The Private Sector And Economic Development Economics Essay 2. Introduction Private sector activity matters for growth as well as its quality, sustainability and inclusiveness. This is no news; but it is at last widely recognized by the international development community, as reflected in the Busan partnership, G20 statements or the European Agenda for Change, among others that the private sector is already central to the lives of the poor and has the power to make those lives better. The motivation for increasing the role of the private sector in development is to make a contribution to poverty eradication and the achievement of sustainable development; not to help private firms make a profit. Private sector constitutes wide-ranging term covering all private actors engaged in economic activity, from the market stall-holder and family farmer to large domestic and foreign corporations. However, it is tempting to concentrate entirely on the role of multinational corporations (MNCs) or large corporations. It is important to recognise that the private sector consists of more than formal businesses. The discussion on equitable and inclusive growth and the achievement of Millennium Development Goals (MDGs), thus, is not complete without considering the role of the private sector. This essay is an example of a student’s work Disclaimer This essay has been submitted to us by a student in order to help you with your studies. This is not an example of the work written by our professional essay writers. Essay Writing Service Dissertation Writing Service Who wrote this essay Place an Order It is important, however, to define what the private sector is before discussing ways of promoting its growth. The Development Assistance Committee of the OECD provides a generally accepted definition of the private sector as: ‘A basic organizing 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’. [1]  Accordingly, the private sector encompasses all economic activities that do not involve production by the public sector and includes all for-profit firms regardless of size, activity (goods, services, or financial), or location (urban or rural), and institutions specifically established to serve the private sector such as industry associations. The boundary between private, for-profit institutions and private not-for-profit organizations is fluid and part of a continuum. But the overall role of the private sector in development, in terms of both local and international private sector activities including foreign investment, is to generate wealth and stimulate economic growth. From an Islamic perspective, private sector plays a critical role in development along with the public sector that allows economic growth and justice to complement each other. Private sector investment that reduces poverty, creates jobs, improves health and education, especially for the needy and vulnerable segment of the population are the types of investment encouraged by the Prophet. Efficiency gained from the private sector meaning that the society getting maximum output from a given level of resources. For much of its earliest history, most social goods in the Muslim community were financed by private sector, as were expenditures on health and education as well as contribution to the provision of the basic needs of the less privileged segment of the community. The focus of the chapter is to analyze the intertwined between private sector and economic development for sustainable development. The chapter also reviews the status and role of private sector in (i) the process of economic growth, job creation, and poverty reduction; (ii) enhancing access to social services for the poor; (iii) providing access to infrastructure services; and (iv) providing access to finance. 2.1 Private Sector, Inclusive Growth and Poverty Among the private sectors, debates about the role and responsibility of the private sector in society have been going for decades. It ranges from argument of Milton Friedman (1970) that the only responsibility of the business is to increase its shareholders’ profit to the ones that see corporations as social institutions that have an obligation to contribute to the well‐being of the society (Brainard, 2006). The latter argument was responded by practices of corporate social responsibility, but still its impact and scale was rather limited, especially with regards to low‐income communities. The private sector can play a much broader in development. The benefits of private participation in achieving development goals can be improved in three ways. First, attracting private participation in the delivery of goods and services will enhance operational efficiency and coverage. Second, by using the private sector to produce services on behalf of the public sector. Thirdly, by using the private sector as a partner in socially and environmentally responsible development. Despite many interactions, the relationship between economic policies and poverty are still not well known. However, majority of the evidences show that economic growth leads to poverty reduction (Datt and Ravallion, 1992; Kakwani, 2000; Fields, 2001). Figure 1 shows that economic growth contributes significantly to poverty reduction and to higher living standards for poor people. [2] Government transfer programs, such as conditional cash transfers, can help, as they have in Brazil, [3] but for most low-income countries and many middle-income countries, the tax rates that would be required to significantly alleviate even extreme poverty ($1.25/day) would be prohibitive. [4]  [Figure 1] It is agreed that the imperative of growth for combating poverty should not be misinterpreted to mean that “growth is all that matters” (Kanbur and Lustig, 1999; Lustig, et al., 2002). All countries considered by the Growth Commission as successful cases of inclusive development have sustained high growth rates for at least three decades (Figure 2). Hence, poverty alleviation requires additional elements: i) poor households need to build up their asset base in order to participate in the growth process; ii) growth needs to be more broad-based and inclusive to reach all segments of society, including the poor; and iii) short-term public assistance measures are needed to protect the vulnerable groups of society. This essay is an example of a student’s work Disclaimer This essay has been submitted to us by a student in order to help you with your studies. This is not an example of the work written by our professional essay writers. Essay Writing Service Dissertation Writing Service Who wrote this essay Place an Order [Figure 2] Growth is required to continue to help improve people’s lives well beyond levels of extreme poverty and is also associated with better attainment of MDGs related to education, health, and environment. [5] While growth on average has significant benefits for the poor, how fast poverty declines for a given rate of growth, particularly over the short to medium term, varies considerably among countries. For instance, one study covering many countries found that when average household incomes rise by 2 percent per year, poverty rates fall by about twice as much on average, but the range among countries can be significant (1.2–7 percent). [6]  Private sector has contributed to the achievement of MDG 1 through: i) aggregate income and wealth creation (indirectly); ii) employment creation and the provision of affordable goods and services for the poor (directly); iii) Removing constraints to labour force participation, enhancing household incomes, increasing tax yields, raising standards and promoting non-discriminatory and rule based systems of exchange. Figure 3 show the private sector contributes to the achievement of MDGs indirectly, through aggregate income and wealth creation, and directly through employment creation and the provision of affordable goods and services for the poor. [Figure 3] The Commission on Growth and Development reports five common characteristics of countries with high, sustained growth. [7] While many of these characteristics relate to actions that governments need to take, also prominent among these is market allocation of resources, led by the private sector. A key mechanism for economic growth is higher productivity and knowledge transfer, and the private sector can be a critical facilitator of this process. Private firms and entrepreneurs invest in new ideas and new production facilities. As shown in Figure 4, although public and private investment can be mutually supportive and the three groups had similar levels of public investment, those with more private investment enjoyed faster economic growth. [Figure 4] In the case Africa, private sector is said to be critical for employment creation, growth and development of Africa (Kurokawa et al., 2008). The development of small and medium enterprises (SME’s) is acknowledged as a key condition in promoting equitable and sustainable economic development in Africa. In fact, the importance of the micro and small medium enterprise to the development of African economies is well documented. Sustainable and inclusive development cannot be achieved without the energy of the private sector, without private enterprise, private initiative, private savings, and private resources. As international aid agencies recognized that there are no automatic trickle down effects in economic development (Dart and Ravallion, 1992; Kakwani, 1993; Bourguignon, 2001, 2003and 2004; Dallar and Kraay, 2002) attention was given to the role of governance in distributing the gains from economic growth rather than only on the economic growth. New initiatives such as Global Compact by the United Nations, Growing Sustainable Business for Poverty reduction by UNDP and International Conference on Financing for Development in Monterrey (2002) has included private sector into the effort of reducing poverty. This approach was reflected in new selection of partners to include the participation of private sectors, local communities and NGOs in international cooperation efforts such as large private charitable foundations (i.e. Melinda-Gates Foundations) without getting into controversies in selecting the issue of cooperation on priority areas. 2.2 Do Private Sector Create More Jobs? In most countries, the private sector is the major component of national income and the major employer and creator of jobs. Over 90 percent of jobs in developing countries are in the private sector. [8] The pace of job growth and the quality of employment in the private sector are thus central to development. A vibrant private sector also contributes to higher wages. More productive firms, nurtured by a good investment climate, can pay higher wages and invest more in training their workers. The expansion of firms can also have knock-on effects, raising the wages of those in smaller firms as the pool of available workers tightens. Similar patterns are found in rural areas, with rising non-farm employment lifting agricultural wages – with significant impacts on poverty reduction. Private sector is the engine for sustainable job creation and the dominant source of jobs worldwide. In 2003 the private sector employed more than 90 percent of people in developing countries and 95 percent of people in countries such as El Salvador, India, and Mexico. Growing economies create more jobs, particularly in developing countries. For the private sector, the impact of investment climate improvements on employment growth can also be seen by looking at experiences in selected individual countries. For example, investment climate improvements in China, India, and Uganda contributed to employment growth of more than 2 percent a year between 1985 and 2000. This essay is an example of a student’s work Disclaimer This essay has been submitted to us by a student in order to help you with your studies. This is not an example of the work written by our professional essay writers. Essay Writing Service Dissertation Writing Service Who wrote this essay Place an Order The private sector are also better at creating jobs and economic growth for few reasons: i) private firms have a profit incentive to cut costs and develop products demanded by consumers; ii) for political reasons, it is sometimes more difficult to get rid of surplus workers in the public sector than private sector; and iii) reduce government spending can free up resources for more efficient private sector growth and job creation. According to World Bank (2009), [9] it is estimated that 40 million jobs need to be created over the coming decade in MENA region. These jobs will have to come from the private sector Governments will not be able to create these jobs in the public sector. Neither will they be created in state-owned enterprises – at least not in sufficient numbers or in a sustainable manner. [Figure 5] Among the private sector, SMEs play a leading role in creating employment, income and value added, and in providing the seedbed for developing and testing entrepreneurial talent. Jobs in small and medium enterprises together (SMEs) account for more than half of all formal employment worldwide. This is especially true in low-income (Figure 6) countries, where SMEs represent on average about 66 percent of permanent, full-time employment. [10] The comparatively high share of employment SMEs provide shows that they play a major role in income generation for broad – and above all often less privileged – sections of the population. This is why the development of the SME sector in developing countries increasingly figures as a central element in poverty reduction strategies. [Figure 6] Poor people believe that having a job (whether self employed or waged) is the quickest and surest way to escape being poor (Figure 6a). And, with limited budgets, governments in developing countries are looking to the private sector to generate the jobs which will reduce poverty – and to help supply the services the poor need to improve their quality of life. [Figure 6] 2.3 Private Sector, Financial Inclusion and Access to Finance By mobilizing savings, facilitating payments and trade of goods and services, and promoting efficient allocation of resources, the financial sector is seen as playing a critical role in facilitating economic growth and, directly through broadening access to finance and indirectly through growth, contributing to poverty reduction. Moreover, expanding market access to all private sector actors and improving how markets function can lead to such results as more jobs, better returns on goods sold, greater affordability of essential goods and services and reduced exposure to risk. But modern development theories very much emphasize that broad financial access is the key to development.  Lack of access to finance is often the critical element underlying persistent income inequality as well as slower growth.  Without inclusive financial systems, poor individuals and small enterprises need to rely on their personal wealth or internal resources to invest in their education, become entrepreneurs, and make their businesses grow. In Africa, less than half the population has an account with a financial institution (Figure 7). Access to finance affects new firms’ ability to raise financing and to support long-term growth through gains in productivity. Firms need mainly two types of finance: short-term credit (i.e., working capital, trade credit, supply credit) and long-term debt for capital investments, equity, leasing, etc; both types are complementary for their operations. [Figure 7] The financial sector plays an important role for private sector access to finance: in mobilizing and allocating resources, managing risks, and facilitating transactions across companies. A developed and well-operating financial sector is essential to achieve economic growth. The financial sector has a key role to play in giving poor people the chance to share in economic growth and its benefits. The literature has found a positive relationship between access to finance and countries’ long-term growth (Figure 8). Studies suggest that financial development helps generate capital accumulation, higher productivity growth, innovation, and entrepreneurship which propel growth. Additionally, access to finance is related to job creation as firms expand operations and become more productive. [Figure 8] A large body of empirical studies has provided evidence of the causal linkages from financial sector development to economic growth and poverty reduction. [11] Financial development (using different measures) is positively associated with employment growth. The measures that had a significant relationship were a strong banking sector (the ratio of private credit over GDP) and financial openness (the sum of foreign assets and foreign liabilities over GDP). While the total credit provided by the financial sector is relevant for job growth, so too is the distribution of these resources among different firms in the economy, the mix of products offered and the costs involved. This essay is an example of a student’s work Disclaimer This essay has been submitted to us by a student in order to help you with your studies. This is not an example of the work written by our professional essay writers. Essay Writing Service Dissertation Writing Service Who wrote this essay Place an Order Empirically, many studies looking at micro data find evidence of a positive correlation between access to finance and poverty. Jacoby (1994), for instance, finds that lack of access to credit perpetuates poverty in Peru because poor households cannot afford to provide their children with appropriate education. Jacoby and Skoufias (1997) show that households from Indian villages without access to credit markets tend to reduce their children’s schooling when transitory shocks reduce their income. Similarly, Dehejia and Gatti (2003) and Beegle, et al. (2003) show that child labour rates are higher in countries with poorly functioning financial systems. 2.4 Private Sector Participation and Infrastructure Infrastructure industries and services are crucial for generating economic growth, alleviating poverty, and increasing International competitiveness. Safe water is essential for life and health. Reliable electricity saves businesses and consumers from having To invest in expensive backup systems or more costly alternatives, and keeps rural women and children from having to spend long hours Fetching firewood. Widely available and affordable telecommunications and transportation services can foster grassroots entrepreneurship and so are critical to generating employment and advancing economic development. The basic rationale that infrastructure is essential for development (growth and poverty reduction) remains predominant in all levels of the literature. The view that private investment is a crucial ingredient in infrastructure development is prominent in the donor literature but contested elsewhere, though it is also quite widely accepted in the academic literature. Recent World Bank estimates now consider that the average infrastructure share of GDP for developing countries needs to double, from 3-4 percent to 7 percent; for low income countries, the financing requirement may be even higher, at 8 percent to 9 percent. The private sector is able to provide essential services such as infrastructure (transport, telecommunications, water, power), health, education, and finance that are important to growth and to improving people’s lives. The private sector played an increasing role in all infrastructure sectors, including power, natural gas, telecommunications, transport (railways, roads, ports, and airports), waste treatment, water supply, and sanitation as governments have sought alternatives to public funding and looked for more efficient ways to deliver services. Estimates for global infrastructure investment needs in developing countries range as high as US$1 trillion per year, over 5 percent of GDP (Figure 8). [12]  [Figure 8] A public-private partnership can combine the respective strengths of the private and public sectors. The private sector can leverage its advantages of greater efficiency, lower costs of distribution, and more complex delivery systems to reach new markets. The public sector can ensure universal access by providing financial support to subsidize impoverished households, thereby enabling private firms to enter large markets with guaranteed consumers. Public funding for the private provision of essential goods and services needs to cover both capital and recurrent costs to “close the revenue cycle.” The private sector has a role to play in the provision of both infrastructure and social services. Where it makes sense, private participation is often best introduced by new entry of private providers, many times by small or medium scale local entrepreneurs. Some form of private participation in various infrastructure sectors has been actively pursued by over 150 governments during the last two decades. Both successes and failures have led to a more balanced assessment of required policy measures, in particular government regulation. Private participation in the social services, while de facto widespread, remains a highly contentious issues. In some countries, private participation in infrastructure now accounts for as much as half of infrastructure spending. [13] During the 1990s, the private sector began increasing its participation in the delivery of essential services partly because of the heavy fiscal burdens of state-owned enterprises and partly because of the increased commercial opportunities in emerging markets for private investors. While governments maintained their role of managing policy and regulatory frameworks, they allowed more private sector provision of services. The shift from public to private provision of infrastructure was rapid – by the end of 2001 more than $755 billion of investment flows and nearly 2,500 private infrastructure projects had been undertaken in developing countries. [14]  In water and sanitation services, private sector participation has been generally touted as the solution to the pressing needs for huge capital investment that have beset many developing countries, allowing governments to free resources for other important sectors (Prasad 2006, Davis 2005, and Trebing 2004). Based on recent historical data (World Bank PPI database 1990–2006) total private investment in water and sanitation averaged $3.3 billion per year (i.e. only about 1.8% of the annual investment needs of developing countries). In practice however, these goals have been difficult to achieve. This essay is an example of a student’s work Disclaimer This essay has been submitted to us by a student in order to help you with your studies. This is not an example of the work written by our professional essay writers. Essay Writing Service Dissertation Writing Service Who wrote this essay Place an Order Approaches to public-private investment, however, have evolved. All options promote, to a differing degree, commercial viability, operational efficiency, increased competition, improved cost recovery and performance-based compensationsThere is now an increasing recognition of opportunities for synergy between hardware and service provision in infrastructure and between private and public investment that may reduce poverty and help achieve the new global goals of the MDGs. The old dichotomies of the past (especially of private versus public provision and growth versus pro-poor targeting) are being rejected in favour of more nuanced approaches to ‘what works’ (Meridian Institute, 2005; UNDP, 2006). There is a wide spectrum of options for private sector participation in infrastructure and public service provisions that vary in the respective roles of the public and private sectors as they concern ownership, management financing, risk sharing, duration, and contractual management with the users. These options may be classified into two groups: (a) those that retain public ownership of the assets while contracting out management, operation, and even investment includes service contracts, management contracts, lease arrangements, and concessions; and (b) those that involve at least partial or temporary private ownership of assets. The first group includes BOOT (Build-Owned-Operate-Transfer and its variations, BOT and BOO), reverse BOOT (whereby the public entity builds the infrastructure and progressively transfers it to the private sector); joint ownership or mixed companies, and outright sale or divestiture. 2.5 Private Sector Role in Health and Education There is ample evidence to confirm the significant role played by the private sector in health and education. Such observable facts, however, are not always accepted as justifying such arrangements or further efforts to engage with, support, or even enhance them. Discussions about the private sector in human development are often driven by value-based positions about whether this role is a good or bad one. Such normative views influence debates about government action. Understanding the basis for these views is important. It is helpful to consider at least three different value-based positions that often underpin views about the private sector’s role in health and education. The first perspective draws on economic theory centered on the role of markets. According to this view, reasonably well-functioning markets exist for goods and services, and better outcomes for human welfare (which economists define as “efficiency”) are obtained when government roles are kept limited and mainly focus on improving the functioning of these markets. This view suggests that the private sector should be encouraged to deliver those goods and services for which there is private demand and little market failure and that the government role should emphasize public goods for which markets may not exist or significantly fail to provide optimal outcomes. A different perspective is propounded by those who argue that all citizens have a right to health and health care as well as education. Rights are typically the responsibility of the state to define and to ensure. Calls for comprehensive and universal health and education services with government financing and delivery are often justified as the appropriate way to fulfill these rights, with the corollary that the private sector’s role should be limited. Rights-based arguments need not always promote a central role for government in service provision. Many advanced countries have universal systems with mixed provision. A third perspective, a pragmatic or results-oriented approach, argues that strong normative positions about government and private sector roles should be avoided. The focus should be on what works to improve outcomes in health, learning, and equity. This approach fosters acceptance of more pluralistic strategies for financing and delivery of health and education services, and this is the position taken in this chapter. This view does not preclude strong conclusions about preferred government and private sector roles in health and education, based on theory and evidence about how markets relevant to human development succeed or fail to produce optimal outcomes, as well as the strengths and weaknesses of government. Private sectors are already playing a significant and increasingly diverse role in both health and education sector. Figure 3.1 presents recent estimates of the share of total health expenditure at the national level that comes from private sources. Across the range of country income levels, private spending accounts for more than half of all health expenditures in about 47 percent of low-income countries and about 51 percent of lower-middle-income countries (figure 3.1 upper). For the low-income countries, private health spending is almost entirely out-of-pocket spending, because private insurance and formal employer-provided benefits are limited. Figure 3.1 (lower) shows that in 80 percent of low-income countries and 93 percent of middle-income countries, out-of-pocket spending makes up over 50 percent of private spending. This essay is an example of a student’s work Disclaimer This essay has been submitted to us by a student in order to help you with your studies. This is not an example of the work written by our professional essay writers. Essay Writing Service Dissertation Writing Service Who wrote this essay Place an Order The private sector is also an important provider of education. Over the past two decades, private participation in education has increased dramatically throughout the world, serving all types of communities—from high-income to low-income families. Unlike for health, information for education is available only for a relatively small set of countries and indicators. Figure X shows recent data on the share of education expenditure from private sources for countries with available information. In some countries, such as Jamaica, Peru, and Zambia, the private sector contributes more than 40 percent of the total expenditures in education. In several others—such as Chile, Haiti, Kenya, Paraguay, and the Philippines—the percentage fluctuates between 30 and 40 percent. [Figure X] Although governments remain the main financiers of primary and secondary education, in many countries private agents deliver a sizable share. Table 3.3 shows the participation of the private sector in primary and secondary education for 1990 and 2006 for those countries with available information. Private enrolment shares at the primary level increased by a large magnitude in countries in most regions, particularly in Sub-Saharan Africa, the Middle East, and Southeast Asia. At the secondary level, private enrolment has also increased, although less uniformly across countries. However, private enrolment shares typically remain higher in secondary education than in primary education. Countries provide different examples of mixes between public and private sector roles in education financing and provision. Some countries make a sharp distinction between the role of the public sector as the education financier and the private sector as the education provider. For instance, in the Netherlands, all education is publicly financed, including private schools, which enroll more than two-thirds of all students. In other countries, such as Chile, the private sector plays an important role in providing education, but the government subsidizes only some of the students who attend private schools. Several African countries have different types of non-public schools, including government-subsidized independent schools (for example, in the Gambia); partially subsidized mission or religious schools (for example, in Lesotho); and partially subsidized community-organized schools (for example, in Kenya). Elsewhere, public schools are supported financially by the private sector in the form of user fees or corporate sponsorship (for example, in Pakistan). 2.6 Other Contributions of the Private Sector in Development Private sector also contributes to development in other ways that are crucial to economic development and poverty reduction: One of the most obvious private sector contributions to national development is company payments of tax revenues and royalties. In most developing countries, they generate a large portion of government tax revenues, without which there would be no sustainable base for funding public health care, education, social safety nets, agricultural research, and other critical expenditures. Private sector investment that can lead to higher tax revenues for developing countries is therefore intimately linked to development objectives. Private sector can contribute to development through their core (i.e. normal) business operations. The poor can benefit from core business activity as employees, entrepreneurs, suppliers, distributing partners, and consumers. Some firms have also adopted “inclusive business models,” which are the subject of a growing body of research that focuses on the links between business activities and development objectives. In countries with competitive economies, leading private firms will constantly seek out information that has practical local uses; to remain competitive other firms will emulate their behavior. Competitive firms improve the quality of products and make them more affordable, thereby boosting the purchasing power of consumers, including poor consumers. In the process, executives and employees upgrade their human capital, productivity, and incomes, contributing to the diffusion of useful knowledge and techniques. The private sector can make important contributions to development efforts through its expertise and innovative approaches and applications. An innovative private sector can find ways to deliver low-cost (even sophisticated) goods and services to demanding consumers across all income ranges. Private business activity adds value to a nation’s given resources, by introducing new ideas on how best to combine them among alternative uses. It can develop distribution links to the consumer in the village and so be better able to harness knowledge about the actual needs of this segment of the market. It can keep costs low through outsourcing, for greater flexibility. The private sector also plays a role in relation to aid processes, include the following: [15] mobilisers of resources through innovative consumer or market based mechanisms of foundations and/or the for profit private sector; contributors of financial and in-kind resources through funding for research; providers of goods and services as implementers/contractors in aid projects; dialogue partners and advocacy on how to enhance inclusive business and market approaches; partners in public-private partnerships (PPPs) through cost and risk sharing, including so called co-investment. 2.7 Conclusions While the private sector was traditionally seen more narrowly as a source of additional financing for development projects, the preceding section has underlined that its role in development is a much broader and more fundamental one. Beyond another resource for development assistance, the private sector can also make many important contributions to long-term development through day-to-day activities such as core business operations that include the poor, the payment of tax revenues and the design, manufacturing and even delivery of key products and services. More generally, the expertise, ideas and innovation that the private sector brings to the table means that it can contribute to the understanding of development problems and the framing of optimal strategies to overcome them. At the same time, development practitioners and businesses have been, and will continue to, test and seek to improve upon the best practices and modalities of private sector involvement in development efforts. This ongoing process reflects the complex and multi-faceted nature of the private sector’s role in development, a fact which was evident in the diverse presentations made to the Committee by witnesses. That testimony also made it clear that a full understanding of this topic requires recognition of the fact that private sector activity occurs within broader governance and institutional frameworks, an idea which will be elaborated upon next