How
can more resources be applied toward development in the world’s poorest
countries? Recent research has pointed to some promising ideas.
August
2013 | byEytan
Bensoussan, Radha Ruparell, and Lynn Taliento
Of
all the efforts devoted
to improving economic and social conditions in developing countries, the most
prominent has been the United Nations’ Millennium Development Goals (MDGs),
which set targets for reducing poverty and improving education, gender
equality, health, and sustainability by 2015. As is true with any type of
development, meeting these targets depends on resources, and a large part of
the resources devoted to the MDGs come from developed countries’ pledges for
what is called Official Development Assistance (ODA). However, since peaking at
$128.7 billion in annual net ODA in 2010, the annual total paid in ODA has
declined for two years running, standing at $125.6 billion for 2012.1
Clearly, more funds will be needed if the
development goals are to be met. Moreover, market inefficiencies—such as
unnecessary transaction costs, misaligned incentives, and lack of performance
measures—often prevent the financial assistance that is available from
achieving desired results.
Given
the level of need, the uncertainty in the general macroeconomic environment,
and the pressures on all government budgets, we looked into potential financing
mechanisms and sources to complement traditional ODA.2 We
assessed a number of innovative ideas that we think merit further investigation
and discussion. In this context, “innovative” refers to finance mechanisms that
might mobilize, govern, or distribute funds beyond traditional donor-country
ODA. Some have already been tried, others have not, and still others may carry
new risks. The point of this article is not to recommend any specific solution
but to shine some light on a collection of ideas we found particularly exciting
as a way to either raise new funds or unlock value as society works to achieve
the MDGs. Many of the ideas have the added benefit of creating a much-needed
bridge for new actors, such as individuals, corporations, and emerging
economies, to deeply integrate themselves into the development community.
In seeking out innovative sources of
development financing, we looked across a wide range of potential contributors,
including citizens, corporations, governments (of both developed and developing
economies), and multilateral institutions. However, the reality is that even
when other contributors are involved, most aid still flows through governments
because they have the scale and responsibility to execute meaningful
development-aid programs. Since we believe innovative financing should
complement, rather than substitute for, government funding, our focus in this
paper is on solutions in which governments are still a core part of the
solution. However, we recognize there are also many good ideas that require
minimal or no government involvement, such as citizen-focused fund-raising
initiatives like Product RED or business-driven solutions such as
bottom-of-the-pyramid ventures. Four ideas rose to the top when we screened our
list based on the size of the opportunity (for example, the ability to unlock a
meaningful level of additional financing or to meaningfully engage multiple
actors), the technical feasibility of implementation within a short- to
medium-term time frame, the potential to gain significant political momentum,
and the existence of a clear and compelling role for government: unlocking
value from diaspora flows, stimulating private-capital flows, encouraging
private voluntary contributions through matching funds, and tackling
sector-specific inefficiencies.
Unlocking
value from diaspora flows
For years, people who have emigrated from
developing countries have been sending remittances to support family and
friends in their native homelands. Around $325 billion of remittances flow to
developing countries every year. There are opportunities to unlock significant
additional value from these flows.
First,
the use of diaspora bonds could be expanded. The issuance of government bonds
specifically targeted at a country’s emigrant population is a time-tested but
underused way to raise money for development. For instance, the pioneers of
diaspora bonds, Israel and India, have leveraged them over time to raise more
than $25 billion and $11 billion, respectively.3 For sub-Saharan African
countries, the World Bank has estimated that these instruments could raise as
much as $5 billion to $10 billion annually, but so far their potential has been
almost completely untapped.4 One could imagine exciting
uses for these bonds, such as the funding of education or infrastructure. To
assist this expansion, donor-country governments could give their counterparts
in developing countries reliable demographic data that would facilitate the
marketing of bonds to diaspora. Customizing the regulatory framework for the
creation and sale of bonds in foreign countries at the international level
could also help spread their use by lowering the costs of compliance across
multiple jurisdictions and speed up the regulatory-approval process.
Second, data collected by the World Bank
show that the average cost of sending money to a person’s home country is about
9 percent. At their 2009 summit in L’Aquila, the G8 countries made a commitment
to cut the global average cost of these transactions down to 5 percent. Given
the volume of annual remittance flows, each percentage point of lowered
remittance costs could unlock as much as $3.3 billion per year for
developing-country recipients. All players could continue efforts toward
lowering these costs. For example, governments can eliminate exclusivity
clauses with money-transfer providers to encourage competition, while the
private sector can continue to launch mobile-phone payment systems, learning
from programs in countries such as Kenya and the Philippines.
Stimulating
private-capital flows
Private
capital is an enormous source of global wealth that has not historically played
as significant a role in development as its scale would suggest. This is not for
lack of interest. Private capital is constantly seeking investment
opportunities.5 However, it
only commits to those prospects that meet its appetite for risk and reward. Due
to a variety of factors, many opportunities in developing countries are often
perceived as overly risky or uncertain for the majority of investors.
Institutions that offer to guarantee portions of loans made for such
investments help investors rebalance their assessments of risk and reward and
subsequently unlock considerable capital into developing countries. For
example, in the past decade, the World Bank has approved 28 guarantees worth a
total of $1.4 billion. These guarantees have stimulated more than five dollars
of private capital for every dollar spent by the World Bank.6 Yet this
type of support remains a very small portion of the bank’s approach to
financing in developing countries. Since the G20 summit in London in 2009,
multilateral development banks have stepped up efforts to do a better job of
leveraging private capital. There is an opportunity for the G8, the G20, or
individual governments to use their influence and encourage multilateral
development banks—and potentially bilateral agencies—to create innovative
instruments that stimulate private flows. Since guarantees may be more
difficult to get through national budget processes than traditional financing,
a starting point could be to work on ways to address these institutional
barriers.
One exciting way for private capital to
contribute to development is by fueling the growth of small and medium-size
enterprises (SMEs) in developing economies. Such companies are often
underfunded in these regions because they typically are too small for
commercial lending but too large for microcredit financing. There could be an
opportunity for multiple players to collaborate in the creation of a set of
financial instruments to serve this segment. Local commercial banks could
provide the capital and deliver the funds when sharing some of the risk with
large multilateral organizations or major foundations that provide first-loss
guarantees. Donors could play a role in funding pilot programs or supporting
demand-side capacity-building initiatives such as credit-scoring initiatives or
skill building for entrepreneurs. One promising area to test this is the
agricultural sector, a driving force of growth in many developing economies.
Two other growing sources of capital that
hold many trillions of dollars of capital are sovereign-wealth funds and
pension funds. Sovereign-wealth funds typically have longer investment time
horizons and often have more flexibility in their investment rules than other
types of investors. Although sovereign-wealth funds are not new, some recently
have been forming innovative coalitions—bringing together such diverse players
as Chinese funds, Middle Eastern funds, multinational corporations, and
developing-country governments.
Not all sovereign-wealth funds are created
equal; each has its own objectives and rules. One characteristic most of them
do share, however, is that, like private investors, their investment decisions
are driven by a risk-reward equation. Beyond financial rewards, many funds also
seek political-security and industrial-policy dividends for their home
countries. But the problem in Africa is that, at least for the time being,
available capital may exceed the viable investment opportunities. While some
asset classes such as infrastructure are more developed, others are not yet
deep enough to attract large pools of capital. Multilateral development banks
can potentially play a role by offering risk-sharing vehicles to improve the
risk-reward profile and, over the long term, help foster an environment that
encourages viable businesses to emerge so that capital can flow accordingly.
A new form of multistakeholder partnership
intended to leverage private capital for scaling solutions to social problems
is the social-impact bond (SIB). In a SIB, philanthropic funders and impact
investors—not governments—take on the financial risk of expanding proven social
programs. Nongovernment organizations deliver the social program to more people
who need it; the government pays only if the program succeeds.
In the absence of SIBs, philanthropic
donors fund pilots that demonstrate the efficacy of preventive programs, but
then these programs—even though they work—are not expanded to the entire
population that needs them. This is because only government has the reach and
the resources to provide the multiyear funding required for scale-up. For their
part, governments’ existing systems tend to focus on remediation, and fiscal
constraints can make it tough for them to introduce alternative approaches.
However, SIBs can facilitate the critical handoff from philanthropy—which
provides the “risk capital” of social innovation by funding and testing new
programs—to government, which has both the capital and policy influence to take
programs to scale.
Since
SIBs are a very new idea, all the potential applications have not been fully
explored. However, SIBs appear best suited for behavior-change programs
requiring intense case management and integrated assessment to ensure quality
replication. To date, the social-impact bond is being piloted in the United
Kingdom in the criminal-justice field. In the United States, New York City and
the Commonwealth of Massachusetts recently announced plans to launch SIBs in
the area of juvenile justice; Massachusetts also plans to launch an additional
SIB to combat homelessness. The Center for Global Development is exploring how
SIBs can be applied in international development.7
Encouraging
private voluntary contributions through matching funds
Governments are in a unique position to
encourage large amounts of voluntary contributions from private corporations
and citizens by setting up matching programs. They are distinguished in having
the credibility to intervene on social issues in a fair and responsible way, as
well as the resources to implement matching programs at meaningful scale. For
example, in 2010, the Canadian government set up a Pakistan Relief Fund that
raised $47 million from individual citizens over a two-month period. This was
based on a promise that the Canadian International Development Agency would
match all citizen contributions of up to $100,000 each. The resulting total
that went to the relief effort ($94 million) was almost five times some of the
best-performing corporate matching campaigns. Government matching programs not
only mobilize new resources but also, almost more importantly, engage a broader
set of players in sharing the responsibility for global development. The GAVI
Alliance (formerly the Global Alliance for Vaccines and Immunization) put in
place an effort to raise a total of $260 million by 2015, with pledges from the
UK government and the Bill & Melinda Gates Foundation to match a total of
about $130 million in contributions from private corporations, foundations, and
citizens.
Countries could commit to establishing a
national-challenge fund that matches commitments from corporations and
individuals up to a prespecified limit. Corporations, in addition to
contributing their own funds, could employ innovative means to engage and raise
funds from their employees and customers. Governments could identify priority
development topics and select eligible private-sector recipients for
challenge-fund proceeds. The most powerful partnerships would be ones where
private-sector players could also contribute their core capabilities beyond
straight financing, such as having telecom companies offer solutions based on
mobile technology.
Tackling
sector-specific inefficiencies
The ideas discussed in this article focus
on raising revenues, and most could technically be applied to a variety of
purposes (for example, health, water, education). Countries could also find
powerful ways to unlock the value of their development dollars by examining
particular market inefficiencies of specific sectors that can benefit from
development aid. Take health, for example. One market inefficiency is that
large private-sector pharmaceutical companies have little incentive to invest
in research and development for developing-country health issues. To create these
missing incentives, several countries created an “advance market commitment”
that provided reassurances in the market for a new pneumococcal vaccine. This
was a groundbreaking approach that used dollars donated for vaccine purchase to
their maximum effect.
Innovation, which is largely about
thoughtful trial and error, is needed to catch up on the world’s bold
development aspirations. Taking a chance with new finance mechanisms may lead
to some failures, but one big success can be a global game changer. Each step
along the way can help enrich the global development community by pulling in
new resources and helping existing stakeholders work better together.
About
the authors
Eytan Bensoussan is a consultant in McKinsey’s
Montréal office, Radha Ruparell is a consultant in the New
York office, and Lynn Taliento is a principal in the
Washington, DC, office.
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