Harvard’s Effort to Help Small Business in Emerging Markets

The Missing Middle


Harvard’s Entrepreneurial Finance Lab is in pursuit of an honorable goal.  In their words,

The goal of the Entrepreneurial Finance Lab Research Initiative is to evaluate the impact of psychometric screening tools and alternative financial contracts on access to finance and entrepreneurial growth in the developing world's 'missing middle.'

What is the missing middle?

Harvard knows that in low income countries, there is a binomial distribution when it comes to size of firms.  Many Micro enterprises followed by large (and probably in some cases, State Owned enterprises) but not much “middle”. In high income countries, the distribution is more normal (I would argue that countries like Canada and Australia have more binomial given many small and few big with not much in the middle either, but I am not going to debate Harvard at the moment).

In Harvard’s words, high-income countries, small and medium enterprises (SMEs) are responsible for over 50% of GDP and over 60% of employment, but in low-income countries they are less than half of that: 30% of employment and 17% of GDP.  This SME gap is called the 'missing middle'.

The Firm Size Distribution

 Harvard Low Inc Middle

What Harvard found was that SMEs in low income countries found access to finance a barrier to growth.  How did they know that for sure?  Their analysis looked at return on capital and found SMEs returns on capital are high.  Therefore their conclusion is that SMEs aren't missing because they wouldn't be profitable -they are missing because finance is not reaching them in an effective way.  I’m not sure I am ready to jump to that conclusion just yet, but the Asian Development Bank aslo talks about a finance gap in emerging markets.

Where this gets interesting is that Harvard began focusing on low-cost screening tools and alternative financial contracts as methods to stimulate entrepreneurial finance. They are looking at 3 initiatives:

  1. Pilot testing various psychometric instruments on over 2000 entrepreneurs across Africa and Latin America to better understand the psychological and intellectual drivers of entrepreneurial ability and risk of default.
  2. Determine how psychometric screening tools help measure future upside potential rather than traditional risk management tools used by banks for debt contracts, which only measure downside risk.
  3. The Lab is evaluating the impact of these pilot trials on risk, performance, and overall access to finance.

It would be interesting to learn more about how these screening tools differ (and work) compared to traditional risk management, credit scores, etc.

As to emerging market finance, there are a number of firms we have covered on Trade Financing Matters that are focused on emerging market finance for SMEs and Social Finance.  They include firms like ApexPeaks, AztecExchange, Trade Finance Market, and many more.

Trade Financing Matters will be launching their 30 Fintech Business Finance Vendors to Watch over the coming weeks.  Please contact me at dgustin at tradefinancingmatters.com if you are interested in learning more.

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First Voice

  1. Sabahat Chaudhry:

    Excellent effort on part of Harvard. Rightly said: “The Beef Patty in the Middle” is missing in both developed and developing countries. Medium enterprises do not have access to funds to ride the high tides.

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