By Raymond King
A leading authority on emerging and capital markets, Dr. Glenn Yago serves as founder and senior fellow of the Milken Institute’s Financial Innovation Lab. His groundbreaking research stems from the use of innovative financial instruments to find solutions to long-standing economic, social, and environmental development challenges.
At the Milken Innovation Center, which is housed at the Jerusalem Institute for Israel Studies, Yago has been working to accelerate Israel’s economic growth through financial technology that increases the impact of government policy, philanthropy, and private-sector investment. Through his work in the Milken Institute’s series of Financial Innovation Labs, he’s also made breakthrough financial policies and programs to solve diverse problems such as affordable housing, small-business financing, water infrastructure, and health care.
In Spring 2016, Yago taught a course for the Master’s in Development Practice Program at UC Berkeley, where he also served as a Practitioner in Residence with the Blum Center’s Development Impact Lab and Big Ideas@Berkeley programs.
There is often debate between the impact of private investment vs. public investment in curbing climate change. How has your experience either domestically or abroad formed your opinions on this?
First of all, the boundaries between private and public investment are very much blurred in the 21st century. The major difference when talking about developing economies is if you look at public spending in terms of multilateral and bilateral assistance, relative to capital flows through private channels, there is an enormous difference. Public flows of overseas development assistance have flattened and declined over time in comparison to massive growth in capital flows abroad. We have to come up with instruments that blend together public and private investments.
Thus, in building capital structures for projects that are key to economic development, it is very important to have public participation in terms of government spending, grants, and investments that guarantees reserve funds but at the same time pulls in and attracts private capital. Because the size of the problems is so much greater than government budgets alone can address.
Some of your work in California is based on its current drought problem. How can your experiences in other regions of the world impact your assessment of our situation here?
Water scarcity has been a huge problem in the development of the state of Israel. Many of the major projects there range from drip irrigation, precision irrigation, and new seed technologies. It was very important for Israel to come up with a food industry that was technology based, technology intense, and low-water. Last summer, Israel had its 14th year of drought, and the lowest rainfall in 150 years. However, the problems associated with drought came to the forefront ten years ago there was a major national commission to just break down the natural water cycle to its constituent parts and develop technologies that lower water consumption. That is, rain capture, aquifer regeneration, and mediation to recycling and desalination. Now, Israel’s per capita consumption of water is less than a third of what it is in California. The country, now with 5 desalinization plants built and 85 percent of water recycled once or more than once, you’re producing 20 percent more water than is consumed domestically and this excess is exported to the neighboring countries like the Palestinian Authority and Jordan. The ability to turn this situation around is a function of public awareness of water conservation and through technological development.
Introducing high technology has been of great importance in this regard. The first major breakthrough of agriculture was watering plants, not soil. The second stage was having sensors on plants that tell the irrigation equipment when to water based on the water cycle of the plant. So if you’re looking at California, where 80 percent of the water is used for agriculture, they are still flooding fields like they did thousands of years ago. The ability to shift existing infrastructure to allow for the penetration of new technologies to grow produce like corn and rice is much more key to curbing the drought problem.
Israel has grown into its role in the global economy as a “start-up nation.” However, many start-ups have taken early exits and sold their ventures in the start-up stage rather than grow it into medium sized companies. What would you say is generally causing this and is it a problem or simply a process?
Israel has increasingly become a laboratory for start-ups. A key export of Israel has in fact been start-ups. We’re not only exporting technologies, we’re exporting early R&D stage companies to places like San Francisco and London, and other cities around the world. In a sense, we’re selling the capabilities to develop technologies. A lot of my students are in San Francisco and Silicon Valley going through rounds of funding and trying to make their way in the global capital market. However, the disadvantage of this is that we want these companies to develop their infrastructure in Israel. The major market failure of Israel’s model is the failure of capital markets to fund stages of growth past the start-up stage. We’ve specialized in this area and one of the things we’re struggling with right now is how to build up capital market micro-structures, the basic structures of the capital market. There was an agreement signed recently with NASDAQ to try to retain these early stage companies, provide them with a runway to develop in Israel and retain some of the employment there. The problem here lies in finding the value of these companies past the early R&D stage of company development.
In fact, $30 billion of the stock market capitalization of Israeli companies isn’t actually listed in the Tel-Aviv Stock Exchange. They’re listed and traded abroad. One of the ideas that stems from this is that Israel is very much a creditor nation, not a debtor nation, so it has the ability to use this disparity to invest. What this means is that Israel can develop many co-innovation projects with other nations, as it is a very small country itself, and needs to have global partnerships in order to reach scale. Some of the discoveries or innovations aren’t relevant to a small, dry country so having partnerships to co-innovate in Asia, Latin America, Africa, or in California are important for moving from early stage to further down the pipeline.
These past four weeks you’ve been teaching a course titled “Innovative Finance for Sustainable Development” as part of the Master of Development Practice program. What would your students say is the the most impactful financial innovation in recent times?
The “Aha!” moment for a lot of students, I believe, was understanding how important it was to go through the process of price discovery in terms of new asset classes such as environmental asset classes. So if you’re interested in financing new technologies that will meet the climate change goals that were defined in Paris a few months ago, you have to have new clean technologies in the field commercialized and operating. Now to get there, you have to have the data science and financial technology that comes together to monitor those things, to prove environmental impacts. If you look at the history of finance, in the 19th century we were very good at understanding what rates of return were in investment. In the 20th century there was an increasing concern over estimating and quantifying the risk of achieving these returns and mitigating these risks, in essence, bridging the knowledge gap between entrepreneurs and investors and between savings and investment.
Today, our concerns are not only with returns and mitigating risk, but with proving impact. That’s because private equity and venture capital firms are very good at being able to prove entrepreneurial risk and business failure. Financial systems, on the other hand, are terrible at measuring and proving the environmental risks and social risks that are associated with sustainability. Meeting the challenges of food security, water security, energy security, and health security, all of which are key drivers of growth, is crucial to develop sustainable infrastructures for the future. So we need to come up with capital structures that align the interests of governments and the private sector so that there is sufficient capital flowing to grow these solution sets.
Your most recent book was Fixing the Housing Market in 2012. How much do you think these past four years have seen innovations to make housing more affordable?
I think some of the ideas I discussed in Fixing the Housing Market have become more popularized. If you look at the city of Detroit, which was decimated by the economic collapse that occurred there, projects have begun, such as land trusts, that have non-profit organizations or the government take ownership of land and then use that to finance the cost of housing. As land costs appreciate due to the rehabilitation of this land, the gains of the appreciation go back into the trust, which is then able to go back into housing, creating a virtuous financing circle between savings, investments, and assets.
The second big idea is shared equity models. In the past, the hugely complex and non-transparent mortgage products that proliferated during the housing bubble really didn’t align interests between house ownership. It just brought a lot of people into the market. Coming up with ways to not have to finance 100 percent of home ownership — to lower equity requirements from 20 percent to 10 percent and bring in a financial partner, for instance, be it a non-profit or government partner — was a key innovation in the US, UK, Spain, and other countries. The idea is to create ways to finance bank owned homes, and coming up with new instruments that are more affordable and that align the interests of the homeowner and the government sponsored enterprises such as banks. Really, coming up with healthier financial products.
The third innovation that I think is remarkable is lowering maintenance cost of homes by creating ways to finance energy innovation. In California, you have the property assessed clean energy bonds (PACE financing) that put solar on roofs and lower the costs of maintaining homes. President Obama actually just expanded the project to 38 states based on the California model. This is definitely another area of future innovation and growth both in the US and abroad.
What financial system would you characterize as a growing or major problem in the developing world that will garner increased focus by institutions such as the Blum Center and others of it’s like trying to solve problems to do with poverty?
A financial instrument that is definitely gaining recognition as a tool to solve poverty related issues and as a barrier to growth I would say is remittance payments. These are a transfer of money by a foreign worker for example, working abroad in the United States, back to their home country or home town. The Inter-American Development Bank, World Bank, and other similar institutions have started looking into that because it is so important to have investment products to people who are remitting funds back home to hometown associations to friends and family.
The reasons for this is to securely make sure that it’s going into the functions of income support they are providing to family members. So for example, if somebody is paying for school tuition for their child in their home country, it may be better, or at least a more secure cash transfer, to send it directly to the school and ensure for people working abroad that their hard earned wages are going to good use. Or, as another example, for their money to be spent investing in housing and infrastructure for family and community members. This can provide them with a better return and their payments and also lower the cost of the transfers.
Obviously with mobile apps targeting these audiences coming online, the increased competition pushes the market to implement the lowest fees but also innovations such as creating individual savings accounts, child development accounts, other types of savings instruments. It has tremendous potential to fuel investment in those hometown communities. Increasingly, there is emerging an emphasis that there should be a return for the individual sending it.
Additionally, if you just think about the way that savings associations grew in the 18th and 19th century, building societies that became different kinds of construction funds for housing; all of those are examples of how financial systems grow. Perhaps having remittances be part of these financial systems in the developing world, we can move past simply sending cash payments to a foreign worker’s home country into a system where they are in fact investing in their hometown community.