NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Tuesday, June 25, 2013

By Tilman Ehrbeck

Across the political spectrum, any leader worth their salt will express support for small- and medium-sized enterprises (SMEs) – remember the “job-creator” debate during last year’s U.S. presidential elections? Globally, the G20 has prominently made SME support a priority of their development agenda, citing that SMEs account for 45 percent of employment and 33 percent of GDP in developing countries.

Sometimes leaders get carried away in their rhetoric: SMEs are the “lifeblood of the economy,” they might say, or that SMEs “are the most powerful engine of economic growth.” While SMEs are clearly important in any economy, this hyperbole is at best misleading and at worst might trigger wrong policy conclusions. Already the “45 percent-employment/33 percent-GDP” statement should give reason to pause. We just said that SMEs on average are less productive than the rest of the economy.

MIT economist Antoinette Schoar recently pointed me to an intriguing piece of research that has mined a number of data sources for the U.S. and found that SMEs are highly concentrated in relatively few industries. More than 60 percent of American SMEs are working in areas where they bring known solutions to known customer groups with little innovation or growth. This includes skilled craftsmen (e.g., plumbers and electricians), skilled professionals (e.g., lawyers, accountants) as well as real estate firms, restaurants, and small shops (e.g., gas station owners). A quick gut check against our own daily business interactions makes this list highly plausible. These types of SMEs do not create many new jobs. As far as job creation potential is concerned, what matters more than size is the age of a firm; younger ones are those that almost tautologically seem to have more growth potential.

The research also summarizes survey data on why people in the U.S. start small enterprises. Typically, they value the freedom and flexibility of being their own bosses. Only a third say at the outset that they want to grow bigger and many of them might not succeed.

SMEs in developing countries similarly create less jobs than one would hope. Many stay small even in industries where economies-to-scale create growth incentives in the U.S., such as manufacturing. Another intriguing piece of research compares the average employment growth of manufacturing SMEs in the U.S. with Mexico and India, where it remains essentially flat over decades.