Thursday, April 1, 2010

Supporting developing private sectors: risk sharing

Under the banner that "innovation is a public good" [groan] Dan Altman proposes that investors could buy private high-risk, high-yield bonds and swap them for lower-risk, lower-yield bonds at participating governments. The theory is that governments have a longer time horizon than venture capitalists and if innovation is a public good they indirectly subsidize anyway, why not here too?

For instance, let's say a cashew producer in Senegal needs $5 million to build a new processing plant. The plant would have equal chances of delivering an annual return of 20 percent or going bust. If the plant is successful, though, it would also creates hundreds of jobs and be an anchor for the development of its community. So far, no one wants to invest. But a venture capital firm might be willing to put up the $5 million if, instead of the 50-50 chance of a 20 percent return after a few years, it received 7 percent per year starting now.

Who would make this swap? A foreign government interested in Senegal's development might. With a big, diversified portfolio full of investments just like this one, that government could expect a 10 percent annual return, on average, after a few years. That's not a very long time to wait, considering government's time horizon; what's a few years, when you're worried about funding Social Security until 2075?

Moreover, the investment would be a quadruple winner: the cashew producer would get its plant, Senegal would develop, the venture capitalist would get a good return, and taxpayers would get an even better one. The government would not be crowding private investors out of this market; rather, it would be facilitating a new market that otherwise would not exist, and then sharing in the gains from trade.

I'm glad someone is paying attention to the fact that donors aren't paying enough attention to the private sector. They aren't. But honestly, did we learn nothing from the current banking crisis? Oh wait, yes, we did. We learned that rich governments are willing to buy bad loans to subsidize hedge funds, banks, insurers, and venture capitalists. The idea could have some merit, but it's going to take more explanation why this isn't a disaster waiting to happen when systemic risk bites.

Other advantages: the government isn't picking winners (in theory). The private sector is picking which firms deserve money. Until governments put conditions on whose assets they will swap to meet certain criteria, anyway.

And can we please differentiate between public goods and merit goods where most of the benefits are captured privately, there are just some nice secondary effects, which incidentally are also privately captured?

Hat tip: Aid Thoughts

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