Building a Market for Everyone: How Emerging Markets Can Attract Constructive Capital and Foster Inclusive Growth

CIPE Insight | Eric Hontz

In the past 30 years, the world has seen remarkable growth in investments across borders and international supply chains. Capital investment, which expanded beyond national boundaries as international treaties and agreements came into effect, is free to find the best opportunities available. These investments travel not only from developed markets into emerging markets, but also among emerging markets at various stages of political and economic development, reflecting the urgent need in fast-growing emerging markets to build out infrastructure and fund rapidly growing companies. But all investment is not created equal. While capital itself has no agency, it is guided by institutions, business culture, and relationships that have the power, in their aggregate, to create either a virtuous cycle of wealth creation or a downward spiral of self-dealing, rent seeking, and economic stagnation.


Investors often assert their own business culture, expectations of conduct, and norms of business behavior through their investments.

Investors often assert their own business culture, expectations of conduct, and norms of business behavior through their investments. As a core institute of the National Endowment for Democracy and affiliate of the U.S. Chamber of Commerce, the Center for International Private Enterprise (CIPE) has a unique vantage point on the intersection of markets and governance. CIPE has identified one potential framework to address the interrelated issues of falling trust in institutions and business, as well as increasing inequality: the concept of constructive capital™. Constructive capital describes investments that are transparent, accountable, and market-oriented. In other words, financial flows that are well-governed, at both the funding source and destination, and respond to voids in the provision of goods or services.


This definition reflects CIPE’s decades of experience in emerging markets, where the aggregate constructive financial flows offer benefits above and beyond added jobs or economic dynamism at the firm level. The cumulative effects of these financial flows drive the creation of a more transparent and market-oriented business culture, leading to a virtuous economic cycle that lessens corruption while augmenting the efficiency of markets, fostering greater inclusion, and promoting societal cohesion. Investments are accountable not only to the investor, but also to other stakeholders that stand to benefit, such as local entrepreneurs and other citizens engaged in monitoring their country’s governance. For example, investments that are subject to robust anti-corruption standards such as the U.K Bribery Act or the U.S. Foreign Corrupt Practices Act must ensure compliance of local providers, thereby transferring the benefits of accountability and transparency standards to networks in the recipient country. In turn, these enterprises become the cornerstones of inclusive, well-governed business cultures where citizens benefit from constructive investments. Citizens have access to improved standards of living, increased economic opportunities, and the freedom to achieve their highest potential.

Constructive investments support broader economic and social goals, such as integrating marginalized groups into the economy, connecting regional markets and boosting integration, or ensuring compliance with environmental and labor regulations.

Shepherded by this dual accountability, constructive investments support broader economic and social goals, such as integrating marginalized groups into the economy, connecting regional markets and boosting integration, or ensuring compliance with environmental and labor regulations. Likewise, CIPE has observed cases of constructive investors taking an active role in the development of local institutions through the donation of their time and financial support, for example, as mentors for local businesses or members of business associations.


The Impact of Constructive Capital and Corrosive Capital


Constructive capital supports markets and the rule of law. It also promotes transparency and improves governance by holding governments accountable for ensuring a level playing field for the private sector. Such benefits often represent positive externalities of purely market-driven investments. These constructive investments tend to be drawn to businesses that support sustainable and equitable economic growth. While a single constructive investment is good for an individual firm and those employees, when taken in the aggregate these types of investments improve returns and increase future business opportunities. At a tipping point constructive capital can spark a cycle of investment and business environment improvements, which supports the development of robust market institutions and supports good governance by supporting initiatives that provide oversight and accountability. Alternatively, decision-makers who control capital investment that is subject to the rule of law, strict anti-corruption oversight, and comes from transparently operated companies will grow increasingly reluctant to invest in less open markets. For example, where investors and businesses have eroded institutions and the business culture to a point where the state is captured and corrupt elites monopolize entire economic sectors for themselves, or where the corrupt elites and the state are one in the same and export their extracted rents to safe havens.


Corrosive capital™, at the other end of a spectrum of investments, is the inverse of constructive capital. This type of investment undermines trust in institutions, weakens the rule of law, promotes opacity, and seeks to exert monopoly power over vast swaths of the economy. CIPE developed the corrosive capital concept to identify individual transactions that lack transparency, accountability, and market orientation. These include many flows from authoritarian regimes into emerging markets. Cumulatively these corrosive capital investments represent a fundamental threat to constructive capital. Investments that are opaque in origin, lack oversight, or respond solely to political pressure often undermine the same market institutions that attract constructive capital. Through this perspective, CIPE has noted that, in certain instances, investments that CIPE has termed “corrosive capital” undermine the development of the rule of law through the exploitation of specific actors or regulatory regimes and poison the business culture. When enough corrosive capital enters the market, it leads to a destructive cycle of endemic corruption, weakens institutions, and creates a toxic business environment that suffocates innovative local firms and leads to greater inequality and less wealth creation. In contrast, constructive capital benefits firstly the investor, but also, when taken in the cumulative, the entire recipient business community.


Constructive capital is market-oriented, but it also requires strong institutions to attract additional constructive investment, whether in emerging or transitioning markets or in countries where authoritarianism still holds sway. Where institutions are weak, corruption is endemic, and the policymaking process is captured by insiders, constructive capital can foster stronger, citizen-driven institutions and alliances with international businesses that begin to carve out a space for a new business culture. Over time, the strengthening of governance and markets can foster a supportive ecosystem of laws, regulations, culture, and institutions that foster innovative enterprises and create wealth for a broader section of society. The business and institutional benefits of constructive capital are intimately intertwined.


CIPE recognizes that efforts by companies, both large and small, to support efforts to encourage constructive capital will face the classic economic free rider problem. Each investor or businesses will attempt to benefit from the efforts and investments of others without contributing; however, it is in the interest of each investor to support constructive capital in transactions. Part of the solution lies with the international development sector, where international organizations, including CIPE, can support nascent institutions and organizations to foment a business culture predisposed to constructive capital and tie individual investments together to create a movement for change. Coupled with real benefits to individual business these partnerships can serve to reduce free rider issues and gain more rapid buy-in from investors and businesses.


Just a few decades ago Venezuela was considered a rapidly advancing emerging market while Colombia was beset by internal strife. Since then Venezuela supported the growth of corrosive capital from within and without, leading to an exodus of investors and an economic collapse. Colombia took the slower, but more stable path towards sustainable growth through the encouragement of constructive capital to build a strong foundation for markets and democratic institutions. CIPE seeks to harness the power of constructive capital to create sustainable, inclusive economic growth while supporting the development of democratic institutions. CIPE supports the ability of developing countries and local companies in these countries to attract constructive capital in several ways: through the engagement of independent, voluntary associations and their interaction with government, enabling and empowering groups that create high standards of governance and compliance, and the creation of progressive business cultures based on trust among business communities.


How to Promote Constructive Capital


Through interactions with multinational firms and businesses in emerging markets, as well as development organizations, international institutions, and the democracy community, CIPE has identified several key elements in promoting sufficient constructive capital investment to spark a virtuous economic cycle. While many of these elements focus on the work being done in emerging markets, they build upon contributions from partners around the world, in both emerging and developed economies. These elements are: fostering freedom of association; building an accountable business culture that fosters inclusive growth; advancing corporate governance; and integrating compliance into business models.


An Abundance of Associations


Constructive capital is drawn to markets where associations of like-minded people and businesses pursue their interests, advocate for change, and create a culture (or community) around an industry or topic. Business associations and professional standards groups, from independent and voluntary chambers of commerce to sector- or profession-based groups, reinforce the positive aspects of markets by working with government to develop effective regulations, identify barriers to competitiveness, and create industry-led standards. Groups of professionals, from accountants to corporate secretaries, foster cultures of high standards in their industries and professions to share best practices. Further, these associations can serve as a bridge between the private sector and their governments to highlight the benefits of constructive capital and the dangers of corrosive capital.


International donors need to support the formation and strengthening of local associations through grants, partnerships, and networks for sharing information. Often there is nearly adequate financial support and interest in such institutions on the local level, but they need the know-how and experience of developed market contemporaries to increase their impact, improve sustainability, and integrate into the business ecosystem. Actors in developed markets should also encourage the expansion of institutional structures for the support of professional associations, such as the Society of Corporate Compliance and Ethics and the Association of International Accountants, to continue their growth into emerging markets and raise awareness and standards. Governments can lend support to such initiatives by including them in dialogue but should be wary of overreach that would suppress independent voices and debate on important policy topics.


CIPE works in many emerging markets with independent, member-based business associations and chambers of commerce. These organizations encourage constructive capital to enter the market by building trust among the private sector. CIPE serves as a forum for discussion, and advocates reform to make markets work more efficiently. For example, in Bahrain CIPE has worked with a volunteer committee of SME business leaders, on policy prescriptions for business priorities. Over two years of work the plan eventually gained the support of the Speaker of the Parliament and members of the Shura Council. Although the work in Bahrain gained impressive policy outcomes, the more important, and sustainable, leave-behind was increased trust among the business community and a transparent process for developing a consensus around key policy ideas and presenting those ideas proactively and constructively to the government.


Creating a Progressive Business Culture


As with all norms of behavior, business cultures are built and can change over time, with associations playing a key role in their development and direction of change. To encourage the flow of constructive capital international businesses, in partnership with local organizations, must build the institutions of the culture they want to see. Business culture needs to be cultivated and built over time through the investment of time, energy, and resources into these organizations that serve as the guardrails of constructive capital. Such institutions that support a progressive business culture can be strong associations, international institutions, or other formal or informal organizations. Another source of support can come from multinationals that engage in an emerging market through the support of suppliers and leaders who work to establish or enhance the efforts of local business or professional associations that support the rule of law, transparent markets, and the professionalization of a culture of doing business in an open and fair manner.

Business and professional associations are a vital link to build the foundations of trust among the business community, even where the rule of law is lacking.

CIPE has found that, while rule of law is necessary, the first step to achieving a better business environment begins with trust among the business community. In the absence of the rule of law, social capital and trust among businesses can be built from private institutions in order to allow investment and development, since the courts and mediation are not an unbiased option to resolve disputes. In many emerging markets where CIPE works, businesses often view investment from developed markets as a way to insulate themselves from unwanted (and unwarranted) attention from tax authorities and special services. Business and professional associations are a vital link to build the foundations of trust among the business community, even where the rule of law is lacking.


Working with the Thai Institute of Directors and the organization’s early member associations such as Thai Chamber of Commerce and the Joint Foreign Chambers of Commerce, CIPE shifted the narrative on corruption in Thailand. In a context where corruption was accepted by many in the private sector as a cost of doing business in the country, the collective action and leadership of many listed firms, under the umbrella of the Institute of Directors, allowed the private sector to gain a seat at the table in the country’s ongoing fight against corruption. These firms took the initiative to say “no” to corruption and business as usual, risking their enterprises and livelihoods, in order to make Thailand a better place to do business and attract additional constructive capital that, heretofore, was unable to enter the market due to the high corruption risks. Sometimes change takes the form of a champion, and the Thai Institute of Directors have fundamentally shifted the dialogue about corruption in the country to spotlight the changing culture of the business community in Thailand as it relates to corruption.


CIPE also recognizes that, like individuals, businesses tend to stick with the trading and business partners that they know. Constructive capital often does not enter an emerging market for the simple reason of business inertia. If businesses in emerging markets have traditionally done business with other markets that lack commitments to transparency and competitive markets it may take an external actor to guide, and sometimes shock, the business community to disrupt patterns of business engagement. CIPE believes there is a vital role for international financial institutions to attract businesses to new markets as a source of constructive capital. These new business relationships and sources of constructive capital need to have a well-defined business case for investment to incentivize businesses to act in an accountable and transparent manner, which may include support from international organizations as well as a national government interested in attracting constructive capital.


Lastly, due to the pervasiveness of corruption and opaque rules in many emerging markets, many investors entering these markets naturally do not want the attention of potentially corrupt actors and officials. For this reason, many have been loath to raise their profile and engage with the local business community. In CIPE’s experience, this is a grave mistake. Companies and investors that enter emerging markets visibly and commit to growing institutions and markets can defend themselves via collective action or through direct public appeals. These champions of change, domestic or foreign, send a signal to the market and the public that it is unacceptable to participate in corruption and that business can play a role in creating a more just society. By shifting the needle on business culture and expectations, international and domestic investors can encourage conditions to attract additional constructive capital, in turn increasing their own investment valuations and realized returns on exit of the investment.


Valuing Corporate Governance


The value of corporate governance goes beyond performance at individual companies. If corporate governance best practices are engrained across a country’s private sector, it will create an environment more attractive to constructive capital. A well-governed company, even in a poor investment environment, can best its competitors, securing a premium for investors and providing a signal for the market to follow. By helping companies and countries attract constructive capital through the creation of an effective corporate governance framework, businesses can provide a foundation for sustained and stable economic growth that delivers wider wealth to citizens. Yet the best approach for corporate governance reforms is one driven by a search for benefits rather than a reaction to crises.


Constructive capital’s preference for strong corporate governance is more than general niceties that benefit firms in emerging markets. There is a solid business case to be made for improving standards. Through the establishment of a healthy environment for corporate governance, long-term investors may realize greater premiums on exits and cheaper access to capital for growth, even in underdeveloped economies. Therefore, it is in the best interest of investors to support, enable, and work with local institutions in emerging markets that focus on improving the corporate governance culture and implementing international standards.


The private sector, government, and international organizations must work together to establish both demand and supply of best practices in corporate governance. The private sector has an interest in ensuring standards are improved and corporate governance principles outlined by the Organization for Economic Cooperation and Development are implemented. For example, working with The Brazilian Institute of Corporate Governance, CIPE has promoted good corporate governance in Brazil and throughout Latin America. With more than 1,000 members and thousands of directors and executives attending its programing annually the Brazilian Institute of Corporate Governance has promoted good governance in the private sector and is influential in a new focus on state owned enterprises. In addition to the focus on governance, the organization developed a new IPO market for small companies as a subsidiary to the main exchange in Sao Paulo, allowing more well-governed companies access to equity markets and expanding the number of participants in the creation of wealth in the Brazilian economy.


Integrating Compliance


Compliance programs play an integral role in ensuring adherence to laws and regulations in advanced markets, particularly the American market where the business judgement rule applies and places an obligation on directors to have controls in place. Certain national regulations, such as the United Kingdom Bribery Act, the United States’ Foreign Corrupt Practices Act, and France’s Sapin II Law follow capital deployed from these nations into emerging markets. Strong compliance programs, and a commitment to cultivating a cadre of compliance professionals and best practices in the local economy, not only allows the investment to adhere to the letter of the law, but helps to entrench a culture of compliance across business supply chains and within entire sectors. By encouraging the growth of the compliance profession and integrating international standards into local small and medium sized enterprises, CIPE can help constructive capital take root.


Over the past several years, CIPE has worked with partners in 14 sub-Saharan African nations to build the Africa Anti-Corruption Compliance Network under an initiative called Ethics First. Through the initiative and local partners in the 14 nations, CIPE is working with SMEs to develop their capacity to integrate into global supply chains and deliver the benefits of a strong compliance program to local firms. By building the capacity of local institutions and, via their training programs, SMEs, CIPE is helping to open the flow of constructive capital to Africa through a culture of compliance and ethics.


An Affirmative Choice


The world has seen unprecedented economic growth, reduced poverty, and better health for citizens over the past thirty years. However, the world is at an inflection point as growth is slowing, and the corrosive effects of certain investments are apparent as the rule of law is threatened and institutional weaknesses are expanding. Businesses must play a positive role in reducing corruption, improving governance outcomes, and reducing inequality through the generation of wealth for a greater and wider number of citizens. Constructive capital investment, guided by institutions, business culture, and relationships, in the aggregate, can create a virtuous cycle of wealth creation, improved governance outcomes, and a better future for the next generation through inclusive growth. Business and investors cannot afford to be passive. The world needs action to affirm the values of free markets and democracy that create a market for everyone and the opportunity for every citizen to thrive.

“Corrosive capital” and “Constructive capital” are trademarks of the Center for International Private Enterprise (CIPE).

Published Date: October 25, 2019