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Investment over aid: Creating sustainable impact in developing countries

November 2, 2017 By: MaRS Centre for Impact Investing

By Emma Hogeterp.

In 2009, global economist and Zambian author Dambisa Moyo made a bold claim is her book Dead Aid: the $2 trillion of aid that had historically been sent from the Global North to the Global South had actually made conditions worse in developing countries. The solution? Greater foreign investment in businesses and social outcomes. The insights of Moyo – and many others – set the stage for a growing focus on impact investment as an alternative to aid in frontier markets.

Since 2010, more than $300 million has been put into social impact bonds, a type of investment vehicle that aims to create measurable improvements in social issues. In the context of frontier markets, a similar vehicle has been created: development impact bonds (DIBs). These bonds are a new concept for aid spending that several stakeholders can take part in, from not-for-profit organizations to high-net-worth private investors.

The first DIB

The world’s first development impact bond for education was created in 2015. Investors agreed to receive payments based on improved learning outcomes and higher enrollment of girls in Rajasthan, a state in northeastern India. Enrollment targets have nearly been reached, but with one year left in the bond’s term improved learning targets are only 50 per cent met. This demonstrates the investment risk profile associated with this nascent vehicle.

There are several advantages to these innovative financing opportunities over traditional aid, which totals $150 billion a year. For example, DIBs are results-focused. The close link between funding and project outcomes holds service providers accountable for creating positive change and robustly measuring it. With the financial risk transferred from service providers to investors, development programs have more flexibility to innovate and access capital than ever before.

However, mechanisms for measuring social outcomes and connecting funders with investments are complex and still experimental. Consequently, transaction costs and risk of project failure for DIBs are higher than those for traditional investments. This has limited the pool of investors to only those willing to take risks and be innovative. The World Bank Group has been among the first to take this leap.

Next wave

DIBs and other forms of impact investing in frontier markets are novel, exciting and uncertain. Moving forward, early adopters must build a compelling track record for the first iterations of DIBs so that subsequent waves can be made more efficient, effective and accessible.

As the international aid landscape and impact investing mechanisms continue to shift and improve, so will the opportunity to turn social issues in frontier markets into investible prospects.

About the author

Emma Hogeterp is a fourth year student pursuing a dual degree in Honors Business Administration at Ivey Business School and Honors Spec. Global Development Studies at Huron University College. Emma is Co-Chair of Ivey Leaders Forum and Co-President of the Ivey Not-for-Profit Club. She has worked as a Transition Project Coordinator for a non-profit organization in Toronto and traveled to Ghana, where she wrote a business case on a start-up hub for women in tech.