By: Tilman Ehrbeck
For those of us who work toward economic inclusion in emerging markets, the year and a half since the outbreak of the COVID-19 pandemic has validated one key element of our approach: The value of emphasizing digital innovation in service delivery and infrastructure has never been clearer.
From the outset, the pandemic has underscored the importance of digital infrastructure in getting relief to recipients quickly. Globally, governments announced about $12 trillion in aid last year. According to research by McKinsey, economies with low-cost digital rails, national digital identity and functioning data regimes were able to disburse relief faster and more efficiently. For example, India’s digital infrastructure investments allowed it to instantly deposit aid payments in over 320 million beneficiaries’ accounts. Meanwhile, in the United States, with decades-old payment rails and no national ID, millions of Americans waited months to get relief payments by paper check.
The government wasn’t the only sector to turn to digital service delivery during the pandemic. As people around the world scrambled to get groceries, to keep earning a living and to stay connected to loved ones while socially distanced, services in nearly every sector moved online. Digital adoption and industry shifts that we thought would take years happened within weeks.
At the same time, the COVID-19 economic crisis was a humble reminder that digital infrastructure, private-sector innovation and market-based solutions are not sufficient to ensure broad-based prosperity.
Financial markets were at risk of seizing up in March of 2020: Without government intervention, the economic fallout from the pandemic — and the impact on people in financial precarity — could have been much worse. The need to intervene and stabilize was unquestioned, and the relief packages passed by governments around the globe were a reminder that some economic challenges are so big that they require state action — and that state action depends on social consensus.
The developments of the last year and a half have implications for entrepreneurs, investors, digital platforms, financial incumbents, policymakers and social advocates alike. As I think about the digital future, I’m simultaneously more ambitious and more realistic about the potential for market-based innovations to make a positive impact on the living standards and financial health of low-income communities. Here are three observations, rooted in the experiences of the pandemic, about the value — and limitations — of private-sector approaches in a post-COVID world.
1. We need purpose-driven success at scale to change the industry for the better.
With COVID-19 accelerating the digitization trends that were already underway, there are ample opportunities for purpose-driven businesses to make a difference, especially in financial services. Digital service providers have new opportunities to reach households, for example, via the many tech platforms in e-commerce, social media and logistics that have become even more relevant in daily life, such as Amazon and Flipkart, Facebook and WeChat, DoorDash and Grab.
Similarly, there’s more opportunity for digital service providers to meet the needs of small businesses. While the vast majority of micro, small and medium enterprises (MSMEs) in emerging markets continue to operate in some degree of economic informality, their underlying activities are increasingly digitizing. This creates new channels and data flows for innovators to offer new financial services — particularly those involving credit and insurance underwriting — that were simply not feasible until now.
Against this backdrop, Flourish Ventures has accelerated its for-profit investments in new platforms and new products relevant for the post-pandemic world: digital services that help gig-economy workers in Mexico and the U.S., smallholder farmers in Indonesia and Kenya, and corner-store owners in Bangladesh, Brazil and Egypt. These innovations can reach more people with better services at far lower costs than the traditional incumbent industry.
As a sector change-oriented investor, we want our individual portfolio companies to be wildly successful. Otherwise, they don’t prove that better ways of serving customers are feasible and viable. But equally importantly, we hope for — and work toward — undeniable demonstration success beyond our own portfolio, at such a scale that incumbents have to follow suit and improve the functioning and performance of the financial system for all.
2. Change takes more than user-facing services – we need public goods and digital utilities.
While digital disruptors are engines for inclusion, they cannot change sectors without functioning digital infrastructure and modern financial regulation. To build a fairer financial system, our economies need a new alignment among a broader set of stakeholders —including the public, private and development sectors.
Some key elements of a better system, in particular in emerging markets, are likely to be public goods. As the McKinsey research on COVID-19 relief showed, reaching the most vulnerable segments is more efficient in countries with unique digital IDs. Public investments in digital identification, along with regulatory approaches that leverage these investments to meet know-your-customer requirements, can lower costs for everyone.
The McKinsey study also underscored the crucial role of digital rails. System functions such as real-time payment settlement benefit from network effects and arguably have monopolistic tendencies — and while they need not be government-provided, they should be regulated as public utilities. For wide-reaching financial system improvements, we need digitally native policies and regulations that promote innovation, ensure competition and protect consumers.
As the broader financial system evolves, it needs more connective tissue between users and non-traditional retail financial providers on the front end, as well as public infrastructure, regulated balance sheets and capital markets at the back end. The connective tissue is often an API, connecting banking data or services to third-party companies.
This creates plenty of opportunities for private-sector, business-to-business (B2B) fintechs. Open API-based financial infrastructure is a burgeoning area of innovation, and in the last 12 months, we have made B2B fintech investments in Brazil, India and the U.S. These B2B services make payment rails more accessible, handle compliance and security, and dramatically reduce the startup costs and time-to-market for user-facing innovations.
3. Even a better, fairer financial system has limits when it comes to the big challenges of our time.
We believe that tech-led innovation and markets can make a big difference in achieving many development outcomes. For instance, at the macroeconomic level, private-sector finance is a powerful tool for channeling savings to the most productive uses. At the microeconomic level, it helps households and MSMEs better manage cash flows, capture opportunities and manage risks.
However, private markets cannot solve some of the biggest social issues of our time, such as income inequality, public health, financial security for the old and infirm, and meeting basic needs for the poorest. Addressing these challenges requires social protection mechanisms and broad consensus across society.
The pandemic laid bare gaps in every country’s social safety net. Even in the most generous, advanced economies, social insurance programs worked well for employees with stable jobs, while informal workers, the self-employed and part-time workers were often left out. Gig workers were hit particularly hard by the crisis. Last year, we surveyed hundreds of gig workers in Brazil, India, Indonesia, South Africa and the U.S. and found the vast majority could barely cover household expenses for a month. We called on platforms, financial service providers and policymakers to help gig workers become more resilient.
Though updates to business models are needed to help vulnerable workers and their communities navigate this sort of crisis, they aren’t enough. Ultimately, these workers need basic pensions, core health insurance, unemployment benefits and other social protections that need to be supported by general taxation.
During the last 18 months of the pandemic, we all have had occasion to reconsider the broader fairness, growth and fiscal considerations of our economic systems and business models. As we move beyond this crisis, many of us feel a renewed sense of purpose in addressing the long-standing issues that have contributed to poverty and inequality around the world. But it’s clear that there is still much work to do, and a new consensus to build, before those challenges will truly be solved.
(Originally posted in next billion)
Photo courtesy of UN Women/Fahad Abdullah Kaizer.