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A Universal Definition of Small Enterprise: A Procrustean bed for SMEs?

Khrystyna Kushnir's picture

Editor's Note: Khrystyna Kushnir is a consultant on micro, small and medium-sized enterprises with the Enterprise Analysis Unit of the World Bank Group.

At the G-20 summit in Pittsburgh last year, the assembled authorities agreed to "scale up successful models of small and medium-sized enterprise (SME) financing." The G-20 assigned the IFC and other international organizations to launch a G-20 Financial Inclusion Experts Group and asked the private sector to come up with ideas through G-20 SME Finance Challenge. This increased attention to micro, small and medium-sized enterprises (MSMEs) begs the question -- what, exactly, should be considered an MSME?

With the issue of MSMEs playing out on an international level, it is tempting to try to find a universal MSME definition. A universal MSME definition would ease the design of loans, investments, grants and statistical research. One such effort is IFC’s SME Definition Deep-dive Analysis and Recommendations, although it's currently on hold because of internal restructuring.

As part of the G-20 follow-up work, IFC is currently working on a 2010 update of the Micro, Small, and Medium Enterprises: A Collection of Published Data. While recording the various definitions of MSME used in 120+ of the most populous world economies, I was struck by the wide range of approaches governments take to define what exactly an 'MSME' is in their economy.

For example, in China an MSME can be an enterprise with 1 to 3000 employees; total assets from ¥ 40 to 400 million and business revenues from  ¥10 to 300 million depending on the industry. Meanwhile, the EU considers an MSME an enterprise with up to 250 employees and turnover of no more than €50 million or a total balance sheet of no more than € 43 million.

Hypothetically, the choice of MSME definition could depend on many factors, such as business culture; the size of the country’s population; industry; and the level of international economic integration. Or it could be the result of businesses lobbying for a particular definition, which would qualify their enterprise for governmental MSME support program. This can result in some very strange distinctions between firms. For example, in one case an enterprise manufacturing petroleum products is considered an MSME if it employs less than 68 persons; but if a similar enterprise manufactures chemical products, then the threshold for it to be considered an MSME is raised to a maximum of 100 employees.

These issues make it difficult to adopt a universal MSME definition and raise the question of whether it makes sense to strive for what, in the end, might simply be a Procrustean bed. It might make more sense to measure MSMEs with a single ruler, e.g. annual sales or turnover and/or number of employees, but tailor the size breakdown to particular conditions in the country of operation.

In their paper Defining SMEs: A Less Imperfect Way of Defining Small and Medium Enterprises in Developing Countries, Tom Gibson and H. J. van der Vaartindeed suggest a less imperfect formula:

An SME is a formal enterprise with annual turnover, in U.S. dollar terms, of between 10 and 1000 times the mean per capita gross national income, at purchasing power parity, of the country in which it operates.

The Gibson and Vaart definition is attractive because annual turnover is a good tool to assess the contribution of MSMEs to GDP. It is also fulfills the criterion of working as a single ruler. But after extensive empirical research on MSME statistics and definitions in over 120 of the world's most populous economies, I can say that it is extremely difficult to obtain data on the annual turnover by MSMEs in developing countries. Also, the informal MSMEs in some developing countries outnumber formal MSMEs by 8 times. So the problem of one-size-fits-all remains even in the Gibson and Vaart definition.

From my research I have found that the number of employees was the most frequent characteristic used in the definitions of national governments and statistical agencies. The data on size breakdown was available for most of countries. The number of employees is also a fair characteristic to assess MSMEs’ contribution to GDP.

To sum up, I think there is both a technical and a conceptual problem with seeking a universal definition of MSMEs. Technically, lack of data is a big problem. But even if that could be overcome, economies have diverse structural, cultural and political reasons to adopt different definitions of MSMEs that would run counter to any universally agreed definition.

Comments

Submitted by nadezhda on
Several decades ago I came to the conclusion that discussions re "how to measure" SMEs are futile and fruitless because they've got the wrong end of the stick. And we keep slicing the old SME concept into more and more subgroups -- like the relatively new MSME -- precisely because attempting to categorize businesses by size of enterprise is so obviously inadequate as a tool for either analysis or policy prescription. We need instead to start with "why do we think SMEs are important but need attention" and work from there. As your survey of endless studies suggests, the answer will be different depending on factors like how developed an economy is, how formal or informal the "SME sector" is, are we dealing with agriculture, manufactures, services, tradeables, etc. The answer will also be different depending on the specific policy context -- the things that make SMEs "special" are different depending on whether we're trying to address financial services or labor conditions or environmental standards or consumer safety, etc etc. So IFC should go back to what (some of it) was trying to do internally about a decade ago before the SME fetish took hold (because it was easier to market to donors and scale up high-profile, big money "SME" programs than to fold a lot of differentiated services and solutions under an "access to financial services" umbrella). It's time to go back to basics -- focus on the problem to be addressed -- access to a range of financial services that are often not available to the majority of businesses which aren't big and powerful. What types of services are needed by and appropriate to different types of business organizations -- it's not all about boosting the amount of lending, btw. What are the typical impediments for obtaining certain types of financial services. Although it's true that certain impediments to financial services access will, within a given economy, often correlate with (some measures of) size of enterprise, that's only to the extent size strongly correlates with important factors that have much more to do with impediments, such as sector, capital-intensity, availability of collateral, business methods, or degree of integration with the formal economy. So we should stop searching for a perfect measure (especially cross-country!) of what is, at best, a fuzzy, indirect tool. In my opinion, the SME size debates simply divert attention from the actual problems that we want to address. So in each country in the G-20 program, first start with inventorying existing financial services, identify gaps in existing services or who can't access what's available (which may or may not correlate with "size"), determine how big a problem that is, and work on addressing the biggest impediments to the most important services. Share cross-country experiments -- legal/regulatory changes, policy experiments, pilot programs, IFC investments, etc. Rinse and repeat. That's why JDW wanted a "knowledge bank," after all. And whatever you do, don't measure success by how much money the program can claim to have moved from developed economies to "SMEs" in developing economies!

Submitted by Mawira on
Very interesting and useful. I like the Gibson and Vaart definition as well as the one that uses number of employees for more informal MSMEs. Whenever possible, the turnover should be used to define MSMEs, as sometimes fairly large businesses are still characterised as MSMEs, especially in agribusiness in Africa.

Submitted by Adam Rein on
At the SEVEN Fund, we looked into this issue while assessing a new indicator to help attract investment capital to SMEs in the developing world. Two issues to keep in mind is that 1-2 employee microentrepreneurs, typically recipients of microfinance, should be separated from other SMEs in terms of data because they do not offer the same potential for employment or growth. In addition, the best kind of SMEs that are innovating often have no turnover in their early years (just look at Silicon Valley), but they should not be ignored from SME statistics. One possible solution to both of these issues is to look at the cost side of the business -- the business-related expenditures that an enterprise makes each year.

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