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Paula Nagler

The Birth, Life and Death of SMEs in Rural Africa

Paula Nagler, Wim Naudé | 20 October 2014

Entrepreneurship is ubiquitous in rural Africa. But why do rural households operate non-farm enterprises? How productive are they? And why do they exit the market?

Entrepreneurship is ubiquitous in rural Africa, where almost one in two households operate a small business, supplying almost anything from transport to trousers. Up to half of household income can originate from these non-farm enterprises. Clearly, small businesses are important. But why do rural households operate them? How productive are they? And why do they exit the market?

Before answering these questions, it is important to understand the economic context of rural Africa. Agricultural households face large risks in farming due to haphazard rainfall patterns, crop diseases, environmental degradation, fluctuating commodity prices and uncertain input prices. They also face household risks, such as illness, injuries and death. Market failures abound, leaving farmers without formal insurance or access to credit. Social protection is largely lacking.

Drawing on the World Bank’s recent Living Standards Measurement Study – Integrated Surveys on Agriculture (LSMS-ISA) which covers six countries in both the east and west of Sub-Saharan Africa, we provide some answers on the basis of our recent studies (see references).

Why do rural households operate small businesses?

Given the risky environment, many households operate small businesses as a form of insurance, to provide income and employment in difficult times or during the off-season. In many countries, households that suffer a shock or adverse event, or with larger families to feed and employ, are more likely to operate businesses (for example by 6 percentage points in Malawi, if the household has experienced an idiosyncratic shock, or by 8 percentage points in Uganda, if the household has experienced food shortage during the past 12 months).

However, not all enterprises are operated out of necessity. Households also pursue opportunities. Significant determining factors include demand and a favorable business environment, such as household wealth, distance to towns and cities, and the local infrastructure. Access to credit and a literate household-head also facilitate entrepreneurship. In Ethiopia and Malawi, for example, rural households with access to credit are 9 and 7 percentage points respectively more likely to operate businesses. In Nigeria, households with a literate head have an increased likelihood of 13 percentage points of operating a business.

Interestingly, the motivation to enter the sector also influences the type of business that a household operates. Households that have suffered a shock are more likely to operate an ‘easy-to-entry’ business such as trade or sales, and less likely to start businesses with higher entry barriers, such as restaurants, transport or professional services.

How productive are these small businesses?

A large variety of factors influence the productivity of these enterprises. Rural businesses are less productive than urban ones, and female-owned businesses are less productive than male-owned ones. The difference is around 30 percentage points by location, and up to 60 percentage points by gender, with large variations by country. Proximity to markets, market access and clustering (giving rise to spatial spillovers) are positively associated with labor productivity. For example, businesses located within 10 km of a population centre are more productive than those located further away.

Why do these businesses cease to operate?

Finally, businesses also exit the market. In rural Africa, many businesses are occasional, operating for only part of the year. In Ethiopia or Tanzania more than half of all enterprises operate only for some months. In Uganda, if they cease operation for good, they do so largely due to a lack of profitability (between 15 and 33%, depending on location and year). The risky environment in which they operate is also reflected in the fact that rural businesses are more likely than urban ones to cease operations due to the ill-health of a household member.

What are our policy recommendations?

We propose a two-pronged approach. First, we suggest curtailing the need for households to operate small businesses. The efficiency gains from improving insurance markets and social protection schemes in rural Africa could be substantial. This could include introducing cash transfer programs to shield farming households from detrimental shocks like crop failures or developing microinsurance schemes. Second, we suggest helping those with entrepreneurial ability to respond to lucrative opportunities by, for example, improving their education, broadening their access to credit and improving the general business environment. Such initiatives have been common in Africa. Additionally, our results support policies to improve information, market access and clustering, and more broadly the development of secondary towns and cities, implying that improvements in urban planning and management should be a priority. For example, rural Africa remains largely without reliable electricity, a critical input for businesses that also enables the wider spread of information and communication technologies. These measures have the potential to raise the productivity of rural businesses, improve their ability to survive and grow, and create jobs for the estimated 10 million new job-seekers entering the African labour market each year.

References

Nagler, P. and Naudé, W. (2014). Non-Farm Entrepreneurship in Rural Africa: Patterns and Determinants, IZA Discussion Paper No. 8008.

Nagler, P. and Naudé, W. (2014). Labor Productivity in Rural African Enterprises: Empirical Evidence from the LSMS-ISA, IZA Discussion Paper No. 8524.

Nagler, P. and Naudé, W. (2014). Non-Farm Enterprises in Rural Africa: New Empirical Evidence, Policy Research Working Paper No. 7066. Washington DC: The World Bank.

Photo credit main picture: Paula Nagler

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Paula Nagler

Paula Nagler is Assistant Professor in Social Protection and Entrepreneurship at the Maastricht S...

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Wim Naudé

Wim Naudé is Dean of the Maastricht School of Management, Professor in Business and entrepreneurs...

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