The Sun That Melts the Butter Also Hardens the Clay – Small & Medium Enterprises for Resilient Economic System?
Back in 2019, we spoke to people from all walks of life in more than 10 countries. Most, with a charming air of vigor and vitality, felt that life was improving. What was striking, however, was the uncertainty that they had about the future.
Fast forward. That was a year before the arrival of the COVID-19 pandemic. We wonder how the farmers we met in Ethiopia and Albania, the migrants in Lebanon and Jordan, the youth in Kosovo, the business people in Moldova, and the women in Bosnia & Herzegovina are faring and coping with the pandemic and its impacts.
Back then, the different people we met had ideas about how to make their life better. They provided or consumed goods and services. We don’t recall seeing them with fancy business plans or telling us their great access to financial capital from banks and other providers. Neither did they speak in sophisticated business languages.
They were entrepreneurs in their own right, part of a complex web of small and medium enterprises (SMEs). They were equipped both with basic survivalist labor and sophisticated and skilled craftwork. Unlike the narrative about the informal sector, SMEs are part of the more formalized economic system in each country.
No doubt, those working for or owning SMEs have been vulnerable and disadvantaged well before COVID. The pandemic is a blow to their livelihoods. But they are resilient, and the pandemic won’t be the final nail in their coffin – from Nepal to Serbia and Burkina Faso people and communities have shown remarkable fusion of resilience and innovation. Regardless, with the intensified crisis, most SMEs may become more informal and survive under high unemployment and poverty. Aside from that, one thing is certain: weakened SMEs will also bring down other sectors of economies.
The ‘yin-yang’ of SMEs
Like the Chinese yin-yang concept, SMEs show duality. They have no shortage of problems. To be fair, most of these problems tend to be more external to the SMEs. What is crucial is we should avoid both romanticizing the ‘small is beautiful’ cliché of SMEs and spending much time on pounding how unproductive and informal SMEs are. If you think it’s nothing, think again.
On the one hand, SMEs are dominant in many transitional and developing economies. In the six countries of the Western Balkans, SMEs make up 99% of all firms, generate around 65% of total business sector value-added and account for 73% of total business sector employment. In Armenia, SMEs constitute 98% of all registered and functioning legal entities, while in Georgia, 99.7% of all firms are SMEs, accounting for 62% of total employment and 56% of total business sector turnover. In Moldova, SMEs employed more than half of the workforce (55.1%).
On the other hand, SMEs remain woefully underserved. The reasons are many. One enduring, but misplaced belief is most SMEs are ‘informal’ and ‘too small’, and hence they hold back economic development. Among others, they are blamed for weakening productivity and undermining the countries’ financial health. Such reasons seem to have put SMEs on the margins of economic systems.
Pigeonholing SMEs in a certain category misses a lot of opportunities for building inclusive and resilient economic systems. This is particularly more important during crises like the COVID-19 pandemic. Conventional measurement of the global poverty line (e.g. $1.90/day income) masks the reality of how people working in and owning SMEs navigate the complexity of daily life. New geography of poverty has emerged within countries. Crises like the COVID-19 pandemic worsen vulnerabilities.
Let’s face it: while SMEs serve as the engines by creating jobs, it isn’t clear whether they score well in creating decent jobs. When compared to larger enterprises, SMEs generally have poorer working conditions. For instance, wage levels, working time conditions, and skills development opportunities aren’t as good in SMEs as in larger enterprises. Generally, employment in SMEs is in low-quality and low-skilled jobs; some of the SMEs offer low wages; and they fall short in terms of productivity, competitiveness, and market share.
In emerging economies, this gap leads to low-income generation and poor growth performance. To close the gap, we must first understand the challenges faced by SMEs. From the employers’ perspective, running a small enterprise can be challenging. However, when the business environment is stacked against them, productivity and innovation suffer as a result. The biggest challenges for SMEs include the regulatory environment, access to finance, and skills shortages.
Complex rules and unpredictable regulations create barriers for SMEs and impede their growth. SMEs also frequently face higher transaction costs than larger enterprises. And SMEs suffer from skill shortages, such as lack of resources and they are less likely to invest in workforce skills development.
The need for better and tailored support
Governments are supporting and keeping businesses and people afloat by minimizing the economic damages caused by the COVID-19 pandemic. This isn’t tragic futility. Yet, we want to add a word of caution: some sections of societies are benefitting from such bailouts – as happened during the 2008 financial crisis – while many others are falling behind. With that said, the impacts of COVID-19 aren’t a replay of the financial crisis of 2008.
Many ad hoc measures may be required to address the economic fallouts from the pandemic. The challenge often, however, is the lack of attention to a crisis in a more systematic way with a medium to long-term perspective.
SMEs have long been operating in uncertain environments. To some extent, personal networks and direct experience of adversity have enabled many SMEs to adapt and thrive in difficult circumstances. However, they aren’t safe from the interruptions of supply chains and shortages of parts and intermediate goods. The impacts of the coronavirus are bigger for those with connections with larger operators (e.g. tourism and export markets for agricultural products). In South Africa, for instance, it’s estimated that 60% of SMEs may close before the crisis is over.
The biggest effect for most SMEs in this difficult time is the shortage of relevant working capital. This is the result of not just the COVID-19 pandemic, but also the limitations of existing financial providers in properly targeting SMEs. Part of the problem is also the low level of financial literacy and management capacities among startups and SMEs. Most enterprises keep financial records and regularly prepare financial statements. However, cash flow planning is far less common, as are written business plans.
More money, however, isn’t the solution. What is crucial is diversified financing options that are available for SMEs’ long-term financing. Also, solutions should go beyond demand and supply analysis. It is critical to provide support related functions such as business services, coordination, and skills development, as well as policy issues to respond effectively to SMEs’ real needs.
Leaving no SME behind
What does all this mean? We haven’t written this blog aghast at our own or SMEs’ helplessness. We are hopeful.
In the wake of the COVID-19 pandemic, governments are seeking to work with the private sector to develop policies that grow their economies, create jobs, and provide opportunities for people. However, large, well-connected enterprises have been able to establish themselves and communicate their interests to governments through nurturing channels and ties. Yet, SMEs are still underrepresented in policy dialogue and unable to advocate for their priorities and rights before the government.
Associations that represent SMEs need specific technical skills, guidance, and peer connections to address systemic issues like corruption. They also need to better engage and empower women, the youth, and other vulnerable groups of people within the business community.
As a case in point, in Moldova, the law on transparency in public decision-making enacted in 2008 provides a framework for advocacy. However, the law has been poorly implemented to date, and associations are lacking the skills necessary to participate in the decision-making process. Armenia significantly advanced in financial inclusion over the last decade. Still, it is large firms that dominate the economy with more power to get credit.
Given these points, the challenge isn’t just the lack of public-private dialogue, but their effectiveness in delivering results that benefit SMEs. Private sector-led advocacy reduces barriers, creates opportunities, or provides incentives that influence the choices that impact the quality of jobs and income. On the flip side, the success of the private sector to influence policies and regulations also depends on to what extent institutions of governance are strong and transparent. This is where initiatives like the RECONOMY regional program can play a critical to improving the access to, and supply of, legal, policy, and regulatory information and other services that serve to stimulate and inform the dialogue.