Memorandum submitted by Lincoln University
1. The Contribution of Private Sector Development
to Economic Growth
1.1 It is axiomatic that poverty is a function
of a lack of economic opportunity and that the private sector
creates the wealth that makes nations wealthy. The growth and
dynamism of the private sector therefore is both essential to
and the primary means of poverty reduction.
1.2 And yet private sector development can lead
to both greater overall wealth and increasing differences in income
and prosperity within a country, particularly when property rights
and institutional arrangements exclude parts of society.
1.3 The challenge of private sector development,
as a result, is to find ways and means that are 'pro-poor' and
that increase the competitiveness of businesses and the economy.
For donors, there is a need to deploy mechanisms that can achieve
these two objectives.
1.4 So, what do we know about the private sector
and its contribution to and role in economic development and poverty
reduction?
1.3 Firstly, micro, small and medium enterprises
dominate both developing and developed economies. Typically, they
create most of the wealth and most jobs.
Micro, small and medium businesses are key to private sector
development.
1.4 Most studies find a clear and strong correlation
between levels of business start-up and local or regional prosperity.
Prosperous areas have high levels of business start-up, and poorer
areas have lower levels.
1.5 Start-ups and new businesses create most
or a significant proportion of new jobs, but are most vulnerable
to closure, exit and failure. Crucial as they are to addressing
unemployment or under-employment, these jobs are vulnerable, at
least in the early years of new firm establishment.
Start-ups create new economic opportunity and future growth.
1.6 Rates of survival of new firms can vary significantly,
and the 'net' start rate is likely to be as important an indicator
of economic growth as the overall, or 'gross', start rate. When
the survival rate is low or unstable, this can lead to net reductions
in economic activity.
Survival of new firms is key to the overall effects of private
sector development on the economy.
1.7 Only a small number of firms grow and generate
most growth over any period. Growth amongst small firms, as a
result, is limited to a small minority of all businesses. However,
growth is interrupted and periodic. Businesses cannot sustain
growth, and so their development is interspersed with periods
of retrenchment, stabilisation and reconsolidation.
We cannot 'pick winners' over anything but the short-term.
1.8 Many developing countries have unbalanced
business structures. A typical structure for a developing economy,
such as those in South Asia and Sub-Saharan Africa would be broadly
as follows: (i) large self-employed population, both formal and
informal; (ii) relatively small number of internationally competitive,
i.e. growing and exporting, small firms; (iii) a 'missing middle',
i.e. few medium-sized competitive indigenous businesses; (iv)
an 'unbalanced' large company structure, typically made up of
companies, often operating as loose or complex conglomerates,
close to and often influenced by government; and (v) dependence
on multi-national companies with headquarters and decision-making
control elsewhere.
1.9 Many transition economies have an under-developed
or relatively immature private sector, typically with the following
characteristics: (i) few nationally and internationally competitive
large privately-owned businesses; (ii) over-reliance on large
companies in basic extractive and processing industries, and other
commodity-type industries; (iii) predominance of private businesses
in lower rather than higher value-added ventures; (iv) high levels
of churn and closure of new and small businesses; (v) a need for
greater clarity about and protection of property rights to create
incentives for people to start and develop viable and profitable
businesses.
The business structures in many emerging and
transition economies display structural problems that require
consideration and are likely to need addressing as one aspect
of a private sector development strategy.
1.10 There are many reasons why private sector
development may be constrained or may be occurring in (spite of)
adverse conditions. Start-up, survival and growth in new and small
businesses is undermined particularly by: (i) macro-economic uncertainty
and turbulence; (ii) institutional weaknesses in market exchange
mechanisms, for example contract law and legislation, insurance,
band credit regimes; (iii) weaknesses in market mechanisms; (iv)
resource 'constraints' and shortages that limit access to finance,
employable people, and other inputs necessary for business growth
and survival; (v) lack of or need to enhance entrepreneurial and
managerial know-how and capability needed to establish and develop
a business.
1.11 Development of a thriving large company
sector is undermined by: (i) ambiguous or weak governance mechanisms
and structures, particularly for enterprises that controlled and
owned by government; (ii) under-developed financial markets and
systems that constrain access to expansion funding; (iii) under-developed
local R&D and IPR production capability that restrict the
scope for innovation and technology development.
There are multiple constraints that can prevent
or slow the development of the private sector. These constraints
are likely to need addressing as one aspect of a private sector
development strategy.
1.12 In conclusion, the private sector is the
wealth creator that offers an endogenous route to economic development
and emergence out of lower income status for nations.
1.13 However, developing a thriving private sector
represents a major challenge in any developing and transition
economy, and there are many examples where this challenge has
not been resolved or worked through in ways that create a conducive
environment for private sector development.
2. Private Sector Development and Poverty
Alleviation and Reduction
2.1 Section 1 argues that the private sector
is the key to economic development and growth that in turn reduces
poverty in lower income countries. Private sector development
is therefore integral to, and indeed should be placed at the heart
of, international development efforts to address poverty.
2.2 The private sector represents a viable form
of development, in that viable profitable businesses are sustainable
through the profits they generate. And entrepreneurs, who create
and renew the private sector, establish and develop their own
businesses, so providing a source of future wealth creation in
an economy. The impacts of creating, ensuring the survival of
and working with or through private businesses will therefore
be sustainable beyond donor intervention.
Private sector development has the potential to generate
genuinely sustainable economic impacts beyond the period and scale
of donor involvement.
2.3 Indirect benefits are as likely to be important
in poverty reduction as direct impacts. Indirect benefits, such
as the expansion of services, and service-based industries, in
response to increasing demand from growing firms and their employees,
can have major beneficial effects for disadvantaged groups that
have little access to or are precluded from 'mainstream' economic
opportunities. This can be through employment in firms servicing
these needs or by starting a new business in response to new opportunities.
Such opportunities are likely to require proactive stimulation
and intervention to be exploited.
The indirect effects of private sector development are generally
overlooked, and may represent a powerful means of engaging with
disadvantaged groups and poorer communities.
2.4 'Trickle down' effects from private sector
development are likely to affect more advantaged groups initially,
in that they will be more disposed and better resourced to exploit
them. Where trickle down effects have a substantial impact on
poorer people, it is likely that this will be because of local
effects, such as inward investment into a poor area.
'Trickle down' is most likely to produce 'pro poor' outcomes
when it occurs at local levels, and in economically disadvantaged
areas.
3. Private Sector Development as a Mechanism
for International Development
3.1 The private sector operates in different
ways to more established local channels of donor engagement, specifically
the public sector and NGOs. In particular, the following principles
are likely to inform approaches to and parameters for private
sector development:
(i) Profit maximisation and the commercial priorities
of firms create agendas and interests within the firm and through
its transactional networks that need to be recognised;
(ii) The private sector works through established
market mechanisms and so will affect social aspects of development
indirectly, although potentially in important ways;
(iii) Direct impacts on poverty are likely to
stem from new employment opportunities, which may be constrained
for individuals that are not employable, thus pointing to the
need for 'supply-side' skills and knowledge development amongst
poorer and disadvantaged groups experiencing personal disadvantage
that reduces their employability;
(iv) The procurement practices of firms can provide
new economic activities for poorer people, but only if productive
capacity exists or can be developed within these groups.
3.2 This suggests that although the private sector
can be a useful mechanism for addressing poverty two conditions
mean that it is appropriate only in particular and clearly defined
circumstances:
(i) Private sector interests need to align or
coincide with international donor and national development objectives
and ethos;
(ii) Private sector solutions designed to alleviate
poverty are mainly (but not exclusively) market-based and-driven.
'Pro poor' private sector development needs
to be 'pro private sector' as well.
3.3 Private sector development therefore requires
careful consideration of the likely (and unexpected) effects on
poverty and on disadvantaged people and communities when used
to pursue poverty reduction objectives.
4. Strategies for PSD: Commentary on the Press
Notice
4.1 The Inquiry Press Notice identifies four
broad dimensions to private sector development:
(1) Creating an effective institutional framework
for market exchange;
(2) Developing a conducive policy and regulatory
regime and framework;
(3) Funding the private sector and its development,
where there are market failures and barriers to access to finance;
(4) 'Making markets work for poor people': by
developing proactive means of gaining access to markets and market
opportunities.
4.2 This is not, however, a complete picture
of private sector development requirements and scope. What appears
to be missing is:
(1) Enhancing the competitiveness and capability
of private enterprises through 'soft' inputs. i.e. BDS, training
and related 'knowledge-based' inputs;
(2) Creating an institutional framework that
stimulates and works with the private sectors, and especially
MSMEs, to enhance their performance and impact on pro-poor
growth;
(3) Using enterprise and entrepreneurship as
a means of enabling poor people to develop their own mechanisms
and means to escape poverty;
(4) Developing the 'supply-side' by producing
more skilled and more enterprising labour, that helps to address
cycles of deprivation and disadvantage;
(5) Mobilisation of assets and resources through
social means, such as community mobilisation to invest in wealth
creation through the private sector;
(6) Diffusion of appropriate technologies to
make the private sector more competitive.
Effective private sector development is focused,
pro-private sector as well as pro-poor and consists of multiple
mutually reinforcing activities.
February 2006
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