Policies and programs that support the advancement of small and medium enterprises (SMEs) play a role in poverty alleviation, especially on the Asian and African continents, even though studies show that there is no direct connection between SMEs and poverty alleviation. To gain clarity on how SMEs reduce poverty, The Borgen Project spoke with management from the Kenya Investment Mechanism (KIM), a United States Agency for International Development (USAID) program launched in August 2018 that has supported the development of micro, small & medium enterprises (MSMEs) in the East African region. “Poverty alleviation is not an explicit goal, but we’re part of the broader theory of change for USAID in terms of their economic growth portfolio,” Rob Henning, the KIM project director told The Borgen Project.
How SMEs Help Reduce Poverty
There are three primary arguments supporting the claims that SMEs reduce poverty:
- SMEs foster entrepreneurship: SMEs are said to increase competition and promote entrepreneurship, which, in turn, boosts the overall efficiency of a local economy, promotes innovation and increases overall economic productivity.
- SMEs are more productive than large companies: Many think that SMEs are more productive than larger co-operations so long as market failures, institutional failures and other barriers receive attention.
- SMEs increase employment more than large companies do: SMEs are arguably more labor-intensive than larger enterprises, leading to the creation of more job opportunities. In this way, SMEs reduce poverty and should, therefore, receive significant investment and subsidization.
What Data Says About SMEs and Poverty
Contrary to popular assumption, innovation is more likely to occur in large firms rather than in SMEs because large firms can afford the expense of research and development. Additionally, SMEs are not more likely to create employment or boost productivity when compared to larger firms. The market and institutional failures that affect SMEs also constrain the development of other kinds of enterprises. What is important, therefore, is not the size of the enterprise but a business environment that encourages competition, innovation and productivity.
Elements of a conducive business environment include the easy entry and exit of markets, legally defined property rights as well as the access to and protection of capital to encourage private sector activities. Creating such an environment largely depends on the financial development of an economy. While investing in SMEs helps foster this environment, this does not illustrate how SMEs reduce poverty in any prominent way.
SMEs and Development
SMEs greatly contribute to the development of the economy with their most obvious impact visible in financial development. As SMEs make up 50% of employment and 90% of businesses globally, building financial infrastructure that supports SMEs positively affects the global financial ecosystem as a whole, especially in the developing world. Countries that support the financial development of SMEs would, therefore, improve their domestic business environment. This promotes economic growth which, in turn, can reduce poverty.
A June 2022 article by Business Daily says Kenya projects that SMEs in the country will “contribute 50[%] of gross domestic product (GDP) growth in the next three years.” The SME sector in Kenya currently employs more than 15 million individuals. This equates to seven out of 10 people working for an SME.
With projects in Indonesia, Nigeria and Kenya as examples, the greatest challenges in supporting SMEs revolve around financing. In these projects, it was found that SMEs struggled with gaining access to markets, receiving financial support and accessing adequate training. In Kenya and the East African region, in particular, KIM noted a lack of specialized financial products and financial awareness and the existence of bias and mistrust from financial institutions.
How USAID’s Kenya Investment Mechanism Operates
The Kenya Investment Mechanism is a USAID program launched in August 2018 with a scheduled end in August 2023. It operates across Kenya and also facilitates transactions within the greater East African region, including in Ethiopia. Its implementation partner is the Palladium Group, an organization with more than 50 years of experience in bringing together governments, businesses and donors for the sake of development.
Henning states that the main task of the KIM program is to connect MSMEs and other underserved markets in the region to financing in order to achieve development goals. To do this, KIM had to bridge the financing gap between financial institutions and MSMEs. Multiple factors contributed to this gap.
For instance, despite standing as the largest employer in East Africa’s financial market, MSMEs received general loan options that business owners found to be inflexible with their business operations. Financial products tailored to the unique needs of MSMEs would be more beneficial. The program had to dispel various misconceptions about MSMEs held by investors. This includes the belief that supporting MSMEs would negatively impact markets and that MSMEs would be indefinitely dependent on grants to sustain their operations.
How the KIM Changed Business in East Africa
KIM essentially served as an intermediary to encourage trust between investors and businesses that needed capital in order to build lasting market relationships. KIM achieved this by providing networking opportunities between financiers, business advisors and MSMEs while working with the national and county governments to support strategic policy reforms that increased access to capital. The program also provided pay-for-results incentive fees to private sector partners to encourage their participation in targeted markets. The incentive fees act as a nudge for the private sector to target MSMEs in specific sectors and regions.
In this way, KIM mobilized its target of $520 million in investment ahead of time from banks, leasing companies, private equity firms, social/impact investment funds, other financial institutions and business advisory service providers. Henning says, in order to build the capacity of these institutions to support MSMEs, KIM also provided training in financing techniques and pitch coaching.
The impact of KIM’s work is visible in the facilitation of new investments, smoothing out of supply chains and much more. Through the efforts of KIM, financial activities are more efficient and sustainable, thereby improving the ease of conducting business in East Africa.
SMEs Indirectly Reduce Poverty
SMEs do reduce poverty, although indirectly. They contribute in their own ways to poverty reduction. What one can say with certainty is that the development of SMEs greatly impacts financial development. Financial development is a key contributor to poverty alleviation. In the fight against poverty, the focus often lies in reduction, alleviation and eradication efforts. However, laying the groundwork for developing systems that create sustainable prosperity is equally important, if not more, for the transition to a world without poverty.
This post originally appeared here on November 16, 2022.