Importance Of Private Sector Development For Poverty Reduction Economics Essay

Since the early 1990’s the drive to reduce poverty has been steadily growing in popularity.Aditionally governments began to take more a more determined effort to poverty reduvtion after the Millenimum Developmenmt goals provided 8 time bound targets to reduce extreme poverty across the world (United Nations,2012).

With regards to poverty reduction, it appears that goal 2 will be achieved. The goal is to halve the number of poor people in the world , that is those living on less than a $US1 a day, by 2015 .

This is largely due to the steady economic growth that has led to reduced poverty levels particularly in China where one fifth of the world’s population live (Vandenberg, 2006;United Nations,2012).However there is a stark difference in sub-Saharan Africa where the number of poor people has risen from 227 million in 1990 to 314 million in 2001 and therefore SubSahran Africa is set to miss this goal of halving extreme poverty (Vandenberg ,2006)

Policy Makers and donor organisations are therefore keen to find sustainable solutions for poverty reduction in Sub-Saharan Africa and the success that China has had in poverty reduction through steady economic growth has lead to calls for a strengthening of private sector growth in Africa in order to achieve similar levels of poverty reduction (Ayapong, 2010).In the past public sector programs have not been successful in reducing poverty and some policy makers argue that aid can create a dependence and stifle creativity and innovation to create wealth (IFC,2000).There are now more calls for private sector debelopment PSD as a plausibale poverty reduction strategy .

Public spending programs have generally failed to improve income distribution on a lasting basis .Temporary handouts tend to breed the opposite of empowerment,creating dependence instead.Lack of political commitment to equity on the part of elites as well as poor administrative capacity explains why high inequality remains in most developing comutries.It follows that growth is the surest way to achieve upward mobility and poverty reduction. (IFC,2000)

Brixova (2010)Subsistence agriculture has been the main source of employment in these countrieswhile a dynamic private sector in industry or high value added industry has remained elusive.

Brixova (2010)For Over the 1980 and 1990’s following the several economic crises there wasa realisation that the stae could not be relied on to spearhead development and the attention of policy makers turned to market led development.Brixova (2010)For many years now policy makers and reasedrchers have recognized entre[reneurship to be a key driver of economic development through fostering of economic growth job creation,technology adoption,and innovation as well as poverty alleviation.

While Poverty reduction papers mention small enterprises,they usually contain very little in terms of a developed strategy . Thios stems from the fact that the World Bank Source Book on PRSP which guides governments is very thin on small enterprise (Vandenberg ,2006)

The informal and formal small enterprise economy is the main non-agricultural employer in most countries. (Vandenberg ,2006)

Small enterprises contribute topoverty reduction when they provide:

Employment and income

Adequate levels of job quality

Low cost goods and services used by the poor (Vandenberg ,2006)

The poor benefit when enterprises operating in competirive markets,produce basic goods and servicesat low cos,therby keeping down their cost of living.In many cases small enterprises provide such services as water,sanitation and education that are not provided by the public sector . (Vandenberg ,2006)

Table of Contents

1.Definition of Micro and Small enterprises

2.Definition of Entreprenueurship ,opportunity and necessity entrepreneurs

3.Definition of Poverty broad and narrow approach ;monetary approach,capability approach,social inclusion and participatory approach

4.The pro and anti sme debate.

5>The Key role of sme in addressing wider issues of poverty:

a)Job Creation, hired workers

b)Human Resource development-apprentices,training provided

c)Gender Equity

d)SME Economic contribution to Growth

5.Key constraints to SME-not graduating to medium scale enterprises

a)Sector

b)Location

c)Gender issues

d)Lack of training /Education

f)Market constraints,business environment- enabling environment -institutional and regulatory frameworks

g)Business development services and supports

h)Lack of finance

6)Key elements of sme development strategy :Micro,Meso Macro level

Case Study

South Africa

Political background

Economic Background

Review of SME programmes in terms of their success in addressing key SME constraints found in the literature.

Literature Review

1.Definition of Micro,small and medium enterprises

Different countries have various criteria for MSMEs (Ayyagari et al. 2003,Agyapong,2010).

Generally MSME criteria is set by the number of people employed , the amount of investment in fixed assests ,sales or investment level Ayyagari et al. 2003, Dixit et al. (2011).Other writers also define MSMEs by legal status and method of production(Abor and Quartey,2010)

However the most commonly used criteria for defining MSME is employment, but the cut off criteria for MSMEs in terms of employment can vary as well and within the same country definitions may vary from intuition to intuition (Mukras ,2003).

Moreover, the restrictions in terms of ‘investment ‘ and ’employment’ are linked to the condition of economic growth in a country ,therefore a small enterprise in a high income country could be classified as a large or medium scale enterprise in a low income country.For example the European Commission defines microenterprises as thise with 0-9 workers,small enterprises as 10-99 workers and medium enterprises as those with 100-499 workers. In the African context there have also been varies criterion used to define MSMEs,howeber the most common is the number of employees (Abor and Quartey,2010).Hoevwer the cut off criteria varies from instutuition to institution.The Ghana statistical Service defines a small scale enterprise as one which has less than 10 employees..The Mational Board of Small Scale industries in Ghana uses both the fixed assests and number of workers definition and classifyies a small scale firm as onw ehich has kess than 9 workersand had plant and equipment ( apart from land ,buildoings and vehicles) to the value of 10 million Ghananian cedis or less (Abor and Quartey,2010).In South Africa the National Small Business Act 102 of 1996 classifies 5 categories of business and the definitions use number of employees,annual turnover and gross assets including fixed assets .

3.2The importance of private sector development for Poverty Reduction

2.1 Definition of Poverty

The breadth of the concept of ‘poverty’ aa far as its definition and its measurement are qually complicated (Mukras ,2003).Poverty encompases material deprivation,such as food and shelter and access to basic services such as health and education (Vandenberg,2006).Poverty as takes account of a variety of nonphysical conditions for example a lack of rights,insecurity ,powerlessness and indignity.The result of combining these material and non-material conditions in the definition of poverty make it problematic to measure poverty and assess the impact of poverty reduction strategies. (Vandenberg,2006 and Mukras ,2003).)Due to the difficulty in defining poverty,most policy statements tend to explain the nature of poverty rather than supply an exact definition (Vandenberg,2006).The OCED has defined poverty as encompassing several dimensions of deprivation that pertain to human development such as consumption and food security,health,education,rights,voice,security,dignity and decent work (OCED,2001).Additionally it is recommended that poverty reduction be considered along with issues such as environmental sustainability and gender equity.The World Bank uses similar critera material and non material vriteria to define poverty but adds voicelessness,vulnerability,exposure to risk and powerlessness to its definition(World Bank ,2001).

The poor in the small enterprise economy comprise of :poor/subsitence entrepreneurs.An entrepreneur is deemed to be poor if the income generated doies not reach above the minimum level of well being. (Vandenberg ,2006),poor workers whose income ,benefits ,rights and protection are not sufficient to meet basic levels of well being.These may be homeworkers or casual workers.Household members dependent on poor workers and entrepreneurs-children and the elderly.The unemployed poor people who are unable to reduce their poverty by starting their own enterprise and poor consumers who can purchase goods and services from MSMEs to reduce theor poverty including basic services if the public sector in undeveloped. (Vandenberg ,2006)

Gender Dynamics

Women constitute another group that can be particulary affected by poverty.They probably constitute the majority of the 1.3billionpeople living on a $1 a day ((Vandenberg ,2006).Poverty especially affects female headed households where women find it difficult to raise children and geberate income.Although,generally most informal enterprises are headed by women lower school attainment and cultural barriers limit women’s ability to obtain well paid employmentor to generate income from enterprisesin the formal or informal economy.Women generally have more difficulty accessing credit,securing premisesand their enterprises are generally less productive when compaored to their male counterparts,this may also be because they have to balance their income-generating activities with childcare and housework.

3.2The importance of private sector development for Poverty Reduction

There is wide consensus that economic growth is can be an effective means of fighting poverty (Eggenberger-Argote, 2005).In additional longterm economic growth seem to be a fundamental feature for sustainable poverty rediction,some examples include China and Chile(Dornberger,2005).

In countries that started off very poor and over time virtually eradicated poverty ,such as Singapore,a clear mutuality of interests has existed among governments ,private ebterprise and the poor (IFC,2000)

Dornberger,2005

-Over the last 50 years only the developing countries that have exposed their private sector to widespread modernaization and international competition have been able to achieve higher growth rates. Dornberger,2005.Private investment has a major ole to play in economic growth and studies show that it is more asscociated with economic growth than public investment (Bouton and Sumlinski,2000)

Only long term economic growth can generate the necessary jobs for providing poor people a regular income Dornberger,2005.A stody of 80 countries over 40 years shows that as the economy grows the income of poor people -defined as the bottom fifth of the population rises by as much as the income of everyone else (Dollar and Akray,2002)

-The poverty incidence at any point in time is largely a reflection of a country’s previous economic growth performance. Dornberger,2005

-The importance relationship between poverty reduction and growth is clearly exemplified by experiences of developing countries in Asia. Dornberger,2005

-In East Asia the poverty incidence decreased after the growth acceleration in the 1980’s and early 1990’s.By Contrast, poverty in Latin America and Sub-Saharan Africa during the same period increased due to slight or partially negative economic growth. Dornberger,2005

-On an empirical level there is a clear connection between economic growth and poverty reduction.

-The poverty incidence (number of individuals who have to live on less than US$2 per day)in Eastern Asiadecreased significantly from 68% to 47% and the number of poor people was reduced from 1.028 to 864 million between 1987-2001.The reason for this was a strong economic growth connected to an increase in the per-capita of an annual average of 6%during the 1980’s and early 1990’s .The much weaker per capita income of 3% per year in South East Asia caused a decline of poverty incidence from in 1987-77% in 2001.In Sub-Saharan Africa the poverty incidence remained on a high level of 76% while the number of poor people increased from 355-516 million between 1987-2001. Dornberger,2005

The basic qyestion is to what extent the poor population can profit from economic growth of a country or region. Dornberger,2005

-Most economc growth has not been explicitly pro poor ,providing all income groups with a roughly proportionate income increase so that the overall inequality is not reduced. Dornberger,2005

-In Vietnam poverty was significantly reduced due to strong economic growth between 1993 -1998 .However this situation did not prevent an increase in of ineqlaity of income distribution .In China the socio -economc gap between poor and rich people was increased in spite of economic growth. Dornberger,2005

-The ideal cases were in Malaysia (1937-1989) and Indonesia between (1978-1984) where growth and distributional effects reinforced each other and led to an even stronger impact on poverty reduction. Dornberger,2005

-In principle ,high growth rates of any kind could be turned into a pro-poor strategy if progressive taxation and targeted government spending on the poor were taken into account. Dornberger,2005

-PSD development leads to higher employment rates and better incomes. Dornberger,2005

Growth creates jobs that use labor ,the main assest of the poor. Dornberger,2005.

Skills and poverty In addition to job creation ,upgrading both jobs and skills is an important path out of poverty .Successful long-run development brings with it massive occupational shifts,in the course of which poverty ,however defined,is reduced.Upgrading within sectors from subsistence agriculture to market agriculture for example or bwtween sectors for instance from agriculture to manufacturing are key to achieving development.Upgrading jobs and skills are cebtral to these processes and private firms are the major source of demand for higher levels of skills and jobs (IFC,2000)

More and better jobs offer the best (often only)opportunity for upward mobility in the lifetimes of the poor and their families (IFC 2000).Upward mobility is key to securing the ultimate objects of development :freedomfrom hunger,longlife,health,greater choice and generally more human fulfillment(IFC 2000)

The creation of jobs and incomes is a necessary condition for lasting poverty reduction.Profitable industrial and commercial activities contribute to increased tax revenues and therefore strengthen the economic basis for public expenditure on health ,education and infrastructure Eggenberger-Argote, 2005

-As growth proceeds ,private sector employment becomes the major source of economic support for the majority of workers and their families. Dornberger,2005

Tax Revenues

IFC (2000)Enterprises-small, medium and large generate the taxes that finance the bulk of government expenditure critical to any attack on poverty. While in some of the poorest countries foreign aid plays an important role, it cannot be regarded as a substitute for a country’s own efforts. It is too small in most countries and in any case is not reliable. Furthermore in developed countries ,private enterprises through the taxes they pay,generate funding in foreign aid.

Growth also increases the tax base that enables government ,acting on good governace principles to finance labour market programs and provide basic social services.Health and education services ,in particular ,give the poor a better chance to increase their productivity and eraning capacity . How much social spending helps raise the income of poor people depends on how governments allocate health and education expenditures-which ,typically,do not favour the poor (IFC,2000).

Private enterprises may also provide arrange of social services directly .This is the case most notably in private delivery of water,sewerage,health and educationservices.In addition private firms are often contracted by government services to deliver other social services (IFC,2000).

Supportes of private sector solutions argue that the pvt sector participation in infrastructure and basic service provision can improve efficiency of the delivery of essential servicesand extend to people in poverty,therby increasing the total amount of resources available,improving equity and multiplying consumer choicesand benefit all income classes.Critics of pvt participoation ininfrastructure projects argue that for profit -organisations are risk averse and in order to avoid a demand risk ,agreements are called to include a graurnteed level of output which will be paid for regardless of actual demand from customers .In the eand the risk would be shifted to the government and therefore taxpayers again. Eggenberger-Argote, 2005

Also Governments with weak capacities for service provision also have weak regulatory capacities .Therefore privatising into unregulated environment will foster unregulated private monopolies for essential services,with obvious adverse consequences for welfare-especially for the poor.Generally,experience shows that private firms tend to neglect service delivery to unprofitable populations.

.Transparency and accountability in government are crucial to that social expenditures reach the poor Dornberger,2005

Eggenberger-Argote, 2005 No country in the world has successfully reduced poverty in a non-growth environment.In short ,growth is critical to development.Without economic growth ,sustainable poverty reduction will not be achieved.

Eggenberger-Argote, 2005 While economic growth is necessary ,it is not sufficient for lasting poverty reduction.There are low and middle income countries with middle and high human development (e.g Cuba ,Uragauy and Tajikistan).

The degree of poverty reduction depends on the type and pattern of growth and how the benefits are re-distributed. Eggenberger-Argote 2005

The overall impact of economic growth depends on a number of factors: the share of the income increase going to nationals, and hence remaining in the country,and the share going to foreign investors, who take the money back to their countries. Eggenberger-Argote 2005

Eggenberger-Argote 2005 Job creation is one of the major paths out of poverty .Sustainable development and poverty reduction ,therefore require the development of productive sectotrs in order to create jobs,generate income and so reduce poverty.In almost all developing countries ,incliding China ,private enterprises are the main spource ot new jobs .Attempts to create jobs by governments and state owened enterpriseshave often turned out to be unsustainable . In most developing countries the private sector produces most of the country’s output and Gross Domestic Product GDP and generates a large portion of the government tax revenues necessary for funding public healthcare,edication ,social safety bets..

) Innovation and Poverty In competitive economies,competitive forms imorove the quality of products and make goods and services more affordablke,thereby boostibf the purchaseing power of consumer Eggenberger-Argote, 2005. A vibrant pvt sector is a an essential prerequisite for triggering economic dynamism ,enhancing productivity,transferring and diffusing new industrial technologies ,maintaining competitiveness ,contributing to entrepreneurship development and ultimately poverty reduction. Eggenberger-Argote, 2005.

The sources of longterm economic growth are often intangible.No single factor such as investment or education can “ignite” development.Much depends rather on the pace at which poorer societies can adapt knowledge that already exists in the more economically advanced economies and put it to use.The challenge is how tp bring about conditions in which knowledge accumalted over decades and indeed centuries can be usefully absorbed and effectively utilized in poorer countries (IFC ,2000).

Throughout the world private enterprises act as knowlwdge recpetors ,Where competitive conditions prevail,leading enterprises will contsyantly seek out information that has practical uses locally .To reamin competitive,other firms in turn will emulate their behaviour.In this process,executives and emplyoyess ubgrade their human capital, productivity and their incomes.IFC 2000

Private businesses also bring innovations to the marketplace in the form of products,services and processes thus broadening choices for the poor as well as more affluent consumers.

Empowerment

When people can participate in the economy by creating or joing an enterprise they gain voice.These are strong empowerment benefits.Enterprise also offers opportunity and some measure of security to the formerly unemployed or underemployed(IFC,2000)

Morover ecomonmic growth can facilitaite empowerment .To a considerable degree political empowerment flows from economic empowerment.Indeedd political and economc empowerment are intertwined.Higher incomes will empower poor people to gain greater political power. (IFC,2000)

Constraints to pvt sector reducing poverty Eggenberger-Argote, 2005.

Not all private enterprises in all environments however generate jobs ,investment and human capitaland thus contribute to poverty reduction.This mainly due to to unecessatu impediments to private sector develooment -an unfavourable investment climate and the absence of regulatory frameworks,policies and strong instituitions capable of preventing high concentration and abuse of market power (monopolies ,oligopolies ‘market failure).In addition,poverty reduction is completly dependent on :private sector development resulting in taxable profits;the existence of a functioning system of taxation ;the taxes actually being collected ,and the proper use of the government revenue..In short before putting trust in market extension anda well functioning and effective private sector,a vast number of components must be assessed and a regulatory framework put in place .Among these are reasonable government sytems promoting adequate property rights and the security of contract ,a well developbed infrastructure;rehulatory frameworks to assure competition,a sound financeila sector,a stable macro-economic environment ,an appropriate tax policy and opness to trade. Eggenberger-Argote, 2005.

3.1 MSMEs and poverty reduction

SMEs are important in creating employment ,income and value added and in providing the foundation for developing and testing entrepreneurial talent.Where economic growth occurs and the number of SMEs increases ,they act as a major engine of upward social mobility ,pulling in people from lower -productivity occupations (IFC,2000)

The comparatively high share of employment SMEs provide shows that they play a major role in income generation for a broad and above all often less priviledged sections of the population.This is why the development of the SME sector in developing countries increasingly features as a central element in poverty reduction strategies. Eggenberger-Argote, 2005.

Eggenberger-Argote, 2005 Promoting SMEs lays thefiundation for a domestic economic structure in which small enterprises can gradually act as suppliers to larger-scale enterprises .Small enterprises also mobilise entrepreneurial initiative and autonomy .This strengthens not only economic but alo pluralistic and social emancipationprocesses-which particularly benefit women,who are heavily represented in SME sector .

In most low income countries, the vast majority of firms are microebterprises (IFC,2000).These informal “unregistered” firms play a very important developmental role..Wherever they thrive ,informal enterprises offer opportunities for empowerment to poor and unskilled people (IFC,2000).Eggenberger-Argote, 2005 Small enterprises are also the ssedbed of the middleclass ,the weakness of which in the majority of low-income countries hampers economic and social progress.

Self employment/Micro enterprises as a means of subsistence are the economic backbone for the livihoods of large sections of the population.in low income countries.However ,often they only offer limited growth prospects .Never the less because of the employment and income they supply they are hightly relevant for development policy Eggenberger-Argote, 2005

3.2 Pro and Anti MSME debate

ANTI

Mukras(2003) It is belived that MSMEs

It is agrgued that promoting MSMEs reduces poverty (increasibg and stabilising income,human resource development,improved lobbying and problem solving capacity) but does not generate substantial economic growth and employment due to persistently small workforces and low investment volumes..Large enterprises show the highest shares of value added and produvtivity .However an increase in value added and productivity is rarely compatible with an increase in employement-at least not in the short run.Strong economic growth and INCREASED EMPLOYMENT can best be achieved through promoting SMEs.In many cases SMEs would not survive without some link to large enterprises

Acs and Varga (2005) studied 11 countries and found that opportunity entrepreneurship has a positive effect on economic development whereas necessity entrpreneurship has no effect. Koster and Rai(2008) business oppourtunities ,wheras necessity entrepreneurs are pushed into entrepreneurship because all other work options are either absent or unsatisfactory.Necessity entrepreneurs can therefore be expected to be less inclined to growth than opportunity entrpreneursas they are motivated by sel -sistenance.Developing countries are assumed to have higher shares of necessity entrepreneurs because of the need for self support and lack of employment opportunities Koster and Rai(2008),People in developing countries ,poarticularlt ifa welfare sysyem is in place,experience less push factors into entrepreneurship.

There is evidence to suggest that firm size may be realted to efficiency .Most studies in developing countries indicate that small firms are the least efficient and there is evidence that both small and large forms are relatively inefficient compared to medium -scale enterprises (Acs et al.2008).It is often argued that small firms are more innovative than larger firms ,howeber the contribution of small forms to productivity takers time and larger firms have more resources to adopt and implement them (Acs et al.2008).SMEs are able to adapt more easily to marlet conditions than larger firmsand are able to withstand adverse economic conditions because of their flexible nature(Kayanula and Quartey ,2000)

PRO MSME

MSMEs have been Abor and Quartey(2010)MSMEs are nore labout intensive than larger firms and therefore lower capital costs associated with job creation.Since MSMEs are more labour intensive ,they are more likely to succeed in smaller urban centers and rural arers where they can contribute to a more even distribution of economic activity in a regionand can help to slow the flow of migration to large cities.MSMEs also improve the efficiency of domestic markets and make productive use of resources thus facilitating longterm growth.MSMEs contribute to a conuty’s GDP by producing goods of value or through the provision of services to both consumers and or enterprises

Acs aet al (2008) Opportunity entrepreneurs base their firms in perceived Countries like Uganda,Peru and Ecaudor are all countries with high levels of entrepreneurial activity-but low levels of percapita income .Countries with much lower levels of entrepreneurial activity for example Braxil and Argentian,appear to have higher levels of per capita income.and are moving towards lower levels of entrepreneurial activity.High income countries like Germany,France ,Belgium ,Italy and Finland have relatively low levels of entrepreneurial activity.Two countries that stand as outliers are Japan and the UnitedStates.Acs aet al (2008) The Global Entrepreneurship Monitor model states that as the economy becomes more developed then fewer people will pursue entrepreneurial activity and .Koster and Rai(2008) tested this model in the case of India and found that entrepreneurship,both necessity and opportunity type has risen as India has taken off economically and entrepreneurship appears to be an important driver in the recent economic growth.From 2000-2006 The number of small firms grew at ana average of 8% whereas the total number of forms grew at an average rate of 6%.India still has low opportunity type entrepreneurs compared to countries witha comparable GDP level.Most business remain small ,the informal sector grows seignificantlt and the share of registered business remains stable at 13% for all business. Koster and Rai(2008)

5.Contraints to Private Sector Development-a focus on MSMEs

Persisitent weakneses and market failures that characterise African countries and the development of a productive sector cannot be left to markets alone.Entering new activities involves substantial fixed costs and risks which may not be undertaken by the private sector without extra incentivesand support from the state (Brixova ,2010).

Foundations for the Private Sector and Pillars of Entrepreneurship

Adapted from: Unleashing Entrepreneurship Making Business Work for the Poor

United Nations Development Programme (2004)

Private Sector Growth

Micro-Economy: Functioning Markets and Competitive environment

Entry Rules,operating rules,tax rules,market rules,exit rules

Access To Finance

Robust Financial instutuitions,finance training for SMEs.

Lending to SMEsand preventing crowding out by public sector

Propoert Rights-Collateral for loans for SMEs

Access to Skills and Knowledge

Human development and Technology Transfer

Rule of Law

Contract law,protection of property rights,Independent Judicialry to enforce laws and regulations. Good governance,political predictability and stablility-

Physical and Social Infrastructure

Adequate roads.ports,water telecommunications to access markets.Basic education and health services for labour force

Domestic Macro-economy

Overall Fiscal policy,limits to deficit generation,monetary policy,exchange rate policy. existence of a functioniong tax system and on taxes actually being collected . Poverty reduction is particularly dependednd on the

Dornberger,2005

The abolishment of macroeconomic distortaions and an improvement of the institutional environment are fundamental conditions for economic growth and for a dynamic development of the private sector

To compete enterprises must be efficient.Increases in productivity will not only allow a firm to thrive but can translate into higher wages and benefits for workers through a process of gain -sharingRoroductivity isincreased through increased market access,as well as through mechainsation and technological advance(Vandenberg,2006).

a)Informality

Eggenberger-Argote, 2005 Because of their scale,smaller firms are especially vulnerable to bad government ,poor policiesand weak instituitions and therefore more adversely affected by high bureaucratic costs than larger firms .For smaller firms remaning unregistered and exiting the formal sector re