Major new report on private finance urges post-2015 focus on quality not quantity

Added 10 Apr 2014

The European Parliament has just released a major report with a clear message for all those engaged in the growing debate about the role of external private finance in development: quality matters far more than quantity. As the post-2015 debate on financing development continues, and the UN gears up for a major Financing for Development conference in 2015 or 2016, this timely paper – authored by four experts* - gives clear recommendations on how European governments can ensure that fighting poverty stays at the heart of this agenda. 

The current picture 

Firstly, here are the main findings of the report’s review of all available data on global private finance flows:

  • Domestic private investment is significant and growing. Public and private investment, taken together, have grown as a proportion of GDP, from 24.1 % in 2000 to 32.3 % in 2011. 
  • Outflows of private financial resources are extremely large. Most are not productive investments in other countries but repayments on loans (over USD 500 billion in 2011), repatriated profits on foreign direct investment (FDI) (USD 420 billion) or illicit financial flows (USD 620 billion).
  • Figures greatly overstate the real net financial private flows to developing countries. Foreign Direct Investment (FDI) is the largest resource flow to developing countries, but outflows of profits made on FDI were equivalent to almost 90% of new FDI in 2011. In addition, FDI includes the reinvestment of earnings from within the ‘destination’ country: not an inflow. 

Things to remember about private finance

The report argues that three facts about external private finance should be at the top of policy-makers minds:

  • It predominantly flows towards higher income countries.
  • It has proved very difficult to target it towards micro, small and medium enterprises (MSMEs), which provide the majority of employment and GDP in developing countries.
  • Its for-profit nature means it cannot tackle several key issues, including much public service provision which is vital for private sector growth. 

Given this, efforts to incentivise or ‘leverage’ increased private investment in developing countries by development finance institutions (DFIs) and others have been disappointing. The report finds that DFIs have:

  • Difficulties in designing programmes that work for MSMEs in low-income countries (just 0.4 % of the portfolio of the European Investment Bank’s portfolio).
  • Little success in generating ‘additional’ private sector investment, with external evaluations showing that many publicly-backed investments replace or supplant pure private sector investments.
  • Low developing country ownership over the institutions and programmes of DFIs.
  • Significant problems in providing adequate transparency and accountability.
  • Increasing debt risks, and very expensive financing, particularly through public-private partnerships, which have proved the most expensive source of finance for developing country governments.

There’s a lot of confusion surrounding the term PPPs  – in the classical sense, PPPs involve a private investment in a ‘public’ service area where the private investor gets repaid over a number of years, either through revenues or – very commonly – by the government. In this latter case, as the killer chart below from the report shows, PPPs are really just an extraordinarily expensive method of government borrowing. 

Here’s the key take home for the post-2015 brigade on using public resources to leverage private finance:

“… it would be more sensible for post-2015 discussions to focus on how international public flows can help reduce the barriers to private sector investment, through investing in essential services, such as health and education, and infrastructure. The issue of how public regulation, incentives and subsidies can be used to direct, increase and improve the impacts of private investment on poverty reduction and sustainable development would be better resolved at the national level, rather than by focusing on the limited role of development finance institutions, or promoting greater use of blending mechanisms to leverage private finance.”

The way forward

So, if focusing on trying to leverage more external private finance into developing countries is the wrong agenda, what’s the right one? Simple – remember that rules, policies and institutions that developed countries control remain extremely important. Here are some suggestions for European governments, the main target of this report: 

  • Recognise the severe flaws in investment treaties which have reduced developing country space to protect their economies from destabilising exits of capital during difficult times (2012 saw the highest number of international claims filed against states by foreign companies, with 66 % filed against developing countries.) 
  • Take action to curb illicit capital flows and reduce tax avoidance and evasion by European companies, for example, by introducing country by country reporting and public registries of beneficial owners.
  • Support efforts to introduce fair and transparent debt workout mechanisms, conduct audits, and reduce the unsustainable debt burdens in many developing countries. A good example of this was the London Debt Accord, which addressed Germany’s debt in 1953. It saw the nation’s payments cut by half and extended over 30 years, so that there was not a negative impact on growth. 
  • Show global leadership in the creation and adherence to responsible financing standards – like the Eurodad Responsible Finance Charter, including requiring fair terms and conditions, adequate social and environmental standards and accountability to affected peoples. 

That seems like a far better agenda than the European Commission’s current focus on unproven and costly blending mechanisms

*[Full disclosure: I was one of the co-authors, together with Matthew Martin (Development Finance International), Javier Pereira, and Tim Strawson (Development Initiatives).

To read a blog by Tim Strawson, Senior Analyst at Development Initiatives and co-author of the report, click here.