30 October 2013

Riding the Wave: Reform, Private Sector Development and Growth in the Pacific

By Paul Holden*
PACIFIC island economies are mostly small, geographically isolated, and relatively undiversified, with narrow export bases. Because of their size, there are few opportunities for economies of scale and limited access to international capital markets. They are vulnerable to natural disasters and rely heavily on development partner assistance and on remittances. They are mostly characterized by large informal sectors, a substantial public sector presence in the economy, and low productivity. Growth performance lags behind other comparable countries in other regions.
And yet the familiar explanations for low growth do not hold in the Pacific. Net domestic investment has not been especially low and its citizens lack nothing in productive capability as their ability to find work in Australia, New Zealand and the United States demonstrates, yet the economic performance of countries in the region has been disappointing. A major explanation for the low growth has been the neglect of private sector development in many Pacific region economies.
Until the early 2000s, the prevailing mindset was that the private sector had little or no role in the development of Pacific countries and responsibility for encouraging growth rested squarely with government and the public sector. The public sector dominated the economy in many countries in the region, with state-owned enterprises (SOEs) crowding out competition, particularly in the key areas of telecommunications, electricity generation, and transport.
However, in recent years there has been a dramatic shift in attitude toward acknowledging that a dynamic private sector should be the driver of growth and poverty alleviation. Extensive analyses of business environments across the region have identified the barriers that investors and entrepreneurs face in establishing and growing businesses. The analyses reveal just how difficult it is to do business in the Pacific. Besides the natural constraints resulting from isolation, small market size, and natural disasters, firms face high costs in doing business arising from inadequate infrastructure, poor communications, limited access to financial markets, outdated legal systems, and inefficient SOEs. And women in Pacific cultures face yet more obstacles in entering the formal economies of the region.
Many of the constraints to private sector growth arise because the institutional foundation for economic development is weak. Earlier analytical work[1] by the Asian Development Bank concluded that Pacific economies were hampered by the failure of the state to develop the fundamental institutions that provide the foundation for investment and entrepreneurship. It identified the main constraints as follows:
  • State presence and interference in a broad swath of economic activity; 
  • Underdeveloped financial markets; 
  • An adversarial mindset toward foreign investment; and
  • Limited provision of public goods, particularly with respect to business law. 
Furthermore, it pinpointed that there was little understanding or contact between the public and private sectors, with the result that neither appreciated the problems each other faces.
Since that work, effective actions to address these constraints in several Pacific has seen attitudes progress from a distinctly anti-private sector and pro-government view of economic organization, to one that in many countries views the private sector as the only potential source of growth. Furthermore, the extent and depth of reforms in some countries matches that which has occurred anywhere in the world. To a great extent, this is the result of the reforms implemented through the Pacific Private Sector Development Initiative (PSDI).
Since 2006, Australia has been the principal funder of the Asian Development Bank’s PSDI, a technical assistance facility that supports inclusive, private sector–led, sustainable economic growth among ADB’s 14 Pacific developing member countries. It entered its third phase in 2013 with a $24 million dollar commitment from Australia over six years.
PSDI has focused on three core areas in its efforts to promote private sector development in the region, namely: business law reform, access to finance, and state-owned enterprise reform and public–private partnerships. Furthermore, in all of its initiatives, it has promoted the economic empowerment of women as a crosscutting theme. In each of these areas it has registered some notable achievements, some of which are among the most far reaching that have occurred anywhere in the world.
The methodology used by PSDI in implementing reform is to:
  1. Undertake extensive analytical work to identify the main constraints to private sector development; 
  2. Engage in intensive discussion with key actors in the private sector and government to arrive at an agreed reform agenda; 
  3. Provide assistance in undertaking reform, and finally, 
  4. Provide extensive follow up to ensure not only that reforms occur but that they are implemented effectively.
There are grounds for optimism from the performance of some of the region’s economies, which demonstrate that private sector-friendly reforms can be achieved, even in countries that have been labeled “fragile.”
There are many examples of successful reform. A particular success story has been Solomon Islands in the areas of business formation, access to finance and SOE reform.
In 2010, with support from PSDI, the Solomon Islands government passed a new Companies Act and installed an online company registry. The new laws eliminate various barriers to company formation, reducing the average time taken to incorporate a company from nearly 3 months to one day. New simpler types of companies were introduced that are far more suitable to the realities of Solomon Islands, including single shareholder companies and community companies, which allow communities to enter into business or receive royalties and rents far more securely than in the past. Data from the registry show the rate of company registration has more than doubled since the reforms commenced.
This followed PSDI’s work in assisting the Solomon Islands government to draft personal property securities legislation, which was passed by Parliament as the Secured Transactions Act, 2008. The law makes it much easier for lenders to obtain collateral to ensure that their loans will be repaid. The result has been a significant increase in lending to businesses. Again this was supported by an online registry.
PSDI has also assisted the government of Solomon Islands in improving the performance of state owned enterprises. These efforts, combined with the Government's commitment to making the SOEs financially sustainable, has resulted in a dramatic improvement in the performance of SOEs. The portfolio has gone from a negative average return on equity of -11.4 per cent from 2002-2010, to an average of 13.6 per cent from 2011-2012.
Similar reforms have taken place in many countries in the region, and the progress made so far is remarkable compared with other regions of the world.[2]
It is true that many believe that these reforms are too abstract and are not really relevant to common people, though nothing could be further from the truth. The changes that have occurred in Solomon Islands, for example, have directly impacted lives for the better.

Paul Holden is Lead Economist for the Pacific Private Sector Development Initiative. 
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*An edited version of this post can be found on the Australian government’s Engage blog.
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[1] Swimming Against the Tide? An Assessment of the Private Sector in the Pacific, P.Holden, M.Bale, S.Holden; Asian Development Bank, 2004. Download at http://bit.ly/HoZeaQ
[2] See PSDI’s Annual Progress Reports, available on ADB’s website at http://bit.ly/19R31r3