The Role of Small and Medium Enterprises

in Job Creation Nigel Twose

Director

Development Impact Department

Large is beautiful

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Source: Enterprise Surveys

• Larger firms tend to be more productive, pay higher wages, offer more training and often better working conditions.

Firms training, wages and labor productivity

by firm size and country income groupLarger firms pay higher wages

Figure uses 138 household and labor force surveys for 33 countries over 1991–2010.Source: Source: WDR 2013 team based on Montenegro and Patrinos (2012)

Compared to micro enterprises, small firms typically offer a wage premium of 10–30%, but large firms offer a wage premium of 20–50%.

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Then why do SMEs matter?• SMEs address a developmental challenge: Job creation

• Jobs are the pathway out of poverty, and promote shared prosperity.

• SMEs account for over 80% of net job creation and 67% of jobs in developing countries.1

• 95% of formal jobs in LICs and 70% in MICs.1

• Job growth rate of smaller firms is twice the average of all firms.

• SMEs have potential to increase productivity, raise wages and reduce poverty.

• Create value in the supply and distribution chain by providing materials and services, and distributing goods of larger enterprises.

• Can foster innovation, improve competition and facilitate labor migration to more productive sectors of the economy.

1 Source: Ayyagari, Demirguc-Kunt, et. al. (2011)

Firm Size WBG Definition: # Employees

Enterprise Surveys Definition: #Employees

IFC’s Financial Market’s Definition: Loan Size Bucket in USD

Micro 0-10 0-4 $1K - $10K

Small 10-49 5-19 >$10K - $100K

Medium 50-299 20-99 $100K - $1M*

Large >=300 >=100 >$1M**US$2 million for more advanced countries, including Argentina, Brazil, Chile, China, Colombia, India, Korea, Mexico, Morocco, Peru, Russia, South Africa, Thailand, Tunisia.

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But not all SMEs can grow into large firms• Smaller companies are more likely to go out of business, and face

“stunted growth”, which impedes economic growth

• This is particularly important in lower income countries since small firms have the highest share of employment.

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Source: Hsieh and Klenow (2011)

Many firms are born small and grow little (stunted growth)

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* Small= 5-20 employees, medium= 21-99 employees, large >= 100 employees. Source: WBG’s Enterprise Surveys covering 46,566 firms in 106 countries.

Firm Size Country income groupConstraints that stunt SMEs’ growth

potential

Access to Finance: • The major obstacle for SMEs. • MENA: lowest access globally (20% of SMEs have credit line from financial

institution).Infrastructure:

• Reliable power supply is major constraint in low-income countries.• MENA: Approx $106 bn annual infrastructure investment & maintenance needs by

2020 • = 6.9% of MENA GDP. Infrastructure jobs represent ~8% of jobs in MENA

(average).Investment Climate:

• Informality is a key issue in middle-income countries and SMEs. Taxation is an important constraint for high-income countries.

• MENA: Informal sector produces about 1/3 of GDP; 67% of workers are employed informally.

Access to Finance: • The major obstacle for SMEs. • MENA: lowest access globally (20% of SMEs have credit line from financial

institution).Infrastructure:

• Reliable power supply is major constraint in low-income countries.• MENA: Approx $106 bn annual infrastructure investment & maintenance needs by

2020 • = 6.9% of MENA GDP. Infrastructure jobs represent ~8% of jobs in MENA

(average).Investment Climate:

• Informality is a key issue in middle-income countries and SMEs. Taxation is an important constraint for high-income countries.

• MENA: Informal sector produces about 1/3 of GDP; 67% of workers are employed informally.

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• Removing obstacles for women to enter male-dominated sectors could trigger productivity increases up to 3-25% (WDR 2012).

Female participation increase productivity

• Implement a comprehensive approach that involves the private sector, and combines education with on-the-job training

• Technological advancement and training helps bridge skills mismatch and improves access to education

Comprehensive approach & technological advancement

• 30-35% for female, lowest labor force participation rate globally

Highest female unemployment rate in the world

• 20-25% youth unemployed, and strong demographic expansion

• Prepare young people for jobs outside the public sector

• Improve the quality and promote technology based education

Youth bulge, skills mismatch

Additional developmental challenges for MENA

FindingsChallenges

• Often prosperous, but need to generate sustainable jobs outside resource sector

• Some countries have weak institutions for their level of wealth, important to form/implement policies to generate jobs in non-resource sectors

Resource rich

countries

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• High Growth SMEs (HGS) create the majority of new jobs in developed markets:- USA: 4% of private firms, but create 70%+ of net new jobs.1

- Europe: 5–10% of firms, but create 50–80% of jobs.2

• IFC definition: HGS have 10-250 employees, and experienced 20% average annual sales growth for 3+ years.

So which SMEs can grow?

Growth orientation • The best predictor of growth is the desire for growth.• Some organizations propose psychometric testing to assess

entrepreneurial characteristics (e.g. IADB, Awethu Project in S. Africa, BDC in Canada).

Experience• Entrepreneur has track record and knows the sector. • Start-ups are not a safe bet… look for firms that are 3 to 10 years

old. • Some basic education needed, but advanced not required.

Opportunity• Entrepreneur sees an opportunity, and is not afraid to take a

chance. • May pursue undefended niches in 2nd and 3rd tier cities.

How to identify HGS

Box source: IFC’s SME and Jobs Committee. IFC interviewed relevant organizations. These are the most common factors mentioned by the organizations interviewed, and backed up by research. Additional sources: 1 Birch et al; 2(Holzl)

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• Encourage financial institutions to lend to SMEs

• Promote scaling-up

• Strengthen financial infrastructure

• Provide advisory support to improve organization, processes, credit assessment, monitoring capabilities, and information technology

How can we best support SMEs?

Source for figure on IFC products through impact: SME and Jobs Committee (2012) “SME and Jobs”, May.

• Underserved SMEs

• Women owned Businesses

• Value Chain Partners

• SMEs in Fragile States

• Climate Mitigation

• Commercial Banks

• Non-Bank Financial Institutions

• Private Equity Funds

• Financial Infrastructure Providers

• DFIs

• Loans

• Equity

• Risk Mitigation

• Bank Capacity Building

• Financial Infrastructure

• SME Training

Products Partners in Development Target SMEs Impact

Growth

Improve productivity

Increased Income

Inclusion & Jobs

Poverty Alleviation

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IFC’s activities focusing on SMEs and job creation

1. Strengthen our reach to SMEs

• Prove innovative equity investment concept: SME Ventures

• Implement investment climate reforms for SME enabling environment

• e.g. business entry reforms, credit bureaux, collateral registries

• Provide financing and advisory services to help SMEs’ growth

• Improve access to infrastructure (e.g. power reliability)

• Provide finance through corporate value chains, not only financial institutions.

2. Invest in deepening our shared understand of job creation

• Micro-case studies for manufacturing, agribusiness and services sector (India, Ukraine, Indonesia, and Africa) as well as financial markets (Sri Lanka, Pakistan, Lebanon and Argentina)

• Macro-case studies in Tunisia, Jordan, Sri Lanka and Ghana

• Direct, indirect and induced.

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Innovative Investments: SME Ventures• Established in 2010 and focused on fragile states – offers blend of risk capital and

advisory services.

• Currently offered in Liberia, Sierra Leone, Central African Republic, DRC, Bangladesh and Nepal.

• Since inception, the local Fund Managers have invested USD $6.8 million in local SMEs.

• Advisory offering includes management and financial skills training for SME owners and managers, improved governance for SMEs, investment climate, and envt & social guidance.

• Challenge: Is there a viable market niche for funds?Lessons Learned from SME Ventures

Successes Challenges

Demonstrates how to reach SMEs in fragile states

Difficult to do in local currencies

Raises market awareness about private equity

Limited scale – how can we operationalize in many more countries?

Enables local SMEs to improve operations, governance and accountability

Limited SME experience and capacity of fund managers

Provides tailored support and assistance to the businesses in which the local Fund invests

Reluctance to straight equity by local entrepreneurs

Habib Bank: Pakistan • Electricity is a main constraint

to business growth

• SMEs prefer to use short term instead of longer term loans for funding needs, from working capital to capital investments.

Micro-case studies: Lebanon and Pakistan

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Fransabank study: Lebanon • Access to finance is major

concern for entrepreneurs with limited track record or without relationship with the Bank

• Youth prefer unemployment to working part-time or in low-skilled jobs

Common preliminary findings:

• SMEs are mostly family businesses

• Limited SMEs with women owners or managers

• Firm growth and job creation have been significantly affected by political instability and economic downturn

• Job preservation was considered a success, given limitations of enabling environment

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Micro-case studies: Sri Lanka

Commercial Bank of Ceylon in Sri Lanka*

• Annual job growth 12% (two times the economy)• Job creation ~2.7K Equal for men and women • More labor productivity• Extrapolation: 140K to 330K jobs ≈ 1.4 – 4.3%

employment in 2011• 10 to 31 jobs created per $100K of credit provided

*Note: Study has methodology caveats

  Direct Jobs Indirect Jobs Multiplier Sector, Country

Mriya 2,505 7,390 3 Agribusiness, Ukraine

Safal* 4,200 24,000 6 Steel, Africa

PRAN 294 2,198 7 Agribusiness, BanglshEcogree

n177 3,646 21 Chemicals, Indonesia

OCL 293 7,156 24 Cement, India

Micro-case studies in Manufacturing, Agribusiness and Services

Supply chains &

distribution networks provide

multiple of direct jobs

• Invest in labor intensive sectors and Financial Institutions (FIs)

• Invest in larger non-FIs & sectors facing international competition

Jordan

Short-term job growth

Long-term job growth

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Transformations

Jordan (Employment per $million

invested)Direct/Indirect Induced

FIs 107 +40%

Non-FIs 14 +45%

Higher number of jobs can be associated withlower value added per job

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1. Macro and Sector Level• Step up competition – increases the incentive to reach out to SMEs• Overcome information asymmetries (e.g. credit bureaus, collateral registries)• Study other approaches to support SMEs (e.g. supply chain finance, new technologies)• Liberalize to encourage entry and lending, but enforce prudential regulations • Step up shared learning on job creation effects

2. Client Level• Increase/guarantee funding to financial intermediaries for underserved groups

• the primary constraint is capital• Fund through corporate value chains• Track jobs and implement micro-case studies

3. SME Level• Try to identify/support “High Growth SMEs” through higher risk financing, plus advisory

support• Implement comprehensive approaches for youth employment and entrepreneurship

training • e.g. E4E, but alongside capital, not self-standing training

• Consider informal SMEs for skill development programs, but create incentives to formalization

• Focus on under-served segments• Consider cash transfer programs!

The way forward

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ANNEX

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• Gender difference is strongest in MENA in shares of farming, self-employment and wage jobs.

• Labor productivity has been stagnant in MENA for many years.

Jobs in MENA vs. Other Regions

2.74%

2.08%

2.01%

1.57%

0.99%

0.10%

0.00% 1.00% 2.00% 3.00%

Sub-Saharan Africa

Middle East and North Africa

South Asia

Latin America and the Caribbean

East Asia and the Pacific

Europe and Central Asia

Annual Change in Employment (2005-2020)

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Countries with High Youth Unemployment *

• Demand for jobs for the young typically outstrips supply.• Mostly rural (e.g. SSA) or urbanizing (e.g. MENA); solutions differ.• Policies and institutions, especially around education and private sector

growth, are typically weaker for countries troubled by youth idleness and unemployment. Essential part of solution is appropriate skills development, with foundation laid by good education.

* 2013 WDR

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E4E strategy• E4E focuses its interventions on targeted sectors constrained by skills gaps

(priority growth sectors) and cross-cutting enablers

• Based on E4E Status Update: • Pursue sector solutions (retail (MAF), construction, health care) following deep dive analysis

by leveraging IFC partnerships and clients (including large employers)

• Invest in a range of provider ‘types’ to maximize impact and reach (e.g. education providers, content developers, student lending, banks, education funds, etc.)

• Bringing to bear IFC’s global footprint and network (e.g. LAC Study Tour, global IFC clients)

E4E Priority Heat Map Jordan Egypt Morocco Tunisia

Tourism

Construction IS

Healthcare IS

ICT/BPO/Offshoring AS AS

Logistics

Manufacturing AS

Retail IS

High potential

Low potential

Note: IS = Ongoing IS project, AS = Ongoing AS project; Status as of October 2012

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Finance: Smaller firms have less access to financing

Source: IFC (2010). Scaling-up SME Access to Financial Services in the Developing World.

Use of bank financing: Small firms: 14%Medium firms: 18%Large firms:25%

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 Informality has barely decreased worldwide in the last decade— going from 52.8% to 49.1%.

Almost one third of workers worldwide are still poor, and about half of them are informal, with women accounting for a disproportionately large share of the informal workforce.

 

Informal firms provide a large portion of jobs in developing countries, but informality is closely linked to poverty

Source: ILO, IMF, World Economic Outlook.