As an engine of growth, jobs and social cohesion, SMEs are receiving increasing attention in the international policy discourse on conflict and development for their potential to foster prosperity and peace.
Yet SMEs continue to be underserved in terms of financial and technical support, and to date, SME support has yielded mixed results.
This is likely to be due, at least in part, to a limited understanding of SMEs’ embeddedness in the informal and formal institutional context. Indeed, the reality for SMEs in developing countries is primarily understood in terms of business constraints and weak statehood or governance failure.
However, particularly in fragile societies, small businesses greatly depend on i) their personal connections and social relations and ii) their allegiance to challenger authorities or alternative governance mechanisms offered by non-state actors.
These dimensions are not captured by conventional business surveys such as the World Bank's Doing Business reports and SME surveys.
In turn, modern thinking on institutional economics has significantly contributed to a better understanding of markets and economic activity in contexts where formal institutions are weak and where, instead, social relations, power and trust determine the rules of the game.
These insights can deepen our understanding of the reality small businesses face when operating in fragile settings. In particular, the role of social relations, personal connections and competing systems of power appear to be critical concepts to elucidate the underlying, often structural, causes of technical constraints.
Where state capacity is weak, international attention is increasingly turning to the private sector as an entry point for stabilisation and peace building. Among the diverse range of businesses in fragile settings, encompassing multinational corporations as well as informal street vendors, local SMEs have attracted particular interest from the donor community and their development partners for the prominent role they can play in post-conflict recovery and in helping fragile economies to transition towards more resilient societies.
And yet, SMEs’ perception of and experience within the broader ecosystem, and the actions they undertake to survive and expand in spite of all the risks, remain under-researched. Only very recent literature hints at the need to understand the interdependence of complex formal and informal institutional arrangements in order to design more effective support strategies for SMEs in fragile settings. Both the perceived relevance of SME development for prosperity and peace, and our limited understanding of the multiple ways in which firms interact with the broader conflict-affected environment, are the topics of the following sections. As such, they prepare the ground for the introduction of two analytical lenses that will be applied to the survey data.
Most fragile states are SME economies. They rely heavily on these types of firms for both high growth rates and the employment they provide for a significant part of the population. Indeed, it is estimated that the vast majority of all formerly registered companies in these markets are SMEs. Contrary to previous beliefs, local firms continue to operate in the midst of war and insecurity, when larger – notably foreign and more riskaverse companies, other than resource-extracting companies (Kolk and Lenfant, 2012) – typically decide to relocate or leave the country.
Based on this reality, domestic firms are increasingly credited with the potential to play a critical role in economic recovery (Naude, 2007; MacSweeney/Naoise, 2008; De Vries/Specker, 2009; UNDP, 2013). First, through the provision of jobs, income, much-needed products and services and infrastructure, they not only provide people in need with a livelihood, they also instigate a sense of security and confidence that can attract larger and foreign direct investment (WB, 2014: v). SMEs are further said to prove more flexible in adapting to volatile circumstances, utilising “opportunities that larger firms, including state-owned enterprises and multinational firms, cannot take” (Naude, 2007: 25). Consequently, humanitarian and development organisations increasingly display efforts to not distort local markets (by importing goods and services that are available locally or by subsidising new businesses), but to engage and strengthen them in their relief and recovery efforts as much as possible (UN 2009; UNDP 2013).
Second, by creating employment and income for a significant share of the local population, estimated by McKinsey to amount to over 50% in emerging markets, SMEs are appreciated for their potential to mitigate causes of conflict. This is believed to happen through two channels. The first channel has been widely propagated through the World Development Report 2011: According to surveys conducted in preparation of the report in areas affected by violence, unemployment and under-employment were highlighted as the most important factors motivating youths to join rebel movements, thereby increasing the risk of violence (WB, 2011: 79, WB, 2010). This correlation, albeit not based on empirical evidence but posteriori perceptions (Collier, 2010: 25), has become a standard argument across various policy domains. Whether in the domain of economic development or state- and peacebuilding, strategies to promote youth employment as a means of conflict prevention are flourishing in the policies of bilateral donors and multilateral development organisations (OECD/DAC, 2011: 72). As a particular facet of youth unemployment, the challenge of reintegrating ex-combatants into productive (self-) employment and preventing them from returning to fighting has received particular interest (UN, 2009; Peschke, 2011: 9).
Whereas a causal relationship between (youth) employment creation and a decrease of conflict remains a contentious issue (Holmes, 2013; Walton, 2011), the potential of SMEs to provide more jobs than larger firms is increasingly recognised, including by actors such as the International Finance Corporation (IFC), which mainly target larger enterprises and banks: “SMEs can have a higher impact on job creation than larger firms when they get access to financing, since they tend to be more labor intensive.” (IFC, 2013: 88) In fact, compared with larger businesses, SMEs have been appreciated for their ability to accommodate workers in places where larger-scale investment is unlikely to become a more common reality.
A more solid correlation links SME development to economic growth and poverty reduction, which in turn positively correlates with a lower risk for conflict. Considering that inequality between identity groups increases the likelihood of violent confrontation, it is further argued that micro, small and medium-sized firms have the greatest potential to generate broad-based and inclusive growth, from which the majority of the population benefit (UNDP, 2013: 68; Keele/Lofbom 2013: 4). Conversely, as the backbone of most emerging economies, a neglect or further weakening of local SMEs (for instance by unfair competition through the large-scale import and free-of-charge distribution of development supplies) can, in turn, reinforce state fragility (OECD/DAC, 2011: 73; UN, 2019: 15; UNDP, 2013: 35, 38, 56, 72).
In light of this strong potential for economic recovery, development agents call for greater engagement with and support for domestic SMEs in contexts plagued by conflict and fragility, be it in the form of development agencies sourcing more systematically from local SMEs, or international companies investing into local supply and distribution chains, or in supporting SMEs in their own right, for the sake of reviving the local economy.
The recent appreciation of SMEs in fragile settings goes beyond their positive economic contribution. A growing body of literature and policy documents advocates the multiple non-economic ways through which these firms can contribute to broader state and peacebuilding goals. In fact, SMEs are believed to have great potential as a critical ingredient for social cohesion, state legitimacy and community security.
The World Development Report (WDR) 2011 on Conflict, Security and Development and its more recent successor on Jobs (WDR 2013) emphasise the positive effects that employment can have on the self-esteem of an individual and his/her position in society. For example, jobs for men are often found to relate to a decrease in sexual violence against women, whereas jobs for women are in some instances correlated with an increase in physical aggression towards women if not promoted in a way that is sensitive to existing norms around women and manhood (UNDP and UNDDR, 2012: 51 ff., 61 ff.). Similarly, employment opportunities for youth, including ex-combatants, can provide young adolescents with a better perspective, provided the older generation is involved in and benefits from the process in order to overcome inter-generational conflict that often lies at the root of youth marginalisation. Hence, gender sensitivity and generational responsiveness are key for successfully linking employment to stability (Kessler, 2013: 8).
The collaboration of SMEs, be it along a value chain or within a cluster, can be instrumental in rebuilding trust and initiate a process of reconciliation between adverse groups at community and regional levels. A quantitative study of local entrepreneurs in the Rwandan coffee sector proved a significant correlation between economic advancement and increased intergroup interaction, which in turn reportedly resulted in a more positive attitude towards intergroup reconciliation (Tobias/Boudreaux, 2009: 2). Overall, these social effects of SME development are understood as critical foundations for rebuilding the social fabric of conflict-affected and fragile societies (WDR 2011: 30 ff.).
It is further argued that local SMEs are usually more interested in making a difference in peacebuilding than large companies as they suffer much more from conflict (International Alert, 2007). In that sense, local SMEs are also seen as a critical partner in “establishing a shared understanding of statebuilding reforms and priorities as they evolve” (OECD/DAC, 2011: 62). In contrast to micro businesses that are more likely than SMEs to operate outside formal regulation and largely rely on unpaid family labour, local SMEs can help restore state legitimacy by (eventually) paying taxes, thereby expanding the revenue base that in theory enables a government to provide better services to its citizens (Peschke, 2011: 10). Finally, local businesses can help address key security concerns by functioning as early-warning systems on potential security breakdowns at community level. (International Alert, 2006: 7).
While these various arguments linking SME development to improved stability are still to be thoroughly tested and substantiated with evidence (Brueck et al., 2015), the purpose of summarising them here is to demonstrate that the current donor discourse on conflict and development emphasises the non-economic, socio-political dimensions of businesses. However, as will be shown later in this report, the socio-political nature and role of small firms as displayed in donors’ ambitious peace and development narratives stands in stark contrast with the essentially economically defined financial and technical assistance strategies deployed to support those businesses in what tend to be socially complex and often highly politicised societies.
Despite the well-established recognition of the economic and socio-political roles that SMEs can play in rebuilding conflict-affected societies, this particular segment continues to be under-served. While local banks are reluctant to offer SMEs access to long-term capital and prefer to serve larger enterprises that have collateral, NGOs cater almost exclusively for micro businesses. As a consequence, the SME segment has come to be referred to as the ‘missing middle’. Evidence suggests that the kind of support that does exist for SME development has yielded limited success, both in terms of firm productivity and job creation (Grimm and Pfaffhausen, 2014).
Notwithstanding its potential positive contribution to state and peacebuilding, research on SMEs in fragile settings is still in its infancy (Tobias/Boudreauw, 2009: 1). Guglielmetti (2010) rightly observes that the growing body of research on the positive effects of entrepreneurship on development and peace has to a large extent neglected the multiple (and two-directional) interactions between enterprises/entrepreneurship and the institutional environment, including the ambiguous role that firms can play in those contexts (Guglielmetti 2010: 1). However, solid corroboration of the peacebuilding potential, particularly of the political and social impact channels, will require a more thorough understanding of SMEs’ embeddedness in the broader political, social and economic context. Before exploring this apparent gap further, we first turn to what we know about SMEs in fragile settings.
To date, our knowledge of the reality that SMEs face in fragile settings has been largely shaped in terms of obstacles and weak state capacity. To explain the poor performance of SMEs in developing contexts in general and in fragile contexts in particular, current research either refers to the type of markets most SMEs operate in and that are characterised by low access and saturation (Altenburg and Eckhardt, 2006) or to the lack of education and skills upgrading that prevents economies from transforming into more capital-intensive manufacturing industries (Golub and Hayat, 2014; Basnett and Sen, 2013). Others point to the particularly unfavourable investment climate in, for example, sub-Saharan African countries (Golub and Hayat, 2014), which would explain 40% of the difference between firm sizes in Africa and the rest of the world (Iavocone et al., 2013).
Most of these economically focused studies draw on the conventional business environment standards and tools used to measure the conduciveness of the business climate. Indeed, conventional enterprise surveys and business environment reports aim to detect, quantify and rank the main bottlenecks enterprises face in order to promote reform towards a more conducive business environment and to develop effective enterprise support strategies.
Box: The benefits and limitations of the World Bank’s Doing Business Reports and enterprise surveys
Among the most prominent and influential data sources used by academics and policy makers alike are the World Bank Group’s annual Doing Business (DB) report and the World Bank enterprise surveys. Both are different but complementary approaches to benchmarking the quality of the business environment across countries. The DB report is aimed at measuring the costs to firms of business regulations. The 2014 DB report covers 189 countries with Libya, Myanmar, San Marino and South Sudan included for the first time, among a total of 33 fragile countries or territories. As to the enterprise surveys, 22 of the 181 countries included are fragile and conflict-affected states (WB, 2013b: 17). By benchmarking the regulations that affect private sector firms, SMEs in particular, the DB report presents a detailed analysis of the costs, requirements and procedures that a specific type of private firm is subject to in all countries, and then, creates rankings for every country.Read more...
Development programmes that conduct their own SME needs assessments have the clear advantage of a narrower geographical focus and the direct involvement of entrepreneurs in the assessment of business constraints (instead of solely focusing on the regulatory framework and relying on the assessment of experts). However, they usually come to similar conclusions, which may be explained by the use of predefined lists of obstacles that surveyed entrepreneurs are then asked to choose from.
Based on those assessments, governments and their development partners have developed support strategies that essentially focus on two levels: removing institutional barriers to entry (macro level) and providing financial and technical assistance to firms aimed at removing (some of) these barriers (micro level). In fact, business environment reform, as well as subsidies, loans and technical assistance to business development service networks can be instrumental in helping local businesses gain access to services necessary for them to expand and unleash their development potential (UN, 2009: 37, UNDP, 2013: 66).
However big the influence of the DB reports in promoting and guiding developing countries’ reforms and attracting (or repelling) potential investment, criticism persists that goes beyond the methodology used and this has been substantiated in recent years. One criticism is that the reports struggle to capture obstacles such as social divisions, and the incompetence and various forms of corruption that infest government bodies (Kaplan, 2013). Spark, in turn (2014) highlights the limited focus on specific obstacles that often prevent young and female entrepreneurs in fragile states from starting or growing a business (SPARK, 2014: 2). According to Spark’s own survey, conflict-related concerns include: i) dealing with the tax administration; ii) paying additional fees (bribery); and iii) obtaining permits (Spark 2014: 13). More generally, Spark expresses surprise that “these more conflict sensitive matters” are currently not being measured by the WB’s business barriers studies. In fact, although the WB’s enterprise surveys, the complementary matching part of the DB report, refer to corruption and bribery, their restrained definition of crime and corruption leaves out a wide range of corruption practices that often determine the survival of local firms.
Another criticism emerges from the growing awareness of the influence that the institutional context has on private enterprise development. Guglielmetti (2010), for example, argues that as long as the specific characteristics of emerging economies in fragile situations with their a-typical informal and formal institutions are not understood, policies will fail to provide effective support to SME development in fragile situations: “The context in which economic agents act varies in terms of opportunities, constraints and incentives, and exerts a strong influence on individual behaviour” (Guglielmetti, 2010: 2).
In addition to the two types of criticism summarised above, two major blind spots emerge. By assessing the business environment through the lens of predefined categories of government regulation and with a focus on commonly found bottlenecks to business creation and growth, the way in which SMEs interact with their ecosystems cannot be understood in its complexity. First, the tools fall short of understanding the multiple ways in which SMEs not only experience but also actively tackle the challenges and opportunities they face. Through their agency, businesses, small though they may be, do influence the institutional settings – both formal and informal – in which they operate and hope to thrive. Predefining certain practices as obstacles (e.g. corruption: WB 2014: 2) may prevent us from understanding them as part of a deeply embedded coping mechanism, second-best in nature, but better suited to the fragile realities than the textbook recipes designed for functioning markets. Addressing corruption solely as an ill is likely to carry its own risks of destabilising informal arrangements, which, at least in the short term, allow businesses to survive or even prosper.
This brings us to the second blind spot: state-centrism. The World Bank and most donors recognise that the state has to play a critical role in creating an enabling business environment, i.e. by defining and enforcing the rules and regulations that will ease strong private sector-led economic growth (WB 2014: 2). However, in situations where state authority is weak or contested, formal institutions and enforcement mechanisms, if they exist, are typically either by-passed or co-opted by competing authorities, including non-state armed groups. As a result, the ecosystem in which SMEs operate in fragile contexts is often shaped by highly personalised or informal institutions rather than by formal rules and regulations, which might exist alongside. In those environments, personal connections and alignment with the interests of powerful elites are likely to determine the success or failure of small businesses.
This report sheds some light on both blind spots, based on the findings that will be presented in the next chapter and that stem directly from SMEs’ perceptions of the risks they face and the strategies they believe to be best suited to confronting and ideally mitigating these risks. But before turning to that, we will further define what is missing in our present knowledge of SMEs in fragile settings and what it is we would need to know in order to come up with more effective policies. With these questions in mind, the following section will develop a framework for the analysis of our survey findings.
There is a fast-growing body of political economy literature that explores the interaction between political and economic processes and grapples with the distribution of power and wealth between different groups and individuals and the incentives and processes that create, sustain and transform these relationships over time. Political economy has proved a valuable tool in assessing why institutional settings serve personal interests rather than the public cause (Corduneanu-Huci, 2013: 2). For example, recent research in the fields of Institutionalist Political Economy (Chang, 2011) and Economic Sociology (drawing on theories of embeddedness) go beyond the narrow notions of efficiency and rationality, and give more weight to the influence of history, culture and power on institutions and economic activity, stressing the non-economic forces in institutional processes and markets. In this sense, modern thinking on institutional economics, particularly institutionalist political economy, has highlighted the limitations of neoclassical theory, on which much of the old institutional economics relies.
Furthermore, the recent institutional debate has contributed greatly to a better understanding of markets and economic activity in contexts where formal institutions are weak. In these environments, markets are found to be highly fragmented and exclusive, with strong power distortions and informal institutions prevailing (Ritchie, 2014: 4, 69).
Indeed, social relations, power and trust – rather than formal institutions – determine “the rules of the game”. Membership of a certain identity group, power over a given resource, or loyalty to a dominant elite faction decide whether an entrepreneur can obtain a business licence in a reasonable number of days. As shown above, there is increasing recognition that conventional business environment indicators fall short of capturing those informal determinants. They merely measure the symptoms of more structural and political dynamics (Gugliemetti, 2010; Stel, 2012; Kaplan, 2013; Spark 2014).
When state institutions fail to provide basic services such as security and livelihoods, entrepreneurs (just like all ordinary people) have to rely on (or turn to) alternative service providers. These tend to be highly personalised, exclusive and may claim payment for their services through violent means (Wood, 2003). Understanding these informal arrangements, social relations, systems of trust and power is critical in order to effectively target and design strategies that will strengthen SMEs’ ability to grow in a conflict-sensitive and sustainable manner.
The present paper seeks to draw attention to this gap between current understanding of SMEs in fragile settings and recent thinking on the interdependence of complex institutional arrangements and markets by presenting empirical evidence. Placing ourselves in the shoes of entrepreneurs, we aim to shed some light on how they perceive and react to environments that donors have come to consider fragile. Mindful, on the one hand, of the earlier identified blind spots (focus on technical bottlenecks and state centrism) and, on the other hand, the impact channels through which policy increasingly expects SMEs to contribute to inclusive development and peace (e.g. through social cohesion, security perceptions and state legitimacy) the findings of two enterprise surveys will be analysed through two lenses. They are of course interrelated, but highlight two different perspectives that have received little attention in analyses of enterprise development in fragile states to date, notably in economists’ circles: a) personal connections, social networks and trust and b) competing systems of power and governance. These will be used to analyse the perceptions obtained from SMEs.
Trust is considered critical for economic transaction. It is both “an outcome and an antecedent of economic activity” (Ritchie, 2014: 71). On the one hand the hiring of labour, sourcing from suppliers and selling to customers requires a minimum level of trust between actors. On the other hand, this interaction, particularly if it grows from a one-off cooperation to a more regular relationship, creates and fosters confidence.
While literature emerging around the concept of social cohesion points to business development and job creation as compelling means of trust building within and between communities, conspicuously fewer efforts have been made to understand the kind and scope of social relations or social capital that underpin economic exchange in markets plagued by high risk and mistrust. In fact, in those environments markets tend to be dominated by family business and economic transactions confined to trusted members of the same identify group (Hellman, 2012; Ritchie, 2014: 70). Missing or dysfunctional institutions are substituted by personal relations between economic actors.
Even scanter is the literature on the ways in which reliance on traditional social networks for doing business in fragile contexts tend to hamper growth and prevent competitive behaviour. Where formal institutions are weak and social, cultural and political affiliation determines access to and scope of participation in market, the performance of insiders is likely to increase (Gugliemetti, 2010: 11). However, the exclusive character of these networks, often grounded in ethnicity, family relations, history and religion, prevents broader participation in markets, thereby risking the reinforcement of existing patterns of marginalisation and horizontal inequality in access to assets, employment and income, all likely causes of conflict (Stewart, 2006; Biggs/Shah, 2006: 4-5).
More generally, confining economic activities to trusted business partners is likely to inhibit growth and innovation. Productivity and growth are hindered as long as hiring, sourcing and marketing strategies are based on allegiance to family and identify groups rather than on merit, quality and market demand. Innovation is unlikely to thrive based on exclusive reliance on well-known business partners and “static patterns of business exchange” (Biggs/Shah 2006: 36; Munshi, 2007: 2; Naude, 2011).
Despite their significant influence on economic growth in contexts of fragility, the inclusiveness (or degree of exclusion) and (im)permeability of the social networks that underpin market activity are not covered in current business surveys. Yet, if not factored into the design of business support strategies, they are likely to undermine the latter’s success.
The second determinant, so far neglected in accounts of business constraints, is the presence of competing (non-state) authorities that in general not only challenge weak state institutions in delivering security and basic services, but also compete in the business of buying and exchanging loyalties and dependencies to broaden their respective constituencies (Reno, 1998; Wood, 2003; Boege et al., 2008). In fact, their legitimacy does not derive from representing a public interest, but from a complex exchange network of personal favours. The resulting competition for power, resources and loyalties prompts an entanglement of politicians and businessmen on the one hand, and of state institutions and traditional authorities on the other. In many instances, these overlap and are commonly referred to as situations of “hybrid governance”.
As Stel convincingly argues, “with regard to entrepreneurship, the most significant aspect of hybrid governance is public-private overlap or entanglement”, an arrangement in which politicians and businessmen alike are less concerned with the general conditions for doing business (for instance, through reforms leading to a more conducive enabling business climate), but primarily interested in their personal business success (Stel, 2012: 5).
The other facet of the entanglement involves state institutions and traditional or other non-state authorities. Such non-state authorities can consist of a group of elders, an insurgency movement or a religious authority. In the absence of legitimate and functioning state institutions, these are found to be critical in providing security and basic services, including to businesses. But they may also look for opportunities to get access to resources in order to maintain the distribution of material benefits to their kin. State institutions, in turn, may have an incentive to tolerate informal taxation by those traditional, competing authorities, if this is part of a broader power balance that guarantees their own hold on power.
Caught in such a highly political marketplace, SMEs often address basic security threats by investing their own political authority (the wealth they accumulate and the employment they generate) into new allegiances with private or traditional authorities, albeit “at the cost of dependent and sometimes bonded loyalty (adverse incorporation)” (Wood, 2003: 457/8). Rarely are they merely victims of corrupt and hybrid governance systems. Their business strategies have to actively engage with those practices if they want to continue operations or grow. Therefore, most viable businesses are more likely to reproduce and reinforce the conditions that ultimately prevent a transition from uncompetitive growth and poverty to sustainable, inclusive growth and stability.
As with the literature on business development, social cohesion and peacebuilding, most research into the link between corruption and business is unidirectional and focuses on the negative consequences of clientelism and corruption for entrepreneurship. Only recent contributions explore the trade-offs between a certain level of patronage and conflict (Khan, 2006; North, Wallis, and Weingast, 2009; de Waal, 2009; WDR 2011). One argument points to the risk that suddenly dismantling these relationships can have unintended destabilising effects. Another argument is that the benefits of short-term stability and some degree of legitimacy that patronage networks entail can offer a starting point for more auspicious reform strategies: readiness to engage with prevailing “second-best” governance arrangements (the WDR 2011 recommends engaging elite pacts in inclusive-enough coalitions) and gradually improving those in terms of accountability and inclusiveness is believed to yield better results than continuing to work with perfect blue prints and zero-corruption tolerance (WDR 2011; Waal, 2009).
Much of the current SME literature and support strategies focuses on regulations and firm performance, rarely paying attention to the political compromises entrepreneurs accept in order to survive, let along thrive. But taking those dynamics of hybrid governance into account is essential in order to understand the constrained choices and options SMEs face in fragile settings.
By adding these two lenses to our understanding of SMEs in fragile settings, this report seeks to do more than merely complement the list of missing business barriers that require more attention in future SME surveys. More importantly, we argue that even the commonly cited and largely technical constraints can only be addressed effectively and sustainably if understood as symptoms of the broader structural context, particularly the reality of social relations and competing systems of power.