Social Finance Innovation and Externalities

This insightful report discusses the advent of social finance and innovation for meeting Sustainable Development Goals 2030. The article looks at the thought process of defining critical enablers at the Addis Ababa Action Agenda meeting in 2015, which set the ball rolling in driving both private sector investments and public-private partnerships in the development space. It includes a small note on externalities and their role in enabling social good.

The importance of Addis Ababa Action Agenda in sustainable development goals cannot be understated. 2015 marked a transition year for the world and the UN in moving towards a comprehensive set of sustainable goals: Millennium Development Goals to the new set of 17 targets under Sustainable Development Goals. The critical thought process was to encourage private capital through innovative social finance tools, a crucial decision for even coming close to the very ambitious set of goals by 2030. 

pic: UN.org

The Addis Ababa agenda set forth the following key enablers for financing the development sector.

# Mobilize all sources of finance and Leverage public finance for social good

# Crowd in the private sector and foster collaboration between different actors in the development sector

# Fortify Multilateral Development Banks (MDB’s) capacity to catalyze funding better

# Innovate using data analytics and harness technology and disruptive business models

Following the agenda meeting, the first step was be to strengthen the domestic economies through fiscal and taxation prudence. To implement a better socio-economic scenario, a framework of parameters was recognized as key performance indicators and enablers to drive transparency, accountability, and reduce inequality. E.g., a 15 percent tax to GDP ratio is required to fund state functions, yet 42 percent of the world’s poorest countries don’t touch the goal. Progressive taxation is a positive step in this direction for increasing tax revenues while the indirect tax has a retroactive effect often marginalizing the poor and middle-class section of the society. However, indirect taxes can be used to dissuade negative externalities like taxing pack of cigarettes. This is one of the few cases of positive assimilation of indirect taxes within the society. Encouraging income and gender equality reforms are a couple of examples of pressing  the button in the right direction. To succeed in this endeavor, implementing disruptive technology like blockchain in areas like taxation and real estate management works wonders esp. in low income and developing countries.

# Crowding in private capital, leveraging public finance and fostering a collaborative model

GIIN estimates $502B with impact investors compared to $269T in private capital markets. It became imperative to develop innovative social finance tools for attracting private capital. World Bank, European Investment Bank and IMF chiefly among the major MDBs promoted innovative social finance tools including blended finance, social bonds, sustainable development bonds, catastrophe bonds, green and blue bonds, concessional finance, micro-funding, etc. to leverage funding or increase private actors within development space. This policy had a ripple effect both within the private and public sector.

First, the agenda endorsed close cooperation between various MDBs, including the South-South cooperation. More corporation among developing countries resulted in more MDBs focused on low and developing countries with a renewed purpose among specialized MDBs like IBRD, MIGA, etc. In 2014, about a year before the Addis Ababa Action Agenda, leaders of BRICS announced the formation of the New Development Bank (NDB) to focus on high or middle level emerging economies. The set up of the new development bank also refreshed the rising importance of high end developing nations within the global trade and world economics. Second, it got buy-in from private capital through structuring innovative blended finance deals using equity and debt. Concessional finance helped in promoting private capital into ventures and projects which otherwise would have been nonviable for private funding. Ease of funding helped such enterprises become sustainable mushrooming social entrepreneurs within the development ecosystem.

Example, IFC provided a $8M loan, including a $4M in concessional financing to the SPCG (Solar Power Company Group) in Thailand. IFC, along with Clean Technology Fund funding enabled SPCG not only to develop 300MW of installed capacity but eased financing through local banks. All social projects are bestowed with a positive externality for the society. SPCG solar farms have avoided over 200,00 tons of CO2 emissions annually, a substantial positive externality challenging to measure. The loan not only successfully funded SPCG in the renewable energy sector but kick-started a revolution in exponentially increasing financing in this sector. It brought in more banks to fund projects by other companies, thus expanding the pie of this space, which was non-existent before.

The social finance innovation not only crowded in asset managers, endowment and foundation but disruptive technology elevated micro-finance by leveraging peer-2-peer technology. MDBs became market makers in creating a viable market for development work and social good. They helped in due diligence of viable projects in the development sector, to render less economical projects sustainable over a while through tailor-made financial tools. Further, MDBs became intermediaries between the private sector and the development sector through catalytic first loss guarantees, etc enhancing liquidity and actors (investors and social entrepreneurs) for an optimal outcome.

#  What are Externalities ? 

Externalities can be considered as market failures and are not included in the cost of goods or services produced. An example of a negative externality is the burning of fossil fuels e.g., gasoline in automobiles. It provides many toxic wastes, especially CO2 emissions, which increases the cost of social good. Negative externalities arise when social costs exceed private costs. Positive externalities result when social benefits (benefits to society) exceeds private benefits. In this universe here there are three actors: consumers, producers, and factors of production. In the above case, a way to measure social costs would be to measure incremental health costs of diseases between two periods related to pollution, but it’s next to impossible to measure the mental anguish, etc. Encouraging the use of renewable energy negates CO2 emissions, an excellent example of positive externality.

 

Another example of positive externalities would be running early morning. Apart from keeping one healthy, which is the stated aim, it motivates others to run, stay fit. Running fosters upbeat mood through the day, in turn helps spread happiness through positive thoughts, remarks, tweets, etc.

Rise of awareness among civic societies towards sustainable issues along with positive externalities creates a halo effect in driving in private investments. International political climate reinforced a move towards SDGs. Crowding in of private sector brought in more transparency with the formation of social exchanges for providing a platform for impact investors and social entrepreneurs to interact, e.g., Social Venture Connexion in Canada and Impact Exchange in Singapore. Recently, the Indian government took a colossal move in announcing the formation of a social stock exchange. Going forward — these exchanges are positive disruptive platforms in enabling social change.

# The Invisible Hand 

These initiatives laid the foundation and structure for the most crucial enabler among the SDGs, i.e., the public-private partnership SDG 17. Private sector through corporate social responsibility, impact investors and social entrepreneurs, governments and MDBs, non-profits, foundations & endowments are a growing list of actors within the ever-increasing development and social ecosystem coexisting with a common aim for social good. In the end, inevitably, a collaborative model of a public-private partnership developed globally as a critical stimulant in addressing market failures at the bottom of the pyramid. As the actors within the development ecosystem increased, collaboration became an embedded feature in decision making. Data analytics and disruptive technology play a circular role in connecting various actors as an invisible hand, completing the loop of enablers of the agenda. In the end, each facilitator formed a connecting chain with other enablers which when well-oiled work as a formidable weapon in progressing towards the 2030 SDGs plan.

 

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