Main relevant SDG targets:
8.3: Promote development-oriented policies that support productive activities, decent job creation, entrepreneurship, creativity and innovation, and encourage the formalization and growth of micro-, small- and medium-sized enterprises, including through access to financial services
9.2: Promote inclusive and sustainable industrialization and, by 2030, significantly raise industry’s share of employment and gross domestic product, in line with national circumstances, and double its share in least developed countries
9.3: Increase the access of small-scale industrial and other enterprises, in particular in developing countries, to financial services, including affordable credit, and their integration into value chains and markets
1. The rationale for policies focussing on enterprise development
In most LDCs, the size distribution of enterprises is generally characterized by a “missing middle”. A multitude of informal micro-enterprises coexist with a few large firms, typically state-owned enterprises or firms owned or controlled by foreigners (LDCR 2013: ch.4).
These large firms tend to operate in the most capital-intensive sectors, such as the extractive industries, energy and telecommunications, air transport and modern financial services. Linkages between the large firms and small and medium-sized enterprises (SMEs) are rare in LDCs (LDCR 2006: part Two ch.6).
Small enterprises in both agriculture and manufacturing often produce at a sub-optimal scale. It is therefore important to enable these small firms to expand their production within the existing methods of production, which are typically labour-intensive and thus, can generate considerable employment opportunities (LDCR 2013: ch.5). With a growing number of medium-sized enterprises, conditions that enable technological progress will improve. This is likely to spur competitive pressure, as well as the ability of firms to innovate.
Small and medium-sized enterprises (SMEs) play an important role in domestic growth dynamics as they primarily use local inputs, thereby linking local primary production with manufacturing activities. From a dynamic efficiency perspective, however, large firms are in a better position to achieve higher rates of capital formation, innovation, scale economies and the accompanying learning effects. In addition, integration into the international economy and growing export activities may not often be possible without the creation of larger production units and transforming SMEs into larger enterprises that have a greater chance to be internationally competitive (LDCR 2006: Part Two ch.8).
Company growth, upgrading and innovation require a sense of entrepreneurship among firm owners and the related competencies at the different layers of management.
Greater managerial competencies in factory layout and material flow management would help achieve better factor and input allocation and support company growth.
Stronger capacity of entrepreneurs in SMEs to formulate appropriate business plans is a precondition for access to external sources of finance, notably bank loans. Moreover, export-oriented firms, or those with the potential to develop export capacities, have to improve the use of and compliance with international product and management standards, which are often vital for international competitiveness (LDCR 2006: Part Two ch.6; DTIS Ethiopia).
2. Approaches to enterprise development
Governments can foster the growth of SMEs in several ways:
• Strengthening entrepreneurial and managerial capabilities through support to institutions that provide managerial training, set product standards and help firms to meet these standards (LDCR 2006: Part Two ch.8).
• Facilitating the access of firms to finance by encouraging banks to extend more credit, especially with longer maturities, for productive purposes and by supporting firms in the formulation of meaningful business plans and the provision of collateral (LDCR 2009: ch.3) (m ch.II.D; o ch.IV.C).
• Improving information flows and strengthening networking and clustering among firms through the provision of relevant information from public institutions and supporting the creation of sectoral associations (LDCR 2013: ch.5) (o ch.IV.C).
In addition, incentives for the formalization of previously informal economic activities must be a key element of enterprise policies in LDCs. Formal firms are in a better position to grow and are more likely to respond to policy measures that support structural transformation and employment creation. Incentives to encourage formalization are
more likely to be effective than repressive measures.23 All policy measures should be designed in such a way that the benefits for firms outweigh the costs of having to pay taxes and observe regulations. Lowering entry costs and increasing the advantages that formalization encourages firms to join the formal sector. Facilitating the registration of firms and providing services such as training, improved access to credit, participation in business forums or assistance with import and export procedures can help to induce firms to enter the formal sector voluntarily (UNCTAD 2009: ch.III). In this regard, special actions are often indicated to remove the de facto discrimination of female entrepreneurs in formalization procedures (LDCR 2016: ch.5). The creation of a “one-stop shop” for businesses where they can register legally, obtain or renew licences, register property and fulfil their other administrative obligations is one of the ways in which states can try to reduce the administrative burden on firms.24
3. The need for stable and reliable supply inputs
The functioning of domestic supply chains and access to imported inputs is a constraint to enterprise development in many LDCs and sectors of activity. A stable and reliable supply of inputs is crucial for the emergence of linkages as part of structural transformation. This is of particular strategic importance when the entry point for industrialization is processing domestically available raw materials (o ch.IV.B). In this case, domestically available raw materials should be processed to the largest extent by domestic manufacturers, instead of being exported unprocessed. On the other hand, the expansion of domestic productive capacities can be enhanced with limited reliance on imports when domestic manufacturers can draw primarily on domestically produced inputs.
It is, therefore, essential for enterprise development in LDCs that productive capacities in the rural economy evolve alongside the development of manufacturing and services activities. The same consideration is valid for ancillary industries. Thus, even if the strategy for structural transformation prioritizes certain manufacturing activities, such as food processing, textiles or leather manufacturing, capacities for the production of domestic inputs to these activities, for example packaging materials, chemicals, or wood, metal and plastic tools, should be supported in parallel (o ch.IV.A).
This will often require supporting the market mechanism by awareness-building, the provision of information and better access of these supplier to finance, as well as improvements in productivity-enhancing infrastructure (o ch.V.A). More stable and reliable supply linkages benefitting both farmers and domestic processors of agricultural produce can be supported by promoting contract farming or he establishment of Rural Transformation Centres, possibly in combination with industrial parks (UNIDO 2014).
Enterprise development can also be stymied by constraints on imports of essential inputs.
Tariffs and excessive customs, tax and foreign exchange formalities in connection with such imports often complicate access to such inputs and raise their costs. Vouchers, duty drawback and bonded warehouse schemes, as they are practiced in many LDCs, may mitigate some of these complications, but tend to create additional administrative burdens for both firms and the public administration. It is therefore important to review and evaluate the costs and benefits of imposing import restrictions (DTIS Ethiopia).
Certain institutional arrangements may help to reduce the costs of imported inputs for both industry and agriculture further. These may take the form of intermediary import enterprises at the national or sectoral levels. Such enterprises could improve access to and lower the costs of, imported inputs. They could support domestic firms and farms by identifying the most suitable suppliers for each input on the world market. Moreover, as they would purchase significantly larger volumes than any individual importer, they would have stronger bargaining power in price negotiations. They might also be helpful in accelerating the management of import transactions and customs services.