Unlocking potential

Ifty Islam

The strong rally in both developed stock markets (the S&P500 with gains of + 30 percent from the lows is the best performance over 2 months since the 1930s) and even more so for emerging markets has seen renewed optimism that the global economic recovery will be imminent.

Oil has crept above $60 a barrel again on expectations for stronger global growth. My own view is that we have likely hit the bottom in the cycle, but that any recovery, especially in the US and Europe, will be relatively weak. With trillions of asset destruction, consumption growth will remain slow for a while, as will the process of finding another engine of growth to replace finance.

However, as Harvard Prof Dani Rodrik has noted, as far as the developing nations are concerned, this need not be a tragedy. After all, “their growth depends on their ability to import and deploy the stock of knowledge that already exists in the rich world -- a stock that will not disappear or dissipate just because growth there has slowed down”.

In a previous column, I highlighted the opportunities for countries like Bangladesh and India to target growth rates of 8 percent + by a greater focus on unleashing the potential at the “bottom of the pyramid”(BOP) paraphrasing the title from the seminal book by University of Michigan Prof CK Prahalad. This was defined as people living on $2 per day and increasing the productivity and income generation opportunities could in turn see not only rapid GDP rates being maintained but also a significant reduction in poverty rates.

Moreover, while the recent announcements of support for industries most affected by the global financial crisis such as jute, leather goods and seafood/frozen food is to be welcomed, to some extent, we need to balance our targeting of traditional export industries with a focus on increasing agricultural productivity and supporting new entrepreneurial activities that can generate new market opportunities both domestically and overseas.

In contrast to Prof Prahalad, Prof Aneel Karnani, also of the University of Michigan, critiques the thinking that the BOP can make vast fortunes for multinationals (MNCs) given the limited incomes and purchasing power there.

He argues, “ Not only is there no fortune, there is not even glory at the bottom of the pyramid. It is a fallacy to claim that there is much 'untapped' purchasing power at the BOP. The poor, in fact, obviously consume most of what they earn, and as a consequence have a low savings rate. Contrary to the BOP argument, getting the poor to consume more will not solve their problem.

Their problem is that they cannot afford to consume more. The only way to help the poor and alleviate poverty is to raise the real income of the poor. There are only two ways to do this: 1) lower prices of the goods that the poor buy, which will in effect raise their income, and 2) raise the income that the poor earn.

Prof Karnani argues for the need to view the poor primarily as producers, not as consumers. By far the best way to alleviate poverty is to raise the income of the poor, and to emphasise buying from the poor rather than selling to the poor. The BOP proposition focuses on the poor primarily as consumers; it does however sometimes cite examples of organisations that treat the poor as producers.

Free market advocates argue that the best antidote to poverty is economic growth. There is much evidence linking poverty reduction to economic growth the so-called 'trickle down' effect. But, the trickle down effect may be too little and too slow. We need to target programmes specifically at poverty reduction rather than just wait for the general growth effect to kick in.

Another interesting observation from Prof Karnani is in asking why is microcredit not more effective? He argues the problem lies not with microcredit but rather with micro enterprises. The United Nations' declaration that micro entrepreneurs use loans to grow thriving businesses leading to flourishing economies is hype. A client of microcredit is an entrepreneur in the literal sense: she raises the capital, manages the business and is the residual claimant of the earnings.

But, the current usage of the word 'entrepreneur' requires more than the literal definition.
Entrepreneurship is the engine of Joseph Schumpeter's dynamism of 'creative destruction.' An entrepreneur is a person of vision and creativity who converts a new idea into a successful innovation, into a new business model. Some clients of microcredit are certainly true entrepreneurs, and have created thriving businesses these are the heart-warming anecdotes.

But the vast majority of microcredit clients are caught in subsistence activities with no prospect of competitive advantage. The self-employed poor usually have no specialised skills and often practice multiple occupations.

Creating opportunities for steady employment at reasonable wages is the best way to eradicate poverty. There is much empirical evidence showing that creating decent employment opportunities is the best way to take people out of poverty.

One suggestion that Prof Karnani has that I agree with is as follows: rather than lending $200 to 500 women so that each can buy a sewing machine and set up a micro enterprise manufacturing garments, it might be much better to lend $100,000 to an entrepreneur with managerial capabilities and business acumen and help her to set up a garment manufacturing business employing 500 people. Now the business can exploit economies of scale, deploy specialised assets, and use modern business processes to generate value for both its owners and employees.

Governments need to facilitate the creation and growth of private (small, medium and large) enterprises in labour-intensive sectors of the economy, through appropriate policies (such as de-regulation), infrastructure (such as transportation), and institutions (such as capital markets).

Small and medium sized enterprises need financing options -- both debt and equity -- in the range of $10,000 to $1 million that are almost non-existent in developing countries.
Hathay Bunano is a great example of a company that started with $5000 of capital in 2005 and has grown to create employment for 3000 rural women making hand knitted toys in the villages. Its CEO, Samantha Morshed, rightly was awarded an MBE in this year's honours list. We need to think of innovative venture capital financing to create more Hathay Bunanos and more effectively unlock the productive potential of the bottom of the pyramid in Bangladesh. This would lay the foundations for an 8 percent growth rate that would also be inclusive in sharing the rewards of growth with the poor.