The big question is: Can they learn to syndicate with other capital, and only use subsidies at the right time.
International development organizations appear recently to have come to the conclusion that there is not enough money in the public sector or in philanthropy to meet the challenges of the world, as expressed by the newly redefined ‘sustainable development goals’. Their solution is to take seriously the opportunity to partner with impact investors and private wealth, who are also focusing on the SDG’s as the compass by which to guide the change they want their for-profit investments to achieve in the world.
But to make that partnership effective, IDO’s will need to start thinking differently. Acting in a traditional unilateral fashion will not work, without regard for initiatives already undertaken in high risk markets by impact investors. There’s also a cure now for the ‘not invented here’ syndrome that propels unilateral thinking; it’s called ‘major budget cuts to international development finance’. Specifically, IDO’s need to carefully consider when to grant, when to subsidize an early market creation, and when to stop subsidizing an intervention because the market has emerged and a subsidy will undercut the market. Take the example of cook stoves in India. The World Bank is currently undertaking an initiative focused on cook-stoves in India, with health as their number one stated priority that lends itself to the conclusion that LPG stoves are the best and only technical option. Whether or not this health factoid is true (and there is ample evidence from the local market that competing local alternative products are strong contenders where it comes to achieving the same emissions goals), this institution is about to flood the market with finance for a stove product sourced in Europe that will essentially wipe out the last 6-8 years of pro-poor, risk financing that impact investors have attempted (at great cost, both direct and indirect) to deploy. This will likely undercut attempts, both historic and current, at local innovation by local players, and yet again, distortive behavior in the frame of good intentions will provide ‘wins’ in the short term, but highly likely losses in the long term.
One of the smartest subsidies I have seen in the last decades is US AID subsidizing the management fees of three funds to remain at around $15 Million in assets, small enough to fund social enterprises in the “valley of death” (with the $300,000 to $750,000 post accelerator funding), and before they are ready for series A venture funding. In the traditional tech markets that is the space occupied by seed funds or super angels, and those entities either don’t exist or are slow to act in the impact space. The economics of managing venture funds makes funds have to reach $20 to $30 million to be viable to hire top talent with a two percent management fee. AID’s subsidy let Village Capital, the Unitus Seed Fund and the Shell Foundation’s fund bridge this structural gap to finance good companies that could eventually reach series A venture funding, or IFC funding at the $2 million range or so.
Subsidies work to seed a market, but also to distort a market at the next phase when subsidies make it hard to impossible for risk capital-backed ventures to compete with IDO-subsidized programs for specific products, like cook stoves. Later, subsidies to intermediaries make sense for bridging structural gaps in the market to enable more efficient capital flows and the absorption of transaction costs that a market may not yet bear.
Knowing when to subsidize, when not to, or when to subsidize an intermediary is a new kind of strategic analytic exercise for IDO’s who typically may not run a full ‘market maturity’ and concentration assessment before they act. They should do, in the same way that major infrastructure and construction projects do environmental assessments in evaluating unintended impacts before beginning to break ground. As our colleague Arthur Wood has frequently stated in explaining his paradigm of the social change value chain, an exercise to undertake a major development project must be tempered by an analytic lens that reaches out into the far long term, the ‘beyond’ point at which unintended externalities may be imagined and even evaluated. Without calculating the imagined value of / or opportunity cost of / or loss /gain of such externalities straight back into the core “cost benefit” budgetary analysis (or outright balance sheet) of a project, nobody can actually achieve a true picture of the impact of a desired intervention.
UN, development and international financial institutions are not known for celebrating their success as a function of measurable outcomes so much as they are known for celebrating their processes. It is not a stretch to assume that a healthy slice of the $2.3+ trillion in aid that has flowed from the Global ‘North’ to the Global ‘South’ since the beginning of recorded ‘aid flows’ has been allocated to the overheads associated with ‘getting the money and people out there’. No one who knows the world of IDOs would actually dispute this. Yet now, as tensions rise, global development budgets are hit, and re-organizations begin, our hope is that traditional unilateral ‘ego’ approaches (particularly when they support subsidies) give way to a flurry of higher quality, more collaborative interactions that showcase the best of what humanity has to offer across all sides of the table.
By Kevin jones and Audrey Selian