Typologies of MSMEs

Formal or informal sector
An estimated 280 to 340 million MSMEs are informal firms, and the informal sector in developing economies absorbs around 60 per cent of the labour force. Informal MSMEs tend to be small in size, are often less productive than formal enterprises, yet contribute significantly to economic activity and employment. Informal firms are estimated to account for around 74 per cent of all MSMEs in the world, and around 77 per cent of all MSMEs in developing countries. Unregistered firms rely mostly on informal financing, which is associated with lower firm growth and increased firm illegality. Small businesses remain informal as they lack the incentives or capacity to formalize. Creating the appropriate environment for informal MSMEs to formalize takes time, as many do not see incentives such as access to new market opportunities and access to financial and non-financial services, making it a profitable decision for them to register their business. The degree of informality varies significantly across developing economies. For example, at the low end of the scale, studies have estimated that the percentage of employment in the informal sector in non-agricultural activities is less than 10 per cent for countries. At the high end of the scale, the percentage surpasses 75 per cent for countries. As a result, different country strategies to cope with informality may be necessary depending on the degree of informality present in the economy.⁹

The definition of informality varies across countries and institutions. Historically three basic paradigms (dualist, structuralist, and legalist) have been established to explain the existence of the informal sector.¹⁰ The Dualist paradigm reasons that the informal sector is the residual component of an economy, and it exists as a subsistence economy, reflecting the inability of the formal economy to provide enough jobs. The Structuralist paradigm argues that the informal and formal sectors are interdependent, and the informal sector is part of and subordinate to the formal sector. The informal sector provides cheap labour, inputs, and products to formal firms, and contributes to the economy’s flexibility and competitiveness. The Legalist paradigm states that the informal sector is made up of businesses that prefer to operate informally to evade the exorbitant costs of complying with regulations. Informality is composed of both informal firms and informal employment. Informal sector businesses are defined as all firms that are unregistered with the registration office, municipality, or tax authority, or owners and employers of micro enterprises that employ few paid workers.¹¹ Informal employment is defined as employment without a contract, unregistered with the relevant authority such as the social security agency or Ministry of Labour, and employment not entitled to receive social security benefits.

Given the background on informal MSMEs, formal MSMEs tend to perform better than informal enterprises. At macro level, an increase in the number and/or size of formal enterprises translates into higher GDP levels and growth rates. The ILO¹² highlights that costs associated with becoming and remaining formal include entry costs (registration costs); taxes, fees and social contributions; and compliance costs (e.g. with labour regulations and property registration). Benefits associated with being formal include a reduction in the risk of closure or having to pay fines or bribes; that it is easier to establish an enterprise at a permanent location. Formal enterprises have better access to (public) business development services, financial services and insurance services and get better access to more diverse markets.

Manufacturing; agricultural/rural, and services MSMEs
Manufacturing MSMEs are enterprises engaged in the manufacture or production of goods pertaining to any industry specified in the first schedule to the industries) or employing plant and machinery in the process of value addition to the final product having a distinct name or character or use. In Malaysia, for example, MSMEs in the manufacturing sector are involved in activities such as processing and production of raw materials, e.g. food, beverages, textiles, petroleum, wood, rubber and the assembling and manufacturing of electrical and electronics appliances and components, among others. Malaysian MSMEs account for more than 90 per cent of the total manufacturing establishments in the country.¹³

Agricultural and rural MSMEs play a key role in securing access to food, alleviating poverty and growing the economy in rural areas that are often underserved. Small companies are found at each link of value chains as input suppliers, farmers, traders, processors, wholesalers and retailers. In countries such as India, population growth is increasing pressure on land and agricultural production cannot absorb the ever-increasing rural labour force in agricultural employment. This leaves rural non-farm MSMEs to absorb those released from agriculture but not absorbed in the urban industries. The   scope   of   rural industries relies on utilizing the natural and human resources existing in the countryside. The features of rural industrialization are low investment of capital, labour intensity and use of simple technology by employing local human and material resources.

Startups or growing enterprises
MSMEs play an important role in the wider eco-system of businesses. Startups and young firms, which are generally small or micro enterprises, are the primary source of net job creation in many countries and are the driving force of innovation and sustainability in the private sector.¹⁴ Startups are different from traditional businesses primarily because they are designed to grow fast. By design, this means that they have something they can sell to a very large market. For most businesses, this is not the case. In the world of business, the word ‘startup’ goes beyond a company just getting off the ground. The term startup is also associated with a business that is typically technology-oriented and has high growth potential. Startups have some unique struggles, especially in regard to financing, because while the promises of fast growth and high returns are appealing to investors, the risks are commensurately high.

The reduction of barriers to entry in some markets that the Internet and digital commerce has brought about has also resulted in startups that might be termed ‘digital native’. These businesses have very limited attachment to any physical location or market, and might consider themselves (in practice more than in legal fact) as being only partially bound by the legal system of any one location. Having the ability to sell digital products or services online, with low overheads, means these firms can access huge numbers of customers and grow extremely fast. For this reason, digital native startups are starting to be recognized as in need of unique regulatory approaches.

Cottage industries, townships and other typologies
A cottage industry is a small-scale, decentralized manufacturing business often operated out of a home rather than a purpose-built facility. In a country such as Bangladesh, cottage industries typically produce artisanal products using traditional methods for local consumption.¹⁵ For these reasons (production in households, traditional methods) cottage industries may be impossible to scale up substantially, or if they can be, it may be difficult to do so without changing the essential character of the business. Cottage industries can, however, have beneficial effects for diversifying income sources in households, and providing opportunities to women and persons with disabilities whose other employment options might be limited. In China, a particular class of business called the Township and Village Enterprise, owned and managed by mostly rural communities, became prominent in the latter half of the 20th century (see box).