BOX 2.12 THE HARD LIFE OF SMALL AND MEDIUM-SIZE ENTERPRISES

Throughout the developing world, small and medium-size enterprises (SMEs) are condemned to a cycle of low productivity, stunted growth, and unstable incomes. Here are the reasons:

Restricted access to institutional financial services. Companies that lack collateral are frequently denied access to necessary financing. While financial intermediaries are often reluctant to lend to SMEs for sound financial reasons (such as the high transaction cost of monitoring), badly functioning financial systems, ineffective laws on collateral, and poor enforcement of financial contracts also limit access to credit.

Lack of access to markets. SMEs' failure to find markets for their products and services often results from inadequate physical infrastructure, high transport costs, and inadequate information about markets.

Lack of access to inputs. Difficulty in getting physical inputs largely stems from input markets that function badly—including those controlled by large parastatals that have preferential access to inputs.

Inadequate technical skills. Unlike large enterprises, SMEs lack the financial and time resources needed to train workers—who often have little formal education. They also have neither the resources to obtain appropriate technology, nor sufficient access to information on it. The combination of rudimentary technology and poor skills makes for low-quality, uncompetitive products.

Restrictive policies and regulations. While SMEs generally regard policy and regulation as less problematic than credit or physical inputs, excessive bureaucratic procedures and the lack of clear-cut regulatory norms impose high transaction costs that deter them from expanding. Indeed, it is often argued that the scarcity of medium-size enterprises in Africa is largely the result of a highly restrictive regulatory environment.

Distorted incentives for growth. Special support programs to promote SME growth distort the overall incentive system and are thus more harmful than beneficial, both to SMEs and to economic development. In India, such programs encouraged SMEs to become dependent on subsidies and inhibited their growth.

Policies that favor large firms. Many low-income countries continue to protect large public enterprise sectors despite the fact that these often crowd out private ventures and monopolize markets. Public policies can also protect large private enterprises by restricting competition and by imposing barriers to entry, subsidies and tax exemptions. In Senegal special exemptions restrict entry, while high effective rates of protection limit competition.

Government technological support came through institutions dealing with standards and quality control and from productivity centers and extension services that help firms adapt existing technologies and improve production and management routines, as in Hong Kong and Taiwan (China) (box 2.14). This is now being successfully tried in India under a technology development project, supported by the Bank Group, to redirect the activities of government research institutes from expensive basic or applied research development to activities of more direct operational relevance to businesses.

A similar approach is being adopted in the agricultural sector. Successful research and extension programs focus on services that the private sector is unable to supply, such as those relating to staple food crops and basic fanning techniques, and on activities that encourage private input suppliers and agro-processing companies, often the best source of specialized advice, particularly for cash crops.

Extension services have benefited from the involvement of producers cooperatives in service delivery. One model of public-private cooperation is the IDA-supported initiative by the National Federation of Central African Livestock Producers, a herders' association that was assisted in taking over the delivery of livestock services. The sale of veterinary drugs increased fivefold, reaching 80 percent of the target population. And the herders association has been transformed into a major service organization—a driving force for livestock development. Similar approaches in other agro-based industries could significantly improve the productivity and earnings capacity of most rural activities, while freeing government resources for use in other areas, such as strengthening the rural roads network.

The quality of the labor force also affects enterprise development. A welltrained labor force increases productivity, makes the shift into new areas of economic activity, and increases the pace of technology assimilation. In many countries, public training systems are overextended and divorced from the needs of the private sector. The most successful programs combine government resources and strengths in analyzing economywide information with better private capacity in managing specific programs to make training systems more responsive to the needs of the economy (box 2.15). Many countries could benefit from modernizing the technology curriculums in secondary schools and helping individuals and fines acquire specialized training abroad.

BOX 2.13 ENTERPRISE DEVELOPMENT THROUGH EXPORT PROMOTION

Access to inputs at world prices. Import restrictions, relatively high import tariffs, and taxes on domestic inputs often handicap exporters in lowincome countries from competing with exporters from other economies who do not face similar restrictions and costs. These cost disadvantages are normally overcome through duty drawback, duty exemption, and tax rebate mechanisms. In China, a welladministered duty exemption system has assisted exporters in maintaining cost competitiveness by allowing easy access to imported inputs-exports under duty exemption arrangements accounted for 27 percent of total exports in 1991. In most African countries streamlining and adequately funding such programs to significantly reduce the costs incurred by exporters will increase export competitiveness.

Easy access to export credit. In most African countries, access to export finance would be facilitated if there were automatic access to export credit and rediscounting facilities for export orders backed by letters of credit; if export credit risk and commercial risk insurance were easily available; and if restrictions on issue and negotiability of trade financing instruments, such as bankers' and governments' trade acceptances, were eliminated to spur growth of market-based trade-financing mechanisms. By allowing exporters to retain all foreign exchange earnings and thus earn the full scarcity premium on foreign exchange, the cost of export finance can be reduced.

Market and product development. Most firms in low-income countries need but cannot fully afford specialized services relating to export market identification, product and process adaptation, and compliance with ISO 9000 standards. In India, IDA assisted firms in acquiring specialized services and in implementing export market development strategies. The assistance, on a cost-sharing basis, enabled beneficiary firms to register average export growth of more than 50 percent. A recent study by IDA—Africa Can Compete—-has shown that poor product quality and production technologies are important constraints preventing African firms from exploiting U.S. demand for Afrocentric textiles and home products estimated at around $200 million annually. A product and technology development program of the type used in India could assist African firms.

Export-oriented joint ventures. Export trading companies in many East Asian countries have provided critical logistical, marketing, sales, technology, and financial services to producers selling to overseas buyers. Enabling the establishment and operation of joint-venture or wholly foreignowned trading companies could help Africa's new entrepreneurs gain access to foreign markets being opened by reform. In addition, export-oriented joint ventures could be facilitated by eliminating investment restrictions and by offering special export incentives. In some instances, export-processing zones have proved effective as interim arrangements for providing exporters with reliable infrastructure and for establishing the credibility of government policies.

BOX 2.14 ENTERPRISE DEVELOPMENT THROUGH TECHNOLOGY SUPPORT

In the late 1 960s the Taiwanese (China) bicycle industry was facing difficulties in competing in export markets. Indeed a number of companies went out of business. The Taiwanese government entrusted MIRL (Metallurgical and Industrial Research Laboratory), a nonprofit, government-supported research institution, with developing and implementing a modernization program in collaboration with producers and the industry association. MIRL identified problems in materials, manufacturing, design, and standards. It then assisted the bicycle plants in three areas. Engineering modifications were made to improve product specifications, to standardize material utilization, and to raise quality control procedures. Production changes were introduced to increase the efficiency of manufacturing and assembly procedures and the interchangeability of components. And greater efforts were made to market the higher quality and safety standards of the bicycles in the United States.

The technology upgrading program, implemented in close collaboration with manufacturers, cut manufacturing time by as much as 40 percent, complied with safety regulations set by the U.S. Consumer Products Safety Commission, and shifted production to lightframe bikes. Bicycle exports grew from less than $3 million in 1970 to close to $200 million by the end of the decade.

Since then Taiwanese firms have maintained their export competitiveness and have moved upmarket. At present, bicycle exports are more than $2 billion.

In contrast, Indian producers, who were bigger exporters than the Taiwanese in the 1 960s, failed to upgrade their technologies. They continued to produce basic models, which were losing appeal in international markets. They lacked a technological support system. And they were unable to combine low labor costs with technology and product upgrading. As a result, India has lost market share. Bicycle exports languish at less than $100 million, even though India is one of the largest producers of bicycles in the world.

This example suggests that technology support can play a critical rote in enhancing the competitiveness of firms. To be effective, however, it must be based on clearly identified and strong needs, quick government recognition of the need, a technologically competent and commercially oriented research and development institution, a wellintegrated action plan that focuses on specific process and design problems of a large number of producers, and continuous interaction and feedback from producers, with industry associations playing an important coordinating role.

In general, government procurement policies can be designed to promote small and medium-size firms. Ten West African countries are using their public investment program to help their budding contracting industry—often the launching pad of large companies—by combining technical assistance and a prompt payment system with contracting out infrastructure maintenance and investments that were previously carried out by the public sector. These efforts have also succeeded in providing, in a cost-effective way, infrastructure services to undeserved small—rural and urban—localities. This program provides a model that many countries could replicate on a large scale (box 2. 16).

The telecommunications sector has considerable potential for developing modern small and medium-size enterprises. New technologies allow telecommunication services to be unbundled. Such value-added services as paging, electronic mail, and database information services can be provided through franchising arrangements without substantial capital requirements. Even in basic telephone services, independent operators can compete with existing operators in such services as pay phones. In India, pay phones have been franchised to small private operators, who have substantially improved access to telephone services and boosted the collection rate for the utility.

BOX 2.15 TRAINING POLICY REFORMS IN TOGO

Until 1 99O, both public and private training programs in Togo were rigidly administered and inadequately financed. Both quality and efficiency were low. In 1 990, the government reformed its policies on training and institutional development, aiming to build a flexible private-public training system that would be responsive to the country's economic demands, provide more practical training, and strengthen the theoretical content imparted during apprenticeship. By upgrading skills, the government hopes to attract foreign investment in labor-intensive light manufacturing and thereby reduce the economy's dependence on subsistence agriculture and on cocoa, cotton, and coffee. The reform includes:

Strengthening government's capacity to monitor and analyze labor markets in both the public and private sector, formal and informal, by analyzing existing data and conducting household surveys, periodic censuses in the urban and rural sectors, and profession-specific studies. The information generated would be analyzed and widely disseminated to schools, training centers, and employers.

"Twinning" managers and instructors with overseas training institutes.

Establishing a national training fund, administered by a private-public management committee, to allocate financial resources to public and private training projects that meet predetermined criteria.