Time for Canada to Get Into the Business of Development

The case for a publicly-owned, profit-driven Development Finance Institution. By Brett House and James Haga.

By: /
2 June, 2014
Brett House
By: Brett House

Deputy chief economist, Scotiabank

Co-authored with James Haga.

About 1 in 5 people around the developing world still live on less than USD$1.25 a day. After decades of experimentation, we have good evidence on what works in the fight against extreme poverty. But we still lack sufficient resources to win this battle.

New estimates indicate that about USD$1 trillion of additional annual investment will be needed to achieve the United Nation’s emerging “sustainable development goals” (SDGs) over the coming decades.

The roughly CAD$5 billion in public aid that Canada provides annually to poor countries is, comparatively, a drop in the global anti-poverty bucket. We already stretch its impact by funneling some of this aid through multilateral organizations, such as the World Bank, and partnerships with private companies.

We can and should do more. At only about 0.3 percent of GDP, our aid budget is less than half of Lester B. Pearson’s internationally-agreed target of 0.7 percent. Despite the ongoing burdens of the 2008 financial crisis, in 2013 the United Kingdom became the first G7 country to reach Pearson’s goal.

As Canada’s federal budget returns to balance, we have room to follow the UK’s lead—not just by increasing our aid dollars, as the Prime Minister’s just-announced CAD$3.5-billion to improve maternal health may do, but also by expanding our development financing toolkit.

Canada is the only G7 country that doesn’t have a publically-owned, profit-driven Development Finance Institution (DFI) that can provide commercial financing to companies working to build markets, create jobs, and drive growth in emerging countries. It’s time to build a Canadian DFI.

A Canadian DFI wouldn’t disburse grants: it would only provide loans and equity finance on near-market terms for profit-making activities that also help to reduce poverty in developing countries. It would complement aid provided by DFATD for public goods and support from Export Development Canada (EDC) to Canadian traders—not substitute for these activities.

It’s natural to ask why a public institution is needed to offer this capital. If there are profits to be made, private actors should already be chasing them.

Commercial financing through a DFI addresses specific gaps left by private financial institutions. Business opportunities in developing countries usually come with high risks or back-loaded profits. Most private financial institutions find it too hard or too costly to provide affordable capital under these conditions—or their shareholders, with their narrow focus on quarterly returns, simply won’t let them.

The entrepreneurs best-placed to build markets in developing countries are often cut off from venture capital and bank lending. For instance, immigrants to Canada and diaspora communities around the world—some of the people with the local nous to build business in developing countries—frequently lack the track records and credit ratings needed to attract private finance.

DFIs can fill these gaps because they’re backed by the full guarantee of their government shareholders. A Canadian DFI could leverage Canada’s now-rare AAA credit rating to raise capital on exceptionally cheap terms and take on above-average risk. A public DFI can also take a strategic, long view on returns.

It’s also reasonable to ask why “little ole” Canada needs its own DFI, especially when we already provide commercial development finance through the world’s DFI, the International Finance Corporation (IFC).

Put bluntly, without a Canadian DFI, we’re leaving money on the table for others. DFIs have a long history of making profits by doing good. Britain’s CDC hasn’t drawn on the public purse for over 15 years. The United State’s OPIC earns USD$8 for US taxpayers for every USD$1 they invest in its overhead. And the IFC’s profits get recycled back into new deals.

About half of the world’s total output and annual growth now come from emerging and developing countries. Canada needs to deploy every tool possible to participate in the rise of these markets. A Canadian DFI would allow us to reduce poverty, extend our influence, and earn a profit all at the same time.

A Canadian DFI would permit us to support business development in middle-income countries with commercial loans and to focus our scarce DFATD aid dollars on the world’s poorest countries, which don’t have—and frankly, shouldn’t have—access to international capital markets. Experience shows that they can’t afford loans at even rock-bottom interest rates.

In a forthcoming paper from the Centre for International Governance Innovation (CIGI), we show that our G7 counterparts offer some lessons in creating a successful DFI.

A DFI’s operations need to be distinct from other government development efforts: a DFI doesn’t provide academic research, public goods, disaster relief, or capacity building—it finances business. A DFI needs to be able to offer a range of financial instruments with a skilled staff to administer them. Whatever the vehicle, DFI financing should be catalytic: small amounts of public money that mobilizes far larger flows of private capital.

The most effective DFIs aren’t limited to working with their own nationals: they underwrite the best ideas and companies. A DFI shouldn’t be a new trough for corporate welfare or industrial policy. Rather, a Canadian DFI should be a self-sustaining channel for investing in profits, poverty reduction, good governance, and environmental sustainability.

Creation of a Canadian DFI has been mooted for around 40 years without action. It’s not a new idea, but it’s an idea whose time has come.

Without a Canadian DFI, we’re not just leaving profits unearned: we’re leaving lives lost and potential unrealized. It’s time to build on the lessons learned by our G7 counterparts to create a Canadian DFI for the 21st century.

James Haga is Director, Policy & Advocacy, at Engineers Without Borders (EWB); Brett House is Senior Fellow at the Centre for International Governance Innovation (CIGI) and the Jeanne Sauvé Foundation at McGill University. They tweet on @JamesHaga and @BrettEHouse, respectively.

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