In early April, the Organisation for Economic Co-operation and Development (OECD) held its annual global forum on development. This year, there was a noticeable shift from traditional, government dominated themes, such as aid spending and delivery towards a more holistic approach and more attention for other capital flows. It is too early to conclude that the aid tribes have met the global lobby tribes, let alone the financial tribes, but if the trend is sustained, it may have consequences for institutional investors.
One example was the tone and content of the new OECD publication States of Fragility – Meeting post-2015 Ambitions. Traditionally, developing countries are classified according to per capita GNP, ranging from high-income and middle-income countries to low-income countries, with specialised categories such as least developed, island and land-locked countries. In the new approach, as the title indicates, all countries (including OECD countries) are classified by a concept, fragility, that includes five partly overlapping elements: violence, justice, security, economics and tax efficiency.
The rating is interesting to judge financial exposure for sovereign risk. It is likely to have a better capacity to provide insight into country risk, but it also aligns interests of investors and aid administrators. As an example, advances towards an impartial and independent judicial system and the rule of law not only help a country to develop and help avert domestic violence, it also makes the country more worthy of the attention of investors.
The report notes that remittances are the largest private flows into fragile countries and that foreign direct investment (FDI) amounts to very little (6%). It fails to notice that the capacity and potential of FDI is much larger than that of remittances, though.
Another OECD activity hinges on investment for sustainable development. This area clearly shows how global issues such as climate change, sustainability and responsible business conduct may become integrated into the developing country framework. ESG does of course already consider such global issues. Integrating them with development issues may bring in new stakeholders, sometimes with a remarkably narrow focus and distance from a complicated reality. However, depending on how things turn out, we may also see new areas for co-operation with aid organisations such as development banks that can mitigate risk, either by shouldering it or by close monitoring on the ground.An example of how institutional investors can play a constructive role in this area is PGGM. The Dutch pension fund investor manages a significant investment in real estate in Mexico. It insists on applying US norms for the projects in its portfolio. This is beneficial for PGGM, as it ends up with good quality, sustainable real estate, but it also helps moving the bar for new construction in Mexico. Nobody loses.
Even activities that do not affect foreign investors directly can make a country more attractive. A fair tax system, collected fairly, will make government revenue more stable, increasing possibilities for private-public partnerships (PPP) and favouring long-term investments by making taxes more predictable. Investments with a long-term horizon will in turn stabilise and increase tax receipts, creating a virtuous circle.
Somewhat bothersome, for a theoretical macro-economist, is that the lessons of Cobb-Douglas seem to have been forgotten again: development starts with an agricultural surplus. It is the basis for an economy that can move beyond agriculture, the basis for the formation of a middle class that has a stake in an equitable economy. It breaks financial monopolies and shifts power from relations to education and merit. Land reforms in Japan and Taiwan have proven the point. Resistance to agricultural reform in Latin America show there is no short cut. Yet, an agricultural surplus does not figure much in the latest OECD publications.
Governments and international organisations cannot move fast. Vested interests will try to block change: any change, whatever its benefits. Nevertheless, this is an area that should be kept under review. Developing countries abound in opportunities; can deliver almost unlimited (but largely unskilled) labour but lack capital. Investors have the capital and are constantly looking for good projects. It seems such a good match. Yet, risk gets in the way. Efforts to mitigate risk in developing countries are not as heart-warming as caring for the sick or feeding the hungry, but they have more potential than anything else for development. The expression give a man a fish and you feed him for a day; teach a man to fish and you feed him for a lifetime applies. It was coined eight centuries ago. Isn’t it time to put it into practice? Link to ESG Global Forum.
Peter Kraneveld, former Chief Economist at PGGM and advisor to APG Asset Management and State Street Global Advisors among others, is a pension expert at PRIME bv.