Good argument, good conclusions, wrong pratical solution

The west has squandered time and money in Afghanistan trying to impose high-minded governance and social preferences rather than addressing real needs. Now, with time running out, we need a new private sector investment led model for economic growth focusing on preparing Afghans for a post-donor world. This is the main argument put forward in a Financial Times article that caught my eye, Aid will not sustain Afghanistan’s economy by Ahmed Rashid and Alexis Crow, published on 30 July. I was delighted to see this kind of argument being put forward with such clarity.

The authors make a point that I have been banging on about for some time; that this predilection for focusing on social preferences has been a distraction from the higher priority (at least in the short to medium-term) task of promoting sustainable economic development. They contrast the western approach to peddling liberal democracy with the way that large Chinese and Indian corporations have got on with investing in Afghanistan. In other words, while we push values on Afghans, others extract value from Afghanistan. I agree with Rashid and Crow that this approach has not only lost valuable time, it has also contributed to antagonising significant sections of the local population.  

Where I part company with the article is when it comes to the practical solution prescribed by the authors, "the US should now encourage bold private equity groups with a long-term, high risk investment strategy".

There are three main reasons why I think that this is not the right way forward:

First, the future success of the large Chinese and Indian investments mentioned in the article (the Aynak copper and Hajigak iron projects respectively) rests to a large extent on governance reforms that will bring Afghan mining legislation and regulation more into line with international norms. So while these corporations have got their foot in the door by securing the deals, real investment will only happen when the Afghans have achieved significant improvements in the investment climate.  Investment, even by large Chinese state-owned enterprises relies on the kind of reform programme that the article implicitly de-prioritises. And this need for reform is not restricted to the mining sector. No amount of external support to investors or willingness to take risk can overcome archaic and anti-business regulation that runs through many economic sectors in Afghanistan. If doing something is unlawful, however out of date the regulation may be, it is not a high risk that can be priced, it is plain stupid (or at least it is for a western private equity group). By all means forget some of the irrelevant/outlandish social preferences of the west, but there is some very practical and boring reform work that has been/needs to be done before investment in Afghanistan will really take off. So the "either mess around with reforms/or get on with investing" choice is overly simplistic, the relationship is much more complex than that and we should be working on demand led reform as a high priority.

Secondly, the same Chinese and Indian corporations are strategic, not financial investors. The idea that Afghanistan could be a playground for swashbuckling private equity groups ignores some fundamental realities of the local society and local ways of doing business. The last 10 years of western engagement are littered with well-intentioned ideas for private equity projects, some of which have even managed to attract funding, but none have ever made an investment. Those with long memories will remember the US$20 (or so) million Afghan Renewal Fund managed by ACAP Partners (now dissolved) and financed largely by USAID which was operational between 2004-06 (or thereabouts). The project report, which can be found online, runs through the deal pipeline from the hundreds of initial contacts to the zero deals done in the several years of the fund's existence. Other donor agencies have tried and failed with similar ideas. Why don't these financial investment projects work? The fundamental problem is that Afghan businesses work differently to the west; first most are family businesses that simply don't want outside investors, and secondly most are totally/partially informal - very few would withstand the kind of due diligence and scrutiny that any responsible equity fund manager would require. Then you have a problem with shared management, in a run-off between a remote fund manager and a local owner with different views on business strategy, my money is on the local owner any day of the week. And finally, you have a small issue of exit - what viable exit strategies are available to equity investors? The same family issues would come up again, there is no room for any kind of secondary market in today's Afghanistan. So, it is probably worthwhile looking at how the Chinese and Indians are investing and learn from their example of setting up at scale with their own companies, their own managers and probably significant amounts of their own workers.

Thirdly, the Chinese investor is a state owned enterprise and the Indian investor consortium includes state owned enterprises. These are not private companies willing to take high risks and a long-term view, there is a great deal of very high level political engagement going on in the background. This is a whole lot different to a private equity group trying to manage a portfolio of private investments in Afghanistan.

So what is the immediate and practical solution? Putting the Aynaks and Hajigaks to one side where there are scale considerations that require a different approach, I would propose the following new model for broad economic development in Afghanistan:

• Focus on incentivising Afghan, rather than foreign, investment. Foreign investment is welcome of course, but the faster, easier route is to get Afghans to invest in their own country.
• Forget private equity, use government investment incentives to get Afghans to invest their cash (and there is plenty of it) today not tomorrow, and to invest in productive assets in Afghanistan, rather than real estate in places like Dubai.
• Go for investments that will provide an anchor for wider economic development - for example, agri-processing factories that will buy Afghan produce from thousands of farmers, or mining service enterprises that will make a viable business out of working with small scale quarries, securing thousands of jobs in the process.

I say "new model", but this is pretty much exactly what DFID (and now AusAID, who have come in as a co-donor) are doing through ABIF. We have some fantastic real life investment projects that are now beginning to get off the ground and which promise to deliver tangible benefits to hundreds of thousands of Afghans. So far, we have committed US$2.5m of donor money contributing to US$13.3m of private investment, and we estimate that some 500,000 Afghans will be better off in one way or another as a result. Give us more money, and there is plenty more opportunity where that came from!