As the EU prepares to significantly scale up its deployment of blended finance, guarantees, and other risk-sharing tools aimed at stimulating investment in developing countries, it has stated its intention to use its development budget to incentivise private investment in health and education. It has not, however, given an indication as to how it will do this and how it intends to surmount some of the key obstacles that deter investment in human capital. So, in a new paper, we set out to investigate the main barriers, putting forward a set of proposals for how the European Commission (EC) could steer greater external investment towards health and education through its European Fund for Sustainable Development Plus (EFSD+).
The COVID-19 crisis has reinforced the strong correlation between human and economic development and the absolute imperative of investing in human capital as a key component in sustained economic growth. Yet, the gulf between current funding for human capital—in particular health and education—and needs continues to widen. With constrained domestic and external public flows amid a global pandemic, private sector investment will be needed to help bridge these gaps.
As the pandemic hit, a range of bilateral and multilateral development finance institutions began to shift their financial focus towards the fight against COVID-19 in developing countries. Given the imperative of strengthening developing country public health and social support capacities, we have seen a sharp increase in investment in health, albeit largely concentrated in upper-middle-income countries and generally directed towards for-profit hospitals and clinics, pharmaceutical manufacturing, and financial services for health (like insurance). And while education finance has traditionally been left to the public sector, private investors are increasingly looking at how to complement government initiatives to strengthen education systems. Nevertheless, there seem to be much more interest and enthusiasm to invest in health, not so much in education.
However, in Europe, experimentation with innovative modalities to finance public service delivery in developing countries has been slow, with social sectors continuing to rely more heavily on traditional grant financing. Only 3.3 percent of the €3.1 billion grant contribution to EU blended finance projects, and only one guarantee out of 28, had been allocated to social sectors.
Through a series of interviews with the EU’s financial partners, we identified three major challenges:
1. The public versus private sector dilemma
Certain development finance institutions argue that health and education should remain exclusively funded by the public sector, and due to their general lack of expertise and experience in health and education, they see little opportunity to enter into these markets. Others recognise that there are niche areas in which they could engage, for example, medicine manufacturing, diagnostic labs or ed-tech. They tend to see space for themselves in higher education rather than basic education or supporting public private partnership (PPP) hospitals rather than primary health care.
2. Generating a pipeline and cash flows
A majority of the development finance institutions highlighted the lack of a pipeline of financially sustainable projects in health and education. They argued that it remains difficult to convince private investors to engage in areas for which returns are longer term and business models are riskier than for say for energy and transport projects.
3. Scaling up investments
The challenge of scaling up innovations and enterprises in health and education was raised as a significant impediment, in particular in moving from a small success story to a model capable of delivering transformational impact on health and education systems.
How can the EU overcome these barriers? And how can it incentivise and steer greater external investment towards health and education?
We suggest that the EU take a leaf from its own internal investment programme—InvestEU—that includes specific objectives on social investment that are reflected in a “social investment and skills” policy window, incentivising financial institutions to mobilise private investment, particularly for underinvested markets, and to address market failures and investment gaps.
A highly discounted and easily accessible EU guarantee for external investment in health and education would go a long way towards lowering risk to a level where the private sector would invest. However, in addition to blended finance and guarantees, the EU could consider developing a suite of results-based financing tools to build upon and complement its traditional grant support for the social sectors, including research & development (R&D) prizes and development impact bond (DIBs). In partnership with it financial partners and the private sector, the EU can test, develop, and scale these and other instruments, and so leverage the private sector’s financial resources, skills, innovation, flexibility, and its ability to bear and manage risk in social sector investments. It will, however, be important for the EU to ensure that private investment in a country’s social sectors does not replace public investment, but rather complements it.
We also suggest that the EU establish an “accelerator hub,” which would provide targeted support to identify, prepare, and develop investment projects in social sectors. The accelerator hub would act as a single access point for funding and expertise for project preparation with the ultimate aim of creating the conditions to expand the potential number of eligible recipients in nascent markets.
With regard to the challenges in scaling up projects, we propose that the EC define social bond standard criteria for an investment to qualify as beneficial for human capital, as it has done for green bonds. And finally, we suggest that the EU launch an investment vehicle— “SocialFI”—modelled on ElectriFI and AgriFI which generate additional resources in the energy and agriculture sectors.