_26_ _Ways Out of Povertv - Diffusing Best Practices and Creating Capabilities_

# VI. **Market failure and the politics of change**

When it comes to generating growth or establishing "competitiveness", special government support beyond allowing the ecology of firms to work is often justified<sup>with</sup> reference to market failures that may plague learning processes and access to finance. Learning needs time, hence it is argued that certain sectors that have potential for growth might need temporary protection of some type until they are ready to face the gale of full international competition. Learning also is to a degree embodied in individuals. When firms spend resources to train individuals the latter may decide to leave and reap the benefits for themselves. Hence firms might be overly reluctant to invest in training.<sup>56</sup> When it comes to access to finance, financial institutions may not be willing to lend to small and medium enterprises, because they have little track record, are likely to<sup>go</sup> bankrupt within a few years and are typically dependent on a single owner or just<sup>a few</sup> persons, who might be affected by illness or other sudden changes in life.

**Large firms as institutions** to **cope with market failure.** Special institutional innovations are needed to cope with such market failures. The larger firm itself is precisely such an institution. It is in fact, the first line of defense against market failure. It is capable of building a track record vis-a-vis financial institutions. It is less dependent on individuals than smaller firms. It can invest in small subsidiaries while they learn and it is more likely to retain staff and benefit from investment in training.

**Collateral and credit information systems.** As a second line of defense, governments can help with access to credit by establishing functioning property rights systems that allow collateral systems to function so that individuals and small finns can get access to credit.<sup>57</sup> In fact, everywhere in the world most of small enterprise finance is secured through collateral, for example through mortgages on the owner's real estate. Credit information systems that help track the payment record of individuals and small firms are another key mechanism to help small market participants to establish their credit, and hence access to finance.

**Support programs for small and medium enterprises and farmers.** Beyond these basic measures, on which there is relatively widespread consensus, governments can establish further programs to support particularly small and medium-sized firms. Directed and subsidized credit programs for small urban and rural enterprises and farms exist in most countries. Advisory services for farms and small firms, for example on new crops or farming techniques or on business management are also widespread. However, the most complete review of studies on the experience with such schemes worldwide suggests that very few schemes have been seriously evaluated.<sup>5 8</sup> Overall, many<sup>remain</sup>

56 Smaller firms can in particular overcome the problem of incentives to train as long as they are able to employ apprentices at very low wages as happens in a number of countries. Many people may then choose to learn at low wages in small firms in the expectation of higher income later rather than taking on an initially better paid job with the state, which, however, tends to yield a lower lifetime income. However, where labor regulations prohibit low wages for apprentices, small firms may not have the right incentives to invest in training.

57 Fleisig, 1995.

5 Batra and Mahmood, 2001.