SMEs, the key for economic growth

by Gamini Warushamana

SMEs can play a big role in helping developing countries achieve high economic growth and create job opportunities, Practice Manager, Asia Trade and Competitiveness Global Practice of World Bank Group, Dr. P.S. Srinivas told the SME forum organised by the Ceylon Chamber of Commerce recently.

Dr. Sirinivas made a presentation on 'Role of SMEs in economic development; international perspectives and experience'.

Excerpts from his speech.

"Around 99.8 percent of enterprises in developing countries are SMEs and they account 24 percent of exports, 80 percent of all jobs and 37 percent of GDP.

In the next 15 years, 600 million new jobs will be needed to absorb new entrants and at present over 200 million people are unemployed globally.

SMEs are important for the creation of formal and informal jobs. Today, around 50 percent of all formal jobs in developing countries are in small firms and SMEs provide two-thirds of formal jobs. The importance of SMEs for job creation is greater in low income countries. Globally, SMEs create 86 percent of new formal jobs and the number rises to 95 percent in low income countries.

Constraints

SMEs that are over 10 years, provide almost 25 percent of the jobs. An extra 60 percent of the jobs are in the informal sector which is mostly in micro enterprises. However, there are some small firms that could grow if constraints they face are solved.

The informal sector correlates with low productivity and poverty. Many large firms employ highly educated professional staff which may not create opportunities across society.

But SMEs provide a path to prosperity for unemployed people through informal employment or

underemployment.

At the same time, most SMEs face an uneven playing field which stunts their potential to grow.

Therefore, helping SMEs to improve productivity and create more jobs is key in eliminating poverty and reducing inequality. They should be provided the right enabling environment.

The composition of the SME sector changes as the income of a country rises. As country income levels increase, informality in the SME sector declines.

SMEs are predominantly involved in low value-addition activities across a large selection of industries.

Labour productivity in the SME sector is low. Growth is higher in the competitive sectors because competition encourages firms to innovate and renew technologies.

Promotion of entrepreneurship can create new firms and evidence suggests that relatively new firms are more productive and create more new jobs compared to older SMEs.

Evidence in Colombia confirms that newer firms create more jobs irrespective of size. According to findings in Indonesia, start-up companies are more productive compared to incumbent SMEs.

All over the world, SMEs face different constraints compared to large firms. They suffer more than large firms from weaknesses in the investment climate, lack of access to finance and lack of leverage with the government.

Many governments support SME sector growth by various incentives, such as financial, subsidies, tax concessions, setting up SME-specific bank branches and input subsidies.

Too many programs, implementing agencies, inadequate or no monitoring and evaluation, limited adaptation of programs based on evidence are the issues that make the incentives less productive.

Several questions arise regarding the measures. Can we do it in a better way and how? Lack of

monitoring and evaluation processes on the effectiveness of the policies is an issue.

The alternative approach proposed include better monitoring and evaluation systems, taking a strategic, comprehensive and demand-driven approach and being ready to change and adopt.

Small firms

In the alternative approach, the focus is on addressing market imperfections, market failures and information asymmetries to help SMEs to create markets.

Avoid having 'permanent' programs and reducing fiscal burden caused by ineffective programs are also important. SME development strategy should be about facilitating entrepreneurship and enabling small firms to grow.

The Government's SME strategy should be evidence-based with a strong built-in monitoring and evaluation component and it should also be flexible as realities change after the outcomes are evaluated.

Only a handful of high impact programs and platforms are needed and each should be led by a single agency that should coordinate with the others.

There are several causes for market failure of SMEs. High transaction cost due to their small size is one. This is a key cause of bank and corporate reluctance to work with SMEs. Identifying efficient ways of transacting with SMEs is critical to level the playing field for SMEs.

Due to lack of information, SMEs are less likely to have transparent information on past performance and present operations, which increases the perception of riskiness. SMEs need solutions that increase transparency, governance and data through partnerships and technology.

Alternatives

SMEs are typically too small to have a high level of specialisation in operations or management and innovations in the SME sector are also limited. Therefore, SMEs need more efficient access to skills, technology and markets that are relevant to the specific needs of the business and sector.

Inefficient markets is another reason for market failure of SMEs. Banks and corporates have alternatives to working with SMEs where there is not much competition and so rents can be high. Identifying opportunities and demonstrating success in the SME space can help markets respond better to SME opportunities.

There are two alternative approaches for SME development, the life cycle approach and ecosystem approach. Globally, SME needs are largely influenced by the stage of development in its life cycle. The needs of the SMEs are different at each stage.

For instance, at the seed level where the SME is only a thought or idea, the need is motivation to start the new enterprise. At the start-up stage where SMEs exist legally the needs are seed funding, ease of entity registration and related licensing, product incubation and commercialisation support.

At the growth stage it needs support for market knowledge, global and local market access, marketing and promotion, ease of regulation and talent acquisition. At the stability stage, it needs cost structure optimisation, new product development and product adaptation and market knowledge.

The ecosystem approach considers infrastructure development, enabling environment, access to finance and access to market."