Cato Policy Analysis No. 260 September 19, 1996

Policy Analysis

Uncle Sam as Investment Banker:
The Failure of Washington's Overseas Enterprise Funds

by Doug Bandow

Doug Bandow, a senior fellow at the Cato Institute, is a nationally syndicated columnist with Copley News Service.

Executive Summary

The failure of traditional foreign assistance programs is now widely recognized and has led Washington to devise new ways to distribute foreign aid. Through the U.S. Agency for International Development and the Overseas Private Investment Corporation, the U.S. government has established investment funds that provide the private sector with billions of dollars in grants and guarantees.

Under the Clinton administration, American taxpayers' obligation to support those funds has increased 10-fold, yet Washington's efforts to "privatize" aid through the enterprise fund approach have been no more successful than were traditional government-to-government transfers. There is no evidence that enterprise funds have generated additional private investment, helped create better investment environments, or had a positive impact on development in poor countries.

Indeed, most enterprise funds are losing money and many have simply displaced private investment that otherwise would have occurred. Conflicts of interest and administrative problems are also common at the funds. In short, the government-supported funds are artificial political creations charged with the impossible goal of investing in profitable private ventures in which the private sector is unwilling to invest.

Congress should recognize that Washington's attempt to become a venture capitalist has failed and vote to get the government out of that business.


One of the issues of greatest contention between Congress and the president has been foreign aid. Although the Republican congressional majority voted to make only modest cuts in planned outlays, the administration responded with invective. Brian Atwood, the administrator of the U.S. Agency for International Development, denounced his critics as "isolationists" and "extremists." He has taken particular umbrage at proposals to eliminate his agency, acting as if U.S. AID equaled aid and only his bureaucracy stood between poor nations and mass starvation.

The administration's defensiveness should come as no surprise. A half century of so-called foreign assistance from the United States, other foreign countries, and international organizations has left little more than corruption, inefficiency, and dependency in its wake. [1] Even U.S. AID reports acknowledge the failure of traditional government-to-government transfers. [2]

Thus, calls for "reform" of foreign aid have been legion. One increasingly popular tactic has been to essentially privatize the delivery of aid by funneling it through nongovernmental organizations. Of particular interest at a time when entrepreneurship and free-market reforms are popular slogans in Washington has been the federal government's experiment in underwriting equity investment in private companies in Third World countries. Unfortunately, a report by the Center for Development Information and Evaluation at U.S. AID admitted that past agency projects of that kind "have been almost uniformly failures." [3] Over the years U.S. AID created funds for Asia, the Caribbean, Latin America, the Middle East, and even Ireland. According to the CDIE, "In none of the cases did the generic 'venture capital scenario' proceed according to plan: i.e., the firm acquired shares in a set of firms, sold them for a profit, and invested the proceeds in new firms." [4] Some funds were poorly structured, most made poor-quality investments, and none achieved profitable divestments.

But "privatization" of aid is the last refuge of a bureaucracy unwilling to admit that supposed foreign assistance does not work, so advocates of foreign aid are now trying to reinvent that failed approach. Over the last decade U.S. AID has established a score of regional "growth" funds; the Overseas Private Investment Corporation, a fount of corporate welfare (subsidized insurance of private investment abroad), has created another seven, and several other regionsl funds are currently raising capital. Between 1990 and 1993 Congress funneled 28 percent of U.S. assistance to Central and Eastern Europe through four regional enterprise funds. The Institute for EastWest Studies enthused that those funds "have become models for other international assistance programs."[5]

Typically the government picks a fund manager to operate as the venture capitalist, supplies initial operating funds, and provides either investment capital or a guarantee to allow the enterprise fund to borrow at reduced rates. All told, since 1989 U.S. taxpayers have provided or committed some $2 billion in grants and guarantees. In fact, the Clinton administration has increased taxpayer exposure more than 10-fold. One OPIC spokeswoman says reassuringly, "What we're doing has very little downside and a lot of upside." [6] But then, everyone said that about federal deposit insurance--it was a great money maker for the government--until the savings-and-loan debacle.

Discouraging Initial Evidence

Evidence is growing that the enterprise-fund approach is little more successful now than it was in the past. Virtually every enterprise fund has turned into a financial black hole. Even one analyst at U.S. AID admits that "equity investment in emerging companies in developing countries is a mirage. Conceptually, it appears likely to pay high returns. In practice, it does poorly." [7] One of the enterprise funds has already self-destructed. The executives and managers of the Czech and Slovak American Enterprise Fund all resigned in the wake of charges of mismanagement, and the Clinton administration is considering closing down the operation.

The theory behind public venture capital is simple. Traditional government-to-government assistance programs have done more to enhance the state sector than promote economic self-sufficiency. Thus, it is hoped, official growth funds will help develop the private sectors of foreign nations.

The most obvious problem with Uncle Sam's attempt to become a venture capitalist is the fact that in real venture capital enterprises the promoters themselves have funds at risk, and thus spend their own rather than other people's money. As a result, they are rewarded or punished according to their success rates. They typically enter markets with which they are intimately familiar, rather than parachute into economies a continent away. Promoters limit overhead, especially at the start. And investments are expected to be liquidated, with profits repatriated to investors. Otherwise no one would capitalize the effort in the first place. On all of those counts, the government effort falls short. There is no shortage of capital, only of "good projects and countries with good policies," complains an executive at one international investment firm whose head sits on a fund board.[8]

A host of studies and audits, undertaken by entities ranging from independent consultants to the CDIE and the General Accounting Office, have pointed to those problems. Particularly striking--and making them worth quoting at length--is the fact that several government-initiated and government-backed investigative reports have reached similarly negative conclusions about such a politically popular government program.

The first failing is simple but fundamental. The managers of private funds are accountable to investors. In government-sponsored efforts, fund employees resist U.S. AID attempts to monitor investments. The GAO, for one, worried about inadequate oversight of enterprise funds, which may result in practices that go against U.S. government interests. [9] But the funds view efforts to ensure that the taxpayers' money is well spent as unwarranted interference. For instance, John Birkeland, chairman of the Polish American Enterprise Fund, has complained that existing government controls are excessive and onerous. The Institute for EastWest Studies contends that "excessive restrictions will frustrate the ability of the Enterprise Funds to fulfill their congressional mandate."[10]Washington's investigation of the scandals at the Czech-Slovak fund caused the chairman, Lawrence McQuade, who later resigned, to argue, "The government is not supposed to tell us what to do." [11]The various enterprise funds also lobbied U.S. AID not to release a critical outside audit of their activities.

In short, no one is happy. According to an assessment last year by Development Alternatives, Inc. (DAI), a consulting firm working for U.S. AID, "The current U.S. government monitoring system is not working. Funds are subjected to an excessive degree of monitoring, whereas the government has neither adequate information on performance nor adequate safeguards commensurate with the $1 billion investment the enterprise fund program represents." [12]

Political Imperatives

The funds are also preeminently political. Although the Institute for EastWest Studies argues that "the best guarantee of sound management and investment decisions is the quality of the Boards of Directors of the Enterprise Funds themselves," [13]directors need know nothing about venture capital or the local market. Joseph Fichera and Robert Rubin, former board members of the Czech-Slovak fund, report that they "found a board that, once invested, was essentially unwilling to aggressively administer the bitter medicine of capitalism where it was warranted." [14]The Central Asian-American Enterprise Fund boasts of having "a Board of Directors composed of distinguished members of the American business and academic communities."[15] But what do "distinguished" academics know about investing in, say, the Kyrgyz Republic? One of this fund's directors, former Democratic representative Stephen Solarz of New York, has opined that the funds are intended first to promote development and only secondarily to make a profit.

An example of the danger inherent to politicized investment is exhibited by the Clinton administration's merger of the $340 million Russian-American Enterprise Fund and the $100 million Fund for Large Enterprises in Russia into the U.S. Russia Investment Fund. The administration passed over Robert Towbin, head of the larger Russian-American fund, to run the new entity because he was viewed as too cautious. Complained Sharon Tennison, a member of the board of the Russian-American fund, "He wanted to operate the fund like a Wall Street fund, but Russia isn't Wall Street. You have to be willing to take larger risks."[16]Of course, it is easier to take risks when one is spending other people's money, especially that of the taxpayers.

Economic considerations appear to take a back seat in other markets as well. The GAO reports that officers at the Czech-Slovak, Hungarian, and Polish funds "concluded that the level of understanding of business practices at the companies in which they had invested was lower than originally thought." [17] Not that that constrained their activities. To the contrary, explained the Polish-American Enterprise Fund in its 1994 annual report, "We continue to press on to new and possibly more risky areas of activity, recognizing that it is our clear mission to offer finance and support where it is least available from other sources," including lending "to people with little or no business experience." [18]

Problematic Investments

Investment almost anywhere in Africa is problematic. Price Waterhouse said that the Africa Growth Fund "is showing that higher rewards along with higher risks do appear possible in a developing, transition economy" but that "the difficulties and challenge of succeeding (realizing these rewards) are formidable and should not be underestimated." [19] That would be fine for private investors who voluntarily assume the risks of investing in emerging markets, but the subsidized enterprise funds leave the risks with taxpayers, not entrepreneurs who will benefit if the investments pay off. In sum, the funds socialize risks but not profits.

That the AGF was created for political rather than economic reasons is obvious from the fact that its attempts to raise private capital were disappointing; the fund fell short of meeting its equity target by 50 percent. According to Price Waterhouse, private investors were reluctant to contribute for several reasons, including "an unsupported/undocumented case for investing in Africa" and "the General Partner's lack of an applicable track record in venture capital." [20]Private firms that provided capital explained that they did so for largely noneconomic reasons, such as their interest in Africa.

The focus on politics makes a mockery of Congress's intention that the funds operate like businesses and return a profit to the taxpayers. Unfortunately, politics intrudes in other ways as well. For one thing, there is pressure to ensure that investments are politically correct. One OPIC official explains that investment decisions take into account workers' safety and effects on U.S. employment and the local environment. [21] Those are worthy goals, of course, but politicos tend to be more interested in what domestic interest groups want than what foreign workers desire. Indeed, environmental protection and labor rights have become backdoor justifications for trade protectionism. Even more unrealistic are the investment guidelines of the Central Asian-American Enterprise Fund, which says that it tries to fund businesses that adhere to U.S. environmental standards. [22] If it is really serious about those sentiments, the fund will end up making no investments, since no company in impoverished Uzbekistan or strife-torn Tajikistan can be expected to meet the regulatory standards of the United States.

Moreover, residents of foreign nations often see the enterprise funds more as government than private operations, which causes international friction. The GAO, for instance, stated that publicity and demand for fund services raised expectations to the point that the funds were pressured to make investments. [23] DAI came to a similar conclusion. It reported that the "political dimension created two serious problems. First, the announcement of the funds created an avalanche of requests for money from would-be business owners, putting a great strain on the funds during their start-up phase. Second, there was a great deal of disappointment and negative publicity in the countries when people discovered that the funds were requiring repayment of the capital with interest." [24]

The potential confusion of political and economic goals is compounded by the fact that, as a U.S. AID regional inspector general's audit observed in 1995, there is no "comprehensive set of agreed-upon specific objectives and measures by which the performance of the Funds can be judged." [25] As a result, federal officials "were seriously disadvantaged in their efforts to improve program efficiency and effectiveness." [26] In short, if no one is sure what the funds are supposed to be achieving, then how can the funds fulfill their mandate?

Administrative Failure

Problem number three is administrative. The funds are partially run from the United States, where it is harder to acquire an intimate knowledge of local markets--the customs, business community, special practices, cultures, and legal systems. Quality senior management, frequent trips, and local contacts are all helpful, but they are not the same as management by indigenous and local entrepreneurs.

For the Bulgarian, Czech-Slovak, Hungarian, and Polish funds, observed the U.S. AID audit, the absence of capital markets and local expertise initially resulted in minimal market knowledge. [27] Over time the Bulgarian and Czech-Slovak funds increasingly relied on the MBA Enterprise Corps rather than hire employees from the host country. Unfortunately, the corps has proved to be a poor substitute, since its members "typically serve for one year," a situation that has led to inadequate knowledge of the local market and high staff turnover. [28]

Curiously, the Institute for EastWest Studies argues that Czechoslovakia was peculiarly inhospitable to the fund because "communism was more entrenched" there. [29] However, that nation was economically advanced and highly industrialized before it fell under communist rule in 1948 and suffered less severely in World War II than, say, Poland. In fact, the fund's wounds appear to be almost entirely self-inflicted, starting at the top. For instance, John Petty, who headed the Czech-Slovak fund until last fall, was not a venture capitalist.

Other enterprise funds have also encountered significant problems in accumulating the information necessary both to choose investments and to monitor firm progress. Observed the GAO,

The president of the Hungarian Fund said that when the Fund started, given the economic and political environment, it was exceedingly difficult to perform a detailed evaluation of a potential investment's management team and its business plan, a process known in the industry as a "due diligence" review. Since Western-style methods of review were unavailable in Hungary, it was hard to determine the best evaluation methods to use. [30]

The Polish fund's managing director admitted that investment decisions were based on less information than is required in the United States. Representatives of the Czech-Slovak, Hungarian, and Polish funds all said they needed to improve their monitoring of investments. And well they should. As the GAO pointed out, "Loan recipients and other companies in which the enterprise funds invested did not always submit timely, complete, and accurate financial statements to provide information to managers on investment performance. Therefore, this source of information on how well investments were performing was not consistently available to fund managers." [31]

Perks before Results

Unfortunately, the funds' administrative emphasis appears to have been elsewhere. All have the sort of bloated overhead and "perks before results," as one U.S. AID official puts it, that tend to characterize government operations. [32] DAI reports that operating costs for the European funds have been unnecessarily high. [33] A U.S. AID regional inspector general agreed, reporting that as a percentage of capital those expenditures "exceed industry averages" for three of the four funds, running 23 percent of Bulgarian fund expenditures and 26 percent of outlays by the Hungarian fund. [34] That, in part, reflects Congress's requirement that the funds have an American board of directors, which has encouraged maintenance of a U.S.-based staff. [35] DAI found the Bulgarian fund particularly overstaffed; as a result, that fund's costs "are out of line with the performance." [36] Personnel and salary abuses forced shakeups at the Hungarian and, more spectacularly, the Czech-Slovak, funds.

Professional fees have also proved to be excessive. The AGF ran up high legal and placement costs by hiring three different sets of lawyers and intermediaries. Although Price Waterhouse found that the AGF's management fee was average, the "legal, placement, and organization costs absorbed" by the fund were high. [37] Costs were even more disproportionate given the relatively small size of the fund. Similarly, a U.S. AID regional inspector general reported in a review of the four European funds:

Next to salaries, expenditures for professional fees is the second highest category of operating costs. We found that invoices documenting legal fees did not include the type of detailed billing for services that would normally be expected by corporations. In addition, there are no controls to ensure that Funds using the same law firm pay only for their share of services provided in matters applying to all Funds. Fund officials complained of high legal fees and less than full transparency on invoices, and some reported that they had received invoices for services that were never requested. [38]

Conflicts of Interest

Also worrisome, in the opinion of the GAO, was the failure of the organizations to contractually prevent staff members from accepting employment with firms with which they had done business as employees of the enterprise funds. [39] The GAO noted potential conflicts of interest in some fund investments. And for good reason. It was questionable financial and staff practices that led to the veritable purge at the Czech-Slovak fund. [40]

Similar questions have been raised about the Bulgarian fund. Expenses have been exceptionally high--$3 million in 1995 on an asset base of $4 million. With investment revenue of only $550,000, the fund had to rely on a $5.5 million U.S. government grant to remain liquid. [41] Observers have also noted some dubious business practices: fund investment in housing used by staffers at the American embassy and reliance on a law firm of which a board member is a partner, for instance. The fund's management has also exercised questionable judgment in other areas. President Frank Bauer and Managing Director Nancy Schiller managed to turn a $200,000 breach of contract action into a $20 million defamation suit by attacking the character of Richard Rahn, head of Novecon, Inc., which had sued the fund. [42] The fund has refused to go to arbitration, instead dissipating taxpayer assets to mount a scorched-earth defense against what originally appeared to be a minor claim. The entire affair seems extremely curious.

Disappointing Financial Performance

High expenses have been combined with lagging revenues. Despite large infusions of free or low-cost capital, virtually all of the funds would be insolvent in the private marketplace, because they lack sufficient income to cover operating expenses. For instance, the AGF, created in 1987, is OPIC's flagship program. Between 1989 and 1992 the fund generated operating revenue of $1 million and costs of $3.9 million. Revenues came to only 27 percent of expenditures. Along with its U.S. AID subsidy of $1.4 million, the fund had to consume another $1.4 million in capital intended for investment.

The experience of other funds has been similar, with revenues making up only a modest percentage of operating expenses. With the exception of one fund's experience during one year, the financial returns for the Bulgarian, Czech-Slovak, Hungarian, and Polish funds have all been negative. The GAO reported that as a percentage of expenses the funds' revenues have run only from 16 percent to 39 percent. [43]

The CDIE noted that two of the four European funds had "experienced substantial losses that are unlikely to be offset by gains elsewhere in the portfolio. The value of the portfolios of the other two Funds appears so far to have increased only modestly, if at all." [44] The GAO found that the Polish fund suffered net losses "in 1991 and 1992 because of low revenues, low manufacturing industry gross margins, high expenses, bad debts, and currency exchange losses." [45] DAI considered the Hungarian and Polish investment portfolios the soundest of the four Central and Eastern European funds, but even those funds had yet to produce "rates of return that are high by any market standard." [46] DAI concluded that the Czech-Slovak fund's "investments are suffering major losses, and are generally marginal both in market and in development terms." [47] Finally, DAI observed that the initial results from the Bulgarian fund were "not positive," with the first two large investments failing and generating about $2 million in losses. [48]

Future prospects may be no better. Price Waterhouse warned about the AGF, "The high annual debt burden . . . on top of the 2.5 percent management fee, will undermine, or in the most severe case, sabotage the Fund's objective to create higher long term equity returns." The accounting firm questioned whether the AGF could "remain economically viable in the middle years without further subsidy or need to prematurely sell-off equity positions to meet cash requirements." [49]

For the four European funds, U.S. AID reported that "only one Fund (Polish) will reach a sustainable operating level soon; the Hungarian Fund could become sustainable if it reduces its legal and professional expenses to an acceptable level; the Bulgarian Fund could only reach a self-sustaining level if it makes some critical changes; and the Czech-Slovak Fund is unlikely to achieve sustainability." [50] DAI reached similar conclusions. Even after discounting administrative expenses, only the Hungarian and Polish funds generated positive returns. Take those costs into account, reported DAI, and "the overall return for [the] funds is negative in almost every time period." [51] According to DAI, only the Polish and Hungarian funds have a reasonable chance to reach sustainability.

Some supporters respond that the funds need more money. The Bulgarian, Czech-Slovak, and Hungarian funds are simply too small to become self-sustaining. [52] But this has long been the standard lament of advocates of traditional foreign aid: if only the Western industrialized states, especially America, would be a bit more generous. Funds operating in markets in reasonably open investment climates with good business opportunities should be able to flourish with capital in the merely tens of millions, rather than hundreds of millions. If those conditions are not present, there is no justification for investment funds, large or small.

Poor Prospects for Taxpayers

Unfortunately, most of the funds have no realistic plan for closing down and returning capital to the initial investors, meaning the taxpayers. Price Waterhouse called the goal of a successful cash out "daunting" and the "ultimate" challenge for the AGF. [53] U.S. AID itself acknowledged that "termination and liquidation dates should be a part of an Enterprise Fund's strategic business plan." [54]

But the prospect for successful liquidations looks poor. The four European funds acknowledge that their portfolios are largely illiquid since the funds have not developed sufficiently to attract investor interest. [55] The president of the Polish fund explained that it would be five years before his organization would know which investments would be successful. In the main, the investments were closely held and not readily marketable.

Not surprisingly, then, all the funds remain artificial political creations dependent on the taxpayers' good credit. The AGF has raised $25 million, but $20 million of that is based on a government guarantee. Moreover, in contrast to conventional venture capital funds, which raise all of their money through equity, the AGF has relied on debt for 45 percent of its capital, which could pose significant future problems. A few private investors have contributed to the AGF, but, reported Price Waterhouse, they had "no expectation of competitive financial return." [56] As noted earlier, they contributed for noneconomic reasons. The AGF exists only because of generous U.S. AID subsidies.

Of the Bulgarian, Czech-Slovak, Hungarian, and Polish funds, only the latter has raised any private capital--though it is equally reliant on the European Bank for Reconstruction and Development (EBRD), another U.S. government-funded entity. Outside financing for the Hungarian fund is all public, from the EBRD and the Japan International Development Organization. All told, reported U.S. AID, as of the end of fiscal year 1994, the federal government had contributed $259 million to the Central and Eastern European funds, but the four funds' assets had a book value of only $200 million. Including the implied cost of capital (what the funds would have had to pay investors to raise money in the financial markets), U.S. AID figured the total program cost at that point to be $100 million. [57]

U.S. AID is also contributing $150 million to the Central Asian-American Enterprise Fund for investment in Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan. Nor is that all. Under President Clinton OPIC has added funds such as the $200 million First NIS (new independent states) Regional Fund, the $155 million Russia Partners Fund, and the $75 million Israel Growth Fund.

At the same time, the government has unnecessarily raised its borrowing costs by at least $1 million a year by advancing more than $20 million in excess of current needs to the European funds. "There are no programmatic reasons to hold the [financial] buffers," explained a U.S. AID regional inspector general. [58]

Doing Good?

Has some good been done by the enterprise funds despite their poor performance? Of course; even Uncle Sam is incapable of spending billions of dollars without achieving something. Certainly, some successful investments have been funded, but how many? The GAO spoke of jobs being created and business experience being promoted in Central and Eastern Europe but offered no figures. Price Waterhouse opined that half of the Africa fund's deals "probably would not have happened without AGF," which means that half would have. [59] DAI estimated that companies in which the four European funds invested employ almost 78,000 people but said that "it is impossible ultimately to prove that these jobs were created or sustained solely as a result of fund investment." [60]

Indeed, Price Waterhouse reported that the AGF appears to have engaged in a "conscious strategy of 'cherry picking' the best available deals," which probably least required official U.S. assistance. [61] Similarly, the Hungarian fund's three best investments, which have given it the highest return of any of the Central and Eastern European funds, involved participation in public offerings of former state enterprises. Early on, the Bulgarian fund joined in a joint venture with a French firm to start a bakery. Here, too, it would appear that the enterprise funds simply grabbed better investments (or what appeared to be better investments; the bakery went bankrupt amidst charges of fraud) that would have been funded anyway rather than promoted new private-sector development.

Even worse, however, are the funds that prefer to pick potential losers. For example, Petty argued that the Czech-Slovak fund was supposed to choose riskier investments so as not to compete with the private credit market. [62]And that is what happened throughout the various funds' territories. DAI observed that a high proportion of recipients of finance from enterprise funds would probably not have received financing from anyone else. However superficially desirable it may seem, providing money to such individuals and groups is not necessarily a good thing. After all, reported DAI, "Many borrowers fit a risk profile such that they might have difficulty obtaining financing even in more advanced market economies." [63] The reason the Czech-Slovak fund has had problems, suggests Harvey Schuster, head of Corus Funds, a mutual fund company in Prague, is that "it was the blind leading the blind," since "the Czechs didn't know how to manage and the Americans didn't know how to invest." [64]

The Impact on Development

Perhaps the most important question, since the theoretical purpose of these initiatives is to promote economic growth and not simply to subsidize a few businesses, is, will the fund investments make a measurable difference in national development? Bad deals certainly will not. As DAI remarked, "No lasting development impact results from an investment that is not sustainable." [65] And, unfortunately, there is no guarantee that good investments will predominate. As Price Waterhouse observed, "At this early stage, impact assessment is largely speculative." [66]

Anyway, a few hotels, gold mines, and prawn farms--AGF investments all--are not the answer, no matter how profitable they become. Rather, what poorer states most need is a domestic climate that fosters private capital markets and entrepreneurship. But government-sponsored enterprise funds are ill-suited to creating such a climate. DAI opined that "the funds are (or can be) effective at providing capital for individual enterprises and development projects, but it is very difficult to demonstrate significant impacts beyond each funds' individual investing programs. Since enterprise funds were never required to track anything but financial performance, even where impacts may be of a quantifiable nature, accurate data for measuring developmental impact do not exist." [67]DAI concluded that the organizations were better able to provide capital to small and medium-sized enterprises than are institutions like the World Bank and EBRD, but that is faint praise--especially when even well run enterprise funds will be able to help only a very small number of new businesses in formerly collectivist and communist economies.

Capital Generation

Do the U.S. funds at least generate additional capital in the region? Price Waterhouse said that it was too soon to assess whether the AGF will be a catalyst for additional venture capital funds. DAI was even more downbeat, finding that the four European funds have not significantly affected financial-sector operations in the various countries.[68] But that may not be a realistic goal, for it appears that U.S. AID and OPIC are attempting to leapfrog ahead of normal market development. According to the CDIE, "The evidence from the rapidly-growing Asian economies suggests that dynamic activity in the equity market is more likely an effect than a cause of rapid private-sector growth." [69]

Indeed, it is the larger private-sector environment that will determine the success of many of the investments. Observed the GAO, "The risk of failure for the enterprise fund investments is heightened by the struggle to create a private business sector from the ground up while the economies suffer from economic depression. The business infrastructure, including the emerging capital markets, lacked modern production, marketing, and distribution networks, as well as a cadre of skilled managers." [70]But there is not much the funds can do about the larger environment. Reported DAI, "One cannot prove that funds' actions are a significant factor in improving the functioning of markets; in establishing transparent and open financial markets; in establishing policy, legislation, and procedures necessary to a market-based financial system; or in establishing systems to regulate private commercial banking."[71]

The funds do not even have much impact on what should be most controllable: local government policy. Although DAI suggested that "on an informal basis, funds can be helpful in providing policy advice or in influencing government actions," it concluded that "funds have little impact on the establishment of policy or enactment of legislation."[72] In fact, it added, "Enterprise funds are not particularly well suited to be instruments for modifying government policy." [73]

That should come as no surprise. Government-sponsored organizations have never proven adept at promoting free markets. In the end, countries either have or do not have the political will to change. The Czechs, who have made the most successful transition to the market of the entire former Soviet bloc, do not need advice from a quasi-government investment fund from the United States. [74] Poland probably could use the advice, given the disappointing pace of its economic reform and the serious impediments to foreign investment. [75] But there is no shortage of other policy advisers: the World Bank, the International Monetary Fund, EBRD, U.S. AID, consultants, think tanks, and a host of academics. Unfortunately, none of them, whether with informal advice or formal loan conditionality, has done particularly well in browbeating Warsaw or any other government into adopting policies that lack domestic support. [76] If local officials will not listen to organizations that directly lend hundreds of millions of dollars to their governments, they are not likely to listen to the funds.

Advice Ignored

Indeed, some governments have no interest in free- market advice. In their response to the DAI report, officers at the Bulgarian fund argued that "because of the disarray in Bulgarian politics, it is not clear that in Bulgaria anyone has been particularly successful at either giving or receiving constructive advice." [77] The result has not been pretty. Bulgaria "has the least conducive country conditions of the countries surveyed," according to DAI. [78] Top officials at the Bulgarian fund acknowledge that "free enterprise is half-hearted and the investment climate is rudimentary at best." [79] The Bulgarian American Enterprise Fund's description of the economy in which it is "investing" taxpayer funds is particularly sobering:

Unfortunately, the investment outlook in Bulgaria did not keep pace with [observers'] earlier, ebullient expectations. The economy spiraled downward as the financial system sunk into disarray, and today's banking and productive sectors are still overwhelmingly under state control. The real work of legal and regulatory reform remains unfinished. Stalled in gridlock, the government pretended to be capitalistic but was seen by many as a reincarnated socialist bureaucracy. [80]

Oddly enough, officials at the fund view that as an argument for their lending program. They contend that their organization should not be compared with conventional venture capital firms; rather, "a much more realistic expectation is to make money over the life of the Fund despite the risks of collapsing economies, commercial anarchy and the other problems that are legion in Eastern and Central Europe." [81]Actually, such conditions offer reasons not to invest taxpayers' resources and leave investment to adventurous entrepreneurs willing to risk their own capital. That is especially so in the case of the Bulgarian fund, which, reported DAI, suffers "from a combination of an investment strategy that turned out to be inappropriate for the country and mistakes by the investment staff." [82] In fact, the president of the fund, Frank Bauer, told the Wall Street Journal in May that foreign investors would soon "recognize that this isn't a place for Western investors--if they didn't know that already." [83] Apparently, the same standards do not apply to American taxpayers.

The funds do not even have any advantage in providing technical business services. Observed DAI, "Although certain specific technical assistance activities of enterprise funds are beneficial and effective, there appears to be little in the way funds are structured and operate that gives them a particular advantage in carrying out broad-based technical assistance when compared with other possible alternatives." [84]There goes another supposed justification for the funds.

Expanding Losses

Unfortunately, expanding the number of enterprise funds only makes poor results more likely. Even though select business investment can flourish in a poor economy, local knowledge and management profit incentives become more important in a tougher economic environment. Yet, observed DAI, "Looking to newer enterprise fund locations such as Romania, Albania, Ukraine, Russia, and Central Asia, one should expect country conditions that resemble Bulgaria more than the Czech Republic or Hungary." [85] DAI considers the performance and prospect of enterprise funds so poor that it concluded that the venture capital firm is an inappropriate aid model, since "the market for conventional venture capital investing is much narrower and less profitable than was originally anticipated." [86] Indeed, DAI suggested that the entire approach is flawed.

The classic venture capital investing model that formed the original approach is applicable only to a limited extent in the transitioning economies. The conditions necessary for successful venture capital investing are not present in much of Eastern Europe. There is an inadequate volume and quality of deal-flow. The exit mechanisms needed to maximize capital gains through public offerings of shares are not present or fully developed. As a result, enterprise funds have not been able to invest their venture capital funds as quickly as was anticipated, and the prospects for earning the desired returns appear limited. [87]

DAI went on to make the amazing observation that "even though definitive data are not available, it appears that the small loan programs could be, on balance, moderately profitable, whereas venture capital investments have on the whole produced losses to date." [88] The consulting firm recommended a greater emphasis on lending--the traditional form of development finance. So much for the new, reinvented strategy of government-sponsored equity finance.


Foreign aid is widely recognized to have failed. Even the Institute for EastWest Studies admits as much, while arguing that "the Enterprise Funds remain a highly efficient alternative."[89] Unfortunately, however, Washington's attempt to be a venture capitalist has also failed. Not that the approach retains no superficial appeal. Argued officials at the Bulgarian fund, "The Fund is unique among U.S. government or other aid programs in that it places money for economic development directly into the hands of private Bulgarian citizens. It is similarly unique in that with reasonable luck the Fund will return all the moneys to the U.S. government with a small profit." [90]Alas, experience suggests that filling B-52s with dollar bills and dropping them over Sofia would have a similar impact--with the same likelihood of making back the taxpayers' money.

Successful private venture capital firms, observed the CDIE, require rapid decisionmaking, a financial stake for managers, commitment to profitability, and effective cost control. Unfortunately, "donors are not particularly good at any of the four." [91]Indeed, as the CDIE put it, "There is just no evidence that donor-supported equity financing activity is a desirable use of scarce resources." [92] But policymakers never seemed to ask if it was. Concluded DAI, "The initial group of enterprise funds was created in the early stage of economic transformation of the region. There was a rush to show that the United States was prepared to support the transformation efforts, so enterprise funds were established quickly and with little advanced planning." [93] Just like so much else in Washington.

"Rarely has the world presented private investors with such a wealth of opportunities," opined OPIC's 1994 annual report. [94] That is true. But politicizing the investment process may have unleashed a variant of Gresham's law, with bad investment pushing out good. No new funds should be created. No more appropriations or guarantees should be provided to existing funds. Finally, Congress should strengthen federal oversight of the enterprises and move toward privatizing them. Uncle Sam's experience as a venture capitalist demonstrates that Congress should leave private investment to private investors.


[1]. There is no shortage of accounts of foreign aid failures. See, for example, Karl Borgin and Kathleen Corbett, The Destruction of a Continent: Africa and International Aid (San Diego, Harcourt Brace, 1982); Peter Boone, "Politics and Effectiveness of Foreign Aid," National Bureau of Economic Research Working Paper 5308, October 1995; Doug Bandow, "A New Aid Policy for a New World," Cato Institute Policy Analysis no. 226, May 15, 1995; Perpetuating Poverty: The World Bank, the IMF, and the Developing World, ed. Doug Bandow and Ian Vásquez (Washington: Cato Institute, 1994); Nicholas Eberstadt, Foreign Aid and American Purpose (Washington: American Enterprise Institute, 1988); Doug Bandow, ed., U.S. Aid to the Developing World: A Free Market Agenda (Washington: Heritage Foundation, 1985); Graham Hancock, Lords of Poverty: The Power, Prestige and Corruption of the International Aid Business (New York: Atlantic Monthly Press, 1989); and Bruce Rich, Mortgaging the Earth: The World Bank, Environmental Impoverishment, and the Crisis of Development (Boston: Beacon, 1994).

[2]. See, for example, U.S. Agency for International Development, Development and the National Interest: U.S. Economic Assistance into the 21st Century (Washington: U.S. Agency for International Development, 1989).

[3]. James Fox, "The Venture Capital Mirage: An Assessment of USAID Experience with Equity Investment," Center for Development Information and Evaluation, U.S. Agency for International Development, Washington, April 1995, p. 1.

[4]. Ibid., p. 8.

[5]. Andrea Gabor, The US Enterprise Funds for Central and Eastern Europe: Lessons from the First Five Years (New York: Institute for EastWest Studies, 1995), p. 14.

[6]. Quoted in "Uncle Sam, Venture Capitalist," Editorial, Wall Street Journal, April 12, 1995, p. A14.

[7]. Fox, p. 1.

[8]. From an interview with the author, November 1995. The executive asked to remain anonymous since he wished to keep his job. Quoted in Doug Bandow, "Uncle Sam, the World's Worst Fund Manager," Wall Street Journal, June 4, 1996,

p. A18.

[9]. General Accounting Office, "Enterprise Funds: Evolving Models for Private Sector Development in Central and Eastern Europe," Draft report (undated photocopy), p. 99. This draft report differs from the final report cited hereafter.

[10]. Gabor, p. 11.

[11]. Quoted in David Ottaway, "At U.S.-Sponsored Enterprise Funds, a Question of Authority," Washington Post, February 14, 1996, p. A19.

[12]. Neal Nathanson et al., "Program Evaluation of the Central and Eastern Europe Enterprise Funds," Development Alternatives, Inc., Bethesda, Md., April 1995, p. x.

[13]. Gabor, p. 47. Emphasis in original.

[14]. Joseph Fichera and Robert Rubin, "Uncle Sam, Venture Capitalist," Wall Street Journal, May 2, 1996, p. A14. Note that Rubin is not secretary of the treasury.

[15]. Central Asian-American Enterprise Fund, "Central Asian-American Enterprise Fund," New York, undated, p. 5.

[16]. Quoted in Steven Greenhouse, "An American Tempest at Fund Created for Russia," New York Times, August 8, 1995,

p. D4.

[17]. General Accounting Office, "Enterprise Funds: Evolving Models for Private Sector Development in Central and Eastern Europe," GAO/NSIAD-94-77, March 1994, p. 4.

[18]. Polish-American Enterprise Fund, "Polish-American Enterprise Fund 1994 Annual Report," New York, November 1994,

p. 5.

[19]. Price Waterhouse, "Evaluation of the Africa Growth Fund," U.S. Agency for International Development, AFR/MDI, March 31, 1993, p. xiii.

[20]. Ibid., p. ii.

[21]. Quoted in Fichera and Rubin.

[22]. Central Asian-American Enterprise Fund, "Questions and Answers Relating to the Fund and Its Activities," New York, undated, p. 2.

[23]. General Accounting Office, "Enterprise Funds," March 1994, p. 52.

[24]. Nathanson, pp. 3-4.

[25]. Regional Inspector General for Audit (Bonn), "Audit of the Economy and Efficiency of Four Central and Eastern Europe Enterprise Funds," Audit report no. 8-180-95-015, Inspector General, U.S. Agency for International Development, August 25, 1995, p. 4.

[26]. Ibid.

[27]. Ibid., p. 8.

[28]. Nathanson, pp. 17, 34.

[29]. Gabor, pp. 10, 21.

[30]. General Accounting Office, "Enterprise Funds," March 1994, p. 52.

[31]. Ibid.

[32]. Interview with the author. The official asked to remain anonymous since he wished to preserve his job with U.S. AID.

[33]. Nathanson, p. x.

[34]. Regional Inspector General for Audit (Bonn), p. 8.

[35]. Nathanson, p. x.

[36]. Ibid., p. 6.

[37]. Price Waterhouse, p. 34.

[38]. Regional Inspector General for Audit (Bonn), p. iii.

[39]. General Accounting Office, "Enterprise Funds," Draft report, p. 8.

[40]. See, for example, Fichera and Rubin; Ottaway; and Leslie Eaton, "Public Money Foots the Bills for 'Privatized' Foreign Aid," New York Times, February 7, 1996, p. A10.

[41]. For a discussion of the Bulgarian fund's failings, see Greg Rushford, "AID's Boondoggle in Bulgaria," Wall Street Journal Europe, January 5-6, 1996; and "Bleeding Money: The Troubled Bulgarian-American Enterprise Fund," Rushford Report, January 1996, pp. 1, 3, 7, 10.

[42]. "More Troubles for the Bulgarian-American Enterprise Fund," Rushford Report, March 1996, p. 9.

[43]. General Accounting Office, "Enterprise Funds," March 1994, p. 31.

[44]. Fox, p. 13.

[45]. General Accounting Office, "Enterprise Funds," March 1994, p. 5.

[46]. Nathanson, p. ix.

[47]. Ibid., p. 6.

[48]. Ibid., pp. ix, 5.

[49]. Price Waterhouse, p. iv.

[50]. Regional Inspector General for Audit (Bonn), p. 13.

[51]. Nathanson, p. 21.

[52]. Gabor, pp. 20-21.

[53]. Price Waterhouse, p. xiv.

[54]. Regional Inspector General for Audit (Bonn), Appendix VII, p. 3.

[55]. General Accounting Office, "Enterprise Funds," March 1994, p. 34.

[56]. Price Waterhouse, p. 15.

[57]. Regional Inspector General for Audit (Bonn), Appendix VII, p. 2.

[58]. Regional Inspector General for Audit (Bonn), p. iii.

[59]. Price Waterhouse, p. ix.

[60]. Nathanson, p. 13.

[61]. Price Waterhouse, p. 30.

[62]. Cited in Eaton, p. A10.

[63]. Nathanson, p. 9.

[64]. Quoted in Eaton, p. A10.

[65]. Nathanson, p. ix.

[66]. Price Waterhouse, p. 37.

[67]. Nathanson, p. 7.

[68]. Ibid., p. 10.

[69]. Fox, p. 20.

[70]. General Accounting Office, "Enterprise Funds," March 1004, p. 52.

[71]. Quoted in Nathanson, p. 18.

[72]. Nathanson, pp. vi, 17.

[73]. Ibid., p. 39.

[74]. The fund itself claims that it was created "because the national interest of the U.S. is served specifically by the establishment of strong democracies in" the Czech and Slovak Republics. Czech and Slovak American Enterprise Fund, "Czech and Slovak American Enterprise Fund: 1993 Annual Report," Washington, p. 7. However, it is not obvious how the funds intended to intervene in the Czech Republic's successful creation of a multiparty democracy and in Slovakia's struggle with authoritarianism.

[75]. See, for example, General Accounting Office, "Poland: Economic Restructuring and Donor Assistance," GAO/NSIAD-95-150, August 1995, pp. 38-40.

[76]. See, for example, Doug Bandow, The Politics of Envy: Statism as Theology (New Brunswick, N.J.: Transaction Publishers, 1994), pp. 167-73; and Doug Bandow, "The IMF: A Record of Addiction and Failure," in Perpetuating Poverty, pp. 15-36.

[77]. Quoted in Nathanson, p. B-25.

[78]. Ibid., p. 33.

[79]. Quoted in ibid., p. B-19.

[80]. Bulgarian American Enterprise Fund, "Bulgarian American Enterprise Fund: 1994 Annual Report," Chicago, p. 6.

[81]. Nathanson, p. B-24.

[82]. Ibid., p. 33.

[83]. Quoted in Ernest Beck, "Bulgaria Is Jockeying to Head Off a Crisis," Wall Street Journal Europe, May 3-4, 1996.

[84]. Nathanson, p. 16.

[85]. Ibid., p. 34.

[86]. Ibid., pp. v-vi.

[87]. Ibid., p. viii.

[88]. Ibid., p. 26.

[89]. Gabor, p. 51.

[90]. Letter reprinted in Nathanson, p. B-26.

[91]. Fox, p. 19.

[92]. Ibid., p. 19.

[93]. Nathanson, p. 39.

[94]. Overseas Private Investment Corporation, "An Innovative Approach to A Global Market: Annual Report 1994," Washington, p. 6.

1996 The Cato Institute
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