The Southern African Development Community (SADC) region, like the rest of Sub-Saharan Africa (SSA), is currently enjoying an economic boom with growth projected to accelerate to 4% in 2014.⁽²⁾ Small and medium enterprises (SMEs) are increasingly being recognised as effective drivers of economic growth and employment generation in SSA where SMEs represent 90% of all businesses and account for more than 50% of employment and gross domestic product (GDP). However, while overall attitudes to entrepreneurship are high ⁽³⁾ and the region exhibits the lowest levels of fear of failure of starting a new business,⁽⁴⁾ SSA continues to grapple with an acrimonious business environment which has resulted in its ranking as the most difficult region to do business globally.

Indeed, the success of SMEs in most SSA countries is hindered by, inter alia, poor access to finance, scarcity of stable and affordable electricity, corruption and bureaucracy.⁽⁵⁾ The challenging business environment presents a stumbling block to meaningful economic development given SME’s crucial role in fostering economic growth, particularly through job creation in a region beset with rising youth unemployment of over 25% in most member states and up to 60%, or 7.5 million people, in South Africa.⁽⁶⁾ As such, the identification and successful implementation of policies that encourage youth entrepreneurship and support for businesses with high employee growth expectations will be vital to ensuring job creation, economic growth and societal stability.⁽⁷⁾

Businesses in the SADC region are already well-positioned to tackle unemployment given that approximately 12-29% of SMEs in countries such as Angola, Namibia, South Africa and Zambia employ more than five employees.⁽⁸⁾ However, in addition to the aforementioned challenges, local SME development is frequently sacrificed at the altar of foreign direct investment (FDI) promotion initiatives. Under improved business conditions SMEs have the potential to create significant socio-economic impact and propel the region to the next level of economic growth and development. Against this backdrop, this CAI paper examines the challenges faced by SADC SMEs with particular focus on access to capital and the impact of FDI attraction policies on small businesses in the region. Figure 1 presents an overview of SADC’s overall performance across 10 indicators in the World Bank’s 2014 Doing Business report.

Limited access to credit

The micro, small and medium enterprise country Indicators ranks access to finance as the second most important constraint for SMEs in developing countries, after access to electricity.⁽¹⁰⁾ Given the complex business environments in which they operate, the importance of extending credit lines to SMEs not only for their start-up but for their sustainable growth cannot be overemphasised. SMEs typically face a finance gap, referred to as the “missing middle,” as their credit avenues are limited compared to commercial debt for large firms and microfinance. SMEs are often perceived as too risky by commercial lenders, whilst microfinance loans are too small to meet most SME’s capital needs.⁽¹¹⁾ While banks may realise the potential of the SME sector, they have little incentive to develop SME products and instead opt to provide credit to larger firms and hold high-yielding government debt.⁽¹²⁾ Limited credit information on business owners also poses a major impediment for financial institutions wishing to extend credit to SMEs.⁽¹³⁾

Government-sponsored SME credit support programmes such as partial credit guarantees and credit lines, including the supraregional African Union African Guarantee for SMEs,⁽¹⁴⁾ can be effective financing mechanisms, particularly if they are combined with capacity-building initiatives. However, more often than not these schemes are underutilised, with the majority of SMEs unaware of the existence of such financing programmes.⁽¹⁵⁾ Further, some of these programmes are widely abused and default rates are high,⁽¹⁶⁾ incurring great losses for SADC governments. Moreover, even if SMEs were aware of these initiatives, lack of managerial know-how and training places development constraints on SMEs,⁽¹⁷⁾ which ultimately renders these well-meaning programmes ineffective and superfluous.

FDI promotion and SME development: A zero sum game?

Although regional member states have implemented various economic development programmes to foster SME growth, these efforts are often disjointed with FDI enhancing initiatives being promoted at the expense of SME development. SADC member states persistently lure foreign investment inflows with incentive packages; tax incentives being commonplace and often at a high cost.⁽¹⁸⁾ For example, it is estimated that South Africa will forego ZAR 5.6 billion (US$ 526 million) in tax revenue by December 2015 through its tax incentive scheme which aims to attract investment in its business process outsourcing sector.⁽¹⁹⁾

While FDI is undoubtedly vital in assisting governments in addressing development needs, its role in meeting these challenges alone can be overstated. Although multi-national corporations (MNCs) significantly and visibly contribute to economic growth, SADC host governments must develop policies that create positive spill-overs of, inter alia, skills, technology and international trade integration by encouraging foreign investor linkages with domestic enterprises, while ensuring that local SMEs are not crowded-out by the larger and better-resourced MNCs.⁽²⁰⁾ For instance, the bulk of FDI inflows into Lesotho are concentrated in the textile and apparel sectors and are mainly related to the preferential tariff agreement, related to the rules of origin conditions, under the Africa Growth and Opportunity Act (AGOA). These tariff preferences induced a large flow of investment from China to this SADC member state. However, the government of Lesotho failed to capitalise on the capital inflow, which resulted in weak local links created by investors in the country,⁽²¹⁾ effectively rendering Lesotho an Export Processing Zone for Chinese manufacturers.

Nevertheless, SADC members recognise the importance of a robust SME sector as evidenced by the implementation of several support initiatives such as the Angola Invest initiative, Malawi’s Youth Entrepreneurship Development Fund, Namibia’s SMEs Compete, and Botswana’s Citizen Entrepreneurial Development Agency Young Farmers’ Fund.⁽²²⁾ However, although fuelled by good intentions, these interventions have produced tepid results and the business ecosystem in the SADC region remains suboptimal. Regional governments can overcome some of these obstacles by ensuring that all agencies involved in investment promotion follow a targeted investment strategy that is aligned with the country’s identified areas of growth, informed by local endowments and development strategies.⁽²³⁾ However, countries must be careful not to fall afoul of the local content and other limitations delineated by the WTO’s Trade-Related Investment Measures (TRIMs) agreement.

Concluding remarks

The importance of SMEs to SADC’s economies cannot be gainsaid. Yet, the business climate remains frigid for local entrepreneurs. Among the many challenges that SADC entrepreneurs face, access to credit remains a major obstacle and regional policymakers tend to focus on FDI promotion policies and incentives to the detriment of local entrepreneurs. Although some strides have been undertaken, the SADC region still has a long way to go in providing a business-friendly environment for SMEs. It is, however, ultimately incumbent on SADC member states to engage in intra-regional information-sharing and technical assistance in order to address these challenges. Without effective reform, true regional integration will remain a pipedream and the SADC region will fail to capitalise on its potentially vibrant SME sector that could catapult the region into an economic powerhouse in its own right.

Written by Kholofelo Kugler ⁽¹⁾

NOTES:

(1) Kholofelo Kugler is a Research Associate with Consultancy Africa Intelligence (CAI) whose key areas of interest are international trade and investment. Contact Kholofelo through CAI’s Finance & Economy unit ( finance.economy@consultancyafrica.com). Edited by Nicky Berg. Research Manager: Feri Gwata.
(2) ‘Africa Economic Outlook 2014 Special Theme: Global Value Chains and Africa’s Industrialization’, African Development Bank (AfDB), 2014, http://www.africaneconomicoutlook.org .
(3) Herrington, M. and Kelley, D., ‘African entrepreneurship: Sub-Saharan African regional report 2012’, GEM, 2012, http://www.gemconsortium.org.
(4) Ibid.
(5) Fjose, S., et al.,‘SMEs and growth in Sub-Saharan Africa: Identifying SME roles and obstacles to SME growth’, Menon Business Economics MENON- publication no. 14/2010, June 2010, http://www.norfund.no.
(6) Wentworth, L. and Bertelmann-Scott, T., ‘SA-EU Summit 2013: Investment and jobs in South Africa and SADC?’, SAIIA, 17 July 2013, http://www.saiia.org.za.
(7) Herrington, M. and Kelley, D., ‘African entrepreneurship: Sub-Saharan African regional report 2012’, GEM, 2012, http://www.gemconsortium.org.
(8) Ibid.
(9) ‘Doing business 2014: Southern African Development Community (SADC)’, The World Bank, June 2014, http://www-wds.worldbank.org.
(10) Kushnir, K., et al., ‘Micro, small, and medium enterprises around the world: How many are there, and what affects the count?’, MSME Country Indicators, 2010, http://www.ifc.org.
(11) ‘Report on SMEs in developing countries through financial intermediaries’, Dalberg, November 2011, http://www.eib.org.
(12) Ibid.
(13) Ibid.
(14) African Guarantee Fund for Small and Medium-sized Enterprises, http://www.afdb.org.
(15) Berg, G. and Fuchs, M., ‘Bank financing of SMEs in five Sub-Saharan African countries: Role of competition, innovation and the government’, The World Bank Policy Research Working Paper 6563, http://elibrary.worldbank.org..
(16) Herrington, M. and Kelley, D., ‘African entrepreneurship: Sub-Saharan African regional report 2012’, GEM, 2012, http://www.gemconsortium.org.
(17) Abor, J. and Quartey, P., 2010. Issues in SME development in Ghana and South Africa. International Research Journal of Finance and Economics, 39. pp. 218-228.
(18) James, S., ‘Incentives and investments: Evidence and policy implications’, World Bank Group, 2009, https://www.wbginvestmentclimate.org.
(19) Perera, O., ‘Investment incentives for sustainable development: the Case of Lao PRD’, International Institute for Sustainable Development, 2011, http://www.iisd.org.
(20) ‘Creating business linkages: A policy perspective’, UNCTAD, 2010, http://unctad.org.
(21) ‘Which domestic firms benefit from FDI?' Evidence from selected African countries’, UNIDO Working Paper 08/2012, 2012, http://www.unido.org.
(22) Herrington, M. and Kelley, D., ‘African entrepreneurship: Sub-Saharan African regional report 2012’, GEM, 2012, http://www.gemconsortium.org.
(23) ‘Which domestic firms benefit from FDI? Evidence from Selected African Countries’, UNIDO Working Paper 08/2012, 2012, http://www.unido.org.