SMEs - Key Drivers of Job Creation, Economic Development & Social Change - Essay Example

Introduction

Small and Medium-sized Enterprises (SMEs) have varied definitions in different economic development levels and different countries. It is typically described as a relatively small business unit based on capital, employees, and scale of operations compared to the large enterprises that operate in the same industry. Regardless of the varying definitions, SMEs are found to play an important role in nearly every economy as it has a tremendous contribution to job creation, economic development, and social stability. The emerging or developing economies across the world offer SMEs the environment to continue their operations, especially in ensuring access to finance. SMEs may have several opportunities that they can use to grow and expand operations, although they face significant constraints too.

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Developing Economies

Emerging markets are also referred to as developing countries or emerging economies that are found to invest in more productive capacity. The economies have started to move away from their traditional economies that typically depended on exports for raw materials and agriculture (Rodrik, 2018). Leaders in developing nations aim to develop a better quality of life for their population. It is established that leaders in developing countries are adopting a free market or mixed economy and are rapidly industrializing.

Emerging economies have several characteristics that define them. They have lower than average per capita income. Low income is perceived as the first essential criterion for grouping developing countries. Leaders in such countries are willing to ensure they undertake a rapid shift to adopt a more industrialized economy that helps them remain in power while at the same time helping their people (Nguyen, 2017, p. 54). Developing nations are also defined by brisk economic growth. Their economies are depicted to grow rapidly compared to developed countries across the world. The next feature of emerging markets is high volatility, which is caused by rapid social change. High volatility is linked to factors such as external price shocks, natural disasters, and domestic policy instability. Emerging economies have a dependence on traditional agriculture. It causes them to become vulnerable to disasters such as drought, earthquakes, etc. The countries experience currency swings and are susceptible to commodity swings. Even though emerging markets experience numerous negative characteristics, they have the potential for growth. Their growth needs to have a lot of investment capital.

Access to Finance

Enhanced access to finance, especially for SMEs, encourages entrepreneurship, innovation, competition, and economic growth. As a result, the area has witnessed increased interest from researchers. Access to adequate capital, which can be used both in sustaining and increasing activities, is a challenge experienced by numerous small businesses (Khan & Anuar, 2018, p. 99). Access to finance, particularly for small businesses, is perceived as a highly risky activity that leads to high costs of transactions and low returns on investment. Further, small businesses should face the difficulties of adapting to the transforming financial environment. They need to meet the increasing complexity and extent of financial reporting. SMEs are considered vulnerable, especially when the entire world is at a crisis to varying degrees. In developing economies, the enhancement of finance for SMEs is usually addressed at nationwide levels. Policies need to be meticulously selective based on the country’s budget constraints. Emerging economies should award priorities to SMEs to improve their access to finance due to the perceived importance of employment and growth.

Small and Medium Enterprises (SMEs)

Small and medium enterprises typically play a key role in the majority of economies, especially in emerging nations (Karadag, 2016). According to the World Bank, SMEs account for most businesses across the world and are crucial contributors to global economic development and job creation. They are found to represent over 50% of employment across the world and 90% of the business (World Bank, 2020). Further, formal SMEs usually contribute up to 40 percent of the gross domestic product in developing countries.

Opportunities for SMEs

Bank lending is regarded as the most common source of external finance for numerous small and medium enterprises. SMEs are, in most cases, heavily dependent on debt to meet their start-up goals, investment, and cash flow needs. Banks are likely to be willing to offer an overdraft and lend in the long term. The lending can potentially be secured using major assets, including buildings and land. There are several other potential sources for SMEs to access finance.

One of the sources is the SME owner, friends, and family, which is perceived as an excellent source of finance since the above investors are likely to be willing to accept a lower return. Nevertheless, the challenge of a limited amount of capital that they can raise affects the financing needs of SMEs. The next opportunity includes using the business angels willing to invest in SMEs and take up the risk. An interested business angel is useful to enterprises since they, in most cases, have great business acumen and numerous useful contacts. SMEs also have the opportunity to access finance from trade credit from their suppliers.

Constraints for SMEs

In the current business world, SMEs are experiencing several constraints in accessing financing sources. While bank lending is commonly applied by SMEs, traditional bank finance usually poses challenges to small businesses, especially to innovative, newer, and fast-growing businesses, with a higher risk-return profile (Paul, 2017). Raising finance to fund SME operations is, in most cases, more challenging for the business since banks are found to be conservative.

According to the World Bank, SMEs are less likely to be in a position to obtain loans from banks than large companies. Rather, they depend on cash from family or friends or on internal funds, to start and run the business (World Bank, 2020). The International Finance Corporation (IFC) offers an estimated 65 million firms representing 40% of the SMEs in emerging economies that face unmet financing needs or approximately $5.2 trillion per annum. The World Bank also reports that approximately half of the formal SMEs fail to have access to formal credit. Besides, the financing gap is found to be even larger if micro and informal businesses are considered.

Recommendation for a Policy Upgrade

Owners and managers in small and medium enterprises should have financial literacy, which is a crucial influencing factor for SMEs' access to sources of finance. The collaboration with owners' or managers' characteristics and firms’ characteristics, particularly in the financial literacy of managers or owners, creates the unification of power resources. As a result, there would be an enhancement in the efficiency and quality of the small businesses' financial decisions to overcome the obstacles to access to finances in emerging economies.

Emerging economies need to enhance SMEs' access to finance and establish multiple innovative solutions that allow the unlocking of capital sources. Developing countries require a holistic approach that combines advisory and lending services to clients to improve the contribution of small and medium enterprises to the economy. They include focusing on underserved segments, including SMEs owned by women. They need to carry out financial sector evaluations to establish areas of improvement in policy and regulatory aspects that enable increased responsible access to finance by SMEs. Nations need to implement support initiatives, including the creation of an enabling environment and designing and setting up a scheme of credit guarantee. Credit infrastructure needs enhancement that helps increase SME access to finance.

References

Karadag, H., 2016. The role of SMEs and entrepreneurship on economic growth in emerging economies within the post-crisis era: An analysis from Turkey.

Khan, S.J.M. and Anuar, A.R., 2018. Access to finance: Exploring barriers to entrepreneurship development in SMEs. In Global Entrepreneurship and New Venture Creation in the Sharing Economy (pp. 92-111). IGI Global.

Nguyen, T. A. N. 2017. Financing constraints on SMEs in emerging markets: does financial literacy matter?

Paul, J., Parthasarathy, S. and Gupta, P., 2017. Exporting challenges of SMEs: A review and future research agenda. Journal of World Business, 52(3), pp.327-342.

Rodrik, D., 2018. New technologies, global value chains, and developing economies (No. w25164). National Bureau of Economic Research.

World Bank. 2020.Small and medium enterprises (SMEs) finance: Improving SMEs’ access to finance and finding innovative solutions to unlock sources of capital. https://www.worldbank.org/en/topic/smefinance