Eric Bloch: SMEs Fuel Economic Growth

ALMOST every economy that has achieved major growth has, as an element of that growth, had a concentrated drive to establish small and micro enterprises (SMEs), inclusive of many coming into being as informal sector operations, but progressively facilitated and motivated to formalise their operations.

Prime examples of economies which have used SME development as a catalyst for economic development include India, China, South Korea and Malaysia, but there are many others who have done likewise.

In virtually all instances, vast numbers of the populations were without gainful formal sector employment, and subject to pronounced poverty.

The respective governments sought to address those critical circumstances by encouraging and facilitating the creation of home industries and other small-scale operations, ranging from production of basic items of clothing and footwear to carpentry and associated production of small furniture items, from food production to manufacture of pottery, from the provision of services such as plumbing and electrical repairs to hairdressing, and from vending to engaging in transportation and cartage operations (be it horse, donkey or cattle driven, or usage of bicycles).

In so doing, not only were the governments enabling large sectors of their populations access to incomes, with progressive enhancement of standards of living and reduction of poverty, but also fuelling considerable downstream economic activity and, in many instances, some creation of employment and — as the enterprises developed and grew — direct and indirect fiscal inflows.

However, in pursuit of the SME development strategy, the governments also recognised the desirability of a progressive transition of the enterprises from the informal sector.

This was necessary if the ventures were to grow and expand, have access to capital for that expansion and growth, were to be compliant with law, and were to be substantive fiscal contributors.

Therefore, the governments strove to minimise the bureaucracy and the fiscal hindrances to formal sector entry. Concurrently they intensively focused upon relaxation of laws that were obstacles to informal sector operations save to such extent as necessary for national security, community health, and like considerations.

They also tried to ease the establishment and operation of SMEs by establishing appropriate cluster areas for the location of the ventures, at low cost, to facilitate access to capital. Of major importance to their vigorous efforts to encourage and enable informal sector economic activity, they ensured minimum regulation and control.

They did likewise, to a considerable extent, to motivate and facilitate movement from the informal to the formal sector, concurrently with the creation and provision of significant incentives for such operational transformation.

In particular, they recognised that one of the biggest factors which motivated informal instead of formal sector operations was that operators sought to avoid the incidence of taxation and other imposts and, to counter that consideration, minimised taxation and like charges on small enterprises, concurrently with the provision of compensatory incentives. Those incentives were of a nature and extent as would induce SME operatives to be willing to be subject to formal sector constraints, as benefits would be perceived to outweigh disadvantages.

Zimbabwe is currently striving to reverse the massive economic decline that has been the principal characteristic of the last decade, and in the last few months (mainly after the establishment of the “inclusive” government), has made some significant initial progress in doing so.

Foremost in the achievements is the elimination of the most pronounced hyperinflation ever sustained by any country, with the first five months of 2009 each experiencing deflation in contrast to gargantuan month-on-month inflation throughout most of 2008.

Government has also succeeded in sourcing some considerable international funding (presently approximately US$955 million, although more than eight times that amount is required).

In addition, it has begun to successfully motivate foreign investor interest, although much of that interest has yet to be converted from interest to intent.  All indications are that the economy is at last, very belatedly, set upon a path of recovery. Nevertheless, the economic upturn is inevitably very slow and it will take many years for complete recovery to be achieved.

Despite the first stages of economic recovery progress, the economy is still greatly debilitated, with intense poverty and suffering being norm for a considerable majority of the population. The Poverty Datum Line for a family of six was assessed in May 2009 at approximately US$427 per month, as compared to US$82 in South Africa.

Almost 90% of the population is believed to be struggling to survive, let alone make ends meet, to levels very markedly below the PDL, whilst more than half the population barely exists at below the Food Datum Line. As a result, extreme poverty, hardship and suffering are the order of the day, with many dying of malnutrition or of ill health.

It is critically important, therefore, that Zimbabwe very urgently takes a leaf out of the book of those nations which have successfully enabled economic growth and wellbeing for the majority of their populations by rapid and intensive enablement of an exponential development and growth of its informal sector, and of progressive transition from the informal to the formal sector.

It has long talked of doing so, but action is now needed, and not talk. As a matter of urgency, in order not to  “reinvent the wheel”, Zimbabwe needs to study the policies and strategies which have so successfully achieved large-scale SME development in other countries, and to obtain requisite guidance and advice from experienced experts within the international community.

Undoubtedly, those policies and strategies will required adaptation and modification to fit Zimbabwean circumstances, but they will be effective guidelines to achieve that which is so very necessary for Zimbabwean circumstances, and to bring about economic vitality. The study must not be limited solely to informal sector economic development, but also to the motivation and enablement of progressive enterprise movement from the informal to the formal sector.

Although only one example of the pro-active measures that could be pursued, it is very notable that, with effect from last Wednesday, South Africa is using its taxation legislation as one way of stimulating SME development. With the intention to enable small  (and medium-sized) business ventures to obtain capital required to fund establishment or growth, the South Africa Income Tax Act now provides for a liberal tax incentive to those who invest in venture capital companies that engage in the provision of funding to small business enterprises.

That tax incentive comprises tax deductibility of the entirety of amounts invested in venture capital companies that provide SME funding. 

In the case of individuals, the deduction allowed is ZAR750 000 in any one year, subject to an aggregate maximum of such deductions over the years of ZAR2, 25 million, whilst listed companies and their 70% or more controlled subsidiaries are accorded deductibility of the entirety of investment in approved venture capital companies.

The legislation prescribes that the venture capital companies must be engaged in investment in the small business sector to an extent of at least 90% of its total investment capital.  Such an incentivisation strategy may, or may not, be apposite to Zimbabwe, but it is indicative of the innovative thinking that could vigorously stimulate SME development.

Yet another could be significant tax relief in the first years of operations of the SMEs, including pronounced leniency on the imposition of indirect taxes impacting upon SMEs in general, and those within the informal sector in particular (instead of the heavy-handed, oppressive indirect tax enforcement recently resorted to by the Zimbabwe Revenue Authority, Zimra, in raids on informal sector traders).

Encouraging formal and informal sector SME development, followed by the progressive transfer of those in the informal sector to the formal sector, needs to be a high priority in government’s drive to re-establish a healthy, virile Zimbabwean economy.