Economic development and the private sector

Ravi Randeniya Fmr. Senior Policy Analyst, Ministry of Trade and Economic Development Govt of British Columbia

Economic growth is driven by private investments and improved productivity. A vibrant private sector prevails in a business environment that is conducive to private investment. It is universally accepted, however, that the business environment is better when there is: effective government, efficient markets, and resilient human resource development to meet modern day challenges.

Many governments in developing countries come under considerable political pressure to find employment opportunities for the millions of young people seeking employment after formal education and trade skills upgrading. Studies show that many of these are in the countries affected by conflict. Added to these difficulties, governments are also compelled to find sustainable ways to finance their operations. In a free market economy, private companies that drive growth and create jobs, which are the major source of tax, to maintain steady revenue collection it must represent a significant portion of the GDP to sustain steady source of revenue for governments.

Without sustained sources of domestically generated revenue, governments labour to provide essential public services such as health and education to their citizens. Therefore, governments’ other alternative is to resort to foreign aid, grants and loans to bridge the gaps created by trailing private sector performance.

Unfortunately, relying on these measures impedes private sector growth and discharge governments from their responsibilities of constructively engaging in economic development. For real economic growth, developing countries must find ways to distance themselves from exclusively counting on external assistance to fix their economies. All governments in developing countries must understand that these are simply stop-gap solutions and not long-term answers to chronic economic ailments.

If the private sector is to generate jobs, raise tax revenues for governments and deliver poverty reduction, developing countries need stronger private sector development agendas. A greater private sector role in economic development can accelerate commercial activities, wealth creation among the poor, which is a significant portion of most developing countries.

Those who are in influential positions can play a key role by focusing attention on private sector development, and by moving wealth creation to the top of the development agenda. They can scale up successful partnerships already established with the private sector, and continue to devise new ways of working with private companies.

Generally, there are many participants in the private sector, from small-scale farmers and traders right through to large firms. Because successful private companies are considered the engine of growth, and the main long-term source of jobs and incomes it is vital for the well-being of a society when there is a vibrant private sector. The contribution private companies can deliver to development and prosperity is highly dependent on their own success.

In principle, successful companies invest, participate fully in commerce, improve productivity, employ people, pay salaries, provide goods and services, generate profits and pay taxes. Private sector development is expected to make a positive contribution to development since they create:

* More and better jobs, higher incomes, empowerment and economic freedom to workforce,

* Higher tax revenues that finance public services,

* Better goods and services via competition and real choices for the poor,

* Innovation, new approaches, higher productivity, technology diffusion to industries.

The axiom ‘engine of growth’ is central to the private sector’s role as the contributor to economic development. Investment in productivity improvements and HR skills development drives growth, and productivity enhancement from private sector is designed to foster innovation. Competitive pressures in markets increase efficiency via optimal utilization of resources and should provide incentives for continued innovation and investment in vital areas in operations. Traditionally, this investment-performance mechanism guarantees continuous economic activity leading to steady growth in employment in the private sector. In successful economies, that scale tips in favour of private sector as the primary provider of employment than the public sector.

Cataclysmic dysfunctional private sector

Unfortunately in many developing countries, governments have become the main provider of formal employment. Notably, the public sector can offer only a limited number of jobs, and as more young people enter the labour market, the private sector has failed to be the primary source of employment opportunities.

Alarmingly, this is clear evidence of ineffectiveness of the private sector’s role in economic development. Its trailing should raise serious questions about the strategies and policies of a government and its inability to make its private sector the ‘engine of growth.’ As a consequence, the markets no matter how well they are framed will fail to function in a responsive manner to government action.

There can be several causes for the private sector’s lack of enthusiasm; their lack of confidence over a government’s ability to make sound fiscal and monetary policies to encourage trade and commerce, private sector participation; disengagement in progressive trade agreements with regional and distant economic zones that could provide new opportunities for the private sector and finally, ill-trained business leaderships failing to recognize and grasp opportunities or diversify into new products or services but preferring to retain unethical business practices that mitigate potential employment for masses are just a few.

When the private sector is a fully fledged participant, taxes from private companies and individuals subsidize core government expenditure such as delivering health, defence and education services. Effective income tax collection from firms and individuals build capacity and accountability on the revenue side of public finance, while providing resources for public expenditure.

It is important to understand that when a government is unable to raise revenue through taxes it is a sign of serious economic woes. An increase in per capita income follows with an increase in tax revenue and offer relative increases in education and health expenditure.

It is unsure to what extent the private sector is mindful of the fact that tax revenue is fundamental to delivering public services to bridge economic disparities in nation building - a healthy educated workforce is fundamental to the prosperity of then private sector. It is for their own good that governments have a tax revenue stream, it helps them perform better under viable economic environments.

Making entrepreneurship work for the impoverished

For impoverished people in developing countries, the private sector offers empowerment and the opportunity to prosper through a private sector which is made up of small household or informal enterprises.

They buy and sell labour, goods and services in private informal markets where prices are dictated by consumer demand and supply. When they earn higher income they increase their ability to exercise choices and reduce their vulnerability.

Creating wealth and achieving economic independence for the impoverished is at the heart of economic development. Consequently, when markets do not function in a fair and efficient way, it is the impoverished who suffers. However, these informal enterprises are not revenue streams for governments; they provide an economy in which the state plays no role and remove them from the burden of providing employment.

In one sense, the private sector is not a ‘sector’ in the way we refer to transport or education. Private companies are part of the fabric of society and operate in all the areas important to the lives of the masses. Also, private companies do have profit making agenda contrasting to the tenets of government agencies.

They are often subject to competitive pressures in markets, and their owners, management and staff are rewarded according to their ability to generate profit. As profit is the only measured indicator of their performance, it needs to have the flexibility to make rapid adjustments to deploy resources to achieve desired outcomes.

The fundamentals of the market place dictate that those companies not making profits go out of business allowing the better performing firms to carry on. Nevertheless, private sector approaches can be harnessed to traditional domains of government services such as infrastructure, health and education which can help to make them more effective and oriented to the needs of consumers.

A vibrant private sector (Ceteris paribus = with other things being equal) is the driving force for growth and development, and how growth leads to poverty reduction. It states that economic growth requires that the productivity of existing activities is increased and that new economic activities are developed.

This necessitates investment by the private sector. The private sector is most likely to invest in countries where: there is an open trade regime and an attractive investment climate; equitable, efficient and contestable markets; and also where they can readily access financial services, appropriate skills, technology and connectivity through good infrastructure and IT.

The World Bank data show a positive relationship between the share of private investment as a proportion of total investment and the rate of GDP growth. Put differently, the higher the level of private investment, the higher the rate of growth. Similarly the same measure of private investment is inversely related to poverty levels. Therefore, when private investment is higher, poverty incidence is lower.

Conventional economic policies i.e. market liberalization, has not reduced poverty through a trickle-down manner, there are too many examples of barriers to equality. Explicit measures are needed to ensure that the poor participate. Growth needs to be made available to all in order to address rising inequality, and provide opportunities and the capability to participate in markets.

Given the predicament, it could be argued that for governments interventions in markets is justifiable where there are significant failures and inefficiencies which limit private sector growth and prevent the participation of skilled men and women. Public resources used intelligently could address the major shortcomings.

To be continued