The Economic Role of Small and Medium Enterprises - Literature review Example

The Economic Role of Small and Medium Enterprises Student’s Name: Course Code: Instructor’s Name: Date of Submission: The Economic Role of Small and Medium Enterprises 1.0 Introduction Various literatures have explored the contribution of Small and Medium Enterprises to the economy. There are those that have posted a positive view about the SMEs while there are those who approach it with caution and do not talk positive about the same. The proponents who are in support of SMEs appreciate the fact that this sector is integral for a local, national economies of developed & developing countries and international economy at large. In their belief, they see SMEs as critical ion offering employment, source of innovation and entrepreneurial spirit, creation of required industrial linkages in terms of input and output, contributes to balance of trade, regional development and empowerment of citizens. On the other hand, the skeptics see it as an inefficient sector with the little to talk about. The subsequent expose highlights the roles of SMEs in the economy of a country and at international level. 2.0 Contextualizing SMEs Due to uniqueness of various economies in the world, various countries and scholars conceptualizes SMEs using same parameters with differing degrees. Thus, there is no universal definition of the same. Before we can see the contribution of SMEs to the economy, it is important to examine what actually constitutes the term SME (Dellberg, 2011, p.6). According to OECD (2002, p.4), EU countries and other OECD members cap the number of employees at 200-250 as a parameter of determining a SME with Japan and America setting it at 300 and 500 respectively. Ayyagari, Beck and Demirguc-Kunt (2005) conceptualize SMEs using various parameters like formality, turnover and number of employees. They note that for an enterprise to be categorized as SME, it has to have 0-250 employees. European Commission (2003, p.37) adds another twist to the parameters by stating that for an organization to qualify has SME, it must have a turnover not exceeding 50 million euro and a balance sheet not surpassing 43 million euro annually. Ayyagari, Beck and Demirguc-Kunt (2003, p.3) citing World Bank gives three definition in an attempt of conceptualizing what SMEs are. The first relates to Micro-enterprises. They observe that this is an organization with up to 10 employees and a total assets/ annual sales of USD 100,000. The same has a turnover in excess of USD 400, 000 and tangible assets in excess of USD 200, 000. The second is the small enterprises which they conceptualize as having 10 to 50 employees, a total assets/ total annual sales ranging from US$ 100, 000 to US$ 3 million. The last is the medium sized enterprises. These are organizations with 50-300 employees having a total assets/total annual sales ranging from US$ 3 million to 15 million. Bolton Committee (1971) in a bid to avoid the ambiguity of generalization, attempted at giving definitions in relation to different sectors. For instances an organization with less 200 employees in manufacturing sector is considered SME while that in construction sector with less than 25 employees is considered SME. However, these definitions might not be applicable to developing and third world countries which are demarcated with informal sectors (Storey, 1994, p.9). 3.0 The Contributions and Participations of SMEs to National and Local Economy The dynamics and contribution of SMEs are meshed and interlocked with contribution starting from individual level, snow balling to local economy and then creating a ripple effect to the national economy (Loviscek, 1982, p.36). This is based on the fact that various sectors have backward and forward linkages where certain sectors provide raw material for others while other sectors utilize the same as critical inputs (Cai, Leung and Mak, 2004, p.1, 2, 3 &4). The proponents who see SMEs as having significant roles in the economy provide various reasons for the same. Hall (2002, p.24) indicates that SMEs contributes 95% of enterprises in East Asia. Their position is enhanced with the emergence of sub-contracting and outsourcing (McIntyre, 2001, p.10). Liedholm and Mead (1999, p.7); McIntyre (2001, p.5 & 6) provides an overview summary of SMEs contribution to development. These include being employment centers & source of income, potential of growing to large firms, regional growth and urban development, source of required industrial inputs, value addition & final products among others. According to World Bank (1994, 2002, 2004 cited in Beck, Demirguc – Kunt and Levine, 2004, p.1) the proponents of SME base their conviction on three premises. The first underpinning is that it enhances competition and thus making business environment vibrant. The second is the fact that it drives entrepreneurship and aggregate productivity and, thus sustaining the required economic benefits. Lastly, these businesses are points of innovation. The same observation is affirmed by Acs and Audretsch (1993, p.2) who note while the role of SMEs in the economy have been questioned, these enterprises play four significant roles. These include entrepreneurial role and innovation, creation of market turbulence in the perspective of competition, promotion of international competition and lastly, generation of jobs. The aim of this section is to interrogate various literatures and present a discourse on the roles of SMEs at national and local level. The focus of the review would be on economic development & growth, employment and innovation among others as identified earlier in the two paragraphs. 3.1 Driving Economic Growth, Wealth Creation, Poverty Alleviation and Source of Livelihood 3.1.1 Economic Growth Economic growth, wealth creation are intertwined factors. Moreover, if a process can create wealth, it forms that required critical livelihood source. SMEs are important factor in delivering the required economic growth of a country by contributing to GDP. According to Beck, Demirguc – Kunt and Levine (2004, p.20 & 21), there is a positive relationship between SMEs and GDP growth. This kind of growth is robust in developing economies. For instance, OECD (2004, p.11) notes that SMEs contribute above 55% to the GDP of high income nations and in excess of 65% of total employment in the same countries. For the developing economies, they note that SMEs contributes to over 60% of GDP and in excess of 70% of job placements. The same trend is visible in middle-income nations whereby SMEs contribute 95% of GDP and 95% of total employment. The tenet of this argument is based on the fact that they engage in entrepreneurial activities (Audretsch, Carreeh, van Stel and Thurik, 2001, p.11 and 12). Schinder (2003) while comparing informal sectors in 22 countries in transition which were under Soviet Union and 21 in the OECD in the period of 2000-2002 proved that this sector contributed to 16.7%, 29.2% and 44.8% of GDP in OECD, Central & Eastern Europe and former USSR members respectively. These small enterprises are critical in expanding production capability of a country. Right from the basic small industries to medium sized ones, these businesses are able to convert raw materials into finished products thus contributing to value addition (Hall, 2002, p.28). The important factor is that a country can’t develop without any proper value addition since their products at local and international level fetches low prices (Hallberg, 2000, p.5). This observation is what development economists have attributed to low level of growth and development in developing countries. For instance, Chambers (2002, p.180) notes that in Kenya, they produce tea and coffee as the main cash crop. However, since they are not able to refine the same coffee and tea, these products fetch low prices. The irony of the same is that once the tea and coffee are refined, blended with others and branded, they are imported back as expensive commodities. However, with this realization, the government of Kenya through Poverty Eradication Strategy 2003 has instituted measures that encourage value addition at small scale through co-operative societies. The hallmark of this process is the linkage that these SMEs offer. Firms do not operate in isolation, but in a connected back and forth model (UNCTAD, 1998). UNCTAD (1998) summarizes these linkages as backward linkages with suppliers, forward linkages with buyers, linkages with competitors, linkage with technological partners and ability to create spill over effects. One key area of cost cutting measures is by concentrating on core functions of the firm. This can only be achieved by efficiently integrating suppliers, manufacturers, warehouses, and stores so that merchandise is produced and distributed at the right quantities to the right location and at the right time (Simchi-Levi, Kaminsky and Simchi-Levi, 2004, p.2). With the emergence of outsourcing in logistics and supplies management the role of SMEs become integral since they are able to fill the voids by doing works that large firms can’t do. For instance, larger firms and other medium sized firms are able to outsource non core functions and contract for provision of integral services with their key role being quality control. 3.1.2 Wealth Creation and Source of Livelihood Livelihood consists of wide array of factors. However, in this context the paper focuses on income generation as result of direct and indirect employment associated with these enterprises. One of the emerging points as the contribution to the local and national economy is the improvement of the individual’s welfare by creating employment and thus a guaranteed income (Liedholm and Mead, 1999, p.7). In a nutshell, these enterprises are centers for wealth creation and poverty reduction. Wealth creation and poverty reduction in the economy is best understood from the concept of development and underdevelopment as conceptualized by various players like Karl Marx, Adam Smith and Max Webber among others. In this perspective, SMEs can be conceptualized as source of capital accumulation which helps in the process of overcoming low capital formation. Karl Marx observes that “… the real science of modern economy only begins when the theoretical analysis passes from the process of circulation (exchange) to the process of production” (Frank, 1975, p.440). There are numerous suggestions that affirm and point to the above said fact that SMEs are integral in offering job opportunities as compared to large corporations. David Birch (1987 cited in Neumark, Wall and Zhang, 2011, p.16) was one of the first few scholars to identify positive link between job creation and SMEs. In his works, he noted that SMEs are the nerve center for job creation. By then he noted that SME sector accounted for 66% of job opportunities in the period of 1969 to 1976. However, Neumark, Wall and Zhang (2011, p.17 & 18) observes that his approach received a lot of criticism. It is in this light that Neumark, Wall and Zhang (2011, p.19) devised a new strategy of proving the same. Neumark, Wall and Zhang (2011, p.20 & 21) in their findings observed that net job creation is high in the favor of small firms and that the same decreases with the increase of the firm’s size if base-year size is used. However, by using average size definition, they do not realize any significant difference. All in all they observe that small size business contributes to more employment opportunities as compared to large one (p.27). The same observation is affirmed by the fact that SMEs contribute above 50% of jobs in mid and low level income countries (Snodgrass and Biggs, 1995, p.53). The same belief is affirmed observed observe is affirmed by Haltiwanger, Jarmin & Miranda (2011, p.28) who notes that small to medium contributes most jobs in United States. For instance, Hall (2002, p.25) observes that SMEs contribute to 50% of job opportunities in East Asia countries. Such statistics cannot be taken for granted since the inability of such sector not performing can lead to economic downfall of these countries. In this perspective hall (2002, p.26) notes that these enterprises are critical to developing economies which is marked with various informal sectors. Moreover, it is these small enterprises that have the ability to grow into the future large corporations and aid in industrialization (Gulbiten and Taymaz, 2000, p.2). There has been a paradigmatic shift in delivering development objectives of most nations with the focus moving away from giving tax holidays to large corporations to small and medium ones based on the possible impact at local level (Edmiston, 2007, p.73). To highlight the same, Edmiston (2007, p.75) contrast the negative effects of large firms in retarding job opportunities. It is noted that while a large firm with over 1000 employees in Georgia is able to add a net of 285 jobs in five year period, but also it will drive away 715 job opportunities. As tool of driving economic change, SMEs formed bulk of the growth when former communist countries like Poland were converting to market economy where government has fewer stakes in investments (Ionica, 2012, p.117). Having stable source of livelihood is critical to the development of a nation into two perspectives. The first is the reduction of associated vulnerabilities and contribution towards capacity development. According to Jha and Dang (2008, p.5) vulnerably is concerned with welfare and income and thus covers average income of household and the risk it faces. Philip and Rayhan (2004, p.1) define vulnerability as “a condition that takes into account both exposure to serious risks and defenselessness against deprivation. Defenselessness in turn is often seen as a function of social marginalization and ultimately results in economic marginalization. He further notes that vulnerability refers to exposure to contingencies and stress, and difficulty in coping with them”. The reality is that once a household has an access to stable income associated vulnerabilities are reduced since that household is able to access basic needs, take children to school and afford other necessities for self actualization. Chaudhuri, Jalan and Suryahadi (2002, p.3) postulates that those who have fewest instruments are the most vulnerable. This is where the connection between SMEs, employment, income and reduced vulnerability exists. Secondly, we can examine how improved livelihood through access to employment and thus an income to support households can be attained through SMEs. The need to make organization and individuals resilient and enable them sustain development gains made without relying on external support has gained paramount position globally (Lusthaus, Adrien and Perstinger, 1999, p.1; Otto, Agapitova, and Behrems, 2009, p.1). This helps in reducing individual’s or organization’s vulnerability (Lusthaus, Adrien and Perstinger, 1999, p.2-5). According to Otto, Agapitova, and Behrems (2009, p.3), “capacity for development is the availability of resources and the efficiency and effectiveness with which societies deploy those resources to identify and pursue their development goals on a sustainable basis”. Pradhan (2010, p.1) observes that people have associated capacity development with training and technical assistance. However, Pradhan (2010, p.1) calls for a paradigm shift with the focus being on “the ability of leaders, organizations, coalitions and society at large to catalyze institutional change to achieve development goals”. One way of attaining this is through SMEs. 3.1.3 Regional and National Development role Ripple Effect and Poverty Alleviation in Developing Economies The summing up observation about the role of SMEs is on regional development. The role of SMEs can be best conceptualized from the regional development perspective. In this context, the issue of hierarchy and threshold comes into play. The first observation is that we can’t have large industries all over since they need larger threshold of population to support them. In the rank size rule, we have hierarchies of cities and other urban centers spread across a region. The lower tiers act as suppliers and supporters of the larger ones in terms of raw materials. On the other hand, the larger ones like service industries create income which is later to be spent in these SMEs. The ultimate end result as per development studies is the opening up of a region (Roehner and Wiese, 1982, p.1449, 1450 & 1451). In attempt at looking how economies develop, it is proven that economies develop from hierarchies by moving from crude to agricultural, industrial and then service industry. Moreover, reducing disparities between the poor rural and the vulnerable urban dwellers forms a sure path of attaining holistic development (Kinda and Loening, 2008, p.1). This kind of conceptualization shows the importance of SMEs in the development process whereby they absorb majority who would be languishing in poverty. A case example is the role small industries have played in the development of American and European economies. From a historical perspective, these countries moved in a lineal continuum to be where they are now. Small and Medium industries were the centers of innovation and development of new products (Hall and Mairese, 2006, p.10). The same argument is extensible to emerging developed economies in G20 and those in BRICS (Brazil, India, China and South Africa). The basis for their growth was through empowerment in livelihood development by allowing individuals accumulate wealth from small and medium enterprises. It can then be argued that SMEs are integral in the development process as they are used to jump start the process by offering employment, providing raw materials, opening up a region, acting as centers of innovation and earning that required foreign exchange for positive balance of trade. Based on this experiences, governments in developing economies have tried to bolster growth by having state funded SMEs (Helberg, 2001, p.5). Contextualizing SMEs in the perspective of development theories leads to two observation. The first is in the context of dependency theory. The dependency theory attributes underdevelopment to the fact that capitalist penetration poses potential threat of creating uneven resource development in this perspective, it seen that underdevelopment is as a result of the centre periphery model whereby the developed areas/ nations withdraw resources in their favor from the periphery (underdeveloped nations/ areas); (Tylor, 1979). However, SMEs can be used to answer this concern since if well spread spatially in line with given regions or villages strengths, it can create a balanced exchange where each village/ center produces what it is best suited to do. SMEs can be used to counter this negative flow of products and services in a unidirectional manner or in favor of one side by making underdeveloped regions to engage in value addition in small scale which if well managed can have that ripple or trickledown effect. Moreover, if SMEs concept is related to world economy view theory, it forms the core that one region of the world need the other and thus, they are best suited to exploit this potential starting from a small scale (Ghai, 1977). In a nutshell, SMEs are crucial for transition of developing economies and consolidating the developed status of developed countries (Tuan, 2001, p.2). 3.1.4 Points of Innovation and Value Addition It has been noted that SMEs are very innovative in their approach to doing business. This was evident during economic downturn in the 1970s (Acs, 199, p.3). (Herrington, 2006 cited in Olawale and Garwe, 2010, p.729) postulates that “new SMEs introduce new products and develop new technologies. As an important source of innovation, new firms bring competitive pressure to bear on established firms”. The SMEs are known for their wide application of innovative competitive strategies so as to stay afloat. The innovation is exhibited in how they deal with their customers so as to lock them in and compete with larger corporations. The next is how they relate with their employees to make a solid working unit (Hall, Lotti and Mairesse, 2009, p.13; OECD, 2000b, P.5-16). For instance, SMEs are known as one of the organizations that are good in localizing concepts observed elsewhere (OECD, 2000c, p.3). Studies indicate that the propensity to patent reduces as the size increases. The same is affirmed by Boud et al. (1984 cited in OECD, 2000b, p.7) who note that companies in U.S which had sales less than $ 10 million accounted for 4.3% of the sale from the sample list, while accounting for 5.7% of the registered patents. Moreover, in comparative basis SMEs are considered to be more innovative as compared to larger enterprises. Gellman (1976, 1982 cited in OECD, 2000, P.7) notes that SMEs contribute 2.45% more to innovation per employee as compared to large enterprises. The essence of being innovative is to be able to fight it out with bigger organizations which have huge resources at their disposal. 3.1.5 Gender Parity One of the social challenges that have bedeviled underdeveloped countries is the low level of gender parity. Almost in all areas of the society men tend to be the dominant ones. Development can’t be attained if only one sector of the society is empowered and the other one is not. This kind of imbalance between the two genders has seen women lag behind in their ability to shape their future. However, various works show that SMEs are changing this kind of experiences. In the study conducted by Liedholm (2001, p.3), out of the nine countries examined in Africa and Latin America, the results show that most SMEs in five countries are owned and operated by women. In his finding, he notes that this kind of ownership is common in sectors like knitting, beer brewing, dress making and retail trading among others. The required parity is attainable in many ways and areas. Liedholm and Mead (1999, p.7) posits that SMEs aid in parity by aiding in social and demographic change. 3.2 The role of SMEs internationally 3.2.1 Engines of International Trade and Factor in Balance of Trade With the current dynamics, countries that are developed are the ones which are able to export their surplus to other countries so as to have positive net flow of income in their favor. This is because imports and exports are significant factors in determining the national income. SMEs are important in attaining higher Gross National Product. The role of SME in the international arena can first be understood in the perspective of foreign exchange and balance of trade. Wignaraja (2003) presents an interesting picture about SMEs and how they aid in positive balance of trade. For instance, SMEs account for approximately 40% and 56% of manufactured exports for East Asian countries like China and Taipei respectively. However, these shares vary according years and the number of employees, but the uttermost importance is that the SMEs are critical in international trade. According to OECD (1997 cited in OECD, 2000, p.4) internationalized SMEs contribute to 25-30% of the world’s manufacturing exports with SME accounting for 4-6% for OECD countries and 12% for Asian countries. 3.2.2 Ability to Grow into Multinational Corporation Numerous huge companies we know of today started from humble beginning. They were not large as we may think of them. This then shows that if SMEs are well nurtured, they have potential being the large multinational corporations of tomorrow. To affirm this, we can review the growth of current multinational companies. One example of company that comes into limelight is Google Inc. the company begun from a simple beginning without sufficient resources grew rapidly and now is one of the leading information technology firm. The emergence of Google is traceable from 1995 when Larry Page and Sergey Brin met at Stanford University. In 1996, they initiated a search engine operating on Stanford servers called BackRub. In 1997, the duo decided to rename the company Google (Google, 2013a). Presently, the company is about 14 years old and with more than 30, 000 employees worldwide. The firm has its headquarters in Mountain View, California. Moreover, it has 70 offices in more than 40 countries worldwide. The company is an information communication and technology based company focusing on different perspectives based on their operations goal of making it easy to find information. The company engages in computer systems design, online information services and web applications. Their business operations have different scopes with over 100 products and services (Google, 2013b). 4.0 Conclusion The aim of this expose was to review the role of SMEs in the economy at national level, local level and at international level. The findings that emerged out the literature were that at national level SMEs contribute to economic growth; value addition & creation of required back and forth linkages and employment opportunities. At the local level the SMEs act as livelihood source for the owners, employees and others who are indirectly related to it. This means they are crucial for development. The last basis is the regional development which is critical for transition of the economies to developed nations. Apart from these are other roles like their contribution to innovation and attainment of gender parity. References Acs, Z. (1999). The New American Evolution, in Z. Acs (ed.), Are Small Firms Important? Acs, Z. J. and Audretsch, D. B., Ed. (1993). 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