Institutions and Policies for Growth and Poverty Reduction: The Role of Private Sector Development

Asian Development Review, 2007 by Hasan, Rana, Mitra, Devashish, Ulubasoglu, Mehmet

This paper goes over some of the recent discussions on the effects on growth and poverty of institutions and policies, especially those that relate to the functioning of the private sector. It examines the empirical relationship between various measures of institutional quality and regulatory policies, and economic growth and poverty. The results suggest that good governance, as measured by a strong commitment to the rule of law, among other things, matters for poverty reduction largely through its effect on economic growth. In terms of business regulations, the paper finds that less restrictive regulations pertaining to starting a business are associated with higher economic growth as well as lower rates of $2-a-day poverty. Political freedom is not associated with either higher growth or lower poverty. Taken together, the evidence here seems to suggest that the delivery of good governance and policies that facilitate the creation of new enterprises are more relevant for growth and poverty reduction than the nature of the political system per se.

I. INTRODUCTION

Despite having made significant progress in reducing poverty over the last several decades, over 600 million people, constituting more than a fifth of Asia's population, live below the $l-a-day poverty line (ADB 2004). On the basis of poverty lines more typically found in low-to-middle income countries as opposed to only low income countries-the $2-a-day poverty line-an even more staggering number are poor in Asia: 60 percent of Asia's population or 1.9 billion people. Faced with such numbers, it is difficult to argue with the notion that the reduction of poverty is the central development challenge facing Asia, and indeed, the developing world at large.

What can policymakers do to reduce poverty? Many economists would argue that igniting economic growth and sustaining it is the surest and most sustainable way to fight poverty. Figure 1, which plots cross-country data on economic growth and poverty reduction, is consistent with this argument. This figure shows, for example, that a 1 percent increase in growth has been associated on average with a 1.5 percent reduction in poverty. Moreover, episodes where poverty grew despite economic growth (quadrant 1) or where poverty declined despite economic contraction (quadrant 3) are clearly the minority. But Figure 1 also reveals that there is a great deal of variation in how much economic growth has reduced poverty across countries, and even within countries over different periods of time. In statistical terms, the variation in economic growth can explain only around 45 percent of the variation in poverty reduction (ADB 2004).

These two "stylized facts" about growth and poverty linkages-that poverty reduction is closely associated with economic growth but that this association is by no means perfect-suggests two challenges for policymakers. First, what are the policies and institutions that can ignite and thereafter sustain growth? second, how does one ensure that growth generates significant opportunities for the poor?

In this paper, some of the recent evidence on both of these questions is discussed, paying special attention to policies and institutions that relate to the development and regulation of the private sector. It carries out some empirical analysis using data on poverty (PovcalNet [World Bank 2004b] and ADB 2004) and recently developed indicators relating to the regulations under which the private sector operates (World Bank 2004a). The objectives of the empirical analysis are modest. In particular, it does not attempt to tease out the deep causal relationships between measures of policies and institutions on one hand, and economic growth and poverty reduction on the other. Instead, the approach is more an attempt at uncovering which elements of the various measures of policies and institutions stressed by the recent literature are more or less robustly correlated with growth and poverty. This is a useful exercise in that it highlights broad patterns in the data and suggests some issues for further research.

The paper's focus on private sector development stems from the now widespread belief that market forces and private initiative provide a powerful basis for generating economic growth. This belief explains the importance private sector development is receiving in the strategies being adopted by both developing country policymakers as well as international development agencies. From the perspective of developing country policy making, for example, scores of countries have moved over the last 10 to 20 years to liberalize their trade and industrial policy regimes. These liberalizations have been underpinned by the belief that greater reliance on private agents-including not only large-scale manufacturing firms but also farmers and micro-entrepreneurs-to allocate resources on the basis of market signals would improve economic performance. Similarly, development agencies, including the Asian Development Bank (ADB) and the World Bank, have made support to private sector development a key component of their overall strategy for assisting less developed countries. ADB 's private sector development strategy (ADB 2000), notes right at the outset that the development of a strong and dynamic private sector is crucial to long-term, rapid economic growth. Long-term, rapid economic growth is in turn seen as a necessary condition for sustained poverty reduction.