Ideas Matter: Improving private sector performance
Unleashing the potential of the private sector in developing countries is critical to achieving productive job creation and inclusive growth. Productivity growth - increasing how much output is realised from a given amount of inputs - is one of the main contributors to economic development (Caselli, 2004, Hall and Jones, 1999). One reason for productivity in developing countries lagging behind developed countries is that the private sector in developing countries is characterised by a small amount of large and unproductive firms (Hsieh and Olken, 2014). These firms, from large formal firms to small-scale family farms, play a central role in productivity growth as producers and employers. Because of this, improving how firms operate, how markets facilitate exchange, and how international trade is utilised become important questions to create productive jobs and shared prosperity.
It is well documented that developing and developed countries differ significantly in productivity and private sector performance. However, why this is the case and how best to intervene is less clear. It is important to identify which barriers are blocking firms from developing their capabilities, so that policymakers can work towards rectifying them. This blog draws on four ideas that could help firms in developing countries work better.
- Adopt better management practices
Stronger and holistic management practices are associated with higher productivity, profits, and growth, but they tend to be significantly worse in developing countries (Bloom et al. 2013; Bruhn et al. 2018; Bloom and Van Reenen, 2007). Such practices include quality control procedures, inventory management, human resource management practices, the quality of the managers themselves, performance management systems, and promotion criteria.
In one instance, an Indian textile firm received extensive management consulting for five months by an international firm, which led to large and long-lasting productivity increases (Bloom et al. 2013). Whilst a very straightforward conclusion, evidence has suggested that the way these management practices are coached to firms matters. For example, simple training programmes on management may not be effective (McKenzie and Woodruff, 2014).
Management practices seem to be important in driving firm growth, but governments, firms, and researchers must understand the best way is instilling these practices within firms themselves.
- Fix market failures in agricultural markets
Agriculture continues to dominate employment in developing countries and tends to make up a large share of national output. As such an important feature of developing economies, it is crucial for economic development to make agriculture more productive and catalyse the movement of labour into higher value-added sectors. New agricultural technologies, such as hybrid seeds and fertilisers, are not being adopted so readily in the developing world.
But why? One study (Bold et al., 2017) found that the seed and fertilisers available in domestic markets were counterfeit and lacking quality, impacting the profitability of farms and constraining any ability of the farmers to invest, condemning them to a low-productivity trap. Following this, another study (Barriga and Fiala, 2018) instead explained the low-quality seed as the result of deterioration along the supply chain, namely in storage and transportation.
Additional contextual research is needed to identify the reasons why the adoption of agricultural technology is low across developing countries. This will help inform policymakers on how best to address it.
- Better allocation of economic resources
The economy is made up of a scarce pool of resources – labour, land, and capital – which should ideally flow to the most productive uses. For example, if a firm is successful and growing, it should attract more workers to maintain growth. Or, if an individual has a great business idea, they should be able to access the capital to realise it. In developing countries, however, resources are often not flowing in the most productive direction. This misallocation hinders economic development.
Balboni et al. (2020)) find that poor people in Bangladesh were unable to take on more productive employment opportunities because they lacked access to capital. Other barriers to better allocation include access to skills, weak infrastructure, limited information, and poor credit. These impediments are affecting the flow of resources, and hindering job creation and productivity growth.
Big push policies are required to address persistent poverty and allow the poor to utilise their talents. Fixing financial and regulatory barriers are important for firm growth and job creation, as is addressing the wedges created by misallocation.
- Improve information flows between jobseekers and employers
In relation to the previous section, recent studies have shown that providing information to jobseekers and employees can significantly improve employment and the allocation of talent in the economy. Unemployment and underemployment are high in developing countries, adversely affecting economic welfare and growth. A recent review found that many interventions, such as training, wage subsidies, and job search support are not particularly effective (McKenzie, 2017).
Research has found that running workshops designed to inform jobseekers on how to present their skills through the job application process leads to significantly higher earnings (Abebe et al., 2018). Providing certificates for vocational training, using reference letters in applications, and informing applicants about the competitiveness of specific vacancies can all lead to better, more effective job applications (Alfsoni et al., 2019; Abel et al., 2017; Ahn et al., 2018).
A low-cost intervention such as improving information flows are low-hanging fruit that can generate substantial earnings for workers as well as benefit firms.
Private sector development plays an important role in poverty reduction. Individuals, firms and markets are intrinsically linked through production, consumption and employment. Making these work more efficiently can create inclusive growth and jobs. Policymakers should seek to understand how they can make such improvements in their respective domains. These ideas, improving management practices, fixing agricultural markets, better allocating economic resources, and improving information flows between jobseekers and employers, have shown success and could be good starting points.
This blog is part of the IGC’s Ideas Matter campaign to celebrate the launch of the Little Book of Growth Ideas.