Unlocking the potential of SMEs for the SDGs

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By Lamia Kamal-Chaoui, Director, Centre for Entrepreneurship, SMEs and Local Development


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SMEs-Dev-MattersA universal definition of small – and medium-sized enterprises (SMEs) does not exist. What is generally undisputed, however, is the fact that the overwhelming majority of private-sector businesses in the world are SMEs and that SMEs account for a very large share of world economic activity in both developed and developing countries.

Look at the data. In the OECD countries where SME definitions are comparable, the contribution of SMEs to national employment ranges between 53% in the United Kingdom to 86% in Greece. The contribution of SMEs to national value-added 1 is between 38% in Mexico and 75% in Estonia. The SME share of economic activity is typically larger in OECD economies than in emerging-market economies, reflecting a mix of stronger SME productivity levels in the former and higher rates of economic informality in the latter. In emerging-market economies, SMEs are responsible for up to 45% of jobs and up to 33% of national GDP. These numbers are significantly higher when informal businesses, which are often more than half of the total enterprise population, are included in the count. Some estimates suggest that when the informal sector is included, SMEs in emerging-market economies account for 90% of total employment.

Given these numbers, the Sustainable Development Goals (SDGs) launched by the United Nations in 2015 can only be achieved if countries manage to build up strong SMEs. SMEs will have a leading role to play in meeting the most “economic” of the SDGs: promoting inclusive and sustainable economic growth, employment, and decent work for all (goal 8) as well as promoting sustainable industrialisation and fostering innovation (goal 9). Indeed, SMEs are already a major source of jobs across all economic sectors and geographical areas. They provide income and access to public services to high- and low-skilled people and those living in well-off and lagging regions. SMEs are also increasingly engaged in addressing societal needs through market mechanisms. Many social enterprises in particular contribute to delivering public goods and services such as healthcare or waste management, while often employing people at the margins of the labour market. SMEs are key drivers of innovation, a point driven home by economist William Baumol in concluding that most breakthrough innovations in recent decades have come from new and small firms because, contrary to large enterprises, they can work outside dominant paradigms and without strong ties to existing products and technologies. In addition, SMEs can reduce income inequalities (goal 10) if they are enabled to provide good-quality jobs. They can help cities become more inclusive, for instance, through urban regeneration projects that emphasise SME development. And, they can help achieve gender equality and women’s empowerment through women’s entrepreneurship. 2

Maximising the potential of SMEs requires policy makers to address market and institutional failures, put in place a business environment and policies to make SMEs more productive, and reduce the productivity disparities between SMEs and large firms and between those firms close to the global technology frontier and the rest. These trends are partly the result of the 2008 global recession that had a disproportionate impact on SMEs. But they also result from long-term structural changes in the economy. Lagging firms will need to make more complex investments than before, including in intangible assets, if they are to catch up to leading firms. Productivity gaps by firm size also are typically wider in emerging-market economies than in OECD economies.

So, what channels are available to support SME productivity? Two critical interventions at the firm level, which the SDGs also highlight, are access to finance (SDG 8.3) and participation in global value chains (SDG 9.3).

First, access to finance is a common problem for businesses. It disproportionally affects new and small enterprises. Information asymmetries in the credit market, lack of collateral and fixed costs for banks in processing loan applications are some of the well-known problems affecting access to bank finance for SMEs. The 2008 global financial crisis compounded these problems, as banks are subject to new prudential regulations making lending conditions for SMEs more stringent than before.

Enterprise financing, however, continues to be the grease of the economy, implying that governments should consider alternative country-specific strategies to boost access to finance for SMEs. Many OECD countries, for example, should more forcefully support new approaches to SME and entrepreneurship financing, such as asset-based finance, alternative debt finance, hybrid debt-equity instruments and equity instruments. Alternative sources of finance can reduce debt exposure in SMEs and prove particularly useful to those new and fast-growing firms that are at the core of productivity growth and job creation. In developing economies, where access to formal banking has traditionally been limited to large businesses, banking sector reforms that increase the number of bank branches, introduce existing banks to the principles of small business lending and foster the supply of microcredit for business purposes are all reasonable approaches on the supply side. On the demand side, this should be matched by stronger formalisation and improved financial reporting in the business sector.

The second key intervention involves strengthening the participation of local SMEs in global value chains (GVCs). This is particularly relevant for emerging-market economies. Tapping into GVCs as domestic suppliers of exporting firms provides SMEs with an indirect opportunity to gain access to foreign markets and foreign technology, with positive effects for SME productivity similar to those of direct exporting. Targeted measures could involve improving managerial skills, with a special emphasis on meeting international product quality certifications and environmental and social standards. They could encourage ICT adoption, as participation in GVCs often requires firms to adopt standard management software programmes such as enterprise resource planning and master ICT solutions such as cloud computing. And such targeted measures also need to focus, yet again, on easing access to finance, not only short-term trade finance such as export credits and export credit insurances, but also “patient finance” to enable longer-term productivity-enhancing investments.

The role of finance in GVCs illustrates that there is no single silver bullet to fulfil the SME potential for the SDGs. What is needed are well-designed and well-targeted programmes for SMEs addressing market and institutional failures in areas such as access to finance, internationalisation, business development services, in-house workforce training, and ICT adoption and training. In short, a whole-of-government approach that introduces regulatory reforms to level the playing field and foster growth is essential for unlocking the productivity of SMEs.

Figure 1. Average productivity gaps between SMEs and large firms in the OECD area

Labour productivity of SMEs (by size band) relative to large enterprises (250+ employees), Percentage values

Figure-1-Lamia
1. Values are unweighted averages of the gaps in productivity between SMEs and large enterprises in 24 OECD countries.
Source: Author’s elaboration based on data from OECD (2016), Entrepreneurship at a Glance, OECD Publishing.


For further reading
:

OECD (2017), Financing SMEs and Entrepreneurs 2016: An OECD Scoreboard, OECD Publishing.

OECD (2016), Entrepreneurship at a Glance 2016, OECD Publishing.

OECD (2015), New Approaches to SME and Entrepreneurship Financing: Broadening the Range of Instruments, OECD Publishing.

OECD and World Bank Group (2015), “Inclusive global value chains: Policy options in trade and complementary areas for GVC integration by small and medium enterprises and low-income developing countries”, report prepared for submission to G20 Trade Ministers Meeting, Istanbul, Turkey, 6 October 2015.  https://www.oecd.org/trade/OECD-WBG-g20-gvc-report-2015.pdf


1. National value-added can be defined as the difference between production and intermediate consumption.

2. This is pointed out by the OECD in its final report to the 2012 Ministerial Council Meeting.