Role reversal: subsidizing the private sector

Here’s an odd thing. Many people with free market instincts about development assistance say that they think that private sector investment, rather than spending by developing country governments, is essential to creating growth and jobs; and they argue that aid should be used to support the private sector (see this, for example).

What’s so odd about that? Well, it is odd to hear people with generally pro-market views advocating public subsidies for private industry. You see, I agree that private sector investment will drive economic growth, create jobs and reduce poverty in developing countries, and I share the scepticism about the value of state enterprises (though I am perhaps less sceptical about the value of government-provided social services such as health and education than perhaps some of these people seem to be). But despite being an old-fashioned, left-of-centre Guardian reader, I think the best way to promote private sector is not to provide industrial subsidies.

Many of the challenges facing the private sector are caused by poor government – ineffective or expensive legal services, delays and costs from corrupt bureaucracies, ropey communications and transport infrastructure, badly designed tax policies, and ineffective public utilities. So I think public sector reform is a very high priority: for the state to get out of things it shouldn’t be doing, and to improve the efficiency with which it does the things it should, especially putting an end to corruption. In many developing countries, this requires serious, long term investment – in skills, equipment, and institutional change. If we seriously want to end corruption, for example, we need to pay public sector workers a reasonable salary instead: and pay reform requires substantial, long term commitment of resources which most developing countries cannot afford. Without long term, predictable donor financing, these public sector reforms are simply not going to be possible. Government should also, in my view, provide essential public goods, including security, legal systems, basic education and health care, transport infrastructure, and democratic institutions to provide the economic, social and legal environment in which firms can safely invest.

To my mind it also seems paradoxical that right-wing and free-market commentators argue that government is such a big part of the problem (a proposition in which there is much truth) but do not conclude that it is therefore a high priority to improve the institutions of government. Instead, they seem to think that we should largely ignore government, and channel any aid that we give to the private sector instead. I cannot see how this can be a long term solution to the problem.

So those of us who believe that we have to work with the governments of developing countries, and provide significant resources to them, do not necessarily have a different view of the role of the public and private sectors in economic growth or the provision of services. Where we seem to disagree is that I do not think that industrial subsidies are likely to be a better long term investment than helping the public sector to be much better at providing an environment in which firms can invest and create jobs, and compete fairly.

2 thoughts on “Role reversal: subsidizing the private sector”

  1. Pingback: Tim Worstall

  2. “If we seriously want to end corruption, for example, we need to pay public sector workers a reasonable salary instead: and pay reform requires substantial, long term commitment of resources which most developing countries cannot afford. Without long term, predictable donor financing, these public sector reforms are simply not going to be possible.” What absolute and utter bullshit Owen. Have you never, ever, actually worked in a third world, away from the elite bureaucracy that is ? You don’t want to pay them even more, they already parasitise on the actual workers, you have to get rid of them out into a productive sector. Ignorance like yours is the major reason why $500 billion dollars in aid has left most africans if anything worse off than they were 40-50 years ago. You, and your ilk are directly responsible for this state of affairs and for its prolongation.

    Owen says:
    Not only have I lived and worked in developing countries, I have been part of a public sector reform program which significantly reduced the number of employees and increased the efficiency of those who remained. It is an expensive business: workers have rights, so cutting the size of the bureaucracy involves buying out those rights and making redundancy payments. And if you want the remaining staff to be effective, loyal and not corrupt, you need to pay them a decent wage to enable them to live on public sector salaries. The transition costs of reform are large; it is a process that can only be undertaken if you are confident that you will have the funding available.

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