Privatising development successfully

Defining the ABIF log frame has made it clear to me that the M4P approach is all about privatising development, which in turn has important implications for the detailed design of ABIF. Maybe this is stating the obvious? However M4P writing tends to focus on changing markets and impacting beneficiaries, rather than on the significance and implications of the approach itself. A quick Google search didn't come up with anything linking M4P with privatising development or how this privatisation process should be managed, so here are some thoughts on this connection.

When designing the ABIF log frame one of the questions we have been debating is what belongs at the output and outcome level. The answer for an M4P programme is very different to a traditional development programme. I remember that at Katalyst we also discussed this for a long time (in fact the first 8 years of the project). Finally with external help, I think that we reached the right conclusion; outputs are all about the changes in the market (supply and demand side), and the outcome is about increasing the competitiveness of small enterprises.

This is also the right structure for our log frame because at the heart of M4P is the confluence of development objectives and commercial incentives. The roles of the project and the target client is not so much to be giver/receiver of development support (although this happens), as to be co-sponsors of a commercially viable project that will deliver development impact. From the project's point of view, we are increasing donor funds by mobilising private sector resources to achieve development objectives, and from the client's point of view, he is increasing private sector resources by attracting donor funds as additional investment capital.

Going back to the log frame, which after all is just a tool to capture the conceptual thinking behind the project design, the private sector co-investor's contribution belongs at the input level. It is as if we have teamed up with a donor funded partner (another project, an NGO or similar), but rather than pooling donor resources, we are co-investing with a private sector partner to achieve the project's objectives. Together (but motivated by different/complimentary objectives), we are working to bring sustainable change to the way that markets work, and this is the output of the project.

Once I made this conceptual leap (from thinking of the client's investment as an output of the project, rather than the project itself), it became clear that M4P is about privatising development. It seems that the development community is at an early stage of this transition, but it appears to be underway, at least for the time being.

Privatising development is an important route towards sustainable development. It is widely recognised that the private sector uses resources more efficiently than the public sector, and the private sector has this defining characteristic of being self-sustaining. The more that the private sector can be harnessed in development (in countries where every penny counts), the better. Logically, the rate of development will be faster the more that the private sector is involved in development.

However, there are two key considerations in following this path:

1. The recent global financial crisis has demonstrated yet again that there is a clear role for the state as regulator to prevent excess and abuse, so the M4P intervention must balance the respective roles of the private sector and the state in markets; and
2. The M4P programme must ensure that it is efficiently incentivising private sector investment, not wastefully subsidising private sector profits.

This second point is something which is a question I have over some of the M4P labelled interventions I have seen reported, so we are consciously addressing it through the ABIF design process in the hope of refining the approach. Why do challenge funds give matching grants, why do grant giving programmes have cost sharing agreements at a particular level? Whenever you ask these questions of specific interventions, there is never a rational or satisfactory answer, because the projects do not talk about the role of risk in business decision making.

As with other M4P programmes, ABIF will co-invest in private sector led projects that invest in pro-poor innovation. So how will we make sure that we incentivise to achieve our objectives, rather than subsidise private sector investment? There are three answers, one conceptual and the other two practical:

1. Conceptually, we focus on the risk part of the investment equation. We will only invest in projects that would be commercially viable in a less risky environment. Our investment is not designed to share project costs or to maximise leverage of private sector investment (a completely irrelevant metric from a development point of view), but to compensate for the high discount factor (the measure of risk in an investment project) applied to those future cashflows. We will therefore only invest in projects that would have a positive NPV elsewhere and we will only invest as much as it takes to turn a negative NPV in Afghanistan into a positive one. So investment project design and the potential impact (rather than financing and the potential leverage) is the key consideration.
2. Practically, we will invest based on competition between proposals. We will define the challenge and we will evaluate proposals received, the only assessment criteria being the impact that the project will achieve and the project sponsor's capacity to implement the project successfully. So we can reach a conclusion on the expected development returns of the project (the expected future impact "discounted" according to the risks arising from the capacity of the project sponsor).
3. We will give grants, not loans. By giving grants we achieve a number of goals: we avoid confusion with commercial finance providers, we are more efficient because we do not have the costs of managing repayments, we tie up less money for the same impact... but most importantly we impose development discipline on ourselves, because we have to keep going back to donors for funding, which means we have to show impact. We are not a pretend private sector investment fund with our own capital, we are a donor funded project entrusted with tax payers' money.

By adopting this approach, the hope is that we will use public money efficiently, to offset a public obstacle to investment and achieve our impact objectives. Inevitably, things will not be quite as simple as this sounds, but at least we have an approach that should minimise the risks of subsidy and allowing the private sector making super-profits from the privatisation of development.

Ease of doing business and M4P

While looking through the World Bank Doing Business survey indicators and trying to reconcile Afghanistan's ranking with the reality of the situation here and with the specific objectives of our project, two thoughts came to me:

1. There are specific ways in which the survey fails to reflect the realities of doing business in Afghanistan and can give a misleading impression of how things are here; and
2. A broader concern that the emphasis in the headline title of "ease of doing business" risks missing the importance of effective regulation of certain ways of doing business.

Of course the Doing Business survey has to work on globally comparable indicators, which means that there are inevitable compromises in the quality and relevance of those indicators for any particular country. However, it is worth thinking about these points because the Doing Business Survey is influential, it is frequently quoted as a reference in measuring Afghanistan's progress towards creating the conditions for sustainable economic growth.

If the survey is misleading in material ways and missing some important points in relation to Afghanistan, then clearly the headline ranking needs to be treated with some caution, rather than quoted without care (as it has been by both critics and supporters of Afghanistan's progress).

To illustrate the first point, I would like to focus on the "getting credit" indicator, where Afghanistan ranks 128th (2011). The indicator has four key components; strength of legal rights, depth of credit information, public registry coverage and private bureau coverage. In each area, apart from strength of legal rights, Afghanistan scores zero.

Under strength of legal rights the survey looks at several legal provisions, for example the law allowing for the use of movable assets as collateral. On this particular measure Afghanistan scores well, it does have a law on movable assets. But will lenders rely on it? They would have to be very brave. The legal provision is in effect almost unenforceable and therefore irrelevant. The problem is not with the statute, but with the way that the court system operates. As a result, bank lending is almost exclusively secured on real estate.

So by taking a mechanistic approach, rather than looking at the reality of the situation in the country, this indicator overstates the level of development. On the other hand the limitations of the survey to public and private credit agencies misses the point that in Afghanistan a thriving informal credit industry plays a hugely significant role in the economy.

Various reports on the hawala system (including from the World Bank) have pointed to its importance as a means of making transfers and also providing short-term trade finance. This kind of finance is very important in a country where trade is the lifeblood of the economy. When making lending decisions, the Hawaladar do not (and would not) rely on public registries or private bureaux, instead they typiclly look at personal reputations and family connections. Thus in a country where such issues matter enormously, there is a viable informal mechanism that is probably just as effective as any more formal system would be at meeting immediate market needs (if not more so).

Would things be any better (in other words would economic growth be faster) in Afghanistan if additional credit related laws were enacted or credit agencies were established? The answer is that in the long-run these things will be a "good thing", but it has to be remembered that there are opportunity costs (parliamentary time, judicial training, loss of reputation linked to unenforceability etc) associated with such reforms and right now there are more pressing priorities. Not least of which would include getting the commercial court system working at the most rudimentary level and strengthening the governance and operations of the formal banking sector.

On the second point regarding the headline "ease of doing business" ranking, the issue is that ease of doing business is looked at in isolation of the responsibilities of doing business. Whereas in M4P, the two need to be looked at together.

The DB survey isn't directly concerned with issues like consumer protection or employee rights (addressed as a special topic, not in the main ranking) or environmental protection etc, so this is not a criticism of the survey itself, more a reflection on the need to balance responsibilities as an integral part of the M4P approach to economic development. It goes without saying that our project is particularly concerned with the poor, as producers, labourers or consumers. Typically, these are the people who most need protecting when making it easier for firms to do business.

If markets are to work for poor people, there need to be adequate safeguards in place (ensuring a growth in the quality as well as the quantity of income). This may not always be consistent with the notion of ease of doing business. In Afghanistan, where strong tribal and family affiliations link many politicians back to their roots, both patronage and protection play important roles. Understanding the nuances of these social and cultural systems is one of the keys to understanding how markets can play a role in Afghanistan's economic development.

We are now moving towards selecting focus sectors and using market analysis to identify key constraints to sector development. It is important that our analysis recognises teh specifics of how market systems work in Afghanistan and that the ease of doing business (in a wider sense than in the DB survey) needs to be balanced with responsibilities, thereby avoiding our work being perceived as an external intervention that somehow threatens the way that markets currently work. It is important that we recognise the role and strength of protections that exist today before we intervene to change the way that markets work. Basically, the objective will be to ensure that there are adequate mechanisms in place to support transition before destabilising current systems.

Taking this approach, achieving "systemic" change will be an incremental process, building on current systems and carefully co-ordinated with a wider development process, rather than something that happens overnight.



Note: An independent review of the Doing Business survey in 2007 made a number of important recommendations, and addressed in general terms some of the Afghan specific comments above. Nevertheless, it does no harm to think through some of these issues once more and to realise the complexity of the environment in which we seek to intervene.