Economic growth has been a longstanding public policy goal, but the microeconomic foundations are only just being unpacked. The important role played by high performance micro and small enterprises are now emerging. They have been variously referred to as “high growth firms”, “high performers”, “competitive SMES”, “transformational enterprises”, “gazelles” etc. Many policy makers
perceive that they can be relied upon as powerful engines of new growth and innovation and that therefore they justify to be an important segment of policy support.
In developing countries, micro and small enterprises (MSEs) are increasingly considered as having the potential to play an important role in employment creation and fostering the development of local economies. However, their growth seems to be hindered while several factors account for the wide variation observed in their performance. Financial sector development is seen by some authors to constitute a “robust determinant of growth” (e.g., Johnson et al., 2002, Levine et al., 2000, McMillan and Woodruff, 2002, and Cull and Xu, 2005). The works of de Mel, McKenzie and Woodruff (2008) show that finance constraints in particular can be so binding that businesses that have potential rates of return far above market rates can go unfinanced while their growth opportunities remain wasted. Other obstacles are also important, but lack of access to finance consistently emerges as one of the most quoted important underlying factors constraining firm growth. In view of this constraint in many economies, various microfinance programmes, with differing levels of effectiveness are being implemented to support MSEs. This section will explore the different perspectives on the role of finance in MSME growth.
Beck et al (2006), from a survey of 10,000 firms in 80 countries conclude that size is a major determinant of financing obstacles of firms. Smaller firms are seen to face
larger constraints and this implies that credit constraints could disproportionately impact on MSMEs’ growth prospects (Beck et al., 2005b; Aghion et al., 2007; Beck
et al., 2008). Studies of SMEs such as Beck and Demirgüç-Kunt 2006 implicitly or explicitly compare them to large firms. Data on the profile of microcredit borrowers is surprisingly scanty, and there is also not enough data that can be matched to comparable surveys of SME employees.
Various researches have established that SMEs can face large financial constraints. (Beck and Demirgüc-Kunt (2006) provide a review of literature) and that these constraints limit their growth prospects. An emerging literature has also addressed the notion that smaller firms may find it harder to access external funding, implying that these constraints could impact disproportionately on MSMEs’ growth prospects (Beck et al., 2005b; Aghion et al., 2007; Beck et al., 2008). It is noteworthy however, that few empirical studies are known to have explicitly examined the positive link between access to finance and firm growth or success rates. (Nitchter, Goldmark, 2005)
Some of the earlier evidences on the effects of credit on a firm’s growth performance are mainly in the form of descriptive statistics from national surveys of MSEs. The studies are typically comparative of the average growth rate of firms that had received credit to that of firms that did not receive any. This approach was adopted by Ngwira
(1993), Parker and Torres (1994), Minot (1996), USAID (1998), and Ebony Consulting International (2000), where it is found that in developing countries, access to credit leads to better firm growth prospects. This approach is however simplistic and does not control for other factors.
A large body of literature has noted how important lending relationships are for small and new firms as it compensates for their lack of credit history (Berger and Udell, 1998). This literature has observed that those firms with access to financial capital resources tend to exhibit higher growth rates (Audretsch, Keilbach and Lehmann, 2006). Demirguc-Kunt & Maksimovic (1998) provide evidence that well- developed credit markets reduce the obstacles that impede firm growth rate. But how can financial policy be shaped to influence the choice of enterprises that have the capacity to generate employment and which could be supported? It is believed that the capacity of capital markets to identify, select and finance the enterprises with the most potential may distinguish the level and quality of entrepreneurship across countries especially developing economies. (Kerr and Nanda 2011; Klapper, Amit, and Guillén 2010).
Through the use of a large panel of firms in emerging economies, Ayyagari et al. (2007) find that a heavier reliance on external finance has a close relationship with higher innovation, even after controlling for potential endogeneity, especially when the funds come from foreign banks. Recent experiments with microenterprises also
suggest that positive liquidity shocks lead to increases in enterprise profits which are sustained over the longer term (de Mel et al 2008, 2012; Field et al 2012). But there is little evidence that liquidity alone allows microenterprises to reach a different growth path that can ultimately lead to an increase in scale to the extent that additional employees would be needed to run the business. In other words, capital leads to higher incomes, but may not necessarily lead to employment generation.
A very recent and highly representative study by Ayyagari et al (2016) investigates the effect of access to finance on job growth among 50,000 firms across 70 developing countries. In this study credit bureaus are introduced as an exogenous shock to the supply of credit and the findings show that increased access to finance leads to higher employment growth, especially among micro, small, and medium enterprises. The results are robust with the use of variables of firm fixed effects, industry measures of external finance dependence, propensity score matching tested on complementary panel data set of over four million firms in 29 developing countries. These findings have policy relevance for interventions aimed at producing job growth in micro, small, and medium enterprises.
Other studies have shown that once an MSE has been started, it appears that they may face a number of other obstacles to growth even where the enterprise has access to finance which is regarded as a major obstacle to many of them. Definitely, access to microfinance institutions’ loans has tremendous benefit for MSE growth but has
not been seen to spur an entrepreneurship revolution in developing countries as much as is being touted.
Banerjee and Duflo (2008) attempted an action research introducing two policy changes, one that included, and tone without, some mid-size Indian firms from a direct lending program. They observed firms that had access to the lending program were able to expand production and increase sales and profit, showing the effect of credit constraints on the firms. Some more recent experiments with microenterprises also suggest that positive liquidity shocks lead to increases in sustained enterprise profits over the longer term (de Mel et al 2008, 2012; Field et al 2012). There is however little evidence that liquidity alone would cause microenterprises to reach a different growth path such that an increase in scale would ultimately reflect in the hiring of additional employees to run the businesses. Again, it is shown that capital may lead to higher incomes, but not necessarily to employment generation.
The quality of jobs created by supported enterprises constitutes another research question. Critics of Muhammad Yunus’ Bangladesh microcredit model argue that if larger businesses (small and medium enterprises) are supported, more and better jobs may be created for poor individuals than microenterprises (e.g., Karnani 2007, Dichter 2006). That may be possible, however, if those larger enterprises engage poor workers in large numbers. The data shows that SME employees work long weeks, a pattern which for example imposes employment barriers on women with
child-raising responsibilities. The findings align with those which demonstrate the lack of a robust correlation between the growth of SME and poverty reduction that was found in cross- country data (Beck et al 2005a).
Macpherson (2007) examines the common assumption that access to credit from formal financial institutions forms an important determinant of firm level growth. Data results from a survey in East Java comprising of 858 small businesses using a full information maximum likelihood approach known as discrete factor method, indicate that access to credit does not constitute a significant determinant of small firm growth, instead, other observable and unobservable characteristics of firms appear to account for the growth.
Likewise, Babajide (2012) investigates the effects of microfinance on micro and small business growth in Nigeria. Employing panel data and multiple regression to analyse a survey of 502 randomly selected enterprises which are financed by microfinance banks in Nigeria, the study exhibited strong evidence that access to microfinance may not necessarily have a positive effect on the growth of micro and small enterprises in Nigeria. However, other characteristics at the firm level such as size and location of business are found to have positive effect on enterprise growth.
Karnani (2007) suggested that individuals who start a microenterprise and obtain credit from microfinance institutions may in fact prefer to find employment at
steady wages, but they may turn to self-employment when wage jobs are unavailable. These individuals may not possess the required skills or motivation to be successful entrepreneurs even if they have access to capital. This is probably one of the possible reasons why recent microcredit evaluations are showing mixed results (e.g., Banerjee et al 2010, Crépon et al 2011).
The message that seems to be coming through from randomized evaluations of microfinance is that poor people face various limitations and their ability to capitalise on opportunities varies greatly. (Bauchet et al 2011, Nichter and Goldmark, 2005). It must be realised that not all microcredit borrowers even want to grow a business or have the capacity to do so. Hence like other factors influencing growth, access to finance is seen to constitute a necessary but not a sufficient condition for growth. (Nitchter, Goldmark 2005)
It is therefore evident that not all small businesses are growth-oriented and can create jobs with or without access to finance. There exists in literature stylised evidence that few firms transform from microenterprises into small or medium enterprises. This stagnation comes despite a plethora of microcredit programmes and projects from government, NGOs and social businesses. Some of these evidences reveal that microcredit may generate important impacts but not transformational positive impacts on firm size (see Attanasioet al. 2011; Augsburg et al. 2012; Banerjee et al. 2011; Karlan and Zinman 2011; Karlan and Zinman 2010). While
literature shows different perception on enterprise growth, there is a paucity of studies of how financing with microcredit contributes to MSE growth and employment creation.