How should governments support small firms?

This article is published in collaboration with The Conversation.

Conventional wisdom on supporting entrepreneurship is that governments should support start-ups and small businesses to spur job creation and economic growth.

The rationale is based on the premise that small firms make up the highest number of companies in developed countries, and that they are the biggest providers of jobs.

But the reality is that the majority of small firms actually do not grow. In fact they fail, and in doing so can destroy employment opportunities.

Nevertheless, the argument goes that by ensuring that start-ups and small firms survive, you increase the likelihood that some of them will become high-growth firms or “gazelles” – which in turn will grow into the behemoths of the future. Have enough of these and you can really begin tackling unemployment by increasing the supply of stable wage paying jobs.

This is not to mention ancillary benefits, such as retaining skilled labourers, productivity improvements and product and service innovation.

With this in mind governments typically support SMEs through a number of mechanisms geared towards ensuring their survival and driving the creation of more high-growth firms.

One size fits all?

But applying the conventional Western approach to Africa is problematic. This is because it is based on principles and dynamics relevant to economies that are already developed. They have large established firms and developed stock exchanges where a large proportion of the “gazelles” are listed.

The situation in many African countries is entirely different. There is no question that there are some outlier countries like South Africa, Egypt and Nigeria. They have economies that are sufficiently developed with well-functioning stock markets.

But most African countries have relatively small stock exchanges dominated by large global or Pan African multinationals, mining, finance and energy companies. In these countries many large firms are typically much smaller than in other regions of the world. Crucially a large proportion of these firms are still run and managed by an enigmatic entrepreneur or family and are often not listed.

Evidence shows that these firms have some very noticeable affects on their local economies. They are more productive than small and medium firms; they tend typically to invest in more up to date technology; they survive longer and grow faster than their small and medium firm counterparts.

The list of Africa’s richest individuals is increasing. There is something striking about the list, which includes names such as Aliko Dangote of Nigeria and Isabel Dos Santos of Angola. Rather than taking the route of growing a single company to mammoth scale, these individuals have grown portfolios of companies to very large scale, with one or two standing out.

Opportunity and portfolio growth

My own research in Malawi, and collaborative work including Ugandan and Egyptian samples, has investigated this phenomenon.

We found that these business portfolios represent an effective investment vehicle and strategy to access the plethora of opportunities within African markets. Our latest findings are to be published shortly. They also allow successful entrepreneurs to strategically move and exploit scarce capital as well as resources to take advantage of short-term opportunities. These sometimes arise due to changes in regulatory and policy environments.

The result is that the entrepreneur forms a portfolio of companies with diverse interests.

This strategic nimbleness is often essential. It allows entrepreneurs to take advantage of opportunities that arise for short periods of time and that have limited potential in terms of scale and scope. It also allows them to hedge against the instability of government policy and challenges in the business and political environment.

For example, my research on large-scale portfolio entrepreneurship in Malawi, one of the poorest countries in the world, shows that these entrepreneurs are especially adept at taking advantages of changes in government policy.

Portfolio entrepreneurs quickly set up new companies then close, scale them down or freeze them. They then reinvest profits in creating new companies to exploit different opportunities.

Where’s the policy?

Portfolio entrepreneurs include a large number of Africa’s and the rest of the world’s fastest-growing and most-influential entrepreneur-owned businesses. But African governments typically focus on start-ups, micro and small firms. Policy focusing on these multiple business owners is almost non-existent.

This is baffling, considering the particular nature of these portfolio entrepreneurs:

• They tend to employ large numbers of people in stable wage employment.
• They tend to start the first of a kind businesses in their countries. They are more innovative than their counterparts and export more.
• They survive longer and are better at adapting to their local business environments due to the advantages they have in terms of financial and human resources.
• They have advantages in knowledge creation, networks and identifying opportunities; and
• They are estimated to represent a large proportion of the entire private sector in many African countries when looking at output (forthcoming).

Policy where it exists is typically focused on a bottom-up approach with the aim of creating a supply of small firms.

But what about doing things differently? What about focusing on a top-down approach? This would focus on helping existing high-growth firms to continue growing and in doing so creating opportunities on the other side of the supply chain for smaller firms.

This would require identifying privately created business groups owned by successful large-scale portfolio entrepreneurs that are critical to national economic health. Create the conditions, without directly assisting the individual entrepreneurs, and by doing so drive the creation and supply of smaller firms, top down.

State-sponsored capitalism or state-encouraged entrepreneurship?

If we think about it, this is a similar approach to what the Japanese, Koreans and lately the Chinese have done in supporting the Keiretsu, the Chaebol and the Chinese-state owned and privately owned business groups, as a policy for economic development.

Interestingly, the deputy president of South Africa, Cyril Ramaphosa, has been vaunting how South Africa should start running its on average poorly performing state owned parastatals, like China, has done as a vehicle for economic development.

I can understand Ramaphosa’s sentiment but I believe Africa should and can do things differently.

Early African economic development after independence echoes this view. Many African nations attempted this approach through the creation of large parastatal or state-owned companies.

Most of these efforts have, or are failing, due to government inefficiencies and privatisation policies enforced by the World Bank that have seen the function of parastatals crumble.

But what if African nations revisit these policies by turning the current state sponsored and assisted approach on its head? Taking a different approach could unleash large scale, high growth entrepreneurship.

Why not drive entrepreneurship policy top down as opposed to bottom up? Focus policy on identifying the privately owned and high-growth business groups created by experienced portfolio entrepreneurs that are critical to national economic health. Create the conditions – without directly assisting these entrepreneurs – needed for these portfolios and high-growth firms to flourish and by doing so drive the creation and supply of smaller firms, top down.

Publication does not imply endorsement of views by the World Economic Forum.

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Author: Antonio Malfense Fierro is a Lecturer in Entrepreneurship and Innovation at the University of Hull.

Image: People and traffic move along a busy street. REUTERS/George Esiri.