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Is the current fuss about SME finance justified?

15.10.2010Christian von Drachenfels

The proposition that dynamic private sector development is essential for poverty reduction holds true especially for less developed countries in Africa. It is argued that small and medium enterprises (SMEs) constitute the backbone of the economy and are seedbed of innovation, thus holding the potential to raise nationwide productivity and create jobs: the comparative lack of competitive SMEs in several African countries, a phenomenon known as the “missing middle”, is therefore a constraint for economic development.

Constraints for SME development in Africa are manifold. Recently, however, there has been a stronger focus on the weakly developed financial systems and the resulting inefficient financial intermediation in several African countries. Empirical research and surveys among SMEs confirm that lack of access to finance is indeed clearly hampering SME development in Africa. This limited access to finance is often referred to as the “mesofinance gap”, the supply gap of finance between microfinance and the financing available to large enterprises.

The increasing efforts of governments, donors and private actors to address the “mesofinance gap” in Africa are therefore a welcome development. Such efforts range from governments’ use of partial credit guarantee schemes to donor-managed funds targeted at SMEs, and have been bolstered by private foundations’ focus on SME finance. These efforts are backed on the global level and most prominently by the G-20 commitment to increase support to improve access to finance for SMEs in developing countries.

As mentioned above, these activities are in general a welcome development. An important critique, however, remains: despite the wide-ranging discussions about SME finance, the debate about a common definition of “SME” continues to be absent, and the role of the sector in economic development is often inadequately understood. Policymakers justify SME policies on the basis of the assumptions described above; yet, when trying to define the target group, different quantitative criteria – ranging from the number of employees to turnover – are used to define SMEs. This quantitative definitions, however, do not tell us much about the competitiveness or the growth potential of specific enterprises in this segment. Addressing the problem of the “missing middle” in Africa does not mean that we need policies that aim at promoting enterprises with a specific number of employees and a specific turnover. The challenge is to promote and make finance available to those enterprises that are innovative, dynamic and competitive. These are the kind of enterprises that currently lack access to finance because of market failures, but can generate jobs and help reduce the productivity gap vis-à-vis the global benchmark.

So, are recent efforts just much ado about nothing? Clearly not. They are based on the important insight that the “missing middle” and the “mesofinance gap” are a serious problem for the socio-economic development of many African countries. Market failures lead to credit-worthy enterprises not being able to get access to the finance they would need for further development. Addressing these market failures is the key challenge for governments, donors and private actors. This is, however, a major challenge, and the risk remains that many current SME finance activities will be at least partly ineffective if they do not adequately deal with the challenge of disentangling the heterogeneous group of SMEs.

 

Christian von Drachenfels is a Research Fellow at the German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE), Dept. V: "World Economy and Development Financing".

 

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