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Can the MSME sector transform the Tanzanian economy?

Although it’s true that the average MSMEs and informal firm is small and doesn’t grow, this doesn’t mean that MSMEs don’t have a key role to play in economic growth and structural transformation. Evidence suggests that a small number of high growth firms can have a growth and productivity impact. Policy needs to accommodate different types of MSMEs and target policy accordingly and a key answer for researchers to address is how to identify high growth potential MSMEs.

In Tanzania, as in many countries, small firms are an area of policy interest. In this blog, I look at the literature on small firms, as well as recent IGC research in Tanzania, to identify some points for policymakers to consider when making Micro, Small and Medium Enterprise (hereon, MSME) policy.

Size and informality

A distinct though related area of research is in the informal sector. In Tanzania, informality continues to be a characteristic feature of MSMEs; according to the 2010 MSME baseline survey conducted by FSDT, only 5% of MSMEs had TIN numbers, and only 4% were registered with BRELLA – the national business licensing agency (FSDT 2012: 13). Some (see De Soto 1989) present the informal sector as an untapped source of future growth and entrepreneurialism, held back by regulation and other external constraints, while others (Farrell 2004) see this sector as operating based on the advantages of not having to pay taxes or comply with regulations. These explanations aside, La Porta and Shleifer (2014) express the view of many when they say that informal firms are typically “small, inefficient and run by poorly educated entrepreneurs”, usually with no growth potential.

Small firm driven growth

At first glance, the evidence seems to support the view that MSMEs and informal firms do not appear to grow. Liedholm (2002), for example, surveys over 28,000 micro and small enterprises in Africa and Latin America, and finds that only 3% expanded by four or more employees. However, even if most MSMEs and informal firms do not grow, some do.

Birch (1979) first argued that a disproportionately large share of new jobs was created by small firms (this view has been subsequently contested); he further proposed that a small number of firms contributed disproportionately to firm growth. Birch coined these high-growth firms as ‘gazelles’ and contrasted them to ‘elephants’, that were large firms which were either not growing or growing slowly, and ‘mice’, i.e. small firms with no growth (Henrekson and Johansson 2010).

Therefore, despite disappointing growth levels for the average MSME, a minority of MSMEs can still exhibit high growth levels, which due to the large number of MSMEs and informal firms, can have a significant aggregate impact. Although only a small number of firms expand, given the high rate of growth of the firms that do expand, the impact on total employment can be substantial. Mead and Liedholm (1998) found an annual employment growth rate of 17% in the MSME sector, at least double that of GDP growth in the surveyed countries. Given the large size of the MSME sector in many countries, MSME growth can have a sizable impact on total employment.

What is the current situation in Tanzania?

Diao et al. (2016) estimate that between 2002 and 2012, informal, private, and non-agricultural firms accounted for 73% of the increase in total employment. MSMEs are therefore contributing to employment growth, but what about productivity? Overall labour productivity can increase through productivity growth within sectors or the movement of labour from less to more productive sectors. The non-agricultural sector, which includes informal small firms, is more productive than agriculture. Even if within-sector productivity is not growing, workers shifting from the agricultural to the non-agricultural sector raises productivity – the so called ‘structural transformation productivity growth’. Diao et al. show that MSME growth in Tanzania has been contributing to aggregate labour productivity growth. The key finding though, is that the contribution of the MSME sector comes primarily from a small set of high growth MSMEs (about 5% of the total, depending on different definitions), that also contribute disproportionately to employment growth.

The evidence therefore suggests that MSMEs in Tanzania have had a large contribution to employment growth and a significant impact on productivity growth. This impact comes from a small set of all firms, much like the gazelles that Birch (1979) identified. However, in Tanzania, these gazelles also appear to exist within the informal and MSME sectors.

Policy relevance and concluding remarks

  1. It is important to recognise that there is significant variation in the productivity and growth orientation of MSMEs and informal firms. In Tanzania, only 10% of MSMEs said they opened the business to try out a business idea they had; most MSMEs appear subsistence-oriented and about half the entrepreneurs would leave to take formal employment if they could (FSDT 2012: 8). It is unlikely that the latter type of firms will ever be growth-oriented. Any MSME support programme needs to recognise this variation in firm types in the sector and tailor interventions to the type of firms they are targeting.
  2. MSMEs can and do contribute to productivity, especially employment growth. However, MSME policies and programmes focusing on employment and productivity growth must try and target the subset of firms that exhibit high productivity and growth potential. Such programmes would involve accelerating gazelles’ growth and overcoming the barriers constrained gazelles face, while separate policies would be needed to address the requirements of subsistence or non-growth-oriented firms. More research is needed to determine how best to target gazelles, and what interventions will most support their growth.

In conclusion, Tanzania’s MSME sector can and will contribute to the nation’s economic transformation. However, if the government and donors want to support this process, they need to target their efforts at the small set of high growth-potential firms and find interventions which truly help these firms grow.

References

Beck, T., Demirguc-Kunt, A. and Levine, R. (2005). “SMEs, Growth, and Poverty: Cross-Country Evidence”, Journal of Economic Growth, 10: 199-229.

Birch, D. L. (1979). “The job generation process”, Cambridge, MA: MIT programme on neighbourhood and regional change, Massachusetts Institute of Technology.

Diao, X., Kweka, J. and McMillan, M. (2016). “Economic Transformation in Africa from the Bottom Up: Evidence from Tanzania”, NBER Working Paper No. 22889. Available at: http://www.nber.org/papers/w22889

De Soto, H. (1989). “The Other Path: The Invisible Revolution in the Third World”, I. B. Tauris: London.

FSDT (2012). “Key findings from Tanzania’s Micro, Small and Medium Enterprise Survey 2010”, FSDT & MITI: Tanzania.

Farrell, D. (2004). “The hidden dangers of the informal economy”, McKinsey Quarterly.

Henrekson, M. and Johansson, D. (2010). “Gazelles as job creators: A survey and interpretation of the evidence”, Small Business Economics, 35: 227-244.

Liedholm, C. (2002). “Small firm dynamics: Evidence from Africa and Latin America”, Small Business Economics, 18(3), 227–242.

Mead, D. C., and Liedholm, C. (1998). “The dynamics of micro and small enterprises in developing countries”, World Development, 26(1), 61–74.

Porta R., and Shleifer, A. (2014). “Informality and Development”, Journal of Economic Perspectives, Vol. 28 (3), pp. 109-126.

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