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GREAT insights Magazine

Private Sector for Development

Distinguishing the Trees from the Forest

October 2012

Byiers, B. 2012. Private Sector for Development: Distinguishing the Trees from the Forest. GREAT Insights, Volume 1, Issue 8. October 2012. Maastricht: ECDPM.

Engaging the private sector for development is a hot topic in donor headquarters. But how to go about this in practice needs us to be clearer about our objectives. This article suggests some ways to break down the agenda and raises some ensuing questions.

“What the private sector really needs is….”

“Walk into a typical micro or small business in a developing country and spend a few minutes talking with the owner and it is often clear that owners are not implementing many of the business practices standard in most small businesses in developed countries. Formal records are not kept, and household and business finances are mixed together. Marketing efforts are sporadic and rudimentary. Some inventory sits on shelves for years at a time, while more popular items frequently are out of stock. Few owners have financial targets or goals that they regularly monitor and act to achieve. The picture is not much better in medium and some large firms, with few firms using quality control systems, rewarding workers with performance-based pay, or using many other practices typical in well managed firms in developed countries.” (1) So begins a recent review of the impact of business training and entrepreneurship programmes in developing countries.

As the extract highlights, promoting private sector development in developing countries is not just a question of improving the business environment, increasing access to credit, or providing access to markets. Nor does providing training have unambiguously positive benefits, as the study goes on to discuss. Might greater impacts come from promoting international investment? In theory, the answer could be yes, as Foreign Direct Investment (FDI) not only has the potential to create employment and spur additional positive spillovers, but it can also improve private sector practices and performance in complying with and supplying larger, international firms and markets. 

But promoting FDI in the hope for positive spillovers (and minimal negative ones) is nothing new, and in the past has met with varying degrees of success. This is due, in part, to the difficulty of linking large investments with local producers who are required to regularly and consistently meet strict quality standards for demanding customers, often in Europe. 

So what can we hope to achieve from greater donor engagement with private sector investment and finance that is different? Is it aimed at overcoming these challenges to private sector development or is it something different? What does greater private sector engagement mean for development policy, for developing country governments, for development partners and for different private sector actors and business models? Is this a case of putting the private sector before the social sectors? Is it pitting stakeholders against shareholders? And what does it mean in terms of development impact?

Engaging the private sector: one agenda or three?

These questions are at the centre of on-going debates on how to “engage the private sector for development”. While many donors have been working with private sector firms for some time, with the EC the latest champion of such an approach as expressed last year in its Agenda for Change, the topic is attracting a widening audience. “Engaging the private sector” seems like a useful approach but how then to gauge development impacts for such a broad agenda? 

It is important first of all to be clear about what we mean by “engaging the private sector”. While a range of instruments are being used for engaging with the private sector, it seems useful to distinguish between private sector development (PSD), and private sector for development (PS4D). Despite the links between the two, the distinction may be useful in terms of discussing development impacts and lessons for the development policy agenda. (2) 

Private sector development is a relatively “old” agenda, focusing very much on policies in domestic countries to promote investment, employment creation, firm expansion, increasing productivity and expansion into larger markets. It is mostly about donors working with developing country governments and sometimes private sector stakeholders to improve the business environment, increase access to credit, and promote greater value-addition within the developing country. This may also include promoting stronger linkages with inward investment.

At the risk of over-simplifying, the PSD agenda works broadly on the assumptions that if the policy environment were better and firms had access to credit, skills and markets, then the private sector would take off, jobs would be created and thus poverty reduced through increased incomes and a virtuous circle of demand. 

The newer private sector for development agenda seems more about how donors can work with developed country (and to a degree emerging player) firms and finance for development purposes, of which private sector development is one element. This agenda can be further divided into private investment for development and private finance for development. The first of these is generally about how to channel public money to private projects, basically subsidising FDI to tilt the balance of commercial risk associated with investing through normal channels. Where this is also intended to promote private sector development, the assumption is that the additional donor contribution can also help overcome the private sector capacity constraints mentioned above. 

Engaging private finance for development is more about how to use public finance to leverage private finance for public projects in areas such as infrastructure. Although the focus is again often on offsetting risks, either through provision of publicly financed guarantees or interest rate subsidies, it is also about tapping the experience and know-how of the private sector. The development implications are likely to differ between engaging with private sector ‘investment’ or ‘finance’.

Some key questions: PSD

Analyses have stressed the need to take account of myriad forms of private sector activity, business models, business scale, sectors, markets, motivations and idiosyncratic risks. These then affect how firms behave and react to different policy reforms.

There is a range of internal constraints to firms that cannot be ignored. Firms have very different levels of capacity for market integration locally and nationally, never mind regionally or internationally, so capacity and productivity are real underlying problems – there is evidence that management is important, although training outcomes are mixed. 

There is also a range of external constraints to firm performance. Business environment and red tape are important as are infrastructures. But the reality is that similar firms face very different conditions in regulatory terms and that while access to roads, energy, communications and water are important, the ways these markets are organized, for example in transport, may be as important, if not more, than road quality. How to address this vast diversity of challenges is a key question that needs to be addressed moving forward.

How should we look at the “private sector”? Pritchett suggests breaking the private sector into a) high-rent vs b) competitive production markets, and c) domestic vs d) export client markets. This leads him to characterize firms as powerbrokers (ac), rentiers (ad), workhorses (bc), and magicians (bd).(3) As the attributed names suggest, firms in each of these categories operate in very different ways, according to distinct constraints and opportunities. And even within these categories, firms are likely to face varying constraints whether they relate to markets or bureaucracy. 

Overall, in designing reforms we need to understand the political economy of reforms that affect the private sector. Why do partner governments undertake certain business-related reforms but not others? Although the private sector, and agriculture in particular, are often touted as partner government priorities, why do operators complain that they are not prioritised in practice? And what can be done to ease the lives of “workhorses” when up against “powerbrokers” and “rentiers”? These are perhaps the real questions for the PSD agenda.

Key questions: Private investment for development

The big questions for engaging private sector investment for development surround the implications for donors of engaging with international firms through different instruments and how to maximize development impact. Plenty of FDI takes place without any need for public funds, and while the need for profit remains, there are increasing examples of this happening with an explicit development objective.

The questions for donors therefore relate to the opportunity cost of using aid to fund investments compared to, say, social programmes, and how to identify and measure the development impact both ex-ante and ex-post to gauge where the burden of risk ultimately lies, and where there are genuinely aligned interests. That is, to what degree are donor contributions genuinely necessary and catalytic, and how can we measure the “stakeholder value vs shareholder value”? Are there lessons to be learnt here from existing models such as Fair Trade, where development standards or criteria have been defined?

Key questions: Private finance for development

In terms of donor efforts to engage private sector finance for development, the principal interest is in the legal frameworks and mechanisms required on the ground to access such funds, the ability to bring suitable projects to market and again to be clear on who ultimately carries the financial risks. In Public Private Partnerships (PPPs), the capacity for negotiation on legal issues is often stronger in international companies, suggesting that risks may fall disproportionately on governments. On the other hand, companies may have little political leverage if sovereign governments do not uphold their side of the contract. It is also important to note the assumption here that a lack of finance is the binding constraint. 

As argued elsewhere, private sector preferences for financial engagement do not always align with public priorities. In particular, the profit motive means there is a tendency to engage in sectors where commercial returns are high, with the risk of producing “sector orphans.” (4) 

Overall, there are a number of balancing acts to be pulled off. This implies a need to learn lessons from existing instruments, by examining the major tradeoffs and how final outcomes compare with original objectives. Similarly, whether talking about PSD or PS4D, it is important to have a good understanding of the private sector perspective – are companies as enthusiastic to engage with donors? And when we talk of engaging the international private sector, could developmental aspects perhaps take advantage of industrial policy? 

And ultimately, if we imagine walking into a typical micro or small business in a developing country in a few years time, what is it that we really expect to see? 

Bruce Byiers is Policy Officer at ECDPM 

Footnotes:
1. McKenzie, D., Woodruff, C., 2012, “What Are We Learning from Business Training and Entrepreneurship Evaluations around the Developing World?”, World Bank Policy Research Working Paper No.6202. http://econ.worldbank.org/external/default/main?pagePK=64165259&piPK=64165421&theSitePK=469382&menuPK=64166093&entityID=000158349_20120919131125
2. See ECDPM Discussion Paper No.131: www.ecdpm.org/dp131
3. Pritchett, L., 2012, Presentation, “Rethinking Development Strategies in a Shifting World: How to Mobilise the Private Sector?”, OECD Conference, Paris 28 Feb 2012
4. Dalleau, M., 2012. Unlocking private finance for Africa’s infrastructure development: Tips and Traps. ECDPM GREAT Insights, May 2012

 

This article was published in Great Insights Volume 1, Issue 8 (October 2012).

 

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