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Contribution of small and medium enterprise to the economic development of Rwanda

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par Valens NYANDWI
Universite Nationale du Rwanda - Licence 2013

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2.8. Is it any correlation between Small and medium enterprises, business environment and


Efforts targeted at the SME sector are often based on the premises that SMEs are the engine of growth, but market imperfections and institutional weaknesses impede their growth. Skeptics question the efficacy of this policy and point to empirical evidence either in favor of large firms or of a size-blind policy approach. While many country-level and microeconomic studies have assessed the importance of SMEs in the economic development and industrialization process (Snodgrass and Biggs, 1996), Beck, Demirguc-Kunt and Levine (2005a) provide the first cross-country evidence on the links between SMEs, economic growth, and poverty alleviation, using a new database compiled by Ayyagari, Beck and Demirguc-Kunt (2003).

Cross-country regressions of GDP per capita growth on SMEs share in manufacturing employment show a strong positive relationship over the 1990s, even after controlling for an array of other country characteristics that can account for differences in growth across countries.

Instrumental variable regressions that explicitly control for reverse causation and simultaneity bias, however, erode the significance of the relationship between SMEs and economic growth.

The regressions do not necessarily lead to the conclusion that SMEs do not foster economic growth. Rather, they fail to reject confidently the hypothesis that SMEs do not exert a causal impact on GDP per capita growth. This finding is consistent with the view that a large SME sector is a characteristic of fast-growing economies, but not a cause of their rapid growth. Beck, Demirguc-Kunt and Levine (2005a) also do not find any evidence for any association of a large SME sector with faster income growth of the lowest income quintile and faster rates of poverty reduction.

While to our best knowledge there is no robust cross-country evidence on the relationship between the business environment and economic growth, industry-level, firm level and survey evidence consistently show a positive association of a competitive business environment with entry, entrepreneurship and investment. Klapper, Leaven and Rajan (2006) show that one channel through which the business environment affects economic development is the entry of new firms.

By using firm-level survey data for 52 countries, Demirguc-Kunt, Love and Maksimovic (2012) show that one of the reasons for this variation in the likelihood of incorporating is the fact that incorporated firms face lower obstacles to their growth in countries with better developed financial sectors and efficient legal systems, strong shareholder and creditor rights, low regulatory burdens and corporate taxes and efficient bankruptcy processes.

Corporations report fewer financing, legal and regulatory obstacles than unincorporated firms and this advantage is greater in countries with more developed institutions and favorable business environments. Further, they find some evidence of higher growth of incorporated businesses in countries with good financial and legal institutions.

Using survey data from interviews with entrepreneurs and non-entrepreneurs in seven cities across Russia, Djankov et al. (2004) provide further evidence for the importance of the business environment for the decision of becoming an entrepreneur. They find that in addition to many personal characteristics the perception of corruption and government officials' attitude towards entrepreneurship affects the decision to become an entrepreneur.

Similarly, Johnson et al. (2002) find that entrepreneurs in transition economies are more likely to reinvest their profits if they feel more secure about property right protection in their country, while Cull and Xu (2005) find that Chinese entrepreneurs are more likely to reinvest their profits if they are more confident in the system of property rights protection and have easier access to credit, with this effect being stronger for small firms.

Are different dimensions of the business environment equally important? Using firm level survey data on the business environment across 80 countries, Ayyagari, Demirguc-Kunt and Maksimovic (2005) investigate the impact of access to finance, property right protection, provision of infrastructure, inefficient regulation and taxation, and broader governance features such as corruption, macroeconomic and political stability on firm growth.

They show that finance, crime and political instability are the only obstacles that have a direct impact on firm growth and finance is the most robust one among those. Together, these results suggest that it is important to have a competitive business environment that allows for the entry of new and innovative entrepreneurs resulting in the Schumpeterian process of «creative destruction» rather than simply having a large SME sector, which might be characterized by a large number of small enterprises that are neither able to grow nor to exit.

Indeed, a large, but stagnant SME sector may be a by-product of a poor business environment itself. Furthermore, the existing evidence suggests that access to finance plays a very important role in the overall business environment, potentially constraining both firm entry and growth (Thorsten Beck and Asli Demirguc-Kunt , February 2006)

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