The Future of CDC

Evidence submitted by ONE

Overview

DFID’s commitment to reform CDC is both welcome and vital to ensure its success as an instrument for stimulating inclusive economic growth. In recent years CDC has been too profit-focused in its investments and needs to recalibrate its approach to seek greater returns in terms of poverty reduction. ONE recognises that macro-economic growth, while necessary and important, is not sufficient. CDC and other Development Finance Institutions (DFIs) can achieve profits, growth and contribute to poverty reduction.

Recent reports show the relationship between poverty reduction and economic growth varies depending upon existing characteristics and inequalities in the type of growth in the individual country (Kalwij & Verchoor, 2007; OECD, 2010). Indeed, in some cases poverty levels have remained the same while inequalities have actually increased with GDP growth (Kalwij & Verchoor, 2007; Ravallion, 2001). Without policies to directly address inequality simply supporting economic growth generation will not achieve the desired results. Growth must be inclusive, raising the pace of growth and enlarging the size of the economy, while levelling the playing field for investment and increasing productive employment opportunities.

To successfully achieve its development mandate CDC must, with regard to its tax situation and investment in developing countries, become a global champion of transparency. In addition to this CDC must lead the world in its accountability to Governments and civil society in the developing countries where it invests and to Parliament and the public in the UK.

Recommendations:

To maximise its potential to support inclusive growth and poverty reduction, CDC should:

1. Ensure investments align with developing country priorities and align with national development and economic growth plans.

2. Require investments to meet appropriate international environmental and labour standards providing ‘decent work’ as defined by the ILO, in addition to protecting fragile environments.

3. Invest in sectors for which there has traditionally been private sector neglect, in particular agricultural research and development, undertaken in country, for locally produced staple food crops

4. Restructure the investment portfolio to invest at least 50% of all funds in low and middle income countries, ensure at least 50% of funds intended for Africa are directed towards LDCs, and investments are used to build developing country human capacity

5. Create stronger oversight and disclosure mechanisms for DfiD, Parliament and the public including better methods of formally consulting civil society in the UK and in countries where CDC invests, coupled with the establishment of a complaints mechanism for those impacted.

6. Commission regular public evaluations to assess the impact of CDC investments on poverty reduction levels based on minimum poverty reduction targets for all its investments to ensure accountability.

7. Restrict the use of tax havens and require timely and full tax payment for all companies in which CDC invests to ensure that gains are re-invested into host countries. As the private equity model gains prominence among DFIs, it is essential that a new set of rules be developed to reduce the use of tax havens.

8. Require all recipients of CDC investment to publicly publish their accounts on a country-by-country and project-by-project basis.

Key areas where CDC should focus its attention:

Inclusive Growth:

If CDC is to showcase how DFIs can contribute to growth that is "broad-based, inclusive and sustainable; in which all people benefit from the proceeds of prosperity" [1] there needs to be an understanding of what this means. The World Bank defines "inclusive growth" as rapid and sustained poverty reduction that allows people to contribute to and benefit from economic growth [2] . CDC should look for investments which support environmental sustainability, absorb a large proportion of unskilled labour, employ the poor - including the poorest of the poor - sustains employment and wealth creation over the long-term, promotes rural economic development and contributes to reducing inequality.

Inclusive growth improves economic security and investment attractiveness. By building a diversified economy with a diversified employment base, the economy as a whole is less susceptible to failure in the event of major shocks within one sector. Reducing vulnerability to shocks and stresses in a specific sector generates an economy that carries lower economic risk for investors and reduces economic inequalities. This has been shown to reduce political risk incentivising future investment (Thorbecke & Charumilind, 2002). Inclusive growth should also permit increased access to affordable food and health and education generating a healthier, more educated and productive workforce (Thorbecke & Charumilind, 2002; ILO, 2002; 2005). Investments that consider and plan around environmental constraints and long-term growth opportunities also suffer less from economic and environmental shock and stress (Smith & Petley, 2009).

Labour Intensive Industries:

Many countries, particularly in Sub-Saharan Africa, have a large, growing labour force and an abundance of people, particularly those under 25. However, foreign investors often choose not to invest in this group due to a lack of required skills. Instead these investors establish themselves elsewhere or bring in experienced labour rather than train and educate the local workforce (Te Velde and Morrissey, 2002; 2004). If unemployed this local population is more likely to generate political unrest and thus increase investor risk. CDC should focus on labour intensive jobs which provide income for this growing workforce, particularly agriculture and other secondary transformative industries such as textiles and apparel and manufacturing.

Agriculture:

CDC should significantly expand its investment portfolio in agricultural development because investing in agriculture reduces poverty and leads to inclusive economic growth. Whereas CDC investments in agribusiness made up close to 50% of all its activities in the early 1980’s, by 2009, this shrunk to just a mere 5% of total investments. As the decline mirrors trends occurring globally for investments in agriculture, which dropped precipitously from 18% of total ODA in the mid 1980’s to under 5% in the early 2000s’, the CDC likewise should follow recent moves by donors to increase investments to agricultural development.

In poor countries, the majority of which are agriculturally based, reducing poverty cannot be done more rapidly and expansively than investing in agriculture. Seventy-five percent of the ‘dollar-poor’ live in rural areas and projections suggest that more than 65% will continue to do so until at least 2025. [3] Agricultural expansion also leads to broad-based growth, as it is labour-intensive and has the capacity to employ ‘untapped’ labour, especially for those who own no land or too little to actually make a living from farming. Furthermore, agricultural growth reduces food prices and acts as a multiplier in local economies, leading eventually to higher rural wages and markets where farmers and workers spend their earnings. Several country analyses show that with each 1% increase in agricultural GDP – as compared with non-agricultural GDP – income rises much more for the poorest households. [4]

However, where, how and for what purposes investments in agriculture are designed impact their return on poverty reduction. Poverty has a lot to do with location and vocation. The severity of rural poverty exceeds that of urban poverty almost everywhere and rural populations in rain-fed areas are among the poorest socio-economic groups. Living in remote, hard-to-access, areas makes reaching these populations physically challenging. Roads often are seasonal making year-round access limited. For farmers in 45% of agricultural communities in poor countries, it takes over four hours by car to get to the nearest market town. [5] This presents a multitude of market access challenges as these producers will face difficulties accessing reliable seed and input markets, in addition to receiving any regular form of support or information regarding advances in agricultural technology, improved farming practices or market prices.

Reaching these populations that live in remote areas and or work unfavourable, degraded lands with solutions that meet their needs will impact returns to poverty reduction. Studies show that in multiple African countries when smallholders produce more food staples like cereals, roots, tubers, pulses, oil crops and livestock and trade in rural markets, equitable growth is more likely. In Rwanda, a 1% cent growth in gross domestic product (GDP), driven by increased production of staple crops and livestock, had a greater effect on poverty reduction than the same rate of growth generated by export crops or non-agricultural sectors. [6] Thus, CDC should incorporate investments into its portfolio that include staple food crops that are not solely intended for export.

Reform of CDC Portfolio Composition

The CDC committed in 2009 to invest more than 75% of "new" Investments in low and middle income countries and more than 50% of their funds in Africa. ONE appreciates this commitment to shift focus to poorer countries, particularly in Africa. However, CDC should go further to ensure that investments are targeted at the poorest countries where they can have the greatest impact on poverty reduction.

A stronger commitment to targeting poor countries would be to invest at least 50% of all funds in low and middle income countries. Of the 50% of funds intended for Africa, a commitment should be made for at least 50% of these funds to be reserved for investments in Least Developed Countries (LDC). Compared to a ‘low-income’ country (defined as a country with a gross national income (GNI) per capita is less than $1000) a LDC is a more comprehensive indicator of poverty drawing on multiple criteria and indexes including:

· GNI of less than $900 based on a three-year average

· Measurements of human resource weaknesses based on indicators of well being and development such as nutrition, health, education and adult literacy; and

· Measurements of economically vulnerability based on indicators of agricultural production; exports of goods and services, importance of non-traditional activities (eg manufacturing and services) to the GDP, and the percentage of the population displaced by natural disasters.

Furthermore, CDC should seek to build in-country capacity where possible. Through its lending practices CDC could invest in building human capacity through committing using African fund managers and other in-country staff to manage, oversee and design its investments.

17 November 2010