How Asia increases productivity through SME internationalization

– by Shigehiro Shinozaki –

Since the 1990s, the global economy has been supported by high growth of labor productivity in Asia. However, the growth pace of labor productivity in the region has been slowing since the 2008/09 global financial crisis, contributing to global economic slowdown. Moreover, as Asia’s population is aging, labor force accumulation will gradually diminish, and it will negatively affect region’s productivity growth. Enhancing labor productivity is thus a central policy issue to sustain growth in Asia.

ADB’s Asia SME Finance Monitor noted that small and medium-sized enterprises (SMEs) play a key role in boosting national productivity. They account for 96% of all enterprises and 62% of national labor force in Asia, but their contribution to national GDPs is still less than half. This suggests SMEs’ potential to reverse the deceleration trend of labor productivity, by strengthening their dynamics.

Global value chains (GVCs) are the key driver for enhancing SMEs’ productivity and advancing Asian economies. Regional cooperation and integration, such as the ASEAN Economic Community, brings global business opportunities to SMEs. The resultant trade liberalization and investment encourages structural changes in the SME business model from being domestically focused to being globally competitive. This has increased SMEs’ attention to participating in GVCs, and requires policymakers to consider how to create and support an enabling environment for domestic SMEs to enter the GVC.

There are several benefits for SMEs to participate in GVCs. For instance, SMEs can increase their competitiveness through business linkages, improve product quality by technology transfer, and expand their business to overseas marketplaces with job creation. On the other hand, there are various factors constraining SMEs from stepping forward, including labor market rigidity, regulations across the country, non-tariff barriers, SMEs’ inability to meet the quality and standards for certain products, managerial constraints, and insufficient financial resources.

UNCTAD (2013) estimated that 80% of global trade takes place within GVCs with multinational firms. This vertical firm linkage model is typically seen in the automotive and electronics industries, where a large multinational firm leads the overall production network and is mainly responsible for final assembly of products, marketing, sales, logistics, and/or exports and imports of products with partner large firms. In this model, SMEs are incorporated in the production network as mostly only end-tier or lower-tier suppliers such as raw material suppliers or partly first-tier suppliers of parts and components. A value chain mechanism that various types of SMEs can tap will need to be developed further, focusing on horizontal firm linkages.

Horizontal firm linkages are a critical model of GVCs in developing Asia, especially in the export-oriented agri-business, food processing, and handicraft industries, where SMEs are involved throughout the production chain as suppliers from the end-tier to the first-tier, the lead firm or producer, packaging and storage firms, marketing agents, wholesalers and retailers, and/or exporters and importers of products. For instance, farm products and raw materials are traded across the border and processed by the small firm in a particular country, and the final products are traded by SME exporters globally. In this model, SMEs often make up a business cluster, but not all clusters are successful because of a lack of the cluster manager coordinating the production process and logistics among participating SMEs and across the country.

SME internationalization has arisen from the demand of an increasingly globalized economy. Participation in GVCs enables SMEs to access a large customer base, learning opportunities from large enterprises and business partners, and boost their productivity and job creation. Strengthening competitiveness and connectivity is required for SMEs in GVCs. In particular, well-coordinated business clusters are essential for functioning horizontal firm linkage models. SMEs need a product quality control, skilled labor, and the owner’s education and ambition, for successful participation in GVCs. To this end, they need to develop business networking, acquire support from business development services (BDS), and secure access to finance. These are critical policy support areas but also areas requiring private sector support.

ADB report identified policy priorities for integrating SMEs into GVCs, which include greater access to trade finance and growth capital through innovative financing models. Economic expansion in Asia has created a base of growth-oriented SMEs with a need for access to long-term growth capital, while the global economic uncertainty has tightened financial institutions’ risk management and financial regulations, making it difficult for global SMEs to tap their timely growth capital funding. This requires new financing solutions for SMEs involved in GVCs, addressing an increased demand for supply chain finance and trade finance.

The currency-swap trade settlement, initially exercised by the People’s Republic of China and the Republic of Korea, is one of the innovative approaches to trade finance facilitation for SMEs. This system enables the importer (buyer) in each country to borrow in the exporter’s currency, to pay for trade bills in that currency. The advent of financial technology or fintech has brought more opportunities for SMEs to access timely and low-cost financing for global business development. Digital finance, represented by mobile banking, internet banking, and crowdfunding, will help them enter into the global marketplaces.

A cross-border policy and regulatory coordination is necessary to support SME participation in GVCs. The development of horizontal firm linkages across the border needs policy coordination among countries concerned in international labor mobilization and trade facilitation. Regulatory coordination in data sharing and financing across the border is crucial for global SMEs to raise timely working and investment capital for international trade. Developing a BDS ecosystem is critical to effectively enhance SME participation in GVCs, which requires public and private sector collaboration. National policymakers need to use broader and coordinated policy approaches for integrating SMEs into GVCs and supporting innovative financing models accessible for these enterprises, which will contribute to accumulating skilled labor forces and stimulate productivity growth in Asia.

This blog rephrased the discussion published as an ADB blog.

Shigehiro is Financial Sector Specialist (SME Finance), Sustainable Development and Climate Change Department, Asian Development Bank (ADB). Shigehiro supports ADB developing member countries in improving SME access to finance through various technical assistance projects. His expertise includes policy issues in microfinance, SME finance, housing finance, and capital market development especially in Asia. Prior to joining ADB, Shigehiro worked at Japan’s Ministry of Finance, the OECD, and as an advisor to the Government of Indonesia.