Private Sector Development in Fragile States

Countries affected by fragility, conflict, and violence pose significant challenges for development. Traditional donor-government development institutions face limited access in such environments and are bound by formal diplomatic relations and security risks. The World Bank estimates that some 1.5 billion people live in areas that are fragile or affected by conflict and no fragile state has achieved a single Millennium Development Goal (MDG). Where official development assistance is not an option, the international community has increasingly looked to private sector development to provide early stabilization, spur long-term growth, improve transparency, raise employment rates, and foster trade.

The CSIS Working Group on Private Sector Development in Fragile, Conflict-Affected, and Violent (FCV) States explored the challenges and opportunities for private-sector engagement in the development of FCV countries. Participants included 40 individuals representing the private, public, and volunteer sectors, including businesses, investors, multilateral organizations, bilateral donors, and government agencies. The working group identified tools available to the international business community and the U.S. government, as well as the gaps in needed resources. Its findings, to be published in a forthcoming report from the CSIS Program on Crisis, Conflict, and Cooperation (C3), are summarized here.

Q1: What are the unique challenges that fragile states face?

A1: Fragile states are set apart from other developing countries by persistent cycles of violence and conflict and are strained by humanitarian crises, civil wars, armed rebel groups, and internally-displaced persons. Government capacity is severely affected with limited administrative functions, ineffective execution of policy, and a lack of legitimacy. The governments of fragile states are marked by high levels of corruption, cronyism, and political infighting. Sometimes groups seize power in areas outside central government control and administer their own justice, policing, and resource distribution. The economies of these states are brittle as well, incapable of generating sustainable employment and frequently dependent on the export of a few primary goods.

The populations of fragile states make up staggering ratios of international statistics on poverty, hunger, and development. Those living in fragile situations account for one-third of all deaths from HIV/AIDS in poor countries, one-third of all people in the world who lack access to clean water, one-third of all children who do not complete primary school, and almost half of all child deaths. Fragile countries also consume more than one-third of all official development assistance from donor countries.

Q2: What are some of the obstacles to engagement in fragile situations?

A2: Both donor governments and the private sector may face serious obstacles to investment and development in fragile countries, some of which could take generations to address and overcome.

First, corruption is more widespread and persistent in fragile states than in other developing countries. In Afghanistan, for example, one-third of all foreign assistance provided since 2001 is unaccounted for due to corruption and mismanagement.

Second, citizens of fragile states have learned to rely on the government, rather than the private sector, to be the main participant in economic activities. Governments of fragile, resource rich countries often have control of lucrative industries such as oil or mining and are reluctant to release holdings.

Third, donors meet an insecure environment, forcing them to tailor engagement for maximum short-term impact rather than creating long-term sustainable development plans. Insecurity creates an informal,

highly distorted trade economy based on extraction and predation. Private sector actors risk exasperating or further entrenching such distortions, especially if ethnic conflict is a factor.

Finally, fragile states frequently lack basic infrastructure, civil society, and financial institutions, hindering investment and development and creating political economies that are difficult for donors to navigate.

Q3: What are some new approaches to engaging fragile states?

A3: Private sector actors and government officials in fragile states recognize that working and investing in these situations is difficult and fraught with risk. To address this, leaders from the 19 fragile states that were furthest from reaching the MDG development goals came together in 2010 to create blueprint for international engagement, called the “New Deal.” The group, called the g7+, advocates for changing the way that foreign actors do work in fragile states. The group was created in part to push for a new approach, where solutions would come from the fragile countries themselves, rather than the international community. The g7+ established five peace-building and state-building goals that focus on legitimate and inclusive politics, new provisions for security, access to and delivery of justice, lowering unemployment rates, and enhancing accountable delivery of goods and services. All goals will work towards a more welcoming and stable environment for donors and private sector actors to do business.

Another new approach is diversification. The private sector is shifting its work in fragile states beyond its historical focus on extractive industries. Developing extractive industries have the potential to be very harmful, especially if the resource in question is a source of communal conflict. Private sector actors risk inadvertently enforcing a system of patronage or supporting a power imbalance. Moreover, investments in this sector have less potential to build local value chains or generate employment in the way that, for example, manufacturing does.

Private sector actors working in FCV countries are beginning to realize the potential in small and medium enterprises (SMEs), which can stimulate sustainable employment, entrepreneurship, and local innovation. SMEs tend to be more invested in their own country and can better contribute to quick economic recoveries. Private sector actors are also recognizing the importance of investing in the education sector in fragile states: higher education opportunities lead to more qualified individuals to work with the private sector, which fosters employment and generates innovation.

Q4: How could the U.S. government help the private sector in fragile states?

A4: There are several areas where the U.S. government could better assist private sector actors to engage in FCV countries. First, the U.S. government could use existing resources to provide more information about the country’s complicated political economy. Such a roadmap could prove extremely useful for investors and donors attempting to navigate local laws, rules, and procedures. This information could be consolidated and distributed by members of the U.S. Commercial Service, which currently sends trade professionals to more than 74 countries around the world. The role of these trade officers in embassies could be greatly expanded.

Second, the U.S. Overseas Private Investment Corporation (OPIC), which currently provides investors with financing, guarantees, and political risk insurance, could also create a fund that provides “first loss” capital. In other words, OPIC could make the investment then absorb at least some of the early losses until U.S. companies gain traction in fragile markets. Such a fund might further sway private sector actors on the fence about investing in ventures in fragile states.

Third, the United States could negotiate more bilateral investment treaties (BITs), an option that has been underused thus far. BITs are pacts between two countries that frame, assist, promote, and regulate foreign direct investment (FDI) flows. They allow the government of a fragile state to signal its willingness to respect international trade standards and business and property rights.

Finally, U.S. trade laws and regulations could be adjusted to open market access for goods from fragile states. These countries are sometimes shut out of trade opportunities because of protectionist laws and regulations that make it difficult to export goods to the United States. Exploring new options or revisiting the existing laws and regulations, especially for those fragile countries that are strategically important, could prove beneficial for the United States. With the emerging markets competing for market share aggressively and squeezing the existing space, the United States could benefit from access to new markets and trade that will help in diversification of the economy.

Sadika Hameed is a fellow with the Program on Crisis, Conflict, and Cooperation (C3) at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Kathryn Mixon is a research assistant and program coordinator with C3 at CSIS. Robert D. Lamb is a senior fellow and the director of C3 at CSIS.

Critical Questions
is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2013 by the Center for Strategic and International Studies. All rights reserved.


Photo Credit: Ilia Yefimovich/Getty Images

Robert D. Lamb

Kathryn Mixon

Sadika Hameed