3. Overcoming barriers.
LEGAL AND REGULATORY BARRIERS
Legal and regulatory barriers in Chile range from requirements to register and maintain a business to labor regulations, tax policies, inspection and environmental practices, and government procurement procedures. These requirements are enforced at the municipal, regional and national levels. Obstacles include inadequate safeguards to promote competitive markets and practices and a low level of enforcement of existing laws in cases of non-compliance. Although government procurement has the potential to become an enormous market for SMEs, regulations covering procurement procedures make it difficult for small and medium businesses to participate.
In response to these perceived barriers--and to improve the regulatory context--Chile developed two projects: (i) Simplification of Transactions and (ii) One-Stop Shops. In addition, laws establishing limited liability individual companies and the standards to facilitate the creation of family microenterprises were also approved.
Networking is the capacity of companies to generate collective action for mutual benefit. Effective networks (also known as clusters, business associations and industry associations) help firms use new technologies efficiently, develop a greater capacity for negotiation with suppliers, diversify markets, and develop new systems to exchange information. The principal incentives for business associations are to increase sales, purchase inputs, learn more about market opportunities and acquire new technologies. Networking can also accelerate the dissemination of new knowledge and improve the entrepreneur's ability to make decisions more effectively.
However, the commitment to sustain the organization may be missing. For example, in 2003, of the over 2,000 business associations listed, most were inactive, did not renew their leadership, or were not fully representative. Many small and medium business owners become entrepreneurs because they have strong values of individualism--and sharing information with a competitor in a small, localized market is not appealing. Moreover, many entrepreneurs not have the time or resources for organizational work. They cannot afford the high transaction costs, membership fees, and they perceive risks in sharing proprietary information and knowledge. (26)
That said, Chile has a number of ongoing initiatives to promote business networks. The methodologies, scale of operations, and effects of each of six of the leading Government network promotion programs are summarized below.
1) Proyectos Asociativos de Fomento (Group Development Projects, PROFOs): PROFO encourages the formation of horizontal networks to overcome scale-based barriers such as access to technology, markets and management skills. To that end, PROFO finances, at a
2) Programa de Desarrollo de Proveedores (Supplier Development Program, PDP): This program provides incentives to link suppliers and larger firms. Large firms provide training on quality standards and product design so that local small and medium firms can become reliable suppliers. The program has been better suited for the agro-industrial sector. (27) Raw materials can be easily standardized, and producers are more homogeneous, allowing for easy dissemination of quality standards and reduction of implementation costs.
3) Programas Territoriales Integrados (Integrated Territorial Development Programs, PTI): PTI combines training activities, innovation, infrastructure, technical assistance, and business and finance networking to improve productivity in a specific region.
4) Programa de Fortalecimiento y Creacion de Organizaciones Gremiales (Program for the Creation and Strengthening of Business Associations). This program seeks to modernize the SME networks, train leaders, and improve the professionalism of the services provided to members. To participate in this program, each organization must present a proposal and contribute 30 percent of the cost of the project.
5) Fondo para la Modernizacion de las Relaciones Laborales y Desarrollo Sindical (Fund for the Modernization of Labor Relations and Union Development). This project finances training and provides technical assistance to labor unions. Micro and small business associations have also qualifed for support. (28)
6) Emprende Chile (New Productive Activities Program). This program coordinates the efforts of a number of ministries and seeks to create an enabling environment for micro and small businesses in a region. The program's ultimate objective is to improve the quality of life and income level of the inhabitants of participating communities, improve labor conditions and competitiveness of micro and small enterprises, and enhance overall regional development capabilities. First, it evaluates business and employment opportunities based on the socioeconomic characteristics of the region, and, second, it identifies the employment and entrepreneurship support mechanisms that can link micro and small firms with markets and commercial networks. (29)
The PROFO program has produced significant results in productivity and profitability. Companies that participated in the program increased their annual sales by 12.9 percent between 1996 and 1999. PROFO offers one of the few independent evaluations with panels and control groups in the entire portfolio of government private sector support programs. The evaluation found that participating firms were much more likely to gain access to public funding, and take advantage of technical resources from universities and other sources. When a private agent was involved, marketing strategies were more developed. When a public sector agent was involved, greater improvements were seen in worker safety and training. The evaluation concluded that the program was "socially profitable" and that government spending was more than offset by the increased tax revenues. (30)
On the other hand, two sectoral networks--wine and pharmaceuticals--were successful without government intervention. These experiences demonstrate the importance of promoting the networking concept as much as providing a monetary incentive. However, both sectors are dominated by large and some medium-sized firms. To insure the efficient use of government funds, it is important to differentiate between those sectors where networks will take place organically, from those that need a stimulus.
There is no available information on how many PROFOs "graduate" from Government subsidies to independent, self-financing status as a network. While there is anecdotal evidence of success, there is no systematic collection of information on PROFOs related to improved profitability, new markets, new product designs, and other concrete impacts for participating firms. A new evaluation, using the survey methodology developed by the University of Chile and expanded to include sectoral and regional subsets, would be an important step toward identifying the "graduation potential" of PROFOs and the limitations of the networking methodology. This would enable the Government to improve its targeting and medium term support.
The effects of regional network promotion programs on firm growth and productivity are less clear. To deepen the local ownership of private sector development products, the Government pushed for the creation of local resource allocation committees (Comites Regionales de Asignacion de Fondos, CARs). The CARs articulate the various private sector development initiatives with regional development strategies and local priorities. The Government also created the Integrated Territorial Program (Programa Territorial Integrado, PTI) to support regional development coordination with local governments and other development institutions and take full advantage of synergies between the initiatives. No in-depth evaluation of the PTI has been carried out yet, so it is still unclear whether such synergies have been produced through this coordination mechanism. An impact evaluation of this program would be advisable.
MANAGEMENT AND WORKER TRAINING
Chile is also a leader in vocational training. Its vocational training model is an exception to the dominant Latin American model, which favors public sector-based training programs. Chile favors private sector solutions to skills improvement through training. As a result, since 1976, the Government's National Training Institute (Instituto Nacional de Capacitacion, INACAP) has competed for training investments from private sector firms on a level playing field. It competes with more than 2,000 universities, schools, centers, and consulting firms. (31)
Chile uses payroll levies to provide an incentive for training. These levies can be used in a variety of ways to achieve different objectives. In some countries, the levies can subsidize smaller firms and training services providers. In other countries, they co-finance training investments with a variety of providers. Best practices promote: (i) keeping employers in charge, and keeping the system voluntary; (ii) increasing competition to foster a wide range of providers; (iii) earmarking funds strictly, using levies rather than government grants; and (iv) ensuring that smaller firms are eligible for and informed about available services.
However, most entrepreneurs identified the availability, quality and costs of human resources as one of the least important obstacles to growth--event though the lack of human capital at the managerial level is a major cause of SME failure. In response, management training has become a central part of the Government's SME development policy. For example, the Management Centers Program (CEGES), begun in 1995, supports small and medium producers to improve their business management skills. Professional multidisciplinary business teams deliver specialized courses and technical services to center members. Other programs include: (i) the Fondo de Asistencia Tecnica (FAT), (ii) the Programa de Asistencia a la Gestion, (iii) the Proyecto Asociativo de Fomento (PROFOs, discussed above), (iv) the Proyectos de Desarrollo de Proveedores (Supply Network development, PDP), and (v) Programa Territorial Integrado (PTI, described above). To reduce the level of uncertainty, costs and processing times, the Government seeks to standardize and streamline the application processes for these programs and attract additional participant firms. (32)
In addition to these programs, the National Training and Employment Service (Servicio Nacional de Capaciatcion y Empleo, SENCE) provides tax incentives for training. Between 1988 and 2002, the number of enterprises that used this service grew from just over 17,000 to over 110,000. SENCE identified 116,000 businesses that used tax incentives for human resources training in 2002--an increase of 42 percent over the previous year's total of 81,790 firms. This massive expansion of coverage resulted from the inclusion of formally registered micro businesses, mainly through training loans provided by banks. However, while the SENCE tax incentive can be used to lower the firm's tax burden, it does not necessarily add to the skills of workers and managers--there appears to be no requirement to show that the person trained is employed by the firm.
Chile's in-firm training culture is also strong. The country's high educational level adds to this tendency--and the large number of government support programs, many targeting micro and small businesses, reinforce this culture. However, the effectiveness and acceptance of support can be limited by the ways in which the programs are promoted. In Chile, the outreach of available programs is weak. As a result, according to one study, few firms could actually identify at least one support program. (33)
ACCESS TO CREDIT AND OTHER FINANCIAL SERVICES
The Chilean financial system is among the most developed in the region. The financial sector reforms of the 1970s lead to a significant increase in the rate of coverage by commercial banks. Many micro, small and medium businesses hold at least one kind of debt. In the process, microbusinesses have proven to be bankable clients and are more than a "boutique" market niche. However, Table 3.1 demonstrates that medium and large firms still enjoy greater access to finance than micro and small firms. Moreover, the absence of significant venture capital facilities and "angel capital" (both of which are discussed below) is evidence of the lack of innovation in financial markets. (34)
In addition, smaller firms pay a higher interest rate for short-term bank credit than do large firms. Lenders justify this higher cost as a risk premium for high administrative costs and a low life expectancy. For example, the lack of audited financial statements increases a bank's costs and risks of lending. A bank may also need to limit access to longer-term credit because of the lack of physical guarantees with verifiable value and clear title. The credit review process, therefore, may restrict credit to short-term maturities, which use consumer credit models to assess small firms. (35)
THE GOVERNMENT AND ACCESS TO CREDIT: FOGAPE
On a continuum of government participation in the economy, the Chilean Government is among the most active. While some countries offer an equally complete menu of programs, Chile's financial programs for SMEs are more operationally oriented, and less oriented toward structural changes to improve productivity. The Chilean portfolio of programs also lacks a philosophical underpinning and internal consistency, compared to approaches in Australia, Ireland, and Scotland (Table 3.2).
Among Chile's business support programs, the Guarantee Fund for Small Entrepreneurs (Fondo de Garantia para Pequenos Empresarios, FOGAPE) facilitates access to credit for smaller firms, especially new firms or those with insufficient or no guarantees; it also promote long-term credit. BancoEstado, a commercially oriented government retail bank--and a pioneer in commercial micro business and SME lending--manages this fund. FOGAPE's value added is in extending the frontier of lending to SMEs. More than 80 percent of FOGAPE loans have maturities of less than three years. These credits can be renewed up to a maximum of 10 years. In 2000, the average loan guaranteed was only 320 UF (about US$7500). That year, legal and regulatory adjustments expanded the program and provided for annual guarantees of US$220 million, covering credits up to US$300 million. This was in line with the needs of small entrepreneurs, since most funds are for working capital. (36)
FOGAPE offers a streamlined bidding process and general selection criteria for clients. This avoids a more traditional system of overlapping, time-consuming individual client evaluations by the financial institution and the guarantee facility, and results in lower transaction costs. FOGAPE also offers a modest incentive for longer-term loans. Banks use this facility to hedge their SME operations at low cost. Since there is no minimum loan amount, banks with specialized SME platforms are more likely to turn to this program for loan coverage. The ultimate measure of FOGAPE's success will be an increased SME portfolio among commercial banks.
In 2003, sixteen financial institutions were providing loans through the FOGAPE program. The Government could encourage private banks to develop similar specialized lending platforms for formal micro businesses and SMEs. These platforms would include cost-sensitive client assessment and delivery mechanisms, but would be supported in the early stages by the FOGAPE guarantee. The development of this SME demand-driven product would require a significant amount of technical assistance in the market analysis and product development and testing stages. (38)
The Government can also support lengthening the maturity of commercial bank loans to SMEs by purchasing subordinated bonds with a quasi-equity character. The quasi-equity feature would be attractive to commercial banks, allowing them to maximize the leveraging aspects of this arrangement. These bonds could be issued by the participating banks at a premium linked to the channeling of funds to longer-term projects presented by SMEs. (39)
In addition, the various government support programs can recognize and support the synergies created by linking guarantees or other financial programs and networks (PROFOs). Banks evaluate favorably those businesses that participate in a PROFO. In the eyes of a commercial bank, participation in such programs clearly represents a reduction in risk. Government support of these links would encourage SMEs and the financial institutions to focus on investments that contribute to increased productivity. It would also encourage the development of new products and the adoption of innovative processes and technologies.
THE ELUSIVE VENTURE CAPITAL MARKET
As a share of the economically active population, the number of Chilean entrepreneurs compares favorably to the number in Japan, France or Spain; this should make the country fertile ground for a venture capital market. However, the results have been disappointing. According to one study, 25 percent of Chilean universities have programs or courses dedicated to entrepreneurship--but the venture capital market remains moribound. The lack of dynamism in venture capital may be explained by business projects not adequately presented to investors or that their profitability is below what venture capitalists would expect, given the combination of country, sector and other risks. It may also be a result of a lack of venues for investors and businesses to meet, or a lack of bankable technologyintensive projects offering high rates of return. (40)
The legal framework that created the investment market (Fondos de Inversion, 18,815), begun in the late 1980s, proved to be inadequate to jumpstart this new financial sector industry. In 1997, the Government launched a credit line to stimulate the creation of Business Development Investment Funds (Fondos de Inversion en Desarrollo de Empresas, FIDES) to focus investment on emerging technology firms. This program offered a 1-to-1 match to the capital raised by a fund administrator. In addition, following the example of the Yozma Fund in Israel, the program attempted to attract foreign investors to establish funds in partnership with domestic investors. However, the regulatory framework's excessive restrictions limited the success of this initiative. The chief problem was the difficulty assessing the value to a firm's intangible assets. This limited investments in firms whose underlying value was primarily linked to innovative ideas.
In late 2000, adjustments to the legal framework sought to encourage private sector participation in venture capital markets. The changes provided much greater freedom to private investment funds. These funds can now rely on their own bylaws to set the rules of the game. (41) At the same time, the Emerging Industries Stock Exchange (Bolsa Emergente) was formed. Registration in this stock exchange is streamlined and provides more protection to minority investors (Ley de OPAS, 2000). The Second Capital Market Reform (Reforma de Capitales 2) now permits all bond and other instruments issued by qualified risk capital funds for up to twice their original equity. These funds can also issue stock options under the new framework. In addition, it exempts stock transactions carried out by these firms from capital gains tax (up to 10,000 UF, about US$270,000, in cases when more than one third of equity is involved) for up to three years. This benefit is transmitted to the holders of "cuotas" (similar to shares) from the Funds. It also allows pension fund managers to invest in these funds. However, this proposed reform fails to include "angel capitalists" as potential beneficiaries.
Given the shortage of private venture capital, the Government launched the Seed Capital program to support business start-ups and those in early stages of development. It is a non-reimbursable subsidy whose objective is to offset the lack of private venture capital. It provides financing for activities such as market research, publicity, legal registration, business plan preparation, management technical assistance and even prototype design and testing. Proposed projects are presented by sponsoring agents who act as a "filter" and receive a payment for assisting the applicant business.
In addition to the Seed Capital program, the Government sponsors national networks of business incubators. These incubators are designed to address the lack of specialized business managers who can turn innovative projects into successful businesses, and to help those with potentially profitable ideas move to the business start-up stage. Academic and technoloy institutes are invited to link their services and knowledge to these incubators. These programs address the concern that the evaluation of proposed projects is too complex, and that there is no critical mass of attractive innovative projects--and no critical mass in the markets.
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|Title Annotation:||Chile: A Strategy to Promote Innovative Small and Medium Enterprises|
|Publication:||Chile: A Strategy To Promote Innovative Small and Medium Enterprises|
|Date:||Feb 1, 2008|
|Previous Article:||2. Understanding micro, small and medium enterprises.|
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