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February 1978

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EMPLOYMENT AND DEVELOPMENT OFSMALL ENTERPRISES

Sector Policy Paper

February 1978

World Bank1818 H Street, N.W.

Washington, D.C. 20433, U.S.A.

Employment and Development of Small Enterprises, a Sector PolicyPaper, was originally prepared for consideration by the ExecutiveDirectors of the World Bank. David L. Gordon was the coordinatingauthor. Contributors to the paper included Gary L. Hyde (economicadviser), Ernst Loeschner (operations adviser), and Nancy M. Barryand Shyamadas Banerji (operations officers). Other staff members ofthe Industrial Development and Finance Department also con-tributed, together with D. Hellinger and R. Rodriquez (consultants).Margaret de Tchihatchef had the responsibility for editing the paperin collaboration with Pushpa Nand Schwartz.

EMPLOYMENT AND DEVELOPMENT OFSMALL ENTERPRISES

CONTENTSPage

Summary and Conclusions .......... ........................... 5

Introduction ................... .............................. 11

Chapter 1: Efficient Use of Resources to Create Employment .... .... 15

Manufacturing Sector ........... ............................. 15

Nonmanufacturing Sectors ......... .......................... 17

Chapter 2: Small Enterprise Development: Advantages and Problems . 18

Efficiency in Using Capital and Labor ....... ................... 19

Problems of SSE Development ........ ........................ 21

Intersectoral Linkages ............ ............................ 23

Chapter 3: Institutional Support ........ ......................... 24

Governmental Policies and Preferences ...... ................... 24

Institutional Lending Policies ........ ......................... 26

Potential Institutional Channels ........ ....................... 30

Other Intermediaries ............ ............................ 32

Informal Sector Channels .......... .......................... 35

Encouragement of Savings .......... .......................... 36

Entrepreneurial Capabilities ......... ......................... 37

Chapter 4: Coordination of Financial and Technical Assistance .... ... 38

Needs of Modern Enterprises ........ ......................... 39

Needs of Artisans and Informal Enterprises ...... ................ 45

Alternative to the Middleman ........ ........................ 49

Chapter 5: Action by the Bank ......... ......................... 52

Lending Policies ............... ............................. 54

Text Tables1. Directories of Technical Assistance Agencies,

Assisting Small-scale Industries ....... ...................... 39

2. Portfolio Analysis and Profitability Data forSelected Development Finance Companies ...... ............. 41

3. World Bank-assisted Projects with SSE Impact ..... ............ 53

3

4 CONTENTS

Annexes

1. Potential Contribution of Small Industries to Economic

Development, .......... ,.,.,.,. ...... 592. Employment Characteristics of Recent DFC Subprojects .733. Selected World Bank-assisted Small and Medium

Enterprise Projects ............ ............................ 85

SUMMARY AND CONCLUSIONS

In most developing countries only a fraction of the new jobseekers can be employed in agriculture. The scarcity of capitalseverely limits the number of new nonfarm jobs that can be created,because investment costs per job are high in modern industry. Aneffective development policy should seek to increase the use oflabor relative to capital, to the extent that it is economically efficient.

A number of studies, including some specific case studies, suggestthat efficient substitution of labor for capital is possible in a broadspectrum of manufacturing activities. The tendency in many devel-oping countries, unfortunately, is to prefer capital-intensive methodsfor several reasons: the prestige and promotion of advanced countrytechnologies, ignorance of alternatives, preference by the rich forimport-equivalent goods, i.e., goods that closely resemble importedproducts, difficulties of dealing with large numbers of inexperiencedworkers, and government policies that tend to favor the use of capi-tal. These influences also affect nonmanufacturing activities.

Small-scale enterprises (SSEs) are generally more labor-intensivethan larger organizations. SSEs include small but relatively modernmanufacturing industry; organized nonmanufacturing activity, suchas construction, transportation, and trading; and traditional or "in-formal" activity. Small manufacturing firms generate more direct andprobably more indirect jobs per unit of invested capital on the aver-age; and in service activities, capital costs are usually even lower. Butsuch generalizations cannot be pushed too far, since reliable datafor making rigorous comparisons at the enterprise level and foridentical products are scarce. Small firms tend to produce goods andservices that are physically and/or qualitatively different from thoseproduced by larger firms. In many activities where the optimal sizeof production unit or sales outlet is small, the most efficient form ofbusiness organization is the small firm.

5

6 EMPLOYMENT AND DEVELOPMENT OF SMALL ENTERPRISES

SSEs provide productive outlets for the talents and energies ofenterprising, independent people, many of whom would not fulfilltheir potential in large organizations. Small firms often flourish byserving limited or specialized markets that are not attractive to largecompanies. They provide a seedbed for entrepreneurial talent and atesting place for new industries. They supply dynamism, and con-tribute to competition within the economy. They enhance commu-nity stability, do less harm to the physical environment than largefactories, stimulate personal saving, promote agro-industrial link-ages, improve rural welfare, and generally raise the level of popularparticipation in the economy. In many countries, small firms furnishparts and subassemblies to large firms at considerably lower unit costthan if the latter were to produce these themselves.

Small enterprises have weaknesses, too, some of which can beovercome by the intense personal commitment of their owner-managers, though others are hard to correct without outside help.Specialized management is rare; one person is usually responsiblefor production, administration, finance, marketing, and numerousother functions which are distributed among several persons in alarge firm. Besides inherent weaknesses, small firms face a number ofartificial disadvantages compared with larger firms. The better-man-aged small firms find market niches and generate impressiveamounts of investment resources for themselves, but often they lackaccess to institutional credit and government facilities. Artisan andinformal activities depend on middlemen and moneylenders forsupply and marketing services and for credit, which are very costlyand often restrictive. Infrastructure facilities are often deficient, andpublic programs of technical and marketing assistance rarely reachthe small firm. Nevertheless, there is definitely a role for SSEs in mosteconomies iust as there is for medium- and large-scale businessorganizations.

Thus, in addition to "getting the prices right," by removing orreducing pervasive factor-price distortions which cause business ingeneral to favor capital-intensive products and processes, specialefforts are needed to help small firms overcome weaknesses andexploit their natural advantages. Some of these efforts could aim to:

* Direct institutional procurement to SSEs, or at least make iteasier for SSEs to compete.

* Encourage subcontracting by large firms to small firms.* Develop industrial estates, especially those which promote

linkages between large and small firms, and provide joint serv-ices and technical assistance to homogeneous SSEs.

SUMMARY AND CONCLUSIONS 7

* Broaden lending by conventional development finance com-panies (DFCs) ' to include construction, transportation, trade,repair facilities, personal services, and other activities.

* Provide working capital, often needed as much as or more thanfixed-asset finance.

* Devise alternative means of loan security that are acceptable tolenders and feasible for borrowers.

* Develop simpler lending criteria and procedures for allocationof funds and loan supervision, so as to reduce red tape anddelays.

The ability of most DFCs to influence client firms' choice of tech-nology is limited, but they can:

* Identify and assist clients to exploit subcontracting opportu-nities.

* Give more weight to labor intensity in subproject appraisals,and discourage unnecessary capital intensity.

* Facilitate access to knowledge of alternative technologies.* Finance the adaptation of technology to local conditions.Despite increasing interest and research in many countries, solid

and up-to-date information on technological alternatives is notalways readily accessible. It may be helpful if the World Bank2actively explored, with other interested agencies, ways to improvethe exchange and use of "appropriate" technological informationthat is becoming available. National agencies for technological infor-mation and development deserve support.

Besides DFCs, other entities which could assist SSEs are:* Commercial banks, which normally have wide contacts and

simple loan procedures but tend to be cautious and conven-tional in outlook.

* Investment companies, which could provide essential seedcapital.

Development finance company (DFC) is a generic term used here to describe any inter-mediary which provides medium- and long-term finance to assist the development ofproductive, nonagricultural enterprise. A DFC project refers to a World Bank loan orIDA credit made to a DFC for re-lending to individual enterprises for specific productiveinvestment purposes. Subprojects refer to investments made by a DFC in individualenterprises.2 All references to the World Bank in this paper refer also to the International Develop-ment Association (IDA), an affiliate which makes credit available on concessionaryterms. The International Finance Corporation (IFC), another affiliate of the World Bankwhich is engaged in promoting investments in the private sector in developing coun-tries, is also beginning to encourage investment in small-scale enterprises. Lending byIFC for this purpose is identified where appropriate. The fiscal year (FY) of the threeinstitutions runs from July 1 to June 30.

8 E9PLOYMENT AND DEVELOPMENT OF SMALL ENTERPRISES

* Mass-oriented intermediaries such as workers' banks, creditunions, and savings and loan institutions.

* Cooperatives which though hard to organize and maintain,offer great potential as channels for credit, guarantees, collec-tions, technical assistance, joint procurement, and marketing.

* Middlemen and moneylenders, until effective institutional alter-natives are created.

* Institutions engaged in integrated urban or rural developmentprograms, which incorporate credit and technical assistance forSSEs.

The savings potential of SSEs deserves special emphasis, andshould be encouraged in all programs. Attractive interest rates ondeposits and other incentives to save should be featured in popularcredit programs.

Credit for SSEs needs to be coordinated with technical assistance,and the design of delivery systems should vary to meet the diversityof SSE needs. Artisans and others in the informal sector are especiallyhard to service, unless similar activities are concentrated. In manysituations, institutional delivery systems need to be designed thatwill simulate the positive aspects of the middleman/moneylendersystem, but avoid its exploitative features.

The cost per unit of assistance and credit for SSEs is generallyhigher than with larger businesses. The credit risk may have to beunderwritten, at least for a time, by partial government guarantees.The cost of such guarantees and of general technical assistanceought to be distinguished from the cost of money. It should becounted as a promotional expense to be paid by the government orpassed on to the SSE beneficiaries. The interest rate charged to SSEclients should normally not be less than that charged to larger clientsand should be significantly positive in real terms. In view of theirrelative lack of sophistication about such matters, SSE clients shouldperhaps pay a fee and let the government assume foreign exchangerisks.

World Bank lending for DFC projects during the fiscal years1972-76 totaled about $2,200 million.3 Only about $100 million ofthis amount, almost all of it since 1973, was explicitly for SSEs, butother DFC and some industrial estate projects also assisted smallfirms to an amount estimated at $80 million. It seems appropriate inthe future to give substantially greater emphasis to SSEs, and encour-age appropriate technology choices for every scale of operation.

' All $ figures are expressed in United States dollars, unless noted otherwise.

SUMMARY AND CONCLUSIONS 9

The Bank is now emphasizing in its economic and industrialstudies the importance of correcting policies which unduly tend toencourage capital-intensive investment and inhibit SSE development.This concern is being reflected in the Bank's continuing discussion ofeconomic policies with governments.

A Bank lending potential for fiscal 1977-81 is suggested whichwould increase SSF lending from about $50 million in fiscal 1977 to$300 million (in constant dollars) in fiscal 1981, an increase in totalDFC commitments from a little more than 5 percent to 30 percent.Such lending would also support several experimental projects thatinvolve new types of intermediaries and technical assistance; newapproaches, such as cooperative programs, cottage industries, orintegrated schemes with minimal fixed cost per job; industrialestates which support SSEs, in part through better linkages withlarger enterprises; and research and development initiatives. At leasta third of total DFC lending should, in the future, support subproj-ects for which the average capital cost per job would be low enoughto make a measurable dent in a country's unemployment problem.

Assistance to SSEs may require some adjustment in the Bank'slending policies, such as greater flexibility in financing local currencycosts, more liberal financing of working capital, and simpler criteriaand procedures for subproject appraisal. New types of intermedi-aries will be used, and appropriate criteria to monitor the programsare being devised. Greater emphasis on SSE lending will entail sub-stantially higher administrative costs per project (and still more permillion dollars lent) than in the Bank's conventional DFC operations.

Although increased Bank assistance to SSEs is expected to lead tosignificant benefits in terms of broadening employment and incomeopportunities among the urban poor, the magnitude of the problemis such that the direct financial impact will be quite modest. TheBank's ability to give timely and perceptive policy advice may bemore important. The basic rationale for Bank support to SSEs indeveloping countries is that SSEs play a major role in providingemployment and income to the urban poor, and that past neglectand policy bias need to be corrected to give small enterprises a fairchance in comparison with large firms. Support for SSEs, such ascredit and technical assistance, need not entail unacceptable costsin terms of overall factor efficiency if reasonable care is taken inselecting the activities.

INTRODUCTION

Most developing countries are characterized by a rapidly growingpopulation and labor force. While much of this labor force will beabsorbed in traditional agriculture, it is clear that an increasingamount of labor will seek employment in nonfarm occupations-roughly two out of every three job seekers over the next 25 years.Some of these jobs may be found in villages and small towns, closelylinked to developments in agriculture. A growing number, however,will have to be found in the larger towns and cities.

Absorbing the growing labor force in productive employment isone of the principal challenges of development. Most new laborforce entrants will be poor and unskilled, coming from rural areasand city slums. Their number and lack of skills mean that in mostcountries, the process of absorption will take place in conditions inwhich real urban wages for the great majority will not increase sub-stantially because of the pressures of population growth and migra-tion.

The prospect of stable real wage rates does not necessarily meanstagnant real incomes; the transfer of labor from agriculture to moreproductive nonfarm activities, together with opportunities for in-creased participation of the population in the labor force, will resultin some increases in average income per head. The lot of theunskilled poor in both rural and urban areas, however, can improvesubstantially only when the demand for labor, relative to supply,begins to exert an upward pressure on wages. In some countries, thisis probably a decade or so away; for others, it could be a muchlonger process.

The potential role of the Bank in assisting developing countries toexpand the demand for urban labor is examined here. Capital isscarce in most developing countries so that in varying degrees, de-pending on a country's resources, capital has to be used as efficientlyas possible to expand the demand for labor.' Small-scale enterprisesusually generate more jobs per unit of investment than do largerfirms, which suggests that SSE development can be an importantcomponent of the attack on poverty. The small entrepreneurs them-

All further discussion is about developing countries in which capital and foreignexchange are scarce, but unskilled labor is ample.

11


selves may not be poor,2 although their prosperity is often pre-carious, but they provide a livelihood for many others in need.

These considerations have led the Bank to examine the potentialfor job creation and other benefits from enterprises of different sizesand degrees of capital intensity; and to look for ways to assist finan-cially, and by other means, enterprises at the lower end of bothscales. Because the latter purpose cannot be accomplished by directloans from the Bank, given the smallness and dispersion of SSEs, it isnecessary to work through appropriately organized and orientedintermediary institutions in the developing countries. Thus, the prin-cipal focus is on the use of intermediaries.

References to broad tendencies and characteristics should not betaken as necessarily applicable to every specific urban activity. ThatSSEs use less capital per worker than do large enterprises, on theaverage, is not offered as a universal truth; some SSEs are doubtlessmore capital-intensive than larger enterprises and some SSEs mayalso use capital less efficiently. After allowing for data problems andthe fact that small firms are likely to produce goods and servicesthat are physically and/or qualitatively different from those pro-duced by larger firms, it still seems that SSEs generally create morejobs per unit of capital investment. They get less output per worker,pay lower wages, have more intimate contact with the urban poor,and seem to get more output per unit of capital.

Some activities are natural candidates for assistance; they servelimited markets (because of product perishability, high unit trans-portation costs, or custom design) and/or are not subject to signifi-cant economies of scale in production. Knowledge is not adequateto enumerate such endeavors, but in time it should be possible toidentify a growing number which, in light of the special circum-stances of each country, have exceptional promise to produce goodsor services at competitive unit cost, to create useful job opportuni-ties, and to survive. SSEs should not be promoted indiscriminatelythroughout the developing world, but in some places, employmentand income opportunities for the urban poor can be improvedthrough the use of coordinated credit and technical assistance andwithout sacrificing efficienc,y.

Assistance to selected SSEs is only the means to an end, since thegoal is increased demand for labor. In developing countries the in-dispensable "ticket" to a share in the national income, for most peo-ple, is a job. Because of the enormous existing and future supply ofunskilled urban labor, unless the supply of investment capital can be

2 In the informal sector, entrepreneurs are usually workers and often they are poor.

INTRODUCTION 13

spread more widely than in the past, unemployment and under-employment will persist or worsen. Hence, the Bank has to encour-age developing countries to change national policies and proce-dures which discriminate against labor and favor excessive use ofcapital. Helping to extend credit and technical assistance to smallfirms is one approach to the problem. Others, including timely andperceptive policy advice, may be more important.

Chapter 1: EFFICIENT USE OF RESOURCESTO CREATE EMPLOYMENT

In the urban areas in developing countries, the growth rate ofindustrial employment generally lags behind the growth of manufac-turing output. New industrial projects frequently have capital costsper job of $15,000 or more, as well as high foreign exchange costs.Very few developing countries have enough capital to absorb, atsuch cost, more than a fraction of the labor force increase.' Publicpolicy must, therefore, aim to stimulate new job creation at muchlower average capital cost, both in manufacturing and in other urbanoccupations.

Manufacturing SectorLow-cost job creation need not imply reducing overall economic

efficiency, i.e., lower total output relative to the combined capitaland labor inputs, appropriately valued. Econometric studies for awide range of countries indicate, with few exceptions, that "efficientfactor substitutability is possible." 2 Engineering and process analysisstudies of a limited number of industries show that "factor substi-tutability does seem to be quite possible, and the differences infactor ratios can be quite substantial," e.g., efficient alternatives inrice milling and marketing ranging from an investment of from $700to $65,000 per worker and in cotton textiles from $6,600 to $21,500and even lower in other calculations.3 Labor-intensive alternativesneed not be invariably preferred; quality standards, economies ofscale, and management or skilled labor requirements may some-times tilt the balance toward more capital-intensive options. But "invirtually all cases, at realistic opportunity-cost wage and interest

' The World Bank has estimated roughly, for a number of countries, at what average costper job the growing labor force could be employed, given the country's capital con-straint and the size of its employment problem. Based on preliminary, unadjusted datafor a job defined as 15 consecutive years of employment, examples are: Brazil-$4,950,India-$450, and Indonesia-$1,150.2 Lawrence J. White, Appropriate Factor Proportions for Manufacturing in Less Devel-oped Countries: A Survey of the Evidence, Research Program in Development Studies,Discussion paper no. 64 (Princeton University. N-J.: Woodrow Wilson School of Publicand International Affairs, 1976), p. 13. See also David Morawetz, "Employment Implica-tions of Industrialization in Developing Countries," The Economic Journal 84 (Septem-ber 1974), pp. 491-542.'White, Appropriate Factor Proportions, p. 19.

15

16 E.MPLOYMENT AND DEVELOPMENT OF SMALL ENTERPRISES

rates [in developing countries], labor-intensive or intermediate alter-natives are economically sensible."'

Supplementing country-wide or industry-wide analyses, there aremany specific examples of efficient substitution of labor for capitalin developing countries. Used equipment, considered obsolete inthe older industrial countries, has been imported at a fraction of theoriginal cost. Machines may be run at faster speeds or for longerhours than in advanced countries, the loss resulting from the morefrequent breakdowns being offset by low wages for repair crews.Machines may be intensively manned to compensate for their lowerreliability. Patching and improvised repairs are often done in thecase especially of vehicles, but also of industrial equipment. Suchexpedients not only economize capital but, over time, act to expandthe pool of mechanical skills. Often a mix of advanced and simplerintermediate technologies is appropriate; some production pro-cesses require a high level of mechanization and quality control,while other peripheral aspects remain labor intensive, e.g., materialshandling, so long as the latter do not constrain output or capacityutilization in the former. The adaptations and innovations are asvaried as the range of industrial products, processes, market seg-ments, and consumer demands, and their viability is stronglyaffected by circumstances and policies in a particular country.5Adjustments need to be worked out by local technical, financial, orcommercial entities, or individual entrepreneurs and mechanics-but such local initiatives could benefit from better internationalexchange of technological information.

Despite the widespread evidence that efficient technologicaloptions exist, and their successful application in Japan, the Republicsof China and Korea, and elsewhere, a combination of mutually rein-forcing influences often leads industrialists in developing countriesto make choices that are more capital intensive than is appropriate.The influences include (1) the prestige of Western technology andthe reluctance of developing country entrepreneurs, officials, andfinancial institutions to take chances on "inferior" or untried alterna-tives; (2) lack of knowledge of such alternatives; (3) selling by

4bid, p. 22.The Pilot Plant of N. V. Philips at Utrecht (Netherlands) is systematically working to

develop and apply commercially, appropriate technologies in the electronics industry.Components and production processes of various electronic goods are analyzed in rela-tion to different countries' resource situations, component-producing potential, and mar-ket to find the optimal technological mix. Based on these findings, overseas plants areestablished in some 20 countries, and their techniques, local content, and product mixcan be progressively upgraded. The Pilot Plant's original purpose was not to create morejobs in developing countries, but to devise commercially viable patterns of local pro-duction, replacing imports despite the small production volume anticipated.

EFFICIENT USE OF RESOURCES TO CREATE EMPLOYMENT 17

expatriate consultants and suppliers of technology and equipmentthat they know; (4) tying of most aid to imported capital goods;(5) favorable tariff and tax treatment, exchange rates, and credit con-ditions accorded imported capital goods in many countries; (6) low-interest credit and fiscal incentives to industrial investment in gen-eral; (7) high levels of protection for modern industry products inthe domestic market; (8) desire to minimize labor-managementproblems; (9) the high wages given to workers in the modern sectorrelative to the rest of the labor force (often reinforced by minimumwage laws and prohibition of layoffs); and (10) consumer prefer-ences among the rich, who disproportionately influence the market,for "import-equivalent" goods.

Nonmanufacturing SectorsAppropriate technology is no less significant for sectors other

than manufacturing-civil works and building construction, trans-port and other services, agricultural processing, and cultivation. Therange of differences in capital intensity in some of these activities iscomparable to that in manufacturing, and they account for a muchgreater share of jobs in developing countries.

The indirect effects of industrial investment and output onemployment may be more significant than the direct ones (see An-nex 1). In mainland China, it is reported, "despite the relativelylabor-intensive character of the small rural industries [as comparedwith modern urban plants], their direct labor-absorbing impact hasbeen small." The rural industries' main impact on employment is topermit the intensification of agriculture "by releasing countless indi-viduals (mostly women) from the arduous tasks of hand grinding andmilling," and to counteract the diminishing returns to labor-intensive cultivation by providing modern types of inputs comple-mentary with labor.6

'Carl Riskin, "Intermediate Technology in China's Rural Industries," mimeographed(1976), pp. 9, 10. (The author is at the East Asia Institute, Columbia University, NewYork, N.Y. 10027.)

Chapter 2: SMALL ENTERPRISE DEVELOPMENT:ADVANTAGES AND PROBLEMS

One way to foster the creation of more urban or nonfarm jobs perunit of capital invested is by encouraging development of small-scale enterprise, which is generally more labor intensive than largerunits.'

SSEs comprise a wide variety of undertakings. They can be cate-gorized in diverse ways depending on a country's pattern and stageof development, policy aims, and administrative setup. The GeorgiaInstitute of Technology has found at least 50 different definitionsused in 75 countries.2 Definitions may relate to the capital invested(with maxima ranging from about $25,000 to $2 million) or employ-ment (maxima from 15 to 500) or both, or to other criteria. Somecountries have no official definition of SSE; others use two or morefor different purposes. As a working definition for this paper, SSEsinclude enterprises classed as "small" in their countries, subject toan upper limit of $250,000 (in 1976 prices) for fixed assets excludingland, before any proposed expansion project. No lower limit is set.3

SSEs thus encompass sole proprietorships, family businesses, smallshops with a handful of workers, cottage industries, artisans, etc.

It is useful to distinguish three SSE categories, which themselvescomprise varied elements:

1. Small manufacturing firms that are relatively modern.2. Organized nonmanufacturing firms, such as those engaged in

construction, repair, transportation, and trading.3. Enterprises not organized or conducted in a "modern" manner,

e.g., traditional artisans, petty traders, and transporters in the "in-formal" sector.

' A more detailed general discussion of the issues is presented in Annex 1, and relevantdata derived from the Bank's DFC operations are analyzed in Annex 2.2 "An International Compilation of Small Scale Industry Definitions," mimeographed(Atlanta, Georgia: Georgia Institute of Technology, Engineering Experimental Station,1975).3 In practice, well over three-fourths of the small enterprises so defined would havefixed assets below $100,000 and employment below 50. The fixed-assets limit is chosento underscore the scarcity of capital relative to labor. Land is excluded because its valua-tion is even more difficult than that of other fixed assets.

18

SMALL ENTERPRISE DEVELOPMENT: ADVANTAGES AND PROBLEMS 19

While the discussion and proposals here relate mainly to SSEs inurban areas, they also apply in substantial part to rural nonfarmactivities.

Efficiency in Using Capital and LaborA meaningful comparison of the capital-labor ratios of small and

large enterprises can be made only for the first category - manufac-turing. The data, although incomplete and not always comparable,strongly suggest that investment cost per job increases with increas-ing scale, whether measured in terms of assets or number ofworkers.

If SSEs tend to employ more direct labor per unit of capital in-vested, is there ground to assume that their total (direct and in-direct) effect on the demand for labor is greater? Large enterprisesoften have far-reaching linkages, on both input and output sides,with other producers and service enterprises. These linkages giverise to employment opportunities far exceeding the direct job cre-ation. Nevertheless, there is some basis for assuming that SSEs gen-erally have greater indirect domestic employment effects, partlybecause of the greater propensity of large firms to import bothcapital goods and raw materials. Small firms generally require amuch lower proportion of imports than large firms; the larger com-panies tend to replace traditional products through imports.

A basic question is whether this SSE characteristic of lower capitalcost per job carries over into its use of other inputs. Although fullyreliable data are hard to find, the available statistics indicate thatgenerally as firm size increases: (1) capital investment per workerrises, (2) value added per worker rises, (3) the wage rate rises, and(4) value added per unit of capital falls (see Annex 1, Table 1:3).'Evidence from a number of developing countries reinforces thepoint that "small enterprises with a lower level of investment perworker tend to achieve a higher productivity of capital than do thelarger, more capital-intensive enterprises." '5

Investigation is needed at the level of the firm and across differentindustries to throw light on such elements as management special-ization and economies of scale and relate them to total efficiencyin the use of inputs. The technology used to produce goods variesgreatly, and the range of choices with respect to plant scale andcapital intensity is very wide. Productivity is a function of labor,

'The data in this table show a break in the trend for the very smallest Japanese firms,possibly reflecting capital indivisibility and hence its underutilization below a certainminimum scale.5 United Nations Industrial Development Organization (UNIDO), Small-Scale Industry inLatin America, publication no. II, B. 37 (Vienna: UNIDO, 1969), p. 56.


capital, scale, and management skill. Some goods can be producedat reasonable unit cost in very small quantities, while others requirea sizable volume of production. Characteristics such as size, weight,handling requirements, and perishability may limit marketing possi-bilities to a small area and prevent high-volume production evenwhen scale economies are feasible. Research can help to identifyindustrial activities that are natural candidates for SSEs.'

A wide range of service occupations is more important thanmanufacturing industry as sources of urban employment. It is esti-mated that services engage three times as many gainfully employedpersons as manufacturing.7 Many of them serve industry directly;almost all depend ultimately on production of industrial (or other)goods. It appears that the ratio between manufacturing and servicejobs is relatively constant, over a wide range of urban economiesand variations in the level of capital intensity of industrialization. Thecreation of additional jobs in manufacturing at low capital cost perworker may, therefore, be expected to have a multiplier effect,creating further service jobs at even lower cost.

Other SSE attributes. Other arguments favoring support for smallenterprises include the role of SSEs in nurturing entrepreneurship, intraining and improving technical skills, and as generators of savings.SSEs serve as sources of stability and coherence in communities, as ameans for reducing inequalities of income distribution between re-gions and economic groups, and as production systems which gen-erally have less adverse environmental impact than do larger firms.Other advantages include the potential of SSEs to help stem migra-tion to metropolitan areas, to use agriculture/agribusiness/industrial

' For example, a recent series of monographs analyzes a number of subsectors-textiles,garments, wood and leather products, ceramics, optics, toys, and electrical goods, eachbroken down by major product categories-to assess their potential for development inAfrica and exports mainly to European markets. For each product category, investmentrequirements (physical and human), costs, value added, profitability, and markets arecompared uinder ELuropeani and African conditions, respectively. See Societe d'Etudes etde D6veloppement IndLustriul, Activit6s de Main d'Oeuvre: Transfer's Industriels versles Pavs en Voie d(e Dvefoppement (Geneva: International Labour Office, 1976). JosephJ. Stern, "The Employment Impact of Industrial Investment: A Preliminary Report,"mimeographed (January 1977), ranks a large number of industrial subsectors in threecountries (the Republic of Ko-ea, Malaysia, and Yugoslavia) by various indices of laborintensity, and also makes cross-country comparisons of labor and capital intensity insome 30 subsectors for different levels of income per head. The subsector categories,however, comprise quite disoarate products and processes, and do not distinguishbetween large and small production units. (The author is at the Harvard Institute forInternational Development, Cambridge, Mass. 02138.)7 Calculations in Stern, op. cit., p. 29, show the Transportation, Communications, andServices n.e.s. categories as having total labor coefficients (man-years of employmentper $1,000 output) higher than any manufacturing subsector in countries with per capitaincomes of $750 and below; for higher-income levels the relationship changes, withservice occupations becoming less labor intensive relative to output.


linkages to increase rural labor productivity and income, and to en-gage very poor people in employment, ownership, and decisionmaking through cooperative and community-based projects. Estab-lishment of outlying small-scale production units to serve markets oflimited radius or as subcontractors to larger industries could helpsignificantly to reduce industrial concentration and the correspond-ingly mounting cost of municipal services. Together with the em-ployment-creation objective, these attributes add up to a powerfulcase for major efforts, through appropriate public policies and insti-tutional measures, to enable SSEs to realize their full potential.

Problems of SSE DevelopmentIn practice, however, SSEs are often handicapped. They pay lower

wages, but usually have to pay higher prices for capital than do largemodern units. In most countries the small-scale sector tends to beneglected by government policy makers. Small units operate largelybeyond the threshold of government regulation, but often of gov-ernment assistance as well. It is typically the products of large-scaleindustry which receive tariff protection, and it is partly this whichenables larger firms to charge higher prices and pay higher wages.They can afford a more skilled labor force with lower turnover, sothat higher wages do not always imply higher labor costs in terms ofefficiency. The small-scale sector's frequent lack of access to institu-tional credit, the extremely high interest rates prevailing in "curb"markets, and great difficulty in obtaining necessary permits andlicenses (and consequent resort to extra-official channels), probablyoutweigh the fact that SSEs pay fewer taxes and lower wages.

The specific problems of SSE development must be distinguishedas between modern, organized small industries and services and theinformal sector. The former typically fit into market niches andchannels; they have a fairly solid internal management and levels oftechnology and organization well adapted to their clientele. Theirneeds for investment and working capital are met largely from in-ternal cash generation and personal savings rather than institutionalsources. Their savings propensity is high, but their lack of technicalknow-how and access to supply and credit facilities inhibits theirgaining a wider market.

The major share of existing and potential nonagricultural employ-ment in most developing countries, however, is outside the modernindustry sector-in repair work, artisan production, market vending,local transportation, handicrafts, custom jobbing, construction, andsmall-scale processing of primary products. Such SSEs generally suf-


fer from a small production base and poor purchasing, production,and marketing organization. Individually they cannot afford the largeamounts of capital and specialized personnel needed for design,sales promotion, and bulk raw material purchase. Inability todevelop products, expand markets, or reap benefits from scaleeconomies keeps them small.

Most SSEs in the informal sector (and sometimes at the margin ofthe modern sector) depend on middlemen or moneylenders forworking capital and personal emergencies. These ubiquitous infor-mal intermediaries also help fill certain marketing and supply gapsthat trouble SSEs; but their cost is high and sometimes they restrictupgrading of products or outlets. The middleman offers the neededfinance, but only in small amounts and on short term, and locks theSSE into a marketing arrangement by which repayment is deductedfrom the selling price. If output is unsatisfactory or payments lapse,the middleman can sever the relationship without having made amajor financial commitment. While middlemen generally have goodmarket links and information, and are responsive to market trends -often more so than government agencies - they tend to take ashort-term view. They are seldom aggressive in their marketing; theycater to known outlets, and are slow to suggest design changes.They rarely lend for fixed investment needs.

For many small producers, obtaining material inputs poses majorproblems: poor access to imported and domestic materials; inade-quate cash or credit for economical and timely purchases; inferiorquality of raw materials and intermediate processing, which reducesthe value of finished products; remoteness which, combined withcash deficiencies, forces artisans to spend disproportionate timefetching small quantities; and great vulnerability to absolute short-ages. The middleman is often an unreliable supplier.

SSEs, especially informal or marginal ones, generally lack access toimproved production technologies. For artisans catering to a limitedneighborhood market, this may not be important. Their skills andgeneral-purpose machines, if any, can readily adapt to changesdesired by their undemanding clientele. If, however, they wish towiden their markets, a modest technological breakthrough may benecessary, e.g., small cobblers might produce for the general market,even for export, if provided with simple cutting, skiving, and stitch-ing machines. The more stringent quality standardization, price, andminimum contract requirements or new markets often force smallproducers to upgrade their skills and/or use more specializedmachinery.


Infrastructure and services available to SSEs, i.e., power supply,water and sewerage, access roads, often are inferior. For many,especially in the informal sector, this is not a serious problem. In-deed, their ability to function without such services may help toprotect their market niche from more powerful competitors. Butagain, these deficiencies will obstruct their growth and transition toa "formal" mode of operation.

Intersectoral LinkagesLarge and small enterprises are not mutually exclusive alternatives.

They can be mutually supportive, as they were in the economicdevelopment of Japan and in the present Chinese strategy of "walk-ing on two legs" (see Annex 1). The object is to enhance the efficientuse of both capital and labor in the industrial sector as a whole.Capital-saving technologies can be used at all levels of the enterprisescale. But to take full advantage of complementarities and linkages,it is desirable that the special handicaps to which SSEs are subjectbe mitigated, so that they have reasonable opportunity to function,and have the market test their efficiency in those subsectors orniches of the economy where they can compete effectively.

Chapter: 3 INSTITUTIONAL SUPPORT

A first, and major, requirement is to remedy the price and incen-tive distortions which tend to favor capital-intensive technology.These biases stem largely from Western technological conceptswhich have been widely advocated and accepted both by develop-ment "experts" and by governmental and business elites in develop-ing countries. They have come under increasing political and intel-lectual criticism. But they are deeply ingrained and, moreover, corre-spond to powerful interests. To redress the balance, it is necessaryto make vigorous and sustained efforts to persuade opinion leaders,administrators, and businessmen in developing countries, and toundertake and disseminate research on technological alternatives.

Governmental Policies and PreferencesPublic policies in many countries give larger enterprises in manu-

facturing or other sectors still other advantages over SSEs. The mostcommon is the supply of institutional credit at artificially low interestrates. Public services - power, transport, water supply - that areused much more by larger firms are frequently subsidized; so alsomay be the cost of premises in industrial estates. Skilled workerstrained in vocational schools at public expense generally gravitate tolarge, modern establishments, whereas the artisan usually bears thecost of apprentice training, although he may obtain a superior result.Some element of the advantage for large firms will persist even ifgovernments try to avoid discriminating, because SSEs will seldombe as capable of dealing with governmental or institutional proce-dures, gaining access to scarce supplies, developing marketingcontracts, etc. So "getting the prices right" is not sufficient in itself,but it is a major first step toward more rational investment decisionsby financial intermediaries, and even more by private or public sec-tor entrepreneurs.

The usual incentives for industrial development-customs exemp-tions, tax holidays, subsidized credit-principally aid the larger(or at least modern) industries, not the typical SSE. Promotionalefforts for the latter need to be pinpointed more specifically to over-coming their handicaps and enhancing their advantages.

24

INSTITUTIONAL SUPPORT 25

Procurement. SSEs can often compete effectively in supplyingpublic or private agencies with standard items, such as hospital beds,office furniture, school equipment, uniforms, and tools. A number ofcountries systematically direct part of government procurement ofsuch goods to SSEs. In India, for instance, 192 types of products arereserved for exclusive purchase from small enterprises; in 1973, theGovernment Stores Purchase Program had 21,000 SSE participants,though total procurement from SSEs amounted to only 6 percent oftotal purchase value. In Botswana and Lesotho, thriving garment ex-porters, sponsored by the local SSE intermediary, got their startthrough domestic contracts for police and school uniforms. But forSSEs to benefit from such contracts, some entity needs systematicallyto call their attention to tender notices; to help them fill out theforms and provide other technical assistance; perhaps to intercedewith the authorities against unduly restrictive specifications or con-tract conditions; and to provide finance, including working capital,when needed.

Subcontracting. In most countries, large, integrated industriestend to displace small fabricators. However, the latter, while perhapsnot financially capable of manufacturing complex final products,could often supply components and intermediate goods to largefirms, if permitted and helped to do so. If they do not, it is the resultof several factors: primitive techniques, low quality, and lack ofcapital in the SSE sector; the desire of larger firms to control quality,deliveries, and prices; advantageous rates of interest and foreignexchange for the large enterprises; and the absence of effectivemeasures to remedy the deficiencies of SSEs and encourage theiruse. Some countries have avoided or overcome these distortions. InJapan, a symbiotic relationship has developed, through which some60 percent of the small- and medium-size manufacturing firms areengaged in subcontracting for larger corporate customers.' The Re-public of Korea has also achieved remarkable success in this field.

Promotion of subcontracting is a practical and cost-effective wayto deliver technical assistance to SSEs and assure markets for theiroutput. Examples in Japan, India, and Latin America are extensivelydocumented - ranging from provision of blueprints (or models forthose who cannot read drawings), to design and fabrication of suit-able machine fixtures, to advice on appropriate machinery, rawmaterials, and the application of new processes, to intensive helpwith technical and managerial problems. Institutional support for

' See Annex 1, Table 1:1 and Chart 1:1, pages 60 and 61.


subcontracting can provide brokerage services to match the needsand skills of large and small producers, staff or facilities for qualitycontrol and design work, and specific technical training to upgradethe skills of SSEs to make them attractive partners for larger enter-prises. DFCs could explicitly encourage their larger clients to con-sider such collaboration with smaller firms in lieu of developing in-house capacity to produce intermediate inputs. Policy support maybe needed in the form of protective legislation for the subcontrac-tors -model enforceable contracts, requirements for timely pay-ments, uniform technical standards, and incentives for decentralizedexpansion.

Industrial estates. Projects for industrial estates usually do notcater specifically to small industries.2 In many countries, the mixedestate, providing space and facilities for a wide range of sizes, isprobably the best model. It may facilitate subcontracting, transport,or maintenance service relationships between small and large units.It may also be financially more viable, with more stable occupantshaving greater rent-paying capacity. However, mini-industrial estatescan help in the transition of SSEs from the informal sector to moresolid commercial status. In Botswana, numerous very small (formerlyhousehold) enterprises are grouped by product categories in severalzones -textiles and clothing, leather goods, metal fabricating, orbuilding contractors. Each has specialized technical assistance, jointprocurement arrangements, and equipment for common use. How-ever, industrial estates are not essential for this purpose. Often coor-dination and common services may be provided at less cost byestablishing the services in a central place, leaving producers attheir existing sites if these do not seriously inhibit growth. Industrialestates sometimes prove ineffective instruments for SSE develop-ment because they are located outside the town, cut off from gen-eral urban services, and remote from their workers or their cus-tomers.

Institutional Lending PoliciesBroadening sector coverage. The discussion so far has related

mainly to the modern manufacturing sector, which had been theprincipal object of lending by DFCs (and not only those assistedby the World Bank). Other kinds of productive activities, however,may offer scope for creating an equal or greater number of jobs

2 Of the four industrial estates so far assisted by the Bank, only one (in the Yemen ArabRepublic) is for small-scale industries. Those in Pakistan and Mauritius are designed formedium and smaller units.


relative to investment cost, and could benefit from institutionalfinance. Such activities could include:

1. Construction, especially financing of contractors' equipmentand supplies.

2. Transportation - bus and trucking services, taxis and jitneys(jeep-taxis).

3. Warehousing and distribution - regional and local depots forgrain collection and storage, and for distributing fertilizer and build-ing materials.

4. Retail trade of all kinds, down to the corner kiosk.5. Fisheries, including vessels, gear, and ice plants.6. Forestry -extraction and transport equipment, as well as saw-

mills and processing of forest products.7. Maintenance and repair facilities-garages, machine shops.8. Organized services, such as garbage and trash collection or

building maintenance in the cities, and contract plowing, sprayingor well-drilling for commercial agriculture.

9. Personal services - restaurants, barber shops, laundries.10. Tourism activities - not only hotels, but also travel and guide

services, tour buses, and folklore exhibits.11. Arts and crafts, including wholesale handicrafts production.Some recent Bank-supported projects deal with sectors outside

the manufacturing mainstream, generally through a project whichfocuses on the sector as such, and uses a specialized institution.Such an approach may be necessary or prudent if a sector has specialcharacteristics and conditions with which a general-purpose DFCmay not be familiar. Nonetheless, it may be preferable to encouragean established DFC, once it becomes aware of opportunities andneeds in a new functional area, to employ the requisite expertise anddevelop appropriate lending criteria, rather than to build a new insti-tution from scratch. For the Bank also, dealing with a known institu-tion may be easier than building a wholly new relationship. Finally,there may be administrative economies and intersectoral linkageswhich a DFC interested and active in several fields could exploitmore effectively than a single-purpose institution.3

Agribusiness is a case in point. As agriculture modernizes andbecomes increasingly commercial, it requires more sophisticatedprocessing, storage, and distribution networks to handle both inputs

I SSE operations in Cameroon and Ivory Coast assist a broad spectrum of enterprises,including bakeries, metal workshops, woodworking, and automobile repair facilities.The Bank for Housing and Construction (BHC) in Ghana finances equipment for civilworks contractors.


and output. These facilities, especially when tied into effectivecooperatives, can help to reinforce and guarantee agricultural creditsto the producer as well as financing for the middleman or coopera-tive. Possibilities for such interlocking systems are being activelyexplored in several countries, including India, Indonesia, Mexico,the Philippines, and Tanzania.

Construction and housing. The Bank has repeatedly emphasizedthe importance of the construction sector for economic develop-ment. In some developing countries, the construction industry hasbecome internationally competitive. For most civil works, locallybased contractors should normally enjoy a comparative advantageand produce a good return to the national economy. Expansion ofconstruction activity, using domestic inputs to the maximum, isprobably the surest means of creating additional employmentquickly and consistently, given effective market demand.

In urban areas, on average, 6 percent to 8 percent of the laborforce is employed in construction of residential, commercial, andindustrial buildings. Most workers are unskilled and come from thelower-income groups. Large and small firms exist side by side, andthe industry is an important source of entrepreneurial talent. Con-struction techniques are generally labor intensive, and local mate-rials are used. The industry frequently suffers, however, from inade-quate supply of materials, which is partly the result of price controlsand other administrative measures. These supply problems, com-bined with the difficulty of finding working capital for small firms,favor larger firms using more capital-intensive techniques and im-ported materials.

The World Bank and DFCs could help to remedy these problemsby assisting both building materials industries and small contractors.For building materials, this would mean lending to smaller firmsproducing a variety of construction inputs. For small contractors theneed is mainly for working capital and some technical assistance. Itis not easy to reach these groups; firms enter and leave the industrywith great rapidity.4 Financing might be provided through commer-cial banks, specialized institutions, or informal channels. Publiclyfinanced projects (including Bank-supported projects in urban areas)can encourage the use of small firms through appropriate design andtendering features, for instance, revolving funds to ensure that small

I In Botswana, the SSE promotion agency has tried to introduce more stability by provid-ing office sites, common procurement of standard construction materials, and sometechnical assistance in accounting. Local contractors have thus been able to competesuccessfully on small civil works, which were previously monopolized by foreign-basedfirms.


contractors are quickly paid for work done and support for appro-priately designed housing schemes. In sum, it is necessary to extendto the building industry measures by which civil works contractingis supported. The labor-intensive nature of the industry is importantfor improving the productivity of the urban poor.

Housing and home improvement could make an especially effec-tive contribution to the welfare of the urban poor. Apart from cre-ating employment for construction and building materials workers,much of the work can be done by the occupants themselves, if thematerials and a limited amount of skilled labor are available.5 Bene-fits in terms of improved health, comfort, and morale are demon-strably substantial; and improvement of housing is an importantincentive to saving.

Demand for housing has been limited in many developing coun-tries because:

1. Long-term financing is often unobtainable, very costly, orheavily subsidized (and hence severely rationed).

2. Standards for government-financed housing are usually toocostly for those most in need, or even the majority.

3. Charges for urban services tend to be skewed to favor upper-income groups.

4. Institutional structures, both technical and financial, are gen-erally weak.

Sites and services projects, with low unit costs, can help directlyto improve the housing situation of the poor. Conventional housingfinance schemes, with resources derived mainly from personal sav-ings, have shown promise in some countries; they cater to middle-income groups, but in doing so create jobs for the urban poor.Possibilities for extending this approach -emphasizing especiallyits potential for encouraging savings-deserve to be actively pursued.

Working capital. For most SSEs, working capital presents the mainfinancial bottleneck; in the informal sector, it may represent almostthe entire investment. It is needed to purchase bulk quantities of rawmaterials when prices are low, and also to finance the holding ofwork-in-process and finished inventories during seasons of slow de-mand; seasonal working capital is critical for industries serving arural population that depends on crops for its income. In bothcases, a buffer of working capital permits steadier production andfuller use of capacity, thereby increasing jobs and earnings at thelowest cost.

I Productive employment is not confined to work done for wages.


The Bank's policy, and usually that of DFCs, has limited the use ofloans to acquisition of fixed assets and "permanent" working capital.This is generally sound practice for institutions whose role is primar-ily to finance fixed investment. But it is also in the interest of suchinstitutions to ensure that their clients get the working capital theyrequire to meet seasonal and occasional needs, as well as forexpansion. Collaboration for this purpose between DFCs and com-mercial, cooperative, or special-purpose banks should be encour-aged. Conventional DFCs might open a new window, with appropri-ate criteria, for providing short-term working capital finance tomodern SSEs.

Collateral requirements. Most nonconventional financing tech-niques are attempts to overcome the SSEs' lack of collateral to satisfythe requirements of formal institutions.6 The Bank of Alexandria inEgypt requires no collateral from SSEs, relying only on an honorcode enforced by their socioethical environment to induce repay-ment, without undue losses so far. But in other environments, sucha policy may be risky.

The collateral problem may be approached in several ways. Rent-ing premises and equipment reduces the loan, and hence the col-lateral required. Hire-purchase arrangements, in part, embody theirown collateral. New forms of security, such as life insurance certifi-cates or cooperative guarantees, may be introduced. For many typesof SSEs, the prospective cash flow is a more reliable safeguard thanconventional collateral. Government guarantee funds can help toreduce the preoccupation with collateral.

A different approach is for some agency to provide collateral(funds or equipment) directly to promising entrepreneurs either asequity participation -which the entrepreneur might be entitled tobuy back on specified terms once he becomes established - or witha contingent liability for repayment, depending on the enterprise'sprofitability. In exceptional cases, an outright grant of seed capitalmight be justified to get a high-priority industry or service started orto keep it going.

Potential Institutional ChannelsInstitutional channels to promote SSE and urban employment

objectives ought to include some of the DFCs that have been themain intermediaries for World Bank financing, and others of a simi-

6 One reason why many small enterprises resort to high-cost borrowings from the curbmarket is that whatever collateral they have is preempted by institutions from whichthey have borrowed previously. The formal credit institutions usually require collateralworth two or three times the loan amount.


lar type. But various organizational patterns and operational stylesare being considered in the search for maximum flexibility, coverage,and contact with the target groups.

Conventional DFCs. Employment considerations do not seernhitherto to have had much influence on project planning by Bank-assisted DFCs (see Annex 2). But a number of them have recentlyshown interest in shifting their emphasis toward (1) favoring morelabor-intensive technologies, where feasible, and (2) assisting smallerenterprises in the modern productive sectors. Ideas and examplesfrom DFCs that show superior flexibility and innovative capabilitycan be fed back into the worldwide DFC information network witha view to stimulating other institutions. As some DFCs have pointedout, however, their ability to influence the choice of technologytoward more labor-intensive alternatives may be limited. Usuallythey become involved in scrutinizing a project only after the spon-soring entrepreneur has reached a fairly firm decision about the pro-cess and equipment to be used. The decision will have been influ-enced by many factors, including government incentives and inter-est rate policies, the problems of managing and training a large workforce, the prospect of labor disputes, and the performance recordand servicing arrangements for the equipment.

Nevertheless, DFCs can have a constructive influence on thechoice of scale and technology in four ways:

1. By taking explicit account in subproject appraisals of theeffects on employment (positive or negative) of technologicalchoices.

2. By identifying, and encouraging clients to explore, possibilitiesfor subcontracting, and helping to work out collaborative arrange-ments.

3. By helping subproject sponsors to gain access to the knowl-edge available worldwide about technologies appropriate to factorproportions in particular countries.

4. In some cases, by financing the development of promisingadaptations of superior technology to local conditions.

The effectiveness of DFCs in performing these functions dependsheavily on governmental policies. The adequacy and accessibility ofinformation on technological alternatives leave much to be desired.Industries patterned on conventional Western, Japanese, or Russianmodels can take advantage of these respective sources of technol-ogy, and of their promotional efforts. But finding or devising moreappropriate technological solutions is harder. Investigation of such

32 EMPLOYMAENT AND DEVELOPMENT OF SMALL ENTERPRISES

alternatives in product design and production processes is still lim-ited in scale and rather widely dispersed, although in a few countries(such as India, the Republic of Korea, and the Philippines) govern-ment agencies give considerable help to DFCs. The exchange of in-formation is increasing through international organizations, as wellas among the consulting fraternity and a few data banks. But, gen-erally, it receives very little attention in aid programs.! The Bankhopes to explore with international and national agencies, and withthe numerous private organizations having expertise in this field,how their resources could be mobilized more effectively so as toapply existing technological information in a quick and practical wayto the specific situation and needs in a developing country.

Still more important for the long run will be to create or strengthenagencies in the developing countries to inform entrepreneurs andfinancial institutions about the availability of appropriate technologyfor both production and product design, and to develop and adaptsuch technology domestically. This might involve trade associations,technology institutes, universities, and productivity centers. TheWorld Bank's assistance might be required in places where suchinstitutions are inadequate. National mechanisms would extend andstrengthen an improved international network; and for them readyaccess to information already compiled, about relevant situations inother cotintries, could avoid duplication-- and perhaps inspire fur-ther adaptations.

Other IntermediariesMany DFCs of the sort the Bank has usually assisted would find it

hard to lend to very small enterprises, and even harder to lend to theinformal sector. Such activity is fraught with problems and risks thata conventional DFC may be ill-equipped to assess. The projectappraisal techniques that the Bank has evolved and shaped with itsDFC clients over the years are too elaborate for very small projects.

'See A. S. Bhalla and F. Stewart, "International Action for Appropriate Technology," inTripartite World Conicrence on Employment, Income Distribution, and Social Progressand the Division of Labour, Rackground Papers, Vol. II, International Strategies forEmployment (Ceneva: International Labour Office, 1976), pp. 169-193.

"Existing institutions concerned with technological development are often working asisolated units, with little communication between them or coordination of their activ-ities. The absence of a wor:dwside communication netwvork reduces the eftectiveness oftheir work, leading to duplication and weak dissemination.

"There is need for an international institution-An International Appropriate Tech-nology Unit-to provide a means of co-ordinating and disseminating work on appropri-ate technology on a worldwide basis and to foster, encoLurage and disseminate newR and D to meet the basic needs strategy."


It is necessary, therefore, to look also to new and differently orga-nized entities.

Commercial banks. Commercial banks, in particular, could besuitable intermediaries.! They usually have a branch network thatcan be more responsive to small enterprises than the more central-ized DFCs. They can better assess the personal qualities of the bor-rower and local business conditions. Furthermore, since many smallenterprises primarily need working capital, commercial banks couldusefully combine their own short-term funds with longer-termfinance from the World Bank.'

Commercial banks are reputedly wary of financing small enter-prises in view of the costs and risks involved. In many countries legallimits on interest and other charges prevent them from coveringtheir costs. Some banks, however, are making a vigorous effort inthis area, and numerous governments are applying pressure or givingincentives for them to do so.'° In some countries, a specific percent-age of the commercial banks' resources must be allocated to theSSEs, as locally defined. In others, cheap money is made available tothe banks for such purposes. Often the government guarantees thebanks, in major part, against loss. Preliminary indications are that acombination of ready access on favorable terms to government orcentral bank resources, plus a guarantee covering 50 percent ormore of the risk of defaults, generally give adequate inducement forcommercial banks to seek SSE business. Part of the repayment riskshould remain with the lending banks, to encourage effective super-vision and loan collection efforts.'' Substitutes for collateral shouldbe actively sought.

Investment companies. For smaller, modern enterprises, provisionof seed capital may often be crucial to a sound capital structure, andessential to obtain institutional credit. Investment companies thusmay play a key role. In the World Bank's experience, government-controlled DFCs have generally given more attention to this need.

' Projects supported by the World Bank in Bangladesh, Indonesia, Kenya, and thePhilippines rely mainly on commercial banks as financial intermediaries.' This calls for synchronization of credit terms, since it is not unusual to find that short-term interest rates are significantly higher than long-term rates.10 Several of the Indian commercial banks, under government pressure but with a

serious commitment to banking competence, are serving a widespread SSE clientele ofsmall-scale enterprises.'' Commercial banks may, in fact, be better at this than DECs, since they may have astronger tradition of hard-nosed collection efforts; and their clients often have to comeback at short intervals for additional loans or renewals, whereas the DFC client mayneed no further long-term funding for five or ten years.


But over a longer history and wider range, private enterprise hasprided itself on promotional capability and success, and its potentialshould not be ignored. Government support in India has providedseed capital facilities at the state level (through the State FinancialCorporations' [SFCs] Special Capital Fund) and at the national level(through the Industrial Finance Corporation of India's Risk CapitalFoundation). Indonesia and Kenya are among the countries thathave established equity funds to help their nationals start enter-prises. But the experience in all these cases has been too brief toenable one to draw definite conciusions. The Bank may also help onoccasion to increase the flow of equity capital."2

Other financial institutions. The World Bank is exploring possi-bilities for operating relationships with mass-oriented intermedi-aries,3 such as workers' banks, savings and loan institutions, creditunions, and institutions like the Popular Credit Bank (PCB) in Syriaand the Citizens National Bank (CNB) in Korea. Their potential forchanneling finance to smaller and less affluent firms seems promis-ing. In countries where they are effective, they have a broadbasedand loyal clientele. They are accessible to the small borrower andbetter able than more remote institutions to assess his needs andmerits, to keep track of his performance, and to give advice whennecessary. Sometimes they can obtain collective guarantees forloans; in any case, their relationship to the community helps to rein-force the moral obligation of borrowers to repay. They facilitate andencourage popular saving.

Where such intermediaries are lacking, it may take time for themto get established and develop community contacts and confidence.This process can be accelerated in the context of integrated urbandevelopment projects which underline the common interest andencourage other related group activities, and where the projectmanagement can give organizing impetus and guidance. The localentity so incubated might then become a nucleus or model for awider network. This would not exclude efforts also to organize on abroader scale from the start, where conditions are propitious. In thelatter case, an apex institution would have to perform the dual func-tion of providing rediscounting facilities for the local intermediariesand of supervising and upgrading them.

1 A Bank loan to the Colombian financieras made in 1976 included a component of$5 million to make it more attractive for the financieras to assist enterprises throughequity investments, but its use is still limited." Such institutions may feature in proiects which are being prepared in Colombia, ElSalvador, Pakistan, and the Philippines.


Cooperatives. The Bank has some experience with rural coopera-tives, but little with those involved in urban or industrial activity.'4

The success of cooperatives in developing countries has been quiteuneven. They require an especially high standard of dedication andintegrity of leadership, assiduous training and supervision to main-tain this standard, and continued education and motivation ofmembers. Potentially, however, they could be enormously useful asa source and channel for SSE initiative and credit programs, a secu-rity and collection mechanism for loans, a delivery system for tech-nical assistance, and a means for joint procurement and marketing.As cooperatives develop in the urban environment, they may estab-lish mutually advantageous links with rural production and distribu-tion cooperatives as an alternative to the traditional middleman.

Informal Sector ChannelsMiddlemen and moneylenders. A significant role is played by

middlemen and moneylenders at the margin even in advancedeconomies; in the developing countries, especially for SSEs in theinformal sector, they are crucial sources of credit for consumer andproducer needs, at interest rates often exceeding 50 percent yearly.Moreover, they may provide indispensable links to raw materialsources and to larger markets. Until institutional support offers asimilarly comprehensive package which is flexible and convenient,middlemen are likely to be needed.'" Possibilities for using themconstructively as channels for financing and services are beingexplored, notably in the somewhat controlled context of urbanprojects. The criteria used by curb market operators for loan de-cisions, supervision, and securing repayment deserve to be studiedby agencies financing SSEs, especially in the informal sector.

Integrated programs/projects. An effective way to promote theemployment of poor people may be through urban and rural proj-

14 A recent World Bank mission to India explored with several institutions, which haveextensive experience in assisting industrial and agribusiness cooperatives, possible waysof using such organizations in a broad attack on urban poverty (see Annex 3). Potentialprojects in several subsectors are being shaped using different approaches; it becameclear that no simple, uniform pattern would suit for all cases. The Indian experiencewith cooperative organizations is especially rich, but varied in its success.' During the mid-1960s, the Korean Government sought to drive moneylenders out ofbusiness. For a while it seemed to be succeeding, but the curb market rebounded andis now alive and well, more so than before. In the Philippines, a special department ofthe Central Bank offers a refinancing facility for pawnbrokers and the curb marketsubject to certain conditions, including audit and interest ceilings well above those ofcommercial banks. Apparently, this approach has had a measure of success, and itsexperience is being studied.


ects with mutually reinforcing components- including some infra-structure and services, but also rental facilities for production prem-ises and tools, credit, technical assistance, and help in organizingprocurement and marketing. Potential entrepreneurs may be iden-tified in the community and given special training, stressing book-keeping and rudimentary merchandising skills. Work- and employ-ment-oriented literacy courses could be helpful for a wider targetgroup.

An urban development project which the Bank is assisting in thePhilippines comprises diverse, interrelated elements. The Bank ishelping to prepare integrated programs of urban and rural develop-ment in India, Indonesia, the Ivory Coast, Mexico, Pakistan, Tanzania,and Upper Volta. In tourism projects, support for local artisans,handicrafts, and other aspects of popular culture (music, dancing)are frequently included.

One difficulty with such integrated projects is that they are com-plex in both conception and administration. Coordination of thedifferent disciplines, time horizons, and bureaucratic interests in-volved, within the Bank and in the project management, may bevery difficult. But this complexity reflects the intricacies of socialorganization and relationships, and community realities. An ap-proach based on these realities has a validity and appeal that moresimplistic conceptions lack. The necessity for a continuing linkageamong the diverse elements of integrated projects calls for highlyflexible and sensitive intermediaries.

Encouragement of SavingsThe savings potential in SSE development of all kinds, and in

programs related to them, deserves special emphasis. As mentionedearlier, small entrepreneurs have a high propensity to save as theirearnings rise above their minimum requirements. The incentive tosave is likely to increase further if there is a realistic prospect ofsupplementary credit on reasonable terms to enable them to makean investment with good profit potential. If, as a result, their pro-ductivity and earnings increase, one could expect much of the incre-ment also to be saved -- and perhaps deposited in the same neigh-borhood credit institution, further reinforcing community linkages.

In all kinds of programs for integrated urban development, forhousing finance, for cooperative production and marketing, and thelike, the importance of savings needs to be stressed, and accessibleand reliable facilities for that purpose built in. Interest rate policiesshould also be designed to encourage saving. People's lending insti-


tutions might give preference in the extension of credit-for ex-ample, for home improvement-to those who deposit a specifiedminimum amount. A lottery feature to allocate loans for standardpurposes in high demand, such as housing or transport vehicles, mayalso create an incentive for making deposits.

Entrepreneurial CapabilitiesSome small entrepreneurs have the aptitude and knowledge re-

quired to succeed. Others have the potential, but need help to real-ize it. Still others may be doomed from the start. Various studieshave identified certain apparent characteristics of entrepreneurship,and have outlined screening and training programs designed toenhance entrepreneurial performance. Small business training andproblem-solving seminars are widely used in North America andEurope; and programs initiated in some of the Indian states and inthe Philippines have shown good results. These approaches need tobe systematically extended and adapted to the conditions of thepoorer of the developing countries.

Closely related to, and following on, such entrepreneurial identi-fication and reinforcement programs, there is a need for permanentand readily accessible business extension services to help SSEs dealwith technical, marketing, financial planning, and other routineproblems. Such services may be associated with financial institutionsor may be provided independently. But they are an importantingredient in any effort to promote SSEs.

Chapter 4: COORDINATION OF FINANCIALAND TECHNICAL ASSISTANCE

SSEs encompass an enormous variety of industries and servicesmodern urban factories producing diesel engines or electrical goods,bakeries and bicycle repair shops in market towns, truck drivers,market vendors, craftsmen serving the local needs of a city or avillage, and artisans making handicrafts for export or for tourists.Small enterprises also have very diverse markets, sources of rawmaterials, levels of technology, and patterns of location and organi-zation. It is not, therefore, possible to prescribe common needs forinstitutional support or delivery systems. A first general requirement,however, is for ways to distinguish genuinely or potentially produc-tive units from a mere spreading of a constant amount of work. Toassist the former category, some combination of financial and non-financial assistance is usually needed, and it is important that the twobe effectively coordinated. But the nature and emphasis of the mix,and the way the assistance is organized and funded, will vary widelyfor different types of enterprises and situations.

The array of agencies that offer technical assistance for develop-ment of SSEs and appropriate technology is too numerous to dealwith here. However, a partial listing of directories that describe tech-nical assistance activities in support of SSE development is given inTable 1. In addition to the United Nations Specialized Agencies,such as the International Labour Office (ILO) and United Nations In-dustrial Development Organization (UNIDO), several bilateral aidagencies have programs to support SSE development and appropri-ate technology. The efforts of a variety of foundations, institutes,nonprofit corporations, universities and research centers, and con-sulting firms are significant. Other institutions have a regional focus,such as Technonet in Asia, or Acci6n International-AITEC (techni-cal division) in Latin America. In addition, there are agencies andinstitutions in developing countries that were formed to deal withnational problems, but which now are capable increasingly of help-ing other developing countries.

The building up of national (or local) technical assistance agen-cies, thoroughly familiar and integrated with their varied nationalenvironments, is crucial to SSE development and to making effective

38

COORDINATION OF FINANCIAL AND TECHNICAL ASSISTANCE 39

Table I

Directories of Technical Assistance Agencies,Assisting Small-scale Industries

1. Appropriate Technology-A directory of activities and projects, National ScienceFoundation (r.a.n.n.) (Washington, D.C., 1977).

2. Small Industry-Development Assistance Abroad, American Council of VoluntaryAgencies for Foreign Service, Inc., Technical Assistance Information Clearing House (New York,December 1976).

3. Management and Productivity-An international directory of institutions andinformation sources, International Labour Office (Geneva, 1976).

4. Directory of Consultants to Small Rural Industries, International Development DataCenter, Georgia Institute of Technology (Atlanta, Georgia, October 1975).

5. Extension Services, Training, and Technical Facilities for Small-Scale Indus-tries, UNIDO/ISID/45/Add. 1/Rev. 1 (July 1975).

6. Small and Medium Industry Development, US Agency for International Development,Bibliography Series (Washington, D.C., No. 1, 1974).

7. Technical Services for Small-Scale Industries, United Nations Publications No.E.70.11.B.19 (New York, 1970).

8. Small Industry Advisory Services: An International Study by Joseph E. Stepanek,Stanford Research Institute (Glencoe, Illinois: The Free Press, 1960).

use of external help. For example, in broadening the availability anduse of appropriate technology in SSE projects, it is essential to iden-tify and assure effective participation of local technical assistance andinformation agencies, and to enhance their capabilities.

Needs of Modern EnterprisesThe modern, organized SSEs-such as small manufacturing plants,

or construction, trading, and transport companies - are easier toreach. It should be possible for DFCs, commercial banks, and otherconventional entities to meet their financial needs, given appropri-ate policy adaptations and some supporting technical assistance.

Apart from strictly technical matters, some modern firms will re-quire assistance in becoming established and obtaining finance (fea-sibility studies, project preparation, choice of technology and equip-ment, setting up accounts, etc.).They may also require assistance intheir current operations (market information, management training,subcontracting brokerage, dealing with government regulations, etc.).These problems tend to be most acute at the frontiers between the


informal and the modern sector, and enterprises attempting to makethis transition need capable help.

Organizational alternatives. There is no unanimity among the "ex-perts" in SSE development on the most appropriate relationshipbetween the technical information and advisory services on the onehand, and the administration of credit on the other, to maximizetheir combined effect. The choices are:

1. A technical assistance agency can be fully integrated into afinancial intermediary-which helps ensure coordination but mayprejudice the independence of financing decisions. It may also con-fuse, in the client's mind, the technical assistance function with thatof loan supervision and collection, making both less effective.Finally, it might concentrate responsibility for SSE development tooheavily in a single entity, and choke off potentially useful competi-tion and unorthodoxy.

2. It is more usual to have a separate technical assistance agency,under the direction of the government's Industries Department. Thiscould lead to friction with DFCs or banks, with the technical agencypushing its clients' proposals in spite of financial and marketingdeficiencies.

3. A satisfactory arrangement, in the World Bank's limited experi-ence, is a technical assistance agency outside, but closely linkedwith, the financial intermediary for SSEs; the financial institutionwould thus act as a sponsor of technical assistance to its clients(actual or prospective) and of its clients to the technical assistanceagency. The entity that provides or controls financing seems oftento have the most leverage (or catalytic influence) on the other twoparties.

But institutional structures, patterns of influence, and policy orien-tation of different government agencies vary from country to coun-try. The essential need is for very close cooperation between thoseproviding technical assistance (in the broadest sense) and thoseproviding credit.

Meeting nonfinancial costs. Financial and technical assistance pro-grams for SSEs, even modern ones, will cost more than similar pro-grams for large firms. Table 2 shows portfolio quality and profitabil-ity data for three countries where the Bank has assisted interme-diaries catering to both large and small (but not very small) firms.The data are not strictly comparable, but they suggest that the inter-mediaries serving the smaller units (Medium Industry Bank in Korea,the State Financial Corporations in India, and the Corporaci6n Finan-

Table 2

Portfolio Analysis and Profitability Data for Selected Development Finance Companies

Republic of Korea India Colombia

IndustrialKorea Industrial Credit and 0

Medium Korea Developmeot State Development Investment Corporaci6n 0:3Industry Development Finance Financial Bank of Corporation Financiera C

Bank Bank Corporation Corporations India of India, Popular Private z

(MIB) (KDB) (KDFC) (SFCs)(5) (IDBI) Ltd. (ICICI) (CFP) financieras >H

Quality of portfolio 0

Principal in arrears for over three °months (% of loan portfolio) 3.5 2.0 2.2 9.8 0.5 2.6 9.5 2.9

Long-term portfolio affected by zarrears of over three months (%) 7.6 14.0 6.6 39.3 4.1 7.4 16.6 4.9 z

Profitability >Spread on borrowings (%) 4.5 1.2 5.2 3.2 1.6 2.8 11.5 5.1Administrative costs as % of average Z

total assets 3.5 0.5 1.7 1.1 0.4 0.4 6.3 1.7 rProfit before tax (but after provisions)

as % of average total assets 0.2 0.6 4.6 1.9 1.6 2.6 1.2 4.1 I

Net profit as % of average equity 7.5 2.4 18.0 8.5 9.3 11.7 4.3 16.3 r

(5) Figures are statistical means, except for the profitability data on India's State Financial Corporations, which were computed on a cnnsolidated basis.

z


ciera Popular in Colombia) have greater arrears than those financinglarger enterprises.' They also have higher administrative costs for sub-project promotion, appraisal, and supervision - a reflection of thelarge number and dispersion of small projects. Costs of technicalassistance provided by other agencies are not included in thesefigures.

The relatively high rate of failure among SSEs is often only to beexpected, considering the deficiencies in finance, technical know-how, and entrepreneurial experience.2 Bankers' typical concern withcollateral more than with cash generation works against SSEs andmakes them more vulnerable. Hence more constructive and flexible(though not less hardheaded) lending criteria might improve the sur-vival ratio of infant enterprises. The SSE borrower, if he has themeans, is often conscientious in paying his debts, so long as he ismade to understand clearly- in part by effective collection effortsand procedures of the intermediary-that his financing is a debtwhich has to be repaid, rather than a gift from the government.There is ground for hope that traditions of repayment will be estab-lished among small enterprises. But until this has been demonstratedin practice, over a considerable period of time, government guaran-tees will be necessary in many countries. In India, assistance to smallenterprises by state development banks and commercial banks hasincreased severalfold as a result partly of a guarantee scheme andpartly of government pressure on the banks to extend their networkto reach such enterprises. However, the guarantee scheme has beenwidely criticized, principally because the conditions for compensa-tion are uncertain. A similar scheme has apparently not worked wellin Nigeria, but has in Brazil. Further studies are needed to identifythe factors affecting the success of different schemes.

Even when the repayment record is good, or guarantees greatlyreduce the risk of default, the unit cost of administering one hun-dred loans of 550,000 each is higher than for five loans averaging$1 million. Different criteria and procedures clearly have to beused. Some current studies are seeking to distill, from the practicesand experience of various entities financing small firms, quick andsimple screening devices that could largely substitute for more for-

' However, some SSE-financing institutions, such as the Popular Credit Bank in Syria, theNational Citizen Bank in Korea, and the Halk Bank in Turkey, do not have greaterarrears problems.2 The statistics may exaggerate the situation. Small entrepreneurs often initiate severalactivities at once-the corresponding "enterprises" consisting of a registered nameand a post box-until one "takes off," at which point the others are dropped. In realitv,most were preinvestment explorations rather than genuine enterprises, but they show upin the figures as failed businesses,


mal appraisals. These rough criteria will vary in different economicand cultural environments but should include potential sales de-mand, unit costs and prices, raw material supply characteristics, anda basic financial ability to withstand market fluctuations. Checklists,with specific questions or minimum data requirements, could guidethe local branch manager's investigation.

Costs of technical assistance for the more modern, better orga-nized SSEs can be divided into at least three categories:

1. Advice associated with supervision (and protection) of thecredit extended, which is in the intermediary's interest and shouldbe deemed part of its administrative expense.

2. Technical or business advice to the client going beyond thescope of normal loan supervision or beyond the intermediary'scapability-generally a government policy or promotional functionparallel to the credit program and separately funded, although thefinancial intermediary might be the catalyst.

3. More elaborate investigations or advisory services, requiringspecial consultancy arrangements, which might be financed from asubproject loan or (if government policy so provides) from a specialpromotional credit or grant.

In general, it seems preferable that technical assistance expend-itures going beyond the commentary and advice normally offeredin connection with adequate loan appraisal and supervision be iden-tified and financed separately, whether the administrative respon-sibility for technical assistance rests with the financial intermediaryor elsewhere. Otherwise, pressures and criteria for controlling theintermediary's strictly administrative costs could be weakened. Ade-quate funding for technical assistance of all kinds needed by SSEsshould certainly be provided, but the cost and financial liability(placed as far as possible on the beneficiary) should be identifiedand controlled.

Financial charges. The pattern of financial charges, and the result-ing margins to intermediaries, usually reflect a confusing combina-tion of risk calculations, administrative costs, inflationary assump-tions, government strategies, and institutional policies that are incon-sistent, differ among countries, and change over time. It is useful, inassessing specific credit programs for support to SSEs, to isolate thecosts of technical assistance and to cover the risk factor with a gov-ernment guarantee. The remaining financial policy issues are com-plicated enough.

The question whether small borrowers should be charged a lower,higher, or the same rate of interest as medium and large enterprises


has been widely disputed. Because of greatly varying circumstances,it is difficult to prescribe any clear-cut general rule. Still, some tenta-tive judgments can be made:

1. For most SSEs in developing countries, the advantage of reduc-ing the interest rate by a few percentage points is less significant thanaccess to credit on any reasonable terms.

2. A subsidized interest rate for SSEs would represent a drain onpublic financial resources.

3. To attain a secure status, and not depend permanently on gov-ernment favors, SSEs must be able, eventually, to meet the financialterms of the marketplace.

4. The costs and risks of lending to SSEs are often higher thanthose of lending to large, established industries, so that equal in-terest charges, in themselves, would constitute a subsidy to SSEs.

5. But much higher interest rates, which fully cover the costs andrisks of lending, would probably meet with severe social and politi-cal resistance.

On balance, it seems reasonable that the norm governing rates foron-lending to SSEs through officially controlled channels should beno less than for medium and large subborrowers in the same coun-try; that would put the two categories on the same general footingas regards the cost of money. A modest implicit subsidy, as in (4)above, can be justified on promotional grounds, and may in factdisappear once lending becomes well established on a low-costhigh-volume basis, such as some efficient financiers of SSEs haveachieved.

Further subsidization of interest rates for SSEs would be self-defeating, partly because it could limit the amount, and requirerationing of credit resources; this could accentuate the role offavoritism in the distribution of such credit. In addition, it couldencourage more capital-intensive production patterns and discour-age saving and reinvestment among those small entrepreneurs whoobtain subsidized loans. Moreover, the lending institutions shouldseek to attract individual savings as an increasingly important partof their resources. This will prove difficult unless they are able to payacceptable rates of interest. It is recognized, however, that politicalattitudes may impose levels of interest for SSEs lower than this normin some countries, and these will have to be taken into account inlending decisions.

DFCs to which the Bank has lent money are expected to protectthemselves from any material risk due to currency adjustments bypassing on the risk to subborrowers or arranging for it to be assumed


by the government or the central bank. In SSE operations, the bor-rowers also should be exempted from exchange risks, since mostwould find them incomprehensible. It seems appropriate for thegovernment to assume the exchange risks in SSE operations, charg-ing a reasonable fee.

The bad financial reputation of SSEs results in part from theslipshod practices of lending institutions. Some of the latter arepolitically influenced and are not clearly seen, either by the publicauthorities providing their funds or by their clients, as being underan obligation to recoup their loans. On the other hand, a number ofinstitutions have shown that they can enforce repayment obligationsstrictly. Perhaps the prime requisite for successful SSE financing is toinculcate such financial discipline, not only to prevent a drain onpublic resources but also to encourage rational investment andmanagerial decisions by borrowers.

Needs of Artisans and Informal EnterprisesTechnical assistance and logistical support. The fragmented and

dispersed character of the smallest SSEs makes it extremely difficultto organize assistance to them. Informal industries normally dependon support from middlemen, which is expensive; or are isolated,cater only to the closest markets, and live from hand to mouth. Theycould benefit if a joint organization or support services could beestablished to provide an integrated package of assistance, thusspreading overhead costs over a number of formerly decentralizedunits. With an organization designed to meet their critical needs,they could reach larger markets, increase and upgrade productioncapacity, and be a better credit risk for banks.

However, the needs are different for different industries, and thesimilarities are often only superficial. While preparing projects, it isnecessary to look systematically at the nature of products and mar-kets, and at specific functional needs. In that way, it is easier todevise appropriate project components and grouping possibilities.Often single-industry, tailor-made strategies are more effective thangeneral-purpose, "catchall" institutional or technical assistanceschemes. But given the diverse and dispersed nature of informalindustries, single-industry support may be impractical and costly. Forinstance, a "full package" approach comprising cooperative produc-tion facilities, technical assistance, bulk raw material supply, andmarketing collection points may be justified for an urban or ruralconcentration of shoemakers. But it would not be justified for scat-tered village cobblers, even though the latter may be in greater need


of an active, integrated approach due to distance and difficult accessto raw material supplies or markets.

When the concentration of informal SSEs is not sufficient to war-rant common services, more intermittent information and advice onspecific marketing, procurement, technical or organizational mattersmight be provided - the emphasis necessarily being on the generalneeds of diverse industries and services. Economies of scale and amore focused strategy might be achieved by selecting for concen-tration a few major industrial lines, potential or existing, in each area,using standard investment and management packages for credit andnew SSE promotion. Also, extension agents can help form looseassociations among existing producers -for example, for villageblacksmiths to organize joint purchase and transport of scrap metal,common sales outlets, and training and information-sharing semi-nars on improved equipment to reduce costs and improve market-ability of agricultural implements. In this way, small single-industrynetworks could develop that depend on outside help only for initialorganization and subsequent troubleshooting.

Service industries, such as commerce, local transport, and repair,usually require less institutional support; nearly all cater to localmarkets, require few raw materials, and have a flexible, autonomousorganization. Access to working capital and investment credit isusually the main need. Cooperatives or associations can providebroader distribution of earnings, possibilities of increasing services,and some wholesale purchasing economies. But integrated supportand active intervention is usually more difficult and less effective inservice industries than for manufacturers.

Marketing is the major problem of most small manufacturers andthe starting point for effective assistance. Small firms often lackdirect access to larger and lucrative markets; distances, poor qualityand design, limited production capacity, and lack of informationabout potential market niches impede their gestation and growth.Firms located at a distance from markets, in rural areas or smalltowns, need institutional support to provide information on growthmarkets and related design, price, and quality requirements; jointcollection points with quality control; and common transportation.Firms closer to the market can get much of the information them-selves and economies in transport are less significant.

Another important factor is the length of the project life cycle; if,as in fashion and high technology items, the characteristics and de-signs of products must respond rapidly to changing demands, thensmall, decentralized industries will need close vertical coordinationto provide quick diffusion of information about market demands


and corresponding design and technology changes. Likewise, tightorganization of collection points, quality control, and delivery willbe needed. On the other hand, for a standard product (for example,of grain mills or tanneries) assistance in distribution may be neces-sary, but quick market information and tight coordination is lesscritical.

When informal producers move into more demanding markets,they often need special technical assistance to make the transitionto reliable and improved quality. In cases where SSEs have vigorousmanagement, they can often find their own market niches, arrangestores and transportation, and persuade commercial banks to lendfor working capital needs. However, such skills are scarce in mostcountries; most small producers work through middlemen or forlocal consumers, and have little knowledge of broader market poten-tial and requirements. Attempts to replace the middlemen withgovernment or cooperative marketing structures have sometimesproved clumsy and done little to improve the artisans' market con-tacts, knowledge, or autonomy.

Raw materials often make up 50 percent to 80 percent of the costof goods sold by SSEs. This is partly because materials are oftencostly and of inferior quality, detracting disproportionately from thefinal product value. Artisans have to buy on a hand-to-mouth basis,and are often squeezed by seasonal or chronic shortages; provisionof working capital could greatly improve their bargaining positionand productivity. Government policies should avoid discriminatingagainst SSEs in access to raw materials, import licenses, or govern-ment-purchased imported stocks.

Backward linkages from SSEs to the agriculture, livestock, fisheries,and forestry sectors are important, especially introduction of tech-niques and incentives to upgrade intermediate processing and han-dling, which could greatly increase the value added at each stage.For instance, improved tools and techniques for flaying and initialpreparation of hides in India could double their value and enhancethe range and quality of markets for finished leather products.

Technology is often stressed unduly by SSE extension networks,relative to marketing, organizational, and raw material needs. Capa-ble artisans in developing countries have generally undergone longapprenticeship and are technically knowledgeable and adaptive.Still, some forms of technological assistance could well increase thecompetitiveness of SSEs or enhance the use of local resources. Exist-ing labor-intensive equipment can be introduced selectively andmade accessible to SSEs by extension work, hire-purchase arrange-ments, and investment credit. Introduction of simple equipment may


give a major impetus to a small, unorganized producer, providedhis other needs are met, opening up new markets and at the sametime imposing stricter quality, price, and minimum contract require-ments that call for further upgrading of skills and/or equipment. Atthis transition point, the SSE may need technical assistance in select-ing machines, a short practical course in their use, and an introduc-tion to methods of quality control. Technical assistance can beimportant to subcontracting arrangements; for instance, light engi-neering SSEs can benefit by joint use of quality-testing equipment,and research and development workshops for developing proprie-tary or joint products.

Institutional support is needed at least as much for organizingproduction as for the strictly technical aspects. Production coopera-tives have had some success, where artisans benefit by pooling orjointly purchasing complementary or expensive equipment (for in-stance, in shoemaking, carpentry, or metalworking). In areas wherecooperatives are more difficult to establish, reciprocal use of indi-vidually owned equipment, combined with joint facilities for opera-tions where bottlenecks exist or which are highly specialized, mayyield similar benefits. Artisans have hesitated to accept industrialcooperatives in some cases because the organizers insisted thatthe artisans pool assets and form joint production units; as in agri-culture, industrial producers, too, are more open to cooperating onmarketing and input supply, since they can benefit from economiesof scale without having to relinquish control over the source oftheir livelihood. Reciprocal arrangements and joint facilities may bearranged around existing production sites or within industrial estates.

Training ought to focus mainly on short, practical sessions toupgrade the skills of existing artisans, and on apprenticeships andwork-study arrangements. It is advisable to avoid lengthy and moreformalized types of vocational training which tend to exclude exist-ing artisans and others in the target group. Conventional vocationaltraining would be necessary, however, in new subsectors, such aselectronics, or in countries where the supply of skills is very limited.

Finance. Very small enterprises are usually short of cash; they hesi-tate to borrow and have little access to institutional credit. Many ofthem could advantageously use local currency loans for raw mate-rials and better equipment; foreign exchange represents a small (al-though sometimes critical) percentage of total credit requirements,especially for informal SSEs. Being labor and raw material intensive,SSEs need credit mostly for working capital rather than fixed assets;and while their permanent capital base is small, their working capital


needs are both relatively large and fluctuating. They keep incom-plete (or no) accounting records and cater to volatile markets; theirrisks and returns are hard to evaluate reliably. Hence, commercialbanks shy away and SSEs, especially informal ones, have to fall backon the middleman or moneylender.

The criteria and procedures for providing finance to the smallestenterprises in a more organized manner need to be drastically sim-plified. This can be done in a variety of ways: by reducing paper-work, with standard packages roughly indicating the amountsneeded for various typical activities 3; making loans primarily on thebasis of the strength of the market, internal management, and insti-tutional support; and relying mainly on strict and continuing super-vision for loan security. Hire-purchase or equipment-leasing arrange-ments may be especially appropriate. Information promotion cam-paigns are necessary; SSEs often have no idea how to approach abank. Amortization terms should be reasonable and flexible; theeventual repayment record of SSEs can be excellent, but temporaryslacks in the market, production problems, or raw material short-ages may cause repayment delays that are recouped later.

Alternative to the MiddlemanA prime objective of effective SSE assistance programs in many

countries must be to devise an institutional delivery system (cooper-ative, private, or governmental) that will simulate the positiveaspects of the middleman system - its "full service" package, itsoperational flexibility and leanness-while reducing the exploitativefeatures. Such a system could:

1. Minimize the need for working capital advances to individualSSE participants, since they could draw raw materials from a com-mon warehouse, return the finished products, and be paid for thevalue added.

2. Assess other credit needs and certify them to the banks.3. Assure repayment, by check-off from sales.4. Assure customers about the quality of the product, through

standard specifications and inspection.

3 Prototypes for such activities as bakeries, automobile repair, wood- and metalworking,and stone crushing, geared to local markets of different size, are a feature of a WorldBank loan made in fiscal year 1976 to assist SSEs in the Ivory Coast. Each model specifiesthe facilities and working capital required for an enterprise of appropriate scale, and itslikely costs and financial results. Guesswork in appraisal is minimized, and the monitor-ing of the subproject greatly facilitated. On the other hand, the number of such stand-ard units that could be introduced and be viable in any locality is necessarilv limited;this too needs to be assessed.


5. Explore wider market possibilities.6. Provide assistance on design or technical problems.7. Establish common facilities, for a fee, for instance, by provid-

ing equipment which an individual SSE could not afford to own orlease as it would be too costly or used too infrequently.

If alternative delivery mechanisms are to compete with the mid-dleman, performance incentives for the extension staff will beneeded. In larger countries it might help to establish at least twocompeting profit centers within the government framework, with nogeographic demarcation, and to make regular comparisons of meth-ods and results. Most of the staff should be in the field and havesubstantial autonomy in making decisions.

Such a model would be suitable mainly for fairly homogeneousartisans' activities. The more diffuse kinds of informal trading, trans-port, and other services are less susceptible to help through packageprograms. The alternative to the moneylender, if any, is a gener-alized commercial banking or credit union program. Banks fre-quently have an extensive branch network to distribute and super-vise credits, and mobile branches could help to reach out moreeffectively. They are seen as commercial rather than dole-givinginstitutions. They have experience in providing working capitalfinance, although mainly so far to established enterprises; but ajudicious combination of guarantees and incentives can move themtoward SSEs.

Industrial cooperatives are an attractive concept since they con-note management and distribution of earnings among the producersthemselves, and the achievement of some economies of scale with-out permanent dependence on government support. However, therecord of small industry cooperatives has generally not been good,mainly due to weak management. To transform rural or slum-dwell-ing artisans into effective cooperative managers or participants islikely to be a slow process, for which support from an interim, self-liquidating government entity, for training and establishing links,would be useful.4

4The rickshaw-pullers' cooperative in Comilla (then East Pakistan) in the early 1960swas a unique example of internal leadership and external reinforcement. Inspired andassisted by the Academy for Rural Development nearby, the rickshaw-pullers, who hadbeen paying something like 60 percent of their daily earnings as rent for their vehicles,banded together to collect a fesv pennies each day to buy them. Their combined sav-ings, supplemented by loans from the central cooperative federation and repayments atan interest rate that was high (by the standards of the 1960s), made them all independ-ent operators within a couple of years. Having learned what miracles compound interestcould accomplish, they went on to become joint owners of a repair shop, trucking com-pany, and commercial farm.


Meeting the costs. The costs of providing effective institutionalsupport to artisans and informal industries are even greater thanthose for "modern" SSEs. But so are the potential economic benefits,including the possibility of raising many of these enterprises abovethe commercial threshold.5 As with the modern SSE sector, it seemsuseful to distinguish the cost of money and loan administration fromother expenses (such as for technical assistance and guarantees) andto set the normal lending rate at a level no less than for larger enter-prises. The other costs would be absorbed by public agencies serv-ing this sector,

5 SSEs are usually fiercely competitive, which accounts in part for their high birth anddeath rates. The benefits of commercial survival and prosperity for some are partly offsetby the losses of others, but the overall result is probably an increase in efficiency.

Chapter 5: ACTION BY THE BANK

From the analysis made so far, the following conclusions seemjustified:

1. A very important, perhaps the most important, method of ben-efiting the great mass of the urban (and rural nonfarm) population isby expanding the effective demand for labor.

2. Smaller enterprises typically provide more jobs per unit ofinvestment than larger ones, service occupations being especiallyeffective in creating employment.

3. SSE development is subject to serious handicaps, stemmingfrom governmental and institutional policies as well as some in-herent weaknesses.

4. A variety of measures have been identified, and tested to someextent, that seem to offer promise for mitigating these weaknessesand also the discrimination against SSEs.

During the five years from fiscal 1972 to fiscal 1976, the WorldBank's financing for DFC projects amounted to about $2,200 mil-lion.' Of this, only about $100 million was explicitly directed toSSEs, almost all of it since 1973. However, most conventional DFCloans, as well as some industrial estate operations, also benefitedsmall firms.2 During this period, total Bank assistance to enterprisesfalling within the definition of "small scale" set out earlier is, there-fore, estimated at about $180 million. Table 3 lists the projectsapproved through June 30, 1977.

In future, the Bank will give greatly increased emphasis to assistingSSEs, including sole proprietorships and firms with only a handful ofemployees. It is not adopting an uncritical "Small is Beautiful"approach. It will sometimes prefer to foster projects which benefitboth small and medium enterprises; depending on the circum-stances in a country, medium enterprises may offer greater potentialfor industrial and service linkages, labor productivity, and employ-

' Additional direct [ending for industry and mining (almost entirely large enterprises)during FY 1972 to FY 1976 was 53,100 million.2 A study of a large sample of Bank-associated DFCs in the 1970 to 1972 period indicatedthat of about 5,000 enterprises financed by the respondent DFcs, about 50 percent (bynumber) had fixed assets after project completion of less than $300,000, and about 30 per-cent below $100,000.

52

ACTION BY THE BANK 53

Table 3

World Bank-assisted Projects with SSE Impact(as of June 30, 1977)

EstimatedAmount SSE share

Country Fiscal year Nature of project (1) (US$ millions) (US$ millions)

Pakistan 1962 Industrial Estates Development 6.5 6.5Pakistan/ 1970/72 TA (Technical Assistance)

Bangladesh and Import Finance 3.0 3.0India 1973176 DFC 65.0 30.0Mauritius 1973 Industrial Estates Development

and Export Processing Zone 4.0 2.0Jamaica 1974 Sites and Services

Development and Credit 1.9 1.9Nicaragua 1974 Sites and Services

Development and Credit 2.5 2.5Yemen Arab

Republic 1974 Industrial Estates Development 2.3 2.3Colombia 1975 DFC and TA 5.5 5.5Philippines 1975 DFC and TA 30.0 15.0Sri Lanka 1975 DFC 4.5 0.2 '2Cameroon 1976 DFC 3.0 1.5Cyprus 1976 DFC 6.0 0.8Ivory Coast 1976 DFC and TA 5.6 5.6Jordan 1976 DFC 4.0 0.3Korea,

Republic of 1976 DFC 30.0 15.0Colombia 1977 DFC/Small-scale Industry 15.0 15.0Kenya 1977 Commercial Banks (IFC) 2.0 1.0Korea,

Republic of 1977 DFC 82.5 7.5Lesotho 1977 DFC 2.5 0.3Liberia 1977 DFC 7.0 2.0Rwanda 1977 DFC and TA 4.0 1.0Senegal 1977 DFC 4.2 0.2Somalia 1977 DFC 5.0 2.0Swaziland 1977 DFC 5.0 0.3Turkey 1977 DFC 74.0 -'33

Total 375.0 121.4

(1) Some projects are described in Arnex 3. The definition of SSE is the country's definition of such anenterprise, with fixed assets of up to $250,000. A DFC project has an SSE share if (1) it has an ear-marked SSE component, or (2) more than 20 percent of the general DFC loan is expected to go to SSEprojects.

(2) This is the portion earmarked. More of the general loan is also expected to be used for SSE projects.(53 Portion below $250,000 in fixed assets will be small.

ment objectives than the smallest category. Enterprises of every scaleof assets and employment would be encouraged to choose tech-nology appropriate to the relative factor proportions in their coun-try, where a choice exists.

In its country economic and industrial sector work, and in itsdialogue with governments on development policy, the Bank willrecommend the correction of policies and regulatory measures thathave the effect of (1) encouraging undue capital intensity in invest-ments, and (2) inhibiting the ability of SSEs to function effectively


and to expand. In some cases, these issues may usefully be addressedwhile considering DFC and SSE projects.

The Bank is emphasizing to DFCs which it has helped finance, itsconcern to increase the employment and income effects of develop-ment efforts, specifically (1) setting forth the rationale for assistanceto SSEs, including the need to involve poor people more directlyin the process and benefits of development; (2) urging DFCs toexamine possibilities for labor-intensive options in their appraisal ofsubprojects; and (3) soliciting their suggestions on effective meansto promote application of appropriate technology and SSE develop-ment in their respective countries, to which the Bank might makesome contribution. Communications to governments convey aparallel message and also emphasize the importance of a favorablepublic policy environment. They make clear that the Bank's assist-ance, though potentially playing a larger role in support of SSE de-velopment, can cover the financial needs only partially. The Bankseeks to encourage further consultation on possible forms of col-laboration in this general area.

Lending PoliciesLocal currency financing. Use of Bank financing through DFCs has

typically been limited to the cost of imported goods and services,sometimes including the estimated import content of locally pro-duced goods.3 This restriction has not adversely affected conven-tional DFC projects to any appreciable extent. But for most labor-intensive and SSE projects, the incidence of imported machinery andraw materials is lower than for larger firms. SSEs often operate in sec-tors where labor-intensive, domestically developed technologies areavailable and adequate; their local markets do not require sophisti-cated technology 4; their lack of access to capital dictates investmentin domestic and labor-intensive rather than imported and capital-intensive equipment; and cumbersome import licensing regulationsoften compel them to buy "off the shelf."

These assumptions are confirmed by the Bank's experience inassisting intermediaries catering to both small and larger enterprisesin the same country. In Colombia, the import content in fixed invest-ment was 24 percent for small firms and 45 percent for mediumfirms. In India, the corresponding figures are 16 percent and 35 per-

' Explicit local currency components have been included in only two projects in Tunisiaand Liberia.4This factor is important in explaining the significant differences which IDA observedin lending to the 18 SFCs in India. SSEs located in backward areas apparently had muchlower import requirements than those in the more developed states.

ACTION BY THE BANK 55

cent. More generally, an analysis of direct import content on thebasis of different project sizes suggests that there is a strong positivecorrelation between the propensity to import and the scale of manu-facturing.' Although no data are available on the informal sector,the direct import component may often be zero and the indirectone small.

To the extent that potentially competitive domestic industries areprecluded from bidding on contracts, benefits from indirect employ-ment and improved local know-how and experience would be lost.The negative consequences of discouraging local production andencouraging capital-intensive imports, if Bank finance is limited toimported goods, will tend to increase with the changing magnitudeand emphasis of Bank programs and the expansion of domesticindustrial capacity. Also, the psychological effect of domestic sup-pliers being excluded runs counter to the attitudes favoring employ-ment creation which the Bank is seeking to foster. For all thesereasons, and subject to specific justification, the Bank will be moreamenable to local-cost financing for SSE projects, particularly in theinformal sector where the loan required may be considerably largerthan the total direct and indirect import component.

Other lending policies. To make the forms and terms of Banklending appropriate to the needs of SSEs, some other adjustments inlending policies may be necessary. These include:

1. Greater flexibility in permitting working capital finance to in-clude certain priority needs of shorter term.

2. Drastic simplification of criteria and procedures reauired forSSE subproject evaluation, compared with those required for DFCoperations.

3. Permitting governments to pass on Bank and IDA funds to anSSE intermediary at a level below the Bank's normal interest rate ifthat is necessary to permit the intermediary an adequate spread tocover high administrative costs, provided the rates charged to ulti-mate borrowers are consistent with the aims noted in Chapter 4.

New intermediaries. Intermediaries that are different from thosegenerally used in the past will be needed in order to reach the targetgroup. The Bank is exploring the potential, in various countries, ofthe institutional patterns and programs outlined in Chapter 3 (seealso Annex 3). Given the lack of reliable knowledge of many factorsaffecting growth of small enterprise and the informal sector, the ap-proach is one of practical experimentation for some time to come.

I See Annex 2.


The experiments will need to be designed with particular care soas to assure that the projects are closely monitored and the lessonsof experience are learned. Monitoring procedures and standards arebeing designed that may be appropriate for SSE operations of variouskinds, and discussions are going on with several institutions with aview to assuring their feasibility and relevance, and assessing theircosts, before a comprehensive monitoring and evaluation system isintroduced.

ANNEXES

Annex 1

Potential Contribution of Small Industriesto Economic Development

The following discussion relates to manufacturing enterprises thatproduce goods and services for a market wider than the neighbor-hood, and that use powered machinery and other relatively "mod-ern" techniques. It does not deal with the traditional or the "infor-mal" sector.

Relationship of Small to Large FirmsThe Industrial Revolution was accomplished largely through

small-scale industries (SSIs) -entities with modest capital, a fewscore workers at most, owned and managed by a single individual orfamily. Really large firms were slow to emerge. As late as 1900, thehundred largest British industrial firms accounted for no more than10 percent to 15 percent of manufacturing value added, and thesame held in the rest of Western Europe and North America. Theexplosive growth of really large-scale organizations occurred in thenext half century; large firms are now the dominant mode. Typically,the hundred largest manufacturing enterprises in developed eco-nomies today control at least half of total manufacturing assets, witha varying but comparable figure for value added. But their share ofemployment is smaller, relative to output.

Nonetheless, many small manufacturers continue to exist in theseeconomies, showing a skewed distribution of manufacturing enter-prises with the modal size being close to the smallest and a longrightward tail stretching toward the giants.' Most of the small firmsare service oriented, or produce for a circumscribed or specializedniche in the market. Many produce intermediate products for largefirms; the development of the subcontracting relationship was par-ticularly marked in the economic history of Japan.2 As industrializa-tion proceeds, small firms seem naturally to shift from activities thatcompete with large firms to complementary ones (see Table 1:1,page 60, and Chart 1:1, page 61).

Besides the small firms involved in subcontracting, why do somany other SSIs continue to exist? A simple answer is that they havedistinct advantages in organization and marketing flexibility. A more

' The data were recently developed by Sighert J. Prais, of the National Institute of Socialand Economic Research, London, England.2 See Suzanne Paine, "Lessons for LDCs from Japan's Experience with Labour Commit-ment and Subcontracting in the Manufacturing Sector," Bulletin of the Oxford !nsultuteof Economics and Statistics 33, no. 2 (May 1971), pp. 115-133, and Table 1:1.

59


Table 1:1

Japan: Dependence of Large-scale Industries on SubcontractedIndustries in Terms of Production Cost

Percentage of production costIndustry shared by subcontracting industry

Rolling stock 70Shipbuilding 70Motor cars 62Textile machinery 34Telephone switchboard 26Sewing machines 40Ammunitions 40Bicycles 31Gauges 30Weaving machines 28Automobiles 28Optical and precision instruments 26Motor bicycles 25Other industrial machines 21Communication apparatus 20Watches 19Vehicles 18Electric motors 17Electrical appliances 11

Source: Data for the top five industries were obtained from Labour and Social Problems of Small-Scaleand Handicrafts Industries in Asia Countries, Asian Regional Conference, New Delhi (Geneva:International Labour Drganization, 1957), p .9. For the rest, fron The Smaller Industry in Japan(Tokyo: Asia Kyokai, 1957), p. 101.

profound answer lies in the nature of the process by which firmsgrow. Even if, in the absence of direct or implicit government restric-tion, the ultimate size of the modern corporation may be unlimited,financial, organizational, and marketing constraints affect its rate ofgrowth. On the financial side, past profits limit future growth; as fororganization, excessively rapid expansion, rather than excessive size,leads to the characteristic forms of managerial inefficiency.3 Enter-prises often play an important role in developing skills, especiallyin developing countries, but there is a limit to the number of peoplewho can be effectively trained in any given period.

Different firms grow at different rates and their growth rates inone period may not be highly correlated with the same rates in thenext period. But there does appear to be a kind of natural rate ofgrowth for any enterprise and a very much faster rate of growth may

'See, for example, Edith Tilton Penrose, The Theory of the Growth of the Firm (NewYork: John Wiley and Sons, 1969), p. 47 ff.; Mason Haire, Modern Organization Theorv(New York: Krieger, 1959), p. 283; Peter Marris, The Economic Theory of ManagerialCapitalism (London: Macmillan & Co., 1964), p. 114 ff.

ANNEXES 61

Chart 1:1

Relative Prevalence of Subcontracting Firms (300 Employees or Less)in Various Japanese Manufacturing Industries, 1976

Percentage of firmswhich are subcontractorsto more thanone primary firm

50

40 -

General machineryIron and steel Transport machinery

30 - Nonferrous * *S* *,/11 / Precision machinery

MetalworkingS Electrical machinery

20 - Pintng unRubber Textiles E20- Printing * Furniture

Paper * i) * Leather Clothing

(Average)

Lumber

10 Cement * *Chemicals

* Coal and oil products

*Food

I I ~~~~~~~II0 10 20 30 40 50

Percentage of the total firms which subcontract exclusively to a single primary firnr.

source: Dai-san-kai Chusho Kigyo Sogo Kihon Chosa Hokokusho, Sokatsu-hen [Report on the ThirdComprehensive and Basic Survey of Small and Medium Enterprises, as of December 31, 1966-GeneralReport], Small and Medium Enterprise Agency (MITI) (Tokyo, March 1969).

lead to loss of efficiency. Many small firms exist because they eitheroperate in fields where there is little opportunity to expand, or lackthe combination of luck and ability to grow larger.

By contrast, the international development effort over the pastthree decades has fostered the "creation" of large-scale organiza-tions, by fiat or "feasibility report." In most developing countries a


conscious industrial development policy was implemented onlyafter World War II. By that time the model of industrial developmentin Eastern European and Western industrialized countries featuredlarge, integrated plants; this is what was available for sale, con-ceptually and commercially. And it was what the new business lead-ers in the developing countries, or their government planners andmanagers, wanted. It seemed the modern way to catch up quickly,using imported technology and turnkey contracts. The big enter-prises, public or private, enjoyed tax, tariff, import licensing, andcredit favors, while smaller units survived as best they could, oftenwith serious handicaps in relation to the administrative and financialestablishment.'

Such exotic industrial implants have a poor record the world over;nationalized industries (other than those directly taken over withoutmajor disruption), many corporate mergers, and state enterprisesprovide familiar examples. In China, enterprises built on previouslyexisting small private firms have displayed a significantly betterrecord of flexible contribution to development, especially withrespect to skilled labor, than state enterprises founded with Sovietassistance in the 1950s.5 A wider literature confirms that the ra-tionale of the Chinese policy known as "walking on two legs" isbased on intermediate technology and organizational potential.

Employment CreationA more explicit case for encouraging SSIs lies in their employment

creation potential. Large firms designed on Eastern European orWestern industrial countries' models have undoubtedly raised indus-trial production and productivity levels in many developing coun-tries, but without reducing unemployment correspondingly, sothat rising output is often associated with widening poverty. Analleged capital-intensive bias in large-firm development is held partlyresponsible, while small firms are said to be more labor intensivewithout necessarily being too costly or unprofitable. These argu-ments need further examination.

A sufficient number of comparative studies of small, medium, andlarge firms in different developing countries, as well as in developed

See, for example, Peter Marris, African Businessmen, Institute of Communitv Studies,London, Report [19] (London: Routledge & Kegan Paul, 1971), and World Bank, "Financ-ing Small-scale Industry," Research Project ref. no. 670-77 (Washington, D.C.: WorldBank, 1974).1 Thomas G. Rawski, "Problems of Technology Absorption in Chinese Industry," Ameri-can Economic Review 65, no. 2 (May 1975), pp. 383-388.6 For a major survey, see Carl Riskin, "Small Industry and the Chinese Model of Devel-opment," The China Quarterly 46 (April/June 1971), pp. 245-273.

ANNEXES 63

countries,7 permits the following generalizations: small firms in de-veloping countries use less capital, produce less value added, andpay lower wages per unit of labor, than large firms. These featuresare also true of the relationships in more advanced industrial coun-tries between medium and large firms on the one hand, and smallfirms on the other.

Comparative investment costs per direct job generated, as shownin Table 1:2 (page 64), suggest that small enterprises use significantlymore labor-absorptive inputs. Three points must be stressed. First,the data reflect investment decisions taken perhaps five to 20 yearsago, and assets since depreciated. Second, asset values would be sub-stantially higher in 1976 prices B; it is likely that small enterpriseswould now show an average fixed asset/direct employment ratiobetween about $1,000 and $3,000, and medium/large enterprisesbetween $10,000 and $20,000. What is, therefore, important is therelative labor intensity, roughly four to 10 times higher for small firms.Third, these figures reflect the situation of the firm as a whole,usually comprising a succession of expansions and improvements;and the cost/job ratios are significantly higher for the later invest-ment in firms of all sizes, on average about three times higher. Inmany cases, as a company grows and prospers, it upgrades its pro-duction technology and becomes more "modern" and capital inten-sive. Some of the later investments are explicitly designed to replacelabor, and still others serve to break bottlenecks, and raise capacityutilization and output, without greatly increasing the work force.Project-related, rather than company-related, cost/job ratios derivedfrom the Bank's DFC borrowers are much higher than the figures inTable 1:2.

A series of Special Studies on "Development Impact of DFCs" insix countries shows an average fixed investment per direct job of$10,200 on the basis of 160 projects, with two-thirds of the projectsbelow the average.9 A more recent study, undertaken in preparation

'See, for example, United Nations Industrial Development Organization (UNIDO),Small-Scale Industry in Latin America, publication no. 11, B. 37 (Vienna: UNIDO, 1969),pp. 89-113; International Labour Office (ILO), Sharing in Development: A Programme ofEmployment Equity and Growth for the Philippines, WEP study (Geneva: ILO, 1974), pp.539-567; Paine, "Lessons for LDCs," pp. 115-133; and Berthold Frank Hoselitz, ed., TheRole of Small Industry in the Process of Economic Growth (The Hague, Paris: Mouton,1968).8 Based on a sample of 435 companies in its portfolio, the Industrial Credit and Invest-ment Corporation of India, Limited. (ICICI) found that their incremental cost/job ratioincreased by 20 percent between 1973 and 1974.' World Bank, Development Finance Companies-Sector Policy Paper (Washington, D.C.:World Bank, April 1976). This average, which would be about $15,000 in 1976 prices, canbe taken as representative of medium-sized projects assisted by the Bank.


Table 1:2

Fixed Assets per Job in Direct Employment forSelected Developing Countries

India(') Colombia(2) Mexico(3) Philippines(4)Size of enterprise (1965/1973) (1974) (1970) (1970)

(US$) (US$) (US$) (US$)Small 278 3,000 3,700 1,020Medium 557 - 9,500 2,850Large 2,450 13,400 14,500 8,000

(5,000)Source: (1) Annual Survey of Industries 1965 (Calcutta: Government of India, Department of Statistics);

the $5,000 figure is from Financial Performance of Companies 1973174 (Bombay: IndustrialCred t and Investment Corporation of India, Limited, 1975), p. 23.

(2) El Mercado de Capitales en Colombia (Bugota: Banco de la Republica, 1974). Other esti-mates of the cost/job ratios in Colombian medium and large enterprises range as high as $15,000to $22,000.

(3) 1970 Industrial Census.(4) Sharing in Development, ILC.

of this paper, confirms that cost per job ratios are also highlycorrelated with project size and not just company size.'" The mainfindings from this study are presented in Annex 2; they are sum-marized here for convenience:

* Compared to data in the earlier Special Studies, investmentcosts have gone up sharply to average fixed investment perjob of $16,000, estimated in 1976 prices. This is mainly dueto inflation, real cost increases for machinery and equipment,and exchange rate adjustments.

* Variations in cost/job ratios according to DFC, region, andsector are sizable.

* Capital intensity is generally highly correlated with project andfirm size, but for at least half of all DFC-assisted projects, afixed cost/job ratio below $8,000 is estimated.

Tables 1:3 and 1:4 present more detailed statistics, from Japan andIndia, supporting the conclusion that smaller firms generally employmore labor per unit of capital. Table 1:3, for Japan, also suggestsmore efficient use of capital by relatively small industries -except

for the very smallest (measured by number of workers) - an assess-ment strongly confirmed by the cross-country comparisons in Table1:5. This conclusion corresponds also to the conclusions of an earlier

' This study involved all subprojects submitted from July 1974 through December 1975for authorization to withdraw from loan accounts, which contained employment infor-mation. The sample is, however, skewed in favor of large projects (above the "freelimit"-the maximum amount of a subloan commitment, as specified in the overallLoan Agreement, that a DFC can make in its own discretion, without advance WorldBank approval), since withdrawal applications for small projects usually did not containemployment information.

Table 1:3

Japan: Production Structure by Scale of Manufacturing Enterprise, 1957

Size (number Y/L K/L Y/K W/L(=w) Lw/Y (Y-Lw)/K(P)

of employees) (X000) Index (YOOO) Index Ratio Index (Yoo0) Index Percent Ratio Index

1-9 192 38 79 31 2.43 122 118 61 34.6 1.59 123

10-19 272 53 76 30 3.59 180 132 69 44.9 1.98 153

20-29 315 62 81 32 3.90 196 144 75 43.8 2.19 1703049 347 68 90 35 3.85 193 144 75 42.1 2.23 17350-99 420 82 120 47 3.45 173 156 81 38.1 2.16 167

100-199 489 96 166 65 2.95 148 168 88 35.7 1.90 147

200-299 566 111 209 81 2.70 136 192 100 33.6 1.80 140

300-499 695 136 309 120 2.25 113 204 106 29.9 1.58 122

500-999 784 153 407 158 1.92 96 228 119 29.6 1.35 105

1,000 and over 921 180 624 242 1.48 74 300 156 33.1 0.99 77

Average 512 100 275 100 1.99 100 192 100 35.1 1.29 100

Note: Y=value added; L=employment; K-value of tangible fixed assets (excluding land); W=amount of wages; P=rate of return on capital.

Source: Kazushi Otkavia and Mutsuo Taiima, Small-Medium Scale Manufacturing Industry-A Comparative Study of Japan and Developing Nations,

Working Paper series No. A-02 (Tokyo: International Development Center of Japan, March 1976).

zX

Table 1:4

India: Ratios of Capital/Labor, Output/Employee, Capital/ Output in Selected Industry Groups by Size, 1965 O

Fixed capital/employee Value added/employee Capital/output ratioIndustry group Small Medium Large Small Medium Large Small Medium Large H

-------- ---- (Rupees) ------------ ------ (Rupees) ------------ z

Grain mill products 2,049 8,345 11,711 2,426 4,590 7,806 0.84 1.82 1.50 rMiscellaneous food preparations 2,066 5,932 8,449 2,243 4,145 8,705 0.92 1.43 0.97 rTobacco manufactures 328 1,144 3,403 1,369 1,441 16,486 0.24 0.79 0.21 <Spinning, weaving, and finishing of textiles 1,313 2,753 3,768 2,423 2,549 3,444 0.54 1.08 1.09Textiles, n.e.c. 1,631 5,017 18,130 1,075 2,827 4,850 1.57 1.77 3.74 -

Sawmills and wood products (except paperand furniture) 1,476 4,423 5,247 1,802 3,279 1,149 0.82 1.35 4.57 z

Printing, publishing, and allied industries 3,061 3,199 5,545 2,777 3,491 4,752 1.10 0.92 1.17 H

Basic industrial chemicals, including fertilizer 4,272 8,173 41,408 4,858 7,957 10,075 0.87 1.03 4.11 °Paints, varnishes and lacquers, and miscellaneous

chemical products 1,983 5,485 11,920 3,286 8,499 13,713 0.60 0.65 0.82 <Nonmetallic minerals products, n.e.c. 1,506 3,771 10,291 2,030 4,302 9,206 0.78 0.88 1.12 >Iron and steel basic industries 2,522 3,656 39,917 2,576 3,014 6,502 0.97 1.18 6.14Metal products, except machinery and transport H

equipment 2,519 5,385 8,939 2,978 4,744 8,213 0.85 1.14 1.09 iMachinery, except electrical machinery 3,445 4,773 12,277 2,782 4,857 5,417 1.24 0.98 2.27Electrical machinery, apparatus, appliances,

and supplies 2,289 4,016 11,814 2,985 5,498 6,622 0.77 0.73 1.78Repair motor vehicles 2,136 3,842 5,050 2,380 2,711 2,373 0.90 1.42 2.13Fur products, except wearing apparel and

manufacturing products, n.e.c. 2,447 4,221 12,569 2,516 4,067 8,441 0.97 1.04 1.49

n.e.c.-Not elsewhere classified.Source: Government of India, Annual Survey of Industries 1965,

Table 1:5Size of Enterprise and Capital Productivity Variance in Selected Developing Countries

India t1965) Malaysia (1968) Mexico (1965) Pakistan (1969/70) Philippines (1970)Size of enterprise Y/Kf(l) Number of workers Y,'Kf(1) Number of workers Y,'Kf' ) Number of workers Y/'Kft O Number of workers Y/Kf(1)

Small 1.16 1-9 2.01 1-5 1.34 1-9 2.15 5-19 0.9610-19 1.30 6-15 0.76 10-19 0.75 20-49 0.98Medium 0.95 20-29 1.32 16-25 0.65 20-49 0.97 50-99 1.2430-49 1.05 26-50 0.64 50-99 1.46 100-199 1.25Large 0.29 50-99 1.44 51-75 0.64 100-249 1.16 200-499 1.18100-199 1.02 76-100 0.66 250-499 0.81 500 and over 1.11200-499 0.77 101-250 0.62 500-999 0.65500 and over 1.13 251-500 0.61 1,000 and over 1.20

501 and over 0.61Average 1.03 Average 1.07 Average 0.64 Average 0.99 Average 1.13(1) Y/Kf-value added per unit of fixed capital; for Malaysia, Kf=book value of fixed assets, excluding land; for Mexico, Pakistan, and the Philippines, Kf-book value offixed assets. including land.

Source: Ohkawa and Tajimrn. Small-Medium Scale Manufacturing Industry, for data on Malaysia, Mexico, and Pakistan,Sharing in Development, ILO, for data on the Philippines. World Bank internal documents for data on India.

zzi

on


study on a number of developing countries "that smaller enterprises(excluding the smallest), with a lower level of investment perworker, tend to achieve a higher productivity of capital than dolarger, more capital-intensive enterprises." '' Table 1:4 brings out thesubsector variances in investment per job, discussed below.

To what extent, however, do smaller industrial units contributemore to employment of poor people in urban or rural nonfarm set-tings? Insofar as they create a greater number of job opportunities atthe margin, it may be that the urban jobless will benefit. Moreover,the data from about 250 recent DFC subproject appraisal reportssuggest that small to medium enterprises sponsor projects with anappreciably higher proportion of unskilled workers than medium tolarge enterprises - 65 percent as compared with about 50 percent.Creation of unskilled jobs certainly has a direct impact on thealleviation of poverty which is greater for small and medium enter-prises than for larger ones.

It is sometimes argued that large firms and projects, even thoughtheir direct fixed investment/job ratios may be high, contribute pow-erfully to indirect employment generation through backward andforward linkage effects. The subject of indirect employment isenormously complex. A World Bank study of financiera-assistedprojects in Colombia made a first attempt to quantify indirectemployment effects, and estimated that they amount to about 50percent of direct employment generation overall. But the study tookaccount only of industrial sector jobs, not services.2 Individual proj-ects show wide variations; in fact, in 13 of 28 projects the indirecteffect is negative and in five of the 13 cases, the inclusion of indirectemployment actually makes the overall industrial employment effectnegative. In many cases, the job-multiplier effect anticipated fromsetting up a major industrial plant does not occur, or occurs onlypartially, because establishment of the large industries has not beenparalleled by a sufficient evolution of the linkages.

In the absence of comprehensive and reliable national input/out-put data, not likely soon to be available for most developing coun-tries, it is difficult to prove conclusively whether SSIs typically gener-ate more total employment per unit of investment than the larger

" Keith Marsden, "Towards a Synthesis of Economic Growth and Social Justice," Inter-national Labour Review 100, no. 5 (November 1969), pp. 389-418.12 Input/output calculations for 52 subsectors in Korea derived employment multipliers(i.e., the ratio of total to direct emiployment, and including secondary and subsequentemployment effects resulting from the initial job creation) ranging from about 1.4 tonearly 42-the higher multipliers generally from a small base. Joseph J. Stern, "TheEmployment Impact on Industrial Investment: A Preliminary Report," mimeographed(January 1977), pp. 25, 26.

ANNEXES 69

ones. Wide variations occur, both in capital intensity and in theripple effects on employment (see Table 1:4). There is, however,strong evidence that small firms do have a greater overall, as well asdirect, employment effect.

The evidence is linked to the inputs used by small and large firms.The latter usually have a much higher propensity to import rawmaterials and capital goods. Small firms buy more domestic inputs,produced by indigenous labor. The import function of an enterprisedoes not provide a complete picture of its net impact on a country'semployment. If a large firm were to export a great deal, its net jobcreation could be superior to that of a small firm. But the factremains that large firms are more iikely to displace existing domesticproducers, and the Colombia Special Study indicates that firms withroughly 90 workers had a markedly higher indirect impact onemployment than firms with 400 workers. In sum, there is a strong,presumptive case that small enterprises do have a greater overallemployment generation effect than large ones.

The size of firm, and/or the capital intensity of its operations,often is dictated by its products and the technology available fortheir manufacture. Backyard blast furnaces have not proved efficientin overall use of resources. However, small foundries or metalwork-ing plants may be both relatively labor intensive and competitive.Many small firms, catering to a limited market, are labor intensivesimply because capital is not divisible below a certain size. On theother hand, large firms, producing for a wider market, may havea choice among relative factor proportions in planning their invest-ments and operations. But use of labor-intensive techniques in largeenterprises often poses special difficulties, e.g., labor union pressuresor government regulations, which weigh much less heavily on SSIs.It is partly to avoid such problems that the large firms move towardcapital intensity and less "appropriate" technologies. So, where anoption exists, SSls may be more inclined and better able than largefirms to use resources efficiently.

The foregoing argument relates essentially to employment effectsin manufacturing industries. Service occupations tend to provideabout three times as many jobs as manufacturing, at every level ofeconomic and industrial development, regardless of the scale orcomposition of the manufacturing sector.3 This conclusion may besurprising; the costs of transporting and merchandising cigarettes,

3 George Beier et al., The Task Ahead for the Cities of the Developing Countries,World Bank Staff Working Paper no. 209 (Washington, D.C.: World Bank, 1975), TableIV-1, p. 55.


textiles, or housewares, for example, would be expected to be fairlyuniform, regardless of whether they are produced in large, modernplants or in labor-intensive SSIs. But the less modern plants are alsooften associated with a less modern distribution system, itself morelabor intensive, less systematic; and its customers are relatively un-demanding. On the other hand, as capital intensity, sophistication ofproduction techniques, and wage rates in the manufacturing sectorrise with development, so also does the remuneration in serviceemployment and, likewise, incentives toward use of labor-savingtechniques. Thus, the balance between manufacturing and services,at various levels of development, remains relatively stable.

The quality of service jobs that may be made available is extremelyvariable. The services category is a catchall -from refuse pickingthrough street corner vending, through diverse modes of transporta-tion, to the most sophisticated kinds of commercial, financial, andgovernmental activity. In most developing countries, the averagevalue of remuneration and value added in service occupations isinevitably lower than in richer economies; this is especially true forservices ancillary to and dependent on SSis.

The present discussion is about the job creation effect of differentscales of industrial organization. It appears that highly labor-inten-sive manufacturing employment generates and supports still morelabor-intensive service jobs in a proportion comparable with large,capital-intensive industries. Thus, it may be concluded that SSIs tendto have substantially greater employment effect-usually, but notalways, at lower productivity and wages - directly and indirectly inmanufacturing, and also through a fairly constant multiplier effect inthe service sectors.

Other BenefitsManagement. SSIs may also make better use of indigenous organi-

zational and management capabilities by drawing on a pool ofentrepreneurial talent that is limited in the early stages of economicdevelopment, and by providing opportunities for these entrepre-neurs to gain experience. The more successful ones will generallygrow larger and doubtless more capital intensive, and in the processwill fulfill an important incubating function.

Enterprise. Managerial and entrepreneurial abilities should be dis-tinguished. The latter is often neglected in development planningand policies, partly because it is hard to define. Yet its importance isevident in performance comparisons among countries and sectorswhere individual or collective initiative is encouraged, and those

ANNEXES 71

which are subject to bureaucratic constraints. Experience and train-ing, and testing entrepreneurial competence, whether individual orcooperative, typically evolves in the small enterprise.

Savings. The potential savings role of SSI development has notbeen adequately tapped. Quantitative data are scanty, but empiricalevidence from many countries over the decades shows entrepreneursare very highly motivated to save and invest; they reserve a greaterproportion of their incomes for this purpose than does the generalpopulation. This reflects, in part, their inability to obtain financingfrom institutional sources; but it also stems from their psychologicalcommitment to the enterprise, which is both their essential securitybase and their best hope for an easier, more secure existence.4 Inrural areas, given conditions of confidence, funds may be mobilizedfrom large farmers and channeled into rural industry. The Chineseexperience is worth noting; their "induced investment mechanism"greatly stresses fixed capital creation, even by families at the sub-sistence level, through a greater social awareness program.

Domestic technology. SSIs are more likely than larger firms to usein their production processes relatively simple, general-purposemachinery, that is often obsolete by developed country standards.Such machinery can often be manufactured locally; small machineshops, themselves quite labor intensive, exist in almost all countries,even the least developed, and are excellent training grounds formechanical skills. Their machinists become intimately familiar withthe customers' equipment, including SSIs. Perhaps originally im-ported, often secondhand, this equipment is likely to need frequentrepairs or replacement parts which the original supplier probably nolonger manufactures. The local industrialist may see ways to modifythe original equipment to suit his needs better, and commission theneighborhood machine shop to work out an improvement. Gradu-ally, machine building and adaptive capability evolves, stimulatedand supported in the first instance by the small-scale user of simple,less "efficient" or elegant machines, with which the "embryonicHenry Fords" can start the evolutionary process. Large, showpieceindustries, seeking instant modernity, provide little sustenance forthe early stages of local machine working.

"4 Studies of SSI financing, insofar as they are available, show that plowed-back profitsare overwhelmingly the primary source of expansion capital. The recent in-depth studyof SS] in Sierra Leone indicates that 60 percent of initial investment, and 90 percent offunds for expansion, came from proprietors' savings. Carl Liedholm and Enyinna Chuta,"Small Scale Industry in Rural and Urban Areas: Evidence from Sierra Leone," mimeo-graphed (Freetown: University of Sierra Leone, 1976), p. 38.


Regional balance. In most developing countries, industry is highlyconcentrated in a few places; historically determined locationaladvantages are reinforced by natural accretion, linkages, and habitualassumptions. As a result, regional imbalances are aggravated between(1) the urban core and the peripheral areas, with the latter remainingrelatively underdeveloped; (2) urban and rural populations, withmigration of the more vigorous elements depleting the rural societyand increasing urban unemployment; and (3) major regions withinthe nation, leading to political tensions. Both large and small indus-tries contribute to these imbalances, the latter especially whenstimulated by or dependent on the former. But SSI generally hasmore locational flexibility; it requires less infrastructure and usuallycaters to a narrower geographic market. Its relatively labor-intensivetechnology is appropriate for the lower wage rates prevailing outsidethe metropolitan centers, while helping in some measure to raisethese rates. Comparative studies suggest that the profitability of SSIsis higher in medium-size towns, away from the metropolis,"5 so thatpromotion of SSI development in outlying towns helps individualentrepreneurs as well as the society as a whole.

Rural development. A major problem in the rural areas of devel-oping countries is underemployment, especially in the slack agricul-tural seasons; rural incomes are depressed and migration to thecities increases. More nonfarm jobs need to be created and, wherethese are industrial jobs, they will generally be in the small-scale sec-tor, because of infrastructure, market radius, and labor skill require-ments. Certain agricultural processing industries may be exceptions;they need to be encouraged both to create employment and poten-tially to increase returns to farmers. But their peak demand for laboris likely to coincide with the peak agricultural season rather thancomplement it. Other types of small-scale production, such asblacksmithing, brick making, lime kilns, tailoring, carpentry, and fur-niture making, are indispensable to rural development.

Environmental impact. SSIs, just as their larger counterparts, maypollute or otherwise affect the environment adversely. However,their smaller size and dispersion, lesser need for massive infrastruc-ture, and generally simpler processes are likely to result in less graveand more easily remedied environmental consequences.

5 Ibid., p. 100.

Annex 2

Employment Characteristics ofRecent DFC Subprojects

The World Bank's Special Study series on the developmentalimpact of DFCs in six countries gathered information on the capital/labor mix of DFC subprojects. However, all the investment decisionsstudied were taken several years ago, and with abnormal priceincreases during recent years, particularly for construction andequipment, and exchange rate adjustments, it was appropriate tostudy more recent investment decisions in order to obtain a realisticpicture of the characteristics of DFC subprojects.

A sample of 315 recent subprojects, almost all submitted to theBank in fiscal year 1975, was studied. The sample is not representa-tive of the universe of Bank-assisted subprojects, and certainly notfor all DFC subprojects, because over half of them are above the"free limit." Relatively large projects are overrepresented becausesmaller subproject submissions contain little or no information onemployment effects. Nevertheless, some general conclusions arepossible which can be supplemented by information from the Bank'sappraisal reports.

Capital/Labor Mix of Sponsoring FirmsFixed assets/job ratios for 106 companies, and the amounts lent

by DFCs to subprojects sponsored by them, are summarized inTable 2:1.

A picture of somewhat surprising extremes emerges: more thanhalf (55 percent) of the companies show a fixed assets/job ratio

Table 2:1

Fixed Assets/Job Ratios and Amounts Lent byDFCs for Subprojects

As percentage of totalNumber of Loan amount Number of Loan

Flxed assets/job (US$) subprojects (US$ millions) subprojects amount

Up to 5,000 39 34.3 37 205,000- 9,999 19 37.3 18 21

10,000- 14,999 10 14.5 9 815.000 - 19,999 5 15.4 5 920,000 -24,999 4 5.0 4 325,000 - 39,999 19 36.6 18 2140,000 and over 10 31.9 9 18

Total 106 175.0 100 100

73


below $10,000, and account for 41 percent of total DFC loan assist-ance to projects. Relatively few companies show fixed assets/jobratios between $10,000 and $25,000; whereas 27 percent of the com-panies, accounting for 39 percent of DFC assistance, are relativelycapital intensive in their operations, with a fixed assets/job ratioabove $25,000. The median value of fixed assets/job ratios for thetotal sample is $8,900, and the median employment per firm is220 people.

The correlation between firm size and the employment createdshows a surprisingly good fit in a logarithmic regression analysis:R2 = 0.50.

Y = 1.56 X065

where Y = number of employeesX = fixed assets of sponsoring firm in thousands of dollars

The size of the exponent (<1) indicates a diminishing rate of em-ployment growth as company size increases above a certain level.This is illustrated by the median employment figures for companiesin four size groups in Annex Table 2:2. Although the sample sizesfor each subgroup are small, the data tend to confirm a relativegreater labor intensity in smaller-scale operations and a significantlygreater capital intensity in companies with fixed assets over $2million.

Table 2:2

Company Assets and Employment

Below $250,000- $2 million- Above$250,000 $2 million $5 million $5 million

Median fixed assets (US$) 96,000 943,000 2,815,000 6,290,000Median employment 29 192 287 450Fixed assets/job (US$) 3,300 4,900 9,800 14,000

DFCs catering to relatively small firms. Given the Bank's recentinvolvement with SSE, few hard data are available as yet, but a com-parison is possible from two countries (Republic of Korea and India)where the Bank has assisted DFCs which cater to different sizegroups of enterprises (Medium Industry Bank [MIB] in the Republicof Korea and the State Financial Corporations [SFCs] in India assistsmall firms, whereas the Korean Development Finance Corporation[KDFC] and the ICICI in India assist larger borrowers). The figures inTable 2:3 corroborate the general conclusions of Annex 1 as to thegreater labor intensity of SSE.

Sectoral comparisons. Significant differences in the labor intensityof various industrial subsectors have been documented. The findings

ANNEXES 75

Table 2:3

Comparison of DFC-assisted Firms

Republic of Korea IndiaMIB KDFC SFCs ICICI

Average fixed assets/job (US$) 5,900(') 17,000 4,300 11,400(1) Data from recent analysis by the Asian Development Bank.

of two recent studies are highlighted here and are supplemented bythe results of a sample survey of DFC-assisted companies.

A recent investigation by the Asian Development Bank of smalland medium firms assisted by MIB in Korea found firms with belowaverage assets/job ratios in the following subsectors: electronicassembly, footwear and garments, cutlery, bicycle parts, small metaland wood products. A much larger sample of 435 Indian companiesstudied by ICICI yielded sector results with below average assets!job ratios for glass and pottery, textiles, machinery manufacture,electrical equipment, and food products (sugar excluded). Highassets/job ratios characterized chemicals, nonferrous metal products,cement, automobiles and cycles, and pulp and paper.

The sample yielded the following average fixed investment/jobfigures which are project-related data, company-related informationnot being adequate to permit sectoral comparisons: leather andfootwear ($5,400), mechanical parts ($9,300), electrical machinery($11,500), paper ($11,900), mining ($14,500), metal products ($15,-900), and textiles ($16,500). Industries with high investment/jobratios include concrete and cement ($41,500), chemicals ($20,500),and hotels ($18,800).

Employment CharacteristicsThe data available on fixed investment/job ratios and on the

amounts lent for 203 subprojects by DFCs are shown in Table 2:4.About half (49 percent) of the 203 subprojects have a fixed cost/jobratio below $15,000 and account for 30 percent of total DFC assist-ance extended. The variation in cost/job ratios is considerably widerfor projects than the range in fixed assets/employment for sponsoringcompanies. About 43 percent of the projects have a cost/job ratioover $25,000, and account for 50 percent of DFC assistance.

These findings are not unexpected, since several large projectsinvolved modernization or balancing operations, with relatively littleemployment creation. Although, as mentioned before, the sample isbiased toward the larger projects, it can be concluded that most of


Table 2:4

Fixed Investment/Job Ratios and Amounts Lent byDFCs for Subprojects

As percentage of totalNumber of Loan amrount Number of Loan

Fixed investment/'job (US$' subprojects (US$ mi,lions) subprojects amount

Up to 5,000 31 28.9 16 85,000 - 9,999 38 28.6 19 8

10,000- 14,999 29 42.9 14 1315,000 -19,999 19 45.7 9 1320,000 -24,999 18 27.9 9 825,000 -39,999 24 64.3 12 1940,000 - 99,999 33 79.3 16 23

100,000 and over 11 26.3 5 8Total 203 344.1 100 100

Note: Details may not add tD totals due to rounding.

the Bank's assistance has supported relatively capital-intensiveoperations.

The median direct employment generation for the sample is about99 jobs, and the median fixed investment/job ratio is $16,350. Theincremental cost/job ratio is thus considerably higher than for thefirm as a whole. A 1975 study undertaken by ICICI of about 500Indian companies in its portfolio confirms this. The incremental,project-related cost/job ratio is almost three times higher than thefixed assets/employment ratios of sponsoring firms.

As with company size, project size tends to be positively corre-lated with employment generation, as indicated by a logarithmicregression analysis: R2 - 0.50.

Y = 0.89 X064

where Y = direct jobs generatedX = fixed investment by project in thousands of dollars

The equation shows diminishing employment generation effectsas project size increases. This feature is confirmed when comparingproject sizes above and below the "free limit," as shown in Table 2:5."B" projects show considerably greater employment effect than "A"projects. (It should be noted, however, that the two categories over-lap, since DFCs have different "free limits.")

Regional comparisons. The regional comparison in Table 2:6 ofselected median figures shows no pronounced differences in cost/job figures, except for the high ratio in the Europe, Middle East, andNorth Africa region and the significantly lower ratio in South Asia.The latter is, however, influenced by relatively many small projects

ANNEXES 77

Table 2:5

Comparison of Projects Above and Below "Free Limit"

A projects B projects(above "free limit") (below "free limit")

Number of projects 166 100Median fixed investment (US$) 1,708,000 730,000Median employment 100 57Median fixed investment/job (US$) 17,080 12,800

assisted by the SFCs in India. The last line of figures in Table 2:6again shows that most DFC financial assistance has gone to relativelycapital-intensive projects.

Table 2:6

Regional Comparison of Selected Median Figures

Europe,Middle

East East, LatinAsia and Anrericaand South North and the

Projects data Africa Pacific Asia Africa Caribbean Total

Number of projects 28 74 61 75 77 315 (1Median fixed

investment (US$000) 1,962 1,732 675 1,639 1,079 1,155Median number of

jobs created 200 141 101 71 62 99Median fixed

investment/job (US$) 16,340 15,090 8,500 19,410 17,580 16,350Average fixed

investment/job,weighted by DFC loanassistance (US$) 17,490 31,130 17,810 33,230 28,310 26,810

I1) Of these 315 projects, information on emp oyment creation was available for only 266 projects. A fewextreme and clearly unrepresentative values have been deleted.

Skilled and unskilled employment. By definition, the demand forlabor has a greater impact on providing jobs to the urban and ruralpoor. Of the total employment generated directly by projects, 62 per-cent was for unskilled jobs, with relatively small projects generatinga higher share, as shown in Table 2:7.

The data should be interpreted with caution since the sample hasfew projects under $500,000 in fixed investment cost with informa-tion on unskilled employment. Furthermore, unskilled labor isdefined differently among DFCs and enterprises. Finally, the data arefor projects of different sizes rather than companies, but it is logicalto expect that small enterprises, particularly in the informal sector,


Table 2:7

Investment Cost for Unskilled Jobs

Fixed investment costBelow $250,000 $250,000 to $500,000 Over $500,000

Number of projects 5 6 68Ratio of unskilled jobs to total jobs (%) 75.6 63.2 61.9Average fixed investment per job (US$) 2,850 8,280 18,900Average fixed investment per unskilled job (US$) 3,760 13,100 30,500

would also generate, on average, a relatively larger share of jobs(about two-thirds as against one-half for larger enterprises) at asignificantly lower investment cost. Comparative data for India andColombia support this hypothesis.'

Project Size and Import PropensityDFCs financed about half of fixed project investment on average.

However, for large projects, above a fixed investment cost of about$1.7 million, the DFC financing share diminished somewhat due to"maximum exposure" considerations. 2

A similar relationship emerges when the Bank's contribution iscompared with fixed investment costs. The former can be taken asproxy for the share of imported machinery and equipment in fixedinvestment, although this underestimates total import share forcountries where indirect imports (off-the-shelf purchases) are sig-nificant and for those projects where other foreign financing isinvolved; data on these aspects were not available, however. Never-theless, a logarithmic regression of the Bank's financing share againstfixed investment shows a relatively strong correlation: R2 = 0.66.

Y = 4.78 X0 -2

where Y = fixed investment of project in thousands of dollarsX World Bank loan for project in thousands of dollars

This demonstrates an almost linear relationship, with the Bankfinancing an import value equivalent to about 21 percent of fixedproject investment. Only for large projects does the Bank sharediminish somewhat on average, which again is consistent with"maximum exposure" considerations. In some cases, for instance,for the private financieras in Colombia, "exposure limits" were nego-

The Colombia Special Studv indicates a 60 percent and 50 percent share of unskilledlabor, respectively, for enterprises with assets below and above Colombian $35 million.In India, the 1975 study by ICICI shows unskilled workers as 44 percent of total employ-ment in 435 assisted, mostly large, companies. By contrast, subproject data for thesmaller enterprises assisted by the SFCs show a 59 percent share of unskilled workers.I "Maximum exposure" is the limit on total amount a DFC can lend to a single client.

ANNEXES 79

tiated by the Bank; for most other DFCs, they are contained in theirpolicy statements.

If all foreign financing other than the Bank could have been cap-tured, the exponent in the above equation would have increasedfrom 0.92 to well above unity, indicating a concave exponentialrelationship between project size and import propensity. Further-more, as noted above, the sample contained relatively few smallfirms and no businesses from the informal sector. These enterprisesrequire mostly local currency financing so that, over the whole sizespectrum of firms, the import content in fixed investment costincreases progressively with project size. Comparative data forColombia, where the direct import content in fixed investment was24 percent and 45 percent for small and medium firms, respectively,and India, where the corresponding figures were 16 percent and35 percent, are indicative of this trend.

A similar trend would characterize the share of imports in recur-ring material inputs for different sizes of firms. The ColombianSpecial Study shows that larger enterprises have a 50 percent higherimport component in material inputs; 11 percent of total materialinputs required by relatively small enterprises (those with employ-ment under 200) is imported, compared with an 18 percent sharefor larger enterprises.

Capital/Labor Mix in DFC SubprojectsThe sample of 315 subprojects yielded a median fixed investment

per direct job generated of $16,350. Excluding a few extreme andclearly unrepresentative projects, the average cost/job was about$20,000 and the weighted average cost/job, with the DFC financingshare in fixed project cost constituting the weights, was $26,810.

Table 2:8 shows selected median values for those DFCs whichwere represented in the sample by at least eight projects. The rangeis wide, from $6,500 to $38,600 in the median fixed investment perjob, with six DFCs (38 percent) showing a median value below$10,000 and 11 DFCs (69 percent) below $20,000. However, severalof the DFCs are represented mostly by "A" projects, so that theresulting median cost/job figures are higher than what the universeof their projects would show.

World Bank appraisal reports of DFCs show the following averagefixed cost/job ratios:

* Private Development Corporation of the Philippines (PDCP)-$27,450 (based on projects approved through 1974).

* Korea Development Bank (KDB) -$18,720 (based on 32 recentprojects to be financed by KDB).

on

m

Table 2:8 :

Median Fixed Investment and Employment for selected DFCs 0

Median Median Z

Number fixed fixed >

Region of investment Median investment zCountry Development finance company projects (US$000) employment per job (US$) D

Africa m

Kenya Industrial Development Bank (IDB) 8 3,050 219 15,030 mMauritius Development Bank of Mauritius (DBM) 8 1,987 270 15,970 0

East Asia and PacificThailand The Industria! Finance Corporation of Thailand (IFCT) 17 1,123 126 16,310Philippines Development Bank of the Philippines (DBP) 12 3,571 227 11,070Indonesia Bank Pembangunan Indonesia (BAPINDO) 10 1,800 70 19,320 °

South AsiaPakistan Pakistan Industrial Credit and Investment Corporation Ltd. (PICIC),

Industrial Development Bank of Pakistan (IDBP) 18 530 130 10,050 -India State Finance Corporations (SFCs) 25 648 100 6,570 mIndia Industrial Credit and Investment Corporation of India, Ltd. (ICICI) 22 1,463 125 11,940

Europe, Middle East,and North Africa

Iran Industrial and Mining Development Bank of Iran (IMDBI) 15 1,547 70 29,200Turkey Tuirkiye Sinai Kalkinma Bankasi, A.S. (TSKB) 20 2,871 137 25,210Morocco Banque Nationale pour le D6veloppement Economique (BNDE) 20 1,442 55 20,480Tunisia Banque de D6veloppement Economique de Tunisie (BDET) 20 1,106 38 12,170

Latin America andthe Caribbean

Colombia Private financieras 24 1,342 73 15,710Ecuador Ecuatoriana de Desarrollo S.A. Compafiia Financiera (COFIEC) 13 576 24 31,510Mexico Fondo de Equipamiento Industrial (FONEI) 22 1,707 61 38,630Trinidad and Tobago Trinidad and Tobago Development Finance Company Limited (TTDFC) 9 170 16 10,600

ANNEXES 81

* Medium Industry Bank (MIB) (Korea) - $2,720 (based on 174projects approved in 1973 and 1974).

* Malaysian Industrial Development Finance Berhad (MIDF) -$14,700 (based on all projects approved in 1973 and 1974).

* Development Bank of Singapore Ltd. (DBS) -$8,420 (based onBank-assisted projects financed in 1973).

* China Development Corporation (CDC) - $25,000 (based on81 projects approved in 1974).

Given the wide range of DFCs' cost/job ratios, it is difficult toarrive at a balanced estimate of the average fixed cost/job figure forthe universe of projects assisted by the about 70 Bank-supportedDFCs. It is clear, however, that the average is substantially higherthan the $10,200 figure yielded by the Special Study series in sixcountries. The best estimates are about $16,600 for the average fixedinvestment per direct job generated for the universe of DFC-financed subprojects assisted during 1976, with a fixed cost/job ratiobelow $8,000 for at least half of them.

These estimates are based, in the first instance, on actual datafrom some 250 Bank-assisted DFC subprojects (average fixed invest-ment/job of $20,000), as well as from over 350 recent DFC sub-projects (average fixed investment/job of $17,800) included inUNIDO's "Scheme for the Exchange of Information on IndustrialProjects in Developing Countries." 3 These data appear in Tables 2:9and 2:10, and are pooled in Table 2:11 to show employment trendswith rising project costs (pages 82 and 83Y-

The data in Table 2:11 indicate a rising capital intensity withincreases in the fixed investment cost of projects. The extreme valuesfor cost/job ratios are under $3,000 for projects with a fixed invest-ment below $500,000 and over $30,000 for projects costing morethan $10 million. The average cost/job is $18,275, or about $20,000to $21,000 in 1976 prices.

As noted earlier, the composition of this sample of 628 projects isnot truly representative of all Bank-assisted DFC subprojects, sincerelatively large projects are overrepresented. No aggregate statisticsare available on the size distribution of projects assisted by all DFCs,but there is some evidence that large projects, with a fixed invest-

' The median and average fixed investment figures of the Bank sample projects were$1.2 million and $3 million, respectively; the corresponding figures weere $1.1 millionand $4.9 million for the 369 DFC projects in UNIDO's sample. The UNIDO samplewhich also contained non-Bank-assisted subprojects siowed median and average fixedcost/job figures of $10,6,0 and $17,800, respectively; i.e., although the UNIDO sampleincluded, on average, even costlier projects than those in the above Bank sample, itshowed lower cost/job figures.

m

zz

Table 2:9 o

Employment Generation in World Bank-assisted DFC Subprojects

Number Fixed Fixed D

Fixed investment of Investment Number investment m

(US$000) projects Percentage (US$000) Percentage of jobs Percentage per job (US$) -

0Up to 500 49 18.9 14,447 1.9 3,036 7.8 4,759

500- 999 50 19.3 36,115 4.7 3,641 9.5 9,7851,000- 1,499 40 15.4 48,979 6.4 4,322 11.1 11,333 >1,500- 1,999 25 9.7 41,704 5.5 2,224 5.7 18,7522,000 - 2,499 17 6.6 39,059 5.1 3,054 7.8 12,790 72,500 - 3,999 29 11.2 94,052 12.4 5,100 13.1 18,4424,000 - 9,999 32 12.3 190,867 25.1 10,630 27.3 17,956

10,000 and over 17 6.6 296,564 38.9 6.900 17.7 42,980 _

Total/Average 259 100.0 761,787 100.0 38,957 100.0 19,555

Table 2:10

Employment Effects of Different Project Sizes in UNIDO Sample of DFC Subprojects

Number Fixed FixedFixed investment of investment Number investment

(US$MM=) projects Percentage (US$000) Percentage of jobs Percentage per job (US$)

Up to 500 128 34.7 27,305 1.5 1,21 1 13.8 1,921500- 999 49 13.3 37,146 2.0 5,599 5.5 6,634

1,000 - 1,499 25 6.8 29,479 1.6 3,682 3.6 8,0061,500 - 1,999 26 7.0 45,687 2.5 4,958 4.8 9,2142,000-2,499 12 3.2 27,742 1.5 1,665 1.6 16,6612,500 -3,999 42 11.4 139,697 7.7 15,635 15.2 8,9354,000 -9,999 52 14.1 309,733 17.0 18,810 18.3 16,466

10,000 and over 35 9.5 1,210,150 66.2 38.138 37.1 31.731Total/Average 369 100.0 1,827,211 100.0 102,698 100.0 17,792

Table 2:11

Project Cost and Employment in DFC Subprojects

Number Fixed FixedFixed investment of investment Number investment

(US$000) projects Percentage (US$000) Percentage of jobs Percentage per job (US$)

Up to 500 177 28.2 41,752 1.6 17,247 12.2 2,421 z500- 999 215 34.2 239,110 9.2 24,476 17.3 9,769 z

2,000 -9,999 184 29.3 801,150 31.0 54,894 38.7 14,595 x10,000 and over 52 8.3 1,506,714 58.2 45,038 31.8 33,454 "

Total 628 100.0 2,588,726 100.0 141,655 100.0 18,275 o


ment of more than $2 million, account for half of total DFC financ-ing.4 Projects costing less than $2 million constitute two-thirds of thetotal number of projects included in the sample of 628 projects. Itcan, therefore, be said that at least two-thirds (probably three-fourths) of DFC-assisted subprojects have a fixed cost/job ratiobelow $11,000, and that at least half of all projects have a cost/jobratio below $8,500.5

Given some uncertainty about the distribution at the upper end ofthe project-size spectrum, the overall estimate for the fixed cost/jobratio in all DFC lending (Bank and non-Bank assisted) is more tenta-tive. The best estimate is that DFC subprojects, as a whole, had afixed investment/job ratio of about $16,000 in 1976.

Another reason for the tentative nature of this estimate is thatdetailed information on recent DFC clients is not available. Some ofthem (for instance, Devlet Yatirim Bankasi in Turkey and BanqueAlgerienne de Developpement in Algeria) assist predominantly largeclients; other recent DFCs (for instance, the Corporacion FinancieraPopular in Colombia, Banque Ivoirienne de D6veloppement Indus-triel in Ivory Coast, and Banque Camerounaise de D6veloppementin Cameroon) assist small enterprises. It is possible that their com-bined effect would tip the scale in favor of relatively capital-inten-sive projects so that the $16,000 figure may be an underestimate. Onthe other hand, the increased emphasis on SSE development in DFCoperations could bring the average cost/job figure down to about$13,000 (in 1976 prices) by 1980. It would then be likely that themedian fixed cost/job figure would drop to about $5,000, and halfof the total number of subprojects assisted would have a cost/jobratio below $5,000.

' Of about 8,500 subloans made by DFCs in the 1970 to 1972 period, 46 percent involvedamounts below $750,000; 54 percent of DFC lending has, therefore, benefited largeprojects with a fixed investment of at least $2 million.I The average loan amount in the 1970-72 sample of 8,500 subloans was S210,000. Aconservative estimate would put the median fixed investmen, for projects in the $500,000to S1 million range. The fixed cost/job ratio for this project size (calculated from Tables2:10 and 2:11) is about $8,000.

Annex 3

Selected World Bank-assisted Small andMedium Enterprise Projects

Industrial ProjectsIndonesia. A $16.5 million IDA credit in fiscal 1974 supported the

construction of an industrial estate on the outskirts of Jakarta. Theproject is a standard industrial estate operation designed to reducecosts of services to industrial firms and to speed the implementationof investment projects. Most firms expected to locate on the estateare large joint ventures. The SSE component of the project, althoughsmall, takes account of the fact that SSEs require help as part of abroad program providing standard factory buildings, credit, andtechnical and management assistance. Although the project doesnot include a credit component specifically for SSEs, or other firms,an estate-located office assists in obtaining credit from existingsources, in production techniques, market surveys, etc.

Pakistan. The IDA credit to Pakistan of $6.5 million in fiscal 1962represents the Bank's earliest explicit attempt to stimulate SSE invest-ment. The project included the purchase and development of twoestate sites, and support for industrial consultants to help managethe estates and appraise estate-located investments. After the Bank'sappraisal, continuing technical assistance was provided to firms aspart of an ongoing government program coordinated through theestates. The objective of the project was to modernize existing firmsand to increase their productivity and output. Entrepreneurs them-selves paid for factory sites and machinery, but were given long-termcredit to do so, as well as advice on obtaining credit for workingcapital needs.

The project encountered significant disbursement delays, and theone industrial estate located relatively farther away from the urbancenter lacked viable investments and was not successful. Neverthe-less, it was demonstrated that small industries can be assisted ifcredit arrangements are relatively straightforward, investment an-praisal techniques sound, and industrial estates are located near nat-ural markets.

Pakistan/Bangladesh. Before the separation of Pakistan's EasternWing and the creation of Bangladesh, IDA had approved a $3 millioncredit in fiscal 1970 to the East Pakistan Small Industries Corporation(EPSIC). As a government agency, EPSIC helped set up and manageindustrial estates, provided and coordinated technical assistance to

85

86 EMPLOYMENT AND DEVELOPMENT OF SMALL ENT! R' E ISES

borrowers, and arranged finance, including, in a limited way, someof its own. The IDA credit, although it included assistance for indus-trial estate management, was basically designed to meet the foreignexchange needs of entrepreneurs.

At the time of the civil war, the credit was two-thirds committedbut only a small amount had been disbursed. After the war, inDecember 1972, the project was reactivated, although the effects oforganizational changes on the delivery of technical assistance tosubborrowers and in the commercial banking sector were not en-tirely clear. In the reactivated credit, technical assistance to the bor-rower was largely eliminated. Under the original scheme the centralbank rediscounted 75 percent of loans made by commercial banks.In case of default the commercial banks and EPSIC shared the riskequally. This plan was retained under the reactivated credit,although the commercial banks were nationalized and consolidated.

Yemen Arab Republic. The objective of a $2.3 million IDA creditfor an industrial estate project in the Yemen Arab Republic, in fiscal1974, was to demonstrate modern industrial techniques to smallbusinessmen and craftsmen. Besides the physical development andinstitutional arrangements for the industrial estate, the credit pro-vides for technical assistance to the estate authority and subborrow-ers, as well as long-term credit through the majority government-owned Yemen Bank for Reconstruction and Development (YBRD).In addition to the normal public utilities provided in industrialestates, a common repair facility is to be provided. Long-term credits(previously unavailable in Yemen) from the YBRD will be availableonly to entrepreneurs with projects approved by the estate authority.

Other. Three other projects, each with some special aspects, havehad an impact on small enterprises. The Mauritian industrial estateproject, for example, supports small- and medium-sized exportingfirms in the modern sector. Although in tune with Mauritian needs,the situation is not a typical one, as there are few countries withexcess cheap skilled labor, situated on major trading routes. Simi-larly, the industrial estate component of a Nicaraguan project meetsa different type of need and focuses on rehabilitation of preexistingfirms. Tanzania's industrial estate project has a very small, 10 percentcomponent for small firms.

Development Finance CompaniesCameroon. The SSE project in Cameroon, supported by a $3 mil-

lion IDA credit in fiscal 1976, relies on a majority government-

ANNEXES 87

owned DFC as the credit intermediary. However, both the govern-ment and the Bank recognize that reaching SSEs successfully requiresmore than financial and operational support for the DFC. In fact, theoriginal request of the government for Bank help was not for creditbut for help to provide technical assistance to subborrowers. Morethan in India, the bottleneck is not only a lack of financial resources,but also management and business failings. As a result, delivery oftechnical assistance to Cameroonian subborrowers, as well as to thefinancial intermediary, was seen as critical by both the Bank andlocal authorities. Operating on the assumption that assistance to sub-borrowers should not be supplied by the financial intermediary itselfbut by one or more of the three existing agencies, the Bank tried tocoordinate the "grab bag" of programs offered by them. Two otheraspects are worth highlighting. First, the government is firmly com-mitted to support SSE as an important part of its overall industrialsector policy. In line with this commitment, the government hasrationalized the incentive system for small businessmen and at-tempted to speed decision making on the use of these incentives.Second, in recognition of the risk involved in promoting SSE, a fundguaranteeing up to 80 percent of loans to SSE firms by the DFC andlocal commercial banks was established with central governmentsupport and a levy on the commercial banks' profits.

Colombia. A $5.5 million Bank loan in fiscal 1975 was made toalleviate the twin constraints for SSEs-insufficient access to creditand technical assistance. To meet the foreign exchange cost asso-ciated with investment, $5 million of the loan was for on-lending tosmall firms, and $500,000 to finance technical assistance to the gov-ernment-owned financial intermediary, Corporaci6n Financiera Pop-ular (CFP), and to subborrowers. CFP agreed to increase its technicalassistance efforts to help its clients. In addition, since many potentialclients require extensive help, especially technical and managementadvice, Bank funds are available for technical assistance credits toentrepreneurs, usually for the services of Colombian consultants,including universities, private consultants, and government-sup-ported groups.

India. The SSE project in India, in fiscal 1973, was the first of itstype undertaken by the World Bank. It was conventional in its pri-mary concentration on institution-building goals, but unconventionalin that it involved 18 state-level institutions. Bank assistance was di-rected to regions and a size-class of enterprises that had previouslynot been touched by the Bank's industrial assistance. The funda-


mental objective of the project and that of another project in fiscal1976 was to meet the financial needs of small and medium enter-prises quickly and efficiently. Taking account of this objective, andthe federal system of government in India, the project relied on atwo-tier, or "apex," approach to make credit available. The Indus-trial Development Bank of India (IDBI), a fully owned subsidiary otthe Central Bank, received a $25 million IDA credit in fiscal 1973and a $40 million World Bank loan in fiscal 1976 to on-lend to 18State Financial Corporations.

This approach enabled the Bank, through IDBI, to address theinstitution-building needs of the SFCs, which are critical to effectivecredit support for SSEs. IDBI deals with SFCs on a regular basisthrough a refinancing/rediscounting mechanism and supervision. Ofthe SFC country-wide operations, 75 percent is for small-scale indus-try, but the SFCs are only marginally involved in mobilizing businessand engineering assistance for small entrepreneurs. In view of theformidable institution-building task, and the fact that technical assist-tance to SSE is available from a wide variety of sources, the Bankconcentrated on the delivery of financial assistance to ease the tradi-tional problems small entrepreneurs had faced with respect tountimely provision of credit. The specific technical needs of SSE arebeing reviewed now, and future SSE operations in India will see aclose integration of credit and technical assistance.

Ivory Coast. In response to the government's desire to upgradethe operations of the local technical assistance agency, Office dePromotion de l'Entreprise Ivoirienne (OPEI), a Bank project loan of$5.6 million was made in fiscal 1976. The objectives are to strengthenand broaden OPEI activities, and provide funds to a local financialintermediary, Credit de la Cbte d'lvoire, for on-lending to SSE. Theproject's central aim is to develop "models" or prototypes in specificsubsectors - bakeries, garages, woodworking -which can be usedfor repetitive operations, thus reducing risk of failure and adminis-trative overhead. World Bank funds finance the foreign exchangecosts of projects, while local commercial bank funds are used tomeet the working capital requirements. Estimated financial and eco-nomic rates of return for the firm to be assisted in the project, largelybakeries, woodworking operations, and garages, range between 25percent and 33 percent. Approximate allocations of the technicalassistance cost to individual subprojects reduce these rates of returnsignificantly, although they still remain about 12 percent. Similarly,adjusting for the cost of assistance raises the average cost per jobgenerated from $5,700 to $8,700.

ANNEXES 89

Korea, Republic of. The Bank loan of $30 million in fiscal 1976 tothe Medium Industry Bank (MIB) was mainly for modern, medium-sized firms in the Republic of Korea, though it is also expected tohave a significant impact on smaller companies. The relatively mod-ern SSE subsector is an important part of the industrial sector and ithas received extensive, well-conceived government support. MIB, afully government-owned financial intermediary, was designed spe-cifically to meet the needs of the smaller to medium-sized firms.As a well-run and sound organization, it has developed, along withthe government's program of assistance and incentives, an in-housetechnical assistance capability which provides help to solve opera-tional and management problems, and some help in preparing feasi-bility studies, training courses, and publications.

Lesotho. A $300,000 IDA credit component, in fiscal 1977, foran SSE project is aimed at institution building. It will assist theBasotho Enterprises Development Corporation (BEDCO), a whollyowned subsidiary of the government-owned DFC, to set up policiesand procedures for effectively channeling credit to small manufac-turers. The IDA credit is for on-lending by BEDCO to finance theforeign exchange costs of SSE projects. Matching local currencvfunds to finance working capital are to be provided from BEDCO'sother resources or by local commercial banks. Although the Bankand the governmeni both recognize that effective assistance to SSEalso requires improved capability of the responsible institution toprovide technical assistance to subborrowers, this is a secondaryobjective of Bank assistance since other bilateral donors are alreadyproviding such assistance.

Philippines. The Philippines SSE operation, supported by a $30million Bank loan in fiscal 1975, is probably the most complex DFCoperation to date. The loan was made in response to the govern-ment's request to improve the access of small entrepreneurs to in-stitutional credit and technical assistance to solve day-to-day operat-ing problems. Because a wide variety of Philippine institutions existto provide credit and assistance to SSE, and because of a need tohave a broadly based geographic impact, the project has four distinctcomponents. These are (1) $15 million for on-lending to SSE by theDevelopment Bank of the Philippines, a wholly owned governmentDFC; (2) a $12 million fund to guarantee up to 80 percent of loansmade by commercial and private development banks; (3) $2.3 mil-lion for on-lending to rural industrial cooperatives through the ruralelectrification authority; and (4) $700,000 for direct Bank support

90 EMPLOYM-NT AND DEVELOPMENT OF SMALL ENTERPRISES

of regional technical assistance centers. National coordination ofall assistance to small entrepreneurs is carried out by the Commis-sion on Small and Medium Industries in the Department of Industry.Most important financial intermediaries, including two supported bythe Bank, are represented on this commission, and field opera-tions are carried out by 50 action teams and at seven Small Busi-ness Assistance Centers. These centers receive technical assistancefinanced by the Bank.

Urban ProjectsProject components to promote small business development are

included wherever feasible in recent urban projects supported bythe Bank. These are largely pilot efforts, and consequently the loanamounts are comparatively small, ranging from $500,000 to $2.4million.

Although there is considerable variation among project designs tosuit local conditions, institutions, and practices, the following threebasic ingredients are generally incorporated:

* Space for workshops and markets.* Credit mechanisms for purchase of tools and equipment, shop

construction or expansion, and working capital.@ Technical assistance and training in fundamental business man-

agement and operations, and technical skills.Eastern Africa. The Second Tanzania Urban Project, approved in

fiscal 1978, seeks to improve the capacity of small business andartisans in selected enterprises in project towns by providing work-shop space, small loans for equipment and working capital, andtraining and assistance in basic bookkeeping, marketing, etc.

Western Africa. The $44 million Urban Development Project loanin fiscal 1977 to the Ivory Coast will support small-scale, informalsector activities by setting aside specific areas within the projectsites. The Caisse Centrale pour la Cooperation Economique is re-viewing a parallel technical assistance and credit line activity to helpentrepreneurs who buy plots in the site and services areas.

East Asia and Pacific. A Bank loan component of $330,000, infiscal 1976, was provided to the Philippines Government to assistvery small businesses and cottage industries in the Tondo and Dagat-Dagatan areas of Manila. This is an experimental effort that includesboth technical and managerial services and credit facilities. Thepackage is primarily designed to fill a gap in financing for smallbusinesses with assets less than $20,000. While funds for small busi-

ANNEXES 91

nesses are nominally available, banks have tended to channel fundsto larger, more secure investments.

A line of credit will be provided to the National Housing Authority(NHA). It will enter into an agreement with commercial banks toadminister loans for subprojects in manufacture of furniture, house-hold implements and simple tools, woodcraft and shellcraft, ma-chine and repair shops, and others. The project will provide 60 per-cent of the loan amount needed, with the remainder to come fromthe commercial banks. The Department of Industry will provide tech-nical services for project preparation and review, professional assist-ance, training, loan processing, and also advice on implementationand supervision. Managerial assistance will be offered under theauspices of NHA, including special courses in business management,elementary accounting, and record keeping.

South Asia. An IDA credit component of $2.4 million, in fiscal1977, has been provided to the Government of India for the city ofMadras, of which $1.6 million is for the construction of work shedsand machinery loans for small industries, and $800,000 for training,equipment, and sheds for cottage industries in the sites and servicesareas and slum upgrading schemes in the Madras Urban Develop-ment Project. Under the project, the work sheds are to be providedby longer-term, lower-interest loans, since the government prefersthat these be built for sale by hire purchase rather than for rent, andit has not proved possible to interest banks in the venture.

The Small Industry Development Corporation will build the shedsand extend loans to small industry entrepreneurs to cover about 70percent of the estimated cost of machinery. The balance is expectedfrom other sources, including local banks. Preference will be givento persons who are prepared to stay in the area and are willing torecruit labor from the project area. Working capital will be providedby banks that have agreed to locate branch offices on the site. Mostof the small industries are expected to be light engineering work-shops that produce for larger industries in the area. Technical, con-sulting, and marketing services will be available. Linkages are ex-pected to be developed between the small and cottage industries,and selected training-cum-production centers might be used fortraining in more industrial activities.

Latin America and the Caribbean. The first urban project in ElSalvador provided limited credit assistance to small productioncooperatives in certain areas. The second project, in fiscal 1977,expanded the credit and technical assistance to any small enterprises


that meet basic eligibility criteria with respect to size, present in-come, and employment. The small-business component of theGuatemala Earthquake Reconstruction Loan, in fiscal 1977, specifi-cally focuses on enterprises that produce home-building materials,such as bricks, blocks, and door frames.

Rural Development ProjectsMexico. A part of the second Bank loan for the national rural de-

velopment program (PIDER), approved in fiscal 1977, is for ruralindustry development. Of a total amount of $14 million for ruralindustry, $9 million is for investment credits to industries owned bygroups of ejidatarios, small farmers, and the landless; $3 million forinvestment in small village industries, each with a total investmentof less than $35,000; and $2 million for technical assistance to ruralindustries, including feasibility studies, additional staff, and stafftraining. Lending is to be limited to 50 microregions throughout thecountry, each with about 50,000 people, chosen on criteria thatbalance poverty level (average per capita income below $100) withpotential for income-increasing, productive activities.

The $9 million component will provide credit to about 50 ruralindustries, engaged in the exploitation of natural resources such assawmill logging, fruit and vegetable processing and packing, feedplants, milling storage, and mineral-based industries. Up to 90 per-cent of loans granted by official and private banks are to be redis-counted by FONDO, the Guarantee Fund for Development of Agri-culture, Livestock, and Aviculture. The $3 million component is forthe development of a plan by PIDER through which governmentagencies will provide finance and technical assistance to village in-dustry. The strategy is to serve local markets and to provide employ-ment at low cost by using intermediate technology. About 300enterprises are to be established in construction materials manufac-ture and handicrafts, at an average investment cost of about $500per job.

International Finance Corporation (IFC)IFC's first small and medium enterprise project, with a loan of $2

million in fiscal 1977 to Kenya, relies on the commercial bankingsystem to provide both credit and basic managerial advice to smalland medium entrepreneurs. The objective is to provide a package ofneeded inputs to small entrepreneurs, and at the same time developan approach which can be applied in other countries.

Commercial banks are already involved in the small-scale sector,providing working-capital loans. Geographic spread is wide, with

ANNEXES 93

continuous contact with consumers. IFC wants to work with institu-tions that are already in place and flexible, and yet separate fromthe government. To meet the needs of small businessmen, IFC ex-pects to lend directly to them roughly 70 percent of the long-termfinance needed. The commercial banking partner will both adminis-ter the IFC loan and lend the residual 30 percent. Needed workingcapital will come from the commercial bank. Nonfinancial assistanceto borrowers will be provided by the commercial institution on aself-liquidating basis and will be useful for basic bookkeeping, mar-keting, and planning. Engineering and technology assistance to smalland medium enterprises is not included in the project.

World Bank OfficesHeadquarters: 1818 H Street, N.W., Washington, D.C. 20433, U.S.A.

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Western Africa: World Bank Regional Mission, Immeuble Shell,64, avenue Lamblin, Abidjan, Ivory Coast; mailing address-B.P. 1850

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