Promoting Private Sector Development

Promoting Private Sector Development

An Analytical Framework For Evaluating Policies Towards The Private Sector

Paul Holden

The Enterprise Research Institute

Introduction

A dynamic private sector is a feature of all countries that have registered sustained economic growth and there are few countries in Latin America where policymakers do not acknowledge the importance of private business activity as the driving force of economic expansion. Besides promoting general prosperity, rising GDP is the most effective means of reducing poverty. A flourishing private sector is central to efforts to reduce the number of poor in Latin America, a view which has been endorsed by the Development Banks which have undertaken numerous loans aimed at developing the private sector in the region, through direct investment by their investment institutions, as well as through the promotion of a private sector oriented philosophy.

However, the actual performance of Latin American businesses has frequently been disappointing and the lackluster growth performance of most economies in the region over the past several years has generally been ascribed to an insufficient private sector response to the reforms of the early 1990s. However, many of the efforts to assist the private sector have been ad hoc. The factors that encourage a vigorous private sector are generally not examined within a comprehensive framework that enables an efficient identification of interventions that will yield the highest return nor which facilitates evaluation of the progress that has been made so far. Perhaps as a result of low growth and the corresponding failure of many countries to register significant declines in the number of poor, the focus of assistance by the International Aid Institutions has shifted to attempts to alleviate poverty directly.

This paper addresses the issues involved in the definition, measurement and nature of a ‘developed’ private sector, its recognizable characteristics, and the feasibility of monitoring change either toward or away from private sector development in any given country. There is no body of theory that specifies how the private sector grows and the topic is so eclectic that it probably not possible to develop one. However, various aspects of economic analysis can assist in identifying factors that are important in promoting a dynamic private sector. This paper suggests various ways policies directed at promoting private sector activity could be analyzed. It suggests various indicators for evaluating the private sector environment. Since the aim is to produce a relatively succinct document, many of the topics are dealt within summary form. Nevertheless, the paper provides a more foundation for more detailed work and suggests direction for further analysis, particularly at the country level which is where most private sector development policies are aimed.

The focus of the analysis is on the firm and the factors that encourage business formation, productivity and expansion. The paper analyses impediments to firm formation, barriers and constraints to efficient and flexible operation, impediments to the growth of firms and barriers to inefficient firms closing down thereby allowing resources to be speedily transferred to more productive uses. The paper suggests ways in which the State can commence the task of identifying and removing the most costly barriers to business formation and growth. It identifies the public goods necessary to support business activity as well as the rationale and limits of public initiatives, particularly with regard to market failure, information asymmetry and market imperfections. It discusses whether the role of the State is primarily to remove barriers to private sector activity or whether it can have a more activist role in promoting the private sector. It examines possible ways in which development banks could assist countries in Latin America and the Caribbean to promote flourishing private sectors.

The paper emphasizes that the private sector cannot prosper in environments that do not provide capital and financing for entrepreneurial activity and looks at the ways in which the State can encourage financial intermediation and the growth of capital markets. It examines the institutional underpinnings of financial markets, and the environment for private sector contracting and dispute resolution. It also addresses the issue of how governments can affect the cost of doing business through such factors as the provision of infrastructure and the regulation of enterprises at various levels of government.

A conclusion of the paper is that the institutions such as the legal system and the financial system that are the foundation for private sector activity are weak in most countries in the region. Transactions cost are high and there are many barriers to entry for small businesses. However, accurate information which identifies precisely where the shortcomings exist and exactly what the costs of transactions facing businesses are is inadequate in most countries in the region. The paper suggests that a heuristic approach which analyzes in detail the conditions facing the private sector on a country by country basis will help reveal appropriate private sector development strategies. This implies that detailed sector work is a prerequisite for the successful design of private sector projects.

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