Ernesto Zedillo discusses the private sector as a weapon against poverty and why it needs to operate within a proper legal framework.

Q Why should the private sector have a role in poverty alleviation in the developing world?

A Historically, the private sector has successfully alleviated poverty through two main channels: contributing to sustained economic growth, job creation and higher incomes; and providing low cost goods and services.

Q Why has private entrepreneurship not been un-leashed to its full potential?

A First, let me say that the private sector is already very important in poor countries. The problem is that most entrepreneurs tend to operate outside of the formal legal system. Without legal status, these informal businesses are constrained to operate in small markets, and are unable to reap the benefits of the wider marketplace, including accessing financing and long-term capital.

Q What are the biggest barriers to higher levels of entrepreneurship?

A Property rights aren’t well protected and government regulation of businesses is excessive. Heavier regulation is associated with more inefficiency in public institutions. Registering a business can be a long and expensive proposition, which can take as long as 200 days and cost as much as 13 times per capita income in some countries. Acquiring legal title to property is even worse.

As a result, the lack of protection of property rights leaves informal businesses unable to convert their assets to capital or seek protection from the judicial system. Informal assets in developing countries, including the potential value of land, represent an enormous resource that is significantly larger than cumulative FDI or private portfolio inflows. But they remain untapped. Because these assets are not legally defined, they cannot be used as collateral for bank loans or mortgaged for any other form of capital useful in expanding a formal business. Frequently, the only option for accessing capital is through illegal moneylenders, who charge high rates and supply only limited funds. Accordingly, the best way to foster capital creation among informal businesses is to bring their untapped assets into the formal property rights system.

Q How do informal businesses operate without the rule of law?

A Entrepreneurs have to do business in small environments where people know and trust one another, losing the economies of scale of larger markets. The most significant problem is the legal system’s lack of expediency in enforcing contracts and resolving disputes. Poor legal mechanisms can raise anti-competitive barriers by protecting the dominant position of large companies. Ultimately, the lack of competition can directly hurt the poor through higher prices and lower quality products. Unreliable credit bureaux and insufficient bankruptcy laws also hamper entrepreneurship, by increasing the risks to creditors and deterring them from extending credit.

Q What else limits small and medium-sized businesses’ ability to compete?

A Cumbersome tax rules and well-intentioned, but poorly conceived labour regulations. Such rules impair capacity to compete but also discriminate against the most vulnerable participants in the labour market.

Q What is your prescription for overcoming underdevelopment?

A In addition to addressing the above issues, the implementation of concurrent macro level reforms is also key to the development process. These include good governance, macroeconomic discipline, price liberalisation, reductions in investment and trade barriers and sufficient investment in infrastructure and education. However, many countries have implemented these macro reforms, but still suffer from high poverty and stagnant growth due to the lack of entrepreneurial activity. This highlights the importance of removing impediments to a vigorous private sector. Without such reforms, poverty will remain intractable.

Ernesto Zedillo is the director of the Yale Center for the Study of Globalization and a former president of Mexico

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