WHY ARE THE RICH JUST GETTING RICHER?

Feedback to: wfisher206@aol.com


By William Fisher

Donor governments and institutions worldwide have long recognized that the private sector is the engine for economic growth, job-creation and poverty reduction in poor countries. It is private sector growth that attracts foreign investment and the transfer of technology and know-how. It is the private sector that provides productive employment. And it is the private sector that gives rise to a middle-class -- historically the catalyst for social reforms and political stability.

The most dynamic and potentially promising part of the private sector in poor countries consists of millions of small and medium-sized companies (SMEs). Yet only a relatively small proportion of foreign aid has been directed toward this part of the private sector. While World Bank assistance to this sector has increased by dramatically over the past few years, individual country donors have traditionally paid relatively little attention to SMEs. One of the results is that, in poor countries, the rich are getting richer while the gulf between luxury and poverty is widening. Yet, even given the enormous challenges these small companies face, they provide more jobs in most developing countries than all the (few) large companies combined!

Why then are aid agencies so reluctant to devote more resources to this part of the private sector? The reasons are many.

Donors: In the US, as in most other donor countries, foreign aid needs to show quick success, principally because of Congressional requirements and the very short time horizons of most members of both houses. Working with large companies – those who need aid least – is most likely to produce these kinds of results (and even this effort has been far from a roaring success). Both Congress and our aid agency, the U.S. Agency for International Development (USAID), are fond of programs that lend themselves to cost/benefit analyses. In working with small and medium-sized companies, the benefits are often not measurable for considerable periods after the work ends. USAID officers in the field move frequently from one country to another; they tend to favor those programs that can show positive results – the more dramatic, the better – on their watch. USAID is a multi-mission agency, handling everything from humanitarian assistance to democratization; it is unreasonable to expect that it give top priority to all these tasks. Because USAID is a relatively small agency, it uses contractors to implement most its programs. This contractor-driven approach has produced some outstanding results, but contractors tend to ignore or to place in subsidiary sub-contractor positions one of our most powerful resources: non-governmental organizations who frequently do their work with all-volunteer personnel. Finally, within the US aid agency, there is little private sector experience in general, even less with small and medium-sized companies.

Recipients: In poor countries, smaller companies rarely have access to credit; banks tend to lend to those they know, who are usually least in need of working capital. Child labor and unhealthy working conditions are the norm. Small companies – in fact, the entire private sector – usually operate in a policy and regulatory environment that places incredible obstacles in the path of private sector growth. Much of this attitude springs from rampant corruption and a tradition of ‘crony democracy’; as one Egyptian tycoon said to me, “Only small companies have problems. Big ones don’t, because we can go talk to the decision-makers or pay someone to fix our problem.” When I worked in Jamaica as a USAID consultant back in the 1980s, large and small companies like – and potential foreign investors – had to visit more than 50 different offices to obtain permission to set up and begin running a business. The so-called ‘one-stop-shop’ we persuaded the Jamaican government to establish promised to reduce these bureaucratic obstacles substantially, but it soon became apparent that those staffing the one-stop-shop had neither the skills nor the motivation to take their mission seriously. While one-stop-shops became the flavor of the day in many developing countries, few worked efficiently. Ludwig Rudel, a veteran of more than 20 years in USAID and countless consulting assignments thereafter, points out that today it still takes an average of 66 days to form a new business in a developing country; in Canada, the time required is two days.

Moreover, in many of the countries where we provide aid, for example, the former Soviet Union and its satellite states, as well as in many other countries, economies based on free markets are a new experience. Governments have traditionally been the country’s principal employers and owners/operators of most of its basic industries, and tradition dies slowly.

As a result of all of the above, most aid recipient countries lack any semblance of pro-growth physical and intellectual infrastructure. Even the few institutions purportedly dedicated to business – chambers of commerce, trade associations, etc. – often tend to be elitist, excluding all but the most powerful commercial interests. A further complication is that recipient governments are often reluctant to take advice from donor governments or their contractors. To this daunting array of constraints, add the fact that small and medium-sized companies usually lack the most basic ingredients of management, technology, marketing and sales, human resources development, performance monitoring and accountability. About the only thing they do not lack is the entrepreneurial will to improve their lives.

Technology transfer provides a microcosmic example of the kinds of problems faced by both SMEs and larger companies. In this area, there have been some outstanding successes; for example, ACDI/VOCA, an NGO, has successfully transferred simple technologies to small farmers in a host of countries by working with cooperatives and one-on-one with growers. But there have been numerous disasters as well. Ludwig Rudel points out that “multinational companies have shown that they will not transfer the latest technologies. They will provide the last generation while they develop the next one so that they keep one leg up over their foreign partners. The Japanese overcame the problem in the 1950s by picking sectors including textiles, optics, steel, and ship building and sending a steady flow of their best young minds to study abroad for long periods. They brought them back to be embedded into local research institutions and companies and then to keep abreast of the state of the art as it matured. Once they got these sectors going, they chose additional ones. Now they operate on a par with many western countries.”

Rudel adds: “The United Nations Development Programme (UNDP) tried to do this with integrated circuits in India. They trained about 50 scientists, tried to get them to return to India (most did) and built an excellent R&D institution at Pilani. It was first class but maybe a half generation behind the rest of the world. Then two problems arose. The institution did not find it in its interest to share the technology with the industry on acceptable terms. And when they went to the Ministry of Finance for funding to attend conferences to keep abreast of the field, they got cut out. "You chaps got lots of assistance in the past while the project was building. Now let others have their turn!" was the reaction from the bureaucrats. The whole thing is in the doldrums now.”

There are other major obstacles. For example, according to Ludwig Rudel: “We are clueless how to foster transition to open market economies in formerly totalitarian societies, much less help SMEs. In these countries, the transition from command economies to free markets has provided a fertile field for organized crime – whose membership now comprises most of these countries’ new-rich. Liberia may be an African example but there are others in lily-white societies that are every bit as bad. In the Baltic states the mafia was (is) a part of (or consequence of) the open markets fostered by our efforts; extortion (protection) runs rampant. In Latvia, the links to the Russian mafia overlay the entire private sector operation and abuses are growing. I know of one case where those resisting illegal pay offs were hounded by former KGB agents who became hit men after being laid off by the KGB.”

The relationship between donor and host government is yet another problem. Before any donor can initiate a new program, it must first obtain the agreement and cooperation of the host government. Private sector development can be particularly problematic. Says Wallace E. Tyner of Purdue University’s Department of Agricultural Economics, a veteran of many consulting assignments for USAID and other donors: “Most of these governments also are trying to retain their power over the economy, so private sector development is not necessarily a priority.”

Yet another problem is endemic to foreign aid generically: There is little or no cooperation or coordination among donors. When I was managing a USAID program in Egypt a few years ago, my team produced an annual review of all donors programs. It was widely distributed, but most of the interest in it came from the donors themselves, many of whom were unaware of the complimentary – or duplicative – programs of other donors. As with most USAID Missions, the Egypt Mission participated in a donor committee, which met monthly. But the information gathered by its senior-level members rarely trickled down to program officers or contractors ‘in the trenches’, where genuine cooperation would need to begin.

Given all these constraints, it is not rocket science to understand why the ‘government should just get out of the way’ dictum so often falls on deaf ears, or to appreciate why aid agencies have not been eager to embrace the SME challenge. The ongoing result is been that the rich have been getting richer while the gulf between rich and poor has been getting bigger.

Is there a solution? There is no one-liner to answer this question. But there are many innovative ideas that are being tried and others that deserve to be tried. And there is enough anecdotal evidence of ’success’ with SMEs to believe that some of these ideas – given more resources, and the right kinds of resources – can help these little enterprises grow larger, employ more people, and help narrow the gulf between opulence and poverty.

What might work?

Dr. Jack N. Behrman of the University of North Carolina – founder of the MBA Enterprise Corps and former Assistant Secretary of Commerce for International Business – finds that host governments may be reluctant to take advice from donor governments or aid agencies, but will frequently listen to private sector volunteers. “NGOs and PVOs have been sending volunteers overseas for many years, but generally they have not been made an integral or large part of the overall effort, mainly because USAID has never given high priority to business or private sector development. “

Behrman adds: “In Eastern Europe, however, USAID and its Missions relied on several PVOs -- notably the merged Agriculture Cooperative Development Initiative and Volunteers for Overseas Cooperative Action (ACDI/VOCA), Citizens Democracy Corps (aka Citizens Development Corps – CDC), International Executive Service Corps (IESC), and MBA Enterprise Corps (MBAEC). These groups were given separate contracts, or worked in collaboration with each other or with private consulting firms. Their volunteers were used successfully in almost every aspect of private sector development -- mainly in direct firm-level assistance, but including teaching in business schools and institutes and in programs to train future
trainers. “

Says Behrman: “In Russia, which initially followed some very irresponsible advice for transforming itself to a market economy overnight, private sector volunteers have recently concentrated on strengthening associations representing SMEs. As a result, President Putin is listening to these small companies for the first time. This also demonstrates that this kind of pressure comes best when it is generated from within -- from SMEs and their associations. The advice of NGO and PVO volunteers is being appreciated, understood, and accepted.”

However, Behrman points out, this process is lengthy and does not fit with the ‘quantifiable goals’ sought by USAID and Congress.” So, first, he contends, there needs to be an ongoing educational process within the US Government. We should be able to learn new approaches, since we now have nearly 60 years of experience with inadequate results. SMEs will arise when there is income to be earned and the policy and physical infrastructure is adequate. Policies are needed to remove obstacles, ease company formation, provide for and protect private property, maintain competitive markets, and establish fair and reasonable regulations on business to protect the consumer and environment. “And these,” he says, “are all areas where knowledgeable volunteers can become credible players – and produce better results at less cost.”

Dr. Wallace E. Tyner of the Department of Agricultural Economics at Purdue University – and a veteran of dozens of overseas development projects for USAID and other donor agencies – suggests another approach. Says Dr. Tyner: “The reality is that we carry out development projects in ‘rent seeking’ (rather than profit seeking) economies. That is, people in both the public and private sectors are accustomed to earning and increasing incomes through favors from the public sector. Instead of trying to become more efficient or effective at what they do or produce, businesses invest more in seeking rent. When a donor project comes along, it is usually the established or well connected that have access to the donor(s). Smaller businesses get left out of the process altogether. Thus, the relatively rich get richer.”
Moreover, Tyner notes, “USAID and other donor organization find it difficult to work directly with the private sector. For better or worse, most aid is channeled through governments. And even if the host government is cooperative, it is still difficult to find mechanisms to aid SMEs directly with donor funds. That is why the indirect mechanisms are so important - infrastructure (to lower business costs), training (to increase business efficiency), and policy reform (to enable the private sector to function to its potential).”
Tyner recommends: “Do everything possible to change the rules of the game towards profit seeking instead of rent seeking”. He suggests investing more in social and physical infrastructure, adding: “This is definitely out of vogue, and that is unfortunate because good roads, electricity, education, etc. create the possibility for people at lower levels to become more productive. Infrastructure is more enabling across a broader segment of the economy than a lot of things we do.”
Perhaps, he adds, “we could do a combination of these things. For example, we might make it clear to citizens and government in X country that the US is prepared to build a road from A to B, if high transport costs are a major barrier to trade, but that this will happen only if regulations x, y, and z are changed. Then those who would benefit from the road would become a domestic lobby to get those regulations changed.”
Part of the reason why the really poor cannot often benefit directly, Tyner says, is that “they are uneducated or relatively less well educated, and thus, their absorptive capacity for assistance is lower than that of the relatively well off. They have to be concerned more with day-to-day survival and cannot afford entrepreneurial endeavors. So we need to invest more resources in basic business education. Entrepreneurship will emerge when social and physical infrastructure creates conditions conducive to change.”
The World Bank Group, which for many years virtually ignored the private sector in favor of government-to-government initiatives, has recently demonstrated a new awareness of the role of business in promoting economic growth and poverty reduction. It has focused much of its effort on the potential of SMEs and has identified lack of access to credit as perhaps the single largest problem facing this group.

Says Harold Rosen, Director of the World Bank Group’s SME Department: “One of the first steps toward a vibrant SME sector is the opening of more financing channels, and ensuring that they are focused on building strong partnerships and trust between SMEs and their local banks. This would have lasting impacts in helping local entrepreneurs obtain the capital they need to build their businesses and create more jobs in economies that sorely need new employment opportunities…The entrepreneurs behind SMEs could -- and should -- play a much larger role in development, but too often are held back by a lack of ready access to financing from local formal sector financial institutions. Viewing these smaller firms as costly, high-risk credits, many commercial banks avoid lending to them, concentrating instead on ‘safer’ options such as financing larger local or multinational corporations, or holding high-yield government bonds….”
The SME Department, a joint effort of the World Bank and International Finance Corporation (IFC), is taking on this agenda, using several strategies to increase SME access to capital.
Rosen explains: “This involves not only supporting the traditional WBG product of channeling of medium-term hard currency loans channeled through local banks, but also several newer capacity building initiatives started by our multi-donor Project Development Facilities (PDFs) to improve commercial banks’ SME lending skills and thus help tap into a potentially large and lucrative domestic markets.”
The IFC currently manages nine multi-donor IFC-managed SME facilities around the world. These facilities, typically funded 20 percent by IFC and 80 percent by our donor partners, are building the capacity of SME lenders in their target regions as part of a broader service package that also includes management training, technical assistance (TA) to businesses and business associations, and helping create greater employment opportunities through large company/small company linkages programs.
In Vietnam, for example, the Mekong Project Development Facility (MPDF) is working to improve SMEs’ access to finance through a Ho Chi Minh City-based commercial Bank Training Center (BTC) it launched in 2001. This initiative began with MPDF analysis that identified internal obstacles keeping Vietnam’s banks from doing more profitable SME lending, leading to a BTC business plan that attracted seed capital of $100,000 from 10 private local banks serving mainly SMEs. These small banks lacked the resources to organize in-house training programs, but have now come together to create a for-profit solution that will provide fee-based training courses to themselves, their competitors, and similar banks in Cambodia and Laos. In its first year, the BTC provided top-quality commercial training courses to more than 2,700 local bankers, offering 30 different courses covering such important areas as Customer Focus and Service Quality, Credit Risk and Lending to the Household and SME Sectors, Risk Management in Banking, and others.
Similar objectives are being met in other countries as well. PDFs have also recently held seminars to introduce local bankers in Bangladesh, China, India, Indonesia and Nigeria to successful foreign models of SME lending. This, says Rosen, “creates new opportunities for knowledge transfers that will enable them to take advantage of the vast underserved ‘middle’ market represented by SMEs in their region. “
In western China’s Sichuan province, where incomes lag far behind those of the more prosperous coastal regions, the China Project Development Facility (CPDF) organized a lending workshop for the management of Chengdu City Commercial Bank. This institution has a solid track record in SME lending with 80 percent of its loanable funds concentrated in financing over 3,000 local SMEs. For a city like Chengdu that is home to more than 129,000 SMEs accounting for 99 percent of the total number of firms, the "Best International SME Lending Practices" conference was an important means by which Chengdu’s bankers and entrepreneurs could learn about successful SME lending models in other parts of the world, to help overcome the "access to knowledge" problem faced in many frontier markets.
A similar approach is being taken by the South Asia Enterprise Development Facility (SEDF). This newly launched initiative, funded by the IFC and other donors, has targeted its efforts towards greater SME financing from local Bangladeshi banks. The Africa Project Development Facility (APDF) is pursuing this agenda as well. In Francophone West and Central Africa, in cooperation with the European Union, it has recently provided training in SME Credit Risk assessment to 241 loan officers from 66 different local and regional financial institutions spanning 13 different countries.
However, increasing credit flows to SMEs is not without its catalog of horror stories. Ludwig Rudel recalls: “ I once evaluated a couple of loans made by USAID in 1982 to The Siam Commercial Bank and the Kenya Commercial Bank. In Thailand, the bankers assured AID that the money would be safely invested. They had some good projects that fit the criteria (rice mills) and they were owned by relatives of the bankers who were excellent credit risks. No danger of loss there. It would all be repaid… In Kenya, the bankers said they would have to find borrowers of Indian origin because the Africans would not repay. Nor could most Africans raise the required 200% collateral required by the banks. The Dutch aid program tried to beat this system by offering tractor loans with no collateral. The farmers ran the tractors until they gave out, then cannibalized them to sell the working parts on the cash market and left the frame in the field.”
So the road to SME growth is, at best, a minefield. Yet, as Harold Rosen says, “No effort toward poverty reduction in developing nations is sustainable without growth of SMEs.” Let us hope that both donors and beneficiaries are getting the message.
* * *
The writer is a specialist in international private sector growth issues, and has managed or participated in dozens of overseas assignments for the US Agency for International Development and other donor organizations.