by Ayman Ismail

Almost a century ago, an Austrian economist, Joseph Schumpeter(1), popularized the idea that entrepreneurship is at the core of economic development. As a result of Schumpeter’s research, entrepreneurs are now recognized as the innovators who create new ventures that grow the economy.

However, as entrepreneurs grow their new ventures to become larger and established companies, they need access-to-finance, beyond what they can sustain through their personal and family savings. They need access to institutional capital, the primary source if which is long-term loans from commercial banks. Therefore, access-to-finance is a critical element of growing these entrepreneurial ventures; however, banks and other financial institutions in many emerging economies, especially in the MENA region are not performing the role of providing this entrepreneurial finance effectively.

A critical part of the economic growth virtuous circle is the efficient mobilization and channeling of national savings and foreign capital towards entrepreneurs by financial intermediaries and institutions. The entrepreneurs in turn build the productive capacity, increase employment and productivity, and translate into more savings and hence additional investments.

However, if an economy is not able to mobilize its domestic savings into new capital investments and entrepreneurial ventures, these savings do not translate into the desired growth and increase in productivity and employment. Therefore, efficient channeling of resources is vital for the MENA region, because there is a huge increase in population that needs to be matched by a corresponding increase in the mobilization of capital to provide employment opportunities for the growing workforce.

Mobilizing savings and efficiently allocating resources are two critical roles for banks and other financial institutions that are key for entrepreneurial development. However, World Bank analysis of emerging economies in the MENA region shows that banks are not performing this role effectively: most entrepreneurial companies have limited access to long-term bank credit, and most banks have extra savings that are not mobilized into local productive investments(2). 

Banks in most emerging economies in the MENA region are not flexible or effective enough to provide the required investments to match the needed growth rates. The state has maintained tight control of the banking system by directly owning and operating the largest national banks; restricting entry of foreign banks; or enforcing strict limitations of the products and services offered by banks. Governments argue that these controls are important to protect their emerging economies against situations like the Asian financial crisis, which may result from rapid deregulation of financial markets.

These controls over the banking sector along with other factors such as the limited capabilities of national banks and other financial institutions also result in restricted access-to-finance for domestic companies from the banking sector. For example, four out of every five Egyptian firms do not use long-term bank credit to finance their investments or working capital; instead, they rely on other sources such as retained earnings or individual investors (family and friends)(3). Given that the role of entrepreneurship in as an engine of growth through creating a diversified economy and creating employment opportunities, the governments of the MENA should encourage competition and innovation in the financial sector and provide a regulatory and incentive framework that ensures availability of long-term commercial debt to entrepreneurs so that they can play a positive role in the growth and development of the economies.

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References

Domar, Evsey. 1946. “Capital Expansion, Rate of Growth, and Employment.” Econometrica 14:137-147.

Levine, Ross. 1997. “Financial Development and Economic Growth: Views and Agenda.” Journal of Economic Literature. 35:2, 688-726.

Ricardo, David. 1963 (1817). The Principles of Political Economy and Taxation. Vol. I. Illinois: R.D. Irwin.

Schumpeter, Joseph. 1942. Capitalism, Socialism, and Democracy.

Smith, Adam. 1979 (1776). The Wealth of Nations. Chicago: University of Chicago Press.

World Bank Enterprise Surveys. http://www.enterprisesurveys.org.

World Bank. 2005. “Egypt Investment Climate Assessment.”