From Monterrey to post-2015

Development Policy02 Dec 2013Iliana Olivié, Aitor Pérez

Rethinking aid as a catalyst for private investment

The Monterrey Consensus stated in 2002 that there is a need to intensify efforts to “promote the use of Official Development Assistance (ODA) to leverage additional financing for development, such as foreign investment, trade and domestic resources”. Since then, several international fora have addressed this question and revalidated the idea of aid as a catalyst for private flows. In general terms, there seems to be a consensus on the complementarities of public aid and private investment to foster development. However, in order to move from general statements to effective aid planning, we still lack relevant knowledge on how aid can trigger types of investments that would have the greatest impact on development. Such knowledge entails going beyond business-environment policies, and to a more targeted approach to private sector development.

Private sector development and international cooperation. Where do we stand?

Although reporting standards on aid do not specify whether or not a donor commitment is addressed to support or collaborate with private actors, we could actually build or estimate this category of public aid for private investment by taking into account all ODA flows classified as equity investments or any other flows channelled via PPP, or addressed to certain economic infrastructures (banking and business services) and productive sectors (such as agriculture, industry, fishing, tourism, mining, construction). Therefore, traditional donors would have devoted 10% of their aid to supporting private investment during the period 2007-11, amounting to a yearly average of US$ 16 billion distributed.

However, given the current statistical limitations, and to understand the logic behind every aid modality, it is mandatory to dig into donors’ private sector strategies and activities. In the framework of a collaboration with UNDESA, we have conducted a study on the role of the public sector as a driver of private investment, which includes a statistical overview of private sector development (PSD) as well as more detailed case studies of two reference donors: the Department for International Development (DFID) and the Inter-American Development Bank (IDB).

How do donors generate a catalytic effect from aid?

Based on these donors’ experience, several criteria must be taken into account in order to ensure a catalytic effect from aid. First, as a precondition, donors must intervene in those regions and sectors unattended by private initiative (additionality). Second, when investing directly in private equity, they must leverage other investors’ resources. For instance, in some particular sector- or country-based interventions focused on institutional and economic factors, public aid’s catalytic effect might consist in removing constraints to businesses and triggering private investment. Third, donors must favour sustainable businesses, so that these and their development outcomes will persist when aid stops. Finally, they can seek a demonstration effect, so that successful pioneer investments can show the path for new investors and multiply development outcomes.

The way forward

Several sources describe private sector development as a catch-all without a clear proposal for achieving development results, but some donors show that a more strategic approach to PSD is possible. Both donors analysed in our study demonstrate that aid addressed to the private sector is a means to an end when facing unemployment and income poverty (i.e. microfinance programs); when contributing to public goods (i.e. performance grants for the low-carbon energy industry); when providing certain goods and services (i.e. R&D incentives in the vaccine industry); or when accelerating structural change (i.e. funding capital-intense activities by SMEs).

In a post-2015 era, both recipient and donor governments are expected to put into practice the Busan consensus on private sector involvement in development cooperation. Therefore, the following elements need to be taken into account when rethinking public aid as a catalyst for development-oriented investment:

  • Clear development goals: Donors must engage with the private sector only with the intent to achieve identified outcomes.

  • Knowledge-based interventions: Although we cannot draw general lessons from the economic literature on FDI and development, analysis of typical investment projects in a specific region or sector may provide information on development that can positively influence the design of development strategies on a larger scale.

  • Alignment to national strategies: Following aid effectiveness principles, donors must align their PSD programs to national development strategies, and national authorities must adopt strategies containing clear guidelines for international donors.

  • Additionality: When private sector contribution to development is possible with the private sector’s own resources, there is no need to detract public aid from other purposes.

  • Leveraging other resources when possible: A catalytic effect is not always possible for businesses involving the poorest communities, and therefore having a greater development impact. Leveraging other resources can be a second-level objective, and must not reduce the pro-poor orientation of aid.

  • Favouring other catalytic effects: Leveraging other investor’s resources when investing public aid in private companies is not the only possible catalytic effect. Removing certain constraints to business development or obtaining a demonstration effect from a specific investment may also mobilize additional private resources.

  • ODA+ accounting system: To keep track of PSD on a global scale, the official reporting system run by the OECD needs to be adapted to specify whether or not there is a commitment to PSD, and to record other public flows not accounted as ODA, including development banks resources and DFI funding.