TUESDAY 17 DECEMBER 2002

__________

Members present:

Tony Baldry, in the Chair
John Barrett
Mr John Battle
Hugh Bayley
Alistair Burt
Mr Tony Colman
Mr Robert Walter
Tony Worthington

__________

LORD CAIRNS, Non-Executive Chairman, MR PAUL FLETCHER, Chief Executive, MR RICHARD LAING, Finance Director and MS GILLIAN ARTHUR, Managing Director, Operations, CDC Capital Partners, examined.

Chairman

Thank you very much for coming to see us again. We all felt it might be helpful to clear the air in the sense that what we had originally intended to do was to take evidence from you in the summer, write to the Secretary of State with some questions and publish that letter and her replies. During the course of the summer the Secretary of State, when the House was not sitting, made quite a number of announcements about CDC, so we felt it would be quite helpful to enable everyone to clarify some issues. The first question really is to try to get some feeling from you as to the sort of institution you see CDC as being. Is it an elephant, a rhinoceros or a gnu? The Clerk, in his briefing for this meeting, has put down certain suggestions as to what it might be. I should be interested to hear what you think you are. Are you a demonstrator institution providing risk equity in a way which mimics or marginally improves current commercial practice, but with a geographic focus on poor countries, a model which aims to maximise the quantity of investment reaching poor countries by showing to commercial lenders that it can be done? In other words, is CDC about trying to persuade other to follow your lead in going into developing countries? Or are you an investor institution which tries to do what the commercial providers cannot do, for example accept that commercial estimation of risk is often exaggerated and thus be willing to invest in higher risk ventures such as SMEs or companies with long-term horizons? Are you an institution which is going for the parts other bits do not go to? Or are you a mixture of those and are you an experimenter leaning towards the demonstrator model but continually experimenting to push the envelope upwards? Or are you simply a venture capital fund like any other venture capital fund? It would be helpful for us to have some understanding of how you see CDC. What makes CDC different from, say, CBC, which is a commercial venture capital fund investing in different parts of the world?

(Lord Cairns) Thank you very much. I perhaps should first of all introduce Paul Fletcher, who has taken over as the Chief Executive from Alan and whom you will not have met before. My other colleagues were here on the last occasion. To answer your question, very simply, one objective is to maximise the amount of third party monies which we can bring alongside government. The second objective is to help create and build sustainable businesses in our chosen markets which we call, in shorthand, the CDC universe. Those are our two objectives. They are very simple, they result in us doing rather different things from a lot of other people by virtue of the fact that our shareholder, DFID, have pointed us very specifically into these markets. We are operating to a standard in those markets which very few other people are able to do, as typified by the number of people we have on the ground in parts of the world where other conventional players might have a fly-in/fly-out role. We hope that through that we can achieve both those objectives in terms of better understanding the businesses which are in those markets and also are able to convince third-party investors that we have something special to offer them and that if they wish to invest in those markets, they would be pretty stupid not to come along and talk to CDC about it. Whether that goes through the alternatives you have offered or not, it would be my way of trying to say what we aspire to and I hope as far as possible can achieve.

Just out of interest, is it possible to give an indication of the sort of scale of third-party investment you are managing to attract?

(Lord Cairns) To date we are responsible for some $400 million of third-party capital. Colleagues will know what our aspirations are, which is really rather more important.

(Mr Fletcher) May I endorse that statistic? Over the last ten years CDC has raised third party funds. I looked at the numbers recently and in aggregate it is about $400 million and just a little over 90 separate investors who have come into these funds across the globe. We do have some experience here. One of the key objectives of CDC is the globalisation of private sector capital alongside the public sector capital which we have today. In aspiration terms I should like to tell you that we are in the process of putting a plan together which will have some landmarks five years out as to the sort of dilution effect we should like to see. I think it is a reasonable aspiration for us to have 30 or 40 per cent of our portfolio in third-party capital in five years' time. I do not want to put hostages to fortune out there because we are right in the midst of our business planning for the next five years, but that seems to me the sort of scale we might realistically anticipate in the difficult markets in which we operate.

Mr Battle

May I say in response to the remarks you have made, that I find it in a way quite encouraging, looked at from a different perspective? You are doing things differently from other conventional players. I should like to ask whether it is possible that you could be thinking, not just about the scale of the mobilisation of capital, but moving away from what I describe as a very old-fashioned, out-of-date view of simply investing this capital and it generating a return, to looking at the link between that risk capital and its impact on poverty. Some have said to me that they would not ask that in the first world. My response to that is that the radical and best are now doing that, they are asking what the impact of investment is in inner city neighbourhoods like mine on the social and economic structure of the neighbourhood. Is it possible to link capital investment to tackling challenges which seem to be not resolved by just looking to a blind trickle-down theory? I should like to ask in particular, if you have that vision that the investment of capital can contribute in terms of social development, economic development, tackling poverty, how CDC would move along that line if there were no systematic assessment of the investment returns' impact on poverty reduction, for example, on poverty reduction targets, millennium development goals? Would you consider linking the objectives of capital investment to those objectives and measuring them?

(Lord Cairns) Gillian, you have probably done more on this than the rest of us. Gillian, among other things, heads the section which deals with the social business principle side of the operation. This is a difficult area.

(Ms Arthur) It is a difficult area. What I would say is that we do look at social impact today; we certainly look at social impact when we invest on an investment by investment basis and go through a whole series of questions and then look to work through those issues. I should say that there are different sectors and clearly the characteristics of those sectors are different and we need to begin to understand that better, to your point about working it through to a poverty reduction connection. We are clearly in industries which have high impact on growth in the country and that is what DFID have asked us to do. For example, if you take financial institutions, which is probably 17 to 20 per cent of our portfolio, they have a high impact on the economic growth of the country, there is great alignment with what DFID is trying to do in terms of creating corporate governance, but the link to poor people is not as obvious. Having said that, there are clearly policies and practices which banks and financial institutions can put in place which we can follow through on in terms of micro-lending, where you can begin to make a far closer connection between the investment and poor people.

What I am groping towards is asking whether it is possible to be dynamic and anticipate the impact rather than just measuring it afterwards. To give a crude example from the north world, a supermarket arrives, there is a big discussion on the impact of the neighbourhood and we try to work out its impact on local corner shopping in our inner city neighbourhood well in advance. We build in the impact on the local economy and some work has been done on that now; not post hoc, not after the investment has gone in, but anticipating and analysing before it goes in. Are you building that capacity into CDC?

(Ms Arthur) I think that some of that capacity is in CDC today. I can think of investments where people have gone through a thought process of considering how this investment will impact on local traders, how this investment will impact on local infrastructure and have begun to think through those things pre-investment. I do not think it is just ad hoc as we go through it. Clearly the first port of call is to make the business sustainable and profitable so that these things have a lasting impact.

The reason I suggest that is I do think you are in a position to get ahead of the game and lead in some of these ways rather than follow the trend and when the whole economic debate is shifting in that direction of linking the micro to the macro. Would you not be much more proactive in leading that rather than following behind?

(Ms Arthur) I would say that today, in terms of where the pack is, we would certainly think that in a number of our investments we have gone through these issues where perhaps others would not. It is very much part of our thinking and I see no reason why it should not become more so.

(Lord Cairns) We see creating sustainable businesses and hoping to create growth as our primary objective. It is not without merit that very recently the Corporation of London, in seeking a social responsibility, social impact assessment looked at CDC as a case study to prove the point.

Where I would perhaps worry about the language is that sometimes we think there are economics and then social impact is a social work added on extra. I do think it is going to become good economics to build the poor in.

(Lord Cairns) We are with you.

(Mr Fletcher) We would agree.

(Lord Cairns) We are with you.

(Ms Arthur) I agree with that. I just go back to the financial institutions, I do think they see that there is a market there, so it becomes very much part of the operating policies and thought processes of a company. That is built in today in the way in which we look at those investments.

Alistair Burt

We talk about promoting and protecting the environment, and your business principles do that, but there is nothing similar on social development; social issues refer to employment standards rather than development. The business principles you have are in fact pretty standard safeguarding measures designed to mitigate adverse consequences rather than maximise positive development outcomes. Our concern is whether mitigation in itself is enough and whether there should be some more positive steps taken towards enhancing your social development contribution.

(Lord Cairns) I hope to some extent we have answered the question in that we do see it in other businesses in which we invest as being good economic policy, good commercial policy to develop, as far as we can, in playing our part, and the part of the companies in which we invest, in all forms of social development, without saying that we can take over the whole world of reforming society in the various countries in which we operate, which we are not equipped to do, but we can play a part.

To what extent do you think you can drive and in some cases push further than would be natural in the circumstances? Where do you feel you can take the lead and be more positive rather than in a sense just playing safe?

(Lord Cairns) Paul, you have been running Africa for a long time. You must have thought about this.

(Mr Fletcher) I do not think we play safe. You are right that we process every single one of our investments, you are right, through the hurdles of our business principles as enunciated. Every single investment we take to the next step and where there are deficiencies we look at what we can do in terms of influencing the outcome. You may know that we sold an investment this year in East Africa. There we found ourselves looking at a very complex inter-relationships around the continued employment of the employees. We took enormous proactive steps to ensure the right outcome, the right outcome for housing, the right outcome for benefits, the right outcome for the social infrastructure for those employees, even though we were selling the business. I do not recognise the rather defensive position you describe for us because we really are very proactive. I would say to you that we could always do better and we shall certainly continue to pay serious attention, as you correctly point out, to taking a leadership role here.

As an example, the International Finance Corporation is moving towards having sustainability as a concept in evaluating its investments. Its investment officers in their job appraisals have to show whether or not the business in which they have invested will add anything developmentally. Is this a practice you could copy?

(Mr Fletcher) Absolutely. All of our investment executives in our Aureos fund are already qualified under the IFC diploma standard. I have asked Gillian to see how we can take a position and effectively replicate that within CDC. The IFC as we speak are doing a multi-country rollout of the standards you describe and indeed have asked CDC not to be a participator but in fact to be a teacher and a case study presenter in that rollout. I would endorse what you say.

To what extent do you measure trickle-down in terms of poverty reduction, such as hiring local people for construction work? Do you do any analysis of this and is this part of your returns process?

(Lord Cairns) I do not believe we do any trickle-down process in any formal sense. Richard, you have had experience in the palm oil plantations in Indonesia and Sumatra. What have you found there?

(Mr Laing) Yes, when you mentioned this proactive nature on the social side I was thinking of an example both in Papua, New Guinea and in Indonesia in a palm oil business. In Papua, New Guinea we took very active steps to improve the schools where our employers were going which we were not happy with. I should say that is going beyond the pure commercial approach. It was important to us in our social approach to the business and we took action there. The second place was in Indonesia, again in the palm oil business, where we were not happy with the housing. This is interesting because our partner in that business said that in his view it was all right. We felt it was not and in this case we put in our own money. It meant bulldozing down some old housing and putting up better housing, against our partners' wishes but we believed it was the right proactive social approach.

In examining something as basic as how much local labour is hired as part of a project in order to ensure that there has been a poverty reduction element in the project, even to that basic extent, to what extent is that measured in your returns on the projects?

(Mr Laing) It is not actually formally measured as such, though the data could be captured if we needed to capture it. We do use local contractors. In the example I just gave, we would use local contractors for that sort of activity.

Do you not think it needs to be measured rather more than you do at the moment?

(Mr Laing) It goes to the heart of what we have been asked to do. It is something we feel strongly about, but at the end of the day our main objective, set for us by our shareholder, is to invest in sustainable private sector businesses, doing it in a principled way, following our business principles. We do measure some metrics, but there are some where we feel at this stage that we do not need to, but we can continue to add to that and we shall continue to add to some of those measures.

Hugh Bayley

In the Doha trade round a commitment was given by the rich world to making it a development round. As far as sub-Saharan Africa is concerned, probably as far as most developing countries are concerned, if we do not do something to improve market access for agricultural produce to the developed world, we shall fail to make it a development round. I should have thought that by common consent that is the single most important area where change is needed in the trade round, yet we heard in our last evidence session that CDC is moving away from agriculture in a strategic way. Do you not think that is a mistake, given your expertise in developing small-, medium- and large-sized agricultural businesses and connecting those businesses with purchasers of their products in developing countries? Is there not an awful lot you could do in this field?

(Lord Cairns) I think I rather got carried away last time by ranting on a bit because it is one of my pet hobby horses. It is perfectly possible under the structure we are looking at, creating CDC going forward, that DFID could say to us or one part could say to the other part of the organisation, "Thou shalt create an agricultural fund which has very low return hurdles". That might be very good social development. I am not sure it would under the current circumstances be a very good way of using scarce capital, just because the circumstances which have been created by the advanced world have made it somewhere between difficult and impossible for that business to become truly sustainable. I regret that as much as you regret that, but for us to develop businesses which do not offer the prospects of attractive returns is to condemn more and more people to live at the margins of society. We may be able to find other ways in which we can help, in terms of developing infrastructure, developing telephone systems which enable more people to operate better in that field. I regret where we are, but those are the facts and we have to operate within the market as we see it. There are certain agricultural investments which we do undertake. You have heard about the massive palm oil business in which we are operating in some of the poorest parts of Indonesia, Kalimantan, Sumatra and Papua, New Guinea. We have a very large business in Zambia, producing a large proportion of the total output there. We are operating in those fields where we feel there is an opportunity to make reasonable returns. I regret there are not more, but under the rules of engagement under which we operate, unless we are given instructions to do something different from what we are doing now, it is very difficult for us to do much for the agricultural sector, although we will always look.

May I lead the conversation directly to Africa? I believe you have a goal to ensure that either half of your business or half of your new business is in sub-Saharan Africa. Is that the case?

(Lord Cairns) Half in sub-Saharan Africa and South Asia; between the two.

It is difficult for me to see any sector of the economy in sub-Saharan Africa which offers greater potential for exports, for earning hard currency, than agriculture. Indeed it so dwarves all the other sectors as far as the poorest countries are concerned that it must be an area in which development policy focuses. Surely a good entrepreneur is not somebody who just does what other people are doing, but someone who spots a niche market, spots something, some field in which they have expertise and can make a contribution which others have not spotted. I am putting it to you that with the expertise which CDC has built up over the years, surely you are in a uniquely good position to build links between producers of agricultural products and markets in the developed world. You have experience of this. Maybe you do not do it through your existing businesses, but surely there is a really important role there to which CDC could make a contribution and I am rather concerned that you are saying this is too difficult an area for you and you back off. I do not see how sub-Saharan Africa can be developed unless we provide access to our markets for their agricultural produce.

(Lord Cairns) There are areas where we are doing this and where we are trying to do this. I suspect we have to stay out of all those commodities which are over-produced by the developed world and where the access is made so difficult. There are some quota places where we can operate at the margin. Paul, you could talk about tea and flowers and vegetables and all sorts of things where we are active.

(Mr Fletcher) You assert that CDC has expertise. I should just like to qualify that expertise. I believe that we have a significant amount of expertise which is deployed in making the judgements as to where best to deploy our capital, which management teams, which entrepreneurs we should back to best effect. I would doubt whether we have or indeed ever had within CDC the underlying expertise to make an appropriate return on investments in the agricultural sector. By way of example, we are actually on the cusp of re-investing in the business I referred to a few minutes ago which we sold this year, which is now run by a truly professional entrepreneur. Where CDC had lost money month after month in that business, in one month he has made money. The reason he has made money is that this is a fully integrated producer-to-market business, able to maximise the advantages of understanding both the freight and the marketing which comes with his position as a producer of horticulture within the African country and a route-to-market in Western Europe. We shall invest in that business and we shall invest significantly in that business. We shall repetitively seek to make investments backing individuals like that within Africa.

Remind me. Is this the York Farm?

(Mr Fletcher) No, it is not.

Which business is this?

(Mr Fletcher) The business we sold was a business called Sulmac.

Was that a horticultural business?

(Mr Fletcher) That is a horticultural business.

(Mr Fletcher) In Kenya.

Surely that process of building a business and then finding a sharp entrepreneur who can sharpen it up, make it into a profitable business, has taught you all manner of things, expertise which you could spread.

(Mr Fletcher) Which we have fully absorbed and going forward we shall continue to seek to expand our portfolio into business of that sort. I fully expect to continue to be able to tell you about our broad agricultural portfolio which we will have. What I suspect we will not have is investments in primary agriculture without the attendant linkages those businesses have to market. The lesson we have learned is that they are very difficult to make money in.

After the last session we had you gave us a list of employment outcomes for the sale of five African agro-businesses, Nanga, Eutco, Kawalazi, Sable and Rwenzori Highlands Tea and three businesses which I think were on the market then, Shiselweni, Sulmac and York farms. In which countries were those businesses and what sort of things did they produce? What lessons can you learn from your experience of running them? In order for them to be profitable, they need to produce good tea and have a deal with Tetley's or Brooke Bond's or someone, do they not? That is a lesson.

(Mr Fletcher) Yes.

What can CDC, having learned those lessons, do to enable other African businesses to get hold over that hurdle, get beyond producing a good marketable product to actually marketing it in a developed country?

(Mr Fletcher) Maybe I could take a specific example . One of the businesses which we have broken up during the course of the year is a business called Tanwat in Tanzania. One part of that business was indeed a tea plantation. We sold that tea plantation to a company in Tanzania called Tanzanian Tea Packers and subsequently injected further money into this. Why? The reason is that this provided another source of production to this company which I believe was established five years ago, with an exceptional entrepreneur who had seen the opportunity not only to source tea within Tanzania but to package tea, brand tea and market it within the local marketplace. We now see a huge opportunity to travel with this entrepreneur, not only in the Tanzanian marketplace, but exporting into international marketplaces. I would totally agree with you. Our ability to replicate that will be governed by our ability to spot the entrepreneurs, the management teams which we can back. They are not thick on the ground.

Do you expect to increase the value of your investments in agricultural businesses and agriculture related businesses in Africa?

(Mr Fletcher) As our portfolio increases in absolute size, I should expect the agricultural component to remain about constant, if we look at a pure statistical basis of today's existing assets.

Tony Worthington

I am seeing this in structural terms rather than project terms. We used to see CDC as a means by which the British Government, CDC, linked the African world, using Africa as shorthand, to our markets. Then the government changed your remit and you could not find ways of making money in African agriculture. If we gave you the wrong remit, then you should not be blamed for following that remit. My perception of the situation is the same as Hugh's. Without agriculture being run better within Africa, forget it. What you have is a policy-free zone, ministries which do not work, no contact with the commercial market, the Food and Agriculture Organisation just a mess, just not there and a country which is dependent on agriculture. What you are not saying and I wish you would say, because you are perceived as our expertise there, although you are now denying it, is that there is a crisis in African agriculture because there is hardly anywhere where they get up to being anywhere near a market situation. Is that true?

(Lord Cairns) I would divide the agricultural business we can look at and we can help with as being those businesses such as tea, such as flowers, horticulture, where those countries have a natural advantage. Last time I was with you I gave the example of sugar, how the cost of sugar production in Africa is 50 per cent more than the world price. I do not see how businesses can work there. We are looking at a number of things which we can do. We are talking very hard at the moment to the Ugandan Government about their electrical distribution company. There is a country which probably has more advantage than most, a comparative advantage in agricultural terms. The hope is that we can start to help distribute more of that power which needs to be distributed more widely than in many other countries, to get to the agricultural sector to create the added value to the agricultural products which they produce up country, but which, for lack of power, go to waste or are sold in second class forms. I hope that we can help in a number of ways.

I am not communicating obviously. I am not suggesting you should do it. What I am saying is that there is a huge amount which is not being done to get African agriculture up to the situation where you can help.

(Lord Cairns) That is largely true in a number of areas. Although there is the example of flower farms, world class, across quite a wide range of agriculture that is the case.

What needs to be done?

(Lord Cairns) First and foremost we have to have some sense in the world pricing of so many of those commodities.

We cannot do anything about that in Africa. What can be done in Africa? We have to tackle world pricing elsewhere. What can be done in Africa?

(Mr Fletcher) As far as CDC is concerned, we are as energetically focused as we ever have been in looking for appropriate investments in this sector. What can we do to change the underlying issue you raise? I suspect very little.

But you have an expertise as someone who is involved and knows those markets which would be valuable if you would say what the inadequacies are in the present structures in various countries in order to reach market situations. You do not seem willing to say that.

(Mr Fletcher) We have a widespread network of individuals across Africa in multiple countries. Many of these individuals are locals, they are very senior people within their own markets and members of the Committee have met some of them. They are constantly exercising influence in the corridors of power, be it government, be it regulatory, in their own markets in order to effect positive change, to create a conducive environment for an investment culture which supports agriculture to flourish. Anyone who has been to Zambia and seen our level of influence in that marketplace, or indeed Tanzania, or indeed Kenya would be testimony to that.

Mr Colman

I would say from my visit to CDC and non-CDC farms in Kenya and Zambia this August on the way to the World Summit for Sustainable Development in South Africa, the expertise in the non-CDC farms was higher than in the CDC farms. My reading was that the Sulmac sale to a local Kenyan farming enterprise was the right way forward and the standards were not lowered and the productivity was significantly better. Would you be able, unless it is commercial in confidence, to explore further what you hinted at, which was the re-investment of those monies from the sale of Sulmac back into a vertical operator, farming both in Kenya and Zambia and elsewhere and having contracts with the major supermarket chains in the UK and elsewhere, as a way of using your real expertise, which is to provide capital where it is quite difficult for capital to go, to get the access into developed countries which African countries need for their agriculture?

(Lord Cairns) You are absolutely right that that is what we are trying to do.

Would you like to give us more information on that?

(Lord Cairns) At the moment we should just say that we are in discussions, but exactly down the line you are talking about. At the moment we are in a confidential period, but in due course I shall certainly let you know.

Could you let the Committee know how that money is re-invested because it is very important?

(Lord Cairns) I will let the Committee know.

Chairman

There is a general concern, shared by members of this Committee and by members of the House more broadly and it is this. You have been given a remit whereby you have to make certain rates of return on your investment. That is understandable. You effectively said that on those rates of return there is no possibility of investing in primary agriculture in Africa and only investing where you can find exceptional entrepreneurs. The consequence of that seems to be that to fulfil your remit CDC is now largely having to invest in power projects. You mentioned Uganda. You very kindly sent me a press release which you are putting out today relating to other power projects in Africa. The four funds which have been set up are Asia, Africa, power and SMEs. How much of your portfolio is going to be power related within five years?

(Lord Cairns) It might be as much as one third; something like that. We would hope that is an area where we can particularly bring in third party funds to work alongside us, both at an individual country level, on a continent by continent level and at a level of the whole power sector. The proportion of the government's money which is in there in three or four years' time is going to be difficult to foretell, but it will still be quite a major part of our portfolio.

Mr Walter

May I explore the new structure of CDC a little more and look particularly at something which your former chief executive, Alan Gillespie said when he gave evidence? He gave great emphasis to the SME sector in terms of your operations. Was it a mistake for CDC to give up on the management of Aureos in which you are a 50 per cent partner? Was this simply window dressing to reduce headcount or was there a genuine reason for doing this?

(Lord Cairns) There was a genuine reason for doing that. We felt that we had already invested significant sums of money in the SME sector and had built up a track record. We had not always got them right, but we have learned a lot through the previous four or five years. We found that by involving Norfund as a co-owner of the management company, they would commit to invest very significant sums alongside us in the future development of that fund and the expertise they had, together with making it more of an international affair than purely a British affair, also encouraged a number of other people who might not have invested in a purely CDC fund, for nationalistic and other reasons, were happy to do so on the basis that it was a more broadly owned operation. The development of the SME sector under the co-ownership of ourselves and Norfund has expanded its horizons and the sort of funds which they are now raising are a testimony to that. Three funds are being raised at the moment. I do not know how far that has got.

(Mr Fletcher) The three funds are East, Southern and West Africa in an aggregate target amount of $150 million. Yesterday I reviewed the status of that fund raising and with CDC and Norfund as co-anchor investors, you will find a mix here which is proving, certainly in initial soundings, reasonably attractive to other investors. SMEs are a difficult sector, Africa is a difficult continent, but the early investor indications are that one if not two of those funds will be successfully launched on time in the first quarter of next year and we are very encouraged by that.

May I just look at your investment company and ask about your relatively high required net rates of return? I am just looking at the evidence you submitted to us earlier in the year showing that compared with most emerging markets' stock exchanges, you did rather well last year with only a minus ten per cent return. You did have a requirement of 20 to 25 per cent net rate of return. Will these same parameters apply to the CDC management company as it tries to raise funds through the investment fund? Are you looking across the board for this kind of rate of return?

(Lord Cairns) Those rates you talk about are gross rates rather than net rates. They can vary. One of the great advantages of the structure we are moving towards is that we can vary the rates of return to what we think is realistically achievable and which can vary from market to market and sector to sector. It may have an effect one way or the other on our ability to raise third party funds for that particular type, offset against which may be the desirable development effects of a particular type. We shall be looking in future and in the new structure we shall be discussing between the investment company and the management company as to the yin and yang of the ability to raise more money against other objectives which the investment company may seek to impose upon us. Clearly in the case of the SME sector the expense base is very high in relation to the size of each investment, which makes the net returns quite hard to achieve. The SME sector is likely to be more attractive to the DFI sector, as opposed to the genuinely private sector.

Chairman

One of the advantages of a select committee is that we sit for the whole of a parliament. This may be an area which we can re-visit in a couple of years' time and see how you are progressing in relation to where you say you ought to be at that time. A rather clearer picture will emerge of CDC post these new funds at that stage. Thank you very much for coming and helping us this morning. I think you will have gathered from the questions which have been asked that there is still a certain level of concern, but only time is going to show to what extent those concerns are justified or unjustified.

(Lord Cairns) Thank you very much, Chairman. If you or members of your Committee want to come and spend a longer period with us to discuss some of these issues, we are very excited about discussing what we are doing because we think it is important and worthwhile. We should love to have any of you come and join us for a session and we shall tell you anything you wish to know.

The Committee tends to visit countries as part of our inquiries, so earlier this year we were in Ghana and Nigeria and maybe one of the tests is that when we go to particular countries we might look and see what CDC is doing on the ground in those countries.

(Lord Cairns) Please do.

Chairman: Thank you very much.

Examination of Witnesses

RT HON CLARE SHORT, a Member of the House, Secretary of State for International Development, MR BARRIE IRETON, CB, Director General, Knowledge Sharing and Special Initiatives and MR GARY JENKINS, Head, CDC Unit, Department for International Development, examined.

Chairman

Secretary of State, thank you very much for your time and thank you for coming to see us twice in so many weeks. If CDC had not existed when you became Secretary of State and you had not inherited it amongst your portfolio of things, do you think it would have needed to be invented? Have you found a role for CDC because it was there or do you think CDC as an institution is a valuable part of the instruments you have in fighting poverty?

(Clare Short) I would not invent the CDC which our government inherited. What we are trying to make it into, I would invent and if it can be a success, it will be an extremely significant development instrument leading to increased and more speedy private sector investment into reforming poor developing countries. If we can achieve that, it will be very important. Prior to 1997, strangely really, my department did very little work on private sector enabling environment. Yet to get the kind of investments in infrastructure and the economic growth which are needed to reduce poverty, the private sector will be the engine of growth. The resources which are needed for infrastructure cannot conceivably come out of the maximum possible aid in the world system or the maximum possible public sector investment which can come out of developing countries. Yet we have our pension funds and our ageing population looking for investment which will produce a really good rate of return to look after our generation. If we can get the enabling environment right, then you can get the investments these countries need, then you get the ten per cent a year economic growth of the Mozambiques which would be good for us as pensioners. There is a win-win there if only we could put it together. It is why we put much more effort into resolving conflict because that destroys private sector investment and economic growth and regional integration, and we have put much more effort into the enabling environment in terms of central bank management of inflation levels and so on. The enabling environment which allows very poor people to have little businesses or medium level businesses in a developing country to grow and thrive is the same enabling environment which attracts foreign direct investment. There are not two conflicting reform agendas. In many countries in the past banks were owned by the state, poor people could save in them but never borrow and therefore they could not even get the tractor or the little motorbike so they could take their goods to market and you had to have licences for everything - everything - so you could not get a business running. All of this matters enormously in reducing poverty. In the past there has been too little attention to the complimentarities and we have to change our mindset on what aid is for, to see it neither as a handout to help the poor, nor as fixing everything, but as an investment fund to create the conditions where countries can fix themselves. The most important thing in the long-term reduction in poverty is creating a climate where the private sector can thrive. You know the figures for Africa. Forty per cent of the savings of Africa leave the continent. What should be the first call for any investment in any country are the savings of its own people because the banking systems are unreliable or political risk is too great. Getting all this fixed is fantastically important. Highly subsidised or very low rate of return investments from the old CDC are almost counter productive because they are almost like saying the private sector cannot invest at normal rates of return in these countries. You need a public sector instrument to get any of this investment flowing. Where you need to put money in, for example to rural areas and agriculture, if it is grant to get land reforms sorted out or credit to rural people or good technical advice as opposed to all the money wasted on extension services which are often very, very poor in developing countries, then it should come out of grant and development funds and we should not muddle up what is grant and what is an investment which is meant to be productive which will help the economy grow and have a rate of return. We could have, indeed I think the original announcement on the changes to CDC implied it was a privatisation and it would have been possible to say this is not really working, we will sell it off and have the £1 billion or so into the development budget and we shall use it as grant for development. We have had a growing budget anyway, so although that was the original announcement, we would just have got some money from somewhere else, so that would not have been a very wise use of resources available to development. We are trying to achieve something more complicated which we very, very strongly believe in, which is to restructure it in a way, use its expertise in developing countries and indeed its links to our government and the expertise which is in my department, not improperly but just the knowledge of countries and how they are moving and how reforms which are improving the enabling environment are moving forward, to encourage private sector funds to partner the public sector funds, to increase the flow of investment to developing countries with very low levels of investment and then to be the first of private sector funds which will follow, because you demonstrate they can have a return. That is what we are trying to achieve and I really believe in it. The first model we had, which we put before parliament and which was fully scrutinised by your predecessor committee and the committee wholly supported it, as did the previous Chairman of the Select Committee, was the idea that once we entrenched the requirement to invest in poor countries and the ethical code, then the private sector would buy into CDC itself and we would get past the magic 50 per cent and it would flow. The market conditions meant that could not happen and it would have been totally irresponsible to sell off because the return would have been so low. I think that the way we have refined the model to have more tightly focused funds is a better model. We have had a lot of private sector advice, we had to refine the model because market conditions meant the first proposal could not flow at that time. I still feel optimistic and quite proud of the fact that we are making this effort. A lot of other development agencies across the world are watching us to see whether it works and whether it brings in responsible private sector investment, and then it would be a new tool in development and potentially very, very beneficial to poor people.

In fairness, this is a dangerously consensual committee and I do not think there has been any criticism about what you have done vis-a-vis not taking forward the privatisation of CDC and everyone recognised the reasons you acted in the way you did. The concern this Committee have - colleagues will ask questions which will speak for themselves - is that the rates of return you have asked CDC to make mean that they have almost entirely had to retreat from investment in agriculture unless they can identify exceptional entrepreneurs to invest in agriculture and that increasingly they are going to be obliged to invest in power projects. Power projects may well be of considerable value in improving the infrastructure of countries, but that is going to be one of the consequences of the model you now have. The anxieties the Committee have are much more around where the investment in agriculture is going to come from. If that is going to come from other mechanisms such as development funds, then that may well satisfy colleagues' concerns. Those are the concerns.

(Clare Short) There is something the Committee ought to understand because I have watched this story flow. When we restructured the staff in order to go with the new CDC, quite a lot of staff who had done loans for agriculture with very low rates of return, where you would never get the private sector to follow, were made redundant, with good packages. They have been going round mounting a campaign, saying CDC is getting out of agriculture and it is a betrayal of the poor and so on. They got some press coverage and then I saw it come back in the Commons; that is how a civil society works. The Committee needs to be aware of groups with vested interests. We understand and respect the work they did, but it was based on that model of focusing only on agriculture and on very low rates of return and that the idea for the new CDC cannot work. The second thing to say is that agriculture is a difficult sector because the trade rules are skewed against investment, particularly in Africa. Seventy or eighty per cent of Africa's exports come out as commodities unprocessed; that is Africa's tragedy. The importance of Doha is to get peace and investment in infrastructure so more agri-processing will take place in Africa, then you get the jobs and the value added and the growth in the economy. If you stick only with agriculture and no agricultural processing, then you will not get any private sector to follow and you will not get the economic growth that poor countries need. They are not the rates of return we have asked for. If you look at rates of return in Africa they are phenomenally high because Africa is seen as such a massive risk that the private sector will only go there for very high returns. If you look at the private sector which is there and the returns they are getting, they are phenomenal. The job of ending conflict, improving the enabling environment is to reduce the risk so that the private sector will come in for a lower rate of return. We are working on that very hard. CDC has to live in the world as we have it at any point in time and if it is going to make investments where realistically the private sector will follow, it has to look at what the private sector is looking for. The beauty of the new funds mechanisms is that the Norwegian development funds have come into one of them, Aureos, so you can have a fund which is expecting a lower rate of return which is leveraging more ODA money into it and you can go into different sectors. Let me say on power, that power is absolutely key to development. I remember when I went to Nepal I went to a rural remote village and sat down on the floor with some women. They said they needed electricity. They could not cook, they had to go and get water, it was dark at night. It is wrong to see power as not wanted by the poor and important for them. There are so many people who are ill because they use wood and biomass to cook inside their houses, etcetera. Power is honourable and it is a sector and the poor want it and it enables people to be more productive. In lots of poor countries there are constant power cuts and therefore businesses cannot thrive and it tends to have been a sector which was owned by the public sector, very inefficient, as it tends to be across the developing world, highly subsidised, sucking away subsidies which should be going into health and education and providing inefficient, subsidised services to an elite. That is the pattern. Reforming power is essential for the economy, but also to get those subsidies out of it so they can be properly spent on the needs of poor people. It is absolutely important that CDC moves into power. Remember there are always groups who do not like reform and there was a group doing very low rate of return unprocessed agriculture in CDC, most of them are no longer there and they have been going round badmouthing the report. They have had the badmouthing and the criticisms they have made taken up. It is called democracy.

Mr Battle

I should like to go back to the potential, the vision of CDC and what it could do, not just in the limited field of crude geographical commitment, but on a much wider and deeper vision of qualitative, new kinds of investment instrument, new models for investment. I get the impression that when you used that expression win-win what we are struggling for is a model which is pulling together two ends which seem to be totally irreconcilable. One is a very narrow old-fashioned, economic model on the financial rate of return, with its whole notion of blind investment to get the rate back, go for the best option. That could be in a hotel anywhere, including in a geographically poor country. At the other end is an increasing understanding that economic efficiency and social obligations to include the poor in development are crucial. How we pull those two together seems to be the kind of area in which you are suggesting CDC should move. It is very interesting that in the inner city areas of Britain the figure is exactly the same. Forty per cent of incomes of inner city dwellers where I live leaves the neighbourhood and we have no banks there now, so who invests in inner city neighbourhoods? The same question, the question of investment in poorer areas. How do you reconcile that? Can we move away from narrow measurements of financial return on capital? How can we do that if we do not do the prior analysis? How do CDC know whether they are contributing to the eradication of extreme poverty if they do not systematically assess investment proposals on the basis of their wider economic rather than just financial return? If they do not relate them to targets for poverty reduction, millennium development goals and the rest, can we build that into the process before investment takes place or are we still crudely measuring the impact of a trickle down of investment after the event?

(Clare Short) I represent an inner city seat which curls round the heart of Birmingham and most of the centre of the city is also in my constituency, so I do not think it is the same question. If people bank in the centre of the city because they shop there, it does not mean Ladywood necessarily loses out unless - and you get this in the inner city - people do not have the confidence to travel into the city centre to take up jobs which are available. So I just want to say that it is not the same. The money leaving the country is different from a locality within a country where people can cross the boundaries of their locality to get jobs very nearby. It is not the same.

May I just explain? I am not complaining about the position of where the banks are. I am perhaps asking why some inner city neighbourhoods have no investment while other areas develop a strong sense of investment. There is a pattern, but it is a different question.

(Clare Short) Indeed. It is a very important question for constituencies like yours and mine but I do think it is very different. The elite are very rich in poor countries. People often miss that. They have a lot of money, they invest it, they save it, most of it is coming out of their countries. It is very noticeable that Asia keeps its savings. They might not always be invested in things which immediately benefit the poor, but they stay in their country, whereas Africa's savings come out of Africa and this is a real issue for Africa in terms of its economic growth and the potential of the private sector. I do not agree with the overall thrust of your question. It is not for the private sector to carry all social obligations. It is for the private sector to have responsible investment which is not environmentally destructive, which treats labour properly, as under the ethical codes which CDC works under, but it probably will not be able to go to the most remote communities where the very poorest are to make its returns. If it can make responsible returns, generate jobs, you might see people migrating from the most remote areas, because the whole world is urbanising faster, getting more jobs, or some of their family members are getting jobs and sending money back and creating economic growth in the country which lifts up more people and pays more taxes which contribute to public services. I do not think you should burden CDC, or the private sector, with meeting every single one of our social objectives. It should be responsible and beneficial investment which is ethical within a well-managed state but then make sure that taxation is fairly distributed, that people in remote communities which are not receiving benefits are helped in other ways. The quality of investment matters, but it should not have to carry all of the obligations of a well-run state. There was an old-fashioned model of saying, in the neo-liberal days - if I may use a semi-neutral term to describe that period - which really went too far, "Let the market rip. Roll back the state and the price mechanism works for everything". So, like in Africa, charges for health, charges for education, the poor were driven out of public services. The whole world agrees that some of that went too far. A lot of the private sector in the old world of investing in developing countries, where corruption was winked at and it was often the sectors you could get into after you had done your bribing where you could get your high rates of return, often minerals, oil and so on, or very dubious investments in the public sector, hospitals and things, which led to some of the debt we are now trying to remove from some of these countries. That is the old-fashioned private sector with no ethics, often into very badly managed economies. The world is moving on and the best of the private sector beyond CDC understands now that with information flowing across the world, with increasingly fussy consumers, who want to buy that rug or shopping list supermarket, that they want an assurance that those things have not been procured in a way which is ripping off people or poor countries; thus the ethical trading initiative, which came out of consumer power. Lots of big powerful companies are worried about their reputation and they are joining up with all these different ethical codes, not just cynically, but to protect their business. This is a fantastic opportunity for us in development to get more and more responsible private sector investment and the private sector wants it too. If we can manage to create the conditions in developing countries, where that kind of investment can flow in, it really can speed up economic development and the reduction of poverty. That is a shift in the political and economic take across the world but also the leading edge in that most constructive players in the private sector are thinking differently.

I would argue that it has gone further than that. It is not just a question of ethics or social responsibility in that interest in the poor is tagged on as a moral obligation. I do think some thinking now is saying that it is good economics to include the poor. Some of the work done in Latin America is looking at even the value of the poor who live in shanty towns to contributing to the economy, not that they hang around and wait for work. There is a new analysis to say that linking the programmes, the investments, to see where the poor figure in all of this, is a different way of looking at the questions. I am not suggesting CDC are not there.

(Clare Short) The private sector has always sold coca-cola to the poor, most of the poor of the world have no health services and what they buy they buy privately. The private sector is not fussy anywhere in the world; it will sell its stuff to anyone. There is more and more understanding that if people are included, if they can consume more, if they are educated, if they are going to be productive workers, that is beneficial for everybody, including the economy.

Just to go back to the question I asked, how can CDC, or will it, measure its impact even in the terms you describe, in terms of corporate and social responsibility? If the only measures are on narrow financial return and not wider economic, will you be broadening the measures? That is what I am asking.

(Clare Short) No, it is operating under a very stringent ethical code and it will operate under those and it also does not do pornography, tobacco, arms, gambling. It has these tough conditions which it will not creep into any of those sectors and it has to meet all these environmental and labour conditions and then it has to make the kind of return which brings benefits to a country but also attracts other private sectors to flow behind it. Those are its tests. You must not ladle onto it everything that the state needs to do.

No, I am not. I know it is what the state ought to be doing. It is the question of how subtle the economic analysis of the contribution of the poor to the future is. That is the question. It is not a moral question about whether you invest in alcohol, gambling or pornography. It is about how you measure the impacts on the poor.

(Clare Short) I am sorry, you are putting together too many things. There is growing understanding, take Latin America because I know you have expert and long historical engagement with Latin America, that a gross error has been made in Latin America.

I am not responsible for it.

(Clare Short) No. It is the most unethical continent and the elite who are incredibly rich and own all the wells and all the land and all the rest thought they could have a successful economy and leave out a lot of their people and it is a less successful economy. The degree of inequality is holding back the development of Latin America as well as creating political -

I am not holding it up as a model.

(Clare Short) No, I know you are not. Please, you ask a question and I am giving you a really very serious answer. I am saying that I think you are trying to impose on CDC a question which belongs to the whole of the values of government, the values of the IMF and World Bank and how it promotes economic development, who is included. You are pointing to the fact that the poor doing better is good for business as well as being good for the poor. I agree with that completely and it gives us a possibility of an era of really much more rapid advance in development. You cannot put the whole of the policy obligation which flows from this new analysis onto CDC. It has to be shared across all the instruments we use in development.

Alistair Burt

May I take you from win-win to quick wins? The longer the period of anticipated return on an investment the more edgy investors tend to get. I am wondering whether you feel there might be a call for CDC to be putting more attention into shorter term investments rather than longer term in order to demonstrate the quick wins which might build up confidence and therefore make investors feel rather happier.

(Clare Short) When I took advice at the beginning of the restructuring of CDC from people operating in the private sector, they said the thing which will kill it is unpredictable political interference. Therefore what we must do is establish a structure where the requirement to invest in poor countries is entrenched, where the ethical code is entrenched, where any political powers are absolutely transparent and the rest is left to the management of the organisation. I have followed that advice and I believe it is the right advice. That is a CDC question. It is not for me and I do not have the powers and I should not have the powers and it would be a recipe for disaster for CDC if I could poke in and say I think they ought to invest a bit more here or they need a quicker return there. It will not work if political powers are used like that. I do not have them and we have created a model where no politician will be able to interfere in that kind of way in the investment decisions of CDC.

Do you think a move to more development results based investment would frighten off investors?

(Clare Short) The development based investment is entrenched in the 70:50 requirement. If we had privatised CDC and left it to the market, it would have become another development organisation, it probably would have built on its expertise in developing countries and shifted to middle income countries. Left to the market, it would not stay in South Asia and Africa with such high ethical standards. So entrenching that is entrenching a very, very strong development objective. Then the ethical code on the sectors it cannot go into. The labour has to be properly treated, the environment has to be considered, these are proper conditions which private sector operators would not have, except some of the companies which are moving themselves very strongly in that direction. That entrenching of human concerns, proper treatment of people, development interest, is my entrenchment of development. Beyond that I say, "Please CDC, go off and be efficient and demonstrate that you can invest in these markets, attract other private sector money to follow you and the private sector can grow and the economies of these countries can grow.

I am interested in and understand your sense of having almost an arm's-length relationship in certain respects so that CDC can run itself and therefore convince investors there is an absence of political interference.

(Clare Short) It is not arm's-length: it is no arms at all. It is entrenched development interests and then no interference.

How you make the distinction between the two is interesting. You do not feel able or prepared to comment on whether or not having a look at some shorter investments might be good news, yet you are very confident on the conditions and principles which you set out as being the government's responsibility to set out. How do you choose between the things you commented on and the things you do not?

(Clare Short) Honestly, with respect, you are not listening to the logic of what I am putting. I do not have any interference of any kind whatsoever in any individual investment. The most we do if someone writes and complains is write to CDC and get them to answer somebody who complains. That is absolutely right. The duty of the government and my duty to try to get this model right is to entrench transparently the development requirements and then allow CDC to be an efficient organisation. If you ask me why I entrench that or why we made this decision and why we are modifying it, all the things for which I am responsible, I shall answer you fully. I am not trying to evade. I just never, ever interfere in those questions. I have a presentation once a year of how it is done and where we are strong and I take a lot of interest in how CDC is doing, but I do not give them any instruction or any interference of any kind whatsoever in where they put their investments. It would be foolish of me to answer that question because it has nothing to do with what CDC is doing.

You made a comment earlier about rate of return and emphasised as far as Africa was concerned, that there were some quite spectacular rates of return and what CDC was looking for was not out of line. We understand that the IFC rate of return is lower than that expected from CDC. Do you have any particular comment on that, particularly in relation to whether or not it might be worthwhile thinking that there is a developmental case for CDC to make some investments with a lower financial threshold of return, maybe not if they do them singly, but perhaps if they do them through a joint venture fund with DFID or something like that? What is your sense of that?

(Clare Short) The first point I make is that IFC's track record is not that impressive. It keeps trying to change its strategies and has had trouble finding its niche and role in development. I shall ask Barrie to come in on this in a minute, because he has lived with this for a much longer time. Secondly, it is not trying to do what we are trying to do with CDC. It is the public sector money investment arm of the World Bank trying to invest public sector money in the private sector, but it is not trying to get the partnership with the private sector which is the essence of what we are trying to get to expand the investment through the reorganisation of CDC. It is a different beast. I have ceased taking a lot of interest in what CDC is doing and it is interested in partnering CDC where it sees CDC pushing forward the boundaries and thinks that would be a good place to put its money. It has a different test, does it not? The World Bank operates on a test because they do concessional loans and so on, they have rules on rates of return. It is a completely different beast.

(Mr Ireton) The IFC tends to operate in more middle income countries on balance, whereas we have tasked CDC to emphasise the poorest countries. On this trade-off point, the Secretary of State has put it extremely well of course, but in the old days we used to struggle with investments and say, "Does this earn foreign exchange? Does it employ people? Is it in a disadvantaged area?", all these things. We had a lot of apples and oranges which we were trying to add up.

(Clare Short) The public sector doing private sector investment.

(Mr Ireton) Exactly; all those things. What we have tried to do is to sort a lot of this out. What we have tried to do is say yes, the governments of these countries ought to be having good policies and that is their responsibility with our help and dialogue. The private sector job is to invest productively in growing the economy, in a regulated way and therefore its prime function is to look at financial rates of return. In a better world that we are gaining now, we do not have to make lots of sophisticated economic - though lots of economists do this - cost benefit analyses which say this is the perfect project in a very imperfect world. Somebody very dear to me, when I asked this question about cost benefit analysis, said "Today we are actually trying to improve the world". That really is what we are trying to do. So we are laying on CDC the responsibility to invest ethically and responsibly, to demonstrate you can actually have profitable investments in poor countries and we, DFID, are working with those countries to bring about a change in the environment you well understand.

(Clare Short) I am desperately trying to reduce the rate of return in that if we can resolve these conflicts in Africa, if there is less political risk, if there are better banking systems, if there is less corruption in the regulatory arrangements, the ports work better, contracts are enforced, private sector will go to poor countries for a lower rate of return. That is where I and DFID and World Bank should come in, not by telling the private sector where to go because the private sector includes your pension money and you might in theory think it is good to have a lower rate of return in poor countries, but you want your pension fund to look after you when you are 80.

Tony Worthington

You have explained extremely clearly what CDC is about and I find that very valuable and I do not quarrel with a word of it. It is what you have left behind which is the problem. The great bulk of economic activity today in Africa is not ready for the market. It is done very ineffectively. You say you leave the policy to the governments. It is an areas where the UN organisation which should be responsible is very, very weak. There just seems to me to be - vacuum is too strong a word - policy inadequacy in areas like agriculture in Africa which really does need tackling. Now that the role of CDC is clarified, my feeling is that we now need to move on to look at how in shorthand terms African agriculture can go to its pre-market stages, its pre-export stages. I should be grateful for your thoughts on that.

(Clare Short) I think that if you seriously mean that the bulk of the economic activity in South Asia and Africa is not ready for the market, then I think you are wrong and I disagree with you. But you are sentencing Africa and South Asia and the poor of the world to continuing decline. If you look at the countries in Africa which got poorer in the 1980s and early 1990s, they have population growth faster than economic growth. Wherever that happens you have invincible growth of poverty and you cannot help through the public sector. You can provide health and education but if there are no livelihoods, if people cannot get jobs, if they cannot earn and their income levels are going down, they are getting poorer with all the flows from that and the public services of a country cannot work. I profoundly disagree with you. Look at some of the reformers in Africa. Mozambique is one of the poorest countries in the world and it is still very poor, but it has had nearly 10 per cent economic growth for ten years. Of course the fruits of it are not fully evenly distributed across the country and all these things have to be attended to. It needs to maintain those sorts of levels of growth for another ten years or so and it really will be in a position to lift up its people. If you look at South Korea, which was as poor as Ghana in the mid-1960s, it grew its economy consistently and consistently and consistently and Africa needs to do that. If you look even at the rural poor in, say, Tanzania, until the reforms which have come in recently the bureaucratic controls were so great, there were no markets, they sold their produce to para-statals who did not collect and never paid, they had rotting food waiting to be collected. Then there were state-owned poor quality manufacturing or processing factories in the city, highly subsidised and the rural poor were giving the food for less than market prices and taking the impoverishment of that economic model. That economic model has completely failed. The Bank of Tanzania in which the rural poor used to save, because the poor save, because the poor know they are going to have crises in their lives, they are savers, would never give credit for anything, for a tractor, for a motorbike, for a sewing machine, things the poor used and there were no markets. Now, with the reforms which are taking place in Tanzania, there are little markets. The little subsistence farmer grows a little bit more than he can consume, takes it to market, gets a little bit of cash and it is starting to improve the livelihood of the country. Tanzania also has famous game parks, tourists coming in, spending a lot of money, some hotels, creating employment, creating a tax base. It is just not true that the private sector cannot work in some countries. Look at the Soviet Union. Look at the failed development model in some of the poorest countries where everything was run by the state and you did not get any economic growth and you got an invincible rise of poverty. I absolutely do not agree that there are economies which are not ready for the market. I did not say we leave the policies to the governments, but you have to have an efficient modern government with laws. You need a legal system which enforces contracts, you need to reduce corruption, you need order and stability, you need ideally healthy and educated people, you need proper regulatory arrangements, so there is no monopolistic abuse of price and so on. All of that was in the old development model. We do not leave it to the government, we work with the governments of developing countries to create a modern, effective, enabling environment where the economy is well run. Lots and lots in countries where there is no foreign debt, there is very high domestic debt because the government borrows massively and then interest rates are massive. Any local business which borrows to develop is absolutely diminished by the levels of interest rates. We work on all these things with the World Bank and with others, to try to create a modern state with efficient government institutions which create the conditions for the enabling environment. Lastly, on policy inadequacy in agriculture in Africa, part of the whole policy inadequacy was thinking that institutions like CDC would give loans for very inefficient agricultural sectors and that was the only hope of agriculture in Africa. As a department we have produced two or three leading edge documents on the way in which agriculture needs to be reformed to help in the reduction of poverty. A lot of the policy on reducing hunger has been wrong because it was all about food self sufficiency in a country rather than making sure the poor can get access to food. There is an analysis on how agriculture can develop and a third one, which has just gone out to consultation. We ought to give these to you as a committee. Of course there needs to be more intelligent strategies about agricultural investment, but I come back to the point I made at the beginning. Without changes in the trade rules Africa will not go to where its comparative advantage should lie, which is agricultural processing. Everything, cashew, coffee, tea, all comes out of Africa unprocessed. The only thing in there which has a fair trade price is the original cocoa bean. Ninety per cent plus of the price is made in Europe. If you look at the tariff escalation on chocolate and if you started trying to make chocolate in Africa, which could be done with refrigeration and so on, it could be a 100 per cent tariff escalation. We have to fix the distortions and the dumping on world markets which really prevent Africa moving towards the agri-processing which is its natural comparative advantage.

May I make it clear that I am not condemning Africans to perpetual poverty.

(Clare Short) If you think there is no place for the private sector, you are.

No. We all go along with all that you said about the wickednesses in our world in trading rules. There is also a sort of assumption around that if we just sort all that out then everything will be okay. I think what you are indicating is that there are now new policies, consultation documents, coming forward from within the department which are saying we need to look at agriculture and poverty in a different kind of way from five years ago. You are absolutely right, that is what we should be looking at as a committee as well. We are seeing the inadequacies of the old policies and why we need to change the emphasis much, much more towards agriculture. When I said markets, I accept that there are many goods quite rightly sold in local markets and we are doing a lot to stimulate that. In terms of the interaction, particularly in agriculture, between African agriculture, apart from the price things, the trade rules and so on, there is a huge amount of work to be done to help those countries to make contact with our markets. We thought CDC was doing that.

(Clare Short) But it was not.

Yes; it was not.

(Clare Short) CDC's investment in agriculture was in raw agriculture, it was not in processing. It was not in the value added which Africa needs. It just was not. Since 1997, we have shifted our rural work to livelihoods. You should not just go rural/agriculture. There are landless people and there are poor people who make a bit of money from their crops, the women of the household might make handicrafts or clothing which they take to the market and they commit more money there. They can do a bit of fishing. The poor of the world are so creative and diverse. Some of the family members will migrate and be working in the city and sending a bit of money. We have focused much more on how to improve the lives of the poor in rural areas and we have been working at that for a considerable time. For example, research shows masses of money is spent in developing countries on agricultural extension. If you closed it all down and just built rural roads, you would get more economic development. We have been working on lots of these things, but we have also produced these three very important documents - and they are influencing the debate internationally - in the recent past on reducing hunger, the contribution agriculture can make to development and the third one. I shall let you have those. It is a fantastically important question and there has been a lot of misguided policy in the past. There has been a lot destroying agricultural production in order to subsidise manufacturing in the cities in the way I described as the story of Tanzania, which has been a disastrous failure, particularly in Africa. We have to learn those lessons and not just continue with some of that. I am afraid there are some elements of those who have been briefing against the reorganisation of CDC, honourable and good people that they are, who are living with those old models which do not work.

Hugh Bayley

I can accept your prescription about the importance of agriculture for economic growth and for pro-poor development in Africa and the importance of getting more value added through processing in Africa. You have made the case very powerfully and I accept it. I am not sure that CDC accept it. We were told in June last year by Lord Cairns that the value of the agricultural part of CDC's portfolio was 11 per cent and we were told this morning by Paul Fletcher that he would expect that part of the portfolio to remain at around 11 per cent, growing slowly as CDC's portfolio as a whole grows slowly. If agriculture is as important as I believe you believe it is to sub-Saharan Africa, should that proportion of CDC's portfolio not be growing with an increased emphasis, as you stress, on processing?

(Clare Short) No. I have been talking to Tesco and the other big retailers to try to find out what would be required to get them investing more in Africa, which is right next to Europe, to get bigger production and the processing and the value added. The first thing I learn is that there are intermediary companies which do the sourcing, there is no direct link with the big retailers. In the case of Ethiopia, which of course has 60 million people, close to Europe, a successful airline in terms of cargo, world famous coffee, $100 a head GDP, desperately, desperately poor country, how can you get the value added in the processing? At the request of Prime Minister Melez, we asked the private sector to go and to report, what it would take, what kind of reforms would be needed in Ethiopia for the private sector to go and invest there and get the value added and the increased investment. To get to agricultural processing it will not be CDC. If you look at how globalisation brought benefits through manufacturing to Asia, where of course they had a lot of people and they invested in educating their people, it was companies moving there and bringing with them all sorts of expertise and investment in order to get the comparative advantage of the lower cost labour and so on. A lot of the agricultural processing change will come in that kind of way to Africa, but my understanding is that CDC - and I am not directing the investment policy - are looking to move more into agricultural processing. Good. I hope we can encourage more of that kind of thing. Let me say that it is not the only thing. For example, call centres, if we can get modern telecoms into Africa. We have call centres in Asia. Different time zone. Africans are fantastically proficient at languages. You get illiterate people who speak five languages in Africa and it is in the same time zone as Europe. There are other sectors, if we can get the continent sorted out and get modern investment. CDC cannot answer all the problems of all this historical failure to put things right. Its job is to get more investment into Africa and South Asia where the poor are and its job then is to try to lead where the private sector will follow. If it is very difficult at the moment to get investment in agricultural processing because of all the other barriers to it, then CDC should not go there. After all, World Bank and the IMF and governments should sort out the conditions which are making it very difficult to get productive agricultural processing.

I agree the bank and donors and above all the WTO need to clear the decks to make it possible and to open up our markets to African produce. Yes, I agree with that. If I were a macro-economist working for the African union or one of the governments, in terms of food processing and the sale of agricultural produce, I would identify two growth markets. One would be within the urbanising parts of Africa, the people who have gone to work in your call centre, if you like, who do not produce, or a tyre factory, or work in paid employment or in some very small business activity, trading in the market in an urban centre, who do not produce enough food on their own land to feed themselves; maybe they produce some food but not enough to feed themselves and therefore they need to make some money in the cash economy in order to purchase food. As population grows and as urbanisation continues, there will be an increasing number of Africans who have a little bit of money and need that primarily for buying food. You must find ways within Africa of incentivising farmers to produce food and incentivising business to process it to some extent, to distribute it to meet that urbanised need. There is a growing market which will continue to grow. I should have thought CDC, through its agricultural investments in the past, which have not always been successful, had learned a lot - you learn through failure as well as success - and had a lot of skills which could be applied to creating that food processing and distribution business in Africa, which is needed by poor people and which is not automatically happening through local entrepreneurs. Could CDC not do more in that field?

(Clare Short) On your first point, you must know the market women of most cities in Africa. As urbanisation is growing, and it will grow further, and as some of the gross inefficiencies of the statist economies are dismantled, you are getting more and more natural markets and people growing some surplus and bringing it to market and supplying food to urban populations. You move on from there to say that there will be more processing. I again insist that you do not know and I do not know whether that is the best investment for CDC in Africa. CDC's job in Africa is to invest responsibly and ethically in sectors which will grow and succeed and where the private sector will partner it and follow it. It is not for you or me to say what will produce agricultural processing. That is why I go and talk to Tesco or I go and talk to the sourcing company. There are people out there. Apparently the Channel Islands, not just Jersey, are massive producers of tomatoes for the European market. They were finding a place, they were finding co-operative arrangements with the local state and where they could get land and train people and then they invested over ten years in the productive capacity and the kind of tomatoes we like to buy, etcetera. Africa could have more and more of that, I am sure of it. We need to ask the private sector what it would take, what would take them there. Africa's coffee comes out as green beans and Germany is a major coffee exporter, the absolute logic of globalisation because labour is cheaper in Africa and it is so close to Europe. If we could just get the conditions in the continent, the end of conflict, more regional integration, that is where it is going to go. If you were a macro-economist, or if I were a macro-economist, it would still be a politician operating in the public sector and you would make a lot of mistakes and I would if I thought I could tell Africa best how to develop its markets in the private sector.

We are getting close to agreeing. My other example would have been the tomato example, the horticulture business which, if well managed can provide a good cash income and standard of living for people working for it.

(Clare Short) I think I should send the Committee that report we commissioned on Ethiopia so you can see what the private sector is saying to a government which wants to make a change about the sort of things which would cause it to invest. The government in Ethiopia is working on it.

If you recognise, which you do, that there is an African domestic market and there is a role for the private sector in processing and distributing food, some very small entrepreneurs, women, market traders, somebody, perhaps a mill, milling corn or something which people can sell in the market, and also the horticulture side, I would agree with you that you or I or any of us as generalists are not the people to go in on an investment by investment basis with the CDC and tell them to go for this one, to go for that one. I think some very bad decisions could be made if any of us took on that role. In terms of strategy, I do think there is a job for you to do in conversation with the CDC to say you can identify two areas of agricultural processing and marketing where Africa has opportunities to expand and earn money which could help to relieve poverty. You do not know the answers, but you want them as an investment bank which is one of DFID's partners to deliver more in this field. Will they go off and work with Tesco's if they are the people to work with and work with milling companies if they are the people to work with and look at ways of ensuring that more investment gets into these areas where it is needed?

(Clare Short) I disagree and if I did that and had the powers to do that, the chances of the private sector investing in CDC would be far fewer. If it depends on me and then whoever replaces me or a change of government and someone has a different fancy, it will not be reliable investment and they will not get their rate of return. Of course we should work on how African economies can grow, the enabling conditions, how more investment can be brought in, etcetera. It is clear in the mind of the Committee, but when the Committee moves to say CDC should be instructed to operate in one sector rather than another and not to make judgements according to what investment will be successful, will attract the private sector, will make the kind of rate of return which can be sustained and more can flow on from it, then you are burdening CDC with public policy objectives which should be carried forward elsewhere. It is a mistake.

Mr Walter

Could we move on to the new structure of CDC? DFID has abandoned the notion of bringing private sector shareholders into DFID for the time being and wants capital attracted to the individual sector funds. You quite rightly said that you do not see your role as directing DFID or recommending to DFID that they should make this investment or that investment. What you have done with your new structure is to make it independent, you are sure where it is going for the time being, but CDC is still prevented from raising loan capital. There is no indication whether or not the new investment company will have any access to the aid programme, is there any prospect of that borrowing constraint being relaxed? Is there any prospect of CDC having access to the aid programme for special purposes or special projects?

(Clare Short) Certanly not. I do not understand the reference to raising loan capital. I shall ask Gary to come in. There is certainly no prospect of it having access to the aid programme and that is the same thing. It has to be efficient, it has to give the rate of return, it has to be transparent. It can have a relationship with us, know where we are working, know where we think economies are going well, where there is a reform agenda, proper information which is available to anyone. The special relationship which we have and access to all our knowledge which is very considerable, that is proper, but subsidy to it, no. We are spending money on agricultural reform or land reform. I agree with whoever made the point - I think Tony Worthington - that market access alone does not mean that a country will take the benefit of that market access. You have to build up the capacity in the country to take advantage of it. We are working on all those kinds of things and that should make it easier for CDC to invest beneficially. We shall not hand over the money which belongs in the public sector to an organisation which has to operate according to private sector disciplines. We have not abandoned the principle of private sector shares. In the new model Investco is the public sector money and has to be looked after in the public sector. The management company, which in the short term will be restructured staff from CDC and will not have the private sector, would, we hope - and these decisions are not made and you need a track record first - then have the private sector coming into that. Then the specific expert funds will be looking for as much private sector partnership and engagement as can be found. Could you answer the point, Gary, on preventing the raising of loan capital?

(Mr Jenkins) One of the reasons for the original proposal to reduce the government's share as an owner in CDC to below 50 per cent was so that CDC would then be classified as the private sector and would not be subject to the Treasury's controls on public sector borrowing.

(Clare Short) Which is why you have to get below 50 per cent.

(Mr Jenkins) Yes. That objective remains: to take CDC out of the public sector. The timing of it at the moment, as everybody knows, is not ideal, but it remains an objective for the future. One of the effects of that will be that CDC will be able to borrow and will be able to gear up its equity and expand.

(Clare Short) In the meantime the private sector can put funds into the investment funds.

(Mr Jenkins) That is the important point.

(Clare Short) But we cannot get it yet into the management company until we get past 50 per cent and out of the Treasury's controls; quite proper controls, let me say. We now hope to set up a track record and there is room for the private sector to come, in whatever quantities it wants, into each of the plans and if the whole thing operates successfully and after a while the economy lifts and there is more investment in developing countries and if CDC builds up a good track record, then we shall be looking at the management company and the possibility of the private sector coming in there and then it is out of Treasury controls on borrowing.

(Mr Ireton) It has never been a central objective in our minds that CDC in whatever guise should be a heavy borrower of loans in the market. What we were trying to do originally was attract in an equity stake to CDC, more recently thinking about attracting third party funding into these funds, co-investing with our own billion, as it were. CDC is essentially primarily an equity player and therefore will not in any case in a business sense be expected to borrow heavily in loan terms on the market. That is the direction.

(Clare Short) This is like EBRD, the bank for the reconstruction of the communist countries, which goes for equity. With that there is expertise in management, responsibility for trying to ensure that companies succeed, more engagement and more sharing of the experience with that kind of engagement.

EBRD have borrowing powers.

(Mr Ireton) It does have borrowing powers because we and others have put large amounts of capital in.

It can also borrow from the market.

(Mr Ireton) It can and it lends.

(Clare Short) So can the World Bank, but there are limits and it is backed up with public sector money and then leveraged. In the case of the World Bank it then loans into middle income countries for a rate of return which is near market and then very concessional lending to poor countries. It is using that public sector money to have a package which has enough guarantees to borrow as cheaply as possible and then a subsidised element of the loan into the very poorest countries.

Chairman

One of the benefits of select committees is that we sit for a whole parliament. Maybe towards the end of this parliament in two or three years' time we can perhaps revisit CDC in a single session again like this and see where we are. Lord Cairns and you have put down a number of markers today against which progress can be judged over that time. Thank you very much for coming and explaining everything, although I think you managed to disagree with every colleague.

(Clare Short) May I just say thank you? I should welcome that. I think personally, out of the disgruntled people who had worked on agricultural loans, there has been a change in the atmosphere in the Select Committee. The previous Select Committee scrutinised the plans for the change in CDC very toughly but did believe in it and were positive scrutineers. There has been a negative coming out of some of the work which I think is regrettable and makes the whole project less likely to succeed. You will all do exactly what you think is right of course, but I just want to say that. This is a very precious possibility, if it works and brings on a lot of faster investment. The markets are slow to see a country which is reforming and it takes a long time to build up the reputation and then attract the private sector. If CDC can operate well and speed up that process, then the reward of getting investment would be quicker for countries and more poor people would have a better life

Quite a number of members of this Committee were on the last Committee. Over time you have changed the model. This Committee is pretty supportive of you generally, Secretary of State. I am not a Gwyneth Dunwoody, so you have a pretty good ride in this Committee.

(Clare Short) I do not mind you criticising me personally. I just want this CDC thing to succeed. I should like us to try to work on that together, if that is possible. That is just a request I put to you. Deal with it as you wish.

There is no issue on which this Committee does not try to work together with you. The problems we have had perhaps collectively with CDC are that it has been quite difficult trying to work out what the model is and what it is that you are trying to achieve and what it is that CDC is trying to achieve. That is the perception of those sitting on this side of the table. I say that what we have managed today and on previous occasions is that at the very least Simon Cairns and you have put down various markers by which you wish to be judged. You have given us an indication of where you hope it is going to go in the next two to three years and longer. Towards the end of this parliament I hope that we as a committee can have a single session again like today and see where it has got to.

(Clare Short) That would be excellent. Thank you.