77924 March 2013 . Number 89 SUPPORTING JOB CREATION AND INNOVATION THROUGH MSME DEVELOPMENT IN MENA Peter McConaghy 1 into internationally competitive companies, generating significant economic benefits Introduction: Employment generation is a through raised productivity, employment, and critical challenge facing policymakers in the economic stability (Nasr and Pearce 2012). MENA region, particularly since the Arab MSMEs, however, often lack the financial and uprisings as citizens challenge governments to investment services needed to access finance. provide greater economic and social They typically suffer from operational opportunities. Unemployment levels in MENA inefficiencies that hamper productivity and are above those of any other region (see figure growth. In addition, many MSMEs in the 1), while the labor force participation rate MENA region find it difficult to expand since remains stubbornly low. Three out of four many markets are dominated by a small working-age women do not participate in the number of privileged and well-connected firms. labor force, constituting 80–90 percent of Finance from banks remains all but shut off to MENA’s inactive workers (World Bank 2012). new and small firms, while early stage seed Unemployment is further complicated by the financing and business incubation services for demographic bulge the region is facing. The new firms is nascent. Addressing these number of young people (ages 15 to 24) challenges to MSME growth and increased from 44.6 million in 1980 to 88.1 competitiveness is central to overcoming million in 2010—doubling in 30 years (UN employment and economic development Population 2010). At around 25%, the youth challenges in the region. unemployment rate exceeds that of any other region in the world (IMF 2012; see figure 1). Figure 1: Total & Youth Unemployment by Region The lack of good employment opportunities in (2010) the region is reflected in high levels of informality: in no MENA country does the formal private sector employ more than 20% of workers (World Bank 2012). In recent years, policymakers have prioritized developing Micro, Small, and Medium-Sized Enterprises (MSMEs) to address the employment challenge in MENA. SMEs account for 20-40% of all private sector Source: IMF and ILO Data, 2010 employment in MENA and contribute more than 50% of GDP output in the region (World The MENA MSME Landscape : There are Bank 2012). A small proportion of high approximately 19-23 million MSMEs in the performing MSMEs have the potential to grow MENA region (IFC-McKinsey 2011). MSMEs 1 represent between 80 percent and 90 percent of Peter McConaghy, Financial and Private Sector Development Group (MNSF1), the Middle East and North all formal sector enterprises, and an even Africa Region, the World Bank. This quick note has been higher proportion if informal enterprises are cleared by Simon C. Bell, Sector Manager, MNSF1. taken into account (Nasr and Pearce 2012). microfinance can be an important source of Only 10% of the total SMEs are formal. The finance for households and micro businesses, it number of formal SMEs is significantly lower is generally not well suited for SMEs as the for transition countries such as Egypt (6%) or credit provided is too small to cover long-term Yemen (5%). This is congruent with the business needs. Similarly, microfinance employment trends in the MENA region. The outreach is limited, reaching only 1.8% of the typical non-GCC MENA country is estimated adult population. to employ as much as 67% of its labor force informally (Loayza & Wada, 2010). Overall, Figure 3: MENA Share of SME Loans of Total Loans SMEs account for 20-40% of all private sector employment in MENA and contribute to over 50% of GDP output in the region (World Bank 2012) (see figure 2). Figure 2: SMEs as Employers in select MENA Countries Source: Union of Arab Banks/World Bank Financial Flagship Report 2011 Bridging the Finance Gap through World Bank Assistance: Since 2010 the World Bank has implemented a series of projects supporting Source: World Bank development indicators access to finance on a commercial basis for MSMEs and providing incentives for banks to lend. The Egypt Enhancing Access to Finance Access to Finance Constraints in MENA: for SMEs project began in 2010 and provides Access to finance remains highly unfavorable $300 million dollars ($150 for microfinance for MSMEs – the total estimated financing gap institutions; $150 for credit and small enterprise for MSMEs in MENA is USD $320-$390 billion finance) in liquidity support. To date the project (IFC-McKinsey 2011). Only 8% of total Bank has supported 3,000 SMEs and 27,000 micro loans go to SMEs in MENA, although this enterprises. The project has contributed to figures ranges widely from 24% in Morocco to creating 80,000 jobs and has served 4,941 2% in the GCC (see figure 3). female-owned microenterprises. The Egyptian government is seeking $300 million in Significant risk aversion and high collateral additional financing for the project because of requirements amongst banks make it very significant demand from participating financial difficult for MSMEs to receive credit. Recent institutions (PFIs). A similar $50 million project studies have shown that over half of the SMEs in Tunisia – effective since 2011 – is disbursing who apply for a bank loan are rejected (Al- rapidly and has led to a 10% increase in the Yahya and Airey 2013). Banks generally require total number of MSME loans made by PFIs. much more stringent collateral and guarantor requirements from MSMEs than from larger MENA FPD projects have also sought to enterprises. Banks usually charge much higher enhance MSME access to finance through interest rates and fees to MSMEs because of the reducing bank risk aversion by sharing down- time and cost of completing due diligence side loses. The Morocco SME Guarantee Facility procedures on small firms. The high number of Project, approved in June 2012, provides $50 informal MSMEs further hinders access since million to support partial credit guarantees to there are licensing and registration mitigate credit risk on loans to MSMEs. requirements to receiving a loan. While March 2013 · Number 89· 2 An Integrated Approach to Address Market of value-added industries including ICT and Bottlenecks Affecting MSMEs: While financial healthcare. The project design will focus on constraints remains a key impediment to making grant schemes sustainable through MSME growth and employment creation in embedding them in permanent government MENA, technical assistance can help address structures. bottlenecks at the enabling environment as well as at the firm and market sub sector levels (see More recently the World Bank has developed a figure 4). With regards to policy and regulation, $4.9 million MSME revitalization project in reform is needed to reduce the cost, time, and Yemen which provides 50% financing for up to inefficiencies surrounding doing business. 400 fresh graduates to complete internship MENA countries on average rank 98 out of 185 programs. The program also includes 400 firms countries in the 2013 World Bank Doing with matching grants (50% of the cost) for Business indicators. Support is also needed at business development upgrading of firms. The the level of MSMEs themselves, in order to, project is particularly important given inter alia, improve operational efficiency, significant contractions in the economy due the upgrade business processes, improve internal recent the political and security crises. controls and risk management, and expand to new markets. Firm-level demand studies In order to integrate TA across the region and demonstrate that business skills and business to provide resources to quickly respond to development assistance (BDA) are perceived by client requests, the World Bank, along with the many SME owners to be nearly as important as IFC launched in 2012 a $30 million technical access to finance (Al-Yahya and Airey 2013). assistance facility to build the capacity of financial institutions for sustainable financing, Figure 4: Key Pillars for MSME Reform in MENA and support MSME business development services through advisory services and policy support. The facility focuses on three broad pillars: a) legal, regulatory, and institutional reforms; b) advisory services to PFIs; and c) Source: Al-Yahya and Airey 2013 support and training to MSMEs. Market Linkages and Business Development Assistance: Business Development Services Letting Gazelles Run - Unlocking the Power (BDS) have been a core focus of World Bank of Startup Firms: Studies on SMEs (which projects for some time. Tunisia’s Export account for the majority of private sector Development II project provided matching employment in MENA), note that only 10%- grants (50% financing subsidy) to firms for 15% of them generate 50-80% of new SME jobs assistance in marketing and facilitating access (Holzl, WIFO 2008). Research in this area to foreign markets. The $37 million dollar demonstrates that net job growth comes from facility – operational between January 2005- large firms and startups (qtd. in Freund 2011). September 2012 – generated incremental One reason why SMEs tend not to create the exports of $550 million and served 1,239 firms, most jobs is that they often have inefficient many of which were first time exporters. An business processes that make them less impact evaluation conducted by the World productive than larger enterprises. Recent Bank found that annual export growth was research (Haltiwanger 2010; Zarutskie 2013) 38.9% higher for assisted firms compared to a finds that startups account for a significant control group in 2004-2008.2 The World Bank is portion of job and productivity growth and currently negotiating a third export younger firms disproportionately hire young development project for Tunisia ($53 million) employees. These findings suggest that which will focus on enhancing export capacity policymakers should be promoting start-ups and fast growing young firms (gazelles) to achieve strong employment outcomes, rather 2Gourdon, J., JM Marchat, S. Sharma, and T. Vishwanath. than broad-based promotion of SMEs. Ex-Post Impact Evaluation of an Export Promotion Matching Grant: Tunisia's EMAF II. Rep. No. 40. Washington: World Bank, 2011. Print. MENA Knowledge and Learning. March 2013 · Number 89· 3 Policies to Identify and Expand gazelles: to create 70 new startups with over $67 million Using data from Investment Climate in equity leveraged through the project. Assessment (ICA) enterprise surveys, Stone and Badawy (2011) found that Egyptian SMEs Figure 5: Financing Constraints amongst New Firms that grew an average of 20% or more over more than 4 years provided workers with more formal training and received international quality certification. Other variables linked to fast growing firms include having a company website, being less than 10 years old, experiencing fewer power disruptions, and using foreign-licensed technology. The analysis also shows that innovation is consistently linked to firms whose workforce includes 5% or Source: World Bank 2012 more of university graduates. These findings direct policy attention towards education, Looking Forward: Addressing the employment training, quality systems, and technology use to challenge in MENA requires a coordinated set promote SME-based employment growth. of policy interventions that combine access to finance for MSMEs with direct business Business Incubation and Early Stage development services, early stage investment Investment: In MENA only 6.3 new businesses for new firms, and broader reforms to the are formed per 100 people, versus 11.4 in other business regulatory and legal environment. developing country regions3 and 42 in high- Moving forward, greater attention will be income countries. Startups require financing in placed on integrating impact assessments into the range of $50 thousand to $1million – the projects to better understand the causal effects range commonly referred to as the valley of of implemented interventions. Similarly, efforts death (see figure 4). In the developed world will be prioritized to target women and youth entrepreneurs with innovative business ideas with access to financial services and training can rely on an ecosystem of financing and towards greater employability and economic mentoring through angel investors, business resilience. These coordinated actions, backed by incubators, and business development support strong commitments of governments in the programs, this is largely absent in MENA. region, can lead to sustained job creation critical to long-term outcomes in MENA. Promoting Innovation and Early Stage Investment: Recognizing the significant gaps in Contact MNA K&L: the innovation and investment ecosystem for Gerard A. Byam, Director, Strategy and Operations. new startups firms, the World Bank recently MENA Region, The World Bank launched a US$30 million dollar project in Lebanon to encourage the equity investment Regional Quick Notes Team: market to increase early stage investment Omer Karasapan, and Roby Fields finance for financially viable new, and existing Tel #: (202) 473 8177 innovative firms. The project’s main component comprises an Innovation in SMEs funding The MNA Quick Notes are intended to summarize lessons learned from MNA and other Bank Knowledge program (the iSME Fund). The iSME Fund and Learning activities. The Notes do not necessarily provides two sources of financing: i) US$2.5 reflect the views of the World Bank, its board or its million for Concept Development Grants member countries. (CDGs); and ii) US$25 million for equity investment in seed, early/venture, and growth stage firms. The project – the first operation of this type in the entire World Bank – is expected 3Includes Latin America and the Caribbean, South Asia, Africa, and Eastern Europe and Central Asia region March 2013 · Number 89· 4