What are the most appropriate private sector development (PSD) interventions for poverty reduction? PSD is very demanding – attracting controversy and requiring highly competent implementing institutions – nevertheless, it remains popular among policy makers. Focusing on areas under the Norad PSD mandate, this paper explores the challenges and opportunities of different interventions. It recommends a number of considerations for a PSD strategy that can deliver the most impact on poverty reduction.
This study applies economic theory – mostly models of market imperfections – and a review of empirical and theoretical literature to identify the potential role of foreign aid to PSD in reducing poverty and to explore examples of what has worked and what has not. It focuses on areas under the Norad Section for Private Sector Development mandate; macro policies, direct investments and agriculture are excluded as are other motives for aid-financed PSD interventions. Beyond the usual obstacles to identifying the impacts of particular interventions, the effect of indirect impacts (such as ‘crowding out’) mean evidence on the impact of various PSD instruments is often inconclusive.
A PSD for poverty reduction strategy should:
- Be relevant to the poor. Interventions should have a logical and explicit link to the poor, their livelihood, and the main asset they possess: their labour. This means supporting sectors and industries that have a high share of unskilled labour, or a potential to employ or provide economic opportunities directly to the poor.
- Prioritise projects that have the potential to cause domino effects in national markets. Support should be given for innovative ideas with a growth potential, for example backing front-runners that others are likely to follow. This would exclude support to companies from the donor’s country without any documentation of innovation, and to those who wished to enter existing, well-functioning markets.
- Be based on the principle of competition among private businesses. International (and event national) competitive bidding means much more value for money and will foster competition for measures to promote technology transfer, private sector experiences and competencies.
- Contain instruments that foster searches in recipient countries for innovative and profitable opportunities in labour intensive low-skilled industries. Private companies themselves should engage in this search with no imposition from donor. Challenge funds can effectively structure a competitive environment that supports self-discovery by financing the best proposed feasibility studies.
- Contain instruments that support growth-orientated MSMEs. The impact of this is likely to be greater than supporting structural transformation which can take generations. Further, many poor people are likely to be directly involved in such businesses or aspire to become involved. Targeted enterprise development programmes that aim to create employment for others should be a main focus.
- Support capacity building, technical assistance, and analytical work to enhance the effects of PSD on poverty reduction. This work needs to be built on the interests and visions of the recipients to ensure ownership.
- Explicitly recognise that such a strategic and innovative approach carries much higher risk. This risk is necessary to generate real impacts, but it is likely there will be many more failures than the current approach. These failures will be more visible as it involves supporting several innovative projects to reach the few that cause domino effect that lead to learning and expansion.