Fighting poverty by cultivating business: Recommendations for Canada’s Development Finance Institution
Canada isn’t the first to promote global development via the private sector. As Chris W. J. Roberts explains, decades of experiments have provided crucial lessons for effective support.
After 40 years of discussion and nearly 20 years of evolving PowerPoint decks floating around Ottawa, a Canadian Development Finance Institution (CDFI) is finally getting rolled out.
Since Prime Minister Justin Trudeau’s announcement in May that the CDFI will be headquartered in Montreal, recruitment of the managing director has been underway and stakeholder consultations have been held. This is an exciting time for those of us who have long advocated for improved Small and Medium Enterprise (SME) access to financial instruments tailored to commercial, employment-creating activities in the developing world. Without a dynamic private sector there is no development.
Thus, this is the exact time to bake in the following four foundational pillars to create a truly innovative, effective, and Canadian DFI: Make it SME centric; ensure all stakeholders have skin in the game; promote business-researcher collaboration; and leverage digital technology to encourage lean operations but a wide presence.
With limited capitalization and a late start, Canada’s DFI needs to become a highly specialized player in development finance if it intends to make a difference. Before I explain these potential foundations in more detail, some context is in order.
Back in 2000, the Chretien government launched Canada’s first Africa Trade Strategy (disclaimer: I was an outside consultant on that project for DFAIT). To quote directly from the appendix: “By far the largest number of Canadian firms targeting Africa are SMEs....developing Canadian sources of financing is necessary to achieve greater Canadian private sector participation in Africa.” The strategy identified a significant funding gap for Canadian SMEs trying to undertake commercial activities in Africa beyond simply exports.
A few years later, after the 2002 G8 Summit in Kananaskis, Alberta, the Canadian Investment Fund for Africa (CIFA) was launched amid great fanfare. The hope was CIFA would catalyze Canadian investment and commercial interest in Africa, the continent with the most pressing financing gaps. Unfortunately, CIFA, based in Montreal and jointly run by Cordiant Capital and the UK’s Actis, failed on both counts even if the money managers themselves did all right (it would take a separate article to justify that conclusion, but a conclusion that is widely shared).
It is not surprising, then, that the initial announcement by the Harper government in 2015 followed by the Trudeau government’s 2017 decision to move ahead with the CDFI has reopened debates about what a DFI should actually do.
There is now 50-plus years of other country DFI experience to examine. Export Development Canada, the responsible agency, commissioned a consultant to review best practices for evaluating developmental impact. While reviewing the existing track record is a necessary step, if Canada wants to create an innovative and effective DFI it has to do some things differently.
Guidelines circulated by government about how this new institution should be implemented are surprisingly well thought-out. They suggest that creating jobs, promoting economic growth and reducing poverty are concurrent objectives. They leave open the door to creative, catalytic financial instruments, not just equity or debt. The guidelines also promote the inclusion of Canadian participation without a hard Canadian content requirement.
Additionally, as there is no doubt that women’s options within the private sector are more constrained on average than men’s, the guidelines ensure awareness of that problem is built into the CDFI’s operational code. This is not just a nice addition, it is crucial. That doesn’t mean only women entrepreneurs will be funded, but it does mean that the extra impediments to women’s success in the private sector need to be identified and those distortions, hopefully, overcome. Ethical, environmental and human rights impacts of supported businesses will also need to be considered.
In other words, so far, so good.
But to ensure the CDFI does not simply recreate the wheel and become another top-down bureaucratic agency that succumbs to risk aversion or the next development fad, four bottom-up foundations (mentioned earlier in this piece) need to be included too.
1. Focus on small and medium-sized businesses.
The CDFI should be purely SME centric for three reasons: capitalization will be modest, SMEs drive economic growth and employment, and that is where the biggest financing gap remains. There are also secondary benefits: for instance, a successful SME in a developing country, even with Canadian partners, doesn’t have the option to engage in complex transfer-pricing and other tax avoidance strategies that larger firms pursue with their teams of lawyers, accountants and Cayman Island subsidiaries.
2. Ensure everyone has ‘skin in the game.’
Second, and the most difficult but most critical recommendation, is to ensure all stakeholders have skin in the game in every transaction. What does this mean in practice? I’ll use the stories of three individual Canadian entrepreneurs (but will withhold their last names) as an example of investee skin in the game — three who tried to make a difference pursuing profit but always with an eye towards the broader local benefits their success would entail. John was enticed to leave Canada and work on a struggling government-owned West African refinery that needed major upgrading. He had to set up a local firm, find skilled workers, import expensive machinery, and take massive financial risks to get the work done. Gerry worked in Tanzania with local fruit growers to connect them to the technology and importers that would facilitate value-added dried fruit exports to North American markets. Allan invested his own cash and time in a joint agri-food business in Zimbabwe with local farmers, trying to enhance productivity across a range of food crops for the local market.
All three of these Canadian SME pioneers in Africa sought to make a lasting difference. Their personal financial success was dependent on the overall success of their projects, and all of these ventures would have significant local economic and employment benefits.
Unfortunately, the long-term success of John, Gerry, and Allan — all in their early-to-mid sixties — was cut short due to fatal ailments. While none of these early deaths had anything to do with tropical diseases, all three faced constant frustrations pursuing commercial projects in markets not always friendly to private sector operations. This is not just a criticism of the countries where they worked — where governments too often remain an obstacle, not a solution, to development — but also with the lack of support and financial instruments available, in Canada or locally, designed expressly for the SME sector.
These were all practical, hard-working Canadians who thought in commercial terms, understood the potential of mutual benefits, and applied their own money, skills and time to make something happen. But too many international and local SME entrepreneurs who have real skin in the game have nowhere to turn. They would see “big development” come and go: local and international bureaucrats, consultants, advisors, bankers and NGOs flit around, launching this project or that initiative. But what really counted, cultivating an environment that allowed local and international SMEs to thrive, was rarely a priority. The incentive structures in the development game are too often skewed towards enhancing development’s actors, not cultivating a vibrant private sector.
These three stories represent a microcosm of what actually goes on below the radar screens of big development and big business. John, Gerry and Allan were all from Western Canada, a region that would pale in comparison to Quebec and Ontario for generating these kinds of entrepreneurial links across the continent. Canadian diaspora communities too, from coast to coast, are increasingly trying to build long-term private sector linkages from Somalia and Nigeria to South Africa and Tunisia. These entrepreneurs expose themselves to financial and other risks. We expect international and local SMEs to take some risk: to have skin in the game is the ultimate incentive. But how do we recreate this attitude for CDFI managers?
The CDFI needs to promote an entrepreneurial culture within its own ranks: not managers and administrators, but empowered, analytical risk-taking partners. Employees need to learn more from venture capitalists and business owners than from development or government administrators. If CDFI launches with complex sets of targets, measures and indicators in place to gauge “development impact,” they will stifle the very sector, SMEs, they intend to help.
3. Promote collaboration.
The CDFI needs to promote a unique, proactive business-researcher collaboration model that leverages the experience and data SMEs produce on an ongoing basis but without extra costs or red tape for those SMEs. The CDFI would then be structured as a dynamic learning organization that increasingly understands the business environment from the bottom-up.
4. Leverage digital technology.
CDFI partners need to gather information and generate knowledge about the institutional impediments facing entrepreneurs, share that with policymakers in Canada and host countries, and hopefully create pressures for changing identified impediments. This can all be done by leveraging the digital world. This approach also links a learning and support component to each business to assist them in managing transparency, corporate social responsibility and environmental issues, rather than just issuing decrees and guidelines that have to be met.
Canada thus has two options, and we’re at the critical juncture now. The first and most likely option is to continue down the current track and create a well-meaning, bureaucratic DFI that will continue the well-established but long-discredited top-down approach towards viewing poverty alleviation as the solution to the development dilemma. With a bit more resources and the right policy framework, this line of thinking goes, a DFI can achieve a host of positive results including, most importantly, instrumentalist poverty alleviation. But the real results of this approach will only be measured in jobs created, in Montreal.
The second option — one with significant potential to create an innovative, effective, and truly Canadian DFI — is to build a dynamic, entrepreneurial practitioner-researcher institution that sees the world from a bottom-up perspective and is willing to partner alongside investees to generate real-time, real-world data about the obstacles facing SMEs in developing markets. This model assumes that commercial SME success in the target economies fights poverty through employment creation, local procurement and asset growth.
The foundational DNA discussed above (that is, a DFI based on four principles: SME centric; skin in the game; business-researcher collaboration; and digital leanness) should become Canada’s unique contribution to the DFI space.