Development Finance: A Missing Instrument for Canadian Power

  • photo courtesy of GoodNCrazy www.flickr.com/photos/40215657@N03/3950937655
    Feb 26, 2014

    Over the last 30 years, the private sector has emerged as an indisputable driver of global development. The prominence of the private sector is no exception in Canada: looking at some of the most significant Canadian industries (e.g., mining and telecommunications), it is clear that a considerable part of Canada’s economic future lies in emerging economies. In this changed landscape, Canada needs the capabilities to engage with and encourage private sector activities in developing countries.

    For decades, Canada has been one of the most reliable donors in global development and was a founding member of the Development Assistance Committee (DAC) of the Organization for Economic Cooperation and Development (OECD). In 2012, Canada disbursed over $5.6 billion in official development assistance (ODA), ranking sixth among all OECD/DAC members, behind only the United States, the United Kingdom, Germany, France, and Japan, all countries with a significantly larger gross national income than Canada. Yet Canada remains the only member of the G-7 group of developed nations (the abovementioned countries plus Italy) to lack a proper development finance capacity. As a major foreign policy and aid actor, Canada requires a development finance institution as an appropriate complementary instrument to its soft power. Canada should draw upon 40 years of development finance experience from its fellow donors and build a development finance institution for the 21st Century.

    What are development finance institutions?

    Development finance institutions (DFIs) work within, and bridge the space between, public development aid and private investments by seeking to encourage economic growth and crowd in private investment through loans, equity investments, and infrastructure projects. By investing in and facilitating investments in areas that the private sector might view as too risky and for which the public sector lacks financing, DFIs sustain themselves by operating to obtain a profit which can then be used for future investments. However, these institutions have traditionally received attention only as an afterthought to traditional bilateral assistance.

    DFIs reflect the changing realities of global development, namely:

    1. a growing recognition of the private sector as the creator of wealth and the engine of development;
    2. increasing pressure on publicly-financed development assistance following across-the-board reductions in aid for traditional donors, particularly traditional grant-making; and,
    3. the reduced availability of lending capital as a result of the global financial crisis.

    PROPARCO (France), FMO (Netherlands), KfW (Germany), and CDC (United Kingdom) are some of the major European development finance institutions that allow these countries’ governments to further their global development goals in the face of shrinking appetites and budgets for ODA. The Overseas Private Investment Corporation is the primary American DFI, though it has its notable limitations. The U.S. government also relies on a variety of other agencies for development finance, including the U.S. Trade and Development Agency, the Millennium Challenge Corporation, and the U.S. Agency for International Development (USAID). In addition, the World Bank’s International Finance Corporation (IFC) and the European Bank for Reconstruction and Development are multilateral DFIs.

    What lessons can Canada learn from other DFIs?

    The recent merger of the Canadian International Development Agency (CIDA) with the Department of Foreign Affairs and International Trade to form the new Department of Foreign Affairs, Trade and Development (DFATD) offers an opportune moment to establish a development finance capacity for the Canadian government.

    Canada can draw on the experience of fellow DAC members in setting up and fine-tuning its own DFI, turning in particular to the Dutch and British approaches. Canada should closely study FMO, which is recognized as a particularly effective approach to development finance, both in terms of its project financing and its relationship with the Dutch government. The British CDC, meanwhile, can also serve as an excellent point of reference for a hypothetical Canadian DFI for a number of reasons, not least the unique relationship between fellow Commonwealth countries. In 2011, the Department for International Development (the British equivalent of USAID) conducted a comprehensive review of CDC, leading to substantial reforms of the organization to improve its effectiveness. As part of these reforms, CDC’s toolkit was expanded, but concurrently, CDC narrowed its scope of activities to low- and lower-middle-income countries, specifically in South Asia and Sub-Saharan Africa. These experiences by other countries’ DFIs offer many potential lessons both for the establishment and operationalization of a Canadian DFI.

    What structure and authority does a Canadian DFI need?

    Canada should build a standalone development finance institution with ties to other agencies but with separate authorities and a distinct culture that accommodates the transaction-based activities that DFIs engage in. A Canadian DFI should also possess certain critical features:

    • the ability to retain its profits;
    • the ability to use its profits to pay for complementary technical assistance (TA) activities;
    •  a standalone TA fund with possible TA implementation capabilities, akin to the IFC’s Advisory Services;
    • the ability to use its profits for transactions that are not fully financial—this could include activities such as “first-loss” funding or other forms of risk-sharing;
    • some equity authority.

    A Canadian DFI should also be governed by a board that includes representation from the different Canadian political parties, the new DFATD, the Department of Finance, Canadian civil society, and the private sector. Its CEO should be an individual with government and/or international financial institution experience, but importantly, someone who possesses some development sensitivity and does not see development finance as a purely banking activity.

    Such an agency could be capitalized for a relatively small amount of money and be set up over the course of a few years. It could take pieces of other deals by other countries’ DFIs to get started, as it develops its own capacities and human resources over time. Initial regions to focus on would be those countries where Canada has a significant foreign policy and assistance presence, especially where DFATD is already pursuing development cooperation activities. Haiti, for instance, is a prime example of an initial target country for a Canadian DFI. Canada might also consider targeting emerging markets with which it is cultivating ties and with which it holds free trade agreements (Canada is party to ten free trade agreements). A Canadian DFI should not limit its activities to the Western Hemisphere or to Canadian companies.

    Development finance is an important way for traditional donors to keep up with the rapidly shifting realities of global development, including domestic constraints and the changing needs of recipient countries. Canada would further global development goals and its own national interest by establishing a development finance institution informed by the experiences of other donors.

    For further reference, see the following CSIS reports:

    Sharing Risk in a World of Dangers and Opportunities: Strengthening U.S. Development Finance Capabilities (December 2011)

    Strategic Foreign Assistance Transitions: Enhancing U.S. Trade and Cooperation Relations with Middle-Income Countries
    (July 2012)

    Our Shared Opportunity: A Vision for Global Prosperity (March 2013)

    Daniel F. Runde is the director of the Project on Prosperity and Development and Schreyer Chair in Global Analysis at the Center for Strategic and International Studies in Washington, D.C. Amasia Zargarian is a research associate with the Project on Prosperity and Development at CSIS.

    Critical Questions
    is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

    © 2014 by the Center for Strategic and International Studies. All rights reserved.

Find More From:

Daniel F. Runde