• Shenglin (Forrest) Chai, Impact & Outreach Intern
  • June, 2022

The role of Impact in the approaching crisis

Summary

The world economy is declining into a period of slow growth from a triple-whammy: a global recession caused by covid; commodity price shocks from the Russo-Ukrainian war and increased interest rates by the United States Federal Reserve. The gains that developing economies have had in the past decade are now being unraveled, and, through these pressures, populations are being pushed back down the poverty line. There is a clear need for intervention and investment into these recovering economies to be more targeted and effective for the businesses and communities that are most underrepresented and vulnerable to reap the benefits.

In the Danger Zone

Through the Covid years of 2020 and 2021, the combination of lockdowns, medical emergencies, travel restrictions and supply chain disruptions have devastated – and continue to devastate – many communities worldwide. The United Nations has estimated that the Pandemic has already caused 77 million people to fall into extreme poverty, with immense debt distress and an increased possibility of food shortage leading to more falling in-between the gaps. The large vaccine disparity during the pandemic and difference in available capital for post-pandemic economic recovery has also created a ‘pandemic recovery gap’ that serves as another obstacle for the global South to overcome. 1,2 

The Russo-Ukrainian war has led to increased prices of commodities due both to the sanctions placed on Russia and the stoppage of Ukrainian exports. These commodities are important for developing countries both in their domestic consumption needs, as well as in their light and heavy industries: wheat, fuel, pig iron, and nickel. These materials are essential to produce commodities further up the value chain for export or consumption (i.e., fuel for tractors; feed for livestock). Strained supply chains affect not just the businesses directly from the availability of material, but they also have a cascading impact on the economy. The overreliance of just-in-time schedules of supply, means that when one sector is affected, the whole chain seizes. Fluctuations in global energy prices from the war has ramifications beyond just higher costs of fuel: fertilizer has become scarce due to the lack of gas, a critical component in their manufacture, without which agricultural production would be affected. These have combined to narrow profit margins for many industries in developing countries, threatening to worsen the already wide ‘recovery gap’ that these countries face coming out of the pandemic, and ultimately setting them back years in their pursuit of the economic recovery and prosperity. 2,3 

The recent announcement by the US Federal Treasury of their plans to increase interest rates bodes ill for development in the coming years in two ways. Firstly, the current, and increasing attractiveness of American and Corporate bonds comes at the expense of investments in the developing world. Global investors would much rather put their investments into safer investments in the Federal Treasury than place them in projects in developing countries which are deemed riskier. Developing countries would thus have less foreign investment to spend on economic recovery, turning instead to drawing on reserves already scarce after the pandemic. Secondly, rising interest rates leads to an increased valuation of the US dollar. As commodities are traded internationally in the US dollar, developing countries would have to purchase US dollars – at ncreasingly unfavorable rates – to purchase commodities – which already are at unfavorable rates due to supply shortages.

These three events – the fallout from a global pandemic, a war in Europe and a rise in US interest rates – are each already significant by themselves, but when combined, have been described by the UN as the ‘perfect storm’ of economic devastation in the years to come.



Restarting Growth

Crises like the above disproportionately affect poorer economies, and we have seen this with past crises significantly hindering their growth and progress in social and economic development. Most impacted are rural areas, especially in developing countries, which saw a gap in growth during the recovery after the Great Recession of 2008, with some areas trailing 5% behind urban centers, resulting in years of lost potential. Bad management and lack of funding may combine to create a situation of years of increasing poverty, as has been experienced in Latin America after the Volger Shock in the 1970s. Another result of a recession would be the risk of unsustainable urbanization from increased rural-to-urban migrations, which has the double effect of decreasing quality-of-life in the cities with a strain put on resources, and reducing economic development in the rural areas. This phenomenon is much reduced in countries with a more even development within the country, and recessions cause a vicious cycle of the lack of development. Without intervention, this lack of development is hard to overcome due to the perceived risks of investment into undeveloped economies, worsened by poor infrastructure and a comparative lack of technological connectivity.

In these economies, the most vulnerable and overlooked area is perhaps the sprawling formal and informal private sector.9, 10  Making up the core of the community’s lives and economies, the Micro, Small, and Medium Enterprises (MSMEs) have an outsized presence, representing >90% of businesses and the sale of 80% of basic consumer goods.11, 12  MSMEs provide most of the employment at >90%, and, if one includes informal businesses, >50% of the national income (GDP) of the emerging economies.13  These MSMEs have been chronically underserved by their governments and international development efforts in a manner that belies their importance, with an approximated 65 million firms (40% of formal businesses) facing unmet financing needs totaling US$5.2 Trillion every year.13  This gap will have to be filled – as best as it can – to see any significant improvement in the outlook for the economies of these countries in the coming storm.


New Development

The broad-ranging public-funded or intergovernmental aid that has been repeatedly used to combat these economic and development issues have seemingly become the be-all-end-all of solutions to crises: stimulus bills to rescue local economies in the wake of COVID-19; top-down grants to assist sectors where affected commodities are critical; IMF and World Bank loans for fledging economies recovering from COVID to weather the incoming storm.14,15  Though there is no denying their importance and good intentions, IGO development financing – historically blunt instruments which are often liberally applied – are limited in their effectiveness.16,17  Retrospective analyses on both the IMF and the World Bank criticized their efficacy in their, sometimes reluctant, role in crisis management and post-crisis development.14,16,18  IGOs often find that their efforts are hindered by inflexibility and an inability to fully penetrate the market, with one IGO report lamenting that despite their best efforts, they were only able to reach 5% of the intended market.17  Constantly beset with issues ranging from the growing complexity from globalization to the lack of oversight on spending and results, IGO funds are increasingly unable to solve crises and sow for development and are urged to reform and evolve in their methods.

International think-tanks like the Brookings Institution, the Carnegie Endowment and even the World Bank’s researchers themselves have pointed to a two-pronged solution to improve international development financing. First, they stress that future approaches should be highly data-centric and that large investments in measuring long-term impacts must be made to wean off an “over-reliance on simple metrics to assess progress.”19  Second, it should incorporate stronger partnerships with private investors on multiple levels to maximize effectiveness of investments.15,16,19  The combination would improve both effectiveness and accountability, shedding light on the true impacts of the financing. This shift toward the increased granularity and an emphasis on the impact allows a greater understanding of each dollar spent and improves insight into the targeted communities that benefit from financing.

The need for impact

It is time for financing to move away from the “sledgehammer” of the previous model of developmental finance and shift toward the scalpel: a data-driven approach that puts true results and impact first. The suggestions to improve developmental financing by the think-tanks and IGOs reflects greater shifts in the space of sustainable finance, shifts that focus on transparency, granularity, and results.

The wide adoption of smartphones in the information age has accelerated development efforts by making the market more interconnected through market coordination and lowered transaction costs. With the approaching global domination of fintech and ecommerce, the sheer quantity of data available in the different levels of the value chain is forcing traditional finance to pick up the methods of fintech and recognize the benefits of big data, allowing for finer granularity and understanding of the effectiveness of each dollar invested. This need for greater clarity and effectiveness is more important now than ever as the financing available would be increasingly limited: all countries will be affected in the coming crisis. A strong, data-led approach with impact at its center would be the approach which would allow financing and development to remain sustainable. Traditional finance – both public and private – will need to adopt these practices to truly make an impact in the crisis that is to come.

References