Institutions and Incentives: A Guide for Policy Practitioners

Have you ever thought what stops some places from developing? Why is it hard for some places to implement progressive policy? What stops people from being more entrepreneurial? Well it can often be the institutions, the “legal and administrative organizations” that underpin society and they predict the ability of a place to prosper (World Economic Forum, 2015).

Institutions are a “consistent and organized pattern of behaviour or activities (established by law or custom) that is self-regulating in accordance with generally accepted norms” (Business Dictionary, ND).

Institutions “are the rules of the game in a society, […] the humanly devised constraints that shape human interaction. […] They structure incentives in human exchange, whether political, social or economic” (North, 1990, p. 4).

Why are institutions important?

Institutions are important because they form what is called the ‘enabling environment’ (World Economic Forum, 2015). Institutions move beyond the concept of an organisation to encompass social structures that guide “human interaction and activity” and include formal and informal rules. Institutions are important social structure as they “create stable expectations for the behaviour of others,” and create the incentives for economic and political development (Hodgson, 2006). Institutions therefore provide a framework for social cohesion and long term prosperity Bakir, 2009).

The four key sectors where institutions play the most effective role in promoting growth are “finance, education, justice, and public administration” and as a result, Institutions need to be a consideration for in policy and program design in both the developed and developing world (Paul, 2017).

In particular, strong institutions support economic development by:

  • reducing the costs of economic activity by lowering transaction costs such as search and information costs, bargaining and decision costs, policing and enforcement costs;
  • promoting a return on investment through common legal frameworks (e.g. contract terms and contract enforcement, commercial norms and rules);
  • reducing oppression, corruption and encouraging trust by providing policing and justice systems; and
  • Encouraging collaboration between public-private sectors to increase social capital (Bakir, 2009; Ferrini, 2012; World Economic Forum, 2015).

More specifically, institutions affect the level of production, adoption of new technologies, entrepreneurship and venture creation, environmental protection, ability to attract investment, property ownership, law enforcement, and levels of bureaucracy and red tape. Thus, institutions need to be a key consideration when designing policy and programs.


Institutions and Policy

Often when transformational policy is required, consideration of the institutional framework is paramount. There are four different types of influences on institutions that practitioners should be aware, these include:

  1. Rational choice: where intuitions are influenced through ‘feedback’ that reinforces the decisions and actions to become norms. For example increasing returns on investments is a positive feedback that reinforces the norm;
  2. Organisational the adoption of common practices (i.e. imitation) and norm from other successful organisations and leaders;
  3. Discursive institutionalism is when self-interests and cognitive ideas are pushed until adopted as norms; and
  4. Historical institutionalism is a mix of the above three where logic and idea have amalgamated over time to become norms (Bakir, 2009).

Practitioners should examine the changes they wish to achieve against identifiable institutions.  Incentives or more specifically, pigouvian penalties can then be designed to help shift behaviours and actions in line policy positions.

Incentive: a moral, coercive or remunerative motive behind an individual’s particular course of action (Johnson, 2005). Incentives do not have to provide positive motivations.

 Pigouvian penalties: is a tax to deter or counterbalance market activities that generate negative externalities (the Economist, 1017).


  • Public transport: Policies to promote public or physical transport uptake may only become effective when society recognises that cars have a negative impact on the environment and are willing to change their behaviour to protect the environment. Policy practitioners may needs to consider the individual rational choice, self-interests and historic institutions that support people to drive cars. For example, if parking was increased in the CBD to support institutional change around driving, does it just push people in to suburban areas where driving is still more cost-efficient? Is advertising to change values and perspectives (self-interests) on driving required? Are additional services or upgrades required to change the efficiency of public transport in addition to car and parking taxes?
  • Welfare: Income welfare that supports disadvantaged people can be relatively ineffective in enabling long term dependents to transition into the mainstream economy when the alternative is low skilled and repetitive work. Thereby dis-incentivising people to transition to employment. Policy practitioners may need to consider if the community, formally or informally, agrees that welfare is a right? If individuals have intergenerational dependency and therefore share similar aspirations? And what are the real incentives that encourage employment and discourage unemployment? Otherwise actions that just consider capabilities will have limited impact.
  • Innovation and technology adoption: for societies wishing to promote innovation and technology adoption, it is also important to look at existing intuitions that may disincentive action. For example what are the red tape barriers (costs) to setting up a business and commercialising ideas? Are there any Government Trading Enterprises that crowd-out the private sector innovations? Are technology rebates and R&D subsidies promoted widely and easily accessed? Does the government have a consistent view and is their machinery (departments and agencies) progressive in their policies?

Finally, strong institutions may not ensure robust growth in the short term but in the long term, a society cannot expect to prosper without them. Thus the policy practitioners need to consider institutional environment when designing interventions.

North, D. C., 1990. Institutions, Institutional Change and Economic Performance, New York, Cambridge University Press.

Part 3: the Innovation Ecosystem – Roles and Responsibilities

To drive an innovation-led approach to economic growth, it is essential to understand the roles of both the public and private sector, including academia; and how each can enhance to the ecosystem.

Innovation ecosystem: is the flow of technology and information among people, enterprises, and institutions central to an innovative process. It contains the interactions between the actors needed in order to turn an idea into a process, product, or service on the market (OECD, 1997).


The public sector has responsibility for creating an environment that ignites innovation and supports entrepreneurs. Yet, as Isenberg (2016), notes “there’s no exact formula for creating an entrepreneurial economy; there are only practical, if imperfect, road maps”.

However, it is generally acknowledged that government have various tools at hand. Governments can create ‘demand factors’ for innovation such as policy, regulation and innovation targets the cause the market to change direction (this is essential to enable economic structural change). While Innovation ‘supply factors,’ may include research and development (R&D) credits, academic partnerships and university graduates.

In Mazzucato’s book, The Entrepreneurial State (2014), she argues that government has a bigger role beyond tax credits and the enabling environment. That is, government can also invest in transformational R&D where there is a public good, the risk is high and long term investment is. Marzzucato suggests that such investment by government often leads to transformational change that can create entirely new sectors and markets. Examples of these types of investment include the nuclear energy, the internet and GPS. For government to take this approach it needs to have a long term agenda for technology change; and work with in partnership academia and the private sector so they too can seize the opportunity along the way to add new information to develop spinouts.

Workforce development is also directly linked to the future of businesses creation and economic growth.  Government set the policy, run many of the programs and fund many academic institutions that develop skilled workforce essential to the capability to develop innovation commercialise but to also enable economic transformation when required (Fetsch , 2016).

Fetsch (2016), Moretti (2012) and (Sandbu, 2017) all argue that government can also drive immigration policy that supports innovation policy through three main factors:

  1. importation of skilled workforce to compliment or build a competitive advantage;
  2. immigrants “play a disproportionate role founding companies that make a big economic impact” because they are naturally risk takers having immigrated in the first place; and
  3. Foreign Direct Investment (FDI) flows often through the expat community to enable innovation and business growth

Isenberg (2010) provides a localised perspective and suggests that many government efforts focus too narrowly on building ecosystem determinants. Instead he suggests that government should focus on the following nine principles to “turbocharge venture creation and growth”. Isenberg’s principles include:

  1. Stop emulating Silicon Valley. Rather you can develop your own culture and practices that underpin entrepreneurship and innovation. Also see the ‘rules’ described in the Hwang and Horowitt (2012) book the Rainforest: the secret to building the next silicon valley;
  2. Shape the ecosystem around local conditions. Home grown solutions that compliment “local entrepreneurship dimensions, style, and climate” (Isenberg, 2010);
  3. Engage the private sector from the start. Reach out and understand industry needs;
  4. Favour the high potentials. This is through focusing on gazelles (high growth firms) and applying economic gardening approaches, as noted in Part 2;
  5. Get a big win on the board. Celebrate successes as success can spur more innovation and entrepreneurship;
  6. Tackle cultural change head-on. Governments can help to promote the benefits of innovation, the opportunities entrepreneurship through setting values that celebrate innovation and entrepreneurship, encourage collaboration and by building a tolerance of failure;
  7. Stress the roots. Let the market determine value – be careful propping up ventures;
  8. Don’t over engineer clusters; help them grow organically. Clusters occur naturally when an opportunity exists and are an important element of an ecosystem. However, government shouldn’t be picking winners, just backing them; and
  9. Reform legal, bureaucratic, and regulatory frameworks. Over regulation at all levels can stifle innovation and entrepreneurship. Examining the institutions and incentives is essential to ensure an ecosystem is guided by positive regulation.



The private sector is the main agent of innovation and value creation. They are the ones that take the risks, commercialise the products and services, and create jobs. Yet private stakeholders are often multifaceted, holding many roles along the innovation pipeline.

Entrepreneurs are the people with the ideas and are risk takers. In his book, Worthless, Impossible and Stupid, Isenberg (2013) notes that entrepreneurship is defined by an individual’s ability to perceive, create and capture extraordinary value.

A Start-ups is an early stage business that is beginning to scale rapidly. Angel investors “Incubators, accelerators, universities, and public agencies” typically provide the majority of help establishing the business in its early stages (Startup Europe India Network, N.D). Most start-ups die in their first two years in a period called the valley of death.

Valley of death: is a common term in the start-up world, referring to the difficulty of covering the negative cash flow in the early stages of a start-up, before their new product or service is bringing in revenue from real customers (Forbes, 2013)

While Small to Medium Enterprises (SMEs) are small businesses that have overcome the valley of death, tested the viability of their product of services, established a customer based and achieved growth that has allowed them to employ staff. Yet SMEs often lack the knowledge on how to scale-up and lack the resources to invest in innovation to fuel productivity and development (OECD, N.D). Once a business has gotten to this stage of its development, it has greatest potential to become a gazelle (see Part 2).

Investors are typically defined based on the capacity they can invest.  Most types of investors provide more than capital, also offering business support, networks and sometimes markets.

Typically early stage investors offer small amounts of capital and include business angels, incubators and accelerators[1], and some seed stage venture capital funds. As the start-up grows, it requires more investment to fund its expansion and will seek an investment from the venture capital investors who are considered growth-stage investors. Private equity investors and corporates are typically investors at a later stage business growth which may include business merges, stock market listing and buy-outs (Startup Europe India Network, N.D).

Hwang and Horowitt (2012) put forward a softer model in their analysis of the innovation ecosystem and identify:

  • Business leaders: who have a reputation of being innovative. What culture, process and strategy does individual business set to in place to innovate within their business to support innovation?
  • Keystones: individuals or businesses who serve as agents that connect people, ideas and investment to catalyse diverse action. Keystones can also exist in the private sector.
  • Stakeholders: anyone who is an entrepreneur, investor, support organisation or participates in the innovation ecosystem.
  • Role models – local entrepreneurs that are visibly successful in the community and offer examples of success and failure. They are people that promote a positive innovation and entrepreneurship culture. They challenge aspirations and values.
  • Community – the industry sectors, services providers and collective human capital that underpin an ecosystem.

 Industry: However ecosystems are also place-based, in that innovation, R&D and spill-overs are happen in a place, that is proximity is important for knowledge diffusion and is primary influenced by local innovation capacity (Rodríguez-Pose & Crescenzi; 2008). As a result a places industry base and industrial clusters become another important organising principle and stakeholder group for analysis.

Industrial cluster: “are geographic concentrations of interconnected companies and institutions in a particular field. Clusters encompass an array of linked industries and other entities important to competition. They include, for example, suppliers of specialized inputs such as components, machinery, and services, and providers of specialized infrastructure (Porter, 1998)”.

Crescenzi & Iammarino (2016) note that “economic and innovation trajectories do not depend exclusively on localised productive and knowledge assets but need to combine ‘local buzz’ and ‘global pipelines’”. Thus looking at a places external linkages through the lens of FDI flows, global supply chains and multinational corporations offers the opportunity to extract information and opportunities to leverage innovation, build capability and establish new markets.

Finally, academia, which provides an institutional framework for developing workforce skills and values that support and drive innovation and enable agglomeration forces which drive productivity. Academia can even compensate for some businesses that are not as well-equipped to do under take R&D through the production of skilled workers; public-private partnerships; and the generation of patents that diffuse into the local innovation ecosystem (Cauce, 2016).


No matter how you analyse your ecosystem, fundamentally what drives success it is how we join up and collaborate to create value. Hwang and Horowitt (2012) note that ecosystems “thrive because of normative culture that accelerates the evolution of human organisation into ever-increasing patterns of efficiency and productivity”.  In other words, we need to create value systems and networks that enable collaborative and symbiotic behaviours across all actors if we are to achieve well-functioning innovation ecosystems. No single individual or stakeholder group can do it alone.


Book References

Isenburg, D (2013) Worthless, Impossible and Stupid. Harvard Business Review: Boston.

Hwang, V. and Horowitt, G. (2012) The Rainforest: the secret to building the next silicon valley.
Regenwald: California.

Mazzucato, M (2015) The Entrepreneurial State. PublicAffiars: New York.

Moretti, E (2012) The New Geography of Jobs.  Houghton Mifflin Harcourt Publishing: New York.


[1] private incubators and accelerators are often owned by investors who use the structure as a mechanism to identify investment opportunities.

Part 2: The Entrepreneurial Ecosystem – Gazelles, Job Creation and Economic Gardening

SMEs are now viewed as a major force in job creation and innovation policy. In particular, the start-up seen has had a lot of attention to what is known as ‘gazelles’ or high growth firms (HGFs).

While representing only around 6 per cent of all business, HGF create around 50 per cent of all new jobs (OECD, 2014). This is because HGF’s have identified a market opportunity and tend to be ’first-movers’ in responding to or changing customer demands (i.e. innovation of new products). For this reason, HGF are “thought to drive productivity growth, create new employment, increase innovation and promote business internationalization” (OECD, 2014).

HGF are also important because they pop up in all sorts of diverse geographical areas, responding to local challenges and opportunities. They also encourage further spin-offs their industry and stimulate wider entrepreneurial activity (Fetsch, 2016).

High Growth Firm: There is no single definition of a HGF and what constitutes an extraordinary growth rate. However, most agree that a firm that is able to increases its revenues by at least 20 per cent annually for three years or more is considered high growth (Financial Times, N.D.; Investopdeia, N.D; OECD, 2012)

Research from the UK found that the majority of these HGFs have less than 50 employees but were relatively established in the market and over five years old. These firms were also found in all industry sectors (e.g. food, health), not just the technology sector (OECD, 2014).

Given the economic benefits of HGFs, it is now recognised that it is important for governments to understand how these firms are established, what drives them and ways to encourage more business growth. To do this, there needs to be a greater focus on support for growth-oriented entrepreneurship, and economic gardening is one tactical approach that could support the establishment of HGFs locally.

Economic gardening: “is an entrepreneurial approach to economic development that seeks to grow the local economy from within. Its premise is that local entrepreneurs create the companies that bring new wealth and economic growth to a region in the form of jobs, increased revenues, and a vibrant local business sector. Economic gardening seeks to focus on growing and nurturing local businesses rather than hunting for “big game” outside the area (ICMA, 2010)”.

Economic Gardening is different traditional types of business assistance as services such as business planning, accounting or workforce development. Instead it about supporting growth firm and letting business owners know how important they are to their community (ICMA, 2010).

The Edward Lowe Foundation (2017) notes that economic gardening is about supporting businesses to:

  • build market intelligence such as trend analysis and new resources;
  • Identify and understand new and existing markets;
  • Raise the visibility of the business through modern advertising such as search engine results and blogs and online communities;
  • To uses the same mechanisms to gain feedback on their products, customers and competitors;
  • Refine strategy to build a competitive advantage and sustainable mechanisms to retain it; and
  • Build the capability leadership and management team development.

Part 1: the Innovation and Entrepreneurial Ecosystem

Recently, entrepreneurship has become a core component of economic development policy all over the world. It is now recognised that entrepreneurs and innovation are key determinants in job creation and economic wealth.

Entrepreneurs play a key role in any economy as they are the people who take risks and have the initiative and capability to develop new business ideas and innovations. If successful, their reward is profits and business expansion, that is, economic wealth and job creation (Investopedia, N.D).

As a result, governments are now striving to create the conditions that foster entrepreneurship, with the “entrepreneurship ecosystem” becoming a common development strategy (Isenberg, 2014).

Entrepreneur an individual who runs a “business and assumes all the risks and rewards of a given business venture, idea, or good or service offered for sale. The entrepreneur is commonly seen as a business leader and innovator of new ideas and business processes”. (Investopedia, N.D)

Entrepreneurship “is much broader than the creation of a new business venture.  At its core, it is a mindset – a way of thinking and acting. It is about imagining new ways to solve problems and create value (Cited in Post, 2017)”.

Entrepreneurial ecosystem:  “refers to the interaction that takes place between a range of institutional and individual stakeholders so as to foster entrepreneurship, innovation and SME growth (SEAANZ, 2014).

Innovation ecosystem: is the flow of technology and information among people, enterprises, and institutions is central to an innovative process. It contains the interactions between the actors needed in order to turn an idea into a process, product, or service on the market (OECD, 1997).

Entrepreneurs may only look at three factors being “accessible markets, human capital/workforce and funding & finance,” however, the ecosystem that enables entrepreneurs to succeed, is a wider and more complex (World Economic Forum, 2013).  The concept of the entrepreneurial ecosystem argues that is it not just business minded people (entrepreneurs) that are required but an environment (i.e. the ecosystem) made of public and private players, which nurture and sustain entrepreneurs and businesses (Financial Times, N.D).

As a development strategy, the entrepreneurial ecosystem can be used as a conceptual framework designed to assess and foster economic development via entrepreneurship.  It contains a set of interdependent actors and factors that stimulate and enable creativity, innovation, small business growth and investment within a place (SEAANZ, 2014).

There are many assessment frameworks and each considers various intervention levels (national, regional and local), as well as various ecosystem determinants (such as policy, enabling environment or culture). These frameworks include the:

On review of these various frameworks, the Aspen Network of Development Entrepreneurs (2013) found that there are three areas of assessing the entrepreneurial ecosystem being:

  1. Entrepreneurial Determinants – the various factors that affect entrepreneurship, and include:
    • Finance (debt access, venture capitalist, access to grants , angels, stock markets);
    • Business support (industry networks incubators/ accelerator legal/ accounting Services);
    • Policy (tax rates, tax incentives, cost to start business);
    • Market (domestic sales, international sales, target market size);
    • Human capital (graduation rates, quality of education)
    • Infrastructure (access to telecom, access to electricity, access to infrastructure)
    • R&D (patents); and
    • Culture (entrepreneurial motivation, leadership/visibility, creativity);
  2. Entrepreneurial Performance – the specific activities that entrepreneurs perform that will ultimately deliver the impacts, and include number of firms created, employment generated and wealth; and
  3. Impact – the value created by entrepreneurs, and entrepreneurship, which may be measured economic growth, job creation and poverty reduction.

Based on an assessment from the aforementioned mentioned frameworks, governments can evaluate whether they have a strong entrepreneurial ecosystem and what actions they should put in place.

However, it is important to recognise that that each entrepreneurial ecosystem is unique and all determinants in the ecosystem are inter-dependent. Thus, governments should also be cautioned against relying on a single element to transform an economy. Instead governments should aim to create a balanced functioning entrepreneurial ecosystem by:

  • building the capabilities of local assets (e.g. innovative firms, universities, incubators);
  • promoting the networks and visibility of entrepreneurs and innovators; and
  • support financing for growth (e.g. venture capital).


Part two will discuss the gazelles and job creation.

Part Three will discuss the role of public and private actors in creating the ecosystem.

How Regions and Places Create Wealth and Grow

With more than half the world’s people now living in cities, cities play a new economic role in the global economy (World Bank Group, 2015). Cities have become their own strategic territories due to their size and location which facilitates a dynamic called economic agglomeration – a powerful force in economic development. It is Agglomeration forces that largely determine why some places grow and become richer and why others decline.

Agglomeration is defined as the “benefits that come when firms and people locate near one another together in cities and industrial clusters” (Edward Glassier, 2010).

Agglomeration is an interesting concept because it contradicts normal economic trends such as supply and demand. For example, the co-location of similar firms does not necessarily reduce demand and profits for goods and services through increased competition. Instead, agglomeration can support productive efficiencies, innovation, job creation and higher incomes which drive the competitiveness of firms and higher living standards for its residents (World Bank Group, 2015). Agglomeration is also an accumulative process, in that, growth continues to attract more people, investment making it places more productive and wealthy.

The following is a summary of the work by Mario Polèse[1], explaining the seven pillars of agglomeration and the economic rationale for growth.

  1. Scale economies in production

Agglomeration enables the firms to benefit from economies of scale through lower fixed costs through the centralisation of their production processes into a single location. Economies of scale is defined as “factors that cause the average cost of producing something to fall as the volume of its output increases (Economist, 2008)”. Locations that offer economies of scale tend to be cities where it makes economic sense for firms to concentrate their production facilities and locate those facilities close to lots of workers, driving down the cost of production.

  1. Scale economies in trade, transportation and distribution

In order for trade to occur in an orderly and efficient manner, facilities such as infrastructure and logistic networks need to be maintained and again this involves fixed costs. Places where there is a concentration of firms using these facilities, tend to have better maintained facilities, more accessible networks and lower unit costs, driving productivity. This is because, for governments and the private sector to invest in supplying such facilities they need to be economically viable and that is driven by scale – users and production through facilities.  When firms are able to benefit from supply chain efficacies and market access, it leads to the attraction of new firms and increased traded out of those places. Increased trade leads to higher incomes and the attraction of more workers propelling the creation of cities.

  1. Falling transport and communications costs

Firms need to be able to access a large enough market to generate a profit and it makes little sense to do this if the cost (time and money) of transporting goods or communicating (e.g. services via the internet, fibre optic etc. ) to the market and suppliers eats into a firms revenue.  Therefore the cost of transport and communication is therefore a “powerful barrier to market expansion”. Falling transport cost and communication enable firms to concentrate activities in one place to be closer their market or market access points to more effectively distribute to or establish new markets.

  1. The need for proximity: industry clusters

Industry clustering is about the benefits that firms receive by being located close to other firms in similar or interconnected industries. Cluster development is not just about the benefits of locating firms in the same place but about the collaboration and competition between competing companies that leads to a range of benefits. These include:

  • business transactions and information that can build economies of scale and improve output;
  • knowledge sharing and industry diversification through spill overs and spin offs’;
  • potential for specialisation (i.e. competitive advantages) and innovations;
  • specialised pools of labour and supports wider workforce development; and
  • lower unit costs of infrastructure.
  1. The advantages of diversity

Firms also benefit from variation and diversity which can only really occur in places such as cities that have large markets. For example, variation supports firms to rapidly scale production due to access to diverse customers, skilled workers and suppliers; and to develop niches that are only viable in large markets. In addition, variation and diversity also supports intangible benefits such as culture and creativity which underpins innovation and therefore the competitiveness of firms and the city.

  1. The quest for the centre

Firms need access to their customers and it makes economic sense to be located in the geographic centre of their markets. However, ‘centrality’ (the centre of somewhere/thing) can also be man-made, as investment overtime can make one location more central for access to other areas and markets (i.e. ports that can act gateway – especially intermodal and ones with multi-connections such as Heathrow, Singapore or Dubai). Consequently, for firms that export, it will be places that provide the best access to customers via market-access infrastructure. Either way, the most strategic location for a firm is one that minimises the cost for the majority of its customers to reach them – and that generally is a city.

  1. The buzz and bright lights

People are also driven to agglomerate. The majority of us, to some extent, want to be located near to near people and with people of similar skills (clusters). People also want access to better services, amenity, culture, and better jobs and higher incomes – all which can generally be found in cities. As Polèse’s notes, agglomeration is undoubtedly an economic driver but it also “fulfils a social need” which makes it a virtuous cycle.


[1] Polèse, M (2009) The Wealth and Poverty of Regions: Why Cities Matter. The University of Chicago Press. Chicago.


Private Sector Development: in Conflict Zones

Promoting economic development is much harder in fragile and conflict situations (FCS), as poverty rates are around 20 per cent higher, economic performance is weak, there are high rates of criminal violence, and international issues such as drugs, arms and trafficking are more likely to be present (Peschka, 2011). Fundamentally, normal market conditions do not exist due to a combination of factors that make programming extremely complex and expensive. Factors include that:

  • the private sector comprises of formal, informal and illegal actors, and displaced communities;
  • workforce and skills are diminished due to death, injury, displacement and unemployment;
  • macroeconomic conditions are volatile due to inflation, currency weakness and fiscal investment;
  • illegal activities and corruption are prevalent;
  • there is limited access to basic services and infrastructure (especially connectivity and IT);
  • legal and regulatory frameworks and institutions have become fragile;
  • there is limited access to finance as investors leave or become risk adverse;
  • market distortions (availability of goods and services) and suspicion of the private sector exit;
  • there is rent-seeking behaviour and ownerships rights has become uncertain; and
  • the government is weakened and its legitimacy is questionable (Peschka, 2011; Rossignol, 2016).

Despite these significant challenges, private sector activity continues and to some extent, remains resilient to volatility. Thus the development community believe that the economic development, especially via private sector development (PSD), has a crucial role to play in economic recovery and achieving peace. This is because only the private sector is capable of growing new enterprises, opening investment opportunities, and providing employment and economic security.

In FCS, the private sector play a vital role in maintaining community structures by providing over 90 per cent of jobs generating income for families, preserving workforce skills and generating sources of tax and export revenues (Arvis, 2016; Peschka, 2011). The private sector are also motivated to support development as they are typically interested in economic and political stability, tend to be SMEs, are labour intensive, less dependent on imports, linked to other enterprises and innovative in their approaches. Individually, firms represent less economic power but they are an easier vehicle for the development community to work. The private sector is also likely to be a first mover in investing in people and economy, thereby making them a powerful force in “reconstruction and regeneration (Peschk 2011)”.

It is recommended that international donors (including NGO providers) and the respective governments work with the private sector and citizens to identify appropriate packages of interventions and enable implementation ownership. PSD interventions may include: access to finance, market access, infrastructure, investment attraction, workforce development, value chain, private-public partnerships, industrial zones, and inclusive growth projects (Arvis, 2016; Peschka, 2011; Jepsen, 2016; Rossignol, 2016).

In addition to generating jobs, creating economic opportunities and filling gaps in delivering basic services, the private sector can help lift business confidence, create legitimacy of the government and apply pressure for more systemic reforms (OECD, 2008). Development efforts should therefore also be coupled with reforms to “establish or strengthen transparency, trust, effectiveness, and legitimacy in the government institutions”, which provides an institutional framework to reinforce PSD and peace (Peschka, 2011).

The Process of Growth

How we grow

The economic growth is defined by two distinctly different processes. As previously noted, we have used the following basic definition to define economic growth as “an increase in the capacity of an economy to produce goods and services, compared from one period of time to another” (Investopedia, N.D). However, the factors that drive these distinct processes are different and it depends on where your economy is in its development trajectory.

The first growth process is catch-up growth. Catch up growth occurs in developing nations when exogenous (outside) knowledge and technologies are applied to build better roads, schools, and hospitals etc. closing development gaps. As underdeveloped nations start with less capital, their productivity is substantially boosted, rapidly driving up productivity by replicating methods of production, technologies, and institutions used in developed economies. As a result catch-up growth can lead to growth rates as high as 5-10 per cent as seen by China and South Korea over the last few decades. (Sachs, 2015).

The second growth process is endogenous growth. Endogenous growth refers to the “economic advancement that emerges from the internal workings of the economy (Sachs, 2015).” Endogenous growth requires nations to have skilled workers, be technology leaders and their business need to have the capabilities to develop new and sustain competitive advantages. Endogenous growth therefore comes from innovation of new machinery, techniques and industries; and a must in order to belong to the developed world.

The process of endogenous growth is sometimes also referred to as “a process of increasing returns to scale or chain reaction economy” as allows for spill-overs that continue to stimulate further and combine innovations (Sachs, 2015). Acemouglu and Robinson (2012) go further in their definition to suggest endogenous growth also is about having the capabilities to transform and respond the “wide spread creative destruction” which is associated with innovation. As endogenous growth is not about adoption but creation, it is harder and slower process at around 1-2 per cent growth in GDP a year (Sachs, 2015).

Why it matters

Making the distinction between the two growth process matters because it requires different institutions[1] in that catch-up growth is about adoption and endogenous growth is about innovation (Acemouglu and Robinson, 2012; Sachs, 2015). And economic developers are not always conscious of this in their interventions.

Catch up-growth requires governments to have a stronger role in stimulating growth directly. Governments of developing nations need to quickly develop infrastructure, advance human capital outcomes and attract investment which are considered a prerequisite for endogenous growth.

While the role of government in stimulating endogenous growth more about enabling the private sector to innovate and be competitive. Government role is more about regulatory reform that enables structural change, advanced workforce development such as STEM programs and R&D.

[1] A  nations cultural, norms and regulative elements