Guarantees, Subsidies, or Paying for Success? Choosing the Right Instrument to Catalyze Private Investment in Developing Countries

37 Pages Posted: 27 Jun 2015

See all articles by Owen Matthew Barder

Owen Matthew Barder

Center for Global Development

Theodore Talbot

Center for Global Development

Date Written: May 5, 2015

Abstract

Governments, donors, and public sector agencies are seeking productive ways to ‘crowd in’ private sector involvement and capital to tackle international development challenges. The financial instruments that are used to create incentives for private sector involvement are typically those that lower an investment’s risk (such as credit guarantees) or those that lower the costs of various inputs (such as concessional loans, which subsidise borrowing). We argue that the public sector is unlikely to have better information about risk and reward than the private sector, so using either instrument shifts downside risk from private firms to taxpayers. We propose a better contract to support private sector investment by enhancing the returns to the private sector, linking payments to specific, measurable, and agreed milestones or outputs. We argue that these contracts are less distortionary and produce better results for a lower expected cost than other incentive programmes. We motivate the argument with an economic and financial model and discuss political economy considerations that reinforce the current status quo in favour of generally suboptimal instruments such as guarantees and loan subsidies.

Keywords: private investment, finance

JEL Classification: F21, F35

Suggested Citation

Barder, Owen Matthew and Talbot, Theodore, Guarantees, Subsidies, or Paying for Success? Choosing the Right Instrument to Catalyze Private Investment in Developing Countries (May 5, 2015). Center for Global Development Working Paper No. 402, Available at SSRN: https://ssrn.com/abstract=2623149 or http://dx.doi.org/10.2139/ssrn.2623149

Owen Matthew Barder (Contact Author)

Center for Global Development ( email )

2055 L St. NW
5th floor
Washington, DC 20036
United States

Theodore Talbot

Center for Global Development ( email )

2055 L St. NW
5th floor
Washington, DC 20036
United States

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