How to identify and support fast-growing firms that can take off, create jobs, and yield significant value in a short period of time is one of our biggest dilemmas in nurturing private sector development in emerging markets.
The Sustainable Development Goals (#8) include the need for decent jobs as an important developmental priority, and small and medium size enterprises (SMEs) are expected to create most jobs required to absorb the growing global workforce.
But many young firms will fail; by some accounts more than half of new firms won’t make it to their second birthday.
However, despite the high rate of firm failure, research from the US and evidence from India, Morocco, Lebanon, Canada and Europe shows that (net jobs are jobs created minus jobs lost) and lasting employment opportunities.
In addition, even when a firm survives beyond the first two years of operation, there are no assurances it will become a fast-growing firm -- a gazelle.
Although estimates vary widely, the share of gazelles -- fast-growing firms that generate a lot of value-added and jobs -- is thought to be only between 4% to 6% of all SMEs, and, possibly, even less in many emerging countries.
All this makes creating favorable conditions for entrepreneurship a priority.
Easing business entry -- the time and cost involved in establishing a new enterprise -- is extremely important. As the annual Doing Business report shows, many countries have made a lot of progress on this indicator over the past decade.
But business exit is an equally critical piece of the puzzle.
A technology bootcamp in Medellín, Colombia. © Corporación Ruta N Medellín/World Bank
The fourth industrial revolution is disrupting business models and transforming employment. It is estimated that 65 percent of children entering primary school today will, in the future, be working in new job types that do not exist today. These changes have been more noticeable in developed countries, with the 2008 financial crisis accelerating this transformation process. However, they are also affecting emerging economies that have traditionally relied on routine blue-collar jobs (e.g., textiles, manufacturing or business process outsourcing) for broad employment and economic development.
Start-ups are at the core of these disruptions in business models. In recent years, we have witnessed how completely new market categories have been created out of the blue, transforming entire sectors of the economy, including transportation, logistics, hospitality, and manufacturing. When start-ups disrupt a market, a new business category is created and new sources of growth and employment are generated.
When we think about start-ups and employment, the first thing that come to mind is the start-up founders, typically highly educated and motivated individuals. However, evidence from New York startup ecosystem, a testing ground of new jobs generated through technology after the financial crisis, suggests otherwise.
First, most of the jobs generated by the tech start-up ecosystem are not in start-ups but in the traditional industries that either are influenced or disrupted by start-up technologies (with over three times more employment generated in the non-tech traditional industry).
Second, more than 40 percent of these new jobs did not require bachelor’s degree skills or above. These are jobs like building a website, a basic database, a web or mobile app.
What are the skills needed to fill these categories — which we can call tech blue-collar skill jobs — and how people are being trained for them?
Sometimes, the drive comes from the senior echelons of government – a reform-minded government leader, an important minister or an agency head. At times, there is pressure from donors. Often, the two combine: The initial idea comes from a donor, which a powerful person in government then takes up as an agenda.
Many reforms happen in this top-down way. But, often, there are questions about their sustainability. Commitment to reforms may not be widespread. Once donor pressure wears off, or once the bold reformer at the top moves on (or loses interest or energy), reform initiatives dissipate. Sometimes, the reforms happen on paper, but implementation remains deficient. Top-down reform initiatives often fail to take on board the front-line officials. Implementation thus suffers, especially when the attention of the top-down driver shifts elsewhere.
The 2015 World Development Report, Mind, Society and Behavior, thus points to the need to understand the motivations and behavioral characteristics of different players, such as politicians and government bureaucrats, and how these affect their decisions and actions. The WDR argues that such an understanding helps design policy interventions and reforms that stand a chance of success even in seemingly intractable situations.
This brings us to a third way of reform, less common but potentially more powerful – one that is driven by the middle tiers of bureaucracy. Reforms initiated in the trenches enjoy, almost by definition, the commitment of those responsible for implementation. Reforms may also be better designed, since the officials know exactly what is feasible and where there are pitfalls. A single bottom-up reform may not be very bold. But one reform may lead to another, and the cumulative impact may make a big difference.
Donor programs usually don’t regard mid-level officials as key drivers of reforms. It is often assumed that such officials will oppose reforms and they should thus be bypassed or, at best, co-opted in some fashion. Such assumptions lead to many lost opportunities. Mid-level officials can often be good initiators of reform if they are properly inspired and engaged. The attitudes and perceptions of this important tier of the bureaucracy have an important bearing on the formulation of policies and regulations, as well as on their implementation. These attitudes are shaped by an awareness of business-related issues, or a lack of it.
South Korea today has the fourth largest economy in Asia, is a member of the OECD’s “Rich Club,” and is part of the G20. Despite sharp economic shocks emanating from the Asian financial crisis in the late 1990s, the global financial crisis in 2008, and the more recent slowdown in the Chinese economy – Korea has bounced back and continues to grow.
So it’s hard to imagine that some 70 years ago, Korea’s future looked very bleak – and akin to many of the excruciatingly difficult post-conflict environments that we face today.
To briefly summarize Korea’s post-World War II history: a 1947 report on Korea commissioned by U.S. President Truman concluded, “South Korea, [as] basically an agricultural area, does not have the overall economic resources to sustain its economy without external assistance …. Prospects for developing sizeable exports are slight ….. The establishment of a self-sustaining economy in South Korea is not feasible.” Then the Korean War compounded these problems – resulting in massive damage to both the north and the south – with destroyed infrastructure, a loss of skilled workers, a million South Koreans killed, and as much as one-quarter of the country’s population refugees.
We have many lessons to learn from Korea – particularly as our institution, the World Bank, increasingly focuses on post-conflict and fragile environments.
Although South Korea is known for its large scale “Chaebols,” which have dominated much of its political and economic life – less well known is the considerable support that the government has provided to small and medium scale enterprises (SMEs). As in most countries, (3 million SMEs), over 80% of all employees (10.8 million employees), and almost 48% of total national production.
The economy is in a restructuring process. Technology-led transformations are no longer limited to technology-related sectors and are beginning to affect structural sectors, including manufacturing, retailing, transportation and construction. Disruptions of business models are surging from a fragmented network of entrepreneurs and innovators. Cognitive skills are increasingly being replaced by technology-led productivity, affecting labor supply in both developing and developed countries. In turn, creativity and social skills are becoming more important and more valuable than ever before. This process has been called the Fourth Industrial Revolution.
Countries that are less prepared to adapt to these structural changes will suffer in their competitiveness. As much as 80 percent of the productivity gap between developed and emerging economies can be explained by the lag in transitioning to technology-led changes from previous economic restructuring processes (for example, the 18th- and 20th-century industrial revolutions). Automation is reducing the cost of traditional labor-intense industries (reducing costs relative to labor by 40 percent to 50 percent since 1990), shifting the cost structures that benefited emerging economies. Trade is shifting increasingly to digital goods and services. Knowledge-intensive flows of trade are already growing about 30 percent faster than capital- and labor-intensive trade flows. Jobs are also being affected, with routine cognitive functions being affected the most, while providers of intellectual and physical capital benefitting disproportionately.
There are also opportunities stemming from this widespread diffusion of technology and transformational changes. Entrepreneurship and innovation is becoming affordable and de-localized. The innovation model of large capital-intense laboratories (e.g., Bell Labs) is not the most effective one anymore. Instead, open innovation (the process whereby large firms co-create innovation with entrepreneurs and other actors, instead of having an internal process) and innovation emerging from startups are increasing. Tech startup ecosystems have emerged in cities worldwide, in both emerging and developed economies, disrupting traditional business and creating new industries. This results in local innovation and business models that can be appropriated by the domestic economies. These ecosystems also generate new sources of jobs emerging from the structural changes produced by technology.
Productivity. Growth. Jobs. These are the outcomes that are at the top of many of our clients’ agendas, and they form a core part of most of our private sector development projects. But where do they come from? Who creates them?
Evidence from high-income countries suggests that the answer might be found in a group of small, young and fast-growing firms that contributes disproportionately to these outcomes at the national level. In the United States, about 50 percent of new firms will have gone out of business before the age of five (Haltiwanger et al, 2013). Among those that do survive, just 12 percent experience output growth in excess of 25 percent, but they account for 50 percent of overall increase in output. Similarly, only 17 percent of surviving firms (less than 10 percent of all that entered) experience employment growth above 25 percent – but they create close 60 percent of new jobs in the U.S. economy (Haltiwanger et al, 2016). There is undoubtedly something special about these few high-growth firms (HGFs).
One key reason that HGFs are able to perform so well is their high productivity. Firms in the 90th percentile of the U.S. productivity distribution create almost twice as much output with the same inputs as firms in the 10th percentile (Syverson, 2004). In developing countries, the gap between firms at the top and bottom ends of the productivity distribution is even larger – up to five times! (Hsieh and Klenow, 2009)
Beyond their own high productivity, HGFs raise national efficiency in several important ways. Their “pull factor” facilitates the convergence of less productive firms to the national frontier (Bartelsman et al, 2008). And when markets for production inputs are competitive, HGFs are able to lift overall efficiency by pulling resources from less productive firms. This is what accounts for their disproportionate contribution to productivity, jobs, and output growth (Haltiwanger et al, 2016).
The Mongolian government’s economic advisors. Photo by Steve Utterwulghe
Misunderstanding, distrust, lack of genuine consultation. These are some of the words that I hear the most from various public and private stakeholders during my regular missions to developing countries.
From Bamako to Ulan Bator, where I am writing this post, the relentless echo of grievances points to the fact that the government doesn’t understand – or want to listen to – the private sector, and therefore doesn’t trust it. And likewise, the private sector sees public authorities as often incompetent, corrupt and an impediment to competitiveness and wealth creation.
While generalizing is a dubious exercise, the similarity and recurrence of complaints across the globe warrants deeper digging.
The issue of trust in policymaking is a complex field of study. The origin of mistrust of the private sector by the government in many developing countries is embedded in the socio-political culture and economic history of the state.
That being said, it is now rare to find a government that categorically denies the contribution of the private sector to the economic development of a nation. About 90 percent of the jobs are created by the private sector in the developing world, and about 50 percent of those are created by small and medium-sized enterprises (SMEs). Furthermore, as José Juan Ruiz from the Inter-American Development Bank (IDB) has written, “Policymakers realize that they need to access the deep knowledge held by the private sector in order to learn about market failure and formulate the right policies to address them.”
On the other hand, the private sector wants a stable and transparent regulatory environment in which to operate. It doesn’t want more regulations, but better regulations that will protect its investments. For that, it needs the government to listen and act in a way that will create an enabling business environment. Building trust is hard work.
Differences between public and private stakeholders certainly exist, but so do commonalities. It never takes long for parties to acknowledge that there is a clear common ground to strive for: sustainable economic development that should lead to inclusive growth. That, in turn, will spur job creation and revenue collection for the state. That’s an irrefutable win-win scenario.
Efficient, accessible and safe retail payment systems and services are necessary to extend access to transaction accounts to the 2 billion people worldwide who are still unserved by regulated financial service providers.
Having interoperable payment services addresses several important challenges regarding financial access and broader financial inclusion. This is because via a single transaction account.
Establishing payments interoperability is a formidable task. Our experience shows it is important to find the right balance between cooperation and competition when reforming retail payment systems. Despite the advantages that interoperability brings, not all market participants will necessarily embrace interoperability initiatives, e.g. if they fear to lose their dominant position and/or competitive advantage. In an earlier Blog the role authorities to facilitate interoperability has been discussed. Central banks are a key driving force in any payment system reform, but they cannot – and should not – act alone. Other regulators – such as financial and telecom regulators – are also important to achieving interoperability.
The investment of pension fund assets has moved from an obscure topic for actuaries, to an issue which raises political attention at the highest level.
This is for the simple reason that it directly touches the social and economic livelihoods of people.
Since the 2008 global financial crisis, developed economies have been looking for additional sources of long-term capital to fill the gaps which bank and government balance sheets can’t fill. This is a search that has engulfed the developing world for much longer if not for as long as they exist. Younger developing economies are starting to see their pension funds grow, side by side with an increasing awareness of the impact which productively invested assets can have on economic growth both today and tomorrow. If invested for the aligned intensions of social impact and financial return, pension funds can improve people’s lives today and secure their income in future. However, this isn’t a general phenomenon – applying only to larger funds which have invested in the intellectual capacity of their Trustees, and in countries which have understood and embraced the strong relationship between the macroeconomic performance and asset performance.
Redirecting pension investments from short-term assets (government paper, bank deposits) to investments with a long-term impact is key to delivering, not only improved, but sustained returns. Private equity (PE) - equity capital not quoted on a public exchange – is one such asset class. PE investment is increasingly in vogue as such capital is the foundation of all economies, and indeed leads to the development of robust stock markets. If structured with pension investors’ risk-return consideration in mind, it can deliver the diversification benefits which these investors need. If properly targeted, such investments will be vital in meeting the Sustainable Development Goals, considering that 15 of the 17 SDGs have a focus on growth, development and sustainability (the last two being on implementation and capital resource origination). Active participation in investee companies by shareholders such as pension funds will be vital for ensuring a future sustainable and shared economy. In turn, for this to work optimally, requires conscientious and capable Trustees.
Did you know that in Kenya less than 15% of the population is covered with old age security? This means that many Kenyans are facing a vulnerability of retiring into poverty. But this is not accidental since established factors identified in studies commissioned by Retirement Benefits Authority (RBA) necessitate this situation.
However, Kenya is starting to tackle some of these factors and to help increase pensions coverage to reach more Kenyans to help reverse the state of affairs.
1. A chief factor limiting pension growth is that the formal sector is creating fewer jobs. Despite the positive economic growth registered in the country, employment growth in the formal sector is slow. For example, only 128,000 out of the 841,600 new jobs created in 2015 were formal. This has a direct effect on the pension services since the structure of the industry is still highly biased towards the formal employment model.
Transactions that facilitate employers and employees to contribute are generally conducted from the pay slip, and formal employers adhere more to the regulations and legislation on the issue compared to those who operate informally. As a result, millions of citizens have been cut off from the pension system.
Luckily, this gap is slowly being narrowed by Individual Pension schemes that are specifically targeting the informal sector workers. An example of this is the Mbao pension scheme. The Plan is an inventive idea that adapts a savings product to marginal population groups and contributes to their improved social and economic security.