By discussing some of the research into some of the other driving factors behind start-up inception in developing countries – particularly South Africa, I hope to bridge the importance of both international credit markets as a driving factor behind innovation and entrepreneurship worldwide, as well as the necessity of supporting these communities during times of economic downturn. South Africa is well-positioned as a middle-income economy from which there is still a significant amount of available data.
Despite being one of the most advanced economies on the continent (the third largest behind Nigeria and Egypt) and the 33rd largest in the entire world, there are significant structural problems within South African society that make it such an interesting place for a case study of start-up culture. It has extremely high poverty – according to the World Bank, in 2014, 55.5% of the population lived below the poverty line – and its crime rates are notorious worldwide. What’s more interesting about this discussion is that South Africa also has extremely high-income inequality – its GINI coefficient of 63% is the highest in the world. That income inequality, driven largely by the country’s history of apartheid and systemic segregation, has also led to an unemployment rate of nearly 35%. An argument could certainly be made that these factors provide a great opportunity for a strong start-up culture within the country – but also that these same factors could be the reason such a culture could never get off the ground.
A 2014 study from the University of Limpopo analyzing business lending within South Africa examined the requirements for lending, and the results were relatively typical: collateral, relationships between banks and the borrower, credit score, etc. What’s more interesting about this paper is that it reaches a similar conclusion: “given the failure of the formal and public sector to absorb the growing number of job seekers in South Africa, increasing attention has focused on entrepreneurship and new SMEs [small and medium enterprises]”. It goes on to explain that despite this, the rate of SME creation in South Africa is among the lowest in the world, and the country has one of the highest failure rates for new SMEs. So, what other variables matter?
A 2008 study by economists from both Europe and South Africa looked to answer that exact question, and they came up with four variables. The first, financing availability, was addressed above. The others were profit rates, education, and agglomeration (the size of an economic area). Profits (by region) were the largest factor, which, as the authors point out, would heavily imply that start-up activity in South Africa is more opportunity-driven. Perhaps the most interesting finding from this study was a negative correlation between agglomeration and start-up rates, which is to say that the more populated/dense an area is, the lower the start-up growth rates in that area will be. The reasons for this are highly debatable, but the authors propose that the phenomenon is likely due to a number of factors, including significantly increased competition, a higher threat of new entrants into emerging industries, and the existence of certain monopolistic market structures. This finding seems particularly notable to me since urban agglomeration is particularly common in many of these developing countries – many of the largest in the world exist in countries like India, Nigeria, and Brazil.
While this finding does seem a bit surprising and it should not necessarily be taken as a proven fact that mass agglomeration harms start-ups, neither is it something that should be ignored. More research is needed, but if it really is the case that this level of urban agglomeration has a negative effect on start-up rates, it would make sense for the governments of these developing countries to work around it. This can include focus on some of the other factors named in the study – namely, education, which has been shown time and time again to be a massive driver behind entrepreneurship and start-up growth but can often fall behind in developing countries. Returning to the discussion of lending availability, the 2014 study also makes mention of the importance of providing information related to lending to both borrowers and banks to promote a healthier lending ecosystem within which entrepreneurs who have the opportunity for productive investment are knowledgeable on how to realize these opportunities and receive the funding necessary to do so.
It’s been said many times over, but entrepreneurship seems to be the key to developing economies continuing to grow and compete on an international scale. South Africa, and other countries like it, would likely benefit from facilitating these companies, or they could risk stagnating.