In the next decade, over a billion young people will reach working age in developing economies. With current trends, around 40% of these young people, disproportionately women, will fail to find a job. Hence, it is not surprising that the World Bank and other global actors have identified the creation of jobs as one of the most urgent needs of developing economies. Jobs drive economic growth and are a key factor in poverty reduction. They impart dignity at the personal level and cohesion and stability at the societal level.
Larger enterprises are acknowledged as essential engines for economic growth and job creation. However, in many developing countries, particularly in Africa, progress in growing a large business sector has been slow. McKinsey estimated in 2018 that there were 345 large firms in Africa with revenues over 1 billion USD, compared with 1,500 firms in China, which has a smaller population: excluding South Africa, Africa has only around 60% of the large firms one would expect, given the overall size of the countries’ economies. Micro and small enterprises (MSEs) – typically defined as businesses with under 50 employees – continue to be the primary engine of job creation in most developing countries. According to the ILO, MSEs’ share of jobs is over 90% in most countries in Eastern, Central, and Western Africa, and South Asia. A high proportion of jobs in these MSEs are informal – as much as 80% in some countries – with people either working informally for others, often family members, or for themselves.
This is far from ideal for several reasons – lack of job security and social safety nets being among the most important. However, in the medium term, there will continue to be a heavy reliance on MSEs, including single-person enterprises, to provide livelihoods. Although MSEs are more prone to failure than larger enterprises, their ease of setup means that as some businesses close, new ones emerge—driving continuous job creation.
Financial services play an important role in both formal and informal enterprises. MSEs require credit, as well as other financial services like insurance, to launch, take risks, grow, and formalize. In adverse conditions, these services help enterprises, and the jobs they support, remain resilient.
But what does the research say about the ability of credit to shape job creation in MSEs in developing economies, and about the contextual factors that strengthen or weaken that ability?
What we are learning from the Impact Pathfinder
The Impact Pathfinder, an interactive platform created by CGAP, synthesizes over 600 studies on the impact of financial services to make research findings more easily accessible and actionable.
While the Pathfinder primarily focuses on the outcomes of financial services uptake, it also highlights ongoing inclusion challenges, particularly with respect to credit. Evidence shows that MSEs still face persistent barriers to accessing and using credit. These barriers, such as lack of collateral and insufficient data trails, are even higher for women-owned enterprises.
For MSEs that have access to credit, the Impact Pathfinder examines credit’s impact on jobs from two key perspectives: (i) enabling MSEs to create new jobs, and (ii) maintaining MSE resilience, which in turn helps protect existing jobs during shocks. The Pathfinder also synthesizes evidence on the contribution digital payments can make to jobs; however, those insights will be shared in a separate forthcoming CGAP blog.
Unlocking opportunity – the contribution of digital credit
The rapid growth in digital credit, increasingly provided by fintechs, and often delivered via smartphones, has been a significant industry response to the challenges MSEs face in accessing and using credit.
Digital credit benefits new enterprises that cannot secure traditional credit through its often less stringent requirements and faster approval processes. Quasi-experimental studies analyzed by the Pathfinder found that increases in digital credit supply correlate with a rise in the number of small and micro enterprises, leading to more jobs, even if they are sole proprietorships.
For established MSEs, the Pathfinder finds that the evidence is mixed. On the positive side, digital credit can significantly improve business performance for MSEs by enabling investment in working capital and accelerating incremental innovation such as process improvements and product refinements. The research shows that, in certain circumstances, these improvements can promote MSE growth, leading to more jobs. For example, studies in Latin America and Southeast Asia demonstrate that up to 20% of firms increase the number of paid workers after adopting digital credit.
However, the job creation effect of digital credit is uneven. In particular, a large systematic review found that digital lending products lead to higher increases in employment, mainly for enterprises that already have several employees. For substantial growth, businesses often rely on transformative innovation, such as the adoption of agri-tech in the rural sector, which requires larger and longer-term financing. Digital credit currently does not offer this, and traditional credit providers are reluctant to extend such finance to MSEs – particularly the smallest, which are viewed as high-risk. This leaves many such enterprises caught in a low-growth trap.
Despite this mixed picture, the Pathfinder finds that credit can contribute to women’s economic empowerment and that there are positive pathways to business growth. Evidence analyzed, on both digital and traditional credit, suggests that credit, combined with effective training in financial capability and business management, can help women entrepreneurs grow their businesses by increasing their asset base and expanding their workforce. Networking opportunities and community engagement are also important factors of success.
Supporting resilience in MSEs
MSE growth represents one side of the jobs coin, while MSE resilience – the preservation of livelihoods and jobs – represents the other. The Pathfinder shows that credit plays an important role in MSE resilience, particularly in preparation for and absorption of shocks.
The evidence of both traditional and digital credit in supporting jobs through enhanced MSE resilience is mostly positive. First, credit can lead to greater liquidity, which helps MSEs prepare for and weather shocks, reduce the need to sell off assets, and prevent them from cutting jobs as coping mechanisms. For example, a widely cited RCT in Mexico found that borrowers were 20% less likely to sell assets to repay loans compared to those who did not receive credit.
Second, evidence on microcredit shows that pairing it with other financial service interventions, such as health insurance, improves entrepreneurship outcomes, including the survivability of enterprises. In addition, research focused on group credit shows that it can reduce the use of negative coping mechanisms among MSEs, for example through peer influence.
While substantial evidence exists on credit’s contribution to MSEs’ ability to absorb shocks, less is known about its effect on recovery from shocks. Most research focuses on the lack of credit after a shock, not its effects on those who manage to borrow. The Pathfinder reports that post-shock credit supply is often limited, available only to certain industries, and comes with strict eligibility conditions. Limited access to credit after a shock can lead MSEs to rely on high-interest informal loans, resulting in over-indebtedness or the use of harmful coping strategies like workforce reductions.
The enduring relevance of MSEs in the jobs agenda
As our hopes of transformational job growth through more and bigger enterprises are tempered by slow progress in many developing economies, especially in Sub-Saharan Africa, MSEs will continue to provide the majority of jobs for years to come. Credit is as important to these enterprises as to larger ones, but it is clear that it does not always meet their needs. While MSEs are more likely to have access to digital than traditional credit, it is often insufficient in loan size and duration to underpin ambitious and sustained growth. By contrast, credit’s role in helping MSEs to be resilient – to weather fluctuations in market conditions and other shocks – has a more consistent record.
Overall, the Impact Pathfinder underscores the importance of credit’s role in job creation and preservation, showing clear opportunities for digital credit to support MSE growth and resilience, and thereby job creation and preservation, but it also highlights pitfalls such as the absence of supportive mechanisms and finance terms and conditions adapted to the needs of the smallest enterprises.
There are gaps in the evidence, such as in credit’s role in recovery from shocks, but the Pathfinder has important insights into where funders and FSPs can improve the range of credit products and supporting programs to help MSEs contribute more to the jobs challenge.
