House of Commons - International Development

Select Committee on International Development Memoranda

Memorandum submitted by the Department for International Development (DFID)

EXECUTIVE SUMMARY

The private sector contributes to economic growth through providing jobs and incomes, and products and services. Through these outputs the private sector provides opportunities to enhance the participation of poor people in improving their economic and social well-being. Governments and donors, working alongside civil society and the private sector, have important roles to play in reducing constraints that prevent the development of the private sector.

In December 2005, DFID published a booklet on "Working with the private sector to eliminate poverty"[193], which illustrates in more detail the many ways in which DFID is active in private sector development. This booklet is an important complement to this Memorandum, as it provides a fuller picture of the range of DFID activities involving the private sector.

This Memorandum looks more briefly at key areas of private sector development (PSD) which the UK Government see as important for improving the development climate facing PSD and growth in developing countries. These areas include: the investment climate, the financial sector, agriculture, infrastructure, trade, and making markets work better for the poor. Examples of DFID activities are provided in each section.

The Memorandum also notes the private sector's own engagement in development activities across sectors such as health, education, utilities and finance. The private sector is also involved in development issues that cut across many sectors such as corruption, HIV and AIDS, environment, and international standards. The information provided in this section is additional to that in the DFID booklet.

In the last 5 years, donor agencies such as DFID have searched out new aid instruments that can contribute to private sector development, and that can be relevant in difficult environments, such as "fragile states". Donors have also become much more interested in achieving coherence of approaches, and lesson learning, internationally. The Memorandum concludes with points on future priorities for DFID.

INTRODUCTION

1. At its broadest level, development is about achieving economic growth and

poverty reduction. Economic growth offers the best prospect for escaping poverty, and poor people want jobs or self-employment to enable them to have a better life and with less vulnerability to shocks.

2. Nine out of ten jobs in developing countries are in the private sector. Poor people are the private sector, whether farmers in agriculture, microentrepreneurs in informal markets, or employees in small businesses. Yet amongst some in the development community, and in some governments, there is a mistrust of the private sector. And there can be hostility to the integration of business to business regional and international trade. This is not in the interests of poor people.

3. The UK Government recognises the vital role of private sector development (PSD), and the part that governments, the private sector, and civil society can play in ensuring that the private sector contributes to economic growth, job creation, incomes, and the provision of goods and services. This Memorandum addresses the issues raised by the terms of reference for the IDC Inquiry into PSD, and has been produced by DFID, with contributions from the Treasury, DTI, DfES, and DWP.

4. This note is organised as follows. Section A briefly looks as the links between growth and private sector development. Section B outlines the main policy issues around key elements of private sector development: the investment climate, the financial sector, agriculture, infrastructure, trade and markets. Section C looks at how the private sector is engaging in development itself, and Section D looks at aid instruments that can be used by donors to encourage PSD. Section E looks at coherence of PSD activities between and within donors.

A GROWTH & THE PRIVATE SECTOR

What can the private sector do to reduce poverty?

5. The term 'private sector' often conjures up the image of large businesses engaged in commerce or manufacturing. This definition is too narrow. Instead, the term should be understood to encompass all private actors - individuals, partnerships, co-operatives and businesses - engaged in risk taking to earn profits and incomes. As such, it includes the smallholder farmer as well as the very large, multinational corporation.

6. The private sector has two roles to play in reducing poverty through "pro-poor growth". The first is to contribute to economic growth, which is usually a prior requirement for sustained poverty reduction. Growth requires productive investment, a well-functioning financial sector, entrepreneurship, and a vibrant private sector. The second role is to facilitate poor people's participation in growth. The private sector provides the vast majority of jobs, creating opportunities for people to apply their talents and improve their incomes. But these opportunities are not equally spread. Decisions in the private sector determine whether, for example, these opportunities are open to women, and whether different ethnic groups are treated equally.

7. "Pro-poor" growth is defined with reference to how fast on average the incomes of the poor are rising. The private sector can contribute to pro-poor growth through the development of opportunities and industries which employ poor people[194].

What are the constraints on the private sector in developing countries and how can they be addressed?

8. Private enterprises face numerous constraints in developing countries. These are often the result of either inaction or misguided action by the state. For example, governments may not allow markets to develop, introduce burdensome regulations, or fail to build support for necessary reforms. Enterprises may also be negatively affected by political or macroeconomic instability, weak property rights, poor infrastructure, an underdeveloped financial sector, or corruption.

9. Tackling these constraints requires a concerted effort on the part of governments and development partners such as civil society and international donors. Maximising the contribution of the private sector to growth and poverty reduction usually requires action in the following five areas (OECD 2005[195]):

providing incentives for entrepreneurship and investment;
increasing productivity via competition and innovation;
harnessing international economic linkages;
improving market access and functioning; and
reducing risk and vulnerability.

10. Other sources classify influences on growth and PSD as occurring at 3-4 different levels, typically "macro", "meso", and "micro" levels[196]. "Macro" level issues include political stability, sound macro-economic management, good governance conditions, and an enabling investment climate. "Meso" levels refer to the availability of underpinning resources for growth and PSD, including a functioning financial sector, good infrastructure, education and health systems, and a functioning labour market. "Micro" levels refer to government and donor interventions to support PSD, with more recent recognition that this should be done in a non-distortionary manner.

B CHANGING THE DEVELOPMENT CLIMATE TOWARDS PROMOTING PSD & GROWTH

Improving the Investment Climate

11. A good investment climate benefits everybody - firms of all sizes (both domestic and foreign), employees, consumers and users of infrastructure, finance and property (World Development Report 2005 (WDR 2005)). This is why DFID places such priority on working with developing country governments, the private sector, civil society, and other donors to support investment climate reforms - getting the conditions right for PSD. The bulk of investment in developing countries - some 80% - is domestic investment, and hence the importance of an investment environment that is good for local large, medium, small and micro businesses.

12. The WDR2005 is an up-to-date analysis of the importance of a good investment climate for growth and poverty reduction, of what constitutes a good investment climate, and of how developing country governments in partnership with donors and the private sector can build good investment climates. DFID worked closely with the World Bank Team during preparation of the WDR2005 - contributing case studies, running workshops with the World Bank and providing funding for global dissemination of the WDR key messages.

13. DFID is working to improve the investment climate in developing countries for domestic and foreign businesses, and to facilitate private sector development and entrepreneurship more generally. Much of our work is designed to respond to the major constraints that businesses face in such countries. Whilst our country-level responses are informed by best international practice, each programme is carefully designed to fit local circumstances: no 'one size fits all'.

14. DFID is seen as a leading donor on investment climate reform. We work at both the country and international levels, and our Investment Climate programmes span a wide range of interventions, covering all of the WDR 'basics' and beyond. Often, we work with other donors and, where the work does not engage directly with the private sector, it is nevertheless informed by the results of business surveys/consultations - such as the World Bank's in-depth country Investment Climate Assessments (ICAs) or the Commonwealth's Business Environment Surveys (BES), both of which DFID supports.

15. The private sector is playing an increasingly significant role in helping governments reform their investment climates. Civil society too can play a positive role on investment climate reform - such as in advocacy for the adoption of competition regimes that benefit consumers and the poor. On the policy side, the private sector provides much of the 'raw data' for serious surveys like the World Bank ICAs, and engages in constructive dialogue with governments to help prioritise reforms that will overcome the key impediments to investment and PSD.

16. Investment climate reform has significant impact. For example, on the regulatory side:

DFID support for the Kenya deregulation programme led to annual savings to the economy of £64 million and reduced business transaction costs by up to 70% in 32 local authorities;
The Uganda Streamlined Business Registration pilot project in Entebbe resulted in 75% lower business compliance costs, reduction of business registration time from 2 days to 30 minutes, a quadrupling of business registrations, and 40% higher revenue collection for that municipality;
In Ukraine, simplification of procedures reduced business registration time in a regional pilot programme by 50%, increased the numbers of businesses by 250%, and increased revenue for the local government significantly;
In Mozambique, customs reform led to substantial increases in government revenues - from 49% (approx US$ 45 million) in year one to 175% three years later. Clearance of goods after the reforms was up to 40 times faster than the pre-reform rate.

Mobilizing the Financial sector

17. The financial sector stimulates investment, underpins private sector development, promotes technological progress, and increases productivity and growth. Access to finance is a crucial component of PSD for firms of all sizes, including potential microentrepreneurs looking for new livelihood opportunities. Yet, in African countries more than 90 percent of the population is financially excluded.

18. In many countries, semi-formal channels such as microfinance institutions (MFIs), play a role in providing financial services to the poor. But MFIs generally cannot mobilise funds on a large scale in the way that more traditional financial institutions can, and they have only limited coverage. As a result, they are reaching only a minority of the bankable population. A widening of financial services provision by commercial banks is necessary to tackle this problem on an adequate scale.

19. Banks are a principal source of domestic investment, providing credit to small and medium enterprises. Their previous reluctance to lend to small enterprises in developing countries is now changing, and some international and developing country banks are moving into microfinance - for example, Equity Bank in Kenya, which has received assistance from DFID, now serves half a million people.

20. Private sector investment vehicles such as the CDC Group plc have helped to boost private sector investment in developing countries. As a private equity fund-of-funds, CDC invests its capital in enterprises - serving as a pioneer, entering difficult emerging markets where private capital is reluctant to invest, providing enterprises with much-needed access to capital, improving their management and, over a period of years, putting them onto a sound economic footing. DFID has supported other investment initiatives such as AfriCap, which provides funding for investment in microfinance intermediaries.

21. DFID and other donors are helping in many ways, including:

Establishing country-level programmes to help improve the policy, legal, institutional and regulatory framework for financial sector development. (DFID has 'umbrella' financial sector programmes in a number of African and Asian countries, in some cases managed jointly with the World Bank and other donors);

stimulating innovation/use of technology that results in improved access to financial services for poor people. The proposed Africa Enterprise Challenge Fund, endorsed by the Commission for Africa, would provide a significant stimulus to innovation.

supporting the collection of financial access indicators and data, in order to incentivise and benchmark policy reform. (DFID is working in partnership with the World Bank to agree headline indicators on financial access);

encouraging improved mechanisms for diaspora to send money back to their home countries, and also to invest there. (DFID has initiated remittance country programmes to help do this, including the Bangladesh remittance country partnership launched by the Secretary of State in 2005).

Raising Agricultural productivity through PSD

22. In most developing countries, farming and other agri-businesses are small in scale and are vulnerable to a variety of risks and investment policy conditions, yet collectively they account for the biggest share of private sector activity. Some 70% of poor people are engaged in agriculture globally, as entrepreneurs and employees. The sector is often highly political, manipulated by vested interests. Dismantling of large parastatals in many countries has left a void presently unfilled by the private sector. Productivity is hampered by poor policy and legal and regulatory systems (including over-protective legislation, insecure tenure, unpredictable and ad-hoc state interventions like input subsidies and export bans).

23. Domestic and regional markets for agricultural produce have untapped potential. And better private sector development in agricultural and agri-dependent enterprises has significant potential to alleviate poverty. So, donors help national governments improve the climate for agriculture by helping them to create improved policy frameworks, regulatory environments and associated spending plans (especially on basic rural infrastructure and agricultural research). Such improvements are made in dialogue with the private sector and other organisations that represent the voice of those engaged in agriculture.

24. DFID is supporting countries:

to reform agricultural regulations (e.g. in India),
to address agricultural product standards (e.g. in Ethiopia),
to build agricultural markets by improving poor people's access to agricultural market information (e.g. in Bangladesh), agricultural inputs (e.g. advice and distribution networks in Malawi), and storage facilities (e.g. Kenya)
to disseminate productivity-enhancing technologies held by the private sector under intellectual property rights (e.g. through PPPs brokered by the African Agricultural Technology Foundation in Kenya).

25. DFID published its new Agricultural Strategy Paper in December 2005[197]. This emphasises the need to increase agricultural productivity, particularly for labour-intensive, small-scale agriculture with its strong links to growth in other areas.

Supporting land and other property rights

26. Property rights have a major role to play in supporting the interests of poor people within a proper legal framework. In Peru around 90% of businesses have no title to their property, making it difficult to borrow and invest. In Vietnam, rural households received increased rights when land was de-collectivised, making it worthwhile for them to invest in their land, raising production and growth.

27. DFID recognises and endorses the need for property rights, and contracts more widely defined, to be enforceable. For poor people the most important aspect of property rights is usually access to and security of tenure over land and living places. DFID provides support to develop or reform land, property and legal institutions to enable secure access to land. For example, in the case of Guyana, DFID has been the principal donor over a 7-8 year period supporting reform and change in the Guyana Lands and Survey Commission.

28. Internationally, DFID is providing support to the UN High Level Commission on Legal Empowerment of the Poor which will target significant issues on legal rights to property and other assets. The Commission aims to promote the extension of the rule of law to ensure that poor people have formal titles to land and property, as well as the right to use it.

Re-emphasising the importance of Infrastructure:

29. Reliable infrastructure is a key requirement for PSD. Since its peak in 1997, infrastructure investments have dropped by half and private investors still remain cautious with regard to emerging markets. Transport costs in Africa are twice that of Asia. The cost of moving a container between Accra and Lagos is three times the cost of moving it to Europe. The role for donors such as DFID is to help address these problems by encouraging governments to increase public investment in infrastructure, and to tackle the constraints to private sector participation, with a focus on underserved markets and sectors.

30. Where properly regulated, the provision of infrastructure by the private sector can lead to improvements in efficiency, innovation, and the expansion of affordable services to the poor. However the real issue for donors is not public versus private infrastructure provision, but too little infrastructure provision. Some developing countries do not identify infrastructure as a priority for poverty reduction, partly due to the bad experience of some privatisations in the 1990s and partly because the donor shift towards budget support for poverty reduction has limited the opportunities for expanding support to PSI.

31. Donors, individually and collectively, could do more to encourage the private sector to develop infrastructure, by: resisting the proliferation of new PSI facilities and scaling-up support to existing ones; increasing donor support to project development; increasing focus on the infrastructure priorities of poor people; increasing attention on the political economy of PSI; increasing assistance to address the specific needs of domestic small and medium scale service providers; and better evaluating the impact of PSI.

32. DFID supports several multi-donor facilities that help governments, where appropriate, to harness private sector investment and participation in infrastructure, including:

technical assistance to support policy reform, improve regulatory systems and develop local capacity (e.g. the Public Private Infrastructure Advisory Facility);
the development of projects suitable to attract private sector investors and partners (e.g. DevCo and InfraCo);
efforts to address credit and capital market failures including loans - both hard and local currency, and guarantees for high risk projects (e.g. the Emerging Africa Infrastructure Facility, and GuarantCo); and
performance-based subsidies to ensure commercially viable projects reach the poor (Global Partnership on Output-Based Aid).

33. In terms of leverage, DFID has spent about £ 100m over 6 years on these facilities, which has mobilised $ 1.5 billion of extra investment in poorer countries. DFID will do more to encourage private sector participation in infrastructure by scaling up support to existing facilities, especially in the area of project development where the intention is to treble our commitment over the next three years. DFID will also be doing more to help indigenous small and medium scale service providers through these existing facilities. These initiatives will increase employment opportunities and so have impact on poor people.

Improving the opportunities for PSD through International Trade

34. Trade reform results in increased trading activity by the private sector. In East Asia, for example, trade reform has been one of the key ingredients of rapid economic growth and poverty reduction during the past few decades. The 2004 DFID White Paper renewed the UK's commitment to support reductions in barriers to trade and to building the capacity of the private sector in developing countries to take advantage of the new trade opportunities.

35. The Doha World Trade Organisation Ministerial Declaration in 2001 committed WTO members to offer Trade Related Technical Assistance and Capacity Building (TRCB) to developing countries to benefit from opportunities generated by the multilateral trading system. TRCB assists recipient countries to:

- develop trade strategies and ICs which are conducive to their private sectors increasing exports;

- stimulate trade by domestic firms and encourage investment in trade-oriented industries; and

- participate in benefit from the institutions, negotiations and processes that shape national trade policy and the rules and practices of international commerce.

Since 1998 DFID has committed £181 million to TRCB.

36. As well as being a beneficiary, the private sector has the potential to contribute to trade policy reform. Private business can play an important advocacy role, assist in the policy design process by providing expertise and, through facilities like the Investment Climate Facility for Africa, can even help finance expensive reforms (such as trade facilitation or complex regulatory changes). Dialogue between the private sector and government is desirable at all stages.

37. In our technical assistance and capacity building work, DFID has been endeavouring to heighten private sector representation and participation. For example, in the context of our aid to enable trade facilitation, we are supporting meetings of the Boksburg Group of developing countries at which private firms and government officials discuss best options for multilateral reforms. Also, as follow-up to the Commission for Africa, the UK Government supported the creation of Business Action for improving Customs Administrations in Africa (BAFICA), a small informal business contact group on customs and trade facilitation reform.

38. In the context of our work with other donors around the Integrated Framework for trade assistance, DFID recognises that trade reform - while leading to large overall gains - also involves winners and losers. The UK Government has committed to provide £ 100m per year in aid for trade by 2010, whilst recognising that the Doha Development Round requires much more progress than achieved in Hong Kong.

Making markets work better for the poor (MMW)

39. The "making markets work" approach seeks to understand the impact of markets on poor people, and to advocate and promote systemic changes which will improve this impact. Markets affect poor people as consumers of goods, as producers and employees, and for selling and buying goods and services. Markets may fail the poor through market practices which deny or limit access to poor people. In "making markets work" terms, markets work well for the poor when they expand the choices accessible to poor people, and produce outcomes which benefit the poor.

40. For business support services, such as accountancy, training, marketing, information and technology advice, donors should work with developing country governments to ensure programmes of support are focused as far as possible on facilitating and catalysing the private sector itself to provide business services on a commercial basis, rather than these being provided on a highly subsidised, costly and unsustainable basis by government.

41. Making Markets Work approaches challenge donors to think about the systematic impact of their interventions in terms of market distortion rather than enhancement. The state has a vital role to play, especially where there are undeveloped or missing markets. DFID is supporting market development programmes in a number of countries, including South Africa (ComMark programme), Nigeria (PropCom), Bangladesh (Katalyst), and Vietnam (Asian Development Bank lead with DFID support).

C THE PRIVATE SECTOR'S ENGAGEMENT IN DEVELOPMENT

42. The private sector has a vital direct role to play in development. As well as the need for more enterprise to drive growth and poverty reduction, firms - through their goods, services, general expertise and ways of doing business - play a significant part in improving quality of life and supporting development. This section will look at the ways in which companies are working to support development by deepening and widening markets, and by addressing key development issues which are influenced by the ways businesses operate.

43. The private sector includes private economic actors of all sizes - domestic and international, small and large. Companies that are contributing to development in ways that go beyond core growth and enterprise areas are often larger businesses. However, companies of all sizes can contribute, and government action can help to facilitate this. Businesses can also contribute through joint approaches, both through national business associations like Chambers of Commerce, or through international initiatives, such as Business Action for Africa. DFID works with business membership organisations, such as BAA, to jointly facilitate the impact of the private sector on development.

Deepening and widening markets

44. Developing country markets are beginning to be more attractive to small and larger companies, including business to business activities, and business to consumer activities such as so-called "bottom of the pyramid" approaches. These approaches refer to the potential at the "bottom of the pyramid"[198] which comprises the 2 billion people worldwide living on less than $ 2 a day, compared to markets that service relatively well off people.

45. Bottom of the pyramid approaches argue that there are significant market opportunities for companies in providing the goods and services poor people need. Examples include household goods such as soap sold in small amounts, financial products such as cheap banking services, and potentially higher value products such as low priced patented medicines.

46. Below we will look at a number of key sector development areas that the private sector is increasingly involved in: health; education; utilities; and financial services. There is much that is relevant in the "bottom of the pyramid" approach, as companies move to make products available to poorer consumers. Expanding the private sector's role can be controversial, for example in water privatisation. DFID, in collaboration with other donors, supports Governments reforming or privatising public enterprises (see section on Public Sector Reform in the DFID & Private Sector booklet). While DFID recognises that private sector involvement is not always appropriate, businesses can play an important part in the provision of basic services and achievement of the MDGs.

Health

47. The private sector plays a significant role in international health, including in the development and delivery of medicines and other health products and provision of health services. HMG has worked to encourage and support this involvement, for example to incentivise private investment in vaccine R & D and manufacturing capacity for vaccines for diseases that disproportionately affect developing countries.

48. One key mechanism has been through global health public private partnerships. These have been set up to develop new medicines, drugs, vaccines or diagnostics relevant to the developing world, or to increase access to existing health treatments and diagnostics. The Global Fund to fight AIDS, TB and malaria (GFATM), the Global Alliance for Vaccines and Immunisation (GAVI), Stop TB and Roll Back Malaria all have significant private sector involvement from pharmaceutical, diagnostics and health commodity companies, as well as companies whose staff are affected by disease and ill-health.

49. HMG has provided direct financial and technical support to these partnerships. HMG has also developed innovative financing proposals, including the International Finance Facility for Immunisation that leverages finance from capital markets to develop underused vaccines and to support the roll out of much needed vaccination programmes in developing countries through GAVI.

50. As well as involvement in health partnerships, the global research based pharmaceutical industry is playing an important part in making their medicines available in developing countries. In March 2005 DFID jointly published with the Departments of Trade and Industry and of Health Increasing people's access to essential medicines in developing countries: a framework for good practice in the pharmaceutical industry [199] containing recommendations for the industry (and clear commitments by the government) to help to increase access to medicines in developing countries. Since publication DFID has held a number of meetings with the pharmaceutical industry to take forward recommendations on increasing investment in research and development for diseases disproportionately affecting developing countries, making medicines more affordable in developing countries, and working in partnership to support health delivery.

51. In developing countries the private sector - formal and informal - is often the major provider of health services. The public-private boundary is increasingly blurred and there is great scope for greater private sector involvement in healthcare provision. For instance, the private sector is increasingly involved through contracting out delivery of district services and family planning services. However, the private sector is often poorly regulated and works outside government plans. DFID works with governments to build capacity to plan and provide healthcare and to work with and regulate the private sector.

Education

52. Governments have an essential role to ensure that people have the skills they need to enter work, and that there is an efficient labour market. In addition to a priority focus on the primary education sector, DFID at country level has supported vocational and other skills development programmes, including in the area of youth employment. The DfES is also active in Ghana on entrepreneurial training. The Youth Employment Network, supported by the UK Government, brings together governments, youth, employers and workers to tackle the challenge of youth employment. This theme is also behind the DFID supported World Development Report 2007 under the leadership of the World Bank.

53. Private sector institutions, as well as charities and community groups, are significant providers of education services in the poorest countries of the world. The private sector is playing an increasing role, particularly in large urban areas in Asia, where research suggests that they have often been able to provide comparative quality education at a lower per student cost than the state.

54. DFID has indirectly supported private sector institutions, charities and community groups through multilateral partners. Increased demand, particularly for secondary and tertiary education in low income countries, which cannot be met by government in the short to medium term, is being met with increased provision by both for profit and not for profit organisations. In Pakistan, for example, the World Bank encouraged sponsorship of community supported skills in Sindh province, and in Africa has adopted a similar approach to supporting the African Virtual University. DFID has also worked with the British Council in the Council's support for private sector involvement in vocational education and training.

Utilities (Water, Sanitation, Energy, Telecommunications)

55. Despite progress in some countries, public water and sanitation services are failing millions of poor people. Significant further investment is required to provide infrastructure and build capacity. In the main the public sector is in the lead here, but the private sector is an additional source of finance and technical expertise. The major constraint to the private sector doing more is the lack of an enabling environment to encourage investment. Many governments lack the capacity to negotiate appropriate contract terms or to regulate the private sector in a transparent and predictable way. DFID helps to build capacity to manage and regulate the private sector where governments ask for our assistance.

56. High profile public failures of large water concessions have resulted in many international companies regarding the risks as too high for limited returns. Whilst investment by multinational companies has been declining, the domestic private sector is proving of much greater importance, in particular small scale providers which tend to reach those unserved by large utilities (e.g. in urban slums). DFID increasingly focuses on working with the domestic private sector, small scale and informal service providers to encourage private sector involvement that is pro-poor.

57. Without reliable energy, economic growth is constrained and individual health and livelihoods compromised. As well as strengthening their own capacity to plan and operate energy services, many governments are interested in harnessing the resources and expertise of the private sector, including by creating the conditions for attracting foreign and local private enterprise. DFID is working with other donors, international financial institutions and the private sector to coordinate initiatives and pool resources to support large new investments. This includes through international multi-donor facilities such as the Public Private Infrastructure Advisory Facility (PPIAF), which helps governments to improve policies, laws, regulations and institutions to better harness private participation in energy and other infrastructure services.

58. Mobile telephony has been a great private sector success story in development. At the end of 2003 there were 6.1 mobile telephone subscribers for every 100 inhabitants in Africa, compared with 3 fixed line subscribers per 100[200]. Research indicates a positive correlation between mobile phone penetration and economic growth as consumers access information on goods and services, and producers find better market information.

Finance

59. Financial exclusion is a major constraint on development. This is dealt with under Section B above, but it is important to note here that financial services companies, including international banks, are increasingly looking at expanding provision of banking services and other financial products to poor communities, including in terms of microfinance HMG has been working with financial services companies on a variety of issues, including microfinance, improving the flow of remittances and provision of social Insurance.

60. The poor need to be insured against life events and shocks which trap them in poverty. Private insurance coverage in developing countries is very limited and many of the poorest are excluded by unaffordable premiums. Governments, donors and NGOs can subsidise the expansion of insurance to the poor. The financial sector can also facilitate social assistance programmes, such as cash transfers, where the private sector can be used in delivery.

Private firms supporting key development issues

61. Private firms can have wider impact through contributing to key development issues connected to their ways of doing business. These include, for example: promoting better public private dialogue; addressing corruption; working to tackle the effects of HIV and AIDS; promoting environmental standards; and working to international guidelines on human rights and sustainable development; and support for labour standards and protecting human rights. The sections below illustrates where HMG is involved in encouraging responsible ways of working in and with the private sector.

Public private dialogue

62. Public-private discussions can help governments design and implement reform strategies that lead to accelerated economic growth. Constraints to effective dialogue include lack of trust between government and the private sector, limited government understanding of the private sector, and limited representative capacity of business associations. DFID and other donors have helped the private sector to engage more effectively with governments through, for example, support to private sector membership forums.

Corruption

63. Companies can have a negative impact on development if they engage in irresponsible practices, notably corruption. The World Bank estimates that corruption costs around 0.5% of global GDP each year. The UK Government encourages companies to commit to relevant leading codes and initiatives on transparency and corruption, e.g. the Extractive Industries Transparency Initiative (see below), the UN Global Compact, and the OECD Guidelines on Multinational Enterprises. Companies should ensure they have robust anti-bribery systems in their corporate governance structures. Also misuse of revenues from the private sector - sometimes illegal - can fund conflicts and strengthen regional factions at the cost of central government capacity and state-level stability.

64. The Government has taken a number of steps to help fight corruption. The Anti-terrorism, Crime and Security Act 2001 gave UK courts jurisdiction over bribery and corruption committed overseas by UK nationals or private sector bodies incorporated under UK law. The UK supports the UN Convention Against Corruption (UNCAC), the first global convention designed to tackle corruption. The necessary legislation to make the UK compliant with UNCAC is now in place. We expect to formally ratify it early in 2006. DFID also provides a wide range of support to African countries working to tackle corruption. Both the Crown Prosecution Service and the Serious Fraud Office provide assistance to foreign authorities.

65. The Extractive Industries Transparency Initiative (EITI) was launched by the Prime Minister in 2002. A DFID led partnership of leading oil, gas and mining companies, NGOs and producing and consuming countries, it seeks to challenge some of the problems associated with natural resource exploitation including corruption, by increasing transparency of payments from extractive companies to governments and government-linked bodies. By increasing public knowledge of revenue levels, it aims to empower citizens and institutions to hold governments and companies to account. 20 countries have endorsed the principles of EITI and 11 are currently at various stages of implementation.

HIV and AIDS

66. AIDS is one of the greatest global threats to reducing poverty. The ILO has estimated that nine out of ten people infected with HIV worldwide are adults in their professionally productive prime. The work force is being severely depleted in many countries through death, illness and as people care for sick relatives or attend funerals. The private sector has responded in a number of different ways, led by large multinational companies. For instance, Diageo has pledged to provide all HIV positive staff in Africa, and their dependants, with antiretroviral therapy (ART) for life, whilst Anglo American has launched a partnership with the Global Fund to extend prevention and treatment programmes to local communities in South Africa. DFID is working with large and smaller companies and business coalitions to promote the spread of good practice.

Environment

67. The private sector can have a significant effect on the environment. Responsible environmental and social performance underwrites sustained economic growth, development and poverty reduction, whereas poor environmental management can exacerbate conflicts, poverty, corruption and undermine development efforts.

68. The poor are frequently affected by companies' poor environmental performance. DFID supports the development of public policy that encourage best practice and the safeguarding of sustainable use of resources. The regulatory environment should establish minimum performance standards, leaving market mechanisms and co-regulatory measures to encourage improved resource efficiency and environmental management. Engagement with World Bank led guidance for the private sector, such as through the Extractive Industry Review, and IFC safeguard revisions, has encouraged improved environmental performance. In addition, through its support for the World Bank hosted Communities and Small Scale Mining (CASM) programme, DFID has helped develop environmental management guidance for small and medium sized enterprises, for example on mercury free gold processing.

69. Another example of DFID's support for better environmental management is the Illegal Logging Programme. This works to challenge demand for illegally harvested wood products and supports industry's efforts to tackle the problem. Action include the adoption of a responsible purchasing policy by members of the The Timber Trade Federation, which specifies procurement of legal timber, and a "trade roadshow" in West and Central African countries where company to company discussions were facilitated.

International standards

70. There are a range of International guidelines promoting responsible business and new ways of working. The UN Global Compact was launched by Kofi Annan in July 2000. It is a voluntary UN agreement where companies commit to uphold and promulgate a set of ten principles covering human rights, labour rights, environmental protection and combating corruption. There are currently over 1700 signatories to the Compact.

71. The Voluntary Principles on Security and Human Rights (VPs) were developed by the UK, US, extractives companies and NGOs and provide guidance to strengthen human rights in extractives company security arrangements in many developing countries. The OECD Guidelines for Multi-National Enterprises are designed as a baseline for corporate behaviour to help multinationals to design their own codes of conduct. The guidelines are voluntary, but include a mechanism which allows individuals or organisations to raise potential breaches of the guidelines with national governments.

72. The UK Government's objective is to see UK businesses, operating at home and abroad, take account of their economic, social and environmental impacts, and act to address key sustainable development challenges wherever they operate. The UK recently published an international strategic framework to promote Corporate Social Responsibility (CSR), which aims to set out the overall objectives and priorities for CSR internationally, including a focus on practical measures.

Labour standards, decent work, and human rights

73. The UK Government supports the promotion of the ILO core labour standards, as set out in the 1998 ILO Declaration on Fundamental Principles and Rights at Work, which cover freedom of association and the right to collective bargaining; the elimination of forced and child labour; and the ending of discrimination in employment. DFID provides direct support to the ILO's technical assistance programmes such as its Special Action Programme on Forced Labour.

74. Poor people should be able to participate in decisions that affect their lives and it is important that they have the freedom to organise themselves in associations which promote their interests. Trade Unions can be vital advocates in promoting human rights, core labour standards, and responsible business. DFID encourages collaboration with free and democratic labour organisations, and has recently launched a guidance note for DFID country teams entitled "How to work with Trade Unions", offering practical advice on working with local trade unions as partners in development.

75. Whilst the primary responsibility for enforcing international labour standards rests with government, companies have a responsibility to ensure compliance in their own operations and supply chains. Most poor people in developing countries work in the informal economy, but international businesses supply chains link with many small local enterprises, and this can be a powerful influence for wider change. DFID promotes a partnership approach to labour standards. DFID helped to establish, and continues to support, the Ethical Trading Initiative. This is an alliance of business, trade unions, and NGOs, which works to improve the labour standards of the workers in supply chains of the corporate members by implementing a code of conduct incorporating the ILO core standards.

76. Companies have a wider responsibility to conduct their business ethically, particularly in relation to human rights. Initiatives supported by HMG, which companies also support, include the UN's Global Compact and the Voluntary Principles (see above). The 2004 UN Commission on Human Rights asked the Office of the High Commissioner for Human Rights to compile a report on existing standards and initiatives, including the UN draft Norms on the Responsibilities of Transnational Corporations & Other Business Enterprises with Regard to Human Rights. HMG believes more work is needed to identify a way forward and has supported the appointment of a Special Representative of the UN Secretary General to identify and clarify standards of corporate responsibility and accountability for business with regard to human rights, as well as an elaboration of the role of States in effectively regulating and adjudicating the role of business

D AID MECHANISMS TO SUPPORT PRIVATE SECTOR DEVELOPMENT

77. DFID has pioneered a number of mechanisms to encourage private sector investors to be more involved in low-income countries, and to stimulate the development of the private sector. PSD is critical as the private sector has far greater potential resources than donors such as DFID, in terms of finance, human resources, and regional and international networks and presence. Mechanisms used by DFID to promote private sector that are highlighted in this section include:

Improving the policy and operating environment for enterprises: in Africa primarily through the Investment Climate Facility;
Encouraging private sector and financial sector innovation and investment in poor people in low income markets - in the 'base of the pyramid': through challenge funds and investment fund mechanisms.
Improving access to financial services, including credit, transaction banking, and payments: through the FIRST Initiative and country-level sector-wide programmes.
Funding development finance institutions specialised in PSD: for example the International Finance Corporation.

78. More could be done to incorporate the private sector into the delivery of development, including through building the capacity of domestic small enterprises. In fragile and crisis-affected states, for example, where state delivery capacity may be weak, private sector firms can be providers of services, and the jobs created by the private sector are essential for the livelihoods of those affected by crises. Mechanisms such as poverty reduction budget support may not be appropriate in such situations due to lack of state capacity, lack of political will, or unacceptably high fiduciary risk, and private sector-specific instruments may well have a role to play.

Poverty Reduction Budget Support

79. An important primary aid instrument for DFID is of course Poverty Reduction Budget Support (PRBS), including support through sector programmes such as in education and health. Budget support is well suited to supporting macro stability (key for the private sector to thrive), and potentially also to building capacity of government agencies to support PSD. There is a need to focus on the enabling environment rather than just public expenditure though, and to ensure that relevant ministries are involved, e.g. Ministry of Trade as well as Education and Health. Clearly budget support is not appropriate as direct private sector support.

80. The OECD Development Assistance Committee (DAC) joint evaluation of General Budget Support, which DFID leads, will report in March 2006 and is testing, amongst other things, the effects of budget support on growth and income poverty reduction. Poverty Reduction Strategy Processes (PRSPs) have often not emphasised the growth sector, but this is improving. "While only 60% of the earliest PRSPs (14 of 25) noted a prominent role for growth this has increased to 80% (13 or 16) for the period July 2003 to June 2004. Over the last year all six new PRSSs have incorporated growth as a central pillar in their strategies." (2005 Review of the Poverty Reduction Strategy Approach - presented to the World Bank Development Committee in September 2005)

81. A common feature of the growth strategy in PRSPs is the primacy given to the role of private sector development and improvements in the investment climate, including macroeconomic stability. Sixteen of 21 PRSPs reviewed (by ODI) emphasized the need to support SMEs, and fourteen emphasized the promotion of foreign direct investment.

82. With regard to DFID country programming more broadly, DFID Country Assistance Programme guidance does signal the need to include the private sector in analysis and dialogue to inform country strategies and programming choices. The private sector is also an important area of analysis in 'Drivers of Change' studies.

83. DFID currently provides PRBS in only 16 countries. In most of DFID's PSA countries therefore, other aid instruments will be more appropriate to encourage private sector development. Even in countries where DFID does provide PRBS, PSD can be promoted by other aid instruments that deal more directly with the private sector, and with the institutions and environment that supports its growth. This includes other financial aid instruments, such as global funds, sector programmes and projects, as well as non-financial aid instruments, such as technical cooperation and policy dialogue. Some of these instruments used by DFID are outlined below.

Investment Climate Facility

84. The Investment Climate Facility (ICF) aims to facilitate the removal of real and perceived obstacles to doing business in Africa. This will involve encouraging support for change, working with governments to formulate business friendly policies and regulation, working with the institutions responsible for administering regulation to improve their capacity and capability, improving platforms for dialogue between government and business, and improving the information and services available to governments and investors.

85. The ICF is an independent trust with strong African representation on the Board of Trustees. It is managed according to business principles. The ICF will work with African governments, regional organisations, donors, companies and civil society to prepare and finance initiatives to improve the investment climate at national, regional and at a continental level.

86. The ICF has eight priority areas to focus on (property rights and contract enforcement, business registration and licensing, taxation and customs, financial markets, infrastructure facilitation, labour markets, competition, corruption and crime). In addition, a key part of the ICF's remit is to support the recommendations that arise from the Africa Peer Review Mechanism (APRM) process in relation to the investment climate. Activities funded under the ICF are likely to include: research and analysis; legislative review and reform; capacity building of institutions such as land registries, company registries and commercial courts; pilot projects (such as streamlined business registration systems); and facilitation of better public private dialogue.

Challenge Funds

87. Whilst improving the environment and investment climate for business is seen as crucial, there is still a vital role for a mechanism that can engage more directly with the private sector, and stimulate or catalyse businesses to act in a certain way that is pro-poor. The review and evaluation of existing challenge funds over the past year has found that challenge funds are an effective mechanism for doing so.

88. Challenge funds provide grants on a competitive transparent basis to the private sector, to stimulate private sector development and leading edge innovation. Their focus is to encourage pro poor activity in sectors/products/markets that would not have taken place without the public funding. Challenge funds are particularly well suited to addressing situations - common to much of Africa for example - in which the market is slow and/or fails to deliver without public sector assistance.

89. The Financial Deepening Challenge Fund (FDCF) is an example of a successful DFID challenge fund facility. Its purpose has been defined to improve access to financial services for poor and previously excluded groups in Africa and South Asia. The fund provided grants of £50,000-£1m to private sector firms in a competitive and transparent manner for project proposals which met clearly defined criteria reflected in DFID's priorities to improve access to financial services. FDCF had a requirement for a leverage ratio of at least 1, and in practice was able to stimulate about twice as much private sector investment as the amount of DFID grant funding. In Uganda, the FDCF supported a leasing company to develop a new leasing product for small and medium-sized enterprises. In Tanzania, the FDCF has supported the development of a "smartcard" which enables customers, including those who had not used banks before, to increase their access to cash and to reduce their banking costs.

90. The Commission for Africa and the G8 (2005) deliberations highlighted that private enterprise is a prime engine of growth and development. A number of initiatives were recommended to boost economic growth, including an Africa Enterprise Challenge Fund (AECF). The AECF has a target capitalisation of $100m over the 7 years it is expected to be operational. It will likely focus on up to 3 sectors, for example financial sector, agribusiness, and possibly one other. Based on the assumption that average grants will be around $800,000, this capitalisation should enable around 100 projects to be funded. The AECF will be multi-donor funded. The fund will begin operations when at least $50 million has been committed from donor funders. DFID has committed £12 million in principle to the AECF.

Investment funds and initiatives

91. A leading instrument to help private sector activity in poorer countries is CDC. Created as a PLC (public limited company) from the former Commonwealth Development Corporation in 1999, it was then extensively reorganised, with the bulk of its operational capacity being de-merged into a new fund management company called Actis Capital in 2004.

92. By investing in companies, Actis shows that these businesses can be profitable and worthwhile, and then private buyers can be attracted to acquire them. CDC's capital is then released to reinvest elsewhere in a similar way. Through this 'demonstration effect', CDC is not only providing direct benefits, from use of its own capital, but is also attracting increasing flows of third-party capital to markets that desperately need it. This mobilisation of capital for poorer countries is arguably CDC's most important function.

93. Since the 2004 reorganisation, CDC's total net assets increased from £982 million in 2003 to £1,494 million by 30 September 2005, and are forecast to reach £1,535 million by the end of 2005, well ahead of their business plan budget. Over the period 2003-2005, it is expected to have mobilised nearly US$490 million (some £275 million) in third-party investment in developing country markets.

94. DFID also supports a number of initiatives to harness the role of the private sector in the financing and delivery of public services for example the International AIDS Vaccine Initiative and the African Agricultural Technology Foundation.

95. The diaspora from developing countries can be a significant source of financing, know-how and trade links for developing country private sectors. Remittances to developing countries in 2004 were estimated by the World Bank to be $126 billion, which is about two and half times as large as net official aid flows. The UK's outflow of remittances to developing countries is estimated by DFID to be at least £2.7bn in 2004, which is not far short of the UK aid budget of £3.8bn. DFID has an active agenda to encourage remittance flows to low income countries, and to make remittances more accessible and lower cost for poorer recipients.

96. The diaspora also have a role as investors. The experience in countries as different as India and Sierra Leone show that in certain circumstances, diaspora entrepreneurs can become early risk-takers, because of their skills and resources, their networks in their country of adoption and country of origin, and their special motivation, not only driven by short term profit but also by a long term vision mixing social and financial agendas. This is dependent in a large part on their being an investment climate sufficiently favourable to allow for investment by diaspora of course. DFID is exploring options for working in this emerging area.

Financial Sector Reform and Strengthening Initiative (FIRST)

97. FIRST is a US$66 million multi-donor programme, supporting capacity building and policy development projects in the financial sectors in developing countries. More specifically, FIRST provides technical assistance grants for short and medium-term projects in the areas of financial sector regulation, supervision and development.

98. DFID has committed £20 million to FIRST over six years (2002-2008) and is by far the largest donor to the project; the other donors are the World Bank and the IMF; the Canadian International Development Agency of Canada (CIDA), the State Secretariat for Economic Affairs of Switzerland (SECO), the Ministry of Foreign Affairs of the Netherlands (MFA), and The Swedish International Development Cooperation Agency (Sida). DFID currently chairs the FIRST Initiative.

99. FIRST has supported PSD in a number of areas, including:

helping develop domestic capital markets that can mobilise and transform local savings in productive assets
encouraging risk management mechanisms such as insurance or capital markets that can help protect the livelihoods and assets of the poor.
strengthening corporate governance of banks, to shore up investor confidence.

Funding to development finance institutions

100. DFID's support to bilateral and multilateral Development Financial Institutions such as the International Finance Corporation, the Multilateral Investment and Guarantee Agency, the European Investment Bank and the European Development Finance Institutions (CDC for the UK), is also a central plank of its PSD strategy. These institutions provide equity finance, debt finance and guarantees to the private sector, and have a clear role to play in supporting early stage investment phases, post-conflict countries and fragile states, infrastructure financing and projects that need patient capital.

PSD in Fragile States

101. Fragile states are an increasingly prominent area of DFID engagement. The private sector can be both a cause of fragility and a potential solution. For example, the mismanagement of revenues from natural resource extraction can fuel conflicts and corruption, but the creation of jobs and trade links can underpin peace settlements and post-conflict reconstruction. DFID has an emerging workstream on the private sector in fragile and crisis-affected states, which seeks to improve DFID understanding and programming

102. The following donor interventions have helped the private sector contribute to stability and development: large scale public works programmes in post-conflict situations; micro-finance; remittance initiatives; community driven development projects; technical assistance to governments on legislation and customs and tax regimes; one-stop shops for investors (simplification of business regulation); financial sector restructuring; monetary policy advice including currency and Central Bank reform; the Extractive Industries Transparency Initiative (EITI).

103. DFID and other donors are exploring the potential for building on this positive experience through such aid instruments as:

extending EITI to other sectors
including economic issues in peace-building agreements
including the role of private and financial sector in aid frameworks like PRS's
political risk insurance for private investors (Multilateral Investment Guarantee Agency)
reducing policy and infrastructure barriers to remittances
strengthening the capacity of regulators to introduce financial transparency and clamp down on abuses such as money laundering
local content requests for donor contractors (i.e. sub-contracting and capacity-building for local firms)
subsidisation of first investors who generate positive externalities for others (e.g. the challenge fund concept)
survey of investment constraints, for example the recent World Bank-led Investment Climate Assessment in Afghanistan.

104. DFID plans to produce a Policy Note, building on lessons learned by DFID country offices and development partners in fragile and crisis-affected states such as Afghanistan, Sierra Leone and Somalia.

E DONOR COHERENCE IN PRIVATE SECTOR DEVELOPMENT

105. At the international donor level, there are a number of existing initiatives that bring donors together in terms of policy and practice in PSD. At the microfinance level, the Consultative Group for Assistance to the Poor (CGAP), is a multidonor organisation based at the World Bank. On enterprise development, there is the Committee of Donor Agencies for Enterprise Development. Within OECD for the past 3 years there has been a DAC group working under the title of PovNet, looking at private sector, agriculture, and infrastructure policy around growth and PSD specifically.

106. In addition to these wide groupings, there are sector groups and various partner organisations in, for example, microinsurance, agricultural research, and urban infrastructure.

107. On the private sector side, a recent development has been the coming together of the Business Action in Africa group, arising from the private sector contributions to the Commission for Africa process.

108. Within DFID, at the level of policy, Policy Division's Growth & Investment Group works with other PD Groups, or sector or geographical interests, such as through partnerships with the International Financial Institutions Department, and Africa Policy Department.

F CONCLUDING POINTS ON DFID & PSD

109. "The primary responsibility for achieving growth and equitable development lies with developing countries .. and any approach to PSD should be grounded in the realization that the savings, investment and innovation that lead to development are undertaken largely by private individuals, corporations, and communities"[201]. The UK Government agrees with this view, and is seeking increased opportunities to encourage the interface between governments and the development community, and the private sector itself.

110. DFID's "'Working with the Private Sector to Eliminate Poverty" highlights a series of guiding principles in designing and implementing its programmes with the private sector, so that DFID:

acts as a catalyst and facilitator, rather than intervening directly in market operations
recognises that partnership is the best approach to development
collaborates with private sector representatives in developing and implementing programmes
recognises that strengthening the business environment impacts positively on all businesses
aims to understand the characteristics of the countries in which we work
identifies more effective routes for increasing the access of the poor to essential services, and
holds to the underlying principle that markets must be made to work for the poor.

111. DFID is committed to building on current experience of working alongside the private sector through EITI (on governance and transparency), large and international banks (on remittances and access to finance), and in other sectors (infrastructure, health, and others). Through encouraging private-public sector partnerships at the domestic level, and co-operation at the international level, the UK will look to contribute to private-public sector initiatives such as Business Action for Africa, the Investment Climate Facility for Africa, in addition to international groupings active in private sector development.

112. Progress here will require strong institutions and capable states. Strong institutions matter and their presence largely explains the difference in growth performance between different states. But it also requires an effective state to create the right environment for PSD. Hence promoting PSD is one part of the UK Government's agenda to work on contributing to, and achieving, strong, stable, and successfully growing states.

March 2006

193 "DFID & The Private Sector: working with the private sector to eliminate poverty" DFID 2005

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194 DFID Pro-Poor Growth Briefing Notes

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195 Accelerating Pro-Poor Growth through Support for Private Sector Development. OECD 2004

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196 "Wealth of the Poor: Eliminating Poverty through Market and Private Sector Development": Sida studies No. 14 2005.

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197 "Growth and poverty reduction: the role of agriculture. DFID 2005 Back

198 C.K. Prahalad "The Fortune at the Bottom of the Pyramid" University of Michigan Business School, 2004

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