Private Equity Finance as a Growth Engine: What It Means for Emerging Markets; Great Potential but Reforms Are Needed

Article excerpt

Entrepreneurship has long been considered crucial for economic development. An important element of entrepreneurship is the willingness and ability to mobilize private capital from both domestic and foreign sources. The private equity sector in the Middle East and North Africa (MENA) illustrates the role that private capital can play in the development of emerging markets. Data on the employment generation and growth performance of private equity provide evidence that it is an important driver of economic growth globally. This paper draws on initial evidence from the MENA region to illustrate the sector's potential there and in emerging markets generally. It then recommends a new generation of reforms to fuel this growth engine. A survey of MENA's private equity industry survey conducted for this paper assesses these developments and the sector's need for proactive reforms to support it. It also shows that international financial market interest in private equity finance does not seem to have abated with the recent market bust. The paper concludes by identifying priority areas for future policy and research.

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Some say discussions of entrepreneurship are nothing but "old wine in new bottles". Yet, we have seen a growing interest over the past 15 years in research, business schools, and the financial sector in furthering ideas, designing educational programs, and creating funds that promote the study and practice of entrepreneurship. Why is there growing interest in studying and discussing a well-known concept? What is the relevance of this to emerging markets, such as the Middle East and North Africa (MENA) region?

The private equity sector in the MENA region, the principal financier of entrepreneurship, has grown from a total capitalization in funds of US$2 billion in 2004 to US$6 billion by Q1 2006 but remains understudied and has not received the attention riveted on the public equity boom and bust cycles there. Data on the employment generation and growth performance of private equity provide evidence that it is an important driver of economic growth globally.

A major source of private equity is private equity funds originating from domestic or regional sources. In MENA, in particular, private equity funds (also "firms" in this paper) are absorbing increasingly large amounts of the surplus from petrodollar recycling through establishments like family offices and through independent, "purpose-built" private equity investment firms modeled along the lines of the general partner/limited partner structures prevalent in the United States and, increasingly, Europe. The private equity sector in MENA is attractive to investors because labor is available, and it is convenient for policy makers because it creates jobs. The private equity sector is also proving to be a significant mechanism for knowledge transfer through partnerships and joint ventures with global firms. Also, it is an attractive employer for highly skilled professionals who bring into the MENA region experience from abroad. This contrasts with public policies to promote knowledge transfer in the MENA region, which have either been inadequate or non-existent, or--even worse--dismal failures due to weak alignment of incentives. This paper draws on initial evidence from the MENA region to illustrate PE's market potential in MENA, and for emerging markets generally. It then recommends a new generation of reforms to fuel this growth engine, partly by properly aligning incentives through requisite institutions. The paper concludes by identifying priority areas for policy and research. The paper is motivated by clear evidence from the MENA region that periods of high liquidity can jump-start new financial sectors such as private equity and that if appropriate institutions are created to complement these sectors, they can generate sustained growth.

The conceptual underpinnings of the paper come from recent developments in agency theory to argue that the promotion of entrepreneurship goes beyond the traditional approach of supporting the private sector through supply-side institutions--such as providing a hospitable regulatory and macroeconomic environment. …