Why small firms are so important?
Federica Saliola, Senior Economist, Enterprise Analysis-WB Unit, 4/30/2012 9:59:17 AM
Considerable effort and attention have been devoted to assessing the critical role of small and medium enterprises (SMEs) in economic development. Thanks to such work, there is extensive evidence showing that SMEs are an important source of employment growth. But against this backdrop, not enough attention has been paid to the importance of small firms, namely firms with 5-19 workers in this context.
Thanks to Enterprise Surveys data of 46,556 enterprises in 106 developing countries, we learn that small businesses constitute a major force and are the primary engine of employment growth in developing economies.
First, small firms show the highest employment growth of 18.6 percent vs. 8.1 percent of medium-size firms (20-99 workers) and -1.0 percent of large firms (100+ workers). Interestingly, small firms display similar growth rates in both manufacturing and services. In addition, when firms are divided by age into young (1-5 years), middle-aged (6-15 years), and old (16+ years), small firms still show the highest rate of employment growth, followed by medium-size and large firms in every age category.
Second, small firms show positive labor productivity growth, indicating that their growth is based on both rising employment and higher productivity. However, their productivity growth rates still lag behind those of medium and large firms.
Third, whereas small firms constitute by far the largest number of firms in the formal private sector in developing countries (55 percent), they provide less than 30 percent of total employment. This is particularly relevant in manufacturing where small firms account for about 20 percent of total employment. In services, the distribution is different, since small, medium-size, and large firms each account for about a third of total employment, with small firms leading the pack at 35.4 percent.
Fourth, although small firms lag behind in terms of the share of total employment in manufacturing, recent trends indicate that the share of small firms in total employment has increased in a two-year period by 3.7 percentage points (pps). In contrast, the employment share of medium-size firms had a small increase of 0.2 pps, and large firms decreased their share of total employment by 3.9 pps.
These days, as public policies are shifting away from traditional measures based on a static notion of industrial organization towards measures aimed to support the dynamic role of SMEs; more focus should be placed on the small firms segment within SMEs. Specifically, public policies should focus more on providing an enabling environment for creating jobs, increasing labor productivity, and encouraging knowledge spillovers and technological change. Investment climate, access to finance, and access to power are among the main constraints affecting private sector growth and development. Relieving these constraints would have particularly positive effects for small firms.