# **1. Introduction: Fragility and its implications for development finance**

Fragile states face multiple problems that reinforce each other, locking them in a recurring cycle of poverty and hopelessness. Typically, society is fractured into opposing groups, with little or no shared identity that might settle differences in a context of cooperation. The state lacks legitimacy with a substantial number of its own citizens, and importantly for the business environment, it lacks the capacity to perform basic functions such as taxation, and providing security, the rule of law, and economic infrastructure. Firms and households face existential uncertainties that discourage irreversible decisions and shorten horizons. There are few formal private enterprises and so the workforce cannot reap economies of scale and specialization, leaving the population unproductive and impoverished. The society is too poor to go through the demographic transition, so there are many youths facing few opportunities. Finally, the polity and the economy are frequently hit by shocks against which they have little resilience.

These problems reinforce each other. Because the society is fractured into opposing groups, the state is typically regarded by parts of society as having been captured by one identity group, which undermines its legitimacy. Because it lacks legitimacy with many of its citizens, the state cannot rely on citizens’ compliance or community engagement, which means that basic functions of the state cannot be properly performed. This, in turn, further undermines the state’s legitimacy. The risks posed by lack of legitimacy, and the inadequacy of basic state functions, combine to discourage formal enterprises. The narrowness of the economy, the surfeit of young people, their lack economic opportunities, juxtaposed with the lack of state legitimacy, expose society to shocks, which the state struggles to cushion due to its limited capacity. In turn, the frequency and severity of adverse shocks keeps derailing attempts to escape from fragility.

This cycle entraps the society in poverty and a sense of hopelessness, and is why fragility is highly persistent. As more successful emerging market countries continue to converge on the income levels of OECD societies, the gap between them and the poorest countries is widening. The concept of the ‘Bottom Billion’<sup>4</sup> identified 60 countries that, as of the millennium, were mired in persistent poverty. The subsequent 2002–17 supercycle was a big opportunity for these countries, but even during this period of economic growth, fragile countries continued to rapidly diverge from emerging market countries (at 2.2 percent per year, per capita, population-weighted).

A few of the bottom billion, such as Rwanda and Ethiopia, transformed; but many others such as the Central African Republic (CAR), the Republic of Yemen and the bulk of the Middle East, which were once seen on track of change, have not only diverged, but they have gone into absolute decline. While the rest of the world has made rapid progress in eradicating extreme poverty, fragile states are increasingly the locus of the remaining extremely poor. For the world to achieve the Sustainable Development Goal (SDG) of eradicating extreme poverty by 2030, most of the improvements will need to come in fragile states.<sup>5</sup> Because rapid private enterprise growth has been central to reducing

> 4 Collier, 2007.

> 5 World Bank Group, 2018a.

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