September 22

Martin Herrndorf

All that Glitters is Good?

In the old and dusty-yet-safe world of development aid, things were easy: Profit was at best a necessary evil of the private sector, at worst a sign that the poor were exploited as cheap labour or consumers. In the new world of impact investing and “BoP strategies”, things become more entangled. A Policy Forum of the German Federal Ministry of Cooperation (BMZ) tried to map the new landscape between profit and development, and shape the future of public-private partnerships in the field.

Profit as “the best measure we have”?

The forum kicked off with a, partly provocative, laudation on profit and private entrepreneurship, provided by Michael Klein, former development banker turned lecturer at the Johns Hopinks University and the Frankfurt School of Finance and Management.

He advocated going beyond the “prostitution theory of profit” – where profit is a necessary evil that allows a business to then do good. Instead, he stressed that profits come from offering a products that consumers actually want, and producing it with resources that are less valuable than would they have been applied in other places. So, profit is good, and a good albeit somehow indirect indicator that a business is making a social contribution. Businesses that make products that nobody (on this blog: the poor) do not want go out of business (or, as a side-note, are rescued with state money to avoid “systemic failure”).

From this perspective, the world of development can be turned on its head. The new heroes are mobile phone operators, providing communication services highly valued by the poor, and soap opera producers providing highly valued entertainment. Low-profit bed-net producers that need access to “patient capital”, however, are lazy laggards that don’t adequately respond to consumers demand, or so this mindset would dictate.

On of the big advantages of such a perspective is that it enables failure. Unthinkable in the world of tax-payer-backed-donor-money, failure becomes possible in the private sector world. And with failure comes the ubiquitous twins of risk and reward – taking higher risks, that include failure, will allow development actors to go for even higher rewards (financial and, by definition, social). And current non-profit, grant-dependent organizations would invest in productivity (and cost savings) and develop service that are higher-valued then their current offerings – converting to profit-driven companies over time.

Apart from being a nice theoretical take, some development actors with a market-based approach start seeing first evidence: Toshiya Masuoka, from IFC, reported on their efforts to identify BoP projects in the portfolio and see how profits and social impacts measure up – what they found was coincidence, not a trade-off.

Power and “the social”

The tone set by the opening speech dominated the discussion afterwards.

One point concerned the role of “power.” While profits in BoP mainly depend on the willingness of poor people to part from their money, the “social” is actually defined mainly by outsiders – in the burgeoning industry of impact investment funds and social measurement experts. Vineet Rai, founder and CEO of Aavishkaar, supported this point by stating that he will “use everything that my investors ask for” in terms of proving that he makes an impact. Still, despite all this report, he is still rather skeptical whether his organisation really has a pervasive “social impact” through reducing poverty.

A related issue has been that of “language”. Many entrepreneurs in developing countries are surprised to learn that they are actually “social entrepreneurs”, in high demand by “impact-first” or “profit-first” social investors. And while their main focus was to serve customers and keep cost low, they suddenly become exposed to elaborate requirements to analyse and prove their social impact.

The limits of profit

While not discussed at the conference, I feel two main counter-arguments can be made against profit as a proxy-measure for social impact.

First, the whole arguments depends on the absence of state and market failures. Businesses that can off-load costs on the environment, or get access to valuable resources through illicit means, for example corruption, might be highly profitable – but surely not considered socially beneficial. Still, markets in developing countries are highly prone to exactly these failures – reasons why companies failed to serve the poor in the first place, and why profit remains a shaky, if not outright misleading measure.

Second, current levels of inequality around the world and within countries distort the meaningfulness of profit as a measure of social impact. Even in mainstream economic theory, a dollar spent by a poor person yields more “utility” than that spent by a rich person (also called the “law of diminishing utility”). In laymen’s terms: Five bucks spent by an Indian tourist on a beer in New York are less representative of progress then five bucks spent for a family’s monthly supply of fresh water in a remote rural village. While inequality in part represents different ability or willingness to work (and thereby contribute to societal well-being), the current levels of inequality are rooted in other factors, closing that intellectual backdoor.

What does that mean for development actors?

The whole conference was about identifying implications for development actors – and will feed into the “G20 Multi-Year Action Plan on Development” and the “Fourth High-Level Forum on Aid Effectiveness” in Busan.

So here, some (broad) implications from my concerns:

First, donors should (continue to) invest in fixing market and state failures – fighting corruption, improving legislation, etc. Second, when making direct investments through development banks, priority should be on businesses that pro-actively avoid exploiting market and state failures – and instead work to minimise their negative impacts. On the problem of inequality, they can support re-distributive policy measures (like conditional cash transfers), or through investing in businesses that specifically target the poor, consciously forgoing larger profits to be made among up-market clients.

Considering the current scale of problems, we surely need to solutions that mobilise the best of the public and private sector for market-building. And donors understanding that profits are not available – but sometimes the direct outcome of doing – is surely an important first step.

This blog post expresses the personal impressions and opinions of the author – a formal summary of the policy forum will be made available by the organisers in the coming weeks.

Impact Assessment
Base of the Pyramid, patient capital, social impact