Get up to speed on the latest issues relating to Private sector development.

It is now widely accepted that a thriving private sector can make a significant contribution towards achievement of development goals. However, there is no simple recipe for creating the right regulatory and economic environment for the private sector to thrive. It requires an in-depth understanding of the local business landscape and culture to enable the key factors constraining private sector development to be identified and addressed. OPM’s experience working in developing countries, combined with specific expertise in private sector and regional development, means we can help donors, regulators, enterprises and government gain the insights they need. We approach the issues from the perspective of both public and private sectors - looking not only at developing public policy but also understanding the motivations and needs of businesses from microenterprises to multinationals.

Skills shortages are one of the biggest barriers to private sector growth in every country. In developing countries in particular, vital technical, functional and managerial skills are in short supply, driving up the costs of recruitment and retention and increasing reliance on imported expertise. So how can countries best build a sustainable skills base? The first crucial step is to understand the existing skills landscape, and the current demand and supply. What skills are needed and where? And who can provide them? Some would argue that the burden should fall on the private sector, but this is not without risk: investment in training is no guarantee of staff retention, especially when demand is much higher than supply, leading to high staff turnover and rising remuneration.

On the other hand, relying on the public sector to develop skills is no panacea, especially where there is no consultation with enterprises to understand what skills they are seeking. Funding is typically channelled through existing state-backed institutions, such as universities, which leads to an overemphasis on academic qualifications, rather than necessarily entrepreneurial and managerial skills. This was one of the issues identified by OPM in the Census of Existing Skills in the Financial Sector in Rwanda. Instead, a balance must be struck between public sector investment and private sector demand. A commitment from the government to support skills training need not mean that the state becomes the provider: a more appropriate way forward is often for some kind of public-private partnership, with government funding enabling private sector delivery.

It’s widely accepted that, left alone, markets rarely serve the poor. As a result, governments - often influenced by donor support - are inclined to intervene. However, any intervention in markets has an impact far beyond what might be first anticipated. The challenge is to identify appropriate interventions, where the likely gains outweigh the likely costs and potential winners and losers can be identified. Reforms often come unstuck as the likely gainers have limited economic and political capital, whereas the likely losers are strong and well informed.

Without careful planning and foresight, external interventions within markets - no matter how well-intentioned - can create significant long-term problems. One common example is the introduction of agricultural subsidies for specific crops: though this provides farmers with valuable support in the short-term, it can lead to distortions in crop selection and reduce incentives to diversify to non farm enterprises.

The challenge therefore is to identify what interventions would be most appropriate, and what safeguards and monitoring mechanisms need to be in place. This requires rigorous analysis of previous approaches - both in the country and elsewhere - and modelling of the potential market impacts. It also demands an honest appraisal of the real barriers to market access: sometimes the problem is not a technical one, but rather a question of understanding how to use markets and services.

Financial services provide a telling example: a policy requiring banks to enhance SME lending may falter if the loan terms are not viable - as proved the case in Nigeria. On the customer side, problems such as physical and cultural proximity, appropriateness of product features and pricing remain: poorer customers may find the banks daunting in terms of products, pricing and culture and thus may be reluctant to use the services.

By considering any potential intervention fully and from a range of perspectives - a task in which OPM’s experience and approach can prove invaluable - governments can use the energy, capital and insights of the private sector to make markets work better for the poor.

Challenge funds

Many of the most effective approaches to increasing access to markets come from market-based actors themselves identifying new and alternative ways to work with the poor on a mutually beneficial basis. As a result, there has been a growing interest in challenge funds which directly incentivise commercial entities to generate and test such ideas. OPM has evaluated such programmes, including DFID’s Financial Deepening Challenge Fund, giving us considerable insight into how such funds can best be designed and implemented.

Though it can be tempting for governments to stimulate enterprise through artificial incentives and backing for individual businesses, the key to establishing a strong Micro Small and Medium Enterprises (MSME) sector is to create the enabling environment for businesses to grow. That means focusing on regulatory and infrastructure aspects and encouraging and incentivising market-based providers to provide relevant financial and non-financial services.

In terms of financial services, the priority is often reducing the risks and costs of providing loans to small businesses - which requires an understanding the causes of high risk and high cost, rather than the symptoms.

One common challenge is security for loans, as in many countries, land is the only accepted collateral. However, given the lack of clarity around land ownership, requiring applicants to produce titles and documentation is costly and time consuming, and as a result, actual lending may be a small fraction of the potential demand. If machinery could be used as collateral, many more applicants would become eligible - reducing the overall cost of provision, and through diversification, reducing the risk, as proved the case in.

Defining suitable non-financial services is no simple task - and the smaller the business, the more difficult it becomes to establish sustainable providers. Microenterprises can rarely afford to pay for such assistance, and often the relevance and value-add to them of advice on tax or HR is minimal. Instead, the most valuable input can often come from their customers, particularly where these are sizable national or international players. For example, the benefits to rural agricultural suppliers of getting advice from the processing company that is most likely to buy their produce are considerable: what crops do the end customers want? Are there farming methods or inputs (seeds, fertilisers, etc) that are proven to deliver best results? Can transportation, sorting and grading be arranged on a timely and cost-effective basis?

In case of natural resource-based industries, governments can introduce local content rules that international investors must follow: these then become an incentive for investors to strengthen local suppliers and ensure that the global business also enhances local economic opportunities. OPM has helped define such rules, striking the important balance between expectations of the Government and local communities and the needs and incentives of the private enterprise.