Opportunities and Challenges of Small Business Enterprises in Gedeo

Zone- Ethiopia: From Policy, Regulatory and Institutional Perspectives

Berhanu Getinet Kibret Dr.Venkateshwar Rao.

Rokandla* Admasu Abera Lalisho Eyoel Sileshi
Belayneh

Abstract
The role of small business enterprises in employment and income generation is increasingly
recognized and has become a major playing field for policy maker and donors with dual
objective of enhancing growth and alleviating poverty. This study investigates the opportunities
and challenges of small business enterprises and presents analysis of policy and regulatory issues
in the growth and development of the sector in Gedeo Zone. The survey was conducted on eighty
randomly selected enterprises in the four major towns. The data were collected through a
structured questionnaire and analyzed using descriptive methods with the aid of Statistical
Packages for Social Sciences (SPSS V 20). Even though, the government gives more emphasis
and attempts to liberalize and improve the policy and regulatory environment of the sector, the
results of this research indicates that there is a divergence between policies and directives issue
and their actual implementation frame work consisting of appropriate action programs, schemes,
and regulatory acts.

The results of the research show that high tax, inefficient tax administration, prices of inputs,
bureaucratic burden, lack of raw materials, inadequate skills, high interest rate and high collateral
requirement are the major constrains hindering the expansion of small business enterprises. To
expand small businesses which result in economic development and job creation the
governmental and non-governmental organizations are expected to coordinate regulatory and
institutional support like business premises, easing bureaucratic bottlenecks, financial services
and training.

Key words: Challenges, Gedeo Zone, Opportunities, Policy, Regulatory, Small Business

I. Introduction
Innovation and entrepreneurship are the major driving forces of growth and prosperity, and the
core elements of national economic development policies in both developed and developing
nations (Tesfa Yohannes, 1998). Maslow (1968) found that the most valuable 100 people to
bring into deteriorating economy are not politicians, economists, scientists, engineers, but self-
motivated, talented and forceful entrepreneurs. This indicates that poor countries need to redirect
their socio-economic development policies and strategies towards this trend to achieve economic
diversification; universal basic needs fulfillment and minimizes vulnerability in the current
turbulent and uncertain global business environment. Small business vitality is more prevalent in
the developing economies as they constitute a significant part of the national economic
productivity, they play a pivotal role in accelerating the evolutionary transition from agrarian
dominated to industrial society (Briscoe, 1995). According to most studies, small business are
more labor-intensive than the large ones and some even find that they also produce more output
(value added) per unit of capital thus generate more output as well as employment for a given
investment than do larger firms (Steel,1990).
The small business sector is described as the natural home of entrepreneurship. It has the
potential to provide the ideal environment for enabling entrepreneurs to optimally exercise; the
MSEs are seen as an essential spring board for growth, job creation and social progress. This
sector is also seen as an important force to generate employment and more equitable income
distribution change and through the combination of all of these measures, to stimulate economic
development (Zewde and associates, 2002).

However, the small business sector in Ethiopia appears to be fraught with a number of policies,
regulations, laws, rules and related challenges that stifle its rapid growth and development as a
means of overcoming poverty and unemployment. Conducive policy environment is increasingly
seen as an important factor in enabling small business enterprises to create more and better jobs.
Thus, this study explores the policy and institutional opportunities and challenges of small
business enterprises.

II. Literature Review

This section examines the main issues of policy and institutional environment of small business
enterprises. The ability of small businesses to realize their economic and social objectives
depend on the regulatory and policy environment with in which they operate (ILO, 2000). While
many countries have recognized the importance of micro and small enterprises and formulated
these enterprises support policies, the other economic policies are still often favoring large
enterprises over the smaller ones. Small enterprises often have to incur unnecessary high costs to
comply with laws and regulations. This argument is emphasized by the OECD (1997), some
regulations may deliberately favor small businesses (many regulations exclude the smallest
firms) in general the adverse impact of regulation on small businesses can be particularly
harmful. This is because small businesses are less equipped to deal with problems arising from
regulation since they have less capacity than larger firms to navigate through the complexities or
regulation and bureaucratic networks.

As per Holden S. and Locklin (1998) argued that payments made to avoid detection of non-
compliance, or pay offs to government officials are the costs of operating in the informal sector.
Lowering the costs to establish and operate a small business and increasing the potential benefits
of registration may be an effective straggly for integrating smaller enterprises into the formal
economy. Regulation on MSEs take different forms: Economic, social and administrative
regulations. And the next section discusses the process through which these regulatory policies
affect MSEs in developing countries.

Arête et al (1994) also emphasized that the process of registering a company and obtaining a
manufacturing license to commence business can be a cumbersome process in developing
countries. Even when the enterprise is registered .most have done so only to avoid complications
from government officials, rather than to receive any benefit from being legal (Wasunti Wongse,
1999). However designing and implementing appropriate economic policies, strategies, and legal
and regulatory frame work are prerequisites for creation an enabling environment to promote
small businesses. A study conducted by the ECA (2001) indicates that although the regulatory
and policy environment for small business vary across African counties such as Cameroon,
Ethiopia, Gabon, Nigeria, Senegal and Uganda have shown that the policy environment in which
small business operate is a major handicap for their expansion and growth.

Requirements on collateral and security are other restrictive policies that hinder small business
development. Since, the sector have generally been considered as risky, financial institutions
demand collateral from entrepreneurs often in the form of landed property prior to the granting
of a loan or credit (Lied Holm and Mead, 1998).

According to Gebre Hiwot and Amha (2004) the tax levied on imported raw materials is often
higher than that on import finished products that use the same raw material Since MSEs export
or import in small quantities, the fixed costs of dealing with import and export procedures
heavily weight against small businesses. Quarter (2001) found that there are three ways in which
taxation affects the transaction cost of small businesses. These include complex tax systems,
enforcement and volatile tax system.

III. Methodology
III.1 Statement of the problem
The pivotal role of small business enterprises to the building of indigenous based and developed
national economies and advancing technological innovations has created the scenario that small
businesses collectively have a greater stake in promoting corporate citizenship in general (Tylor,
2004). They are known for generating mass employment, promoting indigenous entrepreneurship
and meeting broad local demands for goods and services. They are also instrumental in
accelerating the process of transforming traditional industry into a modern one who’s supporting
props or pillars are deeply rooted in the culture and ethics of the indigenous people (Trulsson,
2002).

In spite of this fact, the currently available literatures on small business enterprises indicated that
in most developing countries like Ethiopia face a wide range of constraints and they are often
unable to address the problems they face on their own-even in effectively functioning market
economies. The constraints relate amongst others to; policy and institutional environment, access
to finance and market, business premises, acquisition of skills, lack of raw materials and lack of
infrastructure (ECA, 2011). Recently, these countries adopted poverty reduction strategies that
mainly emphasize promotion of small businesses as a major way to reduce poverty. The efficacy
of such interventions, however, depends on identifying the key challenges confronting these
businesses. Hence, the study is conducted with the intention of investigating the opportunities
and challenges of small businesses enterprises in Gedeo Zone and giving policy
recommendations.

III.2 Objectives of the study

The general objective of the study is to examine the opportunities and challenges of small
businesses in Gedeo Zone- Ethiopia, so as to create meaningful and sustainable employment
opportunities and poverty reduction. Specifically the following objectives have been achieved.
To identify the policy and institutional opportunities for small
businesses To analyze the policy and institutional challenges of small
businesses
III.3 Data and Data Analysis
The descriptive research design was employed to describe the policy and institutional
opportunities and challenges of small businesses enterprises. The sample was drawn from
registered and unregistered small businesses enterprises in the private sector. The data source of
this study was a survey conducted by the researchers on small business enterprises. The study
area covers the four towns in the Gedeo Zone namely: Dilla, Yergacheffe, Wonago and Gedeb.
A total sample of 80 enterprises comprising 30 enterprises from Dilla, 19 enterprises from
Yergacheffe, 16 enterprises from Wonago and 15 enterprises from Gedeb were selected for this
study. The data were collected through a structured questionnaire and analyzed using descriptive
methods with the aid of Statistical Packages for Social Sciences (SPSS V 20).

III.4 Significance of the Study

The present research paper explores the policy and institutional opportunities and challenges of
small business enterprises, thus contribute to the so far scant empirical literature in the zone in
particular and in general in Ethiopia. It acts as an indicator to the policy makers in that it can
ascertain whether it is working toward the economic development via the development of the
sector. Moreover, the paper will be a ground literature for other potential researchers who have
the interest to conduct a further study in the sector

III.5 Scope of the research

This study investigates the policy and institutional opportunities and challenges of small business
in Gedeo zone. The study covers all small business enterprises engaged in activities including
trade, service and manufacturing. Street vending and capital intensive businesses like goldsmith
and jewelry are beyond the scope of this paper.

IV. Results and Discussions

In this part of the study, the researchers analyzed the policy and institutional reforms impacts on
MSE sector, and assessed the regulatory constraints in the MSE sector and finally has given
some policy recommendations for the problems identified based on the findings of the study.

Chart 1: Businesses registered and have operating license

yes No
12, 15%

68, 85%

Source: Own Survey, 2014

In the study the researchers asked business enterprises questions related to their registration and
license status and in this regard the above chart shows the status of business enterprises and from
the total sample enterprises, 85 percent of them are registered and have a license and the
remaining 15 percent are not. The formal sector and staying in formal are costly to the operators.
It includes registration and licensing fees, Braun and Loayza (1994) found that the costs of entry
in to the formal sector and staying formal could have significant impact on business enterprises.
These are costs that can be avoided or evaded by being informal.
Chart 2: Reasons for not being registered and licensed for the small business

61.25
43.6
52.56 53.8
10

Business is small
to have Taxes are too high
No need of Percentage
registration or
license registration and Registration and
license licensing costs Bureaucracy in
(initial and registering and
renewal licensing
expenses) procedure

Source: Own Survey, 2014

In the study the researchers asked business enterprises those who are not registered a series of
questions about the various reasons for not to get registered. For those unregistered, the most
common reasons include ‘taxes are too high’ (61.25%), ‘bureaucracy in registration and
licensing procedure’ (53.8%), ‘registration and licensing costs’ (52.5%) the business is too small
to be registered and licensed’ (43.6%) and ‘no need of registration and license and it is possible
to do without it’ (10%).

On the other side, being licensed is not without cost either, since it involves costs in the form of
penalties (or bribes to escape penalty) up on detection and forgone benefits of not being able to
“take full advantage of government provided goods” (Braun and Losyza, 1994). Accordingly, the
researcher asked the MSE operators about the perceived benefits of registering and having a
license. This is summarized in chart 3.
 Chart 3: Reasons and benefits for being registered and licensed

60 51.2* 49.26 *
50
38.75*
40
30
20
percentage
11.6* *the sum is more than 100% since respondents
6.5*
10

0
I would not I can apply I can apply It increasesI can buy
have to give bribe for the government
for the credit
officials
for landcustomersraw materials in
bulk

Source: Own Survey, 2014

Being registered and licensed has benefits for business enterprises. The study revealed that ‘I
would not have to give bribe to government officials’ (51.2%) ‘I can apply for credit’ (49.29%)
‘I can apply for land’ (38.75%) ‘I can buy raw materials in bulk’ (11.6%) and ‘It increases the
number of customers’ (6.5%) are some of the common benefits from getting registered and
licensed.

Impacts of Policy and Institutional Reforms on Small Business Enterprises

Policy and institutional reforms and liberalization are expected to have a positive impact on the
development, competition, production and productivity of business enterprise. However, placing
the enable conditions alone may not foster the growth of these enterprises and thus it needs
additional conditions among other things like an access to resources such a skill, technologies,
credit, infrastructure, markets, etc. (Ageba and Amha, 2004). This study attempts to investigate
whether there has been an improvement in the policy environment and licensing procedure in the
last 23 years and presented hereunder.

Chart 4: Improvement in policy environment in the sector

100
80
61.25
49 Number
Percentage
18 22.5 13 16.25

Yes No I do not know Total

Source: Own Survey, 2014
The above chart 4 reveals that about 61% of the business enterprises reported that the policy
environment has been improved in the last 23 years. Only about 23% of the operators reported
that they never recognize any improvement in the policy environment for their enterprises. Even
a significant proportion of the business enterprises operators (about 16%) have no information
whether the policy environment for the growth of their enterprises has improved or not. This fact
shows that even though a lot remains to be done by the government to create a good and
permitting environment for the growth of these enterprises, the reform of 1993 improved the
environment for the growth and development of the business enterprises in the zone.

Chart 5: Degree of policy and institutional changes observed in the small business sector
70 62.5
60 57.5 56.25
51.25
50 45 47.5
43.75 43.75
40 36.25
28.75 30 41.25 Increased a lot
30 23.75
17.5 Increased slightly Decreased a lot Decreased
20 16.25 16.25 I do not know
10
0

Source: Own Survey, 2014

Policy and institutional reforms are expected to enhance private investment and competition in
the economy. The results of chart 2 indicate that investment and competition have increased in
the last 23 years especially after the reforms of 1993.The respondents reported that investment,
protection from domestic competition, improvement in infrastructure, access to finance, access to
market, and price of their product are increased slightly while only protection from import
increased a lot. Thus, the result shows there is a favorable change in policy and institutional
variables in the sector.

Regulatory Constraints in the small business sector

There are various policy and intuitional related problems which act as a bottleneck for the
development of small business sector.
Chart 6: Degree of seriousness of problems/constraints in the last 23 years

60 51.25 51.25
50 42.5 45 46.25 43.75 46.25
40 36.25
30
20 21.25 21.25
10 Not problem %
0 A minor problem %
A moderate problem % A major problem %
A severe problem %

Source: Own Survey, 2014

As it can be observed from chart 7, the first three factors rated as a severe problem are high tax,
high collateral requirement and bureaucratic burden in that order. Regarding factors that are rated
as major problems the prominent figures are bureaucratic burden (51.25%), credit access
(51.25%), tax administration (46.25%), high taxes (46.25%), high interest rate (45%), high
collateral requirement (43.75%), lack of raw materials (42.5%) and luck of business premises
(36.25%). And other factors rated as major problems by a significant numeral of respondents are
inadequate skill in the business (21.25%) and entry regulation (21.25%).

V. Conclusion and Policy Recommendations

V.1 Conclusion
It is evident from the survey result; most of the small businesses in the study area are formal and
having a license and got registered. Regarding the policy environment for the small businesses,
more than half of respondents reported that the policy environment has improved for their
enterprises especially after the reform of 1993. However, a good number of the sample firms do
not recognize whether the policy environment has improved or not.

The research results indicate that investment, protection from competition (domestic or foreign),
support from the government, access to finance, access to market, infrastructure and price of the
product have shown an considerable improvement in the last 23 years.

The regulatory constraints which the research investigates as major and/or sever problem
includes high tax, high collateral requirement, bureaucratic burden, lack of credit access,
inefficient tax administration, high interest rate and lack business premises.
The possible reason for the bureaucratic burden is identified as a major problem is due to the
procedures (red-tape) to comply with regulations such as taxation, environmental regulations,
and procedures that necessary to get benefit of government incentives are difficult to comply
with partly due to bureaucratic requirements. While large firms have staffs specialized in these
matters, such requirements represent an enormous burden for small businesses. Thus, the
required change is not exemption or complete deregulation but simplification of procedures.

Also it is possible that the complaint about taxes being too high may partly reflect the fact that
tax enforcement or collection stringent in the last 23 years compared to the period before. For
those who were not paying taxes before the reform of 1993 due to tax evasion or otherwise, not
fully aware of the taxes they are required to pay. There could be yet another possible explanation
once we recognize that; in the absence of book accounts, small businesses pay taxes as assessed
by tax officers and these officers may deliberately over estimate tax obligations (taxable income)
in order to force them to give kickbacks (corrupt) in return for underestimating their taxable
income.

A high proportion of respondents reported that high collateral requirement is one of the major
problems for their businesses. This is due to the reason that commercial banks often discriminate
against small businesses because of that they are considered high risk clients with little or no
resources to provide collateral.

V.2 Policy Recommendations

It is expected that implementation of policy recommendations for creating conducive
environment for small business will result in reducing the number and simplifying the
compliance process. The improvement of regulatory frame work, provision of specialized credit
lines, and risk sharing schemes for financial institutions and fiscal environment will improve the
accessibility of formal sources of financing. Generally speaking, these all are expected to trigger
fast paced creation and expansion of small businesses resulting in economic development and
job creation. In order to meet these targets the present research suggest the following feasible
policy recommendations:
1. Capacity building for the selected sector by initiating and organizing regular training,
work shop and experience sharing from successful enterprises, and provision of
advice and consultancy services for small businesses enterprises.
2. Encourage establishment of small business sector, specifically export oriented marketing
companies by providing matching grants to conduct marketing research, developing
marketing strategies, participating and conducting trade fairs and undertaking
promotional and marketing strategies.
3. Review of prudential regulations, periodically in line with the small business credit
demand and supply data.
4. Establishment of credit guarantees and credit insurance companies; and support financial
institutions in designing and launching small business based program lending schemes.
5. The government should ensure adequate provision of physical infrastructure such as
roads and utilities for the sector.
6. The government functionaries should review and design all-encompassing policy to
address issues related to license/ registration and premises/ location on which small
businesses operate.
 7. Facilitate governmental regular purchasing from smaller business suppliers.
8. Initiating agglomeration such as, creating commercial centers and cooperative marketing
arrangements which could help improving growth of small business.

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