How to identify and support fast-growing firms that can take off, create jobs, and yield significant value in a short period of time is one of our biggest dilemmas in nurturing private sector development in emerging markets.
The Sustainable Development Goals (#8) include the need for decent jobs as an important developmental priority, and small and medium size enterprises (SMEs) are expected to create most jobs required to absorb the growing global workforce.
But many young firms will fail; by some accounts more than half of new firms won’t make it to their second birthday.
However, despite the high rate of firm failure, research from the US and evidence from India, Morocco, Lebanon, Canada and Europe shows that (net jobs are jobs created minus jobs lost) and lasting employment opportunities.
In addition, even when a firm survives beyond the first two years of operation, there are no assurances it will become a fast-growing firm -- a gazelle.
Although estimates vary widely, the share of gazelles -- fast-growing firms that generate a lot of value-added and jobs -- is thought to be only between 4% to 6% of all SMEs, and, possibly, even less in many emerging countries.
All this makes creating favorable conditions for entrepreneurship a priority.
Easing business entry -- the time and cost involved in establishing a new enterprise -- is extremely important. As the annual Doing Business report shows, many countries have made a lot of progress on this indicator over the past decade.
But business exit is an equally critical piece of the puzzle.
South Korea today has the fourth largest economy in Asia, is a member of the OECD’s “Rich Club,” and is part of the G20. Despite sharp economic shocks emanating from the Asian financial crisis in the late 1990s, the global financial crisis in 2008, and the more recent slowdown in the Chinese economy – Korea has bounced back and continues to grow.
So it’s hard to imagine that some 70 years ago, Korea’s future looked very bleak – and akin to many of the excruciatingly difficult post-conflict environments that we face today.
To briefly summarize Korea’s post-World War II history: a 1947 report on Korea commissioned by U.S. President Truman concluded, “South Korea, [as] basically an agricultural area, does not have the overall economic resources to sustain its economy without external assistance …. Prospects for developing sizeable exports are slight ….. The establishment of a self-sustaining economy in South Korea is not feasible.” Then the Korean War compounded these problems – resulting in massive damage to both the north and the south – with destroyed infrastructure, a loss of skilled workers, a million South Koreans killed, and as much as one-quarter of the country’s population refugees.
We have many lessons to learn from Korea – particularly as our institution, the World Bank, increasingly focuses on post-conflict and fragile environments.
Although South Korea is known for its large scale “Chaebols,” which have dominated much of its political and economic life – less well known is the considerable support that the government has provided to small and medium scale enterprises (SMEs). As in most countries, (3 million SMEs), over 80% of all employees (10.8 million employees), and almost 48% of total national production.
At a recent European Commission SME Envoy meeting in Ljubljana, Slovenia, the European group responsible for advising on policy and strategic directions for SME support in the EU discussed options for the way forward.
Battered by continued anemic growth since the 2008 global financial crisis, hit with a flood of Middle Eastern refugees, and (in early June) facing the possibility of Brexit, the mood was anything but upbeat and the future of “Project Europe” seemed to hang in the balance.
, account for 60% of jobs in many countries, and supply as much as 50% to national income. All of this makes SMEs’ contribution to the economy crucial. Yet, since the financial crisis, banks in many countries haven’t managed to bring their SME lending portfolios back up to pre-crisis levels. Many are deleveraging out of riskier lending such as SME loans. Venture capital in Europe remains well below its levels of 8 years ago. And SME capital markets and SME securitization of loans continue to be severely battered by the continent’s ongoing economic malaise.
In many countries Government is the biggest procurer of goods and services, which makes them an attractive client for small and medium scale enterprises (SMEs) seeking to get a leg up in business.
Recognizing the important role that the public sector plays as a purchaser of goods and services, as well as the critical role SMEs have for the economy, Governments frequently use Public Procurement to incentivize, support and otherwise sustain local SMEs.
Also, as in many of our client countries, where the vast majority of SMEs are informal, the lure of a significant Government contract can serve as a strong motivator to register and formalize – bringing these companies in from the shadows.
But there is also a significant downside in many countries. Cash-strapped governments frequently don't pay their bills on time and, in some countries, payment delays of 12 months or even two years are not uncommon. Such delays can seriously compromise the position of a small scale enterprise which – with limited access to formal bank financing – relies critically on cash flow from its clients to sustain its business. A six month delay in receiving payment on a contract can easily put a small firm out of business.
The World Bank and Rabobank Foundation are teaming up to strengthen financial cooperatives in rural areas to improve financial services for smallholder farmers and agricultural SMEs.
Financial services in rural areas are scarce and expensive. Servicing smallholder farmers spread across wide geographical areas isn’t attractive to mainstream financial institutions as their transactions are small, their cash flows seasonal and returns on investments can be risky due to potential crop failures or weather calamities.
To get access to savings and credit, rural households and farms often establish cooperative financial institutions (CFIs). While CFIs have a strong local presence and knowledge, they often have weak institutional capacity and governance, lack access to information technology, and suffer from political interference. Also, the laws regulating CFIs are often inadequate and supervision is weak, all of which hampers CFIs’ ability to deliver financial services. Often, CFIs don’t fall under the purview of the main financial sector regulator and supervisor, but of other entities that don’t always have the required capacity and expertise.
I recently attended an SME Conference in Jordan around SME Finance and Employment – extremely important issues in a troubled region. All participants agree that much more needs to be done to address the lack of jobs in the region and to increase financial access at all levels, to individuals, households and small and medium scale enterprises (SMEs).
despite being a middle income region.
Only 4% of unbanked adults in the Middle East say that they don’t have an account because they don't need one. In other words, it is clear there is widespread unmet demand for financial services.
A person living in the Middle East is less likely to have a bank account than is a low-income person living in Africa or South Asia, and significantly less likely than a person living in Latin America, Eastern Europe or East Asia from comparable middle income country or region. This poses a dilemma – why?
With this week's kickoff of the 2016 China “Business 20” (B20) proceedings in Beijing, this is an opportune time to reflect on some of the key accomplishments of the 2015 Turkey B20. As many readers of this blog know, the B20 is the premier dialogue platform of the business community with the G20 policymakers representing the most important economies of the world, and it is influential in identifying and supporting policies that are crucial for overall economic development. I believe that taking stock of the past enables us to learn from both successes and failures, and helps sustain the momentum on what worked and generated the desired impact.
Looking back at my involvement as Chair of the B20 Steering Committee, what strikes me as a major achievement is the amplification of the voice of small and medium enterprises (SMEs). I believe that, if we want our economies to have healthy and inclusive growths, this must remain as a key priority for the upcoming B20 in China.
Participants in the Turkish G20/B20 process shared the assessment that SMEs’ potential was not being fully realized. SMEs account for about two-thirds of all private-sector jobs globally and about 80 percent of net job growth. They are the engine for equitable growth and poverty alleviation. And they are the backbone of the middle class and of social stability. Yet they suffer disproportionately from limited access to markets, finance, talent, skills and innovation. In addition, regulations also often put them at a disadvantage. Until recently, SMEs had lacked an organization that would champion their cause.
With these major issues in mind, and with strong deliberations of the B20 Leadership and support from the G20 Finance Ministers, last year TOBB and the ICC officially founded the World SME Forum (WSF), with the mission to help improve the overall growth and impact of SMEs globally, by effectively tackling the key challenges they face. WSF aims to provide SMEs with effective representation and to advance the recognition of the role of SMEs in the global economy by partnering with international financial institutions (IFIs) and development agencies. WSF has membership from associations and chambers working in the SME space from all over the world.
WSF is ready to represent SME interests with regional and global bodies, and to advocate for better rules and regulations among standard-setters.
As I am on my way to Beijing, I cannot help but think that this is indeed a major achievement, which will give the SME development agenda a much better chance at succeeding. WSF can be a “bridge” across B20 presidencies, so that we can ensure continuity in the crucial SME agenda. WSF can help avoid any loss of momentum on the implementation of the recommendations we develop during each cycle.
Even better, after B20 China officially decided to continue the SME Development Taskforce, which was started for the first time by B20 Turkey, they invited WSF to be a Business Network Partner for the Taskforce. WSF will therefore be coordinating the network and will help drive the ideas that emerge from the Taskforce discussions into implementation.
I recently attended an interesting presentation about a truly impressive credit guarantee agency, the Korean Credit Guarantee Agency (KODIT), established 40 years ago with $44 billion in outstanding guarantees and 220,000 SMEs guaranteed annually. A truly impressive institution which has opened up bank lending to more and more SMEs, which otherwise would have gone unfunded and unserved. As one of the larger Partial Credit Guarantee (PCG) schemes in the world, the Koreans have clearly achieved remarkable results at an impressive scale.
The one thing that struck me most, however, was the slide reproduced below. KODIT explicitly uses a guarantee instrument on SME loans as a tool of countercyclical policy. So, when the economy enters a down turn, guarantees are more liberally applied to ensure that SMEs don’t go out of business and adversely impact the generally negative economic scenario. “Job Preservation” becomes more important than “Job Creation.” With 99% of registered firms in Korea being SMEs, and with 87% of Korean employment coming from SMEs,supporting this sector in a down turn is clearly very important.
Korea is not unique. During the early days of the Great Recession in 2008, the Small Business Administration of the United States of America increased SME guarantees in the face of an economic down turn. Since the summer of 2015, the Chinese government has begun to offer subsidized loans to SMEs to counteract the effects of the Chinese slow down. Countries such as Turkey, Ecuador, Nigeria, Kazakhstan, Myanmar and Egypt are increasingly seeking World Bank support for SME lines of credit, SME guarantee programs, and other forms of SME support. Supporting SMEs is clearly a well-recognized and frequently applied tool of economic policy.
Yet our own World Bank guidelines stipulate that SME-support interventions are meant to help achieve longer-term developmental goals – broadening and deepening financial markets so that financial systems can ultimately take on these types of lending without the need for outside intervention. In fact, a 2014 IEG Report on “The Big Business of Small Enterprise” criticized the World Bank, the International Finance Corporation, and MIGA for undertaking SME I, followed by SME II, followed by SME III, followed by SME IV, with no visible increase in the capacity of the underlying financial sector to sustain such lending on its own account, very little lengthening of the tenors of SME lending, and seemingly very little increase in the commercial banking sector’s comfort levels in dealing with a clientele which all too frequently is perceived by private lenders as being unduly risky.
It would actually seem, however, that SME Lines of Credit and other forms of SME support, are undertaken for several reasons but within two broad categorizations:
- To help catalyze the market in the development of longer term financing instruments (an output, not an outcome)
- Support employment generation (which is a prime motivation in the current global environment) or other “SME-related” objectives (such as diversification, innovation, geographic dispersion of economic activities, value chain inclusion, women’s employment, youth employment, etc)
- As a tool of countercyclical economic policy.
It would appear that SME support mechanisms can be a legitimate tool of countercyclical economic policy in an economic down turn. However, because speed is generally a prime pre-requisite in such an environment, these types of operations will not necessarily promote the pre-conditions for longer term market development for SME funding, an enhanced appetite for banks to lend to SMEs, or even increased support for “employment-generating” SMEs that may well be the desired target …………. and consequently, the criticism that we are not having a real lasting developmental impact.
Maybe the time has come start thinking about SME lending in two distinct ways:
- As a tool of countercyclical economic policy (much like fiscal support through a DPL, but directed at the private sector) and
- As a more developmental instrument (catalyzing longer term lending markets, developing instruments more attuned to “employment generating” SMEs, supporting a more robust financial infrastructure – including payments system and PCG support schemes, etc).
Green bananas. Saturday morning I head to the market to buy bananas, but I find only green ones at the stand. There is no large banana importer to complain to, no government bureaucrat to sympathize with my need for ripe bananas, and certainly no banana grower to chat with. I have to make an economically rational decision (buy them green, buy them later, or don’t buy at all) and move on to the apples, where the cycle repeats. This is a market imperfection that I understand and have to live with (although it drives me bananas).
But what about when we wear another hat, that of the Bank financial sector project designer? We are used to generating investment projects that fit different market situations, regulatory systems, and political realities. Under tight time constraints, we do what an economist might do – assume there is a market imperfection and brainstorm on the most appropriate effective solution. But a true economist would want evidence of the market imperfection from statistics, recent assessments, etc.
So what is a financial sector specialist to do? The first step is to understand which of the many imperfections represents the binding constraint – the one that blocks government and private sector counterparts from taking the first steps to correct a problem. This is where the economists come in.
Since more than 50% of small and medium-sized businesses (SMEs) worldwide lack adequate access to credit, the international community is proposing reforms that will help countries strengthen their financial infrastructure and make it easier for SMEs to borrow funds needed to operate and expand.