SMEs' competitiveness for sustainable value chains
SMEs represent the missing link to inclusive development. On average less productive than large firms, they pay lower wages and offer less favourable labour conditions. Addressing the ‘productivity gap’ is crucial for inclusive growth. Trade can play a role in this. Small and medium-sized enterprises (SMEs) represent the backbone of economies worldwide. In South East Asia they are estimated to account for 98% of all enterprises and to employ 66% of the labour force. In Latin America and the Caribbean (LAC) region, SMEs account for 99% of firms and 67% of employment. While few pan-African SME statistics are available, SMEs in Africa are known to dominate the means of production to a greater extent than in other regions. For example, in Ghana, SMEs represent 92% of Ghanaian businesses and contribute about 70% of GDP. Definitions of what constitutes an SME differ across countries and statistics are not always comparable across countries. Based on the above, it is nevertheless fair to say that SMEs represent on average over 95% of all firms and that they employ around two thirds of the labour force. SMEs therefore clearly matter for economic activity and for the living and working conditions of millions of people.
Unfortunately SMEs are not always well positioned to offer high wages and good working conditions. SMEs are significantly less productive than large firms and this limits their possibilities to pass on gains to their workers. The existence of this productivity gap between large and small firms is well known. It is less well known that productivity differences between small and large firms are much more pronounced in developing countries than in industrialised ones. Evidence collected by the OECD and UN-ECLAC reveals that the productivity of a small firm in Germany is on average around 70% of the productivity of a large firm in the same country. Figures in other European countries are similar. In Brazil, on the other hand, small firm productivity is only 30% of the productivity of large firms. In India, enterprises with more than 200 employees have been found to be ten times more productive than enterprises with five to 49 employees. Productivity differences between small and large firms find their reflection in wage differences with wages paid in SMEs being significantly lower than those paid in large firms. As a consequence, SMEs tend to employ a larger share of the vulnerable sections of the workforce, namely less experienced and less educated workers belonging to poorer households.
SMEs therefore tend to provide a living to those households that are targeted by efforts to meet the Sustainable Development Goals (SDGs). Increasing SME productivity is therefore likely to contribute greatly to meeting the SDGs as it would have two direct effects: it would contribute to GDP growth because of increased SME productivity, and it would lead to higher wages in the low-wage segment of the economy, with positive distributional effects. This latter effect points to the inclusiveness of the growth potential generated by SME productivity increases. Those effects are likely to go beyond the immediate income effect on poor households. Higher wages for female employees are, for instance, likely to have knock on effects on the wider economy as women in developing countries are known to have a higher propensity than men to invest in their families and in the community at large, leading to positive externalities for the country as a whole.
Globalisation and modern technologies offer new opportunities for SMEs in this context. SMEs that export are more productive than non-exporting SMEs and therefore have the capacity to pay higher wages. Research by the Edinburgh Group has found internationally active SMEs to demonstrate higher employment growth: 7% growth for exporters and 3% for non-exporters. Recent country studies for China and Tunisia commissioned by the International Trade Centre (ITC) have drawn similar conclusions. Internationally active SMEs contribute to more jobs and better jobs. One of the winners of the 2015 Nairobi Trade and Business Forum Awards was the female owner of an IT company based in a least-developed country (LDC). She spoke proudly of her achievements and of the number of jobs her enterprise created. And she also emphasised that she had understood early on that ‘going global’ was the best option for a female entrepreneur in her country to succeed. SMEs going global at an early stage of their existence is an increasingly common phenomenon. While we are used to seeing small firms grow into international business as they become larger, open markets and information and communication technologies are conducive to the emergence of new types of SMEs that are very different from their historical counterparts. This is the case for so-called ‘born-globals’ – SMEs that sell, or intend to sell, to a global client base from the start. A large firm level survey by DHL found that 24% of all SMEs in Brazil, the Russian Federation, India, China and Mexico and 13% of SMEs in G7 countries are born global. Notwithstanding the born-global phenomenon, going global while small is in general not easy and not all ‘born-globals’ stand the test of time. International trade has been and continues to be dominated by large firms with exporting firms being larger, both in terms of number of employees and turnover. There is evidence that in some markets, concentration and market power is high and on the increase, notably in certain agricultural activities that are crucial for developing countries.
It is the International Trade Centre’s mandate to support SMEs in their efforts to internationalise. A thorough understanding of drivers of SMEs’ international competitiveness is a pre-condition for success in this endeavour. At ITC we take the view that in order to be successful in international markets, both as importers and as exporters, SMEs have to be able to connect, compete and change. In a modern, interconnected, fast-changing world, access to information and the ability to interpret and use that information is crucial. This is what we refer to as the ability to connect. Market-relevant information has to be used to design and generate an offer that can compete in targeted markets at any given moment in time. This is what we refer to as firms’ ability to compete. And last but not least, SMEs have to be able to adjust to changes in markets or – even better – pre-empt changes in markets. Adjustment can require investment in financial or human resources or in innovation. This is what we refer to as firms’ ability to change.
Drivers of SME competitiveness can be found at three layers of the economy: at the macro-economic and national policy environment, in firms’ immediate business environment and at the firm-level itself. The importance of national policies is emphasised in well-known competitiveness reports produced by institutions like the World Economic Forum or the World Bank and refers notably to aspects like countries’ trade or financial policies. The immediate business environment refers to firms’ relationship with and access to peers, suppliers and consumers. It also refers to their access to platforms, such as e-commerce platforms, e-pay platforms, information platforms or infrastructure hubs. Last but not least, firm level capability itself will be crucial for firms’ success. For this, managers’ ability is key, which explains the popularity of business schools across the globe. By organising approximately 40 indicators around the three pillars and layers of SME competitiveness just described, it is possible to generate a picture of SME competitiveness that reflects fairly closely the stylised facts known about SME productivity. SMEs are found to be less competitive than large firms and the gap between SME competitiveness and large firm competitiveness is found to be significantly bigger in developing countries than in developed countries. The advantage of looking at indicators that determine competitiveness - rather than productivity figures themselves – is that it makes it possible to identify what drives competitiveness gaps and thus to provide information that is crucial for policy makers and trade and investment support institutions wanting to support SME internationalisation. Based on this approach, SME Competitiveness Outlook 2015 highlighted that weaknesses in connectivity are the main driver explaining competiveness gaps between small and large companies in LDCs. Landlocked developing countries are known for having a physical connectivity challenge with roads and ports. They also turn out to have a virtual challenge as e-connectivity rates are among the lowest in the world.
SME Competitiveness Outlook 2016 will focus on another aspect affecting SME competitiveness: their ability to comply with standards and regulations. Standards and regulations are an integral part of international trade and of international value chains. They play an important role in making international value chains more efficient. They also play a crucial role in ensuring the social and environmental sustainability of international value chains, an issue at the heart of numerous global policy debates, including at the G20 level. Smaller firms find it harder to cover fixed costs to comply with standards and regulations. This is particularly a problem in developing countries. Because of size and productivity differences, the same requirement represents a bigger obstacle to a developing country small firm than to a small firm in an industrialised country. Research conducted by ITC with the European University Institute (EUI) using data from ITC’s Standards Map reveals that lead firms in International Value Chains (IVCs) can play a role in overcoming such obstacles. The research finds that when standards are set by for-profit organisations (firms), producers and other stakeholders (such as buyers in the supply chain) are more likely to share implementation and certification costs. This evidence suggests that when lead firms set standards, they are more likely to help defray some of the compliance costs that would otherwise have been entirely borne by suppliers. Accessing IVCs, however, is easier said than done. Only the most productive players can successfully integrate into such chains. Lead firms have an incentive to look for the most suitable suppliers before entering into commercial relationships with them. Being competitive is therefore a ‘must’ for SMEs in sustainable value chains. For more on the issues discussed in this article see: International Trade Centre. 2016. SME Competitiveness Outlook 2016: Meeting the standard for trade. Geneva: ITC. About the author Dr. Marion Jansen is the Chief Economist of the International Trade Centre (ITC).
This article was published in GREAT Insights Volume 5, Issue 5 (October/November 2016).
SMEs’ productivity gap
Unfortunately SMEs are not always well positioned to offer high wages and good working conditions. SMEs are significantly less productive than large firms and this limits their possibilities to pass on gains to their workers. The existence of this productivity gap between large and small firms is well known. It is less well known that productivity differences between small and large firms are much more pronounced in developing countries than in industrialised ones. Evidence collected by the OECD and UN-ECLAC reveals that the productivity of a small firm in Germany is on average around 70% of the productivity of a large firm in the same country. Figures in other European countries are similar. In Brazil, on the other hand, small firm productivity is only 30% of the productivity of large firms. In India, enterprises with more than 200 employees have been found to be ten times more productive than enterprises with five to 49 employees. Productivity differences between small and large firms find their reflection in wage differences with wages paid in SMEs being significantly lower than those paid in large firms. As a consequence, SMEs tend to employ a larger share of the vulnerable sections of the workforce, namely less experienced and less educated workers belonging to poorer households.
SMEs and the SDGs
SMEs therefore tend to provide a living to those households that are targeted by efforts to meet the Sustainable Development Goals (SDGs). Increasing SME productivity is therefore likely to contribute greatly to meeting the SDGs as it would have two direct effects: it would contribute to GDP growth because of increased SME productivity, and it would lead to higher wages in the low-wage segment of the economy, with positive distributional effects. This latter effect points to the inclusiveness of the growth potential generated by SME productivity increases. Those effects are likely to go beyond the immediate income effect on poor households. Higher wages for female employees are, for instance, likely to have knock on effects on the wider economy as women in developing countries are known to have a higher propensity than men to invest in their families and in the community at large, leading to positive externalities for the country as a whole.
Opportunities for SMEs going global
Globalisation and modern technologies offer new opportunities for SMEs in this context. SMEs that export are more productive than non-exporting SMEs and therefore have the capacity to pay higher wages. Research by the Edinburgh Group has found internationally active SMEs to demonstrate higher employment growth: 7% growth for exporters and 3% for non-exporters. Recent country studies for China and Tunisia commissioned by the International Trade Centre (ITC) have drawn similar conclusions. Internationally active SMEs contribute to more jobs and better jobs. One of the winners of the 2015 Nairobi Trade and Business Forum Awards was the female owner of an IT company based in a least-developed country (LDC). She spoke proudly of her achievements and of the number of jobs her enterprise created. And she also emphasised that she had understood early on that ‘going global’ was the best option for a female entrepreneur in her country to succeed. SMEs going global at an early stage of their existence is an increasingly common phenomenon. While we are used to seeing small firms grow into international business as they become larger, open markets and information and communication technologies are conducive to the emergence of new types of SMEs that are very different from their historical counterparts. This is the case for so-called ‘born-globals’ – SMEs that sell, or intend to sell, to a global client base from the start. A large firm level survey by DHL found that 24% of all SMEs in Brazil, the Russian Federation, India, China and Mexico and 13% of SMEs in G7 countries are born global. Notwithstanding the born-global phenomenon, going global while small is in general not easy and not all ‘born-globals’ stand the test of time. International trade has been and continues to be dominated by large firms with exporting firms being larger, both in terms of number of employees and turnover. There is evidence that in some markets, concentration and market power is high and on the increase, notably in certain agricultural activities that are crucial for developing countries.
SMEs’ ability to connect, compete and adjust
It is the International Trade Centre’s mandate to support SMEs in their efforts to internationalise. A thorough understanding of drivers of SMEs’ international competitiveness is a pre-condition for success in this endeavour. At ITC we take the view that in order to be successful in international markets, both as importers and as exporters, SMEs have to be able to connect, compete and change. In a modern, interconnected, fast-changing world, access to information and the ability to interpret and use that information is crucial. This is what we refer to as the ability to connect. Market-relevant information has to be used to design and generate an offer that can compete in targeted markets at any given moment in time. This is what we refer to as firms’ ability to compete. And last but not least, SMEs have to be able to adjust to changes in markets or – even better – pre-empt changes in markets. Adjustment can require investment in financial or human resources or in innovation. This is what we refer to as firms’ ability to change.
Drivers of SME competitiveness
Drivers of SME competitiveness can be found at three layers of the economy: at the macro-economic and national policy environment, in firms’ immediate business environment and at the firm-level itself. The importance of national policies is emphasised in well-known competitiveness reports produced by institutions like the World Economic Forum or the World Bank and refers notably to aspects like countries’ trade or financial policies. The immediate business environment refers to firms’ relationship with and access to peers, suppliers and consumers. It also refers to their access to platforms, such as e-commerce platforms, e-pay platforms, information platforms or infrastructure hubs. Last but not least, firm level capability itself will be crucial for firms’ success. For this, managers’ ability is key, which explains the popularity of business schools across the globe. By organising approximately 40 indicators around the three pillars and layers of SME competitiveness just described, it is possible to generate a picture of SME competitiveness that reflects fairly closely the stylised facts known about SME productivity. SMEs are found to be less competitive than large firms and the gap between SME competitiveness and large firm competitiveness is found to be significantly bigger in developing countries than in developed countries. The advantage of looking at indicators that determine competitiveness - rather than productivity figures themselves – is that it makes it possible to identify what drives competitiveness gaps and thus to provide information that is crucial for policy makers and trade and investment support institutions wanting to support SME internationalisation. Based on this approach, SME Competitiveness Outlook 2015 highlighted that weaknesses in connectivity are the main driver explaining competiveness gaps between small and large companies in LDCs. Landlocked developing countries are known for having a physical connectivity challenge with roads and ports. They also turn out to have a virtual challenge as e-connectivity rates are among the lowest in the world.
Standards and regulations
SME Competitiveness Outlook 2016 will focus on another aspect affecting SME competitiveness: their ability to comply with standards and regulations. Standards and regulations are an integral part of international trade and of international value chains. They play an important role in making international value chains more efficient. They also play a crucial role in ensuring the social and environmental sustainability of international value chains, an issue at the heart of numerous global policy debates, including at the G20 level. Smaller firms find it harder to cover fixed costs to comply with standards and regulations. This is particularly a problem in developing countries. Because of size and productivity differences, the same requirement represents a bigger obstacle to a developing country small firm than to a small firm in an industrialised country. Research conducted by ITC with the European University Institute (EUI) using data from ITC’s Standards Map reveals that lead firms in International Value Chains (IVCs) can play a role in overcoming such obstacles. The research finds that when standards are set by for-profit organisations (firms), producers and other stakeholders (such as buyers in the supply chain) are more likely to share implementation and certification costs. This evidence suggests that when lead firms set standards, they are more likely to help defray some of the compliance costs that would otherwise have been entirely borne by suppliers. Accessing IVCs, however, is easier said than done. Only the most productive players can successfully integrate into such chains. Lead firms have an incentive to look for the most suitable suppliers before entering into commercial relationships with them. Being competitive is therefore a ‘must’ for SMEs in sustainable value chains. For more on the issues discussed in this article see: International Trade Centre. 2016. SME Competitiveness Outlook 2016: Meeting the standard for trade. Geneva: ITC. About the author Dr. Marion Jansen is the Chief Economist of the International Trade Centre (ITC).
This article was published in GREAT Insights Volume 5, Issue 5 (October/November 2016).
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