Harinder S. Kohli and Anil Sood

Recent experience has led to a re-evaluation of the relative roles of the state and private sector in developing economies. Efficient and dynamic enterprises, whether private or public, and entrepreneurial initiative are crucial to economic development. Such enterprises thrive in a positive business environment, an important factor when governments are considering policy, regulatory, and institutional reforms.

Over the past three decades, in an effort to speed up development and to compensate for the lack of an active private sector, among other things, governments in most developing countries played a very active role in economic development. Most governments not only developed and financed necessary physical and human infrastructure but also invested directly in productive activities through state-owned enterprises. They also heavily influenced investment decisions and day-to-day operations of the private sector. This growth of public sector activity was not generally accompanied by sustained economic growth at rates anticipated by the planners. In many countries, the growth of the public sector created inefficiencies and, combined with constraining government policies and practices, was also detrimental to private entrepreneurial activity. Today, there is a growing disillusionment with such public sector involvement in many economies, and with the rigid planning and import substitution strategies that dominated economic policy formulation in the past. This trend is especially striking in developing countries that have faced a particularly difficult economic environment in the past few years.

Correspondingly, there is increasing recognition that a resumption or acceleration of growth will depend critically on achieving increased efficiency from existing and future capital investments, through greater emphasis on market mechanisms, competitive forces, and individual initiative. This recognition is not limited to any specific set of countries or regions. In the recent past a number of countries as varied in size, history, and economic and political systems as Argentina, China, Hungary, India, Morocco, Sudan, Togo, and Turkey have launched efforts to redefine the role of the state in productive activities in the economy and in the day-to-day operations of enterprises in both the public and private sector. Many countries are now emphasizing “enterprise development,” which can be defined as the development of economically efficient and financially profitable productive enterprises, both public and private. It involves the creation of new enterprises, as well as the reform and restructuring of existing enterprises to improve their productivity and competitiveness.

Supportive business environment

In most economies the most critical prerequisite for developing dynamic and efficient enterprises is the creation of a business environment that encourages efficiency and increased competition in productive activities. The business environment is shaped by a number of factors:

• Market prospects, including market size and macroeconomic performance and stability.

• Resource base, including access to needed imports.

• Government regulations, including those on pricing, trade, taxation, labor, foreign investment, and licensing.

• Institutional aspects, such as the operational autonomy of public enterprises; corporate and anti-monopoly legislation; competitive environment and ease of entry and exit of enterprises; accounting and auditing systems; availability of economic, technological, and market information; and administration of customs and other business-related policies.

• Financial system, including interest rate policies, mobilization of savings, capital markets, banking and credit, and access to foreign exchange.

• Infrastructure, including human resources; power, transport, and communication systems; and marketing, technology, and support services.

To foster enterprise development, countries need to create a positive business environment. Japan, the Republic of Korea, and Singapore have followed such an approach. Three related factors contribute to the creation of such a business environment. First, it is determined not only by the formal policy, institutional, legislative, and regulatory framework but also, and perhaps even more important, by the way in which this framework is implemented. Second, the predictability, transparency, and credibility of policy changes are vital elements of the business environment. While enterprises can adapt to changes in the business environment, lack of continuity and predictability of economic policy can be quite disruptive and reduce the confidence of the business community. A loss of confidence can damage the prospects for growth in any economy. Third, immediate action in some key areas—such as the simplification of regulations and their administration, the breakup of monopolies to increase competition, and the divestiture or closure of inefficient public enterprises—do contribute substantially to improving the business climate.

While many features of a positive business environment would be common across most countries, the priorities and the nature of changes required to remove constraints differ by country, stage of development, and economic, social, and cultural setting. For example, human resource, institutional, and infrastructural constraints are likely to be more binding in less developed economies, such as Chad and Sudan, than in middle-income countries, such as Chile and the Republic of Korea. In the smaller, least developed countries, for example, in Sub-Saharan Africa, improvements in the business environment would normally require direct efforts to develop human resources and provide basic infrastructure and services.

In the more advanced and larger countries in Asia and Latin America, where the basic human and physical infrastructure is more developed and a large number of indigenous enterprises exist, the main efforts need to be on specific functional aspects of the economy, for example on increasing competition from internal and external sources. These may include: improving the functioning of markets, including financial and labor markets; eliminating or simplifying regulations, and breaking of monopolies, both public and private; and facilitating creation of new enterprises. Turkey, a major example in the past of state planning, inward-looking policies, and heavy reliance on public enterprises, has taken steps in most of these areas to increase competition from domestic sources and imports, reduce state intervention in the productive sector, develop financial markets, and increase the autonomy of both public and private enterprises. Another country where the role of the state in the economy was quite pervasive is India. There, the authorities have recently simplified the regulatory framework, reduced taxation, and encouraged private investment in areas—such as telecommunications equipment and fertilizer production—earlier reserved for the public sector. While not as far reaching as recent changes in Turkey, in the Indian context these improvements are significant.

State enterprises

While a positive business environment is essential to improving the performance of both private and public enterprises, additional direct measures are needed to improve public enterprise efficiency and to deal with the special circumstances related to the role of the state as both the owner and regulator of these enterprises. Ownership is not an issue where a state enterprise can operate efficiently and independently on the same business principles as a private company. To improve the efficiency of public enterprises providing commercially traded goods and services, the state’s role as owner must be separated from day-to-day management tasks. Public enterprises should be required to behave more like profit-oriented autonomous businesses operating in a competitive environment. Achieving this requires far-reaching changes, which are difficult to implement, in the way the government looks at and treats state enterprises. It involves setting clear business objectives; permitting market-determined investment, pricing, and costs; insisting on financial discipline and viability; ensuring management autonomy and accountability; appointing management and personnel based on business considerations; and establishing renumeration systems that reward performance. In some cases, this may include restructuring or liquidating inefficient enterprises to eliminate major sources of inefficiencies.

In their efforts to improve the efficiency of the public sector, many governments are also considering divestiture of public enterprises, both profitable ones and those that need restructuring, to deploy scarce financial and managerial resources of the state in activities and public services not appropriate for the private sector. In this context, it is important to remember that privatization is not an end unto itself but a means to enhance the efficiency—overall and at the enterprise level—and achieve a more competitive environment. Many countries in Africa, Asia, and Latin America have recently taken steps to improve the efficiency and financial performance of state enterprises. Turkey, for example, has launched one of the most comprehensive and far-reaching programs to improve the operations of its public enterprises. Budget subsidies for meeting operational losses of manufacturing state enterprises have been eliminated. Prices for the output of these enterprises have been raised to economic levels and, where possible, are market determined. Many of the largest and best-known industrial and transport companies are being considered for privatization, while uneconomic plants and companies are being closed. Meanwhile, companies remaining under state ownership are given much more autonomy in their day-to-day operations and encouraged to compete with the domestic private sector and imports.

Governmental role

Fostering a more positive business environment requires, in most countries, a shift in the role of government from a tendency to intervene and regulate day-to-day activities of enterprises to one of understanding and removing impediments to initiative, innovation, and risk-taking, and thus to the development of efficient enterprises. This ideally involves close cooperation with the business community, as is the case in modern Japan and Singapore.

To help create a positive business environment, the focus of government policy formulation and involvement will need to be shifted in several ways. Policy makers will need to emphasize: simplification of labor policies, laws, and practices, such as effective retraining programs, to reduce rigidities and distortions in labor markets; tax policy reforms, particularly to reduce the level and improve the structure of corporate tax and to improve the potential for profits, savings, and investment; streamlining the legal framework for enterprise creation, operation, and liquidation; deliberate efforts to create competitive market conditions and remove entry barriers imposed by monopolies or other protected enterprises; and, in particular, simplification of regulations and controls relating to investment, production, marketing, prices, direct foreign investment, and technology transfer. Simplification, in this context, means a change in the role of governments away from direct intervention and toward monitoring compliance with clear legislation. For example, governments may consider replacing direct licensing and controls with legislation against monopoly and unfair business practices. Similarly, directed credit programs should, wherever possible, be replaced with decentralized resource allocation decisions by independent financial institutions and bond and stock markets, monitored by stronger legislation governing financial disclosure. For this purpose, greater emphasis needs to be put on developing financial markets as a whole and on increasing competition.

Also, in designing policy and institutional reform programs, governments need to address more directly and systematically issues relating to the practical implementation of the policy, legislative, and regulatory framework. The efficiency and honesty with which policies, such as taxation, customs, and licensing, are administered could be more critical to the enterprises than the policies themselves. Policy reforms need to be coupled with critical administrative and institutional reforms to ensure that institutions have the capacity to implement existing and reformed policies efficiently and fairly. For example, in Indonesia recent trade policy reforms were accompanied by a decision to dismantle the customs authority and to contract out its functions to a private Swiss company.

Equally important, the design of policy and institutional reform programs must be founded on a fuller understanding of the impact of these programs on independent enterprises, and on their likely response. Ideally, selection of the issues to be tackled and policy options for reforms should be formulated after discussions with parties likely to be affected, though the decisions must ultimately be made by the authorities and in confidence. Finally, predictability and transparency of policies and their implementation is vital in motivating and enabling enterprises to plan their own restructuring and development. Overall, the experience of the economies of Hong Kong, Japan, Korea, and Singapore in the last 30 years, and more recently in Turkey, indicates that the creation of a supportive business environment combined with a change in the role of the government along the above lines can have a major positive impact on enterprise development and economic efficiency and growth overall. Many developing economies, only a few of which are cited here, are now trying similar initiatives.

In the least developed countries, governments need to devote special attention and some public resources to the development of the service sector for two reasons. First, in most countries, the service sector is the first activity which attracts entrepreneurs and is the breeding ground for entrepreneurship. Second, the lack of efficient and quality services currently hinders the growth of productive enterprises in most low-income countries. Countries such as Bangladesh, Ghana, Sri Lanka, and Zimbabwe are encouraging the creation and development of small indigenous private enterprises to supply ancillary services for maintenance, marketing, distribution, and transport. In these and many other developing countries, there is also a great need for independent companies to provide management consulting, engineering, information, auditing, and accounting services.

A crucial element of enterprise development is the creation and nurturing of entrepreneurs. The lack of indigenous entrepreneurs is often considered a key constraint to development in the least developed countries, such as those in Sub-Saharan Africa. There are some successful examples of programs to develop entrepreneurs in countries such as Bangladesh, Colombia, India, and Indonesia. (See “Entrepreneurship development: India’s experience” in the March 1986 issue of Finance & Development.) While a wholesale transfer of these models to other countries is inappropriate, interested governments can identify and support pilot efforts to develop and foster entrepreneurial skills based on successful programs elsewhere.

One successful example is the entrepreneurial development program managed by Grameen Bank in Bangladesh. This program finances new businesses started by the poor in rural areas, generally considered a high risk and high cost activity by commercial financial institutions. Under the program, supported financially by commercial banks and the Government, but managed totally by a highly dedicated and autonomous community-based Grameen Bank staff, microenterprises receive loans for up to one year at about market rates without much paperwork. The majority of borrowers are women starting businesses, such as basket weaving, garment making, and rice husking for which they already have technical skills and market opportunities. The key lending criteria are that the activity will enhance family income and ability to repay, and the local bank worker has full authority to grant the loan. Small repayments are collected daily or weekly by visiting the business premises. Since it began as a pilot project in the one district, it has been extended to a much larger part of the country and business volume expanded several fold. The repayment rate is outstanding—over 95 percent—and administrative costs are low. The key to its success appears to be a combination of prudent business practices, minimal paperwork, community-based operations, and the commitment and dedication of the Grameen Bank staff and manager.

World Bank efforts

Enterprise development is an integral part of the overall objective of promoting economic development. The Bank, in recent years, has concentrated increasing attention on several key elements affecting the business environment and thus facilitating enterprise development. It has engaged in policy dialogue and structural adjustment and sectoral loans to encourage the adoption of sound macroeconomic and sector policies. It has also supported individual financial institutions with finance and technical advice, and helped in the reform of entire financial sectors in an increasing number of countries. The Bank has for many years financed projects designed to support the creation and growth of private small and medium-sized enterprises. Finally, the Bank has increased its assistance to borrowers’ efforts to improve the efficiency of public investment programs and the performance of public enterprises; the Bank is assessing a number of countries in public enterprise restructuring and privatization efforts.

In view of the increasing recognition in many countries of the critical role of the private sector and entrepreneurial initiative, the Bank has more recently initiated systematic efforts to support the enterprise development objective in countries that seek such help, for example, Ghana. It is doing this by concentrating its analysis and policy advice on the creation of conditions and on the implementation of measures that would foster enterprise development.