International Finance Corporation — Paths out of Poverty: Why private sector development matters

Paths Out of Poverty: Why Private Sector Development Matters

Paths out of Poverty: Why private sector development matters

1

2

Growth and Poverty Reduction

Paths Out of Poverty: Why Private Sector Development Matters

p

Unlocking growth of these enterprises is key to unlocking poverty reduction (see figures 1 and 2).

50 China

Decline in share of popultion below $1 a day, 1981-2001

rivate firms and entrepreneurs are at the heart of the development process. Driven by the search for profit, they invest in new ideas and new production facilities that strengthen growth and prosperity. In most developing economies they provide 90 percent of jobs, produce the goods and services needed to sustain life (food, housing, finance, transport, and communications), and in many instances provide a large share of water, energy, health, and education services. In addition, private firms and entrepreneurs are the main source of tax revenue for governments.

Figure 1: Poverty reduction is closely associated with growth

East Asia other than China

40

30

20

South Asia other than India

Uganda India

10

Middle East & North Africa Latin America & the Caribbean

0

Eastern Europe & Central Asia Sub-Saharan Africa

-10 -2

0

2

4

6

8

Average per capita growth rate, 1981-2001 Note: Data for are for 1992-2000 use its national level because of data availability.

Note: Data for Uganda areUganda for 1992-2000 and use and its national povertypoverty level because of data availability.

Source: World BankWorld 2004.Bank 2004.

Source:

10

Paths Out of Poverty: Why Private Sector Development Matters

Figure 2: Poverty reduction is closely associated with growth 10

GDP per capita growth

9

Poverty reduction 8 7 6 5 4 3 2 1 0 Pakistan

Bangladesh

India

Vietnam

China

Percent per annum 1992-98 Source: World Bank 2004.

How do the poor hope to escape from poverty?

Figure 3: Paths out of poverty How 60,000 poor people thought they might escape poverty Self-Employment Business

Income from Wages or Salaries

Benefit of Family or Kin

The World Bank’s landmark 2000 report, Voices of the Poor, gives an unequivocal answer: Above all, the poor pin their hopes for escape from poverty on income from self-employment in their own business or on wages earned through employment.

(Figure 3).

Income from Agr., Livestock, Fishing

Opportunities for entrepreneurship and the strongest opportunities for rewarding employment come from a growing economy, fueled by a competitive, thriving private sector. Research shows a strong relationship between growth and a thriving private sector.

Access to Agricultural Land

Skill Acquisition

Hard Work / Perseverance / Thrift Access to Credit

Education Migration

Saving

Male

Hand of God

0%

10%

20%

Source: World Source: WorldBank Bank2004.

2004.

30%

40%

Female

50%

60%

70%

3

Paths Out of Poverty: Why Private Sector Development Matters

Above all, the poor pin their hopes for escape from poverty on income from self-employment or on wages earned through employment.

What should governments do to foster the private sector?

Governments have a decisive impact on the security of property rights, the efficiency of regulation, the functioning of finance markets, and the availability of infrastructure services. Improving government policies that shape the investment climate boosts growth and reduces poverty.

How can the international development community best support government efforts?

International development agencies can best support government efforts through three key areas: b Developing a regulatory environment that fosters opportunities for entrepreneurship and job creation. b Facilitating access to a broad range of financial services—for firms and households. b Mobilizing the private sector to better serve the poor as consumers—not least as a provider of basic social and infrastructure services.

Figure 4: Private investment is strongly associated with economic growth

Investment and Economic Growth in Selected Developing Countries, 1970-98 15

Investment (% of GDP)

4

Private investment Public investment

12

9 6 3 0 Less than 3%

3 - 5%

More than 5%

Growth Rates of GDP Source: Bouton and Sumlinski (2000).

Source: Bouton and Sumlinski (2000).

Paths Out of Poverty: Why Private Sector Development Matters

5

Creating opportunity: entrepreneurship and jobs

o enable growth—and to ensure that the poor can participate in the benefits of growth—the challenge is to create an environment where new entrants with drive and good ideas can get started in business, and where good firms can invest and grow, generating more jobs. Not surprisingly, private investment has grown faster in countries with better business environments (Figure 5).

In many developing countries, small entrepreneurs face substantial barriers to entering the market and competing.

A strong correlation also exists between the quality of the business environment and shareholder returns (Figure 6).

In developing countries, well over half the working population—and an even larger share among poorer people—typically rely on small and medium enterprises (SMEs) for employment and income. So the ease with which such enterprises can get started, mobilize resources, and get their products to market is of immediate importance in determining opportunities for the poor.

Figure 5: Private investment has grown faster in countries with a better investment climate 12

Annual growth of private investment

t

8

4

0

-4

-8 3

4

5

6

7

8

9

Investment profile Note:Data Data presented presented are 1984–2000.

ICRG’s index of “investment Note: areaverages averagesforfor 1984–2000.

ICRG’s index of profile” based on measures enforceability, profit “investment profile” based of oncontract measures of contractexpropriation, enforceability, expropriation, profit repatriation, and payment Higherwith numbers repatriation, and payment delays. Higher numbersdelays. are associated less risk are with less risk and andassociated stronger investment climates. stronger investment climates.

Source: 2004 Source:World World Bank Bank 2004

But for overall growth and dynamism—and better opportunities over the long term—there is a need for a healthy, vibrant ecology of firms of all sizes. Firms that start small but do a good job of responding to market demands become larger. With scale comes

Paths Out of Poverty: Why Private Sector Development Matters

increased productivity, bringing better salaries for workers. Larger firms also tend to thrive longer than smaller ones do.

Figure 6: Shareholders benefit from reform:3-year shareholder return (%) 80%

Removing barriers to entrepreneurship

In many developing countries, small entrepreneurs face substantial barriers to entering the market and competing. As the World Bank Group’s Doing Business project documents, they often bear a big burden of time and cost in starting a business, registering property, or getting credit. These barriers drive many would-be entrepreneurs into the informal sector, where they have fewer chances for expanding their businesses and their employees miss out on the protections and benefits of formal employment.

Large, well-connected firms that are insulated by government patronage tend to dominate. Productivity suffers as a result, and income growth is stunted (in large firms because they are sheltered from competition; in small firms because they are held back). Effective competition—the ability of firms to enter, grow, and challenge incumbents on a reasonably level playing field—is key to progress. By the same token, failing incumbents must be able to exit quickly.

They should not be subsidized to the detriment of new, better, and more innovative firms.

Positive Reforms

Negative Reforms

60%

40%

20%

0% -6

-4

-2

0

2

4

6

Number of reforms 2003-2006 Note:Note: Note:Reforms Reforms those recorded

by Doing the Doing Business Note: areare those recorded by the Business ProjectProject Source: World Bank 2007a.

Source: World Bank 2007a.

8

10

12

7

8

Paths Out of Poverty: Why Private Sector Development Matters

According to the Doing Business project, countries that actively reform their business environment see major benefits. Better rankings on the ease of doing business are associated with more growth, more jobs, and a smaller informal sector.

In Mexico, a program of business environment reforms has cut the time to establish a business from 58 days to 27 days. As a result, the number of registered businesses rose by nearly 6 percent, employment increased by 2.6 percent, and prices fell by 1 percent due to competition from new entrants.1 Other countries too have seen registrations jump after cutting the time and cost to start a business (Figure 7; Box 1). In Eastern Europe, active programs of reform have enabled previously lagging countries to match the entrepreneurial buzz of strongly growing East Asian economies. Georgia, the lead Doing Business reformer in 2006, now has 15 registered businesses per 100 people (matching business-friendly Malaysia). The Czech Republic and Slovakia have 13 (matching Singapore). Cross-country analysis shows that business entry and business density—the number of registered firms as a percentage of the active population—are positively related to ease-of-doing-business rankings.

Box 1: Making it easier to start a business in Lima Obtaining an operating license used to be one of the most bureaucratic steps in starting a business in Peru, accounting for 62 percent of the total time required. To change that, the municipality of Lima, with the help of IFC, launched reforms of the process in January 2006.

The results? b The time to obtain a license fell from 60 days to 3 days. b The number of inspections was cut from five to just one.

Microenterprises commonly operate outside the formal legal system. They can play a major role in employment.

b The costs for small firms were slashed by more than half. b In the nine months after the reform, the municipality registered over 8,314 firms, more than in the previous seven years combined.

Source: IFC

Bruhn 2007.

1

Paths Out of Poverty: Why Private Sector Development Matters

Getting out of informality—and creating jobs

Microenterprises commonly operate outside the formal legal system. They can play a major role in employment. For instance, in Bolivia only 400,000 workers have formal jobs in the private sector—out of a population of 8.8 million. In India, 8 million workers have such jobs—in a country of 1.1 billion people. In Malawi, 50,000 have formal jobs—out of a population of 12 million. In Mozambique, 350,000 have such jobs—in a country of 20 million.

Where start-up procedures are cumbersome, more businesses tend to be informal. And informal businesses tend to stay small. A survey in GuineaBissau found that, controlling for industry, formal businesses hire four times as many workers and produce four times as much output as informal ones.2

Figure 7: Increase in annual business entry after reform (%)

81 10

Countries with higher levels of income generally have lower rates of informality and more small and medium enterprises in the formal sector (Figure 9). Making the transition from a high rate of informality to a thriving SME sector is critical to unlocking opportunities for both growth and employment, including for the poor.

9 8 7

52

6 5 4

How do you move from poor and informal

3

enterprises to wealthier, formal ones?

Business environment reforms that make it easier for businesses to formalize and create jobs are key.

Reforms that reduce the barriers to formalization make it easier for businesses to obtain bank credit, use the courts to resolve disputes, and secure contracts as suppliers to larger (formal) firms (Figure 10).

After reforms

19

22

23

24

26

Finland

Guatemala

Jordan

Madagascar

2 1

Before reforms

0 Estonia

Source: 2007a.

Source:World WorldBank Bank 2007a.

Figure 8: Entry and Density Rates versus Ease of Doing Business Rankings, by Country, Average 2003-2005 Entry rate

Density rate (percent)

20%

20

15%

15

10%

10

5%

5 0

0 0

20

40

60

08

100

120

140

160

Ease of Doing Business Ranking Source: Group Entrepreneurship Database, 2007.2007.

Source:World WorldBank Bank Group Entrepreneurship Database,

Data from World Bank Enterprise Surveys.

2

180

0

20

40

60

80

100

120

140

Ease of Doing Business Ranking

160

180

Mauritius

Saudi Arabia

9

10

Paths Out of Poverty: Why Private Sector Development Matters

These reforms also expand the reach of regulation by bringing businesses and workers into the formal sector, with the following benefits: b Workers can have health insurance and pension benefits.

Figure 9: SMEs become more important and informality less important as countries become wealthier 100% 13 31

80%

47

b Businesses pay some taxes. b Products are subject to quality standards—which, if enforced, means better outcomes for consumers, rich and poor alike.

60%

Women tend to benefit disproportionately from reforms that reduce informality, because they are more likely to work in the informal sector. Indeed, women in developing countries are three times as likely as men to be hired informally, with no legal or social protection (Box 2).

20%

51 39 16

40%

30 37

36

0% Low income countries Remaining activity

Middle income countries

High income countries

Small and medium enterprise

Informal activity

Source: World Report 2005, p. 63.

Source: WorldDevelopment Development Report 2005, p. 63

Figure 10: Advantages of formalization reported

by World Bank-surveyed firms

Mean of firms with no employees Mean of firms with at least one employee Avoid paying fines

Compliance with law

Avoid paying bribes

Gain new clients Gain new clients Improved access to credit

Operation on a greater scale

Legal power to demand contracts upheld

0

1

2

3

4

Rating by firms surveyed Source: Investment Climate Surveys

Source: Investment Climate Surveys (Source: Informality and Exclusion, World Bank, Latin American and (Source: Informality and Exclusion, World Bank, Latin American and Caribbean Studies, 2007.

Caribbean Studies, 2007.

Paths Out of Poverty: Why Private Sector Development Matters

Box 2: Better opportunities for women

FEMALE ENTREPRENEURSHIP

FEMALE UNEMPLOYMENT

(Percentage of entrepreneurs who are women)

(Percentage of male unemployment)

High

High

Low

Low Least difficult

Most difficult

Countries ranked by ease of doing business (quintiles) Source: Doing Business database, Enterprise Surveys Note: Relationships are significant at the 1% level and remain significant when controlling for income per capita

Least difficult

Most difficult

Countries ranked by ease of doing business (quintiles) Source: Doing Business database, World Development indictators Note: Relationships are significant at the 1% level and remain significant when controlling for income per capita

Women are active entrepreneurs in many developing countries, especially in the microenterprise and SME sectors. In the Philippines, women own 44 percent of all microenterprises—and 80 percent of rural ones. In Zimbabwe women run 67 percent of all micro and small enterprises.

A good business environment has particular benefits for women: Countries with better Doing Business scores have larger shares of women among entrepreneurs and in the labor force (see figure above). Making it easier to start a business also can disproportionately benefit women. In Uganda, complex start-up regulations meant numerous contacts between entrepreneurs and public officials, creating multiple opportunities for bribery. Women were especially vulnerable: 43 percent of women entrepreneurs reported harassment from public officials, compared with 25 percent of all entrepreneurs. When business start-up was simplified, business registrations increased—and the increase in first-time business owners was 33 percent higher for women than for men.

Simplifying property registration can also disproportionately benefit women (at least where laws allow women to own property). In Peru, the time required to formalize property has fallen from 6 years to 33 days since the late 1990s. More than 1.3 million titles have been issued, and two-thirds of those issued to individuals have gone to women. And secure title for women has especially great development benefits.

Evidence from Honduras, India, and Nicaragua shows that poor women’s access to property is associated with more investment in the household, especially in children’s health and education.

Source: World Bank

11

Creating opportunity through access to financial services

f

For small and medium businesses, access to credit can be a make-or-break issue. Where financing is available, it may be out of reach due to short payback periods and high collateral requirements. Nonbank financing options, such as leasing, are not always available. And in some developing countries women face particular barriers in getting access to credit, because traditionally they do not own land, which often is the preferred collateral for loans.

Figure 11: finance promotes firm growth Proportion of firms that grow at rates requiring external finance 0.6

KOR THA

0.5

MYS FIN

MEX AUS

0.4

IND

JOR

AUT ESP FRA

USA CHE

ZWE BEL 0.3

In countries with better developed financial systems, firms are better able to access credit and grow at faster rates that are made possible only by external finance (Figure 11).

NZL

JPN

SGP NOR CAN DEU

ITA

GBR

PAK

NLD SWE

TUR 0.2

ZAF 0.0

0.5

1.0

Private credit / GDP

Source: Finance and Pitfalls in Expanding Access, WorldWorld Bank Source: Financefor forAll: All:Policies Policies and Pitfalls in Expanding Access, Policy Policy Research Report,Report, 2007. 2007.

Bank Research

Where financing is available, it may be out of reach due to short payback periods and high collateral requirements..

1.5

Paths Out of Poverty: Why Private Sector Development Matters

Figure 12: access to finance

Roughly two-thirds of the population in developing countries remains unbanked and underserved (Figure 12), and the use of financial services varies greatly by region (Figure 13). This financial exclusion likely results from barriers to physical access, eligibility, and affordability (Box 3).

HOUSEHOLDS WITH AN ACCOUNT

< 20% 20 - 40% 40 - 60%

Moving beyond microcredit

Historically, much of the spotlight has been on developing markets for microcredit for the poor. But the poor have demonstrated a demand for a broader range of financial services, including savings, money transfers (including for remittances), and insurance.

Evidence from microfinance in Africa suggests a ratio as high as six savers for every borrower. And one in every six people in developing countries receives some kind of support through remittances, which amount to an estimated $300 billion annually.

Indeed, in Mexico remittances exceed direct foreign investment; in Sri Lanka they exceed tea exports; and they exceed tourism revenue in Morocco.3

60 - 80% > 80% Source: World Bank 2007b Source: World Bank 2007b

Figure 13: access varies by region...

High

100%

75th percentile Median 25th percentile

80%

Low

60% 40% 20% 0% Sub-Saharan Africa

Data from the World Bank, Development Economics Vice Presidency

3

Source:

East Asia

Europe & Central Asia

Latin America & the Caribbean

Middle East & North Africa

South Asia

13

14

Paths Out of Poverty: Why Private Sector Development Matters

Box 3: barriers to access

...and process

Branch and ATM penetration, by income quintile

Number of days to process SME loan application

Number per 100,000 population 30

Number of bank branches Number of ATMs

60

20

40

20

10

0

Average 10.69 days Median 8.33 days

Lebanon Madagascar Ethiopia Alberia Egypt, Arab Rep. Chile Bulgaria Dominican Republic Nepal Czech Republic India Sri Lanka France Mexico Bolivia Indonesia Sierra Leone Cameroon Bosnia and Herzegovina Lithuania Zambia Columbia Jordan Hungary Armenia Trinidad and Tombago Australia Belarus Malta Kenya Georgia Croatia Turkey Moldova South Africa Zimbabwe Slovenia Peru Brazil Belgium Slovak Repubilc Switzerland Korea Republic Greece Spain Israel Denmark

40

Pakistan Phillipines Uruguay Ghana Mozambique Thailand

50

Bangladesh

Physical access

0

1

2

3

4

5

Income quintile

Affordability...minimum balances

...and fees

Minimum balance required to open a checking account (percent of GDP/capita)

Costs of transferring funds abroad (percent of $250, a typical remittance)

Greater than 50% required 10%

15 - 50% required 10%

Greater than $25 11%

Less than $5 11%

No minimum balance required 32%

5 - 15% required 12%

$5 to $12 27%

$12 to $25 51%

1 - 5% required 17% 0 - 1 % required 19%

Source: Finance for All: Policies and Pitfalls in Expanding Access, World Bank Policy Research Report, 2007

Paths Out of Poverty: Why Private Sector Development Matters

Box 4: bringing cutting-edge technology to microfinance The single biggest hope for the advance of microfinance is the rapid deployment of new technology, such as cell phones, that can provide access to billions of the underserved. Many large banks and microfinance institutions serving the poor now use technology such as credit cards, mobile phone banking, and automated teller machines, enabling customers to make payments, transfers, and cash withdrawals without having to travel to a branch office. In Brazil and Mexico, the government offers welfare payments to poor families through electronic payments.

With more than 3 billion mobile-phone subscribers in low-income countries, the potential for technology to improve access to microfinance is enormous. The key to further unlocking this potential: developing regulatory systems that allow, for example, cell phones to serve as bank branches.

In 2007, CGAP (the Consultative Group to Assist the Poor), the leading industry organization for microfinance housed at the World Bank, launched a major new $26 million technology program with backing from the Bill and Melinda Gates Foundation to pilot the use of new technologies for delivering financial services to poor clients.

CGAP also provides technical and policy advice to encourage the use of technologies, such as mobile phones and card-based networks, that will enable many more people, especially poor people in isolated rural locations, to be reached by financial services.

The good news is that the microfinance sector has grown and evolved dramatically in the past few years. Once a small niche focused on loans to tiny enterprises, microfinance now has practitioners that include hundreds of global and local retail banks, Wall Street and social investors, as well as cell phone and credit card companies (Boxes 4–6).

Today, more than 100 million households have access to microfinance through traditional non-governmental organization (NGO)-based institutions. Increasingly these institutions are following commercial principles, making money by charging adequate interest spreads, focusing on efficiency, and securing strong repayment rates. And NGOs are not alone in this market. Research by the Consultative Group to Assist the Poor (www.cgap. org) into a broad range of socially oriented financial institutions in poor countries (including postal and savings banks) pointed to more than 750 million small-balance accounts in those institutions.

Source: CGAP (Consultative Group to Assist the Poor), see www.technology.cgap.org

More than 100 million households have access to microfinance through traditional nongovernmental organization-based institutions.

15

16

Paths Out of Poverty: Why Private Sector Development Matters

Box 5: ifc and microfinance

IFC is the World Bank Group’s leading investor in microfinance, more than doubling its investment in commercial microfinance over the last two years. By FY07, IFC had committed over $600 million ($196 million in FY07 alone), and its microfinance portfolio was $498 million. Within the next three years, IFC projects investment of $300 million per year and an increase in its portfolio to $1.2 billion.

Leverage: The micro, small and medium enterprises (MSME) portfolio of IFC’s MFI-clients tends to be at least 10 times larger than IFC’s. Given the short tenor of microloans, annual disbursements tend to be even higher: In 2006, MFIs disbursed 7 million loans for $8.2 billion.

Source: IFC

Box 6: IFC project: Tribanco’s “branchless banking” reaches the poor Brazil’s Tribanco has provided access to finance for 2.5 million people through “branchless banking,” an innovation that extends access to credit to the base of the economic pyramid. Tribanco, an IFC client, uses a network of retailers—mostly family-owned micro, small, and medium enterprises—as conduits for credit.

In 2006, Tribanco entered into a capacity-building partnership with IFC (in parallel with a $10 million financing facility structured by IFC’s microfinance unit) to strengthen the financial intermediation role of its 32,000 retailers, who borrow directly from the bank. With assistance from Tribanco, these retail outlets can extend credit to their own customers through a private-label credit card that enables them to identify each customer’s payment pattern and better evaluate credit risk. Tribanco’s outreach to this underserved market through private-label cards grew from 500,000 clients in 2004 to 2.5 million by mid-2007.

Source: IFC

Paths Out of Poverty: Why Private Sector Development Matters

Making a difference: building financial market

Box 7: Microinsurance against events that can tip households into poverty

infrastructure, reducing costs

As shown by the prevalence of informal savings in all developing regions and the widespread practice among poor people of paying roving deposit collectors to store their savings, the essential challenge is to build effective financial intermediation capacity at the local level—intermediation from savings into loans, money transfers across or between countries, and risk sharing through microinsurance (Box 7; Figure 14).

In many developing economies, this means addressing the weak financial market infrastructure—such as payment systems that lack modern instruments and adequate geographical coverage, which translates into high transactions costs, underdeveloped or missing rating agencies and credit bureaus, and shortages of qualified auditors and supervisors. It also means reviewing financial sector policies with an eye to stimulating access to finance while protecting depositors. Policies that allow cost-covering interest rates but also provide for consumer protection are critical. Adapting regulation to the rapidly fusing

When households fall into poverty, the main causes are health and health-related events and death or disability of the breadwinner. Insurance can protect against the financial consequences of such events, and studies show that the poor are willing to pay for it. The challenge is to design and offer an insurance product that meets their needs, is affordable (matches their ability to pay), and ensures that there will be sufficient suppliers.

The World Bank has been instrumental in developing one of the largest microinsurance schemes in South Asia, where more than 3.5 million poor women and their spouses are insured against the risk of the death or disability of the breadwinner. The World Bank provided advice in designing a low-cost mechanism for settling and paying claims that kept premiums low and addressed the insurer’s concerns about moral hazard and adverse selection. The Bank is now helping to replicate the model across South Asia, and pilot-testing the concept in East Africa.

Source: World Bank

Today, more than 100 million households have access to microfinance through traditional non-governmental organization (NGO)-based institutions.

Figure 14: remittance flows across countries Moldova Tonga Guyana Haiti Lesotho Lebanon Honduras Tajikistan Jordan Armenia Jamaica Bosnia and Herzegovina Serbia and Montenegro El Salvador Nepal Albania Cape Verde Philippines Kyrgyz Republic Gambia 0%

5%

10%

15%

20%

Percentage of GDP

Source: Finance for All, p.130 Source: Finance for All, p.130

25%

30%

35%

17

18

Paths Out of Poverty: Why Private Sector Development Matters

worlds of banking, payments, and telecommunications is particularly urgent. The future of access to finance will go beyond traditional channels (Figure 15).

Figure 15: the future of access to finance will go beyond traditional channels

3bn 25mm

Mobile phone payments will climb from $3.2 billion to $37 billion in 2008 2,500

2,000

1,500

1,000

500

0

Western Union

Bank branches

Post offices

ATMs

Source: VISA; UPU 2005, Economist (2/17/07) Source:WB WB2005; 2005; VISA; UPU 2005, Economist (2/17/07)

POS

Payments and securities settlement systems are critical to the effective functioning of market economies. Inefficiencies and high transaction costs in these systems represent a tax on individuals, enterprises, and the entire economy. They can also disproportionately limit access to financial services by the poor.

A well-functioning payments system is also crucial for safe and cost-effective remittance services.

Steps to reduce the transaction costs associated with remittances could have a massive development impact. For instance, a reduction in the price of sending the $280 billion in annual remittances by 5 percent would save the remittance users $14 billion a year, and most of this savings (at least $12.5 billion) would benefit poor families in developing countries. In other words, poor families would get the equivalent of the World Bank’s IDA funding that goes the poorest countries each year.

In addition, remittance services may be the only point of contact with the financial sector for many households, and can be a powerful tool to increase access to finance through mortgages, microcredit, and insurance products.

Paths Out of Poverty: Why Private Sector Development Matters

Figure 16: small firms benefit from credit bureaus Estimates based on data on 5,000 firms in 51 countries

% of Small Firms Reporting High Financing Constraitns

Probability of Obtaining a Bank Loan for a Small Firm

49% 40%

Without credit bureau

27%

28%

With credit bureau

Without credit bureau

With credit bureau

Source: Love Love&&Mylenko Mylenko(2003).

(2003).

Source:

Credit information bureaus have proven critical in allowing financial institutions to safely expand their lending to retail and SME customers (Figure 16). Better creditor rights protection (through the legal system) and well-functioning credit bureaus are both associated with more credit to the private sector—with credit bureaus being more important in developing countries. Recent research shows that in the five years after a credit bureau is introduced, the ratio of private credit to GDP rises by 7–8 percent.4 The presence of credit information also reduces the lending bias against small businesses and women.

New technology is cutting the cost of providing such financial market infrastructure. Government efforts to encourage financial market infrastructure and allow technology to bring down transaction costs—such as establishing credit registries or issuing identification numbers to help establish credit histories, reducing the costs of registering or repossessing collateral, and introducing legislation to support modern financial technology, from leasing and factoring to electronic and mobile finance—will accelerate improvements for the poor.

Djankov, McLiesh, and Shleifer 2007.

4

Box 8: pioneering solution in Colombia: Mobile vans as bank branches In Colombia, just over one in three adults has access to basic financial services.

These services are especially scarce among poor people who live far from a bank, do not have a safe place to store their money, and whose only source of credit is moneylenders. Working with CGAP, Credibanco (the Visa-card-acquiring network in Colombia) is extending and adapting its technology and service infrastructure to help the country’s banks reach poor customers by establishing a network of banking agents. Mobile vans provided by Credibanco will use satellite technology to allow agents to open accounts on the spot and process debit- or credit-card transactions in remote and underserved communities. In mid-2007, Credibanco began to roll out this service with a partner bank, Banagrario, in El Pozon, a small town near Cartagena in the north of Colombia—opening 80 new bank accounts in its first week.

Source: CGAP

The presence of credit information also reduces the lending bias against small businesses and women.

19

Creating opportunity: the private sector and a better deal for the poor as consumers

t

he 4 billion people who live at the base of the economic pyramid (BOP) represent a $5 trillion global consumer market.5 This market is often rural (particularly in Africa and Asia), poorly served, and dominated by the informal economy. As a result, it often is inefficient and uncompetitive. Many in the BOP pay more for basic goods and services than wealthier consumers do, either because the cash price of available services (at the level consumed) is higher or because of the effort involved. “Wealthier mid-market households are seven times as likely as BOP households to have access to piped water.

Some 24 percent of BOP households lack access to electricity, while only 1 percent of mid-market households do.”6 The dominant category of expenditure at the base of the pyramid is food—an estimated $2,895 billion annually. This is followed by energy ($433 billion), housing ($332 billion), transportation ($179 billion), and health care ($158 billion) (Figure 17).

Figure 17: Estimated BOP market by sector

$5 TRILLION HEALTH

ICT

OTHER

WATER

ENERGY

FOOD

HOUSING

Source: WRI p. p.

29.29.

Source: WRIand andIFC IFC2007, 2007,

The BOP is defined as those with incomes of less than $3,000 in local purchasing power.

WRI and IFC 2007.

5

6

TRANSPORTATION

Paths Out of Poverty: Why Private Sector Development Matters

Innovating to meet the needs and constraints of the poor

Critical to improving the options of the poor as consumers is the creation a thriving, competitive, private economy in which firms face pressure to innovate in reducing costs, improving quality, and offering goods and services that are a better match for customers’ needs. This includes innovating to meet the needs and constraints of poor customers, through product design or through packaging and retailing strategies. Successful enterprises are using some or all of the following strategies: b Focusing on the BOP with products, services, or technologies that are specifically designed and appropriate for BOP needs. Examples exist in sectors such as water (point-of-use systems), food (healthier products), finance (microfinance and low-cost remittance systems), housing, and energy. b Localizing value creation through franchising, through agent strategies that involve building local ecosystems of vendors or suppliers, or by treating the community as the customer. Examples exist in health care (franchise and agent-based direct marketing), ICT (local phone entrepreneurs and resellers), food (agent-based distribution systems), water (community-based water treatment systems), and energy (mini-hydropower systems). b Enabling access to goods or services—finacially (through single-use or other packaging strategies that lower purchase barriers, prepaid or other novel business models that accomplish the same result, or financing approaches), or physically (through novel distribution strategies or low-cost technologies).

Examples exist in food, ICT, and consumer products (packaging of goods and services in small unit sizes, or “sachets”), and in health care (cross-subsidies, community-based health insurance). b Unconventional partnering with governments, NGOs, or groups of multiple stakeholders to bring the necessary capabilities to the table. Examples exist in energy, transportation, health care, financial services, and food and consumer goods.

The 4 billion people who live at the base of the economic pyramid (BOP) represent a $5 trillion global consumer market.

21

22

Paths Out of Poverty: Why Private Sector Development Matters

But what are the best business models for success in these segments and markets? And how can more of these enterprises be encouraged?

Empowering participation: access to basic services

The ability of the poor to participate in a growing economy not only depends on the ease with which businesses can be established and jobs created. It also depends on access to the basic services that equip and enable people to participate in economic activity, including: b Access to health care that enables people to grow up fit and healthy. b Ready access to affordable care when they become ill. b Access to education that provides skills (from the most basic to the more specialized). b Access to clean water and energy, without great expenditure of time and effort (not only meeting an essential need but also freeing girls to go to school and women to take up other, more remunerative tasks). b Access to safe and efficient transportation (for everything from the commute to work to the transport of goods to markets).

All these areas of access make a critical difference in the ability of the poor, men and women alike, to find and retain good jobs or start new businesses.

Critical to improving the options of the poor as consumers is the creation a thriving, competitive, private economy in which firms face pressure to innovate

Traditionally, the expectation has been that governments will provide these services, with the private sector contributing primarily through the tax revenue it yields for financing public services. In reality, however, the private sector is a key provider of basic services—including social services—to many of the world’s poor. In many African and South Asian countries, for example, the private sector plays a critical part in providing primary care for rich and poor alike. 7

Data from recent Demographic and Health Surveys show that the majority of households in the poorest quintile rely on private care for such common afflictions as coughs and diarrhea in countries as varied as Bangladesh, Benin, Chad, Egypt, Ghana, Haiti, India, Indonesia, Nepal, Niger, Nigeria, Uganda, and Vietnam.

7

Paths Out of Poverty: Why Private Sector Development Matters

Box 9: Bringing water services to informal settlements in Manila Manila Water has had much success in supplying the East Concession for metropolitan Manila. It serves 870,000 households, up from 325,000 a decade ago. More than 98 percent of its customers today have a 24-hour water supply, up from 26 percent in 1997. More than a million poor urban residents now have clean, safe, and affordable drinking water, and cases of waterborne diseases have dropped by nearly a third.

But what makes Manila Water stand out is its skill in turning its client and community orientation into a highly successful operation. It engages local communities in informal settlements to ensure that collective billing is timely and effective. It employs small-scale entrepreneurs to develop local business, supports microlending to broaden opportunities for its customers, and brings affordable water to schools, hospitals, markets, and households. Manila Water has translated its strategic objectives into measurable goals and action plans for clients, the environment, financiers, and the government. And its decentralized structure fosters a strong sense of ownership and responsibility among employees and local communities.

Source: Making a Difference, p. 40-41

In Africa, a recent study found that more than 50 percent of the poor rely on the private sector for health care. In the Nigerian state of Lagos, 75 percent of schoolchildren in poor urban and periurban areas attend private schools; in Ghana 64 percent do.

In the slums of Hyderabad, India, 65 percent of schoolchildren go to private, unaided schools.8 And these schools compare favorably in quality with their public sector counterparts. “In every setting, teacher absenteeism was lower and teacher commitment—the proportion of teachers actually teaching when our researchers called unannounced—higher, in the private schools for the poor than in government schools. Importantly, the research showed that the

private schools everywhere were outperforming the government schools in key curriculum subjects—even after controlling for background variables.”9 In the infrastructure sector, well-designed schemes for private participation have expanded access to services for the poor (Box 8, Figure 18). Although low-income countries historically have received only a small share of the total private investment in developing country infrastructure, this investment continues to grow steadily.10 And in recent years domestic companies have become increasingly important providers of services in such sectors as water and energy, often working at a smaller scale than the international

Figure 18: Estimated BOP market 105 95 85 75

In Africa, a recent study found that more than 50 percent of the poor rely on the private sector for health care

65 55 45 35 25 0.00

20.00

40.00

60.00

80.00

Private Investment as a share of Total Investment (Avg. 2002-06) Source:

Tooley 2006.

Tooley 2006.

10 World Bank and Public-Private Infrastructure Advisory Facility, Private Participation in Infrastructure Project Database.

8 9

100.00

23

24

Paths Out of Poverty: Why Private Sector Development Matters

companies that dominated the first wave of private participation in infrastructure.11 Private companies are also innovating to provide infrastructure services beyond the boundaries and reach of formal utilities (Box 9). However, private provision falls short where basic services cannot be provided on a cost-recovery basis—where some element of subsidy is required to address basic affordability constraints (such as for connection costs for water, power, or sanitation) or to ensure the provision of services with a large public good element (such as immunization programs). In such cases, fostering private engagement and innovation in service delivery depends on finding ways to provide subsidies that are not tied to public sector delivery and that reward delivery while maintaining incentives for efficiency. Output-based aid (OBA) is a promising means to this end—as evidenced by the growing and successful use of such schemes.

In many countries, the private sector has a key role in providing basic services for the poor—from infrastructure to health and education.

The challenge for the development community

A private sector focus is essential if the international development community is to provide effective support for the efforts of developing country governments to foster growth and reduce poverty— for two simple, practical reasons:

b The private sector will continue to be the key generator of jobs and incomes that help the poor rise out of poverty. b In many countries, the private sector has a key role in providing basic services for the poor—from infrastructure to health and education. Although private sector delivery of these services is often discussed in the aid literature as an innovative “alternative” to government delivery, for many of the world’s poor it is the primary source of basic services. Working with the private sector to expand and enhance the services it provides represents a substantial opportunity for an aid community concerned with progress toward the Millennium Development Goals and sustained poverty reduction.

This key role of the private sector makes it advantageous for the aid community to focus energy and resources on: b Support to governments in improving the business environment, reducing the transaction costs faced by businesses, bringing down barriers to competition, ensuring a level playing field that opens opportunities for jobs and entrepreneurship by women and other historically disadvantaged groups, and fostering productivity improvements and innovations that bring better, cheaper goods and services to poor households.

Box 9: lighting up the world The Light Up the World Foundation, in partnership with Stanford Business School, has developed products based on light-emitting diodes (LED) for rural use, ranging from a flashlight-size device to an on- or off-grid device for ambient or task lighting. Devices can be powered in several ways—solar, hydro, wind, or human effort. One device successful in Nepal is the pedal generator—safe, rugged, economical, able to charge multiple batteries simultaneously, and easy to maintain, repair, and transport, even over difficult terrain.

The foundation now produces multiple configurations of its systems for individuals, households, and village institutions such as schools and clinics. Its systems have been installed in more than 14,000 homes, benefiting more than 100,000 people, and plans for large-scale rollout are under way. Though a nonprofit, the foundation puts enterprise development at the core of its mission. Through “social pricing” arrangements with component suppliers, it helps new businesses get established in local markets and provides mentoring and training to support their sustainable development.

Source: WRI and IFC 2007.

11

Marin and Izaguirre 2006.

Paths Out of Poverty: Why Private Sector Development Matters

b Support to governments in building effective, efficient financial market infrastructure—and in providing solid regulatory oversight while fostering the expansion of a range of financial services to small businesses and poor households. b Support to governments in building opportunities for the private sector to participate in expanding basic social and infrastructure services to the poor: b Through active support for public-private partnerships in these areas. b Through open access and regulatory approaches that facilitate private engagement (including small-scale) in bringing services to those not served by formal public providers. b Through the channeling of subsidies through (and innovation in the development of ) OBA-type approaches for services where affordability or public good concerns are pressing.

In the first two areas especially, effective support can demand more sweat than financial resources. Many Doing Business reforms, for example, cost little: Serbian reforms of business start-up cost 2 million euros ($2.3 million); transforming FYR Macedonia’s labor law cost the time of the legal drafters. The primary contribution of the World Bank and IFC has been constructing clear indicators that clarify the costs of existing regulations and enable countries to benchmark themselves against others, and sharing good practices so that would-be reformers can learn from the experiences of others.

Similarly, to cut the cost of international remittances, the World Bank and IFC can help most by benchmarking the prices of remittance services around the world; bringing together the players to work out an enabling environment for cheap, fast, and safe services, setting international standards and providing advisory services for their implementation where necessary. In the area of domestic payments systems and services, depending on the scope of the reform and the size of the financial sector, the cost to the government of payments system reform can range from about $3 million where a new system is developed to $20 million or more in larger countries. By contrast, the benefits are considerable:

One study in Brazil showed that widespread adoption of a modern payments systems in that country would save the economy 0.7 percent of GDP (nearly $7 billion) a year.

Likewise, for infrastructure and social services, money often is not the problem. Critical are delivery systems that create incentives to ensure that services reach the intended beneficiaries. One example is use of output-based aid—disbursing donor- or tax-funded subsidies only after results are achieved, rather than when projects are constructed. Governments then focus on contracting out projects and providing good regulation.

If development is to be about results for the poor, private sector development must be at the heart of the effort.

25

26

Paths Out of Poverty: Why Private Sector Development Matters

References Bruhn, Miriam. 2007. “License to Sell: The Effect of Business Registration Reform on Entrepreneurial Activity in Mexico.” Massachusetts Institute of Technology, Department of Economics, Cambridge, Mass.

Djankov, Simeon, Caralee McLiesh, and Andrei Shleifer. 2007. “Private Credit in 129 Countries.” Journal of Financial Economics 84 (2): 299–329.

Marin, Philippe, and Karina Izaguirre. 2006. “Private Participation in Water: Toward a New Generation of Projects?” Gridlines series, no. 14. Public-Private Infrastructure Advisory Facility, Washington, D.C. Tooley, James. 2006. “Educating Amaretch: Private Schools for the Poor and the New Frontier for Investors.”

International Finance Corporation and Financial Times, First Annual Essay Competition, Washington, D.C. UNDP (United Nations Development Programme). 2004. Unleashing Entrepreneurship: Making Business Work for the Poor. New York.

World Bank. 2000. Voices of the Poor. Washington, D.C. ———. 2004. World Development Report 2005: A Better Investment Climate for Everyone. New York: Oxford University Press.

———. 2007a. Doing Business 2008: Comparing Regulation in 178 Economies. Washington, D.C. ———. 2007b. Finance for All: Policies and Pitfalls in Expanding Access. World Bank Policy Research Report. Washington, D.C. ———. 2007c. “Financial Sector Strategy for the World Bank Group.” Washington, D.C. WRI (World Resources Institute) and IFC (International Finance Corporation). 2007. The Next 4 Billion: Market Size and Business Strategy at the Base of the Pyramid. Washington, D.C: WRI.

Paths Out of Poverty: Why Private Sector Development Matters

27

28

Paths Out of Poverty: Why Private Sector Development Matters

2121 Pennsylvania Avenue NW Washington, DC 20433 http://www.ifc.org