Supporting African SMEs’ drive towards inclusive and sustainable trade-led growth

Arancha Gonzalez ANALYSIS Trade, Industry & Investment

By 2050, Africa’s collective labour force will be bigger than that of China or India. Creating jobs for hundreds of millions of young labour market entrants will mean the difference between realizing a demographic dividend and risking a social time bomb. Moreover, Africans don’t just need more jobs; they need better jobs. Long-term prosperity hinges on shifting people and resources out of subsistence agriculture and marginal, informal self-employment into steadily more productive activities in manufacturing, agro-industry and formal services.

Building regional production networks and tapping into international value chains would help African companies boost prospects for diversification, increased productivity and creating higher-quality employment. If many of the companies involved are small and medium-sized enterprises (SMEs) – which employ the bulk of people in any economy – the resulting growth would be more inclusive. This is the experience of the International Trade Centre (ITC), a development agency of both the WTO and the United Nations helping developing countries to trade and invest.

While pessimism about African countries’ ability to sustain the healthy growth rates of the prior decade has become fashionable since commodity prices started to fall in 2014, the fact is that Africa’s recent growth has never been just about minerals. Some of the best performers, such as Rwanda and Burkina Faso, are not rich in natural resources. Services like retail and communications, together with agri-business, have been an important part of the growth story.

According to research by the Overseas Development Institute, manufacturing production in sub-Saharan Africa more than doubled between 2005 and 2014, from $73 billion in 2005 to $157 billion in 2014 (in current, rather than constant prices). During the same period, manufacturing exports also doubled, from $50 billion to over $100 billon. There is considerable variation across countries and sectors, but both production and intra-continental trade in manufactured goods are indisputably growing. Countries like Ethiopia and Madagascar are inserting themselves with increasing success into international value chains for clothing and footwear.

Despite this progress, however, the share of manufacturing in the continent’s total GDP, at 11% in 2014, was lower than the 18% registered in 1975. Indeed, in a number of countries, economic growth has barely kept ahead of population increases, and per capita incomes only recently surpassed highs set in the mid-1970s. Africa’s share of global trade hovers around 2%, and its contribution to international value chains remains dominated by forward integration linked to natural resources.

African governments are working to foster a business environment more conducive to value addition and the development of regional and global value chains. Regional integration initiatives – from the 27-country Tripartite Free Trade Area that will bring together three existing regional blocs, to the African Union’s plan to create a single continent-wide market for goods, services, and business people – promise to build a bigger ‘home market’ that will enable African companies to specialize more and benefit from economies of scale.

Recognizing that opening markets is necessary, but not always enough, to make trade happen, African governments have adopted an Action Plan on Boosting Intra-African Trade (BIAT) which seeks to double intra-African trade flows in the decade from 2012. Partners and development banks are backing the integration and infrastructure push. Electricity and regional infrastructure are two of the pillars the African Development Bank’s ‘high fives’ agenda.

Also critical to the future of African SME’s are the remaining components of the African Development Bank’s agenda: encouraging agri-business and industrialization, together with a combined focus on skills-building, entrepreneurship and access to capital. This holistic focus on value addition is appropriate. As manufacturing production becomes increasingly mechanized, African economies will have to simultaneously look to food processing and services to raise productivity and create jobs. A discourse traditionally focused on industrialisation will have to be replaced by one focused on value addition across the spectrum of the economy.

Many of the bottlenecks which impede existing and yet-to-be-founded African firms from connecting to global markets and production networks affect firms of all sizes. But fixed costs by definition weigh more heavily on smaller firms than big ones. Trade-related fixed costs disproportionately affect SMEs’ ability to supply quality goods and services at a price attractive to international customers.
Reducing trade-related fixed costs, therefore, would be especially beneficial to SMEs and their ability to connect to international value chains. The World Trade Organization’s Trade Facilitation Agreement, once fully implemented, promises to cut red tape and associated costs related to border clearance, customs and transit. Non-tariff measures, such as requirements to obtain certificates proving where goods originate, are another source of time and expense for businesses. A survey by the International Trade Centre in six west African countries found that over 70% of SMEs encountered burdensome non-tariff measures when seeking to either import or export merchandise.

But these and other trade-related costs are hardly the only challenges facing SMEs in sub-Saharan Africa.
ITC analysis suggests that the gap between the productivity of small and large firms is wider in sub-Saharan Africa than in any other region. This is despite the fact that available data suggest the footprint of SMEs in terms of output and employment is even higher there than in the rest of the world. Low productivity translates into low incomes and poor working conditions for large sections of society.

ITC’s annual SME Competitiveness Outlook sheds light on country and region-specific constraints to business success, organizing them across three key pillars – the ability of SMEs to connect, compete and change. It examines key determinants of SME competitiveness at the level of companies, their immediate business environment and national policy. The 2015 report showed that sub-Saharan African SMEs perform particularly poorly, relative to their larger competitors, on the connectivity pillar: very few of them have websites and use email in day-to-day operations, limiting their ability to connect to domestic or foreign market opportunities.

Logistics costs tend to be significantly higher for SMEs than for large firms, mainly as a result of high inventory and warehousing costs, but in east Africa these are added to some of the world’s most expensive transport and freight rates – some 50% higher per kilometre than in Europe or the United States. In landlocked countries like Rwanda and Burundi, transport costs can reach as high as 75% of the value of exports – difficult for firms of all sizes, but particularly so for SME unit costs.

SMEs surveyed by ITC rank ‘access to information about export opportunities’ as a top area in which they would also value improvement. Understanding market opportunities is a necessary first step for SMEs to take advantage of them. Inadequate provision of business information by public or private associations is a well-recognised market failure which increases costs and barriers to entry for SMEs. Governments, along with trade and investment support institutions – such as chambers of commerce and trade promotion agencies – should be encouraged to supplement the market intelligence made available online by organisations like ITC, by collecting and publishing the kinds of business information SMEs need to internationalise.

Access to finance is a severe constraint for many SMEs. Many SMEs fall into a ‘missing middle’ of being too big for microfinance institutions but lacking the collateral, size or information sought by traditional lenders. As a result, many SMEs with economically viable projects cannot obtain financing. The International Finance Corporation reports that top banks serving SMEs in developing countries reach only 20% of formal micro-enterprises and SMEs, and a mere 5% in sub-Saharan Africa. Building credit information systems and new collateral frameworks and registries could be particularly effective in facilitating access to finance for SMEs. Direct education and training to help SMEs meet formal lenders’ requirements could meaningfully contribute to expanding access to finance. Even once SMEs are up and running, access to trade finance is a problem. Financial instruments to offset risks of non-payment or non-receipt of merchandise grease the wheels of commerce between sellers and buyers. Despite the fact that default rates are extremely low, SMEs, especially in developing countries, struggle to access trade finance. According to a new publication by the World Trade Organization on trade finance and SMEs, Africa has some of the widest financing gaps, with the estimated value of unmet demand estimated to be $120 billion.

Another major challenge for SMEs is the need to meet voluntary or compulsory standards and other regulatory requirements. Not only do SMEs need to understand the various requirements involved, they also need to adapt products and production processes to comply – and subsequently prove compliance, typically through certification by recognized standards bodies – to reach target markets. In sub-Saharan Africa, only 10% of small formal firms hold an internationally recognized quality certificate, compared to 45% of large African firms. An analysis of the regional prevalence of International Organization for Standardization (ISO) certificates for management and environmental performance is telling: sub-Saharan African businesses have 12 ISO 9001 quality management certificates per million people, compared to 536 in developed countries. For ISO 14001 environmental certificates, the figure for sub-Saharan Africa is 2 compared to 172 for developed countries.

As they seek to promote integration into international value chains and international markets more broadly, African governments will need to address the broader business climate for firms of all sizes. An ongoing ITC project to promote trade and investment across the Indian Ocean has underlined how businesses in the region are frustrated by complicated tax codes, fees and levies of dubious necessity, difficulties enforcing contracts and corruption. Yet the importance of SMEs to inclusive growth, especially because of their role in employment for women and young people, justifies dedicated attention to helping smaller firms internationalise.

To be clear, engaging with international value chains is no panacea: firms could get stuck in low value-added activities and struggle to move up the production chain. Yet participation in global production networks can help increase productivity, access to finance and technology, reduce operational disruptions, improve quality and customer service, and speed innovation – in addition to creating more and better jobs. The key is to develop public and private policies and programmes to support a more inclusive and sustainable trade-led growth.
With wages for relatively lower-skilled workers rising in China, millions of manufacturing jobs are poised to leave for other locations. Attracting many of these jobs, and the related investment, know-how, and technology to Africa should be a top priority for African policymakers, institutions and the broader trade community. Enabling African entrepreneurs and SMEs to connect to more sustainable and inclusive value chains in manufacturing, agriculture and services can create opportunities for the continent’s young workforce, and maximize the development impact of Africa’s economic transformation.

Written by

Arancha González was appointed Executive Director of the International Trade Centre (ITC) in September 2013. A Spanish national, she previously served as Chief of Staff to World Trade Organization (WTO) Director-General Pascal Lamy from 2005 to 2013. During her tenure at the WTO, she played an active role in launching the WTO’s Aid for Trade initiative and served as Mr. Lamy’s representative at the G-20. Before that Ms. González held several positions at the European Commission, conducting negotiations of trade agreements and assisting developing countries in trade-development efforts. From 2002 to 2004, she was the European Union spokeswoman for trade and adviser to the European Union Trade Commissioner.