Why poor countries have too many entrepreneurs and not enough factory workers.
- By Daniel AltmanDaniel Altman is senior editor, economics at Foreign Policy and an adjunct professor at New York University's Stern School of Business. Follow him on Twitter: @altmandaniel.
Is there anyone out there who doesn’t think small business is the lifeblood of any economy? From Washington to Warsaw, politicians and pundits just can’t speak highly enough of plucky entrepreneurs. Even in poor countries, entrepreneurship is one of the most important forces underpinning economic growth, but the best way to raise living standards and reduce poverty is not necessarily to make everyone an entrepreneur. So why do so many costly development programs apparently ignore this fact?
Once upon a time, people who wanted to fight poverty believed in direct approaches that solved identifiable problems one by one. If you wanted to make farmers more productive, you gave them fertilizer. If you wanted to boost manufacturing, you set up factories. To help both of these sectors grow and export goods, you built roads and ports. These kinds of investments quelled hunger and raised incomes in many countries. But recently, an indirect approach arose with promises of still greater benefits.
Daron Acemoglu and James Robinson, social scientists and authors of the bestseller Why Nations Fail, showed through their research that open and inclusive institutions could help economies to grow in a more organic way. This new thinking was embodied in the "golden thread" proposed by David Cameron, the British prime minister. In a Wall Street Journal op-ed in 2012, he suggested that countries pursue the "conditions that enable open economies and open societies to thrive: the rule of law, the absence of conflict and corruption, and the presence of property rights and strong institutions." In other words, given the right environment for business, an economy would bloom on its own.
Cameron’s view might have been music to the ears of the newspaper’s free-market-loving readers, but it also fit well with an existing fad in the global development community: entrepreneurship. Being an entrepreneur allowed poor people to take hold of their destinies, seizing the means of production — at least on a small scale — and realizing their full potential in the economy. High-profile investors based in rich countries, like Acumen Fund and Endeavor, strove to support "high-impact" entrepreneurs in poor countries. And microfinance programs made thousands if not millions of small loans to poor people so that they could start their own businesses.
From the point of view of economic growth, it did not all go swimmingly. First, the investors from rich countries included many non-profits and social investors who did not pick their targets based solely on profitability. They had their own measures of "impact" that steered their financing, things like environmental preservation, access to sanitation, and employees’ incomes. Their investments might have reduced poverty in the short term, but it was anyone’s guess whether they would add the most to an economy’s productive capacity in the long term. Whenever they totted up their own achievements, they forgot to subtract the counterfactuals — how much income and how many jobs would their motivated entrepreneurs have produced even without their help?
Along with them came the microfinance programs — as well as many other aid schemes designed to promote entrepreneurship — which were often based in rural villages where repayment would be enforced primarily by peer pressure among the members. These programs tended to target women, who were viewed as more reliable stewards of the groups’ money. Some women did manage to start their own businesses with the loans they received, but the verdict of research into microfinance’s ability to reduce poverty was decidedly mixed.
There was a simple reason for this. By trying to make microfinance less risky and more sustainable, the program managers also made it less effective.
To understand why, consider a common-sense question: How big can a business be in a rural village? There aren’t many customers there, and incomes aren’t very high either. A business would have to serve several villages to start creating jobs in any significant numbers. Now, consider rural women with families. They may be reliable repayers of loans, but they’re much less mobile than single men. Single men can move to cities, or at least cover a lot of ground in the countryside, in an effort to win new customers. By contrast, even women without children face constraints on their movements in plenty of countries.
Microfinance may have given a lot of people a little, but it was never designed to give anyone a lot. Unlike the microenterprises founded in rural villages, businesses that serve lots of customers take advantage of economies of scale in production and distribution. These economies of scale are essential for economic growth. After all, which economy is more productive — one in which every single person is an entrepreneur, or one in which a minority of entrepreneurs employ the majority of people?
In fact, poor countries already have many more entrepreneurs per capita than rich countries. More entrepreneurship is not what they need; economies of scale are. Indeed, the most productive economies are the ones that balance economies of scale with the benefits of competition. Too many businesses, and workers will fall short of their maximum productivity. Too few businesses, and monopolists will gouge consumers, quash innovation, and fail to serve the entire market.
Cameron’s golden thread of economic and legal reform would indeed make it easier for businesses to thrive, but not just the small, rural businesses favored by the global development community. Eliminating corruption and strengthening property rights would be a green light for some of the world’s biggest investors, both domestic and foreign. These are the kinds of players who open massive industrial parks, agribusiness facilities, and research centers. With investments in the millions and billions of dollars, they create hundreds or thousands of jobs at a stroke.
Of course, these jobs won’t always go to the rural women helped by microfinance programs. Microfinance programs may be one of the best ways to help them, short of having their children take jobs in cities. Nor are these jobs necessarily the ones that fulfill the social goals in the mission statements of Western nonprofit organizations. But they are the kinds of jobs that brought hundreds of millions of Chinese out of poverty and could someday do the same for Indians, Haitians, and Congolese. In these countries, the quickest way to escape poverty is likely to be via bus to the nearest city for a manufacturing job. Hundreds of millions of economic migrants know this, but so-called antipoverty experts are just beginning to understand it.
Unfortunately, lobbying for the policy shifts that will set the stage for mass job crea
tion is not what most people in the global development community are good at. They specialize in micro-level programs that allow them to have a hands-on relationship with the people they’re supposed to be helping, not the macro-level changes whose widespread benefits are more difficult to attach to a single human face. As long as that’s true, the progress they buy with billions of dollars worth of antipoverty programs will never amount to more than rounding error.
Most of these programs are a lot more efficient at generating heartwarming stories than they are at creating jobs, except perhaps for the people from rich countries who are paid to run them.