Private Sector DevelopmentDecember 13, 2006 - nr.50
I Introduction, summary and recommendations
In January 2003 the
1. Is there scope for governments to support private sector development in such a way as to maximise the contribution to poverty reduction? Is it effective, for example, to introduce measures aimed specifically at certain sectors or companies, such as small and medium enterprises (
2. What are the dangers of too much control by governments and donors? The World Development Report (WDR) 2005 indicates that the more specific measures are, the less chance they have of success. This calls into question the value of measures aimed at specific sectors or companies.
3. In what way can the positive role foreign direct investment (FDI) be strengthened, such that it contributes as much as possible to employment and promotes local companies?
4. What do you see as the relatively strong and weak points of the various instruments I have at my disposal to encourage the private sector to play a more active role in Dutch development cooperation? In what ways can these instruments be improved?
In this advisory report, the
‘Private sector is conceived by the donor community as a basic organising principle for economic activity where private ownership is an important factor, where markets and competition drive production and where private initiative and risk-taking set activities in motion.
Poverty reduction is the primary aim of development cooperation. Like the DAC, the
Since the level of poverty is heavily dependent on the local context, that is where the search for solutions must begin. There are no universal, ready-made panaceas. Each individual situation calls for a new effort to identify the particular policies that will do most to alleviate the specific problem of poverty.
Ever since the Millennium Declaration of 2000, the Millennium Development Goals (MDGs) have been at the top of the international development agenda. At the UN World Summit in September 2005, heads of government reaffirmed their intention to achieve the MDGs by 2015. In the case of MDG 1, this means that the proportion of people living on less than a dollar a day must by that date be reduced by half in comparison with 1990.
Finally, it may be useful to indicate the extent of the problem of income poverty. In 2001, 1.1 billion people in the developing countries (including the transition countries) were living under the absolute poverty line of 1.08 U
Poverty reduction is a long-term process and results are often difficult to quantify in the short term.
The structure of the report is as follows. Chapters II and III respond to question 1 in the Minister’s request for advice. Chapter II analyses the relationship between poverty reduction, general economic growth and pro-poor growth. The conclusions of that analysis are taken into account in the analysis of the role of private sector development in economic growth and pro-poor growth presented in chapter III. That chapter also discusses whether it is effective to take measures aimed at specific sectors or companies (such as SMEs), and examines the role of the PRS process and PRSPs in private sector development. Chapter IV addresses question 2 in the Minister’s request for advice, concerning the effects of control by governments and donors in the private sector. Chapter V deals with question 3, on the best way to strengthen the positive role of FDI. Chapter VI discusses the informal economy and policy to stimulate economic growth and pro-poor growth within it, and goes on to consider financial sector development and the importance of universal access to appropriate financial services. Chapter VII answers question 4, concerning the relative strengths and weaknesses of the relevant instruments at the Minister’s disposal, and ways of improving them. The earlier findings of the report are used in this chapter to formulate a number of core elements and quality criteria for private sector development and poverty reduction (Tables VII.1 and VII.2). These are then used to answer two questions: ‘Are we doing the right things?’ and ‘Are we doing things right?’.
Summary, conclusions and recommendations
Chapters II and III
Question 1: Is there scope for governments to support private sector development in such a way as to maximise the contribution to poverty reduction? Is it effective, for example, to introduce measures aimed specifically at certain sectors or companies, such as small and medium enterprises (
The AIV feels that there is certainly scope for governments to support private sector development in such a way as to maximise the contribution to poverty reduction. However, this response requires amplification. The AIV has adopted both the absolute definition of ‘pro-poor growth’ (the fastest possible growth in the income of the poor) and the relative definition of the concept (reduction of inequality between the poor and the remainder of the population).
The AIV’s analysis reveals that growth is by far the most important factor in poverty reduction and that average growth in per capita income among the poor is identical to that in the population at large. It also shows that poverty reduction resulting from economic growth has two components: growth and distribution. The two can reinforce each other - if income distribution is relatively equal - or counteract each other if it is not. In the first case, growth will be pro-poor, in the second it will not. For this reason, it is vital to know - and to be able to influence - the conditions under which the two components will reinforce each other.
Economic growth is the main factor in poverty reduction and the quality of domestic institutions is by far the most important factor in generating faster economic growth.
The best analysis and recommendations on this subject are contained in the latest OECD report on private sector development and pro-poor growth. The starting point of this report is the finding that measures to improve the general investment climate generate faster economic growth, including pro-poor growth. To generate pro-poor growth, priorities must be set within a general programme of reform in order to establish a primary or additional focus on markets, sectors and regions in which poor people live and work. The aim must be to give them improved access to means of production in general, and to business development services and financial services in particular.
Improving the quality of the investment climate reduces costs and risks for the private sector and improves market functioning. Where the private sector is the main engine of growth and encompasses most of society and the national economy, it is an obvious step to explore what policies are required to use it to generate a faster pace of general economic growth and pro-poor growth. In addition to a reduction in trade protection and in measures restricting FDI, more development aid is required to strengthen institutions and improve infrastructure.
As country contexts differ widely, it is hard to devise a universally applicable set of policies and institutions that will ensure pro-poor growth. It is better to follow the example of the OECD and to analyse the likely pro-poor effects of each policy measure and institution on the basis of whether it will:
- provide incentives for entrepreneurship and investment;
- increase productivity, competition and innovation;
- harness international economic linkages;
- improve market access and functioning;
- reduce risks and vulnerability.
As a rule, pro-poor policies should benefit private sector activities and enterprises across the board, while at the same time paying extra attention to particular regions and sectors. Pro-poor growth policies should consist primarily of measures to reduce discrimination against and exclusion of the poor, but also include measures to ensure that the poor can exploit their increased opportunities in practice. These measures will usually need to be generic rather than selective. The right combination of the two will depend on the specific situation.
Policies should not specifically target
Question 2: What are the dangers of too much control by governments and donors?
Improving the general investment climate is likely to generate a faster pace of economic growth and increase the incomes of the poor.
Selective measures in the form of support for individual activities, businesses or business categories should be avoided. More often than not, such measures will damage the national economy by failing to pick the right ‘winners’, promoting rent-seeking behaviour and producing solutions which are not cost-effective.
Question 3: In what way can the positive role of FDI be strengthened, such that it contributes as much as possible to employment and promotes local companies?
FDI is clearly preferable to other forms of foreign capital. It creates no debts and the investment is repaid only if profits are made, and then only after they have been taxed. The flow of FDI has proved to be more stable than that of loans, because it is difficult to withdraw business investments of this kind. FDI is especially popular because it is associated with an efficient form of knowledge transfer relating to production, management, marketing etc. which leads to greater integration in the global economy. As a rule, foreign owners will behave no differently from their domestic counterparts. However, if a limited number of foreign companies were to dominate a major sector of the economy, this might limit the scope for government policymaking and be undesirable on that account.
The opportunities for Dutch development cooperation policy to reinforce the beneficial effects of FDI on poverty in developing countries lie particularly in the field of the investment climate, infrastructure and financial sector development. In addition, the Netherlands might direct its attention to improving public-private cooperation in the development not just of risk mitigation instruments such as guarantees and insurances, but also of newer instruments such as derivatives, for countries, regions or industries with large concentrations of poor people. It would be worth investigating the extent to which Dutch development aid could be supplied in this field to organisations like the Multilateral Investment Guarantee Agency (MIGA) and the Netherlands Development Finance Company (FMO), for example via partial or full reinsurance or counter guarantees. This would make it possible for them to offer insurances, guarantees or derivatives (financial products such as options and futures) to mitigate risks relating to such countries, regions or activities, where this is not currently practicable.
FDI is influenced mainly by the quality of the investment climate. This depends in turn on the efficiency of local markets for labour, capital, goods and services. It would therefore be wrong to influence the outcomes of the market system, except perhaps temporarily in the case of markets which are seriously distorted. Even then, it is important to remember that temporary protection tends to become permanent.
Employment and the volume of transactions with local companies are results of the free market process. Competition is, in fact, the very essence of an ‘enabling environment’ in which the private sector flourishes, generating economic growth and reducing poverty.
Caution should be exercised when seeking to regulate the way investors run companies, for example by obliging them to use local products and services. The World Development Report 2005 refers to the adverse effects of such regulations, in particular where technology transfer and local producers are concerned. They tend to lead to stagnation and ultimately to the withdrawal of foreign investors.
In most cases, the desired policies will consist of measures that increase the productivity of local producers, enhancing the profitability of existing foreign investment so that production can increase, local employment and the volume of transactions with local producers can expand, attracting more FDI. Foreign companies can also be helpful in terms of encouraging corporate social responsibility in relation to managementdevelopment, the environment, corruption, social protection, and child labour. In this respect, the
The informal economy and financial sector development
It is clear that the target group for Dutch development cooperation policy and the MDGs – the 1.1 billion people who live on less than 1 USD a day – is likely to be concentrated in the informal rather than the formal economy. More women than men are active in this sector. Their lives are marked by a lack of social protection and a high level of labour insecurity. The informal economy offers no long-term means of poverty reduction. The only way to reduce poverty is to generate a broad pattern of economic growth that also benefits poor people working in it. The main focus must be on promoting employment and entrepreneurship (including microenterprises) to provide incomes. In addition, it is important to promote the transfer of people and activities from the informal to the formal economy.
To get results, national governments and local authorities, supported by international financial institutions and donors, will have to develop specific policies for each country and sector. Such policies should give priority to the following four aims:
- To encourage entrepreneurship (including microenterprises).
· To promote a level playing field for poor people in general.
· To promote opportunities to earn a living.
· To eliminate barriers to the market participation of women, for example through policies enabling them to own, buy, sell and inherit land.
- To promote the transfer of businesses from the informal to the formal economy.
· Institutional change and policies directed both at reducing the risks and costs of enterprise and at increasing the incentives for enterprise and investment.
· Measures that help actors in the informal economy to move gradually towards formalisation, such as creating formal associations in order to ensure access to microcredit, insurance, land rights and markets.
- Gradually to pare down and simplify regulations, permits, procedures etc. To reduce regulation in the formal economy by eliminating rules which discourage or prevent participation. To reduce regulation in the informal economy by eliminating rules which promote exclusion, as in the case of certain permits and levies.
- To promote the growth of the formal economy (and employment in it), especially in poor regions.
The financial sector has a key role to play in giving poor people the chance to share in economic growth and its benefits. The AIV therefore recommends a considerable strengthening and expansion of support for financial sector development as an effective way of promoting PSD leading to pro-poor growth.
As a first step, the AIV feels that the Directorate-General for International Cooperation (DGIS) should initiate the formulation, together with the Dutch Ministry of Finance and Ministry of Economic Affairs, of a joint strategy and distribution of tasks in the general field of financial sector development. In view of the complementary nature of the three ministries’ responsibilities, competencies and participation in international forums, a joint strategy and clear distribution of tasks in this field would enhance the coherence, and hence the effectiveness, of Dutch government action in this area.
Financial sector development relates to both the public sector (government regulation, supervision and control) and the private sector (management, up-scaling etc.) and, above all, to close cooperation between the two. For that reason, the
The AIV also suggests that the two key themes for this strategy and an action plan based on it should be:
a. risk management; and
b. access to finance.
Risk management will mean two things: improving government regulation, supervision and control of the financial sector, and encouraging the development of instruments such as small-scale insurances, guarantees and derivatives which can be offered to farmers, entrepreneurs and households.
Improving access to finance means increasing and strengthening the links between microfinancing institutions and the existing financial system. Microfinancing has a major role to play in increasing interest in private sector development and financial sector development as a means of poverty reduction. Although nobody doubts the importance of microfinancing as a way of achieving poverty reduction, there are problems in relation to the microfinancing institutions.
These two themes sum up recent insights concerning the role of financial sector development in achieving poverty reduction. They are appropriate in terms not only of the traditional position of the Netherlands in international financial discussions and the approach of the leading multilateral financial institutions in this field, but also of the Netherlands’ ability to offer assistance.
Question 4: What do you see as the relatively strong and weak points of the various instruments I have at my disposal to encourage the private sector to play a more active role in Dutch development cooperation? In what ways can these instruments be improved?
To assess the entirety of Dutch government efforts in the PSD field, the AIV has asked itself two questions in relation to current instruments: firstly, ‘Are we doing the right things?’ and secondly, ‘Are we doing things right?’ To answer these two questions, the AIV has tried to determine the extent to which DGIS’s PSD instruments exhibit a number of core elements in private sector policy likely to generate both general economic growth and pro-poor growth, and the extent to which they meet a number of quality criteria. The AIV would emphasise that this is not a blueprint but a conceptual approach based on knowledge and experience in the business world and elsewhere.
In this context, strategy, the operationalisation of the strategy, evaluation and assessment are the main factors. There are really two levels of planning: strategic and operational. Any planning process should begin with the establishment of a strategy. This will be based both on external knowledge and information (such as authoritative studies by multilateral organisations like the World Bank, the IMF or the OECD) and on internal knowledge and experience, opportunities, competencies, and political and other priorities. The strategy will need regular evaluation and modification at appropriate intervals. The evaluation must consider the progress achieved in processes relevant to PSD and the extent to which PSD is actually being achieved. This is a dynamic process by which to establish ‘what should be done’.
Once the strategy has been established, the next step is operationalisation: in other words, to translate the strategy into the actions and instruments necessary to achieve the strategic aim in practice. This means making choices, setting priorities and formulating objectives in specific areas. At this stage, it will be vital to take account of the importance of the separate areas of action both to the countries involved and in achieving the goals set. Account must also be taken of the efforts of other donors and institutions and of the Netherlands’ own competencies and capacities. Quantifiable objectives must be established for the resulting activities, instruments, etc. These should not be at the lofty level of ‘the contribution to PSD’, but at the practical level of ‘progress made’ (for example, in setting up a land registry). Progress in these terms could be measured, for example, every two years under the aegis of the organisation responsible for implementation. This would produce a constant optimisation of the answer to the question ‘how should it be done?’. If this system is adopted, individual instruments will not be assessed in terms of inappropriate questions like ‘what is the contribution to PSD?’ or, even more ambitiously,‘what is the contribution to PPG?’.
Finally, the AIV arrives at the following conclusions and recommendations:
Within the existing set of P
Grants are sometimes used to encourage investment where guarantees would be more appropriate. Where risk management is the intention, grants are regularly used instead of guarantees or insurances.
Based on the information available and discussions with representatives of various organisations, the
The main policy aim should be to establish the right conditions and meet the necessary preconditions, rather than to provide any form of direct, concrete support for individual businesses.
More effort should be made to achieve synergy between instruments. At the moment, any such synergy is more accidental than the result of deliberate policy.
 Organisation for Economic Co-operation and Development (OECD) DAC,
 Western societies also have informal economies, but they are considerably smaller and less significant than those in developing countries and there is little comparison between the two situations.
 OECD, Accelerating Pro-Poor Growth through
World Bank Research Observer, Vol. 19, No. 2, Fall 2004, pp. 141-169.
 Promoting the
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Chairman of the Development Department
Advisory Council on National Policy Environment
International Affairs Division
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Date: 24 June 2005 Author: J.C.J. Vlaar
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Re: Request for advice on private sector development www.minbuza.nl
In its advisory report of January 2003, entitled ‘Pro-poor growth in the Netherlands’ bilateral partner countries in Sub-Saharan Africa’, the AIV states that private sector development should be a central element in Poverty Reduction Strategy Papers (PRSPs) and that it would therefore be interesting to conduct a follow-up study of the role of the private sector in developing countries, with specific emphasis on the scope for governments to promote private sector development in a way that contributes to pro-poor development. What role do donors and the international business community play in this context? The core issue is how the development of the private sector can be influenced, through the creation of an appropriate business climate and other measures, in such a way that the economic growth it generates directly benefits poverty reduction.
Private sector development plays an important role in current Dutch policy on development cooperation, as laid out in the policy memorandum Mutual interests, mutual responsibilities, through the theme of improving the business climate and the various partnerships in which companies participate directly and for which new instruments have been developed. In the context of improving the business climate, Dutch embassies in the partner countries conduct an annual business climate scan. This ‘ABC scan’ is intended to identify possible areas for specific support activities, in addition to initiatives undertaken by the private sector itself in the countries concerned or by other parties in the Netherlands, as part of or outside the partnership. The policy has since been put into practice by broadening the range of activities being conducted in the partner countries and will be further elaborated in the context of the multi-annual strategic plans (MASPs) which the embassies developed this year.
Internationally, the role of the private sector in economic development and the factors that influence it have also been the subject of much analysis and evaluation in the past two years. Some of the more interesting results of these analyses include the following.
Four reports from the World Bank:
- Doing business in 2005
- World Development Report 2005: A Better Investment Climate for Everyone
- Improving Investment Climates; an Evaluation of World Bank Group Assistance (draft November 2005)
- Economic Growth in the 1990s; Learning from a Decade of Reform
In July 2004 a working group of the Committee of Donor Agencies for Small Enterprise Development produced an interesting report entitled Donor approaches to improving the business environment for small enterprises, and in December of the same year, the Private Sector Development task team of the OECD/DAC/POVNET published an interim report with the title Accelerating pro-poor growth through support for private sector development. The DCD/DAC Investment Committee also publishes interim reports, which will result in 2005 in a document containing recommendations on how ODA funds can be used more strategically to foster private investment that is relevant to development.
Lastly, there are an increasing number of evaluations of the implementation of current PRSPs, and of improved planning processes which lead to greater attention for private sector development in a new generation of PRSPs. In this context I recently requested MDF to analyse bottom-up planning processes in
In light of these studies, I consider this a good moment to ask the
I would particularly like you to address the following questions:
- Is there scope for governments to support private sector development in such a way as to maximise the contribution to poverty reduction? Is it effective, for example, to introduce measures aimed specifically at certain sectors or companies (such as SMEs), what kind of measures should be introduced, and how could they be identified and integrated into a PRSP?
- What are the dangers of too much control by governments and donors? The WDR 2005 indicates that the more specific measures are the less chance they have of success. This calls into question the value of measures aimed at specific sectors or companies.
- In what way can the positive role of foreign direct investment be strengthened, such that it contributes as much as possible to employment and promotes local companies?
- What do you see as the relatively strong and weak points of the various instruments I have at my disposal to encourage the private sector to play a more active role in Dutch development cooperation? In what ways can these instruments be improved?
Agnes van Ardenne-van der Hoeven
Minister for Development Cooperation
The Advisory Council has not yet received a reaction from the government.
The press release is only available in Dutch.