Support for small and medium-sized enterprises increasingly recognised as key to sustainable growth

 

Small and medium-sized enterprises (SMEs) are the engines of global economic growth and employment, accounting for an average of 33% of GDP and 45% of the workforce in high-income countries, and over 60% of GDP and 70% of employment in developing economies. In the case of the latter, the rise in the number of SMEs has been crucial to economic diversification and resilience, particularly in countries vulnerable to commodity price fluctuations.

SMEs have also been at the crest of innovation, taking advantage of their smaller size and agility relative to larger firms to respond more rapidly to technological and commercial opportunities. However, SMEs still face obstacles, such as disproportionately high tax burden, skills and capacity gaps, and credit and trade barriers. Governments around the world have sought to address these issues by enacting regulatory changes, promoting knowledge sharing and creating funding mechanisms.

Driving Industrialisation

In developing countries, SMEs are generally credited with driving the transition from agrarian to industrial-based economies. There are around 25m-30m formal, non-agricultural SMEs in developing countries, or 67% of the global total of SMEs, with the largest share operating in the Asia-Pacific region. Agricultural enterprises still comprise a large part of the SME market in Indonesia and Sri Lanka, with primary industries, including food production, forestry and fisheries, accounting for almost 49% of SMEs in Indonesia, and between one-quarter and onethird of small businesses in Sri Lanka. In the Philippines, meanwhile, SMEs are distributed more evenly among an array of industry sectors, notably trade and retail (46.4%), services (39.4%) and manufacturing (12.5%).

In sub-Saharan Africa, many SMEs are heavily involved in the services and manufacturing sectors, where they account for two-thirds of employment on average, as well as industrial development, such as mining, manufacturing, services, agriculture, fishing and climate research. In Nigeria, for example, SMEs reportedly account for 70% of industrial jobs and 95% of manufacturing sector employment; in Ghana, they account for 85% of manufacturing jobs. Egypt, for its part, has around 2.5m SMEs, accounting for 75% of the labour force, many of which are involved in manufacturing. In some cases, SMEs are at the forefront of some of the most innovative and emerging sectors, such as biotech, renewable energy, green ICT and services.

In Latin America, projects promoting renewable resources, energy efficiency and sustainable agriculture in countries such as Mexico, Peru and Argentina have already gained a foothold. The ICT and start-up space is another area where SMEs can drive innovation, and start-up ecosystems have emerged in major cities.

Challenges

The World Bank estimates that 600m workers will enter the global workforce over the next 15 years, mainly in Asia and sub-Saharan Africa. Of this projected estimate, SMEs are expected to create four out of five new jobs. However, as noted in a 2018 OECD report, most SMEs either fail in the first years of activity or remain very small. Regulatory constraints, high tax burdens, limited capacity to tender for large government contracts and difficulties tapping into global trade markets are some of the challenges facing SMEs in developing economies.

Access to finance relative to large firms is far more limited. According to estimates by the SME Finance Forum, a research unit affiliated with the World Bank’s International Finance Corporation, the finance gap for SMEs widened from $1trn in 2011 to $5.2trn in 2018, and 60m, or 40% of SMEs in developing countries have unmet financing needs. This is often caused by supply- and demand-side knowledge asymmetries: banks face difficulties assessing the creditworthiness of SMEs, which discourages lending to these firms, and SMEs often refrain from applying as they believe their applications will be denied due to insufficient collateral.

Regulatory uncertainty and policy inconsistencies also disproportionately affect SMEs, which are typically less efficient than large firms in negotiating the regulatory environment, particularly across borders. A uniform application of taxes to firms of all sizes also results in a relatively high tax burden on SMEs in many developing economies, creating impediments to growth. Excessive bureaucracy is often an additional obstacle to SMEs, and many governments have yet to formulate policies tailored to the needs of these types of firms.

Financial Backing

A number of initiatives are focusing on closing the funding gap and providing formal banking services to small businesses. According to a 2018 World Bank report, almost 70% of SMEs do not use external financing from commercial financial institutions. SMEs in Asia Pacific have the largest financing gap, followed by Latin America and sub-Saharan Africa. Some governments have taken steps to address funding shortfalls in recent years by creating sovereign wealth funds for SMEs, reforming tax systems to foster small business growth or incentivising commercial lenders to extend credit lines to these types of businesses, among other measures. The governments of Nigeria, Egypt and Oman, for example, are channelling billions of dollars towards SME growth. Nigeria’s Bank of Industry has extended N500bn ($1.6bn) to local businesses over the past three years, a significant part of which has gone to SMEs. Egypt set aside LE30bn ($1.7bn) in loans in 2018 alone, with this expected to increase to LE50bn ($2.8bn) in 2019. The Central Bank of Egypt has also directed commercial banks to increase the number of loans awarded to SMEs to 20% of their total portfolio.

In 2013 Oman’s government established a SME support fund, as well as the Riyada Public Authority of Small and Medium Enterprise Development (Riyada), which have been critical to small business growth and economic diversification in the country. At the December 2018 Oman Forum, a business and investment summit, Ahmed Al Ghassani, CEO of Riyada, highlighted the government’s focus on the twin pillars of enabling and supporting SMEs. “We are focused on empowering SMEs. It is a great opportunity for SMEs to develop and create more jobs,” he said. This strategy appears to be bearing fruit; according to the National Centre for Statistics and Information, the number of registered SMEs grew from 31,835 at the end of 2017 to 36,433 by the end of October 2018.

Elsewhere, tax code reforms aimed at reducing the financial burden on SMEs are driving economic growth. In 2017 the Peruvian government created a special income tax framework for small businesses with a reduced corporate tax rate of 10%. This followed additional pro-business incentives such as tax credits for SME expenses related to employee training costs, and the procurement of equipment and machinery.

Lowering Trade Barriers

Small businesses are under-represented in global trade across both developed and developing economies, and only 10-25% of industrial SMEs export their products compared to 90% of large companies, according to a 2018 OECD report. Furthermore, direct exports represent 7.6% of total sales of SMEs in the manufacturing sector in developing economies, according to a 2016 World Trade Organisation report. Special economic zones, or free zones, offering infrastructure, streamlined business registration processes, tax incentives and access to trade networks are a solution offered by some governments. For example, there are around 50 free zones in the UAE, many with manufacturing areas, research centres and labs, which provide key infrastructure and support. SMEs also benefit from faster and cheaper registration processes and waivers on corporate tax in the UAE’s free zones. The Dubai Multi Commodities Centre, the largest free zone in the UAE, is home to over 15,000 businesses, of which 70% are SMEs.

Simplifying regulations is another measure required to support SME engagement in global trade. Trade facilitation reforms streamline trade and reduce administrative time and costs. Many Asian governments are leading the way in this regard, helping SMEs to expand their export reach beyond the region and tap into global markets. For the first time, in 2018 the proportion of SMEs that export beyond Asia exceeded the proportion that export only to countries within the region. Overall, the number of SMEs exporting beyond Asia increased by 254% between 2014 and 2018.

Skills Incubators

Skills shortages, particularly managerial input and digital know-how, can often hold back SME growth and productivity. In a 2018 study carried out by global professional services firm EY involving 1200 SMEs across six of the largest economies in Asia, skills shortages and talent scarcity were listed as the biggest operational challenges. In general, SMEs have been slower than larger firms when it comes to major investments and integrating Industry 4.0 systems into their production processes, despite often being better placed to adopt new technologies given their size. In response to this, some governments are focusing on skills development through incubators or targeted assistance for SMEs to adopt automation, digitalisation and robotisation. In 2018 the World Bank announced a partnership with the Kenyan government to provide $50m in entrepreneurial and managerial skills investment to almost 2400 SMEs in the country. Upskilling programmes in Myanmar are focused on SMEs in the food industry. According to government estimates, around 60% of Myanmar’s SMEs involved in producing and processing food need help in generating and adding value to their products. The Malaysian government has adopted a different approach to encourage SMEs to take up Industry 4.0 technology by offering tax incentives to firms that adopt automation, robotics and ICT.

State of Play

SMEs face multiple obstacles to unlocking their growth potential, but there are promising signs that governments across the board are serious about supporting small businesses throughout their life cycle. However, state interventions appear to be having a positive effect; a 2018 global survey of 3000 SMEs across 12 high- and middle-income countries carried out by research firm Oxford Economics anticipates annual revenue growth of 7% between 2018 and 2021. Multinationals are also increasingly developing local content policies to support SMEs, motivated by the desire to establish partnerships with local suppliers.

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The Report: Peru 2019

Industry & Retail chapter from The Report: Peru 2019

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