The burden of compliance on SME Growth

Editorial Comment
THE GROWTH trajectory of a small business as it metamorphosises from a micro enterprise to eventually form a large business faces numerous barriers. .

THE GROWTH trajectory of a small business as it metamorphosises from a micro enterprise to eventually form a large business faces numerous barriers. .

Mostly there are the attendant costs and difficulties in formalising small businesses which we will try and unpack in this article.

This basket of issues is now commonly known as the “cost of compliance” and plays a significant role in the decision matrix of any micro or small business that seeks to expand or formalise its operations.

A lot of research across the world, including Zimbabwe, has been done on the subject. One thing that is clear from the research is the existance of a continuum between the formality and informality. Even with the most formal business, very few businesses follow all the rules governing formal enterprise behaviour. On the extreme scale of informality, for their own reasons, some businesses will follow none of the rules set for formal businesses.

The debate on formalisation has settled on the notion that formalisation can be viewed as a gradual process that does not involve moving from one fixed state to another. The degree of formalisation varies immensely from a business that may be registered, but not paying any taxes nor declaring employees’ earnings for the purpose of social security insurance. On the other hand, a business may not be registered as a formal company with the Registrar of Companies or government, but nonetheless comply with many local authority regulations.

A 2004 fact-finding study by SIDA and other researches concluded that entrepreneurs make repeated economic calculations in the form of a cost/benefit analysis, which determines a minimum threshold of participation in formal arrangements for which the costs remain lower than the benefits.

This notes that businesses will embrace formality up to the point where the marginal costs of so doing are less than the benefits they will gain.

For those enterprises that are making a decision about their level of formality, there are certain barriers that are weighed heavily on the cost/benefit analysis.

These barriers have been identified in a number of pieces of researches, such as the SIDA fact-finding study referred to earlier and the annual World Bank doing business reports which conduct compliance cost surveys of the informal sector.

These reports typically suggest that barriers to formalisation fall into several broad categories, which include:

  •   Regulatory barriers;
  • Administrative barriers;
  • Fees and Financial requirements;
  • Corruption in public administration;
  • Socio-cultural attitudes;
  • Lack of key business services and
  • Criminality.

The first three are defined as the microeconomic, regulatory and administrative barriers to formalisation, ie regulatory barriers; administrative barriers, fees and financial requirements. These, including corruption, have a direct effect on entrepreneurs’ willingness to engage with the government. There is a strong global body of evidence to suggest that the above factors, in particular corruption, have the most direct influence on the formalisation decision of small businesses.

The other factors play a part in the decision, but much less directly so and some economists argue that they are perhaps more barriers to growth than specifically to formalisation.

Regulatory barriers, administrative barriers and fees are closely linked and it is sometimes difficult to distinguish between them. They are considered as generic barriers. The specific areas where these three forces converge to give possibly the most significant barriers to formalisation are taxation, business registration/licensing requirements and compliance with labour laws.

Because of the many administrative layers required for one to go through before their informal business may be turned into a more formal one, the bureaucratic processes not only act as a disincentive for entrepreneurs, but create an incentive for the public officials to create rent-seeking opportunities for themselves.

For example, if registering a company takes an inordinately lengthy amount of time, it creates an opportunity for officers from that office to ask for incentives from seekers of those services to “expedite” the process.

Another example being commonly cited in Zimbabwe is in the liquor trade where multiple stage licensing requirements are resulting in entrepreneurs being forced into side contracts with enforcement agents for them to look the other way if their licences are not in order.

Liquor outlets are required to renew their licences every six months, but via several government and local municipal offices who reportedly sometimes take several weeks just to put a stamp on a licence.

In these situations where time costs are converted into financial costs, the revenue from such activities goes into the pockets of the officers and not the institutions they represent. So services will not improve because resources are being diverted and above all the officials themselves will have very little incentive to improve services either as they benefit from the bottlenecks in the system.

Lastly and sadly, some businesses simply will not formalise because their underlying business operations may not be entirely above board in legal terms. The owners have no incentives to have a business setup that may potentially expose them to legal scrutiny.

 Clive Mphambela is a Banker. He writes in his capacity as advocacy officer for the Bankers’ Association of Zimbabwe. For your valuable comments and feedback related to this article, he can be reached on 04-744686, 0772206913, or [email protected].