Entrepreneurship and the role of microfinance in a changing Europe
Delitheou VASILIKI, Ph.D, Assistant Professor
Department of Economics and Regional Development
Panteion University of Social and Political Sciences, Athens, Greece
PapastamatiouGEORGIOS, National Bank of Greece S.A.
MSc in Banking,School of Social Science, Hellenic Open University, Patra, Greece
Abstract
Microfinance is often referred to as a financial tool able to facilitate the transition from unemployment to independent work, through the strengthening of access to finance for vulnerable social groups facing exclusion from the banking system.
In this context, the European Union has already encouraged the development of microfinance in Europe since 2010 by creating programmes facilitating access to finance for individuals, small or social businesses. The first European instrument for the development of this type of financing in the EU was created in 2010 (Decision no. 283/2010 of the European Parliament and of the Council establishing a European Progress Microfinance Facility for employment and social inclusion), while for the period 2014-2020, the baton went to the European Union programme for employment and social innovation (EaSI), according to Regulation (EU) No. 1296/2013.
However, despite the fact that it is considered to be a morally progressive practice, in recent years, there has been a great deal of criticism with the critics of microfinance contesting even the ability of this financial tool to contribute to the fight against poverty and social exclusion, thus causing reasonable questions.
Taking into account the specific challenges which the European Union faces today, as well as the objectives it has set, and placing innovation at the heart of its strategy for growth and job creation, this article examines the effectiveness of the promotion of microfinance for the development of entrepreneurship in cases of developed economies such as those of the European Union, in accordance with the targets it has set as well as the experience gained by Member States; thus resulting in proposals, which can improve the implementation of relevant programmes for encouraging entrepreneurship in the future.
Keywords : Microfinance, entrepreneurship, innovation, development
JEL Classification: G21, L26, O35, F63
1.Introduction
The concept of microfinance includes a wide range of financial services that may contain the form of guarantees microcredit, equity and quasi-equity[1] extended to persons, micro and small enterprises who typically are denied service by mainstream commercial banks, as well as in most cases because they are unable to offer sufficient collaterals, either due to high risk and management cost or other socio-economic reasons, they are considered to be unprofitable activities by the traditional banking system (Baydas et al, 1997).
The most common form of microfinance is that of microcredit, i.e. a very small loan, usually less than $ 200- $ 300 in some developing countries, which is provided to people below the poverty line in order either to create their own small or very small business, or to become self-employed (Hudon & Sandberg, 2013).
This article critically examines the feasibility of promoting the microfinance model in Europe in the wake of the relatively recent outbreak of interest observed for microfinance worldwide and which largely reflects the ‘discovery’ in the 1980s of a supposedly new paradigm of microfinance institution (hereafter MFI) believed to be able to cope dynamically with poverty through the financing of tiny income-generating projects.
Spearheading this new paradigm was the Grameen Bank in Bangladesh, an MFI established in 1983 by Dr Muhammad Yunus. As one of the earliest and most successful pioneers of the ‘solidarity circles’ methodology, wherein joint guarantees by groups of borrowers encouraged very high repayment rates on microloans, the Grameen Bank appeared to be able to sustainably provide hundreds of thousands of microloans to the very poorest in Bangladesh (Yunus, 2003).
This practice of microcredit lending has received global attention over the last two decades, especially since the United Nations declared 2005 the “Year of Microcredit” and the 2006 Nobel Peace Prize was awarded jointly to Muhammad Yunus and the Grameen Bank. As a result of this positive attention, the number of MFIs[2] and the share of financial assistance from developed countries have increased over time (Gähwiler & Negré, 2011).
Corresponding to the increase of interest of microcredit is the criticism of MFIs in emerging economiessince, on the occasion of the successful offering of shares by the Mexican MFI Compartamos in 2007, it was known that the interest rate under which the economically weak borrowers were borrowed exceeded 100% (Ashta & Bush, 2008; Lewis, 2008; Rhyne & Guimon, 2007; Hudson & Sandberg, 2013) while other MFIs have been accused of relying on exploitative lending techniques, using forceful loan recovery practices, and pushing borrowers into “debt traps” (Hulme & Arun, 2011; Karnani, 2011; Hudon & Sandberg, 2013). As a result, several scholars refer to a "moral crisis" in the microfinance sector (Hudon, 2011; Hudon & Sandberg, 2013).
However, the most important critique, regardless of any unfair practices that can be observed mainly in MFIs of developing countries, is the evaluation of the microfinance model itself and whether it can bring real and sustainable results to a competitive business environment that can be developed within a common market such as the European Union. Can microfinance be a remarkable tool in an ever-changing Europe that aims to get out of the crisis by building a society and economy based on knowledge and innovation?
In order to understand the environment of microfinance development in Europe and in particular in the European Union, the second section summarizes the development strategy and the initiatives developed by the EU in the field of microfinance. The third section summarizes the image of entrepreneurship that is currently developing within the EU, with emphasis on the characteristics of very small entrepreneurship, to which microfinance is addressed. In the fourth section follows a critical assessment of microfinancing and its theoretical impact in line with the challenges that Europe is facing today and finally the fifth section summarizes the discussion on the ability of the financial instrument to contribute to the EU's development strategy and it proposes alternatives as well as suggestions for improvement.
- Microfinance in European Union’s developing strategy
There is no doubt that Europe faces a moment of transformation. The crisis has wiped out years of economic and social progress and exposed structural weaknesses in Europe's economy.
An important indication of the EU's structural weaknesses is the EU's lowest average growth rate against its main economic partners (USA, Japan), which illustrates the most important problem faced by the EU and which concerns the widening of the productivity gap.Much of this is due to differences in business structures combined with lower levels of investment in R&D and innovation, insufficient use of information and communications technologies, reluctance in some parts of our societies to embrace innovation, barriers to market access and a less dynamic business environment.
With long-term challenges – globalisation, pressure on resources, ageing to be intensified, E.U has based its strategy for Europe of 2020 in a smart, sustainable and inclusive economy delivering high levels of employment, productivity and social cohesion (Delitheou et al, 2017).
In this context, already since 2010, European Union has also encouraged the development of microfinance by creating programs to facilitate access to finance for individuals, micro-enterprises or social enterprises. The first European instrument to develop this kind of funding in the EU was created with Decision 283/2010/EU of the European Parliament and of the Council of 25 March 2010 establishing a European Progress Microfinance Facility for employment and social inclusion.While for the 2014-2020 period, the baton took the EU's program. For Employment and Social Innovation (EaSI), in accordance with Regulation (EU) No 1296/2013.
The Employment and Social Innovation (EaSI) programme is a financing instrument at EU level to promote a high level of quality and sustainable employment, guaranteeing adequate and decent social protection, combating social exclusion and poverty and improving working conditions.EaSI is managed directly by the European Commission and it brings together three EU programmes managed separately between 2007 and 2013: PROGRESS, EURES and Progress Microfinance.
As of January 2014, these programmes form the three axes of EaSI. They support:i)the modernisation of employment and social policies with the PROGRESS axis (61% of the total budget); ii)job mobility with the EURES axis (18% of the total budget); and theiii)access to micro-finance and social entrepreneurship with the Microfinance and Social Entrepreneurship axis (21% of the total budget). The total budget for 2014-2020 is EUR 919,469,000.
The Microfinance and Social Entrepreneurship (MF/SE) axis supports actions in two thematic sections: i) microcredit and microloans for vulnerable groups and micro-enterprises; ii) social entrepreneurship.The European Commission does not directly finance entrepreneurs or social enterprises, but enables selected microcredit providers and social enterprise investors in the EU to increase lending.
Under EaSI, European Investment Fund (EIF), part of the European Investment Bank Group (EIB), has been entrusted by the European Commission to manage the financial instrument “EaSI Guarantee Instrument”.The EIF, leveraging at least 5.5 times the capital of the financial instrument, provides guarantees and counter-guarantees that partially cover the credit risk of portfolio in microfinance operations, encouraging Financial Intermediaries (e.i.: FI, MFI) to provide loans with a nominal amount of up to and including EUR 25 000, having the obligation to provide directly or indirectly mentoring and training programmes.
However, microfinance actions that can be implemented within the European Union and supported by its budget are not limited to this program. According to article 37.4 of EU Regulation 1303/2013[3], Member States have the ability to utilize Resources of European Structural and Investment Funds (ESIF) in order to support Financial Engineereing Instruments (hereinafter referred to as FEIs).
FEIs are an innovative form of contributing Structural Fundsto Cohesion policy objectives, compared to traditional grants[4]. The contributions could take the form of repayable investments, namely equity, loans and/or guarantees, micro-finance and other forms of revolving assistance.
Taking into account that use of FEIs is being encouraged and it is increased by cohesion policy during programme period 2014-2020, it is certain that member-states will seek to allocate part of the € 351.8 billion of the ESIF budget to microfinance programs, significantly boosting this trend in the EU and - possibly - the emergence of more MFIs in Europe.
The total amount to be committed by each Member State for microfinance actions is expected to be known when the required ex ante assessment will established evidence of market failures or suboptimal investment situations, and the estimated level and scope of public investment needs, including types of financial instruments to be supported.
3.Entrepreneurship in European Union
According to European Commission Annual Report on European SMEs[5], from the total of non-financial corporations[6], in 2015 Small and Medium Enterprises (SMEs)[7] represent 99,8% (22,95 millions of enterprises) of all European Union enterprises in the 28 Member States. The vast majority of SMEs are micro enterprises with less than 10 employees – such very small firms account for almost 93% of all enterprises in the non–financial business sector.However, their total contribution to employment creation and added value, is considerably limited, as it can be seen in the relevant table (table 1).
Indicatively, in absolute terms, in 2015, there were substantially more SMEs and SME employees in the EU28 compared to the USA, yet SMEs in the USA contributed almost 3 times more value added than their EU28 counterparts[8]. Also, indicative of the employment performance of enterprises is the fact that in the US, surviving businesses increase their employment by 60% on average by the seventh year of their operation, while job growth in enterprises survive in Europe is in the range of 10% to 20%[9].
Table 1: SMEs and large enterprises: number of enterprises, employment, and value added in the EU28 in 2015
Source: European Commission (2016), 2015/2016 annual report on European SMEs
As European Commission notes in its report,9the low productivity and the lack of growth presented by EU SMEs related with respective enterprises in the US, are attributed mainly to their small size in relation with the market failures they face which worsen the operating conditions and competition with other players in areas like finance (especially venture capital), research, innovation (as compared to large companies, increasingly fewer European SMEs innovate successfully) and the environment, due to the structural difficulties faced by SMEs in the EU, such as the lack of management and technical skills, and the lack of flexibility that still characterizes labor markets at national level.
In particular, a significant proportion of enterprises in E.U. mainly in the countries of Southern and Eastern Europe, in the regions of which is allocated the substantial part of the Cohesion Policy budget are self-employed (Figure 1), whose resistance limits have been tested during recent recession.Indicatively, while self-employment is high in southern and eastern Europe, the jobs recovery has not started there – and while employment is growing in northern and western European economies, they have not seen a similar rise in the proportion of self-employed workers (Hatfield, 2015).
This phenomenon is due to the fact that one of the usual areas of self-employment is retail, as in this sector appear new ventures emerging in most countries, but are generally they are considered less desirable in a business system as they constitute what is called "Shallow” entrepreneurship. Retail businesses are easy to create in an economy, but especially in times of decline in private consumption, this kind of entrepreneurship is rather unlikely to survive and does not give rise to economic growth, as it is usually characterized by a lack of extrovert strategy, a lack of innovation and a low added value[10].
Figure 1: Self-employment rates, Europe-24 countries, Q2 2014
Source: IPPR (2015), Self-employment in Europe
4.Evaluation of microfinance as development instrument
Below we present a few factors that we consider to be critical for assessing the microfinance model as a lever for microenterprise support, in order to understand the real and sustainable impact that it can play as a development tool in an economic environment such as what is currently being developed within E.U.
- Encouragement of Micro entrepreneurship and self-employment is related with strengthening the informal sector of the economy
The intervention policy of a state is a decisive factor in the structure of an economy which is developed as a result of the incentives that have been given historically, as in the case of the countries with the highest rates of self-employment in the graph above (Figure 1), where they favored mainly self-employment and very small entrepreneurship, applying lower tax rates, insurance contributions, etc.
This structure has made the tax audit more difficult, since controlling and documenting the corresponding income is an extremely complex and difficult process, while at the same time it favors the concealment of incomes by the self-employed (IMF 2013).
The result of the intervention policies of the states that encouraged self-employment to make it a dyke for high unemployment rates, it appears to be largely responsible for the size of their shadow economy. In particular, according to Schneider and Buehn (2012) in a cross-country study estimate the size of the shadow economy during 1999–2010 at around 27 percent of GDP, compared to an OECD average of 20.2 percent.
Looking at the average relative impact of the causal variables on the shadow economy across the 39 OECD-countries between 1999 and 2010, it turns out that indirect taxes have by far the largest relative impact (29.4%), followed by self-employment (22.2%), unemployment (16.9%), personal income taxes (13.1%) and finally tax morale (9.5%).
This situation is different in countries with higher self-employment (over than 20%), with self-employment appears the most significantly correlated variable with the size of the shadow economy, in Greece and in Italy, where, average relative impact in shadow economy is 37,6% and 31% respectively, with the two countries having high rates of shadow economy as a percentage of GDP among the other developed countries, included in the survey for the corresponding period (27% and 26.9%, respectively).
The correlation between the shadow economy and the self-employed is largely attributable to the nature of the activities developed by the latter, mainly in sectors with less contribution to economic development, which are closer to the consumer, (consumer oriented activities), such as kiosks, food outlets, small repair shops, taxis and other forms of cheap transport and small retail outlets.
As it is mentioned, it is relatively easy to create specific enterprises in an economy, however, in periods of private consumption shrinking or "saturation" of the local economy by similar enterprises, this kind of entrepreneurship has a rather lower chance of survival and contributionto the economy.
Micro-enterprises, during their effort to survive, are forced to carry out drastic cost-cutting strategies, while resorting to unfair competition practices such as non-compliance with their tax and insurance obligations, etc. These practices are in the short term able to gain critical market share from other SMEs, which could otherwise reduce unit costs and record productivity growth over the long term (Schneider & Buehn, 2012).
- Microfinance limit the perspectives to create scale economies
A sufficient level of investment is paramount to a micro-enterprise’s survival and eventual growth, and thus also to it materially contributing to a local sustainable development dynamic and poverty reduction.
However, as reported by Bateman & Chang (2009), this is usually not taken seriously by MFIs, when they massively promote the entry of a large number of micro-enterprises into a market, citing the negative structural effects they have, both to larger dairy farms andto the income of the borrowers themselves, the microfinance action for the purchase of a cow (one-cow farms) implemented in Bosnia and Croatia respectively. Additionally, their creation is promoted independently and it is not developed within a tissue of horizontal (clustering, networks) and vertical (subcontracting) connections within the local enterprise sector, is a crucial determinant of a local economy’s ultimate sustainability and progress.
Taking into account that the emphasis on microfinance to create formal and unrelated micro-enterprises, is capable to increase rather than solve a problem, such as lagging and / or economic recession faced by Member States of southern and eastern Europe i.e. where there most of the EU cohesion budget is disposed, stimulation of entrepreneurship by simply increasing the number of start-ups should not be subject of typical development policy programmes since, by this way it is mostly ignored the critical importance of scale in any sector.