Finance: An Indispensable Driver of Economic Growth
Finance is currently front and center in the development community - and it should be. Finance is an indispensable driver of economic growth, the source of human prosperity, and essential to accomplishing USAID’s development objectives.
But the nexus between finance and development is not always clear. For many in development - those trying to accomplish better health, improved education, or cleaner water - the relationship of finance to achieving those outcomes may not be obvious. This post explores how finance fits into the development agenda - as well as how USAID and implementing partners can mobilize more finance in support of development.
But first - a short definition. Finance is a basic human function - humankind has always traded goods and services. And finance is simply the trading of stored value or 'capital' with which to obtain other goods and services. But for this post, we are referring to finance as "the bundling and allocating of capital", primarily done by finance providers (lenders such as banks and pension funds and by investors such as investment funds) to finance seekers (households, businesses and public entities who require capital).
OK - well and good but why does this matter? Simple. Economic growth is driven by productivity improvement, which requires investment of capital - e.g., a higher degree, new technology, modern agricultural processing equipment, etc. Since most households or businesses don't have abundant ready capital sitting on the shelf, this requires the acquisition of capital through loans or the granting of equity (partial ownership in an enterprise), which is finance.
When financing is not available - businesses cannot launch and grow, municipalities cannot invest in critical infrastructure, and households cannot respond to shocks or invest in higher education.
The Good, the Bad, and the Best?
The good news: There is abundant capital in the world - both international capital seeking investments in the developing world, as well as huge pools of domestic (local currency) capital within the developing world.
The bad news: Access to that capital is constrained in our partner countries. It doesn't flow as smoothly as it might, and when it does, the rates tend to be higher as a result of higher transaction costs and risks. As a result - fewer 'good' transactions (producing positive cash flows) obtain financing. And that equates to fewer dollars available for businesses, to finance private rural health clinics, and to fund municipal water purification systems.
The best news? USAID has tools and resources through which it can help mobilize this financing. The Agency has a long history of financial sector development - working systemically with the World Bank and others to create stronger financial sector ecosystems. This includes building good regulatory institutions, as well as building modern financial infrastructure - for example reliable credit information systems, internet-based collateral registry systems, and efficient capital markets. And these efforts have unlocked astounding amounts of capital around the world. For example, Domestic Credit to the Private Sector as a Percent of GDP in Low and Middle Income Countries has grown from 51 percent in 2000 to 119 percent in 2020 - unlocking $33 trillion of credit which can be channeled for development.
We also have the capacity to engage transactionally, to ensure financing for investments with strong economic and social benefits - but perhaps slightly shy of the higher financial returns required. In the Kenya Investment Mechanism, USAID expects to catalyze over $500 million of financing to modernize agriculture - with a project cost of $25 million over five years. Blended finance (the use of public funds to catalyze private capital) has proven to be a powerful new tool. New and disruptive technologies such as FinTech are changing the traditional model of how financial services have been delivered. USAID has developed the Five Point Framework as a tool to identify constraints, as well as potential interventions to overcome or mitigate those constraints.
Finance matters, and USAID is eager to catalyze more financing which supports development. For more information - please see the Marketlinks section on Finance, the Finance Wiki, and the online four hour Mobilizing Finance for Development Course.
If you have any questions regarding this piece, please contact the Marketlinks Team.