SERIES: Learning to Compete Working Papers | Number 4 of 4 « Previous

Learning to Compete: Is Small Beautiful? Small Enterprise, Aid and Employment in Africa

INTRODUCTION

Highlights

  • There are more than 300 public and private investment funds for small and medium enterprises (SMEs) in low-income countries and almost a quarter of their investments in 2010 went to Africa. Official development assistance to SMEs totaled more than US$1 billion in 2009.
  • In our view, public policy, whether by governments or donors, should start with the proposition that entrepreneurs and business people are much better than policy makers and academics at identifying potentially successful business opportunities and binding constraints.
  • Despite the fact that the rationale for aid to small enterprises is centered on their role in creating jobs, we in fact know relatively little about small enterprises and job creation in low-income countries, especially in Africa.

Small firms are big business in the aid industry. Why? In a word, jobs. Globally, small and medium firms—those with less than 250 workers—account for nearly 80 percent of employment in the formal sector in low-income countries (Ayyagari et al. 2011). When micro and informal firms are counted—and they are not counted very well—the employment share of micro- small and medium enterprises (MSMEs) in developing countries rises to an estimated 90 percent of all workers. Not surprisingly, in the wake of the Arab Spring supporting micro and small enterprises has increasingly come to be viewed by the donor community as a ‘quick fix’ to boost job creation for the young and growing populations of Africa, the Middle East, and Asia.

At the 2012 spring meetings of the IMF and World Bank, Andrew Mitchell, then the UK Secretary of State for International Development, announced his government’s intention to provide funds for a seven-year program designed to help 250,000 small businesses in Africa and Asia create one million jobs. In launching the initiative Mitchell said, ‘Small and medium enterprises are a vital engine of job creation in developing countries. Yet they face a huge financing gap—especially in Africa, where SMEs need three times more funding than is currently available’.

Mitchell is not alone. The G-20 created the Financial Inclusion Experts Group (FIEG) in September 2009 to focus on promoting public-, private-, and social-sector finance to MSMEs in developing countries (McKinsey 2011). And, the European Union has asserted, ‘For developing countries, the expansion of the private sector, notably MSMEs is a powerful engine of economic growth and the main source of job creation (emphasis in original)’ (EU 2012).

Donor enthusiasm for small enterprises arises from a happy coincidence of objectives and instruments. Job creation is the objective, and money—in the form of development finance or funding for technical assistance—is the instrument. There are an estimated 365-445 million, formal and informal, MSMEs in the developing world. Of these approximately 70 percent report that they do not use any external financing, although they would do so if financing were available. Another 15 percent are underfinanced. The financing gap is estimated at US $2.1 trillion to US $2.5 trillion (McKinsey 2010, 2011). Filling such a large financing gap in the pursuit of jobs is an attractive objective for both public and private development actors.

In this paper we ask whether aid programs targeted to small and medium enterprises (SMEs) in Africa are the best way to create jobs. Following this introduction, Section 2 describes the current state of donor assistance to SMEs. There are more than 300 public and private investment funds for SMEs in low-income countries and almost a quarter of their investments in 2010 went to Africa. Official development assistance to SMEs totalled more than US $1 billion in 2009.

Section 3 surveys the cross-country evidence on SMEs and job creation. The data available indicate that when a cut off of 100 employees is used SMEs employ nearly 60 percent of workers in low-income countries. Firms in the size range 5-19 workers create the greatest share of new jobs in low-income countries, more than 58 percent, although the data available do not tell anything about how long those jobs last. There are also substantial differences in wages and productivity growth between small and large firms. Small firms consistently trail large firms in wages paid, wage growth and productivity growth.

In Africa firms with more than 100 workers employ about 50 percent of the labor force. Medium-scale enterprises (20-99 workers) constitute the second leading employment category with about 27 percent of the labor force, and small firms employ a further 23 percent. However, consistent with the evidence for developing countries in general, small firms in Africa appear to create a disproportionate share of new jobs. In the median African country about 47 percent of new jobs were created in firms with 5-19 workers.

There are, however, several methodological problems that bedevil attempts to draw strong conclusions from the data available about the ability of small firms to create jobs. The most critical of these is the inability to distinguish between gross and net job creation. Small firms indisputably create new jobs, but if small firms also have higher exit rates, ignoring firm exit, will tend to exaggerate their role in employment creation. The cross-country data are also wholly uninformative with respect to wages and wage growth.

Section 4 attempts to deal with productivity and wages by using a more restricted set of data drawn from enterprise surveys of nine African countries. There is a strong positive relationship between productivity and firm size. The average worker in a 160-worker firm produces as much value-added in 15 minutes as the average worker in a 5-worker enterprise does in an hour. Not surprisingly, workers in small African firms are paid far less than employees in larger firms. The earnings of the average worker in a 100-worker firm are about 80 per cent higher than the earnings of someone working in a 5-worker enterprise. This evidence is consistent with other studies using labor market data that find that the quality of jobs in small firms in Africa is lower than those in large firms.

SERIES: Learning to Compete Working Papers | Number 4