"Cities and regions in a changing Europe: challenges and prospects"

5-7 July 2017, Panteion Univerisity, Athens, Greece

Entrepreneurship and the role of microfinance in a changing

Europe

Delitheou VASILIKI, Ph.D, Assistant Professor

Department of Economics and Regional Development

Panteion University of Social and Political Sciences, Athens, Greece

vdelith@hua.gr

Papastamatiou GEORGIOS, National Bank of Greece S.A.

MSc in Banking, School of Social Science, Hellenic Open University, Patra, Greece

gpapast@gmail.com

Abstract

Microfinance is often referred to as a financial tool able to facilitate the transition from

unemployment to independent work, through the strengthening of access to finance for

vulnerable social groups facing exclusion from the banking system.

In this context, the European Union has already encouraged the development of

microfinance in Europe since 2010 by creating programmes facilitating access to finance for

individuals, small or social businesses. The first European instrument for the development of

this type of financing in the EU was created in 2010 (Decision no. 283/2010 of the European

Parliament and of the Council establishing a European Progress Microfinance Facility for

employment and social inclusion), while for the period 2014-2020, the baton went to the

European Union programme for employment and social innovation (EaSI), according to

Regulation (EU) No. 1296/2013.

However, despite the fact that it is considered to be a morally progressive practice, in recent

years, there has been a great deal of criticism with the critics of microfinance contesting

even the ability of this financial tool to contribute to the fight against poverty and social

exclusion, thus causing reasonable questions.

Taking into account the specific challenges which the European Union faces today, as well as

the objectives it has set, and placing innovation at the heart of its strategy for growth and

job creation, this article examines the effectiveness of the promotion of microfinance for the

development of entrepreneurship in cases of developed economies such as those of the

European Union, in accordance with the targets it has set as well as the experience gained

by Member States; thus resulting in proposals, which can improve the implementation of

relevant programmes for encouraging entrepreneurship in the future.

Keywords : Microfinance, entrepreneurship, innovation, development

JEL Classification: G21, L26, O35, F63

1. Introduction

The concept of microfinance includes a wide range of financial services that may contain the

form of guarantees microcredit, equity and quasi-equity1 extended to persons, micro and

small enterprises who typically are denied service by mainstream commercial banks, as well

as in most cases because they are unable to offer sufficient collaterals, either due to high risk

and management cost or other socio-economic reasons, they are considered to be

unprofitable activities by the traditional banking system (Baydas et al, 1997).

The most common form of microfinance is that of microcredit, i.e. a very small loan, usually

less than $ 200- $ 300 in some developing countries, which is provided to people below the

poverty line in order either to create their own small or very small business, or to become

self-employed (Hudon & Sandberg, 2013).

This article critically examines the feasibility of promoting the microfinance model in Europe

in the wake of the relatively recent outbreak of interest observed for microfinance

1 According to the definition of the Decision No 283/2010/EU of the European Parliament and of the Council of 25 March 2010 establishing a European Progress Microfinance Facility for employment and social inclusion.

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worldwide and which largely reflects the ‘discovery’ in the 1980s of a supposedly new

paradigm of microfinance institution (hereafter MFI) believed to be able to cope dynamically

with poverty through the financing of tiny income-generating projects.

Spearheading this new paradigm was the Grameen Bank in Bangladesh, an MFI established

in 1983 by Dr Muhammad Yunus. As one of the earliest and most successful pioneers of the

‘solidarity circles’ methodology, wherein joint guarantees by groups of borrowers

encouraged very high repayment rates on microloans, the Grameen Bank appeared to be

able to sustainably provide hundreds of thousands of microloans to the very poorest in

Bangladesh (Yunus, 2003).

This practice of microcredit lending has received global attention over the last two decades,

especially since the United Nations declared 2005 the “Year of Microcredit” and the 2006

Nobel Peace Prize was awarded jointly to Muhammad Yunus and the Grameen Bank. As a

result of this positive attention, the number of MFIs2 and the share of financial assistance

from developed countries have increased over time (Gähwiler & Negré, 2011).

Corresponding to the increase of interest of microcredit is the criticism of MFIs in emerging

economies since, on the occasion of the successful offering of shares by the Mexican MFI

Compartamos in 2007, it was known that the interest rate under which the economically

weak borrowers were borrowed exceeded 100% (Ashta & Bush, 2008; Lewis, 2008; Rhyne &

Guimon, 2007; Hudson & Sandberg, 2013) while other MFIs have been accused of relying on

exploitative lending techniques, using forceful loan recovery practices, and pushing

borrowers into “debt traps” (Hulme & Arun, 2011; Karnani, 2011; Hudon & Sandberg, 2013).

As a result, several scholars refer to a "moral crisis" in the microfinance sector (Hudon, 2011;

Hudon & Sandberg, 2013).

However, the most important critique, regardless of any unfair practices that can be

observed mainly in MFIs of developing countries, is the evaluation of the microfinance

model itself and whether it can bring real and sustainable results to a competitive business

environment that can be developed within a common market such as the European Union.

Can microfinance be a remarkable tool in an ever-changing Europe that aims to get out of

the crisis by building a society and economy based on knowledge and innovation?

In order to understand the environment of microfinance development in Europe and in

particular in the European Union, the second section summarizes the development strategy

and the initiatives developed by the EU in the field of microfinance. The third section 2 Microcredit Summit Campaign Report, 2015

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summarizes the image of entrepreneurship that is currently developing within the EU, with

emphasis on the characteristics of very small entrepreneurship, to which microfinance is

addressed. In the fourth section follows a critical assessment of microfinancing and its

theoretical impact in line with the challenges that Europe is facing today and finally the fifth

section summarizes the discussion on the ability of the financial instrument to contribute to

the EU's development strategy and it proposes alternatives as well as suggestions for

improvement.

2. Microfinance in European Union’s developing strategy

There is no doubt that Europe faces a moment of transformation. The crisis has wiped out

years of economic and social progress and exposed structural weaknesses in Europe's

economy.

An important indication of the EU's structural weaknesses is the EU's lowest average growth

rate against its main economic partners (USA, Japan), which illustrates the most important

problem faced by the EU and which concerns the widening of the productivity gap. Much of

this is due to differences in business structures combined with lower levels of investment in

R&D and innovation, insufficient use of information and communications technologies,

reluctance in some parts of our societies to embrace innovation, barriers to market access

and a less dynamic business environment.

With long-term challenges – globalisation, pressure on resources, ageing to be intensified,

E.U has based its strategy for Europe of 2020 in a smart, sustainable and inclusive economy

delivering high levels of employment, productivity and social cohesion (Delitheou et al,

2017).

In this context, already since 2010, European Union has also encouraged the development of

microfinance by creating programs to facilitate access to finance for individuals, micro-

enterprises or social enterprises. The first European instrument to develop this kind of

funding in the EU was created with Decision 283/2010/EU of the European Parliament and

of the Council of 25 March 2010 establishing a European Progress Microfinance Facility for

employment and social inclusion. While for the 2014-2020 period, the baton took the EU's

program. For Employment and Social Innovation (EaSI), in accordance with Regulation (EU)

No 1296/2013.

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The Employment and Social Innovation (EaSI) programme is a financing instrument at EU

level to promote a high level of quality and sustainable employment, guaranteeing adequate

and decent social protection, combating social exclusion and poverty and improving working

conditions. EaSI is managed directly by the European Commission and it brings together

three EU programmes managed separately between 2007 and 2013: PROGRESS, EURES and

Progress Microfinance.

As of January 2014, these programmes form the three axes of EaSI. They support: i) the

modernisation of employment and social policies with the PROGRESS axis (61% of the total

budget); ii) job mobility with the EURES axis (18% of the total budget); and the iii) access to

micro-finance and social entrepreneurship with the Microfinance and Social

Entrepreneurship axis (21% of the total budget). The total budget for 2014-2020 is EUR

919,469,000.

The Microfinance and Social Entrepreneurship (MF/SE) axis supports actions in two thematic

sections: i) microcredit and microloans for vulnerable groups and micro-enterprises; ii) social

entrepreneurship. The European Commission does not directly finance entrepreneurs or

social enterprises, but enables selected microcredit providers and social enterprise investors

in the EU to increase lending.

Under EaSI, European Investment Fund (EIF), part of the European Investment Bank Group

(EIB), has been entrusted by the European Commission to manage the financial instrument

“EaSI Guarantee Instrument”. The EIF, leveraging at least 5.5 times the capital of the

financial instrument, provides guarantees and counter-guarantees that partially cover the

credit risk of portfolio in microfinance operations, encouraging Financial Intermediaries (e.i.:

FI, MFI) to provide loans with a nominal amount of up to and including EUR 25 000, having

the obligation to provide directly or indirectly mentoring and training programmes.

However, microfinance actions that can be implemented within the European Union and

supported by its budget are not limited to this program. According to article 37.4 of EU

Regulation 1303/20133, Member States have the ability to utilize Resources of European

3 Regulation (EU) No 1303/2013 of the European Parliament and of the Council of 17 December 2013 laying down common provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund, the European Agricultural Fund for Rural Development and the European Maritime and Fisheries Fund and laying down general provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund and the European Maritime and Fisheries Fund and repealing Council Regulation (EC) No 1083/2006 (OJ L 347, 20.12.2013, p. 320–469).

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Structural and Investment Funds (ESIF) in order to support Financial Engineereing

Instruments (hereinafter referred to as FEIs).

FEIs are an innovative form of contributing Structural Funds to Cohesion policy objectives,

compared to traditional grants4. The contributions could take the form of repayable

investments, namely equity, loans and/or guarantees, micro-finance and other forms of

revolving assistance.

Taking into account that use of FEIs is being encouraged and it is increased by cohesion

policy during programme period 2014-2020, it is certain that member-states will seek to

allocate part of the € 351.8 billion of the ESIF budget to microfinance programs, significantly

boosting this trend in the EU and - possibly - the emergence of more MFIs in Europe.

The total amount to be committed by each Member State for microfinance actions is

expected to be known when the required ex ante assessment will established evidence of

market failures or suboptimal investment situations, and the estimated level and scope of

public investment needs, including types of financial instruments to be supported.

3. Entrepreneurship in European Union

According to European Commission Annual Report on European SMEs5, from the total of

non-financial corporations6, in 2015 Small and Medium Enterprises (SMEs)7 represent 99,8%

(22,95 millions of enterprises) of all European Union enterprises in the 28 Member States.

The vast majority of SMEs are micro enterprises with less than 10 employees – such very

small firms account for almost 93% of all enterprises in the non–financial business sector.

However, their total contribution to employment creation and added value, is considerably

limited, as it can be seen in the relevant table (table 1).

4 European Commission (2011). Summary report on the progress made in financing and implementing financial engineering instruments co-financed by Structural Funds. Situation as at 31 December 2011.5 European Commission (2016). Annual Report on European SMEs 2015 / 2016. Final Report6 The non-financial business sector consists of all sectors of the economies of the EU28 or Member States, except for financial services, government services, education, health, arts and culture, agriculture, forestry, and fishing.7 According to Commission Recommendation of 6 May 2003 concerning the definition of micro, small, and medium-sized enterprises. (2003/361/EC), Official Journal of the European Union, L 124/36, 20 May 2003, SMEs are defined as businesses which employ less than 250 staff and have an annual turnover of less than EUR 50 million, and / or their balance sheet total is less than EUR 43 million.

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Indicatively, in absolute terms, in 2015, there were substantially more SMEs and SME

employees in the EU28 compared to the USA, yet SMEs in the USA contributed almost 3

times more value added than their EU28 counterparts8. Also, indicative of the employment

performance of enterprises is the fact that in the US, surviving businesses increase their

employment by 60% on average by the seventh year of their operation, while job growth in

enterprises survive in Europe is in the range of 10% to 20%9.

Table 1 : SMEs and large enterprises: number of enterprises, employment, and

value added in the EU28 in 2015

Source: European Commission (2016), 2015/2016 annual report on European SMEs

As European Commission notes in its report,9 the low productivity and the lack of growth

presented by EU SMEs related with respective enterprises in the US, are attributed mainly to

their small size in relation with the market failures they face which worsen the operating

conditions and competition with other players in areas like finance (especially venture

capital), research, innovation (as compared to large companies, increasingly fewer European

SMEs innovate successfully) and the environment, due to the structural difficulties faced by

SMEs in the EU, such as the lack of management and technical skills, and the lack of

flexibility that still characterizes labor markets at national level.

8 European Commission (2016). Annual Report on European SMEs 2015 / 2016. Final Report, p. 91. 9 Communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee and the Committee of the Regions - “Think Small First” - A “Small Business Act” for Europe {SEC(2008) 2101} {SEC(2008) 2102}

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In particular, a significant proportion of enterprises in E.U. mainly in the countries of

Southern and Eastern Europe, in the regions of which is allocated the substantial part of the

Cohesion Policy budget are self-employed (Figure 1), whose resistance limits have been

tested during recent recession. Indicatively, while self-employment is high in southern and

eastern Europe, the jobs recovery has not started there – and while employment is growing

in northern and western European economies, they have not seen a similar rise in the

proportion of self-employed workers (Hatfield, 2015).

This phenomenon is due to the fact that one of the usual areas of self-employment is retail,

as in this sector appear new ventures emerging in most countries, but are generally they are

considered less desirable in a business system as they constitute what is called "Shallow”

entrepreneurship. Retail businesses are easy to create in an economy, but especially in times

of decline in private consumption, this kind of entrepreneurship is rather unlikely to survive

and does not give rise to economic growth, as it is usually characterized by a lack of

extrovert strategy, a lack of innovation and a low added value10.

Figure 1: Self-employment rates, Europe-24 countries, Q2 2014

Source: IPPR (2015), Self-employment in Europe

10 Foundation for Economic and Industrial Research – IOBE (2016), Entrepreneurship 2015-16: A turning point for the growth dynamics of the business sector, p.36

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4. Evaluation of microfinance as development instrument

Below we present a few factors that we consider to be critical for assessing the microfinance

model as a lever for microenterprise support, in order to understand the real and

sustainable impact that it can play as a development tool in an economic environment such

as what is currently being developed within E.U.

I. Encouragement of Micro entrepreneurship and self-employment is related

with strengthening the informal sector of the economy

The intervention policy of a state is a decisive factor in the structure of an economy which is

developed as a result of the incentives that have been given historically, as in the case of the

countries with the highest rates of self-employment in the graph above (Figure 1), where

they favored mainly self-employment and very small entrepreneurship, applying lower tax

rates, insurance contributions, etc.

This structure has made the tax audit more difficult, since controlling and documenting the

corresponding income is an extremely complex and difficult process, while at the same time

it favors the concealment of incomes by the self-employed (IMF 2013).

The result of the intervention policies of the states that encouraged self-employment to

make it a dyke for high unemployment rates, it appears to be largely responsible for the size

of their shadow economy. In particular, according to Schneider and Buehn (2012) in a cross-

country study estimate the size of the shadow economy during 1999–2010 at around 27

percent of GDP, compared to an OECD average of 20.2 percent.

Looking at the average relative impact of the causal variables on the shadow economy

across the 39 OECD-countries between 1999 and 2010, it turns out that indirect taxes have

by far the largest relative impact (29.4%), followed by self-employment (22.2%),

unemployment (16.9%), personal income taxes (13.1%) and finally tax morale (9.5%).

This situation is different in countries with higher self-employment (over than 20%), with

self-employment appears the most significantly correlated variable with the size of the

shadow economy, in Greece and in Italy, where, average relative impact in shadow economy

is 37,6% and 31% respectively, with the two countries having high rates of shadow economy

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as a percentage of GDP among the other developed countries, included in the survey for the

corresponding period (27% and 26.9%, respectively).

The correlation between the shadow economy and the self-employed is largely attributable

to the nature of the activities developed by the latter, mainly in sectors with less

contribution to economic development, which are closer to the consumer, (consumer

oriented activities), such as kiosks, food outlets, small repair shops, taxis and other forms of

cheap transport and small retail outlets.

As it is mentioned, it is relatively easy to create specific enterprises in an economy, however,

in periods of private consumption shrinking or "saturation" of the local economy by similar

enterprises, this kind of entrepreneurship has a rather lower chance of survival and

contribution to the economy.

Micro-enterprises, during their effort to survive, are forced to carry out drastic cost-cutting

strategies, while resorting to unfair competition practices such as non-compliance with their

tax and insurance obligations, etc. These practices are in the short term able to gain critical

market share from other SMEs, which could otherwise reduce unit costs and record

productivity growth over the long term (Schneider & Buehn, 2012).

II. Microfinance limit the perspectives to create scale economies

A sufficient level of investment is paramount to a micro-enterprise’s survival and eventual

growth, and thus also to it materially contributing to a local sustainable development

dynamic and poverty reduction.

However, as reported by Bateman & Chang (2009), this is usually not taken seriously by

MFIs, when they massively promote the entry of a large number of micro-enterprises into a

market, citing the negative structural effects they have, both to larger dairy farms and to the

income of the borrowers themselves, the microfinance action for the purchase of a cow

(one-cow farms) implemented in Bosnia and Croatia respectively. Additionally, their creation

is promoted independently and it is not developed within a tissue of horizontal (clustering,

networks) and vertical (subcontracting) connections within the local enterprise sector, is a

crucial determinant of a local economy’s ultimate sustainability and progress.

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Taking into account that the emphasis on microfinance to create formal and unrelated

micro-enterprises, is capable to increase rather than solve a problem, such as lagging and /

or economic recession faced by Member States of southern and eastern Europe i.e. where

there most of the EU cohesion budget is disposed, stimulation of entrepreneurship by simply

increasing the number of start-ups should not be subject of typical development policy

programmes since, by this way it is mostly ignored the critical importance of scale in any

sector.

In particular, the implementation of interventions that may create an environment for too

many inefficient micro-enterprises, among which the existing volume of work is

continuously redistributed or subdivided, as it was mentioned above according to Schneider

& Buehn (2012) undermines in the long run the functioning of competition and the

development of more efficient SMEs, adversely affecting the productivity and

competitiveness of the latter, which are the most important potential sources of formal

employment and development.

The already significant number of self-employed in the countries of the European South but

also their limited performance in value creation, the use of information and communication

technologies and the integration of innovations, demonstrate the need for interventions

that will contribute more to the upgrading and strengthening of the competitiveness of

these enterprises than to the further expansion of their population.

III. Microfinance encourages the creation of typical low-value business units.

As Shane (2009) characteristically mentioned, policy makers believe a dangerous myth. They

think that start-up companies are a magic bullet that will transform depressed economic

regions, generate innovation, create jobs, and conduct all sorts of other economic wizardry.

In reality, however, it has been proven that just the creation of typical start-up companies is

not a sustainable solution for the promotion of economic development and the creation of

jobs. Shane (2009) also adds that it is preferable and necessary that policy-makers focus on

supporting that subset of companies with growth potential instead of strengthening the

creation of a typical business unit with low added value. This is because, as he has proven, it

is more beneficial for an economy to operate a small number of high growth businesses than

a large number of typical start-ups.

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According to empirical analyses it has been suggested that the employment creating effect

of start-ups is highest in regions with a low level of new business formation and that an

increase in the regional start-up rate beyond a certain level may lead to negative

employment effect. Specifically, their analysis proves that the average quality of regional

start-ups decreases with the number of start-ups, while the costs of the induced resource

reallocation increase.

From the above implies that it is not the number of start-ups but their quality that is decisive

for their effect on economic development. Therefore, a policy aiming at stimulating

economic growth through entrepreneurship should focus on high-quality startups, such as

new businesses in innovative manufacturing and in knowledge-intensive service industries,

make a larger direct contribution to employment than start-ups affiliated with other

industries which Fritsch & Schroeter (2011) refer to another research.

Indeed, as confirmed by various empirical studies that have been carried out, high-quality

entrepreneurship and ambitious entrepreneurship contribute more to macroeconomic

growth than general business does (Stam et al. 2009, Stam et al. 2011, Hermans et al. 2015,

Papastamatiou G, 2016), while, it is possible to be more resilient to recessive economic

cycles, while being an important driver for economic growth (Henrekson και Johansson

2010). However, a prerequisite for the growth of these firms is also that the process of

creative destruction functions so that efficient new and expanding firms can attract

resources from inefficient firms, resources that are released through contraction and exits

(Henrekson και Johansson 2010).

5. Conclusions

This article attempts to raise some important concerns regarding the means of

implementing an intervention policy in the light of the broader objectives and strategies set

by the European Union, against the challenges it faces, by presenting a number of factors

that we consider to be crucial for the evaluation of the microfinance model as a lever for

micro-entrepreneurship, with a view to understanding the real and sustainable impact it can

play in the European Union's economy.

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Having in mind that both European Commission and member states within the framework of

cohesion policy will commit and allocate significant resources to the economy, utilizing the

microfinance model as one of the proposed financial engineering instruments (FEIs), it is

particularly appropriate for the less developed regions of the EU Member States, which are

also the focus of this policy, to examine thoroughly both the existing structure of

entrepreneurship and the size of the very small and self-employed companies they have and

the model of microfinance was traditionally supported on the basis of anecdotal evidence

alone, and few rigorous assessments of its impact were conducted (Duvendack et al, 2011;

Banerjee et al, 2015) with result many scholars today, to doubt the exact relation between

the efforts of microfinance and reduction of poverty, while until today it remains unclear

under what circumstances, and for whom, microfinance has been and could be of real,

rather than imagined, benefit to poor people (Duvendack et al, 2011).

Adjusting theoretically the microfinance model to European environment we find that

encouraging the creation of new, formal, low-value-added businesses not only provides

little, but can also be detrimental to the economy by limiting: a) Public revenues, due to the

strong correlation between self-employment and shadow economy, b) The prospects of

enhancing productivity and business competitiveness, limiting the possibility of creating

economies of scale, and finally, c) Valuable resources absorbed by ambitious or high-quality

entrepreneurship, which is an important driving force for economic growth and

employment.

Having in mind that E.U. has bases its strategy for Europe 2020 on a smart, sustainable and

inclusive economy with high levels of employment, productivity and social cohesion, its aim

should be to encourage "high-quality" or "ambitious" entrepreneurship since as it is found,

that it is more conducive to macroeconomic growth over the general business and appears

more resilient to recessionary economic cycles, while promoting the strengthening of

competitiveness and upgrade of existing micro and small enterprises, encouraging use of

information and communication technologies, integrating innovation and networking of

these firms in exchange for incentives that contribute to further broaden the population of

existing inefficient firms.

Therefore, in the face of the challenges faced by the European Union, the emphasis should

not be placed in the mean but on the desired result by orienting the financial engineering

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instruments towards the transformation and modernization of existing enterprises and the

creation of high quality new ones, which present developmental dynamics and content.

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