In the literature on SMEs in developing countries, among other factors the level of real income per capita and population density are often cited as two most important affecting the pattern or the nature of development and change of the industries. Theoretically, these two explanatory variables affect the transformation process of SMEs through their direct effects
Table 2.3 Pattern of SME development from “Modern” theories perspective Level of income per capitaVariableLevel of variables MIESEMELE Low– Employment shareHighest HighLowerLowest – Output shareHighest HighLowerLowest – Number of unitsHighest LargeSmallerSmallest – Type of goods producedTraditional/simple consumption goodMajority: traditionalMajority modernModern – LocationRuralMajority: ruralMajority: ruralUrban High– Employment shareLowestHighest*Highest*Lower – Output shareLowestHighest*Highest*Lower – Number of unitSmallestHighest*Highest*Lower – Type of goods produced Majority: modern consumption goodsModern consumption & producer goodsModern & sophisticatedMajority: highly sophisticated – LocationMajority: rural Majority: urbanMajority: urbanUrban Note: * SE and ME Highest.
simultaneously on the demand side (output market) and on the supply side (labor market) of the enterprises. The demand-side and supply-side effects of changes of these two factors are reflected in changes in market demand for the SMEs’ products and in the changes in labor supply to the enterprises, respectively.
Systematic changes in the level and pattern of demand for SMEs’ prod- ucts as per capita income rises constitute an important demand factor often mentioned in the literature. With respect to final demand, as income increases demand shifts gradually from food to non-food or manufactured goods (according to Engel’s Law) or from simple (traditional) items to more sophisticated (modern) manufactured goods. Or, as explained in Biggs and Oppenheim (1986, p. 1), on the demand side increases in per capita income result in a shift away from basic commodities toward manufactured products, which require a more sophisticated process of production and organization of supply of inputs and division of labor.
This structural shift in the final demand leads to a decrease in the market demand for “inferior” goods, produced mainly by MIEs, and an increase in market demand for high-income elasticity goods, produced mainly by LEs and to a lesser extent by SEs or MEs. Biggs and Oppenheim (1986, p. 1) also argue that the emergence of new products (often imported) and new technologies with the process of development has made some traditional products and crafts obsolete. In the case of intermediate demand, the higher the level of development or industrialization, the greater is the industrial demand for sophisticated intermediate and capital goods.12
All these changes in demand lead to gradual changes in the manufacturing subsectoral composition of SMEs as well as to changes in the size distribution of enterprises. These changes are also explained in Biggs and Oppenheim (1986, p. 1), who argue that changes in the pattern of domestic demand affect the size distribution of enterprises basically through their influence on the composition of output by sector. If demand shifts toward those goods that are most efficiently produced by large-scale production, then this will be reflected in the shift of aggregate size structure of manufacturing activity from small to large enterprises. In other words, as mentioned before, these kind of demand-shifts in the course of income-increases, over time, may negatively affect enterprises such as MIEs producing inferior goods. However, as generally stated in the literature on “flexible specialization”, changes in the pattern of world demand in the 1980s, especially for consumption goods, in some cases have increasingly favored small, flexible, and efficient plants.
From the debate between the “classical” literature on SMEs in develop- ing countries and the flexible specialization literature, which relies heavily on the experiences of SMEs in a number of developed countries, it can be concluded that the effect of income increases and hence demand shifts on SMEs can be positive or negative. It depends especially on the characteris- tics of the change and how the SMEs adjust to it. The effect can be positive,
as generally stated in the flexible specialization literature, for smaller but more efficient plants which are characterized by three main features: they employ highly skilled workers, they are well organized and managed and have records of their daily activities, and they adopt a certain degree of labor division. The modern or “Western” type of SME is better able than SMEs in developing countries to meet rapid changes in demand (the market).
The effect can, however, be negative, especially for MIEs that use mainly low-skilled family workers without any kind of labor division and without the support of a good management and organization system. In terms of number of units and workers employed in them, SMEs in the developing world, especially in low-income or poor countries, are still dominated by these traditional, craft-based enterprises, and the majority of them are concentrated in rural areas. Because of their “primitive” way of doing busi- ness, they may not be able to compete with modern enterprises or to meet rapid changes in demand or the market (Saith, 1986, p. 12).
Given that the vast majority of SMEs in developing countries (especially poor countries) are located in rural areas, the effect of rural income increases over time on rural demand for rurally made goods is an important issue. In the course of rural development, with the ensuing encroachment of urban culture and expenditure patterns and the improvement of infrastructure, usually accompanied by rural income increases, the preferences of many rural people change in favor of higher-quality goods produced by modern urban industries or imported from abroad. This leads to a decrease in rural demand for rural indus tries’ goods. The entry of “urban goods” (including imported goods) into rural markets, however, is related not only to the increase in rural incomes per capita, but also to the improvement of infrastructure in rural areas.
Anderson and Khambata (1981) try to explain this as follows. In rural areas where agricultural output and rural incomes are rising, the newly created markets for consumer and capital goods like machine tools and equipment for agriculture, as a direct consequence of increases in income and hence demand, are highly dispersed. In a rural area where infrastruc- ture is poorly developed and transport services are badly organized, making it difficult to reach markets, the increase in local incomes and hence local demand induces a fragmented pattern of production in local industries. In such conditions, rural industries are protected by extremely fragmented spatial markets. Differentiated products having low scale economies and products servicing only small markets are also important for the extent and growth of rural SMEs. A variety of tailoring and garments industries and especially food and handicrafts industries belong to this category.
When infrastructure and transport facilities are improved, reducing the transport and marketing costs of many goods, not only do the rural markets for those goods broaden but an increasing degree of entry by urban-based larger producers producing similar goods is facilitated. In time and with continued development (including improvement in infrastructure and
transport facilities) in the rural areas, the transport and marketing costs of goods from urban-based larger enterprises to rural markets will decline to the point where local industries producing similar goods no longer have a cost advantage. In other words, the improvement will reduce all “natural”
barriers facing urban-based goods industries to rural markets, and, with local income increases, traditional goods produced in rural areas will be gradually replaced by modern goods made in urban areas.13
However, the improvement of infrastructure and transport facilities in rural areas may also create new markets (in urban areas), and hence a new growth impulse, for rural industries. Such improvement makes it easier for rural producers to sell their products, either with the help of traders or by themselves, in nearby urban areas. The improvement encourages rural small and medium producers to expand their business or to change their market location. Enterprises in villages near to urban centers will produce more goods for urban markets or have larger market areas than their counterparts in more isolated villages.
This implies that rural–urban economic integration does not always mean that all rural industries are outcompeted or die. It depends especially on how rural industries can adjust quickly, for example, by changing or diversify- ing their product lines, increasing their products’ quality, and shifting their marketing strategy, in response to a changing situation (i.e. newly appearing market opportunities).
This ability to adjust does not depend only on the abilities of the owners/
producers; the more “objective” and general characteristics of the establish- ments themselves also play a role. According to Chuta and Liedholm (1979, p. 9), based on their own observations, the rural industries most likely to be economically viable, and thus to have better opportunities to grow in the long run with the process of rural development and economic integration between rural and urban areas, have four common characteristics:
(1) they use hired and better qualified workers;
(2) they are located in larger settlements;
(3) they operate in workshops away from home; and
(4) they are involved in product lines with better economic prospects such as tiles, furniture, baking, garments, and repair activities.
Increases in rural income stem mainly from output increases in agricul- ture. The rise in agricultural productivity (and hence income) creates more demand for non-agricultural products, implying that the demand constraint for rural industries’ products is partly linked to income growth in the agricultural sector (Islam, 1987, p. 3). It is often argued, however, that the increased demand comes more from the wealthier landowning classes than from poor farm households. Poor households spend a larger share of their incremental income on food grains than do rich households. This implies
that, as far as consumption demand is concerned, not only the level but also the distribution of income in agriculture is important in determining the growth of demand for SMEs’ products. Further, increases in rural demand for non-agricultural products can be catered for by local SMEs, by urban- based LEs, or by foreign firms.14 In this regard, the ability of rural SMEs to survive depends largely on whether their products can compete with those of urban-based LEs or with imported goods.
Although data on the expenditure behavioral pattern of rural households in relation to the demand for rural industries’ goods are scarce and in many cases not very accurate, several studies have managed to identify goods produced by rural industries. These studies show that the rural income elas- ticities of demand for rurally produced non-food products are greater than unity. This evidence suggests that not all rural industries produce inferior goods. However, some have argued that the income elasticities of demand in rural areas for rural manufactured non-inferior goods tend to decline progressively, while those for construction, recreation, transportation, and services, including education and health care, tend to increase if long-term trends are considered and income increases significantly. Thus, there seems to be an indication that the rural consumption of manufactured products tends to increase less than the demand for the above items (construction, recreation, and so on) as rural income grows.
Changes in the level of real income per capita also affect the pattern of employment changes in SMEs via the supply side of the enterprises, that is, through the labor market in terms of labor movement into (or out of) LEs or SMEs in other industries or sectors. Labor movement among units of production is to a certain extent caused by the wage or income gap between units.
The association between the increase or level of income and the growth or level of employment in SMEs via the labor market can be positive or nega- tive. With respect to a positive relationship, if real income per worker in, for instance, agriculture is relatively high or increases, reflecting high labor productivity in agriculture which leads to a labor surplus in the sector, then the movement of labor and/or entrepreneurs from agriculture to SMEs is also high or increases. With high earnings per hour or per day in agriculture, farmers or agricultural laborers have more time or more capital to undertake other non-farm activities.
With respect to a negative relationship, if real income per worker in agri- culture is relatively high or increases, reflecting better work opportunities in the sector, the supply of labor from agriculture into SMEs is low or decreases (“negative growth of labor supply”: there is less supply of labor or entrepre- neurs to SMEs, or many people engaged in the enterprises move out and take other jobs). In terms of differences in level, it is expected theoretically that in a region with high income per capita fewer people are engaged in SMEs in that region than in a region with lower income per capita.
MIEs in rural areas are especially perceived being operated largely by poor people or households, such as small farmers and landless agricultural work- ers (Islam, 1983; 1987). The industries act as a means for them to survive. It is generally believed that the people engaged in these enterprises are being
“pushed” to undertake such activities, either as a primary source of income because they could not find other, better jobs, or as a secondary source of their income, which they need desperately in order to increase their total income (Saith, 1991, p. 467). This suggests that, in a poor region reflected in a low level of real income per capita, the employment share of MIEs is higher than in a rich region with a higher level of per capita real income.
A study by Weijland (1992) on rural industries in Indonesia supports this theoretical proposition, showing that in the settled outer islands, where the people are less poor and labor productivity in agriculture is high, employ- ment in rural MIEs is lower. These enterprises are less specialized, work fewer days per month, and provide less primary income than those in the densely populated center provinces, where the people are much poorer and labor productivity in agriculture is lower. From this finding, Weijland concludes that high supply of labor to MIEs is related to a very low average productivity of labor in agriculture, representing relatively lower earnings in the sector.
The negative association between the increase of income and the growth of employment in SMEs, generating negative growth of labor supply to the enterprises, may suggest another important issue, namely, a positive rela- tionship between employment growth in the enterprises and an increase of unemployed or poor people. It is often assumed that the level of poverty is partly negatively related to the level of income per capita, and partly deter- mined by the nature of income distribution at a given level of income per capita. It means that the higher the rate of unemployment or the level of poverty, the greater is the supply of labor to SMEs. The relationship between per capita income or the poverty rate and the supply of labor to SMEs often relate to “push–pull” factors.
To sum up the discussion, a theoretical hypothesis on the relationship between changes in the level of income and changes in the employment or output share of SMEs might be as follows. The increase in income affects SMEs’ activities positively through the product market (positive demand- side effect: more demand for the SMEs’ goods and, thus, increases in the production volume and hence employment in them) and the labor market (positive supply-side effect: a positive growth of labor supply to SMEs), or negatively via the labor market (negative supply-side effects: a negative growth of labor supply to SMEs) and the product market (negative demand- side effects). In other words, as income increases, it creates both supply-side and demand-side effects, and its “net” effect can be negative or positive.
If, say, the negative supply-side effect of the income increases (that is, lower supply of labor) is weaker than the positive demand-side effect (more
demand) then the net effect will be positive for the SMEs. In this regard, in terms of differences in level (not in change), it can be expected theoretically that in a high-income region demand for goods produced by SMEs (and hence production volume and employment in them) in the region is higher than that in a low-income region.
The level of rural demand for rurally made goods depends not only on the level of real income per capita (and other factors), but, also, among other factors, on population density in the rural areas. In Weijland’s (1992) model of rural industries in Indonesia, population density is included as an impor- tant demand-side factor. As theoretically expected, in a highly populated region local demand for goods produced by SMEs in the region will be higher than in a less populated one. In addition, the change in population density affects the pattern of employment change in SMEs, through its effect on the labor supply to the enterprises. As stated above, the decline in rela- tive average real income per worker in agriculture will “push” labor out of the sector into rural SMEs (or other non-farm activities). An important cause of low average real income or low productivity of labor in agriculture is the high population density caused by high annual growth rates of population in the rural areas. An overpopulated rural area creates an oversupply of labor in the agricultural sector, which results in downward pressure on earnings per worker in the sector. If annual labor-absorbing capacities of agriculture, LEs, and other sectors are limited, high annual rates of population growth may lead to high annual rates of growth in the supply of labor into SMEs or other “marginal” activities.
White (1976, p. 97) drew a distinction between demand factors and supply factors in explaining the magnitude of rural non-farm employ- ment. This employment is determined by a complex interaction between these two blocks of factors. He stated that there are two different types of conditions under which rural labor might shift out of agriculture: (i) when labor is “pulled” or attracted out of agriculture into better non-agricul tural income/employment opportunities, such as in an expanding manufacturing industry or industrial sector; and (ii) when labor is “pushed” or forced out of agriculture by declining employment opportunities in the sector, due to, for example, land constraint or harvest failures, into non-agricultural activities with relatively worse conditions, for example, marginal occupations whose capacity to absorb large quantities of labor is achieved only at the cost of extremely low and possibly declining labor incomes, which can be found especially in MIE activities.
To sum up, the relationship between changes in population density and changes in the employment share of SMEs is positive through the product market (positive demand-side effect) and the labor market (positive sup- ply-side effect). At a given level of real income per capita, the increase in population density creates more demand for the SMEs’ goods and increases the supply of labor to the SMEs. In terms of differences in level, it can be