas (6,084 of 623,112).
Price: Our calculations assume gently declining costs each year for a decade, tied to OECD countries’ first-year refugee costs. In fact, most refugees receive this level of benefits for only in their first year in most of Europe, between six months and five years in the US (it varies across an alphabet soup of programmes), and six months to three years in Canada. So we are being conservative in attributing this scale of cost to refugees for a decade, and only slightly optimistic in assuming that they decrease slowly over time, pricing in payoffs as refugees integrate into local labour markets (which could be much greater in practice).
Time: These figures assume that in the absence of this scheme, a person would spend 10 years on the international refugee caseload. In reality, we have a shaky idea of how long the average refugee spends in and out of camps overseas. The oft-quoted figure of 17 years, for example, turns out to be a zombie fact that has gained currency by virtue of repetition. The assumption of ten years is reasonable but ultimately just that – an assumption.
These numbers seem especially reasonable in light of the European Commission’s proposed scheme to fine countries as much as €250,000 for every asylum-seeker that they should admit, but refuse to. That scheme is intended to be a stick, punishing countries which fail to meet their commitments to share in the “burden” of hosting a small number of refugees. Our proposed system would instead operate as a carrot, creating healthy and fair incentives for countries to go above and beyond this minimum hurdle to the mutual benefit of all involved.
The program could be expanded to many more potential refugees – without reducing commitments to those already on the caseload – by pooling these costs and borrowing from capital markets, backed by donors’ promises to repay. This method of using private capital, repaid from future government budgets, builds on other successful financial innovations. For example, IFFIm is an international fund which borrows from capital markets to pay for vaccination programs, with donors repaying the costs of borrowing over time. IFFIm’s "vaccine bonds" borrow cheaply because donors are largely wealthy OECD countries with strong credit ratings.
The proposed system creates a "triple-win." Potential host countries would have more control over who they admit, and be able to alleviate up-front short term costs. Refugees would be able to escape the long-term destitution and disempowerment of refugee camps and dependence on humanitarian aid; with a job in a safe third country, they would be able to apply their skills and create positive spillover effects for their families and home communities. Donors would assume no additional expenses, transferring the long-run costs of a substantial and growing caseload of humanitarian aid into upfront resettlement investments.
A scheme like this would likely need to have at least three core features in order to be politically viable, and attractive for the refugees themselves. It would need to be
Voluntary: Both refugees and host countries must agree to participate. Under a matching system, refugees would make a list of places they would like to live, while host countries would be asked to identify who they would most like to admit, likely based on labor market needs and integration capacity. The fiscal voucher each refugee brings with them lowers the "relative cost" to potential host countries. (Countries could use the endowment to provide for local services where the refugees are resettled, perhaps reducing possible sources of friction with local communities.) This system would enroll refugees from their current country of residence (Syrians in Jordan), rather than individuals who have arrived in the EU seeking asylum, as proposed by Will Jones and Alex Teytelboym of the University of Oxford.
Additional: People eligible for this scheme would still have to qualify for refugee status in prospective host countries, even though they would be enrolled overseas. Refugee status granted to individuals overseas by UNHCR does not necessarily align with the criteria in place in host countries. To be eligible for this scheme, refugees would have to qualify under both UNHCR and host country rules.
Valuable: In order to earn the lump-sum payment, receiving countries would have to confer real benefits to their new arrivals. In particular, the receiving country would have to grant refugees the right to work and access to public services.
Refugees are a net financial win for receiving countries, paying more into public treasuries than they cost in services. The economic arguments in favour of accepting refugees from Syria – a middle income country before this crisis unfolded, with high levels of education and healthy civic social capital – is not complicated. As our colleague Lant Pritchett explains, Europe’s aging populations are living longer than ever, creating larger cohorts of pensioners and thereby placing increasing tax burdens on dwindling numbers of younger, productive workers.
But as our colleagues Michael Clemens and Justin Sandefur have discussed, “countries struggle to absorb refugee flows when those flows are sudden and concentrated in a limited area.” In other words, the greatest tension comes up front, when host countries scramble to find the time, money, and compassion to facilitate arrival and integration. Those difficulties are compounded by the fact that resettlement schemes are usually centrally-run while pressure on local services is local. This proposed framework slackens the immediate financial constraint, empowering governments and communities to determine where these funds are best spent – a fiscal release valve for some of these pressures.
There are a number of reasons that some countries are unwilling to accept refugees. Some of these may reflect simple-minded xenophobia. But a dab of financial chemistry could at least tackle the fiscal case against doing so, putting a thumb on the political scale in favour of compassion, and helping many people secure better, safer, and more productive lives.
The UK House of Commons International Development Committee is undertaking a very interesting inquiry which happens to be right up our street. It is examining
what might come next in the UK's approach to development, including the coherence of policies which affect development, and the impact of the UKs non-aid policies on developing countries and ... the underlying government mechanisms needed to support any changes.
We have submitted written evidence for the Committee to consider for this inquiry. In the first of three memoranda, “Why Beyond Aid Matters” (PDF), we explain why we appreciate so much the IDC’s decision to focus on these issues, which are the focus of CGD’s Commitment to Development Index. We think these “beyond aid” policies are important for three reasons:
The benefits to poor people that can be brought about by even quite modest “beyond aid” policy changes are likely to be much larger than can be brought about through aid alone.
“Beyond aid” policies mainly address the underlying causes of poverty, while aid often addresses the symptoms of poverty and meets immediate humanitarian needs.
As well as being beneficial for development, most of these “beyond aid” policies would be good for the UK in the short run as well as in the long run. Aid, in contrast, costs the average British household about £428 (about $700) a year: so the long-run benefits come at a substantial short-term cost.
Take trade, for example. Greater market access for exports from poor countries increases the economic returns to starting or growing a business in a developing country and can thereby result in significant economic and development impact. A recent study of the possible impact of the “Doha Round” trade negotiations estimated that real income gains to low- and lower-middle- income countries from lower trade barriers in rich countries would be between $42 billion to $62 billion a year. Liberalizing trade can generate growth even in economies that are usually assumed to to be held back by constraints like lack of access to credit or poor infrastructure. In 2000, the US Congress signed the African Growth and Opportunity Act (AGOA), which provides duty-free access for selected countries to US market. It has been estimated to have increased exports from eligible African countries by $360 million a year.
Many changes to non-aid policies deliver mutual gains – opening our markets to exports from the developing world gives consumers access to cheaper and more varied goods while also benefiting firms in those countries, the employees those firms hired, and the governments to which they paid more in taxes. Trade liberalization is a good example of a policy which could have a very large impact on people in the developing world, tackle the causes and not just the symptoms of poverty, and also benefit the UK.
Overall, these kinds of non-aid policies, ranging from migration to trade, evaluated by CGD’s Commitment to Development Index (CDI) are a potentially very significant but vastly underused way for rich countries to improve poor people’s lives. We do not believe the simplistic slogan of “trade not aid” — these policies are not substitutes for aid: they are complements.
Our first submission to the inquiry: “Why ‘Beyond Aid’ Matters” (PDF), sets this out in more detail. It gives examples of the development benefits that could be achieved through changes to rich countries’ policies studied by the CDI. Do you have other good, evidence-based examples we should add to this list?
We will also soon publish our two other submissions. One looks at how the UK’s beyond aid policies measure up on CGD’s Commitment to Development Index, relative to its peers and how they have changed over time. The other offers an answer to the Committee’s rather pertinent question about whether DFID should remain a separate government department in the coming years.
Overseas development assistance amounts to about $135 billion dollars annually, but the cost of paying for the Sustainable Development Goals will be in the trillions. As a result, blended finance is something of a buzz phrase these days. It refers to financing structures and solutions that mix private capital with public support to get investments — think access to reliable electricity, more and faster-growing SMEs, or better primary health care — off the ground. Australia and Canada are enthusiastic about building new Development Finance Institutions to help do this, and other countries are ramping up the scale of theirs (the UK government just gave the CDC group, its national development finance institution (DFI) a $1 billion capital increase).
I left a workshop on blended finance last week in Paris (organised by the World Economic Forum and the OECD) excited about the potential of these new structures and instruments to deliver social returns. But I was also struck by the challenges DFIs and their advocates must overcome in order to fully realize that potential. Here are four.
1. Risk transfer isn’t the same as risk mitigation
Let’s say that the International Finance Corporation (IFC) lends $25 million to a company building a hydroelectric dam in Vietnam (it might, as many DFIs do, sweeten the deal by agreeing to get repaid later than other lenders or offer a cheaper interest rate). This coverage has a potential cost. If the government reneges on an agreement to pay a certain price per kWh for the dam’s electricity, the project could default. The IFC moves that risk on to its own balance sheet by participating in the deal.
The argument cited in favour of this transfer is that the IFC provides a “political umbrella” or, more evocatively, a “protection racket.” Partners are more likely to play nicely, the reasoning goes, because the institution has access to the right corridors of power and, by being part of the World Bank Group, can threaten wider action than what’s written into contracts or debt covenants.
The problem is that any lowering of risk that comes from a DFI’s clout doesn’t generalise. Public investors might pick deals under the false impression they can mitigate risk, when really all they do is move it to their own balance sheets. When this works, it gives a leg up to investees based on opaque, backroom suasion; when it doesn’t, the deals go sour.
2. Don’t confuse addition for additionality
If that hypothetical $25 million loan from the IFC were supplemented by $75 million in debt and $50 million in equity from private sources, it could seem like IFC had “crowded in” $125 million in “additional” capital — a seemingly impressive 5:1 leverage ratio.
But that calculation implies that the investment wouldn’t have gone ahead if the DFI hadn’t been involved. We should be skeptical. Could this deal have happened without a DFI? Could it have gone ahead at a lower price than the DFI is paying for it, either implicitly through providing a political umbrella or explicitly through offering concessional terms?
Even though DFIs report additionality measures and leverage ratios, these are a kind of convenient fiction. They don’t account for what would have happened in the absence of the DFIs’ involvement; they measure addition, not additionality. (There are ways to measure additionality, but this “counterfactual thinking” doesn’t seem to have been mainstreamed into evaluation or reporting tools as yet).
3. Measurement matters
Many development investors articulate the social outcomes they want firms to deliver. The CDC group’s 2012–2016 strategy, for example, calls for creating more jobs in its target markets.
The trouble arises when these actors measure the outcomes they’ve committed to. There’s been an entire revolution in applied economics around impact evaluation, much of which has made its way into monitoring and evaluation best practice. But DFIs are still measuring quantities like net job creation using well-intentioned but flawed tools such as simple baseline-endline surveys, backing employment out of input-output tables, or other back-of-the-envelope approaches.
Some participants at the workshop pointed out that DFIs don’t have the budgets to pay for rigorous evaluation. That’s a real constraint. But just as we increasingly insist on reliable numbers in evaluating development work that’s publicly funded by grants, we must get in the habit of demanding the same from development that’s publicly financed by equity and debt — and be willing to pay for it.
4. Don’t forget about capture or distortion
It’s natural that development finance practitioners focus on the risks on firms, like macroeconomic risk from volatile exchange rates or regulatory risk from unexpected new laws. But development finance also creates risks that fall on other stakeholders: the public sectors of the countries DFIs represent (and so their taxpayers), and the markets in which their investees work.
The risk of capture arises because DFIs are tempting targets for companies looking for government support. Adverse selection plays a role — the kinds of companies seeking support might not be the most dynamic or the most deserving. And this is exacerbated when it’s institutionalised, like when Germany’s DEG includes supporting the internationalisation of German firms as a strategic objective, or when the Overseas Private Investment Corporation (OPIC), an American DFI, limits its support to projects that are at least a fourth American-owned.
International development has endured a long, bruising fight over tied aid. It’s still ongoing in a few important sectors, like US food aid. We should work hard to avoid tied finance.
Just as capture is a risk that doesn’t fall on the firm but does fall on the public sector, distortion is a risk that falls on the market that firms operate in. Public support for firms can make markets worse off overall because it depends on a small group of experts allocating cheap capital and other help to hand-picked recipients. “Picking winners” can mean that we can end up subsidising inefficient incumbents that stifle competition and discourage more investment in their sectors — precisely the opposite of the long-run results we’re working for.
Tackling these pitfalls early on will help our DFIs evolve into a vital part of our development toolkit for delivering better services, creating new jobs, and increasing productivity at the world’s economic periphery. Failure would be bad, not only because of the market distortions that would result, but also because it would leave taxpayers footing the bill for failure, making a potentially valuable poverty-fighting tool politically untenable.
Millions of people face hazards like cyclones and drought every day. International aid to deal with disasters after they strike is generous, but it is unpredictable and fragmented, and it often fails to arrive when it would do the most good. We must stop treating disasters like surprises. Matching finance to planning today will save lives, money, and time tomorrow.