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. By creating employment opportunities for traditionally economically marginalised groups, such as women, migrants, youths and minorities, SMEs have also been credited with democratising the labour market and driving more inclusive economic growth. In recent years, 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 or commercial opportunities in areas such as biotech and renewable energy.
However, SMEs still face numerous obstacles, which often limit their scope for growth and undermine their long-term sustainability. These include a disproportionately high tax burden, skills and capacity gaps, and credit and trade barriers, making SMEs particularly susceptible to adverse market conditions. As such, in 2018 governments around the world sought to address these structural issues by enacting regulatory changes, promoting knowledge sharing and creating funding mechanisms to unlock the full growth potential of SMEs.
Driving Industrialisation
In developing countries, SMEs are generally credited with driving the transition from agrarian to industrial-based economies by holding key stakes in multiple sectors. 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 at different levels of maturation. 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 one-third 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, 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, SMEs have followed the example set by Europe’s vibrant biotech industry, and major projects promoting renewable energy, energy efficiency and sustainable agriculture in Mexico, Peru, Argentina and elsewhere in the region have already gained a foothold. The ICT and start-up space is another area where SMEs can drive growth and innovation, and start-up ecosystems have emerged in numerous major cities – from Cape Town to Cairo, and Bogotá to Buenos Aires.
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 around $1trn in 2011 to $5.2trn in 2018, and 60m, or 40% of SMEs in developing countries have unmet financing needs. Financing constraints for SMEs are often attributable to supply- and demand-side knowledge asymmetries: banks face a number of difficulties in assessing the creditworthiness of SMEs, which can discourage lending to these firms, and SMEs often refrain from applying for credit because 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. For example, few countries have tender procurement processes that cater to SMEs, meaning that smaller firms typically lose out. A deficit in skills and knowledge limitations are other major factors holding back many SMEs from growing and internationalising, and companies report in terms of skills shortages, particularly managerial and digital skills, as significant barriers. While some developed countries have set up incubator programmes aimed at addressing these skills and knowledge gaps, they have yet to be rolled out across the majority of emerging markets.
Financial Backing
A number of initiatives are focusing on closing the funding gap and providing formal banking services to small businesses that otherwise lack collateral. According to a 2018 World Bank report, almost 70% of SMEs do not use external financing from commercial financial institutions. By region, 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, Oman and Kuwait, for example, are channelling billions of dollars towards SME growth. Nigeria’s Bank of Industry has extended N500bn ($1.6bn) to local businesses between 2016-18, a significant part of which has gone to SMEs. Egypt set aside LE30bn ($1.7bn) in loans in 2018 alone, with this allocation 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.
To diversify its oil-dependent economy, in 2013 the Kuwait government established a $7bn National Fund for SME Development aimed at stimulating private sector growth. The fund has undergone several restructurings, but the contribution of SMEs to Kuwait’s GDP remains relatively low at 3%. However, a number of successful Kuwaiti SMEs such as Boutiqaat – one of the largest online beauty and cosmetics retailers in the Middle East region – have directly benefitted from government support and the country is looking to position itself as a regional tech start-up hub.
In 2013 Oman’s government similarly established an 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 thereby 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. Similar attractive tax frameworks for SMEs have proven important drivers of economic growth. In Tunisia, for example, a new law enacted by the Parliament in April 2018 provides small businesses in the ICT sector with a corporate tax exemption period of eight years, in addition to an exemption of capital gains tax on investments and special Customs procedures.
Lowering Trade Barriers
SMEs often lack the infrastructure and support mechanisms to engage in international trade – a major stumbling block to unlocking their full growth potential. 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 labs, manufacturing areas and research centres which provide SMEs with key infrastructure in supportive business ecosystems. 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 more than 15,000 businesses, of which 70% are SMEs.
Egypt’s government is also supporting SMEs through attractive free zone offerings. Free zones built specifically for SMEs and strategically located along the Suez Canal are set to give light industries and services sector companies access to key global trade routes. Simplifying regulations is another measure required to support SME engagement in global trade. Trade facilitation reforms streamline trade and reduce administrative time and costs, especially for SME exporters that are often most affected by varying Customs procedures around the world. 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.
As of 2018 trade within the region accounted for 53% of export revenues, compared to 42% in 2016. China has the highest proportion of exporting SMEs that sell to markets beyond Asia (83%), closely followed by Malaysia (82%) and Vietnam (80%).
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. SMEs there struggle to improve their productivity due to a lack of experience regarding upgrades and expansion. Limited connections to networks of international mentors, angel investors and venture capitalists are another challenge for Kenyan SMEs, which can hinder growth and the ability to compete internationally.
SMEs in South Africa face similar problems. The government has partnered with local non-profit small business incubators to provide training, certification and guidance on best practices. In Myanmar, meanwhile, the government is focusing on technology and skills transfer to the country’s approximately 200,000 SMEs, many of which lack the technological know-how necessary to add value to finished goods. Upskilling programmes in Myanmar are focused on SMEs in the food industry, which are most in need of technological support. 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, from infancy until cross-border trade. Although there is no one-size-fits-all policy blueprint for supporting SME growth across various economic sectors and different countries, governments are recognising the importance of tailoring fiscal and regulatory environments and policies to SME needs. Similarly, state-backed funding pools and free zones are providing the capital and infrastructure injections required to support SMEs that may otherwise be left without reliable access to capital from commercial lenders. Small businesses are also being prioritised in government contracts, with countries like the UAE already stipulating minimum stakes for SMEs in procurement laws. Other countries are expected to follow this model moving forward.
Read More from OBG
