Private Sector Economic Development

This article will focus on the practice of private-sector economic development. Three models of economic development organizations — private sector, public sector, and public-private sector — will be introduced and serve as the foundation for the discussion of economic development partnerships. Development partnerships between corporations and development agencies, a strong and growing practice in private-sector economic development, allow groups to combine staff, technology, and the funding of resources to achieve development goals such as reducing poverty, improving infrastructure, and providing job training. Barriers to private-sector development, including inhospitable business climates and the need for policy reform in developing countries, will also be analyzed to see how they undermine local businesses and alienate foreign investment.

Keywords Business Climate; Corporation; Developing Countries; Development Agencies; Economic Development; Private Sector; Public Sector; Privatization

Business & Public Policy > Private Sector Economic Development

Overview

Private-sector economic development, often referred to simply as private-sector development, is a strategy for promoting economic development by private industries that benefits the poor in developing countries and regions of the world. The private sector comprises all the micro, small, medium, and large enterprises that are outside of government ownership and control.

Modern private-sector economic development involves numerous private-sector stakeholders, such as development agencies, corporations from industrialized countries, businesses from developing countries, community agencies, and populations in need, who are committed to ending poverty and related conditions in developing countries. The World Bank estimated that in 2013, more than one billion people in the world suffered from extreme poverty, with nearly that number suffering from hunger as well. The World Bank defines extreme poverty as living on less than $1.25 a day. Private-sector economic development efforts are based on the argument that poverty reduction is tied to economic growth.

Combating global poverty is a goal that unites international development organizations and national governments around the world. For example, in 2000, the United Nations Millennium Summit was held to create time-bound and measurable goals for combating poverty and related conditions. The millennium development goals, known as MDGs, have become a blueprint of sorts for national governments, development agencies, and corporations committed to aiding the world's poorest people. The millennium development goals include:

  • Eradicate extreme poverty and hunger
  • Achieve universal primary education
  • Promote gender equality and empower women
  • Reduce child mortality
  • Improve maternal health
  • Combat HIV/AIDS, malaria, and other diseases
  • Ensure environmental sustainability
  • Develop a global partnership for development

While contemporary forms of private-sector economic development are focused primarily on eradicating extreme poverty and related conditions, private-sector economic development has existed in one form or another since the end of World War II. The modern era of sending aid to developing countries began in the 1940s as World War II ended. After the war, world leaders and governing bodies put structures such as the World Bank, the United Nations, the World Trade Organization, and the International Monetary Fund in place to prevent the economic depressions and instability that characterized the years following World War I.

The modern trend of globalization, and the resulting shifts from centralized to market economies in much of the world, has created both a need and an opportunity for economic development in developing countries and regions of the world. International development organizations, national governments, and corporations are coming together to focus on building frameworks for private-sector development as the basis for achieving sustainable economic growth. The following is an analysis of the three main models of economic development used to aid developing countries.

Applications

Three Models of Economic Development Organizations

There are three distinct models of economic development organizations: the private-sector model, the public-sector model, and the public-private partnership model. Economic development organizations of all three kinds tend to share a similar structure, consisting of a governing board, which makes policy decisions, goals, and objectives, and an administrative work force, which carries out the board's instructions. What varies between economic development organizations is the level of participation and funding from either the private or public sector. Private-sector development is increasingly characterized by partnerships between these three different models, described below (Whitehead & Ady, 1989).

Private-Sector Model

Private-sector economic development organizations are funded by contributions from business, industry, and private individuals. Economic development functions include activities such as creating, attracting, and retaining jobs and capital investments. Board members may come from a wide range of non-governmental organizations, such as banks or small businesses. Operational advantages of private-sector development organizations may include freedom from political boundaries or restrictions, freedom to maintain confidentiality about important issues, and knowledge of the business sector's interests and needs. Organizational disadvantages include lack of control over development issues requiring government involvement, such as investment incentives and infrastructure planning. Private-sector economic development organizations may choose the legal form of a non-profit organization, otherwise known as a 501(c) corporation.

Public-Sector Model

Public-sector economic development organizations are funded by local and national governments. The public-sector model is often referred to as the government-agency model. While the governing body of private-sector organizations is usually a board of directors, the governing body of the public-sector organization is most often an elected or appointed government official, such as a mayor or city council member. Economic development functions, similar to those of the private-sector development organizations, include creating, attracting, and retaining jobs and capital investment. Operational advantages may include control and direct access to investment incentives, such as tax abatements, and control over infrastructure planning, such as roads and utilities. In addition, the public-sector model invites, and sometimes requires, input and participation from all sectors of the community. Public-sector economic development organizations are legally defined as government agencies for tax-reporting purposes.

Public-Private Partnership Model

Public-private economic development organizations are funded by both the private and public sectors. Policy direction, objectives, and goals are determined through collaboration between public and private interests. Governing boards include members from business and government posts. Public-private partnership organizations are often called balanced organizations. Reasons for the growing number of public-private partnership organizations include the burdensome and escalating costs of economic development activities. In many instances, those involved in economic development combine public- and private-sector resources to build sufficient funds and staff to accomplish development projects and goals. Public and private sectors combine their respective operational advantages to benefit their communities and service areas.

Two important organizational issues should be considered when choosing a model of economic development. First, there are numerous benefits gained from combining a new economic development organization with an existing agency, either non-profit or governmental. This practice is called piggybacking. The public-private partnership often allows the new organization to use the legal status of the established organization, thus saving time and money. Second, economic development organizations must choose the legal form and tax status most suited and advantageous to their organization. For example, the legal designation of a non-profit organization allows for tax-exempt status, which means that organizational revenues are not taxed and donations are tax deductible for the donor. Economic development organizations usually apply for and are approved for tax-exempt status under sections 501(c) and 501(c) of the Internal Revenue Service (IRS) tax code. The former section applies to a variety of religious, educational, charitable, and scientific organizations. The latter section applies to business endeavors such as chambers of commerce.

Clearly, the organizational structure of an economic development enterprise has the potential to influence the performance and success of economic development organizations and projects. Private-sector development programs, as described in the following section, are an example of the partnership model. The following section analyzes the private-sector development programs and partnerships that have formed between development organizations and businesses in the interest of eradicating poverty in developing countries.

Private-Sector Development Programs

The world's largest and most influential international development agencies, including the World Bank and the Asian Development Bank, endorse private-sector economic development as the best strategy for reducing poverty and improving the quality of life for poor populations worldwide. In 2012, over one-third of the World Bank's "approximately 1000 pieces of analytical and advisory work" being done at the time "support[ed] a critical aspect of private sector development, such as investment climate, competition policy, consumer protection, property rights, or market reforms" (World Bank, 2012). Private-sector development programs are a natural extension of the World Bank's efforts to stabilize and strengthen economies around the world.

The development of the private sector in low-income countries and regions of the world requires cooperation, trust, and partnership between all parties involved in promoting economic development. International development agencies are increasingly turning to corporations for partnership. Development agencies solicit and partner with corporations from industrialized nations to fund, staff, and direct private-sector development programs in developing countries.

Private-sector development programs are interventions that aim to stimulate the development of an economically, socially, and environmentally sustainable private sector in developing countries (Pedersen, 2005). Development agencies encourage corporations to demonstrate corporate social responsibility — the private sector's commitment to improving social and environmental issues — through participation in and funding of private-sector development programs.

Private-sector development programs cover a wide range of economic and environmental support programs and business partnership programs that are introduced by development agencies to stimulate growth in the private sector. Examples of private-sector development activities include liberalizing world trade, investing in physical infrastructure, strengthening the labor market, and offering training and technical assistance to individuals and companies.

Private-sector development programs involve numerous stakeholders. Examples of these stakeholders include the program administrators, companies from industrialized countries that want to invest in a developing country, companies from developing countries that are interested in building a commercial partnership, human-rights organizations, job-training institutions, community-based organizations, and local populations. The stakeholders join together to offer and pool advisory services and financial support.

Private-sector development programs are considered win-win situations for all stakeholders. Development agencies receive benefits from additional funding, staff, and technology resources. Companies are compensated for some of the associated risks associated with investing in markets in developing countries. Developing countries benefit from private-sector investment in their economies.

Corporate investment in private-sector development programs is growing, but many corporations do not invest in development programs or refuse to invest in certain regions. Understanding the obstacles to private-sector investment in certain regions of the world is crucial to reaching the development goal of eradicating poverty and its related conditions. The following section analyzes the problems with the business climate in many developing countries.

Issues

The Business Climate

Private-sector investment drives job creation and income growth, providing poor populations with the opportunity to improve their living standards. Unfortunately, obstacles exist in some developing countries that prevent private-sector investment. Inhospitable business climates with red tape, weak legal systems, aggressive licensing regulation, and inefficient banking systems are part of the experience of doing business in many developing nations. A business climate, also known as an investment climate, is the combined factors that affect the profitability and experience of conducting business in a particular country or region of the world, such as tax structure, public services, government regulations, labor force, and infrastructure.

According to the World Business Environment Survey, conducted in 2000, labor regulations, tax administrations, and customs administration were considered to be the top regulatory constraints of business operations in Latin America, Africa, developing East Asia, South Asia, and the Middle East and North Africa. Why do such business obstacles exist when corporations are eager to invest in developing countries?

Administrative and policy reform is occurring in developing countries to make business climates more hospitable to private-sector investment, but the pace is slow. While attracting foreign direct investment is at the top of the agenda for most countries, there is still much debate about which factors and policies—e.g., rule of law, corruption, legal and regulatory stability, market size, taxes, or infrastructure services—most influence corporate investment decisions.

Developing countries wishing to attract foreign private-sector investment may choose to reform policies to make their business environment more hospitable to investment (Sullivan, 1998). Common policy reform issues in developing countries wishing to benefit from private-sector economic development include:

  • Privatization
  • Bankruptcy and liquidation law
  • Tax system
  • Labor laws
  • Pension system
  • Arbitration and mediation
  • Financial system reform
  • Stock exchanges
  • Access to credit

• Trade

  • Corporate governance
  • Sound accounting systems on internationally accepted principles
  • Preventing insider trading
  • Regulating conflicts of interest
  • Bank-corporation relationships
  • Share registries and custodial arrangements
  • Property rights reform
  • Feedback and participation mechanisms

Countries are increasingly aware of the investment criteria that multinational corporations use to determine investment. The US-Brazil Business Council surveyed multinational companies to discover what factors they regarded as being important in making long-term investment decisions. Common factors included:

  • Strong internal market
  • Freedom of access to the market
  • Available labor force and raw materials
  • Protection from currency devaluation
  • Remittance of dividends, interest, and royalties payments
  • Property-rights protection
  • Export potential
  • Manageable regulatory burdens
  • Favorable taxation and tax incentives
  • Low political risk
  • Reliable infrastructure support

Policy reform may be a voluntary choice made by the developing country or region in an effort to build a better business climate, or it may be a condition imposed from the outside business sector interested in investing and others engaged in building a better business climate. International donor agencies are increasingly making funding conditional on the country's monitoring of a small set of quantifiable indicators or eliminating the obstacles to doing business. In addition to the need for policy reform to attract private-sector investment, policy reform in developing countries is needed to support small-scale indigenous or local businesses in these areas.

Small & Medium Enterprises

Small and medium enterprises — the official term used by international development agencies and governments for a small business — make up more than half of all economic activity in many developing countries. Small and medium enterprises in developing countries are often informal firms with no official legal status. While unofficial firms often remain outside of the tax system and regulatory requirements, these firms are disproportionately burdened by a poorly defined or administered business environment. For example, small firms are often overwhelmed by flat-rate registration fees, the difficulty of securing loans and infrastructure services, and the need to pay bribes.

Economists argue that small and medium-sized enterprises in many nations around the world are regenerating many declining economies. Small-scale entrepreneurs, with great flexibility and simple business structures, are thought to be one of the main agents of change in the economy of many developing nations (Ivy, 1996). Clearly, small and medium enterprises are an important economic resource and stabilizing force in developing countries. The World Bank policy solutions for addressing the business problems facing small and medium enterprises include reducing administrative and regulatory barriers, implementing innovative methods of reducing the costs of regulation, and developing competition policy.

Individual countries are addressing the problems faced by small and medium enterprises (SMEs) in an inhospitable business environment in numerous ways. For example, China passed the SME Promotion Law of 2003 to support the small SMEs operating in the private sector, which is becoming an increasingly important part of the Chinese economy. The law creates enabling institutions and support systems for SMEs at the municipal level (Atherton & Fairbanks, 2006).

The success, and the anticipated economic and social benefits, of private-sector development requires the existence or creation of certain economic market conditions. In particular, private-sector development requires competition in the marketplace between providers and vendors of goods, products, and services. Competitive market conditions, almost always present in industrialized countries, are often absent in developing countries and must be created through the development and implementation of competition law and policy (Cook, 2002). Many national governments of developing countries realize the economic and social benefits of competitive markets and are reforming their economic policies to allow for privatization, support small business, and attract foreign private-sector investment.

Conclusion

The scope of private-sector economic development is vast, encompassing actors from all areas and levels of corporate, non-profit, and government entities. In particular, those engaged in the business sector, whether as entrepreneurs, corporate employees, or staff members of business associations, have the potential to use corporate resources to influence the economies and populations living in poverty in developing countries. Understanding how and why private-sector economic development operates is vital for all those engaged in corporate, government, or non-profit enterprises.

The three models for economic development organizations described in the this article — private-sector model, public-sector model, and public-private partnership model — have real-life applications in the private-sector development work of international development agencies, multinational corporations, and small-scale businesses. While discrete sector models of economic development worked post–World War II to stabilize economies, the current global problems of extreme poverty and related conditions require the shared creativity and pooled resources of public-private development partnerships.

All models of development organizations and all economic development stakeholders will be faced with obstacles to meeting development goals. Obstacles to private-sector development investment include inhospitable business climates in developing countries and extensive program requirements regarding monitoring, reporting, and evaluating. Overcoming these obstacles is crucial to achieving the shared development goals of strengthening world economies and combating poverty.

Terms & Concepts

Business Climate: The combined factors, such as tax structure, public services, government regulations, labor force, and infrastructure, that affect the profitability and experience of conducting business in a particular country or region of the world.

Development Agency: An organization, either public or private, that leads the economic development and regeneration efforts in developing countries or regions of the world.

Developing Country: A country characterized by an underdeveloped industrial base, low per capita income, and widespread poverty.

Corporate Social Responsibility (CSR): The private sector's commitment to improving social and environmental issues.

Corporation: A firm that is owned by stockholders and operated by professional managers.

Economic Development: Programs and strategies aimed at promoting growth in a part or whole of an economy.

Globalization: A process of economic and cultural integration around the world caused by changes in technology, commerce, and politics.

Market Economy: A market in which the prices of items, products, and services are agreed upon by both sellers and buyers.

Private Sector: All enterprises that are outside of government control, including micro, small, medium, and large enterprises.

Privatization: The transfer of ownership or responsibility from the government (public) sector to the business (private) sector.

Public Sector: The economic and administrative enterprises of a local, regional, or national government.

Public-Private Partnership (PPP): A collaboration between private and public sectors in which financial and administrative resources are pooled to achieve shared goals and objectives.

Small and Medium-Sized Enterprise (SME): The term most often used by development agencies and governments to describe a small business, whether formal or informal.

World Bank: An international economic development assistance organization that was founded in 1944.

Bibliography

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Benneh Mensah, M., & Nyadu-Addo, R. (2012). Juxtaposition of the role of small businesses and the state in Ghana's economic development. International Business & Management, 5, 75–82. Retrieved November 25, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=80536269&site=ehost-live

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Whitehead, W. T. & Ady, R. M. (1989). Organizational models for economic development. The Economic Development Review, 7, 8-13. Retrieved March 13, 2007 from EBSCO Online Database Business Source Complete http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=7353715&site=ehost-live

World Bank. (2012). World Bank Group innovations in leveraging the private sector for development: A discussion note. Retrieved November 25, 2013, from http://siteresources.worldbank.org/DEVCOMMINT/Documentation/23170401/DC2012-0002(E)LeveragingPrivateSector.pdf

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Suggested Reading

Carter, R. C. & Danert, K. ( 2003). The private sector and water and sanitation servicespolicy and poverty issues. Journal of International Development, 15, 1067-1072. Retrieved March 13, 2007 from EBSCO Online Database Business Source Complete http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=17110212&site=ehost-live

Hameed, S., & Mixon, K. (2013). Private-sector development in fragile, conflict-affected, and violent countries: CSIS working group on private-sector development in fragile states. Washington, DC: Center for Strategic and International Studies. Retrieved November 25, 2013, from EBSCO Online Database eBook Collection. http://search.ebscohost.com/login.aspx?direct=true&db=nlebk&AN=612679&site=ehost-live

Randolph, R. S. (1994). Economic reform and private sector development in Russia and Mexico. CATO Journal, 14, 109-125. Retrieved March 13, 2007 from EBSCO Online Database Business Source Complete http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9507102444&site=ehost-live

Rondinelli, D. A. (1991). Developing private enterprise in the Czech & Slovak Federal Republic. Columbia Journal of World Business, 26, 26-36. March 13, 2007 from EBSCO Online Database Business Source Complete http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9605306709&site=ehost-live

Essay by Simone I. Flynn, PhD

Dr. Flynn earned her doctorate in cultural anthropology from Yale University, where she wrote a dissertation on Internet communities. She is a writer, researcher, and teacher in Amherst, Massachusetts.