The challenge: How can foreign direct investment fulfil its development potential?

DCR 2016Today’s post, by Karl P. Sauvant, Resident Senior Fellow, Columbia Center on Sustainable Investment, Columbia University, is published in collaboration with the 2016 OECD Development Co-operation Report: The Sustainable Development Goals as Business Opportunities.

International investment, and in particular foreign direct investment, has an important role to play in helping to achieve the Sustainable Development Goals. It can be a powerful international mechanism for mobilising the tangible and intangible assets (such as capital, technology, skills, access to markets) that are essential for sustainable growth and development.

Yet to fulfil this potential, foreign direct investment must increase substantially; it must be geared as much as possible towards sustainable development; and it must take place within a framework of international investment law and policy that is enabling, yet at the same time respectful of host governments’ own legitimate public policy objectives.

Foreign direct investment flows reached their peak in 2007 at around USD 2 trillion, dropping to USD 1.2 trillion by 2009 as a result of the international financial crisis. While this represents a relatively small share – about 10% – of gross domestic capital formation, in individual countries this share can be even higher than domestic investment.

To help meet the investment needs of the future, these flows have to increase substantially. There is no apparent reason why they could not do so over the longer term, say to a level of USD 4 or 5 trillion annually.

How to get there? Improving the economic determinants, the principal factors governing investment decisions, is fundamental. Official development assistance will continue to be important, especially for the least developed countries, including to leverage higher foreign direct investment flows. This is a long-term challenge.

However, national regulatory frameworks and investment promotion efforts can be improved in the short term, especially in the least developed countries.

The first challenge is to increase foreign direct investment through a concerted international effort to help developing countries, and especially the least developed among them, to improve their foreign direct investment regulatory frameworks and investment promotion capacities. At present, there is no such international effort – along the lines of the Aid-for-Trade Initiative and especially the Trade Facilitation Agreement – in the area of foreign direct investment. But in a world of global value chains, these trade arrangements can help only so much, precisely because they address only one side of the task, namely to increase trade. But a concerted international effort for foreign direct investment, such as an international Aid-for-Investment Initiative or even a Sustainable Investment Facilitation Understanding, could help developing countries, and especially the least developed among them, rapidly to improve their regulatory frameworks as well as their capacity to promote investment – thereby helping to increase investment flows to developing countries.

Encouraging higher foreign direct investment flows is, however, not enough.

The second challenge is to promote foreign direct investment that is geared as closely as possible towards sustainable development: “sustainable foreign direct investment for sustainable development”. This presents the challenge of defining “sustainable foreign direct investment”. A first approximation could be: commercially viable investment that makes a maximum contribution to the economic, social and environmental development of the host country and takes place in the context of fair governance mechanisms, as established by host countries and reflected, for instance, in the incentives they offer. Yet any definition needs to be operationalised. So this challenge would also involve developing an indicative list of sustainability characteristics to be considered by governments seeking to attract sustainable foreign direct investment (and to encourage sustainable domestic investment). Such a list would also be a helpful tool for international arbitrators considering (as they should) the development impact of investments, as well as for identifying the mechanisms – beyond those deployed to attract foreign direct investment in general – that encourage the flow of sustainable investment and increase its benefits for host countries.

The third challenge is to reform the international investment law and policy regime. National foreign direct investment rule making increasingly takes place in the framework of international investment law and policy. For this reason, it is important to ensure that the international investment regime constitutes an enabling framework for encouraging the flow of sustainable foreign direct investment, while at the same time allowing governments to pursue their legitimate public policy objectives. This requires asking several questions, including: How can the objective of sustainable development be made the lodestar of the international law and policy regime? What are the implications of such a concept for the regime’s rights and obligations? How will this affect the mechanism for settling disputes between investors and states? This last function is central to the regime and gives it its strength, yet it is precisely the existing dispute-settlement mechanism that is strongly questioned – especially by non-governmental organisations, but also by a number of governments. Any reform needs to address this challenge adequately to avoid threatening the very legitimacy of the regime.

In conclusion, governments need to find ways and means to increase sustainable foreign direct investment flows within a reformed international investment law and policy regime to realise the sustainable development potential of this investment.

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The challenge: Can social impact investment serve the “bottom of the pyramid”?

DCR 2016Today’s post, by Julie Sunderland, Director of Program-Related Investments, Bill & Melinda Gates Foundation is published in collaboration with the 2016 OECD Development Co-operation Report: The Sustainable Development Goals as Business Opportunities.

It’s not surprising that the private sector faces challenges in serving bottom-of-the-pyramid customers: the largest and poorest population groups. By definition, bottom-of-the-pyramid populations don’t have much income, making margins slim. In addition, the often weak infrastructure and distribution channels in developing countries make the transaction costs of reaching these customers high. Much of the procurement of basic goods and services for the poorest populations goes through government-managed development co-operation channels, which are often bureaucratic and opaque to companies.

Nonetheless, there is still great potential for the private sector to serve bottom-of-the-pyramid populations. Capital flows into the private sector, both via investment and revenue, dwarf flows from philanthropy and development co-operation combined. The private sector’s commercialisation and manufacturing capabilities can allow for scaled production and delivery of affordable, life-saving products. The private sector can bring critical knowledge, capabilities and resources to solving social sector problems, and its capacity for research, development, innovation and entrepreneurship can be applied to generate transformative technologies and new business models.

Social impact investment can help to realise this potential. When done well, it can address market failures that keep the private sector from investing in social sectors. At the Bill & Melinda Gates Foundation, we’ve seen in practice how patient, flexible risk capital can support innovative models that provide affordable, accessible, quality products and services to bottom-of-the-pyramid populations. When done badly, however, social impact investment can distort markets and prop up unsustainable businesses.

For social impact investment to become a credible bridge to a private sector focus on bottom-of-the-pyramid populations, it needs to address three challenges.

Align incentives for social and financial goals. Except for the limited resources allocated to corporate social responsibility, private companies and investors are driven by financial goals. While a new class of impact investors may be willing to sacrifice some financial returns to generate social impact, investment capital at the very least needs to be repaid out of the cash flows generated by the business activity. One of the current challenges for making social impact investment work effectively, therefore, is identifying (and working creatively to expand) the opportunities for aligning revenue/profit generation with the achievement of social goals.

A great historical example of such alignment is the proliferation of cellular technology. Mobile phones have had significant social impact in fields as diverse as disease response, financial inclusion and technical assistance. Mobile phone companies have also provided excellent returns for their investors. Yet most social goals will lack the natural alignment with scale and profit evidenced by mobile telecommunications. Social impact investment has the potential to bridge this gap through risk reduction mechanisms, such as guarantees; through the application of low-cost scaling capital to validate nascent distribution models; and through company-building equity investment in technologies that hold promise similar to that of mobile phone technology.

Change the economics of reaching bottom-of-the-pyramid populations. Capital-intensive, complicated or transaction-heavy business models that might work elsewhere will not be sustainable in bottom-of-the-pyramid markets. The private sector can develop new technologies, products and business models that are adapted to the needs of bottom-of-the-pyramid populations, allowing for rapid uptake and producing high sales volumes, even if margins remain slim. For example, there are innovations that have the potential to cut delivery costs, ranging from sachet-sized consumer products to agent-based distribution models and pay-as-you-go financing. Social impact investment can support the further development and demonstration of these new business models by leveraging and, ultimately, crowding in private sector investment.

Cultivate top-tier, on-the-ground investment and entrepreneurial talent. Access to capital is often cited as a primary limitation to the growth of small and medium enterprises, and to social sector businesses. Yet access to talent may be a bigger and more persistent constraint as promising models replicate and grow. Social impact investment needs to develop two levels of talent: strong intermediaries and fund managers who are good at allocating capital and building companies; and strong entrepreneurs and managers to lead social sector businesses.

Over time, improving secondary and post-secondary enrolment and education, and increasing entrepreneurial expertise in local markets and among diaspora, will allow talent to flourish. Social impact investors can speed up this process by taking the risks and investing in emerging intermediaries and entrepreneurs, recognising that while they are learning they will be developing experience and networks. A handful of successful cases can encourage others in the private sector to seek out and further develop untapped human capital.

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Doing good business, for profits, people and the planet

DCR 2016Erik Solheim, Former Chair of the OECD Development Assistance Committee (DAC), based on the editorial of the 2016 OECD Development Co-operation Report: The Sustainable Development Goals as Business Opportunities.

In 2015, when world leaders adopted the Sustainable Development Goals, we committed to the most inclusive, diverse and comprehensive and ambitious development agenda ever. By doing so, we acknowledged that development challenges are global challenges. The new global goals represent a universal agenda, applying equally to all countries in the world.

The year 2015 was the best in history for many people. We are taller, and better nourished and educated than ever. We live longer. There is less violence than at any other point in history. Over the past decades many countries, spearheaded by the Asian “miracles” – such as in Korea, the People’s Republic of China and Singapore – have had enormous development success. By believing in the market and the private sector, these nations have experienced strong economic growth and several hundred million people have been brought out of poverty. The debate within the development community on the importance of markets and the private sector is a thing of the past. The debate is won.

But based on astonishing success, we need to bring everyone on board. The 2030 aim is to eradicate extreme poverty, but to do it in an environmentally sustainable way. Luckily – for the first time in history – humanity has the capacity, knowledge and resources needed to achieve this. Never before was this the case. The leaders of the past have never set such goals, nor did they have at their disposal the policies and the resources to reach them. The Sustainable Development Goals cover the economic, social and environmental dimensions of life. And they emphasise that increased co-operation between the public and the private sector is vital to reach them.

Implementing the new Sustainable Development Goals will require all hands on deck, working in concert to build on each other’s strengths. In this report we look at the opportunities for businesses both to make money and do good for people and the environment. We must go beyond traditional thinking that business revenues depend on destroying the environment. Smart investment in sustainable development is not charity – it is good business and it opens up opportunities.

In developing countries, small and medium enterprises are considered the engine of growth. In Asia, they make up to 98% of all enterprises and employ 66% of the workforce. Especially for green growth, small and medium businesses can play an important role by acting as suppliers of and investors in affordable and local green technologies. For instance, in Africa several businesses offer “pay-as-you-go” solar energy to low-income households that do not have access to central resources.

Over the next 15 years, billions will be invested annually by the public and private sectors. We need to make sure that this money creates jobs, boosts productive capacity and enables local firms to access new international markets in a sustainable way. What’s more, these flows are often coupled with transfer of technology that has positive and long-term effects.

This report cites the results of interviews with executives from 40 companies that had performed above the industry average in terms of both financial and sustainability-performance metrics in various sectors – including oil and mining, gym shoes, soup, cosmetics and telecommunications. The research demonstrates that sustainable action can contribute to increased efficiency and profits, gains above and beyond their social and environmental benefits. The returns on capital include reduced risk, market and portfolio diversification, increased revenue, reduced costs, and improved products.

We need to take these experiences further. The 17 Sustainable Development Goals represent a pipeline of sustainable investment opportunities for responsible business. But fulfilling that potential will mean ensuring that business does good – for people and the planet – while doing well economically.

Although some countries are making progress, no country has achieved environmental sustainability. The worse things get, the more difficult it will be to find solutions. We need to take action now. There is more bang for every buck when profits are combined with bringing people out of poverty, improving environmental sustainability and ensuring gender equality. For example:

  • Ethiopia’s growth has benefited the poor and the country aims to become a middle-income country without increasing its carbon emissions.
  • Brazil has reduced poverty and equality while cutting deforestation by 80%.
  • Costa Rica has revolutionised conservation by providing cash payments for people who maintain natural resources. Forests now cover more than 50% of the country’s land, compared to 21% in the 1980s.
  • The Indonesian rainforests, the largest in Asia, are doing much better than recently. Deforestation decreased for the first time in 2013 and the positive trend is continuing. The main palm oil companies have made a no new deforestation pledge.

Poverty reduction can be green and fair. But we need to remember that neither developing nor developed countries will sacrifice development for the environment. But development comes to a stop if natural resources are exhausted, water continues to be polluted and soils are degraded beyond manageable levels.

For those who do not benefit from all the success stories, it is necessary to identify and replicate good policies that actually improve lives. Official development assistance is important for the least developed nations and countries in conflict. Aid remains at a record high at USD 132 billion in 2015, but private investments are more than 100 times greater than aid and more important for poverty reduction and economic growth.

In order to make the most of private investments for sustainable development, it is fundamental to know more about how much is being mobilised from the private sector as a result of public sector interventions. In this report the OECD describes how it monitors and measures the amounts being invested. The European Union found in 2014 that by blending public and private investments, EU countries used EUR 2 billion in public finance grants to mobilise around EUR 40 billion for things like constructing electricity networks, financing major road projects, and building water and sanitation infrastructure in recipient countries. We should be inspired by this example to do more. Business prospers when society prospers.

Each and every decision we take today related to private investment will have historic implications. We must learn that more and better investment is possible. Balancing economic growth with environmental sustainability is not only feasible – it is fundamental.

In this report we look at the opportunities the new Sustainable Development Goals offer for doing good business, for profits, people and the planet. It offers guidelines and practical examples of how all sectors of society can work together to deliver the 2030 Agenda. Investing in sustainable development is not charity, it is smart. We just need to go ahead and do it.

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Challenges Facing Asia and Pacific in Terms of Sustainable Development

NAECStephen P. Groff, Vice President (South East Asia, East Asia and the Pacific), Asian Development Bank

Despite great strides in reducing the number of people in abject poverty, Asia and the Pacific remains home to more than half of the world’s extreme poor. With the global and regional economic outlook uncertain, the key challenge facing Asia is to sustain the growth needed to create jobs and reduce poverty.

Just as important is making sure that development efforts to address poverty tackle the multi-dimensional nature of the problem. The Sustainable Development Goals (SDGs) recognize that many challenges overlap in areas such as water, sanitation, education and health,—and demand an integrated approach. Balancing multiple components in a single project adds to complexity, so we need to take careful note of lessons learned from such past interventions. Doing so ensures that our efforts at a project level reinforce structural and macro-economic reforms to promote economic growth, and increase well-being.

In that regard, there is wide agreement that growth must be socially inclusive. Performance on many Millennium Development Goal (MDG) indicators demonstrates that economic growth and income poverty reduction alone have not reduced many forms of deprivation. While countries were generally able to meet the primary education-related MDG targets for enrolment and completion rates, the target for reducing the number of underweight children, child health and maternal mortality, will not be reached. Many were also off-track on access to basic sanitation, which is associated with poor health. While the MDG on gender parity in education is expected to be achieved, progress on women’s empowerment is lagging.

These persistent gaps are worrying, as rising disparities of income and access within and across countries and subregions can undermine social cohesion and erode development gains. Continuing gender disparities, for example, lead to loss of valuable productive human resources, which affects a country’s economic performance as well as the social fabric of its communities.

Compounding these problems are environmental threats such as increasing greenhouse gas emissions, loss of biodiversity, and changing weather patterns leading to flooding and droughts, which harm the livelihoods of vulnerable people in particular. They also intensify pressures on natural resources, which are likely to worsen as Asia’s population grows.

Such realities highlight the inter-linked and multiple dimensions of challenges to be addressed under the SDGs.

What can we learn from the implementation of the MDGs?

In this context of overlapping challenges, well designed projects and programs can make a real difference to people’s lives. Our experience with multi-sector activities in the social sectors “pre-2015” offers useful insights for such programs going forward.

First, for international finance institutions, difficulties in achieving targets in multi sector projects can lead to low performance ratings and inadvertently create internal disincentives. In response, we have shifted our operational strategy by:

simplifying project design; a sector-specific approach with fewer components should be adopted if conditions don’t suit a multi-sector approach; assessing, and where needed, strengthening the capacity of the government in undertaking multi-sector operations e.g. for municipal services; creating incentives for citizens to access services through approaches such as conditional cash transfers; working with governments to engage alternative and efficient service providers, like NGOs, SOEs and the private sector, for service delivery and accountability; and modifying financing arrangements to better support large government-led programs, where these work well and are delivering outcomes reasonably well.

Second, while the MDGs were primarily viewed as goals for governments, their implementation has highlighted the importance of partnerships between governments, citizens, and the private sector if we are to deliver on the SDGs. While the understanding and commitment to the SDGs from all partners is strong, much more remains to be done at the country and regional levels to translate these international development goals into laws, regulations and operational policies adhered to by all parties.

Third, the implementation of the MDGs underscores the importance of data and knowledge to guide incremental improvements in operations. The advent of the SDGs is opportune as it coincides with technological advances in a more open and globalized world that will allow us to undertake operational research using new tools such as the web, satellites and mobile phones; communicate with stakeholders with powerful images and data on what is happening in our classrooms, to our forests, and within the oceans; and use social media to debate, inform policy priorities and fine tune government programs.

These lessons help to expand country ownership, sharpen the focus on development results, attract private sources of financing, and encourage innovation. They build on lessons from the MDGs and can be scaled up under the SDGs.

Role of International Financial Institutions (IFIs) in supporting the SDGs

The SDGs are ambitious and demand integrated agendas for action, providing new opportunities for IFIs to respond to the evolving needs of countries. Two particular areas deserve increased attention to enable integrated actions that deliver results: financing for development and sustainable development investment.

IFIs can play crucial roles in strengthening financial markets, catalyzing private sources of finance towards development, expanding domestic fiscal resources and, importantly, helping direct increasing resources for climate finance to countries where such investment is needed.

Asia’s diversity makes it critical that investments in sustainable development and other financing instruments are tailored to individual country conditions. ADB is expanding its financial capacity to provide significantly higher resources for lending operations, based on the differing needs of our member countries. We plan to boost annual lending, increasing from an average of $13.6 billion in 2012-2014 to at least $16.8 billion by 2018, and possibly reaching $20 billion by 2020.

Meeting the SDGs will be an operational challenge, but one that offers IFIs a chance to recalibrate their strategies for maximum impact. ADB has started work on a new long-term strategy for 2030 to respond more effectively to the region’s fast-changing needs. Meeting the SDGs in the region will be a core goal, and providing integrated, multi-sectoral assistance will be central to our success.

Useful links
Asian Development Bank VP Stephen Groff on development in Asia-Pacific

OECD work on the Sustainable Development Goals