The Finance Gap

UN Secretary General Antonio Guterres’s foreword to a 2021 UN Inter-agency Task Force on Financing for Development report exhibits a prevalent piece of common sense in sustainable development circles: 

Financing for sustainable development is at a crossroads. Either we close the yawning gap between political ambition and development financing, or we will fail to deliver the Sustainable Development Goals (SDGs) by the deadline of 2030. 

The question of how to bridge this “yawning gap” between the aims of sustainable development and available financial resources, however, can be solved by only one method, according to the full report: “a boost in private investment.” This formula—the existence of a “financing gap” and the subsequent need to expand private investment—is an increasingly prominent focus in the development world, across a range of areas.

Though he is a very prominent voice, Guterres is far from alone in making claims like these. This emphasis on private financing is the first premise of what Daniela Gabor calls the “Wall Street Consensus”—the growing agreement among development agencies about the need to “escort” private capital into development projects through various forms of “derisking.”

At preparatory discussions for the post-2015 Sustainable Development Goals, policymakers identified large financing needs, and a concomitant need to “un[lock] the transformative potential of people and the private sector” in order to address that gap. This was the basis for the World Bank and other Multilateral Development Banks to lay out what was initially called the “Billions to Trillions” agenda following a 2015 meeting in Addis Ababa. The agenda is based around the core principle that meeting the SDGs will require “intelligent development finance… that can be used strategically to unlock, leverage and catalyze private flows and domestic resources.” This will require “using the ‘billions’ in ODA and in available development resources to attract, leverage, and mobilize ‘trillions’ in investments of all kinds: public and private, national and global, in both capital and capacity.” Development aid, in this context, needs to be targeted at the so-called crowding in of other sources of financing. The Bank’s new slogan is “Maximizing Finance for Development” (MF4D), indicating the need to marshal private investment to help close the development gap. 

The invocation of the term “finance gap,” in identical or very similar terms to those seen in Guterres’s foreword, has a much longer history than we often assume. And its invocation often is an anodyne or depoliticizing way to describe a systemic tendency towards uneven development and the true structural obstacles that tendency poses for equitable development. Indeed, the sheer persistence of the finance gap as a frame reflects the structural constraints with which development projects have often grappled. It is by studying the longer history of the finance gap that its political dimension is most clearly revealed—particularly the subset of development practice aimed at expanding access to formal credit.

In the sphere of development, discussion of the finance gap tends to paper over the political dynamics of financial resources—that is, who controls them, and what this means for fiscal and monetary policy outside of the metropolitan centers. For states and multilateral institutions confronting these structural constraints while needing to mitigate the worst social and ecological consequences of uneven development, an appeal to mobilizing private finance has often appeared as the path of least resistance. But those sought-after flows of finance capital have usually proved to be unattainable.

A colonial prelude

The finance gap long precedes the Wall Street Consensus. In 1951, a British colonial official, writing on a proposed scheme to establish credit cooperatives for African borrowers in Kenya, noted that:

These societies are not likely, in the near future, to attract many deposits either from members or non-members. They will therefore have to depend on other sources for their working capital either government or commercial banks. No government has sufficient funds to finance many peasant cultivators and in the end, finance will have to come through the commercial banks.

Reference to the government’s lack of funds, as well as the impetus to develop private and commercial finance is clearly echoed in a statement like Guterres’s. It’s a statement that reflects the specific context of late-colonial Kenya. African agriculture in Kenya had historically been explicitly and directly underdeveloped. With the advent of white settlement in the first decades of the twentieth century, land and agricultural policy increasingly reserved access to finance and markets for settlers, and sought to produce a population of cheap African laborers. As Abreena Manji notes, in this sense, “Kenyan land policy was… racialized at its inception.” 

There were tentative efforts to change entwined systems of credit allocation and property relations so as to support African agriculture as early as the 1930s. Facing the effects of the Great Depression, the colonial state sought to both expand its fiscal base and contain growing political threats. Proposals in the 1930s and 1940s foundered, but efforts at reform were ramped up in the aftermath of the Mau Mau rebellion—the armed revolt led by the Kenya Land and Freedom Army, which was brutally repressed by the colonial state. 

The colonial government appointed Roger Swynnerton, Assistant Director of Agriculture in Kenya to develop a scheme for agricultural development in late 1953. The resulting report—commonly referred to as the Swynnerton Plan—marked a significant shift towards unambiguously encouraging the development of African agriculture.

Swynnerton’s proposal aimed to do this by mobilizing private lending for farming. This meant changing the way that African farmers held land so as to make it more compatible with existing financial systems. The shift was explicitly justified in terms that are echoed very closely in statements like Guterres’s above: Swynnerton argued that it was impossible to mobilize sufficient resources from the public sector alone. Some lending from public sources was necessary, but “were each farmer with a registered title to his land to borrow up to [£300] against the security of his title, ultimately borrowing would greatly exceed the resources of Kenya.” 

The solution mainly consisted in encouraging the much wider adoption of formal land titling. The explicit purpose of this was to encourage much greater access to commercial credit for African borrowers: “If Africans are to develop their lands to their full potential they will require much greater access to finance and if they achieve titles to their land in economic units, much greater facilities should be made available to them for borrowing against the security of their land.” The plan was expressly intended to create a small middle class of property-owning African farmers capable of employing wage labor and, crucially, accessing productive credit.

The affinity with the finance gap here is telling. Here was, first and foremost, a set of expressly conservative responses to the increasingly visible fragility of the colonial order. It was an approach doomed to fail. The colonial financial system itself militated against the expansion of credit to African farmers. Even after the halting formalization of African land tenure, the commercial banking sector, dominated by expatriate British banks, remained largely uninterested in lending to African farmers. Indeed, it lacked the basic infrastructures in terms of branches, staff, transport, and communications they would have needed in order to do so. In the years that followed, commercial banks actually increased the proportion of their lending for urban commercial operations rather than for farming.

Mobilizing investment for housing

A similar dynamic obtains if we skip ahead two decades to the policies aimed at promoting access to housing at the World Bank and USAID. 

British architect John F. C. Turner was hugely influential over Bank policy in the 1970s and 1980s, especially after the publication of his 1972 book, Freedom to Build. Turner was skeptical of state involvement in housing and celebrated the self-organizing capacity of slum-dwellers. He called for targeted “self-help” programs which would provide access to basic services and secure tenancy. It’s in large part thanks to Turner that from the mid-1970s, the Bank’s discussions of housing policy have supported informal housing as legitimate dwellings, while regularizing their residents’ access to land tenure and credit for upgrading buildings and services.  

The Bank’s first housing project was in Senegal. Project documents make note of the government’s turn to a more widespread sites-and-services approach based on “a growing awareness of the impossibility of providing more than a small proportion of families” with homes on a public or state-owned enterprise basis. Phasing out subsidies for public housing, the project was organized around “self-help” principles instead. This was justified as a means of “freeing” scarce public resources to be spent elsewhere. At the same time, the broader approach to housing very quickly started to reflect a recognition that scaling-up these projects required injections of outside capital.

The response at the Bank and elsewhere to these issues presaged key components of the Washington Consensus. Restrictions on access to credit for housing were largely blamed on government interference. Expanding access to mortgage finance was understood primarily as requiring liberalization. A study commissioned by the Bank on financing housing in developing countries, for instance, would note that, “Points of view that interpret usury as an evil have often led to the pegging of commercial bank interest rates at artificially low levels… With excessive demand thus created by controlled interest rates, banks prefer lending to the least risky borrowers.” 

Yet this “negative” liberalization was always accompanied in practice by more active efforts to shift the risk-reward calculations of private investors. One prominent example here is the Housing Investment Guaranty Fund (HIGF), administered by USAID. The HIGF of $10 million was launched by the US Congress in 1961. By the mid-1970s, it guaranteed more than $1 billion in loans. The HIGF was designed to mobilize American commercial lenders for housing projects in favored countries in the Global South. It worked with national governments and local lenders to design projects, often with a strong institutional development component, aiming to:

Assist in the accumulation of local capital for long-term mortgage finance operations, the promotion of effective cost recovery systems, the reduction of subsidies, the elimination of unrealistic standards for basic services and the stimulation of the private sector to expand economic development opportunities in urban centers.

The HIGF guaranteed the original principal and interest to commercial lenders who backed approved housing projects. Again, the arguments used then are echoed in today’s finance gap: without private participation, housing lacked adequate funding. A 1983 review of housing interventions at the Bank, for instance, notes that, “During the early 1970s it became clear that it was beyond the financial resources of all but a handful of developing countries to solve a problem of this magnitude.”

It is worth noting that interventions under the HIGF generated deeply uneven outcomes that often mirrored the already-existing geographic distribution of capital flows. The HIGF was, even according to its managers, ill-suited to mobilizing finance for the poorest people or countries. This point was made explicit in a number of evaluations, which emphasized that USAID “does not believe that countries with very low per capita incomes are suitable recipients for [HIGF] project loans, since these loans are made on commercial rather than concessional terms.” Likewise: “The commercial-rate financing provided under the… program is not, for the most part, appropriate to meet either the shelter needs of the very poorest income levels (below the 15th income percentile).” 

Like Swynnerton’s proposals, the flows of capital that were generated through the HIGF or through the Bank’s programming never met the expectations of their promoters, and tended to exacerbate existing patterns of uneven development. Equally important, these interventions over housing help make clear that the finance gap has been shaping the development of neoliberalism for some time. Housing policy at the Bank and USAID operated on a relatively restricted scale, never reaching the level of MF4D, but nonetheless laid a notable amount of the groundwork for the era of structural adjustment.

Securitizing microfinance

On a wider scale, microfinancing has also been recently identified as suffering a perceived finance gap, which it has sought to bridge by way of a range of investment vehicles and structured finance mechanisms. In the mid-1990s, officials at the World Bank’s Consultative Group to Assist the Poor (CGAP) noted that microfinance institutions (MFIs) “probably reach fewer than 5% of potential clients. Serving this market will require funding far beyond what donors and governments can provide.”

Responding to these concerns, support for commercial microlending flourished in the 2000s, in part an effort to scale-up microcredit markets. Microfinance Investment Vehicles (MIVs) proliferated rapidly in the 2000s, with considerable financial support and other forms of encouragement from the Bank and CGAP, as well as key donors. Though differences between the various MIVs exist, they all share a basic model. Investors buy shares in a specific fund offered by an MIV, and the MIV takes those funds and invests in MFIs, either by buying equity or (more likely) by lending funds to MFIs “on the ground.” MIVs mediate between capital markets and MFIs themselves. As Rob Aitken notes, “In order to fully constitute micro-credit as an investable asset, there need to be formalized and regularized routes opened through which it can be accessed by global capital.” 

A handful of funds—Blue Orchard, Oikocredit, Omidyar, and ProFund in particular—largely dominate the market for MIVs. These large, relatively diversified MIVs are accompanied by several hundred smaller funds which generally specialize in a particular regional or thematic niche (e.g. investing in MFIs specializing in the poorest borrowers). There are significant differences between these firms in terms of how they are set up, but in general MIVs are intended to channel funds from metropolitan investors to microfinance institutions in developing countries. They tend to operate with considerable support from donors. Investors in MIVs essentially delegate decisions about where profitable returns can be made by investing in different MFIs. Expanding rapidly in the 2000s, the MIV sector’s estimated global portfolio grew from just over $1 billion in 2005 to more than $8 billion in 2012.

Securitization and structured finance were also widely seen as means of mitigating information problems and managing investor risks in ways that might enable greater commercial investment in MFIs. One contemporary economist, Hans Byström, described the appeal as follows:

Instead of the MFI itself borrowing in the capital market to finance its lending to the microborrower, it can simply transfer the actual assets (the microloans) from the balance sheet to the investor. This is securitization and it could potentially be a viable way for microborrowers to get access to capital.

The securitization of microfinance was typically framed as a way of ramping up access to lending capital and driving expansion, but it always invoked tensions around commercialization. MIVs and the World Bank played a key role. In 2004, Blue Orchard launched a $40 million collateralized debt obligation (CDO) to fund a set of nine MFIs. The CDO was split into four tranches, a senior tranche backed by a $30 million guarantee provided by the US Overseas Private Investment Corporation (OPIC—at the time, the US government’s development finance arm) and three junior tranches. The CDO financed a group of MFIs, predominantly in Latin America. A follow-up issue was launched in 2005, referencing a slightly larger group of MFIs, and with slightly less participation from OPIC. 

In 2006, Blue Orchard again followed up these earlier issues with a public CDO referencing twenty-two MFIs and raising USD 106 million. The Blue Orchard CDOs were not collateralizations of micro-loans directly, but rather of loans to MFIs. And indeed, to a geographically uneven handful of MFIs. The first actual securitization of micro-loan payments was launched in 2006, by Bangladeshi MFI BRAC, raising USD 180 million in a securitization issue traded in local currency in Bangladesh. At least part of the aim for BRAC in securitizing its receivables was to diversify its sources of funds, and hence to evade political pressures to reduce interest rates that had tended to come with financing from official sources in Bangladesh. Like most of the other microfinance securitizations, BRAC’s issue was underwritten by a guarantee from development banks—in this case, KfW along with the Dutch FMO.

These efforts to mobilize private capital to fill this finance gap had impacts that were broadly similar to both Swynnerton’s reforms and USAID’s housing finance programming. Namely, microfinance securitizations and MIVs mobilized much less capital than hoped, and invested it in highly uneven ways.

Microfinance securitizations were never widespread; in practice only a handful of the largest MFIs in a few countries were able to carry them out. The Blue Orchard CDOs and BRAC securitization were by some distance the largest and most prominent. They weren’t widely emulated, and it’s doubtful that they could have been. SKS in India followed suit with a securitization of USD 42.6 million worth of microloan receivables in 2009, but SKS was already one of the largest and most commercially oriented MFIs. Indeed, the latter exacerbated the uneven distribution of microcredit within India as well by piling new sources of credit into already saturated markets in Andhra Pradesh where microcredit operations were well-established. This ultimately exacerbated growing crises of overindebtedness, leading to the catastrophic breakdown of the region’s microfinance sector following a spate of suicides by distressed farmers. 

MIVs were, in practice, the source of the largest inflows of capital into microcredit. But these were also distinctly uneven and had limited success in mobilizing private capital. At least in principle, MIVs were heavily marketed to “ethical” investors concerned with their “social impact,” and the market for “socially responsible” investments was identified as a key potential source of further investment in MIVs. In practice, IFIs, including the World Bank’s private lending arm the International Finance Corporation (IFC) as well as regional development banks, have consistently been the largest investors in MIV funds. MIV investments are, moreover, heavily skewed towards a few large MFIs—in 2007, ten MFIs accounted for 26 percent of total MIV investments. And more generally, they were also heavily weighted towards a few countries primarily in Latin America (Peru, Ecuador, Mexico and Bolivia) and post-Soviet Eastern Europe and Central Asia (Azerbaijan, Georgia, Serbia), along with Cambodia and India.

Politicizing the finance gap

Put together, the examples above show that contemporary invocations of the finance gap are part of a longer lineage of efforts to coax private finance capital into being redeployed in developmentally beneficial ways.

It’s notable that financial institutions themselves are rarely in the driver’s seat of the various interventions discussed above. Although Swynnerton, HIGF, MIVs, and MF4D all explicitly privilege the interests of private finance, there is little indication that these past and present efforts to plug various finance gaps have been directly driven by the interests of finance capital itself. Development agencies and states have spent quite a lot of time, with variable success, trying to lure finance capital, but in each case they encounter a structural impasse, indicating the limits of finance capital’s capacity to address poverty and underdevelopment.

There is truth to the argument that states acting alone lack the resources to fund a rapid transition to a decarbonized economy or reductions in poverty—at least as they’re presently constituted. This is especially true for peripheral states, which tend to feel the disciplinary effects of global finance much more intensely. Yet to frame uneven control over money as a gap skips over the dynamics of overaccumulation and uneven development.

Invoking the finance gap has always been, implicitly or explicitly, a way of diverting claims for wider redistribution. It means rejecting the public or collective provision of housing, basic needs, and basic infrastructures. The long history of failed efforts to “close” such gaps suggests that these objectives cannot be met without redistributive and democratically controlled public action. The initiatives and reforms described above uniformly failed to meet their objectives, even on their own terms, and often exacerbated existing inequalities in the process. 

The long history of the finance gap, in short, suggests that the only way we might meet the accelerating social and ecological catastrophes of the twenty-first century is with public or collective control over resources. This means taking expressly redistributive action aimed at repairing the structures of financial subordination which have inhibited meaningful development progress to date.