LITTLE REAL SUCCESS FOR SMEs IN TRANSITION Recent research (McIntyre and Dallago 2003) shows that the reported success of SMEs in transition economies is largely illusory. Small retail shops and kiosks proliferated, at least temporarily, but productive local small enterprise systems have not developed, leaving a still gaping small enterprise 'black hole'. This paper further argues that: (a) the weight of SME stimulation policies as an anti-poverty measure had been wildly exaggerated; and (b) the mechanisms required for the healthy SME and local economy growth misunderstood. There is much resistance to such "negative" conclusions about the effects of the SME sector in the transition countries, but these results are supported by a new World Bank study covering 80 countries (2003). 

Robert J. McIntyre

 

Institute for International Economic and Political Studies, Moscow

 

 

 

Assumptions about the automatic emergence and developmentally functional articulation of markets led to a failure to work seriously to establish the institutional, structural and demand conditions that would allow real growth, which embodies or is accompanied by SME growth but is not caused by it.  Foreign Direct Investment (FDI) is often seen as a solution to the resulting stagnation of domestic productive activity, but may intensify the problem of building self-sustaining local economic development by destroying indigenous small enterprises.

 

This paper analyzes the implications of these reappraisals and goes on to explore the multi-dimensional relationship between the formal sector, the informal sector, large enterprises, small enterprises and local government, pointing to the crucial role of integrative credit and governance institutions.  It calls attention to lessons from Asia on bringing informal activity into the open by the provision of real services. "Real services" must be understood to include both: a/ provision of conventional business services to local small and micro enterprises (where there are strong local externalities); and b/ provision of local-level social services to citizens, legitimizing the intensification of revenue collection efforts by local government as part of "formalization". It points to the dynamizing role of locally-controlled integrative institutions, specifically credit cooperatives (not grant-based micro-credit) along the line of French Canadian, Finnish (and other Nordic) practice, organized into small "basis" units and local level federations.

 

2.  LOCAL-LEVEL SUCCESS REQUIRES PATIENT POLICY

Despite the tendency to think of and present SMEs as an alternative to the former SOE, except for the face-to-face retail and service delivery sector little can be expected from the SME without either: (a) active support efforts at the local level; or (b) the survival or development of a healthy large enterprise sector which the SME can utilize as supplier, customer and provider of various social and technical externalities.

 

The SME sector needs the large enterprise sector as a source of inputs, a market for its output and also as source of individual entrepreneurial leadership. This requires a synergistic relationship between SME and large enterprise sectors, not a zero-sum environment where 'success' of the small can only be secured by destroying or disassembling the large.  FDI does not solve these problems, but may (for reasons cited below) exacerbate them.

 

3.  THERE ARE SUCCESSFUL POLICY APPROACHES 

An argument is developed that real SME-stimulation alternatives exist which have spread effects able to produce poverty reduction, drawn from the developmental experience of the local developmental state (Johnson 1982). This approach shows that national-level success in triggering growth sufficient to drive significant poverty reduction requires measures carried out by local-level governments as part of a national-level strategy. FDI generally plays a significant role only after locally-rooted development had been initiated or resumed.

 

These examples point to the centrality of a small-enterprise system for both micro- and macro-level success and support consideration of a wide range of possible organizational and ownership forms.  The arrival of FDI does not change or ease this need for effective policy.  The issue of how the SME sector interacts with the large and/or foreign-owned sector is central. In both cases positive overall developmental effects are strongly dependent on the conditions under which FDI interacts with the local economy. This is especially true if poverty reduction is given serious weight in defining developmental success. 

 

4.   "INCENTIVE COMPATIBLE" REGULARIZATION OF THE INFORMAL 

 Successful efforts to 'regularize' the informal economy have depended on providing active incentives for 'emergence', usually taking the form of local-level provision of real services. Few of the Eastern European and CIS transition countries have embraced this kind of local-level industrial policy.  As a result proven policy approaches drawn from directly relevant East and South Asian experience are ignored by recipient government, in part because they are seen as 'market unfriendly' by potential providers of FDI.  This company-level logic sharply contradicts the longer-term interests of the European Union in stable and social harmonious accession states and their nearby 'periphery'.

 

Development of integrative locally-controlled institutions, specifically credit cooperatives (not grant based micro-credit) along French Canadian, Finnish (and other Nordic) lines (organized into small "basis" units and local-level federations) is shown to be a highly effective strategy.  Russian and other transitional economy examples are used to illustrate the ability of this approach to mobilize the energies of local government for constructive local economic development, while at the same time providing significant incentives for improved local economic governance.

 

5.   FDI DOES NOT SOLVE THE PROBLEM

            Because transition governments too often treat foreign direct investment as a cure-all with automatically positive macro- and micro-level effects, they have failed to negotiate conditions sufficient to secure positive and sustainable development effects from what FDI has occurred.  Blind enthusiasm for FDI partially results from systematic confusion between pure 'asset swaps' which create no new productive capacity, the management changes that may or may not accompany them, and new 'real' investment in the correct and economically meaningful use of the term ('green-field' entities or upgrading of old production capacities).

 

Lack of policy attention to this issue means that even countries that have secured extensive green-field expansion often see construction of 'cathedrals in the desert': modern facilities highly dependent on imported components and sub-systems with few positive spill-overs into sub-contractor and supply-chain links involving local small enterprises.  The immediate local-level result is little employment or poverty reduction impact, while the macro situation is often marked by sharply increased current account deficits. 

 

The unexpected coexistence of large current account deficits with large reported FDI inflows at least in part reflects this lack of local participation in the supply chains of the new facilities. It also reflects loss of market access by local producers who are replaced by imports as retail distribution channels change, often in the absence of actual consumer choice. If the on-going character and geographical distribution of FDI in transition economies continues, it is likely to expand the informal economy and increase poverty, at least in those areas away from the national capital or other FDI concentration points. These are difficult policy-making circumstances, where the desperation of recipient governments (to show evidence of immediate 'success') makes good bargaining difficult, but clearly more active and far-sighted government engagement is required to assure that the positive developmental potential of FDI is realized by these recipient countries. 

 

6. ASYMETRIC OPENING: MARKET ACCESS AND LOCAL PRODUCTS

The major problems of SME development -- an inadequately developed institutional/organizational context, lack of product market access for small-scale producers and most critically finance -- are made worse by rapid, uncontrolled and asymmetric market opening.  A UNCTAD (2002) study suggests that the process of opening up even well-established market economies has strong negative effects on the SME sector.  This reflects a mixture of the effects of domestic demand repression and the arrival of more mature foreign competitors in all economic sectors. More negative results should be expected in those (many) transition countries where an era of normal growth is yet to occur, magnifying vulnerability to outsiders.

 

With the arrival in developing markets of large, well-financed foreign producers and distributors, even potentially promising local production capacities may be destroyed before finding their feet.  Local producers may expire as a result of short-run 'predatory' tactics (penetration pricing, loss-leaders, bribery/black mail of distributors or retailers, etc.) or loss of market access. A central but often invisible aspect of the survival or growth of productive SMEs is the ability to expose their products to the processes of consumer choice. It is especially important to maintain consumer access to locally produced goods when new distribution channels emerge. Only a short period of exclusion from the market is enough to kill off otherwise viable and promising local production capacities

 

Dynamic economic growth that works for the poor regions and the poor nationally requires credit cooperatives and other forms of locally-owned banking institutions tasked with serving local small enterprise interests. Locally-owned banks and local small enterprise systems in various countries function successfully on 'social capital' that is very costly for large banks with no inherent local development mission. It does not make sense for them to provide the type of patient, step-by-step credit and other financial service support that firms of a nascent small enterprise sector require. Consolidation, restructuring, and privatization of large banks prevented the establishment and development of financial institutions for SMEs in most transition countries.  Once under foreign ownership local banks are very unlikely to devote significant resources to support foundation or growth of SMEs in areas where poverty is concentrated.

 

7.   CONCLUSIONS

Successful long-term development will not occur in ways that significantly reduce poverty unless there is sustained growth of internal demand and active policy measures to protect local capacities. A successful SME sector that goes beyond neighbourhood-level services and retail distribution (the later often doomed in any case) requires both active support services at the local level and the survival, revival or development of a healthy large enterprise sector as supplier of inputs, output market, provider of various social and technical externalities, and also (unexpectedly) as source of individual entrepreneurial leadership. Systems success is more a question of quality than quantity, particularly concerning the interconnection of all the elements that form the economic system. SMEs are a crucial element, but policies that target the SME sector without paying attention to these surrounding conditions are unlikely to have substantial and long-lasting positive effects, either on growth crudely measured or development defined to give poverty reduction an important weight.

 

Hopes that internationalization and the specific local effects of globalization will make it unnecessary to formulate local-level development polices are likely to be forlorn.  Internal 'liberalization' only intensifies the need for SME policy and when unmediated FDI arrives it is likely to devastate the nascent productive SME sectors of transition countries.  Only early policy attention to building positive linkages between specific FDI projects and local productive entities will prevent an exploding current account deficit from being only the first on a list of unhappy 'side-effects' of FDI in-flows. Unless poverty reduction is built into the structure of growth initiatives, little poverty reduction can be expected, even in the presence of large FDI flows and other signs of global integration.

 
NOTE: THIS IS AN EXTENDED ABSTRACT, NOT THE FULL PAPER  

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