17
2
SME Development Pattern:
A Theoretical Consideration
competitive, increasingly focus on core competence and buy in other prod- ucts and services. Through such production linkages, mainly in the form of subcontracting, SMEs are often exposed to the muscle power of the LEs, leading to unpleasantness and problems for SMEs. One obvious problem is that many SMEs, as the LEs’ suppliers, have difficulties meeting the tight schedules and product specifications (Semlinger, 1993). The problem, which is mainly of a technical, management and organizational nature, observably exists not only in developing countries but also in developed countries.
Kaplinsky (1994, p. 339), for instance, found in a number of countries that SMEs face difficulties delivering products “just in time” and with high standards of quality, as is increasingly required by LEs.
With respect to the technology factor, as explained in Panandikaer (1996, p. 10), if the economic size dictated by the technology is large, SMEs will be outcompeted in the market because they cannot produce effi- ciently due to a lack of economies of scale. For instance, in the electronics industry the state-of-the-art technology may indicate a large size, so LEs are viable. But neither the market nor the technology is fixed for all time;
they constantly change. Since the late 1990s the world has witnessed rapid innovations in technology, at least in some fields like bioprocess- ing of materials, information, telecommunications, television, satellite, fax, cellular phones and pagers, computers and automation. Many LEs experienced serious problems in adapting themselves to changing tech- nologies and hence the business environment in terms of making shifts in planned production and changes in planned investment and division of labor (including the recruitment of new workers with certain high skills needed by new technology), and are therefore unable to perform. In such circumstances, SMEs have a better chance of survival.
In discussions of industrial systems and the role of SMEs within these systems and their pattern of overall development in developing countries, attention usually focuses on seminal articles by Hoselitz (1959), Staley and Morse (1965), Parker (1979), and Anderson (1982), among others. Their works are often classified as the “classical” theories of SMEs’ development.
The “modern” theories, on the other hand, include the works of Berry and Mazumdar (1991) and Levy (1991; 1993), among many others, in the newly industrializing countries in East Asia like Taiwan and South Korea, and the literature on the flexible specialization thesis based on many experiences from SMEs in west European countries. These theories explicitly emphasize the importance of subcontracting networks and the economic benefits of agglomeration and clustering for the development of SMEs.
In their substantial study, based on the experience of industrialized and developing countries, Staley and Morse (1965) identified three categories of conditions for the predominance of SMEs, namely, location, manufacturing process, and market. The two most important local conditions are factories processing dispersed raw material (mainly rural industries) as products for
local markets and relatively high transport costs. Among the most important conditions for the predominance of SMEs with respect to manufacturing processes are separable manufacturing operations, craft or precision hand- work, and simple assembly, mixing, or finishing operations. The market con- dition is differentiated by products with low-scale economies serving small markets. The significance of these influences may be different for SMEs in different subsectors. For instance, industries serving small markets are a par- ticularly important determinant for the dominance of SMEs in the wood and furniture industries because total demand for such products is usually more limited than that for other consumer goods; whereas factories processing a dispersed raw material is considered as the condition for the dominance of small-and medium-scale food industries in rural areas.
Among these conditions, Staley and Morse (1965) argued, separable or specific manufacturing operations (e.g. SMEs producing certain components for LEs) and differentiated products having low-scale economies were the most important explanatory factors for the presence of SMEs in developing countries.1
Although some authors have explored the relationship between the size of business establishments and the process of economic development by analyzing historical stages of development, the theoretical literature on the issue of how SMEs are influenced by increases in per capita real income (as an indicator of economic development) remains limited. Hoselitz (1959) first paid attention to this particular issue in his study on industrialization in Germany. His study indicates that in the “early” stage of development the manufacturing sector in the country was dominated by artisans or craftsmen, and as development proceeded many of them grew into large industrial establishments while others died out.
However, Hoselitz (1959) did not deal explicitly with the nature of the relationship between the increase in the level of industrialization and structural change within the manufacturing sector. He emphasized more on the characteristic of low costs of production, which he concluded was the key to the success of SMEs. He attributed the low cost of production mainly to the use of unpaid family workers.
Following Hoselitz’s work, Parker (1979) and Anderson (1982) developed general growth phase typologies based on the experience of the industrialized countries to explain changes in the size and structure of industry by region and over time in developing countries. According to this approach, in the course of economic development the composition of manufacturing activities, if classified according to scale, appears to pass through three phases. In phase one, at the “early” stage of economic or industrial devel- opment which may be characteristic of predominantly agrarian economies, MIEs or household and artisanal activities in manufacturing industry (they can be characterized as the most traditional type of enterprises in manufacturing industry) are predominant in terms of their total number
of production units and share in total manufacturing employment. This is a stage of industrialization in which a large number of MIEs (mainly in rural areas) coexist with quite a limited number of larger-scale enterprises (mainly foreign firms or state-owned companies located in urban areas or large cities). In this stage, MIEs are predominant in activities such as gar- ment-making, smithery, footwear, handicrafts, masonry, industries making simple building materials, and various crop-processing industries. They are closely related to agricultural production, as providers of rudimentary inputs to and of processing services for output from agriculture, and of the non-food needs of the rural population. In developing countries these subsectors are characterized by substantial ease of entry. Particularly for clothing, food, and handicraft industries, initial capital requirements are very low, and for the producers involved there is no need for high skills and special separated workshops to carry out these activities. Perhaps for this reason, the activities are undertaken largely by women and children work- ing part time. However, the income function of such activities is important as it is the secondary source of family income for many poor households.
Most enterprises in such activities are self- employment or one-person units in which the owner undertakes all activities.
In phase two, in more developed regions with higher incomes per capita, small and medium workshops and factories emerge and increase at a compara- tively rapid rate, and act to displace MIEs in several subsectors of manufacturing.
Certain factors might explain the expansion of these industries in this particular stage. Steel (1979), for instance, emphasizes the importance of a growing cash market for the expansion of SMEs. He argues that growing urbanization and expanding cash markets reflecting economic modernization give rise to a shift from traditional household activities employing non-paid family members as workers/helpers (which in Asian developing countries are predominantly MIEs) to complete specialization of the entrepreneur in small- scale production using employed laborers (p. 9).2
In phase three, at the “later” stage of development, large factories become predominant, displacing the remaining SMEs in some activities.
According to Anderson (1982, p. 914) this phase is partly a product of phase two, since the recorded growth of output and employment in LEs can be divided into (a) the growth of once small enterprises through the size structure and (b) the expansion of already large domestic and foreign enterprises (p. 914). However, the expansion of LEs at this stage may also be caused, to a certain extent, by new large-scale entrants, a possibility that Anderson does not explicitly take into account. A hypothesis similar to Anderson’s has also been proposed or supported by authorities such as Davila and Satterthwaite (1987), Little (1987), and Nanjundan (1989), stating that increasing levels of economic development inevitably will bring about the replacement of SMEs, especially the most traditional ones (i.e. MIEs) by larger factories (LEs).
In this final phase, the use of economies of scale with respect to plant management, marketing, and distribution (depending on the type of prod- uct and flexibility in production), superior technical and management efficiency, better productive coordination and access to supporting infra- structure services and external finance, and concessionary finance along with investment incentives, tariff structures, and government subsidies are all powerful causal factors acting as incentives for firms to grow. In reality, it is often found that these factors are more favorable to large or modern industries than to small and traditional ones, and so they may explain the eventual better performance of larger enterprises than that of smaller ones in advanced stages of industrialization. Schmitz (1982, p. 25) states that only those SMEs that can take advantage of some or all of these factors can grow or, at least, survive against heavy competition from LEs.
The empirical evidence on the systematic pattern of structural change in industrial establishments, though still limited, is richer than the cor- responding theoretical literature. Empirical evidence from many countries collected by Snodgrass and Biggs (1996) and Tambunan (1994) may suggest that there is a systematic trend whereby the employment shares of MIEs and SEs in higher-income countries tend to be lower than those in lower-income countries.3 They claim that (i) many SEs may have grown into MEs and some MIEs into SEs; (ii) there might be many new small factories and medium and large-scale entrants in the industry; and (iii) many MIEs die out.
Beck et al. (2003) undertook the first large cross-country empirical study on the link between SMEs and economic growth using a database on the share of manufacturing employment accounted for by SMEs in many coun- tries in Africa, Europe, Asia and America. For the analysis, they constructed two measures of the size of the SME sector. The first measure (A) is the share of SMEs in the total official labor force in manufacturing, with 250 employees taken as the cutoff for the definition of an SME. This variable provided the authors with a consistent measure of firm size distribution across countries. The second measure (B) is the share of SMEs in the total official labor force in manufacturing when the official country definition of an SME is used, with the official country definition varying between 100 and 500 employees. Table 2.1 lists GDP per capita and the two measures of the size of the SME sector. As can be seen, there are large variations in eco- nomic development and the relative size of the SME sector. GDP per capita ranges from very low in Burundi (US$171) to very high in Luxembourg (US$ 45,185). The importance of SMEs varies from Belarus, with less than 5 percent of total formal employment in SMEs, to Thailand, with 87 percent, as indicated by SME 250.
The output composition of SMEs in the manufacturing industry also appears to shift with development. As income per capita increases, the activities of SMEs shift from “light” manufacturing (such as food processing, beverages, wood, furniture, paper, printing and publishing, non-metallic
Table 2.1 Level of economic development and the size of the SME sector in selected countries
Country GDP per capita (US$) A (%) B (%)
Luxembourg 45,185 70.9 70.9
Switzerland 44,717 —* 75.25
Japan 42,520 71.7 74.13
Denmark 34,576 68.7 78.4
Norway 33,657 — 61.5
Germany 30,240 59.5 70.36
Austria 29,619 66.1 66.1
United States 28,232 — 52.54
Sweden 27,736 61.3 56.5
Belgium 27,572 69.25 69.25
Iceland 27,497 — 49.6
Netherlands 27,395 61.22 58.5
France 27,236 67.3 62.67
Finland 26,814 59.15 59.15
Singapore 22,874 — 44
Hong Kong, China 21,842 — 61.3
Australia 20,930 — 50.6
Canada 19,947 — 58.58
United Kingdom 19,361 56.42 56.42
Italy 19,218 79.7 73
Ireland 18,528 67.2 72.1
Brunei 17,984 — 69.4
New Zealand 16,084 — 59.28
Spain 15,362 80 74.95
Taiwan, China 12,474 68.6 68.6
Greece 11,594 86.5 74
Portugal 11,121 79.9 81.55
Korea Rep. 10,508 76.25 78.88
Slovenia 9,758 — 20.26
Argentina 7,484 70.18 70.18
Czech Rep. 5,015 64.25 64.25
Hungary 4,608 45.9 45.9
Chile 4,476 86 86.5
Croatia 4,454 62 62
Brazil 4,327 59.8 59.8
South Africa 3,923 — 81.53
Estonia 3,752 65.33 65.33
Slovak Rep. 3,651 56.88 32.07
Costa Rica 3,405 — 54.3
Poland 3,391 63 61.81
Mexico 3,390 48.48 48.48
Panama 2,999 72 72
Turkey 2,865 61.05 61.05
Russian Fed. 2,614 13.03 13.03
Country GDP per capita (US$) A (%) B (%)
Thailand 2,590 86.7 86.7
Belarus 2,523 4.59 4.59
Latvia 2,419 — 20.63
Colombia 2,290 67.2 67.2
Peru 2,162 67.9 67.9
El Salvador 1,609 — 52
Ecuador 1,521 55 55
Romania 1,501 37.17 37.17
Kazakhstan 1,496 — 12.92
Bulgaria 1,487 50.01 50.01
Guatemala 1,460 32.3 32.3
Yugoslavia Fed. Rep. 1,271 44.4 44.4
Ukraine 1,190 5.38 5.38
Philippines 1,099 66 66
Kyrgyz Rep. 972 63.22 63.22
Indonesia 963 — 79.2
Côte d’Ivoire 746 18.7 18.7
Albania 744 — 9.49
Georgia 737 7.32 7.32
Honduras 706 — 27.6
Cameroon 653 20.27 20.27
Zimbabwe 643 15.2 15.2
Tajikistan 566 — 35.91
Azerbaijan 558 5.34 5.34
Nicaragua 432 — 33.9
Zambia 419 36.63 36.63
Ghana 377 51.61 51.61
Kenya 341 33.31 33.31
Vietnam 278 74.2 74.2
Nigeria 257 16.72 16.72
Tanzania 183 32.1 32.1
Burundi 171 — 20.51
* = no data available.
Source: Beck et al. (2003, p. 23).
Table 2.1 (Continued)
mineral products, textiles, clothing, footwear, construction, metal fabrica- tion, and leather) with simple processing to “heavy” manufacturing pro- ducing intermediate and capital goods with more complicated processing.
Industries in the heavy manufacturing category include rubber and related goods, chemical products, petroleum, basic metal, machine and transport equipment). In other words, the higher the income per capita, the lower is the share of light manufacturing in total employment in SMEs and the
higher the share of heavy manufacturing, especially in the machine and transport equipment industries (Biggs and Oppenheim, 1986). As well, with the process of development a shift of SMEs also takes place from producing
“traditional” goods (i.e. the kind of activities undertaken mainly by women and children) to making more sophisticated or “modern” goods, not only as between manufacturing subsectors but also within subsectors. In other words, in the course of development, the share of SMEs producing “tradi- tional” goods as a percentage of total employment or units in a particular industry declines (Liedholm and Parker, 1989, p. 12).4
In addition, Biggs and Oppenheim (1986) show evidence which indicates that the sectoral shift or the shift from making traditional goods to making modern goods within an industry is also accompanied by changes in the size of industrial establishments, that is, from MIEs into SEs, from SEs into MEs, and from MEs into LEs. However, the authors do not clearly indicate in their study whether these sectoral shifts are causally related to, rather than only accompanied by, the shift in firm size.
In earlier studies of SMEs in developing countries, these enterprises, in particular MIEs, were commonly treated and in a way dismissed as tradi- tion-bound, low-income and economically backward activities, offering few and probably decreasing opportunities for raising incomes. But, as found in many African countries, MIEs were actively engaged in a much wider range of activities, including various resource-based and agro-processing activities, than only traditional activities producing “inferior” goods, as often thought.
This evidence may suggest that with economic development not all MIEs will disappear. Indeed, in many developing countries a sizeable number of these industries survive to the present day. Some of them remain small and traditional while some others have developed into larger factories.5 An important factor that might explain why in many “more-developed”
countries within the developing world a large number of MIEs survived and even grew larger, despite heavy competition from larger industries and policies biased against them, is a specific skill or specialization owned tradi- tionally by the producers/owners. This is also indicated by Hoselitz’s study (1959) on early industrialists in Germany who started out as artisans or craftsmen and later came to own large industrial establishments.
Within a country, differences in the pattern of transition within SMEs (that is, from MIEs to SEs, and SEs to MEs or from MEs to LEs) are also appar- ent between urban and rural areas. These differences are explained mainly by differences in the level of development between rural and urban econo- mies and in the characteristics of rural and urban SMEs. As for differences in characteristics, many studies show that more “traditional” crafts such as blacksmithery, weaving, and mat- and pottery-making are relatively more important in rural areas and that they are characterized by a higher propor- tion of self-employment units, while MEs tend to predominate in urban areas. Apprentice and wage labor are relatively more important components
of total employment in urban SMEs, while rural MIEs rely more heavily on unpaid family labor. Furthermore, the larger share of manufacturing employment, particularly in MIEs, in rural areas as compared with urban- based SMEs is highly seasonable, consisting of part-time non-farm activities that peak during the slack season in farming activities.6
With respect to entrepreneurship, Liedholm (1973, p. 5) argues that in rural areas micro or small entrepreneurs have substantially different educational and occupational backgrounds from those of their counterparts in urban areas. People engaged in rural enterprises have a lower level of education than those in urban enterprises, even in the same size category, and in rural areas they are mainly from farm households in contradistinc- tion to those in urban areas.
Rural SMEs also differ from their urban counterparts in market orienta- tion. Some studies found that rural SMEs appear to be less outward-oriented for both output and inputs than SMEs in the urban areas. Most rural SMEs serve only local markets and use local inputs, whereas many urban SMEs sell their products to other regions within a country, or export them. As well, many urban SMEs use imported inputs, though this depends very much on the goods produced.7
Further, Chuta and Liedholm (1985) found in some African countries that the growth rates of the total number of SMEs and of the persons employed in them are positively correlated to the size of the locality, indicating that the growth rate of SMEs in urban areas is higher than that in rural areas. The important reason, according to Anderson (1982, p. 920), why urban SMEs grow fast while their rural counterparts are declining or stagnating is the growing market in urban areas, which is due to a larger population (actual or potential buyers) growing at a higher rate, higher real income per capita, and, more importantly, larger middle- and high-income segments in urban areas. This condition creates more opportunities for urban SMEs to expand their output or to diversify their market; and urban SMEs servicing the urban high-income segment can also grow rapidly as urban demand from this income group increases.8
Moreover, intermediate demand from LEs is mainly concentrated in urban areas. This may thus provide more opportunities for urban SMEs servicing this market segment (for example, through subcontracting) to grow. In the rural areas or isolated regions, on the other hand, local enterprises are engaged in the production of more traditional and low- or negative-income elasticity goods, for a small local market, in particular for rural low-income segments (Mazumdar, 1976, p. 660). Byerlee (1973, p. 15) gives his own explanation of why such different patterns of change and development are really occurring.
He states that the supply and demand pattern of rural enterprises is different from that of urban enterprises from the same size group. Both the demand for output and the supply side of rural enterprises are closely related to agri- cultural incomes and production, which vary seasonally.