The last two decades have witnessed a growing interest in the impact that the private sector – and more specifically SMEs – can have in fragile and conflict-affected situations. On the one hand, it has been more and more widely recognised that SMEs can play a constructive role in improving people’s livelihoods. In these difficult economic and social contexts, SMEs have the potential to make a positive economic contribution, for instance by providing the local urban population with employment, and also by ensuring the availability of a range of goods and services. At the same time, SMEs can have a positive impact through non-economic contributions. For instance, increased employment can generate positive social externalities and contribute to reconstruction following conflict, cooperation among SMEs can increase the level of trust in society, and taxes paid by these businesses can contribute to restoring the legitimacy of often weak states.
This potential notwithstanding, SMEs operating in FCAS are faced with a wide array of challenges that threaten to stifle their operations and their growth. First of all, in conflict-affected settings businesses are constantly faced with a lack of physical security – not only for their staff and their assets, but also for the infrastructure they rely on (most notably energy and transport). This is compounded by a high level of political volatility, as well as weak legal frameworks and public institutions, which create an unpredictable environment for enterprises. Post-conflict economic troubles – including macroeconomic instability, market distortions and reduced purchasing power – further complicate the economic environment in which these businesses operate. Finally, other specific issues – such as difficulties in accessing finance and skilled labour, as well as unresolved (land) ownership disputes – often make it even more challenging for SMEs to operate in FCAS.
While SMEs have the potential to positively affect people’s livelihoods in FCAS, the circumstances in which they operate make it difficult for these businesses to flourish. It can be an interesting opportunity for policymakers – both locally and internationally – to find ways to enable these enterprises to thrive and to realise their full potential in terms of contributing to the societies in which they are embedded. With this in mind, this chapter will analyse how formal and informal institutions shape the environment in which SMEs operate, as well as how entrepreneurs in FCAS tend to confront the challenges they face. This analysis will serve as a background to understand the issues faced by Somali SMEs and the coping strategies adopted by Somali entrepreneurs in a crisis, with an eye to the most appropriate policy responses that international donors could promote to improve the socioeconomic situation in Somalia.
2.1
Institutions and business
It is broadly understood in the literature that institutions – i.e. ‘the rules of the game in a society’ – influence the development of entrepreneurship, for instance by creating incentives, opportunities or constraints to the action of entrepreneurs. These institutions can be either formal or informal in terms of regulatory authority or practical terms. On the one hand, formal institutions consist of all rules that have been coded and made explicit. These include, for instance, legal and judicial systems aimed at enforcing contracts, securing property rights and protecting economic freedom. Moreover, they also include policies that regulate the operations of businesses, ranging from taxation to enterprise support. Besides these codified institutions, by contrast, there is a range of other institutions not explicitly defined, and hence categorised as informal. These include commonly held values and the ensuing norms of behaviour, attitudes, conventions and codes of conduct – all ‘rules of the game’ that are based not on a formal agreement, but rather on norms, culture and social relations. While a division between formal and informal institutions can be helpful when analysing a specific economic system, it is equally important to note that often there is not a strict separation between the two, as with the strong connections between formal and informal markets. Individuals often move between the formal and the informal and the relationship between the two is often one of coexistence and symbiosis rather than exclusivity.
As far as entrepreneurship in FCAS is concerned, it has been argued that formal institutions are subordinate to informal ones. This can be traced to the fact that formal institutions, in order to function appropriately, generally need to be trusted, both personally and institutionally. Informal institutions, which are rooted in a society’s values and norms, have the power to generate such trust, and thus can play a major role in shaping a country’s economic performance. This is particularly true in contexts where the reliability of formal institutions – and hence people’s trust in them – is low. Therefore, in emerging economies, and even more so in fragile and conflict-affected settings, informal institutions acquire a greater importance, as they come to play the regulating role that ineffective formal institutions cannot play.
In their efforts to address economic issues affecting emerging economies and FCAS, international actors – and especially Western-led entities such as the World Bank and the International Finance Corporation – have often stressed the importance of developing formal institutions in order to promote economic development and business opportunities. In these actors’ analyses, a number of barriers to the growth of SMEs are identified. These often include weak legal frameworks (e.g. contract enforcement, property registration), access to finance (e.g. availability, cost, sources), and infrastructure constraints (e.g. electricity, transport, water). In order to effectively address these issues, a number of recommendations are outlined, often focusing on the legal, administrative and policy domains, and devoting much attention to the state’s capacity to regulate and influence the business environment.
While the issues identified by these actors are indeed common problems for SMEs in fragile settings, the problem with the analysis outlined above lies with the solutions that it advocates. Grounded in the experience of advanced economies, the World Bank’s analyses often propose solutions based on the reform of formal institutions, focusing on issues such as legislative reform, new policies and the enhancement of state capacity. This tendency, however, clashes with the fact that, as mentioned above, in fragile contexts informal institutions are actually more influential than formal ones in shaping the incentive structures experienced by entrepreneurs on the ground. This does not mean that formal institutions do not matter; rather, it suggests that a lack of clarity on what formalisation should entail can have adverse effects. In fragile and conflict-affected settings this means that attempts to change formal arrangements without regard to informal dynamics can at best have limited impact or, in some cases, have the potential to trigger resistance.
The World Bank’s Doing Business (DB) reports provide a good example of the distinction between formal and informal institutional dynamics, as well as the peculiarity of fragile contexts. To begin with, the DB exercise has been criticised for its excessive reliance on formal indicators (e.g. legislation and assessment by local experts), which in fragile contexts could provide a picture that is quite different from what is actually happening on the ground. In addition, critics have noted that the DB reports neglect some pivotal aspects of entrepreneurship in fragile settings, such as the potentially ambiguous role (i.e. both positive and negative) of entrepreneurs, and the complex legacies of conflict economies. In light of these observations, therefore, it seems advisable to analyse entrepreneurship in fragile settings through a different lens – that is, one that stresses the embeddedness of these entrepreneurs in their particular social, political and economic context.
2.2
Embeddedness and social capital
In contrast (and in response) to the relatively standardised approach outlined above, there is a growing body of literature that highlights the need for context-specific analyses of entrepreneurship in fragile settings, calling for a greater consideration of the informal institutional dynamics that shape the business environment in emerging economies or in FCAS. It is generally understood that individuals are affected by their social contexts. The same applies to entrepreneurs, whose activities are deeply embedded in local, indigenous institutions that allow for the creation of the trust and variety of relationships needed to conduct business. In this context of embeddedness, the economic success of many SMEs in fragile settings derives not from the strength of formal institutions, but rather from the degree to which these businesses are able to overcome market and institutional failure by leveraging local, informal support systems.
Research has shown how SMEs in FCAS develop a variety of social and business networks built on trust and cooperation, which allow them to function in the absence of strong formal institutions. In order to compensate for the weakness of public institutions, SMEs in emerging economic and fragile settings have developed a wide array of strategies. One of these entails increasing reliance on family or ethnicity-based networks, which can improve a business’ capacity to access credit or resources. Alternatively, businesses can substitute for weak institutions by establishing private support mechanisms, including long-term business relations in business groups, as well as horizontal and vertical cooperation networks among firms. SMEs might also resort to particularistic practices as a way to overcome security threats or obtain services from formal institutions that might otherwise be unable or unwilling to provide them. Finally, another solution for businesses operating in fragile contexts where state presence is weak is to cooperate with non-state actors, who often come to substitute for the state’s authority in FCAS. Overall, it is thus crucial to stress that entrepreneurs in emerging economies and FCAS do not just succumb to institutional weakness. Rather, they respond strategically and reflexively to the situation that they find themselves in, in order to steer their business towards success – or at least survival.
Literature generally distinguishes between bonding social capital and bridging social capital. Bonding social capital refers to cohesion within small groups, usually limited to family members, close friends and neighbours. Bridging (also called weak-tie) social capital leads to contacts and collaboration with members outside of an individual’s immediate group of contacts, such as distant friends, associates and colleagues. Literature has often stated that those in fragile or poor settings are typically more inclined to rely on a close-knit circle of connections than on extensive bridging social capital that would allow them to get ahead and gain access to contacts far outside of their social circle. However, empirical studies have generated mixed results about the importance of bridging social capital in developing countries.
Over recent years, research about the embeddedness of SMEs in fragile contexts has also included works that, instead of merely focusing on the business environment in which SMEs operate, try to investigate the experiences of entrepreneurs themselves – i.e. the challenges they face, as well as the solutions they tend to adopt. Research in this regard has shown that many businesses in FCAS – despite being equipped and eager to grow – often deliberately choose to limit themselves to coping strategies, in order to minimise risks and avoid creating mistrust in the communities where they operate. This means that instead of being focused on growth, these businesses often opt for resilience, a strategy that in FCAS can still be perceived as productive and producing positive effects in the broader political and societal environment.
These observations should induce both local and international actors (i.e. donors) to start a serious reflection on their practices in terms of support to the private sector – and especially SMEs – in fragile contexts. Currently, funds and technical support are often provided to SMEs that can exhibit optimistic plans for growth. However, as it becomes evident that in fragile contexts growth is not necessarily sought by entrepreneurs, nor does it automatically translate into positive social outcomes, this approach should be recalibrated. Rather than focus on growth, for instance by interventions that primarily target start-up businesses, the focus could be broader and consider how to stimulate economic development that includes the growing field of middle-sized entrepreneurs that have development and stabilisation potential.
2.3
Conclusion
A survey of the existing literature has shown that a strong focus on embeddedness is of crucial importance in order to understand how SMEs operate in FCAS. Most of the time, constraints identified in salient analyses represent real challenges for entrepreneurs in fragile settings. However, what these analyses often miss is how these entrepreneurs navigate these challenges by leveraging the support of informal institutions – be it in the form of long-term business relationships, or family- and ethnicity-based social networks. These observations have important repercussions for the policy choices that governments in FCAS and their international supporters will have to make. In order for SMEs to have a positive impact on the fragile settings in which they operate, a full understanding of both formal and – especially – informal dynamics is thus of paramount importance.
