Development cooperation – the risk of marketplace distortion

Why do many critics of development cooperation see marketplace distortion as one of the most critical issues? And what can be done about it?

First, it is essential to realize that a certain degree of marketplace distortion will occur virtually any time funds or goods from outside, obtained at rates under those of the international financial markets, are injected into a country, region, city or institution. So what is critical here is the degree to which the distortion occurs and whom it disadvantages.

Food aid has (in my view rightly) been severely criticized for the distortions it causes: Just as an example, instead of delivering expensive, subsidized European and American grain to starving areas, a less distorting form would be to purchase it from regional farmers.

But the distortions caused by numerous technical assistance projects are just as harmful.

If a country has a sole institution or organisation responsible for working in or developing a particular sector, providing technical support to that organisation may create less distortion than selecting partner institutions from among several contenders each with similar offerings. This is particularly true when the “losers” in the process will have to compete (for markets, clients, financing, staff or anything else) with the selected few. It applies to projects supporting small and medium enterprises (SMEs), banks, microfinance institutions, farmers, producers, non-governmental organisations (NGOs), “business development organisations” or any other beneficiary.

Donor organisations usually argue that the selection process is open to any interested and qualified party, but that is just the problem. If an organisation or institution does not comply with the criteria or rules set down by the donor, it is disqualified and left to compete on its own on the market. Is it really an optimal use of taxpayer money that we set rules which we think private or semi-private companies and institutions in a country should respect and when they don’t we punish them by financing and supporting their competition?

The issue is particularly critical when companies or organisations are disqualified from participation in international projects because they are too small. And it is not solved by merely publicizing the results (for example on a website, with handouts or at a conference), as many projects tend to do.

A better way might be to go to the next level (for example, very often the biggest problems of SMEs, farmers, rural credit institutions or other economic actors have to do with policy, regulation, incentives, etc., so easing and improving these problems could potentially have more impact than working with individual beneficiaries). Alternatively, for those projects with a strong training component, instead of offering tailor-made training courses to specific recipients, broadly-based, open courses could potentially reach more beneficiaries.

But probably the first place to start is to examine the project philosophy and ensure that – prior to approval – projects are submitted to a “competition review”, the aim of which would be to assess the potential market distortion. And only approve those projects which specifically do not cause distortion.

If a strong need for support is observed in an area where the risk of distortion is medium to high then creative solutions are called for, which help achieve the goals without causing the damage that market distortion does.