SMALL INDUSTRY IN DEVELOPING COUNTRIES - IELTS Reading Answers & Explanations

You should spend about 20 minutes on Questions 27-40, which are based on Reading Passage 3 on the following pages.

SMALL INDUSTRY IN DEVELOPING COUNTRIES

The role of small industries in the development process has been the subject of a large number of studies over the past 30 years. Although large industry has absorbed huge shares of total investment, it still accounts for small shares of industrial employment in all but a few countries now in advanced stages of industrialization. It is also concentrated in metropolitan areas. In contrast, household (or 'cottage') industries and small workshops and factories account for appreciably larger shares of recorded industrial employment, are more labour intensive in aggregate, and more widely dispersed in provincial towns and cities. Case histories of medium and larger sized firms have also suggested that much of the growth of employment in large industry is due to the expansion of previously small firms through the size distribution. For these and other reasons it is argued that a shift of investment towards small industry would both improve earnings opportunities for a larger share of the labour force and encourage regional industrial development. In a large measure, these arguments have been accepted and, in most developing countries, governments have introduced special programmes of support – for example in the form of small industry finance, extension and advisory services, infrastructure, and programmes for the training of managers and workers.

When considered in terms of the contribution to employment and earnings, the continuing interest in small industries in developing countries, among those concerned with development policy, seems justified. Indeed, the issues ahead no longer relate to the 'significance' of small industries but to the effects of various policies and programmes upon them. Over long periods of the industrialization process, employment in household manufacturing, and in small workshops and factories, far outweighs that which is (or could be) provided by large industry, notwithstanding the huge concentration of investment and of supporting services on the latter over the past twenty to thirty years.

Turning to programmes of support for small industries, several issues arise. The most general one, concerns the shortage of ex post evaluations of the many programmes that have been undertaken in developing countries. Even particular aspects of these programmes, such as the provision of training and advisory services, vary greatly in approach between one country and another, and it is obvious that there would be much to be learned from a comparison of the experiences of different countries.

With respect to small industry finance, several parallels with the findings of those who have studied agricultural credit were noted. Principally, the much discussed risks of the owners of small industries defaulting on loans are often proving to be real. In fact, the default rates are high enough in some programmes to raise the most fundamental questions about the economic desirability of the continuance of those programmes as they are presently designed.

Concessionary finance, for example, has been the general rule, attracting – and for the most part going to – influential borrowers of good standing. Since these borrowers are, in theory, low risk, it is hard to avoid the conclusions that concessionary finance, with its attendant administrative controls, invites loose banking practices and aggravates the risks. Hence the commonplace argument for cost and risk-reflecting interest rates exists.

While higher interest rates than now prevail would be desirable, however, we have argued that this alone would not secure an efficient flow of institutional finance to potentially low-risk borrowers currently denied access to it. Risk-reflecting interest rates would be far higher than is commonly supposed until the financial institutions are fully adapted to the task of lending to large numbers of small borrowers; even if they were politically tolerable, which is unlikely to be the case, they would probably extinguish the market, and impose a significant external cost on potentially low-risk borrowers. Further, the lack of an accounting base in the large majority of small firms in developing countries, the absence of legally acceptable documentation of assets held, the underdevelopment of insurance markets and of legal procedures for handling foreclosures and maintaining repayment discipline, all argue against simple appeals for 'commercial' rates of interest as the sole element of financial policies. As long as such problems remain significant the conclusion is unavoidable that a transformation of the financial institutions' policies will not take place – except over an exceedingly long period – without risk guarantee programmes and the involvement of the public banks. It is nevertheless clear that the financing programmes would function better if they were accompanied by a relaxation of administrative controls on interest rate policies and on the borrowings and lendings of financial intermediaries. Under these circumstances the interest rates would rise to levels that would roughly reflect the costs of raising resources and lending to low-risk borrowers. This argument is not new. But it is strengthened; it is hoped, by the evidence presented in the text and by reference to recent research on uncertainty in economics.

The small industry programmes themselves are also accompanied by administrative controls in many countries, e.g. in terms of the types of firms and assets to be financed. Ostensibly, they were intended to encourage the intermediaries only to finance 'job creating' projects, and have led to, among other things, the much discussed neglect of working capital finance and to the exclusion of firms seeking to raise output without necessarily expanding employment. Again, we have argued that such controls both increase the risks of the programmes and reduce their capacity to improve employment opportunities.

It is sometimes argued that if leading sector policies were more appropriately chosen, direct interventions to assist small industries would not be necessary. Under leading sector policies are included tariffs, investment incentives and policies towards agriculture. However, this is a fundamentally wrong way of interpreting the purposes of small industry programmes. Properly considered, these programmes are not intended to be an alternative, but instead to address specific sources of market failure (e.g. in the capital markets) and of inefficiency that would limit the effectiveness of a movement towards more desirable leading sector policies. Equally, it is true that small industries would stand to gain from the long-standing proposals for a reform of these policies – in particular from a more labour demanding structure of industrial incentives and tariffs, and from a more broadly-based growth of agriculture. For this reason it was concluded that the more efficient (and also the more labour demanding) the leading sector policies, the more efficient the small industry programmes are likely to be.