The private sector is the portion of an economy owned and controlled by private individuals, households and businesses rather than by the state. It ranges from street vendors and family farms to small and medium-sized enterprises, large private firms and companies whose shares trade on a stock exchange. Firms in the private sector generally aim to earn a profit, raise their own funds from owners, lenders and investors, and compete for customers in markets.
The private sector is defined in contrast to the public sector, which covers government and state-owned enterprises. In national accounts, statisticians split the private economy into non-financial corporations, financial corporations such as banks and insurers, households, and non-profit institutions serving households. Charities and other non-profit groups are sometimes treated separately as a "third sector".
The private sector in plain terms
Think of a town market. The council owns the square, sweeps it and sets the opening hours; that is the public part. Everything sold from the stalls, the bakery, the phone repair shop, the café, is run by people who put up their own money, choose what to sell and keep what they earn if it goes well, or lose it if it does not.
The private sector is all of those stalls across a whole economy. It produces most of the goods and services people buy and employs most workers, guided by prices, competition and the hope of profit rather than by a government plan.
Role in the economy
In most countries the private sector produces the majority of output and jobs. The World Bank's World Development Report 2013 noted that the private sector provides about nine out of ten jobs in developing countries, many of them in small or informal firms. In OECD countries, where general government accounts for around 18% of employment on average, most of the remainder is private. Private firms carry out most business investment and research and development, and the drive of the entrepreneur to start firms and introduce new products is central to innovation and what Joseph Schumpeter called creative destruction. A large share of private activity in developing countries takes place in the informal economy, outside tax and regulation.
Measuring the private sector
Statisticians measure the private sector in several ways. On the spending side of GDP, household consumption and private business investment usually make up most of total demand. On the employment side, labor force surveys separate private employees and the self-employed from public employees. A common indicator of financial development is domestic credit to the private sector as a share of GDP, published by the World Bank: it is well above 100% in some advanced economies and far lower in many low-income countries, where firms rely more on their own savings and informal lenders. Business surveys, such as purchasing managers' indices, track private activity month by month.
How the private sector is financed
- Owners' funds and retained profits. Most small firms start with the founders' savings and grow by reinvesting earnings.
- Bank credit. Loans and overdrafts from commercial banks, shaped by interest rates and monetary policy.
- Capital markets. Larger firms issue shares and corporate bonds on the capital market, including through an initial public offering.
- Private investors. Venture capital, private equity and private credit funds finance firms that are not listed.
- Foreign capital. Foreign direct investment brings capital, technology and management from abroad.
Private sector and public policy
Governments shape the private sector through taxes, regulation, property rights, competition law and trade policy. Development institutions such as the World Bank's International Finance Corporation lend to and invest in private firms in poorer countries, and governments use public-private partnerships to bring private finance and management into infrastructure. Waves of privatization since the 1980s moved telecoms, airlines, utilities and banks into private hands in many countries, while some crises led to temporary nationalization. Macroeconomists also track the private sector's financial balance, the gap between its saving and investment, which together with the government and foreign balances must sum to zero; large private deficits funded by debt preceded several crises, including the 2008 financial crisis.
Debates
Advocates of free-market economics and capitalism argue that private ownership, competition and the profit motive allocate resources more efficiently than state control, encourage innovation and limit the concentration of power in government. Critics, from social-democratic to Marxist perspectives, argue that private firms under-provide public goods, ignore externalities such as pollution, may gain monopoly power, and can worsen inequality without regulation and redistribution. Debates over stakeholder capitalism concern whether companies should serve only their owners or also workers, customers and communities. Most economies in practice are mixed, and the argument is mainly about where to draw the line.