Finding # 1: Many business constraints in fragile settings are driven by deeply entrenched informal institutions, such as social networks and non-state authorities. These structural drivers of business performance are not captured by conventional business surveys. They however shape and often reinforce the widely measured business constraints such as a ‘lack of access to finance’.

Implication: The nature and persistence of SME constraints in fragile settings can only be understood in light of the often informal interaction between companies and their socio-political and economic context.

Considerations for:

research: A better understanding of the socio-political constraints of SMEs will require a more qualitative assessment of the interaction between the ‘rules of the game’ and entrepreneurs.

policy makers: Combine the existing business (environment) surveys with political economy analysis as a basis for agenda setting and strategy design.

implementers: Adjust intervention tools to the reality of SMEs by accommodating the role of social networks and non-state authorities, instead of treating them as taboos.

Finding # 2: In instances of insecurity and unpredictability, SMEs’ coping strategies are often aimed at resilience rather than at growth.

Implication: Whether an SME aims at growth or consolidation has implications for support strategies. In some instances growth strategies may have destabilising effects.

Considerations for:

research: Analyse past experience, in which efforts to enhance productivity and expansion of small businesses have yielded limited results and sometimes even exacerbated tensions.

policy makers: Define realistic objectives for SME promotion in fragile settings (e.g. stabilisation versus economic growth?) and anticipate the trade-offs. Make sure that policy objectives align with the objectives of the target group, i.e. the genuine aspirations of entrepreneurs, and take account of the acceptance level within broader society.

implementers: Reflect the policy goal in intervention tools. Develop tools that differentiate between (but value equally) businesses that have the potential to grow and firms that, with the right support, will be able to survive and build resilience.

Finding # 3: By neglecting the underlying institutional drivers of SME constraints, support strategies can easily reproduce and foster the social, economic and political conditions for insecurity and exclusive growth.

Implication: Embed SME promotion strategies in more comprehensive support strategies that take account of the institutional environment and power configurations.

Considerations for:

research: Research into SMEs’ reliance and dependency on powerful elite coalitions can reveal promising entry points for de facto business environment reform.

policy makers: Embed SME promotion in broader business environment reform that involves/takes into account the role of non-state actors, social identity groups.

implementers: Recognise the political nature of interventions, combine business development with mediation skills and anticipate the potential harm that can be created.

Slide 4

This report has presented and analysed the evidence of SMEs in fragile settings by combining current insights from new institutional economics, with evidence from small and medium-sized firms. This last chapter will summarise major findings with regard to business constraints, firms’ strategies and donor support. From these, a number of practical considerations will be derived for policy makers, development practitioners and researchers committed to supporting SMEs in their endeavours to cope and grow.

3.1 Major findings

Finding # 1: Structural drivers of business constraints

Many business constraints in fragile settings are driven by deeply entrenched informal institutions, such as social networks and non-state authorities. These informal institutional factors, although increasingly recognised, are not captured by conventional business surveys. As defining characteristics of the business reality in many fragile settings, however, they form an inherent part of firms’ day-to-day business strategies.

Qualitative evidence gathered in this research project confirms recent insights that technical business constraints are to a certain extent the mere symptoms of a more structural phenomenon. The role of mistrust, the recourse to personal networks, and the influence of competing (state and non-state) governance systems shape to a significant degree the reality of SMEs in fragile markets. On the one hand, belonging to a certain identity group can decide whether a business will have access to electricity, finance or raw materials. This correlation was testified to by interviewees in very different contexts, ranging from Pakistan where the distribution of electricity mirrors a region’s ethnic affiliation, to South Sudan or Burundi, where obtaining capital depends on having a relative in the right position, or Afghanistan and the DRC where, due to high levels of insecurity and mistrust, family connections are critical to source inputs in a reliable manner. Yet, the very same social networks that allow entrepreneurs to operate in the absence of trust and services are based on adherence to a given (ethnic, religious, regional, political or gender) identity and hence exclusionary in nature. They can exclude qualified new actors from business and trade, prevent innovation and nurture exclusion.

On the other hand, readiness to cooperate with non-state governance systems, such as the Taliban in Afghanistan and Pakistan, frequently becomes a sheer necessity for running a business in a certain region or addressing some immediate security concerns for personnel and goods. Also, women or younger entrepreneurs in patriarchic or traditional societies depend on the authority and consent of elders to gain access to the more lucrative, hence more exposed, selling spots in the local market (Afghanistan). While these alternative service providers serve the business case in the short run, their vested interests in the status quo are likely to prevent reforms towards more accountable, transparent and equitable arrangements of service provision and market access in the long term.

Much of the literature describes firms’ reliance and dependence on personal networks and/or competing governance systems as a consequence, rather than a cause, of non-functioning formal institutions and the lack of public goods (such as security, electricity, transport infrastructure). However, based on the findings of this study, we argue that the causal relationship works both ways. Where formal institutions have been substituted or complemented (and challenged) by personal networks and non-state governance structures, they are likely to remain in place and survive the most ambitious institutional reform programme. In many cases, the deeply entrenched informal arrangements will either bypass or co-opt reformed institutions, making the latter indicators of de jure change, while remaining irrelevant to the de facto reality of SMEs.

Conventional SME surveys struggle to capture these structural informal constraints by focusing on readily quantifiable and measurable symptoms, such as access to finance. For example, corruption paid to non-state actors is not recorded by the World Bank’s enterprise surveys. Nor is non-state actors’ ability to provide security to their supporters and their obstructive effect on efforts to create more sustainable and inclusive security arrangements. A recent publication on private firms and crime (Goldberg et al., 2014) puts it in a nutshell: By forging a narrow understanding of corruption as “forced donation”, the authors argue, the WB’s enterprise surveys fail to differentiate between the various shades of corruption, thereby undermining the huge grey area ranging from voluntary contribution to outright extortion. Moreover, corruption is essentially understood as a bribe payment to public officials, leaving out informal payments to alternative governance arrangements that may co-exist alongside the state.

An inevitable first step to understanding the complex reality in which many SMEs operate will require an approach that straddles the formal and informal spheres, dismantles the patron-client thinking of corruption, and views the entrepreneurs neither solely as victims or perpetrators of corruption but as a junction, where security of assets and access to services are being traded for employment opportunities. Or access to electricity, for example, is granted on the basis of voting for the right political party.

Finding # 2: Consolidation rather than growth.

In instances of insecurity and unpredictability, SMEs’ coping strategies are often aimed at resilience rather than growth.

The majority of interviewed businesses – notably in South Sudan, Afghanistan and Pakistan, where insecurity and unpredictability were perceived most burdensome – have adopted resilience strategies focused on survival rather than growth. Contrary to growth-oriented tactics, those coping mechanisms involve short-term (rather than medium- to long-term) planning, minimum investment (rather than economies of scale), restriction to local markets (rather than looking for expansion), a low profile (going with the flow rather than being innovative), and sticking to long-established relationships and networks (rather than opening up to new business linkages).

To fully appreciate the value of SMEs’ consolidation strategies in fragile settings, it is important to realise that business success can have multiple meanings. As increasingly recognised, the impact of firms goes beyond their economic effects. Even if a business stagnates commercially, and fails to grow or to meet its commercial targets, it can still be productive and have positive effects on the broader political and societal environment (Naude, 2007: 9). A company that fails to create paid jobs (to non-family members) and expand operations may still deliver a key service or product to the community and sustain hope for a more peaceful and prosperous future.

However, risk management in the present involves loyalty to institutions, organisations and personal networks that work and deliver livelihoods today, whatever the longer-term cost. Whether they are insurgents, corrupt government officials, terrorist groups or relatives in high places, as long as they provide critical ingredients for business survival, SMEs are likely to postpone more strategic business preparations for the future in the pursuit of survival and security in the present. This often comes at the price of dependency and sometimes bonded loyalty. By paying bribes and buying permits from non-state actors, those informal short-term security arrangements reproduce and perpetuate the conditions for long-term insecurity.

Clearly, in order to grow out of resilience mode, a business needs to overcome these networks of dependency. As Naude (2007) points out, those elements of a business strategy that prove to work well for survival, might actually hamper companies from growing in times when prospects are better. In fact, many companies interviewed in Sierra Leone and the DRC were in the process of switching to more flexible business strategies, adopting more long-term planning, searching for new markets and means to decrease their dependency on a small group of suppliers and customers, and buying in stock. But this switch is likely to encounter some resistance from those more powerful players whose power and resources have relied on the loyalty of their protégé SMEs, a phenomenon that was attested to by respondents in Sierra Leone.

As the discrepancy between identified business bottlenecks and priorities for external intervention reveals, the ambitious growth aspirations that dominate most interviewees’ wish lists – with financial assistance and employees’ training ranked highest – may match donors’ combined investment and development agenda better than what SMEs consider their most pressing needs. Only a careful analysis of small firms’ embeddedness in a complex social and governance context will prevent financial and technical assistance pushing entrepreneurs into growth strategies that could easily undermine their resilience, and potentially pose a risk to the broader stabilising effects of these firms.

Finding # 3: the risk of exacerbating fragility

If the structural drivers of business constraints in fragile contexts tend to be ignored and eventually reinforced by conventional donor interventions, there is a risk of reproducing and fostering the social, economic and political conditions for insecurity and exclusive growth. Attempts to reform the rules of the game will, in turn, meet resistance from those with vested interests in the status quo.

While the Doing Business report and ensuing business reform processes have, in many cases, led to better regulations and country rankings, enforcement of the rules and actual improvements in SME conditions often fail to occur. In particular, macro-oriented reform programmes have been described by some authors as an “expensive failure” (Schramm, 2010: 90-91; Patterson, 2010: 226). This is likely to be at least partly due to the fact that fixing formal institutions and their ability to deliver services will not automatically dismantle and replace the role of the incentives networks and power structures that have grown in their absence. On the contrary, additional resources into good governance programmes and state capacity building have proven to fuel and foster the complicity of those institutions, further undermining the accountability, impersonality and inclusiveness they were meant to build or restore (Corduneanu-Huci, 2013).

The mixed results of SME development programmes in fragile settings have so far at least partly been explained by a focus on readily measurable business constraints and formal institutions. By seeking to fix the symptoms rather than the underlying causes, de facto obstacles will remain, as generalised patterns of clientelism and corruption are likely to persist. At the level of the individual entrepreneur, resources directly channelled to SMEs are likely to create extra incentives for state officials and non-state actors alike to extort the beneficiary businesses or misuse control over access to security provision, transport infrastructure, electricity or finance as lucrative channels to exchange favours for additional rents or loyalties. Evidence from OnFrontiers and RVO offers various examples in which entrepreneurs describe their increased exposure to government officials or warlords who extract rents from those businesses that have visibly or reportedly benefited from financial donor support.[107]

At the level of the overall business environment, reforms that are not accompanied by broader social, political and economic transformations that include considerable benefits for the main beneficiaries of the status quo, will inevitably feed into and therefore strengthen the existing personalised arrangements. Where patronage is commonplace, this assistance can easily evaporate in an opaque system without achieving its target. But more importantly, assistance in such an environment also carries the risk of reinforcing the same structures that prevent small businesses from growing and fragile situations from stabilising. However the necessity to instigate and sustain a de facto reform process towards a level playing field for SMEs comes with its own challenge, as persistent attempts to transform the power configuration into a more equitable, transparent and fair business environment are likely to trigger strong opposition and potentially violent resistance.

Slide 5

3.2 Implications for policy, practice and research

In an attempt to bring the analysis back to the policy and programming domain, the above findings suggest a number of practical considerations for policy makers, practitioners and researchers. In short, the above findings call for i) a better understanding of the socio-political constraints on SMEs in fragile settings, ii) clarity on the objectives of SME promotion policies and programmes in those contexts and lastly, iii) a systematic embeddedness of SME promotion strategies in more comprehensive approaches in order for them to be effective in complex and contested institutional settings.

Implications of finding # 1:
The structural causes of SME constraints in fragile settings can only be understood by exploring the often informal interaction between companies and the broader socio-political and economic context.

Conventional understanding of small firms in fragile settings has largely been framed in terms of typical business constraints and dysfunctional regulations that can be addressed by readily available financial and technical assistance packages. A lack of access to finance will be countered by the provision of loans. A disproportionate number of days needed to register a business will be reduced by the establishment of a one-stop shop. Low production capacity among businesses will be tackled by enhancing the capacity of business development service providers. However, in environments that are largely determined by personal connections and competition between state and non-state authorities, technical remedies will not remove the structural barriers and political incentives at play.

…for research

A more qualitative and political assessment is needed to gain a better understanding of the institutional complexity that shapes SMEs’ day-to-day operations. In particular, the extent to which social networks help or hinder SME development deserves further investigation. Also the role of non-state actors in providing services that are critical for SME survival in the short to medium term – but that often maintain competing power structures, which undermine statebuilding and more sustainable stability – needs to be better understood. Research into the structural causes of SME constraints and potential needs to:

take into account the perspective of the entrepreneur;

consider both constraints and coping mechanisms; and

not be limited to state institutions, but extend the analysis to firms’ interaction with social networks and non-state authorities (including traditional leaders, rebel groups, etc.).

One theme in particular would benefit from further research. It concerns the many shades of corruption, and the much larger phenomenon of patronage, of which SMEs often form part. Understanding the exchange of goods, money and favours through a narrow and normative patron-client concept fails to comprehend the workings of a wide range of bribes, from voluntary payments to forced extortion, which link entrepreneurs to multiple, often competing (state and non-state) patrons, while securing loyalty and dependency from customers, employers, and suppliers. A more nuanced understanding of such an opaque web of favours and payments in the absence of transparent institutions will attest to the limited relevance of anti-corruption clauses in loan contracts. It will further demonstrate the powerful vested interests that any anti-corruption reform process will need to prepare for.

…for policy makers

The World Bank’s Doing Business report and enterprise surveys should be complemented by political economy analysis to form a basis for agenda setting and policy instruments. In fragile contexts where informal power arrangements rather than the rule of law and formal institutions determine the business environment, understanding who the power holders and their support bases are, and how they interact, will provide critical information on both the growth and stabilisation potential of a given industry.

Grounded in a deeper understanding of the stabilising and destabilising effects of corruption and patronage networks, future policy making will have to rethink its anti-corruption strategies in fragile contexts. Although not a direct consequence of conflict or fragility, corruptive practices appear to intensify and become entrenched where state capacity is dysfunctional at best. If the exchange of informal payments and favours is the rule rather than an exception for most entrepreneurs, and if these informal, potentially illegal, transactions are not only a means to access services that dysfunctional state institutions struggle to provide, but also a critical means to maintain some kind of power balance between competing systems of authority, strict adherence to a zero-tolerance of corruption stance will inevitably have destabilising effects.

…for implementers:

Adjust intervention tools to the reality of SMEs accommodating the role of social networks and non-state authorities, instead of treating them as taboos.

In addition to a qualitative assessment of the business context as described above, loan applicants (firms or financial intermediaries) and any potential SME beneficiaries of a support programme could be asked to include elements of such information in their regular feasibility study or/and risk assessment.

Donors and development implementers should bundle resources, gather and share information on SMEs’ social networks, patronage webs and links to non-state actors.

Consider the (facilitation of) cooperation with unusual partners, such as the military or human rights activists and research institutes, which are well placed to gather such sensitive information in a particular region or sector. Recognise that this is the kind of information that is not readily available to foreign investors or development actors.

Implications of finding # 2:
Whether an SME aims at growth or consolidation has implications for support strategies. In some instances, growth strategies may have destabilising effects.

In the context of converging trade and development agendas and a growing donor interest in fragile contexts, this research encourages policy makers to reflect upon the trade-offs that will inevitably arise if SME promotion is to serve multiple goals. In fact, from the perspective of small firms, looking at the emerging enthusiasm among donors to entrust SMEs with the task of bringing prosperity and peace to their conflict-ridden societies raises important questions with regard to the distinct policy goals at play. What exactly are SME promotion policies and programmes designed to achieve? To what extent do these (complementary but sometimes conflicting) goals align with the targets that small entrepreneurs have set themselves?

While the prevailing trend of combined policy agendas emphasises the synergies of different goals (e.g. trade and development, but also stabilisation or peace- and statebuilding), essential differences persist but receive much less attention. Evidence suggests that in fragile settings these trade-offs are particularly severe.

First and foremost, the research illustrates some obvious trade-offs between a focus on development and a focus on growth. For instance, productive enterprises operating in fragile settings are generally believed to be of particular relevance for inclusive development, and even more so if headed by women or youth. However, rather than aspiring to grow and create employment, many of these enterprises are found to be focusing on consolidating their operations, keeping a low profile and minimising risks. It was also argued that women-owned or managed enterprises would be even less likely to expand due to security risks and cultural bias.[108]

Furthermore, and maybe more importantly, the anecdotes gathered in this research illustrate some serious trade-offs in combining stabilisation and economic development agendas. In order words, the underlying assumption that links SME promotion to peace sees itself confronted with a business reality whose fragility can worsen in multiple ways as a result of SME promotion. The influx of resources, through (non-)financial assistance, and the stiffening of competition not only provoke a shift in power balances but also expose beneficiaries to a heightened risk of rent seeking and extortion.[109] At a more general level, where entrepreneurs’ ability to grow and invest (and eventually pay back their loans) hinges on their readiness to rely on unlawful security and service providers, their (immediate) economic progress is likely to come at the high price of reinforcing exclusionary structures that will impede more inclusive systems of security and service delivery in the long run.

Having said that, donors’ and programme managers’ insistence on zero-tolerance of corruption as a conditionality of eligibility for support is arguably a safe way for donors and development implementers to keep their distance from unlawful practices. However, urging entrepreneurs to refrain from paying off their loyalties to powerful actors can destabilise the social order these actors, unlike the state, are able to maintain in the short to medium term.

Ultimately, the needs and ambitions of the SMEs themselves will decide which among development, growth or stabilisation objectives has primacy over the others. Taking the multiple ways of defining SME success as a starting point, there is a strong argument in favour of supporting SMEs in fragile states even if they are not able to grow in the short term from a stabilisation and development perspective. However, this support will require a different strategy and tools aimed at business consolidation and risk mitigation, i.e. direct support to business organisations and public-private dialogue rather than market-based business development services, loans and equity.

If support strategies seek to invest in SMEs with a broader (stabilisation or development) ambition, a thorough understanding of the multiple interaction between the firm and its social and political context is even more crucial.

…for researchers:

Confronted with the pressing demand for evidence that links SME promotion to improved stability, it remains critical to analyse past experience. The mechanism through which business strategies have either fuelled tensions or contributed to great societal cohesion need to be carefully studied to test existing policy assumptions and inform more effective programming.

…for policy makers:

It is critical to define realistic objectives for SME promotion in fragile settings (e.g. stabilisation versus economic growth?) and problematise the trade-offs. Policy objectives should align with the objectives of the target group, i.e. the genuine aspirations of entrepreneurs, which not only depend on the health and growth potential of the company, but also on the entrepreneur’s own assessment of how safe it is for the company to grow (and whether that means an increased visibility and risk exposure). If stabilisation is the main objective, the positive contribution of small firms to more resilient societies needs to be defined beyond increased productivity and job creation.

Prioritising job creation, in turn, will require recognition of the fact that in societies with high levels of mistrust, employment is likely to be offered on the basis of group membership, not merit. Instead of creating trust between adverse groups, such employment patterns might then reinforce exclusion and marginalisation. Similarly, putting the promotion of young and female entrepreneurs high on the policy agenda might expose these target groups to greater gender and intergenerational tensions if the cultural and socio-political context is not addressed as a whole.

…for implementers:

Develop SME development tools that differentiate between businesses that have the potential to grow and firms that, with the right support, will be able to survive and build resilience.

Analyse the needs for finance and non-financial support in the context of businesses’ existing coping mechanisms.

Think of possible trade-offs at programme level. For instance, weigh the development relevance through job creation against the development relevance through female ownership, etc.

Consider offering technical assistance to strengthen firms’ resilience, e.g. by combining business skills with conflict mediation skills, early warning mechanisms, anti-corruption campaigning.

If the objective of SME promotion is (among others) to stabilise the environment, a monitoring and evaluation system should be developed with the businesses to capture potentially stabilising and destabilising effects of SME development through their community relations, employment practices, influence on state legitimacy, etc. The monitoring can also serve the business as an early warning system.

Implications of finding # 3:
Embed SME promotion strategies in more comprehensive support strategies that take account of the institutional environment and power configurations.

While the literature suggests that SMEs are best placed to generate broad-based, inclusive growth, our research suggests that SME support strategies that ignore the embeddedness of enterprises in the wider socio-political and economic context can reinforce rather than counter-balance exclusionary structures. Given that personal connections and the competition and sometimes collusion of state and non-state authorities shape the ‘rules of the game’, an injection of financial or non-financial resources (assistance) into structures that suffer not only from a lack of capacity but also and, more importantly, from infiltration of personalised interests, are likely to entrench exclusive structures even further and, hence, do harm.

…for researchers:

If evidence suggests that those entrepreneurs who have the right connections and enjoy the protection by relevant authorities are most likely to grow successfully, a critical question in view of improved stability and development needs to be answered: What strategies need to be in place in order to not only promote the well-connected high potential businesses but also create the incentive structures that will gradually open the benefits of SME growth to a broader and more diverse group of beneficiaries? In other words, a better understanding is needed of the role small firms could play in what the World Development Report 2011 called ‘inclusive enough coalitions’. These are essentially groups of actors with power, whose beneficiaries and support bases are restricted to a certain identify-based group and whose interests align to a minimum extent with the ambition of broad-based development. Research into the SMEs’ reliance and dependency on such powerful coalitions can identify entry points for de facto business environment reform.

…for policy makers:

It is important to recognise that challenges to SMEs in fragile contexts cannot be effectively addressed with financial assistance and standard technical assistance packages and that such interventions run a real risk of reinforcing unbalanced wealth distribution structures, thereby hampering rather than facilitating a transition to more inclusive and stable societies.

Policy strategies and instruments for SME promotion have greater chances of success if they are embedded in broader business environment reform that involves non-state actors and civil society leaders from different (ethnic, political, religious, gender, age) groups in a public-private dialogue. For such a comprehensive approach, close coordination and collaboration with the host government and other western and non-western donors is essential. It is equally critical for donor governments to engage with their home-based multinational companies on issues of local sourcing. Not only do these larger companies have a significant share in the local market, they also have - through the employment, income and business opportunities they generate for different parts of the populations - political leverage that can be harnessed for broader political reform.

…for implementers:

Financial and technical assistance in fragile states has a greater chance of success as part of a more comprehensive business environment reform that is neither restricted to state institutions nor exclusively targeted at the economic sphere. For example, connecting SME promotion to public-private dialogue that involves both formal and informal institutions and organisations is likely to contribute to a more level playing field and to do so in a sustainable manner.

Technical assistance could be designed to improve the conflict-sensitivity of businesses when it comes to their operations vis-à-vis: their employees (training on balanced and transparent recruitment and employment practices); the community (training on communication and mediation strategies and on local conflict history and current conflict lines); and the government (training in communication, local legislation, advocacy and lobbying).

It is important to realise that any external support to businesses in fragile contexts comes with two types of conflict-related risks. On the one hand, there is a risk of doing harm by exposing the beneficiaries of external support to a heightened propensity for extortion and greed. On the other hand, an unequal distribution of financial or technical assistance can easily reinforce the predominance of a certain group, thereby underpinning existing horizontal inequality and fuelling potential grievances. Similarly, prioritising the promotion of female or young entrepreneurs should anticipate possible effects on traditions and value systems in order to navigate possible conflicts. Both risks should be carefully monitored and mitigated.

Slide 6
For example, this point was emphasised by a local adviser in Afghanistan: OnFrontiers, Adviser Notes, Afghanistan, (p. 5) and by an RVO staff member working on the investment programme in the Palestinian Territories.
Sequencing may solve some of the conflicts between objectives (consolidation first, growth and jobs later), but not all. The improvement of production capacity may be a necessary first step for a company to grow. It may entail the reduction of labour in the short run, to optimise productivity and competitiveness that will prompt additional hiring in the medium to long term. However, that is not a guaranteed course. And conditionalities that are meant to safeguard greater development relevance, such as for instance the business being owned by a woman, may impose natural impediments to business growth due to prevailing security and cultural constraints. Changing the latter demands more comprehensive forms of support than setting a numeric target for SME support to be channelled to women entrepreneurs. More generally, the challenge of achieving both development and economic growth is not sufficiently addressed by imposing compulsory target groups on otherwise demanding criteria for eligibility.
A situation described by RVO staff during the April workshop.