In advance of last week's G-8 Summit, President Bush announced a new initiative to promote private sector development in Africa. While overshadowed by the news of economic sanctions against Sudan and the climate change debate, the Africa Financial Sector Initiative (AFSI) is a step forward in the administration’s foreign aid policy. By providing much-needed technical assistance and creating private equity funds for underserved markets, the U.S. has made an intelligent choice in its fight against poverty in Africa.

By combining the incentives and ingenuity of investment banking with the idealistic, do-gooder ethos of the development world, the AFSI could lead to sustainable poverty reduction. But the announcement was vague about how the AFSI will be implemented, managed, and assessed. 

By combining the incentives and ingenuity of investment banking with the idealistic, do-gooder ethos of the development world, the AFSI could lead to sustainable poverty reduction.

The AFSI calls for multiple departments of the U.S. government to contribute to private sector development in Africa. The Overseas Private Investment Corporation (OPIC) will lead the way. OPIC has created two investment funds, the Africa Capital Markets Fund and the Africa Social Development Fund. While the former seeks to finance fund managers who will build emerging market portfolios of all kinds through securities underwriting, mezzanine financing, and other forms of capital market development, the Africa Social Development Fund will focus specifically on businesses serving important social needs and contributing to grassroots development. These businesses will include small and medium enterprises, social infrastructure businesses such as health care and renewable energy, and businesses that cater to rural and underserved populations earning less than $4 a day. In other words, AFSI will support businesses that serve the "Bottom of the Pyramid" (BoP), a concept pioneered by C. K. Prahalad of the University of Michigan Ross School of Business.

In his groundbreaking book, "The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits", Prahalad argues that the four billion people earning less than $2 a day can become integrated into the world economy. “Low-income,” he writes, “is not no-income.”  Even the poor participate in the market, and their aggregate purchasing power is significant. Yet, with the exception of mobile phone companies, few businesses take advantage of the opportunity. According to a recent study by the World Resources Institute (WRI) and the International Finance Corporation (IFC), the aggregate income of the BoP market in Africa is $429 billion. That’s 71% of Africa’s purchasing power. It’s simply bad business to ignore it.

The Africa Social Development Fund is not the U.S government’s first foray into the BoP, though it is the first to demonstrate a solid understanding of the BoP concept. USAID recently sponsored research and participated in a handful of projects, but it chose specific ventures to fund and (sometimes) matched the funding of the commercial partner dollar for dollar. While the government should provide some backing for the ventures, BoP projects must let market dynamics run their course. There is no reason why USAID should decide which projects to pursue: the BoP markets will themselves decide through their purchasing power, with background U.S. help.

'Low-income,' writes Prahalad, 'is not no-income.' Even the poor participate in the market, and their aggregate purchasing power is significant.

In the case of the AFSI, OPIC will only finance between one-third and one-half of the fund’s total capitalization, and fund managers and their clients, not the government, will be responsible for choosing viable, sustainable, and scalable ventures that clearly produce economic returns in addition to social returns. The fund managers will have a greater incentive to provide much-needed knowledge and expertise, contribute to the board of directors of their clients’ companies, and generally invest more time and effort into assuring the success of the business/social ventures. Just because people are good doesn’t mean they’ll do any good. The AFSI and the Africa Social Development Fund bridge this gap, making it easier for good people to do well.

But no one says that the BoP market in Africa is easy. There remain many challenges for fund managers and clients to overcome. The BoP market is distinct from traditional markets, and (as the telecom firms have discovered) it demands products and services that are uniquely catered to the dynamics of rural, low-income life. Perhaps the most tragic of all mistakes would be to transfer a developed world product directly to the BoP market without sufficient tailoring. Basic business strategies such as packaging and marketing and even the product itself must be reevaluated and modified.

Consider diapers: While an American family with one child can go through six pairs of diapers in a day, all which will be disposed of through the local waste management system, a family at the BoP cannot afford such quantities and, in any case, has no hygienic way to dispose of them. Thus the diaper sold in the BoP market must be more absorbent so that fewer are used each day, and environmentally friendly to minimize the impact on the local ecosystem.

There are many other examples of successful BoP products, such as the solar flashlight or the PlayPump, a merry-go-round that also serves as a water pumping and irrigation system. Such successful examples show that the BoP market demands entrepreneurial spirit, innovation, and a proper assessment of the consumer at hand. Contrary to most assumptions, the poor are indeed brand-conscious, price-conscious, and able to readily accept new technologies. Until now, they have simply not been respected as active consumers and producers in the world economy.

The opportunities to fight poverty through the BoP market are endless. By localizing supply chains, businesses can create employment. By creating new health care and education products and services, they can support the development of human capital. The market is lucrative, but it is separately and additionally inspiring to think of how much BoP products and services improve the quality of life and future prospects for those who live on less than $2 a day.

Alas, the AFSI is only a needle in the haystack of U.S. foreign aid projects. These initiatives succeed or fail because of their scalability and accountability. It is promising to see that previous OPIC sponsored private equity flows helped develop a track record, or a “demonstration effect", that induced other investors to commit capital and enter emerging markets. Hopefully, equity flows into the BoP market will do the same. The Bush Administration must also be held accountable for the projects it proposes in the AFSI. This initiative calls for the FDIC, the Treasury Department, and USAID to contribute in addition to OPIC. Yet the president named no director to oversee the operations of AFSI and specified no benchmarks for success. Such a promising initiative should not be left to function organically, without coordination, oversight, and assessment.

By moving away from giveaways and intricate, over-managed social projects toward market-driven programs such as the AFSI, U.S. foreign aid can catalyze the integration of poor markets into the international financial system, which is a much more effective and sustainable tool for combating poverty. The bottom of the pyramid assessments by Prahalad and WRI/IFC indicate that even the most indigent are willing and able to join the global economy.

Apoorva Shah is a research intern in development policy at the American Enterprise Institute.