The reform agenda

With the severity of poverty and the speed of population growth in most lowincome countries, even the respectable growth rates of the successful performers are not enough. With population increases of 3 percent a year, a 4-5 percent GDP growth rate means per capita incomes will rise only 1-2 percent a year. At that rate it would take African countries more than half a century to join the ranks of middle-income countries. To reduce the number of poor, low-income countries must grow by 7-8 percent a year and ensure that the benefits of this faster growth reach the more than I billion people living in poverty. These high growth rates are also required to absorb the unemployed, new entrants into labor markets, and those made redundant by public enterprise and civil service reforms.

The key to accelerated growth is much higher investment and domestic savings, combined with systematic efforts to introduce structural reforms, which are necessary to maintain macroeconomic stability and stimulate the private sector. This is particularly true for the slow-growing economies, which need to raise savings and investment rates from the current 12-16 percent of GDP to at least 20-25 percent.

Raising the level and efficiency of investment requires further reforms to create a competitive, enabling environment for the private sector, to redirect financial resources to support private production and investment, and to shift the composition of public expenditures toward infrastructure and human resource investments that are essential for long-term sustained development. These reforms represent a fundamental change in the role of the state in the economy—from direct owner and operator to partner and regulator of the private sector.

The agenda requires governments to:

Create a competitive yet attractive business environment. An efficient private sector-led development strategy means shifting from am protecting domestic industry to making concerted efforts to reduce the cost of doing business—so that firms can compete in the global economy. To help firms respond quickly to changing market conditions, competent and agile institutions are needed— particularly those responsible for creating and enforcing legal and regulatory systems and tax and customs administration, and those dealing with trade, investment, and technology support. Fostering competition means going faster and farther with trade reform and price deregulation, removing remaining restrictions on FDI, and eliminating incentives and regulations that inhibit competition. By harnessing the skills and creativity of all segments of the population—including ethnic minorities and foreigners—the benefits of economic liberalization will support pluralistic societies. (Creating an attractive business environment and introducing an array of legal, regulatory, and institutional reforms are the subjects of chapter 2.)

Stop the hemorrhaging of public enterprises. Fiscal stability is fundamental to sustained growth. The key elements are broader tax bases and improved tax collections to increase fiscal revenues and, above all, reductions in government dissaving. For most countries, this means greater efforts to stem the losses of public enterprises—through privatization or, as an interim step, through the imposition of a hard budget constraint. As a first step, better information on state-owned enterprises is required to allow policies, programs, and performance targets to be defined. Privatization programs, beginning with the largest loss-makers, will have a bigger impact on the fiscal account and establish credibility for the overall program. Failure to deal with state enterprise losses will keep low-income countries from making social and infrastructure investments needed for growth and poverty alleviation. (These are the subjects of chapter 3.)

Increase the flow of financial resources to the private sector. The priority should be severing the links between banks and nonperforming assets. This means not only eliminating the leakages from the financial system to public enterprises and privileged firms, but also strengthening prudential supervision and regulation of the banking system. Reducing public sector ownership and promoting entry and competition will increase the volume and efficiency of financial intermediation. Removing impediments to private sector development in general will drive this process. At the same time, development of basic financial infrastructure—such as payment systems—is crucial. (Chapter 4 examines issues of financial sector development.)

Although all low-income countries share this reform agenda to some degree, their diversity—in initial conditions and the extent to which reforms are already completed or under way—means that priorities, sequencing, and implementation will vary.

The key to accelerated growth is much higher domestic saving and investment to reduce the dependence on aid flows China's priority is to maintain its current growth rate and good macroeconomic management and to concentrate its efforts on integrating its segmented domestic market. Restructuring large public enterprises, building the financial sector, and strengthening the legal and regulatory frameworks are critical challenges. And large investments in infrastructure are needed to sustain growth.

For South Asia, the priorities are to reform tax systems, improve tax administration, accelerate the efforts to liberalize trade, deregulate the economy to increase internal competition, significantly reduce the cost of doing business, and accelerate the reform of public enterprises (particularly utilities) and the financial system.

In low-income countries with low domestic savings and low per capita GDP growth rates, including Bangladesh and most of Africa, the key to accelerated growth is much higher domestic savings and investment to reduce the dependence on aid flows. Reducing government dissaving in Africa will require a major change in the size and structure of public revenue and expenditure—by broadening the tax base, improving tax collections, and stopping the hemorrhaging of public enterprises. Increasing the flow of financial resources to the private sector will depend on cutting links between banks and nonperforming borrowers, privatizing banks, and strengthening prudential regulation and supervision.

Private sector development calls for a major effort to reduce the cost of doing business through deregulation to complement steady progress in trade reform. But private sector development is only one element of the development agenda. Complementary public investments in people, infrastructure, and the environment are essential. The emergence of a vibrant private sector will also hinge on a major sustained effort to develop competent, respected, and agile public institutions—a difficult and slow process.