The rise of SMEs in sub-Saharan Africa

If you’ve ever set foot on the African continent, then the idea of seeing dozens of corner shops, table shops, shops on wheels and even “walking shops” is not at all foreign to you. If you’ve spent some time there, then you know that most people and even yourself rely on these businesses on a daily basis for absolutely anything as they cover a range of sectors and if you find yourself looking for a job in the private sector, chances are, a small or medium sized business owner will be your employer. In Sub-Saharan Africa, SMEs constitute a noteworthy part of the economy but most of them remain in the informal sector having, therefore, little to no direct impact on the economy. Deepankar Rustagi CEO of VConnect declared, in April at the Africa Tech Summit London, that “Africa is on the precipice of rapid economic expansion, this expansion will be through the emergence of stronger small business enterprises that will help lift millions out of poverty and create a large, much needed middle class”.

In this study, we will examine SMEs and how they affect development, the barriers encountered by entrepreneurs in Sub-Saharan Africa and what long-term solutions can be considered to generate benefits for SMEs and the overall economy.

What are SMEs?

SMEs represent a variety of firms in different sectors of the economy. It includes micro, small and medium-sized enterprises, from the one with subsistence level revenues and only a couple employees to the fast growing ones with up to 250 employees; according to the March 2017 World Bank report on Lessons from financing SMEs they add up to more than 95 percent of registered firms worldwide, account for more than 50 percent of jobs, and contribute more than 35 percent of Gross Domestic Product (GDP) in many emerging markets. In Sub-Saharan Africa, this translates to about 95% of firms. Generally, smaller or micro firms encounter challenges ranging mostly from unpredictable revenues, coarse entry regulations and lack of knowledge and specialization while for small and medium sized firms they are mainly limited access to investments and financing, stable infrastructures and technology.

Most economies in this day and age have understood the importance of SMEs in correlation with growth. As we prepare for the June 17th International MSME (Micro, Small and Medium enterprises) day, the 193 members of the UN adopted a resolution calling on stakeholders, states, UN entities and civil societies to observe the day and raise awareness on the impact SMEs could have towards reaching the goals in the 2030 Agenda.

How does/would Africa benefit from SMEs?

  • Employment opportunities and poverty alleviation

In Africa, about 75 million of the 200 million young people, aged between 15-24, are looking for work, the World Bank estimates that for the next 15 years, about 600 million jobs will be needed only to sustain the current workforce and the IMF to add “by 2035 the number of Africans joining the working age population (ages 15–64) will exceed that from the rest of the world combined.” Seen from this angle, there is an urgent need to address the rising population and the decreasing number of jobs. In emerging markets “most formal jobs are with SMEs, which also create 4 out of 5 new positions” (World Bank, 2015), SMEs are behind most of the jobs created in Sub-Saharan Africa, the World Economic Forum found that, in 2015, they generated an average of 80% of jobs in the region. They are a powerful mean to include women and youth in the economy but determining their actual weight is problematic given the high prevalence of SMEs in the informal sector.

Generating jobs is the biggest challenge for governments across Africa and the majority of the population is employed in the private sector with most part of the informal sector (which greatly contributes to the formal economy). In a study, the World Bank found that there are between 365-445 million micro, small and medium enterprises (MSMEs) in emerging markets: 25-30 million are formal SMEs; 55-70 million are formal micro enterprises; 285-345 million are informal enterprises. “In the absence of sufficient opportunities in the formal sector, informal activity is an essential safety net that provides employment and income to a large number of people who might otherwise be bound to poverty.” (IMF, 2017, p. 54)

  • Economic growth

MENON Business economics found that “SMEs first start to drive economic growth when levels of income start to climb. In this way, the role of SMEs in economic growth and development becomes highly important when a country is set on track along a development path based on persistent economic growth”. By number, it is clear that SMEs are dominant in the global business sphere nevertheless, their contribution varies from region to region and many other institutional factors. The fact that the informal sector in the economy is large in Africa and that there is a high concentration of SMEs on that side is not necessarily a positive thing for the economy because most of them are not regulated by the government, don’t pay any taxes and are not included in the GDP. The African development bank stated in 2013 in Africa, SMEs in the formal sector contribute to about 33% to gross GDP whereas the figure can reach up to 64% in high-income countries according to the International Finance Corporation.

What are the barriers to entry in Africa?

  • Weak business environment

In a weak business environment, SMEs cannot strive and prosper. In the 2017 World Bank Doing Business Index, Sub-Saharan Africa region ranked “the economies with the least business-friendly regulations on average.” (World Bank, 2017, p. 6) The reasons most businesses opt to remain in the “grey economy” are regulations associated with entering the private formal sector, corruption, and heavy taxation. The process to officially start a business it the hardest struggled faced by most entrepreneurs.

  • Access to financing

Access to financing remains the biggest challenge for SMEs. Most micro and small businesses rely solely on micro financing, personal loans, and moneylenders. Given the hardship associated with entering the formal sector, most SMEs that remain in the informal sector will not have access to government channels and lines of credits and given the difficulty that even the SMEs in the formal private sector encounter, there is no real incentive for the ones remaining in the informal sector and also for aspiring entrepreneurs. The 2007 Making Finance Work for Africa by the World Bank found that there is indeed a correlation between access to private credit and GDP per capita.

Rajan & Gleacher (2007) found that “the availability of external finance is positively associated with the number of start-ups—an important indicator of entrepreneurship as well as with firm dynamism and innovation … finance is also needed if existing firms are to be able to exploit growth and investment opportunities and to achieve a larger equilibrium size.” Compared to OECD countries and countries in Central Asia, there is little involvement by African Banks to provide credits. It was also found that there is a higher correlation between investments in the private sector and GDP growth than in the public sector. A functioning financial system plays a fundamental role in growth of the business sector, economic growth and consequently poverty alleviation.

  • Electricity and Infrastructures

The World Bank considers electricity generation as “basis of any power system, and generation adequacy is determined by the availability of resources as well as by their cost.” Sub-Saharan Africa has been for the longest plagued with troubles of the energy sector. The lack of electricity in combination with the high reliance of most businesses on electricity usually results in high prices. It is surprising that the prices of electricity in Sub-Saharan Africa are almost identical to those of OECD nations and as one can imagine, this has a direct effect on efficiency, production and therefore economic growth.

Regarding infrastructures, Sub–Saharan Africa nations are geographically limited given the lack of adequate infrastructures to expand production and access African markets.

Recommendations

Maximizing and capitalizing on SMEs is essential for Sub-Saharan Africa because of all the factors relating to economic growth that if ignored might be fatal for its rising economy. With a very young population and not enough jobs to offer, SMEs are the only solution for Africa. According to the research that we have made and the extensive literature on the topic, this will be possible following three simple steps in Sub-Saharan Africa:

Relax entry regulations to give entrepreneurs and aspiring entrepreneurs the confidence to enter the market. Increase Investments and better access to financing are the most important because, no matter how easy it is to create a company, the hard part remains building and maintaining it. Africa is full of survivalist entrepreneurs and we might see many good enterprises go to waste because of lack of resources and a decent business environment. This is mostly of concern for medium-sized enterprises since, as we have stated earlier, micro-sized companies have, even if menial, means to somehow sustain themselves and bigger and better-established companies usually have less trouble accessing credits and attracting investments but when we move to the medium-sized firms, the lacking involvement of banks in fueling the economy remains the major issue. Provide better access to information and educate entrepreneurs on everything they need to know to build strong and sustainable business models and companies. In Sub-Saharan Africa, most entrepreneurs have little to no knowledge on how to do business in their own countries let alone the continent and many of them end up building botched businesses that could have been profitable but lack strategy; they remain in the informal economy and have no impact on economic growth or end up failing.

Africa is building its identity and needs to empower its population by the provision of jobs. SMEs have proven, in many instances and many regions, to be an essential driver of the economy. The World Bank highlights in its Doing Business 2017 that “the opportunity to find a job or develop one’s business idea is crucial for most people’s personal satisfaction. It creates a sense of belonging and purpose and can provide an income that delivers financial stability. It can raise people out of poverty or prevent them from falling into it” and we would like to add that many of the conflicts in Sub-Saharan Africa result from a lack of resources and chronic poverty. Because there are no jobs, there is no income hence no way for many to satisfy their basic needs, sustain their families, access to education remains lower than desirable and lack of occupation forces people to make poor decisions. Achieving Agenda 2030 will require leaders and policy makers to pay serious attention to SMEs and entrepreneurship in Africa. Small and Medium sized Enterprises are key to economic growth in Sub-Saharan Africa.

References
“The AfDB SME Program Approval: Boosting Inclusive Growth in Africa.” African Development Bank. N.p., n.d. Web.https://www.afdb.org/en/news-and-events/the-afdb-sme-program-approval-boosting-inclusive-growth-in-africa-12135/
MENON Business Economics. “Growth and Poverty in Sub-Saharan Africa.” (2016): n. pag. Web. http://www.norfund.no/getfile.php/133983/Bilder/Publications/SME%20and%20growth%20MENON%20.pdf
Saleem, Qamar. “Overcoming Constraints to SME Development in MENA Countries and Enhancing Access to Finance.” N.p., n.d. Web.https://www.ifc.org/wps/wcm/connect/1e6a19804fc58e529881fe0098cb14b9/IFC+Report_Final.pdf?MOD=AJPERES
“Small and Medium Enterprises (SMEs) Finance.” World Bank. N.p., n.d. Web. http://www.worldbank.org/en/topic/financialsector/brief/smes-finance
The World Bank Group. “About Doing Business.” Doing Business 2017: Equal Opportunity for All Doing Business (2016): 13-24. Web. http://www.doingbusiness.org/~/media/WBG/DoingBusiness/Documents/Annual-Reports/English/DB17-Report.pdf
The World Bank Group. (n.d.): n. pag. Web. https://www.mfw4a.org/fileadmin/data_storage/documents/other-internal-documents/Making_Finance_Work_for_Africa.pdf
The World Bank Group. “What’s Happening in the Missing Middle?” (n.d.): n. pag. Web. http://documents.worldbank.org/curated/en/707491490878394680/pdf/113906-WhatsHappeningintheMissingMiddleLessonsinSMEFinancing-29-3-2017-14-20-24.pdf
Written by José Filomeno De Sousa Dos Santos, Chairman of the Board of Directors, FSDEA. “Why SMEs Are Key to Growth in Africa.” World Economic Forum. N.p., n.d. Web. https://www.weforum.org/agenda/2015/08/why-smes-are-key-to-growth-in-africa/