Marketizing Development: KfW and the Rise of Financial Instruments for Development

Abstract

Development institutions have heralded financial instruments with donor government risk assumption as key to development policy. Why have development institutions promoted these financial instruments, and why have donor governments accepted risk sharing in developing country investments? I argue that development institutions created marketized development financial instruments to improve financial sustainability and promote private investment abroad. Since they existed at the nexus of the public and private spheres, development institutions were the only actors able to create donor government-backed financial instruments. However, while the World Bank spearheaded early iterations, it was not until the 1980s that intense political pressures forced donor governments to fully embrace risk-sharing financial instruments. Using extensive archival research and over 70 interviews, I focus on the experience of Germany’s KfW to illustrate this process. KfW experimented with new financial instruments in the late 1980s, but three political crises—reunification, the collapse of the Soviet Union, and the Balkan crisis—pushed the German government to accept marketized development financial instruments as policy. In order to maintain proper incentives on the part of recipients, KfW gained the ability to directly establish and manage the new financial instruments, as well as administer them according to market principles. This was a significant departure from prevailing development policy. Moreover, this combination of institutional flexibility and strong political backing enabled KfW to serve as one of the leading institutions in the creation and propagation of marketized development financial instruments, particularly in microfinance and structured funds for development.