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p. 4 of 14 BACK | NEXT The need for a strategy Why a strategy now Why a comprehensive strategy Private sector and poverty reduction The strategy The required internal changes The implementation plan

Private Sector Development Strategy : The need for a strategy

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Private sector and poverty reduction

It is widely accepted that the private sector is needed and better suited for sustaining rapid growth. And the Asian experience shows that growth is the most powerful weapon in the fight against poverty. Growth creates jobs that use labor, the main asset of the poor. As growth proceeds, private sector employment becomes the major source of economic support for the majority of workers and their families. Thus, improving labor market operations is an important element of strategies to promote pro-poor growth and reduce poverty. It also helps allocate a country’s human capital resources to their most productive uses, enhancing general economic welfare, and encouraging further growth and development. Well-designed labor market policies help societies make growth more equitable by smoothing income fluctuations and broadening access to human capital development and employment opportunities. However, it is also important to recognize the linkages across factor markets (labor, capital, and land). Thus, an integrated approach to the removal of distortions in different factor markets is essential for sustained success in the fight against poverty.

Growth also increases the tax base that enables government, acting on good governance principles, to finance labor market programs and provide basic social services. Health and education services, in particular, give the poor a better chance to increase their productivity and earning capacity. Transparency and accountability in government are crucial to ensure that such social expenditures are effective and can reach the poor.

Data for several developing regions in the world illustrate that poverty incidence at any point in time is largely a reflection of a country's previous economic growth performance (Box 1). This important relationship between poverty reduction and growth is exemplified more clearly by the experiences of developing countries in Asia. In East Asia, for example, poverty incidence decreased following growth acceleration in the 1980s and early 1990s. By contrast, also in East Asia, the negative growth resulting from the 1997 financial crisis led to a rise in poverty incidence in the affected countries. Indeed, no country or region in the world has successfully reduced poverty in a no-growth environment.

Box 1: Economic Growth and Poverty Reduction Differences in economic growth across the world's developing regions, as well as across countries (see chart below), largely explain the differences in poverty incidence. To illustrate, during 1987-1993, poverty incidence in East Asia (excluding the People's Republic of China) decreased significantly from 23 percent to 14 percent, and the number of poor people declined from 109 million to 74 million, following over 6 percent real per capita income growth during the 1980s. In South Asia, where income per capita was growing annually at about 3 percent during the 1980s, poverty incidence dropped slightly from 45 percent in 1987 to 43 percent in 1993, although the number of poor people rose from 480 million to 515 million. By contrast, in Latin America and the Caribbean, where per capita income contracted in the 1980s, poverty incidence increased from 22 percent in 1987 to 24 percent in 1993 and the number of poor people increased considerably from 91 million to 110 million. Similarly, in Sub-Saharan Africa, where the growth of income per capita turned negative in the 1980s, poverty incidence remained high at 39 percent and the number of poor people increased markedly from 180 million to 219 million. Sources: Pernia, E.M., and M.G. Quibria, 1999. "Poverty in Developing Countries." In Handbook of Regional and Urban Economics, edited by Cheshire P. and E.S. Mills. Amsterdam: North-Holland; and World Bank. 1996. Poverty Reduction and the World Bank: Progress and Challenges in the 1990s. Washington, DC: The World Bank.

In all countries, where direct poverty reduction and social safety net programs are necessary to address poverty, budgetary spending typically involved in these programs would be difficult without economic growth. Poverty support programs have a stronger constituency when the economic pie is growing. Alternative funding from foreign aid or borrowing could help, but is not sustainable in the long run.

Of course, both the level of growth and its pattern (or how the benefits of growth are distributed) matter for poverty reduction. The extent of participation of the poor in a growing economy is key. However, East Asian countries have shown that growth can lead to a decline in poverty despite a rise in inequality. During 1993–1998 in Viet Nam, for example, poverty declined substantially due to rapid growth, and despite a rise in inequality (Box 2). The case is clear that the contribution of growth to poverty reduction was significant and robust. There are, of course, cases where the rise in inequality exceeded growth and the poverty situation worsened, as in Thailand during 1975–1986 and rural People’s Republic of China during 1985–1990. The ideal case was seen in Malaysia (1973–1989) and Indonesia (1978–1984), where the growth and distributional effects reinforced each other and led to an even stronger impact on poverty reduction.

The private sector can also affect poverty in other ways. For example, private investment in infrastructure projects that are properly regulated can relieve pressure on public budgets and, thus, enable governments to redirect more resources to social spending. Private sector participation in infrastructure can also improve the delivery efficiency of essential services and extend these to the poor. Experience has shown that efficiency gains from privatizing utilities can benefit all income classes. But with effective regulation that ensures appropriate tariff policy, lower-income groups tend to gain relatively more than higher-income groups, improving the distribution of income.4 Concessions can be designed such that bidders are required to provide service to poorer areas (e.g., through public standpipes charging low lifeline tariffs for water supply), with the associated cost to be borne by government in the form of lower concession revenues. Public-private partnerships with features such as this can help address poverty, as governments recognize that such activities must be underwritten by the public budget, and as private companies realize the value of collaborative investing, both in terms of community relations and financial returns. Such an approach makes the subsidy to the noncost-recovering activity transparent and best represents good public policy. Cross-subsidies are neither transparent nor sustainable. Although they can be useful for helping the poor in situations where better means of transferring resources to the poor do not exist, there can and should be better instruments that, over time, can be developed and used to replace cross-subsidies.

Private provision of goods and services with public financing can also be well-suited to the social sectors, as another form of support for poverty reduction, where the private sector can sometimes be engaged on a contractual basis to operate not-for-profit social facilities, like schools and health clinics. With proper regulation, private sector management is often more efficient than public administration and can deliver better and more innovative service at a lower cost. In many countries, health services are provided by the private sector but with public financing. In addition, the private sector can, and often does, supply for-profit social services to the higher income groups—for-profit hospitals, higher education, etc.—freeing up government resources for the needs of lower income groups. Clearly, the private sector can play some modest role in poverty reduction. However, it is neither in a position to provide noncost-recovering social services on its own balance sheet, nor to engage in not-for-profit activities without compensation. Thus, the private sector cannot be expected to undertake extensive poverty interventions on its own.

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