By Sergio Arzeni, President of The International Network for Small and Medium Enterprises (INSME).
This Issues Paper has been developed for the 2022 INSME Annual Meeting “Empowering SMEs: economic diversification and green growth” held in Baku, Azerbaijan. Learn more on the event here.
Prologue
The current international context cannot be more complex as we are witnessing generalized inflation, high interest rates, a recession around the corner, the growing damages produced by climate change from floods to drought, the Covid-19 pandemic that is transforming itself and has not yet disappeared, an enduring war in Europe that has ripple effects all over the world, particularly on energy and food prices and supply, not to mention the other 53 armed conflicts of which is dotted the planet.
All this poses serious obstacles to economic growth and to its qualifying elements that are always more difficult to reach, i.e. inclusivity, sustainability, greening, job rich.
According to a Gallup poll published by the Financial Times on 24 August 2022, the institution in which a majority of Americans have more confidence are small business. In a world depressed by pandemics, wars, climate change, inflation and recession, people see a ray of hope for a better life in the potential stemming from SMEs, entrepreneurship and innovation. No wonder that, at least in America, but probably also in other countries, citizens place small business at the top of the institutions to trust in, ahead of the military, police, medical system, god (religion/church) and public schools.
We know that trust is a crucial factor to unleash entrepreneurship, innovation end economic growth and this is why public policy should pay a special attention to SMEs, not only because theyd have suffered the highest economic price to Covid-19 pandemic, but also because SMEs are the most vulnerable victims of high energy prices. The current economic horizon is clouded with business shutdowns, value chains disruptions, volatility in financial and trading markets which have a negative impact on SMEs, threatening the survival of many viable enterprises and entrepreneurs. All that could lead to massive wealth destruction, growing poverty and unemployment, social and political turmoil.
To avoid that we badly need governments diplomatic skills to be activated to de-escalate international tensions and to focus less on big business and more on SMEs and the entrepreneurial eco-systems from which depend innovation, economic growth and job creation. If we want that the dual transitions to succeed, both the green and digital transformations which are so crucial for a more sustainable world, if we want to combat climate change, save the planet and reduce inequalities, then we have to commit every government in earnest for the full involvement of SMEs in this process and provide full support to facilitate and accelerate a structural change.
The Picture
Small and medium-sized enterprises (SMEs) are a major component of the world economy, accounting for more than half of formal employment globally and contributing on average between 50% and 60% of national GDP in OECD Member countries.
SMEs and start-ups provide an important stimulus to employment and productivity growth. They can play an important role for meeting specific market needs including in regions and sectors where scale may be limited or of lesser relevance, and can help foster competition in established sectors.
SMEs, including those that scale up and innovate, benefit the economy, stimulating markets, making available new and innovative products and services – delivering benefits to consumers and wider society, and contributing to productivity growth and job creation.
SMEs are often strongly linked to their local economies, contributing to social cohesion and integrating diverse populations into the economy.
The population of SMEs is very diverse in terms of age, size, business model, performance, and the profile and aspirations of entrepreneurs. These differences, including across sectors, regions and countries, affect their contributions to innovation, productivity, quality job creation and growth. Firm heterogeneity also has important implications for the design of policies across countries and for different types of SMEs.
While not all SMEs aspire to grow, many continue to face challenges related to their size; limited resources (such as skills and finance); or industry and market conditions, including within supply chains and with larger enterprises, which may impact the firm’s ability to fulfil its growth potential, scale up, and take advantage of regional and global value chains.
Strengthening SMEs and entrepreneurship, including women- and youth-owned businesses, is important for achieving more inclusive societies and growth; particularly at a time when digitalization, the next production revolution, demographic trends and, last but not least, in some cases, the circular economy and the transition to a low-carbon economy are changing the opportunities and challenges for firms to start up and grow.
Rationale for Government action
An enabling and evidence-based policy environment and supportive SME infrastructure are needed to offer opportunities for diverse firms and a level playing field for all enterprises.
Such conditions are critical to enable SMEs and entrepreneurs to thrive, scale up and contribute to an open, digitalized and inclusive economy. This includes an effective regulatory environment, effective contract enforcement and civil justice systems, and transparency and integrity in the public sector.
There are good reasons for policy- makers to give attention to the fate of SMEs, for which interventions may need to be designed very differently from those for larger firms.
SMEs are important for many reasons, not least their contribution to employment, their very different geographic distribution from that of large companies, and the importance of the “striving” SME environment for entrepreneurship.
SMEs make a significant contribution to total employment around the world, up to 80 per cent of jobs in countries such as Italy and Japan.
Where there is a risk of SMEs failing, policymakers need to consider whether and why to provide support rather than depending simply on social safety nets to mitigate the consequences of failure.
Two formal central bankers, Mario Draghi and Raghuram Rajan, in a paper for the Group of 30, have clearly spelled out that “the following economic and social costs may persuade policymakers to support SMEs:
- SMEs may be under greater pressure than larger firms since they will have fewer options for financing; they largely depend on relationship banking, and many loans may carry personal guarantees.
- The geographic distribution of SMEs differs from that of large firms, so the social effects of unemployment resulting from their failure may be widespread across communities with limited alternative employment options.
- Preservation of small firms may be desirable in those sectors and jurisdictions where it limits the market share of a small number of larger companies, with beneficial competition effects.
- In developing countries, failure of SMEs may set back development of the formal economy and increase the size of the informal economy, seen by some as an obstacle to economic development.
- Bankruptcy frictions are larger for SMEs than for larger firms.
- Many smaller businesses may hold significant intangible and relational capital (relative to their size), although this is likely to vary substantially by individual firm and the nature of its business. Admittedly, where this is relatively limited, and particularly where social safety nets exist and support could be provided to develop new businesses once the crisis has passed, failure may be an economically rational outcome (notwithstanding possible social costs described above).
Challenges for SMEs
For small and medium-sized firms, which are not typically highly leveraged even in normal times, the fundamental problem is the lack of significant hard collateral, higher levels of cash-flow risk, and limited information, all of which leads to financial constraints.
Traditionally, this segment relies on “relationship banking” as a primary source of funds. Thus, the existing lending relationships would be the cheapest source of additional funding, since lack of significant collateral and public information might make switching costs prohibitively expensive, especially in the context of a pandemic.
From the bank perspective, and especially given the systemic nature of the shock, this would imply taking on higher risk. When done at scale, this is likely to push the bank against its own capital constraints. This risk absorption by the banking sector also might not be desirable for a broader economy due to it destabilizing nature. Existing bank relationships for this segment, therefore, are the desirable channels of capital flow. However, such capital flows may not take place at the scale needed in the absence of government assistance.
The objective, and the main challenge, is to unleash the power of SMEs of all kinds to lead the green and digital transitions. The aim is to considerably increase the number of SMEs engaging in sustainable business practices as well as the number of SMEs employing digital technologies. A better involvement of SMEs into public procurement is an example of SMEs oriented initiative. Indeed, Public procurement represents approximately 12% of gross domestic product (GDP) and 29% of total government expenditures in OECD countries; as such, its potential impact on a range of policy objectives is significant. This purchasing power of the public sector can be used to support SMEs and as a stimulus for innovation.
On the one hand, engaging SMEs in public procurement can be beneficial to SMEs because they can lower the business risk, access new markets, strengthen their competitive advantage, scale up and gain a trusted status and recognition. On the other hand, governments working with SMEs can enjoy lower costs due to more suppliers and a greater competition and a quicker responsiveness from SMEs because of simpler decision-making organizational processes. Furthermore, SMEs are often the source of radical innovations and the play a pivotal role in the green markets. Ultimately, the goal for every country is to become the most attractive place to start a small business, make it grow and scale up in the national and international markets.
The field of SME and entrepreneurship policy is complex and must be tailored along the lines of local and regional eco-systems to be effective and to ensure proper implementation. For achieving that goal, the role of national and regional development agencies is crucial.
National Development Agencies can be instrumental to:
- enhance SME participation in the national and global economy enabling SMEs to seize the opportunities offered by global value chains and by public procurement and increase their productivity.
- fostering conditions for SME adoption and diffusion of innovative and digital technologies.
- facilitating enterprise creation and growth in established and emerging industries, including through collaborative practices.
- extolling the importance of local and regional ecosystems, networks and clusters for strengthening SME economic competitiveness, including by fostering greater cooperation among actors in the SME support network, such as incubators, accelerators, small business development and export assistance hubs.
- promoting inclusive growth by enhancing entrepreneurial opportunities for all segments of the population, and better understanding and addressing the unique challenges faced by women and other underrepresented entrepreneurs, such as youth, seniors or certain ethnic groups.
Baku Roadmap for INSME
More entrepreneurship is good for the economy. New businesses try out fresh ideas and ways of doing things, while drawing capital and people away from firms that are stuck in their ways.
Many economists draw links between the low rate of entrepreneurship and the weak productivity growth. In addition, a recovery with lots of startups tends to create more jobs, since young firms typically seek to expand and thus hire new staff.
The competitiveness of every business depends from the professional capacities of its human capital, therefore it is fundamental for governments to build the competencies needed for successful start-up and growth of enterprises, and strengthening training and upskilling of entrepreneurs and workers to participate in a digital, creative and knowledge-based economy, while fostering SME dynamism and the right conditions to attract and retain talent.
Studies on self-employment programs show that those who fail to set up their own business come out from the experience as people much wanted by employers. They become more employable, and this is a strong argument for funding public initiatives promoting self-employment programs.
Data show that founders have a better chance of getting it “right” the second or third time — if they have the guts to come back fighting.
This is why thriving entrepreneurial societies must overcome the stigma of failure that is common in several cultural contexts. In this sense we can say that culture matters, and is a key factor for having an eco-system conducive to innovation and entrepreneurship. The lack of awareness, internal resources and financial capacity are among the main challenges to SME digital adoption.
We have to acknowledge that SMEs are often slow in adopting digital technologies that could enhance their business. The Paris-based Organization for Economic Co-operation and Development (OECD) has produced very solid analysis explaining that SMEs have problems:
a) to match supply and demand for tailored digital services and trainings.
b) to overcome the lack of knowledge of training and mentoring opportunities.
c) to face higher relative costs in finding and retaining talent are all factors that explain why.
Digital skills are not limited to technical knowledge, it is a mind-set that allows to perform intuitively in a digital environment. In order to make digital tools “work” within an SMEs, many other “soft” skills are needed that go beyond the “hard” knowledge of how to use software at a basic or advanced level.
The ability to search and evaluate information, to solve unexpected problems, to communicate and collaborate effectively and to be creative, are all instrumental to the successful use of digital technologies within a firm – together with the management of skills needed to make the change happen.
For entrepreneurs and workers in SMEs the ability to successfully use digital tools should never be considered a skill that is acquired once and for all, but rather a process that needs continuous updating.
This adds to the importance of skills such as “critical thinking” and “ability to learn”.
Development of digital skills is a life-long process, continuous learning is essential to keep pace with the evolution of digital skills. In the knowledge-based economy the key feature is the rapid obsolescence of knowledge itself. SMEs need people able to master the wide range of soft skills that complement the technical digital skills to ensure the effectiveness of the digital shift.
This is a fundamental condition for a more inclusive and sustainable ecosystem for SMEs, innovation and entrepreneurship.
Reducing entry barriers to entrepreneurship implies a drastic improvement of access to credit.
The Washington-based International Monetary fund (IMF) estimates that better access to credit could increase Gross Domestic Product (GDP) in the Middle East Northern Africa (MENA) region by one percentage point and generate 15 million jobs over the next 5 years.
However, we must underline that a pre-condition for building an entrepreneurial society requires breaking the culture of dependence, whereby your future depends from someone else than yourself. People, and youngsters in the first place, must have confidence in their capacity and be convinced that nothing is difficult if you really want (Nihil difficile volenti, as the old Romans used to say).
In several countries there are two labor markets that squeeze proper entrepreneurship:
on the one hand, we have the world of the privileged, of those working for government, state-owned enterprises (SOE) or for multinationals;
on the other hand, there is the world of underdogs, the unfortunate that work in the informal market, because that is the only form of necessity entrepreneurship for survival.
In those countries there is no room, or limited space, for opportunity entrepreneurship. In this context is very important to break the culture of dependence from government and combat coziness between large firms and government. Otherwise the most brilliant and promising youngsters will find more rewarding to seek a job in government, or a big firm, or, more often, abroad, rather than start-up their own new firm and stand alone.
The mission of INSME is not only to exchange best practice in the implementation of effective policies for entrepreneurship and SME growth but also to improve our understanding of the drivers of SME productivity and growth and how policies can ensure that SMEs and entrepreneurship strengthen their contributions to quality job creation and inclusive growth.
