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Promoting sustainable, inclusive growth and development through building the small business ecosystem

Image of Brian MacDonald against a grey backdrop wearing a blue pinstriped shirt

Brian MacDonald

Senior Private Sector Engagement Specialist

Micro, small and medium-sized enterprises (MSMEs) are a critical part of the economy in lower and middle-income countries (LMICs), contributing up to 40% of their GDP, according to the World Bank. These businesses span from informal small producers to registered firms and are prevalent in diverse industries, ranging from rural agriculture to artificial intelligence.

The value of MSMEs in emerging economies goes beyond just being sources of work. They are recognized as key drivers of innovation and creativity, provide goods and services to low-income populations and serve as vehicles for inclusive growth and poverty reduction.

Despite their importance, MSMEs face numerous barriers in realizing their full potential. A lack of capital is among the oft-cited challenges, with high collateral requirements for small borrowers, loan terms that do not match clients’ needs and underdeveloped equity markets as notable constraints. Business development services — a range of non-financial services, such as marketing, product design and communications — are important for improving enterprise performance and rendering a company “investment ready.” Yet, such support is often fragmented, of poor quality or built on a “one size fits all” approach. Regulation remains an issue in many countries, with complex registration and taxation procedures creating strong disincentives for firms to operate in the formal market, while limiting growth for those who do.

MSMEs are also particularly vulnerable to climate change, as they have relatively few resources to deal with its effects. In addition, restrictive social and gender norms affect women entrepreneurs across all aspects of the market system. These discriminatory factors hinder their ability to assume leadership roles, thrive in the business world and achieve economic empowerment.

Negative impacts of market failures

The consequences of these barriers are severe. Male and female workers receive lower wages than they would under more favourable conditions, resulting in less income for personal needs, such as child schooling, healthcare and a nutritious diet. In many lower-income households, women and girls are disproportionately affected and may be compelled to supplement their family’s earnings by working in risky occupations or at the expense of receiving an education.

Enterprises themselves are also affected. Reduced reinvestment in a business leads to less expansion and an inability to capitalize on opportunities, resulting in lower market growth for that industry. Innovation also suffers as startups, particularly those in higher-risk but dynamic fields such as technology, are unable to move past proof of concept or pilot operations. At a national level, the stifling of MSME development can hinder a country’s transition to a stable, market-based economy, resulting in a lower level of accompanying revenue and less sociopolitical benefits for the state and society at large.

Addressing the constraints to inclusive, sustainable MSME growth: An ecosystem approach

In response to these factors, development actors are increasingly adopting an ecosystem approach to supporting MSMEs. This strategy recognizes that businesses exist in an interconnected system, also known as a market system, which involves many elements that enable buyers and sellers to interact and conclude transactions. An ecosystem approach also acknowledges that siloed support in limited areas, which fails to account for interrelated systemic challenges, is unlikely to yield meaningful, long-term impact for MSMEs. For example, improved business development services may not result in better small business performance without a corresponding increase in access to finance for the firm, which in turn may depend on a country’s financial sector framework.

Given the complexity of MSME ecosystems, research is critical for understanding their components, identifying entry points for interventions and capturing and sharing evidence on what works and why. Such learnings are key for improving ecosystem programming, to ensure efforts are fully supporting innovation, poverty reduction and reduced inequality for marginalized groups.

Against this backdrop, IDRC has begun applying an ecosystem approach across its work with MSMEs. To illustrate, the Transforming the Care Economy through Impact Investing initiative comprises three pillars: i) business profiling of MSMEs, to showcase diverse business models and opportunities for investors; ii) business development support to early-stage and established MSMEs, to help prepare a pipeline of “investible firms”; and iii) outreach to policymakers, business and investment associations, to engage in research on regulatory frameworks and policies on investing in MSMEs in the care industry. Combined, these efforts are making a meaningful contribution to advancing women’s economic empowerment and global gender equality.

Emerging experience further suggests that strong ecosystem approaches are often achieved with certain tools, beginning with market systems mapping. Such mapping goes beyond stakeholder analysis and identifies the relations and dependencies among market elements, such as how low-quality technical skills providers and gender-based norms combine to create barriers for women entrepreneurs in high-tech industries. Those elements that show up most frequently often serve as leverage points to target. Applying a political economy lens to this analysis can deepen the insights obtained, by uncovering additional factors governing ecosystem actor behavior and how they may be incentivized to change.

There are a wide range of potential interventions within an ecosystem approach, and it takes time for changes in one area to yield results in another. Because of this, the duration of ecosystem-based support tends to be longer. Such increased timeframes also facilitate the capturing of impacts across the system and help confirm whether assumptions made during the project planning phase continue to hold true.

Lastly, partnership is a key component of MSME ecosystem building. Researchers, private firms, business associations, civil society and policymakers all have a role to play in driving change to benefit MSMEs and create wider impacts in the societies in which they operate. Through collaboration and leveraging of different skills and resources, diverse stakeholders can work together to expand the potential for MSMEs to support inclusive growth, innovation and women’s empowerment, thus increasing this critical economic actor’s contributions to the advancement of the UN Sustainable Development Goals.