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WP/2016/07
Poverty Alleviation and Inclusive Development: Rethinking the Role of Private Sector
Muhamed Zulkhibri
3 Rajab 1437H | April 10, 2016
IRTI Working Paper Series
Islamic Economics and Finance Research Division
IRTI Working Paper 2016-07
Title: Poverty Alleviation and Inclusive Development: Rethinking the Role of Private Sector
Author(s): Muhamed Zulkhibri
Abstract
The study argues that private firms play a vital role in enhancing inclusive growth prospects as
investors, employers and creators of new and upgraded productive potential. Private sector activity
matters for growth as well as its quality, sustainability and inclusiveness. Similarly, it is evidenced
that Islamic approach to private sector development emphasises the need for balanced
development, which covers both physical and spiritual development. Islamic finance for instance,
which is based on risk-sharing help mobilize resources from a large spectrum of the population,
substantially increase the share of equity in business, and advance profit and loss sharing (PLS) in
entrepreneurial activities. The analysis suggests that private firms have the capacity to enhance
inclusive growth prospects given their ability to create new and higher value productive capacity.
The capability of firms to launch new export products and raise product quality generates higher
profitability and productive potential with spill over benefits to other firms and industries.
However, private sector activity per se does not automatically result in equality of opportunity
across individuals and firms. It has been very thoughtful to many countries to facilitate various
actors to come together in public-private collaboration to build ‘Inclusive Business Models’ based
on inclusive markets.
JEL Classification: O10, O53
Keywords: Private sector; Inclusive development; Poverty reduction
_____________________________________________
Suggested citation: Muhamed, Zulkhibri (2016). Poverty Alleviation and Inclusive Development: Rethinking the Role
of Private Sector, IRTI Working Paper No. WP/2016/07, Jeddah: Islamic Research and Training Institute.
Islamic Research and Training Institute
8111 King Khalid St. Al Nuzlah Al Yamania Dist., Jeddah 22332-2444
Kingdom of Saudi Arabia
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2
Poverty Alleviation and Inclusive Development: Rethinking the Role of Private Sector
Muhamed Zulkhibri1
1. Introduction
Private sector constitutes a broader term covering all private actors engaged in economic activity,
from the small market seller and farmer to large domestic and foreign corporations. The private
sector consists of more than formal businesses or corporation, even though many discussions have
tempted to concentrate on the role of multinational corporations (MNCs) or large corporations.
The discussion on equitable and inclusive growth and the achievement of Sustainable
Development Goals (SDGs) is not complete without considering the whole spectrum the private
sectors and its contribution in economic development.
It is important, however, to define what the private sector before discussing its roles in
promoting growth. According to the Development Assistance Committee of the OECD (1994), the
generally accepted definition of the private sector is as follows:
“A basic organizing principle for economic activity where private ownership is
an important factor, where markets and competition drive production and where
private initiative and risk-taking set activities in motion”.
The boundary between private, for-profit institutions and private not-for-profit
organizations is fluid and variety. The private sector encompasses all economic activities that do
not involve production by the public sector and includes all for-profit firms regardless of size,
activity (goods, services, or financial), or location (urban or rural), and institutions specifically
established to serve the private sector such as industry associations. Nonetheless, the overall role
of the private sector in development, in terms of both local and international private sector
activities including foreign investment, is to generate wealth and stimulate economic growth.
1 Senior Economist, Islamic Research and Training Institute (IRTI/IDB). Email: [email protected]
Debate on the role of private sector has changed in recent decades based on the assumption
that economic growth is best achieved through the private sector participation. These changes have
been precipitated by both internal and external factors: i) empirical research indicating high levels
of growth with dominant private sector participation and market-based economies experience more
rapid growth; ii) growing difficulties with government intervention in industry and trade in
particular the nature of intervention; iii) changes in the international environment following series
of financial crisis; and iv) the desire to reduce the burden on government budgets and debts.
The focus of the paper is to analyse the intertwined between private sector, poverty
alleviation and inclusive economic development. The paper also reviews the role and contributions
of private sector in the process of economic development: job creation, access to social services
and finance, infrastructure, human capital and poverty reduction and others contribution in whole
segment of economic activities for the poor.
This paper is set out as follows: Section 2 discusses the rationale of private sector approach
to inclusive growth. Section 3 briefly provides Islamic the perspective on private development.
Section 4 provides the relationship between private sector, economic growth and poverty. Section
5 explores the role and contributions of private sector to the economy. Section 6 provides the
conclusion.
2. What is Inclusive Growth?
Inclusive growth is defined as growth that is sustainable and sufficiently broad based to incorporate
a number of economic sectors and mobilize large shares of the local labor force. (Commission on
Growth and Development 2008; Ianchovichina and Lundstrom 2009; De Mello and Dutz 2012).
Unlike pro-poor growth, inclusive growth focuses on growth in equity and equality of opportunity
across a wider range of firms and individuals. It requires unfettered access to markets and unbiased
regulatory environments. For policymakers, promoting inclusive growth includes balancing
growth across sectors, i.e. between private stakeholders and the government and between tradable
and non-tradable sectors. (De Mello and Dutz 2012).
4
Three main pillars of a private sector development strategy to support inclusive growth are;
(i) support for new, higher value products, markets and firm capabilities; (ii) creating a high
performing business environment, clusters and cities and (iii) development of globally competitive
institutions and new technology. By promoting development of new, higher value products and
markets, policymakers can help create new and higher value productive potential. Similarly, the
expansion of broad-based firm capabilities is important for diffusing knowledge and expertise
across a wide range of sectors and industries. Second, a strong business environment which
supports competition and diversity helps create entry and scalability for young, dynamic firms and
medium size and medium productivity sectors. Equally important is support for cooperation and
emerging areas of specialization and agglomeration through industrial clusters and city
development strategies. Finally, support for globally competitive and specialized institutions such
as customs authorities, financial intermediaries and investment promotion agencies can promote
firm entry and growth at critical junctures. Development and diffusion of new technologies
through support for ICT, Technology Development Funds and Joint Ventures with Multinationals
can help move firms closer to the global technology frontier and does not come at the expense of
existing products, sectors and unskilled workers.
Promoting inclusive growth does not mean redistributing assets and opportunities from the
rich to the poor or from large firms to small firms and from urban to rural areas. While much of
the focus of existing inclusive growth approaches is reaching segments at the Bottom of the
Pyramid (BOP) and extending private sector activity to disadvantaged groups such (i.e. rural areas,
SMEs, women, unskilled workers), this is only part of the story. In the process of economic
growth, patterns of specialization and concentration of resources and talents across firms and
individuals, cities and sectors naturally arise and are important engines of growth and dynamism
(World Bank 2009). Export superstars, high performing clusters and cities and world-class
institutions are an equally important part of the inclusive growth story. They are vital sources of
dynamism and specialization, which make the diffusion and diversification of economic
opportunities across broader groups possible and sustainable.
Well-functioning markets and productive firms can be powerful agents of inclusive growth
by determining whether economic opportunities are defined by individual or firm level skill or
initiative as opposed to family wealth, social status and political connections (Levine 2012).
However, where policy biases, distorted incentives and unforeseen circumstances prevail, private
sector activity does not necessarily expand economic opportunities for society. Where
governments direct credit to smaller enterprises for inclusive growth purposes, for example,
research suggests that powerful vested interests can distort the impact of such policies,
undermining growth in broad based opportunities (Barth, et al 2006; Khwaja and Mian 2005).
Growth in productive potential in competitive markets is inclusive growth; it catalyzes firm
expansion in intensity and scale. Firms everywhere can profit from lower costs and higher value
products through innovation and gains to TFP, but such gains are much more substantial in
competitive business environments (Dutz et al 2012). Young, innovative firms are an important
source of productivity potential. Recent empirical studies suggest that relative to old (15 years+)
and mature (5-15 years old) firms, the average growth of young (less than 5 years of age) firms is
significantly higher. (Dutz et al 2012). Firms operating in competitive markets, on the other hand,
profit even more by not only adjusting production technology, but also selling more intensively
and widely through lower prices and better marketing and distribution channels. Inclusive growth
is achieved as increases in production include unskilled as well as skilled workers and market
opportunities provide incentives for more and better job creation (Dutz et al 2012).
3. Islamic Perspectives on Private Sector Development
The philosophy of Islam and its law are always based on values and ethics, which are represented
in a set of rights that included all human beings without distinction between colors, races or
languages, and included the human behavior in dealing with each other in the private spheres.
These values and ethics are represented in maintaining and applying these rights with the authority
of Islamic law and imposing sanctions upon offenders. The concept of private sector development
should be underpinned by the principle of Islamic solidarity that can take several forms ‒ such as
social (the welfare of society), financial (giving Zakat - obligatory almsgiving and Sadaqah -
voluntary almsgiving), and political (the implementation of the Shari’ah laws, both technological
and moral).
6
It is clear that economic, financial, and social issues are closely linked. The linkage arises
partly because economic prosperity is among important determinants of “sociological” change and
partly because the resources produced by economic growth enable social policy expenditures. In
this process, the availability of finance in accordance with the moral and social preference of
society is also important as it not only directly contributes to the social well-being, but also
indirectly through enhanced financial inclusion. Islamic approach to private sector development
emphasises the need for balanced development, which covers both physical and spiritual
development. Moreover, an essential principle of Islam is its focus on social betterment, promoting
self-sacrifice in terms of acting for the betterment of the community as a whole versus an
individual’s self-interest. There is a standard of living life in modesty, simplicity, and frugality, an
aim for contentment versus greed and a desire for contentment through avoidance of excess and
wastefulness.
The entire structure of Islamic economy is built upon a set of objectives or Maqasid. In
other words, Islamic economics is normative in nature with the objective of the Shari’ah (Maqasid
al-Shari’ah) being to promote the well-being of all humanity, which lies in safeguarding the faith,
lives, intellect, posterity and wealth. Islamic system promotes a balance between market, family,
society and the state. Thus, Islam values prosperity and happiness. It does so by promoting both
the material and the spiritual urges of the human self, foster peace of mind, enhance family and
social solidarity. The existence of Islamic banking is supported by these key Islamic principles
that can be summarized in the prohibition of exploitation, ethical standard, moral and social values,
and a link between risk and rewards. These principles for a unified and coherent framework that,
if followed, guarantee the dynamism of the production system and the distribution of the wealth
created.
From an Islamic perspective, private sector plays a critical role in development along with
the public sector that allows economic growth and justice to complement each other. Private sector
activities that reduces poverty, creates jobs, improves health and education, especially for the
needy and vulnerable segment of the population are encouraged by Islam due to efficiency gained
of the private sector involvement. Overall society gets the maximum output from a given level of
resources as a result of private sector activities. In fact, many examples in the Muslim community
in past were financed by private sector such as expenditures on health, education and basic needs
of the less privileged via voluntary private individuals and institutions. For instance, voluntary
sector of zakat and waqf institutions is another source for such support that can improve private
sector involvements in inclusive development through reducing the cost of doing business by
private sector agents.
Islamic finance, which is based on the principles of Islamic law (also known Shari’ah) and
guided by Islamic economics are supportive of private development programme. The two basic
principles behind Islamic finance are the sharing of profit and loss and, significantly, the
prohibition of the collection and payment of interest, which is not permitted under Islamic law.
Islamic finance, therefore, should, in its ideal form, help mobilize resources from a large spectrum
of the population, substantially increase the share of equity in business, and advance profit and
loss sharing (PLS) in entrepreneurial activities. Risk sharing ensures that Islamic financial
institutions thoroughly evaluate business proposals as it creates an incentive for financial
institutions to internalize the costs related to bankruptcy. In addition, risk sharing is implemented
through equity-based financing, the opposite of debt-based financing, which lends itself to all kinds
of explicit or implicit interest income.
The institution of zakat and waqf in the contemporary socio-economic set-up should be
seen as an additional source to support the private sector development programme relating to
poverty alleviation. The history of zakat and waqf suggests that these institution can be used to
mobilize additional resources for poor sections of the society to address socio-economic issues
such as: i) education; ii) skills and micro entrepreneurial development; iii) health care; d) water
and sanitation facilities in rural areas. Waqf can also maintain a fund, which if properly invested,
can be utilized in periods of famine and other crisis to help extreme poor to survive the crisis or
the famine.2 By assuming the number of poor people in the Muslim world in the year 2010 reaching
830 million people, the potential world zakat will be able to overcome 24 percent of the poverty.
2 Kahf (1999) the estimated potential of zakat ranges between 1- 6% depending on various definitions and the cash
holding is estimated to be in the range of 40-60%. Based on the estimated proportion of GDP every Muslim country
in 2010, the estimated potential of zakat in the world a year is not less than US$600 billion with the assumption that
every poor person will be able alleviated with greater empowerment of zakat funds of US$3000 per person.
8
4. Private Sector, Economic Growth and Poverty
Private sector activity matters for growth as well as its quality, sustainability and inclusiveness.
Figure 1 shows that economic growth contributes significantly to poverty reduction and to higher
living standards for poor people.3 This is no news; but it is at last widely recognized by the
international development community, as reflected in the UN Millennium Summit in 2010, Busan
Partnership, G20 Statements and the European Agenda for Change, that the private sector is
already uplifting the life of the poor and can make those poor lives better.4 The motivation for
increasing the role of the private sector in development is to make a contribution to poverty
eradication and the achievement of sustainable development but not merely to help private firms
make a profit.
3 For a recent review, see Francisco Ferreira and Martin Ravallion, “Global Poverty and Inequality: A Review of the
Evidence” (Policy Research Working Paper 4623, World Bank, Washington, DC, 2008). Also see Commission on
Growth and Development, Growth Report, (2008), p. 14. 4 At the UN Millennium Summit in 2010, 11 bilateral donors issued the Bilateral Donors’ Statement in Support of
Private Sector Partnerships for Development at the UN Private Sector Forum.
Figure 1: Growth Reduces Poverty (1981-2005).
Source: World Development Indicator (2012); PovcalNet (accessed on 16 February 2013)
East Asia & Pacific
Latin America &
Carribbean
Middle East & North Africa
South Asia
Sub-Sahara Africa
Indonesia Malaysia
0%
1%
2%
3%
4%
5%
6%
7%
8%
0% 2% 4% 6% 8% 10% 12% 14% 16% 18%
GD
P Pe
r Ca
pita
Gro
wth
Per
Yea
r (C
onst
ant
2000
$U
S)
Headcount Poverty Reduction Per Year (US1.25)
As successful cases of inclusive developments, the Commission on Growth and
Development (2008) shows that all countries considered in its analysis have enjoyed sustained
high growth rates for at least three decades (Figure 2). However, it is also agreed that the notion
of “growth is all that matters” for combating poverty should not be overemphasized (Kanbur and
Lustig, 1999; Lustig, et al., 2002). Hence, poverty alleviation requires additional elements to be
inclusive5: i) asset base of poor households need to be build up in order to participate in the growth
process; ii) more broad-based and inclusive growth are required to benefits all segments of society
including the poor; and iii) short-term public assistance measures are needed to protect the
vulnerable groups of society.
5 Zhuang, J., Gunatilake, H., Niimi, Y., Khan, M.E., Jiang, Y., Hasan, R., Khor, N., Lagman-Martin, A.S., Bracey, P.
and H. Biao Huang (2009) “Financial Sector Development, Economic Growth, and Poverty Reduction: A Literature
Review” ADB Working Paper No.173, ADB: Philippines.
Figure 2: Inclusive Approaches Generate Rapid Growth
Source: The Commission on Growth and Development (2008)
Botswana
Brazil
Indonesia
Korea
Malaysia
China
Thailand
0
2000
4000
6000
8000
10000
12000
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43
GD
P P
er
Cap
ita
(Co
nst
ant
20
00
US$
)
Number of Years
10
Growth is required to continue to help improve people’s lives well beyond levels of
extreme poverty and is also associated with better attainment of SDGs related to education, health,
and environment.6 While growth on average has significant benefits for the poor, how fast poverty
declines for a given rate of growth, particularly over the short to medium term, varies considerably
among countries. For instance, one study covering many countries found that when average
household incomes rise by 2 percent per year, poverty rates fall by about twice as much on average,
but the range among countries can be significant (1.2-7 percent).7
The Commission on Growth and Development (2008) reports five common characteristics
of countries with high, sustained growth.8 While many of these characteristics relate to actions that
governments need to take, also prominent among these is market allocation of resources, led by
the private sector. A key mechanism for economic growth is higher productivity and knowledge
transfer, and the private sector plays a critical facilitator of this process by investing in new ideas
and new production facilities. As shown in Figure 3, countries with the level of public investment
but high level of private investment enjoyed faster economic growth, despite the fact that public
and private investment can be reciprocally supportive.
For decades, debates about the role and responsibility of the private sector in society have
been going among the private sectors. Starting from argument of Milton Friedman (1970) that the
only responsibility of the business is to increase its shareholders’ profit to argument that see
corporations as social institutions that have an obligation to contribute to the well‐being of the
society (Brainard and LaFleur, 2005). Despite the limited impacts and scale of private sector
towards low-income communities, the latter argument was responded by practices of corporate
social responsibility in recent decades.
6 World Bank, Global Monitoring Report 2011 (Washington, DC: World Bank, 2011), chap. 1. 7 Commission on Growth and Development (2008), Growth Report, 14. 8 Commission on Growth and Development, The Growth Report: Strategies for Sustained Growth and Inclusive
Development (Washington, DC: World Bank, 2008).
Private sector has contributed to the achievement of SDGs through9: i) indirectly -
increasing aggregate income and creating of wealth; ii) directly – creating employment and
provision for the poor on affordable goods and services; and iii) increasing tax yields by promoting
rule based systems of exchange. Moreover, the benefits of private participation in achieving
development goals can be improved in three ways: i) attracting private participation in the delivery
of goods and services will enhance operational efficiency and coverage; ii) by using the private
sector to produce services on behalf of the public sector; and iii) by using the private sector as a
partner in socially and environmentally responsible development.
In Africa, private sector is seen to be playing a critical role with respect to employment
creation, growth and development (Kurokawa et al., 2008). Moreover, in promoting equitable and
sustainable economic development in Africa, the development of small and medium enterprises
(SMEs) is acknowledged as a key factor. In fact, the importance of the micro and SMEs to the
development of African economies is well documented. Sustainable and inclusive development
9 UNDP (2007) Private Sector Strategy: Promoting Inclusive Market Development, United Nation: New York.
Figure 3: Economic Growth and Private Investment in
Developing Countries (2004-2007)
Source: World Development Indicator (2013)
0
3
6
9
12
15
18
Less than 3% 3-5% More than 5%
Investment (% of GDP)
Growth Rate of GDP
Private Investment Public Investment
12
cannot be achieved without the energy of the private sector, without private enterprise, private
initiative, private savings and private resources.
Since there was no automatic trickle down effects of growth and the fact accepted by
international aid agencies in economic development (Dart and Ravallion, 1992; Kakwani, 1993;
Dollar and Kraay, 2001), attention is now directed to the role of governance in distributing the
gains from economic growth. Historically, private sector has been included in many new reform
and governance initiatives by international development organization in the efforts to reduce
poverty. For example, inclusion of local communities, and NGOs in international cooperation
efforts (i.e. Melinda-Gates Foundations) without getting into controversies in the issue of
cooperation.
5. Private Sector for Inclusive Growth
5.1 Private Sector and Jobs Creation
In most countries, the private sector is the major component of national income and the major
employer and creator of jobs. The pace of job growth and the quality of employment in the private
sector are thus central to development. A vibrant private sector also contributes to higher wages.
As result of a good investment climate workers can be paid higher and invest more in personnel
development, if the private firms are more productive. The expansion of firms can also have knock-
on effects, raising the wages of those in smaller firms as the pool of available workers tightens.
Similar patterns are found in rural areas, with rising non-farm employment lifting agricultural
wages - with significant impacts on poverty reduction.
Private sector is the engine for sustainable job creation and the dominant source of jobs
worldwide. Over 90 percent of jobs in developing countries are in the private sector and 95 percent
of people in countries such as El Salvador, India, and Mexico.10 Growing economies create more
jobs, particularly in developing countries. In addition, the impact of investment climate improves
10 World Bank, World Development Report 2005: A Better Investment Climate for Everyone (Washington, DC: World
Bank), Chap.1
employment growth of the private sector can be seen by looking at experiences in selected
individual countries. For example, investment climate improvements in China, India, and Uganda
contributed to employment growth of more than 2 percent a year.11
The private sector are also better at creating jobs and economic growth for few reasons: i)
private firms have a profit incentive to develop products in line with consumer demand and to
reduce costs for market share expansion; ii) undermine the political reasons of employment by
having flexibility to fire and hire (surplus/shortage of workers) compared to the workers in the
public sector than private sector; and iii) free up resources by reducing government spending can
more efficient private sector growth and more job creation. According to World Bank (2009),12 it
is estimated that 40 million jobs need to be created over the coming decade in MENA region.
These jobs will have to come from the private sector Governments will not be able to create these
jobs in the public sector (Figure 4). Neither will they be created in state-owned enterprises – at
least not in sufficient numbers or in a sustainable manner.
11 Ibid. 12 World Bank (2009) From Privilege to Competition: Unlocking Private-Led Growth in Middle East and North
Africa, Washington, DC: World Bank.
Figure 4: Public and Private Sector Contribution to Total Employment
Growth (2000-05)
Source: World Bank (2006)
-0.1 -0.20.4
2.2
0.2 0.3
2.3
3.7 3.2
1.9
4.2 3.6
2.5
-0.5
0.5
1.5
2.5
3.5
4.5
5.5
6.5
Morroco Iran Saudi Arabia Jordan Egypt Algeria
per
cen
tage
po
ints
Public Private Work at home
14
Among the private sector, SMEs play a leading role in creating employment, income and
value added, and in providing the seedbed for developing and testing entrepreneurial talent. Jobs
in small and medium enterprises together (SMEs) account for more than half of all formal
employment worldwide. This is especially true in low-income countries as shown in Figure 5,
where SMEs represent on average about 66 percent of permanent, full-time employment.13 The
comparatively high share of employment SMEs provide shows that they play a major role in
income generation for broad – and above all, often less privileged – sections of the population.
This is why the development of the SME sector in developing countries increasingly considered
as a central element in poverty reduction strategies.
According to World Bank survey, poor people believe that having a job (whether self-
employed or waged) is the quickest and surest way to escape being poor (World Development
Report, 2005). The private sector is more than just the engine of growth; it is also a key mechanism
for women and men to participate in and contribute to that growth and increase the opportunities
13 IFC (2013) Assessing Private Sector Contributions to Job Creation and Poverty Reduction Washington, DC:
International Finance Corporation.
Figure 5: Firm Share of Total Employment (in %)
Note: Based on number of permanent full-time workers.
Source: Enterprise Surveys (2013)
0
10
20
30
40
50
60
Low Income Countries Medium Income Countries High Income Countries
Small (5-19) Medium (20-99) Large (100+)
SME
for poor people. With limited budgets, governments in developing countries are looking to the
private sector to generate the jobs, which will reduce poverty – and to help supply the services the
poor need to improve their quality of life.
5.2 Private Sector, Access to Finance and Financial Inclusion
The financial sector is seen as playing a crucial role in economic growth by mobilizing savings,
facilitating payments and trade of goods and services and promoting efficient allocation of
resources. In addition, it is directly affects the private sector through broadening access to finance
and indirectly through growth as well as contributing to poverty reduction. In order to enhance the
impact of private sector on development (i.e. greater affordability and better returns on essential
goods and services and more jobs), financial sector can help to reduce private sector exposure to
risk, expanding market access and improving functioning of markets.
Broad financial access is the key to development according to modern development
theories. The critical element underlying persistent income inequality as well as slower growth is
Figure 6: The State of Financial Exclusion
Source: FinScope Survey (2014)
Adults with accounts at a formal financial institution
High Income OEDC and non-OECD
87.1%
Sub-Sahara Africa
20.9%Latin America and
Caribbean
32.1%
Europe and Central Asia
40.7%East Asia and
Pacific
42.0%
South Asia
31.3%
Middle East & North Africa
26.6%
16
often associated with the lack of access to finance. In case of non- inclusive financial systems,
poor individuals and small enterprises need to rely on their personal wealth or internal resources
in order to invest in their education, setup and grow businesses. In Africa, less than half the
population has an account with a financial institution (Figure 6). Access to finance affects new
firms’ ability to raise financing and to support long-term growth through gains in productivity.
Firms need mainly two types of finance: short-term credit (i.e. working capital, trade credit, supply
credit) and long-term debt (i.e. capital investments, equity, leasing), but both types are
complementary for their operations.
The financial sector plays an important role for private sector access to finance in
mobilizing and allocating resources, managing risks, and facilitating transactions across
companies. A developed and well-operating financial sector is essential to achieve economic
growth. The financial sector has a key role to play in giving poor people the chance to share in
economic growth and its benefits. The literature has found a positive relationship between access
to finance and countries’ long-term growth (Figure 7). Studies suggest that financial development
helps generate capital accumulation, higher productivity growth, innovation, and entrepreneurship,
which propel growth. Additionally, access to finance is related to job creation as firms expand
operations and become more productive.
Figure 7: Financial Inclusion and Income
Note: Findex is defined as percentage of adult population with access to some intermediary accounts.
Source: World Bank (2012)
Singapore
UAE
Italy
Turkey
Peru
Egypt
Sri Lanka
Tajikistan0
10
20
30
40
50
60
70
80
90
100
0 10,000 20,000 30,000 40,000 50,000 60,000
Findex*
GDP Per Capita (PPP US$)
A large body of empirical studies has provided evidence on the direction of causality from
financial sector development to economic growth and poverty reduction.14 Financial development
(using different measures) is positively associated with employment growth. The measures that
had a significant relationship were a strong banking sector (the ratio of private credit over GDP)
and financial openness (the sum of foreign assets and foreign liabilities over GDP). While the total
credit provided by the financial sector is relevant for job growth, the distribution of these resources
among different firms in the economy, the mix of products offered and the costs involved.
Empirically, many studies looking at micro data find evidence of a positive correlation
between access to finance and poverty. For instance, Jacoby (1994) finds that lack of access to
credit perpetuates poverty in Peru because poor households cannot afford to provide their children
with appropriate education. Furthermore, Jacoby and Skoufias (1997) show that in India when
transitory shocks reduce household income, children’s schooling dramatically reduce for those
without access to credit markets. Similarly, Dehejia and Gatti (2003) and Beegle, et al. (2005)
show that countries with poorly functioning financial systems have higher child labour rates.
5.3 Private Sector Participation and Infrastructure
Infrastructure industries and services are crucial for generating economic growth, alleviating
poverty, and increasing International competitiveness. Safe water is essential for life and health.
Reliable electricity saves businesses and consumers from having to invest in expensive backup
systems or more costly alternatives, and keeps rural women and children from having to spend
long hours fetching firewood. Widely available and affordable telecommunications and
transportation services can foster grassroots entrepreneurship and so are critical to generating
employment and advancing economic development.
The basic rationale that infrastructure is essential for development (growth and poverty
reduction) remains predominant in all levels of the literature. The view that private investment is
14 For instance, Beck et al. (2004), “Finance, inequality, and poverty: cross-country evidence”, World Bank Policy,
Research Paper No. WPS3338; DFID (2004) “The importance of financial sector development for growth and poverty
reduction”.
18
a crucial ingredient in infrastructure development is prominent in the donor literature but contested
elsewhere, though it is also quite widely accepted in the academic literature. According to
McKinsey Global Institute (2013), in order to keep up with the projected global growth rate,
US$57 trillion infrastructure investment is required globally in the next 20 years. In addition,
recent World Bank estimates now consider that the average infrastructure share of GDP for
developing countries needs to double, from 3-4 percent to 7 percent while for low income
countries, the financing requirement may be even higher (8 percent to 9 percent).15
The private sector is able to provide essential services such as infrastructure (transport,
telecommunications, water and power), health, education, and finance that are important to growth
and to improving people’s lives. In recent decades, the private sector played an increasing role in
infrastructure sectors particularly power, natural gas, telecommunications, transport (railways,
roads, ports, and airports), waste treatment, water supply, and sanitation as governments have
sought alternatives to public funding and looked for more efficient ways to deliver services.
15 McKinsey (2013).
Figure 8: Infrastructure Investment with Private Participation in Developing
Countries
Source: PPI World Bank Database (2013)
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
% of GDP
Energy Telecoms Transport Water & Sanitation
Estimates for global infrastructure investment needs in developing countries range as high as US$1
trillion per year, over 5 percent of GDP (Figure 8).16
A public-private partnership can combine the respective strengths of the private and public
sectors. The private sector can leverage its advantages of greater efficiency, lower costs of
distribution, and more complex delivery systems to reach new markets. The public sector can
ensure universal access by providing financial support to subsidize impoverished households,
thereby enabling private firms to enter large markets with guaranteed consumers. Public funding
for the private provision of essential goods and services needs to cover both capital and recurrent
costs to “close the revenue cycle.”
During the last two decades, many governments have actively pursued some forms of
private participation in various infrastructure sectors. Moreover, new entry of private provider such
as frequent and active participation of small or medium scale local entrepreneurs to provide some
form of social services is often the best mechanism. Despite of the increasing involvement of the
private sector, private participation in the social services remains highly contentious issues. A more
balanced assessment of policy measures is required for both successes and failures in private
participation particularly the government regulations.
In some countries, about half of infrastructure spending consists of private participation in
infrastructure.17 During the 1990s, the private sector began increasing its participation in the
delivery of essential services partly because of the heavy fiscal burdens of state-owned enterprises
and partly because of the increased commercial opportunities in emerging markets for private
investors. While governments maintained their role of managing policy and regulatory
frameworks, they allowed more private sector provision of services. The shift from public to
private provision of infrastructure was rapid with more than US$755 billion of investment flows
and nearly 2,500 private infrastructure projects had been undertaken in developing countries.18
16 World Economic Forum, in collaboration with PricewaterhouseCoopers, Paving the Way: Maximizing the Value
of Private Finance in Infrastructure (New York: World Economic Forum, 2010). 17 See specific country examples in the annex to Commission on Growth and Development, Growth Report 2008. 18 Clive Harris (2003), “Private Participation in Infrastructure in Developing Countries: Trends, Impacts, and Policy
Lessons” World Bank Working Paper No. 5, Washington, DC: World Bank.
20
In water and sanitation services, private sector participation has been generally touted as
the solution to the pressing needs for huge capital investment that have beset many developing
countries, allowing governments to free resources for other important sectors (Prasad 2006; Davis
2005,). Based on World Bank PPI database (1994-2011) total private investment in water and
sanitation averaged US$3.2 billion annually (about 1.8 percent of the annual investment needs of
developing countries). In practice however, these goals have been difficult to achieve.
Approaches to public-private investment, however, have evolved. All options promote to
a differing degree, commercial viability, operational efficiency, increased competition, improved
cost recovery and performance-based compensations. There is now an increasing recognition of
opportunities for synergy between hardware and service provision in infrastructure and between
private and public investment that may reduce poverty and help achieve the new global goals of
the SDGs. The old dichotomies of the past (especially of private versus public provision and
growth versus pro-poor targeting) are being rejected in favour of more nuanced approaches to
‘what works’ (Meridian Institute, 2005; UNDP, 2006).
Private sector participation in infrastructure and public service provisions varies in the
respective roles of the public and private sectors. There is a wide spectrum of models it concerns
ownership, management financing, risk sharing, duration, and contractual management with the
users. However, these models may be classified into two groups: (a) public ownership of the assets
is retained while contracting out management, operation, and investment; and (b) at least partial
or temporary involvement private ownership of assets. In practice, the models include BOOT
(Build-Owned-Operate-Transfer and its variations (BOT and BOO), reverse BOOT (whereby the
public entity builds the infrastructure and progressively transfers it to the private sector); joint
ownership or mixed companies, and outright sale or divestiture.
5.4 Private Sector Role in Health and Education
The views about the private sector’s role in health and education can be categorized into three
perspectives: i) on the role of markets – private sector should participate to deliver goods and
services for which there is private demand and less market failure; ii) all citizens have a right to
health care and education – private sector should play limited private sector role in providing
universal health and education services, while government should provide financing and delivery;
and iii) government and private sector roles should be avoided in these sectors. Nonetheless,
approach that fosters more pluralistic strategies between private and public for financing and deliv-
ery of health and education services received more acceptances.
Although there are always disagreements about the role of private sector in health and
education, there is ample to confirm the significant role played by the private sector in health and
education. However, not all corporations aspire to do so and not all countries allow the private
sector to run schools. According to The Economist (2009), education around the world are
becoming increasingly involved by corporations based on a survey of 211 private sector education
executives. The report shows that about 76 percent responded positively on the potential of
increasing private sector involvement in education.19
The scope of potential private sector role in human development goes beyond service
provision that includes financing both government and non-government actions as well as
introducing new service delivery and strategies. The SDGs achievements are well- established
within wider population through private corporate financing for health and education service
delivery programmes. As the role changes in both local and international economic as well as
social conditions, new model of public-private partnership in health and education is also
emerging. 20 Nonetheless, there are already many models of private sector involvement in
education throughout the developed and developing world.
In the health sector, the private sector already plays a significant role domestically and
globally. Private giving to global health has increased tremendously in recent years such as Bill
and Melinda Gates Foundation. According to the International Finance Corporation (2007) about
60 percent of the US$16.7 billion spent on health in Sub-Sahara Africa was private, most out-of-
19 The Economist (2009) Global Education 20/20: What Role for the Private Sector? New York: Economist
Intelligence Unit Limited 20 For instance, Global Education Initiative and Jordan Education Initiative launched at World Economic Forum in
2003, Global Education Alliance in Rwanda, United Nations’ High Level Task Force on Innovation Financing for
Health Systems, and Global Alliance for Vaccines and Immunization.
22
pocket money spending by individuals (Figure 9).21 However, the total average private health
expenditure in term of GDP is remained low at about 2.6 percent (World Bank, 2007). In term
education spending, Figure 10 exhibits the national level estimates of the share of total education
expenditure that comes from private sources. More than half of private expenditures on education
accounts for private spending accounts for across the range of country income levels. Low-income
countries account about 47 percent while a lower-middle-income countries account about 51 per-
cent.
The private sector is also play an important role as provider of education. Table 2 shows
primary and secondary education by the private sector providers for 2000 and 2010. According to
the World Bank, the world average of the private primary school enrolment was at 15.9 percent
while for private secondary school was at 20.1 percent in 2010. In most regions, enrolment at the
primary level in term of share of private sector has increased by a large magnitude. Recent trend
in various countries indicate that different education financings and provisions as well as models
21 International Finance Corporation (2007) The Business of Health in Africa: Partnering with the Private Sector to
Improve People’s Live, Washington DC: IFC.
Figure 9: Out-of-Pocket Health Expenditure (% of private health expenditure,
2010)
Source: World Health Organization: National Health Account database (2013)
0
10
20
30
40
50
60
70
80
90
100
0 10,000 20,000 30,000 40,000 50,000
mixing the role between public and private
sector roles have contributed to this trend.
Although less uniformly across countries,
private enrolment at the secondary level has
increased and typically higher than in
primary level.
For instance, in the Netherlands, 83
percent of enrolments are in private schools
that receive a fixed amount of government
funding per student (with extra funding for
disadvantaged students). In Sweden,
parents can send their children to any
school in the country, including private
schools that could be run by corporations.
In Japan, high schools use private tuition
support, which has been shown to lower
dropout rates among students taking less
academic study pathways. In other countries such as Pakistan, the private sector supported public
schools financially in the form of corporate sponsorship or user fees. In Chile, the private sector
plays a role in providing education mainly through government subsidizes for limited numbers of
the students who attend private schools.
5.5 Private Sector in Others Economic Development
Private sector also contributes to development other than those mentioned in the previous section
in many other ways that are crucial to economic development and poverty reduction:
One of the most obvious private sector contributions to national development is company
payments of tax revenues and royalties. In most developing countries, sustainable funding for
public health care, education, agricultural research, social safety nets and other critical
Figure 10: Private Education Expenditure
(2004)
Source: UNESCO, EdStats World Bank (2005)
0 10 20 30 40 50
Norway
Portugal
Finland
Sweden
Turkey
Denmark
Austria
Greece
Belgium
Ireland
Italy
Iceland
Hungary
France
Poland
Spain
U.K
Germany
Mexico
Israel
Canada
Japan
Australia
U.S
Korea
Chile
% of Total Education Expenditure
24
expenditures is closely associated with private sector contribution to make a large payment of
tax to the government revenues. Furthermore, through private sector investment, developing
countries can collect higher tax revenues that are intimately linked to development objectives.
Private sector can contribute to development through their core (i.e. normal) business
operations. The poor can benefit from core business activity as employees, entrepreneurs,
suppliers, distributing partners, and consumers. Some firms have explored the alternative
models that include both social and environmental responsibilities built into them due to the
current CSR model do not effectively meet the key challenges. Some firms have also adopted
“inclusive business models” (see Figure 11) which are the subject of a growing body of research
that focuses on the links between business activities and development objectives.
Private firms constantly search for information that has practical local uses in order to remain
competitive in most countries, while other firms will copy their behavior to stay in the market.
During this process, private sector’s executives and employees upgrade their expertise,
entrepreneurial capability, productivity, and incomes, contributing to the dissemination of
useful knowledge and techniques. Hence, to enhance the consumers’ purchasing power,
improve the quality and affordability of products, private firms have to remain competitive.
Table 2: Private School Enrollment for Secondary and Primary*
Note: * in % of total for secondary and primary school respectively; Yellow shaded indicates Muslim
countries
Source: author’s calculations based on World Development Indicator (2012)
Countries
% of Total
School
Enrollment
Countries
% of Total
School
Enrollment
Countries
% of Total
School
Enrollment
Countries
% of Total
School
Enrollment
Bangladesh (2007) 95.63 Lithuania (2007) 0.65 Fiji (2008) 99.08 Romania (2007) 0.33
Macau (2008) 95.52 Russia (2007) 0.64 Macau (2008) 96.00 Azerbaijan (2008) 0.31
Fiji (2008) 92.13 Macedonia (2007) 0.63 Belize (2008) 95.19 Algeria (2008) 0.26
Aruba (2008) 91.79 Ukraine (2008) 0.42 Zimbabwe (2003) 86.91 Croatia (2007) 0.21
Netherlands (2004) 82.79 Serbia (2008) 0.24 Grenada (2008) 78.51 Slovenia (2007) 0.15
Guatemala (2008) 74.12 Belarus (2007) 0.05 Aruba (2008) 77.16 Belarus (2008) 0.07
Tonga (1999) 72.83 Algeria (2005) 0.00 Lebanon (2008) 71.19 Serbia (2008) 0.05
Zimbabwe (2002) 71.27 Israel (2005) 0.00 Netherlands (2004) 68.91 Swaziland (2004) 0.00
Belize (2008) 70.11 Cape Verde (2004) 0.00 UAE (2007) 66.78 Sri Lanka (2007) 0.00
Belgium (2007) 68.35 Swaziland (2004) 0.00 Chile (2007) 54.86 Israel (2005) 0.00
Secondary School Primary School
Top 10 Bottom 10 Top 10 Bottom 10
The private sector can make important contributions to development efforts through its expertise
and innovative approaches and applications. An innovative private sector can find ways to deliver
low-cost (even sophisticated) goods and services to demanding consumers across all income
ranges. Private business activity adds value to a nation’s given resources, by introducing new ideas
on how best to combine them among alternative uses. It can develop distribution links to the
consumer in the village and so be better able to harness knowledge about the actual needs of this
segment of the market. It can keep costs low through outsourcing, for greater flexibility.
The private sector also plays a role in relation to aid processes, include the following:22
mobilisers of resources through innovative consumer or market based mechanisms of foundations
and/or the for profit private sector; contributors of financial and in-kind resources through funding
for research; providers of goods and services as implementers/contractors in aid projects; dialogue
partners and advocacy on how to enhance inclusive business and market approaches; partners in
22 Davies, P. (2011) The Role of the Private Sector in the Context of Aid Effectiveness, Consultative Findings
Document Final Report, 2 February 2011.
Figure 11: Basic Components of Inclusive Business Model
Source: Adapted from Clarks et al. (2010)
26
public-private partnerships (PPPs) through cost and risk sharing, including so called co-
investment.
6. Conclusion
Private sector role in development is a much broader and more fundamental one rather than
traditionally seen more narrowly as a source of additional financing for development projects. The
private sector also make many important contributions to long-term development through day-to-
day activities such as core business operations that include the poor, the payment of tax revenues,
and delivery of social services. More generally, the expertise, ideas and innovation that the private
sector brings to the society means that it can contribute to the understanding of development
problems and the framing of optimal strategies to solution to development. Many countries have
enjoyed prosperity and growth through private sector participation. The Report of The
Commission for Africa23 advocates support for business development as part of its coherent
package for Africa, supporting three Private Sector Development instruments (financing, business
advisory and investment climate reform) to stimulate entrepreneurship in Africa. There is broad
consensus on the fact that the private sector alone has demonstrable potential to generate sufficient
local economic activity and growth to reduce poverty and attain the social well-being that is
quantified by the SDGs.
Private sector activities that reduces poverty, creates jobs, improves health and education,
especially for the needy and vulnerable segment of the population are encouraged by Islam due to
efficiency gained of the private sector involvement. The emergence of Islamic finance, which is
based on the principles of Islamic law and guided by Islamic economics are supportive of private
sector activities toward achieving inclusive development. Islamic finance helps mobilize resources
from a large spectrum of the population, substantially increase the share of equity in business, and
advance profit and loss sharing (PLS) in entrepreneurial activities. On the other hand, it has been
very thoughtful to many of countries towards ‘Inclusive Business Models’, which is promoting the
23 On 6th June 2005, the Emerging Markets Group, under the Business Action for Africa Initiative, convened a
‘practitioners’ roundtable on enterprise development in Africa with representatives of the private sector and public
sector. The commission is also known as the Blair Commission for Africa.
notion of inclusive development. Some such models have been specifically designed to address
private sector contributions towards SDG achievements, using collaboration between all possible
actors. This includes facilitating these various actors to come together in public–private
collaboration to build “inclusive markets” and sector-specific strategies, thereby enabling and
incentivizing such business models and value chain approaches.
All countries recognize that suitable and timely private sector reforms can go a long way
toward improving efficiency and productivity. At the same time, development practitioners and
businesses will continue to test and seek to improve upon the best practices and modalities of
private sector involvement in development efforts. This ongoing process reflects the complex and
multi-faceted nature of the private sector’s role in development. It is also clear that a full
understanding of the role of private sector requires recognition of the fact that its activity occurs
within broader governance and institutional frameworks. To date, many successful private entities
such as entrepreneurs, philanthropists, corporate organizations and civil societies have come to the
support for inclusive development and combat poverty. However, in many developing countries
private sector is facing many challenges and unnecessary impediments such as poor business
environment and investment climate, political instability, weak governance and institutions,
complicated taxes and regulations and macroeconomic uncertainty.
28
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