Impact Investing As A Poverty Solution: The Case For Patient Pessimism


The growing impact investment industry (II for short here) is entering hype territory, a sign that less is going on than meets the eye. The language of II promotion is buoyant, breathless, boosterish, and in some cases un-believable. "We have helped create 30,000 jobs and improved 96 million lives," says one private equity firm that invests in emerging markets (Bamboo Capital Partners). A non-profit, also focused on developing countries says it "helps break the cycle of poverty for millions of farmers around the world" (Root Capital). A $350 million private equity firm that works in Sub Saharan Africa suggests that impact investment is "a paradigm shift" in the way we intervene to solve poverty (Vital Capital Fund). The Omidyar Network, calls itself a "philanthropic investment" firm. Its impact investing "seeks to generate both social change and a return on capital. It ends the old dichotomy where business was seen solely as a way to make a profit, while social progress was better achieved only through philanthropy or public policy." As for the world's largest philanthropy, the Bill and Melinda Gates Foundation, involved in many areas including II, they describe themselves as "Impatient Optimists."

Based on my experience over the last 50 years in poverty reduction in the developing countries, the high expectations of impact investment are at best unreasonable. The history of poverty reduction interventions contains countless cautionary tales that should dampen the II movement's enthusiasm. The chances are slim that poverty and profit can produce a lasting and happy marriage, or that infusing start-ups with capital will create growth, or that people can be trained to be entrepreneurial, or that small promising cases can be scaled up to large nation-wide successes. Instead of hubris, the II field needs humility. The wisest attitude should not be impatient optimism, but "patient pessimism." Patience because the one sure factor in the solution of social problems is time: Time to estimate long term impact, time up front to do serious homework into the complicated interactions between the political economy, social structure and culture of places where II wants to go. Pessimism because experience tells us that the pickins are likely to be slim and that even when things look good now, they can go down hill fast later on.

An old friend, one of the three founders of Chicago's ShoreBank, the first U.S. financial institution to consciously attempt – almost a half century ago - what today would be called social impact investing told me a few years ago:

“It’s very hard to predict about businesses coming up from the bottom. The barriers are structural, social, cultural, educational, locational and so on. ShoreBank in the ‘60s was doing lending to South Side [Chicago]“re-habbers.” [enterprises aiming at the rehabilitation of slum housing]. At one point we were doing 100 of these loans a year. Today the South Side of Chicago is back where it was, it all got wiped out.“

Here are an additional five reminders from past history that may help the II field regain a healthy degree of sobriety.

  1. Despite the growth in the number of organizations explicitly engaging in II (estimated as having grown by a factor of five in the last 20 years), impact investing is in its infancy and pinning down its claims about dual impacts remains a challenge. As the field has grown more organizations of all types conveniently define themselves as II firms, from private VC firms seeking the cachet of social impact, to big financial institutions like Prudential and US Trust, to old style poverty alleviation NGOs. Given this array of big and small, family and corporation, non-profit and for-profit, mutual funds, banks and foundations, the promised impact of the II field remains hard to determine. When for example Morgan Stanley reports that sustainable investing funds met or exceeded the median returns of traditional equity funds, one has to ask which of II's many players they are referring to.
  2. As regards the double bottom line that impact investors talk about - a financial AND a social ROI, history reminds us that a financial ROI is risky enough; market based solutions don't fit well with problems that result from market failures and or lacunae in the political economy. As Kevin Starr wrote in 2012 in the Stanford Social Innovation Review. "Few solutions that meet the fundamental needs of the poor will get you your money back. Scalable rural livelihoods, basic health care, basic education solutions,...—with very few exceptions, you don’t make money off this stuff, sorry. ... Fully unsubsidized clean water for really poor people? Essential services to millions of one-acre farmers? Saving lives from the most common diseases?... Forget it—you’re not going to make any money."
  3. Much of emerging market II may be supply driven, as was the case in the heyday of microfinance. Then a common assumption was that because many poor were "unbanked" this meant the existence of huge unmet demand. Micro lenders went after poor people to offer them loans. But as researchers like me found, many poor people simply don't want to take on debt unless they have to. They understand that the flip side of credit is debt. Today, many impact investors in emerging markets lament the lack of high quality investment opportunities. Instead of seeing that their money might be chasing what isn't there, some II organizations make the assumption that what's holding things back are missing skills and so they get into the training business - helping a proto-entrepreneur do a business plan, or pitch an idea or join a business accelerator program. But as with microfinance, it is possible that existing businesses do not want to grow, and for good reasons. In both the developed and the developing world there are hundreds of thousands of businesses that do not want to grow. Their owners work hard, put in long hours, take calculated risks, and pursue a vision of sorts, but they are not Entrepreneurs with a capital "E" and don't want to be.
  4. Linked to this point is the common II belief that start-ups need help. Omidyar Network for example seems quite sure that "impact investments are most valuable at the earliest stages of innovation. It’s a time when outcomes are the least certain and entrepreneurs need the most help." But economic history tells a different story. Most successful businesses everywhere have managed to grow without formal investors in their start-up stage. The subtle interaction between risk tolerance and entrepreneurial psychology has often resulted in a go-it-alone approach and a reliance on family and friend networks as a smart risk mitigation strategy. History shows a minimal role for formal finance in the majority of businesses, whether venerable ones like Mattel (Ruth and Elliot Handler began Mattel with their own savings in their garage), Playboy (Hugh Hefner started Playboy with $600 of own savings, and informal loans including $1,000 from his mother), or newer ones like Starbucks (Jerry Baldwin, Zev Siegel and Gordon Bowker each put up $1,350 to open the first Starbucks in 1971), Microsoft and Apple, or start-ups in emerging market environments like Solerebels in Ethiopia (a $2m Ethiopian shoe company that uses recycled materials to make trendy shoes which it markets to 55 countries, started by a woman who borrowed about $10,000 from family members.)
  5. Separating impacts (social from financial) is inherently problematic. Simple ROI can be measured and the question of attribution is not critically important. But if in addition to a financial ROI one is looking for a reduction in child poverty, where does one focus? On a particular group of children, at a particular point in time, and for how long? Is the poverty reduction sustained or only temporary? How does one separate the variables that may have led to the poverty impact, such as chance, location, teacher quality, parental character, the size and presence of the extended family, etc?

A wise future course for II is to curb its enthusiasm by investing first in understanding context. Even in developed countries, there are areas like Chicago's South Side where the socio-political economic context restrains long-term impact. In the developing world these contextual barriers are much harder to pull down: Political instability, poor governance, the lack of an institutionalized rule of law, unclear property rights, ethnic violence and so on, do not make a fruitful context for business growth. Take a dynamic small enterprise owner, operating, say, in a place like Kinshasa, in the Democratic Republic of the Congo. For such a person future prospects are limited; in the context of tribalism, government corruption, inadequate infrastructure, an unreliable supply chain, and a host of other complex political, social and cultural obstacles, you can be all dressed up but have no place to go. Impact investing, like microfinance and many other enthusiasms before it, is at best just one small part of the answer to the conundrums of poverty.

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I've had a long career in foreign aid. During almost five decades, I've worked for the World Bank, the UN, numerous government aid agencies as well as in the world of NG...