The Role of Small and Medium Enterprises in Job Creation

1. The Role of Small and Medium Enterprises in Job Creation Nigel Twose Director Development Impact Department

2. Larger firms tend to be more productive, pay higher wages, offer more training and often better working conditions. Firms training, wages and labor productivity by firm size and country income group Larger firms pay higher wages Large is beautiful Figure uses 138 household and labor force surveys for 33 countries over 1991–2010. Source: Source: WDR 2013 team based on Montenegro and Patrinos (2012) Compared to micro enterprises, small firms typically offer a wage premium of 10–30%, but large firms offer a wage premium of 20–50%. Source: Enterprise Surveys 2

3. SMEs address a developmental challenge: Job creation • Jobs are the pathway out of poverty, and promote shared prosperity. • SMEs account for over 80% of net job creation and 67% of jobs in developing countries.1 • 95% of formal jobs in LICs and 70% in MICs.1 • Job growth rate of smaller firms is twice the average of all firms. • SMEs have potential to increase productivity, raise wages and reduce poverty. • Create value in the supply and distribution chain by providing materials and services, and distributing goods of larger enterprises. • Can foster innovation, improve competitionand facilitate labor migration to more productive sectors of the economy. Then why do SMEs matter? • *US$2 million for more advanced countries, including Argentina, Brazil, Chile, China, Colombia, India, Korea, Mexico, Morocco, Peru, Russia, South Africa, Thailand, Tunisia. 1 Source: Ayyagari, Demirguc-Kunt, et. al. (2011)

4. But not all SMEs can grow into large firms • Smaller companies are more likely to go out of business, and face “stunted growth”, which impedes economic growth • This is particularly important in lower income countries since small firms have the highest share of employment. Many firms are born small and grow little (stunted growth) 4 Source: Hsieh and Klenow (2011)

5. Constraints that stunt SMEs’ growth potential Firm Size Country income group * Small= 5-20 employees, medium= 21-99 employees, large >= 100 employees. Source: WBG’s Enterprise Surveys covering 46,566 firms in 106 countries. • Access to Finance: • The major obstacle for SMEs. • MENA: lowest access globally (20% of SMEs have credit line from financial institution). • Infrastructure: • Reliable power supply is major constraint in low-income countries. • MENA: Approx $106 bnannual infrastructure investment & maintenance needs by 2020 • = 6.9% of MENA GDP. Infrastructure jobs represent ~8% of jobs in MENA (average). • Investment Climate: • Informality is a key issue in middle-income countries and SMEs. Taxation is an important constraint for high-income countries. • MENA: Informal sector produces about 1/3 of GDP; 67% of workers are employed informally.

6. Additional developmental challenges for MENA Challenges Findings • Resource rich countries • Often prosperous, but need to generate sustainable jobs outsideresource sector • Some countries have weak institutions for their level of wealth, important to form/implement policies to generate jobs in non-resource sectors

7. High Growth SMEs (HGS) create the majority of new jobs in developed markets: • USA: 4% of private firms, but create 70%+ of net new jobs.1 • Europe: 5–10% of firms, but create 50–80% of jobs.2 • IFC definition: HGS have 10-250 employees, and experienced 20% average annual sales growth for 3+ years. How to identify HGS • Growth orientation • The best predictor of growth is the desire for growth. • Some organizations propose psychometric testing to assess entrepreneurial characteristics (e.g. IADB, Awethu Project in S. Africa, BDC in Canada). • Experience • Entrepreneur has track record and knows the sector. • Start-ups are not a safe bet… look for firms that are 3 to 10 years old. • Some basic education needed, but advanced not required. • Opportunity • Entrepreneur sees an opportunity, and is not afraid to take a chance. • May pursue undefended niches in 2ndand 3rd tier cities. So which SMEs can grow? Box source: IFC’sSME and Jobs Committee. IFC interviewed relevant organizations. These are the most common factors mentioned by the organizations interviewed, and backed up by research. Additional sources: 1 Birch et al; 2(Holzl)

8. How can we best support SMEs? • Encourage financial institutions to lend to SMEs • Promote scaling-up • Strengthen financial infrastructure • Provide advisory support to improve organization, processes, credit assessment, monitoring capabilities, and information technology ProductsPartners in DevelopmentTarget SMEsImpact • Underserved SMEs • Women owned Businesses • Value Chain Partners • SMEs in Fragile States • Climate Mitigation Growth Improve productivity Increased Income Inclusion & Jobs Poverty Alleviation • Loans • Equity • Risk Mitigation • Bank Capacity Building • Financial Infrastructure • SME Training • Commercial Banks • Non-Bank Financial Institutions • Private Equity Funds • Financial Infrastructure Providers • DFIs Source for figure on IFC products through impact: SME and Jobs Committee (2012) “SME and Jobs”, May.

9. IFC’s activities focusing on SMEs and job creation • 1. Strengthen our reach to SMEs • Prove innovative equity investment concept: SME Ventures • Implement investment climate reforms for SME enabling environment • e.g. business entry reforms, credit bureaux, collateral registries • Provide financing and advisory services to help SMEs’ growth • Improve access to infrastructure (e.g. power reliability) • Provide finance through corporate value chains, not only financial institutions. • 2. Invest in deepening our shared understand of job creation • Micro-case studies for manufacturing, agribusiness and services sector (India, Ukraine, Indonesia, and Africa) as well as financial markets (Sri Lanka, Pakistan, Lebanon and Argentina) • Macro-case studiesin Tunisia, Jordan, Sri Lanka and Ghana • Direct, indirect and induced.

10. Innovative Investments: SME Ventures • Established in 2010 and focused on fragile states – offers blend of risk capital and advisory services. • Currently offered in Liberia, Sierra Leone, Central African Republic, DRC, Bangladesh and Nepal. • Since inception, the local Fund Managers have invested USD $6.8 million in local SMEs. • Advisory offering includes management and financial skills training for SME owners and managers, improved governance for SMEs, investment climate, and envt & social guidance. • Challenge: Is there a viable market niche for funds? Lessons Learned from SME Ventures

11. From 2000 to 2010, 494 Firms financed by IFC’s private equity funds created, net of job loss, ~300K jobs Strong growth compared to small portfolio. Micro-case studies: Lebanon and Pakistan • Habib Bank: Pakistan • Electricity is a main constraint to business growth • SMEs prefer to use short term instead of longer term loans for funding needs, from working capital to capital investments. • Common preliminary findings: • SMEs are mostly family businesses • Limited SMEs with women owners or managers • Firm growth and job creation have been significantly affected by political instability and economic downturn • Job preservation was considered a success, given limitations of enabling environment • Fransabankstudy: Lebanon • Access to finance is major concern for entrepreneurs with limited track record or without relationship with the Bank • Youth prefer unemployment to working part-time or in low-skilled jobs

12. Micro-case studies: Sri Lanka • Commercial Bank of Ceylon in Sri Lanka* • Annual job growth 12% (two times the economy) • Job creation ~2.7K Equal for men and women • More labor productivity • Extrapolation: 140K to 330K jobs ≈ 1.4 – 4.3% employment in 2011 • 10 to 31 jobs created per $100K of credit provided • *Note: Study has methodology caveats Micro-case studies in Manufacturing, Agribusiness and Services Supply chains & distribution networks provide multiple of direct jobs

13. Jordan Higher number of jobs can be associated withlower value added per job Transformations • Short-term job growth • Long-term job growth • Invest in labor intensive sectors and Financial Institutions (FIs) • Invest in larger non-FIs & sectors facing international competition

14. The way forward 1. Macro and Sector Level • Step up competition – increases the incentive to reach out to SMEs • Overcome information asymmetries (e.g. credit bureaus, collateral registries) • Study otherapproaches to support SMEs(e.g. supply chain finance, new technologies) • Liberalize to encourage entry and lending, but enforce prudential regulations • Step up shared learning on job creation effects 2. Client Level • Increase/guarantee funding to financial intermediaries for underserved groups • the primary constraint is capital • Fund through corporate value chains • Track jobs and implement micro-case studies 3. SME Level • Try to identify/support “High Growth SMEs” through higher risk financing, plus advisory support • Implement comprehensive approaches for youth employment and entrepreneurship training • e.g. E4E, but alongside capital, not self-standing training • Consider informal SMEs for skill development programs, but create incentives to formalization • Focus on under-served segments • Consider cash transfer programs!

15. ANNEX

16. Jobs in MENA vs. Other Regions • Gender difference is strongest in MENA in shares of farming, self-employment and wage jobs. • Labor productivity has been stagnant in MENA for many years.

17. Countries with High Youth Unemployment * • Demand for jobs for the young typically outstrips supply. • Mostly rural (e.g. SSA) or urbanizing (e.g. MENA); solutions differ. • Policies and institutions, especially around education and private sector growth, are typically weaker for countries troubled by youth idleness and unemployment. Essential part of solution is appropriate skills development, with foundation laid by good education. * 2013 WDR

18. E4E strategy • E4E focuses its interventions on targeted sectors constrained by skills gaps (priority growth sectors) and cross-cutting enablers • Based on E4E Status Update: • Pursue sector solutions (retail (MAF), construction, health care) following deep dive analysis by leveraging IFC partnerships and clients (including large employers) • Invest in a range of provider ‘types’ to maximize impact and reach (e.g. education providers, content developers, student lending, banks, education funds, etc.) • Bringing to bear IFC’s global footprint and network (e.g. LAC Study Tour, global IFC clients) Note: IS = Ongoing IS project, AS = Ongoing AS project; Status as of October 2012

19. Finance: Smaller firms have less access to financing • Use of bank financing: • Small firms: 14% • Medium firms: 18% • Large firms: 25% Source of financing for working capital and fixed investment needs (%) Source: IFC (2010). Scaling-up SME Access to Financial Services in the Developing World.