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.
SMEs in most Western European countries represent over 95% of all registered firms , 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.
I was struck by how much this most developed part of the world was grappling with exactly the same problems that we face in our emerging economies – supporting stronger growth, increasing employment opportunities, and fostering innovation. Which is precisely why the World Bank Group was invited to attend this event so that the EC’s SME Envoy members could hear how we are dealing with similar issues in our client countries.
The emphasis at the event was on restoring growth and generating more jobs through the SME sector as an engine for growth .
The received wisdom of the group was that it was mainly young firms that generated most growth and job creation. Studies from a growing number of countries – both developed and emerging – show that firms younger than five years-of-age generate most employment, despite a considerable amount of job churn (jobs created and jobs lost).
Consequently, supporting start-ups was a major focus of the meeting. This, however, is a problem as most commercial banks are unlikely to finance a young, start-up entrepreneur with little track record. Indeed, using depositor’s money, commercial banks should probably NOT be involved in this segment of high risk lending where the failure rates are high. This then argues for developing and supporting an array of pre-bank financing instruments around angel financing, seed financing, and other early-stage financing mechanisms that will eventually lead a successful entrepreneur to a bank, an IPO, or some other more formalized market linked financing support.
Since the failure rate among start-ups is fairly high, the focus is on the much smaller group of scale-up SMEs -- variously estimated at between 4% to 6% of SMEs segment -- which will eventually gallop like a gazelle or fly like a unicorn, bringing growth and jobs in their path.
This is particularly important because, if one considers the MSME sector as a whole, it is the medium-sized firms that generate most jobs and value added. They add much more than the small-sized firms which, in turn, are much more effective in generating jobs and adding value than the large number of tiny or micro firms, which exist in many countries.
Supporting firms through a growth and financing continuum from micro-to-small-to-medium is the challenge. It’s also a challenge to be able to identify potential gazelles from within the large MSME universe of firms.
While the mood in Ljubljana was somewhat gloomy, the outlook was optimistic.
Participants compared Europe with the United States, which has managed to exit the financial crisis better, with a reasonable level of growth and unemployment levels below 5%.
Many reasons explain this difference between the two continents. However, as a group focusing on financing issues, participants discussed the differences in the two financial systems:
While SME lending in many European countries hasn’t yet recovered to pre-crisis levels, SME lending in the US is reasonably robust. While venture capital remains depressed in Europe, it has bounced back in the US and, even more interestingly, the angel financing industry has grown to levels which now rival the country’s venture capital industry. European enterprises, particularly SMEs, continue to rely heavily on bank-based financing, while market-based financing in the US contributes much more to business financing. And, on both continents, Fintech and related activities such as crowdfunding, are only beginning to emerge, with the US and the United Kingdom leading in this space (China is also a very big player here).
This begs several questions in our quest for reducing poverty and increasing shared prosperity:
- In a growth- and employment-challenged world, shouldn’t we be placing considerably more importance on the financing of the SME sector as an engine of growth rather than existing policies which are deleveraging out of SME lending and possibly perpetuating the downward spiral?
- As The Economist touted several years ago, “Is this the end of banks?” and shouldn’t we be working on finding much more innovative SME financing solutions (early stage financing, angel financing, crowd funding and other forms of Fintech, etc)?
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