It is increasingly recognized that "governments need to do less in those areas where markets work or can be made to work reasonably well" (World Bank 1991b) and more in those areas—such as education, health, nutrition, and regulation—where markets alone cannot be relied upon. By unleashing competitive forces and enhancing international competitiveness, a healthy private sector can provide both growth and jobs.
Many developing country governments are shifting their priorities from preserving jobs in a stagnant public sector to creating jobs in a vibrant private sector. This shift implies a fundamental change in the role of government—from owner and operator to policymaker and regulator, working closely with the private sector to develop a competitive, outward-looking economy (World Bank 1995e). This section provides indicators that reflect these shifting roles.
The new strategy requires that developing countries:
Establish a more inviting business environment. Sound macroeconomic management has to supplant stop-go policies that undermine the confidence of the private sector. But governments also have to promote competition and reduce risk—and especially to cut the high costs of doing business. This means pressing ahead on an array of policy, legal, regulatory, and institutional reforms in partnership with business and labor. Accelerate financial reform. Governments also have to restructure and, when appropriate, privatize banks, strengthen regulation and supervision, and develop the basic financial infrastructure to service a broad segment of the population, especially small businesses. Go faster and farther with public enterprise reform. Governments have to privatize utilities and large enterprises—and, where appropriate, liquidate major loss-makers. Employing only a small fraction of the labor force, these enterprises absorb a large part of government expenditures and account for a large part of the losses of the banking system. Failure to deal with these losses threatens reform programs and diverts resources from pressing social needs.
Two major objectives of the new strategy are to stop the hemorrhaging of the banking system and to improve infrastructure services essential for competing in a dynamic global economy.
Many countries have implemented parts of this new strategy for private sector development, and the response has been impressive. But even in countries with well-established institutions and legal systems—and the human resources to translate commitment into action—reform is a long process that may take more than a decade and is subject to reversal and fragility.
The poorest countries lack many of the prerequisites for such a sustained effort—and have little latitude for error. The challenges are particularly daunting in Africa, where the business environment for entrepreneurs is shaky, markets are small, skills are shallow and narrow, the supporting infrastructure is weak, and laws and regulations are very restrictive.
Tracking progress
How to track countries' progress in developing the private sector? By following three sets of indicators (World Bank 1991a). A changing public-private balance is reflected in an expanding private sector and a dwindling government role in the economy. Private sector growth shows up in higher private sector credit and investment, in flows of private capital, and in expanding capital markets. As the private sector grows, the government shifts out of providing services and into building human resources—and its intervention in the economy subsides. This shift shows up in the amount and composition of central government expenditure, in the amounts of public investment, publicly guaranteed debt, and domestic borrowing, and in the shares of government and state-owned enterprises in economic activity. To capture the potential of the economic environment to promote private sector development, incentives for investment are measured by integration with the global economy, trade policies, key prices in the economy, trade competitiveness, tax policies, and the legal and regulatory framework. And because support systems are essential for increasing the potential for private sector development, we look at the financial sector's depth and efficiency, the level of people's skills, the dependability of infrastructure, and scientific and technological capacity.
Going private
The private sector's share in economic activity has increased dramatically in many countries and in the developing world as a whole, but in far too many countries excessive fiscal deficits still crowd out private investment and raise the cost of domestic borrowing.
Even so, some countries have begun to attract sizable amounts of private capital flows in recent years (tables 5.1 and 5.2). For countries, this reflects their greater receptivity to foreign capital, and for investors, their search for higher returns and for better diversification of risk (box 5a).
Developing country stock markets are also beginning to attract significant inflows of foreign portfolio equity investment—as well as domestic funds. In 1990–95 the stock market capitalization in developing economies rose from $390 billion to $1.5 trillion, up from 4 percent to 8 percent of global stock market capitalization (table 5.3).
Stock market development is closely related to economic development. In the initial stages of economic development, commercial banks tend to dominate the financial system. As economies grow, specialized financial intermediaries and equity markets develop. The reason? Many profitable investments require a long-term commitment of capital, but investors are typically reluctant to relinquish control of their savings. By allowing savers to acquire liquid assets, equity markets make investments less risky and more attractive—and allow companies to tap capital for their longer-term investments. The development of stock markets also makes it easier for governments to sell off state-owned enterprises.
But despite more than a decade of divestiture efforts, state enterprises remain as ubiquitous in developing economies as they were 20 years ago. Indeed, their presence has shrunk significantly only in the former socialist economies and a few middle-income countries. In most developing countries, particularly the poorest, bureaucrats run as large a share of the economy as ever (table 5.4).
State enterprises often are less efficient than private firms, and their deficits are typically financed in ways that undermine macroeconomic stability. In addition, subsidies to state enterprises often divert scarce funds from public spending on education and health. And because state enterprises tend to loom large in low-income countries, they are likely to be most costly in countries that can least afford them.
Privatizations of state enterprises in developing countries generally have so far had more qualitative effects than quantitative effects—increased efficiency, more new domestic firms, and a proven government commitment to private sector development. And even though sales have yet to generate much revenue, public enterprises are accruing fewer losses than they once did.
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