United States Institute of Peace

International Network for Economics and Conflict

Business as Usual in Fragile States? Part 1. Leveraging Aid for Private Sector Development

*Written by Sadaf Lakhani, Advisor with invest2innovate and Featured INEC Blogger

This week, the G8 leaders will meet to discuss, amongst other issues, how to spread prosperity and grow economies around the world, and how to ensure greater accountability in international development assistance. One set of countries for whom the summit is likely to have important implications is those considered to be ‘fragile situations.’ Per capita income in these countries has been growing only slowly, at just over half the rate of that in low-income countries, and they suffer from high levels of income inequality. Fragile situations and conflict-affected states are home to about one-third of the world’s poor (that’s 1.5 billion people), with this figure expected to rise to about half the world’s poor by 2015. 

Fragile states matter more and more to development practitioners, and, for reasons of stability and trade, to the rest of the world too.

We know this. Yet, countries that not too long ago had been considered ‘stable’  – such as Mali, Libya, Syria and even Turkey - have recently experienced violent conflict or far-reaching political and social upheavals. Old-timers on the list of fragile situations, such as Afghanistan, Democratic Republic of Congo, Pakistan and Iraq, which have been recipients of large volumes of overseas development assistance (ODA) over several years, have not made it off the list and don’t look as though they will anytime soon. As World Bank President Jim Kim has emphasized: we need to do things differently in fragile situations. Stepping up support for private sector development is being proposed as one of the ways in which aid should be used towards development goals in fragile contexts. Here’s why: 

Although levels of ODA to fragile states have grown significantly in recent years, and currently constitute the largest financial flow to these states the current fiscal challenges experienced in OECD countries mean that many fragile states are likely to experience declining levels of aid in coming years. At the same time, while 10 years ago the group of countries classified as ‘fragile’ encompassed primarily low-income countries, now almost half of those in fragile situations are middle-income countries. This shift is, in some ways, an important one.[1] Many of these states are not eligible for concessional development financing, and aid does not constitute a significant percentage of total resource flows or of government budgets. In general, international development assistance is becoming less significant in fighting fragility than it has been in the past. With international development assistance losing its comparative significance - in terms of volume - in fragile situations and conflict-affected states, this juncture presents the international development community with an opportunity to change the way we use aid. With other kinds of financial flows becoming increasingly important resources to address fragility, smarter use of aid would focus on assisting structural changes that can catalyze the impact of other investments which have the potential for reducing fragility and sustainable development.

Creating jobs, securing livelihoods and incomes and broad-based growth have been highlighted as key areas of focus in addressing fragile situations, and encouraging private sector development has been determined as a strategic priority for fragile situations by development agencies such as the U.S. Agency for International Development and development financing institutions including the World Bank Group[2] as well as by the G7+ group of states involved in the New Deal for engagement in fragile states.[3]

Smarter programming of ODA can help facilitate private investments, create jobs and spur economic growth. While the private sector is often able to function in fragile situations even in the absence of stability, businesses face considerable constraints and costs to operating in these kinds of contexts. ODA should be targeted to help address these constraints. Reliable electricity and access to credit have been cited as being amongst the greatest challenges faced by businesses in fragile states, compared with concerns about the regulatory environment as one of the most common challenges experienced in developing countries. And even more than in other contexts, businesses, particularly smaller domestic enterprises, can face high and uncertain transaction costs when operating in fragile situations. These are the result of the very particular environments created by weak government institutions, deep divisions between social groups and a legacy of poor-investment in infrastructure and human development that characterizes many fragile situations. Development assistance for the private sector however, has tended to be concentrated in the extractives sector, and more recently in financial services and telecommunications.

The question ‘What must we do differently?’ is deservedly being addressed by ongoing research that will be able to guide approaches employed in fragile situations.[4] What we shouldn’t forget when seeking to define effective strategies is that peacebuilding is a highly political process. The approaches taken in private sector development and employment creation can contribute to promoting peace; for instance, when job creation addresses needs and grievances or when it reduces tensions and the causes of conflict such as by securing civilian livelihoods in a post-conflict economy or ensuring a more equitable distribution of wealth. At the same time, approaches may also exacerbate or create new conflict dynamics and even ignite violence; for example, by sowing perceptions of injustice by supporting the ‘winners’ of the conflict or one specific social group over others. Understanding the social dimensions of such change and how they can impact conflict drivers or stressors must be central to research and design of effective aid strategies supporting private sector development.

Part two of ‘Fragile States: Business as Usual?,’ looks in more detail at how the private sector can contribute towards peacebuilding goals and to development objectives of a post-2015 MDG framework in fragile situations.

[1] It’s also important to note that almost half of all ODA to fragile states goes to only 7 countries.

[2] The World Development Report 2011 emphasized the importance of building legitimate institutions in fragile situations, which will provide people with security, justice and jobs. See also the USAID Fragile States Strategy (January 2005) which highlights economic support- including job creation as one of the four priority programming areas for fragile contexts.

[3] ODA investment in private sector development has increased worldwide in the past decade. E.g. investments by the World Bank Group grew from $10 billion to $35 billion in the period 1998 to 2008. Unfortunately, the same trend –of growing aid investments in the private sector- has not been seen in fragile states.

[4] For example the UK Overseas Development Institute recently launched a project looking at channels for job creation in fragile states in sub-Saharan Africa.

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