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Evidence shows that the relative importance of SMEs and the informal sector (shadow economy) are inversely associated with economic development

Dr Gift Mugano
Small and medium-sized enterprises are a very heterogeneous group. SMEs are found in a wide array of business activities.

These range from the single artisan producing agricultural implements for the village market, the coffee shop at the corner, the internet café in a small town to a small sophisticated engineering or software firm selling in overseas markets (in the case of developed economies) and a medium-sized automotive parts manufacturer selling to multinational automakers in the domestic and foreign markets.

The owners may be or may not be poor; the firms operate in very different markets (urban, rural, local, national, regional and international); embody different levels of skills, capital, sophistication and growth orientation, and may be in the formal or the informal economy.

Over the years, across the globe, SMEs, including the informal sector, were perceived as a synthetic construction mainly of “social and political” importance, especially throughout the 1980’s and up to late 1990’s. In Zimbabwe, we still disrespect SMEs. We call them vanaMuseyamwa. Although domestic SMEs and the informal sector constitute most of what could be and what are still deemed as “the” private business activity in most developing countries, private sector development strategies advocated for and implemented in these countries were skewed towards the needs of large-scale business, including foreign invested ones.

Empirical studies show that SMEs contribute to over 55 percent of Gross Domestic Product and over 65 percent of total employment in high-income countries.

SMEs and informal enterprises, account for over 60 percent of GDP and over 70 percent of total employment in low-income countries, while they contribute over 95 percent of total employment and about 70 percent of GDP in middle-income countries.

Evidence also shows that the relative importance of SMEs and the informal sector (shadow economy) are inversely associated with economic development.

In low-income countries, especially in the least developed economies, the contribution of SMEs to employment and GDP is less than that of the informal sector, where the great majority of the poorest of the poor make a subsistence level of living.

Therefore, an important policy priority in developing countries is to reform the policies that divide the informal and formal sectors, so as to enable the poor to participate in markets and to engage in higher value added business activities.

Notwithstanding the contribution of SMEs contribute to employment and income generation and export revenues in emerging markets and high income countries, in most developing countries like Zimbabwe the contribution of SMEs is below potential.

Hence, in order to tap into the potential of SMEs for development and poverty reduction, transition and developing country, governments, development partners and SMEs themselves need to address a number of challenges:

The domestic SME/private sector has to expand, through the creation of new and innovative firms and the graduation of as many informal enterprises as possible into the formal sector.

SMEs have to become more competitive and productive at their home base.

At least a proportion of these nationally competitive SMEs have to achieve a level of competitiveness that will enable them to integrate into the global value chains through trade (exports and internationalisation) and investment, including linkages with foreign direct investment.

Dealing with these challenges against the background of trade liberalisation and regional integration is a complex task.

On the one hand, globalisation has the potential to open up access to new markets, technologies, skills and capital for SMEs.

On the other hand, further economic integration brings with it a striking increase in competition from imports, the entry of new foreign investors and the strengthening of domestic, large firms that start to take over traditional, mostly local SME markets.

No matter how hard the game is we can’t just watch, we also need to play. The world is changing we have to change with it!

We need to work around the clock and come up with our own strategies aimed at strengthening our SMEs.

Strengthening the competitiveness of SMEs is embodied in the characteristics of the firm; namely:

The current efficiency and effectiveness of the use of resources,

The willingness and the ability to relate profitability to growth of capacity (i.e. the willingness to invest), and

The ability to innovate to improve technology and organisation and thus improve efficiency and effectiveness.

Economic theory state that competitive advantage, which must be measured in relation to rivals in markets, is determined by how efficient and effective the prevailing markets for products, labour and capital are. In the same vein, entrepreneurship; the introduction of new productive combinations and innovation is the driving force that continually creates new competitive advantages and opportunities for profit and growth.

It is important to note that competitiveness is created at the firm level, but that it is partly derived from a systemic context and emerges from complex patterns of interactions between Government, enterprises and other actors, and will therefore exhibit different forms in each society.

SME development strategies generally are country and context specific. Each country will have its own challenges, opportunities and priorities for change.

Resources available for implementation will vary by country. Hence, the results achieved will also be different.

For example, in the 1980s and most of the 1990s, enterprise policy in European countries focused on employment creation, and initiatives supporting new business creation were prominent.

Then, emphasis changed to one of achieving international competitiveness and programs encouraging business growth, support for technology based businesses and creation of an enterprise culture within the society started to gain in importance.

However, using international best practices on SME development, the following are generally accepted lessons which are useful and are independent of region and level of development among countries:

Peace and stability is a key requirement for the development of SMEs and for attracting foreign investment. Studies show that war and crime are main deterrents of private investment, in particular for foreign investors.

SME development requires a crosscutting strategy, (that is, its success depends on the ability of Governments to implement sound macroeconomic policies, the capability of stakeholders to develop conducive microeconomic business environments, and the ability of SMEs to implement competitive operating practices and business strategies). Good policies come in clusters. Thus, SME development strategy must be integrated into the broader national development strategy and/or poverty reduction and growth strategy of the country like the Zimbabwe Agenda for Socio – Economic Transformation as in Zimbabwe’s case.

Dialogue and partnerships between the stakeholders is essential (public sector, private sector and civil society) Dialogue and partnership foster ownership of SME strategies, engenders them more implementable (by better addressing SME needs), politically more credible, and more sustainable.

Investments in physical infrastructure and business services and the implementation capacity of policy makers, local level administrators and support structures determine success. Access and integration of SMEs into local, national, regional and global markets require substantial investments in sustainable physical infrastructure development and business service delivery to SMEs in all areas, including those that are rural and/or remote. Continued dialogue and partnerships between stakeholders in the implementation and review of supportive measures, particularly, those related to capacity building in institutions at all levels, yields improved outcomes.

Enhancing women’s ability to participate in SME development should be taken into account at every stage and level, as women account for an important share of private sector activity and contribute most to poverty reduction. Gender dimensions need to be main-streamed throughout SME development strategies and programs, with additional specific, targeted initiatives directed at critical roadblocks.

Dr Mugano is an Economic Advisor, Trade and Competitiveness Expert, Research Associate at Nelson Mandela Metropolitan University (SA) and Visiting Lecturer at Zimbabwe Ezekiel Guti University.