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Finance & Development, March 1982
Article

Economic development and the private sector: Private enterprise and development—comparative country experience

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1982
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Helen Hughes

The constantly changing environment in which economic development takes place necessarily produces a background of uncertainty and varying degrees of risk. Examples of these uncertainties abound. In agriculture, both absolute and relative prices of agricultural products can change from year to year, or even from month to month, because of changing weather or market conditions. Mineral output is affected by new discoveries and by changes in technology and prices—that is, by changes in demand and in supply. In industry, technological innovation is continually altering the design of products, the variety of products offered, and their cost. The original shift from coal-fired to diesel and electric locomotives and the further recent shifts away from oil as a result of higher oil prices illustrate this process. In the area of consumer goods, changes in electrical and electronic industries offer a similar example of a continuous adaptation of products, production processes, and prices.

Individual entrepreneurs—such as farmers and small businessmen—and individual enterprises—such as manufacturing, construction, transport, and wholesale enterprises and collective farms—continually face risks. Whether they are privately or publicly owned, they must take account of uncertainty. Private entrepreneurs and the managers of private enterprises take risks, despite the heavy costs of failure, because of the possibility of high profits or large bonuses. In any case, they must run their business efficiently if they are to make a profit and survive.

In contrast, the managers of public enterprises (whether directly or indirectly state owned or collectively owned) tend to be risk averters. Indeed, risk aversion is usually, and perhaps inevitably, the emphasis of public service training. Entrepreneurs and managers of public enterprises must be offered incentives if they are to be efficient and take risks, yet they must also be penalized to discourage them from taking foolish risks or making too many mistakes. Devising appropriate incentives is very difficult. A variety of possible measures—some positive, such as bonuses for managers, and some negative, such as budget and operational controls—can be used in the public sector; even so, the problem often remains intractable.

If an economy is made up of a large number of entrepreneurial units, risks can be spread among them; even though some enterprises may fail, others will be successful and the economy as a whole can grow rapidly. When inefficient units do not have access to subsidies or to other public assistance, they must improve their competitive position or disappear. Such failures need not be excessively costly because the economy’s expansion creates job and income earning opportunities for entrepreneurs and employees of failing enterprises. Some of these may be in “informal” or small-scale activities and may not be counted in the formal employment sector. They nonetheless provide gainful employment.

Unfortunately, experience shows that although private enterprises have to compete to survive, in most countries public enterprises are protected from failure by implicit or explicit subsidies. Public enterprises are often also expected to create employment opportunities for political reasons. But allowing public enterprises to operate inefficiently has very heavy costs in the long run. It affects not only a country’s ability to produce efficiently but also its capacity for saving and investing for future production.

Private enterprises and entrepreneurs can function smoothly—and contribute to development—only in an appropriate public policy environment. The prices prevailing in domestic markets give enterprises signals about what goods to produce and which resources to employ. It is therefore critical to the functioning of the private sector that market prices reflect the relative costs of resources and value of products. It remains an overriding challenge to government in all developing countries to create an environment of public policies that will encourage and enforce competitiveness and efficiency.

Limitations on the role of the private sector are usually established in practice either by economic factors or by national political considerations. On the political side, some governments are antithetical to the private sector and do not regard private enterprises as a suitable vehicle for economic development. In their view, state or collective enterprises should own and operate all major economic activities. The role left for the private sector is sometimes negligible. In other countries, policy leaves as much economic activity as possible to the private sector.

However, some economic factors place limits on the private sector. There are some “natural” monopolies, particularly in land and such infrastructure as ports, railways, and electricity supplies, that would allow enterprises that supply these service facilities to enjoy “monopoly rents” or “super profits.” They are, therefore, usually either owned or controlled by governments so that equitable prices can be set for such services. (Infrastructure facilities in developing countries are also often needed to encourage and enable private firms to operate.) Moreover, because the demand for infrastructure (such as power or sewage disposal) is generally more stable and predictable than that for consumer and producer goods, infrastructure is generally easier than agricultural, manufacturing, or service production for public enterprises to manage. At the early stages of development, when local entrepreneurs are scarce and transnational firms are often reluctant to go into production, some governments also establish industries they consider to be critical, such as steel, chemicals, and cement production. This may serve to ensure supply of vital inputs for the economy and also to encourage private producers to enter these fields subsequently. Developing countries have thus exhibited a varied mix in the relationship between the public and the private sector in the past.

Planning

Because capital, skilled labor, land, and other resources are usually scarce, governments are concerned that they might be wasted, and therefore plan to use them efficiently. Planning at various levels and for varying time periods is, of course, an integral part of economic activity in any economy. A shoe factory plans how many and what sort of shoes it will produce in the next six months. A chemical factory has to have a somewhat longer production plan and an even longer construction horizon. A province might plan the transport and other basic infrastructure facilities needed during the next five to ten years for its industrial development. A national government might plan overall infrastructural investment requirements, particularly those with long gestation periods (such as those for the production of energy) some 15 to 20 years ahead.

But planning, whether by a firm or by a country, cannot determine how each economic unit should behave in all circumstances, and it cannot impose certainty on the real world. Planning must be flexible enough to accommodate itself to changing circumstances, as well as to being limited to what can reasonably be planned at each planning level, if it is to effectively support and complement the decisions of entrepreneurs and enterprises. If consumers and producers are to be innovative and efficient, most decisions must be left to them.

A country’s development strategy can take the form of an indicative plan that provides a framework of medium-term to long-term economic targets. Such a plan must be very flexible, if it is not to become a brake on development as circumstances change. It must, moreover, be implemented by appropriate government policies that provide general rules that translate plan targets into signals for individual entrepreneurs and enterprises. Such policies also reconcile social with private objectives to give consumers and producers correct prices on which to base their actions. Such measures as tariffs on traded goods and value-added taxes that affect the prices that face all consumers and producers are generally the most efficient policy instruments because they affect all economic actors and units equally. Moreover, they require a relatively small administrative bureaucracy for implementation and do not leave much room for bureaucratic decision making. In contrast, such direct measures as production licenses, import licenses, and price controls rely on officials, often very minor ones, to make often arbitrary decisions—a situation that almost inevitably encourages venality.

The diverse experiences of the developing countries clearly demonstrate that there is no single road to development. Large countries, and countries well endowed with natural resources, have more options than those that are small and poorly endowed, but all must choose a combination of development policies that will help them fulfill their own particular aspirations. The evidence suggests that those countries that have grown most rapidly have adopted a policy framework that enables private enterprise to thrive. Where efficiency in production becomes confused with equity in distribution, neither goal is well served. The creation of an economic climate that is conducive to development requires clearly defined development targets, planned development of infrastructure, and policies that stimulate strong entrepreneurial activity. A look at how some developing countries have handled this combination follows.

BrazilKenya
Planning and the provision of infrastructure facilities.The central government exercises a strong influence on the overall direction of economic growth and on short-term macro-economic trends, mainly through monetary, fiscal, and commercial policies. The central and provincial governments undertake infrastructural planning and operations.Kenya’s planning largely consists of setting targets, with monetary, fiscal, and commercial policies directing the economy. The central government plans and provides the infrastructure facilities. Both social and physical infrastructure are relatively well developed in comparison to that of neighboring countries.
The role of private and public enterprise in production.The degree of public involvement in minerals, manufacturing, and such services as banking has varied over time. Public enterprises enjoy a monopoly or near monopoly position in petroleum and account for a large share of the production of steel and petrochemicals. Foreign direct investment is welcomed but regulated.Kenya is private enterprise oriented, with private farms and business accounting for the bulk of national output.
The role of markets and prices.Relative prices are affected by exchange rate policy and protective tariff and non-tariff barriers to trade. Tax and credit incentives are frequently used to direct private sector investments.In general, prices do not reflect resource availabilities. They are distortive in agriculture, and manufacturers are protected from foreign competition. Direct controls, such as production licensing, limit the operation of markets.
The role of specialization and trade—the openness of the economy.Import protection and export subsidization have been used, in varying degrees over time, to spur industrial growth and/or manage the balance of payments. A crawling peg exchange rate system has tried to offset the domestic-external inflation differential in order to maintain the competitiveness of exports.Kenya has not been able to expand and diversify its agricultural exports in the 1970s, but it has begun to expand its exports of manufactures. The narrowness of its production base makes it difficult for local entrepreneurs to compete internationally, but foreign investment is expanding production horizons.
Savings, investment, and the role of financial and fiscal policies.Domestic savings account for roughly 20 per cent and investment 25 per cent of GDP. The public sector, has run a sizable deficit in recent years. These subsidies, coupled with intermittent interest rate ceilings in the private market, have caused distortions in the financial system and contributed to inflation.Conservative fiscal and monetary policies were reflected in moderate inflation and relatively high savings until recently. Kenya still has the most developed financial sector in sub-Saharan Africa. Investment, at about 20 per cent of GDP, is relatively high for Kenya’s income level and more productive than in many neighboring countries.
Employment and income distribution.Brazil’s development strategy has tended to favor capital-intensive industrialization, but the rapid growth achieved has resulted in substantial employment creation. Wide income disparities exist, but all income groups have derived some absolute gains from the process.Employment creation has been relatively rapid but cannot keep up with the very high population growth rate.
Average annual growth of real gross national product (to the nearest 0.25 per cent):1960–705.5 per cent5.75 per cent
1970–798.5 per cent6.25 per cent
Source: World Bank, Economic and Social Data Division
Source: World Bank, Economic and Social Data Division
SingaporeThailandYugoslavia
Singapore moved from year-to-year detailed planning to target setting and reliance on monetary, fiscal, commercial, and social policies in the late 1960s when the economy began to grow faster than the planners could plan. Singapore is an island state with the attendant advantage of compactness. The high quality of its infrastructure has been a major factor in facilitating local private investment and attracting foreign investment.Thailand has traditionally set overall targets for the economy and planned and built infrastructure, but left it to monetary, fiscal, and commercial policies to give direction to the private sector. Power, railways, and similar services are publicly operated. Thailand has a long tradition of public education begun by the Buddhist temples centuries ago.Planning is detailed. Indicative planning and specific targets for key variables at the federal level are translated into investment programs by the republics and provinces through the banking system. Provision of infrastructure and social services is, in the main, decentralized to republics and communes, except for projects of national significance. The system has been successful in stimulating fairly rapid growth but it has also caused some duplication and the distribution of resources among regions is still uneven.
Singapore used public enterprises to start the production that private enterprise was unwilling to undertake in the 1960s, but they were run on entrepreneural lines. Private enterprise now dominates in manufacturing and service activities.There are a few public enterprises in manufacturing, but production is traditionally and largely private enterprise oriented. Medium-sized farms predominate, and farmers have proven highly responsive to price signals, as have the manufacturing and service industries.Large-scale farming, manufacturing, and services are conducted by collectively owned enterprises managed by workers. However, 84 per cent of arable land and about 4 per cent of the active labor force is in the private sector. Social sector enterprises are fairly responsive to price signals and thus quite efficient and profitable.
Singapore has always taken its price signals from international markets. Price distortions, introduced in the 1960s when Singapore was briefly a member of the Malaysian Federation, have been removed.The economy is essentially market oriented. There are many distortions, however, in the form of production taxes and protection for manufacturing, but these are of relatively minor importance and are often not even binding.Markets for final goods operate reasonably well, but there is some government intervention in markets for intermediate goods and for essential goods and services. Markets for primary factors (labor and capital) are fragmented.
Singapore’s economy is open. The moderate protection of the mid-1960s has been largely dismantled. The current strategy is to move to a higher skill content in production (almost all of which is at least partly for export) by raising real wages and revaluing the exchange rate.Because protection for manufacturing and taxes on exports have not been high, and because Thailand has a well-developed private enterprise base (including considerable foreign investment), the country has been able to steadily increase and diversify its agricultural and manufacturing exports. Realistic exchange rates have been maintained.Official policy has consistently stressed the need for outward orientation and participation by Yugoslavia in international trade; however, export performance in the 1970s was generally disappointing, reflecting organizational and policy weaknesses. Trade, exchange rate, and investment policies have tended to encourage production for import substitution rather than export.
Conservative fiscal and monetary policies have kept inflation below international levels, stimulated savings and capital inflow (much of it in the form of direct investment to gain access to new technology and markets), and kept total investment high. Singapore has become an international financial center.Conservative fiscal and monetary policies have kept inflation below international levels and savings have been quite high, supplemented by foreign investment and other capital inflows. Investment has been relatively labor intensive and productive.Savings rates have been high, but a constrained financial system has stimulated high investment and helped lead to inflation. The decentralization of fiscal authority makes it difficult to use fiscal policy for stabilization purposes, placing more pressure on monetary, credit, and foreign borrowing policy to restrain investment.
Population growth has declined dramatically. Unemployment has fallen from some 13 per cent in 1965 to zero, and there has been an inflow of temporary migrants from Malaysia. Real earnings have been rising and with full employment income has been rising even for very poor families. Social services are highly developed.The growth of productive employment has made the main contribution to increased welfare. Rapidly falling population growth has also helped. Poverty is largely a problem in outlying provinces, particularly in the northeast, but it has been mitigated by migration to more prosperous areas.Yugoslavia has been successful in transferring labor from underemployed private agriculture into social sector employment, although substantial differentials in wage levels between the two sectors have created some open unemployment in the less developed republics. The country has an impressive record of mobilizing resources for transfer to its less developed regions; despite this effort substantial regional disparities persist.
8.75 per cent8.5 per cent6 per cent
8.25 per cent7 per cent6.25 per cent

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