If foreign aid is not necessarily the best approach to economic development because it muddles incentives and is ineffective, what are our alternatives? Can we help those trapped in poverty through enterprise? Are there any caveats to this approach?
In my last post, I said that enterprise is the most effective solution to poverty because it creates jobs. However, we need to be careful about what types of jobs we are creating. An important statistic that compares and contrasts high-income countries and low-income countries is that of the percentage of people working in small-medium enterprises versus the informal sector.
What exactly is the informal sector? It’s the part of the business world that is not subject to government rules, regulations, or taxes. Examples of jobs in such sectors include everything from babysitting to selling vegetables on the side of the road.
In high-income countries, the small-medium enterprise sector contributes more than fifty-one percent of the gross domestic product (GDP) of the country with only thirteen percent of GDP coming from the informal sector. However, for the low-income countries, the small-medium enterprise sector constitutes only sixteen percent of GDP whilst the informal economy is a massive forty-seven percent.
What exactly do all those numbers mean? Well, the exceedingly large informal sector in the low-income countries can have a number of negative effects on their economies.
The Poor Need Rights and Resources
The first negative effect arises from the characteristics of the informal sector. This sector is dangerous because the poor tend to stay poor since they do not have property rights, mailing addresses, assets, credit history, or cheap financing. In contrast, if these businesspeople were to become a part of the small-medium enterprise sector they could become a part of the networks within the formal economy. Thus, they would have access to trade, financing, technology, human capital development, and communications.
Comparing these two lists of attributes, it is obvious the small-medium enterprise sector provides for far better job creation. It creates the greatest number of jobs and is where the entrepreneurial and innovative drive of the country is found.
What if Governments Put Their Citizens First?
Another important reason for creating jobs in the small-medium enterprise sector versus the informal sector involves the government. Since in low-income countries the informal economy is so large, the tax base is very small. These governments, therefore, do not depend on tax revenues from their citizens to run their countries. Thus, they do not have a social contract with their citizens.
Instead, the governments are outward-facing. They are more concerned about building relationships with foreign governmental and philanthropic donors than the views of their own citizens. This result has terrible implications for the countries’ citizens! The governments will support foreign countries’ agendas over doing what’s best for their own citizens.
Here’s a Plan for Effective Job Creation
Putting these two ideas together, I claim that to end poverty, we need to create jobs in the small-medium enterprise sector and transition the poor from the informal into the formal economy. The poor will then make a wage that incentivizes hard work and gives each person a sense of dignity. Also, the tax base will widen, so the citizens of the country can be the government’s main priority.
In order to support such job creation, there are a few tactics we can follow:
- reduce interest rates on loans to make investment, and therefore enterprise, more desirable;
- provide access to energy in order to allow for more reliable and inexpensive sources for SMEs to utilize;
- introduce more competition into key infrastructure industries to reduce the cost of telecommunications, transportation, and energy.
These priorities will allow for increased enterprise. Utilizing competition spurs innovation and development. Finally, this list of taxes will allow small-medium enterprises to be more prosperous, causing more job creation and overall economic growth.
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Editor’s note: This is a continuation our series of excerpts from IFWE’s forthcoming book, For the Least of These: A Biblical Answer to Poverty. This post is the second part of Lord Brian Griffiths’s and Dato Dr. Kim Tan’s chapter entitled “Fighting Poverty through Enterprise,” which examines the effects of aid and various ways of introducing enterprise to the poor as a means of reducing poverty.
This post was coauthored by Dato Dr. Kim Tan.