SME financing, performance, and innovation in developing countries – the impact of the institutional and regulatory business environment in Africa.

Abstract

Small and medium enterprises (SMEs) contribute enormously to the industrial output and export of goods and services in developing countries and play a significant role as the engine of growth in these countries, accounting for large proportions of manufacturing and general employment. However, SMEs in developing countries tend to be financially constrained, less productive, pay lower wages, and are less likely to introduce new products and services than large firms. While it is known that some elements of the business environment (BE), such as weak macroeconomic conditions, are to blame for the peculiar challenges faced by SMEs in developing countries, very little is known about the influence of other elements of the BE (such as institutions) on the operations and financial performance of SMEs. Consequently, this PhD thesis aims to explore how some elements within the BE – such as institutions, the regulatory business environment (RBE), and innovation systems – impact (1) access to finance and funding choices; (2) the financial performance; (3) the funding choices – financial performance relationship, and (4) the innovation profiles and output of SMEs in Africa. Using a rich panel sample of 39,461 firm observations (27 African countries) from the World Bank Enterprise Surveys and employing panel regressions, Propensity Score Matching (PSM), and Structural Equation Modelling (SEM) methods, these findings were noted: First, the supply of external finance increases in African countries with enabling institutional and RBEs, however, this increased supply of finance does not translate to greater patronage by SMEs. Second, not all dimensions of an enabling RBE enhance the performance of SMEs in African countries. While an enabling business licensing and tax administration environment improves the performance of SMEs, trade facilitation impedes the performance of SMEs due to their limited capacity to compete with foreign firms and financial constraints. Third, working capital funding from internal sources (such as owners, family, and friends, and retained earnings) and trade credit results in weaker financial performance for SMEs in African countries, while working capital funding from financial institutions (banking and non- banking) results in stronger financial performance for SMEs in African countries. Fourth, SMEs in African countries are more likely to adopt DUI (innovation based on learning-by-doing, by-using, and by-interacting) drivers than STI (science, technology, and innovation) drivers due to their specific institutional and innovation environment. Fifth, SMEs that adopt a combination of STI and DUI drivers are more effective at generating business process (or non-technological) innovations than product (or technological) innovations. And sixth, financial constraints have a greater effect on the generation of product innovations than on business process innovations for SMEs in Africa. These findings indicate the need to tailor policies and interventions aimed at improving specific elements of regulatory institutions and innovation systems, since these institutional elements have profound impact on the operations, innovation, and financial performance of SMEs in African countries.