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Colombo, October 13, 2014 Dr. P. S. Srinivas, Practice Manager, Asia

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Presentation on theme: "Colombo, October 13, 2014 Dr. P. S. Srinivas, Practice Manager, Asia"— Presentation transcript:

1 The Role of SMEs in Economic Development: International Experience and Perspective
Colombo, October 13, 2014 Dr. P. S. Srinivas, Practice Manager, Asia Trade & Competitiveness Global Practice World Bank Group 1

2 200 million people are unemployed globally
Developing countries need jobs and growth…….and SMEs are big part of the solution and SMEs are part of the solution 200 million people are unemployed globally 600 million new jobs needed in next 15 years to absorb new entrants 99.8% of enterprises in developing countries are SMEs 37% of GDP is accounted for by SMEs 80% of all jobs are in SMEs 24% of exports are generated by SMEs

3 Employment Shares across countries
SMEs and jobs Employment Shares across countries by Size and Age* Share of Formal Jobs 50% of all formal jobs in developing countries are in small firms ….and SMEs contribute 2/3 The importance of SMEs for jobs is greater in low income countries (LICs) SMEs create 86% of new formal jobs , a number that rises to 95% in low income countries Older SMEs (>10 years) provide almost ¼ of jobs An extra 60% of jobs are in the informal sector which is mostly micro; but has some small firms that could grow if constraints are solved. Creation of Formal Jobs While creating the most new jobs, SMEs also have high turnover so their net contribution to job creation is lower – extent is unknown Informal Jobs *Source: Small vs. Young Firms Across the World: Contribution to Employment, Job Creation and Growth, World Bank Policy Research Working Paper #5631, April 2011 by M. Ayyagari, A. Demirguc-Kunt and V. Maksimovic; Based on WBG Enterprise Surveys

4 Many different kinds of SMEs…..but all critical to economic development
Informal sector correlated with low productivity, and poverty Many large firms employ more highly educated professional staff so may not create opportunities across society For unemployed people, informally employed or underemployed, SMEs represent a key path to prosperity At the same time, most SMEs face an uneven playing field which stunts their potential to grow Improving the ability of SMEs to become more productive and create more jobs is key to achieving many governments’ objectives of eliminating poverty and reducing inequality In the formal sector 4 out of 5 new jobs are created by SMEs, although they are not necessarily the “best” jobs and there is high turnover Most individuals in EMs work in the informal sector – from previous slide

5 The composition of the SME sector changes as country income rises
SME Share of Formal Employment , Informal Sector and Entry Density* (Entry/1000 pop.) As country income levels increase: Informality declines SME “churn” increases with active entry and exit SME productivity increases Large firms grow their share of employment There are fewer binding constraints to growth due to improvement in Institutions As country income levels increase: Informality declines as (i) “entrepreneurs by necessity” get access to formal sector jobs and (ii) high-potential informal firms become more integrated into the formal economy through access to finance and value chains SME “churn” increases with active entry and exit, demonstrating the importance of competition, efficient markets and productivity improvements SME productivity increases with increased competition, access to finance, improved enabling environment and better labor and management skills Large firms grow their share of employment There are fewer binding constraints to growth and they are less severe and of a less systemic nature (e.g., power, investment climate, informality, access to finance) all improve with economic development * Small vs. Young Firms Across the World: Contribution to Employment, Job Creation and Growth, World Bank Policy Research Working Paper #5631, April 2011 by M. Ayyagari, A. Demirguc-Kunt and V. Maksimovic

6 SMEs are predominantly involved in low-added activities across a large selection of industries

7 SME Productivity SME labor productivity is low %
SME Labor Productivity (US$’000) Thailand SME Labor Productivity (US$’000) % Source: Economic Intelligence Center 2012 7

8 Competitive sectors register more high growth firms
Competition encourages firms to innovate and renew technologies Rubber Wood Elect. Equipment Communication Equipment Apparel Paper Vehicle Textile Tobacco Office Equipment Petroleum Source: World Bank

9 SMEs vs. Young firms – Focus on promoting entrepreneurship
Entrepreneurship is the creation and growth of new firms. Young firms create more employment and are more productive. Colombia – Young firms create most jobs regardless of size Indonesia – Start up companies are more productive1 relative to incumbents Employment created Productivity of startups relative to incumbents Add definition – and see if we also have information on the exit on this graph Talking points: Talk about developed countries! Small and mature companies create the jobs… Evidence of developed economies… then we move to the emerging literature on developing countries. Define what we mean by entrepreneurship – creation and growth of new firms What does this mean?! On Employment creation Double-check the data here!!! Figure 5 reproduces this exercise using our Colombian data (upper left side panel), and extends it to the dynamics of output and the capital stock. Comparing the employment panel of Figure 5 with the comparable panel of Figure 4 (lower right panel) shows interesting differences between the US and Colombia. The strongly decreasing pattern of destruction from exit over age categories that we observe in the US Figure is not reproduced by the Colombian data. Moreover, growth by young continuers in Colombia is also higher than in the US. The younger in the Colombian sample look, relative to the old, healthier and more dynamic than their US counterparts. Interestingly, the phenomenon of old firms boosting growth by dropping old establishments and adding new ones does not seem prominent in the Colombian data. Figure 6 shows that, in Colombia, growth patterns across age categories do not present much difference if calculated at the firm or the plant level. It is especially striking that the relatively high rates of exit for older Colombian plants carry over to relatively high exit rates for relatively older firms. Figure 6 shows that, in Colombia, growth relatively high exit rates for relatively older firms. In addition, one might have thought that exit rates for young firms would be higher than those of young establishments (since the latter can be part of older firms). But we see little difference. Though multi-plant firms represent only 3% of the total number of firms, at a 19% of total employment they are sufficiently important that from a purely accounting perspective it was not fully expected that moving to the firm level would have such little impact on calculated growth rates. This may suggest that multi-plant firms in Colombia, though large compared to the rest of Colombian firms, are nothing like the larger of US big corporations. We plan to explore this issue further in future versions of this work. Size of firm Productivity of start-ups surpasses incumbents in year three after onset of firm – no evidence that these are concentrated in specific areas. Age of firm (years) 0-4 5-9 10-14 15+ All Source: Eslava and Haltiwanger (2013); Data Timeframe ( ) Source: Javorcik, Fritani and Iacovone (2012) 1: Total factor productivity

10 Summary…….. rationale for public policy
They represent all but 0.2 % of enterprises, account for nearly 80 percent of jobs, but for only 37% of GDP and 24% of exports. 1 2 Most are in low value added activities, and in services, despite SME policies in almost all countries They are generally less productive than larger companies and most remain small, over time 3 Only a small portion (1 percentile in most Asian countries) grow and account for the bulk of value added and jobs. Most remain small over time 4 5 Rate of informality is high. 6 SMEs face different constraints compared to large firms. Suffer more than large firms from weaknesses in the investment climate, lack of access to finance, and lack of leverage with government 7 Constraints vary by stages of development of SMEs 10

11 Typical approach to SME Programs
Well intentioned Governments want to remove constraints but in most cases end up “throwing money at the problem” 1 2 Too many programs, too many implementing agencies, no or inadequate M&E, limited adaptation of programs based on evidence 3 Focus on incentives, tax breaks, subsidies, reserve sectors Fiscal incentives – reduced tax rates, tax holidays, investment tax credits, VAT exemptions, lower import duties 4 SME-specific bank branches, SME bank lending targets, interest rate subsidies, credit-guarantee schemes 5 Are these being done because they are the right things? Or because these are relatively easy to implement – effective or not? Input subsidies, typically in agriculture 6 Effectiveness? Efficiency? Are policies achieving desired results? Can we do better? How? 11

12 Instead….an alternate approach
1 Take a strategic, comprehensive, demand-driven approach. Be ready to change and adapt. 2 Focus on addressing market imperfections, market failures, and information asymmetries --- help create markets , avoid having “permanent” programs. Reduce fiscal burden caused by ineffective programs 3 SME strategy should be about facilitating entrepreneurship and enabling small firms to grow Strategy should be evidence-based with a strong built-in M&E component and flexible as realities change and outcomes are evaluated 4 Only a handful of high impact programs/platforms needed each led by a single agency that would coordinate with others 5 Based strongly on public-private partnership 12

13 High Transaction Costs Small Scale Operations
Sources of market failures and information asymmetries Due to their small scale, the cost of working with SMEs can be high. This is a key cause of bank and corporate reluctance to work with SMEs. Identifying efficient ways of transacting with SMEs is critical to leveling the playing field for SMEs. High Transaction Costs SMEs are less likely to have transparent information on past performance and current operations, which increases the perception of riskiness SMEs need solutions that increase transparency, governance and data through partnerships and technology. Lack of Information SMEs are typically too small to have a high level of specialization in operations or management. Limited innovation. SMEs need more efficient access to skills, technology and markets that are relevant to the specific needs to their business and their sector. Small Scale Operations In inefficient markets, banks and corporates have alternative to working with SMEs where there is not a lot of competition so rents can be high Identifying opportunities and demonstrating success in the SME space can help markets respond better to SME opportunities Inefficient Markets

14 Stages of SME Lifecycle
SME Sector Strategy – Life-cycle approach or Staged Development Globally, countries are recognizing that SME needs are largely influenced by the stage of development SME Needs SME Needs Ease of divesture procedures Ease of M&A regulations and procedures Talent retention Cost structure optimization New product development / product adaptation Market knowledge SME Needs Market knowledge Global & local market access Marketing and promotion support Ease of regulation Talent acquisition 5 Seed Start-up Growth Stability Exit / Expand SME Needs Seed funding Ease of entity registration and related licensing Product incubation and commercialization support 4 The SME decides on further expansion or exiting business Stages of SME Lifecycle 3 The SME acquires loyal customer base and has stable product base SME Needs Motivation to start new enterprise 2 The SME embarks on begins entry into new markets and products The SME exists legally 1 SME sector needs change as per the different stages of the development lifecycle The SME is only a thought or idea Time

15 Take an ecosystem approach to SME development strategy
Reliable and low-cost power and water supply Well constructed and maintained roads, railways and ports A modern telecommunications backbone Infrastructure A regulatory regime that provides a level field for SMEs A stable and fair system for contract enforcement An educated workforce with access to skills and knowledge A national innovation system Enabling Environment Deep financial systems, financial infrastructure and regulation A range of savings, credit and insurance products for SMEs Growth capital for high-growth SMEs Access to Finance Access to Markets Efficient and reliable access to good quality inputs Modern technology & logistics to improve productivity Efficient access to local, national or international buyers If even one part of the ecosystem is not working, SMEs will have difficulty increasing productivity and growing

16 Example: The Malaysian SME Masterplan
Constraints to Growth Innovation & Technology Limited participation in national innovation system Low product commercialisation and R&D spending Poor technology uptake Human Capital Development Workforce lacks job readiness Low utilization of existing training Non-competitive rewards & benefits Access to Financing Underdeveloped non-banking Poor creditworthiness Lack of know-how and resources Market Access Low bargaining power Information barrier for exports Limited focus on marketing & branding Legal & Regulatory Framework Ease of obtaining licenses Bankruptcy law limits entrepreneurs High cost of tax compliance Infrastructure & Security Low and infrequent trade volume Inefficient trade facilitation system

17 New SME Development Framework
Globally competitive SMEs across all sectors that enhance wealth creation and contribute to the social well-being Vision SME Development Framework Increase Business Formation Intensify Formalisation Raise Productivity Expand Number of High Growth Firms Goals Innovation & Technology Human Capital Market Access Focus Areas Legal & Regulatory Environment Infrastructure Access to Financing Institutional Support Reliable Database Monitoring & Evaluation Effective Coordination Effective Business Services 5. Vision, Goals and Strategy (B) 17

18 SME development: A shared responsibility
SME development through public -private sector partnership Private Sector Industry associations, chambers & NGOs to develop SMEs Large firms to mentor SMEs Participation in design & implementation of programs Government Facilitator Act as catalyst


20 Strengthen operating environments
Enabling environment and Infrastructure Strengthen operating environments Without power and hard infrastructure such as roads, railways and ports, SMEs face higher and sometimes insurmountable costs to doing business. Power & Infrastructure The burden of over-regulation, taxation, crime and corruption falls disproportionately on SMEs who typically do not have the management bandwidth, connections or financial strength that larger entities do. Investment Climate SMEs depend on the education system to prepare workers and management for the needs of the modern economy. SMEs have fewer ways to improve the skill level of their employees. Educated Workforce Efforts to improve the enabling environment need not be targeted at SMEs to have an important impact on SME growth and productivity

21 Finance: The most common constraint
Access to Finance Finance: The most common constraint Link to Jobs Finance allows SMEs to growth, invest and become more productive; and it increases firm start-ups, dynamism and innovation. Financial sector deepening, independent of targeted SME programs, is also strongly and disproportionately correlated with SME growth. 30% increase in SME finance required in Emerging Markets, up to 300% in Africa and MENA 70% of SMEs have bank accounts ; 23% have loans Deeper gaps exist for some products and segments (e.g., leasing, growth capital) Lack of collateral and skills of entrepreneurs High transaction costs for banks Weak credit data and ability to manage risk Opportunity costs for banks that operate in inefficient markets Formal SME Credit Gap Increase Required (%) 7-8 The Gap 25-30 13-16 Constraint 5-6 9-11 26-32 To reach the goal of full financial inclusion by 2020, new models driven by technology and non-bank FIs are needed

22 Market linkages Access to Market
SMEs operate across agribusiness, manufacturing and service sectors, with services becoming more important as economies grow SMEs can only grow and create jobs if they have access to inputs and ready buyers for their products and services Most SMEs operate in corporate value chains or industry clusters; 1/3 of all economic activity globally is associated with the 200 largest transnational corporations High-growth companies tend to be SMEs that are involved in trade and utilize more modern technologies, making them both more productive and greater contributors to job creation Market linkages not only enable the transfer of goods and services, but also facilitate the introduction of new skills and technologies, and increased efficiencies to SMEs Integration into formal markets also help pull high-potential informal SMEs towards greater formalization, and can improve SME access to finance

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