Peace Dividend Trust: Factor Finance for Procurement (3FP)

Competition Finalist

This entry has been selected as a finalist in the
The G-20 SME Finance Challenge competition.

Local procurement by donors multiplies the economic impact of aid. The Peace Dividend Marketplace projects help local SMEs win donor procurement contracts, redirecting over $537m into local economies to date. The Factor Finance For Procurement (3FP) concept will increase this by providing Line of Credit guarantees so smaller SMEs can bid on larger contracts, unleashing more aid money locally.

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About You

First Name

Scott

Last Name

Gilmore

Your Organization

Peace Dividend Trust

Country

Canada, ON

About Your Organization

Organization Name

Peace Dividend Trust

Organization Phone

+1 613 233 6711

Organization Address

200 Catherine St, #510, Ottawa, ON, K2P2K9

Organization Country

Canada, ON

Organization Type

Non-profit/NGO/Citizen-sector Organization

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Your solution

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Name Your solution

Peace Dividend Trust: Factor Finance for Procurement (3FP)

Describe Your Solution

Local procurement by donors multiplies the economic impact of aid. The Peace Dividend Marketplace projects help local SMEs win donor procurement contracts, redirecting over $537m into local economies to date. The Factor Finance For Procurement (3FP) concept will increase this by providing Line of Credit guarantees so smaller SMEs can bid on larger contracts, unleashing more aid money locally.

Country your work focuses on

Afghanistan, XX

If multiple countries, please list them here. If your solution targets an entire region, please select it below

Haiti, Liberia, Timor Leste, Afghanistan

Region(s) your solution focuses on:

Africa, East Asia and the Pacific, Europe and Central Asia, Latin America and the Caribbean.

Range of turnover in your target firms, in USD

Less than $1 Million, $1-5 Million, $6-10 Million.

Average turnover in USD of your target firm

5000000

Number of employees in your target firms

Fewer than 5, 5-24, 25-49, 50-74.

Average number of employees of your target firm

45

Specify the size, average and range of expected loans or investments in each target firm

According to recent surveys of Haitian, Timorese, and Afghan entrepreneurs, the need for short term operating lines of credit among competitive SMEs on the small end of the spectrum ranges from $30k to $1.5m over periods of 3 to 12 months. Using the data from these surveys to estimate demand, the Factor Finance for Procurement (3FP) project would aim to guarantee a total of 100 Lines of Credit in four countries (the above three plus Liberia) per year at an average amount of $700k for a total of guaranteeing $70m in LoCs annually.

What stage is your solution in?

Operating for 1‐5 years

Innovation

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What makes your innovative solution unique?

The Peace Dividend Marketplace (PDM) projects are the only large-scale initiatives currently underway to help local entrepreneurs in post-conflict countries find and bid on tenders for international contracts (typically for the delivery of aid programs such as school or road construction). The PDM teams translate and distribute tenders, assist SMEs to bid on contracts, and help international procurement officers find local vendors using our database of verified local SMEs. Operating in Timor, Afghanistan, Haiti and soon Liberia, the project has redirected or accelerated over $537m into the local economies, the comparative equivalent of 1% of GDP annually. This has, in effect, helped donors spend the development dollar twice. The Factor Finance for Procurement (3FP) concept will set up loan guarantees so local banks will provide lines of credit to SMEs so they can bid on larger international contracts. These LOCs would be at rates and amounts that “factor” in the size and nature of the contracts won.

The 3FP concept is unique because:

1. It addresses an overlooked but massive and systemic problem of international aid, which is that typically less than 30% of donor spending is actually spent in the recipient economy.

2. The project uniquely reduces “Adverse Selection Risk” as it does not propose to find or pick potentially viable businesses, but supports existing winners who have already won a procurement contract.

3. This idea literally helps donors spend the development dollar twice. Instead of just spending $1m to build a school, it will also redirect the money into the local economy leaving behind a $1m school and $1m worth of wages.

4. This project keeps the intermediary costs low, as it piggy-backs on the existing PDM projects, capitalizing on its existing knowledge assets (namely the identities and details of local SMEs who are capable of successfully competing for international contracts).

How does your proposed innovation leverage public intervention in catalyzing private SME finance?

• 3FP leverages the PDM projects by helping smaller SMEs to secure a line of credit so they would have sufficient funds to execute large donor procurement contracts.
• 3FP would establish a fund to serve as the counterpart guarantee of up to 80% of a locally-provided line of credit for up to 50% of the value of those procurement contracts. (eg, an SME wins a $1m contract; they would be eligible for a LoC of up to $500k of which 3FP would guarantee $400k, the local bank assuming the risk on 20%)
• Approximately 6 percentage points of the interest charged by the local bank would go to the 3FP fund to cover costs.
• This rate would factor the nature of the contract and the buyer to provide lower rates to less risky borrowers.
• The LoC would be provided by a local bank or other financial institution.
• To reduce the amount of capital needed in the guarantee fund (and increase the leverage ratio) the fund would be backstopped by donor governments.
• Once the fund has been established long enough to develop its own credit history, government donors could be phased out with private investors on a for-profit basis.

Overall, 3FP leverages 3 existing public interventions:

1. It will leverage donor spending (and emerging donor desire to procure locally as demonstrated by the “Afghan First” policy) by redirecting more aid into the local economy. In Afghanistan, only 37% enters the local economy, the majority being spent on international contractors and imports. Economists believe that donor money that is spent on local procurement is very productive, however, having a Keynsian multiplier effect of 1.5x. The PDM projects have already partially addressed this by connecting local vendors to international procurement officers. Providing factored LoCs will allow smaller SMEs to compete for bigger tenders that are currently executed by international contractors.

2. It will leverage the existing donor funded Peace Dividend Marketplace projects. These project teams have built up a database of over 9700 active local SMEs in Afghanistan, Timor, and Haiti. The project staff help these companies to win international contracts. As a result, they have accumulated valuable knowledge of the capacity and potential of local SMEs. The 3FP project will leverage this knowledge to reduce the adverse selection risk associated with providing finance to new loan recipients.

3. The 3FP project will leverage the latent capacity of the existing local financial institutions. In Afghanistan, Haiti, and elsewhere, local banks are reluctant to extend financing to the “missing middle” those enterprises which are too small to secure formal bank loans, and too big to apply for micro-finance loans.

What barriers does your proposed solution address?

Asymmetry of information, Informality, Lack of collateral, Lack of financial capacity, Lack of SME access to skills / knowledge / markets, Unavailability of financial products tailored to SME needs, Lack of institutional capacity of financial intermediaries, High transaction costs for financial intermediaries to serve SMEs, Lack of competition / incentives for financial intermediaries to serve SMEs, Underdeveloped local capital markets (term local currency funding, exit options for SME equity), Lack of financing to women entrepreneurs, Specific barriers to fragile and weak states.

If you checked any of these barriers, describe how your solution addresses them

Asymmetry of info: The PDM projects already focus on this by providing international procurement officers with information on the local marketplace, and local vendors with information on how to win international tenders. The addition of 3FP would address the adverse selection risk of asymmetric information by providing data on the viability of local SMEs who have won an international contract.

Informality: For local SMEs bidding on international contracts, most of their existing credit comes from informal family loans. This project would help shift this to the banks.

Lack of collateral: In “factor finance” the collateral is provided by the invoice from the contract the SME has won.

Lack of financial capacity: 3FP project teams will increase and deepen the current financial literacy assistance being provided to local SMEs by the PDM projects.

Lack of access to knowledge /markets: This is the core of the 3FP concept. It helps local SMEs access the billions in international aid money that is already being spent, just not locally.

Unavailability of financial products tailored to SMEs: Our surveys of local entrepreneurs bidding on international contracts in Haiti, Timor, and Afghanistan show that the financial product they need the most, which is not available, is short term operating lines of credit as being proposed by the 3FP concept.

Institutional capacity: Local banks have the administrative capacity to provide operating lines of credit, but lack exposure or understanding to more advanced financial instruments such as factor finance. This project will help introduce it.

High transaction costs: The 3FP concept will reduce some of this cost by lowering the default rate due to adverse selection risk and to a certain extent the moral hazard risk. By providing a contract-specific LoC to the SMEs, the borrowers would only be able to draw upon it with proof of outstanding bills to deliver on the contract being executed. For example, SME wins a contract to build a road and the 3FP project guarantees a LoC at the local bank. The SME then brings a bill for gravel to the bank, which would then either provide the funds for that bill, or pay the gravel supplier directly. This reduces the borrowers cash in hand and thus the moral hazard risk.

Incentives for financial intermediaries: The “missing middle” is a large untapped market for local banks. 3FP will demonstrate that LoCs can be profitably be provided to local SMEs.

Women entrepreneurs: The PDM projects prioritize female owned SMEs, especially in Afghanistan. The 3FP concept would mirror this approach.

Specific barriers: This project focuses on nations that are the larger recipients of aid, and thus tend to be fragile states.

Impact

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Provide empirical evidence of your proposed solution's success/impact at present. If your project is in the idea phase, please provide evidence that speaks to its potential impact

The latent potential to increase the economic impact of existing international aid procurement is enormous. The 2006 peer-reviewed study of the Economic Impact of Peacekeeping (http://2.ly/crbg) showed that “less than 10 percent of mission spending has gone directly into the local economy, although in four mission areas with very low economic activity, even such a low fraction of spending boosted local Gross Domestic Product by 4 to 8 percent.” A similar 2009 study (http://2.ly/crbh) of donor spending in Afghanistan found that only 37% of aid money was entering the Afghan economy.

The efforts to unleash this potential local procurement by the Peace Dividend Marketplace (PDM) projects have delivered impressive results (http://2.ly/crbn) largely among smaller SMEs. The Afghan project has redirected or accelerated $514m of new donor procurement spending into the local economy, representing (comparatively) 1% of GDP per year. In Timor, the number has been $23m, also the comparative equivalent of 1% of GDP per year. In Haiti, the project has just begun but has redirected over $750k in the first few weeks of full operation. And in Liberia, the project is expected to redirect $20m over the first 3 years.

In efforts to increase local procurement, the PDM project teams have conducted surveys of local SMEs to determine the most pressing barriers faced by entrepreneurs attempting to do business with international buyers. In Afghanistan, 57% of these SMEs needed $100k or more in financing.

The proposed addition of the Factor Finance For Procurement (3FP) concept would seek to increase the number and size of international donor contracts being won by local vendors.

Currently, the average size of the international procurement contract being won by SMEs assisted by the Peace Dividend Marketplace projects is just over $750k. The 3FP concept would focus on servicing the larger contracts in the $400k-$2m range, providing guarantees for lines of credit in the $200k-$1m range. (A $2m contract would not require a $2m line of credit, but something considerably smaller as these larger scale projects get paid in tranches). The objective is to leverage the savings or capital that the entrepreneurs currently can access. Based on the survey of the local SMEs in Afghanistan and Haiti, we would expect to finance 50 additional procurement contracts over the first year. (Assuming LOCs of an average of $700k on procurement contracts of approximately $1.4m)

Assuming the 3FP fund is capitalized at $35m, it could be used to provide guarantees of up to $70m on LoCs totaling $86m (the fund would guarantee up to 80% of a line of credit for up to 50% of the value of those procurement contracts). The total amount of the procurement contracts leveraged by this facility would be twice the LoCs, or $172m. Due to the use of sub-contractors, economists agree the Keynesian multiplier effect in these circumstances is at least 1.5x (http://2.ly/cru6), meaning a local economic impact of $258m, bringing the total investment to impact ratio to 1:14 over two years.

How many firms do you expect to reach?

The 3FP concept has a target of guaranteeing 100 lines of credit per year among smaller SMEs. This would break down as in 50 Afghanistan, 10 in Timor, 30 in Haiti, and 10 in Liberia. Note that in executing larger scale donor procurement contracts, smaller local SMEs almost always engage multiple sub-contractors. So the total amount of primary and secondary beneficiary firms would be much higher.

What is the volume of private SME finance you aim to catalyze?

3FP concept aims for a 1:10 leverage ratio over 2yrs. Assuming the 3FP fund is capitalized at $35m, it could be used to provide guarantees of up to $70m on LoCs totaling $86m (the fund would guarantee up to 80% of a line of credit for up to 50% of the value of those procurement contracts). The total amount of the procurement contracts leveraged by this facility would be twice the LoCs, or $172m.

What time frame will be required to reach these targets?

Given that the 3FP concept would be added on to the existing Peace Dividend Marketplace projects, much the logistical requirements are already in place. Therefore, deployment could be accelerated. It would take 3 months to hire specialist staff and put project teams in place. After that, it would take another 3 months to finalize agreements with local financial institutions and identify the first recipients of the factored lines of credit. Targets at the end of the first 12 months would be approximately $35m in lines of credit catalyzed. With the annual $70m target rate reached at the 18th month mark.

Does your solution seek to have an impact on public policy?

No

What would prevent your solution from being a success?

• Delinquency and loan loss rates among SMEs too high to make loan guarantees economically viable in the long run.

• Local financial institutions unwilling to take on 20% share of risk, although this could be negotiated down, it would not be ideal.

• Operating costs too high to be covered by the revenue generated from the interest on the LoCs.

• Current donor support for increased local procurement for aid spending could waiver.

• Security situation could deteriorate (in Afghanistan in particular) and reduce economic activity.

• Donor spending in the targeted economies (and thus the amount of available procurement contracts) could be dramatically reduced.

Describe the social impact of your innovation. Please include both numbers and stories as evidence of this impact

To date, the PDM project has redirected over $537m of new spending into the Afghan, Timorese, and Haitian economies. This has created thousands of sustainable jobs. For example, a recent survey (http://2.ly/crht) in Helmand province in Afghanistan showed that from 61 reported contracts totalling $22m:

-1,882 jobs were created, 335 (18%) of which were permanent and 1,547 (82%) temporary;
-418 (22%) of the jobs created were skilled labour, and 1,464 (78%) were unskilled labour;
-71 (4%) jobs were retained by employers even after the contract closed

Similar data collection in Afghanistan by other organizations has suggested that as a rough rule of thumb, one full time annual job is created for every $10k of increased local procurement. This ratio varies from country to country, however.

Another example of social impact of local procurement: Eve Corporation is a female Afghan-owned logistics and construction company. 80% of its employees are female, the majority of whom are former refugees with manufacturing skills learnt in refugee camps in Pakistan. PDM project helped Eve Corporation win a contract to supply laundry and housekeeping services worth over $100,000. Several subsequent contracts then were won as the company is now considered a preferred business partner.

In Haiti, Les Jardins d’Hydroponiques d’Haiti (JHH) is a supplier of fresh vegetables. Following Haiti’s earthquake JHH, lost a significant number of its customers and was facing financial ruin. As a result of PDT’s targeted matchmaking services, JHH won a $100,000 contract to supply a camp for UN staff which allowed it to expand its operations.

The inclusion of the 3FP concept to the PDM project model will increase the number of companies like these able to win international contracts, and the size of the contracts being won.

Sustainability

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List all the funding sources that are required for the sustainability of this solution

1) A pool of seed capital would be needed for the investment fund. Based on demand calculations, the target is $35m. This would initially come from government or multilateral donors. A backstopping guarantee from a donor government would also allow for higher guarantee ratios rates with local banks.

2) Once the 3FP had demonstrated a sustainable ROI and acceptable loan loss ratios, private international investors would be sought to replace the government money in the fund.

3) 3FP would need approximately $980k per year for operational funding to cover salaries, HQ, and field costs. These costs will be kept low by utilizing the collocating with existing PDM offices.

Note that the PDM projects have confirmed donor support for the next 3 years in Afghanistan, 2 years in Haiti, 1 year in Timor and 1 year in Liberia. This proposal assumes these activities continue.

Demonstrate how your proposed solution has the capacity to graduate from dependence on public finance. What is the time frame?

This project would graduate from public to private finance in three phases over 42 months. The first “proof of concept” phase would last for 24 months and operate in Afghanistan, Haiti, Timor and Liberia. The 3FP team during this phase would use donor funding to provide loan guarantees for SMEs who have won aid procurement contracts. The objective of this phase is to determine i) the likely loan loss rates for SMEs in these markets, ii) the interest rate that SMEs would be willing to pay for these LoCs, iii) the most efficient framework for sharing risk with local financial institutions, and iv) the transaction costs of providing this form of credit.

In the second “transitional” phase, lasting 18 months, assuming that there is a manageable default rate, that an efficient risk-sharing framework with local financial institutions is established, and that transaction costs are sufficiently low, the funding model will shift to for-profit. Efforts would be made to reduce operating costs, and focus operations on the more profitable market areas. Lessons learned in the first phase would be applied to reduce loan loss rates. Modeling the RoI, based on the assumptions outlined in this proposal, suggests that fund investors could achieve a 4-8% return. This would be sufficiently competitive to attract triple-bottom-line or socially responsible investors. Therefore, the capital for the fund could be transitioned from the government donors to private or institutional investors

At the 42 month mark, the 3FP project would graduate entirely to private investment for the fund, phasing out the dependence on public finance. However, in order to maintain higher exposure ratios, donor government backstopping would be desirable (if not necessary). Going forward, in the ongoing “for-profit” phase, all costs would be recovered through returns on the private investment.

Demonstrate how your proposed solution will survive a potential loss of its largest private funding source

In the first phase, while the 3FP project is dependent on public finance, multiple government donors will be sought to diversify the funding pool. There will also be multiple local banks used in the four target country areas to further spread the risk. During the second and third phase of the project, a similar approach will be applied to the private and institutional investors. Instead of a single large investor, 3-6 partners will ideally be used. As the project matures in the third (for-profit) phase, a capital fund will be built up to be used as an additional buffer.

Please tell us what kind of partnerships, if any, could be critical to the greater success and sustainability of your innovation

There are two key elements to ensure the success of the 3FP concept. The first is the ability to reduce the “adverse selection” risk, namely the likelihood that bad lenders are chosen. Therefore, the project team will need to increase the amount of information gathering that is already underway within the local business community. The second key element is to ensure there is a minimum amount of credit that is being extended per year, in order to cover the sunk costs of the 3FP project (core staff, etc). Therefore, it will be necessary to adequately market the availability of these loan guarantees within the local business community. In order to address both of these issues, it will be essential to also expand existing partnerships with the local business associations and chambers of commerce, as well as with local banks and the local government.

Are there non-financial issues that could threaten the sustainability of your proposed solution?

In descending order of importance:

• Political instability is the largest risk, as these projects will be focused in the first stages on 4 post-conflict/post disaster economies that have faced considerable turmoil in the recent years. In each, however, there is a large international presence and investment in maintaining future stability.

• The ability to recruit and retain key staff is always a challenge when launching new projects in these environments. Adding an extra challenge is that this project will need the expertise of individuals with applicable factor finance and loan guarantee experience in the private sector.

• This project focuses on using loan guarantees to increase the amount of donor spending being channeled into the recipient economies. If donor spending levels dramatically decreased, it would reduce the amount of potential local procurement available. In the four initial economies being targeted, this currently appears unlikely (though possible).

Please tell us if your proposed solution aims to scale up through a high growth sector, expand immediately to multiple sectors, and/or scale up geographically

In the first phase of the 3FP project, the LoC guarantee will be extended in the four target markets of Afghanistan, Haiti, Timor and Liberia to established local firms who have demonstrated an ability to deliver on international procurement contracts. During this phase, the facility will only try to expand within this sector, adjusting its target market based on current donor procurement demand.

In the second phase, once 3FP has demonstrated commercial viability, it will begin to scale up by expanding geographically to other markets with large international donor presence. The objective being to leverage existing donor spending and seek to facilitate a higher level of local procurement in the many places the donors are already located, this would significantly accelerate the trend towards prioritizing local procurement which is beginning to develop within the donor system. Likely candidates include South Sudan, Zimbabwe, and Chad.

During this phase, guarantees could be further targeted to support SMEs which have the highest job creation impact. For example, one SME may have a contract for road construction in a particularly poverty stricken region, while the other contract could be a simple import contract for computer parts with almost no local job creation. In this case, the first SME would be given preference. This form of targeting would scale up the economic impact of the 3FP concept.

If the ROI is sufficiently high, the LoC guarantee facility could be expanded to include SMEs who have won contracts which are not necessarily related to international procurement.

Comments

Edward Rees profile img
Sun, 10/31/2010 - 04:14

Seems that the first press to cover this has been Timorese press, likely because they are 8 hours ahead of Europe and 12 hours ahead of East Coast USA - have a look here. http://temposemanaltimor.blogspot.com/2010/10/will-obama-meet-pdt-in-sou...

Edward Rees profile img
Tue, 11/02/2010 - 09:49

From the PDT Blog: About 4 months ago Scott came to me and asked what I thought about Factor Finance in the place we work – I told him its alot of bollocks, quite reasonably and its turns out quite inaccurately. He sent me some scribblings and over a stiff gin (I do not drink Grey Goose vodka) I realised that he was onto a dramatically unreasonable idea. One which is so unreasonable its positively a game changer. Anyway the idea was banged around a bunch of people in record time – and we came up with a way to deliver credit to SME’s that is so obviously smart and needed its amazing a zillion dollar a year industry has not done it already. Kind of like, buying locally. Hmmph. This idea was then submitted to the Ashoka Foundation G20 SME Finance Challenge being run in cooperation with the G20 – and we won. We found out 4 days ago. Quite amazing.

See here for the full post: http://buildingmarkets.org/blogs/blog/2010/11/02/on-being-unreasonable-i...

Matt Guttentag profile img
Thu, 11/11/2010 - 12:45

On October 27, 2010, the judges reviewed entries for the Changemakers G-20 SME Finance Challenge competition and would like to pass on the following feedback for your entry (below). Thank you for applying and for your hard work in the field. We are excited to archive your entry to serve as a leading solution for the worldwide community of innovators. We wish you continued luck with your innovative, sustainable, and socially impactful initiatives.

All the best,

The Changemakers Team

This organization is working in one of the toughest areas of financing: post-conflict zones. If you can make businesses competitive in a post-conflict environment, then you can truly have transformational change. It is great to see organizations engaging with businesses even under such difficult circumstances.

Beyond the post-conflict environment, the core idea is solid and applicable in other settings. It looks like an idea that could really go places beyond post-conflict, and it brings in the critical element of local procurement. A potential barrier could be donor requirements for formality and experience, which could favor foreign sources.

Edward Rees profile img
Thu, 11/11/2010 - 13:20

How the G20 Can Fix International Aid
By Edward Rees
Expected to be high on the agenda of the G20 meeting in Seoul this week is the international aid that rich countries spend on efforts to lift conflict-affected states out of violence, economic collapse, human and material ruin. While many of the problems that these states suffer are homegrown, they are often exacerbated by an ineffective international aid industry that delivers chronically poor results. Yet there's a promising new approach to transforming the international aid system now in play -- and the world's greatest recipients of international aid are already calling for it.

The counterpoint to the G20 is the g7+ group, established in 2008, which consists of Afghanistan, Burundi, the Central African Republic, Chad, Cote D'Ivoire, the Democratic Republic of the Congo, Haiti, Liberia, Nepal, the Solomon Islands, Sierra Leone, Southern Sudan, and Timor-Leste. The g7+, an independent forum of fragile and conflict-affected states, seeks to communicate the concerns of the bottom billion to the top billion. No topic is more important to them than reforming international aid systems, be it in disaster relief, peace operations, or development assistance.

According to the World Bank, net official development assistance and aid globally is approximately $130 billion USD/annum. But are we getting good value for our money? The Associated Press reported in 2009 that after ten years of comprehensive aid, Timor-Leste had slipped on all major indicators. Why is this? A significant amount of aid money, in Timor-Leste and other aid recipient nations, is in the form of expensive technical assistance (i.e. western advisers) or goes toward goods and services purchased outside of the assisted country. As a result, a great deal of aid money does not ultimately go to the country for which it's been designated. Instead, the aid agenda should focus on the generation and equitable distribution of wealth within the targeted country. Successful countries have successful economies, end of story.

Leaders of the international community burn through much of its resources trying to recreate states in their own images. American legal experts, for example, often seek to build American-style legal systems in countries that have never had them. But this can take years and eat up scarce aid money, often to disappointing results.

This fascination with democracy and governance programming often comes at the expense of the "missing middle," the underdeveloped working and middle classes. They want order, good infrastructure, basic governments services, and above all economic prosperity and jobs. Though they are often overlooked by the aid community's emphasis on top-level reforms and assistance for the poorest of the poor, the assisted country's fate will ultimately rest with them. Emerging economies such as Brazil, India, or Indonesia, for example, have risen on the waves of growing and vibrant middle classes, driven by small and medium business.

One of the ways that the international community can best help the missing middle is by directing its massive aid budgets into local business. Business is efficient; its winners survive and create jobs. It is also sustainable; what is more self-sustaining than a profitable, popular enterprise?

Since 2006, there has been a rising groundswell in support of the idea that procuring goods and services locally will create wealth and jobs and build private sector capacity. The United Nations pioneered research in these ideas in 2005-2006, and in 2008 the United Nations Integrated Mission in Timor-Leste endorsed the approach, though they failed to follow through. In 2009, the United Nations Assistance Mission in Afghanistan pushed the international community to buy locally. The United Nations Procurement Division recently signed an agreement with the International Chamber of Commerce to get more local-businesses access to aid money. More recently, NATO, the United States government, and General David Petreaus have all publicly embraced an "Afghan-first" approach in Afghan aid policy. Canada, the U.S., Australia, Norway, and others are now funding local procurement projects in Afghanistan, Timor-Leste, and Haiti.

In April of this year, the g7+ held the Dili International Dialogue, seeking consensus on policy towards international donors. The recipient states say they are exasperated, as most aid money still follows the old model. The g7+ plan to take their message to the fourth High Level Forum on Aid Effectiveness in Seoul in November 2011, and no doubt to the entire G20. They plan to call for the use of local systems, an end to policy conditionality, country-driven capacity development, mutual accountability, and reduced transaction costs.

The G20 is already awakening, if slowly, on the missing middle. It recently launched the first G20 Small and Medium Enterprise Finance Challenge. It has asked for financing models to best harnass the economic power of the missing middle. The G20 Finance Challenge has already pinpointed one of the most pressing challenges to economic growth in g7+ states: the lack of access to credit.

The micro-finance sector is an over-extended market, and has so far struggled to assist micro-enterprises that are robust enough to make much of a difference. On the other end of the spectrum, large borrowers are undesirable because they are often foreign and mostly draw their credit through commercial banks. These borrowers are also often part of the problem, being closely allied with exclusive power elites. In between lies the missing middle, business enterprises whose requirements are too large for micro-finance but who lack the resources to secure commercial credit. So what to do? Aid groups could help by establishing a short-term line of credit service just for small and medium local businesses. The service would require loan recipients to bid on, win, and fulfill a contract - for example, perhaps a USAID contract to build a school. This would level the playing field between smaller local businesses and larger foreign ones, ensure that more local businesses can access credit, and enable international aid groups to create local jobs. The international community would, in effect, be able to spend the development dollar twice. You get a school, but you also get a profitable local business, increased local business capacity, and jobs.

Timor-Leste President José Ramos-Horta is fond of saying that "aid funds are spent on Timor-Leste, but not in Timor-Leste". If there is an independent South Sudan in the near future, and there may well be, will we hear the South Sudanese President repeat this same line in 2020? It may be too late to have a major impact on Timor-Leste, but perhaps it is not too late for South Sudan, or any number of emerging aid crises, to benefit from a reformed international aid system. Certainly the missing middle in Juba would welcome it.

Image: Protesters in Seoul, dressed as the world leaders convening nearby for the G20 summit, call for a great focus on alleviating poverty worldwide. By Chung Sung-Jun/Getty Images.

This article available online at:

http://www.theatlantic.com/international/archive/2010/11/how-the-g20-can...

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