By Vassav Gupta
Introduction
Particularly in today’s fast-paced global economy, entrepreneurship is vital to any nation’s socioeconomic health. Entrepreneurial success leads to innovation, higher employment, and happier consumers – all of which stem from greater competition. As Austrian political economist Joseph Schumpeter famously theorized in 1942, economies naturally go through “creative destruction,” the process by which new innovations replace old ones and rapid economic growth takes place 1. Entrepreneurship is instrumental in allowing an economy to undergo this process, and governments and societal conditions play a key role in fostering economically-productive entrepreneurial spirit. Yet, entrepreneurs in developing nations – where entrepreneurship is needed the most – face various challenges and are often prevented from attaining large-scale financial success to achieve socioeconomic mobility. However, entrepreneurial spirit is present in many of these low-income nations. In Ghana and Bangladesh, 66.9% and 75.4% of people work as one-person entrepreneurs, compared to only 6.7% in Norway, 7.5% in the United States, and 8.6% in France 2. This white paper will discuss the significant barriers and challenges entrepreneurs face in developing economies, particularly compared to developed nations.
Corruption
Corruption is an issue that developing countries often suffer from, and it can negatively impact entrepreneurship. Of the ten lowest nations on the Global Entrepreneurship Index, nine are in sub-saharan Africa 3. Correspondingly, Sub-saharan Africa has the lowest average Corruption Perception Index, of 33, where zero is “highly corrupt” and and 100 is “very clean” 4. Some nations’ individual scores are even lower. South Sudan, for example, has a score of 11.
One reason why corruption decreases entrepreneurship in developing economies is because of financial difficulty. In a research paper titled “The Impact of Corruption on SMEs’ Access to Finance,” researchers Mohammad Amin and Victor Motta used large-scale survey data from 114 countries and found that increasing corruption from its smallest to greatest value increases the chance of a small-medium enterprise being financially constrained by 6.9% to 10.9%. This is especially significant because only 18.2% of the private firms are financially constrained in the studied areas 5. There are various reasons for this pattern. When there is widespread corruption in an economy, officials may expect bribery and entrepreneurs may need to rely on it to get things done. Often, aspiring entrepreneurs are already on a low income and the excess costs of bribery and other bureaucratic costs impede growth by reallocating capital that the business could have retained. Additionally, the financial costs of corruption, like embezzlement bribery, etc., may necessitate higher prices and make attracting customers difficult. Furthermore, customers may lack trust in businesses if they feel corrupt methods are being used to grow the business.
Weak property rights and little protection from the government have similar entrepreneurship-stifling effects. When individuals feel that ownership of their private resources is unsecure, they may be less likely to take on ventures. According to the World Bank, only 30% of the global population “has a legally registered title to their land” 6. In many nations, citizens have less secure private lands which may include farms and shops. If entrepreneurs feel that their physical capital and land is unsecured and subject to unreasonable seizure by the government or others, they may be discouraged in creating land-requiring private ventures. Furthermore, research has shown that, paired with high income inequality, weak property rights may increase corruption 7. This drastically increases hassles for businesses in low-income nations: In the Middle East and North Africa, 53% of companies said that corruption is a major constraint when dealing with the government. Only 11% of companies in high-income OECD nations said the same 8.
There is also a clear link between corruption and political instability. Researcher Christos Cabolis of IMD Business School correlated values of Transparency International’s corruption perception index with survey data on political instability. He found a strong positive relationship between the two, with a correlation coefficient of 0.78 17. Because many developing nations have high levels of corruption, the political instability may make entrepreneurship difficult, particularly with regards to labor. Workers may be preoccupied with conflict and armed service. Additionally, if businesses need foreign labor or workers from other politically stable nations, they may have difficulty getting them to move to their nation for work.
However, in specific conditions, findings have shown that corruption can actually help entrepreneurship. Because of bribery and other underhand methods, corruption can help businesses “overcome” cumbersome rules and regulations, and surpass inefficiency from weak institutions. This “grease the wheels” hypothesis was tested and found to be true in certain areas and industries, yet it is important to note that the same paper finds that corruption slows economic growth in the long run 10.
Funding
Critical to any entrepreneurial venture is access to funding and investment. However, this is often difficult in developing economies. According to the Brookings Institution, “developing countries’ average interest cost on external borrowing is three times higher than that of developed countries” 11. For many of the risks outlined in this whitepaper such as political instability and poor infrastructure, lenders see a greater risk in giving funds to entrepreneurs and thus charge a larger interest rate. In Africa, interest rates from local banks for the public are sometimes as high as 20-25% 11, while the average among many European nations is just 2.56% 18. Many individuals in low-income nations do not even have access to these formal banking institutions and rely on alternative lenders with higher, more predatory interest rates. While microfinance is a popular option, the small size of these loans and high operating and implementation expenses make them high in interest rate as well. This is emphasized by the fact that many aspiring entrepreneurs are low-income individuals seeking economic mobility, they often do not have savings to pull from and rely on loans. To make matters worse, poor entrepreneurs needing loans often lack collateral, making them even more susceptible to high interest rates. However, since this funding is so critical, developing-economy entrepreneurs have no choice but to take high-rate loans. A World Bank study found that Entrepreneurs in low-income nations generally spend 50% of their per capita income to start a business, but for high-income nation entrepreneurs it is only 4.2% 13. These high interest rates can prevent entrepreneurs from funding their ideas as it limits the affordability and accessibility of necessities such as land, labor, and machinery.
While, in many cases, funding may be available, low-income entrepreneurs may be unable to access it due to lacking financial literacy and documentation. Entrepreneurs may not know how to use proper channels to secure funding. According to a Borgen Project study, only 54% of people in developing nations can or know how to open a bank account and have low access to financial institutions 14, and a survey in South Africa found that nearly 60% of respondents did not understand basic financial terms like “interest”. Additionally, many individuals in developing economies who lack financial literacy may have identification issues. Low-income entrepreneurs who lack formal IDs may have a harder time getting loans. Even when easy identification is present, lacking regulation in many of these nations means difficulty in finding safe and secure financial platforms for not just entrepreneurs, but everyday people.
Infrastructure
Because many developing nations lack financial resources, technological capability, and economic power, they have weak infrastructure in areas like transportation, communication, and power. These are aspects which are critical for any business’s success regardless of location. In Africa, poor road, rail, and port infrastructure add 30 – 40% to the costs of goods traded 15. This increases start-up cost and the necessity of loans for low-income individuals who seek socioeconomic mobility, and entrepreneurs may have difficulty securing investments. Moreover, low transportation standards (delays/congestion, unsafe roads and bridges, lack of trustworthy drivers) increase the risk of entrepreneurship, particularly for low-income individuals. This may make it difficult for entrepreneurs to hire workers who need to commute, discouraging entrepreneurship (particularly in the service sector where frequent trips need to be made in some cases).
Similarly, deteriorating water infrastructure increases costs due to more floods, shutdowns, and storm damages. This, combined with other factors, results in unreliable electricity. Physical stores and in-person businesses requiring offices and shops come to standstills when electricity is absent. Necessities such as lighting, broadband and WiFi for online and virtual services can become inaccessible. This can prevent growth in certain sectors that may rely more heavily on electricity than others. In developing nations, this is evident. North America and Europe have average electricity access rates of 100%, compared to only 9% in Burundi, 19% in the DRC, 13% in Malawi, and generally lower rates in many other developing nations 16.
Conclusion
Entrepreneurial spirit is one that is vital to any nation’s financial health, regardless of wealth or economic status. Despite this, too many entrepreneurs face challenges which make individual ventures impractical and more difficult than they should be. The economies which present the most challenges for entrepreneurs are where entrepreneurship is needed the most because of its ability to uplift an economy through tough times and bring innovation, competition, and productivity to financial markets. Spes Nova works to encourage and improve conditions of entrepreneurship in developing economies. By connecting low-income artisans and entrepreneurs to academic institutions and international consumers, Spes Nova encourages entrepreneurship in under-resourced communities where it may otherwise be difficult. To learn more about Spes Nova and its network of artisans and entrepreneurs, please visit www.spesnova.org.
Citations
1 Schumpeter, Joseph A. Capitalism, Socialism, and Democracy. Harper & Brothers, 1942.
2 Chang, Ha-Joon. “Unu-Wider : Blog : Poverty, Entrepreneurship, and Development.” UNU-Wider, United Nations, Oct. 2010, www.wider.unu.edu/publication/poverty-entrepreneurship-and-development.
3 “Global Entrepreneurship Index.” Global Entrepreneurship Development Institute, Global Entrepreneurship Development Institute, 2019, thegedi.org/global-entrepreneurship-and-development-index/
4 “2021 Corruption Perceptions Index Reveals a Decade of Stagnating…” Transparency.org, Transparency International, 25 Jan. 2022, www.transparency.org/en/press/2021-corruption-perceptions-index-press-release-regional-africa.
5 Amin, Mohammad, and Victor Motta. “The Impact of Corruption on SMEs’ Access to Finance.” Open Knowledge Repository, World Bank, Oct. 2021, openknowledge.worldbank.org/bitstream/handle/10986/36430/The-Impact-of-Corruption-on-SMEs-Access-to-Finance-Evidence-Using-Firm-Level-Survey-Data-from-Developing-Countries.pdf?sequence=1.
6 World Bank Group. “Why Secure Land Rights Matter.” World Bank, World Bank Group, 24 Mar. 2017, www.worldbank.org/en/news/feature/2017/03/24/why-secure-land-rights-matter.
7 Dong, Bin, and Benno Torgler. “Democracy, Property Rights, Income Equality, and Corruption.” SSRN, Basel: Center for Research in Economics, Management and the Arts (CREMA), 9 Feb. 2011, papers.ssrn.com/sol3/papers.cfm?abstract_id=1756816.
8 Khokhar, Tariq. “Chart: 1 in 3 Companies Constrained by Corruption.” World Bank Blogs, World Bank Group, 9 May 2016, blogs.worldbank.org/opendata/chart-companies-constrained-corruption.
9 Globerman, Steven, and Daniel Shapiro. “Governance Infrastructure and US Foreign Direct Investment – Journal of International Business Studies.” SpringerLink, Palgrave Macmillan UK, 28 Nov. 2002, link.springer.com/article/10.1057/palgrave.jibs.8400001.
10 Bologna, Jamie, and Amanda Ross. “Corruption and Entrepreneurship: Evidence from a Random Audit Program.” West Virginia College of Business and Economics Working Papers, West Virginia University, 30 Mar. 2015, busecon.wvu.edu/phd_economics/pdf/15-05.pdf.
11 “Supporting Small and Medium Enterprises in Sub-Saharan Africa through Blended Finance.” CSIS, Center for Strategic and International Studies, 7 July 2021, www.csis.org/analysis/supporting-small-and-medium-enterprises-sub-saharan-africa-through-blended-finance.
12 Carbajo, Marco. “10 Stats That Explain Why Business Credit Is Important for Small Business.” SBA.gov, US Small Business Administration, 9 Mar. 2017, www.sba.gov/blog/10-stats-explain-why-business-credit-important-small-business.
13 “Doing Business 2020 – World Bank.” World Bank Open Knowledge, World Bank Group, 2020, openknowledge.worldbank.org/bitstream/handle/10986/32436/9781464814402.pdf.
14. “How Improving Financial Literacy Helps Reduce Poverty.” The Borgen Project, The Borgen Project, 24 Nov. 2021, borgenproject.org/improving-financial-literacy/#:~:text=Financial%20Literacy%20in%20Developing%20Countries&text=Data%20indicates%20that%20just%2054,lack%20access%20to%20banking%20institutions.
15 Mayaki, Ibrahim. “Why Infrastructure Development in Africa Matters.” United Nations Africa Renewal, United Nations, www.un.org/africarenewal/web-features/why-infrastructure-development-africa-matters.
16 Routley, Nick. “Mapped: The 1.2 Billion People without Access to Electricity.” Visual Capitalist, Visual Capitalist, 27 Nov. 2019, www.visualcapitalist.com/mapped-billion-people-without-access-to-electricity/.
17 Cabolis, Christos. “Corruption, Democracy, and Political Uncertainty: IMD Article.” IMD Business School, IMD Business School, 12 Feb. 2019, www.imd.org/research-knowledge/articles/com-february-2019/.
18 “Real Interest Rate in Europe.” TheGlobalEconomy.com, www.theglobaleconomy.com/rankings/Real_interest_rate/Europe/.
Cover Photo: Kamugisha, Erasmus. “A local fruit Vendor in the old town”. Wikipedia Commons, 24 March 2021, https://commons.wikimedia.org/wiki/File:A_local_fruit_Vendor_in_the_old_town.jpg
