Economic growth is central to achieving the Millennium Development Goals (MDGs) and a vigorous private sector is vital for strong, sustainable growth. The private sector drives job creation and improved productivity, and provides most of a country’s income. Revenues from private sector transactions and incomes pay for many of the public goods provided by governments.
Growth led by the private sector benefits the poor. The expansion of job opportunities is the single most important pathway out of poverty, according to World Bank analysis. When average household incomes rise by 2 percent, poverty rates fall by about twice as much, on average (Ravallion, 2001).
With the ongoing financial crisis, credit is hard to come by across the world and private firms are downsizing, laying off workers, and delaying or even canceling investment plans. There is an urgent need to ensure that the private sector has the tools it needs to grow, supported by fiscal and monetary policies.
The agenda involves improving the enabling environment in which businesses of all types and sizes operate, and increasing the attractiveness of economies to investors at home and abroad.
How to enable the private sector to recover and grow
Access to finance and infrastructure and the quality of business regulation are three key determinants of the enabling environment for the private sector.
In the current credit crunch, it is important to shore up the private sector’s access to finance for investment and trade, both of which have contracted sharply.
Governments and development partners need to quickly focus on access to finance for small and medium enterprises (SMEs) that are critical for job creation. SMEs are one of the main areas targeted by the World Bank’s Vulnerability Framework, along with social safety nets and infrastructure.
Simultaneously, broader reforms are needed to stabilize financial systems, including strengthening financial regulation and supervision.
Countries that need to recapitalize distressed financial institutions must prepare for that possibility in advance.
Finance is essential for development. When financial markets work well, they help boost growth, improve income distribution, and reduce poverty.
Financial development accounts for 24 to 50 percent of the impact of GDP per capita on several MDG indicators. This is large in relation to other policy effects.
The ratio of private credit to GDP is 88 percent in rich countries and 16 percent in low-income countries. Research shows that a 10 percentage point increase in the private-credit-to-GDP ratio reduces poverty ratios by 2.5 to 3 percentage points.
Responses of 70,000 firms in over 100 countries to the Enterprise Surveys show that SMEs in low-income countries rank finance as an especially high barrier for growth.
Increasing access to finance for low-income groups is not easy and can involve risks, as seen in the US subprime lending market. Regulation and supervision in developing countries should be designed to help increase access sustainably.
Large infrastructure gaps remain in areas crucial for the MDGs: 1.1 billion people without safe access to water, 1.6 billion without electricity, 2.4 billion without sanitation, and over a billion without access to telephones.
The most urgent challenge related to infrastructure in developing countries is finance. Multilateral institutions will need to help viable ongoing public-private partnership (PPP) projects in financial distress. The World Bank’s Infrastructure Recovery and Assets (INFRA) Platform, with the IFC’s Infrastructure Crisis Facility, aims to support and refinance PPPs at risk.
However, more financing is not the only challenge. It is estimated that, for example, Sub-Saharan Africa could reduce its infrastructure financing gap of about $40 billion annually by as much as 45 percent, by managing investments better, reducing operating efficiencies, and recovering more costs.
Even in tighter financing conditions, countries that implement reforms of the institutional and regulatory framework for PPPs in infrastructure can expect to attract more private investment and enhance its development effectiveness.
Investments in energy-efficient infrastructure contribute to immediate economic recovery and growth, as well as mitigate climate change in the long run.
Substantial scope for regulatory and institutional improvements
The financial crisis has reinforced that the aim should be better, not necessarily fewer, regulations. Simplified procedures should ensure protection of public interests. The crisis has highlighted the role of appropriate regulatory oversight.
Measured by the World Bank Group’s Doing Business and Enterprise Surveys, developing countries have implemented significant regulatory reforms to assist private sector activities.
Regulatory reforms are more effective in stronger institutional environments. In many countries, firms report corruption as a major constraint to business.
The areas in which the least regulatory reform has taken place across countries in the past five years are contract enforcement, labor market rigidity, and disclosure.
Effects of regulation on SMEs, the informal sector, and women
SMEs—typically an economy’s main engine of job creation—are the most affected by investment climate weaknesses, compared to either micro or larger firms.
The regulatory burden faced by small firms particularly influences whether they operate in the formal or informal sectors. The heavier the regulatory burden faced by small firms, the more likely a country is to have a large informal sector.
Enterprise Survey data confirm that women’s participation rates in business are lower than men’s. But as regulatory burdens fall, more women tend to become entrepreneurs. Better economic opportunities for women are associated with higher incomes, higher literacy, better health, and faster economic growth.