1.1. The rise of small business development
A small business is a business that is privately owned and operated, with a small number of employees and relatively low volume of sales. Small businesses are normally privately owned corporations, partnerships, or sole proprietorships. The legal definition of "small" varies by country and by industry. The abbreviation SME (Small and Medium Enterprise) occurs commonly in the European Union and in international organizations, such as the World Bank, the United Nations and the WTO. EU Member States traditionally have their own definition of what constitutes an SME. SME development policy is a specific area of public policies aimed at the development of the SME sector in a particular country or region.
Small businesses are common in many countries, depending on the economic system in operation. Typical examples include: convenience stores, other small shops (such as a bakery or delicatessen), hairdressers, tradesmen, lawyers, accountants, restaurants, guest houses, photographers, small-scale manufacturing, and online business, such as web design and programming, etc.
Since the 1980s international donor organisations - such as the European Union, the World Bank and the OECD – moreover national, regional and local governments have increasingly recognised that the isolated measures for supporting small and medium sized enterprises need to be integrated into what has become a relatively new policy field: small business development policy.
Governments and international organisations have increasingly taken measures to influence entrepreneurship through 1
• macro-economic policies that encourage potential entrepreneurs to invest,
• regulations which take into consideration their differential impact on firms of different sizes
• direct support measures and programmes offered for small firms
• developing market economy institutions
• and developing entrepreneurial culture and the social acceptance of entrepreneurship.
This dimension of development policy was justified by the increasing positive role of SMEs in increasing the level of employment, in enhancing competition, in spreading innovations, in diversifying the supply of products and services and in maintaining supplier chains. Moreover, on the social level, it was understood that a strong SME sector promotes the stability of democracies through strengthening the middle classes, offering realistic perspectives to young people, unemployed persons and minorities.
The attention of governments to SME development policy was especially raised in the 80s when in developed countries it was discovered that the majority of new working places were created in small firms and more generally that entrepreneurship generates economic growth. In several countries SME research was directed to discover the dynamics of new firm creation. In the first phase of SME policy, decision makers have focused on the aim that new companies should offer more employment, than the number of working places lost by disappearing firms.
Local and regional governments have recognized that the birth of new firms or the re-settlement of existing companies into the localities administered by them can positively affect local economic development in a wider sense than just increasing employment. It was acknowledged that small businesses improve the income position
1[Smallbone-Welter 2009]
of the population, increase tax revenue, and provide additional services for local consumers and businesses. 2 Moreover, it was acknowledged that entrepreneurship may increase social capital on the local and regional level by providing good life perspectives for young people, minorities, women and other groups, moreover by creating networks of co-operation and trust.
As a consequence, the various levels of government have become a major enabling or facilitating factor of entrepreneurship by removing obstacles to enterprise creation, by establishing a facilitating environment for private sector development. The awareness of decision makers has been raised about the importance and widely ranging effects of rules, procedures and administrative practices affecting the starting and developing of businesses. One of the major tasks of regulatory activity is to reduce informality, to fight the grey economy, to favour legal economies as opposed to second or illegal economies. Therefore, regulations must be developed and implemented in a transparent way and enforced in a consequent manner in order to motivate compliance and to reduce informality.
Governments and international organisations have issued an increasing number of strategy documents on SME policies. These documents have formulated major aims and objectives of this policy area, such as creating equal opportunities for smaller and larger companies, simplifying the legal, administrative and institutional environment, facilitating access to finance, know-how and markets. In the first phase of SME development policy interventions have focused on creating equal opportunity for small businesses, but in the 1990s the priority of those aims which were connected to enhancing competitiveness of SMEs has gradually increased.
Consequently those measures and interventions have gained ground that were related to the removal of trade barriers, to the introduction of new business models, to the organisation of new business networks, to the promotion of innovative practices and to the development of electronic business.
The direct subsidies and incentive programs that were offered for companies by states, regions and cities were also highly criticized. It was frequently stated that such programmes waste public money without creating new jobs, subsidize companies for economic actions that they would have taken anyway, create unfair competition by helping some arbitrarily selected firms, and distort the prices in international trade. Another recurring subject of criticism was that many regulations were superfluous and clumsy and that the administrative procedures were bureaucratic and over-centralised. 3
In the subsequent debates about the justification of small business development policies and programmes, the use of evaluation and impact assessment studies has become an important component of good governance.
1.2. Special features of SME development in Central and Eastern Europe an transition countries
Most case studies and examples of this book that have been selected to demonstrate the methodological approaches of impact assessment and evaluation are taken from the practice of SME development in transition economies of Central and Eastern Europe . This does not restrict the applicability of these methods in any way:
they are generic, i.e. their relevance is not restricted to a specific level of economic development, political circumstances or regulatory environment.
In those countries which were or still are in transition from a centrally planned economy into a market economy, small businesses are facing challenges that are quite different both (a) from the challenges of SME development as they appear in developed countries and (b) from those in developing countries. Consequently, the portfolios of the applied policy instruments that have been applied in these countries for facing these challenges have been rather special to the post-socialist region.
In Central and Eastern Europe , during the decades of central planning, many forms of private business ownership were restricted, have been criminalised or subsisted in the grey or informal economy. Private business activities were tolerated to a certain extent in each socialist country and in certain periods, policy makers have experimented with encouraging some forms of private initiatives. However, following the geopolitical changes that took place between 1989 and 1991, the former socialist countries and Soviet republics have begun their transition from a centrally planned economy towards a market economy favouring private sector development and entrepreneurship and an emancipation and re-emergence of private enterprises took place. [bib_2] The countries of the region became transition economies that were facing deep economic, social
2 [Nolan 2004]
3[Schweke 2000]
and political crises while struggling to transform the public sector and the production systems just inherited from socialism.
The reform process called ―transition to market economy" included the following major components: 4
• Changing the ownership structure of the economy. This was implemented through the privatisation of former state-owned enterprises and land, and also through the creation of new privately owned enterprises. In particular, ’small-scale privatisation’ (e.g. of shops, garages and restaurants) has contributed to the evolution of a new class of entrepreneurs. In the same time, effective protection had to be granted to property rights.
• Economic liberalisation. This included price liberalisation, the liberalisation of factor markets (such as the labour markets, the capital markets, the markets for raw materials, and the markets for management or entrepreneurial resources), as well as the liberalisation of markets for final products and services. The power of monopolies had to be restrained and the principles of fair trade had to be enforced by introducing a brand new policy field, competition policy.
• Building and consolidating market institutions. This included the establishment of company registries, SME support centres and also the transformation of the financial infrastructure.
• The promotion of Foreign Direct Investment (FDI) was important, partly because of the shortage of capital, and partly because FDI is an integral part of an open, international economic system and a major potential catalyst for development through linkages to subcontracting SMEs and through spillover effects such as the spreading of know-how.
The first measures were to reform the banking system, to safeguard property rights, to liberalise prices and to privatise a large proportion of the state property. Among the new owners there were foreigners, surviving entrepreneurs of the socialist epoch, former landowners or any person being in the possession of the necessary capital, to buy the assets in all post-socialist countries. But privatisation procedures have also favoured former and incumbent company directors, leaders of the former public administration and ruling parties, other decision makers moreover their family members. This latter process has contributed to the evolution of the so-called
„nomenclatura entrepreneurship"
The above measures were very important interventions, but still not sufficient to create a viable SME sector. The institutions inherited from the socialist system, the under-capitalisation of most SMEs and the lack of entrepreneurial culture were serious obstacles to a sustainable small business development.
Within a few years millions of small enterprises were created in the Central and Eastern Europe a region.
Experience has shown that it was not sufficient to introduce policies that facilitate the creation of many new firms. Additionally, measures had to be taken to ensure the survival and growth of these companies by improving the business environment, by facilitating the access to loan and equity capital and by developing the capabilities of these companies to employ persons or to implement innovations of technology or organisation.
While the numbers of self-employed individuals and micro companies has grown spectacularly, there was a clear shortage of middle sized firms.
In the post-socialist transition countries the following major deficiencies of SME development and the respective challenges to small business development policy should be highlighted.
• Necessity-based entrepreneurship. A significant proportion of new companies has come into being as a reaction to the deep crisis accompanying the transformation and was serving the immediate consumption needs of the entrepreneur and his/her family. Wide social groups have escaped from unemployment into self-employment. Most frequently, the small firms created by them have not employed anybody except the owner, or only offered informal or part-time employment to a few family members. Most small firms were unable or unwilling to separate the budget of the household from that of the business and lacked any ambition to grow.
• Dual economies. A number of Central European countries were rather successful in attracting foreign investors. By the 1990s in some of these countries the contribution of foreign owned companies to production and export has surpassed the contribution of domestically owned firms. At the same time there were scarcely any linkages between local SMEs and multinationals, due to weaknesses of SMEs in quality management, just-in-time delivery and marketing. Policies were needed to facilitate and encourage subcontracting relations between bigger and smaller firms.
4[Smallbone-Welter 2009]
• Attitudes to innovations. Most new enterprises were based on some traditional business idea. Only a minority of small enterprises were based on innovative business models. Businesses based on some technical or organisational innovation were rather an exception than the rule.
• Trust and compliance. At the early stage of transition frequently forms of behaviour could be observed such as survivalist muddling through and a tendency to avoid the compliance with rules. In the early years of transition, entrepreneurs have faced a high level of uncertainty and ambiguity. The result was a low level of trust which did not facilitate the development of legal forms of inter-firm co-operation, neither the evolution of entrepreneurial networks. In particular, wide groups of SMEs in the Central and Eastern Europe an transition countries can be characterised by avoidance and non-compliance behaviour, which can be explained by the weaknesses of entrepreneurial culture, by the instability of the institutional environment and by the deficiencies of enforcement.
It was not expected that spontaneous market processes would lead to competitive economic structures in the medium or even in the long term. 5 Therefore, for the last two decades a series of progressive measures were taken in order to develop the business climate in these countries. For example, a wide range of such interventions were made in order to facilitate the access to credit and to credit guarantee services for SMEs [bib_3] and access to microcredit [bib_4]. The development of the business climate was also extended to investment promotion and Central European countries have become competitors both in attracting multinational investors to outsource their business processes to them and in motivating local SMEs to start a business on their territories [bib_5]
The Europeanisation process . Although in the countries of Central Europe the formation of SME development policy was under the authority of the nation states and local governments, still the major blueprints of the necessary institutional reforms and their financial background were determined to a large extent by the European integration process. During the 1990s most of these countries became candidate countries of the EU, subsequently joining to the European Community in the early 2000s. Moreover, a series of other Central and Eastern European countries have intended to join the EU or at least to participate in the advantages of the Common European Market. Consequently, these countries have joined various SME development initiatives of the EU and have signed agreements, charters and other key policy documents about aims and instruments of their national SME development policies. These moves were followed by the harmonisation of a wide range of European legal provisions and by the channelling of a vast amount of EU aid into the region aimed at developing the SME sector. The programmes and projects financed or co-financed by the EU were facilitating SME development by simultaneously spreading European institutional patterns. In those transition countries which became EU member states, the development of the business climate continued well after joining the EU.
1.3. The relationship between SME policy and other policy fields
It is not only the targeted SME and entrepreneurship policies that influence the creation and the development of small businesses. Governments also implement other policies without specific focus on SMEs that strongly influence small and medium sized companies, such as monetary and tax policies, education, social and labour policies, environmental, regional and sectoral policies, and trade and innovation policies. As a rule, the government departments responsible for the above policy areas are only indirectly concerned with small business development, in fact, their responsibilities for small businesses are very limited. However, these institutions spend much public money on programmes that benefit small firms. Analogously, in most countries the responsibilities for delivering local and regional support to SMEs is shared by many public and non-profit organisations of various legal forms, such as local SME development centres, regional chambers and others.
The following examples demonstrate how policy areas not directly concerned with small businesses may influence the development of this sector.
• Fiscal and monetary policies . Entrepreneurship can be inhibited by interest rates that are substantially higher than inflation, by macroeconomic stagnation or instability. Entrepreneurial performance can be discouraged by high taxes on profits, sales and inheritance However, high tax regimes also contribute to the rise of informal economy. Tax evasion under certain circumstances is easier for SMEs than for bigger companies 6.
5[Dallago 1999]
6 See Reference XLVIII at the end of this document about the size of informal economy in Hungary.
• Regulatory policy . SME activities are reduced by heavy regulations - causing much administrative burden - on licensing, on starting a business, on hiring and firing workers, on registering property, on getting credit, on protecting investors, on paying taxes, on trading across borders, on enforcing contracts and on closing a business. 7 Policies simplifying administrative procedures and fighting corruption contribute to SME development. In particular, business registration is an important government function, because it prevents fraudulent or unqualified entrepreneurs to appear on the markets with their products and services and cause harm to consumers, to their employees or to the environment. However, cumbersome licensing regulations or those with high compliance costs keep entrepreneurial persons and groups in the informal economy or reduce their willingness to start businesses.
• Competition and consumer protection policies . Policies ensuring fair competition can contribute to equal treatment of bigger and smaller firms by banks, by other service providers and in the public procurement process. [bib_6] However, policies ensuring the conformity of products to certain norms or facilitating the entry of new firms to the markets, are frequently debated by existing companies, in spite of the fact such measures may contribute substantially to better product quality and lower prices.
• Education policies are not only responsible for the training of potential employees of companies.
Additionally, in an increasing number of countries, attention is paid to developing entrepreneurship education in secondary schools and in universities. 8
Decision makers of SME and entrepreneurship policy must co-operate with other departments of the government responsible for the above policies. They are expected to lobby at other Ministries and government departments for regulations and for support that takes into consideration the interests and the special needs of small businesses. In particular, the development of inter-departmental interest representation within the government might be necessary:
• For implementing reforms of regulatory policy in order to simplify administrative duties of SMEs;
• For creating equal opportunities for SMEs in public procurement;
• For increasing SME related subsidies within funds devoted to regional development;
• For creating specific support schemes for innovative SMEs under technology and innovation policies.
And in many other issues that were under the responsibility of fiscal, environmental, labour and other authorities.
In particular, it is an important function of evaluations of SME interventions that they should facilitate discussions between the respective departments of the government.
7See Case Study „B" about the World Bank’s „Doing Business" indicators in this document.
8[Szirmai 2005]
Figure 7. The relationship between SME policy and other policy fields