Entrepreneurship Development in Africa: An Approach Which Can Reduce Poverty?
Poverty, demographic growth, and weak job creation in Africa demand more focused economic development efforts, although growing a business remains a challenge
A positive development of the last decade concerns the progress in reducing global poverty. Indeed, only 8% of the world’s population, or 592 million people, was living with less than USD 1.25 per day in 2019 according to the World Data Lab. Thirty years ago, the percentage of people living in extreme poverty was almost four times higher at 29%. However, this global reduction is hiding a weaker decrease in the poverty rate in Africa. The continent now counts 428 million people or 34% of the population living in extreme poverty. Following the significant reductions in China and India, poverty is becoming more concentrated in Africa with 72% of the world’s total. Given the first sustainable development objective of the United Nations is to eliminate extreme poverty by 2030, how can this be achieved in Africa?
For many, development starts with individual empowerment. Fostering economic development, and especially entrepreneurship development represents an approach to reduce poverty supported by many governments and international organizations. An International Labor Organization report found that only 14% of the population had a job or owned a business in the formal sector in Sub-Saharan Africa in 2018. Another 86% of the population operated in the informal sector, a majority as independent workers, but also a significant share as either owners or employees of informal businesses. The lack of capacity of the formal sector to absorb the millions of youths who are entering the job market each year largely explains the size of the informal sector. This nonetheless generates a large number of small businesses across the continent.
According to World Bank research, the increase in the number of people having a paid job and the associated income growth represent the main source of poverty reduction across many developing countries. Moreover, when a mother has a job and her income is increasing, this directly improves the educational and health status of her children. Therefore, having a job and revenues reduces both monetary and social dimensions of poverty, even if social transfers and access to basic services also play a key role. However, despite the many differences between African countries, earning a sufficient income to cover basic needs remains a daily challenge in most countries. Given the lack of formal jobs, the population needs to turn to informal entrepreneurship to generate revenues. The question then becomes whether it is possible for the resulting small businesses to increase their revenues and create jobs?
“Transformational” Versus “Subsistence” Entrepreneurship
In African countries surveyed by the Global Entrepreneurship Monitor, more than 32% or about one-third of the working-age population was either launching or already operating a business between 2011 and 2018. Among those, there were on average three women entrepreneurs for every four men entrepreneurs. A majority or 55% of these businesses were operating in the commerce, hotels, and restaurants sector characterized by low productivity. Only 10% of these businesses operated in agriculture, forestry, and fisheries, and 8% in manufacturing.
Two types of entrepreneurship must be distinguished. Independent workers that aim to generate revenues and will not hire employees compose the vast majority of businesses. These “subsistence” entrepreneurs often launch an informal business given they have no other work opportunity. They earn revenues and improve their living conditions, even if their businesses rarely survive for more than a few years. Moreover, these businesses remain unsophisticated, reproduce existing business models, create few if any jobs, and contribute little to economic growth.
On the other hand, a small proportion of businesses, less than 10%, adopt more productive methods, hire employees, and manage to grow fast. These are the so-called “transformative” businesses. It is these businesses that contribute the most to economic growth and the modernization of African economies, and ultimately to poverty reduction. Besides, as an economy will grow, the proportion of transformative businesses will tend to increase, thus creating a virtuous development cycle that further stimulates growth. The main challenge becomes to differentiate between subsistence and transformative businesses and to modulate the targeted support depending on their characteristics. Identifying transformative enterprises and supporting their growth represents the best opportunity from the point of view of economic development and job creation in the medium and long term.
The Constraints to Growing Businesses in Africa
According to the World Development Indicators, 55% of the African population was working in agriculture in 2016. The majority practiced subsistence agriculture, using rudimentary techniques while generating low yields. A significant share of rural populations is migrating to urban areas looking for better opportunities. Whether in rural or urban areas, for youth or older people, skills are often lacking. In 2016, 30% of men and 45% of women could not read and write. This means that one out of three men and almost one out of two women cannot fill documents to register a business or obtain a loan. In addition, only 45% of young men and 40% of young women had completed a lower secondary education. Despite the progress of the last decades, human capital and technical abilities remain limited for launching, managing, and growing a business.
The World Bank conducts an annual global survey of entrepreneurs asking about the main obstacles to business growth. Key constraints cited by African entrepreneurs include:
- Access to finance represents the most frequently cited constraint. Obtaining a loan requires access to a financial institution, a formal business status, provision of a financial guarantee, and the ability to pay typically very high interest rates. These conditions are difficult to satisfy for most African entrepreneurs, including for many types of microfinance loans.
- Access to electricity is the second most cited constraint, as it is not always reliable, often very expensive, and limited outside urban areas.
- Informal sector practices form the third constraint on the growth of formal enterprises. These businesses have to pay taxes that those in the informal sector can avoid. Consequently, formal firms must deal with competitors who have lower operating costs, which limits their growth. This explains in part why typically only larger businesses will belong to the formal sector.
- Other significant constraints include political instability and corruption, the level of taxes and their frequently problematic administration, along with the difficulty of obtaining land titles.
Social norms also disadvantage women entrepreneurs in Africa. In the household, women are often seen as subordinate to the man, including for financial decisions, and end up with the majority of domestic chores. Besides being disadvantaged in education, they will also have more difficulty accessing funding. Women will also have less confidence in themselves and sometimes face persistent prejudices. This deprives Africa of much of the economic potential of women.
How to support business growth?
Developing human capital and technical capabilities, working to reduce the most important constraints to the emergence of businesses, and reducing barriers for women entrepreneurs are priorities for stimulating African economies. Developing entrepreneurship requires much more than helping to create small businesses and then letting markets and the economy grow.
In terms of dedicated services, entrepreneurship development requires the availability of technical training and mentoring services for entrepreneurs in urban or rural areas. However, research demonstrates that training on its own is not sufficient for launching and growing a business without providing access to financing. On a smaller scale, microcredit can play a role to stabilize the revenues of subsistence entrepreneurs. However, the growth of transformative entrepreneurs will require access to financing and loans from banks or investors that are more substantial. Indeed, microcredit, with loans of 500 to 2000 dollars, cannot finance equipment purchases that will generate productivity gains, employment, and larger-scale production. This aligns with a conclusion from an evidence review which demonstrates that stimulating job creation through entrepreneurship development can work when focused on larger established businesses that are already profitable.
The provision of technical training services combined with access to microcredit will still enable smaller businesses more focused on subsistence to stabilize their revenues. This has a significant impact on the wellbeing of those entrepreneurs and their families. Nevertheless, stimulating employment growth will require a more sophisticated strategy to identify businesses with transformative potential, provide them with training and mentoring, in addition to more substantial access to financing. The growing use of business incubators and accelerators are strategies that align with this approach.
Selecting economic sectors that are conducive to growth and job creation is also key. Despite the predominance of the agricultural sector in Africa, it remains underdeveloped and too few agro-processing firms exist. For example, due to a lack of processing and packaging for cashews, coffee, cocoa, or mango juice, consumers on the continent often have to buy imported products. This while the raw materials are produced locally and exported unprocessed. Women are also particularly active in agriculture and transformation, and they stand to benefit from a focus on this sector. Fostering the development and productivity of agricultural and agro-processing businesses represents a particularly effective strategy for creating jobs and reducing poverty according to research on economic development. Developing those businesses and the related value chains are also most susceptible to generate growth that will include the majority of the population, one out of two people being already active in this sector in Africa.
A recent publication of the OECD and the African Union also considers global economic development strategies adapted to the main subregions of the African continent. This includes focusing on strategic sectors, basic infrastructure, innovation, the business environment, and developing regional and international trade.
The Conditions for Reducing Poverty Through Entrepreneurship
Returning to our initial question, reducing poverty through entrepreneurship development in Africa will only be possible if businesses create jobs. Dedicated support to subsistence entrepreneurs can stabilize their revenues and improve their living conditions in the short term. However, this will not increase job creation and will have only limited effects on poverty over the longer term. On the other hand, targeted support to transformative entrepreneurs will require the identification of successive cohorts of established businesses with growth potential. More intensive support combining advice and finance, focusing on a more limited number of businesses, then enable their expansion and the creation of sustainable jobs. Although not all transformative enterprises can be successful, these firms stimulate innovation and productivity, and cumulatively help modernize African economies.
Prioritizing the development of value chains in agriculture and agro-processing also maximizes job creation, while meeting the growing demand of African consumers. The growth of this sector also has direct effects on poverty, disproportionately benefits women, and later provides a basis for extending innovations to other sectors of the economy.
Therefore, stimulating economic growth and job creation requires the multiplication of transformative enterprises. It is these businesses that can help raise people’s incomes, and ultimately help reduce poverty in Africa.
