An SME development agenda

An excellent compilation of studies done by IPA researchers on interventions to support SMEs has several good ideas. But the vast majority of the studies focus on micro-enterprises, especially small traders, whose promotion while important, may actually be secondary to policies that focus on small and medium enterprises.

As I have blogged earlier, the problem with many developing countries like India is not lack of enterprises or entrepreneurship, but more likely an excess of them. There are too many small and unproductive, mostly run by family members, micro-enterprises, all of which exist in the informal sector. Worse still just a handful of them manage to grow beyond subsistence and create jobs. The vast majority of these people turn to such entrepreneurship only as a survival option in the absence of adequate wage employment opportunities.

Instead, as the "missing middle" research shows, one of the biggest economic growth challenges for developing countries is to get some proportion of their massive numbers of micro and small enterprises grow in size and create jobs. As the historical trajectory of growth shows, jobs are created when firms start small and formal and grow to become medium sized enterprises. So the focus of attention should be on the growth prospects of small enterprises to become medium sized ones.

The conventional wisdom on SMEs in developing countries is that they are constrained by difficulties in accessing credit and skilled labour, infrastructure bottlenecks, excessive bureaucracy and regulations, and high taxes. While these are undoubtedly important, their meaningful enough resolution is a longer game. Instead, a growing body of evidence points to how adoption of better management practices can help boost firm productivity by a quarter to a third.

Therefore, the biggest win in SME policy could be from supporting these firms with business development services. They would include adoption of accounting standards, better management practices (inventory and quality control, targets and incentives, monitoring frameworks etc) assistance in market access or linkage, help in preparation of technical documents for procurements, benchmarking quality and standards etc. 

It may be worthwhile to repurpose a share of the industrial policy allocations away from concessions and subsidies towards the provision of business development services as a public good. Governments can empanel consultants and service providers and offer to bear a share of the service fees. This would align the incentives of both the firms purchasing these services as well as those of the service providers. The support can be restricted to firms with certain number of employees and for a duration of 2-3 years for each firm.  

Such business development services have another crucial advantage over concessions and subsidies. The latter confer benefits which are completely privately appropriated and most often temporary. In contrast, business development services have significant spill-overs on the entire neighbourhood eco-system. Further, its benefits are not transient and more likely to be permanent and diffuse among the entrepreneurs, management, firm, and employees as well as generate spill-overs across the eco-system. 

Access to credit comes at or near the top of concerns for SMEs across the world. Government's have preferred to intervene heavily in enabling access by establishing SME financing institutions and providing concessional loans. But such policies may not have achieved their objectives given the near inevitability of political capture and cronyism. Consequently, they distort incentives and come in the way of the market test in accessing capital.

In the circumstances, the best that governments could do would be to create the enabling conditions for SME credit access. A critical contribution would be to facilitate the development of simpler mechanisms for credibly assessing the credit-worthiness of SMEs. Regulators should facilitate consolidation of data available with various institutions like banks and non-bank financiers, e-commerce platforms, mobile phone companies and so on to develop credit information companies. This should complement simplified credit application processes. At the macro level, mandating SME lending targets as a share of total bank credit supply may be necessary to ensure that SMEs don't get marginalised in the formal financial intermediation channels.

Other instruments, many of them validated by IPA research, include supporting the development of deeper networks among SMEs. They would include platforms to facilitate information sharing and co-ordination in areas of mutual interest among interested firms, as well as connecting firms to the eco-system of service providers.

Another potentially beneficial instrument would be to use public procurements to support SMEs. However, this would have to involve making changes to typical procurement policy (pre-qualification norms etc) that favours entrenched larger enterprises over new SMEs.