How For-Profit Businesses Can Reduce Corruption in Development Aid

Although for-profit businesses often are epicenters of corruption-related problems, there are opportunities for small and medium enterprises (SMEs) to reduce corruption in development aid—particularly in locales and sectors where NGOs and the government do not seem to have an impact, or where the NGOs and governments are themselves part of the problem. Development practitioners and policymakers should consider greater use of for-profit businesses, as opposed to non-profit NGOs, for implementing development projects.

There are several reasons why SMEs may be able to successfully run for-profit social ventures that are potentially more resistant to corruption:

  • First, although most NGOs are genuinely altruistic and aim to help locals in developing countries, their reliance on scarce external funding means their priorities often shift to organizational survival, and this pressure sometimes leads to dishonest reporting of the work that they are doing. The need to secure external funding also leads some NGOs to chase whatever happens to be the latest trend or fad in the donor community, a tendency that often leaves initiatives incomplete and can waste aid resources in the long run. SMEs, by contrast, can secure funding from private impact investors rather than traditional donors. Impact investors are willing to sacrifice maximum returns in order to ensure the social value is being achieved, but they also ensure the company is held accountable. Impact investors still hope to make a profit—or at least break even—by supplying the contracted-for goods or services at a cost lower than the contract price. This is in contrast to donors, who often say goodbye to their money and hope it is used well. And the insistence that further investment will be contingent on results is much more credible coming from impact investors than it is from donors. This leads to more transparency and accountability, and adds a level of protection against corruption. Furthermore, because SMEs are not donor-funded, there is less of an incentive for fraud and misreporting in order to acquire external funding, as the long-term profit-motive combined with the risk of eventual detection outweighs short-term misreporting in many cases.
  • Second, NGOs are not immune to problems like embezzlement, fraud, and bribery. While the managers of most NGOs are people of integrity who would like to eliminate these problems, they do not have sufficient incentives to invest substantial resources in doing so. For a for-profit business, the incentive for management to crack down on forms of employee corruption, such as embezzlement of funds, that eat into bottom line is much stronger. Further, the costs of corruption on a business’s finances are exacerbated in smaller companies, especially in development aid where the profit margins are thin.
  • Third, the involvement of private businesses allows more effective implementation of so-called “social/development impact bonds,” in which companies are awarded contracts based on results, and payment is contingent on successful achievement of the social goal specified in the bond. The bond works by private investors financing the interim costs, the service provider completing the task and earning the bond’s value upon successful completion (as determined by an external evaluator), and the return of investment to the private investors, with some profit for the service provider. Whether the payer is the local government or a donor organization, the successful completion of their objective is the only thing that requires them to pay to the company. This discourages corruption, since money lost could result in a complete loss of the contract. The social bond model can be used with NGOs as well, but the organizational setup of most non-profits means that they would be highly unlikely to assume such risk. For example, in a hypothetical development aid sector where vaccines need to be distributed in rural Africa, NGOs would require lots of donor money, which could potentially be embezzled. In the case of a business working to achieve the same goal on the impact bond model, the business would achieve the goal using capital provided by impact investors, and, if the project were successful, would receive the impact bond payment from governments or other donors, return the investors their share, and retain the rest as profit. The social impact bond model has already been successfully deployed in some contexts, such as Goldman Sachs’ social impact bond in early childhood education. Although this is an example of a social impact bond in a developed country by a large business, it demonstrates the benefits of such a system. The World Bank recently has moved towards social impact bonds as well, financing a small project in Palestine, dealing with youth unemployment.

To be clear, I am not advocating removing NGOs or donors from development work. And I also acknowledge that the potential for corruption exists with SMEs as well, and proper implementation will require taking measures to avoid such scenarios. Nonetheless, for the reasons sketched above, in areas of development aid where NGOs have been unsuccessful using private, for-profit SMEs funded by a combination of impact investors and/or impact bonds, have the potential to reduce corruption and increase effectiveness.

One thought on “How For-Profit Businesses Can Reduce Corruption in Development Aid

  1. Pingback: How For-Profit Businesses Can Reduce Corruption in Development Aid | Matthews' Blog

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