Rethinking Private Capital for Development
December 14, 2017
The debate on the role of the private sector in development is not new. The need to crowd-in private investments for global challenges was first discussed in the creation of the UK’s CDC Group in 1948 and the International Finance Corporation (IFC) in 1956. Now, there is broad consensus that the private sector is the engine for economic growth, innovation, and progress, generating 9 out of 10 jobs in developing countries. What is novel in this discourse is the central role that private investment can play in financing development.
For a long time, international development focused on increasing the amount of foreign aid, or official development assistance (ODA), to help solve global challenges. During the last 15 years the centrality of ODA as the major source of development financing has shifted. The role of ODA has been redefined as a “catalyst” to mobilize additional investments; while domestic resources of developing countries (taxes, savings, and other revenues) as well as private-sector investments have been promoted for financing development initiatives. Private financing has now become a central component to fund the UN Sustainable Development Goals (SDGs).
This recognition is in part due to foreign direct investments (FDI) overtaking the volume of ODA by a factor of 5 to 1. But even the current hundreds of billions of dollars of foreign investment will not be enough to cover the trillions of dollars needed to meet the 17 SDGs in 2030. More resources will be needed.
Two concurrent trends have further elevated the prominence of private capital in development finance: the aid budgets of major donors have stagnated in recent years and private investors are increasing their appetite for new investments in emerging markets, partly driven by more accommodating investment climates and partly as a result of low interest rates in the mature economies. Additionally, the potential of domestic resources as a source of development funding is growing.
The outstanding question is how private capital can help fill the gap in funding levels for the SDGs, to move financial assistance from the “billions” in ODA to “trillions” in development investments. Donor countries, aid agencies, and development finance institutions can be important players and catalysts to channel private capital into developing countries. Aid agencies are being challenged to offer more innovative products and approaches to enhance the reach of private resources. The recent World Bank Group’s “Cascade” approach announced in April 2017 underscores the use of private-sector finance in development activities. Aid agencies are also exploring financing modalities such as blended finance.
Although there are several institutions, instruments, and innovative approaches that have been designed to channel private capital, barriers for scaling investments to align with development remain. This report analyzes some of the issues surrounding private capital in development. It provides a brief description of the development finance landscape and discusses some of the main limitations that exist in channeling those private funds into developing countries. Finally, it offers a set of broad recommendations for donor countries, aid agencies, and development finance institutions to help channel private capital for development.