Accelerating Pro-Poor Growth OECD

D A C N e t w o r k o n P o v e r t y R e d u c t i o n

Accelerating Pro-Poor Growththrough Support forPrivate Sector Development

Accelerating Pro-Poor Growththrough Support for

Private Sector Development

An Analytical Framework

ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT

Pursuant to Article 1 of the Convention signed in Paris on 14th December 1960, and which cameinto force on 30th September 1961, the Organisation for Economic Co-operation and Development(OECD) shall promote policies designed:

- To achieve the highest sustainable economic growth and employment and a rising standardof living in member countries, while maintaining financial stability, and thus to contributeto the development of the world economy.

- To contribute to sound economic expansion in member as well as non-member countriesin the process of economic development.

- To contribute to the expansion of world trade on a multilateral, non-discriminatory basis inaccordance with international obligations.

The original member countries of the OECD are Austria, Belgium, Canada, Denmark, France,Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain,Sweden, Switzerland, Turkey, the United Kingdom and the United States. The following countriesbecame members subsequently through accession at the dates indicated hereafter: Japan (28thApril 1964), Finland (28th January 1969), Australia (7th June 1971), New Zealand (29th May 1973),Mexico (18th May 1994), the Czech Republic (21st December 1995), Hungary (7th May 1996), Poland(22nd November 1996), Korea (12th December 1996) and the Slovak Republic (14th December 2000).The Commission of the European Communities takes part in the work of the OECD (Article 13 ofthe OECD Convention).

In order to achieve its aims the OECD has set up a number of specialised committees. One ofthese is the Development Assistance Committee (DAC), whose Members have agreed to securean expansion of aggregate volume of resources made available to developing countries and to improvetheir effectiveness. To this end, Members periodically review together both the amount and thenature of their contributions to aid programmes, bilateral and multilateral, and consult each otheron all other relevant aspects of their development assistance policies.

The Members of the Development Assistance Committee are Australia, Austria, Belgium,Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Luxembourg, theNetherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom,the United States and the Commission of the European Communities.

The DAC Network on Poverty Reduction (Povnet) was originally established in 1998. Recognisingthat the quantity and quality of growth in the productive sectors will have an important bearingon achieving the Millennium Development Goals, a meeting in June 2003 tasked Povnet with a newmandate to develop policy guidance for donors on using aid effectively to promote economic growthand poverty reduction. This led to a decision to form three Task Teams to focus on three specificareas: agriculture, infrastructure and private sector development.

© Photo: World Bank Photo Library

© OECD 2004

Permission to reproduce a portion of this work for non-commercial purposes or classroom use should beobtained through the Centre français d’exploitation du droit de copie (CFC), 20, rue des Grands-Augustins,75006 Paris, France, Tel. (33-1) 44 07 47 70, Fax (33-1) 46 34 67 19, for every country except the United States.In the United States permission should be obtained through the Copyright Clearance Center, Customer Service,(508) 750-8400, 22 Rosewood Drive, Danvers, MA 01923 USA, or CCC Online: http://www.copyright.com/. All otherapplications for permission to reproduce or translate all or part of this book should be made to OECDPublications, 2, rue André-Pascal, 75775 Paris Cedex 16, France.

Table of contents

Preamble ......................................................................................................................................4

Executive Summary ....................................................................................................................5

Chapter 1: Pro-Poor Growth and the Private Sector ..............................................................11I. Poverty Reduction and Pro-Poor Growth ....................................................................11II. What is Pro-Poor Growth? ............................................................................................12III. What Determines the Rate of Pro-Poor Growth? .....................................................13IV. How do the Poor Participate in and Benefit from Growth?.....................................16V. The Private Sector and Pro-Poor Growth....................................................................17VI. The Role of Institutions and Policies in Pro-Poor Growth ......................................18VII. In Summary..................................................................................................................19

Chapter 2: Accelerating Pro-Poor Growth................................................................................21I. Providing Incentives for Entrepreneurship and Investment ....................................21II. Increasing Productivity: Competition and Innovation..............................................26III. Harnessing International Economic Linkages ..........................................................31IV. Improving Market Access and Functioning...............................................................34V. Risk and Vulnerability ..................................................................................................41VI. In Summary...................................................................................................................45

Chapter 3: Delivering Pro-Poor Change...................................................................................49I. Processes for Pro-Poor Change.....................................................................................49II. Priorities and Sequencing Change..............................................................................52III. Mainstreaming Private Sector Development in PRSPs ...........................................55IV. In Summary ...................................................................................................................55

Chapter 4: Donor Support in the New Private Sector Development Agenda ....................57I. Donors in the New Private Sector Development Agenda.........................................57II. Forms of Donor Intervention in the Past....................................................................58III. The Role of Donors in Supporting Private Sector Development

to Accelerate Pro-Poor Growth ...................................................................................59IV. Bringing about Systemic Change ...............................................................................60V. Change the System without becoming Part of the System......................................62VI. Implications for Development Agencies ..................................................................63VII. In Summary..................................................................................................................64

Bibliography...............................................................................................................................67

Accelerating Pro-Poor Growth through Support for Private Sector Development

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Preamble

“The private sector is where much of our focus is going to have to be to meet the overarchingchallenge of poverty reduction and human development. Growth, jobs and opportunity belongthere not in the gift of government”. Mark Malloch Brown, Administrator, UNDP.

With just a decade left to the target date of 2015, the governments of developing countriesand their donor partners are struggling to achieve the first Millennium Development Goal(MDG1) of halving the proportion of people with incomes below USD 1 a day. In manycountries, progress in reducing income poverty has been slow, and the danger of failingto deliver on the Goal is all too evident. What is less clear, however, is how to bring aboutthe dramatic change in the rate of poverty reduction necessary to fulfil the Goal.

In 1995, the Development Assistance Committee (DAC) of the OECD published theDAC Orientations for Development Co-operation in Support of Private Sector Development. TheOrientations focused on the policies and programmes required for the private sector topromote economic growth and deliver sustainable development in developing countries.In 2001, the OECD published the DAC Guidelines: Poverty Reduction which provided a robustframework for reducing poverty. These Guidelines recognise the importance of ‘vigorous,sustained economic growth in the private sector’ for providing jobs and incomes for thepoor. Subsequently, other organisations have published reports on how to establish a dynamicprivate sector and what constitutes pro-poor growth.

This report builds on the DAC publications and recent reports by elaborating howpro-poor growth, essential for the achievement of MDG1, can be accelerated throughsupport for private sector development. It provides an analytical framework for practitionersin development agencies and concerned governments to help them to understand thefactors that matter for pro-poor growth and the processes needed to bring it about.

This report was produced by the Task Team on Private Sector Development set upby the DAC Network on Poverty Reduction (Povnet). Its completion brings to a close thefirst phase of the Task Team’s work. In its subsequent work, the Task Team will be developingpolicy guidance for donors, anchored in this analytical framework, on using aid effectivelyto promote economic growth and poverty reduction through support for private sectordevelopment.


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Executive Summary

Pro-Poor Growth and the Private Sector

The rate at which the average income of the poor is rising will determine whether countrieswill achieve MDG1. This rate is made up of two components: the rate of economic growthand the distribution of the resulting rise in average incomes. Whilst growth is necessaryfor the incomes of the poor to rise, the distribution component should also favour, or atleast not disadvantage, the poor if the rate of poverty reduction is to be maximised. It isimportant to note that it may not be necessary to trade-off growth against distribution:strong overall growth can, in the right circumstances, be compatible with a decline ininequality, and, by the same token, redistributive policies need not preclude strongeconomic growth. The key issue is to identify those factors that affect the magnitude anddirection of each component. There is mounting evidence that high initial levels ofinequality both lower the rate of growth and increase the likelihood of negative distributionaleffects. In addition, the pattern of growth, both geographically and across different sectorsof the economy, also has an effect. If growth is broad-based, encompassing the whole countryand economy, it is likely to be faster and provide greater opportunities for the poor.Similarly, rapid growth in those regions in which the poor live and those sectors from whichthey earn a living will also assist poverty reduction: for example, increased agriculturalproductivity has been a significant factor in poverty reduction in many countries.

This report focuses on the role of the private sector, operating in a market economy,in delivering pro-poor growth. In market economies, it is risk taking to earn profits and incomesthat is the main motivator, and in most economies it is the private sector, which includesindividuals and households as well as businesses, that is the main engine of growth. Butthe extent to which the poor are able to benefit from growth is determined significantly bythe terms on which they are able to access markets and take advantage of the opportunitiesavailable. Institutions play a key role in determining the terms of access, and in ensuringthat development is sustainable (i.e. accompanied by social cohesion and environmentalsustainability). The key challenges, then, are to identify the institutional and policy changesrequired to stimulate pro-poor growth, but also to determine how these changes can bestbe brought about in practice. These issues are addressed in the following two sections.

Accelerating Pro-Poor Growth

As country contexts differ widely, it is difficult to arrive at a universally applicable setof policies and forms of institutions that would ensure pro-poor growth. What is possible,


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however, is to provide an analytical framework to assess whether the conditions are in placefor the private sector to deliver growth, and to identify those changes to institutions andpolicies that would help to make growth more pro-poor. The analytical framework consistsof five interlinked factors:

1. Providing Incentives for Entrepreneurship and Investment2. Increasing Productivity: Competition and Innovation3. Harnessing International Economic Linkages4. Improving Market Access and Functioning5. Reducing Risk and Vulnerability

In addition to boosting growth, changes in institutions and policies also need toaddress the terms on which the poor access markets, help to empower the poor to takeadvantage of these opportunities, and deliver public goods such as social inclusion andenvironmental sustainability that also impact on the sustainability of growth.

Entrepreneurship and investment influence the rate and pattern of growth. Rates ofentrepreneurship and investment vary substantially between countries, with low rates beingassociated with poorer countries and high rates with countries that have been better ableto deliver and sustain high rates of growth and incomes. Institutional change and policiesthat lower the risk and cost of doing business and provide greater access to productiveresources increase the incentive for entrepreneurship and investment and lead to apro-poor pattern of growth, particularly if they establish a level playing field for the poor.The risk of doing business is likely to be lower if the rules of the game are transparent,predictable and well enforced, property rights are secure and there is a level playing fieldin competing against other businesses. The cost of doing business is affected by the levelof barriers to starting, operating and closing businesses, the bureaucracy involved indoing business, access to and the cost of infrastructure and the cost of enforcing contracts.Rates and patterns of entrepreneurship and investment are affected also by access toproductive resources, in particular, access to capital. Lack of access to capital limitsentrepreneurship and investment. More generally, if the level of incentive is low, growthis likely to be confined to a few sectors and regions and the poor are less likely to benefitfrom growth. Inappropriate institutions and policies can also drive the poor into theinformal economy, where they are more likely to experience lower wages and poverty, jobinsecurity and a lack of protection from labour and other legislation.

Rapid and sustained growth is facilitated by a virtuous circle whereby entrepreneurshipand investment lead to higher productivity, which increases the return on investment, andthus the availability of additional resources for future investment. Higher output peremployee also allows wages to increase. As well as increased investment, productivity canalso be raised by innovation and the introduction of new technology, and by improvementsin efficiency that result from shifts in resources from activities with low productivity to moreproductive areas of the economy. These benefits result from a process of ‘creativedestruction’, encouraged by competition, through which innovators and more inefficient


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firms replace older technologies and less efficient companies. Productive resources shouldalso flow to those sectors in which they earn the highest returns, facilitated by appropriateinstitutions. To accelerate growth that is particularly pro-poor, productivity needs to risein sectors from which the poor earn their livelihoods and in the sectors that provide newopportunities for them to participate in and benefit from growth.

Rapid growth is also associated with greater international trade and investmentlinkages. Greater trade integration enables the economy to focus resources on sectors ofcomparative advantage, and enables the private sector to access large and rapidly growingmarkets for their products. Greater integration can also stimulate foreign direct investment(FDI), which as well as raising productive capacity also tends to produce benefits in theform of the transfer of knowledge and skills. However, reducing tariff barriers and attemptingto attract FDI has not proved sufficient for many developing countries. These countriesneed to examine whether there are sufficient incentives for businesses, appropriateinstitutions and infrastructure, and that resources are able to flow to sectors of comparativeadvantage. The poor need to be able to benefit from trade and FDI by improving theiraccess to rapidly growing markets and helping them to diversify their sources of income,including reducing their reliance on commodities with falling real prices. Safety nets mayalso need to be provided for the poor who stand to lose from trade liberalisation.

Whilst the above will lead to higher growth and provide opportunities for the poor,the benefits may be increased by improving access to those markets that matter most fortheir livelihoods and consumption needs. Access to and the efficient functioning of marketsfor productive resources are vital for pro-poor growth. In these markets, the poor should,ideally, participate on equal terms with the rest of the private sector. Improved access tofinancial, human and natural assets increases the incomes the poor earn from traditionallivelihoods. For example, growth in private credit is pro-poor even when access to creditremains low. Moreover, increases in non-farm activity in rural areas have strong pro-poorimpacts, even though the poor may continue to earn most of their livelihood from agriculture,as they provide the opportunity to diversify the sources of, and hence maximise, householdincome. Increased private credit, higher rates of formal employment, security of landtenure and use are all important factors. In addition, infrastructure is a prime example ofhow access may be denied to the poor or returns to their assets reduced. For example, alack of power may prevent rural areas from processing their crops or the high cost oftransport from a rural area served by poor roads may make many activities uneconomic.Improving market access and functioning depends upon developing appropriatemarket-regulating, facilitating and promoting institutions, addressing market failures,lowering transaction costs, and reducing social exclusion. The provision of basic servicesof health, education and infrastructure and actions to empower women, such as femaleliteracy, are particularly pro-poor.

The poor are vulnerable to man-made shocks and natural disasters. When crises occur,the poor may have to consume or sell productive assets such as seed and land, suffer theerosion of human capital through disease or hunger and see their access to, and returns


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from, natural assets decline, establishing a poverty trap from which they take many yearsto escape. In the absence of insurance and publicly provided safety nets, the poor haveadapted their livelihood strategies to manage and cope with these risks. The problem isthat such risk mitigation strategies may not allow them to maximise incomes. Producingdrought resistant crops that may not provide the highest return is an example, andcontinuing to produce some staples when land is better suited to livestock is another. Withsome access to credit and a diversity of income sources, the poor do not have to resortto measures that undermine their ways out of poverty, and could borrow to meet healthcare needs rather than running down productive assets. Encouraging the insurance industryto provide risk cover may also improve risk management and coping strategies. Forexample, it is possible in some developing countries to get cover for drought, livestockand other agriculture-related activities. Savings schemes that provide a buffer againstadversity also have a role to play.

Delivering Pro-Poor Change

Having identified the institutional and policy changes required to stimulate pro-poorgrowth, it is necessary to determine how to bring these changes about in practice.Institutions and policies result from the interaction of the state, the private sector and civilsociety. These three parts of society consist of various groups and organisations that wishto promote their own interests, and which may in the process neglect the interests of thepoor. It may be necessary for progressive elements within the three parts of society, inconjunction with donors, to highlight the plight of the poor and provide evidence of howpro-poor growth benefits society in the long term, both in terms of rising incomes and socialcohesion.

Delivering pro-poor change is likely to involve a politically sensitive mix of negotiationand contestation, otherwise the process risks being blocked by powerful interest groups.For pro-poor institutional and policy change to succeed, it may be necessary to helpbuild constituencies for change over a specific issue, comprising like-minded organisationsand individuals. These constituencies need to be enabled to engage with vested intereststo overcome resistance to change. Analysis of stakeholder interests, including who standsto win and lose from change and what their specific interests are, should help to revealhow vested interests may be overcome. The constituency may need to overcome resistanceto change through evidence-based dialogue, piloting reforms and, if necessary, findingways to compensate the losers. This is increasingly becoming part of the way that donorsare planning and implementing their assistance to their partner countries, as discussedbelow.

The priorities for and sequencing of institutional and policy change depend upon theattitudes and perceptions of the principal actors in the specific country context. Engagementbetween the state, the private sector and civil society should help identify priorities. ThePoverty Reduction Strategy Paper (PRSP) process represents an opportunity to institutionalise


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such engagement. At present, PRSPs frequently do not set specific benchmarks for privatesector development and do not involve the private sector and civil society in monitoringoutcomes. If possible, stakeholder engagement should include participatory monitoringand learning in which the views of the intended beneficiaries, including the poor, help toinfluence the future course of action and thereby set in motion a continuous process ofimproving institutions and policies.

Donor Support in the New Private Sector Development Agenda

This report suggests that the agenda for accelerating pro-poor growth through supportfor private sector development is broader than the old private sector developmentagenda, which mainly focused on providing support to private sector enterprises that wereconsidered important for the livelihoods of the poor, particularly small enterprises andagribusinesses. Evidence suggests that a higher contribution by small enterprises to aneconomy is associated with, but not a cause of, higher growth and may not necessarily bepro-poor. It is market outcomes that may be more or less pro-poor, not particular typesof enterprise. The new agenda recognises that what matters is the extent to which the rateand pattern of growth provide opportunities for the poor and the degree to which theyare able to take advantage of these opportunities. The focus is thus on institutions andpolicies that influence market outcomes.

The aim of practitioners should be to bring about systemic change, altering theincentives provided to the private sector in order to make it deliver pro-poor outcomes.Systemic change is likely to involve a combination of institutional and policy change andsupport for accelerating the development of markets that the poor need to improve theirlivelihoods. This approach is being adopted progressively in the main types of privatesector development support that donors provide. Thus, in the provision of businessesdevelopment services (BDS), for example, there is a growing recognition that BDS provisionis not an end in itself but a tool to bring about pro-poor outcomes in markets, to supportregional development, and to target specific beneficiaries such as women. It may involveboth large and small enterprises.

For the purpose of long-term sustainability, it is preferable that donors attempt to changethe system without becoming part of the system. For institutional change, donors may fosterthe emergence of change agents who can build constituencies for change, overcomevested interests and institutionalise stakeholder engagement with participatory monitoringand evaluation. To improve the supply of goods and services, they may use facilitators tocatalyse the development of markets, intervening pre and post delivery. In this way, thesustainability of the intervention will be driven by market forces.

Instead of regarding private sector development as just one of a number of tools, itshould be regarded as a major, if not a central, part of the country assistance that donorsprovide. Within the development agency, accelerating pro-poor growth through private


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sector development should be a cross-cutting issue and expertise in this field placed withinthe organisation so it may support all country-facing departments, akin to a policy function.The range of skills employed should be wider than enterprise development and financefor small enterprises. It should also encompass macroeconomics, governance and institutionalchange, and the provision of basic social services and transfers to reduce poverty traps.

The uncertainty of progress on delivering institutional change and bringing aboutpro-poor outcomes means that donors will need the greater flexibility that programmesprovide over projects, allowing the sequencing of support to be altered if necessary.Moreover, the new broader agenda calls for greater donor co-ordination, through sector-wideapproaches that involve the private sector and the poor. It is unlikely that a single donorwill have the resources or competitive advantage to support the delivery of all of theconditions that contribute to pro-poor growth. By co-ordinating with other donors, theywill be able to ensure that the breadth of interventions required for their programmes ismade available.


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Chapter 1

Pro-Poor Growthand the Private Sector

The multiple dimensions of poverty may be addressed throughpro-poor growth. This chapter explores how accelerating pro-poorgrowth through support for private sector development can contributeto achieving the first MDG of halving by 2015 the proportion of peopleliving on less than USD 1 a day. It considers what we mean bypro-poor growth, what influences its rate and what is the role of theprivate sector in accelerating pro-poor growth.

I. Poverty Reduction and Pro-Poor Growth

The DAC Poverty Reduction Guidelines and otherframeworks for poverty reduction1 describe the manydeprivations that the poor experience. In addition to lowincomes, the poor suffer from a lack of an effective ‘voice’in shaping policies that affect their lives, a lack of accessto assets that undermines their capability to earn livelihoods,discrimination on the basis of gender or social group andvulnerability to natural and man-made shocks and disasters.To address these multiple dimensions, the PovertyReduction Guidelines state that a strategy for the sustainablereduction of poverty must include six complementary policyelements (see box 1).

The pace and quality of economic growth have a directrole in reducing income poverty, and they also influencethe ability to bring about the other elements of theframework for reducing poverty:

• The pace of growth affects the revenues available togovernments to fund the basic social services thatthe poor need to lead productive lives.

Poverty is multipleforms of deprivation.

The pace andquality of growthimpact all aspects of poverty.


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• Growth may empower (or deprive) the pooreconomically and this may increase (or decrease)their ability to influence the policies and institutionsthat affect the pattern and distribution of growth.

• The sustainability of growth influences the extent towhich the poor are exposed to economic shocks.

• The inclusiveness and equity of the growth processdetermine the extent of economic discriminationagainst women, who make up a disproportionately highproportion of the poor.

• The nature of the growth process affects resourceuse and the extent to which environmentalsustainability is integrated with economic and socialdevelopment.

Monitoring the rateof growth in theaverage incomes of the poor revealswhether MDG1 willbe met.


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Box 1: The Framework for Poverty Reduction

• Pro-poor economic growth: pace and quality matter – its rate, composition, distributionand sustainability are vital for reducing income poverty.

• Empowerment, rights and pro-poor governance – the poor need to be able to exercisetheir human and political rights to influence their own lives and the system of governanceshould protect those rights.

• Basic social services for human development such as access to health, education andtransport, safe water and adequate nutrition.

• Human security: reducing vulnerability and managing shocks. Human security meanssafeguarding human development by protecting people from shocks and disasters.

• Mainstreaming gender and enhancing gender equality. Gender inequality is a majorimpediment to sustainable development.

• Mainstreaming environmental sustainability using sustainable livelihood approaches.Achieving the MDG’s calls for an integrated approach combining economic and socialdevelopment and environmental sustainability.

II. What is Pro-Poor Growth?

But what, precisely, do we mean by pro-poor growthand how should it be measured?

There are different views on what constitutes pro-poorgrowth. For some,2 growth is pro-poor when the incomes ofthe poor are rising more than average incomes, thus showingthat the poor are benefiting disproportionately from growthand that inequality between the poor and the non-poor isfalling. This is the relative definition of pro-poor growth. Forothers,3 what matters is the rate at which the incomes of the

poor are rising. This is the absolute definition of pro-poorgrowth. It recognises that the rate of growth in the incomesof the poor determines when their incomes will exceed$1/day, the target embodied in MDG1. Governments anddonors have a choice as to how they define pro-poor growth.In practice, practitioners may refer to both definitions, theabsolute when discussing the reduction of the headcountpoverty index (and the achievement of MDG1) and therelative when assessing the extent to which inequality ischanging during the growth process.

At the heart of both the absolute and relative definitionsof pro-poor growth is a concern with increasing the incomesof the poor. But what is the right measure of the rate at whichthe incomes of the poor are rising? Again, practitionershave a choice in this regard. They may focus on the incomesof those who are marginally poor, as this is the crucialmeasure for reducing the poverty headcount, or the rateat which the gap between the incomes of the extreme poorand incomes at the poverty line is falling, to assess how longit will take to eradicate poverty.4

However, a consensus seems to be emerging that theappropriate measure is the growth of the average incomesof all poor people, i.e. all people below the (national orinternational) poverty line.5 This focuses attention onpolicies that ensure that all sections of the poor benefit fromgrowth, not just those nearest the poverty line or indeedthose furthest away. Other measures are also useful and maybe referred to when examining, for instance, the time it willtake to eradicate poverty.

The critical point that emerges from the absolutedefinition is that pro-poor growth is a rate not a state, andso practitioners need to address how it can be increased.It should be noted, however, that there are major limitationson the availability and quality of data to measure the rateof pro-poor growth across time periods and countries.6

III. What Determines the Rate of Pro-Poor Growth?

There is now widespread agreement that increasingaverage incomes [gross domestic product (GDP) per capita]

Growth of averageincomes is a neces-sary condition forpoverty reductionbut the effect ofgrowth on theincomes of the poorvaries substantially.


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is a necessary condition for reducing poverty and that thehigher the rate of growth, and the longer it is sustained, themore rapid the process of poverty reduction.7 Acrosscountries and time periods, it has been found that, asaverage incomes rise, the incomes of the poorest fifth ofthe population8 rise proportionately. Over long time periods,between 66% and 90% of the reduction in poverty can beexplained by changes in average incomes.9

But the effect of growth on the incomes of the poor variessubstantially between countries and time periods.10 Thereare examples of periods of growth in individual countriesthat have not had much impact on reducing poverty.11 Suchepisodes draw attention to the issue of the extent to whichthe poor benefit from growth.


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Growth and Pro-Poor Growth Rates

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-3 -2 -1 0 1 2 3 4 5 6

Overall GDP Growth in the Economy

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Chile

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BangladeshGhana

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Figure 1

Figure 1 shows the relationship between the growth ofaverage incomes and the growth rate of the incomes of thepoor.12 Whilst growth in average per capita incomes wassimilar in Brazil and Ghana, the incomes of the poor rosetwice as fast in the latter. As a result, inequality betweenthe poor and the non-poor fell in Ghana, as it did in allcountries above the 45-degree line, but increased in Braziland other countries below the 45-degree line.

The rate of poverty reduction is a combination of agrowth and a distribution component.13 The growthcomponent measures the extent to which the incomes ofthe poor would have risen if the distribution of incomehad remained unchanged. The distribution componentmeasures the effect on the incomes of the poor of changesin the distribution of income.

The two components may work in the same or oppositedirections, and the net effect on reducing poverty will dependupon their relative magnitudes. Hence, in Vietnam andChina, substantial reductions in poverty have been achievedthrough rapid growth, even though the distribution componenthas been negative. If both are roughly equal in magnitudeand work in opposition, poverty reduction will be low. Forexample, in Ethiopia between 1981 and 1995, growth shouldhave resulted in poverty reduction of 31%. In practice, anegative distributional effect of 37% resulted in a net increasein poverty of 6%.14 It is important to consider growth anddistribution simultaneously and to recognise that thoughgrowth is necessary, distribution may matter as much.15

The critical point to note is that it may not be necessaryto trade-off growth against distribution. It is possible to havehigher growth that impacts positively on distribution.Evidence from across the world shows that inequality fallsalmost as often as it increases as an economy grows.16 Whatis important is to identify the conditions under which thetwo components complement each other.

What factors affect the magnitude and direction of eachcomponent?

There is mounting evidence that high initial levels ofinequality in incomes and in access to productive assets


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lower the rate of growth and increase the likelihood of thedistributional component having a negative impact onpoverty reduction.17 Countries with high rates of initialinequality need higher rates of growth to reduce povertyat the same rate as those with lower initial inequality.

In addition, the pattern of growth, in geographical andsector terms, also has an effect. If growth is broad-based,encompassing the whole country and economy, it is likelyto be faster and provide greater opportunities for the poorto increase their incomes, thus contributing to a positivedistribution component. Economic growth in the regionsin which the poor live and sectors from which they earnincomes is likely to affect the incomes of the poor positivelyand directly. In many countries that have substantiallyreduced income poverty, increased agricultural productivityhas been a strong factor in increasing the incomes of thepoor and has contributed to the structural transformationof the economy by facilitating new sectors that eventuallylead growth.18 For the growth and distributional componentsto complement each other, it is also important that thepoor have the opportunity to participate in and benefit fromrapidly growing regions and sectors.

IV. How do the Poor Participate in and Benefit fromGrowth?

The poor are participants in the growth processalongside the non-poor. Potentially, growth should benefitthe poor in the following ways:

• As farmers and entrepreneurs, they should benefit fromgreater demand for their products and services. Theimpact on the incomes of the poor will be greatest ifthey have access to the assets that they need to earntheir livelihoods, if the productivity of those assetsincreases and if they are able to take advantage ofthe opportunities provided by the growth process.

• As workers, they benefit from greater demand for labour,more jobs and higher wages. These benefits increaseif growth occurs in sectors that are labour intensive,or if labour demand increases in sectors in which

Private sectordevelopment isfundamentallyabout peoplereleasing andharnessing theirproductive potentialand satisfying theirhuman needs.


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many of the poor participate, particularly if higherproductivity enables higher wages to be paid.

• As consumers, they should benefit from lower prices andbetter quality products that result from higher, moreefficient production. These benefits would be greaterif the high costs of serving poor consumers, particularlyin rural areas, could be reduced.

• As potential recipients of tax-funded services or transfers, theyshould benefit from a stronger tax base that enableshigher expenditure by government. Better access tobasic social services such as health, education, safewater and adequate nutrition would enable the poorto improve their ability to earn livelihoods whilstimproved infrastructure would improve access tomarkets.

V. The Private Sector and Pro-Poor Growth

What is the private sector and what role does it playin delivering pro-poor growth?

Whilst for many the term private sector conjures up theimage of a business engaged in commerce or manufacturing,analysing the characteristics of the private sector leads toa deeper understanding of its nature and widens thecoverage of the term.

The DAC Orientations define the private sector as ‘a basicorganising principle of economic activity where private ownership is animportant factor, where markets and competition drive production andwhere private initiative and risk taking set activities in motion’. Thecritical point is that it is markets, through the process ofcompetition, that determine what is produced andconsumed. This is what distinguishes market-basedeconomies from other organising principles.

In market economies, it is risk taking to earn profits andincomes that sets economic activity in motion. Suchmotivation is not just confined to businesses. It is also themotivation for individuals and households when they selltheir labour, farm or produce other goods and services.

The private sector is more thanbusinesses. It includes the poorand multinationalsparticipatingalongside each otherin markets.


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The term private sector, therefore, covers all private actors- the poor and the rich, individuals and businesses - engagedin risk taking to earn profits and incomes. It applies to thesmallholder farmer as well as to the very large, multinationalcorporation.

The world over, the private sector is the major contributorto GDP and employment and so is the engine of theeconomy. Growth, as measured by increases in GDP, issimply the sum of the increase in value added by theactivities of all participants engaged in production andmarket exchange.19 The greater the capability of privateactors, including the poor, to add value and create wealth,the faster will be the pace of growth.

VI. The Role of Institutions and Policies in Pro-PoorGrowth

What makes for pro-poor outcomes in markets?

The critical determinants of whether market outcomesare pro-poor are the terms on which the poor are able toaccess markets, which can disadvantage the poor, establisha level playing field with the rest of the private sector, orempower them to take advantage of the opportunitiesprovided by growth.

Markets need appropriate ‘rules of the game’ to ensurethat they function efficiently and allow stable, secure andfair transactions. Institutions, the rules of the game andthe governance exercised over them may serve to promotemarket exchange or deny access. For example, the absenceof appropriate regulatory institutions may reduce themotivation of the private sector (including the poor) toengage in economic activity, reducing growth or makinggrowth less pro-poor. Institutions may serve to link andempower actors, particularly the poor, or marginalise themfrom the growth process. The poor start from a disadvantagedposition in terms of wealth and incomes compared to therest of the private sector. Promoting and facilitatinginstitutions may help to ensure that this disadvantagedoes not become a ‘poverty trap’,20 excluding the poorfrom the growth process.

“Private sectordevelopment is theinterplay betweenthe State asformulator of therules of the game,players in theprivate sector andcivil society”. Sida:Making MarketsWork for the Poor.


18 © OECD 2004

Institutions may also play the crucial role of ensuringsustainable development in which growth is accompaniedby social cohesion and environmental sustainability.Institutions, both formal and informal, may help to ensurethat social conflict, particularly over the use of naturalresources or access to markets, is reduced. Such conflictoften reduces growth and results in exclusion, almost alwaysfor the poor. Institutions may ensure that price signalsreflect the true cost or benefit of using or conserving naturalresources,21 providing the motivation for the private sectorto manage environmental impacts.

Policies with respect to the way that tax-funded transfersare used also impact terms of access. Thus, if the governmentaddresses initial inequality with respect to access toproductive assets and basic services of health and educationand infrastructure, it will help to level the playing field.Similarly, investment in developing the skills of the poorwill enable them to take greater advantage of theopportunities provided by growth.

VII. In Summary

Pro-poor growth addresses income poverty and alsoinfluences the ability to bring about other elements of theframework for poverty reduction. For growth to be pro-poor,what matters is that the rate of growth is high, that thepattern of growth provides opportunities for the poor toincrease their incomes, and that they are enabled to takeadvantage of these opportunities. The growth anddistribution components of the rate of pro-poor growthare not in contradiction, and to maximise the rate,practitioners need to identify the conditions that allow thetwo components to complement each other. The pace andpattern of growth are influenced by the signals the privatesector, including the poor, receives through market outcomes,which are in turn influenced by institutions and policies.


© OECD 2004 19

Notes

1. For instance, see World Development Report 2000/1 Attacking Poverty, World Bank.

2. For example, Klasen, S. In Search of the Holy Grail: How to Achieve Pro-Poor Growth, 2003.

3. For example, Ravallion, M. and Chen S. Measuring Pro-Poor Growth, Economic Letters (78),2003.

4. Klasen S. 2003.

5. Ravallion M & Chen S. Measuring Pro-Poor Growth, 1997.

6. Guidance on how the rate of pro-poor growth can be calculated is available from DFID (email:[email protected]).

7. Kraay, A, When is Growth Pro-Poor, World Bank, 2003.

8. Dollar D. & Kraay A. Growth is Good for the Poor, World Bank, 2003.

9. Kraay, A. 2003.

10. Ravallion M. Growth, Inequality & Poverty: Looking Beyond Averages, 2001.

11. Bourguignon F., The pace of Economic Growth & Poverty Reduction, 2001

12. DFID Briefing Note Number 1, 2004.

13. Bourguignon, F. The Growth- Inequality-Poverty Triangle, Feb 2004.

14. Bourguignon F. 2004.

15. Bourguignon F. 2004.

16. Ravallion M. Pro-Poor Growth: A Primer, 2004.

17. Ravallion M., 2004.

18. Reaching Millennium Goals: How well does agricultural productivity growth reduce poverty?Noman Majid, ILO 2004.

19. Simply put, growth is the sum of the increase in value added (outputs less bought in goodsand services) across all economic activities in an economy.

20. Dercon, S. Poverty Traps & Development: The Equity-Efficiency Trade-off Revisited, 2003.

21. Markets for trading carbon emissions are an example of institutions that reinforce the conser-vation of natural resources.


20 © OECD 2004

Chapter 2

Accelerating Pro-Poor Growth

In some countries, the challenge is to increase economic growth,on a sustained basis, to levels that have never been achieved before.In others, there is a need to ensure that growth is more pro-poor thanpreviously. This chapter provides an analytical framework forunderstanding what factors enable the private sector to accelerategrowth and what institutions and policies help to make growth pro-poor.

As country contexts differ widely, it is difficult to arriveat a universally applicable set of policies22 and forms ofinstitutions23 that ensure pro-poor growth. What is possible,however, is to provide an analytical framework to assesswhether the conditions are in place for the private sectorto deliver growth, and to identify changes to institutionsand policies that would help to make growth more pro-poor.The analytical framework consists of five interlinked factors:

1. Providing Incentives for Entrepreneurship andInvestment.

2. Increasing Productivity: Competition and Innovation.3. Harnessing International Economic Linkages.4. Improving Market Access and Functioning.5. Reducing Risk and Vulnerability.

I. Providing Incentives for Entrepreneurship andInvestment

a) How does providing incentives for entrepreneurshipand investment affect the rate of pro-poor growth?

In search of profits and incomes, entrepreneurs24 seteconomic activity in motion by bringing together productiveresources to produce goods and services. Investmentcontributes to growth by increasing the productive capacity

Five interlinkedfactors form anenablingenvironment for theprivate sector todeliver growth.

Entrepreneurshipand investmentaffect the rate ofgrowth andinfluence itspattern.


© OECD 2004 21

of the economy, creating jobs, and, by introducing newtechnology, can also serve to increase the productivity ofother factors of production.25

Rates of entrepreneurship vary tremendously acrosscountries. For instance, Ukraine has less than 10 enterprisesper thousand population compared to 120 in Thailand.26

Countries with high rates of entrepreneurship are likely tohave dynamic private sectors, better able to deliver andsustain high rates of growth. A high rate of investment isone of the key differentiating features of countries thathave sustained high rates of growth. In high-growth countries,investment typically exceeds 25% of GDP, whereas itstruggles to reach 20% in low-growth countries. Whereinvestment is low, 14% of GDP in Bolivia for instance,27 theproductive capacity of the economy fails to increase,resulting in lower rates of growth and job creation, andthus in fewer opportunities for the poor to improve theirlivelihoods.

b) What factors influence the rate and pattern ofentrepreneurship and investment?

The concept of incentive is critical to understanding themotivation of the private sector to engage in entrepreneurshipand to undertake investment. Incentive refers to the balancebetween anticipated risk and reward, not just the taxincentives that might be given to business. The higher therisk, the greater the profitability of the venture has to be tojustify the investment. The higher the cost of transactions28

(doing business), the higher the potential returns have tobe to cover these costs. Both risk and transaction costs thusreduce the incentive for investment.

Institutions are critically important for determining thelevel of risk and the costs of doing business. The risk of doingbusiness is likely to be lower if the rules of the game aretransparent, predictable and well enforced, if there issecurity over rights to property and other assets, and if thereis a level playing field in competing against other businesses.The cost of doing business is affected by the barriers tostarting, operating and closing businesses, the bureaucracyinvolved in doing business, access to and the cost ofinfrastructure and the cost of enforcing contracts.

Risk and transaction costsreduceentrepreneurship and investment.

Transparent andpredictable rules ofthe game, alongwith good gover-nance, reduce risk.Simpler businessregulations andimproved access toinfrastructurereduce the cost ofdoing business.


22 © OECD 2004

Rates and patterns of entrepreneurship and investmentare also affected by access to productive resources. Accessto capital is fundamentally important as it enables themobilisation of all productive assets. The greater the flexibilityof labour use and the higher the level of human capital ofthe work force, the more incentive entrepreneurs have toemploy labour and hence provide opportunities for thepoor.29 The easier it is to establish and transfer title to land,the more likely it is that it can serve as collateral to raise capital.Access to other natural resources, such as forests, water andclean air, helps to provide opportunities for investment, butthe use of natural resources must be sustainable.

Where there are high risks and costs of doing businessand limited access to productive resources,entrepreneurship and investment are likely to be limitedto the few sectors and regions that offer sufficiently highrates of return to offset them. The poor are likely to be mostdisadvantaged as they frequently suffer higher risks andcosts of doing business and lower access to productiveresources. Hence, the opportunities growth provides for thepoor are likely to be lower. Poorer countries tend to haveless transparent and predictable rules of the game, lesseffective governance30 and limited access to productiveresources. Institutions and policies that address theseshortcomings and help to bring about a level playing forthe poor help to make growth pro-poor.

The institutions and policies that affect entrepreneurshipand investment are set out in Box 2.

High risk and costof doing businesswill confine growthto a few sectors andregions makinggrowth less pro-poor.


© OECD 2004 23

Box 2

Institutions & Policies forEntrepreneurship and Investment

Entry & Exit Barriers• Ease of business establishment • Ease of bankruptcy procedures• Less bureaucracy

Effect on Pro-Poor Outcomes

• Reducing barriers to establishing, operating orclosing businesses, in the form of numerous orcostly procedures and bureaucracy, reducesrisk and cost of doing business, increasing theincentive for entrepreneurship and investment

• The lower the barriers, the more likely that thepoor will be able to participate asentrepreneurs, leading to higher pro-poorgrowth


24 © OECD 2004

Box 2 (cont.)

Institutions & Policies forEntrepreneurship and Investment

Predictable Rules of Exchange• Transparent decision making• Enforcement of contract• Transferable property rights• Level playing field with the

public sector and largerbusinesses

Macro stability• Political and social stability• Monetary & fiscal discipline• Wider tax base• Redirecting public expenditure

towards basic services for thepoor and increasing theproductivity of investment inthem

Governance• Law and order• Access to justice• Protection of human rights• Lower corruption

Factor markets• Financial sector deepening• Flexible labour markets with

growing demand for labour• Secure access to natural

resources on a sustainablebasis


• Transparent decision making, security ofcontract and the use of property, and faircompetition lower risk and provide incentivesfor entrepreneurship and investment

• Higher risk is likely to limit growth to a fewsectors and regions that offer potentially highreturns, making growth less pro-poor

• Macro stability reduces risk, monetary andfinancial discipline frees resources forinvestment by the private sector and a widertax base reduces the burden of taxation onbusiness, contributing to higher rates ofentrepreneurship and investment and broaderbased growth

• It also reduces the risk of economic recessionsthat often reduce the incomes of the poor morethan average incomes

• Stability and greater access to capitalencourage long term investment in fixedassets, increasing job creation and hence therate of pro-poor growth

• Investment in basic services enables the poorto participate in and benefit from growth

• Lower risk to property and the person, securityof personal freedoms encouragingentrepreneurship and investment

• Poor are particularly disadvantaged bygovernance failures as the rich are betterplaced to circumvent them

• Ease of access to factors of productionfacilitates entrepreneurship and investment

• Financial sector deepening, increased rates ofjob creation in the formal sector and secureand sustainable access to natural resourcesincrease the rate of pro-poor growth

c) What are the main challenges in providing incentivesfor entrepreneurship and investment that will contributeto pro-poor growth?

Over the past two decades, substantial progress hasbeen made in bringing about macro stability across thedeveloping countries. However, fiscal and monetarydiscipline, a wider tax base and, in particular, redirectinggovernment expenditure towards providing basic servicesto the poor, remain elusive for some governments. Progressin improving governance has been far less impressive andit remains a major challenge to overcome the vestedinterests of those who benefit from poor governance.

The role that reducing the cost of doing business playsin increasing investment has been recognised for sometime but there are wide variations in the ability ofgovernments to deliver improvements. Hence, in Australia,it takes just 2 days to register a business as against the 203days it may take in Haiti. The cost of enforcing a contractrepresents 0.3% of per capita income in Jordan as against120% in Madagascar.31 The need to co-ordinate the activitiesof numerous government agencies, improve access tojustice and overcome resistance to change from thebureaucracy are the main barriers to progress.

Evidence shows that the process of financial deepening,whereby a country’s financial sector increases the proportionof its assets used for investment by the private sector, isone cause of higher rates of pro-poor growth.32 In developedand rapidly developing countries, credit to the privatesector represents close to 100% of GDP. In the low-growtheconomies of Africa, the rate is under 10%. Strikingly, cross-country evidence suggests that, between 1960 and 1999,had Brazil had the same level of financial deepening asKorea, the incomes of the poor, instead of remainingstagnant, would have increased by 2% p.a., the same rateas average incomes.33

Inappropriate institutions that reduce the incentive forentrepreneurship and investment may drive the poor intothe informal economy. In Africa, as much as 78% ofnon-agricultural employment is estimated to be informaland the rates for South Asia and Latin America are not far

Private creditincreases incomes of the poor.

Informality isassociated with lowrates of pro-poorgrowth.


© OECD 2004 25

behind.34 Informality increases with the number of proceduresneeded to start a business,35 poor governance, discriminationagainst women and ethnic minorities, insecure propertyrights, a high tax burden and high costs of employment.

In the informal economy, the poor are more likely toexperience poverty. Informal workers are unlikely to beable to exercise their rights, their jobs are likely to be lesssecure and they are likely to receive lower wages thantheir formal sector counterparts. It is in the informal economythat the highest incidence of child labour is to be found.Addressing informality is, however, a major challenge,calling for further research. The distinction between formalityand informality is not clear-cut,36 there are many types ofbusiness in the informal economy and for many informalityis the only means of survival. Some of the poor, such aswomen with families, prefer to work informally. They are likelyto remain informal and need assistance in coping with riskand vulnerability, as discussed below.

II. Increasing Productivity: Competition and Innovation

Though high rates of investment are necessary, they arenot sufficient to ensure high rates of pro-poor growth. In theformer communist countries of Europe, despite investingin excess of 30% of GDP, growth was slow and ultimatelyunsustainable.37 Growth is likely to be faster, more sustainedand more pro-poor if additional investment is accompaniedby growing productivity so that returns to investmentincrease, making available additional resources for futureinvestment: a virtuous circle for growth.38 Growingproductivity should allow higher wages, benefiting thepoor as workers, and, if the productivity of the poor increases,their incomes as entrepreneurs and farmers should also rise.

a) How does productivity increase?

There are two main drivers of productivity growth:

• Increasing the efficiency with which factors ofproduction are combined to produce goods andservices through the use of better technology.Economists call this technical, static or productive


26 © OECD 2004

efficiency, and it is driven by innovation. It is a majorcontributor to the growth of rich countries, such asthe United States, and has contributed to the rapiddevelopment of East Asian countries.

• Shifting resources from activities with low productivityto more productive areas. Economists call thesegains in allocative or dynamic efficiency, and manyof the rapidly growing Asian economies havebenefited from this.

Entrepreneurship is not just about more people doingthe same thing. It is also intimately connected with whatSchumpeter described as new combinations or innovations.39 Itis these new combinations that result in higher value additionand hence growth, through introducing new or better productsand more efficient production methods to drive upproductivity. The process of the development of the privatesector is likened by him to creative destruction.40 Those unableto compete with the innovators are driven out of the market,giving way to the more innovative and efficient. This requiresthat there are low barriers to entry and exit and that thereis a hard budget constraint, so that governments do not keepon bailing out the inefficient. Without the pressure ofcompetition, the need to innovate is diminished.

Knowledge of how to combine factors of production toproduce goods and services more efficiently has beenconsidered by many to be the fourth factor of production.41

Such knowledge covers not only technology but also theability to manage businesses. Access to this knowledgeimpacts the rate of pro-poor growth. If it is confined to partsof the private sector or excludes the poor, growth is likelyto be confined to a few sectors and the poor will benefit less.

With globalisation and the information andcommunications technology (ICT) revolution, the conditionsfor diffusing knowledge have never been better. But the paceof innovation does not depend upon knowledge alone. Itdepends also upon the business relationships and structuresthat enable the adoption of new technology.

The development of business networks, in the form ofhorizontal and vertical clusters, and the strengthening of

Private SectorDevelopment is aprocess ofinnovation andcreative destruction.

Access to knowledgeaffects the rate ofpro-poor growth.


© OECD 2004 27

business organisations have an important role to play ininnovation and increasing productivity. Horizontal clusters,of the type found in Italy, and vertical clusters, such asthose comprising Japanese multinationals and their SMEsuppliers, help to share knowledge, enable specialisationand flexibility in meeting customer needs throughco-operation, and combine the advantages of scale inmarketing and assembly.42

Such linkages are based on trust and so it is difficultto establish clusters where they do not exist organically.With or without clusters, for linkages between firms toincrease, it is important that the costs and risk of doingbusiness with other firms is kept low in relation to costs withinthe firm.43 Developed economies are characterised byhigher levels of transactions between firms that allowgreater productivity through specialisation. They are ableto achieve this through security of contract and lower costsof doing business with each other.

For productivity to increase, resources should also flowto the most productive use. This may involve resourcesshifting to higher value-added products and services withina sector or, in broad terms, from agriculture to industryand services, which tend to have higher levels of productivitythan agriculture. For resources to move to more productiveuses, the role of regulatory institutions is critical to ensurethat there is adequate access to information, that marketswork efficiently to provide appropriate price signals andthat there is flexibility in the use of productive resources.At the same time, they must also ensure that marketsprotect the providers of capital, labour and natural resources.

For higher rates of pro-poor growth, it is important thatthe poor have the opportunity to increase the productivityof their assets in traditional sectors and the ability to re-deploy their assets to more productive uses when theyemerge. This depends upon the pattern of growth. Increasingagricultural productivity, non-farm employment and incomesin rural areas, and formal employment in manufacturing andservices are important determinants of the rate of pro-poor growth. Countries such as Zambia and Nigeria, whereformal employment in manufacturing has increased slowly,have experienced low rates of poverty reduction, whereas

Business networkshelp to spreadknowledge andboost productivity.

Greater formalemployment offersopportunities forpoor households todiversify andincrease theirincomes.


28 © OECD 2004

in Cote d’Ivoire formal employment has increased fasterand poverty has fallen more significantly.44

To maximise its impact on poverty reduction, growthof productivity in manufacturing and services should ideallybe accompanied by increases in agricultural productivity,which will boost wages in all three sectors. As well asboosting incomes from traditional occupations, this willalso allow the poor the opportunity to earn incomes fromemployment in other sectors, enabling them to adoptstrategies that will maximise household incomes. Migrationto urban centres, for example, may help to increasehousehold incomes even when the wages received arelow, as wage remittances add a new source of income.

Investment in the human capital of the poor (i.e.education and training) allows them to increase productivityin traditional activities and to move into new, moreproductive sectors.

The institutions and policies that affect productivity areset out in Box 3.


© OECD 2004 29

Box 3

Institutions & Policies forProductivity

Factor markets• Financial sector deepening• Flexible labour markets with

growing demand for labour• Investment in the human

capital of the poor• Secure access to natural

resources resources on asustainable basis

Business services, structures &Networks• Disseminating knowledge• Business services• Business linkages• Clusters• Business organisations


• Enables investment to raise productivity acrosssectors contributing to pro-poor growth

• Greater formal employment, along with risingproductivity in traditional sectors, provideshigher wages and greater diversity ofopportunities

• Sustainable natural resource use increases theproductivity of natural resources, includingthose used by the poor

• Spreads knowledge of how to improveproductivity across the private sector, includingthe poor

• Business linkages facilitate innovation, raiseproductivity through specialisation andflexibility in meeting customer needs andenable economies of scale

b) What role do SMEs play in increasing productivity?

In the past, there has been an assumption that SMEshelp to increase growth and help to make growth pro-poor.Recent research casts doubt on the universal validity of theseassumptions.45 Micro-level evidence has for some timequestioned whether SMEs are, in fact, more innovative orproductive than their larger counterparts and better at jobcreation. SMEs tend to pay lower wages and the jobs theycreate are less secure. In fact, the proportion of the workforceemployed in large firms increases with the level ofdevelopment of the economy.46 Cross-country evidenceshows that, whilst a higher proportion of SMEs in theeconomy is associated with higher growth, it does not causehigher growth or necessarily lead to pro-poor growth.47

This is not to say that SMEs do not have a role to playin increasing pro-poor growth. Rather, the evidence suggestsis that it is outcomes in markets that matter to the poor thatare important, not the size of businesses. Provided growthresults in opportunities for the poor to improve theirincomes, then it will be more pro-poor. Support for thedevelopment of SMEs may be appropriate in instanceswhere the comparative advantage of the country lies insectors with low economies of scale, to support productivitygains through business linkages, and where there is a needto increase competition in selected markets that matter forthe poor, as described in Section III. If the playing field isnot level for SMEs, it will hinder entrepreneurship andinvestment and so lead to lower pro-poor growth. What isquestioned by these findings is the assumption that supportfor SMEs is necessarily the most pro-poor form of support.


30 © OECD 2004

Box 3 (cont.)

Institutions & Policies forProductivity

Research & TechnologyOrganisations, Academia• Agricultural research

& extension• Scientific research• Innovation support


• Partnership between private and public sectorsin adapting technology and innovation to meetlocal needs and help to spread knowledge.Technical support for innovation can improveaccess to knowledge, including to the poor

III. Harnessing International Economic Linkages

a) How do international economic linkages affect therate of pro-poor growth?

As recognised in the DAC Poverty Reduction Guidelines,international economic linkages, both trade and foreigninvestment, could help to accelerate pro-poor growth.There is substantial evidence to suggest that greater tradeintegration, as measured by the ratio of exports and importsto GDP, is associated with higher rates of economic growth.48

As external demand has been growing faster than domesticdemand in many countries, those economies that havebecome integrated into the international trading systemhave experienced high rates of growth. International tradeshould help economies to move to the production of goodsand services in which they have a comparative advantageand increase competition for domestic businesses, resultingin higher productivity. Exporters tend also to have higherproductivity in order to compete internationally. Highlevels of trade protection cause higher domestic pricesand this impacts the poor adversely.

However, harnessing the potential benefits fromincreased international trade requires more than just thereduction of tariff barriers. Without the right conditions inplace, tariff reduction may not increase the volume of tradeappreciably, but may disadvantage the poor. Despite tariffreductions, a group of the least developed countries havefailed to increase their share in international trade.

For countries to achieve higher levels of tradeintegration, tariff reduction needs to be accompanied bythe dismantling of non-tariff barriers, better trade facilitatingand promoting institutions, investment in infrastructureand macro policies that result in a competitive exchangerate. To accelerate growth, productive resources shouldflow into competitive sectors, compensating for thecontraction of other sectors, and exports should include awide range of products to reducedependence oncommodities that are subject to sharp fluctuations in price.

The framework of the WTO Agreement recognises thatdeveloping countries may need “differential treatment”, in


© OECD 2004 31

order to allow them to reinforce or transform their productioncapacity before being exposed fully to liberalisedinternational trade. To make the effects of greater tradeintegration pro-poor, these countries may need to addressthe inequality of opportunity that the poor face inparticipating in and benefiting from international trade.Institutions and policies that address the access of thepoor to knowledge, infrastructure and productive resourcesare important. Inevitably, greater trade integration willresult in winners and losers. For the poor who stand tolose from trade integration, policies to help them to findnew ways to earn a living and provide safety nets of the typedescribed under Risk and Vulnerability below, may benecessary.

Foreign direct investment is an important source ofcapital, several times the value of development assistanceon a cumulative basis,49 though the least developed countrieshave yet to attract sizeable inflows of FDI. But perhaps thegreater contribution of FDI is through innovation andproductivity. In most countries, the vast majority ofinvestment is domestic.50 FDI’s main contribution may comefrom the transfer of knowledge and skills. In Bangladesh,for instance, the rapid expansion of the garment industry,estimated to have taken one million women and theirdependents out of poverty, was frequently undertaken bythe former managers of foreign joint ventures51 who learnedtheir skills from foreign counterparts. For 40 years, theIndian automobile industry, protected from competition,produced the same models of car. The opening up of theindustry to FDI revolutionised, within a decade, an industryfossilised for four. India’s much lower ability to attract FDIhas probably contributed to its lower rate of productivitygrowth compared with China.52

The contribution that FDI will make to growth is likelyto be higher if the knowledge of better technology it bringscan be spread to domestic businesses through businesslinkages. Its impact on the rate of pro-poor growth will behigher if these businesses purchase goods and servicesproduced by the poor and create jobs for the poor.

The institutions and policies that affect internationaleconomic linkages are set out in Box 4.

FDI contributes tolocal investmentand productivity.


32 © OECD 2004

b) What are the main challenges in ensuring thatinternational economic linkages are harnessed toaccelerate pro-poor growth?

Up to now, trade policies have focused on tariffreduction. Attention is only now shifting to the institutionsand policies that are required if tariff reduction is to leadto greater trade integration. There has been little attention


© OECD 2004 33

Box 4

Institutions & Policies forInternational Economic Linkages

Trade Openness• Tariff & non-tariff policy• Trade facilitation• Domestic & trade infrastructure,

improving access for the poor • Building domestic capability to

trade & compete, exportdiversification

• Competitive exchange rates• Access to knowledge and

productive resources,particularly for the poor

• Polices to help the poor takeadvantage of new opportunitiesand to protect the vulnerable

Foreign Investment• Conditions for

entrepreneurship andinvestment

• Few regulatory restrictionsapplied transparently

• FDI facilitation, particularly insectors likely to benefit thepoor

• Business linkages withdomestic firms

• Prudent borrowing from abroad


• Openness to trade allows the country to focuson areas of comparative advantage,contributing to sustained growth

• Domestic infrastructure directed at the poorenables them to participate in trade

• Greater ability to compete will increase theimpact of trade openness on growth andreduce reliance on volatile commodities

• Flexible factor markets and access toproductive resources provide opportunities forthe poor to benefit from trade openness

• Uncompetitive exchange rates will depressexports, including those produced by the poor

• Reducing the dependency of the poor onvolatile commodity markets, helping themmove out of activities that are likely to losefrom trade integration and helping them copewith the loss of income in traditionallivelihoods will contribute to pro-poor growth

• Enabling investment by both domestic andforeign entrepreneurs, providing theopportunity to establish business linkages

• Lower regulatory risk, increasing theattractiveness of investment

• Attitudes to foreign investment are an indicatorof likely risk of policy change and hence affectentrepreneurship and investment

• Harnessing FDI to provide opportunities forthe poor to supply goods, services and labour

• Transfer of knowledge to domestic firmsleading to higher productivity

• Exposes the country to sovereign risk which leads to economic crises that hurt thepoor disproportionately

paid to who wins and loses from greater trade integration,nor to the policies and institutions required to ensure thatthe poor benefit from new opportunities and are helpedto cope with the potential loss of income in traditionaloccupations.

There is also a need to influence the evolution of theinternational trading system to increase its pro-poor impact.Tariff peaks and escalation that may impede exports ofprocessed products from developing countries, subsidieson agriculture and the proliferation of technical barriers totrade – which already affect over 90% of trade in goods andrepresent substantial impediments to market access - areon the WTO agenda. A pro-poor Doha Round has thepotential to lift 144 million people out of poverty, asubstantial contribution to achieving the first MDG.53

At present, FDI is concentrated in a few countries, withthe top 10 recipients accounting for over three quarters oftotal flows to developing countries. These countriesfrequently have in place the conditions for greaterentrepreneurship and investment described earlier. Theyalso tend to have fewer regulatory restrictions on FDI andapply regulations more transparently. Allowing for differencesin size of country, it is these conditions, rather than taxconcessions, that account for the differences in attractingFDI.54 The least developed countries and others that haveyet to benefit substantially from FDI need to improve theirinvestment climate for both foreign and domesticinvestment. Foreign-owned firms should be made awareof the importance of improving the impact of their operationson the poor, and be supported in doing so.

IV. Improving Market Access and Functioning

a) How does market access and functioning affect the rateof pro-poor growth?

While the measures discussed above will deliver pro-poor growth, the benefits may not reach all the poor orbenefit the poor to the fullest possible extent. For thepoor to benefit fully, the mechanisms through which theyare able to take advantage of the opportunities to increase


34 © OECD 2004

their incomes have to work effectively. The criticalmechanisms through which the poor participate in andbenefit from growth are the markets for productive resourcesand goods and services that the poor rely on most for theirlivelihoods and consumption needs.

Frequently, the poor are disadvantaged by the termson which they are able to access these markets. The poorshould, at the least, participate in and benefit from thesemarkets on equal terms with the rest of the private sector.Where this is not the case, practitioners need to identifyand address the causes.

b) What are the appropriate policies and institutions forthe markets for productive resources to deliver higherpro-poor growth?

Markets for productive resources (capital, labour andnatural resources) are key mechanisms through which thepoor may benefit from a pro-poor pattern of growth. Theyenable the poor to participate in and benefit from growthin two main ways:

• Directly, by improving access to financial, humanand natural assets.

• Indirectly, as a result of new opportunities beingcreated for the poor to earn livelihoods as workers,entrepreneurs and farmers.

Improved access to financial, human and natural assetsincreases the incomes the poor can earn from traditionaloccupations. For example, increased private credit is pro-poor even when access to credit remains low, because itallows the poor to indirectly benefit from the opportunitiesresulting from stronger growth. In addition, increases innon-farm activity in rural areas, in formal employment andin wages have strong pro-poor impacts, even though thepoor may continue to earn most of their incomes fromagriculture. Markets for productive resources provide thepoor with the opportunity to diversify sources of, and hencemaximise, household income, but in practice the poor mayface disadvantages in accessing these markets as a resultof inappropriate policies and institutions and a lack ofaccess to basic services. Practitioners need to examine the


© OECD 2004 35

pace at which these markets are developing and the termson which the poor are able to access them.

The critical determinants of growth of private credit are:i) macroeconomic management, which affects savings, thebalance sheets of banks and the extent of crowding out bygovernment; ii) the effectiveness of the regulatoryinstitutions, legal systems and contract enforcement;iii) informational and transactional infrastructure, includingcredit bureaus and inter-bank markets; and iv) the structureof the banking system in terms of ownership andconcentration, which affects competition and hence theincentive to innovate.55 The most common causes of thefailure of private credit to grow rapidly are poor regulatorysupervision of the banking system, crowding out of theprivate sector by the public sector, governments imposingpolicies to direct the lending of the banks and a lack ofcompetition in the banking system.

The pro-poor impact of financial deepening would begreatest if increased private credit resulted in better accessto credit for the poor, thus enabling the poor to benefit bothdirectly and indirectly. This requires the financial sector toimprove its ability to assess and mitigate risk and reducethe cost of offering savings and loan products to the poor.As discussed in Chapter 4, there are examples of how theformal financial sector may use technology to achieve thisand how micro-finance institutions, with low transactioncosts and better information about the poor, are becomingintegrated into the formal financial system.

A number of conditions need to be met if the labourmarket is to function efficiently: i) labour regulations shouldstrike a balance between the rights of labour and employersin terms of wages and employment conditions; ii) investmentin education and skills training is needed to increase labourproductivity, redressing any initial inequality in access;and iii) there should be no discrimination with respect tolabour market access by women and ethnic minorities. Inaddition, what matters is that the economically active areable to find work in the formal economy. Restrictive practicesthat result in high wages and good working conditions fora few employees but low economic participation for the restshould be avoided.


36 © OECD 2004

Access to agricultural land and other natural resourcesis crucial for the livelihoods of the poor, the majority ofwhich live in rural areas. Title to land and security overits use, and over other natural resources such as forests,rivers and marine and inland fisheries, contribute toentrepreneurship and investment.56 Sustainable use ofnatural resources ensures that their productivity doesnot decline. Policies and institutions need to take all ofthese factors into account. Providing market-basedincentives to reduce adverse environmental impacts andreward the conservation of natural assets, such as marketsto trade carbon emissions, have an important role to play.The need to take account of social factors means thatpolicies and institutions that govern access to naturalresources are likely to have to be tailored to the specific,local context.

c) How can policies and institutions help to deliver pro-poor outcomes in the markets for the goods and servicesthat the poor sell and consume?

Markets are composed of value chains that stretch fromproducers to the final consumer. They may either beproducer or consumer driven, depending on barriers to entryand the processes that create value. In consumer-drivensupply chains, the balance of market power lies with theconsumer. These tend to be commodity or undifferentiatedmarkets with low barriers to entry in which producersreceive a small share of the total value created in themarket. Agricultural commodities such as coffee, tea andpalm oil are examples. On the other hand, producer-drivenvalue chains tend to be those in which products aredifferentiated by technology, design and/or natural attributesand with barriers to entry. In these markets, the balance ofpower tends to lie with the producer. Blue Mountain coffee,from Jamaica, is an example, as are many manufacturedproducts and service markets. And of course, there aremany value chains that fall between these extremes, wherea particular process in the value chain exercises the greatestmarket power.

Institutions have an important role to play in deliveringhigher returns to the poor. Even in commodity markets, itmay be possible to differentiate products based on particular

Returns to the poordepend upon wheremarket power lies invalue chains.


© OECD 2004 37

attributes. Thus organic production, the area of origin or aspecialist flavour may help to differentiate coffees. Thedevelopment of rules of certification and the systems fortheir delivery have a vital role to play in this regard. If theyare not accessible to the poor, only the rich will be able tobenefit from product differentiation. The provision ofinformation helps to ensure that the poor may makeeconomic decisions on the basis of informed choice andthat those they trade with are not able to exploit themthrough superior access to knowledge.

High costs of doing business, caused by inappropriateinstitutions and lack of access to basic social services, mayalso disadvantage the poor. Infrastructure is a primeexample: a lack of power may prevent rural areas fromprocessing their crops. Moreover, the cost of transportfrom a rural area served by poor roads may make manyactivities uneconomic. Further, if linked markets are under-developed, then the poor may be denied access. Forinstance, if the leasing market does not extend to agriculturalmachinery, hire services for such equipment will beundeveloped and the poor will not be able to able to usethem.

The critical determinant of market outcomes is theextent of competition across the functions of the valuechain. The lower the competition, the higher the proportionof the total value added by the chain that a particularfunction will be able to capture. So, if there are fewprocessors but many producers of a commodity, processorswill capture a higher proportion of the total value of thecommodity. Increasing competition in key functions of thevalue chain, through supporting new entrants and SMEs,is a valuable policy instrument in making markets workbetter for the poor.

Social exclusion, through discrimination on gender orethnic grounds may also reduce market access. Policies thataddress gender equality may be particularly pro-poor as,frequently, a higher proportion of women than men arepoor and women spend a higher proportion of their incomeson food, health and education for their families. Investingin the human capital of women, through literacy and skilltraining, is particularly pro-poor. Very often, the poor rely

Competition drivesmarkets to serve theneeds of the poor.

Markets work insocial space. Socialnetworks may be asource of conflictthat preventsaccess.


38 © OECD 2004

on their social capital to provide security (bonding capital),access to complementary resources (bridging capital) andto higher levels of decision-making and economic power(linking capital).57 However, there are numerous examplesof markets in which one ethnic or social group predominatesand where others are excluded. In the extreme, there maybe conflict over market participation, which disrupts theirfunctioning entirely. Increasing the use of social capital, whilstensuring that it is not used to shut out others from accessingmarkets, can help improve access to and the functioningof markets.

d) What are the main issues for improving market accessand functioning?

Labour markets play a critical role in providingopportunities for the poor to participate in and benefitfrom growth. In many parts of the world, though, rates ofjob creation are inadequate, forcing many to seekemployment in informal ‘survival’ businesses that providelow incomes and where they may not be able to exercisetheir rights. Finding the mix of policies and institutionsthat would ensure that there are incentives to increaseemployment in the formal economy whilst protecting wagelevels and working conditions remains a major challengefor practitioners.

Development agencies have been addressing valuechains for some time with the objective of promotinggrowth and exports. Whilst many have targeted thegrowth of small enterprises, these interventions havetended not to focus on the extent to which marketoutcomes are pro-poor. Bringing about pro-poor outcomesmay require a combination of agricultural development,infrastructural change, private sector development toincrease the market power of the poor in the value chain,social interventions to empower the poor, andenvironmental sustainability. Such multi-disciplinaryactivities face organisational barriers within thedevelopment agencies that require new approaches todonor support, as discussed in Chapter 4.

The institutions and policies that affect market accessand functioning are set out in Box 5.


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40 © OECD 2004

Box 5

Institutions &Policies for MarketAccess and Functioning

Capital Markets• Macro stability• Interest rate liberalization• Reducing government

interference in the lendingdecisions of the banks

• Financial codes & standards• Corporate governance• Financial infrastructure• Competitive banking system • Increasing the integration of

financial institutions serving thepoor into the mainstreamfinancial system

Labour Markets• Core labour standards.• Health & safety.• Realistic minimum wages.• Flexible labour markets. • Information on opportunities.• Education & vocational training

to reduce inequality for thepoor.

Natural Resource Markets• Secure rights of access.• Equal access for the poor.• Sustainable natural resource

use.

Correcting Market Failures• Monopolies and restrictive

practices.• Aligning private and public

benefits.• Private provision of public

goods through• public-private partnerships.• Addressing inequality in access

to information.• Developing linked markets.


• The incentive to save and lend is increased,the risk of lending reduced and it becomespossible to lend to smaller enterprises.Competition drives the banking system togreater efficiency.

• Financial deepening associated with higherprivate credit leads to higher pro-poor growth,particularly if access to finance is improved forthe poor through mainstreaming financialinstitutions best placed to serve their needs.

• Policies and institutions protect the rights oflabour, encourage employment, provideinformation on jobs and skills to improve thematch between demand and supply andenable labour to move its most productive use.

• Investment in human capital leads to a moreproductive workforce for employers and higherwages and better working conditions foremployees, including the poor.

• Security of access encourages investment innatural resources. Equal access contributes topro-poor growth.

• Sustainable natural resource use contributes tolong term productivity.

• Level playing field for the poor in terms ofaccess to markets and information andprotection from the abuse of monopoly powerand restrictive practices.

• Linked markets help the poor to usetechnology that they may otherwise not beable to use.

V. Risk and Vulnerability

Unless the risk aversion of the poor and theirvulnerability to shocks, man-made and natural, areaddressed, there is a danger that they will not be able toparticipate and benefit fully from growth. The poor may becaught in ‘poverty traps’ whereby lack of access to assetsprevents them from escaping poverty. Where such povertytraps exist, a case may be made for polices that provideeconomic opportunity and increase access to assets. Forthose who cannot participate in productive activities, whathave been termed ‘smart transfers’ may help to reducevulnerability.

a) What factors help to reduce risk and vulnerability andhelp the poor escape the poverty trap?

As far as possible, it is important to reduce the incidenceof man-made shocks, through sound political, social andeconomic management, as they tend to hurt the poordisproportionately. The currency and sovereign debt crises


© OECD 2004 41

Box 5 (cont.)

Institutions &Policies for MarketAccess and Functioning

Pro-poor value chains• Regulating & promoting

standards, quality.• Certification to reach the poor.• Competition to reduce the

value captured by functions inthe value chain.

• Providing linked services.

Social Cohesion & Sustainabledevelopment• Institutions for gender, ethnic

discrimination • Mitigating conflict• Building bridging and linking

capital without excluding others• Sustainable development


• Institutions provide the incentive for valuechains to increase value addition, including forthe poor.

• Reducing market power in other functions inthe value chain increases incomes of the poor.

• Prevents conflict thus reducing risk, opens upmarket opportunities previously reserved forparticular social groups, builds co-operationbetween groups in economic exchange andfacilitates access to decision makers toinfluence policy

• Economic development is accompanied bysocial cohesion and environmentalmanagement

that affected East Asia, Russia and Latin America during the1990s were caused by an absence of sound macroeconomicpolicies and hurt the poor disproportionately. Social andpolitical conflict, of the type witnessed in the Congo, alsohurt the poor disproportionately, and effective measuresare required to mitigate such conflict.

Deprivation caused by man-made or natural shockstends to have long-term consequences. In Ethiopia, thereis evidence that four years after the last crisis, the poor arestill coping with its consequences.58 When crises occur, thepoor may have to consume or sell productive assets suchas seed and land, suffer the erosion of the productivity oftheir human capital through disease or hunger and witnesstheir access and returns to natural assets eroded,establishing a poverty trap from which they take manyyears to escape. Losers from trade liberalisation amongstthe poor may also find themselves caught in a trap witnessingtheir incomes falling but lacking the knowledge and accessto resources to diversify their livelihoods. It is importantto have policies in place that help the poor cope with theseshocks and escape the poverty trap.

The ability of the poor to cope with shocks is affectedby the level of development of markets for productiveresources. For instance, financial deepening is correlatedwith lower rates of child labour and infant mortality,irrespective of levels of per capita GDP.59 With some accessto credit and a diversity of income sources, the poor do nothave to resort to measures that undermine their ways outof poverty and can borrow to meet health care needs.Where these markets are underdeveloped or the shockparticularly severe, there is a strong case for helping thepoor cope with the disaster in the form of food for work tobuild infrastructure that they may use, medical assistance,if required, and economic assistance to revive livelihoods.

In the absence of insurance and publicly providedsafety nets, the poor have adapted their livelihood strategiesto manage and cope with risk.60 The problem is that suchrisk mitigation strategies may not allow them to maximiseincomes. Producing drought resistant crops that may notprovide the highest return is an example and continuingto produce some staples when land is better suited to


42 © OECD 2004

livestock is another. The result will be a lower contributionto growth by the poor and slower pro-poor growth. Risk-coping strategies such as keeping livestock are also notefficient as the animal is likely to be sold when others areselling theirs, resulting in low prices.

Encouragement of the insurance industry to provide riskcover for the economic activities in which the poor areinvolved may improve risk management and copingstrategies. For example, it is possible in some developingcountries to get cover for drought, livestock and otheragriculture-related activities. Savings schemes that protectagainst risks to livelihoods also have a role to play.

Sickness and old age may debilitate and reduce theability to participate in and benefit from growth. Effectivehealth care may prevent and mitigate such vulnerability.However, for those living with HIV/AIDS, the old and thosewith other chronic conditions, there may be a need toprovide social safety nets, publicly funded if need be. Thecurrent thinking is that, as far as possible, such socialprotection should take the form of ‘smart transfers’ wherethe poor are assisted so long as they help themselves.Mexico’s Progresa/Oportunidades and Brazil’s BolsaEscola/Bolsa Familia are examples of smart transfers foreducation and health.61

Even countries that are experiencing rapid growth andpoverty reduction, such as China and Vietnam, may haveregions that are caught in poverty traps. Essentially, thelocational advantages of some regions result in growthbeing concentrated in them. The coastal regions of China,with access to ports, are examples. Though other regionsmay benefit from this growth through migration, they maynot be able to reduce poverty. A frequent response is tooffer tax incentives for the private sector to locate in thedisadvantaged regions. Often, this does not work, or if itdoes, serves mainly to divert rather than increase growth.What is required is for such measures to be accompaniedby a reduction in the risks and costs of doing business,knowledge transfers to improve productivity, investmentin basic services and improved market access andfunctioning to ensure that productivity and incomes increasein the region.


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44 © OECD 2004

Box 6

Institutions & Policies for Risk &Vulnerability

Macro Economic Stability• Prudent fiscal, monetary policies• Sound banking supervision• Low currency and sovereign risk

Markets for Productive Resources• Increased access to finance to

support recovery from shocks• Greater opportunity for

diversifying livelihoods• Greater access to natural

resources

Markets for risk insurance• Drought insurance• Livestock insurance• Savings instruments to mitigate

risk

Social Safety Nets & SmartTransfers• Food for work• Smart transfers for health

& Education• Livelihood support after shocks • Social insurance (disability,

pensions)

Investment in DisadvantagedAreas • Increasing the incentive for

entrepreneurship andinvestment

• Stimulating productivity growth• Efficient public expenditure on

health, education, water, otherinfrastructure, particularly inareas in which the poor live

• Area based programmes toimprove market access andfunctioning


• Fewer or smaller man made shocks that hurtthe poor disproportionately

• Less recourse to distress sales of assets, use ofchild labour and destructive use of naturalresources that undermine future incomes

• Less risk aversion on the part of the poorleading to higher incomes

• Greater participation by the poor in the growthprocess, better access to markets and quickerrecovery after shocks

• Stimulating economic activity in the region,offering greater opportunity for the poor

• Increased productivity of labour andaccumulation of human capital that will help toincrease growth and the incomes of the poor

• Better access to markets for the poor

The institutions and policies that address risk and vulnerability are set out inBox 6.

VI. In Summary

The five factors described above form an environmentthat enables the private sector to deliver growth. Theinstitutions and policies that help to bring them about alsoinfluence the pattern of growth, affecting the extent towhich growth provides opportunities for the poor to increasetheir incomes. The factors are interlinked. If one is not inplace, then it will slow down the rate of growth, or makethe pattern of growth less pro-poor. Thus, if entrepreneurshipand investment, productivity and the harnessing ofinternational economic linkages are providing opportunitiesfor the poor to increase their incomes, but the poor are notable to access markets or escape poverty traps, they willbe less able to participate in and benefit from growth.Equally, the poor are unlikely to be able to escape thepoverty trap if the conditions are not in place forentrepreneurship and investment across a wide range ofsectors and regions. The development of markets forproductive resources affects all five factors.

To bring about a pro-poor pattern of growth, policiesand institutions need to ensure that there is a level playingfield for all players in the private sector, including the poor.Policies that address the initial inequality that the poor sufferin participating in and benefiting from growth are vitallyimportant if support for the private sector is to acceleratepro-poor growth.


© OECD 2004 45

Notes

22. See for instance, Easterly W., The Elusive Quest for Growth-Economists’ Adventures andMisadventures in the Tropics, 2001.

23. Rodrik, D, Growth Strategies, Harvard University, 2003 discusses differences in institutionalarrangements

24. Entrepreneurship refers to risk taking by both individuals and firms.

25. Source: Kauffman Foundation.

26. Source: Kauffman Foundation.

27. Countries at a Glance: Bolivia, World Bank.

28. Transaction costs – The costliness of information is the key to the costs of transacting, whichconsists of measuring the valuable attributes of what is being exchanged and the costs of pro-tecting and policing and enforcing agreements. North, D 1990.

29. World Development Report 2005, World Bank.

30. See for instance, Doing Business in 2004, Michael Klein, World Bank 2004.

31. Doing Business in 2004, Michael Klein, World Bank 2004.

32. Finance, Inequality and Poverty: Cross Country Evidence, Beck T., Demirguc-Kunt A., andLevine R. 2004.

33. Beck T., Demirguc-Kunt A., and Levine R. 2004.

34. Becker, Kristina Flodman. The Informal Economy in Developing Countries: a Fact FindingStudy, Sida. 2004.

35. Klein M., The Cost of Doing Business, 2004, World Bank.

36. Rethinking the Informal Economy: Linkages with the Formal Economy and the RegulatoryEnvironment, Chen M. EGDI and UNU-WIDER Conference, 2004.

37. Ways Out of Poverty: Diffusing Best Practices & Creating Capabilities, Michael Klein, 2003.

38. See for Instance, IMF Working Paper ‘And Schumpeter Said: This is How Thou Shalt Grow, TheFurther Quest for Economic Growth in Poor Countries. Philippe Beaugrand, 2004.

39. Schumpeter J. 1911, Theory of Economic Development, p66.

40. Schumpeter. Capitalism, Socialism and Democracy (New York: Harper, 1975), pp.82-85.


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41. Some observers refer to entrepreneurship as the 4th factor but they are referring to the use ofknowledge or skills in combining factors of production.

42. Snodgrass D. & Winkler J., Enterprise Growth Initiatives, Where are they Going, DAI, 2003. Thisargument applies also to service industries where the practice of out-sourcing is gainingground leading to new types of cluster.

43. Coase, R The Nature of the Firm, Economica 4, 1937, explores the effect of inter and intra firmtransaction costs

44. Islam R. The Nexus of Economic Growth, Employment &Poverty: An Empirical Analysis, 2004.

45. Small & Medium Enterprises, Growth & Poverty, Beck T, Demirguc-Kunt A and Levine R, 2003.

46. Snodgrass D. & Biggs T., 1996.

47. Beck T, Demirguc-Kunt A and Levine R, 2003.

48. For a discussion of how and when trade may contribute to growth and poverty reduction seeSida Trade Briefs, Trade & Poverty, Constantine Michalopoulos, 2004.

49. See for instance, World Investment Report.

50. Even in China, the world’s largest recipient of FDI, it accounts for less than 30% of grossdomestic investment.

51. Unleashing Entrepreneurship: Making Business Work for the Poor. A report to the SecretaryGeneral, UN, 2004.

52. McKinsey, India: The Growth Imperative, August 2001.

53. World Bank Global Economic Prospects, 2003.

54. A survey on the Role of Taxation in Attracting Foreign Direct Investment in Southeast Europe,OECD, April 2003.

55. See, for instance, Financial Development, Growth & Poverty: How close are the links?Honohan P., 2003.

56. De Soto, H. The Mystery of Capital: Why Capitalism in the Works in the West and FailsElsewhere, 2000.

57. World Development Report, 2000/1 Attacking Poverty, World Bank.

58. Dercon S., Growth & Shocks: Evidence from Rural Ethiopia. 2003.

59. Dahejia R & Gatti R. Child Labour: The Role of Income Variability & Access to Credit in a CrossSection of Countries, 2002.

60. Poverty Traps & Development: The Equity-Efficiency Trade-off Revisited, Dercon S., 2003.

61. World Development Report, World Bank, Making Services Work for the Poor, 2003/4.


© OECD 2004 47

Chapter 3

Delivering Pro-Poor Change

Chapter 2 addressed institutional and policy change to acceleratepro-poor growth. The critical issue is how to bring about the requiredchanges, transforming markets in order to make the private sector deliverpro-poor outcomes and implementing policies that enable the poor totake advantage of the potential benefits of a growing economy. Thischapter analyses the necessary processes for establishing institutionsand policies to deliver pro-poor growth through private sector developmentand suggests how such change may be institutionalised throughPRSPs.

To accelerate pro-poor growth through private sectordevelopment, we need to know not only what has to be donebut also how to bring about change. In Douglas North’sview, we have known for some time the conditions requiredfor growth and poverty reduction, what we have not knownis how to bring about such conditions.62 All too often,technically sound proposals for change proposed bypractitioners have not been implemented because they havelacked support or have been blocked by vested interests.

I. Processes for Pro-Poor Change

Institutions and policies result from the interaction ofthe state, the private sector and civil society. Thoughgovernment is the main actor in developing policies andinstitutions, the private sector and civil society also playkey roles. Whilst the state plays the crucial role indetermining the rules under which markets function andthe terms on which the poor access markets, by developingformal institutions and providing infrastructure and accessto basic social services, civil society and the private sectorhave an important influence. Civil society influences

Institutions andpolicies result fromthe state, theprivate sector andcivil societypursuing theirrespective interests.


© OECD 2004 49

government in developing formal institutions. Informalinstitutions, arising out of culture and social interaction, alsodetermine the terms on which the poor access markets. So,informal saving and loan clubs may provide access tofinance but traditional land use practices may deny accessto women. The private sector influences the rules of the gametoo, both by interacting with the state in the design offormal institutions and in developing institutions itself.Market outcomes are influenced also by conventions thatare developed by the private sector.

The three parts of society have different interests. Ingeneral, governments tend to be concerned with exercisinginfluence over the political economy of growth: who getswhat and how. The private sector focuses on how‘pro-business’ institutions are and hence on the incentivefor entrepreneurship and investment. Civil society’s roleis to articulate the interests of society and hence it isconcerned with social and economic outcomes. Institutionsand policies develop out of engagement between thesethree groups, with each pushing its own interest, with therespective strengths of each determining the mix of policiesand institutions.

The extent to which the three parts of society takeaccount of the interests of the poor varies markedly betweencountries. In practice, within parts of society, there are adiversity of organisations and interest groups promotingtheir own interests, and they may disagree with others onspecific issues. Where interest groups drawn from the elitecombine to capture institutions and resources for theirown self-interest, institutions are unlikely to be pro-poor.Each status quo represents an accommodation between themost influential interest groups, as illustrated in Figure 2.

For those seeking to bring about pro-poor change, itis important to initiate a dialogue within the three parts ofsociety on the need for, and benefits from, pro-poorinstitutional and policy change. Even where elites havecaptured institutions and resources, there are likely to begroups within each part of society that are sympathetic tothe case for pro-poor change. Working with such groups, thecase for pro-poor change needs to be articulated. However,any change involving such important issues threatens the


50 © OECD 2004

political settlement that is the status quo. Securing theinstitutional and policy changes required to acceleratepro-poor growth involves issues of political economy thatneed a careful, politically sensitive mix of negotiation andcontestation, otherwise the process risks being blocked bypowerful interest groups.

Building andempoweringconstituencies forchange may helpovercome vestedinterest.


© OECD 2004 51

Figure 2

GrowthAgenda

Institutions

TaxTransfers

Policies

Basic Services

Interest Groups

Social Conditions

Economic Outcomes

Productivity Jobs

Entrepreneurship

Investment

Articulatingsociety'sinterest

Influencingpolitical

economy

Pro-Businessregime

PRIVATE SECTOR

GOVERNMENT CIVIL SOCIETY

Stakeholder Engagement for Pro-Poor Growth

In proposing change, it may be preferable to start witha specific, less challenging issue to build momentum forchange. Even with such an issue, resistance to change fromsome groups will be inevitable. In many situations wherethe need for change is clear, the key barrier to pro-poorchange is likely to be that the potential losers from thatchange use their power or influence to block change.63 Forinstance, whilst parts of the private sector and civil societymay agree that reducing restrictive business proceduresis desirable, the bureaucrats and those who have alreadyestablished businesses may oppose it because they willlose influence or it will result in greater competition.

To overcome such resistance, it may be useful to helpbuild and empower constituencies for change drawn fromgroups within each part of society. These constituencies maythen engage with those opposed to change and theuncommitted to overcome resistance. For instance, itmay be possible to build a constituency in favour of reducing

business procedures from within government, especiallythose responsible for supporting small businesses, therepresentatives of small business and parts of civil societythat support employment generation. The constituencymay present evidence to demonstrate likely gains forentrepreneurship, investment, jobs and productivity and,to make the change acceptable to bureaucrats, propose anincrease in registration fees in exchange for fewer, moretransparent procedures. Change may be facilitated byevidence-based dialogue, offering technical solutions tomeet the concerns of those opposed to change, and,ultimately through negotiating compensation with thepotential losers from change.

The process of bringing about issue-specific changeneeds to begin with mapping stakeholders and theirinterests, capabilities and opportunities, and, if possible,what evidence or compensation is required to overcomethe resistance to change. This could be followed by thebuilding of the constituency for change by bringing togetherstakeholders and showing them how the change may helpto deliver their diverse, desired outcomes. The constituencyfor change may then be provided with the range ofalternative policies and institutions that may deliver theintended outcome, so that they become fully committedto an agreed course of action. The constituency may thenbe enabled to undertake a process of influencing policymakers and dialogue with those opposed to change.

An approach based on these principles is an explicitrecognition that pro-poor growth through support for privatesector development involves not only economic and socialchange but is also inextricably linked with political economy.Knowing who gains and who loses is thus an essential partof delivering pro-poor change. This is increasingly becomingpart of the way that donors are planning and implementingtheir assistance to their partner countries, as discussed inChapter 4.

II. Priorities and Sequencing Change

Is it possible to develop, on a priori grounds, a sequenceof policy and institutional change for ensuring pro-poor


52 © OECD 2004

growth? The answer is, unfortunately, no. The prioritiescan only be set in the local context by analysing the extentto which growth is pro-poor, as described in Chapter 1,whether the factors that constitute an enabling environmentfor private sector development described in Chapter 2 arein place, whether the pattern of growth resulting from themoffers opportunities for the poor, whether outcomes inimportant markets are pro-poor, and the extent to whichrisk aversion and poverty traps exclude the poor. Thepriorities must also take account of current politicalsettlements and the level of resistance to change, asdescribed above.

Diagnostic tools such as private sector assessments64

and guides for economic analysis may be a useful startingpoint in this regard. A recently developed tool,65 forinstance, recommends analysing growth in geographic,sector, institutional and beneficiary (including gender)terms, helping to highlight how growth can be made pro-poor.

The conditions and measures described in Chapter2 are not meant to be a full and prescriptive list of policies,nor are the factors described there meant to be absolutes.What matters most is how the private sector perceivesopportunities, risks and constraints, not whether a countryis better than its peers in absolute terms. So, in countryA, a 5% rate of inflation might be considered to besufficiently low to constitute stability and in country Bthe very epitome of a high-risk macro environment. Arate of tax that is considered acceptable in one countrymay be considered penal in another. Private sectordevelopment results from an implicit contract betweenthe private sector, the state and civil society. The prioritiesfor change depend on the factors that the mainstakeholders believe are undermining the contract ormay help to improve it.

Thus, tools such as the World Bank’s investment climateassessments or UNCTAD’s investment compass are useful.They help to provide evidence in support of change andshould be used as part of an engagement process to identifythe key constraints in the local context as perceived by theprincipal actors. There are also various alternative

Local contextsdetermine prioritiesand the sequencingof change.

Engagement helpsidentify prioritiesand build consensusfor change.


© OECD 2004 53

institutional arrangements that may lead to the sameoutcome. So, independent targeting of inflation is possiblewith and without an independent central bank. What worksdepends on the views and attitudes of the key decisionmakers. It is important in developing institutions to consultthe main stakeholders.66

Growth may start from a variety of sources includinglocation advantages, natural resource endowments,comparative advantages from factor endowment, theentrepreneurship and competitive advantages developedby the private sector, and institutional and policy change.There are many instances of short-lived growth spurtsthat have been sparked in these ways.67 Even acomparatively small change in government’s attitudestowards business may spark growth, as occurred in Indiaduring the 1980s.68 But turning growth spurts into sustained,pro-poor growth involves a continuous process ofinstitutional and policy change. Whilst growth may bestarted by pro-business reform, to generate pro-poorgrowth this must evolve into pro-market reforms, embracingthe five factors described in Chapter 2 and policies thatenable the poor to benefit from growth. With no setguidance on priorities and sequencing, experimentationwith institutional change and monitoring outcomes isinevitable. Hence, the emphasis on stakeholderengagement above. Institutionalising such engagement istherefore important in developing conditions for pro-poor growth.

Effective monitoring of outcomes should involveparticipatory learning, so that the intended beneficiariescan feedback on how effective the change has been, andwhat should be done to improve the process to achievebetter outcomes in the future. Pro-poor growth is aboutoutcomes rather than outputs. Outcomes are best assessedby those impacted by change. Engaging the poor indetermining the extent to which they have benefited frominstitutional change must be part of the process ofinstitutionalising stakeholder engagement. Moreover, asconditions for pro-poor growth and outcomes are locationspecific, the need to engage local stakeholders, so thatparticipatory monitoring is carried out at local, sub-nationallevels, is clear.


54 © OECD 2004

III. Mainstreaming Private Sector Development in PRSPs

In view of the role of the private sector in deliveringpro-poor growth and the crucial role that pro-poor growthplays in poverty reduction, private sector developmentmust be mainstreamed in national development andpoverty reduction strategies of the type that PovertyReduction Strategy Papers (PRSPs) are meant to represent.PRSPs also offer an opportunity to institutionalise the typeof stakeholder engagement and participatory planning,monitoring and evaluation described above. In fact, arecent study69 shows that the private sector was usuallyconsulted in PRSP formulation, through participation inthe planning committee that drafted the PRSP, but that itsactive involvement in monitoring and evaluation, and thatof civil society, occurred only in a minority of cases.

That study showed that most PRSPs now acknowledgethat the private sector is essential for poverty reduction,that growth and market forces are central to it, that policiesfor trade openness are important and that governanceneeds to be improved. What is less well addressed arespecific changes to business regulations, specificbenchmarks for the development of the private sector,market access and functioning. Thus, they acknowledgethe role of the private sector without specific commitmentsas to how it will be enabled to deliver pro-poor growth. Thisis a shortcoming that must be addressed if PRSPs are tobecome strategies for poverty reduction through pro-poorgrowth.

IV. In Summary

Bringing about pro-poor change requires a soundunderstanding of political economy. Institutional and policychange may threaten the current political settlement andso must involve a careful mix of contestation and negotiation.Bringing about change, issue by issue, appears to offergreater prospects for success than wholesale reform. Toovercome resistance to change, mapping stakeholderinterests, helping to build constituencies for change andempowering them to overcome vested interest throughevidence-based dialogue, technical solutions and

PRSPs can helpinstitutionalisestakeholderengagement.


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negotiating compensation for losers, appears to be a fruitfulapproach. It is not possible, on a priori grounds, to determinepriorities and sequencing of change. That can only bedetermined in the local context, using diagnostic tools andunderstanding stakeholder interests. Institutionalisingengagement between the three parts of society, includingparticipatory monitoring and evaluation by the intendedbeneficiaries, appears to be the way to introduce acontinuous process of changing institutions and policies,monitoring outcomes and then introducing further change.PRSPs offer a valuable mechanism for institutionalisingsuch a continuous process.


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Notes

62. North D. Institutions, Institutional Change & Economic Performance. 1990.

63. What does Drivers of Change mean for DFID (A draft approach paper). DFID: August 2003.

64. These are used by the Asian Development Bank, for instance, to take stock of conditions forprivate sector development.

65. Economic Analysis Reference Guide, SNV, 2003.

66. Rodrik D. Growth Strategies, 2003.

67. Rodrik D., 2003.

68. Rodrik, D. & Subramanian, A. From "Hindu Growth" to Productivity Surge: The Mystery of theIndian Growth Transition Cambridge: NBER Working Paper No. w10376: 2004.

69. Poverty Reduction Strategy Papers: How Do They Treat The Private Sector, USAID, 2004.

Chapter 4

Donor Support in the New PrivateSector Development Agenda

What has been described in the previous chapters represents abroadening of the private sector development agenda. This chapterexamines the implications of the new private sector development agendafor the way that donors provide support. It takes stock of how they providedsupport in the past, discusses the key principles for providing supportin the future and assesses the organisational implications of the new,broader agenda.

I. Donors in the New Private Sector Development Agenda

Both governments and their donor partners have forsome time now recognised the role of the private sectorin bringing about growth as a necessary condition forpoverty reduction. The DAC Orientations were one of manyframeworks developed to support the private sector in itsrole as engine for growth. Donors supported governmentsin providing technical and financial support for the privatesector, especially if it involved the poor, e.g. agribusinessand small enterprises. The paradigm for private sectordevelopment was that the poor relied on these businessesfor their livelihoods, these businesses were disadvantagedand that that justified subsidising their access to knowledgeand finance.

The discussion above shows that the way the poorparticipate in and benefit from growth is more complex. Itdepends on a set of factors that provide an enablingenvironment for the private sector, including the poor, togenerate rapid and sustained growth, and to help to increasethe opportunities for the poor to raise their incomes. Ithighlights the importance of outcomes in a set of key


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markets that help to increase pro-poor growth and the roleof institutions and policies in shaping those marketoutcomes. This broader private sector development agendarecognises that the poor benefit from growth both directlyand indirectly, and hence is broader than the old agenda,which focused mainly on targeting the livelihoods of thepoor directly. It is also based on the understanding that itis market outcomes that are pro-poor rather, than the sizeor type of business.

II. Forms of Donor Intervention in the Past

The majority of donor support for private sectordevelopment in the past was direct support to the privatesector. For example, it is estimated that 80% of the WorldBank’s support for private sector development was directto businesses70, although some of this took the form ofsupporting public-sector business support agencies. Anotherpopular intervention amongst donors was to encouragebusinesses in the donor’s country to form joint ventures andother types of alliance with businesses in developingcountries. Technical support, in the form of businessdevelopment services to improve productivity and hencegrowth, was provided through donor projects or usingbusiness organisations and other agencies, frequently withsubsidies provided to users. In providing finance, thechosen mode was to provide funds and technical supportfor banks serving SMEs or microfinance organisations, oftenwith subsidies to reduce the cost of borrowing. Many of theseforms of intervention remain in practice today.

The shortcomings of these forms of intervention were:

• They frequently distorted markets through attemptingto ”pick winners”. The interventions may have helpedensure the success of entrepreneurs that shouldhave failed through the process of creativedestruction.

• Provision of services by public-sector agencies anddonors crowded out private sector provision of theseservices and caused market distortions. Marketdeepening slowed down, disadvantaging micro andsmall businesses in the long run. Some suffered


58 © OECD 2004

moral hazard with the lending organisation not beingoverly concerned with how it lent someone else’smoney.

• In the end, the interventions were unsustainable.Governments ran out of money or developed otherpriorities and donors moved on to other projectsand countries.

These shortcomings have resulted in new approachesbeing adopted progressively that stress the importance ofestablishing an enabling environment for private sectordevelopment, deepening markets and improving terms ofaccess through institutions and policies, as describedbelow.

Perhaps the most glaring deficiency was the neglect ofinstitutional change. With inappropriate institutions leadingto unfavourable conditions for pro-poor growth, directsupport was likely to be ineffective. When institutionsstarted to get the attention they deserved, developmentagencies attempted to drive change through the technicalmerits of their intervention and even resorted toconditionality. For institutional change, the most commonform of intervention was to use technical experts, providedby donors or local experts, to develop new regulations orstrengthen regulatory or facilitating organisations. Inevitably,such initiatives ran into resistance from vested interests,including the private sector, which blocked change. It isnow recognised71 that change must be internally drivenwith development partners playing an enabling role.

III. The Role of Donors in Supporting Private SectorDevelopment to Accelerate Pro-Poor Growth

The new private sector development agenda and therecognition that the role of donors is an enabling onemeans that donors need to change their approach toproviding support for private sector development with theaim of accelerating pro-poor growth. They need to supportpartner governments to measure the extent to which growthis pro-poor, helping with data collection and analysis. Theyneed to support them in analysing the extent to which thefive factors that contribute to an enabling environment for


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private sector development are in place and highlightinstitutional and policy weaknesses that may cause growthto be less pro-poor. They may provide the analytical supportrequired to use diagnostic tools that reveal weaknesses inthese conditions through examining patterns of growth andthe ability of the poor to participate in and benefit fromgrowth. Perhaps most importantly, they need to support theprocess of stakeholder engagement that leads to pro-poorinstitutional change. They may use their influence andresources to help institutionalise the process, using PRSPsor other mechanisms, and ensure that participatorymonitoring and evaluation forms part of the process. Thepriorities for donor support should emerge from theirfacilitation of the process of stakeholder engagement.

IV. Bringing About Systemic Change

The new paradigm that is emerging to provide supportfor private sector development is based on the concept ofsystemic change, changing the incentives within marketsto deliver pro-poor outcomes rather than providing directsupport to enterprises. Systemic change usually involvesa combination of:

• Institutional change: Changing the way marketregulating, facilitating and promoting organisationswork (formal and informal) to provide rules of thegame that facilitate and promote pro-poor outcomes.

• Improving access and catalysing the deepening ofmarkets by supporting enterprises through thedevelopment of linked markets for goods and servicesthey require.

To illustrate the approach, business developmentservices (BDS) and access to finance, two major areas fordirect donor support in the past, serve as useful examples.In the past, donor projects provided services to help smallenterprises to survive and grow as an end in itself, the costbeing justified by increased output and jobs. It is nowrecognised72 that high-impact BDS interventions targetparticular outcomes in markets, e.g. in value chains and sub-sectors to increase the incomes of the poor, contributingto regional development, helping target beneficiaries such

Market outcomesare pro-poor, notnecessarily the sizeof business.


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as women and improving market access for the poor. Forexample, the BRAC programme in Bangladesh has improvedthe value chain for poultry by selective interventions toimprove functions such as hatcheries, chick rearing andfeed, resulting in higher value addition and job creationfor thousands of poultry farmers.73 The programme does notwork exclusively with small enterprises, and supports thegrowth of large hatcheries. This is a recognition that it is notthe size of enterprise that is pro-poor but market outcomes.And, there are many other examples of such BDSinterventions.74

Other ways in which the new approach to BDS differsfrom the past are:

• It is recognised that the absence of fee for serviceproviders does not mean that the services thatbusinesses need are not being provided. Embeddedservices provided by large enterprises may also playthis role and these may be supported by providingmarket-based incentives.

• A market-based approach to BDS aims to deepenservice markets by critically examining institutionalconstraints and demand and supply-side problemsto ensure that the intervention will address specificconstraints and not distort the market. Thus, if trustis a problem, the solution may be to develop asystem of training and accreditation of BDS providers.

The principles of introducing systemic change areillustrated by the new approach to providing access tofinance. In the past, donors provided finance for the poorthrough specialist microfinance organisations. Subsidisingthe cost of borrowing was justified by helping the poor outof a poverty trap. The result was that the microfinanceorganisations remained separate from the rest of thefinancial system, dependent on continued donor supportand their separate existence possibly reduced the incentivefor financial deepening to reach the poor. Only a few of thelucky poor benefited.

The new approach to access to finance recognises thatwhat is required is systemic change that leads to financialsector deepening, which progressively increases the

“To achieve its fullpotential,microfinance mustbecome a fullyintegrated part of adeveloping country’smainstreamfinancial system”Elizabeth Littlefield,CGAP.


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availability of credit to the poor. The institutions and policiesdescribed in Chapter 2 to improve private credit(macroeconomic policies, effective governance over theprivate sector and strengthening competition) are thereforeas much a part of the new agenda for improving access tofinance for the poor as is microfinance. The evidence suggeststhat private credit is a causal factor in pro-poor growth.

To accelerate the access of the poor to finance,microfinance has a vital role to play. But for it to do so aspart of financial deepening, it must become part of themainstream financial system and is, in fact, potentially themost high-risk, high-reward part of it. To achieve thisobjective, the approach:

• Works with microfinance providers to help them workon a commercial basis.

• Supports commercial banks who enter the market formicrofinance either on their own or by developingalliances with microfinance organisations.

• Develops the financial infrastructure and institutionsrequired to integrate the microfinance organisations,including credit bureaus, credit rating agents andaccreditation systems, and wholesale finance markets.

• Works with both microfinance organisations andcommercial banks to introduce technology thatenables transaction costs to fall and increasescoverage into rural areas.

Mainstreaming microfinance will reinforce systemicchange within the financial sector, providing incentives forthe commercial banks to lend to the poor. Like the approachto BDS, the new approach to microfinance works with themarket, using commercial criteria to introduce change.

V. Change the System without becoming Part of the System

In delivering such change, donors can either intervenedirectly or use change agents and facilitators. The problemwith the former is that it makes the intervention part of thesystem. That may alter the system for a time but makeprogress dependent on continued or further intervention.This is unlikely to be sustainable.


62 © OECD 2004

To bring about institutional change, what is requiredis to support change agents in the process of engagementand dialogue. Change agents are likely to be influential andknowledgeable individuals or organisations with an interestin bringing about pro-poor change, but who command therespect of those opposed to change. They can help tobuild constituencies for change and facilitate the initialengagement process. Donors may sponsor and empowerexisting change agents or foster the emergence of newagents. The evidence to support the case for change and,if required, technical support, can be provided throughthem to stakeholders. Donors may influence and enablethem to help institutionalise the process of engagement,monitoring and evaluation. This should ensure sustainedprogress on reform.

VI. Implications for Development Agencies

In the past, private sector development support formeda component of donors’ country assistance strategies orprogrammes, separate from economic and governancereform, sector-wide approaches (SWAps) and assistancetargeting the livelihoods and risk and vulnerability of thepoor. The new private sector development agenda requiresthat pro-poor growth through support for private sectordevelopment should form a major strand, if not the centre,of country assistance strategies or plans, bringing togetherthe strands of economic and governance reform, supportfor private sector development and livelihoods and risk andvulnerability. The strategy should itself be derived from theprocess of stakeholder engagement that the donor issupporting, or at least have stakeholder buy in.

Internally, private sector development was consideredone of a number of separate tools that the donor coulddeploy in support of poverty reduction. The new privatesector development agenda suggests that pro-poor growththrough private sector development is a cross-cutting issuethat should help to inform and guide much of the work ofdonors. Organisationally, support for private sectordevelopment was frequently a separate department staffedwith skills in enterprise development and finance for smallenterprises. Accelerating pro-poor growth through private


© OECD 2004 63

sector development requires bringing together a widerrange of skills. Its place in the organisational structureshould enable it to support the work of country-facingdepartments and to co-ordinate the work of a number ofsector or skill departments. It should therefore be placedin a position within the organisational structure similar tothat of a policy department.

In the past, donors have provided assistance throughprojects and evaluated them in terms of inputs and outputs.The new private sector development agenda calls forprogrammatic assistance, a series of specific interventionsthat are co-ordinated under the umbrella of a programme.One-off assistance is unlikely to be able to capture therange of assistance required to bring about desiredoutcomes across the range of conditions required forpro-poor growth. Moreover, as progress on interventionssuch as bringing about institutional change throughstakeholder engagement cannot be predicted with preciseaccuracy, it is important to build in flexibility in the deliveryof assistance. Programmes allow such flexibility. Monitoringand evaluation should focus on outcomes not outputs andinclude participatory evaluation and learning.

Externally, the new private sector development agendapresents a useful framework for donor co-ordination. Giventhe breadth of the agenda, it is unlikely that any single donorcould take on the whole agenda on its own. This paperprovides a common framework for analysis to ensure thatall contributing factors for pro-poor growth are beingaddressed. SWAPs may be a useful mechanism for suchdonor co-ordination but to accelerate pro-poor growththrough support for private sector development, SWApsshould involve not only government but also the privatesector and civil society groups that represent the interestsof the poor.

VII. In Summary

The new private sector development agenda is broaderthan the old agenda that focused on supporting particulartypes of business e.g. small businesses or agribusiness. Itaims to bring about favourable conditions for pro-poor


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growth through institutional and policy change andrecognises that it is market outcomes that may be more orless pro-poor, not types of business. It aims to bring aboutsystemic change that alters the incentive for the privatesector to help make it deliver pro-poor outcomes. In bringingabout systemic change, donors should aim to change thesystem without becoming part of the system.Institutionalising systems of stakeholder engagement,including participatory monitoring and evaluation, shouldput in place processes for local stakeholders to bring aboutsystemic change. Within donor organisations, acceleratingpro-poor growth through support for private sectordevelopment should form the core of country strategies andplans and be regarded as a policy function to support allcountry-facing departments. The function needs to have abroader set of skills than enterprise development. Externally,it requires effective donor co-ordination, perhaps throughSWAps that also involve the private sector and civil society.


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Notes

70. Small & Medium Enterprises, Growth & Poverty, Beck T, Demirguc-Kunt A and Levine R, 2003.

71. Stiglitz, Towards a New Development Paradigm. 2003.

72. Developing Commercial Markets for BDS. Primer, ILO. 2003.

73. Newnham J. The BRAC Poultry Programme in Bangladesh. 2000.

74. BDS. Primer, ILO. 2003.

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