FROM THE OFFICE OF PUBLIC AFFAIRS

Thank you for inviting me to speak at this important meeting on improving the role of private business in the multilateral development banks.  The developing world is in desperate need of a huge new thrust of job creation from the private sector—this is the only way there can be a significant and lasting reduction in poverty around the world.  Brainstorming meetings like this one, therefore, are very welcome, and I look forward to seeing the ideas that emerge from the meetings translated promptly into action on the ground to improve people’s lives. 

It is a particular pleasure be on today’s program with the extraordinary men and women who serve the United States as Executive Directors of the multilateral development banks. 

The Bush Administration has developed a substantial reform agenda for the multilateral development banks—a new focus on policy performance and measurable results and new funding of magnitudes not seen for many years. The U.S. Executive Directors are key part to this reform agenda: They helped to develop it and now they are helping to implement it.  Because of their many years of private sector experience, they are in a unique position to be our “agents of change.”  They have already developed good cooperative relationships with our fellow shareholders.  A hallmark of their efforts will be a close, proactive engagement with staff and management long before programs, projects, loans, and grants come to the Executive Board in order to ensure that measurable results with explicit time lines are incorporated and tied to broader country and institutional goals.

Today I would like to highlight the role of private enterprise in the Bush Administration’s economic development agenda.  This is a subject that we have been talking a lot about during the past year, but today I also would like to make a new proposal—one which builds on our reform agenda and enhances the role of the private sector.

Productivity Growth and the Private Sector

During the last year I had the opportunity to visit many private firms in many poor countries—in Central America, in South America, in Africa, in Eastern Europe, in Central Asia and in Southeast Asia.  It is clear that private firms play an important role in reducing poverty and raising incomes in the places I visited. But they represent a tiny fraction of what they need to be if we are to be successful in reducing poverty around the world.

To explain the role of private enterprise in this economic development agenda let me first be specific about the problem that we are trying to solve and how we are all trying to solve it.  The problem is that many people and many countries around the world are still very poor; over 1.3 billion people live on less than $1 a day.  Why are these countries so poor? The proximate answer is that there is a lack of high-productivity jobs. I do not have to tell the business people in the audience that productivity--the value of the goods or services that a worker produces per unit of time—is the source of higher wages and higher income per capita.  If there are only a few high productivity jobs in a country, then the country is poor. If the number of high productivity jobs in a country is rising, then the country is becoming less poor. If there are already a lot of high productivity jobs, then the country is rich. If you want to reduce the number of poor countries then you have no choice but to increase productivity in poor countries.

Now, it is the private sector that creates higher productivity jobs and thereby raises productivity growth. You can see this all over the world.  Whether it is textile makers, electronic component firms, fish smokers, green coffee processors, cut flower producers, tuna processing and canning firms, small dairy farms. In each case jobs are being produced by the private sector. In order to reduce poverty significantly many more high productivity jobs must be created in poor regions. Productivity growth must rise significantly. But how?

Productivity depends on two things: the amount of capital (machines, tools, computers) that workers have to work with and the level of technology, including general know-how. The more capital and the more technology, the higher is productivity. So if you want to raise productivity, somehow you have to raise capital or technology. If there were no impediments to the flow and accumulation of capital and technology, then countries or areas that are behind in productivity would have a higher productivity growth rate. Capital would flow to where it is in short supply relative to labor, and capital is in short supply relative to labor throughout the developing world. And technology would spread through education, foreign investment, or even the Internet.

 For these reasons, poor areas or countries should be catching up to rich areas or countries

.

Consider the following example from my recent trip to Afghanistan.  I visited a UNDP construction project in Kabul where I saw nearly 100 workers moving dirt with picks and shovels—say about 15 picks and 75 shovels.  There was no machinery to be seen.  On the way back home I changed planes in Amsterdam. Looking out the window from the airport waiting room I saw 2 workers moving more than 50 times as much dirt in an hour as all those 100 workers in Kabul.  The difference of course was capital.  One of those workers in Amsterdam was driving a huge dump truck and the other was operating a mammoth backhoe.  Productivity—the amount of dirt moved per hour—thus appeared to be 2500 times greater because of that capital.

For another example, consider two green coffee processing firms that I visited while I was with Secretary O’Neill in Africa—one in Kampala, Uganda, and one in Addis Abba, Ethiopia.  Both these firms select and sort green coffee coming off the farms and prepare it for export or roasting. The Ethiopian firm had recently installed a new conveyer belt to bring green coffee more efficiently to workers for sorting. That new conveyer belt—a piece of capital—substantially increased productivity at that firm. In fact, to illustrate the improvement, the owner of that firm was kind enough to show us how coffee was sorted before he bought and installed the conveyer belt. In contrast, the Ugandan firm had no such conveyer belt. It was still sorting by the old method; productivity was much lower at that firm despite the available technology. In some sense, therefore there was an impediment for the flow of capital and technology.

A third example shows the impact of technology. The International Livestock Research Institute operating in Ethiopia shared their research with me.  By breeding Ethiopian cattle with European stock, they found it is possible to increase milk productivity by over 700 percent. And, if adopted on a large scale, that 700 percent increase in productivity could occur in Ethiopia in a short period of time.

Historical evidence shows that when there are few impediments to the use and accumulation of capital and technology, there is evidence for “catch up” in productivity.  You see this kind of catch up in productivity growth if you look at the United States since the 19^th century or at the original members of the OECD since 1960.  But if you look around the whole world, you don’t see this.  The reasons for this lack of catch up are related to bad policies that have inhibited, distorted, and restricted the flow of capital and ideas and that are holding private enterprise back.

One can group these impediments into three areas:

Poor governance, including the lack of rule of law or enforceable contracts and the prevalence of corruption, raises the cost of doing business and creates disincentives for the private sector to create high-productivity jobs. For example, it costs $230 to ship cattle from the Sahel area in Burkina Faso to the coast of Ghana compared to only $80 to ship cattle all the way from Europe to the same point.

 According to International Livestock Research Institute, which I visited in Africa, “numerous checkpoints and bribes” factor into this large cost difference.

Inadequate education impedes the development of human capital. Workers without adequate education do not have the skills to take on high-productivity jobs or to adopt new technologies to increase the productivity of the jobs they do have. The workers in a computer services firm I saw in Ghana had good writing, reading, and computation skills and could thereby use the new computer technology to raise productivity.

Restrictions on economic transactions prevent people from buying or selling goods or capital, or adopting new technologies. Lack of openness to international trade, monopolistic state marketing boards, and excessive regulations and red tape are all examples of restrictions that create disincentives for the private sector to invest and innovate so as to boost productivity. For example, until recently the government of Uganda operated a marketing board, which controlled most of the buying and selling in the Ugandan green coffee market. The marketing board held down the price paid to farmers for their coffee. After the government eliminated the marketing board, income to coffee farmers increased by nearly a factor of four—from 20 percent of the world price to 70 percent of the world price. So even with the drop in world coffee prices in recent years, many coffee farmers have begun to have higher standards of living.

But there are still many similar restrictions in other markets, in other countries, and between countries. Restrictions on imports into developed countries still reduce the opportunities to create jobs in the export sectors of developing countries. And there are also significant barriers to international trade in developing countries. In Uganda, for example, there is a 45 percent tariff on the import of specialty coffee bags needed for shipping more perishable roasted beans. This tariff is a factor in keeping Ugandan firms out of the roasted coffee market.

The Bush Administration’s Development Strategy

The Administration’s development strategy endeavors to deal with these impediments to catch-up.  The strategy has two parts: (1) it provides for substantial increases in development assistance and (2) it aims this assistance at countries that have policies that promote economic growth and private enterprise, while demanding that assistance show measurable results in improving people’s lives. 

How are we implementing this strategy?  President Bush has already made several significant proposals for increasing development assistance.  In July of last year, the President called upon the World Bank and the other multilateral development banks to increase the portion of their assistance provided as outright grants rather than loans for education, health, nutrition, water and sanitation in the poorest countries.  One year later, we succeeded in finalizing agreement on a substantial increase in grants within the International Development Association (IDA) – the arm of the World Bank that provides assistance to the poorest countries.

As a result of this agreement, nearly 100% of IDA assistance will be provided on grant terms for education, health, nutrition, potable water and sanitation in countries whose people live on less than a dollar a day. On top of this, the Administration proposed increasing the U.S. contribution to IDA – as well as to the African Development Fund – by 18 percent, reversing the downward trend of U.S. contributions during the 1990s.

The President has also proposed that the United States increase its core assistance to developing countries by 50 percent over the next three years – resulting in a $5 billion increase over current levels in FY 2006.  The increased assistance will be put into a new account called the Millennium Challenge Account (MCA). 

Now, what about addressing the impediments to private enterprise and demanding measurable results?  Consider the MCA.  Funds from the MCA will be provided only to countries that are – to use the President’s terms – ruling justly, investing in people, and encouraging economic freedom.  In other words, countries that have demonstrated the right leadership in pursuing sound policies that promote economic growth and private enterprise will be eligible for the increased U.S. development assistance.  You will note that the three areas that the President has designated as criteria for MCA eligibility are exactly the areas critical to removing impediments to private enterprise.

            In addition to emphasizing policy performance in directing development assistance, this Administration has demanded that assistance provided show measurable results.  The recent replenishment agreement for IDA provides for the development of a system to measure and evaluate results in the areas of education, health, and private sector development.  For the first time, this enables donors to link their contributions to the World Bank to the achievement of measurable results of the ground.  The U.S. contribution is linked in this way.  This helps scarce donor dollars be directed toward the activities and projects that are actually improving people’s lives.

Africa Small Business Fund

In another major accomplishment in the recent IDA replenishment, the U.S. secured international agreement that IDA resources, which have traditionally gone only to the public sector, also be used for private sector development in IDA-eligible countries.  The idea is to expand collaboration between the IFC, the World Bank Group’s private sector finance arm and the World Bank in IDA eligible countries.  Collaboration is essential to removing the obstacles to private sector led-growth.

Today I would like to propose a specific way in which IDA should work with the IFC to promote private sector-led growth.  Some of you may have read a recent Economist article about the success of the EBRD in building micro and small business finance banks in Eastern Europe.

 The success of the EBRD facilities proves that with adequate capital and the right training in lending techniques new financial institutions can profitably serve small businesses.  This model can be extended to other parts of the developing world.

In this regard, we have been working with the IFC to develop a small business lending program for Africa.  IDA funding can play a key role in the program.  Today I would like to propose that the IFC and IDA join hands to begin implementing the program as soon as possible.

Broadly the small business loan program would work in the following way.  The IFC would create an investment facility that would make investments in existing local African banks and extend loans to these banks.  IDA funds would also be invested in this facility.  The facility would also sponsor the creation of new local banks to serve small businesses.  The funds would serve as a pool of capital from which the local banks would lend – in local currency and on commercial terms – to small businesses.

As experience elsewhere has shown, however, simply providing the funds is not enough.  There is also the need to develop the technical capacity within the local African banks to serve the small business sector.  That is where IDA funding comes in.  Grant financing, provided by IDA, would be used to create a technical assistance facility.  This facility would be used to train the local bank staff in areas such as loan appraisal, credit risk assessment, portfolio management, accounting, and information systems management.  The combination of financing from the IFC and technical assistance funded by IDA will help give these local financial institutions the resources and the know-how to serve profitably small businesses.

In total, the program would aim to establish or upgrade approximately 12 banks to serve small businesses over four years.  The investment facility itself would ultimately involve approximately $135 million of investment capital over four years.  During the same period, about $35 million in additional funds would be devoted to technical assistance.  We expect that these funds would be able to create new loans amounting to approximately $250-300 million.  These are the funds that African small businesses can use to expand their operations, invest in capital equipment to raise productivity, and finance imports and exports.

Conclusion

Harnessing the spirit of private enterprise is essential to raising living standards around the world and lifting people from poverty.  I know that our Executive Directors will continue to work with the management and staff at their respective institutions to take a pro-active approach to private sector development.  Economic creativity and the innate desire for self-reliance often find expression in the opening of a store front, or the hanging of a shingle, in countless and often unimaginable forms all across the globe.  It is this spirit we intend to nurture.