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In promotion of small businesses, prioritise social capital

by Hans Dembowski

In depth

Printing traditional Javanese textile patterns in a small-scale workshop

Printing traditional Javanese textile patterns in a small-scale workshop

When it comes to promoting small industries, a prominent Indonesian economist argues that social infrastructure is more important than hard infrastructure.

Your recent book “Periphery and small ones matter” deals with how to tackle inequality in Indonesia. What does the conventional wisdom regarding development economics get wrong?

Well, when the World Bank, the International Monetary Fund and many other donor agencies consider inequality, they tend to look at income inequality, but do not pay enough attention to what is driving income inequality. They thus fail to take note of two important kinds of disparities. First, average incomes vary greatly between regions, and second, incomes and opportunities vary greatly between small and large businesses. To some extent, moreover, these two phenomena are mutually reinforcing because large companies tend to be based in either the more prosperous or natural resource-rich regions. The implication is that inequality will keep growing unless policymakers intervene. The full truth is that Indonesia is still marked by deeply entrenched dualism.

In development sociology, dualism means that two diverging sets of norms coexist within a society, formally codified law on the one hand and on the other, traditions that are shaped by culture and religious beliefs. Typically, the poorer and less well educated people adhere to the latter because they are often only vaguely – if at all – aware of the former. The elites, by contrast, know how to deal with both sets of norms. Do you use the term dualism in this sense?

Yes, I do, and it is precisely what Julius Herman Boeke had in mind when he coined it. He was a Dutch scholar who was employed by the colonial government in Indonesia in the first half of the 20th century. His notion of dualism helped to explain why many policies and programmes that the colonial power wanted to implement did not work. The Dutch tried to introduce values that were supposedly modern, but obviously served their imperialist interests, and the colonised people stuck to their traditional norms. Though Indonesia became independent in 1949, the impacts of social dualism are still evident. Both the inequality between regions and between different kinds of companies can be traced back to the colonial era. Today, more than 95 % of the business units are small. Only a tiny percentage are large, but they account for most value creation.

Are small businesses the same as informal businesses?

No, they are not, but there is a huge overlap. Most informal businesses are small, but a few are not. There are also some formal businesses that do not employ many people – consider a small law firm or IT-based start-up companies, for example.

What can policymakers do to put a check on ever-increasing inequality?

Well, they should pay attention to several things. One is the force of economics of agglomeration. Activities benefit from being located close to other activities. Another is that social capital and culture matter very much especially when we deal with small and informal activities.

Let us consider agglomeration first. It is an important reason why, in high-income countries, specific industries tend to cluster in particular cities. In Germany, for example, Frankfurt is a hub of banking and Stuttgart of car manufacturing. Clusters of this kind enhance an individual company’s productivity because proximity facilitates networking, because the pool of skilled workers is larger and because the local infrastructure suits their needs. Is this what you are thinking of?

Yes, in principle, but in an even more fundamental way. Imagine ten small companies are ploughing ahead on their own and compare them with ten small companies that are clustered. The second group will invariably be more productive. They will share information, procure some inputs in cooperation and cooperate on improving the infrastructure they depend on.

That sounds like the Otigba Computer Village in Lagos, Nigeria (see Johannes Paha and Lydia Wolter on www.dandc.eu). It is a cluster of informal companies that specialise in IT hardware and software. One of the great advantages is that skilled staff can switch from employer to employer fast, and that software and hardware providers can deliver joint services to customers.

I am not aware of this case, but yes, the forces of agglomeration always exist, and informal companies can benefit very much. If market dynamics are entirely left to themselves, however, the impact will be more inequality. The reason is that the large businesses have the capabilities to cluster in particular locations and gain benefits from it, while many small businesses will keep operating in isolation. The result is, rising inequality between locations/regions and between small and large businesses. Therefore, governments should do their best to promote the healthy impacts of agglomeration for small activities and at the same time mitigate the harmful impacts of inequality between regions as activities tend to concentrate in particular locations.

In practical terms, this probably means that governments should provide good physical and social infrastructure.

Well, good social infrastructure is actually much more important, as our research has shown. What small businesses lack in particular is networks, knowledge and information. Let’s do a short thought experiment. Company A is large and urban; company B is small and rural. In all other regards, both exist in the same environment. When company A faces a difficulty, its management will look for help. It may hire an adviser, it may lobby the government or perhaps it will find out who to bribe. Company B, by contrast, will be left to its own devices and will keep struggling with that difficulty. Social capital is really essential and it results both from professional competence and personal contacts. Either way, education is essential.

But isn’t hard infrastructure in terms of roads, electric power supply et cetera similarly important?

It is important, yes, but it tends to be overestimated, whereas social infrastructure is often neglected. Governments around the world have again and again tried to reduce inequality between regions by building hard infrastructure in disadvantaged areas. But this approach does not bridge the inter-regional gaps. The most striking example is probably Italy, where the South was supposed to catch up with the North thanks to heavy infrastructure spending, but it actually kept falling further behind. In Germany, your experience is similar. Since reunification, the eastern states have not caught up with the western ones.

How do you explain the growing disparity?

Well, additional hard infrastructure does help the region concerned to some extent, but as it begins to prosper, it buys increasingly more goods and services from the more advanced regions, so those regions actually benefit even more. The gaps widen. People in disadvantaged regions still lack the knowledge and networks to make small businesses more productive and more competitive. Social capital must not be neglected, and experience shows that better education and better health care boost productivity throughout a nation without entrenching regional disparities more deeply.

What about financial services?

We did a survey of small companies in Indonesia. Among other things, we asked them whether they had access to loans from banks. The result was that many of the very small businesses did not want to rely on bank credit, because they knew they would have to pay the money back at some point and were afraid that they might not be able to do so. Culturally, this is a hindrance even where a local branch office of a bank may exist. If leaders of micro businesses did borrow money, they borrowed from relatives and members of the local community. Cultural norms matter very much. Education and awareness raising can make a difference.

Does digital technology matter?

Well, the internet can help to bridge regional divides. To the extent that people have access, it can become a big leveler.

But internet access depends on hard infrastructure, not education.

When small businesses are run by elderly with a lack of internet knowledge and education, they have difficulty to operate using the internet. So, internet literacy is often more important than the quality of their access, and it will spread fastest where companies are clustered and some people have a basic understanding of the matter. Even where connectivity is poor, well-informed business leaders will thus be able to make good use of it.

Iwan J. Azis is professor of Emerging Markets within the Dyson School of Applied Economics and Management at Cornell University in Ithaca, New York, and visiting professor at the University of Indonesia in Jakarta.


Azis, I. J., 2022: Periphery and small ones matter – Interplay of policy and social capital. SpringerLink (Open Access)


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