Thorsten Beck, one of the world’s major experts in SME finance, argues that the “size” of the SME sector in an economy does not really matter for economic development. What counts is its dynamism:
Policy efforts targeted at SMEs have often been justified with arguments that (1) SMEs are an engine of innovation and growth and (2) they help reduce poverty because they are labor-intensive and thus stimulate job growth, but (3) they are constrained by institutional and market failures. Cross-country, country-level, and microeconomic studies, however, do not support these claims. One study shows that, although faster-growing economies have a higher share of SME employment in their manufacturing sectors, it is not the size of this segment that drives growth.
… The empirical evidence thus points to the entry of new firms—which are mostly small at entry—and the possibilities for successful SMEs to grow as decisive. It is not the size of the SME segment but their dynamism that helps economic development. Recognizing dynamism rather than size of the SME sector as the source of economic development identifies another important distinction that analysts should make among the firm population: informal microenterprises, the establishment of which is often the result of a lack of alternative economic opportunities, and small formal enterprises, some of which might have high growth potential.
I do not entirely agree on the last point. Although it is true that many businesses operate for survival, my experience in Kenya is that the distinction between “informal microenterprise” and “small formal enterprise” is just not clear in the real economy.
I see this blurry boundary as a sign that dynamism can occur at an extremely small scale, namely the “micro-to-small” (MSE) segment. If we go to an even smaller scale, the “graduation” of some businesses from “self-employment” to “micro-enterprise” is also very interesting. In other words, whenever a business is growth-oriented, no matter how “micro” it is, should get more attention
More (from Thorsten Beck’s paper) here
I don’t really understand this study’s conclusions. Saying that the entry of new (formal?) is good while saying that informal enterprises are just the result of a lack of other options and so are not that great seems almost contradictory. Like you said, an informal business and a small new-entrant enterprise are almost identical, just that one has decided to register with the government. Yes, that is a clear indicator of commitment or seriousness, but says less about the growth potential of any particular sector. I also don’t follow Beck’s reasoning, why would the percentage or size of the SME sector prove or disprove points 1, 2, and 3 as to why SME initiatives are worthwhile? Underdeveloped economies have unrealized industrial and entrepreneurial potential– encouraging SME growth should be a main focus of economic development. What percentage of manufacturing employment is currently due to SMEs doesn’t even seem like a particularly interesting point. “Dynamism” by a constant flow of new entrants could also suggest that there is a lot of failure in establishing businesses, which might be due to a lot of constraints like poor infrastructure and corruption. Lots of economic decisions are made because of “a lack of alternative economic opportunities”– that hardly impugns the worthiness of the entrepreneurial endeavor in and of itself.
Thanks for the comment Matt. The point I do not agree with Beck is that there’s a clear cut distinction between informal micro and small formal enterprises, that is just too arbitrary. If we look at an area like Kariobangi, you see businesses that are smaller and some that are larger, some that “look more formal” and some that don’t, but dividing them into two types simply doesn’t work. That would over-simplify a very complex reality.
I like better his idea that dynamism is more important than size, that is: rather than counting “how many” SMEs there are in an economy, what matters is their capacity to grow. There’s a section in his paper where he compares the situation in Italy and the UK. Although the situation in the Kenyan contexts is very different, it illustrates quite well the point he’s trying to make. Thanks again!