Issue 26: July-August 2003

WIDER study debunks
'fairy tale' of SME boom

When the Berlin Wall collapsed in 1989 and helped send Soviet-style communism tumbling across central and eastern Europe, fashionable economists in the West predicted that thousands of small businesses would quickly take root in a capitalist revolution rising from the ground up, the Dow Jones Newswires* reported.

Nearly 15 years later, as economists try to sift through the reconstruction, a new study by UNU World Institute for Development Economics Research (UNU-WIDER) puts that dearly held assumption on its head and warns that flattened economies don't necessarily build solid foundations if left to their own devices.

Rather than flourishing, many of the smaller enterprises that were launched in the early 1990s quickly withered and early reports of their spectacular growth were nothing more than "a fairy tale picture" of life after central planning, the study found.

"Little in fact has been accomplished in building up a productive, modern small-enterprise sector," said Robert McIntyre, co-editor of Small and Medium Enterprises in Transitional Economies and a senior researcher at the Institute for International Economic and Political Studies in Moscow.

The WIDER study asserts that initial talk of businesses with fewer than 250 employees flourishing in the region were fueled less by facts than by "an eager audience for statistical good news based on pervasive over-counting of registrations and statistical immortality once registered."

It also argues that small companies ultimately can't be expected to survive unless local governments nurture them through supportive policies, allowing them to vertically integrate with larger firms in a symbiotic relationship. The preliminary numbers looked extremely promising. According to the European Bank for Reconstruction and Development, for instance, 23% and 24% of employment in Poland and Hungary, respectively, were derived from small and medium enterprises in 1993-94.

But the EBRD stopped publishing data on SMEs in 1995, perhaps because it recognized that many of the numbers circulating were "garbage," said McIntyre.

Research from the late 1990s indicated that 70% of such registered enterprises in Poland had only one full-time employee, raising questions about just how much they were contributing to the local economy. In Bulgaria, meanwhile, nearly half the registered SMEs appeared to be doing nothing by the mid-1990s. "They just had an address," said Bruno Dallago, co-editor of the report and an economics lecturer at the University of Trento in Italy, during a presentation of the findings at the UN headquarters in New York.

The SME experiment in Russia also appears to have run out of steam. According to government data, the number of small enterprises in Russia soared to roughly 800,000 in 1994 from a little more than 200,000 in 1992, but the number hasn't budged since then.

Instead, these days the talk in Russia is of a newly entrenched oligarchy that's not afraid to throw its weight around. Eight conglomerates control 85% of Russia's largest 64 privatized companies, a recent study estimated.

Corruption, red tape and the rise of organized crime are all cited as reasons for why SMEs have failed to take hold in Europe's transition economies.

But a dearth of financing probably has posed the biggest roadblock, according to the study's authors, with banks providing little financial intermediation beyond investing in government bond markets. As a result, after having launched ventures by pooling together family savings, many small-scale entrepreneurs had nowhere to turn when they tried to expand their businesses or simply keep them alive.

"The lack of proper financial solutions is an important obstacle, not so much for the establishment of SMEs, but for their development," said Dallago.

The study also argued that SMEs in central and eastern Europe found powerful - and usually overwhelming - competition from abroad as protectionist measures were largely discarded in the rush to modernize local economies.

* Adapted from a Dow Jones Newswires report by Mike Esterl. © 2003 Dow Jones Reuters Business Interactive LLC (trading as Factiva). All rights reserved.  

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