POVERTY REDUCTION THROUGH PRODUCTION

Many of the world´s 50 least developed countries (LDCs) have achieved higher economic growth recently - overall, their growth rate was 5.9% in 2004 -- but there is a widespread sense that this is not translating effectively into poverty reduction and improved human well-being. The problem, UNCTAD´s Least Developed Countries Report 2006: Developing Productive Capacities(1) says, is that for the average citizen of an LDC, what matters is not an overall increase in Gross Domestic Product but a stable job providing a decent living - and, increasingly, a job outside the agricultural sector.

The key to reducing poverty in the world´s poorest countries, the report contends, is a process called developing productive capacities. The report urges Governments and international aid programmes to focus increasingly on enabling such countries to develop the ability to produce, efficiently, goods and services that can be sold both at home and abroad - goods and services that gradually increase in variety and sophistication - so that a "virtuous circle" of increasing employment and stable growth takes hold. A country that succeeds at this process will reduce poverty for itself, will ultimately no longer need periodic doses of humanitarian aid, will keep its best-educated citizens at home (instead of losing them to jobs overseas), and will reduce the floods of desperate migrants who now seek to enter Western Europe and North America.

In almost all LDCs most workers have to earn their livings in household-based enterprises - now dominated by agriculture on plots averaging less than 1 hectare in size - with rudimentary tools and equipment, little education, poor infrastructure, and weak supporting institutions. Labour productivity is low and there is widespread underemployment. This is the basic cause of persistent mass poverty in LDCs. From 2000-2003, it required five workers in LDCs to produce what one worker produced in other developing countries, and 94 LDC workers to match the productivity of one worker in a developed country.

Developing productive capacities will not emerge automatically from the workings of market forces alone, but from the interplay of entrepreneurship, public policy and international action. Policies should purposefully focus on: (i) developing the domestic productive resources of the LDCs through increasing public and private investment in physical and human capital; (ii) developing their entrepreneurial capabilities and facilitating technological learning; and (iii) facilitating structural change and the development of dynamic linkages between sectors and enterprises, including between domestic and foreign investors.

Simulations in the report show that LDCs could achieve over 7% growth rates if their labour forces are fully employed and various potential sources of labour productivity growth which are available to all poor countries are exploited. These simulations indicate how it is possible to achieve a type of economic growth which reduces poverty in the LDCs rather than producing jobless growth. Moreover, they show that there is a major opportunity for substantial and sustained poverty reduction if the policies are right.

To develop productive capacities, the report says, country-specific strategies have to be designed to relax key constraints on investment, technological progress and structural change. These will vary between countries. However the report identifies three broad areas which are likely to be relevant in many of them:

• Improving physical infrastructure: "Most of the LDCs have the lowest and poorest-quality of transport, telecommunications and energy infrastructure in the world," the report notes. The stock of roads per capita in LDCs was lower in 1999 than in 1990. Particularly important is providing more widespread and reliable electricity. "(C)urrent low levels of access to electricity increase costs for firms, reducing their available funds for investment, and are a basic source of the technological incongruence between LDCs and the rest of the world." The report argues that closing the "electricity divide" is at least as significant for economic growth and poverty reduction in the LDCs as closing the digital divide.
• Addressing institutional weaknesses constraining private investment and innovation, notably the "missing middle" in the business sector and weak financial and knowledge systems. Most LDCs lack the medium-sized businesses that are critical for domestic employment, investment, innovation, and for linking small firms and micro-enterprises with large corporations. Weak formal banking alongside very costly informal credit systems are a major constraint on private investment. Moreover, modern knowledge systems, which are vital for technological learning and international competitiveness, are often fragmented, with specialized creators of knowledge, such as research institutes, unresponsive to the demands of users.
• Addressing demand-side constraints. Growing domestic and foreign demand for the products of a country are critical aspects of a good investment climate and also the basic stimulus for the development of productive capacities. "Evidence for a small but varied sample of LDCs shows that expansion of domestic demand has contributed most to their economic growth," the report notes, and because agriculture remains the major source of livelihood in most LDCs, trends in domestic demand are closely related to what happens in the agriculture sector. Policies should thus seek to generate a "virtuous circle" in which demand stimulus from agricultural growth induces investment, entrepreneurship and employment in non-agricultural activities. But exports also matter because imports are essential for investment and economic growth. Analysis in the report shows that, over the long-term, the positive contribution of exports in lifting the balance of payments constraint on economic growth in LDCs has been seriously reduced by declining terms of trade and currency depreciation. Upgrading the export structure of the LDCs is thus vital to lifting demand-side constraints.

The production- and employment-oriented approach to poverty reduction advocated in the report is not something totally new. But it is very different from the current focus of policies intended to reduce poverty. In recent years there has been a strong shift in international aid towards social sectors; the percentage of aid dedicated to social programmes, emergencies and debt reduction amounted to 62.1% of total net overseas development assistance (ODA) disbursed to LDCs in 2002-2004. By contrast, a declining proportion of aid has been committed to such matters as infrastructure improvement and enhancement of productive sectors. These sectors received 48% of aid in 1992-1994, 32% in 1999-2001, and 24% in 2002-2004.

Trade expansion and foreign direct investment (FDI) also have been touted as the key to poverty reduction. But export sectors have often been weakly linked to the rest of the economy, and FDI into LDCs has focused on the so-called extractive industries: some 70% of FDI to LDCs in 2004 went to oil- and mineral-exporting LDCs. The report notes that these activities generally do not lead to broad-based growth in employment or to widening economic activity in the host nations because of lack of linkages to other economic sectors.

A production- and employment-oriented approach would include increased social sector spending and efforts to expand trade. But there would be increased aid for productive sectors and also steps to expand non-tradable activities as well as achieve efficient domestic substitutes for a variety of imports so that the jobs and profits involved in producing them stay at home. Much more attention would also be given to mobilizing productive resources and entrepreneurial capabilities within LDCs which are now underutilized.