Policy

BII Research and Policy blog. Various posts on development finance and impact investing.

BII Insights Paper: Risk, return and impact.

Understanding the relationship between financial returns – incorporating risk – and development impact requires understanding how assets are priced, and how DFIs interact with private investment markets. Some of what DFIs exist to do implies making market rates of returns, other things do not. It also involves thinking about how these relationships look at a portfolio level, and the difference between expected returns and expected impact, and realised returns and realised impact.

BII Portfolio Level Impact Scoring Tool

A case study, written for Impact Frontiers, that describes how our impact scoring tool fits without our overall impact management system, and explains some of the dilemmas we faced and design decisions we took when developing the system.

BII Our approach to investor contribution

Investor contribution - often referred to as additionality - is central to development finance. We would not achieve our objective if we displaced private investors, without making a difference to development outcomes, or if we allocated capital to businesses that are already impactful without increasing their impact. We have adopted an approach to rating the contribution of investments that recognises our confidence in our additionality, and that the scale of contribution relative to the overall impact of the investment, varies from case to case. We take investment decisions after viewing our contribution rating alongside our assessment of the impact of the investment.

CDC Insights Paper: The Economics of Development Finance

As part of our strategy development process, we went back to first principles and asked ourselves: what is development; how does private investment contribute to it, and why do we need publicly owned DFIs to intervene in private markets? By answering these questions, we can identify where to invest to contribute the most to solving global development challenges, and prioritise investments under our three new impact objectives: productive, sustainable and inclusive.

CGD Note: Are Development Finance Institutions Good Value for Money?

Finance institutions take money from foreign aid budgets to invest in private enterprises. How much should they be given? We can make some progress on that question by looking at the return on investment in the form of higher real incomes for workers and customers, and comparing that to a cash transfer benchmark. There is considerable uncertainty, but what evidence we have suggests returns on investment are in a range that compares well to that benchmark. There is also a diversification argument that because we don’t know which of the things that aid can finance will ultimately prove most important for poverty eradication, aid allocation should hedge its bets. A low single digit percentage of aid allocated to increase the quantity and quality of private investment in low- and middle-income countries seems reasonable.

Video presentation: https://youtu.be/RN07GRnokaE

CDC Insights Paper: Decarbonising Africa's grid electricity generation (2021) with EED Advisory, Nairobi.

The challenges that African countries face to decarbonise their electricity grids are fundamentally different to those of wealthier economies with mature energy infrastructure and relatively flat demand. Most African countries are starting from a very low base, and must build up their power networks and generation capacity rapidly if they are to stand any chance of achieving their urgent development objectives. This report looks at what constrains the pace of decarbonisation in the African context.

ODI EDFI Essay Series (2021) - two entries: one on how DFIs should take decisions about whether to invest in gas power generation (page 71) and one on the need for standardisation in how impact data is interpreted and communicated (page 92).

CDC Insights paper: Investment and poverty reduction (2021) with Gregory Thwaites, Nottingham Uni)

Over recent decades the world has made great progress in reducing extreme poverty, but in some regions of the world the number of people living in extreme poverty is still rising. How could that trend be reversed? This paper explores the statistical relationships between private investment and the rate of poverty reduction in Africa and South Asia.

CGD note: The subsidy sorting hat (2020) with Mark Plant

Using mechanism design to sort between entrepreneurs that really need a subsidy, and those that merely want one. Based on work by Saul Lach, Zvika Neeman and Mark Schankerman.

Devex article: How private equity can work for development

Equity is a really important form of capital, and fund managers are the best way we have of making it available to firms that want to grow in developing countries.

Devex article: Measuring impact may never be as straightforward as measuring financial returns

A pessimistic take that we need to give up on the idea of telling investors "how much impact" they've had.

CDC Insights paper: How job creation fits into the broader development challenge (2019) with Professor Petr Sedlacek, Oxford Uni)

Some facts about labour markets in Africa and Asia, and how the concept of creative destruction brings together gross job creation and productivity growth, and how adding demand to labour markets has effects that extend beyond the firm.

ODI/EDFI essay: Understanding the the contribution of development finance institutions to economic transformation. In Impact of development finance institutions on sustainable development : An essay series

Transformational investments have an impact that ripples out across the production network, causing firms to expand, enter and exit by increasing the returns on offer to other investors

The Elusive Quest for Additionality - Center for Global Development Working Paper 495 (2018) with Nicolas van de Sijpe and Rafael Calel.

Development Finance Institutions (DFIs) are frequently asked to demonstrate their additionality—meaning that they make investments that the private sector would not—but what evidence of additionality would look like is rarely articulated. This paper examines potential quantitative and qualitative evidence. We investigate whether it is possible to infer additionality from observational investment data, and show how the demand-led nature of DFIs’ business model can create bias in standard statistical techniques used to identify causal effects. Having established that rigorous evidence of additionality may continue to elude us, we discuss circumstantial evidence that would increase confidence that additionality is present, and propose a probabilistic approach to additionality.

The taxation of foreign aid: Don’t ask, don’t tell, don’t know (2018) ODI briefing note

Official development assistance (ODA) has generally been exempt from taxation in developing countries since the 1940s. Despite the longevity of this practice, justified primarily on the basis of maximising the quantity of aid, there is relatively little evidence on how much tax is exempted and the impact on development outcomes. The practice is coming under scrutiny as ODA providers increase support for domestic resource mobilisation (DRM) to meet the Addis Tax Initiative (ATI) commitments. The policy incoherence between tax exemptions for ODA and efforts to support DRM has become more apparent. The Platform for Collaboration on Tax (PCT) has pledged to review ODA tax exemptions and issue guidelines. The PCT should focus first on increasing transparency and improving the evidence base before issuing guidance on what specific ODA tax exemptions should or should not apply. At the same time, the most harmful practices should be ended, including the ‘don’t ask, don’t tell’ practice of contracting that facilitates income tax avoidance for aid workers and private contractor

The World Bank's preference for private finance explained (2018) CGD blog

The Bank's cascade model seen through the lens of efficiency and the scarcity of public finance. An unconditional preference for private finance is untenable.

The pitfalls of leverage targets (2018) CGD blog

DFIs need to do more to mobilise private investment but setting targets for the ratio of private to public finance in deals may introduce more problems than it solves.

DFIs embark of a voyage of discovery (2017) CGD blog

Demand from private investors for more programmatic investments will pull DFIs towards supporting national development strategies, despite their historical reluctance to get tangled up in local politics.

Why competition for development finance is not always healthy (2017) Development Finance magazine op-ed

Subsidies can be misused for winning deals

Solving the private sector imbroglio (2017) CGD note

Disagreement over how investments in the private sector are counting to aid is threatening to overwhelm the OECD Development Assistance Committee. There are no perfect solutions here; governments must find the least-bad compromise. We point the way forward.

Subsidising the private sector: lessons from mechanism design (2017) With Francesco Decarolis and Nathaniel Young. Boston University Institute for Economic Development Working Paper.

The paper discusses insights from the theory of mechanism design in the context of development finance institutions (DFIs) who wish to allocate subsidies for private investments, to achieve development objectives. A dominant theme in donors post- 2015 development finance strategies is the idea of using aid to ‘catalyse’ other financial flows, motivated by the observation that estimated investments exceed donor budgets by an order of magnitude. However, DFIs face a problem of dealing with private investors who have an incentive to pretend they need financial support. DFIs need a mechanism to select projects that: a) will deliver development outcomes b) will be delivered efficiently c) genuinely require a subsidy to be commercially viable. The paper discusses circumstances under which the mechanism design approach indicates that this asymmetric information might hinder the activities of DFI.

Why do Development Finance Institutions use Offshore Financial Centres? (2017) ODI report and CGD blog

Development Finance Institutions (DFIs) invest public money in private enterprises, with the aim of accelerating the economic development of low- and middle-income countries. One of the greatest threats to development is popularly perceived to be the network of tax havens that drain billions from developing countries, in part by allowing cross-border investors to avoid taxes. And yet these public institutions that exist to promote development regularly route their investments through tax havens. Why?

The short answer is the one that DFIs have always given: they use intermediary jurisdictions not to avoid tax, but to make up for shortcomings in the legal systems of the poorest and most capital-scarce countries that would otherwise dissuade private investors from entering these markets. The longer answer involves examining: what these legal shortcomings are; what taxes should be paid and where; how tax havens or offshore financial centres (OFCs) can be used to reduce them; and the economics and politics of taxing capital. However, the most compelling argument concerns what would happen if DFIs stopped using OFCs. The alternative would be to use an onshore OECD financial centre, which would be no more favourable for developing countries.

Maximising bang for the buck: Risks, returns, and what it really means to use ODA to leverage private funds (2016) OECD Development Matters blog

Subsidies should be applied at the portfolio level where possible

Contracts for adaptive programming (with Kevin Bryan, 2016) ODI

The idea that development actors should experiment, learn and adapt is hard to disagree with. But how can this approach, referred to here as adaptive programming, be delivered through contractual arrangements with implementation partners? This report surveys a branch of economics known as contract theory, with the objective of drawing attention to some of the challenges that emerge when viewing adaptive programming from a contracting perspective.

The allocation of World Bank Group resources to leave no one behind (2016) ODI

The World Bank Group will soon announce the results of its Forward Look exercise, to map out its medium to long-term strategy. It will also shortly finalise IDA118, the first replenishment of its concessional lending arm during the Sustainable Development Goals (SDG) era. This paper is intended to inform the response of World Bank Group (WBG) shareholders and stakeholders to the resource allocation elements of IDA18 and the Forward Look. We ask whether the allocation of WBG resources is well aligned with its twin goals of eliminating extreme poverty and boosting shared prosperity, and the fundamental ambition of the SDGs: to leave no one behind. The paper has three parts: an analysis of the proposed allocation under IDA18; an exposition of an allocation benchmark model created by DFID economists and a comparison of IDA18 against that benchmark; and a look ahead at how the allocation of WBG resources could be reformed.

Where next for development effectiveness? Investing in private enterprises (2016) ODI

Conference note discussing the application of Busan development effectiveness principles (the Global Partnership for Effective Development Cooperation) to investments in private enterprises.

Five ways to deliver aid in the UK national interest (2016) ODI

The national interest is now a guiding principle behind UK aid spending, as evident in the new UK aid strategy and statements by the new Secretary of State for International Development. This briefing highlights five ways in which aid brings benefits to the UK, and actions that the Secretary of State can take to accomplish her mission of building a safer, more prosperous world, in a way that delivers for our national interest. In this briefing we set aside important issues like migration and security, in order to focus on the national economic interest.

Domestic Revenue Mobilisation in Australian partner countries (2015) ODI - with Stephanie Sweet, Shakira Mustapha and Cathal Long.

This paper provides a comprehensive survey of tax theory and evidence to inform the policy of the Australian Department of Foreign Affairs and Trade towards taxation in its partner countries. It will cover the role of taxation in development, and the theory and evidence that underpins the nature of tax reform. The state of taxation in Australia’s partner countries will be summarised, with more detailed data presented in an annex. The role of various international actors in the field of taxation will be examined, before taking a more in depth look at the practicalities of international interventions in taxation and lessons from experience. The report will conclude with some potential lessons for Australian policy towards taxation in its development partners.

Blended Finance: some simple supply and demand analysis (2015) UN FFD

A blog pointing out that unless the "demand curve" of projects looking for money is very shallow, small subsidies won't produce many more projects.

Why subsidise the private sector? What donors are trying to achieve and what success looks like (2015) ODI

Subsidising private investment in developing countries is a legitimate use of aid when the benefits to society exceed private returns. Ideally only projects that genuinely require a subsidy to be viable would be subsidised, but some misallocation is inevitable. Many social benefits of investment emerge slowly and are hard to trace. Results evaluations can only provide a partial view. Using grants to lever-in private finance on market terms does not help close the financing gap when donors can already provide the same finance at the same cost to taxpayers. Subsidies should not be used to mobilise private finance for the sake of “getting from billions to trillions”. Investments should only be subsidised when there is a case grounded in public economics. Putting more money into investment funds will yield diminishing returns unless more is done to increase the supply of projects

Allocating aid to DFIs CGD recorded.pptx