The New Development Banks and the Financing of Transformation in Latin America and the Caribbean

Introduction

The world urgently needs to address three daunting challenges. Growth levels to be substantially higher to lay the foundation for lasting, inclusive prosperity. And to reach the sustainable development goals, long-term investments are needed to improve access to energy, clean water, accessible transportation, and more inclusive and cleaner urban environments. Finally, nations need to move the world onto a low-carbon growth path and to mitigate the dramatic consequences of global warming. Properly executed, massive sustainable infrastructure investment can help address these challenges, and pave the way to a more prosperous, inclusive, and sustainable future. Not surprisingly, a significant number of communiqués coming from global forums, such as the G-20, have elected boosting such investment as one of the primary goals set in international institutions and even national authorities.

The estimated additional volumes of investments needed globally are in the order of S90 trillion or more, much more than the currently existing global investment stock. Over 60% of it takes place in emerging market and developing countries. In developing nations, and particularly in Latin America and the Caribbean region, the focus of our analysis, the challenge is overwhelming. Public and private sources of investment financing are knowingly limited, and the cost of capital tends to be significantly higher than in developed nations. Domestic private banks often lend with maturities and other credit conditions that are incompatible with the type of investment needed, and their securities markets are relatively shallow and concentrated in a small number of large, internationalized companies.

Development banks from developing and developed nations working in collaboration can and should be part of the solution to this problem. Historically they have been part of multilateral, regional, and national strategies to promote transformation, by fostering the origination, by financing, co-financing, and crowding-in private capital. However, making DBs part of the solution will require rethinking public strategies and policies, and revitalizing existing both multilateral and national institutions. This process of cultural and institutional change can be facilitated and sped up by international cooperation, and it is in this context the creation of new multilateral development banks — such as the Asia Infrastructure Investment Bank (AIIB), and the New Development Bank (NDB) — may present an opportunity. The change in culture and modus operand) of the multilateral system that they may help unlock public and private resources in developing nations towards transformational investment.

This chapter discusses the potential role that these new institutions have and how developing countries may benefit from them entirely - and it is structured accordingly. Section 2 presents an analytical view of the potential of development banks as agents of growth and transformation. Part 3 discusses the financing implications of the changes required for sustainable development, with a focus on infrastructure. Sections 4 examines the emergence of new multilateral banks, and the impact they may have on changing “hearts and minds” about development banking and in helping build innovative platforms to foster infrastructure investment. Section 5 analysis the development-banking landscape in the region, with a more detailed look at its largest development institution - Brazil’s BNDES — to assess the state of readiness to Latin America DBs to seize the opportunity and benefit from cooperating with new development banks. Section 5 presents our findings and conclusions.

Development banking, growth and transformation

Like in many other economic phenomena, economists have distinct visions of the role and ultimate functioning of financial institutions and markets. This separation sets the stage for the understanding of the actual and potential role of development banks.

For most economists, financial institutions are mere intermediaries between savers and investors, and cannot affect in the long run the supply of capital and the investment levels. Savers’ intertemporal preferences of assets ultimately shape the amount and conditions of resources available to finance consumption, production, and investment needs, and the real rate of interest represents the reward paid for postponing the use of these resources. In this view, the efficiency of the financial system depends upon their capacity to playing this intermediary role in the most cost-efficiency and frictionless matter. It is what one of these authors elsewhere called the “prior-saving approach,” whereby the forces of thrift ultimately determine the pace and the path of development (Studart, 1995).

Because this view assumes that market forces also lead to higher microeconomic efficiency, government interventions represent an unnecessarily misallocation of resources. And these distortions end up with undesired macro-economic shortcomings - such as lower levels saving, investment, and growth.

This approach has become the analytical core of different mainstream views on development banks, and of how economists often justify their existence. There are two main sets of “exceptional cases” that are used to explain the roles of such institutions.

First, in the early stages of financial development, state-owned financial institutions (SOFI) may efficiently cover for the inexistence of market forces that can guide credit creation and the efficient intermediation of savings. Development and deepening of such market forces, perceived as a natural outcome of free market forces, should make such public institutions less necessary. A logical result of such a view is that the insistence on maintaining them not only demonstrates an irrational dirigisme, often associated by authors persuaded by this view as signs of capture or pure corruption,² that can only delay further the development of market forces and institutions — a recipe, as mentioned, for inefficiency, poor longterm growth performance, and development (e.g., McKinnon, 1973; Shaw, 1973).

Second, SOFIs can be justified by very particular malfunctioning of market forces. As summarized by Castro (2017):

Intuitively, the framework on market failures departs from the overall assumption that, under certain conditions, the free market will always arrive at a Pareto optimal result, where an economic outcome is said to be optimal if it is impossible to make any individual better off without making other worse off (First Welfare Theorem). In that perspective, only in very specific situations will the market “fail”, and government intervention can raise economic welfare. These failures occur in cases with the presence of I) public goods; ii) externalities; Hi) asymmetric information; and iv) market power. The existence of DBs is justified, therefore, to the extent that these institutions can reduce such failures and, so, (probably) enhance overall welfare.

This mainstream approach, however, only partly seems useful to explain two main historical facts around development banking. First, SOFIs were often created in moments where a significant increase of resources was needed to produce fundamental transformation - be it through the building or rebuilding of infrastructure or logistics, the promotion of meaningful innovation and the rearrangements of resources. Because such investments have changed the countries structurally, intermediation based on savers’ evaluating return and risk of assets is logically impossible - simply because past frequency distribution cannot be a guide to outcomes. It was the case of the creation of the contemporary multilateral banks, such as the World Bank, and many national development banks (NDBs hereafter) as part of the effort to rebuild the infrastructure and productive sectors destroyed by war or natural disasters. Second, the “prior-saving argument” does not match with the fact that most of largest NDBs nowadays are extremely active in well-developed economies (e.g., Germany and South Korea), or countries engaged in producing rapid transformations as part of their national development programs (e.g., China, Brazil, and India). For that, there is a need to go beyond the “prior-saving” approach. Here is where some critical dissent views come handily.