The importance of small and medium enterprises.

Transition in Central and Eastern Europe ended constraints to economic freedom and was widely expected to create large numbers of competitive small- and medium-sized enterprises (SMEs). According to a study--small and Medium Enterprises in Transitional Economies--sponsored by the United Nations University's World Institute for Development Economics Research (WIDER), barely anything like this happened. If proper institutions and structures and economic growth are not in place, even if the number of SMEs increases and booms, their economic strength and role remain weak.

In some cases, SMEs are too few compared to the number existing in comparable market economies. However, the problem has been labelled as "too many, too small", particularly in Central Europe. Indeed, the large majority of SMEs are survival entities of very small size, investing neither in modernization nor growth, with unusual concentration in small-scale trade. Numbers should be taken with care though, since there may be different and varying statistical definitions of SMEs and official numbers have been overestimated. Since registration was free and without control, many firms registered only to obtain fiscal and credit benefits or take advantage of privatization and were not removed from registers when they ceased to operate. When this changed, such as in Hungary in 1996, the number of registered firms abruptly fell.

A modern and thriving SME sector supports the transformation of the economy by creating jobs and helping the innovation and adaptation of the economic system. Particularly in Central Europe, there is a growing segment of SMEs investing in growth and modernization as suppliers mostly to transnational companies, or sometimes as final producers and exporters. This development is supported by the accession and integration to the European Union. There is also some evidence that competitive firms cluster together and pull economic revival and growth, but generate territorial and industrial dualism.

However, most SMEs meet grave obstacles due to: the nature of transition, including the lack of relevant institutions and infrastructure and the experience and expertise necessary to successfully operate in a competitive market economy; poverty and low income that depresses demand for SMEs and prevents the formation of investment capital; and policy mistakes, including the inconsistency and instability of policies and their SME-averse character. With disruption of government and the spread of criminality, these factors caused uncertainty and insecurity for SMEs and gave an indirect boost to tax evasion and regulation avoidance as adaptation mechanisms.

Obstacles to SME activity change during the life cycle. Credit is an issue in point. While the lack of it might not be a major obstacle to SME foundation since alternative financial sources are available, it prevents the firm's growth and modernization.

Insufficiency and distortion of spontaneous processes open the question of what policies are necessary Supporting job creation in traditional SMEs would help absorb employees who are expelled through company restructuring. Other policies help the transformation of the SME sector and include fostering: modernization and competitiveness of individual SMEs, e.g. by stimulating and easing investment activity; SME vertical integration with domestic and foreign companies; and horizontal integration among SMEs.

Neutral policies influencing the general context are preferable if spontaneous processes only need a favourable context to unfold their positive outcome These include growth policies, macroeconomic stabilization, and policies fostering the development of financial markets and the flexibility of labour markets. If these are insufficient, then specific policies are necessary. For instance, during transition, SMEs are hardly bankable because large banks must afford much higher transaction costs than when dealing with large firms. Market processes may fail to solve this because of informational problems that might prevent venture capitalists from entering the market. Thus a parallel informal capital market takes place to finance the establishment of SMEs, but not their development; policies could then support the development of small, locally-based banks specializing in lending to SMEs. In all of these, local governments would likely play a dominant role, since SME conditions and needs vary from place to place and central policies are often too general and rigid.

Special organizations and structures implementing specific policies would have the advantage of specialization and specific knowledge, information gathering and elaboration. However, this would increase transaction costs, further segment the economy and create special interests that would make policies biased and more rigid. Particular cases apart, it appears preferable to trust existing (general) organizations and structures with working out and implementing SME specific policies. Although specialization could be weaker under these circumstances, chances are that better policy coordination, lower costs and weaker special interests would overcompensate that disadvantage.

Bruno Dallago is professor of political economy and comparative economic systems at the University of Trento (Italy) and directs the Masters in Local Development for the Balkans, at the University of Trento and the University of Bolzan. He co-edited with Robert J. McIntyre the above-mentioned study on SMEs.