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Not without the public sector

Hilary Nwokeabia | 04 December 2014

In Africa's developing economy, small and medium enterprises (SMEs) should be the cornerstone for inclusive industrial development. But what makes a strong formative stage for SMEs? What are the components of the formative stage? Public intervention in managing value and supply chains are critical for SMEs, argues Hilary Nwokeabia.

In a developing region such as Africa, small and medium enterprises (SMEs) should be the cornerstone for inclusive industrial development.  Historically, SMEs play a significant role in the economic and social growth of economies. It is these enterprises that invest and trade among the wider population. Also, positive growth in many industrial catch-up countries like China, Korea and Japan has been marked by a strong formative stage of SMEs.The question is: what makes a strong formative stage for SMEs? What are the components of the formative stage? Industrial development literature shows that SMEs grow more sustainably in a situation where the public sector is active on the issue of the common good. Specifically, public intervention in managing the critical control points 1 of value and supply chains are critical for SMEs, at least during the start-up stages.  

Empirical evidence for public sector intervention

Empirical analysis confirms this line of argument (see for instance, Aghion and Howitt (1998)). Growth regressions by Barro and Sala-i-Martin (1995) and the work of Mankiw, Romer and Weil (1992) broadly argue for critical work by the public sector and growth in Africa.  Based on a large sample of countries during the period 1965-1985, Barro and Sala-i-Martin (1995) found that public institutions have a significantly positive effect on growth: a 1.5% increase in the ratio of public spending on education to GDP during the period of 1965-1975 raised the average growth rate of the economy by 0.3% per year.  In essence, it is easier to make SMEs work when public institutions are effective: promoting positive change in aggregate efficiency, including threshold organizational functions. Despite the key formative function of the public institutions for enterprise development, African countries have had limited success in promoting SMEs in the past thirty years. Two key reasons have been at the core of the limits: technical capacity to engineer growth in the value chains and unreliable supply chains.

Value and supply chain management as public goods

The commonest response of African governments aiming to stimulate SMEs is to provide them with financing as an empowerment tool. Governments that go deeper, as in the case of Nigeria and South Africa, have provided equipment and physical capital inputs like brand new engines, electricity generating machines and other operational apparatus. Very few of these governments provide needed continuous technical support (a public good) and logistics for supply chain management (a quasi-public good) such as designing geographical entities into sustainable specialties and comparative advantages.

Yet, evidence from successful economies such as China and Japan show that these two components, easily classified as public and quasi-public goods and requiring non-exclusive innovation processes, cannot be overlooked (Johnson 1982).  The consequence of them being overlooked in Africa is a constant failure of SMEs to go up the growth ladder in the continuous and additive manner need to generate industrialization (see Nwokeabia 2009).

As public goods, SMEs require the catalytic role of public institutions. The argument is that public institutions can pool resources to cushion SMEs from some high-cost and non-exclusive innovations and direct their activities with an eye on the common goals of society to maintain a set industrial objective.  In the example of Japan, there is no doubt that the Ministry of International Trade and Industry (M.I.T.I) drove down the cost of securing foreign technology, as a critical control point, for Japanese enterprises. By intervening between Japanese firms and foreign companies, M.I.T.I. acted as a single buyer of technology, in order to reduce the royalties that Japanese concerns had to pay on technology licenses. By keeping domestic patent periods short, M.I.T.I. encouraged rapid diffusion of technology. It also made it a condition of entry into the Japanese market that foreign companies share many of their technological secrets with potential Japanese competitors (Johnson 1982).

Ways of public intervention

In conclusion, African governments with the capacity to pool resources can act in two key ways: through incentives (prices and regulations) and/or by investing directly to assist with high-cost and non-exclusive innovation for SMEs and recalibrate marginal intensive or extensive efficiency gains. In particular, these public institutions should provide the phasing, and undertake multi-stage non/no-profit functions through which SMEs and economy-wide priorities are selected and switched - the ‘transition experiments’ such as adaptation of technologies (foreign and local), as conditions dictate.

As such, countries that develop effective and sufficient depth of functional institutional capacity to engineer the critical control points for these purposes are able to design industrial policies and implement them better and contribute more to the growth of SMEs and make development a lot more inclusive. African countries could contribute better to SME-led industrial growth as a basis of their development through higher marginal allocation to critical control point development of SMEs. African private participants in SMEs are too poor to engage in these types of venture, but most importantly, they cannot appropriate all the rents for doing them to themselves and usually avoid the sunk costs. As such these points require the intervention of public institutions for SMEs to prosper, especially in Africa.  

Footnotes

1 Critical control points for SMEs in Africa are defined as knowledge for design of complimentary production systems, adaptation and innovation of technologies and regulation of supply chains.

References

Aghion and Howitt (1998).  Endogenous Growth Theory.  Cambridge Massachusetts: The MIT Press.
Barro, R. J. and Sala-i-Martin X. (1995). Economic Growth.  Cambridge Massachusetts: The MIT Press.
Johnson Chambers (1982).  MITI and The Japanese Miracle: The Growth of Industrial Policy 1925-1975.  Stanford University Press.
Mankiw, N. Gregory, Romer, David and Weil, David N. (1992). "A Contribution to the Empirics of Economic Growth," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 407-37, May.
Nwokeabia Hilary (2009).  Why Industrial Revolution By-Passes Africa: A Knowledge System Perspective.  Addonis and Abbey, London: UK.

The views expressed in this expert opinion are those of the author and do not necessarily reflect those of any organization.  All comments related to the paper should be addressed to the author at hnwokeabia@yahoo.com.

Photo credit main picture: Erik Jackson Photography / via flickr

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Hilary Nwokeabia

Hilary Nwokeabia is an economist with the United Nations Conference on Trade and Development (UNC...

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