06 August 2014

It is a common refrain by consultants in the Middle East: nurture small to medium enterprises to generate employment.

But while regional governments in principle have acknowledged the importance of developing an SME sector, the execution has been far from satisfactory.

This is especially true in so-called Arab Countries in Transition (ACT) such as Egypt, Morocco, Jordan, Tunisia and Lebanon, where SMEs have failed to get the attention they deserve as the countries face tremendous upheaval.

Youth unemployment in the Arab world stands at 25% of the population, highlighting the scope of the problem facing regional authorities.

A World Bank report estimates that despite the challenges faced by SMEs, they represented between 80% and 90% of all employment in formal sector enterprises in the Arab world.

"Moreover, SMEs contribute a large share of private sector employment opportunities, typically accounting for somewhere between 20% and 40% of all private sector employment; and between 4% and 16% of total employment, including public sector and non-governmental organizations (NGOs) employment."

Still, the sector needs further nourishment if it is to prosper and turn into a job-creating machine.

"The experience of other industrializing countries, as well as of the ACTs, suggests that specialized public financial institutions created to serve SMEs and the use of directed credit have yielded meager results," according to Shahid Yusuf, an analyst with the International Monetary Fund.

While lack of funding for SMEs is a global phenomenon, the problem in ACTs and virtually everywhere is that commercial banks - while supplying a portion of the working capital to the larger SMEs and some collateral-based lending - service too small a portion of the remaining needs of SMEs.

"Moreover, they are easily discouraged by downturns and by uncertainties such as those plaguing the ACTs currently, even though SMEs are responsible for a small fraction of nonperforming loans," the author said in a working paper.

Banks are especially reluctant to lend to SMEs due to high transaction costs, lack of collateral, lack of credit information and inability of bank staff to understand issues faced by SMEs and tailor products focused to the segment's unique needs.

While conventional banks have been unable to meet the needs of the SME, can Islamic banks provide a more homespun solution focused on the industry?

For SMEs in MENA, Shariah-compliant Islamic finance has emerged as an additional and arguably more accessible source of funding, Yusuf notes.

"It offers a number of advantages because banks engaged in Islamic practices rely on leasing, partnership instruments and trade-based contracts."

"By encouraging banks to behave more responsibly, internalize more stringent ethical values, and prioritize socially responsible lending, Islamic banking has the potential of involving banks more directly with the SME/real sector while requiring them to abide by prudential rules.

Islamic banking is a growth sector in MENA, but it has yet to make an impact on SME development, a lacuna that deserves policy attention."

A NEW SOCIAL CONTRACT

While regional governments have long promised to provide social aids and facilities to citizens and lift them out of poverty and economic malaise, the current set of political and economic crisis occurring in ACT countries are unprecedented.

Rising unemployment, poor economic activity and high population growth rates are conspiring to shake authorities out of their complacency to seek new solutions instead of resorting to old formulas.

The citizens themselves need to change their mindset. As Yusuf notes,

graduates from educational institutions in ACTs are not well prepared for a life of entrepreneurship. They prefer to eschew risk and wait for secure, stable public sector employment.

"There are few true entrepreneurial role models; schools give little effort to instilling the venture ethic; and authoritarian states have long neglected the cultivating of entrepreneurial mores and sought instead to ensnare elites by bestowing resource rents and offering comfortable public sector jobs."

But unprecedented changes necessitate an unprecedented response from governments to create employment.

The answer is not to bloat the public sector to appease population, but create and nurture trading sectors such as tourism that don't need government financing and can contribute foreign exchange to the government.

"In addition to macroeconomic policies, tourism, trade promotion, SME development and infrastructure could be targeted for short-term action," Yusuf noted. "Longer-term policies could target improvements in the business environment; state enterprise reform and private sector development; 21st-century industrial policies; entrepreneurship; and an upgrading of education and training."

Finally, regulations are going to be a key growth facilitator. SMEs bear the brunt of regulatory burden not just in the Arab world, but globally as well.

"The large, well-established firms operate in a limited competition regime while SMEs strive to survive," notes the World Bank. "Most Arab countries also suffer from the lack of effective and well enforced competition and consumer protection policies. This requires countries in the region to level the playing field so that marginalized or discouraged enterprises and entrepreneurs can compete fairly with large enterprises."

The feature was produced by alifarabia.com exclusively for zawya.com.

Zawya 2014