1. INTRODUCTION

The recognition that structural transformation and productivity growth provide the key to enhancing growth is a core component of economic theory and economic policy. These objectives could be met, Adam Smith argued, through the division of labour within and between enterprises. Further, added Smith, the division of labour was a function of the size of the market—the larger the market, the greater the scope for specialisation. Coupled with Ricardo’s argument that specialisation in comparative advantage allows for win–win outcomes through exchange, these core ideas in classical economic theory provide an effective rationale for international trade, especially for small- and medium-sized economies with limited domestic markets.

Trade in manufacturing has played an especially prominent role in global economic growth, particularly in recent decades. This is partly because the manufacturing sector has been the major arena for technological change and productivity growth, partly because linkages in manufacturing spread efficiency gains across the manufacturing sector and to other sectors, and partly because manufacturing’s employment intensity has helped to spread the gains from exports and economic growth. However, African manufacturing faces severe challenges in growing manufacturing activities in the face of China and Southeast Asia’s (SE) competitive dominance of global manufactured product markets. This impact occurs in two forms: indirectly blocking African-manufactured exports’ market growth in third-country markets, and directly through African manufacturing producers being undermined by cheaper Asian imports (Edwards and Jenkins, 2015; Kaplinsky, 2008; Morris and Einhorn, 2008). A more recent indirect development is the potentially destructive impact of export of raw materials to China and SE Asia economies which inhibits local production through a reduction in the availability of inputs or an increase in their prices. For example, the export of raw timber from Gabon to China undermines local processing into higher-value added veneer products which had previously been exported to Europe (Kaplinsky et al. 2011). The felling of wild shea trees in Ghana and Burkina Faso and their (mostly illegal) export to SE Asia as timber for furniture production constrains the local Small- and Medium-sized Enterprise (SME)-based shea butter processing industry. Likewise, the export of scrap metal to Asian economies starves domestic metal fabricating SMEs of access to cheap local inputs.

The observed reality of 300 years of economic progress since the onset of the Industrial Revolution is that economic growth and cross-border trade have gone hand in hand. Global trade is heavily concentrated at the corporate level. It was estimated that at the turn of the millennium the largest 500 global firms controlled 70% of global trade.¹ Hence, it is natural to conclude that economic growth in Africa can best be fostered by facilitating a growth in manufacturing exports by large firms. And because there is a dearth of large indigenous firms in many African economies, this will necessarily involve increased foreign investment. Many African economies have concentrated on this route to export growth, including through the promotion of export processing zones.

This reliance on large firms as a driver of trade is problematic, not least on the African continent. For one thing, large firms tend to be capital intensive, and unemployment is perhaps one of the greatest challenges facing Africa. Between 2000 and 2008, the rate of employment growth was less than half that of economic growth, and even though the rate of employment speeded up between 2009 and 2014, it still lagged economic growth by an average of 1.4% annually (UNECA, 2017). Slow employment growth disproportionately affects women and youth (Africa’s youth population is anticipated to grow from 226 million in 2015 to 321 million by 2030) and has enormous poverty and political impacts. In recent influential papers, Rodrik has presented evidence to show that manufacturing is unlikely to be a major source of employment growth globally (Rodrik, 2016; Rodrik, 2018a). Further, on the basis of growth trends in Africa involving manufacturing exports by large firms in Global Value Chains (GVCs), he has expressed particular pessimism about the capacity of export trade to make a significant contribution to meeting Africa’s employment challenge (Rodrik, 2018b). Moreover, with the advance of the Fourth Industrial Revolution there is widespread recognition that, globally, employment growth will pose a major challenge to society and economic policy.

From the African perspective there is an additional employment challenge to be confronted, and that is the limited capacity of the formal sector to absorb labour. As in other parts of the developing world, a very large proportion of Africa’s labour force earns its incomes in the informal sector. This is particularly the case for Sub-Saharan Africa (SSA), as Table 1 indicates, where more than two-thirds of employment outside of agriculture is in the informal sector, and this proportion has grown.

Hence, it is critical to find a route to a synergistic trade and economic growth path which is more inclusive, that is, one that is more employment intensive, more decentralised and which provides scope for enhanced activities by indigenous and small-scale industry. This is not to argue for the exclusion of large firms or Foreign Direct Investment (FDI) in economic growth, but rather to argue the case for an increased presence of indigenous small-scale firms in the economy and in export trade. However, before addressing the evidence in this regard, it is necessary to highlight six related key drivers of global trade which have grown in importance since the mid-1980s.

The first of these is the centrality of GVCs in trade. In recent decades value chains have become increasingly fragmented and this follows directly from the division of labour anticipated by Adam Smith. In a highly competitive world, in which the degree of competition has heightened with widespread trade liberalisation, producers have specialised in core competences in which their command over producer and product rents provides barriers to competition. Activities in the chain which are not protected by entry barriers are outsourced. Increasingly this outsourcing has taken a global dimension such that value chains have evolved into GVCs. The definition of GVCs in trade statistics involves the exchange of products involving productive activities in more than two economies. United Nations Conference on Trade and Development and the World Trade Organisation calculate that this trade now accounts for more than two-thirds of total global trade.² Much of this global trade is in intermediates, rather than in raw materials or finished products.

The second relevant development is the extent of governance of trade in GVCs. In many cases, global trade continues to occur on the arms-length basis beloved by economic texts; some of this is within GVCs as it involves more than two economies in the production process. However, the growing complexity of trade in intermediates, particularly in products involving the assembly of imported intermediate inputs, has enhanced the significance of logistics in managing these global production systems. The need for sophisticated logistics controls is heightened by just-in-time production which necessitates delivery reliability and total quality control along the chain. In addition, the fragmenting of final product markets requires careful control over the distinctiveness of intermediate inputs. Consequently, an increasing (although unmeasured) proportion of trade in intermediate products requires detailed control by lead players in GVCs, that is, chain governance. Here, there has been a pervasive growth in the importance of buyers in many sectors (Gereffi, 1999). For example, in the case of final simple consumer goods, retail chains, category buyers and other intermediaries dominate the organisation of global production and exchange along the chain. In more complex durable goods such as automobiles and electronics, the chains are dominated (i.e., governed) by lead firms who control access to supply chains and determine the rules of incorporation.

Third, a primary mechanism of governance in GVCs are the standards which suppliers have to meet to be included in the chain (Kaplinsky and Morris, 2018). Typically, at the corporate level, the key standards are Q–C–D. This involves requirements with regard to quality (Q), demands for cost-containment/reduction (C) and reliability and frequency of delivery (D). If suppliers do not conform adequately, they may have to pay a penalty or receive lower prices (or both), or be ejected from the chain. However, corporate standards are not the only set of standards affecting gainful participation in GVCs. In an increasing number of final product markets, civil society organisations set standards affecting the conditions under which production occurs, such as with regard to labour standards and the environmental provenance of production processes. While both corporate and civil society GVC standards involve a trade-off between the degree to which standards are met and the rewards to suppliers, governments and intergovernmental bodies such as the European Union set regulations which determine entry into final markets. These regulatory standards provide no scope for the degree of conformance and are a basic requirement for market entry.

Fourth, the extent of governance and the character and importance of standards are critically determined by the nature of the final market. In general, the higher are per capita incomes in the final market, the greater is the degree and complexity of governance and resultant standards in GVC trade. This applies not just as a basic differentiator between the economies to which exports are destined, but also to the niches which are served within different economies. Some markets in low-income countries involve standard-intensive value chains, and similarly, some low-end markets in high-income countries are relatively standards free (Guarín and Knorringa, 2014).

Fifth, the relative importance of intraregional trade at a global level is often underestimated. Made in China is in reality often made in East Asia. Formal regional agreements not only facilitate the movement of goods across regional borders, but also of people and capital. Much of this regional integration occurs within the framework of Regional Value Chains (RVCs), through regional economic hubs and decreased transport costs expanding the scale of regional markets and the scope of regionally based FDI and production. When RVCs create backward and forward linkages, this often spills over local borders and extends the scope of regional integration. Hence, regional integration is often integrally intertwined with RVC expansion and linking to global trade through GVCs (UNIDO, 2018).

In Asia such economic hubs, coupled with shared norms and institutions which facilitate trust networks and reduced transaction costs, have expanded regional economic integration. These have expanded the scope of RVCs and their integration into export-oriented trade to the extent that “value chains are often organized regionally rather than globally” (UNIDO, 2018; p. xviii). As a consequence, “Southeast Asian economies source over 40% of their foreign value added in exports from Asian partners” (UNIDO, 2018; p. 18).

Likewise, in SSA there is evidence that regionally determined rules of origin have facilitated market entry into economic hubs. Regional market entry is governed by large regional retail firms, and the RVCs which arise are driven by large regionally located manufacturing firms, building cross-border supply chains in the process. However, unlike Asia, these have often resulted in an integration between RVCs and GVCs in global export-oriented industries. For example, the large foreign Transnational Corporations (TNCs) which dominate apparel exports to the United States and European Union have not, at least yet, created backward supply chain networks throughout the region (Morris et al., 2016).

Finally, and this goes almost without saying, global markets have become increasingly competitive as trade liberalisation has proceeded and as production capabilities have grown globally. Producers who are unable to improve their offerings (in production processes, product character or both) are either excluded from the market or experience extreme pressure on margins. In the worst case, surviving firms and economies are driven into an immiserising growth path in which incomes fall despite an increase in the resources devoted to production and exchange. Hence, the capacity to upgrade, continuously and not just as a single action, is key to gainful participation in global export markets.

We now turn to a discussion of the factors which determine the gainful participation of SMEs—including those in the informal sector or the margins of the formal sector—in the growth of global and especially regional exports in African economies.

2. “THE PROBLEM FOR SMEs IS NOT THAT THEY ARE SMALL, BUT THAT THEY ARE LONELY”³

By virtue of their size, SMEs are confronted by a number of challenges which undermine their competitive capacity. These affect their direct costs of production (transforming inputs into outputs), their indirect production costs (product development and design, supply chain management and marketing) and their control over input and output markets.

With regard to direct expenditures which affect the variable costs of production, capital goods may have inherent scale economies. For example, the ratio of volume to circumference in spherical containers is 1.6, which provides an important impetus to scale in the chemical and biological process sectors. Even when these scale economies are not technologically determined, the global concentration of Research and Development (R&D) in large firms and high-income economies means that the spectrum of efficient technologies available for purchase is often in reality confined to large-scale and capital-intensive techniques. With regard to indirect costs of production, the capacity to defray investments into R&D, marketing and logistics is a function of scale—spreading these fixed costs over large volumes of sales. The financial muscle of large firms allows them to drive down the price of inputs, to offer financial incentives to obtain market share and to gain from privileged access to low-cost and long-term finance. Finally, the inability to produce in large volumes excludes SMEs from feeding into value chains serving large and often global markets.

By contrast, SMEs benefit from a number of competitive advantages. They are often flexible and agile; not being held back by large corporate bureaucracies allows them to respond rapidly to changing market conditions. SMEs are often particularly adept in developing new products and technologies, and are not weighed down by path-dependent innovation trajectories (Dosi, 1982; Nelson and Winter, 1982). They are often able to escape costly compliance to regulatory regimes, including with respect to minimum wages, health and safety, and child labour. Their bureaucratically thin administrative structures endows them with lower cost structures than their large corporate rivals. Although their incapacity to produce in large volumes constrains their capacity to feed in as suppliers into large-volume value chains, small volume production allows them to serve small-scale and niche markets.

While in many cases, such as in the chemical sector, SMEs are disabled by inherent technological constraints, in other cases seemingly insurmountable scale challenges can be surmounted. For example, with regard to the direct costs of production, there are often alternative sources of technology which can produce effectively at low volumes. In East Africa, in the furniture, apparel and farm-mechanisation sectors small producers have rapidly switched their capital goods imports from large-scale equipment sourced from Northern economies to smaller-scale and cheaper equipment sourced from China and India (Agyei-Holmes, 2014; Atta-Ankomah, 2014; Botchie, 2015; Hanlin and Kaplinsky, 2016). In recent years, the development of mobile telephony and its rapid expansion in Africa reduces many of the indirect scale barriers, linking individuals into global and regional information sources, and hence, allowing small producers to shop around for alternative suppliers and alternative markets (Aker and Mbiti, 2010). Moreover, indirect costs can be shared with other firms—for example, as will be shown below, SMEs can effectively market their produce under a shared brand name. And in relation to market power, SMEs can join together to purchase collectively and hence to drive down input costs.

Globally, there are many examples of vibrant clusters of SMEs who compete effectively in export markets, particularly in the early stages of an industry’s development.⁴ Perhaps the most widely cited case is that of the Third Italy. During the 1970s and 1980s, Italy was the world’s largest net exporter of furniture, apparel and footwear, yet in each of these sectors the average firm size was <11 employees (Best, 1990). But, clusters of SMEs in industrial districts are not confined to either Italy or high-income economies. Between 1970 and 1990, a cluster of almost 2000 firms in the Sinos Valley in Brazil specialised in the production of women’s shoes and raised its share of world leather footwear exports from 3% to 12%. By 1991 they exported nearly 100 million pairs of shoes annually, valued at $900 million. These firms covered a range of links in the footwear value chain, and created more than 15,000 jobs (Schmitz, 1999). The surgical instrument cluster in Sialkot, Pakistan, produces scissors, forceps, and other precision instruments using stainless steel. In the late 1990s it comprised more than 300 manufacturers, subcontracting work to more than 1500 SMEs, and sourcing inputs from 200 local suppliers and more than 800 service providers. Over 90% of output was exported and the cluster accounted for more than 20% of global trade, making Pakistan the second largest exporter after Germany (Nadvi, 1999).

So, what explains the dynamism of clusters and the predominance of small firms within many of them? Industrial districts are not a new phenomenon and their significance in the UK’s industrial development was analysed by both Alfred Marshall and Karl Marx. Marshall’s explanation of clustering, which he referred to as industrial districts, was ascribed to external economies arising from colocation. Examples of external economies are a pool of skilled labour, the agglomeration of suppliers, the pull of buyers to locales where they had a choice of suppliers and the development of specialised support institutions and service providers (Marshall, 1969).

More recently a distinction has been drawn between the simple and unintended external economies resulting from colocation observed by Marx and Marshall, and collective efficiency when firms in the cluster engage in purposeful, planned joint action (Schmitz, 1995). This collective action can take a number of forms, including joint purchasing of inputs, joint market intelligence and marketing, product development, skills upgrading and lobbying for support from government. When policy design and delivery are effective, cluster dynamics are greatly aided by appropriate backing from local and national governments (Best, 1990; Van Djik and Sverrisson 2003; Morris and Barnes, 2006; Morris and Robbins, 2007). The most dynamic clusters, particularly in contexts of a challenging external environment, tend to be characterised by joint actions of various forms. Furthermore, critically, particularly in the context of increasingly competitive global markets, cluster dynamics and sustainable and inclusive growth depends on the capacity of individual enterprises and their clustered collectivity to upgrade their offerings (Pietrobelli and Rabellotti, 2011). This requires product development, improvements in process, the adoption of new business strategies, the penetration of new markets and sustained investments in joint action.

3. SMEs, CLUSTERS AND INDUSTRIAL DISTRICTS IN AFRICA

Clusters of SMEs are pervasive throughout Africa. Visitors to any city or peri-urban town cannot fail to notice the hive of activity of small enterprises, many of whom are engaged in the same line of business. Characteristically, a large proportion of these are informal, operating in sheds barely protected from the elements and with poor and unreliable access to infrastructure such as power and water. Indeed, as discussed earlier, in SSA the informal sector provides more than two-thirds of employment outside of agriculture.

The predominant view is that these SMEs, particularly those in the informal sector, are survivalist, providing meagre incomes and with little capacity to upgrade their operations. The reality, however, is much more complex. True, there are very many SMEs and very many clusters which scrape along the bottom of subsistence production, displaying few signs of dynamism. In the same way, even in high-income economies, there is widespread failure in the SME sector, and routinely, nine out of 10 start-ups fail. Yet, at the same time there is evidence of dynamism in Africa, both within individual SMEs and in clusters of SMEs. In understanding the challenges faced by this sector, and in examining the prospects for their participation in external trade, we review the experience with innovation of 25 African clusters.⁵ These span nine economies, namely, Egypt, Ethiopia, Ghana, Kenya, Nigeria, Mauritius, South Africa, Tanzania and Uganda (Table 2). They include clusters in the south, east, west and north of the continent, and in both the manufacturing and agricultural sectors. These African cluster experiences are considered in the light of the major determinants of cluster dynamics in other regions of the global economy reviewed earlier.

In reviewing the experience of the cluster dynamics, the first consideration is to map the nature of external economies which arise from colocation. These are the spillovers between colocated enterprises which are unplanned, in particular with regard to labour and skills, the proximity of suppliers and customers and the extent of specialisation between firms. The second aspect considered is the nature of the market for the cluster’s output and the relationship, if any, between the locale of the market and the cluster’s upgrading capabilities. Third, beyond unintended external economies lies the possibility of joint action between enterprises, distinguishing in our analysis logistics, marketing and training. Finally, the institutionalisation of assistance to each of the clusters reflects the nature and effectiveness of policy support. This support may be provided by government, by formal associations developed by the private sector and by parties external to the economy, such as lead firms or aid agencies. We assess the significance of innovation in these cluster dynamics by classifying them in terms of their growth performance (sales/employment) and our reading of the case studies with regard to their capacity to innovate and to upgrade their processes, products and business organisation.

4. FURTHERING AFRICAN SME EXPORTS IN GLOBAL MARKETS

To briefly recap the discussion so far on the basis of global experience, the preceding discussion has reviewed six major developments relevant to SME participation in global trade. First, without the capacity to upgrade, and in the context of a highly competitive and liberalising global economy, sustainable growth cannot be achieved. Second, drawing on the work of Adam Smith, GVC analysis and innovation studies, the capacity to upgrade and the direction of upgrading are a function of market size and market characteristics. External trade is an important conduit for increasing market size, particularly for economies with small markets. Third, the greater share of global trade occurs within GVCs, and a large proportion of this is governed, subject to exacting market preferences, and consequently involving standard-intensive value chains. Fourth, and perhaps surprisingly, in many parts of the world SMEs manage to participate in export markets, but this invariably involves colocation in industrial clusters and various forms of collective action. Fifth, regional markets play an important role in enabling developing-country firms, especially SMEs, to learn about exporting, in many cases through less standard-intensive RVCs as a transition to GVCs. Sixth, despite the overwhelming preponderance of informality in African clusters, there is evidence of growing SME participation in wider markets and related enterprise and cluster dynamism.

Unfortunately, there are no measures of the extent and share of SMEs in Africa’s trade. However, given the need to enhance the inclusivity of growth paths in Africa, and given the latent and exploited competitive advantages which SMEs possess, there is clearly an important policy requirement to enhance their participation in both regional and national markets. We can group these policy challenges in four major areas, the first three of which predominantly involve formal sector SMEs: (i) participation in governed GVCs feeding into high-income markets, (ii) export sales to non-regional low-income markets, (iii) export sales to regional markets and (iv) informal sector cross-border trade to regional economies. The analysis and policy prescriptions which follow address SME participation in global trade as exporters. There is an analogous discussion to be pursued with regard to imports by SMEs which can be both productivity enhancing (cheaper and better inputs) and consumer welfare enhancing (cheaper and better consumption goods), but these are outside the scope of this paper.

5. CONCLUSION

Given the low industrial base that Africa starts from, trade and industrialisation are integrally linked. Attempts to facilitate regional trade policies, whether they concern existing regional integration of current blocs or the continent as a single regional entity, cannot ignore the need for developing appropriate industrial policy. This is especially evident in respect of SME development. In other words what is required from African regional integration at any level is adopting an approach of developmental regionalism.

This consists of overcoming a number of policy challenges, addressing macro-economic policy, supply-based policies (firm and cluster upgrading) and market-focused policies (market access). First and foremost is the need to assist SMEs accessing external formal export markets. This takes the form of ensuring preferential trade access in order for SMEs to enter GVCs globally as well as RVCs within African regional blocs. Second, SMEs need supportive activities to become more competitive and ensure they remain, upgrade and grow in value chains. Essentially, this involves industrial support measures which develop managerial capabilities and skills levels of workers with SMEs, especially those able to generate collective efficiencies within clusters. Third, meeting value chain standards requires institutional capacity directly geared to providing knowledge-intensive skills to meet such requirements. Fourth, all firms whether formal or informal, small or large, require sound hard and soft infrastructure, good transport links and efficient logistics to ensure that goods and people are able to move smoothly across borders. Fifth, the need for regulatory harmonisation within African blocs as well as across regions to avoid creating unnecessary bureaucratic obstacles and free up impediments to trade. Sixth, tackling existing country protectionist policies on certain products (e.g., rice and poultry in Nigeria) by large economies which undermine regional integration and block regional trade access by smaller economies.

Currently regional growth and integration occurs in spite of, rather than because of, any regionally articulated policies and vision. If the current low level of SME development and nascent clusters are to grow and expand into viable and vibrant collectives of exporting SMEs, then a much grander vision of trade and industry integration has to be adopted and implemented.

CONFLICTS OF INTEREST

The authors declare that they have no conflicts of interest.

ACKNOWLEDGMENT

We are grateful for the constructive and helpful input from an anonymous reviewer on an earlier draft.