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Problems of Financing for SMEs in UAE
There are many reasons why SME’s are considered to be the drivers of economic growth. One is that most large companies and multi-national enterprises (MNE’s) have relatively humble beginnings and being a small or medium enterprise can be seen as the foundations from which future behemoths grow. Alongside this, it is the nature of market economies to be competitive and thus, assuming that market failures are adequately dealt with by governments, there is the generic for increased competition. This, of course, benefits consumers and overall living standards if the economy and entrepreneurs within it are constantly founding small businesses, some of which will compete successfully and go on to become medium sized and ultimately large companies (McConnell and Brue 2008). The dynamic of the ‘invisible hand’ (Smith 1904) of the market, if allowed to be successful, fundamentally enables the growth and transition of economies so that they constantly develop. This process, of course, depends not only on entrepreneurs, but also on the market conditions that will enable such a flourishing and constant replenishment of SME’s.
Alongside these points, the nature of the world economy has changed dramatically in recent decades and entrepreneurs are thus faced with increasing competition within what may be called a ‘globalised’ economy and increasingly integrated markets. Thus, it can be argued, constant innovation and change as well as the increased competition that is driven by the creation of new businesses may be the decisive factor which determines not only the relative success of a nation, but also its placement within the world economy. Griffiths et al (2007, p. 11) discuss and encapsulate these points by noting that the economic environment in which SME’s operate has changed over the past half a century and “has been subject to accelerating change” and, further, that there have been “significant sectoral shifts in the composition of national economies combined with the increasing ‘openness’ of the global economy.” Such changes, note Griffiths et al (2007, p. 11), have had significant effects in causing changes in value chains, which requires the positions of SME’s to be “reconfigured.”
However, whilst we can discuss at length the opportunities and challenges which are faced by the owners of SME’s, and ponder the most appropriate strategies for their development by individual entrepreneurs, there are several important institutional factors which may inhibit their development. In other words, if we accept that there is an inherent desire amongst some people in every nation to take business risks and thus start businesses, there must be wider reasons for the relative success of some countries over others. Solow (2000) developed his famous theory of economic convergence in the original publication of his book in 1970 and we can note, for example, that whilst economic convergence (between developed and developing nations) should take place within this macroeconomic theory, one of the vital provisos is that institutional constraints must be removed (the other major constraint is the propensity to save). One important potential difficulty lies in raising finance and this may often be a particularly disadvantageous factor in developing nations for a number of reasons.
This issue is discussed by the ADB (2009) and a number of salient points are made. For example, that in terms of risk and cost strategies banks will (other things equal) be more averse to lending to smaller rather than larger companies. This point is supported by SME’s themselves, who consistently report a lack of available finance in terms of bank borrowing as one of the major obstacles to doing business. Ayyagari et al (2006) further emphasise this difficulty with empirical evidence which draws an association between the size of firms and the extent to which bank financing is a major problem.
Hallberg (2000, p. 11) importantly points out that one reason for a limited availability of funds in developing nations is the relative lack of competition in some of them in terms of the financial sector. Thus, we can suggest that banking sectors have the potential to act in an oligopolistic fashion and, indeed, have the further potential, given the wrong institutional environment, to collude and thus act as a monopoly (Carlton and Perloff 2005, p. 634). Of course, the pitfalls not only for consumers but also SME’s if such a market failure exists can be catastrophic because the banks can not only set draconian interest rates, but demand collateral to the point that they no longer act as banks in terms of taking and managing risk because they effectively eliminate almost all danger (of risk) by such practices. One further and, perhaps, underreported constraint in numerous developing nations is a lack of enforceable bankruptcy laws. Fundamentally, if there are no effective such laws, banks have no choice but to insist on the collateralisation of lending, thus severely limiting borrowing options, particularly amongst SME’s.
One further problem lies, perhaps, with the cultures and practices within some developing nations in terms of equity financing. This is one potential way in which firms can surmount the difficulties in bank borrowing, and may even obviate the competitive disadvantages associated with high bank interest rates. However, a lack of understanding of the advantages by many emerging and developing market entrepreneurs in the role of venture capital, as well as other constraints, means that the role of equity financing “has been very limited” (UNCTAD 2001, p. 33).
References
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