Government Matters

To date, much of the discussion about policy for impact investing has been about specific tools, such as special purpose legal vehicles (e.g., the benefit corporation), or tax incentives for investors. While this is important, we would suggest there is a more urgent need—to align interests between those who are trying to serve disadvantaged populations from a business perspective and those in government who feel they represent the disadvantaged.

Political Risk and Vulnerability

The microfinance crisis in Andhra Pradesh and the No Pay movement in Nicaragua were not random anomalies. Explosive questions about appropriate pricing and quality of service are central to all for-profit efforts serving the disadvantaged. So, too, are questions about political interests, threatened incumbent players, and colliding ideologies.

Impact investors cannot afford to ignore critical political considerations. Enlightened politicians and policymakers have the potential to dramatically speed up the rate at by which an industry can scale to responsibly serve hundreds of millions. Conversely, when impact investors fail to align with policymakers, we will find ourselves at risk of double jeopardy. We can fail because the companies we invest in may have a hard time growing in the most challenging of markets. Or we can fail because these same companies may eventually be seen as too successful and profitable—inviting a powerful and potentially destructive backlash from public opinion, threatened incumbent commercial interests and/or politicians.  

The Role of Government

Governments have numerous powerful levers at their disposal to accelerate new industries for impact. Among the most important policy imperatives are: ensuring fair and robust competition; establishing appropriate regulation; and promoting entrepreneurship.

1. Ensuring Robust Competition
In both India and Mexico, a significant percentage of the population lives in poverty. And in both countries, poor people use mobile phones for everything from banking services to getting health advice when they’re too far from a hospital. But whereas in India, the typical mobile phone user pays less than a cent per minute of airtime, in Mexico, this same service costs 27 cents per minute. Why this difference?

In the late 1990s, the Indian government deliberately adopted policies (including a major decrease in licensing fees) to move the mobile market from a duopoly to a market in which 14 major players actively compete. As a result, prices have dropped and demand widened—leading to far greater inclusion of the disenfranchised. In Mexico, meanwhile, Telcel controls about 70 percent of the mobile telephony market and has been able to successfully maintain a situation of limited competition. According to a January 2012 OECD report, Mexican consumers are being over-charged by $US 13.4 billion a year for phone and Internet services. Monopolistic or oligopolistic players not only charge higher rates, of course, they also tend to hinder innovation.

The importance of competition is also underscored by the experience in microfinance.  Intense competition—rather than interest rate caps or government fiat—has been one of the single most important drivers of declining interest rates and improving customer service, according to a 2006 CGAP study. 

2. Establishing Appropriate Regulation
Policymakers must be proactive in ensuring appropriate consumer protections for the poor and disadvantaged consumers. But they have a wider variety of tools to do so than one might frequently assume. In microfinance, for example, successful countries like Bolivia and Peru have strict regulations to ensure the financial solvency and responsible credit underwriting methodologies of lending institutions.  But regulation should not be overly onerous and should encourage innovation rather than protect incumbent players. Significantly, many countries permitted MFIs to provide savings as well as credit products, allowing MFIs to serve customers better, even while diversifying their revenue base and reducing reliance on interest-charging credit products. Many industry observers note that the Indian governments refusal to allow MFIs to accept deposits contributed to the MFIs obsession with rapid credit expansion and client over-indebtedness, which were contributing factors to the crisis in Andhra Pradesh.

Mobile payments is another sector in which government policy can either accelerate or hinder market development. When considering the enormous utility and growth potential of mobile payments, most governments have legitimate concerns about money laundering and less high-minded concerns about the business risks that such innovations pose for the frequently coddled banking sector. In Kenya, the government has worked with M-Pesa, the popular mobile payments provider, to establish limits on the size of money transfers, thereby substantially reducing money laundering risk. M-Pesa has been an enormous success, and now serves more than 70 percent of Kenyan adults and handles the equivalent of 25 percent of Kenyan GDP. Unfortunately, mobile payments has been far less successful in many countries where vested interests are stronger. In too many countries, regulators have taken a much more restrictive approach and been less resourceful in developing appropriate solutions to enable the safe and reliable mobile money transfers.

3. Promoting Entrepreneurship
New sectors are only as good as the entrepreneurs and teams that develop innovative products and services. There’s a lot that governments can do to ensure the quality and vibrancy of entrepreneurial activity.

Rwanda, for example, has achieved an impressive 8.4 percent growth rate over the past decade.  Part of this is due to reforms initiated by President Kagami that have made it easier to start businesses, register property, protect investors, and access credit. Kagami’s approach was bottom-up rather than top-down; he saw entrepreneurs as directly responsible for building the economy, and devised policies to get out of their way.  He also promoted specific sectors and facilitated the creation of relevant infrastructure to help them scale. 

With a similar philosophy, Omidyar Network recently worked with the Government of India on a series of recommendations to build the country’s entrepreneurial ecosystem. The recently released report highlights a variety of proactive steps the government can take—including scaling up venture incubation facilities, as well as providing appropriate regulations around capital gains to encourage easier exits for angel and early-stage investors.  An excellent overview on the ways in which government can help drive a more entrepreneurial environment is available here.

Philanthropists and not-for-profits also play a critical role in creating more vibrant entrepreneurial ecosystems. Endeavor, a global not-for-profit headquartered in New York City, for example, seeks to catalyze long term economic growth by selecting, mentoring, and accelerating high impact entrepreneurs in many countries around the world. Among other things, Endeavor is cultivating the creation of a powerful network of entrepreneurs: entrepreneurs who are not only successful in their own right, but entrepreneurs who—through collaboration, mentoring, and investing—are creating a network and an ecosystem that can have a massive multiplier effect on country-level innovation.  Indeed, Endeavor’s experience suggests that a robust network of entrepreneurs and mentors can overcome even challenging macroeconomic and policy environments. Endeavor’s work in fostering an entrepreneurial network in Argentina has been particularly impressive, as highlighted in this short video.

Politics and policy are but two factors that fundamentally shape the trajectory of new sectors. Ultimately, success is best achieved when supportive politicians and policies are married with entrepreneurs and a diverse set of investors who are deeply committed to innovation and sector level change. Getting this formula right can mean the difference between impacting hundreds and hundreds of millions of lives.   In the our next and final article, we turn to the question of what is at stake at the critical junctures of market development: how do markets actually scale and what are the points at which entrepreneurship, different kinds of capital, and policy come together to a make meaningful difference in the lives of millions of people.

Read more stories by Matt Bannick & Paula Goldman.