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The following remarks were delivered on April 25, 2007, at a conference sponsored by the Parker Foundation. 

Drawing upon my studies, my work with business and my recent government experience in the international area, I would like to establish the context for discussion of development of SMEs, or small-to-medium-sized enterprises. We are entering a period of unprecedented bottom-up innovation.  If the 20th century was about top-down, rule-driven bureaucracy, the 21st century will be about social entrepreneurs, private philanthropy, public-private partnerships and global grassroots linkages involving faith and civic communities. 

A number of trends illustrate this point: 

Technical solutions to the problems plaguing the third world are proliferating as more and more companies apply their research and knowledge products to confront third world poverty. 

Globalization is taking technology to the farthest reaches of the earth. C.K. Prahalad in “Fortune at the Bottom of the Pyramid” describes how globalization can open up entire vistas of investment and wealth creation for the 3 billion human beings who live on $2 a day or less. He calls for mobilizing the resources, scale and scope of large firms to co-create solutions to the problems at the bottom of the pyramid. 

There is unprecedented involvement by social entrepreneurs internationally using both creative philanthropy and hands-on partnering. 

There is a revolution in bottom-up participatory civil society – what one author called an “associational revolution” – and with it comes communications technology that enables the poor to speak for themselves for the first time in human history. When the poor speak for themselves, the world discovers what they really want is opportunity, not handouts. 

We are in what Peter Drucker called the century of the nonprofit, an era in which a growing number of people will be employed to think about and confront these problems. Nonprofits now comprise 8 percent of domestic and 5 percent of worldwide GDP. 

We are witnessing the demise of centralized coordination of development by aid agency experts. 

These are powerful and irreversible trends that are at work. Twenty five years ago, 70 percent of resources from the U.S. were foreign aid, or traditional government-to-government development assistance. Today, 85 percent of all outflows come in the form of private investment or some form of private aid flowing through NGOs and other channels. Development assistance in the past, except for a few notable exceptions, didn’t really produce development. 

By private I mean the entire range of nongovernmental sources: NGOs, philanthropy, corporate citizenship, congregations, faith-based charities, universities, entire conglomerates of development-oriented enterprises (I would include the Gates and Clinton Foundations). And more and more, the lines between NGOs and profit-seeking enterprises are blurring. 

Today, there are thousands of worthy projects and programs underway that simply did not exist 15 years ago. Do a web search of international development programs and initiatives and I am told they run into the hundreds of thousands. 

We are transitioning from decades of government domination, to public-private partnerships (particularly between business and government), to a period in which the private sector will dominate. At almost any forum you go to today, the emphasis is on the private sector and what it can do. 

Government policy is now working at its best when it is doing two things: leveraging greater private investment and partnering and leveraging reforms of state institutions in developing countries. 

Traditional aid will never come close to building critical mass for social and economic development. Many advocates for the poor are moving beyond aid and charity models to promote a range of growth-producing strategies, including village banking, micro-enterprise, micro-franchising, partnerships with SMEs in emerging markets and private equity funds. 

I had the privilege of being directly involved in shaping the President’s Faith-Based Initiative and later, less directly, the Global Development Alliance, the Millennium Challenge Corporation, Volunteers for Prosperity and the President’s Malaria Initiative. All of these initiatives were grounded in the premise that our policies must leverage greater private sector involvement and drive state reforms. I will return to the latter shortly. 

The last mission I carried out was private sector coordination for tsunami reconstruction at the State Department. While the Congress dickered for three months and ultimately passed only $657 million in government aid, the private sector spontaneous generated over $2 billion through business, civic and even Internet-based philanthropy campaigns. The private-to-public funding ratio turned out to be about 3 to 1. For the first time in history, hundreds of millions in donations flowed into U.S. faith-based organizations, such as World Vision, from unlikely places, such as Australian, Korea and Japan. This is the difference globalization is making. 

But there was more than money involved. Dozens of companies immediately instituted prearranged emergency response systems consisting of databases of staff experts who had signed up in advance to volunteer, donate products, provide supply chain expertise and build IT and communications systems. In some cases, entire operating units were employed on an emergency basis. The private sector is no longer synonymous with amateurism, which has historically been the accusation. 

As a result of these trends, aid is going to become more personal, less bureaucratic, more results-oriented and more geared toward generating a culture of self-help. In short, aid will become more transformative. 

Globalization is bringing about radical change by allowing information to come to the attention of investors and also by making it far easier to bring the money, networks and expertise of the American private sector to bear, bypassing big institutions and the supervision of development officials and experts. The work of reducing poverty will be less shrouded in the technical jargon of state development bureaucracies and more guided by a simple question: What works? In other words, what produces growing economies, higher incomes and less poverty? 

I have taken your time on these broader themes and trends to suggest one important point: The opportunity to lead the global poverty reduction effort is falling to people like you. 

I cannot state strongly enough how important it is that we seek to move beyond the charity model.  To be fair, there will always be need for charity, even in the richest country on earth. We just can’t make that the primary focus when the task is poverty reduction. More and more, we’re finding that what people everywhere want is the opportunity to be self-reliant. 

Few would deny that the poor have moral worth and dignity, but the poor are rarely valued on the same terms as those who are not poor. While the poor have weighed on the minds of humanitarians workers, 80 percent of them are effectively invisible and ignored as potential actors in an emerging global market place, as both consumers and entrepreneurs.     

They will be valued when they are seen as indispensable to wealth creation and when they are seen as potential customers with both production and purchasing power. The poor will never achieve their dignity if they remain dependent on the kindness of strangers and are not made partners in their own development. 

The second point I want to make concerns the need for more positive “enabling environments” for business to flourish. That’s a fancy term for a lot of things, including infrastructure, rule of law, anti-corruption measures and sound governing institutions – the kinds of thing we take for granted but which rarely exist in the developing world. To put it all in a more understandable context, most business investors would not look first for business opportunities in South Philadelphia – as opposed to Lancaster, where I am from – unless they were doing so on charitable grounds. 

Just as the state of Pennsylvania is experiencing very uneven development, so is the rest of the world. More than fifty countries are worse off today than they were in 1990. Not surprisingly, only 1 percent of all outflows of direct investment go to the world’s least developed countries. If we are to confront poverty with business-based solutions, if we are to move these countries from charity and subsidies to internal growth based upon improving livelihoods, we must figure out how to dramatically reduce the disadvantages. 

What does it really take to foster enterprise? Why do some countries and communities flourish and others stagnate? 

Is it usually a lack of motivation or aptitude? Well, to be honest, sometimes, yes. While we should not stereotype the poor, neither should we underestimate the power of world view and core values. But most of the time the problem isn’t motivation. It isn’t a lack of native ingenuity or work ethic. In so many cases poverty is less a lack of things than a lack of power to change circumstances. 

Development must come with a demand for better governance. We need to work with the poor and indigenous civil society groups to advance stronger, more competent governments. 

Now a couple comments about SMEs and how they might be relevant. The potential is quite obvious: According to the Organization of Economic Cooperation and Development, SMEs account for 95 percent of manufacturing enterprises in less developed countries. Additionally, SMEs generate two-thirds of private sector employment and are the principle source of new jobs in these countries. 

SMEs have the capacity to drive greater growth. Studies show that those countries in which SMEs dominate experience more growth. In low income countries, micro-enterprise accounts for nearly 50 percent of GDP as compared to only 13 percent in high income countries, according to the World Bank. And in growing economies, banks have become the main source of financing for business. 

SMEs represent what has been called the “missing middle.” Many underdeveloped countries have a handful of large well established firms, often extractive industries with political connections, and a far larger number of small micro-enterprises operating in the informal economy. A strong and thriving SME sector can help grow micro-enterprise, supplying demand for their products and generating broader consumer purchasing power. 

There are many things internally that must be done for that missing middle gap to be closed.   Research shows that SMEs are stifled by perverse regulatory climates and poor access to a variety of normal business inputs, especially capital. These restrictions include poor access to markets, rampant corruption, lack of technology, weak accounting standards, poor public services such as electricity and roads, and more. The biggest need is building the capacity of the financial sector by expanding basic banking capacity and adopting modern practices and standards.     

This is what we are talking about when we mention “enabling environments.” We are talking about how hospitable or inhospitable the climate is for investment and growth. We are talking about basic things like social and political stability, safety and infrastructure.  

The biggest challenge to advancing SME is reducible to one word: risk.     

Perhaps the most worrisome factor emerging on the global stage is ethnic, sectarian and tribal conflict. Somewhere between 40 and 50 of the poorest countries appear hopelessly dysfunctional, with rising populations and declining GDPs. Sixty countries are crippled by systemic corruption, and 30 are at the brink of civil war. Some predict the retreat of nation-states in these regions combined with the rise of private non-state entities, or “statelets,” run by criminal gangs and militia. Conditions in these countries may continue to get worse before getting better, and it will be a long time before they move much beyond the charity model. 

There are profound consequences when the state is weak and corrupt or is steadily replaced by violent criminal elements. The key to capitalist success is the same for the poor as it is for the rich: capital. Capital is king. And capital, it has been said, is cowardly. Lack of credit plays a huge role in keeping the poor poor. Survey after survey by the World Bank has cited financing constraints as the chief impediment to the growth of SMEs. 

“Imagine a country where nobody can identify who owns what, addresses can’t be easily verified, people cannot be made to pay their debts, resources can’t be conveniently turned into money, ownership can’t be divided into shares, descriptions of assets are not standardized and cannot be easily compared and the rules that govern property vary from neighborhood to neighborhood and even street to street.” Imagine that, says Stephen Smith of Western Governors University, “and you have just put yourself into the life of a developing country.” 

Something so simple as capital, in other words, isn’t so simple when you consider the wide array of legal, regulatory, currency and banking barriers that exist. Peruvian economist Hernando De Soto’s studies show that there is a vast reservoir of entrepreneurial talent and potential capital for investment that can’t be fully harnessed for development because it operates outside of legal structures. He finds in many countries it takes hundreds of days to register a business, gain legal authorization to build a structure on a plot of land, carry out hundreds of administrative steps covering dozens of agencies in governments that are often decades, if not centuries, behind in their professional capacity. In one country, he found that obtaining title to land required a total of 728 steps. 

Upwards of $9 trillion in equity exists in the hands of the world’s poorest, but it cannot be used to leverage business development effectively because of the lack of banking institutions, property titles and basic laws protecting private enterprise.    

The greatest potential asset of the poor is land, which could be used as collateral for loans. Yet a UN study found that half a billion people till land they do not securely own. The untitled land in Haiti is valued at $5.2 billion. In the Philippines, that number is $133 billion.    

De Soto says fully five-sixths of humanity have potential sources of wealth, but they lack the process to represent their property and create capital. They have houses, but not titles, crops but not deeds. Ninety percent of small entrepreneurs are excluded from financial services in their countries. In the vast majority of poor countries, banks simply prefer to deposit their reserves in a Western bank. These are the characteristics of the type of enabling environment that cripples enterprise development.  

These enabling environment obstacles are far more consequential for SMEs that have the innate potential for growth than they are for single micro-entreprenuers who are basically managing improvements in their individual livelihoods through small loans. Micro-enterprises typically function within small local markets while SMEs will likely require more access to wider markets and stronger and better governing institutions. 

From the standpoint of outside investors, one of the greatest needs is simply improving information regarding SMEs. Despite infertile enterprise environments, there are worthy businesses all over the developing world. They just don’t show up on the radar screens of Western investors. 

The consulting firm Booze Allen is working on an advanced web-based global intelligence system to serve a “mega-community” of businesses and nonprofits, which, when up and operating, will enable anyone from anywhere to survey the civic and economic map of virtually every community in the world. The system will offer “market intelligence” that can help potential investors know vastly more than they do at present regarding critical factors affecting business success. This tool is only one of many that will bridge the knowledge gap. A big factor in investing anywhere is reducing the number of uncertainties that arise from areas like social and political environment or factors relating to a particular firm. Spreading knowledge about SMEs will help reduce this uncertainty. 

Also important are new investment mechanisms. There is a growing trend of individual business investors who discover a small third world firm and choose to partner with it, often providing mentoring and some form of assistance in market development. There is a fair amount of this kind of one-on-one mentoring and partnering going on. 

There is also a trend toward existing NGOs and lending institutions creating venture capital funds. There are a variety of programs, such as the African Development Foundation, that are government-funded but which could be replicated easily in the private sector. These would essentially be NGO-managed SME initiatives. Presumably, these NGOs would do much of the necessary intermediary work to back emerging entrepreneurs with mentoring and business development help.   

There is also the possibility of strictly private sector based venture capital funds modeled after the so-called “angel investors.” These venture funds would either operate at the dotted line separating charity and investment or would be set up strictly on a market basis. As a result, they would carry the expectation of high returns in response to high risk, which would be reflected in the cost of the credit and where the credit is extended.   

A final suggestion is that as we examine SME funding as an emerging trend, we also need to consider another model that could help drive growth in this sector: micro-franchising. There are a variety of strengths that are inherent in micro-franchising that are not necessarily present in other small-scale enterprise models.   

In conclusion, while SME development as an emerging field is highly promising, I don’t think SMEs will just happen. As I have said, enabling environments are critical. And there is a major need in many cases for technical assistance, industry expertise and partnering. Venture capital initiatives will likely need much assistance with research and due diligence during the early stages and oversight as they grow. I imagine a major role emerging for nonprofits in this respect.   This vital function of vetting and capacity building, if met, would likely result in far more SME investment.