Entrepreneurship and SMEs in Southeast Asia 9789812302519, 9812302514

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available at < http://bookshop.iseas.edu.sg >

The Institute of Southeast Asian Studies (ISEAS) was established as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the many-faceted problems of stability and security, economic development, and political and social change. The Institute’s research programmes are the Regional Economic Studies (RES, including ASEAN and APEC), Regional Strategic and Political Studies (RSPS), and Regional Social and Cultural Studies (RSCS). ISEAS Publications, an established academic press, has issued more than 1,000 books and journals. It is the largest scholarly publisher of research about Southeast Asia from within the region. ISEAS Publications works with many other academic and trade publishers and distributors to disseminate important research and analyses from and about Southeast Asia to the rest of the world. ii

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Entrepreneurship and SMEs in Southeast Asia’s Economic Development Edited by

Denis Hew and Loi Wee Nee

INSTITUTE OF SOUTHEAST ASIAN STUDIES, Singapore iii

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First published in Singapore in 2004 by Institute of Southeast Asian Studies 30 Heng Mui Keng Terrace Pasir Panjang Singapore 119614 E-mail: [email protected] World Wide Web: http://bookshop.iseas.edu.sg All rights reserved. No part of this publication may be reproduced, translated, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies. © 2004 Institute of Southeast Asian Studies, Singapore The responsibility for facts and opinions in this publication rests exclusively with the editor and contributors and their interpretations do not necessarily reflect the views or the policy of the Institute or its supports. ISEAS Library Cataloguing-in-Publication Data Entrepreneurship and SMEs in Southeast Asia / edited by Denis Hew and Loi Wee Nee. Papers presented at the ASEAN Roundtable 2002, Singapore, 7–8 November 2002, organized by the Institute of Southeast Asian Studies, Singapore and supported by Konrad Adenauer Stiftung. 1. Small business—Asia, Southeastern—Congresses. 2. Business enterprises—Asia, Southeastern—Congresses. 3. Entrepreneurship—Asia, Southeastern—Congresses. I. Hew, Denis. II. Loi, Wee Nee. III. ASEAN Roundtable (2002 : Singapore) IV. Institute of Southeast Asian Studies. V. Konrad Adenauer Stiftung. VI. Title: Entrepreneurship and small-medium enterprises in Southeast Asia HC441 A843 2002 2004 ISBN 981-230-251-4 Typeset by Superskill Graphics Pte. Ltd. Printed in Singapore by Seng Lee Press Pte Ltd Credit: The photo on the cover is by Sinartus Sosrodjojo/JiwaFoto. The Sosro factory in Slawi, Java, is a 100% Indonesian business which started small a few decades ago and has grown since. The company uses locally grown tea-leaves to produce varieties of bottled tea and tea-related beverages for sale all over Indonesia. iv

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Contents List of Tables List of Figures Acknowledgements Contributors Foreword by Tharman Shanmugaratnam

vii xi xii xiii xv

1

Introduction: Entrepreneurship and SMEs in Southeast Asia’s Economic Development Denis Hew

1

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Entrepreneurial Development: The Necessary Conditions Tan Wee Liang

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3

SMEs in Southeast Asia since the Asian Financial Crisis Henry Sandee and Jan ter Wengel

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4

Financing SMEs in Southeast Asia During the Crisis Period: The Cases of Thailand and Malaysia Shujiro Urata

44

5

An Overview of Donors’ Role in SME Development in Southeast Asia after the Crisis Edgard R. Rodriguez

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6

Strengthening SMEs in Southeast Asia’s Agricultural Sector Anne Booth

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Contents

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7

The Development of SME Clusters in Indonesia Hendrawan Supratikno

119

8

Entrepreneurship in Malaysia’s Electronics Industry: The Role of SMEs Vijayakumari Kanapathy

131

9

Government’s Role in Developing Entrepreneurship and SMEs in the Philippines Brenda Mendoza and Gilberto Llanto

150

10

SME Policies and SME Linkage Development in Singapore Denis Hew

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11

SME Development in Thailand’s Automotive Industry Somkiat Tangkitvanich

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Developing Entrepreneurship and SMEs in Southeast Asia’s Transitional Economies Nick J. Freeman

221

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List of Tables 2.1 2.2

Institutional Facilities of an Entrepreneurial Infrastructure: A General Framework Summary of Definitions of an Entrepreneur

12 14

3.1 3.2 3.3 3.4

The Increase in Exports with Respect to GDP The Ratio of FDI to GDP The Reshuffling in the Industrial Sector Exports by Firm Dynamics, Indonesia, 1996–2000 (Billion of Constant 2000 Rupiah)

26 27 33 35

4.1

Demand for Financing by SMEs in Thailand and Malaysia Demand for Financing and Sales Orientation of SMEs in Thailand and Malaysia: 1999 Purposes of Financing by SMEs in Thailand and Malaysia Sources of Financing for SMEs in Thailand and Malaysia Financing Needs and Complaints against Financial Institutions in Thailand and Malaysia Total Loans Outstanding by Types of Financial Institutions in Thailand Loans Outstanding to SMEs by Types of Financial Institutions in Malaysia Credit Lines for SMEs by Public Financial Institutions in Thailand

47

4.2 4.3 4.4 4.5 4.6 4.7 4.8

47 49 50 53 56 57 61

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List of Tables

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4.9

Credit Lines for SMEs by Public Financial Institutions in Malaysia

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5.1

Importance of Manufacturing SMEs in East Asia (as % of Total Industrial Labour Force, Excluding Firms with Fewer than Ten Workers) Pre- and Post-investment BDS: Linking SME Finance and Managerial Capacity

68

5.2

6.1 6.2

6.3 6.4 6.5

6.6

6.7

6.8 6.9 6.10

6.11

6.12

Annual Average Growth of Per Capita Agricultural Output, 1963–1999 Ratio of Agricultural Output per Agricultural Worker to Average Output per Worker in South East Asian Economies Percentage Breakdown of Farm Holdings, Farm Area and Labour Force by Holding Size, Thailand 1993 Percentage of Total Farm Income from Farm Operation, Thailand Index of Growth of Farm Household Incomes and Personal Consumption Component of GDP in Thailand (1995/6 = 100) Percentage of Economically Active Farm Household Members over 13 Wholly Engaged in Agriculture by Holding Size, Thailand 1993 Percentage of Agricultural Holdings Where Agriculture is the Sole Household Income Source by Holding Size, Thailand 1993 Breakdown of Agricultural Households by Size of Holding and Main Income Source: Indonesia Sources of Non-agricultural Income for Agricultural Households, Indonesia 1993 Percentage Breakdown of Agricultural Household Income by Agricultural Income Source and Income Size, Indonesia 1993 Percentage Breakdown of Agricultural Household Income by Non-agricultural Income Source and Income Size, Indonesia 1993 Percentage Breakdown of Rural Households in Vietnam, 1997 by Source of Household Income

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74

93 95

96 97 97

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100 103 104

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List of Tables

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6.13

Linkage Ratios and the Percentage of Total Farm Income Accruing from Off-farm Employment

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7.1

Rural Clusters by Sub-sector: Weight, Clusters Size, Investments and Yearly Gross Output (1989) Linkages of Cottage and Small Enterprises with Larger Firms Leading Firms in Some Active and Dynamic Clusters

121

Performance of the Electronics Industry Structure of Manufacturing Exports Backward and Forward Linkage Effects in the Electronics Industry Local Sourcing in the Electronics Industry in the Penang FIZs/LMWs, 2001 Local Procurement by Industry Type in the Penang FIZs/LMWs, 2001 Sales of Manufactured Products by Industry Type in the Penang FIZs/LMWs Participation of SMEs in the Electronics Industry Performance of SMEs in Electronics Industry

133 134 136

7.2 7.3 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8

123 125

137 138 139 140 141

9.1 9.2 A9.1

Number of Manufacturing Establishments Profile of Philippine SMEs (as of 1994) Proposed and On-going Programmes and Projects for SME Development

152 152 165

10.1 10.2

Main Industries in Singapore Contribution of Domestic SMEs to Singapore’s Economy in 1999 LEFS Loans Approved and Number of SMEs Reached, 1996–2001 LETAS Loans Approved and Number of SMEs Reached Enterprise-level Strategies and SME Development Programmes Sector-level Strategies and SME Development Programmes Broad-based Strategies and SME Development Programmes

177 179

10.3 10.4 A10.1 A10.2 A10.3

189 190 203 204 204 ix

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List of Tables

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11.1 11.2 11.3 11.4 11.5 11.6

Thailand as a Leader in Automobile Production Exports of Vehicles and Parts Profiles of Direct Suppliers, Classified by Product Categories Capacity Utilization in Auto Industries Quality Systems of Parts Suppliers in Thailand Capabilities of Direct and Indirect Suppliers to Meet International Standards

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207 209 210 212 215 216

List of Figures 3.1 A3.1 A3.2

The Increased Share of Exports by China Exports and Imports from the Various Countries Export Growth and Sectoral Export Regression Analysis

29 40 43

10.1

Value Added per Worker of Domestic SMEs and Large Enterprises, 1994–2000

180

11.1

Production Capacity of Automobile Industry in Thailand

211

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Acknowledgements The editors would like to thank all the individuals who contributed to the realization of this volume. Our thanks to the paper-writers for their valuable contributions. Their papers were first presented at the ASEAN Roundtable 2002 on 7–8 November 2002, held at the Institute of Southeast Asian Studies (ISEAS) in Singapore. To Professor Chia Siow Yue, former Director of ISEAS, for her guidance in conceptualizing this project, our sincere thanks. We are grateful to the administrative staff of ISEAS, especially Karthi Nair, who worked tirelessly to ensure that the Roundtable ran smoothly. Our thanks also to Chen Yen Yu for her editorial assistance and to the ISEAS Publications Unit for their valuable input in getting this volume published. Finally, this project would not have been possible without the generous contribution of the Konrad Adenauer Stiftung. We would like to express our appreciation for their continued support in the many ASEAN Roundtables that ISEAS has organized over the years.

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Contributors Anne Booth is Professor, Department of Economics, School of Oriental and African Studies, University of London. Nick Freeman is Associate Senior Fellow, Institute of Southeast Asian Studies, Singapore and Senior Advisor, Mekong Capital Ltd, Vietnam. Denis Hew is Fellow, Institute of Southeast Asian Studies, Singapore. Vijayakumari Kanapathy is Senior Analyst, Institute of Strategic and International Studies (ISIS) Malaysia, Kuala Lumpur. Gilberto Llanto is Under-Secretary, National Economic and Development Authority (NEDA), Pasig City. Brenda R. Mendoza is Director for Trade, Industry and Services, National Economic and Development Authority (NEDA), Pasig City. Edgard R. Rodriguez is Economist (SME), Asian Development Bank, Manila. Henry Sandee is Senior Research Fellow, Economic and Social Institute, Vrije Universiteit Amsterdam, Amsterdam. Hendrawan Supratikno is Professor, Satya Wacana Christian University, Salatiga. Tan Wee Liang is Associate Professor, Singapore Management University, Singapore. xiii

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Contributors

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Somkiat Tangkitvanich is Research Director (Information Economy), Thailand Development Research Institute, Bangkok. Shujiro Urata is Professor of Economics, School of Social Sciences, Waseda University, Tokyo. Jan ter Wengel is Senior Economist, Economic and Social Institute, Vrije Universiteit Amsterdam, Amsterdam.

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Foreword SMEs: A New Role in Economic Growth Strategies Tharman Shanmugaratnam Senior Minister of State for Trade & Industry and Education, Singapore

It gives me great pleasure to be here this morning at the ISEAS’ ASEAN Roundtable 2002. The topic of this year’s Roundtable, Entrepreneurship and SMEs in Southeast Asia’s Economic Development, is timely. Across the region, countries are looking afresh at their economic strategies, to achieve more resilient growth in a less certain environment. There is a fresh focus on the role of SMEs in this regard. Having been generally neglected in past growth strategies, SMEs and entrepreneurship are now viewed as integral to future growth. Past Growth Strategies — Fostering Large Players There are a number of reasons for the predominant role of large firms in economic growth strategies in Southeast Asia, and indeed much of East Asia, in the last forty years. First, economic development in the region has centred on export-oriented growth, encouraging firms to look outward and compete with global players. Second, the initial base of entrepreneurship in most countries in the region was not wide. There was especially a shortage of industrial expertise. The region had no more than a rudimentary industrial economy until the 1960s and early 1970s. Countries had to quickly attract or nurture firms capable of competing in world markets and generating jobs. This was quite in contrast to the natural evolution of industrial capabilities in most of the advanced economies, which had taken many decades and in less xv

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competitive global markets. Jumpstarting the industrial economy in the region inevitably meant a dose of dirigiste policies, which focused incentives, funding or other resources on the most capable players. The Southeast Asian economies relied heavily on attracting multinational corporations (MNCs) to build up an export manufacturing capability. The MNCs, first American and European and later Japanese, brought with them capital, technology, know-how in factory and supply chain management, and markets. They allowed new Southeast Asian manufacturing centres to leapfrog established producers, and accelerated the move up the ladder of skills, productivity and wages. Quite apart from expertise, economies of scale and long gestation periods were initially an important deterrent to entry of new entrepreneurs in some industries — especially in capital-intensive industries like steel, shipbuilding or petroleum. In several countries, governments have sought to develop such industries for strategic reasons, either by giving preferential treatment to large local players or setting up state-owned enterprises. But these experiments have met with varying degrees of success. In general, success has been limited in cases where enterprises have been shielded for some time from foreign competition. There is no doubt a sense in which political economy has also played a role in the favouring of selected entrepreneurs, in a number of countries. This is particularly evident where firms have been protected from competition, or given preferential regulatory treatment, in domestic markets where there is no lack of potential new entrants. This has not been an unmitigated disaster, in economic terms. Large companies led by capable entrepreneurs have in many instances contributed to the development of industrial prowess. However, the granting of domestic subsidies, preferential tariffs or monopoly privileges to selected players has led to an increasingly inefficient allocation of resources over time, and a self-reinforcing pattern of corruption that has had a progressively corrosive effect on both economy and society. The Asian financial crisis revealed many of these weaknesses. Relationshipbased capitalism, as scholars politely describe it, has outlived its usefulness. It has to give way to market-oriented economic policies which aim at providing a level playing field for enterprises, and at allowing resources to be allocated to the most competitive players. The focus on large enterprises has not been unique to Southeast Asia. In Japan and Korea, which relied much less on foreign MNCs, local conglomerates — the keiretsu which followed on the pre-war zaibatsu in Japan, and the chaebols in Korea — played a decisive role in their industrialization, typically in markets protected for some period from imports. Taiwan and Hong Kong xvi

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have been the main exceptions, largely on account of the broader base of entrepreneurs they inherited. SMEs were the driving force behind Hong Kong’s exports in the years when it had a manufacturing economy. In the case of Taiwan, a vibrant entrepreneurial culture has also allowed the SME sector to successfully compete with large enterprises despite government industrial policies that often favoured larger players. With the exception of Hong Kong and Taiwan, SMEs have been incidental in the growth of the East Asian economies. Even where they account for a sizeable share of output and employment, they have been mostly in the domestic and informal sectors, and caught in a low-cost, low-productivity activities. The gap in efficiency between SMEs and non-SMEs in the region tends to be wider than in countries like the U.S., Taiwan, Germany and several of the smaller northern European economies, where SMEs are often internationally competitive and the most dynamic sources of growth. For example, small enterprises in the U.S. account for more than half the innovations, and approximately three-quarters of fresh job creation. Future Growth Strategies: Fostering the Development of SMEs We have entered a new and more challenging economic environment. It is vastly more competitive than in the last few decades — witness just China — more globalized, and more fast changing. It is also seeing the rapid emergence of the knowledge-based economy. East Asian countries are rethinking their economic strategies, to stay relevant and sustain growth and higher living standards in this new environment. Foreign MNCs should remain an important source of investments, technology and jobs for Southeast Asia. It is far too early to write-off the role of MNC-centred, export-oriented manufacturing. Similarly, many large local companies, operating without the shelter of monopoly privileges, will continue to play a key role in spearheading exports and economic growth. But increasingly, countries in Southeast Asia need to pay greater attention to the development of SMEs. First, a strong SME sector will help cluster strategies to work. MNCs are increasingly focusing on their core competencies, and outsourcing noncore work to other companies. An important consideration in their investment decisions is thus the availability of competent and high quality suppliers of components and other supporting parts and services, who are able to adapt quickly to new demands. A nimble base of local SMEs adds strength to such clusters. They can help to anchor MNCs in the region, and improve national competitiveness. xvii

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Second, in a rapidly changing economic environment, it will be much more difficult to spot winners and pick potential champions. There is also greater churn, and shorter company life spans, in the knowledge-based economy. While Southeast Asian economies will continue to specialize in sectors in which they have competitive advantage, it will not be possible to bet on which companies will succeed. The markets will produce the winners, oftentimes surprising winners. Having a broad and diverse pool of companies, will improve the chances of economic success, and provide greater resilience to national economies. A third reason for promoting SMEs has to do with the importance of domestic enterprise in general, in capturing value in the knowledge based economy. Many of you would be familiar with the “smile curve”, which illustrates that most value accrues to upstream activities like R&D or product development, and downstream activities like branding and marketing. Production, in the centre of the curve, is increasingly characterized by narrow margins. This is exacerbated in industries where there is an overcrowding of players in the production segment, as improvements in production machinery and processes have lowered entry barriers. On the other hand, ideas and intellectual property are commanding higher rents and a growing portion of the value pie. While MNCs play a critical part in moving economies up the value creation curve, we need a complementary strategy of growing domestic enterprises that can capture more of the value, by developing their own products and owning the associated intellectual property. Countries in Southeast Asia are recognizing the importance of developing the SME sector and putting more effort into it. For example, Thailand has embarked on a range of schemes to help small businesses and widen its base of entrepreneurs. Malaysia has in its recent Budget reaffirmed its focus on the development of SMEs, and has lowered the effective corporate tax rate for SMEs. In Singapore, across the board corporate tax cuts and the partial exemption from tax of the first $100,000 of a company’s income, will mean an effective tax rate for SMEs of 5.5 per cent to 10.5 per cent from Year of Assessment 2003. SMEs will benefit from the planned further cuts in corporate taxes (to 20 per cent within three years). A Case for Government Intervention Let me next address the question of why governments have to play an active role in SME development, or why this cannot be left to market forces.

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One reason for government intervention is that markets do not always provide a level playing field for small companies. Even companies with good business ideas and strong growth potential often face impediments at the growth stage, especially in obtaining financing. This is partly due to the intrinsically higher risks of funding new businesses, but may also reflect incomplete markets. Traditional financial intermediaries are often reluctant to engage in the higher costs of obtaining and assessing information on SMEs, and of monitoring their risks. In addition, early stage financing through private equity markets is at a nascent stage of development in Asia. Indeed, the private equity markets are a relatively recent phenomenon anywhere outside of the U.S. Without a well functioning capital market for small enterprises, there is a need for governments to catalyse market funding of SMEs, and to even share some of the risks. There are also important economic externalities in promoting entrepreneurship and facilitating the start-up and growth of small companies. A vibrant landscape of start-ups and up-starts produces an environment of constant experimentation and innovation. Government support for SMEs can thus lead to greater economic dynamism all around. Finally, governments need to ensure that incumbents do not abuse the power of incumbency, to stifle new entrants and potential challengers. Regulations aimed at ensuring a level playing field are essential to a healthy market economy. There are therefore good reasons for government assistance programmes to develop SMEs. Even the U.S., well known for its free markets, has a long history of government help for its SMEs. The Small Business Administration (SBA), established in 1953 to champion small businesses, provides them with financial, technical and management assistance. Last year alone, the SBA backed more than US$12.3 billion in loans to small businesses.1 In addition, Small Business Investment Companies (SBICs) licensed by the SBA also provide equity capital, long-term loans, debt-equity investments and management assistance to small businesses. Many big businesses which are now household names, such as FedEx, Intel, Nike, Apple, Ben & Jerry and AOL, just to name a few, received help from SBA as they grew. SINGAPORE’S STRATEGY FOR GROWING SMEs Let me share with you the Singapore Government’s approach and basic strategy for developing local SMEs.

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Providing a Pro-Business Environment There are two broad prongs to our strategy to help grow SMEs. The first, and more important, prong is to provide an overall business environment conducive to the growth of enterprise, big or small. When some of our trade officials visited Sweden about two years ago to learn from their experience in enterprise development, the Swedish Trade Council (STC) pointed out that a business environment that is good for big companies may not necessarily be favourable for small companies. However, the converse is always true, that is, a business environment that is conducive for small businesses will also be good for large companies. This comment held much relevance for Singapore. In our first few decades of development, the emphasis of economic policy was on providing incentives aimed at attracting and encouraging the growth of large, established players. Some incentivization of new activities remains important even as we go forward. But we are seeking to regear our policies, focusing on improving the business environment for small and large companies alike by cutting red tape, reducing income taxes, encouraging risk taking and fostering competition. We are seeking to remove regulatory impediments that stifle businesses, acting on feedback from the public. We are systematically reviewing and streamlining the number of licences and licensing requirements for setting up businesses. To encourage enterprise, we have lowered corporate and top-tier personal income tax rates to 22 per cent, with plans to further reduce them to 20 per cent within three years. We have also revised our bankruptcy laws as part of an effort to foster a culture more tolerant to risk-taking and failure.2 In addition, to safeguard competition and help forestall any abuse of dominance, we plan to enact a competition law within two to three years. Strengthening the Competitiveness of SMEs Besides working on a pro-business environment across the board, the government also seeks to boost the growth of the SME sector by helping SMEs themselves to build capabilities, so they can better compete. There are three guiding principles underlying government’s help to SMEs. They are: provide a leg-up and not a crutch; help them build capabilities, i.e., help on the supply side rather than the demand side; and leverage on market mechanisms rather than substitute for the market. I shall elaborate on each in turn. xx

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First, provide a leg-up and not a crutch. The government’s assistance programmes for SMEs are designed to help companies who take the initiative to upgrade themselves. We have to reward the competitive spirit, and discourage over-reliance on government support. Grants under the Local Enterprise Technical Assistance Scheme (LETAS), which helps the company acquire external advice to improve its operations in areas such as financial management, IT usage and quality control, are limited by a funding cap of 70 per cent. This co-funding approach ensures that the companies receiving assistance assume ownership and responsibility for their upgrading projects. Second, help on the supply side rather than the demand side. We believe that we should help SMEs by strengthening their capabilities — by improving their access to critical resources such as training, technology and finance. This is a better and more effective approach than giving SMEs preferential access to demand, e.g. in government procurement policies. SMEs that compete for contracts in the marketplace will ultimately be more resilient. Third, leverage on market mechanisms rather than substitute for the market. Our assistance schemes for SMEs are designed to rely and leverage on market players. For instance, in the Local Enterprise Finance Scheme (LEFS), credit assessment and judgements on loan worthiness are left to participating financial institutions, with the government stepping in to co-share default risks. Similarly, instead of using a public agency to provide training or advice on capability upgrading for SMEs, the government provides partial funding for companies to engage private sector training providers or consultants. Shifting the Focus in SME Assistance — Creating Synergies These guiding principles underlying government’s help to strengthen the competitiveness of SMEs remain relevant to the future. However, the focus of Government assistance for SMEs has evolved from one catering to individual companies to one centred on cluster development. When we started out, our SME developmental assistance was targeted mainly at individual companies, each looked at in its own right. Loans and grants were provided to small companies to improve their business operations and manpower capabilities. The scope of this firm-level assistance has broadened with time, from a focus on finance and technical skills to fostering the acquisition of softer capabilities such as financial management, quality assurance, and branding. While a firm-based approach has helped individual SMEs strengthen their internal capabilities, this approach by itself was sub-optimal. We were not creating the synergies, and exploiting positive externalities, that could be xxi

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derived from a more integrated approach involving other industry players. We thus began to embark on a cluster development approach, which aims to strengthen linkages between suppliers, complementary players and supporting firms within various industry sectors by fostering greater collaboration and co-operation. Government assistance programmes such as the Local Industry Upgrading Programme (LIUP) and Business Upgrading through Inter-linkages Development (BUILD) encourage MNCs and large local enterprises to share their expertise with their smaller supply chain partners. The larger companies also benefit from having more reliable and efficient suppliers and distributors, creating a win-win situation. The Industry Productivity Fund encourages players in an industry to work together to raise the productivity of the cluster. One successful example of this approach is the National Productivity and Quality Specifications (NPQS) project. Through the standardization of building design specifications and the creation of a web-based application to enhance information exchange, the construction industry is expected to save $370 million annually upon the project’s full adoption. CHALLENGES It will take some time for us to develop a more entrepreneurial culture, and build a vibrant SME sector. We have achieved some progress, but there are challenges that we need to overcome. I will highlight three of our current priorities: (1) improving the availability of finance; (2) taking SMEs international; and (3) providing a springboard for foreign SMEs. Availability of Finance Financing is arguably the number one problem faced by SMEs in any country. In Singapore, the problem is exacerbated by our small market, which makes it less viable for financial institutions to devote resources to building expertise on SME financing. We have to continue to plug the gaps in funding at the early and mezzanine stages of a company’s growth. The Start-Up Enterprise Development Scheme (SEEDS) was launched in October 2001 to help embryonic companies with innovative ideas to raise funds through matched equity financing by the government.3 In addition, we have to find ways to spur the availability of “angel” funds. We also need to explore mechanisms to strengthen the private equity market for early and mezzanine stage companies, especially in view of the shift seen over the last two years in the focus of VC funds to later stage, lower risk ventures. xxii

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SMEs at the expansion stage, where loan financing is more typically obtained, also face difficulties in getting funding. A key problem faced by SMEs is that banks traditionally lend on the basis of balance sheets rather than cash flows. Many expansion stage SMEs, who have a track record and have made gains in market share, still find it hard to meet the banks’ requirements for collateral. This problem is compounded in times of economic downturn because of falling asset values. Government assistance schemes such as LEFS, the Micro-Loan Programme and the latest Loan Insurance Scheme that we have introduced will make loans more accessible to SMEs. However, we need to see how we can encourage either existing or new financial players to develop other forms of debt financing. One option is cash flow financing, which will require banks to build up the expertise to make cashflow projections and monitor companies’ positions on an ongoing basis. We will also need to help our SMEs to improve their financial management and accounting transparency in order to make them more loan worthy. Taking SMEs International The next challenge we are focusing on is that of taking SMEs international. Globalization has opened up new opportunities for small companies. SMEs with good products and services can tap demand worldwide, expand their markets and grow quickly. This is especially pertinent for SMEs in Singapore. Given the limited size of our domestic market, our SMEs can only sustain their growth if they eventually go abroad. However, this is not an easy task. On their own, SMEs usually lack the networks and resources, and the skill-sets, to venture abroad. International Enterprise (IE) Singapore (previously the Trade Development Board) was reoriented in April this year to focus on helping local companies grow and internationalize. IE Singapore offers a range of services to help them shorten the internationalization learning curve, develop marketing and distribution channels, and make the right connections. It is building up its network of overseas centres and business support offices to provide market intelligence, advice, and on-the-ground facilitation. There is a lot of work ahead in this area. Providing a Springboard for Foreign SMEs Finally, the challenge of fostering cross-border SME alliances and collaboration in today’s globalized markets. We want to attract SMEs from all over the xxiii

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world set up business here, and use Singapore as a springboard into the region and beyond. The presence of foreign SMEs will encourage the cross-fertilization of ideas, expertise and best practices, and help our own local SMEs gain competitive strengths. Foreign SMEs can benefit from our strong economic ties with the region and the major markets, a growing pool of venture capital, and our advanced logistics and communication networks. China’s Ministry of Science and Technology has decided to base its first overseas high-tech enterprises innovation centre in Singapore, with further plans for a national-level trade promotion office here. This is a significant move, and offers great potential. It complements several other foreign enterprise incubators operating in Singapore, including a French, a German, a Korea and a Japan Centre. To make things convenient for foreign SMEs, IE Singapore has set up an International SME Business Centre (ISBC), which provides ready facilities at affordable prices and flexible terms for them to set up a presence in Singapore quickly. It also offers business matching services to help them form partnerships with local SMEs through the PartnerSingapore programme. CONCLUSION SMEs play an integral role in supporting the next stage of growth in Southeast Asian countries. This requires bold policy changes to foster a more conducive environment for all businesses, and competitive markets. It also requires innovative programmes to help SMEs develop capabilities and compete effectively on a level field. This will not be an easy process, and there are challenges and issues remain to be resolved. Governments cannot do it alone, but will need to work hand in hand with the markets. There will also be benefit in getting insights and analysis from the academic and research community. I am therefore glad that ISEAS has organized this roundtable to improve the understanding on entrepreneurship and SMEs in the region. I wish you a fruitful discussion and hope that the forum will provide further ideas in our efforts to build a more vibrant SME sector. NOTES 1

While the SBA has no funds for direct loans, grants or low interest rate loans for business start-up or expansion, it can guarantee as much as 85 per cent on loans of up to $150,000 and 75 per cent on loans of more than $150,000. In most cases, the maximum guarantee is $1 million.

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Since 1999, the minimum amount of debt that must be incurred before a winding up petition can be brought against a company has been raised from $2,000 to $10,000. For every dollar raised from an independent third party investor by the start-up, the government will invest a matching dollar, up to maximum of $300,000. Fifty companies have since benefited under this scheme with $28 million of funds raised.

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Introduction: Entrepreneurship and SMEs in Southeast Asia’s Economic Development Denis Hew

There has been considerable interest among policy-makers and academics in examining the role of entrepreneurship and small- and medium-sized enterprises (SMEs) in Southeast Asia’s economic development. Indeed, this area of research has become particularly important in the light of the Asian Financial Crisis of 1997–98 and the regional economic slowdown in 2001. Clearly, both events have been a wake-up call to Southeast Asia, which have forced policy-makers in the region to re-evaluate the economic strategies and policies that have served Southeast Asia well in the past. The “China factor” is the other reason why Southeast Asian policymakers are re-evaluating their economic policies. Over the past decade, the external environment has changed dramatically with the rise of China as an industrial powerhouse. Since the early 1990s, China has absorbed a sizeable chunk of East Asia’s foreign direct investments (FDI) and appears to be well on its way to becoming the world’s largest manufacturer in the coming decade. According to United Nations Conference on Trade and Development (UNCTAD), China is now the largest recipient of FDI in the developing

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world — the country received US$53 billion in FDI inflows in 2002 compared to ASEAN’s US$14 billion. China’s continental size economy, huge labour force, and its ability to manufacture products across the value chain will pose a serious competitive challenge to not just the Southeast Asian economies but also the more developed East Asian economies of Japan, Korea and Taiwan. The rapid and sustained economic growth experienced by Southeast Asia — especially the ASEAN-4 member countries: Indonesia, Malaysia, Singapore and Thailand — over the past three decades has been truly spectacular. Growth was accompanied with rise in income per capita, significant reductions in poverty and improvements in social indicators. For example, from 1975 to 2000, GDP per capita in Southeast Asia tripled while life expectancy rose from 54 years to 67 years (ADB 2001). Economic development in Southeast Asia was also largely driven by strategies that favoured FDI and from multinational corporations (MNCs) and export-orientated manufacturing industries. Differences in economic strategies in East Asia would seem to indicate that there is no single East Asian Development Model (EADM).1 Nonetheless, Freeman and Hew (2002) suggest that the reliance on foreign capital such as FDI and emphasis on export-led industrialization forms the basic element of Southeast Asia’s economic development model. Against this backdrop, it is observed that domestic enterprises in Southeast Asia are predominantly SMEs involved in traditional sectors such as agriculture or services.2 Most of these domestic SMEs have little or no linkages with MNCs. The statistical definition of SMEs can vary by country depending on the number of employees or value of assets. A common definition used is the number of employees. According to Hallberg (2001), the lower limit for small-scale enterprises is normally between 5 to 10 workers and the upper limit is between 50 to 100 workers. Meanwhile, the upper limit of mediumscale enterprises is between 100 to 250 employees. The development of domestic SMEs was observed to have fallen behind during this period of economic expansion and industrial development. Industrialization in Southeast Asia was focused on mass production for exports. Hence, SMEs were in general not agents of industrial development in the region (Abonyi 2003). This has resulted in an under-developed domestic SME sector with poor access to skills, technology and market access. By neglecting the domestic enterprises such as SMEs, it underutilizes domestic demand as a source of economic growth, which impedes countries from moving up the economic development ladder (Masuyama and Vandenbrink 2001).

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At the same time, one cannot examine SME development without also examining entrepreneurship as they are often associated with each other. What is entrepreneurship? There have been many contributions by scholars to the concept of entrepreneurship over the past two centuries. Richard Cantillon, an eighteenth century economist described entrepreneurs as risktakers and entrepreneurship as any form of self-employment. In the twentieth century, Schumpeter (1934) emphasized the role of entrepreneurs as innovators and linked entrepreneurship to five main combinations: i) ii) iii) iv) v)

introduction of a new product; introduction of a new production process; opening of a new market; conquest of new sources of supply; and the carrying out of a new organization of industry.

However, this concept of entrepreneurship may be difficult to apply to developing countries in Southeast Asia where much less innovation is undertaken. Instead, many Southeast Asian entrepreneurs, particularly in traditional sectors tend to imitate or adapt new products, production processes or techniques from developed countries. More recently, Ronstadt (1984) defined entrepreneurship as a dynamic process of creating incremental wealth, created by the entrepreneur who takes major risks in terms of equity, time, and/or career commitment or provide value for some product or service. The product or service may or may not be new or unique but value must somehow be infused by the entrepreneur by receiving and allocating the necessary skills. Whichever way one may wish to define entrepreneurship, there is no doubt that this entrepreneurial spirit has led many Southeast Asian entrepreneurs to start up their own enterprises, most of which tend to be SMEs. As policy-makers and academics re-examine existing economic strategies and policies, it would undoubtedly include the role of entrepreneurship and SMEs in rethinking Southeast Asia’s economic development. SMEs clearly play an important role in economic development, contributing to employment, production and national income as well as providing opportunities to alleviate poverty. In the light of the nature of economic downturn experienced by the region over the past few years, it seems propitious to examine the salience of entrepreneurship and SME development and their contribution to revitalizing the Southeast Asian economies. Could these be the new engines of growth? The ASEAN Roundtable 2002 — from which this book directly emanates — brought together academics and experts in the field as well as representatives

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from multilateral institutions to discuss pertinent issues on entrepreneurship and SMEs in Southeast Asia. The main objective of the Roundtable was to identify new policies (with regards to entrepreneurship and SMEs) that can contribute to Southeast Asia’s economic development in the years ahead. This Book This book covers regional and country-specific issues on entrepreneurship and SMEs in Southeast Asia. In Chapter 2, Tan Wee Liang notes that regardless of the nebulous nature of entrepreneurship (spanning enterprise development to entrepreneurial mindset), policy initiatives are clearly needed for entrepreneurship development. But policies can be best directed when the concept of entrepreneurship is clearly defined. Moreover, policy-makers must look beyond the entrepreneurship infrastructure and incentives for firms to address sociocultural factors and education. In Chapter 3, Henry Sandee and Jan ter Wengel note that since the Asian Financial Crisis, there are new export opportunities for SMEs in Southeast Asia. To increase exports, business alliances and linkages with international markets need to be established by SMEs. They find that governments can also play a facilitating role to promote SME exports. In Shujiro Urata’s case studies of Thailand and Malaysia in Chapter 4, he suggests that SMEs can improve their credit worthiness to financial institutions by enhancing their competitiveness. This can be done by improving technical and managerial skills through training and education. He also finds a serious lack of capability on the part of financial institutions in evaluating the credit worthiness of SMEs. Therefore, he recommends that financial institutions should increase their knowledge about SMEs by expanding their business contacts with SMEs as well as collecting useful corporate information about them. In Chapter 5, Edgard Rodriguez finds that multilateral and bilateral donor agencies have increasingly moved towards a more integrated approach for SME development based on institutional reforms, better services and financial tools under a less regulated environment where there is greater participation from the private sector. He argues that there is a need for better understanding by donor agencies of the business environment they work in and its influence on SMEs. These agencies also need to design appropriate tools and techniques for measuring the impact of donor-supported reforms as

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Introduction

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well as identify and promote best practices in donor-supported reforms. Such reforms will have an impact on the accessibility and availability of financial resources for SMEs. In Chapter 6, Anne Booth finds that national governments play an important role in supporting agricultural and rural development programmes in Southeast Asia. Since most of the poor in Southeast Asia are still mainly located in rural areas, and in marginal farms and landless households, she recommends that rural and agricultural development strategies should be directed to boosting employment opportunities and incomes for them. In Chapter 7, Hendrawan Supratikno finds that SME clusters are significant in Indonesia and may have a seedbed function in the country’s industrial development. He argues that the Indonesian Government should assist in creating a healthy and enabling environment for SME clusters to grow. The government should also reinforce and build on established and emerging SME clusters, rather than attempt to create entirely new ones. In Chapter 8, Vijayakumari Kanapathy notes that the Malaysian experience in the electronics industry has shown that it is necessary to have a critical mass of demand for products and services from larger companies before statesponsored programmes to develop SMEs can take off. In Chapter 9, Brenda Mendoza and Gilberto Llanto finds that in the Philippines, it is important to consider factors such as financial, human resource and organizational constraints that impact on the sustainability of policies, programmes, and projects to promote SMEs and micro-enterprises. In Chapter 10, Denis Hew argues that in Singapore, the time may be opportune to set up a dedicated agency for SMEs to expedite the implementation of the SME 21 strategic plan. Such an agency would not only assist SMEs in overcoming their constraints but also foster closer linkages with larger domestic enterprises, MNCs and government-linked corporations (GLCs). In Chapter 11, Somkiat Tangkitvanich recommends that the following initiatives would assist SMEs especially in Thailand’s automobile industry: i) develop design and test capabilities; ii) promote linkages between MNCs and local suppliers; and iii) improve the governance and incentive systems of the Thailand Automotive Institute.

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In Chapter 12, Nick J. Freeman finds that for the transitional economies of Southeast Asia (i.e. Cambodia, Laos, Myanmar and Vietnam), policy emphasis may be usefully expended in the following five areas: i) promoting greater venture capital activity; ii) taxation reform; iii) continued reform of the StateOwned Enterprises sector — potentially a large source of “new SMEs”; iv) building greater linkages with overseas companies; and v) developing business development services. NOTES 1. 2.

For example, FDI had a far greater role in the economic development of Southeast Asia than Northeast Asia. In fact, SMEs dominate the world’s private sector — both in developing and developed countries. SMEs comprise over 90 per cent of all enterprises in the world and 50–60 per cent of total employment (Abonyi 2003).

REFERENCES Abonyi, G. “Challenges of Industrial Restructuring in a Globalizing World: Implications for Small- and Medium-Scaled Enteprises (SMEs) in Asia”. ISEAS Working Paper, Visiting Researchers Series no. 3, 2003. Asian Development Bank. “Moving the Poverty Agenda Forward in Asia and the Pacific: The Long Term Strategic Framework of the Asian Development Bank (2001–2015)”. Asian Development Bank, March 2001. Freeman, N.J. and D. Hew. “Introductory Overview: Rethinking the East Asian Development Model”. ASEAN Economic Bulletin (Special Focus) 19, no. 1 (April 2002). Hallberg, K. “A Market-Orientated Strategy for Small and Medium-Scale Enterprises”. International Financial Corporation, Discussion Paper no. 4, The World Bank, 2001. Masuyama, S. and D. Vandenbrink. “Industrial Restructuring in East Asian Economies for the Twenty-first Century”. In Industrial Restructuring in East Asia: Towards the 21st Century edited by S. Masuyama, D. Vandenbrink and S.Y. Chia. Singapore: Institute of Southeast Asian Studies and Nomura Research Institute, 2001. Ronstadt, R.C. Entrepreneurship. Dover, MA: Lord Publishing Co, 1984. Schumpeter, J.A. The Theory of Economic Development. Cambridge: Harvard University, 1934. New York: Oxford University Press, 1961. Stiglitz, J.E. and S. Yusuf, eds. Rethinking the East Asian Miracle. New York: Oxford University Press Inc., 2001.

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2

Entrepreneurship Development: The Necessary Conditions Tan Wee Liang

1. Introduction There is little doubt that entrepreneurship is important for continued economic well-being in many economies. In Southeast Asia, dynamism is not merely represented in the size of the markets or access to labour but also in growing enterprises and entrepreneurship (Kao and Tan 2001, pp. 2–3). With most of the countries making a transition from control economies to market economies, new enterprises have become part and parcel of economic environments. Promoting their good health means cultivating entrepreneurship and facilitating enterprise development, both of which are fundamental to economic growth and the well-being of many individuals. Promoting and developing entrepreneurship requires an understanding of what entrepreneurship refers to. Similarly, commenting on entrepreneurship development in Southeast Asia requires a basis upon which comparison can be made. Most of the time, the term “entrepreneurship” is used with reference to businesses. Policy-makers, on the other hand, have employed various definitions. The definitions employed among policy-makers may also differ across departments or ministries. An education ministry might have a different opinion on entrepreneurship compared to a labour or trade and industry ministry. However, their definitions of entrepreneurship are usually confined to enterprises, and predominantly, to the small- and medium-sized enterprises

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(SMEs). The academic community has different definitions of entrepreneurship and has yet come to an agreement on one definition (Shane and Venkataraman 2000, pp. 217–26). They have recently extended “entrepreneurship” to include social enterprises under the concept of social entrepreneurship (Thompson, Alvy and Lees 2000; Tan and Tan 2002). Assuming there is a common understanding of what entrepreneurship is, there is also the question of whether entrepreneurship can be developed. This question often appears in the form, “Can entrepreneurship be taught?” or in a statement “Entrepreneurs are born, not made”. Of course, one could always draw a distinction between the content that can be taught which contributes to entrepreneurship development, and acknowledge that certain aspects of entrepreneurship may be outside the purview of these development activities. Apart from what entrepreneurship development encompasses, there is a need to consider the role that the environment plays on an individual. Do certain environmental conditions lead to a greater representation in enterprise start-ups and entrepreneurs? Hence, this chapter focuses on the development of entrepreneurship by first examining entrepreneurship development in Southeast Asian countries, as well as other definitions of entrepreneurship, and whether entrepreneurship can be developed and what can be done to develop it. 2. Differing Views on Entrepreneurship and its Development This section discusses what is deemed to be entrepreneurship development. It is necessary first to discuss some of the prevailing ideas associated with entrepreneurship development. At the same time, we highlight the roles of the parties interested in entrepreneurship as a phenomenon, and to some extent, their motivations. We return to these points when we discuss the definition of entrepreneurship. Apart from academicians, entrepreneurship development is also of interest to policy-makers, particularly, those responsible for economic development. Much has to be attributed to Schumpeter (1934) and his theory of economic development that places the entrepreneur at the centre of the disequilibrium that he causes, when he brings about new combinations which could take the form of new products, new production methods, new markets, and new forms of organization. In Southeast Asia, policy-makers appear to equate the development of small businesses or small and medium-sized enterprises to entrepreneurship development. In such instances, entrepreneurship development would often be associated with the development of enterprises or enterprising behaviour.

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2.1. Entrepreneurship Development as Small Business Development and/or SME Development In Southeast Asian countries, where entrepreneurship development has mostly been associated with SME development or small business development, one need only peruse the papers of most conferences or note the key elements of their APEC SME ministerial meetings to notice that there is an emphasis on associating SMEs development with entrepreneurship development. At these conferences, one would find that the word “entrepreneurship” might be bandied about. There would be references to “entrepreneurs” and “entrepreneurship” development. However, the organizations of interest are the SMEs. The Asian Productivity Organization (APO) based in Japan has an initiative that focuses on entrepreneurship. At a recent APO symposium, “Entrepreneurship in Knowledge-based Industry”, in Taipei in July 2002, much of the discussion was focused on SMEs even though the theme was on entrepreneurship. In policy circles, entrepreneurship development has been closely identified with small business development while micro-enterprise development and public policy efforts have been directed at business establishments that are smaller in size. There is, however, no generally accepted definition for “small business” (Kao and Tan 2001, pp. 2–3) as is the case for SME. The emphasis on SMEs or small business is often linked to the stage of economic development or the extent of unemployment in a country. Where there is unemployment, policy-makers have often emphasized entrepreneurship as a means of job creation. This policy motivation can be attributed to David Birch (1981) who demonstrated that small firms in the U.S. created jobs to replace those lost when larger businesses left town. Apart from the job creation motivation, the motivations for focusing on SMEs or small business development include economic development and the improvement of a country’s total factor productivity, as in the case of Singapore.

2.2. Entrepreneurship as Innovation Another view of entrepreneurship development to that above, is the identification of entrepreneurship with one of its associated characteristics: innovation. In this respect, the policy measures to develop entrepreneurship of this kind have some overlap with national policies for science and technology. The emphasis would be on the promotion of innovations, the provision of national innovation systems (Cooke and Wills 1999; Maillat 1998; Ernst, Ganiatsos and Mytelka 1998), and the establishment of technical information mechanisms for SMEs.

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2.3. Entrepreneurship Infrastructure There would be some who would not be overly concerned with the identification of entrepreneurs or entrepreneurship. Their concern would be to meet the perceived needs of small businesses and the SMEs. In general, the policy instruments addressing the needs of small businesses and SMEs are similar. The policy instruments can be grouped into an entrepreneurial infrastructure (Tan, Tan and Young 2000). While industrial infrastructure refers to the place-specific notion of facilities and services underpinning all of the industry and populations residing within a given location, (Porter 1990, pp. 76–80), entrepreneurial infrastructure refers to a sub-set of a more general industrial infrastructure concept. Hence, entrepreneurial infrastructure represents the facilities and services present within a given geographic area which encourage the birth of new ventures and the growth and development of small and medium-sized enterprises. Such facilities and services encompass formal support systems and networks for encouraging the creation of new businesses as well as the growth and development of existing SMEs. Entrepreneurial infrastructure provides support systems and networks to new business owners, owners of small growing businesses, and existing small- and medium-sized enterprises, in the form of (1) assistance with tasks which the business owner or small firm must accomplish, (2) resources — physical or monetary, (3) information, and (4) knowledge. 2.3.1. Assistance with Tasks Potential and existing owners of small, growing businesses are continually faced with a series of tasks which they must perform if they are to start, grow, and develop commercially. Such tasks include planning, directing, organizing various functional activities of an enterprise and other activities for which business owners may require external assistance. 2.3.2. Required Resources: Physical or Monetary Business owners and small firms require facilitative resources (Bruno and Tyebjee 1982) in the form of adequate physical accommodations and capital (e.g., incubators and industrial parks). 2.3.3. Required Information Owners of small businesses and small, growing businesses require information in order to carry out their work effectively (Cooper, Folta and Woo 1991;

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Woo, Folta and Cooper 1992). For instance, information is needed regarding the environment, economic, market, legal, technological, and other environmentally related data available from public facilities or private sector organizations such as consulting firms, chambers of commerce, trade associations, or not-for-profit mutual help groups. A lack of specific business and market-oriented information and knowledge is particularly problematic for smaller firms (Cromie 1991). 2.3.4. Required Knowledge Small businesses will be ultimately successful only if the business owner or firm has attained a level of knowledge that is adequate for accomplishing the tasks they face. Such knowledge can also be acquired through formal training in the concepts and skill areas that can be directly applied within the business venture (e.g., Barnes and Jones 1995; Ghosh and Block 1993). The infrastructural offerings by policy-makers for SMEs in the Southeast Asian countries can be classified under the four basic support elements shown in Table 2.1 (Tan, Tan and Young 2000). The table lists several examples of institutional facilities of an entrepreneurial infrastructure under each of the support elements. Each facility is capable of rendering several services, some of which could in fact overlap one or more of the other basic areas (McMullan and Long 1987). The entrepreneurial infrastructures in Southeast Asian countries provide some or all the forms of assistance listed in Table 2.1 to persons starting or developing SMEs. The provision and availability of the infrastructure depends on the country, the state of its economy, the industry structures, and the private and public institutions interested in assisting ventures, and policy considerations. The development of these infrastructures is consistent with the best practices in other countries. The notion of assisting the small business sector with a network of support organizations is well-established in many European countries (Klofsten and Mikaelsson 1996) as well as in the U.S. (Shapira, Roessner and Barke 1995). Facilities comprising entrepreneurial infrastructures can be either publicly or privately-owned (e.g., Abetti and Wheeler 1990).

2.4. Other Forms of Entrepreneurship Entrepreneurship is neither confined to business start-ups nor the development of enterprises in the form of vibrant SMEs. The definitions discussed so far have been adopted by policy-makers in the field of economic development.

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Support Networks University Programmes

Venture Capital Networks

Libraries

Government Agencies

Data Banks

Venture Capital Firms

Science Parks

Incubators University Programmes

Know-How Networks

Chambers of Commerce

Business Support Organizations

Associations

Knowledge

Sources: Tan, T.M., W.L. Tan and J.E. Young. “Entrepreneurial Infrastructure in Singapore: Developing a Model and Mapping Participation”. Journal of Entrepreneurship 9, no. 1 (2000): 1–33.

University Programmes

Small Business Development Centers

Chambers of Commerce

Community-Based Loan Funds Government Loan Funds

Business Support Organizations

Banks

Business Support Organizations

Professional Firms

Associations

Resources

Tasks Information

Support Elements

Table 2.1 Institutional Facilities of an Entrepreneurial Infrastructure: A General Framework

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There are other definitions that governments employ. At times, in the educational realm, one hears about entrepreneurship education, creativity and innovativeness, and business clubs. At other times, politicians have referred to entrepreneurship in the same vein as “the spirit of enterprise” or culture. One notable Asian leader referred to political entrepreneurs when he referred to the early generation of leaders who served with him in developing Singapore (Lee 1994). It has also been used to refer to entrepreneurship of the state through public enterprise (Lee and Low 1990). There are times when references are made to highlight an entrepreneurship culture that exists at the national level. Policy-makers have also been known to use the term to refer to an innovation culture. Despite these other definitions, the predominant approach to entrepreneurship development is a focus on the development of new start-ups or existing enterprises in the form of SMEs. While policy-makers have primarily focused on business enterprises, entrepreneurship encompasses more than business start-ups and SMEs. Where the policies address new business start-ups, they may come close to one variant of entrepreneurship as is understood in the field of entrepreneurship research: venture creation. At this juncture, we turn our attention to the entrepreneurship research literature to study the appropriate scope of entrepreneurship and its development. 3. The Need for a Definition of Entrepreneurship Academicians have not agreed upon a common definition for entrepreneurship. The field of entrepreneurship is a new discipline. It has drawn interest from researchers who originate from other diverse fields of economics management, finance, psychology, and sociology, explaining the phenomenon whereby entrepreneurship is examined from different perspectives. The economists would have a perspective different from the psychologists. Initial interest in the field focused on the individuals: the entrepreneurs. Much of the literature still delves into the individuals as it would be the individuals who take the initiative to start businesses or engage in entrepreneurial activities in organizations. Table 2.2 is a summary of the various definitions that have been employed over the years. It is a modification of definitions found in Kao (1995, p. 71), to which Kao’s definition has been added. However, the definitions are incomplete as they focus on the actors and not on entrepreneurship. Definitions on entrepreneurship are few. Low and MacMillan (1988) suggest that entrepreneurship be defined as the “creation of new enterprise”. This definition has been commonly used by many

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1730 1767

1803/1810 1910 1921 1959

1960 1961 1962 1964 1965

1976 1979 1985 1990 1993

Richard Cantillon Abbe Nicollas

Jean-Baptiste Say Joseph Schumpeter Frank Knight Edith Penrose

J.E. Stepanek D.C. McClelland Robert L. Budner Orvis F. Collins W.D. Litzinger

J.B. Rotter Israel Kirzner J.A. Timmons McMullan and Long Raymond W.Y. Kao

A self-employed person with uncertain returns A leader of men, a manager of resources, an innovator of ideas, including new scientific ideas, and a risk-taker A co-ordinator of production with managerial talent A creative innovator A manager responsible for direction and control, who bears uncertainty A person with managerial capabilities separate from entrepreneurial capabilities, and able to identify opportunities and develop small enterprises A moderate risk-taker A person with a high need for achievement A person with a high tolerance for ambiguity A person with a high need for autonomy Low need for support and conformity, leadership, decisiveness, determination, perseverance and integrity Internal locus of control An arbitrageur “A” type behaviour pattern Person who exercises strategic creativity through a business venture Person who undertakes a wealth-creating activity and value-adding process, through incubating ideas, assembling resources and making things happen

Contribution

Sources: Modified from list provided in Kao, R.W.Y. 1995, Entrepreneurship: A Wealth Creation and Value Adding Process. Singapore. Prentice Hall-Asia, 1995, p. 71.

Period

Contributors

Table 2.2 Summary of Definitions of an Entrepreneur

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entrepreneurship researchers. McMullan and Long (1990) also refer to entrepreneurship as venture creation in their strategic-creativity theory of entrepreneurship (pp. 142–44). These definitions are not exhaustive as the field has expanded to encompass internal corporate entrepreneurship, which is otherwise known as intrapreneurship (Pinchot and Pinchot 1985, pp. xv–xviii) or corporate venturing (Block and MacMillan 1993, pp. 13–15). The term entrepreneurship has also been extended to cover community and social enterprises, referred to in the introduction of this paper. Others relegate entrepreneurship to business start-ups under the wider concept of enterprise (Bridge, O’Neill and Cromie 1998, pp. 13–36). Under the enterprise concept, entrepreneurship is subsumed under the spirit of enterprise and enterprises as well. This approach may have been adopted because the policy-makers in the U.K. have policies that address enterprise rather than entrepreneurship. Of late, entrepreneurship researchers appear to have adopted the definition of entrepreneurship as the scholarly examination of how, by whom, and with what effects opportunities to create future goods and services are discovered, evaluated, and exploited (Venkatraman 1997). This definition directs the attention of researchers to the study of opportunity identification and exploitation. Unfortunately, this definition may be of little appeal outside the narrow confines of research where some academicians share the views of policy-makers that entrepreneurship should encompass the “entrepreneurial mindset” (Cartwright 2002; McGrath and MacMillan 2000, pp. 1–8; Kao 1995) or “entrepreneurial spirit” (Stevenson and Gumpert 1985). What is needed is a definition of entrepreneurship that encompasses the array of views. Essentially, what is required is a definition that can accommodate varying levels of analysis in the study of entrepreneurship, the types of activities and the subjective aspects under the concepts of “mindset” and “spirit”. Some researchers are unclear about such indefinite concepts of “spirit” and “mindset”. Part of the difficulty in defining entrepreneurship has been accommodating differing levels of interest: the individuals, corporations, organizations and societies (Davidsson and Wiklund 2001). Other difficulties include the myriad of activities ranging from innovations to inventions, from business activities to community activities, and activities considered to be part and parcel of employment (corporate ventures). Kao (1995) suggests that a definition must be one that is capable of application. He defines entrepreneurship as the process of doing something new and/or different to create wealth and to add value to society. It is a broad definition that only requires a mindset change for application. It has also been used by a few universities in their entrepreneurship courses.

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This discussion on the definition of entrepreneurship is required because the definition adopted would determine the targets of policy initiatives for activities, individuals, organizations and segments of society. As we have seen in our brief discussion on the definitions, the scope of entrepreneurship ranges from venture creation to mindset. It is the definition one adopts that shapes and influences the policy initiatives needed in each country’s context. The definitions of entrepreneurship can provide insights into the areas where policy could address. Our earlier discussion indicates a policy focus on SMEs in Southeast Asia. This focus is, however, accompanied by other references to other forms of entrepreneurship by political leaders. Having a clearer understanding of the various forms of entrepreneurship will aid policymakers in their choice of policies. If entrepreneurship is defined narrowly as business creation, then policy instruments are needed to assist with venture formation. If there is a lack of skills and knowledge in business creation, special programmes or a first-stop helpdesk can be established. On the other hand, where the intention is to change society’s perception of entrepreneurship with a desire to inculcate entrepreneurial mindsets, the longer-term policy may require changes to school education. Adopting a broad definition like Kao’s (1995) lends a wider perspective to policy-makers who may wish to address mindsets and society at one level, and the needs of corporations at another. Clearly, understanding what entrepreneurship encompasses also prevents isomorphism occurring where policy instruments are employed by replicating what others have done. 4. Whether Entrepreneurship can be Developed Notwithstanding the lack of a universally accepted definition for entrepreneurship, there remain questions of what can be developed and how it should be developed. In this section, we examine some recommendations. These questions do not trouble policy-makers who only aim to develop existing enterprises: SMEs. One possible reason that entrepreneurship has been equated with the development of SMEs is that SMEs are identifiable targets and their growth as a result of development activities can be measured. Furthermore, if one were to approach entrepreneurship purely from an economic development perspective of competitiveness through enterprises, identifying SMEs as a group satisfies both conditions, i.e. they are identifiable and measurable. Even so, while enterprises are identifiable, the question of whether entrepreneurship itself can be developed or nurtured remains, and will affect the policies that are designed if more are envisaged.

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4.1. Nature vs Nurture — The Role of the Environment There are two diametrically opposing views on the question of whether entrepreneurship can be developed. One view favours nature. In this view, for instance, America is naturally an entrepreneurial society, producing entrepreneurs because Americans are natural entrepreneurs. Educators and practitioners generally hold the other view that entrepreneurs can be nurtured. Training and development programmes would thus play a part in this school, as would the environment. In this section, we consider the aspect of nature; i.e. the environment. Most would concede that both nature and nurture have roles to play. The National Commission for Entrepreneurship in America in its recent publication in 2002, American Formula for Growth: Federal Policy & the Entrepreneurial Economy, 1958–1998 assesses the role of American public policy between 1958 and 1998 in the rise of the entrepreneurial economy in America. The study notes that public policies have created an American formula that has contributed significantly to an acceleration of activities by America’s entrepreneurs enabling the entrepreneurial revolution of the last quarter of the twentieth century. It advocates an improvement in the American formula for the future. The NCOE’s recommendations address five challenges in the areas of finance, research and development, intellectual property protection, manpower development for entrepreneurial growth companies, and access to markets and infrastructure. Its recommendations focus on the politicoeconomic environments for business, and also address the needs of SMEs and business start-ups. The attention paid to politico-economic factors may be justified as research has found some support for the influence of these factors on the intention to start a business. A study the author was involved with (Begley et al. 1998) found that favourable market opportunities showed the most consistent predictive ability across a fourteen-country sample. The implication is clear: favourable financing, supportive infrastructure, and government encouragement will mean very little if the opportunity does not exist to identify promising markets. The study also found that favourable government regulation was associated with lower interest in starting a business in East Asia. In examining the influence of politico-economic factors on the perceived feasibility and desirability of starting a business, it is found that the variance explained by the politico-economic variables is, on average, higher for feasibility than for desire. This result is not surprising since several of the variables, such as support available, favourable financing, and government regulation, are used

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by public policy-makers to influence potential entrepreneurs’ assessment of the feasibility of starting a business. It appears that influencing the desire variable seems trickier. Begley et al. (1998) speculated that cultural features might exert more influence on desire and that avenues such as early education and high status for entrepreneurs in the society might be relevant. In addition to the politico-economic environment, governments may wish to consider the socio-cultural environment. A number of socio-cultural factors have been suggested to influence entrepreneurship in a country, including: placing a high value on innovation, risk-taking, and independence (Kolvereid and Obloj 1994; Shapero and Sokol 1982), personal values (Huisman 1985; Shapero and Sokol 1982), high social status for entrepreneurship (Davidsson 1995; Ray and Turpin1990; Shane, Kolvereid, and Westhead 1991), the importance placed on work in a society (McGrath, McMillan, Yang, and Tsai 1992), and failure, meaning loss of face (McGrath, McMillan, and Scheinberg 1992). Begley and Tan (2001) have found that at the cultural level, social status of entrepreneurship and shame from business failure predict interest in entrepreneurship better in East Asian than Anglo countries. At the individual level, social status predicts interest in entrepreneurship in the entire sample of East Asian and Anglo countries. Hence, the higher an individual perceives the status of entrepreneurs to be, the greater would be that individual’s desire and intent to become one. This research provides impetus for policies that promote entrepreneurship through the identification of role-models, the sharing of success stories, the creation of awards to provide recognition of entrepreneurs with the view of creating greater awareness, and elevating the social standing of entrepreneurship. However, Begley and Tan (2001) also found that the shame of failure in East Asian countries is negatively correlated with the intention to start a business. In this regard, therefore, efforts to encourage entrepreneurship and to reduce the stigma and “face” issues relating to failure in business or failure in general might be helpful.

4.2. The Role of Education Thus far, we have examined the intention to start a business and what could be done to influence that intention. We now turn our attention to nurture. But what about the development of the other aspects of entrepreneurship? Here is an area where educators can play a role. At the tertiary level, entrepreneurship education has been spreading around the world at an ever increasing pace since the late 1960s. In 1985, there were 253 schools with

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entrepreneurship courses, and this number further increased to 369 in 1991 (Vesper 1992). In recent years, the U.S. and Europe are not the only places where entrepreneurship is recognized as playing a major role in economic development. Former communist countries and others are also focusing a great amount of effort to fostering entrepreneurship education (Brockhaus 1992). The objective behind most of the entrepreneurship courses is the inculcation of entrepreneurial skills. These courses include skills identified as being key to successful entrepreneurship such as decision-making, leadership, communication, management, technical, interpersonal, and conceptual skills. Some countries have enterprise education at the high school level as in the U.K., New Zealand and in some states in Canada (Ontario is one such state). In Singapore, entrepreneurship is indirectly introduced through creativethinking skills and project work that permeates the curriculum in schools. These efforts address skills, and through exposure, offer entrepreneurship as an alternative career option. They may also be able to contribute to the inculcation of the entrepreneurial mindset — to be entrepreneurial in all settings. If individuals would seek to create wealth and add value, they would ultimately contribute to economic development. In a paper, the author explored the question of whether entrepreneurship can be learnt (Tan 2002, pp. 259–81). Arguing that entrepreneurship is learnt if (a) there is a change of attitude as a result of participating in a class or (b) when there is conceptual learning on the part of the student, it was found that it was possible for students in a course to report a change in their attitudes towards entrepreneurship and their conceptual model of what entrepreneurship is. The students in the study evinced changes in their responses to open-ended questions posed to them prior to the commencement of the class or seminar and at the end of the class or seminar: who is an entrepreneur and what entrepreneurship is. Prior to the class or seminar, they only had concepts of traditional entrepreneurship — starting a business. Subjected to intervention in the form of the class or seminar, their ideas had changed, indicating that it is possible to shape thinking and mindsets. Intervention is probably needed in the area of education, formal and informal, if governments are interested in extending entrepreneurship development to the entrepreneurial aspects: mindsets and culture. Each government has to determine the target for their entrepreneurship policies and the nature of the policies. Once it is clear what will be the focus of entrepreneurship policies, and the extent to which it should be manifested in society, the elements of entrepreneurship education and other policy initiatives can be put into place.

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5. Conclusion While there is only some agreement on the nebulous nature of entrepreneurship which spans enterprise development to entrepreneurial mindset, there is a general consensus that policy initiatives are needed for entrepreneurship development. However, policy initiatives can best be directed when the concept of entrepreneurship is clearly defined. To confine entrepreneurship to enterprise development alone is inadequate as it ignores the nascent entrepreneurs (aspiring entrepreneurs) in society. To include this group is also insufficient as one would omit the larger enterprises that also need to be entrepreneurial. The employees in these enterprises must be trained and equipped to exercise entrepreneurship. Yet to stop there would not be satisfactory, as there is a need for whole societies to be entrepreneurial. Remembering that only one or two out of a thousand ideas will see the light of day in the market place (Hamel 2001, pp. 130–31), there is a need to engender entrepreneurship at all levels of society. Policy-makers must then look beyond the entrepreneurship infrastructures and incentives for firms, to measures that address socio-cultural factors and education. Defining entrepreneurship is the starting point and also the basis for comparison. REFERENCES Abetti, P.A. and P.A. Wheeler. “Planning and Building the Infrastructure for Technological Entrepreneurship: Field Studies in the USA, France and Mexico”. In Frontiers of Entrepreneurship Research, edited by Churchill N. et al. Babson Park, MA: Babson College, 1990, pp. 422–37. Barnes, L. and S. Jones. “Small Business Training Programs in Victoria: A Survey of Course Content and Effectiveness”. Journal of Enterprising Culture 3, no. 1 (1995): 21–57. Begley, T. and W.L. Tan. “The Socio-cultural Environment for Entrepreneurship: A Comparison Between East Asian and Anglo Countries”. Journal of International Business Studies 32, no. 3 (2001): 537–54. Begley, T.M., Tan W.L., H. Schoch, et al. “Politico-Economic Factors Associated with Interest in Starting a Business: A Study of Pacific Rim Countries”. In Frontiers of Entrepreneurship Research 1998, edited by Reynolds P.D. et al. Babson Park, MA: Babson College, 1998, pp. 46–47. Birch, D. “Who Creates Jobs”. The Public Interest (Fall 1981): 3–14. Reproduced in E. McMullan, W.E. and W.A. Long, Developing New Ventures: The Entrepreneurial Option. San Diego: Harcourt Brace Jovanovich, 1990. Block, Z. and I.C. MacMillan. Corporate Venturing: Creating New Businesses within the Firm. Boston, Mass.: Harvard Business School Press, 1993.

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Bridge, S., K. O’Neill and S. Cromie. Understanding Enterprise, Entrepreneurship and Small Business. Houndsmills: Macmillan Press, 1998. Brockhaus, R.H. “Entrepreneurship Education: A Research Agenda”. In IntEnt 1992: Internationalizing Entrepreneurship Education and Training, edited by H. Klandt and D. Müller-Böling. Köln, Dortmund: Förderkries Gründungs-Forschung, 1992, pp. 3–7. Bruno, A.V. and T.T. Tyebjee. “The Environment for Entrepreneurship”. In Encyclopedia of Entrepreneurship, edited by C.A. Kent, D.L. Sexton, and K.H. Vesper. Englewood Cliffs, N.J.: Prentice-Hall, 1982, pp. 288–307. Cartwright, R. The Entrepreneurial Individual. Oxford: Capstone, 2002. Cooke, P. and D. Wills. “Small firms, social capital and the enhancement of business performance through innovation programmes”. Small Business Economics 13, no. 3 (1999): 219–34. Cooper, A.C., T. Folta and C. Woo. “Information Acquisition and Performance by Start-up Firms”, in Frontiers in Entrepreneurship Research 1991, edited by N.C. Churchill et al. Wellesley, MA: Babson College, 1991, pp. 276–90. Cromie, S. “The Problems Experienced by Young Firms”. International Small Business Journal 9, no. 3 (1991): 43–61. Davidsson, P. “Culture, Structure and Regional Levels of Entrepreneurship”. Entrepreneurship and Regional Development 7 (1995): 41–62. Davidsson, P. and J. Wiklund. “Levels of Analysis in Entrepreneurship Research: Currentpractice and Suggestions for the Future”, Entrepreneurship Theory & Practice 25, no. 4 (2001): 81–99. Ernst, D., Ganiatsos, T. and Mytelka, L., eds. Technological Capabilities and Export Success — Lessons from East Asia. London: Routledge Press, 1998. Ghosh, A. and Z. Block. “Audiences for Entrepreneurship Education: Characteristics and Needs”. In The Art and Science of Entrepreneurship Education, 1 and 2, edited by F. Hoy, T.G. Monroy, and J. Reichert. Berea, Ohio: The Project for Excellence in Entrepreneurship Education, 1993/94, pp. 65–82. Hamel, G. “Inside the Revolution: Innovation’s New Math”. Fortune, 9 July (2001): 130–31. Huisman, D. “Entrepreneurship: Economic and Cultural Influences on the Entrepreneurial Climate”. European Research (Special Section) 13 (1985): 10–17. Kao, R.W.Y. and W.L. Tan. Entrepreneurship and Enterprise Development in Asia. Singapore: Prentice-Hall, 2001. Kao, R.W.Y. Entrepreneurship: A Wealth Creation and Value-Adding Process. Singapore: Prentice-Hall, 1995. Klofsten, M. and A. S. Mikaelsson. “Support of Small Business Firms: Entrepreneurs Views of the Demand and Supply Side”. Journal of Enterprising Culture 4, no. 4 (1996): 417–32. Kolvereid, L. and K. Obloj. “Entrepreneurship in Emerging Versus Mature Economies: An Exploratory Survey”. International Small Business Journal 12 (1994): 14–27.

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Lee, K.Y. “Political Entrepreneurs”. The Straits Times, Excerpts of Senior Minister’s Speech in Parliament on the White Paper on Competitive Salaries, 2 November 1994, p. 22. Lee, T.Y. and L. Low. Local Entrepreneurship in Singapore: Private & State. Singapore: Times Academic Press [for the] Institute of Policy Studies, 1990. Low, M.B., and I.C. MacMillan. “Entrepreneurship: Past Research and Future Challenges”. Journal of Management 14 (1988): 139–61. Maillat, D. “Innovative milieux and new generations of regional policies. Entrepreneurship and Regional Development 10, no. 1 (1998): 1–16. McGrath, R.G. and I.C. MacMillan. The Entrepreneurial Mindset: Strategies for Continuously Creating Opportunity in an Age of Uncertainty. Boston: Harvard Business School, 2000. McGrath, R.G., I.C. McMillan, and S. Scheinberg. “Elitists, Risk-takers, and Rugged Individualists? An Exploratory Analysis of Cultural Differences Between Entrepreneurs and Non-entrepreneurs”. Journal of Business Venturing 7 (1992): 115–35. McGrath, R.G., I.C. McMillan, E.A.Y. Yang, and W. Tsai. “Does Culture Endure, or is it Malleable? Issues for Entrepreneurial Economic Development”. Journal of Business Venturing 7 (1992): 441–58. McMullan, W.E. and W.A. Long. “Entrepreneurship Education in the Nineties”. Journal of Business Venturing 2, no. 3 (1987): 261–75. McMullan, W.E. and W.A. Long. Developing New Ventures: The Entrepreneurial Option. San Diego: Harcourt Brace Jovanovich, 1990. National Commission on Entrepreneurship. American Formula for Growth: Federal Policy & the Entrepreneurial Economy, 1958–1998. Washington, D.C.: National Commission on Entrepreneurship, 2002. Pinchot, G. III. and E. Pinchott. Intrapreneuring: Why You Don’t Have to Leave the Corporation to Become an Entrepreneur. New York: Harper & Row, 1985. Porter, M.E. The Competitive Advantage of Nations. New York: The Free Press, 1990. Ray, D. and D.V. Turpin. “Factors Influencing Japanese Entrepreneurs in High Technology Ventures”. Journal of Business Venturing 5, no. 2 (March 1990): 91– 102. Schumpeter, J. The Theory of Economic Development. Boston: Harvard University Press, 1934. Extract reproduced in E. McMullan and W.A. Long, Developing New Ventures: The Entrepreneurial Option. San Diego: Harcourt Brace Jovanovich, 1990, pp. 78–86. Shane, S., L. Kolvereid, and P. Westhead. “An Exploratory Examination of the Reasons Leading to New Firm Formation Across Country and Gender”. Journal of Business Venturing 6 (1991): 431–46. Shane, S. and S. Venkatraman. “The Promise of Entrepreneurship as a Field of Research”. Academy of Management Review 25 (2000): 217–26.

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Shapero, A. and L. Sokol. “The Social Dimensions of Entrepreneurship”. In Encyclopedia of Entrepreneurship, edited by C.A. Kent, D.L. Sexton and K.H. Vesper. Englewood Cliffs, N.J.: Prentice-Hall, 1982, pp. 72–90. Shapira, P., J.D. Roessner and R. Barke. “New Public Infrastructures for Small Firm Modernization in the USA”. Entrepreneurship and Regional Development 7, (1995): 63–84. Stevenson, H.H. and D.E. Gumpert. “The Heart of Entrepreneurship”. Harvard Business Review 63, no. 2 (1985): 85–95. Tan, W.L. “The Inculcation of Entrepreneurship as a Mindset”. In The Dynamics of Entrepreneurship: Growth and Strategy, edited by W.L. Tan. Singapore: PrenticeHall, 2002, pp. 259–81. Tan, W.L. and T.M. Tan. “Social Entrepreneurship in Singapore”. In Radical Change in the World — Will SMEs Soar or Crash?, edited by U. Fügistaller, H.J. Pleitner, T. Volery and. W. Weber. St. Gallen: Swiss Research Institute of Small Business and Entrepreneurship, University of St. Gallen, 2002, pp. 133–42. Tan, T.M., W.L. Tan and J.E. Young. “Entrepreneurial Infrastructure in Singapore: Developing a Model and Mapping Participation”. The Journal of Entrepreneurship 9, no. 1 (2000): 1–33. Thompson, J.L., G. Alvy, G. and A. Lees. “Social Entrepreneurship, A New Look at the People and the Potential”. Management Decision 38, no. 5 (2000): 328–38. Venkatraman, S. “The Distinctive Domain of Entrepreneurship Research”. In Advances in Entrepreneurship, Firm Emergence and Growth 3, edited by J. Katz. New York: JAI Press, 1997, pp. 119–38. Vesper, K.H. “The State of Entrepreneurship Education”. In Internationalizing Entrepreneurship Education and Training, edited by Klandt, H and MüllerBöling, D. Köln, Dortmund: Förderkries Gründungs-Forschung 1992, pp. 8– 15. Woo, C., T. Folta, and A. Cooper. “Entrepreneurial Search: Alternative Theories of Behavior”. In Frontiers of Entrepreneurship Research, edited by N.C. Churchill et al. Wellesley, MA: Babson College, 1992, pp. 681–95.

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian > Wengel 24 Studies. Individual articles are available at < http://bookshop.iseas.edu.sg Henry Sandee & Jan ter

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SMEs in Southeast Asia since the Asian Financial Crisis Henry Sandee and Jan ter Wengel

1. Introduction This chapter presents a general overview of SME development in Southeast Asia since the Asian Financial Crisis of 1997–1998. In particular, it focuses on SME exports. It is argued that new business opportunities have emerged in international markets in the wake of the Crisis. A key question is to what extent these opportunities are sustainable once economies and currencies recover. This chapter is in a certain sense speculative as it intends to address trends and issues with only limited data and scant quantitative research. Therefore, the chapter will concentrate its analysis on Indonesia as we have the best access to data and research findings for this country. Section 2 provides a brief summary of debates on SME development, with particular reference to exports. Section 3 discusses the macro-economic development and export growth in the region since the Crisis. In Section 4 (scattered) evidence on the development of the SME sector is presented in Southeast Asia since the Crisis. More detailed analysis on Indonesia are discussed in Section 5 and 6. In Section 5 the overall changes in the industrial structure and industrial exports since the crisis in Indonesia are discussed, while in Section 6 trends discussed in the previous section will be illustrated by a case study on the Jepara furniture export industry. Finally, conclusions are drawn in Section 7.

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2. Dynamics of the Small Enterprise Sector The manufacturing sector transforms as an economy develops. This transformation has an impact on the role and position of the SME sector. Anderson (1982) published a frequently quoted article on the changing role of small manufacturing enterprises in economic development. He analyses how large firms gradually become the engine of growth of the manufacturing sector. Scale economies become prominent with respect to plant, management, marketing and distribution. Small enterprises may remain, playing a vital role in the development of the manufacturing sector through growing involvement in sub-contracting. Hill (1995) adds that (during this phase) government policy is of high importance for the growth potential of the SME sector. The extent of concessionary finance, investment incentives, tariff structures, government subsidies and so on determine the importance that big firms attach to sub-contracting and the opportunities for small firms to find viable market opportunities. Hill adds that the relative underdevelopment of the SME sector in Indonesia compared with neighbouring countries is explained partly by differences in industrial policies. The policy environment in Indonesia is reported to be less favourable to SME development compared to several neighbours. Liedholm and Mead (1999) analyzes the transformation of the SME sector during good and bad economic times. Their findings for a number of developing countries suggest that when the economy as a whole is growing, small- and medium-scale enterprises add more employees to their workforce. At the same time, the smallest businesses tend to close down and there is less pressure to start new micro-enterprises. By contrast, the opposite forces are at work during an economic downturn. Under these circumstances, many SMEs remain stable in terms of employment, shed some labour or close down. Simultaneously, a shortage of employment opportunities in the overall economy increases the pressures on people to start their own new business even though these may generate only very low incomes. These trends are relevant when discussing adjustments in the manufacturing sector in Southeast Asia since the Crisis. Berry, Rodriguez and Sandee (2001) argue that SMEs enjoy greater flexibility relative to larger firms. This is especially important in industries and economies that face rapidly changing market conditions, such as the sharp economic downturn that Southeast Asia faced during the Crisis. The stagnation of domestic demand during the crisis made it highly important to benefit from new business opportunities on export markets. Evidence from Southeast Asia suggests that a substantial part of SME exports originate from clusters of small enterprises. Clustering facilitates penetration in distant markets

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because of cost advantages in production and marketing. Clusters can be defined simply as sectoral and spatial concentrations of firms. A fine example of a well-known furniture cluster in Indonesia will be discussed in Section 6. Recent literature on SME exports stresses that a string of actors is involved in production and distribution. Frequently, decisions on products, design and quality are not made by the small producers but by traders, wholesalers and retailers. In many product lines, international buyers set the terms for others in the chain. They decide what is to be produced, where, by whom, and at what price. International buyers concentrate their purchasing orders in clusters because it makes it possible to buy in bulk from many small firms at “a single stroke”. (Knorringa and Schmitz 2000). There is ample evidence from Southeast Asia that highlights the key role played by buyers in promoting exports from the region since the Crisis. Business opportunities for SME on export markets are volatile and very much dependent on actors and factors on which the small entrepreneurs have little influence. The currency depreciations in the region appear to have offered new export opportunities in chains that are dominated by international buyers. 3. Export Growth in the Region Before discussing SME development and SME exports, it is important to emphasize that the Asian miracle was based to a large extent on exports. There are two ways to look at these exports. First, by considering the ratio of exports to GDP. Table 3.1 shows how the ratio of exports to GDP increased continuously in all Southeast Asian countries in the past four decades. It is salient, for example, how Thailand increased its ratio of exports to GDP from 13 to 16, to 21 and to 31 and finally to 52 per cent. Also worth

Table 3.1 The Increase in Exports with Respect to GDP Exp/GDP China Hong Kong Korea Singapore Indonesia Malaysia Thailand Philippines

61–70

71–80

81–90

91–97

98–2001

55.6% 5.5% 105.9% 11.1% 42.9% 13.8% 11.4%

5.6% 64.1% 22.8% 113.1% 23.1% 44.2% 16.3% 15.4%

10.3% 90.0% 30.9% 138.4% 22.7% 53.3% 21.6% 16.4%

19.1% 116.8% 25.1% 135.0% 23.2% 75.3% 31.6% 22.5%

20.6% 114.6% 37.5% 140.8% 42.1% 104.2% 52.4% 48.2%

Source: IMF Financial Statistics.

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mention is the increase in the ratio of exports to GDP in the wake of the Asia Financial Crisis. The large increase in the ratio of exports to GDP is primarily the result of the higher valuation of exports with respect to domestic output as a consequence of the devaluation of the national currencies. Nevertheless, it must also be noted that after an initial contraction in 1998, exports continued to grow in all Asian economies. Appendix 1 presents graphs for the growth of exports and imports before and through the Asian Financial Crisis. The second way to look at these exports is in relation to imports. In spite of the phenomenal growth of exports, imports stayed ahead of exports in all countries except China, Indonesia and Malaysia. The fact that China is an exception can be explained by the fact that China was not integrated into the world economy until fairly recently. Why Malaysia and Indonesia present surpluses is not clear. It may be that they are oil exporters but the question remains wide open. The excess of imports over exports was generally paid by an inflow of capital. Although foreign direct investment has been stressed as one of the pillars of the East Asian miracle, Table 3.2 shows that it did not amount to much. The comparison of Tables 3.1 and 3.2 reveals that FDI did not have anything near the importance of exports in the propelling of the East Asian miracle. The sudden reversal in financial flows forced East and Southeast Asian countries to curtail their imports starting in 1998 as is shown in the graphs in Appendix 1. The reduction in the imports of these countries also affected the exports of the other East and Southeast Asian countries. Thus, the dip in the export growth registered in 1998 was to a large extent caused by the reduction in imports by the neighbouring countries. Table 3.2 The ratio of FDI to GDP FDI/GDP

71–80

China Hong Kong Korea Singapore Indonesia Malaysia Thailand Philippines

0.2% 6.4% 3.7% 0.4% 0.4%

81–90

91–2000

91–97

98–2001

0.6%

4.1% 20.9% 0.8% 9.5% 0.7% 5.7% 2.6% 1.8%

4.2%

4.0% 19.2% 1.7% 7.8% –1.8% 4.0% 4.4% 2.1%

0.3% 10.5% 0.4% 3.4% 1.2% 0.7%

0.3% 10.3% 1.7% 6.4% 1.6% 1.7%

Source: IMF Financial Statistics.

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The Asian Financial Crisis led to much turmoil in the export industries of the diverse East and Southeast Asian countries for two reasons: 1. The devaluation of the currencies of neighbouring countries, competing in the same export markets, caused abrupt changes in the demand for exports of particular sectors in particular countries. 2. The reduction in the imports from the neighbouring countries had a direct impact on the demand for exports in the other countries. The integration of China into the world economy is expected to have significant “neighbour effects” on the Southeast Asian countries. This is because China is a large neighbour that can compete in many of the sectors appropriated by these countries. Thus, it is very probable that the demand for exports from Southeast Asian countries will be affected. This has often been referred to as the “China Threat”. Although it would be ideal to document this threat with reference to specific industries and sectors, for the time being, a view of the increased importance of China as an exporter in relation to the other Southeast Asian countries can be provided as is shown in Figure 3.1. When viewing Figure 3.1, it is important to note that China increased its share of exports from 14 to 24 per cent at the same time that the Southeast Asian countries were registering significant export growth rates. If Hong Kong is included in the Chinese figures, the increase in the share of exports is from 30 to 55 per cent. The growth of exports of China, however, only presents one side of the neighbour effect. The other side of the neighbour effect relates to the imports from China. In contrast to the import side effects of the Asian Financial Crisis, Chinese imports lead to increased demand for the exports from the Southeast Asian countries. In fact, during the Asian Financial Crisis, the steady demand for imports by China proved to be a stabilizing factor in contrast to the neighbour effects from the other nations. 4. SME Development in the Region since the Crisis The section above revealed that FDI has been important but it cannot explain the phenomenal growth of exports from the region. Neighbour effects need to be taken into consideration to understand why the depreciation of currencies during the Crisis did not always result in substantial increases of exports. Specific attention is given to the role played by buyers in fostering SME exports from the region. There is evidence for various countries that the micro-enterprise sector has expanded during the Crisis years. Micro-enterprises are roughly defined

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Figure 3.1 The Increased Share of Exports by China Exports 1980 Thailand EXP Malaysia 5.3% EXP 10.6%

Phillipines EXP 4.7%

China EXP 14.9%

Hong Kong EXP 16.2%

Indonesia EXP 18.0%

Singapore EXP 15.9%

Korea EXP 14.4%

Exports 2000

Malaysia EXP 9.5%

Thailand EXP 6.7%

Phillipines EXP 3.9%

China EXP 24.2%

Indonesia EXP 6.0%

Singapore EXP 13.4% Korea EXP 16.7%

Hong Kong EXP 19.6%

Source: IMF Financial Statistics.

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as establishments with less than five workers while SMEs employ between five and fifty workers dependent on the country taken into consideration. Van Diermen (2002) argues that there has been a general downward shift in size and informality during the Crisis. Alternative markets for labour grew especially in the micro sectors of the economy offering employment to those that lost their jobs in bigger establishments. In addition, he argues that the Crisis has contributed also to a feminization and a casualization of the workforce. More females entered the labour force especially through selfemployment or micro-business ventures to complement family incomes. Many workers lost their access to steady wage employment but, instead, they have become more dependent on (informal) contracts to carry out specific tasks. The growth of this micro-enterprise sector is clearly a sign of distress adaptation offering employment to those that have lost access to better jobs or to those that need to complement their low family incomes during the Crisis. It is expected that the micro-enterprise sector will shed labour as soon as economies start growing again. The impact of the Crisis on SMEs is more diverse. On the one hand, there are small firms that have stagnated due to the shrinking of domestic demand while, on the other hand, other small firms have been able to find new markets, especially abroad. Hall (2002) provides a profile of SMEs in East Asia since the Crisis. He estimates that SMEs (including microestablishments) generate about 30 per cent of exports in the region. SME exports range from 5 per cent or less in Indonesia to around 40 per cent in Korea. Part of this growth is related to foreign direct investment. Hall notes that Korean, Japanese and Taiwanese SMEs contribute most to foreign direct SME investment in the region and their contribution has increased in recent years. Harvie (2002a) presents an overview of the responses of the SME sector in the region to the Crisis. Evidence from Taiwan suggests that many SMEs changed the regions to which they exported. Changes were made in accordance with changes in exchange rates and economic growth in different countries and regions. SMEs from Taiwan that exported to countries like Thailand and Indonesia changed the method of payments, which they requested, from customers. Harvie notes also that SME exporters from Taiwan were hit harder than their larger counterparts because they are in a weaker position for price negotiations. Ross (2002) also discusses the impact of foreign exchange rate movements on SME exports in the region. The reliance on US dollars invoicing for most of the regional SME exports resulted in substantial transaction gains for some exports and substantial losses for some imports. He concludes that some SMEs were assisted by a collapsing local currency

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through a boost to competitiveness. Other SMEs were wiped out by an inability to pass on devaluation-induced price increases on imported goods and services. Richards et al. (2002) found for Vietnam that the country’s SME exports are mainly directed to other Asian countries. The drastic depreciation of currencies in neighbouring countries made Vietnamese exports less price competitive. In addition, reforms that were implemented in crisis-afflicted countries made them more attractive to investors and foreign buyers. Berry and Rodriguez (1999) discuss the impact of the crisis on SMEs in the electronics and car parts industries in the Philippines. SMEs dominate the assembly industry while large firms dominate the production of parts; by contrast, in the automotive industry the production of parts is dominated by SMEs while larger firms concentrate on the assembly of parts. Both industries were aiming primarily at exports markets prior to the crisis and these markets have remained buoyant. There is also some evidence that the domestic markets for car parts has been quite resilient because the crisis has led to a postponing of purchases of new cars and increased the demand for replacement parts. In another contribution, Rodriguez and Berry (2002) refer to a World Bank survey in the Philippines that found that non-exporting large firms were among the hardest hit. In the sample, there was a strong representation of foreign-owned SMEs that were able to boost their export sales. Rasiah (1999) shows for Malaysia that the successful participation of SMEs in the export trade requires often communication and collaboration among SMEs, big domestic firms and foreign buyers. However, such links do not come about spontaneously and regional governments may play a supportive and facilitating role. Proactive support may bridge the gaps between SMEs and other parties in the value chain. Moha’s study (2002) on SMEs in Malaysia during the crisis argues that the most affected businesses were SMEs as these enterprises aim generally at the domestic market that was severely depressed. Only a limited number of small firms were able to redirect their efforts to foreign markets. Evidence from China also stresses the importance of business alliances in fostering SME exports. “Successful town and country enterprises (TVEs) are likely to be those able to develop into new organizational forms based upon business alliances with other enterprises, involving cooperation and joint ventures between TVEs, state-owned enterprises, private domestic and foreign enterprises, and also with research institutes and universities in order to gain access to advances in science and technology. This will enable them to compete in both domestic and international markets, as well as invest overseas” (Harvie 2002b, p. 69).

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SMEs have been hit by the crisis just like big firms. However, there is also evidence that SMEs were able to sell more to export markets. A substantial part of all SME exports are traded within the region. Accordingly, SME exports have undergone reshuffling in accordance with exchange rate and economic growth trends of the various countries in the region. Successful participation of SMEs in export markets does not come automatically. SMEs need to establish business alliances and link up with international market chains. Thus the Crisis and the depreciation of currencies offers new export opportunities but the cases suggest also that government, especially regional authorities, have played a facilitating role in fostering SME exports. 5. Reshuffling of the Manufacturing Sector and SME Exports in Indonesia The objective of this section is to draw insights from the response of Indonesia to the Asian Financial Crisis, to suggest how the industrial structure might have responded in the region to the crisis. The analysis of the industrial structure of Indonesia between 1996 and 2000 reveals that the firms in the diverse sectors did not grow proportionately to the macro-economic figures (see also Ter Wengel and Rodriguez 2002). It is a picture that presents a lot of turmoil. Some firms grow. Others shrink. Some are forced to close. Others open in their place. This section will discuss the reshuffling in the manufacturing sector with specific attention on SMEs. The Annual Manufacturing Survey (1996) produced by the Central Bureau of Statistics, recorded 22,997 firms in operation in 1996. 6,100 of these firms, 26.5 per cent, closed between 1996 and 2000. At the same time, during the same period, 5,277 new firms were started up. The Annual Manufacturing Survey (2000) registers 22,174 firms. These figures suggest turmoil in the industrial sector caused by the Asian Financial Crisis. Since our interest in on the performance of SMEs, the sample needs to be sub-divided according to firm size. The data do not cover firms with less than twenty workers and, consequently, they do not provide insight into the dynamics of the micro-enterprise sector since the Crisis. Fully aware of the pitfalls of SME definitions in Indonesia, the following six size categories are defined: 1. 2. 3. 4.

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Size 1 – Small 1: From 20 to 49 workers. Size 2 – Small 2: From 50 to 99 workers. Size 3 – Medium 1: From 100 to 199 workers. Size 4 – Medium 2: From 200 to 499 workers.

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5. Size 5 – Large 1: From 500 to 999 workers. 6. Size 6 – Large 2: Above 1000 workers. Table 3.3 shows that the small industrial enterprises were more affected by the Crisis than the large ones. Thus among the smallest, 35.7 per cent were forced to close. The “out-of-business” percentage declines with industry size. Only 6.7 per cent of the largest firms closed between 1996 and 2000. While the small- and medium-sized enterprises recorded the most closures, the SME sectors also showed the most vigorous response to the new opportunities presented in the five-year period. Thus, 3,232 Size 1 enterprises were started between 1996 and 2000. This represents an increase in the Size 1 industries of 40 per cent. The creation of new industries also declines with industry size. Size 1 industries recorded an increase of 40 per cent while the Size 6 sector only recorded an increase of 10 per cent. This enormous reshuffling of firms had a great impact on exports. But the impact on exports did not occur in the way that economists infused with the concept of comparative advantage might have thought. With all things constant, the significant devaluation of the rupiah should have led to an export boom. In those conditions one would have anticipated that the sectors with substantial exports would grow and increase their exports. Along the same lines, it would have been expected that the sectors with a significant ratio of exports to production would have increased their exports as a result of the higher prices for exports compared to domestic sales. Contrary to expectations, at the five digit ISIC level, it is found that the growth of exports by sector (over the period 1996–2000) is negatively correlated to the both the sectoral exports in 1996 and the ratio of exports to production in 1996. The results presented in Appendix 2 contradict expectations because it was expected that sectors with a demonstrated competitive advantage would increase their

Table 3.3 The Reshuffling in the Industrial Sector Size

START 1996

CLOSE

% close

REMAIN

NEW

% new

IN 2000

1 2 3 4 5 6 SUM

12519 3798 2607 2261 1007 805 22997

4468 772 400 304 102 54 6100

35.69 20.33 15.34 13.45 10.13 6.71 26.53

8051 3026 2207 1957 905 751 16897

3232 878 559 400 133 75 5277

40.14 29.02 25.33 20.44 14.70 9.99 31.23

11283 3904 2766 2357 1038 826 22174

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exports given the large devaluation of the rupiah. This did not happen as anticipated because of what might be called the “neighbour effect”. Under the “neighbour effect”, change in the demand for exports from a particular country results from the increased competition by its neighbours in its export markets and decreased demand for imports by its neighbours. Thus, the growth and decline of sectors and sector exports in particular was the result of booms and busts at the firm level within sub-sectors of the manufacturing sector. Some firms ceased to exist. Some firms continued to exist but ceased to export. Other firms that continued to exist all of a sudden began to export. Among the firms that continued to exist, some increased their exports and others saw their exports decline. Then, in addition to this all, there were new entrants that started exporting right away. Table 3.3 showing number of firms and Table 3.4 showing firms with exports reflect the process of “creative destruction” described by Joseph Schumpeter more than 75 years ago. Table 3.4 presents the impressive increase in exports by SMEs. When one compares the 2000 figures with the 1996 figures, small firms increased their exports by 83 per cent while the exports of the largest enterprises decreased by 10 per cent (see Table 3.1 below). Despite the impressive growth in exports by small firms (those with fewer than 100 workers, that is, categories Small 1 and 2), their share of total industrial exports continues to be quite minuscule: It grew from 2.8 per cent in 1996 to 4.1 per cent in 2000. When medium firms (those with fewer than 500 workers, that is, categories Medium 1 and 2) are added, the share of exports from small- and medium-sized firms in total exports is shown to be more sizeable: it grew from 28.4 per cent in 1996 to 34.4 per cent in 2000. New entries have been important for SME export growth in Indonesia. SMEs are characterized by both relatively high entry and exit rates since the Crisis. Reshuffling appears to have taken place not so much between subsectors of the manufacturing sector but rather, within specific sub-sectors. In the next section, these trends are illustrated by means of an analysis of the preand post-Crisis developments in the Indonesian export furniture industry. 6. Reshuffling and Transformation of the Jepara Furniture Cluster in Indonesia1 Furniture production is clustered in Jepara and spread out over a large number of villages (14) in the regency. It has a long history that dates back to pre-colonial times. In the 1980s and 1990s the industry profited from the growth in domestic consumer demand that made quality furniture more accessible to the growing Indonesian middle class. The furniture export

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608 571 2866 3204 7170 –5486 8934

(2)

(1)

–354 –448 –830 –1832 –2793 –5288 –11546

Change in Exports because of Expansions

Change in Exports because of Firm Exits

Source: 1996 and 2000 Industrial Surveys.

Small 1 Small 2 Medium 1 Medium 2 Large 1 Large 2 TOTAL

Worker-based Size1

579 1287 3311 4279 5608 4540 19604

(3)

Change in Exports because of New Entries

833 1409 5347 5652 9985 –6233 16992

(4)=(1)+(2)+(3)

Total Change in Exports in 2000

1001 2531 7346 23958 23440 64336 122613

(5)

Total Exports in 1996

83.2 55.7 72.8 23.6 42.6 –9.7 13.9

(4)/(5)

% Export in Growth

Table 3.4 Exports by Firm Dynamics, Indonesia, 1996–2000 (Billion of Constant 2000 Rupiah)

1.3% 2.8% 9.1% 21.2% 23.9% 41.6% 100.0%

(6)=(4)+(5)/TOTAL

Percentage of total exports in 2000

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industry received a boost by the 1986 devaluation and the 1997 depreciation of the Indonesian currency. The growth of the export trade has brought important adjustments to the cluster such as technology upgrading, switch to modern designs, and, importantly, a switch from production for stock to participation in buyer/order-driven marketing channels. The export industry stimulated the emergence of sub-contracting networks in the cluster with specific parts of furniture production being contracted out to specialized small firms and craftsmen. The number of exported containers went up from 200 to 2,000 per month in the period 1996–2000. Since the outbreak of the Crisis, the number of production units in the cluster has increased from approximately 2,500 to 3,500. The majority of these enterprises are small but there are also more than 100 medium-scale production units that employ each some to 100 workers. There are intensive sub-contracting networks and the production of certain export items may involve more than five different sub-contractors. In the same period, employment had gone up from 38,000 to 57,000 workers. Presently, the cluster is in distress with exports declining more than 50 per cent over the period 2000–2002. In the same period, employment levels remained unchanged, suggesting a re-orientation to domestic markets, at least partially. Various reasons have been brought forward to explain the current poor performance of the export industry. First, quality control has not received sufficient attention during recent years of fast expansion. Consequently, there is evidence of foreign traders that have shifted their attention to other furniture clusters inside and outside Indonesia. Second, overcrowding and the somewhat unfavourable location of the Jepara cluster have stimulated groups of producers to try new business ventures elsewhere in Central Java. Third, the IMF agreements have allowed again the export of wood logs and, consequently, prices of inputs for the Jepara industry have gone up significantly, which has negatively influenced the cluster’s competitive position vis-à-vis exports from neighbouring countries. In the year 2000, Jepara furniture was exported to 68 countries. Foreign buyers have played an important role in the development of the export market. Many of them have established their own factories in the Jepara cluster mainly through joint ventures. The export industry is very much a buyer-driven industry in which production takes place exclusively after orders have been received. Direct government support has played a limited role in the development of the industry. More important has been government policy to develop the nearby Semarang harbour to make it ready for container transport and

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improve local infrastructure. Also in this cluster there have been attempts to establish a cooperative to improve the access of smaller firms to wood. This has not been successful. There are regular complaints about the negative role that government plays through its control and bad management of wood supplies. Teak and mahogany wood are frequently being sold illegally and insufficient attention is paid to replanting which leads to depletion in the years to come. In addition, recent deregulation policies have increased the need for local governments to strengthen the local tax base. The Jepara case study shows that foreign buyers play a leading role in the development of the export industry. There have been new entries by both large and small firms to accommodate the new export opportunities. The case suggests also that dependency on buyer-driven development is not free of risks. The current problems are caused, to an important extent, by the decisions of buyers to purchase increasingly products elsewhere. Jepara has developed very rapidly and it is in dire need of consolidation. It can no longer rely on its low costs of production that has made it such a successful participant in world markets. Upgrading of technological capabilities is important so that it can find new markets. 7. Conclusions Trends in the manufacturing sector in the region follow patterns that have been observed for other developing countries as well. During good times SMEs grow while micro-businesses lose some of their importance. During bad times opposite trends dominate with micro-firms offering work to those that have lost access to better paid jobs elsewhere in the economy. During the Crisis, entry and exit rates had been very high in the SME sector in the region. This was illustrated for Indonesia using nationwide statistics. Since the crisis, there is evidence that SME exports have gone up substantially though they remain small vis-à-vis those by larger establishments. Foreign buyers have played an important role in stimulating SME exports. The Jepara case study shows that such buyer-driven export growth may not be sustainable. The main challenge for small producers and their associations is to strengthen their production and marketing capabilities and gain structural access to international markets. NOTE 1.

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This section is based on Sandee et al. (2003).

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REFERENCES Anderson, D. “Small Industry in Developing Countries: A Discussion of Issues”. World Development 10, no. 11: 913–48. Berry, A. and E. Rodriquez. “Dynamics of SMEs in a slow-growth economy: The Philippines in the 1990s”. Paper prepared for Worldbank Conference on Smalland Medium-scale Enterprises, Chiang Mai, Thailand, 1999. Berry, A., E. Rodriguez, and H. Sandee. “Small and Medium Enterprise Dynamics in Indonesia”. Bulletin of Indonesian Economics Studies 37, no. 3: 363–84. Hall, C. “Profile of SMEs and SME Issues in East Asia”, in The Role of SMEs in National Economies in East Asia, edited by C. Harvie and B.C. Lee. Cheltenham: Edward Elgar, 2002, pp. 21–49. Harvie, C. “The Asian Financial and Economic Crisis and its Impact on Regional SMEs”. In Globalization and SMEs in East Asia, edited by C. Harvie and B.C. Lee. Cheltenham: Edward Elgar, 2002a, pp. 10–42. Harvie, C. “China’s SMEs: Their Evolution and Future Prospects in an Evolving Market economy”. In The Role of SMEs in National Economies in East Asia, edited by C. Harvie and B.C. Lee. Cheltenham: Edward Elgar, 2002b, pp. 50– 88. Hill, H. (1995). “Small-medium Enterprise and Rapid Industrialisation: the ASEAN Experience”, Journal of Asian Business 11, no. 2: 1–31. Liedholm, C. and D.C. Mead. Small Enterprise and Economic Development. The Dynamics of Micro- and Small Enterprises. London and New York: Routledge, 1999. Moha Asri Abdullah. “An Overview of the Macroeconomic Contribution of Small and Medium-Scale Enterprises in Malaysia”. In The Role of SMEs in National Economies in East Asia, edited by C. Harvie and B.C. Lee. Cheltenham: Edward Elgar, 2002, pp. 181–201. Rasiah, R. “Small and medium machine tool firms and subcontracting. Links with microelectronics multinationals in Malaysia”. Paper prepared for Worldbank Conference on Small and Medium-scale Enterprises, Chiang Mai, Thailand, 1999. Richards, D., C. Havie, Ha Nguyen and Nguyen Van Lan. “The Limping Tiger: Problems in Transition for Small and Medium Sized Enterprises in Vietnam”. In The Role of SMEs in National Economies in East Asia, edited by C. Harvie and B.C. Lee. Cheltenham: Edward Elgar, 2002, pp. 89–135. Rodriguez, E., and A. Berry. “SMEs and the New Economy: Philippine Manufacturing in the 1990s”. In The Role of SMEs in National Economies in East Asia, edited by C. Harvie and B.C. Lee. Cheltenham: Edward Elgar, 2002, pp. 136–57. Ross, D.G. “Trade Finance for East Asian SMEs and the Asian Financial Crisis”. In Globalization and SMEs in East Asia, edited by C. Harvie and B.C. Lee. Cheltenham: Edward Elgar, 2002, pp. 83–94. Sandee, H. “SMEs in Southeast Asia: Issues and Constraints in the Pre- and Post-

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Crisis Environments”. In Globalization and SMEs in East Asia, edited by C. Harvie and B.C. Lee. Cheltenham: Edward Elgar, 2002a, pp. 61–82. Sandee, H.S. Sulandjari, and B. Isdiyoso. “SME Clusters in Indonesia. An Analysis of Growth Dynamics and Employment Conditions”. Report to the International Labour Organization, Jakarta/Amsterdam, 2002. Van Diermen, P. “SMEs and Regional Labour Market Dynamics: Major Trends since 1897”. In Globalization and SMEs in East Asia, edited by C. Harvie and B.C. Lee. Cheltenham: Edward Elgar, 2002a, pp. 209–24. Wengel, Jan ter and Edgard Rodriguez. SME Export Performance in Indonesia after the Crisis: The 1996–2000 Industrial Data, ADB, September 2002.

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Appendix 3.1 Exports and Imports from the Various Countries China 350 000 300 000 250 000 200 000 150 000 100 000 50 000 0 1993

1994

1995

1996

1997

Dots export

1998

1999

2000

2001

1999

2000

2001

1999

2000

2001

Dots import

Hong Kong 250 000 200 000

150 000

100 000

50 000

0 1993

1994

1995

1996

1997

Dots export

1998 Dots import

Korea 200 000 180 000 160 000 140 000 120 000 100 000 80 000 60 000 40 000 20 000 0 1993

1994

1995

1996

1997

Dots export

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1998 Dots import

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41

Appendix 3.1 (continued)

Singapore 160 000 140 000 120 000 100 000 80 000 60 000 40 000 20 000 0 1993

1994

1995

1996

1997

Dots export

1998

1999

2000

2001

1999

2000

2001

1999

2000

2001

Dots import

Indonesia 70 000 60 000 50 000 40 000 30 000 20 000 10 000 0 1993

1994

1995

1996

1997

Dots export

1998 Dots import

Malaysia 120 000 100 000 80 000 60 000 40 000 20 000 0 1993

1994

1995

1996

1997

Dots export

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41

1998 Dots import

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Appendix 3.1 (continued) Thailand 80 000 70 000 60 000 50 000 40 000 30 000 20 000 10 000 0 1993

1994

1995

1996

1997

Dots export

1998

1999

2000

2001

1999

2000

2001

Dots import

Philippines 45 000 40 000 35 000 30 000 25 000 20 000 15 000 10 000 5 000 0 1993

1994

1995

1996

1997

Dots export

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1998 Dots import

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SMEs since the Asian Financial Crisis

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Appendix 3.2 Export Growth and Sectoral Export Regression Analysis Estimated equations: Growth of Exports = a + b* Sector Exports Growth of Exports = a + b* Ratio of Exports to Production Equation 1. Variable Intercept Sector export

Parameter estimate

t-value

Level of significance %

175.23 –7.36E8

3.16 0.94

0.20 nil

Parameter estimate

t-value

Level of significance %

4.01 2.63

0.01 1.00

Equation 2. Variable Intercept Ratio of exp. to prod’n

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303.24 –5.57

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian > Urata 44 Studies. Individual articles are available at < http://bookshop.iseas.edu.sg Shujiro

4

Financing SMEs in Southeast Asia during the Crisis Period: The Cases of Thailand and Malaysia Shujiro Urata

1. Introduction The Asian Financial Crisis started in Thailand in July 1997, and it then spread to other East Asian countries. The impact of the Crisis in many East Asian countries was dramatically devastating. After experiencing rapid economic growth from the mid-1980s to the outbreak of the Crisis, growth rates of all East Asian countries, with the notable exception of China, declined substantially because of the Crisis. Indonesia, Korea, Malaysia, and Thailand were hit seriously, as their growth rates in 1998 were –13.1, –6.7, –7.4, and –10.8 per cent, respectively. Although all the countries except Indonesia achieved speedy recovery in 1999, their growth performance has not been recovered to the pre-Crisis level. Among firms of different sizes, the impact of the Crisis on small and medium-sized enterprises (SMEs) was especially serious. According to a

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survey conducted by the World Bank, the capacity utilization level after the crisis for small firms is significantly lower compared to large firms in the five crisis-hit countries, Korea, Indonesia, Philippines, Malaysia, and Thailand by 3 to 12 percentage points (See Dwor-Frecaut et al. 2000). One of the influencing factors was the shortage of financial resources, which resulted mainly from the collapse of the financial sector during the Crisis. SMEs play a very important role in many East Asian countries. For example, more than 90 per cent, and in many countries more than 95 per cent, of the firms are SMEs, and SMEs provide employment opportunities for 60 to 70 per cent of the workforce. Moreover, many SMEs with innovative and entrepreneurial capabilities are important sources of dynamism, which would propel economic development. Recognizing the financial difficulties SMEs have to deal with and also recognizing the importance of developing competitive SMEs for economic development, this paper examines SMEs’ financial problems and identifies the causes, so as to find ways to alleviate their situation. We examine this issue from two perspectives; those of the SMEs and the financial sector. Due to the lack of data availability we will only examine the cases of Thailand and Malaysia. JBIC conducted in-depth questionnaire surveys and interviews on SMEs and financial institutions in 1999. The questionnaire surveys obtained responses from 642 SMEs in Thailand and 221 SMEs in Malaysia, which will be used for our analysis.1 The structure of the paper is as follow. Section 2 analyzes the characteristics of financial problems that SMEs in Thailand and Malaysia had to deal with after the crisis. After elucidating the severity of the financial problems in Section 2, Section 3 examines the sources of financing for SMEs. Section 4 examines SMEs find it difficult to access loans and finances, from both the demand and supply side. Finally in Section 5 some policy recommendations are made to ease the financial problems of SMEs, so that potentially competitive SMEs could acquire financing to expand their business, and thereby contribute to economic development. 2. Financial Needs of SMEs in Thailand and Malaysia In line with GDP developments, sample SMEs in Thailand and Malaysia experienced a decline in sales in 1997 and 1998 before recovering somewhat in 1999. In Thailand and Malaysia, SMEs with strong export orientation fared better than those with local-sales orientation.2 This reflects serious negative impact on local demand from the financial and economic crisis, while the negative impact on export demand was less serious.

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Various factors were responsible for the decline in domestic sales in the countries surveyed. In both Thailand and Malaysia, similar factors including increase in input costs, decline in domestic demand, increase in labour costs, and credit constraints were found to be important. One interesting finding is the proportion of sample SMEs that indicated those factors as the reasons for the reduction in domestic sales was significantly higher for SMEs in Thailand when compared to those in Malaysia. Specifically, the proportions of sample SMEs in total sample that indicated the increase in input cost, decline in domestic demand, increase in labour cost as the reasons for the reduction in domestic sales were 82.7, 72.1, and 73.3 per cent, respectively, in Thailand, while the corresponding values for SMEs in Malaysia were significantly lower at 56.6, 52.0, and 48.4 per cent.3 These differences in the proportions appear to reflect the differences in the severity of the decline in domestic demand in Thailand and Malaysia, as domestic sales in Thailand declined more than those in Malaysia.4 Similar to the finding on the differences in the decline in domestic sales in Thailand and Malaysia, the severity of credit crunch was much more substantial in Thailand than in Malaysia. This observation is based on the fact that the proportion of the sample SMEs in total sample, which indicated credit constraint was one of the reasons for a decline in domestic demand, was 68.3 per cent in Thailand, much higher than the 51.1 per cent in Malaysia. Credit constraint was found to be a limiting factor for SMEs for their operation in Thailand and Malaysia. The responses to the question concerning demand for additional loan by SMEs attest to this assertion. In Thailand 38.5 per cent of 642 sample SMEs indicated the need for additional financing, and 9.5 per cent of them responded that they needed it urgently (Table 4.1). This finding appears consistent with an observation that 40 per cent of the respondents experienced a decline in production from 1998 to 1999. The financial situation of SMEs in Malaysia appears more serious, as 59.3 per cent of 221 sample SMEs indicated the need of additional financing, and 22.2 per cent of them indicated that they need it urgently. Earlier we found that SMEs with domestic market orientation faced more serious problems when compared to those with export market orientation. These differences in the severity of the problems faced by SMEs with different market orientations are reflected in the differences in the need of additional financing. In Thailand among 481 SMEs with domestic sales orientation (that is those with domestic sales shares of total sales being 50 per cent or higher), 11 per cent of them were in need of additional financing urgently and 29 per cent were in need of additional financing (Table 4.2). The

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47

Table 4.1 Demand for Financing by SMEs in Thailand and Malaysia Yes

No

NA

Total

186 29.0

394 61.4

1 0.2

642 100

82 37.1

79 35.7

11 5.0

Urgent

Not Urgent

Thailand # of SMEs Shares (%)

61 9.5

Malaysia # of SMEs Shares (%)

49 22.2

221 100.0

Source: JBIC (2001a, 2001b)

Table 4.2 Demand for Financing and Sales Orientation of SMEs in Thailand and Malaysia: 1999 100% Domestic Sales

Majority 100% Majority Domestic Domestic Sales Sales

Thailand # of SMEs Total Yes, urgent Yes No No answer

342 37 93 211 1

139 16 44 79 0

481 53 137 290 1

% of total Total Yes, urgent Yes No No answer

100 10.8 27.2 61.7 0.3

100 11.5 31.7 56.8 0.0

100 11.0 28.5 60.3 0.2

Malaysia # of SMEs Total Yes, urgent Yes No No answer

44 6 23 13 2

89 26 34 24 5

% of total Total Yes, urgent Yes No No answer

100.0 13.6 52.3 29.5 4.5

100.0 29.2 38.2 27.0 5.6

Domestic MajorityExports 100% 50:50 Exports

13 1 3 9 0

148 7 46 95 0

642 61 186 394 1

100 7.7 23.1 69.2 0.0

100 4.7 31.1 64.2 0.0

100 9.5 29.0 61.4 0.2

133 32 57 37 7

– – – – –

88 17 25 42 4

100.0 24.1 42.9 27.8 5.3

– – – – –

100.0 19.3 28.4 47.7 4.5

Source: JBIC (2001a, 2001b)

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Total

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221 49 82 79 11 100.0 22.2 37.1 35.7 5.0

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financial problem for SMEs with export orientation was less acute, since only 4.7 per cent of SMEs with export shares of 50 per cent or higher need additional financing urgently, and 31.1 per cent need additional financing. This relationship is illustrated more succinctly in Malaysia. For domestic market-oriented SMEs, 24 per cent of them needed additional financing urgently and 43 per cent needed additional financing. By contrast, for export-oriented SMEs the corresponding figures were substantially lower at 19 and 28 per cent, respectively. These findings are consistent with the earlier observation that export-oriented SMEs fared better than domestic marketoriented SMEs in their business performance. The severity of the credit constraint for the seriously impacted SMEs may be observed in Thailand and Malaysia from the finding that 64 and 56 per cent of SMEs in need of additional financing in these countries needed it to deal with a shortage of working capital (Table 4.3). The shortage of working capital was more serious for SMEs in urgent need of financing, as 78 and 61 per cent of SMEs needing additional financing urgently indicated acquisition of working capital as a reason for additional financing in Thailand and Malaysia, respectively. Other motives for obtaining additional financing by Thai SMEs include purchasing of machinery and equipment (41%), refinancing of loans (25%), acquisition of land and building (11%). For SMEs in Malaysia, purchasing of machinery and equipment (53%) was also an important motive, while refinancing of loans (9.2%) was not as important in Malaysia as in Thailand. 3. The Sources of Financing for SMEs We observed that significant shares of SMEs in the total sample in the survey needed financial resources to cope with the problem caused by the Asian Financial Crisis. Let us examine how and from where SMEs acquired financing during the Crisis-hit period in this section. SMEs in Thailand and Malaysia obtained financing from various sources. For both of them commercial banks were the most important source of finance, as 57 and 62 per cent of financing for working capital for SMEs in Thailand and Malaysia in 1999 were acquired from commercial banks, respectively (Table 4.4).5 Albeit at a lesser degree, for financing for investment, commercial banks were the most important source, accounting for 37 and 21 per cent of total financing for investment for SMEs in Thailand and Malaysia, respectively. Financing from commercial banks took several forms including overdraft, L/C, bank guarantee for the financing of working capital, and long-term loans for fixed investment. The importance of commercial

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55.7 61.2 51.2

% shares Total Yes, urgent Yes 52.7 55.1 50.0

69 27 41

40.5 41.0 40.3

100 25 75

Machinery and Equipment

Source: JBIC (2001a, 2001b)

73 30 42

63.6 78.7 58.6

157 48 109

Malaysia # of firms Total Yes, urgent Yes

% shares Total Yes, urgent Yes

Thailand # of firms Total Yes, urgent Yes

Working Capital

28.2 22.4 31.7

37 11 26

11.3 4.9 13.4

28 3 25

Land and Building

19.8 20.4 19.5

26 10 16

6.5 6.6 6.5

16 4 12

R&D

9.2 12.2 7.3

12 6 6

24.7 27.9 23.7

61 17 44

Refinancing of Loans

– – –

– – –

3.2 4.9 2.7

8 3 5

Raw Material

– – –

– – –

6.9 3.3 8.1

17 2 15

Expansion of New Business

Table 4.3 Purposes of Financing by SMEs in Thailand and Malaysia

11.5 14.3 7.3

15 7 6

4.9 8.2 3.8

12 5 7

Others

– – –

– – –

0.8 1.6 0.5

2 1 1

N.A.

100.0 100.0 100.0

131 49 82

100 100 100

247 61 186

Total

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Table 4.4 Sources of Financing for SMEs in Thailand and Malaysia Working Capital 1996 1999

Thailand The number of usage Public financial institutions Commercial banks Finance companies Informal finance Overseas/offshore financing Other lending institutions/factoring Sales proceeds Company’s internal reserves Head office Percentage shares of total (642) Public financial institutions Commercial banks Finance companies Informal finance Overseas/offshore financing Other lending institutions/factoring Sales proceeds Company’s internal reserves Head office

Malaysia The number of usage Development Finance Institutions Commercial banks Finance companies Government concessional loan & grant Informal finance Overseas/offshore financing Other lending institutions/factoring Sales proceeds Company’s internal reserves Percentage shares of total (221) Development Finance Institutions Commercial banks Finance companies Government concessional loan & grant Informal finance Overseas/offshore financing Other lending institutions/factoring Sales proceeds Company’s internal reserves

23 377 8 43 8 3 292 132 21 3.6 58.7 1.2 6.7 1.2 0.5 45.5 20.6 3.3

7 131 15 2 23 5 5 70 39 3.2 59.3 6.8 0.9 10.4 2.3 2.3 31.7 17.6

24 365 7 54 9 2 309 150 19 3.7 56.9 1.1 8.4 1.4 0.3 48.1 23.4 3.0

9 138 15 10 30 7 3 74 50 4.1 62.4 6.8 4.5 13.6 3.2 1.4 33.5 22.6

Investment 1996 1999

16 265 11 26 14 4 113 96 21

14 235 9 33 10 3 131 99 19

2.5 41.3 1.7 4.0 2.2 0.6 17.6 15.0 3.3

2.2 36.6 1.4 5.1 1.6 0.5 20.4 15.4 3.0

15 45 38 2 9 2 7 25 25

8 46 35 8 14 2 6 29 34

6.8 20.4 17.2 0.9 4.1 0.9 3.2 11.3 11.3

3.6 20.8 15.8 3.6 6.3 0.9 2.7 13.1 15.4

Note: The figures in the upper portion of the table indicate the number of usage, while the figures in the lower portion indicate the proportion of the actual usages per respondent (=the number of usage/the number of respondents) Sources: JBIC (2001a, 2001b)

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banks in terms of their share in SME financing declined in Thailand after the Crisis, but it remained more or less at the same level for Malaysia. This difference reflects the differences in lending performance of commercial banks in Thailand and Malaysia. Specifically, the loan outstanding of commercial banks to SMEs in Thailand declined by 10 per cent from December 1997 to December 1999, while the loan outstanding of commercial banks to SMEs in Malaysia increased as much as 97 per cent. The next important source of finance was self-financing in the forms of sales proceeds and internal reserves for both Thailand and Malaysia. Selffinancing was more important for the acquisition of working capital than financing for investment. This is understandable, as the funds for investment tend to be larger than those for working capital. As such, SMEs with limited financial resources find it difficult to finance investment with their own funds and thus use loans from financial institutions. The role of financial companies in SME financing is different in the two countries. In Malaysia, financial companies have significantly greater role in financing SMEs, as 6.8 and 15.8 per cent of SME finance for working capital and investment came from financial companies in 1999, respectively, while the corresponding values in Thailand were significantly lower at 1.1 and 1.4 per cent, respectively. It is to be noted that informal financing became more important for SMEs after the Crisis for both Thailand and Malaysia, reflecting increased difficulty in obtaining financing from formal sources such as commercial banks. Informal financing was particularly important for SMEs with an urgent need of financing, as 15 per cent of SMEs in Thailand and 22 per cent of SMEs in Malaysia with an urgent need of financing for working capital used informal financing.6 It is surprising that the proportion of SMEs that acquired financing from public financial institutions remained low even after the Crisis. This appears to indicate ineffectiveness of public institutions in mitigating financial problems of SMEs during the Crisis. Indeed, many SMEs that obtained financing from the public financial institutions were not satisfied with the service. Major complaints of SMEs concerning financing from the public financial institutions included excessive amount of documentation, excessively long processing time, and small loan size.7 So far we have examined how SMEs acquired financial resources during the Crisis period. One of the interesting observations was the increase in informal finance for SMEs in both Thailand and Malaysia after the Crisis, reflecting increased difficulty in acquiring financing from formal financial institutions. To investigate the kinds of financial problems which SMEs were faced with in obtaining loans from the financial institutions, let us examine the complaints that SMEs had concerning financing by financial institutions.

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The results of the response in Table 4.5 show that stringent requirement for collateral, banks’ refusal for loan roll-over, insufficient loan amount, complicated procedure and document requirement, high interest rates, and long processing time were major complaints of SMEs with urgent need of financing for SMEs in Thailand and Malaysia. Judging from the proportion of SMEs indicating complaints of the bank’s refusal of loan roll-over, complicated procedure and document requirements, and long processing time, such problems are more serious and pronounced in Thailand than in Malaysia. As for collaterals, more than 80 per cent of SMEs were asked to offer land or building as guarantees for the loans. Besides land and buildings, machinery and stocks were increasingly offered as collaterals after the Crisis. A substantial decline in land prices as a result of the burst in the real estate bubble after the Crisis resulted in the increased importance of machinery as collateral. The problem of SMEs requiring collateral in the form of land and building in the total number of SME borrowers was significantly smaller (around 40 per cent) in Malaysia. Moreover, the importance of machinery and stocks as collateral did not change after the Crisis in Malaysia, unlike the case in Thailand. 4. The Causes of Credit Shortage for SMEs SMEs have difficulty in acquiring financial resources even during normal economic conditions when compared to large firms. Levy et al. (1999) found in their study of Indonesia, Japan, Korea, and Colombia that SMEs were put in a disadvantageous position vis-à-vis large firms in the financial market. They identified several factors behind disadvantageous treatment of SMEs in the financial market. The factors can be divided into two groups. One group of factors concerns the credit worthiness of SMEs and the other concerns the attitude and capability of financial institutions. We examine these two groups of factors for explaining credit shortage for SMEs in this section.

4.1. Demand-side Problems: Problems of SMEs The factors affecting the credit worthiness of SMEs include, a lack of resources such as human resources, technological capability, and marketing skills. These resources are required for successful business operation. In addition, the low collateral value of SME assets makes it difficult for SMEs to acquire bank loans. Having noted the factors resulting in low credit worthiness on the part of SMEs, it should be emphasized that such assessment may be correct for the average SMEs but not for all SMEs. There are many SMEs that have excellent

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13 15 3 0 31 26.5 18.3 3.8 0.0 14.0

44.9 19.5 7.6 0.0 19.9

47.5 15.1 7.6 100.0 13.7

29 28 30 1 88

22 16 6 0 44

42.6 32.8 11.9 0.0 20.9

26 61 47 0 134

Source: JBIC (2001a, 2001b)

Malaysia The number of firms Yes, urgent Yes No NA Total Proportion to total (%) Yes, urgent Yes No NA Total

Thailand The number of firms Yes, urgent Yes No NA Total Proportion to total (%) Yes, urgent Yes No NA Total

24.5 39.0 20.3 0.0 27.1

12 32 16 0 60

34.4 44.1 22.1 0.0 29.6

21 82 87 0 190

49.0 35.4 8.9 0.0 27.1

24 29 7 0 60

50.8 38.7 15.5 0.0 25.5

31 72 61 0 164

16.3 23.2 10.1 9.1 16.3

8 19 8 1 36

39.3 39.8 21.8 0.0 28.7

24 74 86 0 184

20.4 37.8 10.1 0.0 22.2

10 31 8 0 49

31.1 28.5 13.7 0.0 19.6

19 53 54 0 126

– – – – –

– – – – –

1.6 2.2 1.5 0.0 1.7

1 4 6 0 11

14.3 3.7 3.8 9.1 6.3

7 3 3 1 14

9.8 3.2 1.5 0.0 2.8

6 6 6 0 18

Complicated Bank’s Stringent Procedure Insufficient Refusal High Conditions and Long UnLoan of Loan Interest on Document Processing satisfactory Amount Roll-over Rate Collateral Requirement Time Service Others

– – – – –

– – – – –

0.0 2.7 0.5 0.0 1.1

0 5 2 0 7

NA

Table 4.5 Financing Needs and Complaints against Financial Institutions in Thailand and Malaysia

100.0 100.0 100.0 100.0 100.0

49 82 79 11 221

100.0 100.0 100.0 100.0 100.0

61 186 394 1 642

Total Respondents

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human resources and/or technological capability. Indeed, one of the notable characteristics of SMEs is their heterogeneity, reflecting wide variance in their characteristics. Let us examine how SMEs see their problems in acquiring financing. We have already seen that insufficient collateral on the part of SMEs made it difficult to acquire loans. Many SMEs realize that a lack of technical and managerial capability is a serious obstacle to successful business operation. In the JBIC survey, in both Thailand and Malaysia technology upgrading is considered to be the most serious issue as it received the highest count, 47 and 58 per cent in the respective countries.8 In addition to technology upgrading, the following items were identified as important: upgrading quality control technology, strengthening marketing in the domestic market, export market, and upgrading capabilities of human resources, for both countries.9 As to the reasons for low technological capabilities, budget constraint and low capabilities of human resources were most important for both countries. Although not as important as the two items indicated above, lack of cooperation with companies in the same industry and support from public institutions were also identified as obstacles to technology development. SMEs in Thailand in particular see these as serious obstacles. SMEs with resource constraints benefit substantially from inter-firm relationships, particularly in obtaining information on marketing, technology and others. Business associations can play an important role for obtaining and disseminating information. However, a large number of SMEs do not belong to any such associations in Thailand. JBIC (2001a) finds that 44 per cent of sample SMEs in Thailand were not members of any business associations, indicating a lot of potential for improvement in this area.10 In Malaysia as many as 87 per cent of sample SMEs are members of industry associations. High participation ratio is reflected in a smaller portion of SMEs indicating lack of cooperation with companies as an obstacle to improving technological capability. Concerning public assistance, tax incentives and subsidies are generally the most wanted measures by SMEs. Indeed, as much as 66.2 per cent of respondents in Thailand indicated their desire to utilize tax incentives and subsidies. The next most wanted policies include technical and marketing assistance, as 20 to 50 per cent of the respondents indicated their desire to receive such assistance. The proportion of the respondents desiring financial assistance was 27 per cent, significantly lower when compared to other public assistance. One should not be misled by the low proportion of SMEs desiring such assistance to indicate that SMEs do not need financial assistance. Faced with the difficulty in acquiring financing from the private

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sources by SMEs, it is natural that such SMEs would be interested in acquiring financing from public institutions. Considering these factors, one may argue that a lack of knowledge on the availability of public financial assistance and a perception of cumbersome procedures associated with acquisition of public financial assistance on the part of SMEs resulted in low expectation of public financial assistance.

4.2. Supply-side Problems: Problems of Financial Institutions Now that we have discussed the problems associated with SMEs in obtaining financial resources, we turn our attention to the supply side factors pertaining to the financial institutions. A lack of incentives toward SME financing on the part of financial institutions results in a shortage of credit allocated to SMEs. One reason behind the low incentive for financial institutions to lend to SMEs has to do with economies of scale associated with lending operations. Given that the cost of processing loan application is more or less the same regardless of the size of the loan, financial institutions attach greater weight to the loan requested by large firms, since loan amount requested by large firms tends to be larger than the loan amount requested by SMEs. In fact, the cost of processing loan application is likely to be high for SMEs due to a lack of transparency concerning their managerial and financial situations, making the provision of loan to SMEs less attractive. Having noted the factors that reduce incentives on the part of financial institutions for extending loans to SMEs, one has to note a lack of experience and capability in extending loans to SMEs on the part of financial institutions as a factor behind shortage of financing to SMEs. As noted above, many SMEs have the potential to succeed because of their innovative skills in technology and management. However, even those potentially successful SMEs have difficulty in acquiring loans, because financial institutions cannot evaluate their business potential appropriately. Before proceeding to the analysis of SME financing, let us briefly examine the recent trends in overall financing in Thailand and Malaysia. Overall lending in Thailand continued to decline after the crisis through the end of 1999, as reflected in the decline in loan outstanding from 7.7 trillion baht at the end of 1997 to 6 trillion baht at the end of 1999 (Table 4.6). Similar to the situation in Thailand, bank loans in Malaysia (Table 4.7) continued to decline from 1997 through 1999, as loan outstanding at the end of these years declined from 421 billion RM to 392 billion RM. It is worth noting that in both Thailand and Malaysia the interest rates declined substantially in the post-Crisis period, resulting from the easy monetary policies in these

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Source: Bank of Thailand

Small Industry Credit Guarantee Corporation (SICGC) Total

Commercial banks Finance companies Industrial Finance Corporation of Thailand (IFCT) Small Industry Finance Corporation (SIFC) Government Savings Bank (GSB) Bank for Agriculture and Agricultural Co-operatives (BAAC) Government Housing Bank (GHB) Export-Import Bank of Thailand (EXIM Bank) Sub-total

Types of Financial Institutions

2.1 0.0 1.3 2.6 3.6 0.3 100.0

160.3 1.2 97.2 197.2 278.7 24.1 7687.3 1.7 7689.0

73.5 16.6

5651.4 1277.2

End of 1997 Outstanding Share (Baht Billion) (%)

1.5 7103.4

25.2 7101.9

206.6 296.2

2.0 122.6

138.9

5216.9 1093.5

0.4 100.0

2.9 4.2

0.0 1.7

2.0

73.5 15.4

End of 1998 Outstanding Share (Baht Billion) (%)

4.6 –7.6

4.8 6.3

66.7 26.1

–13.3

–7.7 –14.4

1.3 5988.4

30.1 5987.1

222.4 282.9

2.2 120.8

138.5

4889.2 301.0

0.5 100.0

3.7 4.7

0.0 2.0

2.3

81.7 5.0

End of 1999 Change Outstanding Share (%) (Baht Billion) (%)

Table 4.6 Total Loans Outstanding by Types of Financial Institutions in Thailand

19.4 –15.7

7.6 –4.5

10.0 –1.5

–0.3

–6.3 –72.5

Change (%)

56

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11,403

2,593

40,592

Merchant banks

Total

Source: JBIC (2001b)

26,596

Commercial banks

Finance companies 100.0

6.4

28.1

65.5

60,836

3,677

16,563

40,596

100.0

6.0

27.2

66.7

49.9

41.8

45.3

52.6

62,461

3,452

15,482

43,527

100.0

5.5

24.8

69.7

2.7

–6.1

–6.5

7.2

66,793

939

13,506

52,348

100.0

1.4

20.2

78.4

6.9

–72.8

–12.8

20.3

End of 1996 End of 1997 End of 1998 End of 1999 Types of Financial Outstanding Share Outstanding Share Change Outstanding Share Change Outstanding Share Change Institutions RM Million (%) RM Million (%) (%) RM Million (%) (%) RM Million (%) (%)

Table 4.7 Loans Outstanding to SMEs by Types of Financial Institutions in Malaysia

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countries. These two seemingly contradictory developments, the decline in the loan outstanding and the easy financial situation, appear to indicate the presence of structural problems in the financial market in both countries. We now examine the roles of different financial institutions in the provision of loans in Thailand, as the information necessary for the analysis is available in Table 4.6. Wide variations are observed for the lending performance among different financial institutions. Private financial institutions, that is, commercial banks and finance companies, registered continuous decline in their loan outstanding from 1997 to 1999. Particularly striking was the drastic decline in lending by finance companies in 1999, as their loan outstanding declined by 72.5 per cent from the previous year. The decline in lending by commercial banks was attributable to deterioration in the problem of non-performing loans, which in turn resulted from the Crisis. Closure of 58 finance companies by the government ordinance because of their unsound financial situation led to the dramatic decline in their lending. In contrast to the decline in lending by private financial institutions, most public financial institutions increased lending. This was in response to unfulfilled demand for financial resources by Thai firms in the midst of the Crisis. It should be noted that despite the decline in lending by the private financial institutions and the increase in lending by the public financial institutions, the share of private financial institutions in total lending remained very high at 86.7 per cent at the end of 1999, a slight decline from 90.1 per cent at the end of 1997. We observed a decline in overall lending in Thailand and in Malaysia after the Crisis. The rate of decline is particularly dramatic in Thailand. We now turn to the trends in SME financing in two countries. To begin with the case of Thailand, although accurate patterns cannot be observed because of the lack of statistical information, a similar decline appeared to have taken place for lending to SMEs. According to the estimate by JBIC (2001a), which assumes that loans with the size ranging between 5 million to 100 million baht as those to SMEs, commercial banks and financial companies reduced the loan outstanding to SMEs by 11 and 62 per cent from December 1997 to December 1999, respectively.11 Having observed a substantial decline in lending in Thailand, it may be odd to find that the lending capability of commercial banks increased in 1998 and 1999. Indeed, the ratio of loan to deposit for commercial banks declined from 140.1 per cent in 1997 to 109.6 per cent in the fourth quarter of 1999.12 A similar “apparent” soft lending market situation may be indicated by low interest rates prevailing in the post-Crisis period. The minimum lending rate increased from 13.38 per cent in June 1997 to 16 per cent in

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March 1998, and then declined sharply to 8.63 per cent in December 1999. One wonders why commercial banks were hesitant in lending in the post-Crisis period despite having abundant funds and that SME lending was given high priority by the government. Several reasons can be identified. First, worsening of non-performing loans caused banks to practice conservative banking. Second, due to fears of non performing loans, commercial banks began to assign greater importance to the value of collaterals in making loan decisions. With limited asset value, many SMEs were unable to acquire bank loans. Third, a lack of capability on the part of commercial banks in assessing the non-tangible asset such as technology and management know-how of SMEs discouraged lending to SMEs. Unlike the case in Thailand, SME lending in Malaysia increased in the post-Crisis period, attributed largely to government policy that encouraged active lending by commercial banks (Table 4.7). Indeed, loan outstanding by commercial banks increased by 29 per cent from December 1997 to December 1999, while loan outstanding by finance companies and merchant banks declined by 18 and 74 per cent, respectively. As a result of these differences in the lending behaviour of three financial institutions, the share of commercial banks in SME lending increased from 67 per cent in 1997 to 78 per cent in 1999. Active lending by commercial banks stem from their perception that the Malaysian government attach high priority to the development of SMEs, and also that the banks themselves regard SMEs to be important customers in the future. A substantial decline in lending by merchant banks and finance companies was due to their difficult financial situations, which in turn resulted from increasing non-performing loans. Financial companies used to specialize in auto loans. But as a result of liberalization in the financial sector, they expanded their operation in housing and real estate business. The outbreak of the financial crisis led to a collapse in these markets, resulting in non-performing loans. It is to be noted that in Malaysia, similar to the case in Thailand, private financial institutions became more conservative in lending to SMEs because of their difficult financial situations. So far the paper has examined the role of private financial institutions. We now turn to public financial institutions, which allegedly played an important role in providing finance to SMEs, to mitigate SMEs’ financial problems. Earlier it is observed that the share of financing by public financial institutions in total financing remained more or less at the same level before and after the Crisis in Thailand. Recognizing the difficult financial situation faced by SMEs, the Thai government increased the availability of financing by public financial institutions to SMEs after the crisis. For example, the

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credit line by all public financial institutions except the Bank of Thailand increased after the Crisis. Specifically, the total credit line by Industrial Finance Corporation of Thailand (IFCT), Small Industry Finance Corporation (SIFC), Government Savings Bank (GSB), Bank for Agriculture and Agricultural Cooperatives (BAAC), increased from 20 billion baht in 1999 to 33.3 billion baht in 2000, while the rediscount facility of the Bank of Thailand declined sharply from 42 billion baht to 13 billion baht during the same period (Table 4.8). What has to be noted is the decreasing amount of approved credit, as it declined from 35 billion baht in 1999 to 13 billion baht in 2000. Indeed, the share of approved amount to the allocated amount declined from 53.8 per cent in 1999 to 28.8 per cent in 2000. Low utilization of public financing by SMEs points out problems in carrying out public financial assistance by the Thai government. Some of the problems are lack of experience in dealing with SMEs, under-development of the evaluation capability of SMEs, cumbersome procedures for loan application and others. In Malaysia (Table 4.9) disbursement of public loans has been more favourable. The Fund for Small and Medium Industries, which was set up to deal with the Crisis in 1998, disbursed 88 per cent of the funds allocated to the Fund. Bumiputra Industrial Fund also had a good disbursement record, although its line of credit is smaller when compared to other sources. Some of the problems with public financial institutions in their lending include long processing time, and cumbersome application procedures. 5. Conclusions SMEs play various important roles in achieving economic development in developing countries. SMEs not only provide employment opportunities to abundant labour force but also generate dynamism by realizing entrepreneurial capability. Despite the importance of developing competitive SMEs, SMEs are generally treated adversely in the market when compared with large firms. Discriminatory treatment of SMEs becomes serious when economic condition becomes unfavourable. Indeed, during the Asian Financial Crisis of the late 1990s, SMEs in the Crisis-hit countries suffered tremendously not only because of the decline in demand but also because of the difficulty in obtaining items such as finance and other inputs, which are necessary for production. The analysis of the financial problems faced by SMEs in Thailand and Malaysia identified several causal factors. They can be divided into two groups. One pertains to the factors related to SMEs and the other to those related to financial institutions. The factors that reduce SMEs’ credit worthiness

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77

500

1,184 675 34,960

2,000 1,000 65,000 1,282 – 36,242

11,051 6,542 561

12,000 5,000 3,000

4,500 – 69,500

14,947

42,000

15.4

28.5 – 52.1

59.2 67.5 53.8

92.1 130.8 18.7

35.6

4,000

5,500 10,000 61,800

4,000 1,300 46,300

15,000 7,000 6,000

13,000

237

1,875 12 15,239

2,258 459 13,352

4,423 1,497 633

4,082

5.9

34.1 0.1 24.7

56.5 35.3 28.8

29.5 21.4 10.6

31.4

2000 (as of 30 June 2000) Share of Credit/ Approved Approved Guarantee Amount Amount Line (a) (b) (b/a) (%)

Notes: 1) Bill discount facility 2) Joint Development Fund for Supporting SMEs established on 25 January 1999. 3) Established in February, 2000. Source: JBIC (2001a) which compiled the data from the Bank of Thailand.

Krung Thai Bank 2) Bangkok Bank 3) Credit line total Small Industry Credit Guarantee Corporation (SICG)

Bank of Thailand 1) Industrial Finance Corporation of Thailand (IFCT) Export-Import Bank of Thailand (EXIM Bank) Small Industry Finance Corporation (SIFC) Bank for Agriculture and Agricultural Co-operation (BAAC) Government Savings Bank (GSB) Subtotal

Financial Institutions

1999 (as of 31 December 1999) Share of Credit/ Approved Approved Guarantee Amount Amount Line (a) (b) (b/a) (%)

Table 4.8 Credit Lines for SMEs by Public Financial Institutions in Thailand

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Source: JBIC (2001b)

100

1,000

Fund for Food Scheme (3F)

Bumiputera Industrial Fund (BIF)

1,850 1,250

Fund for Small & Medium Industries (FSMI)

New Entrepreneur Fund (NEF)

Financial Institutions

Credit/ Guarantee Line (a)

77

260

652

236

75

355

681

1,634

Outstanding Disbursement 1998 1999 (b)

Table 4.9 Credit Lines for SMEs by Public Financial Institutions in Malaysia

75.0

35.5

54.5

88.3

Disbursement Ratio (b) / (a) (%)

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include a lack of collateral and a lack of competitiveness. SMEs cannot do much to increase the value of their collateral, but they can do much to improve their competitiveness. Improving technical and managerial skills through training and education should be effective in improving competitiveness. In practice, collaboration and cooperation with and assistance from other firms and public institutions facilitate the process. In particular, the effective use of information technology (IT) should be emphasized. Several problems were uncovered that have led to banks’ conservative attitude toward lending to SMEs. One is the presence of non-performing loans, which resulted from the Financial Crisis. The problem of non-performing loans has to be dissolved speedily by carrying out structural reform programmes. Another serious problem is the lack of capability on the part of financial institutions in evaluating credit worthiness of SMEs. This problem is largely attributed to a lack of experience in dealing with SMEs. As noted above, one of the important characteristics of SMEs is their heterogeneity. It is in the best interests of the financial institutions to identify potentially competitive SMEs and give loans to them. In order to be able to evaluate the credit worthiness of SMEs appropriately, financial institutions should not only increase contact with SMEs but also expand their networks for the collection of useful information on SMEs. Public sector can also support SMEs and SME lending by private financial institutions by providing training programmes and financial resources. The public sector should closely collaborate with the private sector in implementing these programmes. This chapter has only examined credit as a means of raising funds for SMEs, because of its importance for SME financing at the present. However, it is very important to develop alternative sources of funds such as from the capital market. This is especially so, when commercial banks and other financial institutions are likely to continue their conservative business practices. For the development of capital market, SMEs have to improve their technological and managerial capability as noted above and in particular improve their transparency. The government has to formulate the rules of capital market and enforce them strictly, in order to develop capital markets successfully. NOTES 1. 2. 3. 4.

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For a detailed description of the surveys, see JBIC (2001a, 2001b). JBIC (2001a), Table 3.11 and JBIC (2001b), Figure 3.1. JBIC (2001a), Table 3.12, and JBIC (2001b), Table 3.11. This observation is based on GDP growth rates, because domestic sales of SMEs

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5.

6. 7. 8. 9. 10. 11. 12.

in Thailand and Malaysia are not reported in the survey. GDP growth rates for Thailand and Malaysia were –10.8 and –7.4 per cent in 1998, and 4.2 and 6.1 per cent in 1999, respectively. The proportions of SMEs, which received loans from the bank and other financial institutions, in overall SMEs in Thailand and Malaysia in the survey are significantly higher than the corresponding proportion in Indonesia, where selffinancing accounts for a dominant share of funding (Urata, 2000). One of the factors leading to these contrasting patterns in Thailand and Malaysia on the one hand and in Indonesia on the other hand, is the difference in the size of the firms under study. SMEs in Thailand and Malaysia in the survey are significantly larger than those in the Indonesia study. This figure, which is not shown in Table 4, was taken from JBIC (2001a). JBIC (2001a), pp. 37–38. JBIC (2001a), Table 3.36 and JBIC (2001b), Table 3.46. JBIC (2001a), Table 3-35. JBIC (2001a), Table 3-9. JBIC (2001a), Table 4.4. JBIC (2001a), Table 4.2.

REFERENCES Dwor-Frecaut, Dominique, Francis Colaco and Mary Hallward-Dreimeir, eds. Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries. The World Bank, 2000. Japan Bank for International Cooperation (JBIC). “Issues of Sustainable Development in Asian Countries: Focused on SMIs in Thailand”. JBIC Research Paper no. 8, 1 January 2001a. Japan Bank for International Cooperation (JBIC). “Issues of Sustainable Development in Asian Countries: Focused on SMIs in Malaysia”. JBIC Research Paper no. 8, 2 January 2001b. Levy, Brian, Albert Berry and Jefferey B. Nugent, eds. Fulfilling the Export Potential of Small and Medium Firms. Kluwer Academic Publishers, 1999. Urata, Shujiro. Policy Recommendation for SME Promotion in the Republic of Indonesia, Japan International Co-operation Agency, 2000.

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. articles are available at < http://bookshop.iseas.edu.sg > Donors’ Role inIndividual SME Development 65

5

An Overview of Donors’ Role in SME Development in Southeast Asia after the Crisis Edgard R. Rodriguez 1

1. Introduction The Asian Financial Crisis of 1997–1998 and the subsequent threats of regional economic slowdown have underscored the importance of having fast growing and adaptable SMEs in Southeast Asia (SEA). In fact, the Asian Financial Crisis was a rude wake-up call to Southeast Asian countries as well as multilateral and bilateral donor agencies that work in the region. Based on past experiences, governments and donors have been taking steps to review their own roles in SME promotion and are switching their approaches to adjust to changes posed by the new economic environment. One of these changes in the economic environment is the apparent decline in SEA’s share in global foreign investment.2 In the past, Southeast Asia relied heavily on foreign direct investments (FDI) for the rapid economic growth it experienced over the last three decades. Past development strategies largely favoured FDI from large corporations and export-orientated manufacturing industries to large domestic enterprises.3 Today a sizeable chunk of FDI that used to come to SEA are already being diverted to lower

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cost countries such as the People’s Republic of China (PCR), which is well on its way to becoming the world’s largest manufacturer in the coming decade. With less FDI available, domestic investment needs to rise to the challenge to sustain economic growth in the coming decades. However, most domestic enterprises in SEA are predominantly micro-enterprises and SMEs. These numerous enterprises are mostly in traditional sectors such as agriculture and services, and few or no contacts with foreign enterprises or technology to improve their operations. Those in manufacturing, a higher value-added sector compared to agriculture or services, continue to lag behind, displaying low levels of productivity.4 In fact, the uneven development of SMEs vis-à-vis the large corporate sector has resulted in a widening of productivity gap between small and large firms (Little, Mazumdar and Page 1987; Berry and Mazumdar 1991). The neglect of the domestic SMEs has kept some countries from moving up the economic development ladder faster. Not surprising, competitiveness of SMEs has been recognized as a priority policy area for the Southeast Asian economies. Competitiveness is defined as the ability of enterprises to remain profitable by delivering to the market the products and services that consumers desire and demand. Firms become more competitive by competing with other firms. The Crisis resulted in a re-evaluation of industrial policies to place greater emphasis on improving the climate for investment. The key to successful future interventions in the coming years is that governments and enterprises across SEA devise strategies to take full advantage of the potential benefits that competition, technology and globalization offer (See ADB, 2003b, Part III). Adaptability and efficiency of SMEs should then be added to the fact that SMEs provide employment potential. Together, gains in competitiveness and increased employment would contribute to sustainable poverty reduction in the region (see Harvie and Lee 2002). The paper focuses on stock-taking the efforts by donors to support development of SMEs, with particular emphasis on SEA (see also ADB, 1990 and 2002 for a review on SME assistance in Asia). Most of the work reflect the discussions by the SME Donor Committee, and other donor meetings. Section 2 reviews the issue of definition and the chronic under-development of SMEs in SEA. Section 3 focuses on the role of donor support in promoting better business environments. Section 4 examines the constraints of managerial resources and the donors’ view on promotion of Business Development Services (BDS). Section 5 reviews the challenges of SMEs in getting access to financial resources and the tools available to donors to promote greater and better access to these resources. Section 6 provides concluding remarks.

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2. Defining SMEs in Southeast Asia Comparable definitions of SMEs are seldom available, even though they are necessary to clearly describe the target of any SME policy. The statistical definition of SMEs continues to vary widely by country, based on the number of employees, value of assets or value of sales. SMEs are commonly understood to be in the processing or manufacturing (including food manufacturing) and services sectors. Most reliable data refer to manufacturing SMEs. A common definition of a SME is based on the number of employees. According to World Bank’s SME Department (Hallberg, 2001), the lower limit for small-scale enterprises is normally between 5 to 10 workers and the upper limit is between 50 to 100 workers. Meanwhile, the upper limit of medium-scale enterprises is between 100 to 250 employees. Asset- or sales-based definitions are even harder to evaluate size-wise, let alone definitions over time or across countries (see Chapter 2 in Katrak and Strange 2002). To have a clearer picture of the target enterprise segment, micro-enterprises could be excluded. Although the micro-enterprise sector employs a large segment of the manufacturing workforce, the great majority of micro enterprises are non-growing enterprises that mainly rely on unpaid family labour. Also, they tend to be established during economic crises as the result of the lack of better employment opportunities elsewhere, which means that as economic recovery picks up again, many of the micro-enterprises started during the crisis are likely to close down. Once we use comparable indicators, the relative size of the sector made up by SMEs (those with 10 to 99 workers) tends to appear smaller in economies with structural constraints, such as in Indonesia and the Philippines. Japan, Republic of Korea and Hong Kong, China have almost half of the manufacturing labour force in enterprises with 10 to 100 workers, and Malaysia and Singapore show an intermediary stage with one-third of the labour force in SMEs. Philippines and Indonesia however have less than a quarter of the labour force in this type of firms, and both countries continue to have large micro-enterprise sectors which have low potential for growth. Table 5.1 shows that small enterprises (with 10 to 99 workers) tend to have a significant presence in more mature economies with broad-based characteristics such as Japan and Republic of Korea. In less developed and more polarized economies, employment is divided between very small survival cottage enterprises and large family or foreign conglomerates.

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Table 5.1 Importance of Manufacturing SMEs* in East Asia (as % of Total Industrial Labour force, Excluding Firms with Fewer than Ten Workers)

Indonesia** (1996) Philippines (1994) Singapore (1985) Malaysia (1981) Japan (1993) Republic of Korea (1993) Hong Kong, China (1991)

10–99 workers

100–199 workers

200+ workers

Total Labour Force*

14.8 23.9 31.8 35.5 47.1 47.8 56.4

8.7 11.8 13.4 16.1 13.6 11.7 14.6

76.5 64.3 54.8 48.4 39.3 40.5 29.0

100 100 100 100 100 100 100

* Excluding micro-enterprises with fewer than ten workers. ** Only for Indonesia, the figures exclude firms with fewer than twenty workers. Sources: Rodriguez and Tecson, Liberalization and Small Industry — Have Manufacturing SMEs in the Philippines Benefited?, Small Enterprise Development (1998; Table 1 and 2). Data from Indonesia from Rodriguez and Ter Wengel (2002, mimeo).

Many factors have constrained the growth and development of small businesses in Southeast Asia (and many other parts of the developing world too). These constraints include: (i) a poor policy environment to conduct private business which disproportionally penalizes SMEs because it is relatively more expensive for SMEs to deal with a myriad of overlapping and sometimes contradicting regulations; (ii) the lack of adequate market for advisory services for SMEs in an environment where the governments and donors have provided services at low cost without substantial outreach or sustainability; and (iii) the lack of financial and physical infrastructure to support SMEs with access to markets with reliable production, and even exports. Assistance by donors were traditionally aimed at reducing and eliminating these constraints through a series of interventions. The new directions for donors5 indicate an integrated approach to SME development, or what some refer as the “Three-Legged Stool”. The approach involves improving the enabling environment, offering high-quality and sustainable business development services, and improving access to financial markets by building capacity in financial institutions and promoting SME financial instruments. 3. Donors’ Experience in Improving Investment Environments: Lifting Regulatory Constraints Reducing or eliminating the regulatory burden on SMEs is one of the greatest spurs to entrepreneurship. Problems stem from regulatory systems

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developed in the image of large firms, rewarding economies of scale and stability rather than flexibility. Small firms have reduced capacity to absorb unproductive operating expenditures because they have less capital as well as fewer managerial resources. SMEs identify the following factors to be onerous constraints that they face, namely high compliance costs, extensive and complicated paperwork and economic regulations. (Foreign investors tend to face even more onerous hurdles.) The multilateral institutions involved in SME development in Southeast Asia have examined whether their role and operations have changed significantly since the crisis. The SME donor committee work gives some insights about the operational aspects of how multilateral institutions approach their work in this area. Based on their collective findings, it is possible to list possible new strategies and instruments with regards to SMEs. The most evident is the emphasis on strengthening the business climate to foster growth and competitiveness. The Committee of Donor Agencies for Small Enterprise Development was established in 1979. Drawing from a diverse range of multilateral and bilateral agencies, the Committee has sought to improve the practice of donors in small enterprise development by commissioning research and sharing information. In 2001 the Committee established a Working Group (WG) for Enabling Environment, that endeavours to learn from experiences in donor-supported efforts to reform the business environment for SME development. Reports were commissioned by the Working Group to review experiences from interaction among donor agencies in small enterprise policy reform in several countries.6 Many donors working in the business environment in which SMEs operate were found to define the concept of the business environment loosely. When defining the business environment, it was important to draw a distinction between business environments that enable private sector development (PSD) and those that enable SME development. Research has shown how SMEs are more vulnerable to biases and constraints in the business environment than larger enterprises. Thus, within the broad thrust of PSD, SME development has a unique position. Reforming the business environment for SME development can be lost among efforts to reform the environment for PSD. SMEs have a specific set of concerns that need to be addressed separately in the business environment (e.g., anti-SME bias) and it is important to ensure that reform measures respond to the needs and priorities of smaller enterprises. According to the reports, there were five fields of donor intervention commonly used by donors in the promotion of a more enabling business environment for PSD and SME development:

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1. Supporting a stable macro-economic environment (general PSD). To create a market-oriented economy in which private sector development (including SMEs) can operate in an efficient manner with the aim of achieving national development goals, such as poverty reduction, employment and wealth creation, etc. 2. Direct policy and legal reforms (general PSD). To ensure that policies, laws and regulations do not unduly encumber the private sector. Reforms occurring in this field are not specifically targeted toward the SME sector. 3. Direct policy and legal reforms (specific to SME development). To remove anti-SME biases found in policies, laws and regulations and to ensure that the reform of these instruments (including financial and banking reforms) are responsive to the conditions of SMEs. 4. Strengthening institutions for policy design, implementation and enforcement (general PSD). To ensure that existing and newly created or reformed policies, laws and regulations are properly implemented and enforced in a transparent, equitable and market-oriented manner. This may also involve financial institutions (see Section 5). 5. Strengthening institutions for representative and advocacy (specific to SME development). To ensure that the SME sector is properly represented in policy and legislative reform dialogues, and that representative institutions can advocate for change to government in a consistent and knowledgeable manner that is driven by mandates that come from SMEs themselves. Within these five fields of intervention, the regional/country reports identified several tools and processes used by donor agencies. These ranged from technical and financial assistance, to the facilitation of high-level dialogue and consultation processes, to training, study tours and demonstration projects. The application of these varied according to national circumstances and reform priorities. Many donor agencies have made use of broad development strategies, such as Poverty Reduction Strategy Papers, to locate their support for reform efforts. Often government in close co-operation with multilateral and selected bilateral agencies has formulated these strategies, which have provided a framework for a number of donor agencies to identify priorities for reform that they can support, and to work with the various governments in pursuit of these reforms. They have also helped government agencies take the lead in reform measures. Good practice in donor efforts to support reform in the business environment for SMEs was found to stem from two core principles. One is the need for donors to recognize the broad strategic role they perform in

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development efforts in the client country and the role that the SME business environment plays. The second principle encourages donors to consider the way they design, package and deliver their support. In the first instance, effective donor agencies were found to consider their role in the political dynamics of the country and position their reform support interventions in such a way as to promote change, while remaining sensitive to the political domains of local actors. When doing this, donor agencies ensure that domestic actors drive reform processes. Donors themselves do not attempt to force reforms. Thus, donor agencies find ways to enrich domestic reform processes, rather than come up with their own agendas and try to convince others of these. Also, it is important that donors recognize that reforming the SME environment requires an overarching strategy that integrates social, cultural and political elements and policies, laws, and regulations, as well as the institutional framework. Thus, donor agencies should stimulate debates on the value of reforms and foster relationships with domestic counterparts. When designing, packaging and delivering their support, good donor practice recognizes that reforming the business environment is a timeconsuming process that may engage donors well beyond their normal project cycles. Donors need to find ways where they can support a reform agenda over time by extending their project timeframes, engaging counterparts over a long period of time (i.e., building long-term professional relationships), and stabilizing staff and information resources so that donor-counterpart relations can be constant. Good practice in the support of reforms to the business environment also involves supporting social dialogue and strengthening the role key stake-holders can play, especially SME representative organizations. In addition, donor-supported reform interventions were most effective when they offered sound analysis of the business environment (before and after reforms) and brought international best practices and up-to-date knowledge. Donor-to-donor collaboration and coordination was considered to be an important strategy in the support of reforms, but such arrangements were found wanting in many of the regions and countries. Also, measuring changes in the business environment proved to be a difficult task, and quantifying the impact of specific reform interventions even more so. Few donors were able to assess their efforts beyond the simple measurement of inputs and outputs. 4. Donors’ Experience on Business Development Services (BDS): Lifting Constraints in Managerial Capacity of SMEs Governments and international agencies agree that schemes to support SMEs will be unsuccessful in the absence of a vibrant entrepreneurial sector, consisting

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of those who sense opportunities and take risks in the face of uncertainty and develop new goods and services using available resources. The entrepreneurial process remains complex. Social, cultural and political factors influence framework conditions that in turn put limits on entrepreneurial opportunities. But it is the vitality of the entrepreneurial sector that drives business dynamics — the birth, expansion, contraction and death of SMEs — and fuels overall economic growth (see Inter-American Development Bank 2002). Lack of markets for Business Development Services (BDS) (defined broadly as short-term services to improve business performance) constrains SMEs in developing countries (see also Levitsky 2001, for BDS Markets in Asia). In some cases, government and donor intervention have prevented the development of sustainable markets for these services through the traditional approach of heavy and direct intervention to subsidize and provide direct supply of services to SMEs. The result of the traditional approach was poor quality services, irrelevant to SMEs and with very limited outreach. The market for BDS providers is growing as the supply of domestic professionals rises and as SMEs acknowledge the usefulness of external and timely advice on a number of areas related to their business growth. Under a more innovative approach to spark entrepreneurship and enhance the quality of SME production and financial management, donors have supported the development of markets for BDS by private providers. Also, BDS comprise a number of short-term services that help small entrepreneurs upgrade their enterprise productivity by improving workplace organization, handling inventories, improving product design, using bank credit among others. Similar to the case of high regulatory costs, it is onerous for SMEs themselves to assume all these productivity-enhancing BDS because each type of BDS involves some high first-time, entry or learning cost. For instance, in terms of financial management techniques, some SMEs do not even apply for credit because they know they cannot fulfil the entry requirements. The proper use of BDS could help SMEs initiate or upgrade their financial inputs from banks whether through general financial advice on using bank accounts and writing high-quality business plans for long-term loans. For advanced production techniques, the cost of learning or transfer of these processes may be lowered through the use of BDS but also through sub-contracting for larger firms (vertical learning) or through clustering among other SMEs (horizontal learning or learning from peers). In fact, subcontracting7 appears to have made learning more accessible for SMEs in Japan and the Republic of Korea, where SMEs have successfully been integrated into the export-oriented manufacturing sectors. This is less obvious in Southeast

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Asia though clustering has helped SMEs lower the costs of exporting, especially where design and marketing matter. In order to provide SMEs with access to BDS, traditional development programmes focused on one institution, providing subsidies that allowed SMEs to access services free or at very low cost. There is now agreement in the field that this approach has had limited impact because programmes were generally short-term, small-scale, and expensive. Some non-profit BDS providers, learning from the success of micro-finance institutions in sustainably reaching large numbers of people, began charging fees for services. Only a few have become financially sustainable, but tended to remain small. The “Market Development Paradigm”, adopted by the SME Donor Committee, is a new approach to BDS design and delivery that has the potential to reach large numbers in a cost effective manner and able to develop a broad market of BDS suppliers and SMEs that access services through networks of businessto-business relationships. The “Market Development Paradigm” proposes a new vision for success, one that looks like a healthy, private-sector business services market with numerous suppliers of BDS who offer a wide range of services to large numbers of SMEs. The programmes start by understanding the existing supply of BDS from the private sector, donor supported programmes and government, and the market failures that lead to a gap between supply and demand for BDS. The goal of market development interventions is to overcome these market failures and take advantage of opportunities to expand the service market for SMEs. The desired result is that numerous SMEs buy the BDS of their choice from a wide selection of products offered (primarily) from unsubsidized, private sector suppliers in a competitive and evolving market. The market development perspective recognizes that the provision of operating subsidies to particular suppliers may crowd out other private sector suppliers that do not receive subsidies. Market development programmes tend to promote as many suppliers as the market will bear. Some programmes also stimulate demand by providing information about services and marketing, or by temporarily discounting services. The main activity of a subsidized BDS programme is not direct service provision. It is, rather, market research, provision of information for consumers, new product development, supplier training, monitoring and evaluation, and activities aimed at “facilitating” market improvement by increasing demand or improving supply. The practitioners have converged around the Donor Committee conferences8 to summarize and present this “Market Development Paradigm”, and, although

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it is still quite new, a small, but fast-growing number of new programmes have adopted it (see “The Reader” by Miehlbradt and McVay 2002). Combining BDS and SME finance is the next challenge in donor (bilateral and multilateral) efforts to develop SMEs. The possibility for SMEs to obtain support-advice services prior to loans is crucial to make investments safe and sustainable. The WG for Finance within the SME Donor Committee has identified the following examples of support services for small entrepreneurs in the form of pre- and post-investment BDS. The difficulties pertaining to SME financing encountered by financial institutions include unequal access to information and the perception of extreme risks, along with excessive transaction costs. All these difficulties could in large part be solved if SMEs could better make use of non-financial BDS (see examples in Table 5.2). It can also be to the financial institutions’ advantage to outsource some of their application analysis, recovery monitoring among other functions, to outside providers. This externalization has its limits, however, and financial institutions should not outsource their main activity such as commercial risk analysis and risk-taking. Since the volume of funds available for investments tends to be much higher than real absorption capacity by SMEs, BDS obviously have a crucial role to play in activating demand for financing, improving the pertinence of the supply, and above all stimulating an adequate match between supply and demand. The international community’s reflections and work on SME access to consultancy and training services have fortunately improved practices considerably in this area. The question remains, however, of how to combine the provision of BDS and financing. Critical assessments of an entire generation of “integrated projects” implemented in the 1980s that combined credit and consultancy in the same hands, in substitution to private practitioners, have generated a Table 5.2 Pre- and Post-investment BDS: Linking SME Finance and Managerial Capacity Pre-investment BDS • Initial flash diagnostics to verify and clarify perceived investment needs, • Technical and commercial information to find appropriate solutions, • More in-depth diagnostics to elaborate the projects, and • Support establishing business plans and seeking appropriate loans.

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Post-Investment BDS • Regular visits to provide monitoringsupport for the investments, • Management advice and training to lead the growth of production units, • Assistance with modernization in marketing, production, staff, etc., and • A hotline service for instant advice for occasional needs.

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great deal of reservations and prudence. It is generally thought that this combination must be done strictly through market mechanisms. A new type of intervention implies that donors withdraw to a “wholesaler” position, and limit themselves to stimulating and supporting market dynamics that are supposed to meet SMEs’ needs. Other innovative interventions test incentive mechanisms based on prior agreements between BDS providers and financial institutions such as training for small entrepreneurs which would result in lower interest rates charged by the financial institution, a business plan certification that could reduce the level of guarantee demanded by the financial institution, among other mechanisms to link BDS and financing. 5. Donors’ Experience on SME Finance: Increasing and Expanding Access to Financial Markets by SMEs While BDS may help to activate demand for bank loans among SMEs, difficult access to funds or low availability of funds (whether actual or perceived) continue to constrain growth prospects for many SMEs, especially after the Financial Crisis. Has access to funds improved for small enterpreneurs? What are the new sources of financing available? What are the latest developments in financing SMEs in Southeast Asia? Most SMEs lack access to formal financial markets, mainly standard bank lending. High collateral requirements, complex and time-consuming credit application procedures, small size of credit, general distrust towards outsiders are some of the factors that explain why SMEs do not tend to use bank loans and prefer other — sometimes even more expensive — sources of financing. For example, the Asia Foundation and ADB found that only about one-fifth of all Indonesian SMEs tend to have loans with banks. When the Crisis hit, only a minority of SMEs were affected through increased interest rates and reduced profits, according to a recent World Bank report for Indonesia, one of the economies most affected by the Crisis.9 In fact, the low exposure to bank loans by the majority of Indonesian (and other Southeast Asian) SMEs gave them an additional advantage after the Crisis. However, a chronic low exposure to credit constrains the long-run growth potential of SMEs, which would have grown faster in an unconstrained credit environment. In general, there is consensus that, in most developing countries, there is a gap in the financial market where supply and demand do not meet. Situated between where micro-finance ends and commercial banks’ lending starts, the gap leaves SMEs with little possibility to finance small investment needs. There is consensus about the existence of a financing gap for SMEs. But the definition of the gap varies according to context. In terms of loan

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amounts, some set the lower limit for the financing gap somewhere between $2,000 and $10,000 and its upper limit between $100,000 and $1 million. Without entering the recurrent debate on the formal definition of SMEs (as elucidated in Section 2), it would nevertheless be necessary to segment the target in order to better apprehend the financing gap for SMEs. Notably, one must obviously differentiate between “small” SMEs that focus mostly on the domestic market and are often managed (sometimes informally) by families, and medium-sized modern sector enterprises oriented towards export. Distinctions also need to be made in function of the SMEs’ different growth potentials according to their positions in their sectors and markets. Indeed, credit availability issues for these different segments of enterprises can be very different, and it is safe to say that the credit requirements of micro-enterprises are substantially different from those of SMEs or large corporations. Background analysis of economic development shows that the quality and dynamism of the financial system is often one of the most decisive factors in the economic success of a country. Numerous macro-economic parameters are to be taken into account such as a country’s finance policy, monetary policy, debt treatment, banking system performance, role of the central bank, existence of a securities market, the quality of the insurance industry, etc. Downstream from these general parameters, it is also possible to develop techniques to improve financial markets’ core operations in favour of SMEs by introducing or streamlining credit scoring,10 rating, credit bureaus, and the use of ICT among other specific actions. The banking sector continues to be the private sector’s main source of loans. How can developing countries’ commercial banks (which are currently very little involved in medium-term loans to SMEs) develop a real commercial interest in the SME market segment? Some observers believe that, except for a few individual cases, commercial banks will not evolve in this direction for many reasons. Banks are not interested in medium-term loans and prefer short-term loans in the context of these countries or prefer to invest their resources in reliable treasury bonds rather than risky investments in the economy. Also, commercial banks perceive SMEs as a non-creditworthy, high risk, and not profitable (excessive costs in relation to expected earnings) market segment that they do not know much about and they do not have either the means or the culture to analyze this particular type of risk and exposure. Finally, banks may also be hampered by various obstacles such as banking regulations that have overly high reserve requirements, monetary policies that produce excessive key interest rates, property laws that do not allow foreign banks to issue mortgages, a constricting and insufficiently reliable legal system, etc.

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Increased competition between commercial banks due to the entry of new stake-holders into a financial market moving towards full liberalization and the increase in competition for the medium and large clients who have alternative sources of financing should logically oblige commercial banks to turn slowly but surely to the untapped market for SME loans. Banks could find SME loans to be profitable if they modify their approach to this segment by changing their focus from products to clients, and by mastering new loan technologies that lower both their costs and their risks. Finally, there is no sustainable solution to bridge the SME finance gap other than helping existing commercial banks “downscale” towards this new clientele. Therefore, it is a matter of inciting them to do so with various support measures such as long-term provision of funds at concessional rates, risk-sharing, indirect subsidisation of the cost of managing small accounts, technical support and training in new practices, externalising marketing and monitoring costs, among other interventions. Some practices by donors have taken the form of credit lines, guarantees, technical support for banks, but also, establishment of micro-finance institutions, SME specialized agencies, venture capital funds and leasing. All these interventions have advantages and disadvantages to consider, summarized below, drawing on work by Paris (2001).

5.1. Credit Lines The most frequent form of support comes from international financial institutions (also part of the “donor” community) that provide commercial banks in developing countries with refinancing lines that give them longterm access to funds either directly or through a central bank. Indeed, if many of these banks do not have liquidity problems, it is usually a matter of shortterm deposits. But banks commonly look for support to face the risk of shifting from short-term to medium- or long-term financing. Multilateral and bilateral institutions have tended to provide medium- or long-term financial resources in the framework of development co-operation. However, the era when these credit lines were placed with specific banks on condition that they apply subsidized borrowing rates to selected SMEs seems to have come to a close. Donors’ strategy to ease the scarcity of term finance by providing funds and improving the banking system’s ability to lend to SMEs was based on the objective that term finance would ultimately encourage employment and diversify the economic structure into manufacturing and exports. In 1996, the World Bank (WB) undertook for the first time a detailed empirical analysis of its SME support in three countries over a period of more than

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twenty years,11 and the ADB is launching a similar review of its operations (See ADB 2003). The WB study concluded that the expected outcomes of credit lines for term financing were not always achieved, and provides three key lessons for future operations. First, support for SMEs can create more jobs, but it could fall below expectations. In the Philippines (WB 1998), support for SMEs was considered to be effective in creating jobs, and less so in reducing poverty, boosting Philippine exports, or shifting the location of industries as originally stated objectives. In Sri Lanka, too (WB 1998), SMEs were a good vehicle for creating jobs, especially important in an economy undergoing restructuring. The results were less impressive for Ecuador. Second, banks needed to learn more about SMEs. Starting with more flexible financial products, such as basic short-term credit, one way to start to reduce the risk perception of SME clients is by using building blocks toward a more complex banking relationship before using long-term loans. In both cases (the Philippines and Sri Lanka), direct support to SMEs in Sri Lanka did go a long way toward improving the prudential soundness of the banking system and NPLs among SMEs was below the market average. Finally, the report concludes that good institutions cannot overcome a weak policy environment. By providing deeply subsidized credits to SMEs (such as in Ecuador), rather than access to credit, the credit lines merely substituted government transfers for borrower finance. Reforming the financial sector or relying on a sustainable microfinance institution would have been a better way to provide support for SMEs unable to get credit. Together with the accumulation of lessons learned from decades of interventions using credit lines, donors are aware that the liberalization of financial markets needs to avoid the high costs and risks of distortion. Making concessional rates more market-based runs into the difficulty of passing the cost to banks and SME borrowers. Their reluctance to assume “higher than” concessional rates has resulted in some donors to cover the costs from their own margins. Regardless of the solution to donor use of funds in financial markets without causing distortions, commercial banks continue to face low use of the banking system by SMEs. The long-term challenge can only be tackled step by step and in the field. To help bank loans “penetrate” the SME segment more fully, the WG for Finance recommends that credit lines clearly need to be supplemented by other measures. One has already been discussed in Section 4 and deals with the development of the BDS market both pre- and post-credit so as to make the investments both safe and sustainable. Other complementary tools include the provision of guarantees to reduce bank

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risks; and technical support to banks in renewing their practices vis-à-vis this market segment.

5.2. Guarantees to Increase SME Lending Donors frequently set up guarantee funds to cover part of the risk taken by commercial banks in addition to the refinancing lines that they offer. This measure is in theory a powerful tool to encourage banks to take greater risks in giving out medium-term loans to SMEs. Indeed, providing guarantees allows banks to increase their volume of loans by acting on two important limiting factors. First, guarantees reduce the impact of the loans granted on the prudential ratio concerning solvency that monetary authorities supervise (equity/loans).12 Also, in the case of losses, rapid compensation restores the banks’ funds before the conclusion of recovery proceedings. The use of guarantees has nevertheless been strongly criticized for the low impact of numerous guarantee funds, their excessive administration costs, their slow response times, and their tendency to reduce banks’ responsibility leading to degradation of bank portfolios. These flaws may be due to poor design of the tool that could be corrected through the analysis of lessons learned. If they are to contribute to bridging the SME finance gap, guarantee funds must have real leverage on banks’ practices vis-à-vis SMEs, encouraging them to grant medium-term loans that they would not have granted without the presence of guarantee funds. In light of past experience, the WG for Finance has at least four basic recommendations for interventions that use guarantees: 1. Clear risk-sharing contracts between the Bank and the guarantor; 2. Independence of the guarantee institution from the political authorities; 3. Risk coverage should be sufficiently attractive for banks but share of the risk should still be enough to keep banks involved in risk analysis; 4. Credibility of guarantees should be a reflection of easy and timely recovery in case of default.

5.3. Technical Support for Banks for SME Lending To be better equipped to serve the SME clientele efficiently and profitably, commercial banks in developing countries generally need to restructure their internal organization and devote considerable efforts to training their loan officers. They can be pushed to do so by competition, their own specific

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strategies, or through the establishment of a trusting relationship with an outside donor. Only when banks are determined to invest in this technical support that donors support the capacity building effort. Commitment from banks is critical. Strategies to develop new skills must be led by a strong internal team guided by a clear and assertive vision. Indeed, banks should strive to introduce radical changes in risk analysis methods as well as in new product distribution methods, implement innovative marketing schemes targeted at the new SME clientele and streamline related administrative procedures. Banks that wish to enter the SME segment must evolve on two fronts simultaneously: First, when it comes to risk analysis, banks should focus on the following changes: • carry out market studies of the SME clientele and determine the feasibility of a credit offer that is adapted to investment needs; • segment this SME market by profitability level and by level of need in order to adapt products and prices accordingly; • use credit scoring or rating techniques to improve risk analysis and link interest rate levels to risk levels; • strengthen regular reporting, authorizations prior to investment, obligations for SME borrowers as covenants; • examine the possibility of applying variable rates destined to incite borrowers to remain in a solid financial position (rate indexed on specific monitored financial indicators), and • implement a specific human resources policy by selecting and training specialized SME loan officers with internships and specific career paths, reducing their administrative tasks, and using outside expertise. Second, when it comes to reducing transaction costs, banks should aim at: • restructuring the loan treatment process to reduce all forms of bureaucracy, decentralizing decision-making, concentrating administrative tasks in a common unit, and leaving loan officers available for marketing; • reducing the amount of information requested from SMEs to what they can realistically produce and really need; • standardizing loan application and risk analysis procedures, automating decision-making procedures, and • using ICT systematically (and as far as local communications infrastructures allow) to accelerate the application procedures. In order to tackle simultaneously the various constraints that prevent commercial banks from granting medium-term loans to SMEs, a certain number of stake-holders are implementing integrated intervention programmes

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containing refinancing, guarantee funds, and technical support to restructure banking practices. This is what IFC is doing with its Global SME Credit Enhancement Facility that contains a $50-million financial component with local currency possibilities and concessional rates for banks, and partial risk guarantees between 40 per cent and 60 per cent for their SME portfolios, and a $12-million technical support component that contains training banks in risk management, SME loan technology, formulating credit policies, and BDSs to improve SMEs’ managerial and planning skills.

5.4. Financing SMEs Beyond Commercial Banks: Micro-finance, Venture Capital and Leasing for SMEs Most financing for SMEs and private sector at large tends to come from the commercial banking system. However, in addition to commercial banks, one could examine the possibility of micro-finance institutions, SME specialized agencies, venture capital funds and leasing companies contributing to bridging the SME finance gap. Are these institutions able to expand their financial services upwards to the SME segment and do they wish to do so? Opinions are highly divergent in the donor community. 5.4.1. Micro-Finance Institutions A whole series of reasons leads numerous observers to think that the solution will not come from micro-finance. First, micro-finance institutions do not seem to be moving towards SME lending. In Latin America, where microfinance institutions have developed quite rapidly, there is only a slight increase in average loan size — from $400 to $900 — when micro-finance institutions reach the status of regulated financial establishments. This is still far from meeting the financial needs of SMEs. In addition, no micro-finance institutions have yet shown clear interest in entering this niche, and the only observed cases of such evolutions were motivated by the desire to accompany the high end of the micro-finance clientele towards larger loans. Finally, micro-finance may face other, more important challenges. Micro-finance’s attachment to its primary social mission tends to lead it to remain in the niche of credit for the poorest where huge market reserves remain to be tapped.13 Many microfinance institutions are sufficiently occupied with maintaining equilibrium (seeking equity, recovery, formalizing their status, among others). When their growth and the competition between micro-finance institutions lead them to adopt a more “commercial” and aggressive approach, they tend to be pushed to diversify their offer to meet the same segment of the clientele’s other needs such as micro-loans for housing, micro-insurance and micro-savings.

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Micro-finance institutions also face obstacles to entering SME market segment. First, they encounter the same dissuasive factors as commercial banks, namely difficulties in assessing risk for this type of loans and the high administrative costs that this generates in relation to expected earnings. Next, they need to find the necessary funds for the medium term, which raises the problem of managing their financial position. Micro-finance institutions have two forms of financing: either they collect savings (usually demand deposits) or they obtain refinancing from donors or commercial banks, the difficulty being the increasing scarcity of funds at concessional rates (high market refinancing rates may endanger their profitability). In addition, to enter this new niche, micro-finance institutions must hire and train adequate higher educated and skilled staff with different social profiles. Finally, they must face the disturbances caused by the development and launch costs for new financial products while maintaining the profitability of their basic micro-loan portfolio. However, this evolution can only take place in solid micro-finance institutions whose micro-credit activities have reached maturity, those that have sufficient funds, and those with skilled staff to provide management advice to clients, and those with a status compatible with banking regulations. 5.4.2. SME Specialized Institutions Faced with the problem of the SME finance gap and given commercial banks’ hesitation to embrace this s niche and micro-finance’s difficulties up-scaling to it, one naturally concludes that the solution might come from a third type of financial institution that specializes in SME lending, all the more so because this type of institution exists in industrialized countries where intervention in favour of SMEs is relatively strong, usually in the form of public development banks with private, autonomous management. A few examples are BDPME in France, SBA (Small Business Agency) in the USA, and JFS in Japan who intervene through private finance institutions by covering 80 per cent of the risk and paying commissions to agencies that lend to SMEs, and SIDBI in India, a governmental agency that issues loans directly to SMEs through its thirty-eight regional agencies, refinances financial institutions, and supports NGOs and institutions that provide BDS. However, in developing countries, this type of institution and development banks in general have faced the problems of low profitability viability, which instils caution with regard to this solution. It is probable that these SME Development Banks can only operate validly in countries that are sufficiently structured so as to allow them to be independent of the political sphere. At

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this stage it is therefore preferable to count on the emergence of a new type of private financial institution that focuses innovatively on SME lending with clearly commercial purposes and a comparative advantage in this niche. If public funds are used to support this type of institution, they must do so in an optic of private business and with an aim to complete privatization. 5.4.3. Venture Capital The acquisition of shares or granting of participatory loans (remunerated in function of profits) by venture capital companies offers many advantages as a response to enterprises’ financing needs. They increase the enterprises’ equity and multiplies its medium- and long-term debt capacity by as much; do not require complex guarantees because the risk is shared with the enterprise and remunerated by the expected success, and usually come with technical knowhow, advice, or participation in management that can help the enterprises grow. Venture capital funds are particularly useful for financing the start-up phase for innovative enterprises, the most risky phase and one for which venture capital is almost the only available mode of financing (with the expectation of very high remuneration in the case of success). However, this type of funds is clearly reserved for enterprises of a certain size that are entering niches where the potential for return on investment is high. Indeed, given the risk taken, venture capital companies need to maximise the profitability of their investments. They therefore take more interest in high investment amounts in leading sectors. Yet, numerous developing countries suffer specifically from a lack of high-return investment opportunities, which limits investment funds’ potential targets. Venture capital’s interest in these countries is also limited by management and accounting deficiencies, endemic among SMEs, and the difficulties investment companies have in acquiring sufficient shares to influence decisions and in withdrawing capital when the time comes to do so. The Small Enterprise Assistance Fund (SEAF) is an example of a secondtier venture capital fund established by the WB group in 1995 that manages $140-million in fourteen different investment funds that target SMEs with staff of between 10 and 100 and turnovers between $200,000 and $2 million. This venture capital fund invests between $100,000 and $1 million per enterprise, a sufficient amount to have minority influence in the enterprise. The investment is secured by technical support to the enterprise (approximately, $15,000 a year). Partner enterprises can also receive subsidized BDS. SEAF has invested in 165 enterprises in Central Europe, Eastern Europe and Latin America, mainly in agri-business, light industry, and high-tech services, with

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an average return on investment of 36 per cent. One of the identified success factors is the provision of key one-to-one BDS to enterprises, not only for general strategic choices but also in day-to-day operations. 5.4.4. Leasing Companies Capital lease contracts distribute ownership and use of equipment between two contracting parties. This can be done according to three methods: (i) financial leasing (the equipment remains the property of the leasing company until payments are completed and can be purchased at a reduced rate by the user); (ii) hire-purchase (ownership of the equipment is progressively transferred to the user in function of the instalment payments); and (iii) operational leasing (temporarily renting equipment so that the ownership and responsibility for maintenance of which remains with the leasor). This form of medium-term financing is particularly well adapted to SMEs’ needs for production or service equipment. It does not, however, allow them to meet the working capital needs that may be associated with use of the equipment in question and that the entrepreneur will need to finance by another method (failing which, the acquisition of the equipment may fail to generate profits). This mode of financing investments provides solutions to some of the difficulties that contribute to creating the SME finance gap because it reduces the risk14 for financial organization vis-à-vis SMEs; and the transaction costs.15 Leasing companies for SMEs reduced or closed their operations in postCrisis Southeast Asia. However, some good examples of donor assistance in South Asia have continued. Swiss Development Cooperation (SDC) supports two leasing companies in Pakistan, where 32 leasing companies operate. Analysis of the Swiss operation shows that leasing can effectively contribute to bridging the SME finance gap that, in this country, ranges between $1,000 and $10,000. In addition, these companies’ activities reveal how certain innovations can improve the system such as variable instalments throughout the year to adapt to the seasonal fluctuations in enterprises’ incomes; the inclusion of life insurance for the SME clients; acceptance of post-dated checks to pay instalments, which reduces paperwork and contributes to extending banking services to enterprises; and the alliance with NGOs and institutions participating in equipment distribution, etc. 6. Concluding Remarks Donors have increasingly moved towards a more integrated approach for SME development based on institutional reforms, better services and financial

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tools under a less regulated environment where the private sector has a more central role than ever before. With respect to the business environment, the findings by donors on SME interventions for the enabling environment call for the need to better understand the business environment and its influence on SMEs; design appropriate tools and techniques for measuring the impact of donor-support reforms; and identify and promote best practices in donor-supported reforms. These reforms will have an impact on the access to — and the availability of — financial resources for SMEs. With respect to BDS, the promotion of these services (not direct provision) helps improve the use of formal finance among SMEs. Linking BDS and financing remains an empirical challenge for donor assistance and commercial banks. Provision of better BDS is not enough. With respect to financial resources themselves, donor support to traditional credit lines has been put in question based on less than optimal results. However, provision of credit lines alone is not enough either to overcome the SME financing gap. Technical support for banks, well-planned guarantee mechanisms, and other tools could be put in place to bridge the SME financing gap. Ultimately, a combination of macro-economic stability, increased availability of BDS providers, greater sophistication of SMEs, further financial competition, and better financial governance are some of the forces that will help close the gap. Progress will continue to rely on how long financial sectors in SEA take to emerge completely from the crisis, and support the emergence of competitive SMEs in the region. NOTES 1. Mr. Rodriguez is an economist (small and medium enterprises) at the Southeast Asian Department, Asian Development Bank (ADB). The paper was discussed at the ASEAN Roundtable 2002 on Entrepreneurship and SMEs in Southeast Asia’s Economic Development, 7–8 November 2002, Institute of Southeast Asian Studies (ISEAS), National University of Singapore; and presented at the Norman Paterson School of International Affairs (NPSIA), Carleton University, Ottawa, Canada, 13 November 2002. The views presented in this paper do not necessarily reflect the views of the Asian Development Bank (ADB). 2. According to UNCTAD (2001), investment inflows into Southeast Asia (ASEAN10) remained below the pre-Crisis level. The sub-region’s share in total FDI in developing Asia continued to shrink, from over 30 per cent in the mid-1990s to 10 per cent in 2000. This was largely due to significant divestments in Indonesia since the onset of the Asian Financial Crisis.

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3. 4. 5. 6.

7.

8. 9.

10.

11. 12. 13.

14.

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See Lin, Cyril (1999). See Snodgass, Donald, and Biggs, Tyler (1996). See Wallich (2001). The World Bank prepared the report on the Balkans (encompassing Albania, Bosnia-Herzegovina and FYR Macedonia); Department for International Development (DFID), the Caribbean (specifically Dominica, Grenada, Guyana, and Jamaica), the International Labour Organization (ILO), the report on Peru, the Dutch Ministry of Foreign Affairs, the report on Tanzania, and German Technical Cooperation (GTZ), the report on Vietnam “Approaches to Support the Development of an Enabling Environment for Small Enterprises”. Country Report: Vietnam. 2002 (available at www.gtz.de). Sub-contracting is common among medium-sized exporters in rattan, furniture, and garments. See Levy et al. (1999). Also, see examples of trading houses for Indonesia in Brazier and Rodriguez (2002). The committee’s most recent meetings took place in Turin, Italy in September 2002 and Copenhagen, Denmark in September 2003. The report shows that only less than 9 per cent of SME debt at banks can be classified as category 5 risks. Based on surveys on the use of bank loans, the report concludes less than 2 per cent of all SMEs may be benefited by the decree on SME debt restructuring approved in July 2002. See van Gelder and Broadfoot (July 2002). Credit scoring techniques spread in the 1990s for consumer loans and were widely transferred, notably in the U.S.A, to SME loans. These techniques consist of assessing risk statistically, by comparing client profiles to typical characteristics of a large sample of borrowers. Large American companies specializing in credit scoring exported this method to Japan, Mexico, Belgium, Portugal, Germany among others. This approach is a radical shift from traditional application analysis habits and applies insurance methods based on a probability matrix to credit risks. See World Bank (1998) for a summary of the findings from three impact evaluation studies on SME financing (Ecuador, the Philippines and Sri Lanka). At least when local banking regulations agree to deduct the amounts guaranteed. As an indication of this position, the World Bank considers that the average loan size granted by micro-finance should remain, depending on the country concerned, approximately the GDP per inhabitant. The renter himself acquires the equipment, which avoids investment diversions or errors and does so all the more because the leasor’s position vis-à-vis the supplier allows him to obtain the best terms. The users receive, in addition to the equipment, technical support not only in choosing equipment but also in maintaining and using it. If payment is not made, seizing the equipment is simplified by the fact that it still belongs to the leasor if the local judicial context facilitates this type of recovery. Usually, the user must also provide an initial

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guarantee deposit (10 per cent of the equipment’s value, for example), and finally, the interest rates (higher than bank interest) make it possible to fully cover the risk. 15. The need for guarantees is avoided. The decision-making process can be simple and rapid. Banking regulations tend to be less for leasing companies because there are no savings to protect. REFERENCES Asian Development Bank (ADB). The Role of Small and Medium-Scale Manufacturing Industries in Industrial Development: The Experience of Selected Asian Countries. Manila, 1990. ADB. Technical Assistance for the Development of a Framework for SME Support. TAR OTH36147 Manila, December 2002. ADB. Special Evaluation Study: SME Policies and Operations. Operations Evaluation Department. Internal Document. Manila, 2003a. ADB. Asian Development Outlook 2003. Manila: Oxford University Press, 2003b. Brazier, Roderick and E. Rodriguez, eds. Indonesia: Small Business through the Economic Crisis. The Asia Foundation, Jakarta, 2002. Hallberg, Kristin. A Market-Orientated Strategy for Small and Medium-Scale Enterprises. International Financial Corporation, Discussion Paper no. 4, The World Bank, 2001. Harvie, Charles, and Boon-Chye, Lee, eds. 2002. The Role of SMEs in National Economies in East Asia. Vol. II. Massachusetts: Edward Elgar Publishing, Inc., 2002. Inter-American Development Bank. Entrepreneurship in Emerging Economies: The Creation and Development of New Firms in Latin America and East Asia. Washington, D.C., 2002. Katrak, Homi, and Roger, Strange, eds. Small-Scale Enterprises in Developing and Transitional Economies. Great Britain: Antony Rowe Ltd, 2002. Levitsky, Jacob, ed. Small Business Services in Asian Countries: Market Development and Performance Measurement. London: ITDG Publishing, 2001. Levy, B.; Berry, A.; Nugent, J. (1999). Fulfilling the Export Potential of Small and Medium Firms. Boston: Kluwer Academic Publishers. Lin, Cyril. Strengthening Corporate Governance in Asia: Issues and Options. United Kingdom: University of Oxford, 1999. Little, Ian M.D., Dipak Mazumdar, and John Page, Jr. Small Manufacturing Enterprises: A Comparative Analysis of India and Other Economies. Washington D.C.: Oxford University Press, 1987. Miehlbradt, Alexandra and Mary McVay. “Developing Commercial Markets for BDS: Are How-to-do-it Recipes Possible?” Third Annual Seminar, Turin, Italy, 9–13 September 2002. Seminar Reader, SEED-ILO.

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OECD. OECD Small and Medium Enterprise Outlook. Paris: OECD Publications, 2002. Paris, Pierre. “Supporting Mesofinance in Developing Countries — Intervention Orientations: an Inventory”. Ministry of Foreign Affairs, France, 2001, mimeo, presented at the SME Donor Committee meeting. Turin, Italy, 16–20 September 2002. Rodriguez, E. and Gwendolyn Tecson. Liberalization and Small Industry —Have Manufacturing SMEs in the Philippines Benefited?, Small Enterprise Development 9, no. 4 (December 1998): 14–22. Rodriguez, E. and Jan ter Wengel. Small and Medium Exporters after the Crisis: Microlevel Data, 1996–2000. Small Business Economics, forthcoming. 2004. Snodgass, Donald, and Tyler Biggs. Industrialization and the Small Firm Patterns and Policies. California: International Centre for Economic Growth and the Harvard Institute for International Development, 1996. United Nations Conference on Trade and Development — UNCTAD. World Investment Report: Promoting Linkages. New York and Geneva, 2001. van Gelder, F. and C. Broadfoot. SME Debt Restructuring in Indonesia, Jakarta: World Bank, mimeo, July 2002. Wallich, Christine. Investing in SMEs: Lessons Learned and New Strategies “Perspectives from Asia”, Asian Development Bank, Speech at the Conference on Globalization and SME Development, Langkawi, Malaysia, July 27, 2001. World Bank. Support for Smaller Enterprises, Precis no. 173, World Bank Operations Evaluation Department, Autumn 1998.

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Individual articles SMEsStudies. in the Agricultural Sector are available at < http://bookshop.iseas.edu.sg > 89

6

Strengthening SMEs in Southeast Asia’s 1 Agricultural Sector Anne Booth

1. Towards a Typology of SMEs in the Agricultural Sector In Southeast Asia, as in most other parts of the developing world, the most important type of “SME” in the agricultural sector is of course the farm enterprise. I have enclosed the term “SME” in inverted commas because I am aware of the definitional problems which surround the term; it is probable that many, although by no means all, farms in Southeast Asia would be termed “micro-enterprises” rather than SMEs by many researchers in this field. In this paper I propose to be rather cavalier about such distinctions; I will simply define a SME in the agricultural sector as a farm-based enterprise located in a rural area, which operates at most ten hectares of land, and employs fewer than fifty either on a permanent or temporary basis, including family workers, over a period of a year. In my opinion, most farm enterprises in Southeast Asia fall into this category although my definition would of course exclude the large agricultural estates, which are still to be found in parts of the Philippines, Indonesia and Malaysia, as well as in southern Vietnam.2 It would also exclude large commercial farms in some parts of Thailand, and in Burma.

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Of course a definition of this kind is rather arbitrary, and embraces a wide variety of farm enterprises, as well as many enterprises which derive part of their income from farming, but are also involved in sectors such as manufacturing, trade and transport. It is thus sufficiently flexible to take into account the millions of rural enterprises throughout Southeast Asia which are involved in both agricultural and non-agricultural activities. There is now much evidence to indicate that off-farm, and non-agricultural, incomes of agricultural households have grown rapidly in many parts of Southeast Asia in recent decades. For example, according to the 1993 Agricultural Census for Indonesia, incomes from off-holding sources accounted for 50 per cent of total incomes of agricultural households. In Thailand in 1996/97, only 37 per cent of total cash income accruing to farm households was derived from agricultural production.3 This in itself is hardly surprising; a large body of literature now exists which demonstrates that agricultural households throughout Asia, Africa and Latin America are deriving significant and increasing shares of their total incomes from off-holding activities.4 Indeed it has been argued that rural households “increasingly come to resemble miniature highly diversified conglomerates, many of them with a foothold in the urban sector” (Cain and McNicoll 1988, p. 105). While this is true to an increasing extent of at least some parts of Southeast Asia, we should not overlook the fact that the great majority of those households classified as “agricultural” in censuses and surveys still report that agriculture is their “main” source of income. To the extent that income diversification is taking place, agriculture is still the core activity for most agricultural households. But at the same time, many millions of households in rural areas of Thailand, Malaysia, the Philippines and Indonesia have virtually no involvement with agriculture at all. They are either deriving their income from wage employment outside the agricultural sector, or are working as employers or self-employed workers in enterprises in sectors such as manufacturing, construction, trade, transport and personal services. Some of these enterprises may be “agriculturally related” in the sense that they are involved in the processing and transport of agricultural output. Others may in fact have little to do with agriculture at all, except for the fact that they happen to be located in rural areas.5 In this chapter, I will have little to say about the last type of enterprise, although they are certainly providing a substantial, and growing, share of employment in rural areas in many parts of Southeast Asia. Instead I will concentrate on farm enterprises operating under ten hectares, and employing fewer than fifty people, bearing in mind that these enterprises are themselves now often highly diversified, and in many cases are deriving less than half

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their total incomes from agricultural production. I will be especially concerned with allocation of farm household labour to on-farm and off-farm activities, and sources of farm household income by holding size. But first, it will be useful to briefly survey recent trends in agricultural growth, and the role of agriculture in the economies of Southeast Asia. 2. Agricultural Growth and the Changing Role of Agriculture in Southeast Asia It is well known that while arable land has been declining relative to population in most parts of the world since the 1950s, there are very striking differences in trends in the proportion of the population dependent on agriculture for at least a part of their income (the agricultural dependency ratio), and in agricultural output per capita. In most of the developing world, there has been a decline in the agricultural dependency ratio, and in some regions there has also been a decline in absolute numbers employed in agriculture. In East and Southeast Asia, the agricultural dependency ratio has fallen from 76 per cent in 1950 to 44.9 per cent in 2000. Accompanying this decline has been a steep reduction in the headcount measure of poverty since 1960 in most parts of rural East and Southeast Asia (Lipton 2001, Tables 1 and 2). In most of Asia, food output, and total agricultural output per capita increased over the last four decades of the twentieth century, although the rate of growth has been faster in East Asia (including Southeast Asia) than in South Asia. In sub-Saharan Africa, by contrast, food output per capita has been declining since the mid-1970s (Platteau and Hayami 1998, Table 12.2). In East, Southeast and South Asia, a large part of the growth in food output has come not from extending the cultivation frontier, but from growth in yields. Yields growth of cereals, roots and tubers in East and Southeast Asia averaged around 2 per cent per annum over the two decades from 1960 to 1980, although the rate of growth has fallen since then, and was less than 1 per cent in the years from 1990 to 1998 (Lipton 2001, Table 4). There is little dispute about these broad facts. But a problem with much of the literature on Asian agriculture is that it is very aggregated. “East and Southeast Asia” is usually treated as one block, which ignores the considerable heterogeneity of a region which encompasses China, North and South Korea, Taiwan, Indonesia, Thailand, Vietnam, Laos, Cambodia, the Philippines, Malaysia and Myanmar (Burma). Elsewhere, I have argued that the record of agricultural and rural development policies in Southeast Asia is a very mixed one, producing both successes and failures (Booth 2002a). Indeed even within countries, there are often marked disparities in outcomes amongst

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regions. This should not be surprising given the different bio-physical conditions in different parts of Southeast Asia, and the different policies pursued towards different parts of the agricultural sector in both the colonial and the post-independence eras. Following a classic paper by Myint (1967) it is often argued that the economies of Southeast Asia can be divided as being “inward-looking” or “outward-looking”, depending on the trade and exchange rate policies they have adopted, and their stance towards foreign investment, and foreign aid and borrowing. In some respects this remains a useful distinction, but as far as agricultural policies are concerned, it is probably more helpful to distinguish between those governments which have treated the agricultural sector mainly as a source of tax revenues, and those that viewed it as an engine of growth, to be supported through subsidies and other policy interventions. But even this distinction frequently breaks down as most governments in Southeast Asia, in both colonial times and more recently, have adopted very different policies in different parts of the agricultural sector. Important export crops have been taxed through export taxes, which usually depressed the prices received by local producers, while at the same time other producers (or even the same producers) have been assisted through provision of infrastructure at low or zero prices, subsidized inputs and credit. Indeed it has been said with some justification that no country in Southeast Asia has pursued an integrated rural development policy. Rather, they have adopted an unco-ordinated bundle of crop-specific policies, which have themselves often varied considerably over time. The outcome of this very mixed approach towards agricultural and rural development since the mid-1970s is shown in Table 6.1. In per capita terms, agricultural output grew at close to, or over, two per cent per annum in most parts of Southeast Asia from 1974 to 1984. In Malaysia, agricultural output growth in per capita terms accelerated over the decade from 1985 to 1996, but in the Philippines the poor growth performance of the earlier decade continued.6 Elsewhere in Southeast Asia, with the important exception of Vietnam, there has been a trend towards slower growth in agricultural output per capita. The reasons for the trends shown in Table 6.1 vary considerably by country. In Thailand, where a high proportion of agricultural output growth in the past has been due to the expansion of cultivated area, rather than to yields growth, the slowdown of growth since the mid-1980s is in part attributable to the fact that there is now little land left with arable potential that is not already under some form of cultivation.7 Furthermore the government has become alarmed at the rate of deforestation over the past three decades and is now trying to replant land that was earlier cleared

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for grazing or cultivation. Many Thai agricultural economists have urged that the government respond to these challenges by adopting policies designed to increase yields, especially for crops such as rice. But in spite of some reforms through the 1980s which were intended to increase farm-gate prices and thus the profitability of using fertilizer and new varieties of seed, rice yields in Thailand remain well below those in most other parts of the region (Table 6.1). Most other countries in Southeast Asia have been more successful in disseminating new yield-increasing technologies in smallholder agriculture, especially in the food crop sector. Malaysia in particular has also had considerable success in increasing yields for smallholder tree crops such as rubber. Those countries which adopted the new rice varieties earliest (especially the Philippines) did experience rapid output growth but this slowed down once most farmers in well-irrigated areas were operating near the technology frontier. Further yields growth would have required investment in irrigation and through the 1980s, successive governments in the Philippines were unable to make such investments (Balisacan 1993: Bautista 1994).8 In Indonesia, the adoption of new rice and corn varieties led to rapid growth of output but again output growth slowed once farmers operating in the more favourable bio-physical environments had achieved maximum yields. In Burma, output growth was rapid in the decade from 1974/75 to 1984/86; almost all this growth was due to growth in output per hectare, as total land area grew very slowly (Mya Than 1988, pp. 9–17). But over the next decade, from the mid-1980s to the mid-1990s, output growth slowed sharply, although there

Table 6.1 Annual Average Growth of Per Capita Agricultural Output, 1963–1999 Country

Average Annual Growth Rate of Per Capita Agricultural Output 1963–1975

1976–1985

0.7 1.6 2.8a –0.7 0.7 0.7 –0.5

3.1 6.3 –0.9 3.4 –0.4 1.5 2.6

Indonesia Laos Malaysia Myanmar Philippines Thailand Vietnam

Paddy Yields Tons/ha.

1986–1999 (average 1994–96) 0.8 0.8 1.1 0.5 0.1 0.9 3.0

4.4 2.6 3.1 3.2 2.8 2.4 3.6

a

Peninsular Malaysia only. Sources: FAO Production Yearbook, 30 (1976), Table 7; 41 (1987), Table 10; 53, 1999, Table 10.

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was an acceleration in growth after 1995. In Vietnam where dissemination of new rice varieties only occurred in the 1980s, and where government reforms after 1986 reformed the agricultural pricing regime, and gave greater production responsibility to individual households, output growth per capita has been sustained at a high rate through the 1990s.9 While there is broad agreement about the main causes of agricultural output growth in Southeast Asia since the 1970s, there has been far more debate about the consequences of that growth for income distribution and poverty decline in rural areas. Has slowing agricultural growth adversely affected the SME sector relative to larger farms and estates, and thus led to growing disparities in income and wealth within rural areas? Has the sluggish performance in the agricultural sector since the mid-1980s in rapidly industrializing countries such as Indonesia, Malaysia and Thailand led to greater polarization between urban and rural areas? To what extent has rapid growth in the non-agricultural sectors created more off-farm employment opportunities for agricultural SMEs, especially those controlling small amounts of land, thereby improving income distribution as well as alleviating poverty? This benign outcome is widely supposed to have characterized rural development in Taiwan over the years from the mid-1950s to the mid-1980s. But has it been widely replicated in the ASEAN region? In searching for answers to these complex questions, we must also bear in mind that in most parts of Southeast Asia over the past three decades, there has been a rapid decline in the agricultural sector’s contribution to GDP, and as a source of employment (Table 6.2). In most countries for which we have data over a period of decades (namely Indonesia, Malaysia, Myanmar, the Philippines, Thailand and Vietnam), the decline in agriculture as a share of GDP has exceeded the decline in the percentage of the labour force employed in agriculture, with the result that agricultural output per worker has declined in relation to total GDP per worker.10 In principle, this could mean that over time, the income gap between agricultural households and households on other parts of the economy has been widening. But we also have to take into account the process of income diversification to which I have already referred. If indeed many agricultural households are earning an increasing share of their income from off-farm, or non-agricultural activities, then the decline in relative agricultural productivity cannot be assumed to reflect a decline in agricultural households relative to the national average. But at the same time, access to off-farm sources of income may not be equal across all agricultural households. In the following three sections of this chapter, I will take three case studies and review the evidence on sources of farm household income, and access to off-farm employment

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Table 6.2 Ratio of Agricultural Output per Agricultural Worker to Average Output per Worker in South East Asian Economies Agricultural Productivity Ratio

Percentage of GDP from Agriculture

Percentage of the Labour Force in Agriculture

Cambodia (1999)

0.55

42.2

76.3

Indonesia (1971) Indonesia (1983) Indonesia (1999)

0.67 0.41 0.45

43.6 22.9 19.5

64.8 55.4 43.2

Lao PDR (1995)

0.65

55.2

85.5

Malaysia (1970) Malaysia (1983) Malaysia (1999)

0.60 0.67 0.49

31.4 21.1 9.1

52.6 31.5 18.4

Myanmar (1976) Myanmar (1983) Myanmar (1997)

0.73 0.72 0.94

47.5 47.6 58.9

65.3 66.1 62.7

Philippines (1971) Philippines (1983) Philippines (1999)

0.59 0.44 0.43

29.6 22.4 15.9

50.4 51.4 37.4

Thailand (1971) Thailand (1983) Thailand (1999)

0.36 0.29 0.23

28.6 20.1 11.2

79.2 69.1 48.5

Vietnam (1986) Vietnam (1999)

0.53 0.40

38.1 25.4

72.3 64.1

Source: Asian Development Bank, Key Indicators 2001: Growth and Change in Asia and the Pacific (Manila: Asian Development Bank 2001).

and income by holding size from the Thai agricultural statistics, the agricultural censuses conducted in Thailand and Indonesia in 1993, and from two surveys conducted in Vietnam during the 1990s. 3. Patterns of Employment and Income Sources on Thai Farms Agriculture in Thailand has historically been based on smallholdings. Unlike those parts of Southeast Asia under colonial control, large agricultural estates owned by either local or foreign capitalists did not emerge in large numbers in Thailand in the late nineteenth and early twentieth centuries. According to

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the 1993 Agricultural Census, more than 95 per cent of holdings were under 60 rai (9.6 hectares) and 75 per cent of land was in holdings less than 60 rai (Table 6.3). Well over 90 per cent of all economically active population living in agricultural households were to be found in holdings under 60 rai. But not all the economically active were working on the holding; especially on smaller holdings many also had off-farm employment. But even allowing for this, on a per hectare basis, there was a much higher number of on-farm workers on the smaller holdings than on the larger ones (Table 6.3). Since the early 1970s, the Ministry of Agriculture in Thailand has been collecting and publishing statistics on farm household incomes from both onholding and other activities. Over time, there has been a clear tendency for the proportion of total farm household income, which is derived from offholding sources to grow, so that by 1995/96 for the country as a whole, only 37 per cent of farm household income was derived from on-farm agricultural activities. In the North East, average income from on-farm agricultural activities was much lower than in other parts of the country, and accounted for only 19 per cent of total farm household income in 1995/96 (Table 6.4). It appears that access to off-farm employment has had some equalizing effect on total farm incomes by region, although not necessarily by household.

Table 6.3 Percentage Breakdown of Farm Holdings, Farm Area and Labour Force by Holding Size, Thailand 1993 Percentage Breakdown Holding Size (Hectares)

Farms

Area

Total Labour Forcea

Under 0.32 0.32–0.96 0.96–1.60 1.60–3.20 3.20–6.40 6.40–9.60 9.60–22.4 Over 22.4 Total

2.6 17.2 13.2 28.6 25.7 8.0 4.3 0.5 100.0

0.1 3.0 4.7 18.4 32.6 17.8 16.2 7.3 100.0

2.2 14.9 12.3 28.1 27.6 9.2 5.2 0.6 100.0

Labour force On-farm Working Workers On-farma per ha. 1.7 13.0 11.9 28.5 29.1 9.9 5.6 0.6 100.0

a

21.6 3.3 1.9 1.2 0.7 0.4 0.3 0.1

Total labour force refers to all economically active persons over the age of 13 in farm households; the on-farm labour force refers to all economicaly active persons who are wholly or mainly engaged in work on the farm holding. Source: Kingdom of Thailand (1995).

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Table 6.4 Percentage of Total Farm Income from Farm Operation, Thailand Year

Whole Kingdom

NorthEast

North

Central

South

1971/72 1975/76 1982/83 1986/87 1991/92 1995/96

53.9 44.6 41.3 40.4 32.8 36.9

51.5 34.0 31.4 37.2 24.0 18.8

56.3 50.7 48.1 46.5 45.0 40.3

66.1 54.5 52.1 43.2 35.1 45.8

40.2 44.8 35.2 36.1 37.4 53.5

Average household income 1995/96 (Baht ’000)

80.9

62.7

64.8

121.3

125.4

Source: Onchan (1990), Table 2.13; Agricultural Statistics of Thailand, various issues (Bangkok: Ministry of Agriculture and Co-operatives).

The steady growth in incomes from off-farm and non-agricultural activities in Thailand over the past three decades has meant that total farm household incomes have more or less kept pace over time with increases in the household income component of GDP, expressed on a per capita basis. Indeed, over the years from 1986/87 to 1995/96, total farm household incomes grew slightly faster than the household income component of GDP (Table 6.5). This would suggest that in spite of the relatively slow decline in the percentage of the labour force employed in agriculture in Thailand over the past three decades, it has been possible for farm family living standards to keep pace Table 6.5 Index of Growth of Farm Household Incomes and Personal Consumption Component of GDP in Thailand (1995/6 = 100) Year 1971/72 1975/76 1982/83 1986/87 1991/92 1995/96

Household Income from: On-farm All Activities 7.6 14.2 32.9 30.2 37.7 100.0

5.2 11.7 29.4 27.6 42.2 100.0

Per Capita Personal Consumption 6.6 12.7 30.2 35.3 65.4 100.0

Source: Onchan (1990), Table 2.13; Agricultural Statistics of Thailand, various issues (Bangkok: Ministry of Agriculture and Co-operatives); data on personal consumption component of GDP from Statistical Yearbook of Thailand, various issues (Bangkok: National Statistical Office).

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with those in other parts of the economy. But these data refer to averages for all farm holdings, and it is quite likely that there has been an increase in farm income inequalities over these years, with poorer households operating smaller holdings falling further behind. Unfortunately, the Ministry of Agriculture’s data on farm incomes are not broken down by holding size. Some indication of the importance of off-farm employment for farm households broken down by holding size can be gleaned from the 1993 Agricultural Census data which indicate, as one would expect, that off-farm employment and income is more important in those households operating small parcels of land (Tables 6.6 and 6.7). On very small holdings (less than 2 rai or 0.32 hectares), under 40 per cent of those households members who reported themselves as economically active were employed on the holding full-time. The percentage was much lower (30 per cent) in the southern region. Holdings above 60 rai (9.6 hectares) by contrast gave full-time employment to a much higher percentage of farm household workers. But the great majority of holdings (over 90 per cent) were between 2 and 60 rai, and they gave full-time employment to between 53 and 70 per cent of the farm household labour force. Similarly, between 38 and 54 per cent of farm households falling into these size categories reported agriculture as the only source of household income. There was very little regional variation in these percentages (Table 6.7). The picture presented by the Ministry of Agriculture survey data, together with the agricultural census figures, indicates that there has been substantial diversification of farm household incomes in Thailand over the past three Table 6.6 Percentage of Economically Active Farm Household Members over 13 Wholly Engaged in Agriculture by Holding Size, Thailand 1993 Holding Size (ha)

Whole Kingdom

NorthEast

North

Central

South

Under 0.32 0.32–0.96 0.96–1.60 1.60–3.20 3.20–6.40 6.40–9.60 9.60–22.4 Over 22.4

39.4 53.2 59.0 63.2 67.6 70.6 72.3 72.8

40.9 52.9 58.5 62.7 69.4 73.5 76.1 75.7

41.3 58.8 61.8 65.0 68.1 70.6 71.6 71.6

38.7 50.4 56.4 59.8 64.6 68.2 71.0 74.8

29.8 45.9 54.3 60.4 66.8 70.4 70.7 63.4

Average

63.1

62.0

65.6

60.4

59.2

Source: Kingdom of Thailand (1995), Table 9.4.

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Table 6.7 Percentage of Agricultural Holdings Where Agriculture is the Sole Household Income Source by Holding Size, Thailand 1993 Holding Size (ha)

Whole Kingdoma

NorthEast

North

Central

South

Under 0.32 0.32–0.96 0.96–1.60 1.60–3.20 3.20–6.40 6.40–9.60 9.60–22.4 Over 22.4

26.5 37.9 42.5 46.4 50.5 53.9 55.5 57.7

(43.3) (59.7) (69.3) (76.6) (83.5) (87.0) (87.8) (86.0)

28.6 38.0 43.2 48.1 55.9 60.3 61.8 61.1

26.6 41.1 43.1 45.7 47.6 50.0 50.5 52.1

26.6 36.8 42.3 46.5 51.1 54.8 57.6 62.5

19.7 32.6 39.7 46.3 52.9 65.4 56.5 48.1

Average

46.0 (75.0)

47.0

45.6

46.5

44.7

a

Figures in brackets show the percentage of holdings where agriculture is the sole or main source of income. Source: Kingdom of Thailand (1995), Table 10.1.

decades, so that by the early 1990s, a majority of farm households operating under 10 hectares (our cut-off point for an SME in agriculture) were earning at least part of their income from off-farm activities, including agricultural labour. Not surprisingly, over 70 per cent of those households operating very small holdings (under 2 rai or 0.32 hectares) were earning at least part of their income off the farm. Unfortunately, we cannot deduce the impact of these off farm earnings on the distribution of incomes among households cultivating agricultural land from the published data of the 1993 Agricultural Census. The ensuing section on Indonesia, based on data from the 1993 Agricultural Census in Indonesia, throws more light on this issue. 4. Patterns of Employment and Income Sources on Indonesian Farms In Indonesia, successive agricultural censuses since 1963 have shown that the great majority of operated farm holdings are quite small; indeed the 1993 census showed that well over 90 per cent of operated holdings were under 2.5 hectares (Table 6.8). But it must be noted that the agricultural censuses make a clear distinction between indigenous farm holdings on the one hand and agricultural estates on the other. Elsewhere I have argued that if large agricultural estates were combined with smallholdings, the pattern of land ownership in Indonesia would more closely resemble the distribution in the Philippines, with at least 20 per cent of all land in holdings over 10 hectares, rather than

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Table 6.8 Breakdown of Agricultural Households by Size of Holding and Main Income Source: Indonesia 1984 Size of Cultivated Holding (Hectares)

1993

Percentage Percentage of Percentage Percentage of Breakdown of Households Breakdown of Households Holdings by with Main Holdings by with Main Holding Size Income from Holding Size Income from Agriculture Agriculture

Under 0.1 0.1–0.249 0.25–0.49 0.50–0.99 1.00–2.49 over 2.5

8.5 16.4 21.3 24.1 23.4 6.3

62.6 69.7 79.8 87.0 90.5 92.2

7.0 18.4 22.3 22.4 24.2 5.7

56.4 66.5 75.5 83.1 89.5 92.1

Indonesia

100.0

81.7

100.0

78.5

Source: Central Bureau of Statistics (1987), Table 5; Central Bureau of Statistics (1995), Table 5.

that of egalitarian Taiwan, where after the land reform of the 1950s, less than 5 per cent of land was in holdings over 5 hectares (Booth 2002a, Table 2). Indeed it is probable that by the latter part of the 1990s, an even higher percentage of land was in holdings over 10 hectares, as land under large-scale palm oil estates has grown rapidly since the 1980s. Farm household income surveys were carried out in Indonesia as part of both the 1983 and 1993 Agricultural Censuses, although the earlier survey in fact referred to the calendar year 1984. These two surveys give us important insights into sources of farm household incomes in different parts of Indonesia, and how these sources have changed between the two surveys. In 1984, the average annual agricultural household income in Indonesia was Rp. 664,000; nine years later this had increased to Rp. 1,760,000 in nominal terms. Although this also implied a substantial increase in real terms, these nine years witnessed rapid growth in the non-agricultural economy and the real growth in farm household incomes was slower than real growth in total household expenditures as given in the national income statistics, which indicates that farm incomes on average were falling behind those in other parts of the economy. This is indeed confirmed by the data from the Social Accounting Matrices (SAMS) which show that all categories of agricultural household (except those operating very small holdings) experienced some decline in their incomes relative to the national average between 1985 and 1993 (Booth 2000, Table

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7). Between 1984 and 1993, the proportion of total farm household income which came from operating the farm holding (usaha pertanian) fell from 55 to 50 per cent. The proportion derived from wage labour (both agricultural and non-agricultural) also fell while that from other non-agricultural activities stayed roughly constant. The most rapid growth was in income derived from “other” sources which included income from remittances, and pensions (Booth 2002b, Table 2). The two surveys permit us to examine the changes in total income accruing to farm households, and the percentage derived from the farm holding by province. By 1993, when on average 50 per cent of total farm household income was being derived from the farm holding itself, seven provinces were deriving less than 50 per cent and two (West Java and Yogyakarta) were deriving less than 40 per cent (Booth 2002b, Table 3). At the other end of the provincial distribution, farm households in eight provinces were still depending on the farm holding for over 60 per cent of their income, and in three of these (Jambi, South Sumatra and South Sulawesi) the proportion had increased between 1984 and 1993. Neither in 1984 nor in 1993 was there any correlation between total farm household income from all sources by province and the proportion derived from the farm holding. There were several provinces (Jambi, Riau, South Sumatra) where total farm household income from all sources was well above the national average and where there was a relatively high dependence on income from the farm holding itself. But there were also provinces (Yogyakarta, Bali, North Sulawesi) where total farm household income was above the national average but where the reliance on income from the farm holding was much less. Similarly if we look at the provinces where the total farm household income was well below the national average, some such as Central Java had a high reliance on off-farm income while others such as East Nusatenggara and East Timor derived over 60 per cent of their total income from the holding itself. It is possible that in a province such as Jambi, most farm households can make a reasonable living from agriculture and feel less need to seek extra income elsewhere, while in a province such as East Nusatenggara, farm households would like to supplement their relatively meagre incomes from the farm holding but have little opportunity to do so.11 It is clear that income from the farm holding (usaha pertanian) has accounted for a diminishing percentage of total household income in recent years in many parts of Indonesia, as in many parts of Thailand. But it was still the case in the mid-1990s that the great majority of households which were involved in agricultural activities claimed that agriculture was the “main” source of household income. (This of course does not mean that it accounted

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for a large part of total household income; simply that it was more important than any other single source). In 1984, almost 82 per cent of farm households claimed that agriculture was the main source of their income; by 1993 this percentage had dropped only slightly (Table 6.8). In both years, there was a marked tendency for the percentage of households reporting agriculture as their main activity to increase by holding size. In 1993, only about 56 per cent of those households cultivating less than 0.1 hectares reported that agriculture was the main source of household income, compared with over 90 per cent of those cultivating more than 2.5 hectares. There are clear parallels with the situation in Thailand, where the 1993 Agricultural Census reported a steady increase in the percentage of households stating that agriculture was their only or main source of income by holding size (Table 6.7). Of those agricultural households in Indonesia who reported that agricultural activities (including agricultural wage employment) were not the main source of household income in 1993, the majority gave services as the main source. Fewer than 2 per cent of all agricultural households gave remittances and other earnings as their main income source. Manufacturing (both agricultural processing and other forms of manufacturing) was the main source of income of only 4 per cent of all agricultural households. There was a very pronounced inverse relationship between holding size and the percentage of households reporting trade and other service sector activity as the main source of household income (Table 6.9). This inverse relationship was also clear for households reporting manufacturing as the main income source. The presence of this inverse relationship could be used to support the view that off-farm activities in the manufacturing and especially in the service sector in Indonesia have had an equalizing effect on incomes accruing to agricultural households, in the sense that those households with fewer agricultural assets (as proxied by size of operated holding) are more reliant on these activities for the bulk of their income. Thus it could be hypothesized that the asset-poor agricultural households compensate for their low earning potential in agriculture by earning most of their income from other activities. But the evidence does not really support such an argument. The data in Table 6.9 do not tell us whether the asset-poor households are in fact earning sufficient from their off-farm activities to compensate for lower incomes from their farm holding. Rather, they simply indicate that the households with smaller operated holdings tend to rely more on non-farm activities for their “main” source of income. To explore the impact of off-farm earnings on the overall distribution of income between agricultural households, we need to examine the breakdown

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Table 6.9 Sources of Non-agricultural Income for Agricultural Households, Indonesia 1993 Size of Cultivated Holding (Hectares)

Percentage of Households with Main Income from Non-agricultural Activities

Main Source of Household Income Manufacturing Trade Other AgriOther Services processing

Other

Under 0.05 0.05–0.099 0.10–0.249 0.25–0.499 0.5–0.999 1.0–2.499 2.5–4.999 5.0–9.999 Over 10 hectares

45.8 42.4 33.5 24.5 16.9 10.5 7.6 8.7 15.6

1.6 2.0 2.0 1.6 1.1 0.7 0.6 0.8 ..

6.3 6.5 4.9 2.9 1.9 1.1 0.7 0.5 2.0

12.8 12.6 10.8 8.3 5.5 3.1 2.2 2.0 5.4

20.2 17.8 13.6 10.3 7.5 5.0 3.7 4.7 6.4

4.9 3.5 2.2 1.4 1.0 0.7 0.4 0.7 1.8

Average

21.5

1.3

2.7

6.8

9.2

1.4

Source: Central Bureau of Statistics (1995), Table 19.

of income accruing to agricultural households from different sources by total household income class. Fortunately, the 1993 Survey of Agricultural Household Incomes did present data on this (Table 6.10). There was no strong evidence of an inverse relationship between the income size group and the percentage of income derived from non-agricultural sources. Quite the reverse, as a matter of fact. With the exception of the smallest and the largest income size group, there was a steady tendency for the percentage of total household income derived from the farm holding, and from all agricultural activities including wage labour, to fall as household income increased. There was a significant degree of positive correlation between income from the farm holding (by total income class) and the proportion of total income derived from non-agricultural sources (r = 0.53).12 As total agricultural household income from all sources grew, nonagricultural wage earnings and income from self-employment activities (manufacturing, trade and other services) both accounted for a growing percentage of total household income (Table 6.11). There was some sign of an “inverted U” relationship for non-agricultural wage income, and of a “U” relationship for other income (which includes pensions and remittances), although other income only accounted for more than 30 per cent of total household income in the top income class. The top income class in turn

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Table 6.10 Percentage Breakdown of Agricultural Household Income by Agricultural Income Source and Income Size, Indonesia, 1993 Income per Month (Rp. ’000)

Percentage of Agricultural Households in Income Group

As Percentage of Total Household Income Farm Agricultural All Wages Agricultural Holdinga Incomeb

Under 20 20–24 25–29 30–39 40–49 50–74 75–99 100–149 150–199 200–299 300–399 400–499 500–749 750–899 Over 900

2.0 1.4 2.1 5.2 6.2 17.0 15.6 21.5 11.2 9.7 3.8 1.8 1.6 0.4 0.7

48.3 (71.2) 55.6 (73.2) 53.3 (71.2) 54.4 (68.6) 54.1 (64.5) 54.2 (60.5) 54.1 (57.3) 54.2 (52.5) 52.3 (47.7) 48.5 (43.5) 45.1 (39.7) 44.2 (38.1) 44.1 (33.7) 39.7 (23.9) 46.7 (12.4)

7.4 10.5 11.5 13.0 13.9 14.2 13.1 10.7 8.3 5.8 3.4 2.7 2.1 1.4 0.4

62.5 73.3 72.2 74.4 74.4 74.3 72.3 69.8 64.1 57.1 50.6 49.0 47.9 42.4 48.0

Indonesia

100.0

50.0 (45.4)

7.4

60.7

a

Figures in brackets show the percentage of farm holding income which is derived from foodcrop agriculture. b Total agricultural income is the sum of income from the farm holding, agricultural wages and “other sources”, not shown here. Typically they would include hiring out of agricultural equipment and land. Source: Central Bureau of Statistics (1995), Tables 8–12.

accounted for a very small percentage of all agricultural households. The top four income classes, all of which derived less than half of their total income from agricultural activities, only accounted for about 4.5 per cent of all agricultural households. This apparently paradoxical combination, of a rising percentage of onfarm to total income as holding size increases and a falling percentage of onfarm to total income as income size increases, has in fact been found in a number of Latin American case studies (Reardon, Berdegue and Escobar 2001, p. 404). On the one hand it seems reasonable to expect that those agricultural households operating larger than average holdings have less need to seek off-farm work. But how can we explain the fact that the richer agricultural households (ranked by income, rather than by operated land holding) are more dependent on off-farm income than the poorer ones? The

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Table 6.11 Percentage Breakdown of Agricultural Household Income by Non-agricultural Income Source and Income Size, Indonesia, 1993 Income per Month (Rp. ’000)

As Percentage of Total Agricultural Household Incomea NonManuTrade Other Other All Nonagricultural facturing Services Income agricultural Wages Income

Under 20 20–24 25–29 30–39 40–49 50–74 75–99 100–149 150–199 200–299 300–399 400–499 500–749 750–899 Over 900

3.2 1.7 2.4 3.4 4.1 5.8 8.3 10.7 14.3 19.5 25.3 28.3 25.3 21.0 5.7

1.3 1.1 1.6 1.6 1.7 1.8 1.9 1.9 1.9 1.8 2.0 2.1 3.4 3.6 3.1

1.1 1.4 2.1 1.8 2.4 3.1 3.9 5.2 6.9 8.1 8.1 8.2 7.4 10.1 7.0

0.3 0.4 1.1 0.7 1.0 1.2 1.6 2.0 2.2 2.4 2.4 2.4 3.3 5.5 3.4

31.7 22.1 20.7 18.2 16.5 13.7 12.0 11.0 10.6 11.0 11.5 10.0 12.6 17.4 32.9

37.5 26.7 27.8 25.8 25.6 25.7 27.7 30.7 35.9 42.9 49.4 51.0 52.1 57.6 52.0

Average

14.6

2.1

6.3

2.3

13.4

39.3

a

Manufacturing includes both agro-processing and other forms of manufacturing. Other sources of income includes pensions and remittances and also sources not elsewhere included. Source: Central Bureau of Statistics (1995), Tables 8–11.

direction of causality is clearly more complex when we examine rankings by income size, and it appears that in Indonesia, as in a number of Latin American economies, households which have managed to diversify their economic activities away from agriculture, and especially those households which have managed to gain access to non-agricultural employment opportunities, have been the most successful in increasing their total incomes. These are sometimes, but by no means always, those households which control relatively large amounts of agricultural land. But control over other assets, including educated labour, permits households to diversify successfully into non-agricultural activities, and are thus important determinants of total household income. 5. Recent Evidence on Off-farm Employment in Vietnam The recent agrarian history of Vietnam is very different from that in both Thailand and Indonesia. In the 1950s, there was a land reform campaign in

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North Vietnam (from 1953 to 1956) that redistributed land but according to Fforde (1989: 11) “could not end many economic inequalities” in rural areas. The land reform was followed by the formation of agricultural cooperatives; by 1959 nearly 90 per cent of peasant households with 70 per cent of the land had joined cooperatives. Over the 1960s many of these cooperatives were amalgamated and transformed into “higher level” cooperatives. In South Vietnam, where land ownership was highly skewed in the colonial era, there was some attempt at land reform during the 1960s and the first part of the 1970s.13 The thrust of the reforms in the south was to give land titles to tenants, and by 1973 almost one million titles had been distributed, involving over one million hectares of land (Dacy 1986, Chapter 4). After reunification, much more coercive methods were used to redistribute land and break up traditional rural power structures, but after 1986, with the introduction of the economic restructuring programme, there was a return to a “household responsibility” system mirroring similar reforms introduced in China. By the early 1990s, agricultural markets for both inputs and outputs had been greatly liberalized, and new technologies were being successfully disseminated, especially in rice production. From 1986 to 1999, growth in agricultural output per capita was faster in Vietnam than in any other part of Southeast Asia, and by the mid-1990s rice yields were higher than in any other country except Indonesia (Table 6.1). Vietnam also experienced rapid growth in the non-agricultural economy over the 1990s, and although unemployment remains a serious problem, especially among young people in urban areas, there can be little doubt that accelerated growth did open up new employment opportunities for many millions of rural households.14 In his analysis of the 1992/93 Vietnam Living Standards Survey, Vijverberg (1998, Table 5.1a) found that 88.4 per cent of employed rural males and 88.8 per cent of employed rural females were active in the agricultural sector. Of these around 14 per cent of men and 16 per cent of women were also active in some kind of non-farm self-employment activity. Smaller percentages of both men and women in rural areas were fully engaged in non-farm businesses. A multivariate probit analysis revealed that “the decision to run an enterprise is influenced by the presence of a regularly operating market, the level of local wages, the availability of secondary schools, and the spread of electricity and piped water in the community” (Vijverberg 1998, p. 148). In enterprises such as retail trade, preparation and sale of food, and textile manufacturing, most of the workers are women. This study also emphasized the bureaucratic barriers to the establishment and expansion of rural

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enterprises. Registration and licensing procedures are cumbersome, and there appears to be few opportunities for obtaining credit from formal banks to start or expand a business. Where credit is obtained it is usually through informal channels. In spite of these handicaps, it appears that the number of rural businesses continued to expand in Vietnam over the 1990s, and many are adjuncts to farm-based enterprises. A 1997 survey reported that 26 per cent of rural households in Vietnam were “mixed type” households engaged in both agricultural and non-agricultural activities. Of these mixed enterprises, almost 42 per cent had been started between 1993 and 1997. The great majority was either in agricultural processing or in services (Table 6.12). Most respondents replied that low household income and under-employment of household members were the main reasons for establishing the enterprise. It is as yet difficult to judge how this growth is affecting rural income distribution, although more intensive analysis of the 1997 survey data could shed some light on this question. Table 6.12 Percentage Breakdown of Rural Households in Vietnam, 1997 by Source of Household Income North

South

Whole Country

100.0

100.0

100.0

Agriculture only

67.8

59.1

62.2

Mixed Agriculture Industry/Construction Services

23.9 10.1 4.8 9.0

28.0 8.3 3.2 16.5

26.5 9.3 4.1 13.1

8.3

13.0

11.3

2.0 3.5 2.8

2.0 3.8 7.2

2.0 3.7 5.6

58.0 31.5 8.5 1.9

44.8 39.3 13.6 2.4

50.8 35.8 11.3 2.2

Total rural households

Non-farm Agricultural Processing Industry Services Reasons for starting a non-farm enterprise Under-employment Low income Market demand Other

Source: Ministry of Agriculture and Rural Development (1998), pp. 37–38.

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6. Linkages between Growth of On-farm and Off-farm Incomes Over the last two decades, much research has been carried out in many parts of the world which examines the nature of linkages between the agricultural and non-agricultural sectors of rural economies.15 There seems to be little doubt that interactions between different sectors of the rural economy have varied greatly both between countries and over time. Some authors have put forward an “Asian example” where the combination of a “relatively egalitarian distribution of income, well-functioning factor markets, and a strong emphasis on educational expansion” has produced rapid growth of non-agricultural employment in rural areas, which benefits most rural households (Deininger and Olinto 2001: 464). This benign outcome is then contrasted with the much less egalitarian outcomes, which have occurred in many parts of Africa and Latin America. But in fact the so-called “Asian” result seems to be based on the recent history of just one country, Taiwan, and there is growing evidence that the Taiwanese experience is far from typical of other Asian countries, let alone other parts of the developing world.16 Ranis, Stewart and Angeles-Reyes (1990) and Ranis and Stewart (1993) have investigated differences in urban-rural linkages between the Philippines and Taiwan. They argued that the more skewed distribution of land and income in the Philippines, combined with the more capital-intensive, urbanbiased nature of the industrialization process, have led to a much slower growth of non-agricultural employment and incomes in rural areas in the Philippines compared with Taiwan. This in turn has meant that a given amount of agricultural income growth created fewer non-agricultural employment opportunities in rural areas compared with Taiwan. Thus the ratio of growth in non-agricultural incomes to growth in agricultural incomes was much lower in rural areas in the Philippines; in fact over the two decades from 1965 to 1985 they estimate that rural non-agricultural incomes grew more slowly than agricultural incomes (Ranis and Stewart 1993: Table 14). In similar vein, Bautista (1994, p. 98) has addressed the puzzle of why the rapid growth in agricultural output in the Philippines between 1965 and 1980 failed to ensure rapid growth in other parts of the economy. “The explanation lies in the inequitable distribution of income gains from agricultural growth and the failure to generate rural-based, labor-intensive industrialization”, which in turn could have absorbed more rural labour. The agricultural household income surveys in Indonesia and Thailand can be used to estimate linkage ratios for both countries over the 1980s and 1990s. For Indonesia as a whole, the growth of off-farm income of agricultural

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households was only about 24 per cent faster than the growth in income from the agricultural holdings (Table 6.13). As would be expected, the average for the country as a whole masked considerable inter-provincial variations. In the five provinces where the proportion of total agricultural household income derived from the farm holding was lowest in 1993, the linkage ratios were higher than the national average. But even in Bali, the linkage ratio, although higher than the average for Indonesia, was much below that found in Taiwan between 1962 and 1972. The evidence suggests that Indonesia, like Thailand, is an “intermediate case” between Taiwan on the one hand and the Philippines on the other. Faster overall rates of economic growth over the 1980s and the first part of the 1990s, in both Thailand and Indonesia, compared with the Philippines, must have played an important role in generating faster growth in off-farm earning opportunities even if the result was hardly as impressive as in Taiwan.

Table 6.13 Linkage Ratios and the Percentage of Total Farm Income Accruing from Off-farm Employment Country/Years

Linkage Ratioa

Per Capita Percentage of Farm Income GDP from Off-farm Sources (Initial Year)b Initial Final Year Year

Taiwan (1962–80)

3.55

1364

25

60

Philippines (1965–85)

0.94

1248

45

56

Taiwan (1962–72)

2.99

1364

40

60

Thailand (1971/2–1982/3)

1.38

1507

46

59

Indonesia (1984–93) West Java Yogyakarta Central Java West Sumatra Bali

1.24 1.34 1.35 1.54 1.60 1.70

1602

45 58 58 50 48 41

50 65 64 59 58 55

a

Growth in off-farm incomes over the period shown divided by growth in farm incomes. ICP dollars in 1985 prices adjusted for changes in the terms of trade. Data taken from Penn World Tables (version 5.6). Source: Taiwan (1962–80) and the Philippines: Ranis and Stewart (1993), Tables 9 and 14; Taiwan (1962–72): Ho (1986), Table 4.2; Thailand: Onchan (1990), Table 2.13; Indonesia: Central Bureau of Statistics (1987), (1995).

b

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6.1. The Impact of Off-farm Employment on Agricultural Production The Taiwanese experience indicates that off-farm incomes grow fast, relative to on-farm incomes, in an agrarian system based on small, owner-cultivated holdings where agricultural output is itself growing rapidly. In Taiwan, rural areas were provided with good infrastructure so that transport of both goods and people between large urban centres, smaller towns and rural villages was fast and efficient. In addition, there were apparently few temptations, at least in the early stages of industrialization, for farm household members to leave the farm completely. Although some young adults shifted out of the household on a permanent basis, many stayed and could contribute their labour to the farm enterprise at peak periods while engaging in various types of off-farm employment at other times. This in turn led to an egalitarian pattern of growth in rural household incomes, at least up until the early 1980s. The Taiwanese experience has been much studied but no other Asian country has managed to emulate it. One reason is that in many parts of Asia, and indeed in many other parts of the developing world, farm household members often leave the household on a permanent basis and are not available to work in the farm enterprise at any time of the year. Low (1981) argued that in both Lesotho and Swaziland, over the 1970s, many young males left farms to work in the mining sector and this led to a fall in agricultural output and incomes. These workers were pulled out of agriculture by the availability of well-paid work in the mines, but the mass movement of young people out of agriculture has led to falling production and little new investment in the agricultural sector. The result is a technologically stagnant agricultural sector where there is little incentive for young people to stay on the farm and a greater “push” incentive to seek non-agricultural employment. How relevant is Low’s argument in the Southeast Asia? Angeles-Reyes (1987), in her examination of changes in sources of farm household income in Bicol between 1978 and 1983, found the same pattern of falling net farm income and high out-migration as Low had noted in southern Africa. In the context of falling farm incomes, farm households were sustained by growing remittances from family members working in Manila and abroad. But unlike southern Africa, Bicol is a labour-surplus area where the government had invested heavily in rural infrastructure. The falling farm incomes in the early 1980s were caused by rising prices of inputs (especially fertilizer) and lack of credit especially for tenant farmers cultivating small plots. Even allowing for continuing high out-migration, Angeles-Reyes argued that there was still an urgent need for a small-farm oriented development programme, including

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land reform. Only through such a programme could farm household incomes increase and rural poverty decline. Her arguments have implications for other parts of Southeast Asia characterized by slow-growing or stagnant agricultural incomes and high outmigration, at least some of it abroad. In Northeast Thailand, agricultural output per hectare and per worker has, in recent decades been lower than in other parts of Thailand and farm incomes have grown slowly relative to the national average. But as we have seen, there has been a steep decline in incomes from the farm operation as a percentage of total farm household income (Table 6.4). In 1995/96, 15 per cent of all off-farm earnings in the North East was from foreign work, where one presumes the worker was gone for a long period and was not available for any farm labour. Most of these workers left for foreign employment because of the lure of higher wages; while it is possible that their absence has had a negative effect on farm productivity, the Northeastern region of Thailand still had, in 1995/96, a higher proportion of the labour force employed in agriculture than any other part of the country. So it is unlikely that the productivity impact of long-term out migration is very severe. As in Bicol, stagnant agricultural incomes would seem to be mainly due to agro-climatic conditions and low government and private sector investment in the agricultural sector. Even so, there is still a tendency on the part of some observers to argue that those regions where agricultural production is stagnant, and a high proportion of farm household income is derived from off-farm sources (including worker remittances), additional investment in agricultural infrastructure and in research into higher yielding crop varieties is money wasted. While this may be true in some extreme cases, it is at least as likely that it is the neglect of small farm development in many parts of Southeast Asia over the past two decades that led to a situation where many young people are forced to seek long-term employment off the farm, even if this means working far from home, or abroad. There is much evidence from many parts of Asia that growth in agricultural output, especially in the context of a reasonably egalitarian land distribution, is more likely to reduce rural poverty than growth in other parts of the economy. And given that most of the poor are located in rural areas, the argument in favour of more investment in both infrastructure and in agricultural research seems compelling.

6.2. Policy Implications From the above discussion of SMEs in agriculture in different parts of Southeast Asia, the following conclusions can be drawn:

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(1) Throughout Southeast Asia, the evidence indicates that farm households operating plots of land under ten hectares are increasingly dependent on a variety of off-farm (usually but not always non-agricultural) income for a substantial part of their incomes. In both Indonesia and Thailand, farm households on average were deriving over half their total incomes from off-farm sources. In both countries, there was a tendency for the proportion of off-farm to total income to decline by holding size. (2) There is strong evidence to suggest that increasing diversification of farm household income has been an important factor in the decline in rural poverty which occurred in Indonesia and Thailand at least until the crisis of 1997, and also to a lesser extent in the Philippines.17 (3) The effect of increased diversification on income distribution within the farm household sector is less clear. The evidence from the 1993 Agricultural Census of Indonesia shows that the percentage of total farm household income from non-agricultural sources tends to rise by total farm income size. This confirms the findings of White (1991, pp. 60–61) that those farm households with higher incomes can invest more in various types of capital goods, as well as in education of household members, which in turn enables them to earn higher incomes in the future. (4) The Taiwan evidence supports the view that rapid rates of agricultural growth are linked to even faster growth of off-farm income. But these “linkage ratios” vary considerably across Southeast Asia and within large countries such as Indonesia. More research is needed on both the causes and consequences of these variations. (5) In Vietnam, where land reform policies have been implemented in both the northern and southern regions since the 1950s, it appears that in the late 1990s, an increasing number of small farms were becoming engaged in non-agricultural activities in order to boost family incomes. Most farms gave “push” factors such as high underemployment among farm household members and low incomes as the chief reason for establishing non-farm enterprises. (6) It is possible that in some parts of Southeast Asia, low agricultural productivity is leading to high rates of out-migration on a permanent basis, which in turn may harm agricultural production in the future, mainly through labour shortages. But there is in fact not much evidence of rural labour shortages anywhere in Southeast Asia (especially after the crisis) except Malaysia. In some regions such as Bicol and the Northeast of Thailand, agricultural productivity could be enhanced through both tenure reform and the provision of inputs such as fertiliser at prices which made their adoption profitable to farmers. While remittances from family members working in other parts of

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the country or abroad help to boost farm household incomes in these regions, there would be less incentive for young people to move out if farm incomes were higher and if more attractive off-farm employment was available locally. That there is still a role for government-initiated small farm development programmes in rural Southeast Asia seems indisputable. In the decade up until the crisis of 1997, most governments in the region appear to have lost interest in agricultural and rural development and to have given higher priority to industrial development and the infrastructure necessary to support it. This reflects a wider tendency in many parts of the world to rely on the private sector to fund agricultural research and development, but as Lipton (2001, p. 824) argued, giant agricultural firms do not have the incentive to direct their huge resources to the fight against third world poverty. That must remain the responsibility of national governments and multilateral and bilateral development agencies. To the extent that most of the poor in Southeast Asia are still mainly located in rural areas, and in marginal farms and landless households, rural and agricultural development strategies must be directed to boosting employment opportunities and incomes for these households. This does not necessarily imply a huge increase in budgetary outlays; it is obvious that most governments in the region are in no position to fund significant increases in expenditures in any sector of the economy. But there is much that both national and regional governments can do to foster programmes that can be self-financing if not from the outset, at least in the medium term. A good example are self-financing rural credit programmes such as KUPEDES in Indonesia. This is a general rural credit scheme which replaced various subsidized agricultural credit programmes in the 1980s. It is operated by a state bank but has had a sound repayment record over the years and during the severe downturn in 1997/98, KUPEDES borrowers continued to pay back almost all their loan servicing obligations (Patten, Rosengard and Johnston 2001, p. 1063). Such programmes can have a very positive impact on rural SMEs whether in agriculture, agriculturally related or non-farm. Lack of access to formal credit programmes is frequently cited as a major constraint on expansion by rural SMEs everywhere in Asia, and KUPEDES offers a useful model for other countries to follow. In other parts of the ASEAN region, government-backed agricultural credit programmes have often been plagued by corruption and mismanagement. In addition there is still a need for reforms in input and output pricing, and in exchange rate policies which discriminate against rural producers of both export and import-competing crops. In Burma (Myanmar) there have been episodes of reform in the agricultural pricing regime, but

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these have not been consistently implemented over long periods of time, or across all crops. Fertilizers remain both highly priced relative to farm-gate prices of crops, and in short supply (International Monetary Fund 1999, p. 10). Where farmers are confronted by high prices for inputs and supply bottlenecks, together with low prices for output, it is unlikely that they will be able to increase yields as rapidly as is technically feasible. NOTES 1. I am grateful to participants in the ASEAN Roundtable 2002 for their helpful comments, and especially to Dr Mya Than for both comments and additional information on Burma. 2. The estates/smallholdings distinction is widely used in many parts of Southeast Asia, but is not, in my view, a very helpful one. Definitions vary widely across countries and in the same country over time. In the Indonesian context, the distinction has sometimes been made on legal grounds (estates are registered as companies under the relevant legislation) and sometimes in terms of holding size, or of size of the employed labour force. My understanding that in the Philippines and Malaysia the distinction is a legal one, rather than simply based on size of holding. 3. It should be stressed that “off-holding” income is not the same as “non-agricultural” income. In both the Indonesian and the Thai surveys, off-holding income included agricultural wage labour and also income from renting out land, equipment and livestock. 4. The literature on off-farm employment is now substantial. Oshima (1984) and the papers in Shand (1986) review the evidence up until the early 1980s in the context of Asia. Saith (1992) draws on work in both Asia and other parts of the developing world, as do Lanjouw and Lanjouw (1995), and FAO (1998). Ellis (1998) gives a comprehensive survey, albeit with a focus on sub-Saharan Africa. There is also a body of literature for Indonesia based on colonial censuses and surveys which demonstrates the importance of non-agricultural employment in the early decades of the twentieth century in Java, especially for women. See the essays in Alexander, Boomgaard and White (1991) for an extensive discussion and analysis of these sources. 5. The definition of a rural (as distinct from urban) area is usually made in terms of population densities and provision of “urban-type” facilities; in many parts of the region over the past two decades re-zoning is slow to catch up with rapid changes on the ground. 6. Agricultural output in the Philippines grew rapidly between 1965 and 1980, at around 5.6 per cent per annum, but slowed markedly thereafter. This rapid growth performance has usually been attributed to widespread adoption of new production technologies. See Bautista (1994, p. 98) for further discussion.

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7. A detailed examination of the sources of growth in the rice sector in different parts of Asia between 1930 and 1980 is given in Barker and Herdt (1985), pp. 46–53. 8. Balisacan (1993: 301) points out that the evidence does not support the common view in the Philippines that much of the growth in agricultural output between 1965 and 1980 was due to the green revolution in rice. In fact growth in rice output accounted for only a small fraction of growth in total agricultural output over these years. 9. See Asian Development Bank (2001) for time series data on real agricultural output for the main ASEAN economies after 1985. These data are taken from national income accounts. 10. The main exception is Myanmar where the data are questionable, although there does appear to have been very little structural change in the economy over the past three decades. Indeed the share of agriculture in total GDP has increased although this probably reflects changes in the agricultural pricing regime as much as structural economic shifts. 11. Booth (2002b), Table 11, examines the correlates of agricultural household dependency on income from the farm holding by province with a range of geographic and economic indicators. Significant negative correlations were found with population densities, road densities, and the percentage of rural households not owning land. An OLS regression analysis indicates that around two thirds of the inter-provincial variation in dependency on income from the farm holding (as shown in Table 6.4) can be accounted for by rural poverty, and some agricultural variables including area per farm, and value added in smallholder agriculture per hectare. 12. White (1991, Table 10) compares the impact of non-farm incomes on the overall distribution of farm household incomes in Java and Japan. He argues that whereas in Japan in 1978, off-farm earnings made the overall distribution more equal, the opposite was the case in Java. 13. See Murray (1980, pp. 428–35) for a discussion of the evidence on agrarian structure in South Vietnam in the colonial period. 14. Data on unemployment in urban and rural areas can be found in Statistical Publishing House (2001). In 1999, urban unemployment among 15 to 24 year olds was over 19 per cent; in Hanoi it was 19.4 per cent and in Ho Chi Minh City, 21 per cent. 15. See Lanjouw and Lanjouw (1995) and Ellis (1998: 19–23) for a discussion of the literature. 16. Ho (1979) in an early examination of the Taiwanese success with decentralized industrialization, stressed the difference between Taiwan and South Korea. In the latter country, a labour force survey carried out in 1974 showed that less than 30 per cent of total employment in commerce and services was located in rural areas. 17. Huppi and Ravallion (1991) discuss the impact of growing off-farm employment

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on rural poverty decline in Indonesia. Balisacan (1992) examines the impact of a number of variables, including access to off-farm work on rural poverty in the Philippines. REFERENCES Alexander, Paul, Peter Boomgaard and Ben White, eds. In the Shadow of Agriculture: Non-farm Activities in the Javanese Economy, Past and Present. Amsterdam: Royal Tropical Institute, 1991. Angeles-Reyes, Edna. “The Structure of Rural Household Income and its Implications on Rural Poverty in Bicol, Philippines”. Journal of Philippine Development, XIV, no. 2 (1987): 302–20. Asian Development Bank. Growth and Change in Asia and the Pacific: Key Indicators 2001, Manila: Asian Development Bank, 2001. Balisacan, Arsenio. “Rural Poverty in the Philippines: Incidence, Determinants and Policies”. Asian Development Review 10, no. 1 (1992): 125–63. Balisacan, Arsenio. “Agricultural Growth and Rural Performance: A Philippine Perspective”. Journal of Philippine Development, XX, no. 2 (1993): 289–317. Barker, Randolph and Robert Herdt with Beth Rose. The New Rice Economy of Asia, Washington: Resources for the Future Inc., 1985. Bautista, Romeo. “Dynamics of Rural Development: Analytical and Policy Issues”. Journal of Philippine Development, XXI, nos. 1 and 2 (1994): 93–134. Booth, Anne. “Poverty and Inequality in the Soeharto Era: An Assessment”. Bulletin of Indonesian Economic Studies 36, no. 1 (2000): 73–104. Booth, Anne.“Rethinking the Role of Agriculture in the ‘East Asian’ Model: Why is Southeast Asia Different from Northeast Asia?”. ASEAN Economic Bulletin 19, no. 1 (2002a): 40–51. Booth, Anne. “The Changing Role of Non-farm Activities in Agricutural Households in Indonesia: Some Insights from the Agricultural Censuses”. Bulletin of Indonesian Economic Studies 38 no. 2 (2002b): 167–88. Central Bureau of Statistics. Sensus Pertanian 1983: Sampel Pendapatan Petani, Seri I (Agricultural Census 1983: Sample Survey of Farm Incomes). Jakarta: Central Bureau of Statistics, August 1987. Central Bureau of Statistics. Sensus Pertanian 1993, Seri D1: Pendapatan Rumahtangga Pertanian dan Indikator Sosial Ekonomi (Agricultural Census 1993, Series D1: Agricultural Household Incomes and Socioeconomic Indicators). Jakarta: Central Bureau of Statistics, 1995. Cain, Mead and Geoff McNicoll. “Population Growth and Agrarian Outcomes” in Population, Food and Rural Development, edited by Ronald D. Lee et al. pp. 101– 17. Oxford: Clarendon Press, 1988. Dacy, Douglas. Foreign Aid, War and Economic Development: South Vietnam, 1955– 75. Cambridge: Cambridge University Press, 1986. Deininger, Klaus and Pedro Olinto. “Rural Nonfarm Employment and Income Diversification in Colombia”. World Development 29, no. 3 (2001): 455–65.

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Ellis, Frank. “Household Strategies and Rural Livelihood Diversifications”. Journal of Development Studies 35, no. 1 (1998): 1–38. FAO. “Rural Non-Farm Income in Developing Countries”. In The State of Food and Agriculture. Rome: Food and Agricultural Organization, 1998. Fforde, Adam. The Agrarian Question in North Vietnam, 1974–1979. New York: M.E. Sharpe, 1989. Ho, Samuel P.S. “Decentralized Industrialization and Rural Development: Evidence from Taiwan”. Economic Development and Cultural Change 28, no. 1 (1979): 77– 96. Ho, Samuel P.S. “Off-Farm Employment and Farm Households in Taiwan” in Offfarm Employment in the Development of Rural Asia, edited by R.T. Shand, pp. 95–128. Canberra: National Centre for Development Studies, Australian National University, 1986. Huppi, Monika and Martin Ravallion. “The Sectoral Structure of Poverty During an Adjustment Period: Evidence for Indonesia in the Mid-1980s”. World Development 19, no. 12 (1991): 1653–78. International Monetary Fund. Myanmar: Recent Economic Developments. Washington: International Monetary Fund, November 1999. Kingdom of Thailand. Report on the 1993 Agricutural Census. Bangkok: National Statistical Office, 1995. Lanjouw, Jean O. and Peter Lanjouw. “Rural Nonfarm Employment: A Survey”. Policy Research Working Paper 1463, Washington: World Bank, May 1995. Lipton, Michael. “Reviving Global Poverty Reduction: What Role for Genetically Modified Plants?”. Journal of International Development 13 (2001): 823–46. Low, A.R.C. “The Effect of Off-farm Employment on Farm Incomes and Production: Taiwan Contrasted with Southern Africa”. Economic Development and Cultural Change 29, no. 4 (1981): 741–47. Mya Than. Growth Pattern of Burmese Agriculture: A Productivity Approach. Singapore: Institute of Southeast Asian Studies, 1988. Ministry of Agriculture and Rural Development. Nganh Nghe Nong Thon Vietnam (Rural Industries and Services in Vietnam 1997: Result of Non-farm Survey 1997). Hanoi: Agriculture Publishing House, 1998. Murray, Martin J. The Development of Capitalism in Colonial Indochina (1870–1940). Berkeley: University of California Press, 1980. Myint, H. “The Inward and Outward Looking Countries of Southeast Asia”. Malayan Economic Review XII, no. 1 (April 1967): 1–13. Onchan, Tongroj. “A Land Policy Study”. Research Monograph no. 3, Bangkok: The Thailand Development Research Institute Foundation, 1990. Oshima, Harry T. “The Significance of Off-Farm Employment and Incomes in PostWar East Asian Growth”. Asian Development Bank Economic Staff Paper no. 21, Manila: Asian Development Bank, 1984. Patten, Richard, Jay K. Rosengard and Don E. Johnston. “Microfinance Success Amidst Macroeconomic Failure: The Experience of Bank Rakyat Indonesia during the East Asian Crisis”. World Development 29, no. 6: 1057–69.

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Platteau, J-P. and Y. Hayami.“Resource Endowments and Agricultural Development: Africa versus Asia”. In The Institutional Foundations of East Asian Development, edited by Y. Hayami and M. Aoki, pp. 357–410. London: Macmillan, 1998. Ranis, Gustav and Frances Stewart. “Rural Non-agricultural Activities in Development: Theory and Application”. Journal of Development Economics 40, no. 1 (1993): 75–101. Ranis, Gustav, Frances Stewart and Edna Angeles-Reyes. Linkages in Developing Economies: A Philippine Study. San Francisco: International Center for Economic Growth, 1990. Reardon, Thomas, Julio Berdegue and German Escobar. “Rural Nonfarm Employment and Incomes in Latin America: Overview and Policy Implications”. World Development 29, no. 3 (2001): 395–409. Saith, Ashwani. The Rural Non-farm Economy: Processes and Policies. Geneva: International Labour Office, 1992. Shand, Richard T., ed. Off-farm Employment in the Development of Rural Asia. Canberra: National Centre for Development Studies, Australian National University, 1986. Statistical Publishing House. Statistical Data of Vietnam, Labour-Employment 1996– 2000. Hanoi: Statistical Publishing House. Vijverberg, Wim P.M. “Non-farm Household Enterprises in Vietnam”. In Household Welfare and Vietnam’s Transition, edited by David Dollar, Paul Glewwe and Jennie Litvack, pp. 137–78. Washington: World Bank, 1998. White, Benjamin. “Economic Diversification and Agrarian Change in Rural Java, 1900–1990”. In In the Shadow of Agriculture: Non-farm Activities in the Javanese Economy, Past and Present, edited by Paul Alexander, Peter Boomgaard and Ben White, pp. 41–69. Amsterdam: Royal Tropical Institute, 1991.

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Individual articles are available at < http://bookshop.iseas.edu.sg > SME Studies. Clusters in Indonesia 119

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The Development of SME Clusters in Indonesia Hendrawan Supratikno

1. Introduction The term “cluster” in the Indonesian context is only adopted recently. In the past, the Ministry of Industry used the term sentra industri (industrial centre) to define the geographical groupings of at least twenty enterprises producing more or less the same products. In 1979, the ministry also introduced what was formally known as Lingkungan Industri Kecil (Small-scale Industrial Estate) by inducing and bringing together many small enterprises at one location. While sentra industri grows more naturally, the emergence of lingkungan industri has grown out of government involvement. There were two patterns in developing industrial estate, namely, one which was established in the same location where the producers lived (called Perkampungan Industri Kecil (PIK) or Small-scale Industry Neighbourhood) and another which was established by relocating producers in a new area (named as small industrial estate). This programme of “clustering” was originally intended to provide a better sort of government services — in terms of cost and its effectiveness — for SME development. Schmitz (1997a) defines a cluster as a group of firms concentrated in one geographic location and working in the same sector. A cluster, therefore, can be defined as sectoral and spatial concentration of firms. In its most rudimentary

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form, a cluster is composed of only a few enterprises that produce the same products for poor consumers in nearby local markets. In its most advanced form, Porter (1998b) proposes a definition of a cluster as a geographically proximate group of inter-connected companies and associated institutions in a particular field, linked by commonalities and complementarities. In this definition, a cluster is broader than an industry, as it captures various linkages that cut across firms and industries. As such, a cluster can range from a single town, city or state to a country or even a network of neighbouring countries. The growing literature shows that clusters are common in many different countries and sectors. There are various reasons for firms to cluster. Marshall (Schmitz 1997) identifies three reasons to explain the localization of industrial production, namely labour market pooling, the availability of intermediate inputs and services, and technological spillovers. Schmitz (1997) argues that while incidental external economies, as identified by Marshall, are of importance in explaining the growth of industrial clusters, there is also a deliberate force at work, namely consciously pursued joint actions. Thus, the competitive advantage of a cluster stems from two sources: agglomeration economies (passive and incidental) and joint action (active and purposeful).1 Meanwhile, Porter (1998b) argues that clusters are more pronounced in advanced economies. According to him, clusters in developing economies tend to be shallow and to rely primarily on foreign components, services, and technology. Many of them take the form of hierarchical, hub-and-spoke networks surrounding a few large companies, no matter whether those large firms are local or foreign. From another perspective, Harrison (1994) suggests that the success of small enterprise clusters has been over-rated and the strength of the large corporation under-rated. In his view, the dominant form of industrial organization is the large company controlling networks of small suppliers. It is the strategic outsourcing of the large firms that is responsible for much of the dynamics of the small firms. This paper tries to discuss key issues related to the development of SME clusters in Indonesia. First, the importance of SME clusters in Indonesia will be described, and next the paper addresses factors contributing to the clusters’ performance. A number of case studies of successful clusters are described succinctly. A small account of the relation between clustering and entrepreneurship is also outlined. Finally, some policy implications will be drawn. 2. The Importance of SME Cluster in Indonesia When defined as “sentra industri”, industrial clusters in Indonesia are relatively “well documented” because they are a special target group for industrial

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policy (Klapwijk 1997; Weijland 1999). According to data of the Ministry of Industry, some 10,000 out of the nearly 70,000 Indonesian villages are registered as industrial clusters. The most widely used data dates from 1989 though this data set should be treated cautiously in the light that the general climate of The New Order (from 1965–1998) was the spirit of “Asal Bapak Senang” (as long as the boss likes), and the bureaucrats had been in competition to submit officially impressive figures. This caveat does not necessarily imply that the data are totally unreliable. It is still of relevance, albeit limited. The more recent data from the Ministry of Industry and Trade, unfortunately, did not specifically document the cluster of SMEs. Bearing in mind such a reservation, Sandee et al. (1994) and Klapwijk (1997) in their studies found that industrial clustering was significant in Indonesia. Using the data of Central Java, a relatively poor and densely populated province where there were 4,400 clusters, they estimated that such clusters employed more than 50 per cent of all manufacturing workers and provided some 63 per cent of all employment in cottage and small-scale manufacturing.2 Table 7.1 Rural Clusters by Sub-sector: Weight, Clusters Size, Investments and Yearly Gross Output (1989)a Product

Percentage of Cluster Total

Enterprises per Cluster

21.5 1.4 17.8 10.7 0.8 5.6 6.2 3.0 4.5 3.3 4.7 1.2 0.4 2.4 0.8 0.8 14.9

69.4 64.8 120.0 28.0 45.2 59.1 41.5 18.3 38.9 96.7 65.0 33.4 35.4 33.6 86.3 47.1 40.0

11.8 17.1 27.6 38.6 51.9 76.8 87.1 97.5 112.7 117.8 148.7 154.3 241.7 299.5 385.7 731.6 177.2

751 680 599 4,854 4,404 4,340 3,147 1,977 5,187 1,536 1,814 3,273 9,761 11,853 46,482 13,143 5,474

100.0

63.9

85.6

3,446

Bamboo weaving Ceramics (Pottery) Sugar processing Tempe (soy) Textile weaving Krupuk (crispy) Bricks Tailoring Furniture Batik (cloth print) Roof tiles Farm tools Leather Tahu (soy) Embroidery Garments Other Total a b

Investment Gross Output per Enterprise per Enterprise (Rp. 1,000)b (Rp. 1,000)b

Source: Klapwijk (1997: 76) 1 US$= Rp. 1,780 (in 1989)

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Various studies show the importance of clusters in Indonesia. Smyth (1992) described how clustering of rattan furniture producers has absorbed an entire village in Tegal Wangi, West Java, and created numerous satellite activities in neighbouring hamlets. Schiller and Martin-Schiller (1997) presented the same story on how the clustering of the woodcarving industry in Jepara, Central Java, has transformed the town into a thriving commercial centre with an eleven-kilometre avenue of furniture showrooms and factories, modern hotels, new banks, supermarkets, telephone and fax stalls, video parlours, satellite dishes, karaoke bars, European restaurants, and all the paraphernalia of modernity. Soemardjan (1992) reported how Pejaten, a small village on the island of Bali, actually became a “big factory” of roof tiles, after a small group of young and enterprising roof tile makers were sent to Kebumen in Java to learn how to make and sell better quality roof tiles. This roof tiles cluster has turned poverty into prosperity. Clusters of SME are of importance for small firms’ development because productivity in clusters appears to be higher than in dispersed firms (Klapwijk 1997; Weijland 1999). One of the main reasons is that clustering stimulates active involvement of traders and large firms in agglomeration of small firms. Buying a large amount from several small producers through a single visit reduces transaction costs (Berry, Rodriguez and Sandee 2001). There is also increasing empirical evidence that small firms that are parts of clusters are in a better position to adopt innovations than their dispersed counterparts (Sandee 1995). Weijland (1999) shows that in the Indonesian context, clustering is a common survival strategy for cottage industries. Grouping village-wise to gain critical mass, it overcomes disadvantages of smallness and isolation that incur high transaction costs and problems of technical indivisibilities. In view of this, clusters may have a seedbed function for industrial development in a country like Indonesia. There is no doubt that the prevalence of SME clusters suggests that they benefit small- and medium-enterprise development (Berry, Rodriguez and Sandee 2001). At this juncture, however, some remarks should be made. Sato (2000) shows that there is only little evidence of the effects of clustering. She observes two kinds of firm preferences that are mutually related: an orientation towards integration rather than specialization of work processes, and a preference for linkages with firms outside rather than inside the cluster. Based on a research of eight clusters in Central Java, Supratikno et al. (2002) report two striking features of those clusters: joint actions — an important ingredient for a cluster to grow — are very limited,

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and the relation within cluster is typified by almost absolute dependence of producers on outside merchant capital. Viewed from a broader perspective, it appears that the ability of small enterprises to link up with the larger firms is still problematic. Central Board of Statistics (2001) reports more than 90 per cent of cottage and small enterprise do not have linkages with larger firms (Table 7.2). This finding indirectly suggests that most of the Indonesian clusters are lacking in specialization and collaboration. 3. Cluster Diversity: Evolutionary Process or Dual Structure? Explaining differences in clusters’ performance is hard. Why do some clusters do well and others stagnate? How and why do some segments within clusters prosper while others simply survive? How do clusters evolve over time? Why are some clusters which were thriving in the 1990s, now struggling or even suffering? What determines whether clusters have the capacity to respond to opportunities and threats? What causes cluster atrophy? In short, there are differences between clusters, within clusters and over time and finding systematic explanations is not easy (Schmitz 1997). From various studies, we may safely conclude the following: a. Clusters perform better the more urbanized their location (Weijland 1999). b. Clusters connected to the outside world through traders have higher than average incomes than those that are not connected (Weijland 1999).

Table 7.2 Linkages of Cottage and Small Enterprises With Larger Firms Type of linkages 1. 2.

No linkages Linkages/partnership

2.1 2.2 2.3 2.4 2.5

capital materials marketing training others

Cottage Industry (units)

%

Small Industry (units)

%

2,188,926 101,746

95.56 4.44

203,808 21,795

90.34 9.66

33,311 55,461 45,021 1,468 2,930

32.74 54.51 44.25 1.44 2.88

10,881 11,542 11,056 509 652

49.92 52.96 50.73 2.34 2.99

Source: Central Board of Statistics, 2001.

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c. Buyer-driven clusters perform better than producer or government-driven clusters (Sandee 1995). d. Clusters characterized with stagnant markets, low technology levels and low barriers to entry tend to get overcrowded. This overcrowding results in low output and low earnings (Weijland 1999). Schmitz (2002) distinguishes three types of clusters, namely survivalist clusters, internationally competitive clusters and intermediate cases. Markhusen (Barkley and Henry 1997) offers different typology. In one way or another, classifying clusters involves a process of simplification. When the preceding stage ends and the next stage starts — if such an evolution occurs — is sometimes a matter of qualitative judgement. From various studies on clustering of firms in Indonesia, we may mention four types of clusters. The first type is the so-called dormant clusters. The majority of clusters, more than 90 per cent, belongs to this type. This corresponds to Schmitz’s survivalist cluster. This type of cluster displays many characteristics of informal sector, with levels of productivity and wages being much lower than those of medium- and large-scale enterprises. Dormant clusters are characterized by lack of change through time: the producers produce the same products, with the same technology, that are sold to the same outlets as decades ago (Sandee and ter Wingel 2002).3 The second type is active clusters. These are clusters that have shown some technological upgrading but still face quality-related problems. The markets of these clusters are mainly domestic. Roof tiles clusters (Kebumen, Jatiwangi, Karangpilang, Pejaten), metal-casting clusters (Tegal, Klaten, Sidoarjo, Sukabumi), shuttle-cocks clusters (Tegal, Malang), shoes cluster (Cibaduyut) and brass-handicraft cluster (Juwana) can be classified as active clusters. In these clusters, some firms start to influence the development trajectory of the clusters. The third type is dynamic clusters. We treat this as a separate type since many producers in these clusters have developed extensive trade networks overseas. Internal heterogeneity within clusters in terms of size, technology and served market is more pronounced. Textile weavings in Majalaya (West Java) and Pekalongan (Central Java), furniture cluster in Jepara, wig and hair accessories cluster in Purbalingga (Central Java), and handicraft cluster in Kasongan (Yogyakarta) can be cited as examples of such clusters. Interfirm specialization and co-operation develop, but one of the most striking features of this type may be the decisive role of leading firms (pioneering firms), usually larger and faster growing firms, to manage a large and differentiated set of relationships with firms and institutions within and

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outside clusters. Interestingly, in some cases, there are considerable direct investments made by foreign immigrants.4 Table 7.3 presents some leading firms in these clusters. The fourth type is modern or advanced clusters. Very few clusters fall into this category. In this cluster, some leading firms have utilized cuttingedge technologies in production. Examples are the clove cigarettes cluster in Kudus, tea-processing cluster in Slawi, and Bali’s tourism cluster. The previous two clusters, surprisingly enough, sell their products mainly to the domestic market. In the case of the clove cigarettes cluster in Kudus, their products are able to outperform MNCs’ products (i.e. Philip Morris and BAT). Similarly, the tea-processing cluster in Slawi, led by a company named Sosro, has become the market leader in the Indonesian soft drink market, leaving a giant Coca Cola behind. At this juncture, two remarks are worth mentioning. First, for a country with a big domestic market like Indonesia, the requirement of exportorientation to characterize an advanced cluster is not necessary, not to mention misleading, as the most immediate concern of the country is how to defend (read: prevent) the domestic markets from total domination by MNCs. Second, our most recent study notes that some clusters that prospered in the past – frequently celebrated and cited — are now struggling. Various reasons have been expressed by the clusters’players, such as the frequent increases in the prices of raw materials, gasoline, minimum wage level and taxes, high import content of the products made, and heavy burden from bureaucratic red tapes (Supratikno et al. 2002). Sandee, Isdijoso and Sulanjari (2002) report that the current poor performance of Jepara’s furniture cluster is because of three reasons. First, Table 7.3 Leading firms in Some Active and Dynamic Clusters Cluster

Location

Leading Firms

Wig and Hair Accessories

Purbalingga (Central Java)

Handicraft

Kasongan and Sleman (Yogyakarta) Pekalongan (Central Java) Jepara (Central Java)

PT Royal Korindah and PT Indo Kores PT Out of Asia

Textile Weaving Furniture Abadi Brass handicraft Roof tiles

Juwana (Central Java) Kebumen (Central Java)

PT Pismatex Grista Mulya, Satin Krisna, Samarinda Mas Sokka

Note: PT means a limited corporation (closed corporation).

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quality control has not received sufficient attention during previous years of fast expansion. Second, overcrowding and the somewhat unfavourable location of the Jepara cluster have stimulated a group of producers to try new businesses elsewhere. Third, the IMF agreements have allowed again the export of wood logs and, consequently, prices of input for the industry have gone up significantly. Schmitz and Musyck (1994) conclude that successful advanced clusters in developed and developing countries share six common characteristics that relate to market, specific knowledge and skill of entrepreneurs and workers, internal organization, the role of self-help organizations and common service facilities, the quality of local government support, and networking with local providers of education and technology. Various studies on successful Indonesian clusters seem to support these characteristics, with extra weightage given to the market-related conditions and the pace of technological upgrading. The growing market condition justifies new needed investment, whereas the latter enables firms to serve more demanding segments. 4. Clustering and Entrepreneurship There is an increasing agreement that clustering helps small enterprises to overcome growth constraints. Many argue that clustering is particularly relevant for the early stages of industrial development by helping small enterprises to grow in gradual, relatively less risky steps. Producers do not have to acquire equipment for the entire production process, and therefore the investment capital is needed in small rather than big sums. Clustering draws out the less exceptional and more ordinary entrepreneurs (Schmitz and Nadvi 1999, p. 1505). Porter (1998b) also stresses the function of clusters as powerful sources of new business formation. Clusters provide the inducement to entry through better information about opportunities. The existence of a cluster in itself signals an opportunity, and a growing cluster definitely signals rich opportunities. Needed assets, skills, inputs and staff, which are often readily available at cluster location, can be assembled more easily for a new enterprise. Healthy rivalry within clusters, due to both lower entry and exit barriers, can act as an essential driver of rapid improvement and entrepreneurship. This entrepreneurial climate is continually enhanced through constant comparison and experimentation amongst the participants. Further, according to Porter (1998b), clusters represents a kind of new spatial organizational form in between arm’s-length markets on the one hand, and hierarchies, or vertical integration, on the other. It is an alternative way

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of organizing the value chain. Clusters mitigate the problems such as trust and co-ordination inherent in arm’s-length relationships without imposing the inflexibilities of vertical integration or the management challenges of creating and maintaining formal linkages such as networks, alliances and partnerships. Thus clusters can powerfully shape the trade-offs between market and hierarchies. Notwithstanding the above-mentioned merits, clusters do have disadvantages. Geographers emphasize the negative impact of agglomeration on congestion both in the output and input markets. The positive effects of clustering seem to diminish as the cluster gets larger and older. Recently, researchers also warn the negative implications of cultural homogeneity in the cluster (Boari 2001). 5. Policy Supports for SME Clusters As aptly described by Berry, Rodriguez and Sandee (2001), almost all known types of intervention for small industry development have been tried at one time or another in Indonesia. On the surface, what is repeatedly mentioned is that the government has an obligation to guide and uplift the weaker groups in society, who are working overwhelmingly in small businesses.5 This philosophy is regarded as a commitment toward ekonomi kerakyatan (people economic system). Government officials always state that the growth of the small enterprises and its resilience during the crisis, as an indicator that their intervention and service provision are bearing fruits. However, Berry, Rodrigues and Sandee (2001) show convincingly that these claims are not valid. Barkley and Henry (1997) provide an overview of the advantages and disadvantages of promoting industry clusters as an industrial development strategy. To them, the disadvantages of an industry cluster approach are the difficulties in picking winners that best fit their local economies, the timing of development, and in providing supportive institutions. They argue that in the majority of rural areas, clustering may be an impractical way to promote small enterprises. To justify cluster development efforts, some seeds of a cluster should have already passed a market test. At the macro level, Porter (1998b) argues that the government should aim to reinforce the development and upgrading of all clusters, not choose among them. This implies that the best thing for them to do is to create a healthy and enabling environment for the clusters to grow. At the cluster level, the government should reinforce and build on established and emerging clusters, rather than attempt to create entirely new ones.

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As has been noted earlier, the majority of Indonesian clusters are dormant. For this type of cluster, the most crucial factor is how to transform their traditional values into modern ones. Without any doubt, this kind of task requires time and patience, and perhaps a non-policy approach is more appropriate at this moment. NOTES 1.

2.

3.

4.

5.

Being together in a certain location in itself creates various benefits that accrue to all players in the cluster, such as the reduction of transaction costs, better dissemination of information of any kind, better in attracting potential buyers, etc. However, in order to fully tap the benefits of being together, the players should be able to develop various types of synergistic co-operation among them. Indonesian Central Board of Statistics used the following definition: a cottage firm is a firm with 1 to 4 employees, and respectively, a small firm has 5 to 19, a medium-sized firm has 20 to 99, and a large firm has over 100 employees. Although such clusters have been in existence for many decades, they had shown little or no growth. They are truly marginal almost in all respects. They only use primitive or obsolete tools and equipment. Many of the workers (and producers) are illiterate. They are very passive in marketing. Many of them do not even have an idea where their goods are sold and how big is the market potential for their products. They stick to known products and wait for buyers to come. They remain so poor and stagnant that one may wonder whether the producers would not be better off elsewhere. Foreign immigrants who established manufacturing facilities have contributed significantly to the clusters’ dynamics. They are clearly in an advantageous position vis-à-vis local producers, as they have better accesses to markets, technology, and financing sources. Some critics argue that the bottom line is that government officials have to justify various projects in order to get extra income to compensate their low-paid jobs. Small firms, which so far have been squeezed by so many pungutan (illegal payments), do not need any supports except a sounder business environment. They have been supporting the life of government, not the other way around.

REFERENCES Barkley, D.L. and M.S. Henry. “Rural Industrial Development: To Cluster or Not to Cluster”, Review of Agricultural Economics 19, no. 2 (1997), pp. 308–25. Boari, C. “Industrial Clusters, Focal Firms, and Economic Dynamism: A Perspective from Italy”, World Bank Institute Working Papers. Stock No. 37186, 2001. Berry, A., E. Rodriguez and H. Sandee. “Small and Medium Enterprise Dynamics in Indonesia”. Bulletin of Indonesian Economic Studies 37, no. 3 (2001), pp. 363– 84.

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Harrison, B. Lean and Mean — The Changing Landscape of Corporate Power in the Age of Flexibility. New York: Basic Books, 1994. Klapwijk, M. Rural Clusters in Central Java, Indonesia: An Empirical Assessment of Their Role in Rural Industrialization. Ph.D. Dissertation, Tinbergen Institute Research Series no.153, Vrije Universiteit Amsterdam, 1997. Porter, M.E. “Clusters and the New Economics of Competition”, Harvard Business Review, Nov–Dec (1998a): 77–90. Porter, M.E. “Clusters and Competition: New Agendas for Companies, Government and Institutions”. In On Competition. The Harvard Business Review Book Series, 1998b. Sandee, H., P. Rietveld, H. Supratikno, and P. Yuwono. “Promoting Small Scale and Cottage Industries in Indonesia: An Impact Analysis for Central Java”. Bulletin of Indonesian Economic Studies 25, no. 2 (1994): 79–98. Sandee, H. Innovation Adoption in Rural Industry: Technological Change in Roof Tiles Clusters in Central Java, Indonesia. Ph.D. Dissertation, Vrije Universiteit Amsterdam, 1995. Sandee, H. and J. ter Wengel. “SME Cluster Development Strategies in Indonesia: What Can We Learn from Successful Clusters?”. Paper presented for JICA Workshop on Strengthening Capacity of SME Clusters in Indonesia. Jakarta, 5–6 March 2002a. Sandee, H., B. Isdijoso, S. Sulanjari. “SMEs Clusters in Indonesia — An Analysis of Growth Dynamic and Employment Conditions”. Report to the ILO, 2002b. Sato, Y. “Linkage Formation By Small Firms: The Case of A Rural Cluster in Indonesia”, Bulletin of Indonesian Economic Studies 36, no. 1 (2000): 137–66. Schiller, J. and B. Martin-Schiller. “Market, Culture and State in the Emergence of Indonesian Export Furniture Industry”. Journal of Asian Business 13, no. 1 (1997). Schmitz, H., and B. Musyck. “Industrial Districts in Europe: Policy Lessons for Developing Countries”. World Development 22, no. 6 (1994): 889–910. Schmitz, H. “Collective Efficiency and Increasing Returns”. IDS Working Paper 50, March 1997a. Schmitz, H. “Collective Efficiency: A Way Forward for Small Firms”. IDS Policy Briefing Issue 10, April 1997b. Schmitz, H. and K. Nadvi. “Clustering and Industrialization: An Introduction”. World Development 27, no. 9 (1999): 1503–14. Soemardjan, S. “Pejaten: Poverty Turned Into Prosperity”. Prisma The Indonesian Indicator, no. 52 (1992): 27–42. Smyth, I. “Collective Efficiency and Selective Benefits: The Growth of the Rattan Industry of Tegal Wangi, Indonesia”. IDS Bulletin 23, no. 2 (1992): 51–56. Supratikno, H. “Subcontracting Relationships in Indonesian Manufacturing Firms”. Gadjah Mada International Journal of Business 3, no. 2 (May 2001): 141–57. Supratikno, H. et al. “The Strategies of Cluster Upgrading in Central Java”. A Preliminary Report to Disperindag, Salatiga, 2002.

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Tambunan, M. and L.T. Sunaryanto. “The Great Vertical Immobility of Small Enterprises in Indonesia”. Paper presented at the First International Conference on Medium Enterprises Development: The Missing Middle. University of Durham, U.K., July 2002, pp. 14–16. Van Dijk, M.P. and R. Rabelloti, eds. Enterprise Clusters and Networks in Developing Countries. EADI Book Series 20, London: Frank Cass, 1997. Weijland, H. “Microenterprise Clusters in Rural Indonesia: Industrial Seedbed and Policy Target”. World Development 27, no. 9 (1999): 1515–30. White, B. “Differentiation and Dependence: Notes on the Social History of SmallScale Industries in Java”. Prisma The Indonesian Indicator, no. 52 (1992): 14–26.

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Individual articlesIndustry are available at < http://bookshop.iseas.edu.sg > SMEsStudies. in Malaysia’s Electronics 131

8

Entrepreneurship in Malaysia’s Electronics Industry: The Role of SMEs Vijayakumari Kanapathy

1. Introduction The level of entrepreneurship varies across regions, industries and time periods, and it is determined by a host of factors that influence the opportunities as well as inclination for entrepreneurship. Verheul et al. (2001) have summarized these factors into the demand and supply side of entrepreneurship. The demand side represents the entrepreneurial opportunities which are influenced by factors such technology, consumer demand, industrial structure and policy measures, while the supply of entrepreneurs is determined by demography, resources and abilities and attitudes of individuals. The paper attempts to examine the role of entrepreneurship in the electronics industry in Malaysia.1 This industry has been chosen for several reasons. The electrical and electronics industry (hereafter referred to as the electronics industry) has been in the forefront of Malaysia’s industrialization process. The industry has been spearheaded by multinational corporations (MNCs) and has grown into a sufficiently vast industry with substantial opportunities for spawning local entrepreneurs. Literature on the development

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of the electronics industry in Malaysia is littered with anecdotal evidence of entrepreneurs who have successfully established supporting industries (Lim Pao Li 1992; Rasiah 1995; Giovanni 1996 and Narayanan 1997). But unlike other East Asian economies such as Japan, South Korea and Taiwan which it tried to emulate, Malaysia has yet to develop a critical mass of supporting industries to ensure sustainable growth of the industry. (Best 1997 and Karkomi 1998). In the initial two decades, the industry thrived by attracting direct foreign investment (DFI) with attractive investment incentives and low-wage labour. As rapid industrial growth eroded its competitive advantage in lowwage labour, the industry repositioned itself by focusing on skills development and moved up the production ladder by automating its production process. However, the technology associated with such complex production methods is still MNC-driven, with the local workforce acquiring higher technical and managerial skills in tending these automated processes. The complex production techniques have not been diffused sufficiently enough among local firms. The development of domestic production capabilities through a vibrant network of ancillary firms supplying intermediate parts and components, characteristic of other East Asian success in developing a dynamic electronics sector, has yet to materialize (Best 1997). Malaysia can no longer rely on past growth trajectories with the emergence of new competitors as well as changing technology that has enabled more flexible production systems in advanced industrial economies. The present industrial strategy is to foster local production capabilities by nurturing supporting industries and linking them up with the larger MNCs that dominate the industry. An analysis of the extent and nature of entrepreneurship in the electronics industry will provide some useful insights for policy-makers striving to promote local enterprise in this sector. Entrepreneurship is a multi-dimensional concept and in practice, its definition depends on the focus of research undertaken (OECD 1998). In this chapter, the focus is on the development of ancillary or supporting industries, and since supporting industries are composed primarily of smalland medium-scale enterprises (SMEs), entrepreneurship is defined as the number of SMEs in the electronics industry. The chapter begins by tracing the development of the electronics industry in the country and the challenges it encounters. Next, the level and nature of entrepreneurship in the electronics industry is examined by reviewing the performance of SMEs in the industry. This is followed by a review of policies governing SME development in the country, focusing on the electronics industry. The final section summarizes the findings and conclusion. Data on

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supporting industries, let alone SMEs, are not readily available.2 Hence, the analysis of SMEs in the electronics industry is carried out using unpublished data from the Department of Statistics, company interviews and other primary and secondary data. 2. Development of the Electronics Industry in Malaysia The electronics industry in Malaysia is dominated by FDI, and its growth and development can be traced to three overlapping phases in the inflow of foreign investment into industry. The initial phase began in the early 1970s with the establishment of Free Industrial Zones (FIZs) and Licensed Manufacturing Warehouses (LMWs) and continued until the mid-1980s and consisted primarily integrated circuit (IC) assembly, dominated by American firms. In the late 1980s, a second wave began with the inflow of East Asian DFI and consisted mainly consumer electronics and related components. Since the mid-1990s, a third much reduced inflow of investments in computing hardware has taken place. The electronics industry contributes to about 41 per cent of MVA and employs 35.1 per cent of workers in manufacturing. It is also the largest export earner, contributing about 72 per cent of manufacturing exports in 1999 (Table 8.1). Changing comparative advantages and industrial policy changes have helped to upgrade the industry from simple assembly of ICs in the 1970s to assembly of more complex products, and manufacture of simple parts and components by ancillary industries. Today, it exports a wide range of final goods worldwide and supplies parts and components to various nodes in the production network in the region. Industry upgrading is reflected in the changing composition of its exports. Exports of semiconductors accounted for over 70 per cent of total electronic exports in 1978 in contrast to only 30 per cent in 2001, whereas

Table 8.1 Performance of the Electronics Industry Year

1988 1996 1999

Value Added

Employment

Exports

RM mil

%

’000

%

RM mil

%

2,999.4 24,703.9 35,842.2

16.1 34.5 40.8

142.7 479.0 477.2

17.2 33.1 35.1

15,161.6 104,272.0 195,047.2

56.5 65.8 71.8

Sources: Department of Statistics, Annual Survey of Manufacturing Industry, various issues. Bank Negara Malaysia, Monthly Statistical Bulletin, various issues.

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the share of electronic equipment and parts has risen from about 14 per cent to about 40 per cent during this period (Table 8.2). Similarly, there has been a four-fold increase in the exports of consumer electrical products and industrial and commercial products. These transformations reflect changes in the production structure and indicate an increasing scope for the expansion of ancillary industries. However, the potential for developing a more integrated production system by linking local firms with MNCs has not been fully tapped. There were hardly any links between MNCs and local firms during the first phase. In the early 1970s, when the electronic industry was first established, indigenous technical competency in manufacturing was rudimentary. The economy was essentially a primary commodity producer and its local production capability was restricted to the manufacture of simple consumer products. Hence, in the early phase of the development of the electronics industry, the linkages that did develop were restricted to simple machining and stamping in the fabricated metals sector (Rasiah 1990). Past industrial policy was partly responsible for the weak linkages. The MNCs were isolated in the FIZs/LMWs which reduced their inclination to interact with the domestic firms. The incentive policies further discouraged the links between firms within the FIZs/LMWs and those located in the principal customs area. Sales to firms within the FIZs/LMWs were not treated as exports and thereby making them ineligible for incentives. However, since the mid-1980s, the electronics industry has undergone significant structural and operational changes that have expanded the scope for developing local production capabilities among SMEs. There has been a worldwide tendency among large firms to concentrate on “core competencies” and “outsource” non-core activities that are considered less profitable or more risky and thereby creating opportunities for entrepreneurship (Suarez-Villa 1998). Table 8.2 Structure of Manufacturing Exports (Percentage Distribution)

Semiconductors Electronics equipment and parts Consumer electrical Industrial and commercial Electrical industries machinery and equipment Household electrical appliances

1978

1985

1990

1995

2001

72.0 13.7 2.6 3.3 8.0 0.4

68.4 7.0 8.9 5.5 9.4 0.8

44.1 13.8 20.9 12.6 8.1 0.5

34.3 24.4 22.1 10.4 8.2 0.6

30.2 39.5 11.8 11.7 6.2 0.6

Source: Bank Negara Malaysia, Monthly Statistical Bulletin, various issues.

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Though the scope for local sourcing had risen in the 1980s, according to industry sources, the final decision on local sourcing of inputs and other services still rested with the parent company. With the exception of very large companies such as Intel and Motorola, very few outsourced their activities during this period. Moreover, the level of technical capabilities among Malaysians who had worked in the MNCs had improved vastly. Nonetheless, only a handful were keen to break out on their own to set up enterprises using accumulated competencies and links with the MNCs. Many were still young, and with high remuneration and job security, they were reluctant to move out of their comfort zone to take on the risks associated with starting a new enterprise (Lim Pao Li 1992). The case studies show that market security and technical competencies were important factors fostering entrepreneurship in the electronics industry. There are regional differences in the level of entrepreneurship in the electronics industry. Local sourcing by MNCs is more visible in the Penang industrial zone than elsewhere in the country (Narayanan 1997). A clear industrial cluster focusing on the electronics industry has developed in Penang, and regional clusters are known to foster entrepreneurship (OECD 1996). The ethnic factor has also been cited as an important factor for the higher level of involvement of SMEs in the electronics industry in Penang. The state leadership was ethnically Chinese, who are known to be more entrepreneurial, and they led and financed most of the local industrial and commercial activity (Narayanan 1997). By the mid-1990s, many of the electronics firms have moved along the value chain into marketing and distribution, as well as into research and development activities. Clearly, the level of linkages has been on the rise since the late 1980s, but the problem is that these positive developments have not developed to a level sufficient for sustainable dynamism of the industry. The industry is still heavily dependent on foreign technology. The following examines the extent of linkages development to assess the level of integration of the electronics industry into the economy.3

2.1. Linkages Development Due to the predominance of MNCs in the electronics industry, linkages between MNCs and local firms are fundamental to industrial broadening and deepening as highlighted in the First (1985–1995) and Second (1996–2005) Industrial Master Plans. Both inter- and intra-industry linkages are important for industrial transition. Inter-industry linkages are derived using the input-

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output tables, while the intra-industry linkages assess the ties between large firms and the SMEs. It is shown in Table 8.3 that from 1978 to 1991, the linkage structure of the electronics industry has recorded little change. Domestic sourcing as reflected by the backward linkage coefficient does not seem to show any definite trend. It declined from 25 per cent in 1978 to 23 per cent in 1983, but increased significantly to 34 per cent in 1987. But since 1987, it has declined to 26 per cent. This is puzzling since one would expect domestic sourcing to increase with the increase in domestic ancillary industries and the relocation of foreign subsidiaries in Malaysia to supply parts and component to its affiliates. It appears that domestic firms are more linked with foreign firms via imports of inputs. In fact the import coefficient has risen to 54 per cent in 1991 from 38 per cent in 1987. On the other hand, the dependence of all other sectors on the electronics industry, as shown by the forward linkage coefficient in Table 8.3, is also weak, as the output of the industry is mainly absorbed into the final demand. The forward linkage coefficient fell from 18.1 per cent to 12.2 per cent between 1978 and 1983, and further to 5.8 per cent in 1987. The abnormal phenomenon is attributed to the peculiar behaviour of firms in “export enclaves” (Rasiah 1990). In 1991, the backward linkage coefficient has risen significantly to 20.8 per cent. This could be due to two factors — the increase in domestic sourcing from local firms and from foreign subsidiaries that have relocated in Malaysia since the late 1980s. Because of the slow development of local ancillary firms, many of the large MNCs have encouraged their own SMEs from their home base to invest in Malaysia to continue to meet their demands (Lim Pao Li 1992). However, the leakage continues to increase with greater export-orientation of the industry. Table 8.3 Backward and Forward Linkage Effects in the Electronics Industry (Percentage) Direct Backward Linkage

1978 1983 1987 1991

Direct Forward Linkage

Net Effect

Leakage

Total

Net Effect

Leakage

Total

24.93 22.83 33.70 26.43

46.48 48.66 38.32 54.20

71.41 71.49 72.03 80.63

18.09 12.24 5.80 20.82

64.88 73.33 91.13 89.78

82.97 85.57 110.60 96.93

Source: Rasiah (1990) for 1978 and 1983. 1987 and 1991 estimates are computed from the 1987 and 1991 Input-Output Tables.

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The incidence of intra-industry linkages whereby large firms source local services and parts and components from SMEs has been on the rise, especially since the late 1980s. Both supply and demand factors have induced greater intra-industry linkages. Stiff competition and technological changes have forced large firms to procure parts and components locally, provided key considerations such as cost, quality and delivery time are met by local suppliers. At the same time, local firms have also seized market opportunities by tying up with the larger firms through technological and financial assistance. National data on links between SMEs and larger firms is not available. Hence, regional survey data on local sourcing by large firms in the FIZs/ LMWs in Penang is used as a proxy for assessing the extent of such linkages in the electronics industry. Until the 1ate 1980s, MNC linkage with the domestic firms has been rather weak. This is understandable as the initial phase of the growth of the electronics industry has been in the assembly of ICs, where opportunities for local participation have been negligible. Local sourcing in the electronics industry was 0.2 per cent in 1976, and has increased progressively to about 8 per cent in 1986 (Table 8.4). Thereafter, it has more than doubled to around 18 per cent within a year. The global shakeout of the electronics industry in the mid-1980s and the subsequent restructuring to higher value added activities have precipitated a shift to greater local sourcing to trim costs. Thereafter, the rising cost of production in the Asian Newly Industrializing Economies (NIEs) and the withdrawal of their GSP (Generalized System of Preferences) facility in 1988 have induced foreign subsidiaries to relocate in Malaysia to supply parts and components to their local affiliates. However, such domestic procurement has been limited to precision engineering, plastic parts fabrication, stamping, tool and die making and packaging (Rasiah 1990 and 1991). Table 8.4 Local Sourcing in the Electronics Industry in the Penang FIZs/LMWs, 2001 (Percentage) Year

Local Sourcing

1976 1980 1984 1986 1987 2001

0.2 2.3 6.9 7.9 17.7 25.1

Sources: Rasiah (1991) and Penang Development Corporation (unpublished).

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Not surprisingly, consumer electronics seem to display greater linkages with local SMEs. Firms producing electronic components purchased only 8 per cent of their intermediate inputs form SMEs, with another 7 per cent from the larger firms in the FIZs/LMWs. Eighty-five per cent of its inputs were imported. On the other hand, firms manufacturing consumer electronic products procured between 23 to 36 per cent of their inputs from local firms (Table 8.5). Generally, domestic sourcing is higher in industries that are more amenable to a smaller scale of production employing less capital and lower technology. In the case of sales to the domestic economy, over 80 per cent of the output of firms is exported, with the exception of the output of electrical apparatus and appliances (Table 8.6). This industry also produces parts for firms within the FIZs/LMWs, whereby about 30 per cent of its output is sold to firms located in FIZs/LMWs. There is some evidence of “vintage” effect, whereby firms manufacturing household electrical appliances and apparatus appear to be more integrated to the local economy. These industries were established as early as the 1960s. Apart from inter-industry and intra-industry linkages, inter-institutional linkages also play a vital role in fostering local enterprise. Linkages between government agencies, research and academic institutions and business enterprises help to stimulate the growth of local enterprise (Ahn Choong

Table 8.5 Local Procurement by Industry Type in the Penang FIZs/LMWs, 2001 (Percentage) Type of Purchase

Total

Direct Import

FIZ/LMW

Local Firms

Electronic components

85.1

7.0

7.9

100.0

Telecommunications and computer peripherals

61.4

10.3

28.3

100.0

Audio visual products

63.6

0.4

36.0

100.0

Electrical apparatus and appliances

68.1

8.5

23.4

100.0

Total

74.9

7.9

17.2

100.0

Source: Penang Development Corporation (unpublished data).

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Table 8.6 Sales of Manufactured Products by Industry Type in the Penang FIZs/LMWs (Percentage) Type of Purchase

Total

Direct Import

FIZ/LMW

Local Firms

Electronic components

82.6

16.2

1.2

100.0

Telecommunications and computer peripherals

88.4

9.7

1.9

100.0

Audio visual products

96.7

1.1

2.2

100.0

Electrical apparatus and appliances

36.2

29.1

34.7

100.0

Total

84.5

13.0

2.5

100.0

Source: Penang Development Corporation (unpublished data).

Yong 1995). This is particularly true for industries that are dominated by large MNCs as has been the experience of Singapore. Until the 1990s, such interactions have been limited, especially between universities/research institutes and business enterprises. However, electronic firms in Penang appear to have better linkages than firms in other industrial zones in the country (Narayanan 1997). 3. Entrepreneurship in the Electronics Industry Entrepreneurship in this paper is defined as the number of SMEs. A more dynamic concept is the exit and entry rates of SMEs. The SMI Development Plan (SMIDP) defines SMEs in manufacturing and manufacturing-related services as firms with annual sales turnover not exceeding RM25 million or full-time employees not exceeding 150.4 Based on this definition, electronics firms accounted for only 7.9 per cent of total SMEs in 1999. Within the electronics industry, they accounted for 38.4 per cent of all firms. But they contributed only 2.4 per cent of value added, 4.6 per cent of employment and 3.8 per cent of total wages and salaries in the electronics industry (Table 8.7). They only exported 17.3 per cent of their output in 1996 (SMIDP 2002, p. 81) Clearly, large firms dominate the electronics industry. The small establishments were concentrated in the manufacture of gramophone and pre-recorded magnetic tapes (85.7 per cent), refrigerating,

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Table 8.7 Participation of SMEs in the Electronics Industry Industry Code

Sub-sector

38250 Office, computing and accounting machinery 38291 Refrigerating, exhaust, ventilation and air-conditioning 38310 Electrical industries, machinery and apparatus 38321 Radio, TV and recording sets 38322 Gramophone and pre-recorded magnetic tapes 38329 Semiconductors and electronic components 38330 Electrical appliances and houseware 38391 Cables and wires 38392 Dry cell and storage batteries 38393 Electric lamps and tubes 38399 Miscellaneous electrical appliances and apparatus n.e.c.

No.

Value Emp. Fixed Wages Added Assets

15.8

0.4

0.7

0.8

0.4

64.5

1.0

3.0

1.5

1.3

57.5 5.7

6.9 5.7

10.2 9.2

17.4 5.7

10.4 5.7

85.7

85.7

0.2

85.7

85.7

15.3 57.1 34.0 40.0 87.5

0.4 27.5 5.5 19.1 69.8

5.7 85.6 1.2 30.7 13.9

0.6 27.2 4.9 19.9 72.0

0.7 29.2 9.8 19.9 72.1

75.0

27.4

21.2

44.1

31.9

38.4

2.4

4.6

3.2

3.8

Total Source: Department of Statistics (unpublished data).

exhaust, ventilation and air-condition (64.8 per cent), electrical appliances and houseware (57.1 per cent) and in electrical machinery and apparatus (57.5 per cent). Opportunities for participating in the semiconductor and electronic components, radio, television and recording sets and office and computing machinery were limited for SMEs as these industries are both technology- and capital-intensive. The value added per worker in SMEs was only half that of the larger firms. On the other hand, fixed assets per worker was higher at around 68 per cent. SMEs had a higher unit labour cost of 0.06, compared to 0.04 for the large firms (Table 8.8). It also paid its workers lower wages. The average annual wage for SMEs was RM14,986 compared to RM18,284 for the large firms.

3.1. SME Development Models: Case Studies Seven SMEs operating in the Klang Valley (four) and the Penang FIZ (three) were interviewed and the development processes of three local ancillary firms in the electronics industry are discussed below. These three ancillary firms typify the different entrepreneurial models of SMEs in the electronic industry. A detailed trajectory of the development process provides a better

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Table 8.8 Performance of SMEs in Electronics Industry Performance Indicators Value added per worker (RM mil) Average annual wages (RM mil) Fixed assets per worker (RM mil) Unit labour cost

SME

Large

Total

45,700 14,986 52,700 0.07

89,000 18,443 77,500 0.04

87,100 18,284 76,300 0.04

Source: Department of Statistics (unpublished data).

understanding of the underlying factors behind the establishment and growth of SMEs in the electronics industry. Model I: Accumulated Competency The firm was officially established in 1980 with an initial paid-up capital of RM1,000. The owner had originally worked in a family-run foundry. It started with five workers, all of whom had technical skills. Its first customer was a large American firm located in the Penang FIZ. The firm started by supplying jigs and fixtures to the electronics firm. The MNC was its first large customer, and his business grew after the second year when another three MNCs approached the company for similar products. As his customer base grew, he begun to specialize in fabricating parts for his customers and established a stamping division to increase his product line. A couple of years later, he further expanded his operations by establishing a new workshop with machining and tooling facilities. He established his new operation within the industrial zone to be near his clients and to take advantage of the growing opportunities for sub-contracting from the MNCs during the mid-1980s. During this period, many of the MNCs were automating their production processes to trim costs, and the entrepreneur with his initial experience in fabrication was able to manufacture fully automated systems for the MNCs. He received considerable technological advice and support from the MNCs, and worked closely with them to upgrade his facilities to meet stringent industry demands. Within a decade he expanded his operations to five centres with enhanced capabilities in metal stamping, precision machining and the assembly of automation equipment. He upgraded his technology by investing in capital equipment such as CNC machines. He now exports his automation equipment and engineering components to customers in South Korea, China, United States and Singapore. In 1994, the company was listed on the Stock Exchange. He has now invested in China and Thailand by forming joint ventures with overseas partners.

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Model II: Ex-Employee Start-Up This firm is typical of ex-employees with high technical skills who venture out on their own and start offering services to the employer who represents their first major customer. Two engineers from a large U.S.-based firm producing electronics parts and components formed a partnership with a third entrepreneur who owns 30 per cent of the company. The company was formed in 1989 with an initial paid-up capital of RM100,000. The company started off manufacturing PCBA products for a large US company as a sub-contractor. Later, it expanded its customer base and product range and now produces a range of products that include pin-grid arrays (PGAs), plastic lead chip carriers (PLCC) and ceramic packages. Though it has diversified its customer base, its original anchor company is its main customer. It works closely with its main anchor company, and receives training and technical advice as well as equipment from its principal anchor company. Its annual sales turnover is around RM80 million. Model III: State-Sponsored Start-Up This is a relatively new company established in 1993 with substantial assistance from the state. It is 100 per cent locally-owned company with 70 per cent of the equity held by individuals with strong political connections, and the remainder by a local private company. The company was initiated through an agreement between a large US electronics company and the Malaysian government as part of the on-going initiatives to transfer technology to Malaysians. The local company started off as a vendor to the US-based company supplying mother boards for mobile radios, PCBA, chargers, cordless telephones, CD players. It now supplies to others through customers identified and approved by the lead company. The lead company provided the technology and training for the local company. The company now sources 60 per cent of its inputs locally, thereby contributing further to the expansion of other ancillary firms. In all three cases, the SMEs had a secure market to begin with. They all started by supplying to one major client for a sufficiently long period before diversifying their customer base. They also had personal attributes in terms of the necessary technical competencies or were supplied with the technology by the MNCs. They also worked closely with the MNCs to upgrade the production capabilities. Expansion centered on their core activities in which they had acquired competencies. All three indicated that finance was not a major issue.

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4. SME Development: Policy and Response Policy measures can influence the level of entrepreneurship (Storey 1994). The government can influence entrepreneurship either directly through specific measures or indirectly through generic measures. The following briefly traces the policies that have directly or indirectly affected the development of SMEs in manufacturing. The electronics industry is an MNC-dominated industry, both in terms of technology and markets, and domestic entrepreneurship in the form of a vibrant network of SMEs with strong linkages to these MNCs is crucial to harness the technological spillovers of FDI. Policy support can facilitate the development of technically competent and efficient SMEs that are capable of manufacturing parts and components for the MNCs. SMEs have received substantial policy and institutional support since the 1970s, but such support system was ethnically focused and not directed at developing the industrial sector. Bumiputeras were given substantial state support to establish business enterprises under the New Economic Policy (1970–1990) and the subsequent National Development Policy (1991–2000) to create a commercial and industrial community that is at par with the more commercially inclined Chinese community. The pre-occupation with increasing bumiputera participation in commerce and industry also saw the introduction of the Industrial Co-ordination Act in 1975, which discouraged the growth and expansion of non-bumiputera SMEs. The Act required that all manufacturing firms with shareholders’ fund of above MR100,000 or employing more than 25 employees had to be licensed. These firms had to reserve 30 per cent of their equity for bumiputeras. The threshold has been revised upwards to RM250,000 or 25 workers and later to RM1 million, following protests from the non-bumiputera community. In 1986, it was further raised to RM2.5 million. Though the tiny firms remain unaffected, in the initial years, it served as a deterrent to further investment for the higherend non-bumiputera SMEs. It was not until the late 1980s that state support was directed at SMEs in manufacturing to broaden and deepen the industrial structure. The policy shift was precipitated by the economic crisis of the mid-1980s that exposed the structural weaknesses of the industrial structure and led to a review of past strategies for industrial development. The Investment Incentives Act of 1968 was replaced in 1986 by the Promotion of Investment Act of 1986. SMEs were now eligible for pioneer status and the investment tax allowance. The former entitles firms to a tax-free period of five years while the later allows a

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firm to accumulate tax allowances equivalent to the value of its investment during the five years of its operation. There was also an attempt to promote linkages for SMIs. A Sub-Contract Exchange was established in 1986 for specific sectors, one of which was the electronics industry (others include auto components, light engineering, and rubber and plastic products). The state-led programme received little support from MNCs and was replaced with the Vendor Development Programme in the early 1990s. The linkage programme was complemented by efforts to upgrade technology. An Industrial Technical Assistance Fund was established in 1989 under SIRM with an initial capital of RM50 million. Matching grants were extended to firms for various forms of technological upgrading. Due to poor response from firms, the programme was extended to sole proprietorships and SMEs under the incubator programme in Technology Park Malaysia. The take-up rates of these programmes were, however, very disappointing. The bumiputera SMEs had a shorter history of participating in the manufacturing sector and were less commercially or technically ready to benefit from these programmes. On the other hand, the non-bumiputeras were wary of government support programmes which they perceived to be ethnically biased. Many of the non-bumiputera SMEs operated as backyard industries with little regard for rules and regulations and were generally suspicious of government involvement. Meanwhile Malaysia’s unprecedented economic growth since the late 1980s was led by manufacturing and dominated by exports from MNCs with limited links to the domestic economy. Many of the state-led heavy industries launched in the early 1980s experienced financial difficulties, weak external demand and continued to operate under heavy protection. By then, a pool of bumiputera entrepreneurs had emerged. These developments paved the way for a more industry focus on SME development. Several policy changes were introduced in the Seventh Malaysia Plans (1996–2000) and the Second Industrial Master Plan (1996–2005) to integrate SMEs into the mainstream industrialization process by linking them with the larger MNCs. By the mid-1990s, a concerted approach was adopted for SME development with the establishment of Small and Medium Scale Industries Development Corporation (SMIDEC) in 1996. The government continues to support the development of bumiputera entrepreneurs by adopting “two parallel tracks in the policy approach to the development of SMEs” (SMIDP 2000, p. 3). The development of SMEs in manufacturing and related services is the responsibility of SMIDEC under the purview of the Ministry of International Trade and Industry (MITI). On the other hand, the development

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of bumiputera entrepreneurs focuses on new start-ups in trading and services and is under the purview of the Ministry of Entrepreneur Development. SMIDEC’s main programmes for SME development include the Industrial Linkage Programme (ILP) for fostering sub-contracting with large-scale industries (LSIs), technology development, skills upgrading, enhancing access to funding and export development programmes, notably the Global Supplier Programme and infrastructure development. The ILP fosters partnership between SMIs and MNCs to provide market opportunities as well as strengthen their competitiveness in the global market. The ILP targets key industry clusters with the biggest potential for linkages and crucial for sustainable industrial dynamism. One of the four industries targeted is the electronics industry which consists of four industry clusters as identified under the Second IMP: consumer electronics, semiconductor and electronics components, computers, peripherals and telecommunications and electrical/electronic appliances and apparatus. By 1999, 54 industries have been linked with LSIs, generating sales worth RM7 million. Firms that participate in the ILP must achieve a high level of competency in supplying parts and components required by the LSIs. Hence, firms participating in the programme receive other support schemes as well to enable them to become cost efficient and competitive suppliers to the leading companies, and later enter the world market. The ILP is complemented by the Global Supplier Programme (GSP) which involves training in critical skills by tying up with the larger firms. By participating in this programme, SMEs are able to interact with the larger companies and have an opportunity to be chosen as potential suppliers worldwide. This programme has been highly successful in the Penang industrial zone. At present, the highly effective Penang Skills Development Centre (PSDC) conducts training programmes in collaboration with nine electronics MNCs. Over the last three decades, Penang has successfully developed a critical mass of electronics firms that has spawned sufficient opportunities for developing local technical competencies and local enterprise. These demand side factors have also helped to foster greater inter-institutional linkages. The government also provides assistance under the factory-auditing grant for SMEs to undertake self-assessment or to enable SMEs to be assessed by larger companies. In order to be suppliers to larger firms, SMEs must meet specified criteria in terms of cost, quality and delivery. To enhance the technological capabilities of the SMEs to meet the stringent requirements of the large companies, technological assistance is provided through the Industrial Technological

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Assistance Fund (ITAF) which operates four different programmes: advice on business planning and development, support to improve processes and develop new products, quality enhancement and certification, and export market development. SMIDEC has now taken over the management of ITAF. In addition, SMEs can obtain grants from the Technology Acquisition Fund (TAF) to facilitate the acquisition of state of the art technology. SMIDEC oversees the TAF Programme and the funds are channelled through the Malaysian Technology Development Corporation (MTDC). The E-Manufacturing Grant was launched in 2002 to provide assistance for SMEs to purchase ICT software for manufacturing and related services. The government provides matching grant of up to a maximum of RM500,000 per company. SMEs can also participate in the Skills Upgrading Programme launched in 1997. SMEs participating in the technical training course carried out by the Skills Development Centre of SMIDEC receive financing of up to 50 per cent of their training fees. SMEs contributing to the Human Resource Development Fund (HRDF) are eligible to claim an additional 45 per cent of the training fees. One of the main complaints of SMEs is the lack of awareness of government incentives and programmes. SMIDEC thus provides advisory services through its weekly Business Clinic Programme. SMIDEC also holds an annual “SMI Showcase” or exhibition to match SMEs with large businesses. To further increase the outreach of its programmes, SMIDEC has set up a branch office in Bukit Tengah in the north and is planning to set up other regional centres soon. It also maintains a database of experts in various fields under the SME Expert Advisory Panel (SEAP) Programme whereby SMEs can tap the knowledge of these experts for a nominal fee. Physical infrastructure support was also provided for SMEs. Industrial estates were developed throughout the country with factory space, which was offered for sale or rent to SMEs. The idea was to concentrate SMEs so that firms could learn from one another and the larger firms could easily locate them. By December 2001, 1,115 units were completed, with a take-up rate of 74 per cent. There are also numerous sources of funds for SMEs. Currently, there are twenty-two credit or financing schemes for SMEs, three of which are specifically reserved for bumiputera SMEs. These financing schemes are channelled through four financial intermediaries that include Bank Industri and MIDF for industrial finance, Bank Pembangunan for bumpitera SMEs and CGC which guarantees loans for SMEs obtained through banks.

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The current policy is more conducive to nurturing local enterprise within the electronics industry. It is much more co-ordinated and focused and is targeted towards making SMEs more competitive, both in terms of cost and quality, so that they can provide more inputs to multinational operations in the country and eventually break into the export market. Unlike large firms, there is no database on SMEs at present to monitor the progress of SMEs and to reach out to the SMEs. An attempt has been made to register all firms, regardless of size. At present, only information on the total number of SMEs in the various sectors is available. SMIDEC has only recently recruited two statisticians to handle the SME database. It has a long way to go before adequate data on SMEs is available. 5. Summary and Conclusion Both demand and supply factors influence the nature and extent of local entrepreneurship. The opportunities or demand created by MNCs induced by changes in technology and production management systems and the changing structure of industries must be harnessed by complimentary local initiatives such as concerted policy and institutional support and individual motivations driven by personal attributes and competencies to foster entrepreneurship. Market opportunities provide impetus for the growth of local enterprises. The early development of the electronic industries consisted of simple assembly and testing of ICs by large MNCs located within FIZs and LMWs. Such production activities involve simple production processes and offer limited scope for local enterprise. At the same time Malaysia’s level of technical capabilities in manufacturing in the 1970s was rudimentary. It was only in the late 1980s that MNCs faced with intense competition resorted to local sourcing to trim costs, thereby expanding opportunities for spawning local enterprise. Demand side factors such as changing technology and production management systems have helped to foster local enterprises. But supply-side factors such as weak policy and institutional support and other shortsighted policy inhibitions discouraged local entrepreneurs from developing a dynamic network of SMEs working in close collaboration with the larger companies. While concerted policy and institutional support is fundamental for converting the opportunities presented by large MNCs to stimulate domestic enterprise, Malaysia’s experience also shows that there must be a critical mass of demand for products and services from larger companies before statesponsored programmes can take off. Both of these factors are now more

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favourable and present a more optimistic outlook for the development of the SMEs in the electronics industry. NOTES 1. 2.

3.

4.

The electrical and electronics industry consists of sub-sectors under the MIC three-digit code 383 and five-digit codes 38250 and 38291. Though the need for a national database on SMEs has been recognized as vital for policy formulation, and attempts have been made by MITI and SMIDEC to register all SMEs, to date, there is no such database. Based on the data sourced from the Registrar of Companies, SMIDEC has estimated that currently there are about 49,000 SMEs in the country in all sectors. The backward linkage index (Lbj = Uj/Xj) measures the dependence of sector j on all other sectors in terms of the ratio of material inputs (Uj) to the value of total production of that sector (Xj), whereas the forward linkage index (Lfj = Wi/Zi) measures the dependence of all sectors on sector i by the ratio of intermediate (Wi) to total demand for that sector (Zi). The definition of SMEs by SMIDP is as follows: Small — less than 50 full-time workers and less than RM10 million sales turnover. Medium — 50–150 full-time workers or RM10–25 million sales turnover. Large — more than 50 workers and more than RM25 million sales turnover.

REFERENCES Ahn, Choong Yong. “Linkage Development of Malaysia: Issues and Policy Directions”. In Managing Industrial Transition in Malaysia, edited by Kanapathy, V. Institute of Strategic and International Studies, Malaysia, Kuala Lumpur, 1995. Best, H. Michael. Electronics in Malaysia: The Challenge of a Stalled Industrial Transition, IKMAS Working Papers, Institute for Malaysian and International Studies, Universiti Kebangsaaan Malaysia, 1997. Capannelli, Giovanni. Industry Relocation and Technology Transfer: Japanese Consumer Electronics Firms in Malaysia, Discussion Paper Series, APEC Study Centre and Hitotsubashi University and Institute of Developing Economies, Japan, 1996. Department of Statistics. Malaysia: Input-Output Tables, 1987, Kuala Lumpur, October 1994. Department of Statistics. Malaysia: Input-Output Tables, 1991, Kuala Lumpur, September 2001. Institute of Strategic and International Studies. “Industrial Transition in the Malaysian Electronics Industry”. Consultancy Report prepared jointly with UNIDO and the Economic Planning Unit, 1998. Japan Bank for International Cooperation. “Issues of Sustainable Development in

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Asian Countries: Focused on SMIs in Malaysia”. Research Institute for Development and Finance, Research Paper no. 8-2, 2001. Karikomi, Shunji. “The Development Strategy for SMEs in Malaysia”. Working Paper Series 97/98, no. 4, APEC Study Centre, Institute of Developing Economies, Japan, 1998. Lim Pao Li. “Mechanism for Developing Linkages between SMIs and LSIs: Subcontracting Arrangements”. In Enhancing Intra-Industry Linkages: The Role of Small and Medium Scale Industries, edited by Ismail Salleh and Latifah Ibrahim. ISIS and Fredrich Stiftung. Kuala Lumpur, pp. 117–1130, 1992. Linden, Greg. “Japan and the United States in the Malaysian Electronics Sector”. In International Production Networks in Asia: Rivalry or Riches?, edited by Borrus, M., D. Ernst and S. Haggard. London: Routledge, 2000. Malaysian Institute of Economic Research & DRI McGraw-Hill. Electronics and Electrical Industry Group, Volume II: Industry Studies. Technical Report prepared for the Second Industrial Master Plan, Kuala Lumpur, 1996. Ministry of International Trade and Industry. Malaysia: International Trade and Industry Report, 2001. Kuala Lumpur, 2002. Narayanan, S. “Technology Absorption and Diffusion among Local Supporting Firms in the Electronics Industry: Explaining the Divergence between Penang and the Klang Valley, Malaysia”. IKMAS Working Papers, Institute for Malaysian and International Studies, Universiti Kebangsaaan Malaysia, 1997. OECD. Fostering Entrepreneurship, the OECD Jobs Strategy, OECD, Paris, 1998. Rasiah, R. “Review of Linkage Development in the Export Processing Manufacturing Sector — Participation Focus on the Electrical/Electronics and Textile/Garment Industries”. Consultancy Report prepared for the Government of Malaysia and UNIDO, Kuala Lumpur, 1990. Rasiah, R. “Foreign Firms in Penang’s Industrial Transformation”. Jurnal Ekonomi Malaysia, December (1991): 91–97. Small and Medium Scale Industries Corporation. SMI Development Plan (2001– 2005), Kuala Lumpur, 2002. Storey, D.J. Understanding the Small Business Sector. London/New York: Routledge, 1994. Suarez-Villa, L. “The Structures of Cooperation: Downscaling, Outsourcing and the Networked Alliance”. Small Business Economics 10, no. 1 (1998): 5–16. Thurik, R. and S. Wennekers. “A Note on Entrepreneurship, Small Business and Economic Growth”. Centre for Advanced Small Business Economics, Erasmus University Rotterdam and EIM Small Business Research & Consultancy, Discussion Paper, 2001. Vandenberg, Paul. “The Evolution of SMI Policy in Malaysia”. ISEAS Working Papers, Visiting Researchers Series, no. 15 (2000). Institute of Southeast Asian Studies, Singapore, 2000. Verheul, I. et al. “An Eclectic Theory of Entrepreneurship”. Discussion Paper, Tinbergen Institute, Rotterdam, 2001.

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian > Llanto 150 Studies. Individual articles are available at < http://bookshop.iseas.edu.sg Brenda Mendoza and Gilberto

9

Government’s Role in Developing Entrepreneurship and SMEs in the Philippines Brenda Mendoza and Gilberto Llanto

1. Introduction The Philippine Government, for some years now, has adopted a policy of relying on the private sector as the engine of growth. As such, the government has been getting out of activities which the private sector is in a better position to undertake, and concentrating on improving the business environment to enhance the competitiveness of its industry and services sectors. For reasons cited in the paper, the government is giving special attention to the development of entrepreneurs and small and medium enterprises or SMEs. The objective of the paper is to present the role of the government in the development of SMEs and entrepreneurs (represented here by microenterprises) in the Philippines. The paper starts with a discussion of the rationale for government involvement in SME and entrepreneurship development. It then presents the Philippines’ experience in SME and entrepreneurship development and the role of the government therein, including an assessment of the policies, programmes and projects that were

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and have been adopted to promote SME development. Where possible, these policies, programmes and projects are compared with the experience of other countries especially in the ASEAN region. Finally, an attempt will be made to identify lessons that can be drawn from the Philippine experience. 2. Economic Rationale for Government Involvement in SME and Entrepreneurship Development There is a large body of literature providing justifications for supporting the development of SMEs and entrepreneurs/micro-enterprises. These justifications include, among others, the contribution of SMEs to employment generation and economic growth. Vibrant SMEs could also serve as a foundation for a strong and competitive industrial sector as was the case of the newly industrialized countries of East Asia that have relied on dynamic SMEs to boost their competitiveness. SMEs have a vital role in the development of rural areas as these disperse economic activities to the countryside, and hence contribute to a more equitable distribution of income. These use indigenous resources, support export growth and encourage entrepreneurial development. Being more flexible, SMEs are being increasingly viewed as sources of innovation and agents of change. Thus, these are contributing to the development of new technology, the improvement of skills of workers as well as the development of new products and processes (Intal 2002). The development of SMEs also contributes to the expansion and diversification of markets as well as to increasing the savings rate and investment base. However, being largely owner-owned and managed, SMEs are usually unable to compete with large enterprises in terms of access to resources such as raw materials, financing and technologies, among others; thus, SMEs need to be supported by the government to enable them to develop. 3. Philippine Experience in SME and Entrepreneurship Development

3.1. Profile of SMEs in the Philippines SMEs in the Philippines are defined as business activities or enterprises with total assets, excluding land, valued at between PhP1,500,001 to PhP15 million after financing for small enterprises and between PhP15,000,001 and PhP100 million for medium enterprises. Micro-enterprises, meanwhile, are those with total assets, excluding land, valued at PhP1.5 million or less after financing. In terms of number of workers, micro-enterprises are those with less than 10 workers while small and medium enterprises are those with 10 to 99 and 100 to 199 workers, respectively.

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Data on SMEs in the Philippines are sadly inadequate. Nevertheless, it is estimated that SMEs and micro-enterprises (excluding cooperatives, farmers and the informal sector) account for 99 per cent of the country’s total number of enterprises (Table 9.1). Of the 99 per cent, 91 per cent are microenterprises with the rest accounted for by SMEs. SMEs are also estimated to account for 67 per cent of total employment and around 33 per cent of gross domestic product. In terms of distribution by sector, smaller enterprises tend to be in the services sector while medium and large enterprises are mostly into manufacturing (Table 9.2). Philippine SMEs are typically family-owned; domestic market oriented with multi-functional management, workers and equipment; innovative; and use resources more efficiently than large enterprises. However, these are usually characterized by low productivity, low level of technology and skills, lack of records and low product quality. These also suffer from a lack of access to financing, markets and information. Table 9.1 Number of Manufacturing Establishments No. of Workers

No.

1972 Per cent

1–9 10–99 100–199 >200 Total

3,583 307 437 4,327

83 7 10 100

No.

1983 Per cent

4,369 505 716 5,590

78 9 13 100

No.

1987 Per cent

3,815 482 703 5,000

76 10 14 100

1999 Per cent

No.

113,864 14,611 1,137 1,323 130,935

87 11 1 1 100

Source: National Statistics Office.

Table 9.2 Profile of Philippine SMEs (as of 1994) Scale

Definition Asset Size Limit (PhP)

Micro Small Medium Large

1.5 15.0 60.0 >60.0

M M M* M*

No. of Workers 1–9 10–99 100–199 ≥200

Distribution

Manufacturing to Services Ratio

No. of Per cent Establishments 207,158 19,261 1,165 1,202

91 8 0.5 0.5

40:60 48:52 65:35 76:24

* In 2001, this was adjusted to PhP100 M. Source: Department of Trade and Industry.

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Given the characteristics and importance of SMEs and micro-enterprises to the economy, the Philippine government has more often than not adopted a policy of supporting and promoting the development of SMEs.

3.2. Policies and Strategies to Promote SMEs There are a number of studies on SME development in the Philippines but this section draws mainly from Lapar (1991). According to Lapar (1991), efforts to develop SMEs gained momentum in the 1960s with the creation of the University of the Philippines Institute of Small Scale Industries (UP-ISSI) in 1966 to extend assistance to small- and medium-sized industries. In 1969, the “Magna Carta for Social Justice and Economic Democracy” was adopted to signify the government’s commitment to the development of small-scale industries. However, it was deemed to have provided for a limited form of assistance since it was focused only the financial needs of the sector. In 1970, the National Council for Small and Medium Industries was created to “integrate all government agencies servicing small-and medium-scale industries and establish guidelines for government policies to ensure the stability and continued growth” of the sector. The Council was replaced in 1974 by the Commission on Small-and MediumScale Industries which was renamed Council on Small- and Medium-Scale Industries (CSMI). The CSMI was established to coordinate and integrate the policies and programmes of all agencies involved in the development of small- and medium-sized industries to make these more responsive to the needs of said industries. It was abolished in 1981. It was also in the 1970s when a supervised credit programme was implemented by the UP-ISSI and the Social Security System to provide longterm financing to small industries and the Development Bank of the Philippines (DBP) became the primary institution for financing small- and medium-scale industries in the rural areas at very attractive and liberal terms and conditions. With the change in administration in 1986, the development of micro, cottage, small and medium industries was lodged with the Department of Trade and Industry (DTI), specifically with its Bureau of Small and Medium Business Development or BSMBD (which has been renamed to Bureau of Small and Medium Enterprise Development or BSMED) and its Micro Industries Development Programme. Other programmes and projects were also developed in conjunction with the private sector and non-government organizations such as the Philippine Business for Social Progress (PBSP). To spur the rapid development of the rural areas, Republic Act (RA) No. 6810

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or the Countryside Barangay Business Enterprises (CBBEs) law, also known as the Kalakalan 20 law, was enacted in December 14, 1989. The said law was patterned after the “Law of 20” of Italy. It aimed to remove bureaucratic restrictions on the setting up of, and provide incentives to, CBBEs to encourage these to grow in as free an economic environment as possible, and in the process, encourage those in the informal sector to join the formal sector. The Kalakalan 20 law expired on 13 December 1994. On 4 January 1991, RA 6977 or the “Magna Carta for Small Enterprises” was enacted “to promote, develop, and assist small- and medium-scale enterprises through the creation of a Small and Medium Enterprise Development (SMED) Council, and the rationalization of government assistance programmes and agencies concerned with the development of small- and medium-enterprises, and for other purposes.” RA 6977 as amended by RA 8289 on 6 May 1997 requires banks to lend at the minimum 6 per cent and 2 per cent of its net lending portfolio to small- and mediumenterprises, respectively. It also created the Small Business Guarantee and Finance Corporation or SBGFC to source and adopt development initiatives for globally competitive small and medium enterprises in terms of finance, technology, production, management and business linkages, and provide, promote, develop and widen in both scope and service reach various alternative modes of financing for small and medium enterprises, including but not limited to, direct and indirect project lending, venture capital, financial leasing, secondary mortgage and/ or rediscounting of loan papers to small business, secondary/regional stock markets.

The SBGFC is attached to the DTI and is under the policy, programme and administrative supervision of the SMED Council. SBGFC was merged with the Guarantee Fund for Small and Medium Enterprises on 30 July 2001 with the issuance of Executive Order No. 8 and the surviving entity (SBGFC) was renamed SB Corporation. The merger was made to enable the new organization to be more responsive to the credit requirements of the SME sector and to widen the coverage of alternative financing instruments needed to make Philippine businesses competitive in a rapidly globalizing environment. Under the 2001–2004 Medium-Term Philippine Development Plan, the promotion of SMEs shall be pursued to enhance the competitiveness of the industry and services sectors. In line with this strategy, the Philippine Government is working with the banks to enable the latter to understand and service the needs of SMEs, and hence be encouraged to reduce bank requirements and lend more to SMEs. Alternative sources of financing are

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being pursued, including guarantee programmes and micro-financing. Relative to micro-financing, the Bangko Sentral ng Pilipinas recently opened a rediscounting facility for banks engaged in micro-finance lending. The facility will be made available to rural and co-operative banks to maximize their ability to serve enterprises that would not otherwise qualify for credit from big commercial banks. Industry clustering which will facilitate the provision of cluster-specialized resources such as technology, skills or networking infrastructure as well as marketing and distribution support to SMEs is being promoted to increase the pace of development of SMEs in the rural areas. The improvement of facilities of existing provincial SME Development Centres to enhance their capacity to provide SMEs with information, training and advisory services is being looked into along with the feasibility of putting up a National Business Registry to track all business firms from start-up to closure and provide an up-to-date picture of the status and location of business establishments at any time. The numerous existing training programmes for SME entrepreneurs, managers and workers are being rationalized in co-ordination with the private sector to improve content and delivery as well as to ensure that these address the needs of SMEs.

3.3. Financial and Technical Assistance Aside from creating the institutional and policy support to assist SMEs and micro-enterprises, the government has also set up financial and technical assistance programs and projects that micro-, small- and medium-enterprises could tap for their needs (Appendix 1). Financial assistance programmes have mainly been in the form of directed credit programmes (DCPs). In the sixties and seventies, the direct lending programmes provided funds at preferential (i.e. below market) interest rates, and repayment terms and conditions. As the government moved to enhance the business environment through the removal, if not minimization of market distortions, among others, these funds (with the exception of those aimed at financing environment-friendly activities) became available at market-determined rates. Financing programmes have been and continue to be established to fund the acquisition of fixed assets, working capital requirements, export finance and packing credit. While most programmes are still collateral-based (with land, unencumbered project assets, or even personal property as part of collateral requirements), some non-collateral-based programmes have been introduced. Credit guarantee schemes have also been put in place to persuade banks to reduce collateral requirements.

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Most financing programmes are coursed through government and private financial institutions, but a number of non-government and private voluntary organizations such as the PBSP and Tulay sa Pag-unlad have also been tapped to address the financing needs of micro, small- and medium-enterprises. Other alternative sources of credit include money-shops that are located mainly in and around public markets. Technical assistance to entrepreneurs and SMEs is provided by both the public and private sectors. The DTI is the government agency tasked with providing such assistance to SMEs, although other departments/agencies may also do so in coordination with the DTI. Technical assistance provided includes technical training and consultancy services, advice on production technologies as well as on improvement of product quality and design, and marketing and trade promotion mainly through trade fairs. Training programmes cover such topics as entrepreneurship, management and accounting principles, among others. Non-government organizations, meanwhile, provide technical assistance, training, education, and consultancy services mainly to micro-enterprises. 4. Assessment of Government Policies and Programmes to Promote SME Development If one is to assess the effectiveness of government interventions to promote the development of SMEs and micro-enterprises on the basis of the latter’s contribution to economic growth, one may conclude that these policies and programs have not had much impact as large enterprises continue to account for the larger share of industry value added. Agriculture continues to be the main source of income in the rural areas and unemployment continues to be a major problem for the Philippines. On the other hand, one may also conclude that government policies and programmes to promote SME and entrepreneurship development have had some degree of success if the increase in the number of SMEs and microenterprises as well as the support services is used as the performance indicator. The policies, strategies, programmes and projects aimed at SME development did not change much from administration to administration. However, the manner by which these have been implemented has changed, shifting from being interventionist (e.g. providing credit at less than market rates to selected sectors) to being facilitative (e.g. introducing reforms to enhance the business environment). The shift may be traced mainly to constraints on the government budget arising from the economic crisis

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experienced in the early eighties, and the Asian financial crisis in 1997, among others, which made it difficult to sustain assistance programmes requiring government funding support. As to the various laws on SME development enacted, an assessment of the Kalakalan 20 revealed that it was a failure for a number of reasons. An inherent defect of the law was its assumption that offering partial tax exemption would be enough to get CBBEs in the informal economy to join the formal economy. Since those in the informal sector do not pay taxes, the partial tax exemption privilege was not sufficiently attractive to get these informal sector enterprises to register with the relevant authorities. The law also did not address operational problems encountered by CBBEs that were not related to taxes but hindering their growth. These problems include access to financing, raw materials and skilled labour and high CBBE fees, among others. Local government units (LGUs) had a lukewarm attitude towards the programme which was felt to impinge on LGU revenue collection. Vague provisions of the law, and its implementing rules and regulations gave rise to interpretation and implementation problems. CBBEs were also required to comply with the minimum wage law, although the Department of Labour and Employment exempted CBBEs from complying with minimum wage adjustments. Moreover, the law was perceived to be anti-growth as it had limitations on asset size or number of employees. The mandatory allocation of credit to SMEs provided for in RA 6977 is being complied with (latest reports show that banks are over-complying), but access to finance remains as the main problem for SMEs despite liquidity in the banking sector. In addition, the macro-economic policy environment remains biased towards large enterprises despite reforms being put in place to reduce the cost of doing business, particularly for SMEs. Studies on SME development in the Philippines have generally focused on financing programmes, as these comprise the bulk of assistance provided to the SMEs. The studies, however, tend to focus on the problem of access to finance by micro-enterprises, as evidenced by various studies that have been conducted (e.g. Llanto 1997 and Lamberte 2001), and measures that have been adopted, over the years on micro-lending. These could be among the reasons why the problem of SME access to funds has remained more pronounced. According to the study “Expanding Banking Services to Micro, Small and Medium Enterprises and Poor Households in the Philippines” (Lamberte 2001), the policy environment is a significant factor in expanding banking services to micro-enterprises, SMEs, and poor households. While the policy

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environment, particularly for micro-finance, has considerably improved since 1990 with the implementation of various measures to increase the access to financial services of micro-enterprises and SMEs, banks still encounter constraints in further expanding their services to these sectors. The constraints include macro-economic instability, which can make loans to SMEs and entrepreneurs much riskier as cash flows can easily dry up during the sudden downturn of the economy. A stable macro-economic environment is conducive to the expansion of financial services to these enterprises. Likewise, access to long-term credit is positively related to labor productivity and growth of SMEs, and thereby contributes to the “success” of these enterprises. Inadequate infrastructure (especially cheap and reliable electricity and telecommunications system) increases not only the cost of doing business for enterprises, but also of providing financial services; thus, affecting the efficiency of financing institutions in processing deposits and loans and enhancing access to financial services. Among other constraints that banks face are regulations on deposit mobilization, limited capital which sets a ceiling as to how much deposits can be mobilized, and the need for exposure to micro-finance lending technologies. The latter is especially true for thrift and rural banks. Private banks also find undue competition from government banks to be a serious obstacle to the expansion of services. This is because government banks have access to official development assistance while private banks do not and government agencies have to deposit their funds in government banks. Banks rarely lend to SMEs due to perception that lending to small-scale borrowers is highly risky, lack of acceptable collateral and high transaction cost of processing small loans. In response, the government created a number of credit programmes intended to provide access to financial services. The private sector, meanwhile, make use of micro-finance institutions or MFIs to reach small borrowers. However, the lack of access to micro-finance services and formal credit persists. As a result, credit granting NGOs have emerged as alternative sources of funds. In this regard, Llanto (1997) has raised the need for viable and sustainable MFIs that offer and deliver financial products and services continuously. The weak financial base of MFIs affects the viability and sustainability of these institutions. Credit NGOs, in particular, need to raise their capital, mobilize substantial deposits, and tap the financial markets. Encouraging large banks to infuse equity into small banks (i.e., rural and thrift banks), and to venture into micro-finance business via exposure to micro-finance lending technologies has been part of the recommendations to address the problem.

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The viability of MFIs is also affected by their ability to develop and offer new product lines and services, and to design and implement new microfinance technologies and practices. Building capability in these areas is needed to enable them to stay strong and become/remain stable institutions. Client training is also indispensable for successful micro-finance programmes, but this requires huge investments that MFIs are incapable of providing. In this regard, the matching of government/donor funds with MFI funds could improve outreach performance. The foregoing suggests that the need to ensure access to, and delivery of, various forms of financial products and services to micro-enterprises and SMEs in a sustainable manner, is more important than the provision of credit. Improved internal financial policy and organizational priorities and procedures (in the areas of financial reporting and monitoring systems, portfolio management, assessment and management of risks, product packaging and pricing, and management of loan arrears), and enhanced and institutionalized performance standards, particularly in loan repayment, reduction of loan defaults, and installation of appropriate accounting and internal audit systems, are likewise crucial in bringing about viable and sustainable MFIs. MFIs, especially credit NGOs, have been prevented from reaching a great number of clients by their lack of legal authority to act as real financial intermediaries. This has limited their capacity to develop and legally offer innovative financial products and mobilize deposits, thus hindering their growth as viable and sustainable financial institutions. Informality of the organization makes any attempt to mobilize deposits, develop various financial products and services, and offer these to the public, illegal (Llanto 1997). The government has used loan guarantee schemes to provide small-scale borrowers with access to formal credit, believing that loan guarantee programmes can address the main barriers to loan access. Studies have shown, however, that these guarantee schemes have failed to motivate bank lending to small borrowers and have restricted the outreach of banks because of, among others, weaknesses in the guarantee system including the lack of risk management capabilities of credit guarantee institutions, the lack of a credit rating agency and the poor database on SMEs. The lack of a credible credit guarantee institution for SMEs that performs credit analysis and undertakes credit rating of SME borrowers seeking credit guarantee in lieu of their inadequate collateral has also been identified as a

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weakness that needs to be addressed, particularly if development banking is to function properly for SMEs (Angelo King Institute for Economic and Business Studies, De La Salle University 2002). Looking at the experiences of other countries, the dynamism of Korea’s SMEs has been partly attributed to the wide range of financial support systems available to these enterprises, from both the government and the private sectors. The Korean government has established a number of funds that provide financial services for various purposes (e.g., technology development, equipment modernization, structural adjustment, purchase of locally produced capital goods, working capital, among others). The Korean SMEs widely use the different financing sources, being able to choose and pick from the alternative sources available. Two credit-guarantee funds provided by the government are available (for SMEs in general and for technologyintensive sectors) to benefit those that do not have collateral. Worth noting though, is that programmes under Korea’s financial support system incorporate incentive structures to encourage timely repayment of loans. On the other hand, the Japan Finance Corporation for Small Businesses (JFS) provides an example of a financial institution that offers a nearly comprehensive set of long-term financing packages that cater to the various needs of small businesses (Angelo King Institute for Economic and Business Studies, De La Salle University 2002). It provides both general-purpose and special-purpose loans (e.g., facility funds for entering new fields with high growth potential and for dealing with environmental and energy problems, and long-term operating funds for small enterprises expanding their products, rationalizing their operations, etc.). JFS likewise has special funds to provide emergency loans to small businesses adversely affected by natural disasters or changes in the economic and financial environment. Loans for special purposes require only partial collateral support. The institution also offers long-term financing (up to twenty years), fixed interest rates (or adjusted every five years) to enable long-term business planning, and low interest rates equivalent to the long-term prime rate or lower with deferred interest payment. In addition, the variety of long-term financing packages is complemented by the JFS’ business information and economic research services, thereby integrating funding and information for optimal use of funds. The bank undertakes management analysis (e.g., future prospects of business, validity of business plan from a medium- and long-term view) in the course of loan arrangement; feeds back to its clients its analysis to enhance the latter’s business management ability; and also conducts surveys to help SMEs gain a better understanding of the rapidly changing business and economic environment.

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In both cases, the government financial support systems for SMEs primarily function to supplement and complement private financial institutions, especially in the provision of long-term loans. This is where SMEs are particularly constrained due to the lack of market credibility and their small size, which prevents them from accessing the capital markets via, for instance, the issuance of bonds. Insofar as technical assistance programmes are concerned, Lapar (1991) notes that a study conducted by Tecson et al. (1989) observed that these had a number of shortcomings. SMEs either did not know of or lacked information on the different programmes offering technical assistance. It was also observed that there was a lack of co-ordination among the different agencies offering related or similar services resulting in duplication of efforts and dissipation of limited resources. Some of these service providers suffered from a shortage of skills, and government agencies tended to wait for the SMEs to approach them for help rather than seek these out to offer their help. Reliable statistical data needed for policy formulation were also lacking. A report on the survey conducted in January to March 2000 for the Asian Productivity Organization (APO), where responses from 135 respondents were processed but not validated, shows that the most useful government services are marketing support, information and training (Orbeta 2002). Of the marketing support provided, those SMEs that responded found general marketing assistance to be most useful followed by export promotion facilities, government linkages for sub-contracting and e-commerce support. Of the training provided, those found to be most useful were those on production skills, followed by training programmes on production technology, management, and design. While information technology (IT) and IT management training was also considered very useful, the training was unavailable to some respondents. As to consultancy services provided, those on production and design were considered more useful than those on management. Some respondents indicated that government financial services (loans, credit guarantees and equity funding) were very useful but almost the same number considered these to be not available. When asked to what extent government services had contributed to the improvement of their business, 50 per cent or more of the respondents ranked three areas as significant (i.e. most significant and partly significant). These were (a) entry into new markets (most significant — 29 per cent, partly significant — 27 per cent), (b) plant safety improvement (16 and 36 per cent, respectively), and (c) worker skill improvement (25 and 28 per cent, respectively). The areas where government assistance was considered to be of little or no benefit were development of new products (very little significance — 20 per cent,

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not significant — 27 per cent), packaging development/improvement (16 and 30 per cent, respectively), and certification for international standards (10 and 36 per cent, respectively).

4.1. Lessons to be Drawn from the Philippine Experience As mentioned earlier, the effects of government efforts to promote SMEs and micro-enterprises are not evident from macro-economic data. Nevertheless, it is believed that SMEs and micro-enterprises have enabled the Philippine economy to weather the Asian Financial Crisis and the slowdown in the world economy in 2001. The foregoing sections also show that support to SMEs and micro-enterprises do not show immediate results, and thus need to be sustained over a longer period as compared to programmes for large enterprises. It is thus important to consider factors such as financial, human resource and organizational constraints that impact on the sustainability of policies, programmes, and projects to promote SMEs and micro-enterprises, especially in the face of increasing competition brought about by closer integration of the global economy. How these factors should be considered may need to be looked into further, e.g. is there room for government to leave to the non-government sector more of the services that it is currently providing to SMEs and micro-enterprises, or should it continue to provide these at the expense of maybe basic social services. The results of the APO survey also reveal the government services considered to be most useful and the areas of assistance where government services contributed the most to the Philippine SMEs and entrepreneurs. It may be worthwhile to focus on and improve these services, especially those that the private sector is not willing to provide. Relative to government financing services, which some survey respondents ranked low among the services provided, it is worth looking into how these may be improved given that access to financing remains the number one concern of Philippine SMEs and entrepreneurs. While SMEs and microenterprises do experience difficulties in accessing finance, the factors behind this problem may differ between these two types of enterprises. Thus, SMEs and micro-enterprises may have to be treated and studied separately to effectively address the underlying problems in their access to financing. It should be noted that different sets of institutions cater to the financial needs of these enterprises. MFIs, which comprise banking (thrift and rural banks) and non-banking (credit NGOs and credit co-operatives) conduits, cater to micro-enterprises. Commercial banks, on the other hand, provide most of the financing to SMEs. MFI clientele or the micro-enterprises are excluded from

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the traditional banking system due to their perceived credit risk, inability to provide loan collateral and low incomes. Moreover, access to micro-finance means not only access to credit but to a broad range of financial products and services as well (e.g., deposit taking, loans servicing, payment services, money transfers and insurance products, among others). Micro-enterprises and SMEs also have different needs; hence, differ in their demand for financing. These also have different abilities to meet bank requirements, among others. With resources becoming increasingly limited, it has become important that the government work with the private sector and civil society in implementing its development programmes and projects. In identifying potential partners in programmes and projects to promote SMEs and entrepreneurs, it is important to consider the differences in the needs of SMEs and micro-enterprises/entrepreneurs. The roles expected of each potential partner and the required capabilities to ensure effective partnership in a proposed intervention should be identified. It would also be important to consider the possible linkages between potential partners involved, such as in developing or institutionalizing innovative and customized financial products and services, expanding the outreach of various programmes, developing more focused or specialized financial co-operatives or groups, and in ensuring permanence, reliability and convenience which are valued more than the cost of credit, among others, so that the whole mechanism for enhancing access could function properly. As to other possible interventions, among those being proposed for consideration is the strengthening of the country’s credit guarantee institutions for SMEs. Banks still ask for collateral despite the presence of credit guarantees. To help SMEs without collateral get access to loans, the perceived challenge is how to strengthen the credit rating system for these enterprises so that the credit guarantee system will become more credible. A working credit rating system for SMEs that will improve the capability and credibility of the credit guarantee institutions may need to be put in place. Making Philippine financial support programmes more comprehensive and geared towards promoting the transformation of firms from being small to becoming medium enterprises, but at the same time looking at the extent to which market and non-market factors can help to bring this about, should also consider the possibility of transforming financial institutions into viable, sustainable and responsive institutions as credit delivery using inappropriate and ill-prepared conduits denies target groups such as micro-enterprises and SMEs from accessing more stable, reasonably priced, and responsive financial services over the long-term.

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Other possible interventions include enhancing the banking relationship between large and small banks; making the requirements for loan approval less stringent; and enhancing and strengthening the linkages between the various players involved in enabling SMEs and entrepreneurs to access funds. REFERENCES Angelo King Institute for Economic and Business Studies. “Report of the Impact Assessment Study on Industrial Support Service Expansion Program-1”. Mimeographed. Manila: De La Salle University, 2002. Intal, Ponciano S. “Why, What and Financing SME Development”. Mimeographed. Manila: De La Salle University, 2002. Lamberte, Mario B. Expanding Banking Services to Micro, Small and Medium Enterprises and Poor Households in the Philippines. Discussion Paper Series no. 2001-24. Makati: Philippine Institute of Development Studies, 2001. Lapar, Ma. Lucila A. Growth and Dynamics of Small and Microenterprises: Does Finance Matter? PIDS Working Paper no. 91–12. Makati: Philippine Institute of Development Studies, 1991. Llanto, Gilberto M. Using Microfinance Institutions in Poverty Alleviation: A Case of the Blind Leading the Blind? Policy Notes no. 97–09. Makati: Philippine Institute of Development Studies, 1997. Medium Term Philippine Development Plan, 2001–2004. Pasig City: National Economic and Development Authority, 2001. Orbeta, Meynardo R. “Philippines National Report” in SMEs in Competitive Markets. Tokyo: Asian Productivity Organization, 2002.

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2. SME Finance Acceleration Programme

A. PROPOSED 1. Support Programme for SME Development Plan in the Republic of the Philippines

Project Title

DTI

DTI/BSMED

Proponent Agency

ADB/$575M

JICA/P200M

Funding Source/Project Cost

8 months starting Jan. 2003

1 yr.

Duration Project Description/Scope

PPTA

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continued on next page

The PPTA will provide the necessary inputs for joint formulation of the ensuing SDP by various stake-holders including the DTI, BSP, DOF, SB Corp., PhilExim, financial institutions, SMEs, business chambers and donors. An in-depth analysis of the constraints to SME financing including a thorough review of the BSP’s prudential

Technical The project will prepare a Philippine assistance (TA) SME Development Plan 2002–2004. It involves, among others, the assessment of current policies, strategies and programmes on SME development. A Japanese expert and a team of consultants will be hired to assist the DTI in the preparation of the Plan, which will contain strategies, programmes, and a plan of action to be implemented in the short to medium-term for the development of SMEs in the new global economy.

Type of Assistance Requested

Appendix 9.1 Proposed and On-going Programmes and Projects for SME Development As of 15 October 2002

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3. Private Sector Development Programme (PSDP)

Project Title

Appendix 9.1 – continued

DTI; TESDA

Proponent Agency

GTZ/DM5.7M (€2.915M)

Funding Source/Project Cost Duration

TA

Type of Assistance Requested

166

The programme will focus on improving SME potentials and competitiveness which would contribute to the generation of employment and income as well as the promotion and development of a strong and competitive private sector. It has four components, namely, enabling business environment for SMEs, BDS, financial services, and technical and vocational education and training (TVET).

The results of the project will be disseminated among policy-makers and financial practitioners, who are expected to deepen their understanding of the need for SME finance acceleration and contribute to the project output through participation in workshops and forums, policy and technical discussions and the conduct of an SME Financing Summit in 2003 to be hosted by the SB Corp.

regulations on SME finance and the provisions of the Magna Carta for Small Enterprises, a survey on the business development services (BDS) most needed by SMEs, and an analysis of the organization and operation of government credit and credit supplemental institutions shall be conducted.

Project Description/Scope

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DTI will implement components 1, 2 and 3; while TESDA will handle component 4.

Component 1 will address SME problems in trade liberalization, market distortions, institutional biases, industry deregulation, and advances in IT, both at the national and local levels. Component 2 will focus on the continuous analysis of BDS in selected sectors and clusters which will be selected on the basis of an assessment of the regional competitive advantage of Iloilo, Cebu and Leyte provinces, on the identified complementarities between the regions, and on raising the demand for BDS as well as building capacities of service providers in moving towards market orientation and commercialization. Component 3 consists of support for the development of a credit scoring system, client risk assessment, credit approval process, loan monitoring, procedures for workout loans, collateral valuation, organization of the credit department of banks, and the preparation of a credit manual for SMEs. Component 4 involves skills and staff development together with BDS, developing product sectors and promoting employment and entrepreneurship.

promotion and development of a strong and competitive private sector. It has four components, namely, enabling business environment for SMEs, BDS, financial services, and technical and vocational education and training (TVET).

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5. Business Advisory Project II (BAP II)

4. Capacity Building for the Mindanao Economic Development Council (MEDCo) to Enhance Private Sector Activity in the Philippines EAGA

Project Title

Appendix 9.1 – continued

Canadian Executive Services Organization (CESO)

MEDCo

Proponent Agency

CIDA/ Cdn$7.35M

ADB/$200M

Funding Source/Project Cost

5 yrs.

1 yr.

Duration

TA

TA

Type of Assistance Requested

This is an extension of a similar project implemented by CESO in 1999–2002. It proposes to increase the operating effectiveness of SMEs through the use of short-term business advisory services provided by Canadian expert advisers. The proposal will pursue two major thrusts,

Training consists of building up MEDCo’s capability in integrating and unifying SME development programmes and activities in Mindanao using a learning-by-doing and direct technology transfer approach or methodology.

The project proposes to build up the capacity of MEDCo’s private sector/SME development unit through the provision of intensive training and capacity-building activities for the build-up of LGU-private sector synergy; promote co-ordination and communications; enhance business development support and enhance private sector leadership. The project is also expected to enhance MEDCo’s capability as the Philippine Co-ordinating Office for BIMP-EAGA.

Project Description/Scope

168

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6. Private Enterprise Accelerated Resource Linkages (PEARL) II Project DTI/BSMED CIDA/$10M 5 yrs. TA

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The project has three components. The first or sectoral enhancement component involves working with strong sector associations which will play a role in delivering business support services and mobilizing SME members and other related suppliers, to improve their production performance, market expansion, management capabilities, and long-term

The project aims to strengthen the capacity of business organizations (e.g. industry, manufacturers and exporters’ associations, co-operatives, chambers of commerce, among others) in delivering better support services to SMEs.

namely: operationalization of the Philippine Executive Services Organization (PESO) that would effectively develop and transform the PESO to be a sustainable technical assistance delivery mechanism that is capable of replacing the CESO BAP by the end of the project and the continued use of CESO’s technical advisers in delivering Canadian technical assistance to micro/ cottage and SMEs. It also proposes to expand the TA to cover clusters that hold the greatest potentials for job creation in the Visayas and Mindanao.

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B. ON-GOING 1. Industrial Guarantee and Loan Fund

Project Title

Appendix 9.1 – continued

DBP

Proponent Agency

WB/ADB

Funding Source/Project Cost Duration

Loan

Type of Assistance Requested

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The programme provides term loans for capital asset expenditures and for working capital requirements; short-term loans for production credit; and export packing credit for working capital financing for exporters. It also provides credit risk guarantee cover of

Created in 1951, the IGLF programme is a facility which provides funds to accredited participating financial institutions for relending to eligible micro, cottage, small and medium enterprises engaged in the manufacture or processing of a product as well as the delivery of services supportive of manufacturing activities.

sustainability. The second is the partnership development facility (PDF), which is an adaptation of a responsible mechanism that has been operating in the Philippines under PEARL I for three years. The third is on capacity development for investment promotions (CDIP), which will continue to work with the BOI and local investment promotion groups to increase their capacity to promote Philippine SMEs as potential strategic partners of foreign companies. Focus areas are the NCR, Cebu and Davao.

Project Description/Scope

170

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2. Industrial Pollution Control Loan Project (IPCLP) DBP KFW/DM30

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Phase II: 2001–2005

Phase I: 1997–2001; Loan/TA

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continued on next page

IPCLP II finances the acquisition of equipment (locally-made and imported) and provides working capital for environment projects as well as consulting services to the sub-borrowers. Its objective is to improve the entire environmental performance of borrower-SMEs through the introduction of environmental management systems (EMS) and environmental self-monitoring (ESM)

IPCLP I is a policy-based lending programme to support investment projects of industrial enterprises, primarily SMEs which reduce industrial pollution and improve industrial efficiency and the quality of the environment. The TA component provides assistance to DBP in the effective implementation of the programme as well as assistance to SMEs in the preparation, design and implementation of environmental projects.

up to 80% for cottage and small industrial loans, and 50% for medium industrial loans. Meanwhile, collateral short guarantees are extended to cottage and small industrial enterprises for up to 60% of the total loan or 100% of the unsecured portion of the loan, whichever is lower. Loans and guarantees under the programme are available to subborrowers under two schemes, namely, accreditation scheme and sponsorship scheme.

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DBP

DBP

4. JEXIM Untied Loan to DBP 4

Proponent Agency

3. Environmental Infrastructure Support Credit Project II

Project Title

Appendix 9.1 – continued

Miyazawa Initiative/ $500M

JBIC (OECF)/ $40.6M

Funding Source/Project Cost

2000–2005

Duration

Loan

Loan

Type of Assistance Requested

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Loans under this programme will be used for the purchase of plant and equipment, for capital and lease financing. Eligible projects include manufacturing, exports, utilities, infrastructure, construction, power, transportation, telecommunications, tourism, etc.

A spin-off of DBP’s first, second and third loans from JEXIM Bank, the objective of which is to finance wholesale and retail operations of DBP and to help alleviate the operational and financial difficulties experienced by businesses as a result of the Asian Financial Crisis. It will also assist industries in sustaining their growth in the midst of the credit crunch, acquire better technology, improve productivity, efficiency and global competitiveness of industries.

An extension of a similar project that seeks to promote the protection and enhancement of the quality of the environment as well as mobilize, encourage and support investments in environment-friendly activities.

methodologies in pollution abatement and control over and beyond simply financing the acquisition of environmental equipment and facilities.

Project Description/Scope

172

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7. Private Enterprises Credit Support Project

6. Credit Line for Small and Medium Enterprises

5. Domestic Shipping Modernization Programme II

DBP

DBP/LBP

DBP

173

WB/$100M

KFW/DM50M (DBP) and DM50M (LBP)

JBIC (OECF)/ Y19,990M

20 yrs. w/ 5 yrs. grace period

Mar 2000 to to Dec 2002; extended to Dec. 2005 (subj. to approval by KFW of revised loan closing date)

1999–2007

Loan

Loan

Loan

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continued on next page

For modernization and expansion, i.e., purchase of factory site and construction of new plant facilities, acquisition of new or second-hand machinery or equipment, expansion of existing facilities, working capital and lease financing.

To alleviate the operational and credit problems of enterprises arising from the credit crunch in 1998. It is an instrument for the rehabilitation of industries suffering from unforeseen escalation of costs of capital and severe lack of both long and short-term financing.

The project involves the provision of subloans to finance SMEs’ importation of capital and intermediate goods as well as spare parts.

A policy-based lending programme to support investments of enterprises engaged in domestic shipping and shipping-related industries such as repair, shipbuilding, cargo handling and terminal operations, port development particularly in the rural areas and maritime schools.

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174

DBP

Proponent Agency

NIB/$20M

Funding Source/Project Cost

20 yrs. w/ 5 yrs. grace period.

Duration

Loan

Type of Assistance Requested

Source: Trade, Industry and Utilities Staff, National Economic and Development Authority.

8. Nordic Investment Bank (NIB) Credit Facility

Project Title

Appendix 9.1 – continued

The credit is used for the acquisition of equipment, plant, improvement and construction; and for working capital requirements associated with investments in plant and equipment. The loan is made available to private Filipino corporations/ proprietorships and LGUs. The loan is disbursed directly to suppliers.

The NIB, a multilateral financial institution organized by five countries in the Nordic region, namely: Finland, Iceland, Norway, Denmark and Sweden, has extended a commercial line of credit to DBP to finance investment projects in the country having Nordic interest. The projects may comprise delivery of goods originating from Nordic countries, joint ventures with Nordic equity participation or license agreements with Nordic companies.

Implemented by DBP using a three-step loan process where the funds will be on-lent by DBP, as a wholesale bank, to accredited PFIs for re-lending to investment enterprises/subborrowers according to agreed loan criteria.

Project Description/Scope

174

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Individual articles are available at < http://bookshop.iseas.edu.sg > SME Studies. Policies in Singapore 175

10

SME Policies and SME Linkage Development in Singapore Denis Hew

1. Introduction In just three decades, Singapore has successfully transformed its economy from a regional entrepot into a highly industrialized economy. From 1965 when the city-state became independent until the Asian financial crisis of 1997, the economy grew at an annual average rate of over 8.5 per cent. Despite constraints such as its small land size and lack of natural resources, Singapore is one of the world’s most open and competitive economies. As a result of its impressive economic growth, Singapore has clearly prospered — the city-state has one of the highest income per capita in the world. A major feature of Singapore’s economic development strategy has been the pro-active role played by the government to attract foreign direct investments (FDI) to fuel its export-driven industrial policy. By adopting a liberal FDI policy regime as well as providing superior trading and financial infrastructure, Singapore was able to become a leading manufacturing hub for multinational corporations (MNCs). However, the Asian Financial Crisis and regional slowdown in 2001, have underscored the need for Southeast Asian countries (including Singapore) to develop domestic-based sources of growth and to reduce its dependence on FDIs. As Singapore makes the transition to a knowledgebased economy, domestic private enterprises, particularly small and medium-

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sized enterprises (SMEs), will play an important role in the country’s longterm economic development. Section 2 provides the various definitions of SMEs since the 1960s as well as the contribution SMEs have made to the domestic economy. Section 3 shows the evolution of Singapore’s strategies and policies with regards to SME development since the 1980s. This section also highlights the main weaknesses of SMEs as well as the various government assistance schemes that are available to them. Section 4 examines the development of linkages between SMEs and MNCs as well as among SMEs. Section 5 concludes with policy recommendations to further develop the SME sector in Singapore. 2. Singapore’s SME Sector The Singapore Competitiveness Report (1998) defined three tiers of domestic enterprises according to the role they play in the economy which are: i)

World-class companies with global orientation, market dominance, strong core competence and brand name. ii) Strategic value-adding partners and suppliers to MNCs which tend to be manufacturing companies that indirectly target exports markets via MNCs. iii) Domestic-market orientated SMEs which make up most of domestic enterprises, and are concentrated in the services sector such as commerce, community, personal and social services, construction and real estate. In Singapore, the manufacturing sector continues to be a key driver of economic growth, contributing over 20 per cent of GDP and about 20 to 30 per cent of employment. Over the past three decades, Singapore has been very successful in developing world-class industrial clusters in the area of electronics, chemicals, engineering and more recently in wafer fabrication and bio-medical sciences. Table 10.1 shows the list of main industries in Singapore. The transport and process sector tends to be concentrated among a few large companies while there is a wider base of domestic enterprises in the electronic and chemical sectors. Supporting industries in contract manufacturing and precision engineering dominate the manufacturing sector. For example, there is an extensive network of supporting industries that provide parts, components and other services to MNCs in the electronics cluster. Currently, more than 60 per cent of the value-added contributed by supporting industries in the manufacturing sector are derived from domestic enterprises. Singapore has had several definitions for small- and medium-sized companies over the past three decades. In 1960s, to qualify for loans under

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Table 10.1 Main Industries in Singapore Sectors

Industries

Manufacturing

– Electronic clusters (semiconductors, data storage and imaging products, computers, communications and consumer electronics, key modules and devices) – Chemical cluster (petroleum, petrochemical, pharmaceutical and industrial/specialty chemicals) – Engineering cluster (precision engineering, process engineering and transport engineering)

Commerce

– Wholesale and retail – Hotel and cateringa

Services

– – – –

Domestic Services

Business establishments that sell their final goods and services primarily to customers in Singapore. These include industries from: Construction sector Commerce sector Community, social and personal servicesd

Financial and insurance servicesb Community, socialc and personal services Transport and communication services Real estate and business services

Notes: a Catering trade covers businesses engaged in the sale of prepared food and drinks for in-premises consumption or on a take-away basis but excludes hawkers and stall-holders. It includes restaurants, fast food outlets and other eating places such as coffee shops, cafes, canteens, food caterers, coffee houses and snack bars. b Excludes financial institutions under the purview of the Monetary Authority of Singapore, viz. finance, securities and insurance companies, and banks. c Community, social and related services from education, medical, social and community, environmental health, recreational, cultural and sporting activities. d Comprising education services, medical and health services, social and community services, recreational and cultural services, and personal and household services. Source: SME 21.

the Light Industries Services scheme,1 a small company was defined by the Economic Development Board (EDB) as one that employed less than 50 workers with fixed capital assets of less than S$250,000. In 1979, a small company had to have fixed productive assets not exceeding S$2 million in order to be eligible for financial assistance under the Small Industries Finance Scheme (SIFs).2 In 1988, the SME Master Plan defined a SME “as a company with at least 30 per cent local equity and not more than S$8 million in net fixed asset

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investment if it is in manufacturing, or employs not more than 50 workers if it is in commerce or services” (p. 9). More recently in 2000, the SME 21 defines domestic SMEs as companies with at least 30 per cent local equity and fixed productive assets (i.e. net book value of building, machinery and equipment) of not more than S$15 million and staff strength of not more than 200 if they are in commerce of service sectors. Domestic SMEs clearly play an important role in Singapore’s economy. In 1999, there were 102,750 domestic SMEs constituting 89 per cent of total establishments and 52 per cent of employment. However, domestic SMEs contributed only 30 per cent of total value-added and 24 per cent of total sales. At the sectorial level, domestic SMEs accounted for 16 per cent of the total value added in the manufacturing sector. The proportion of total valueadded from SMEs in the commerce and services sectors was higher at 43 per cent and 34 per cent respectively. (See Table 10.2 for latest available statistics on domestic SMEs and their contribution to Singapore’s economy). The SME 21 noted that SMEs have played an important role in Singapore’s economic development, contributing to the city-state rapid economic growth over the past three decades. Since the 1960s as Singapore rapidly industrialized, many domestic SMEs had leveraged on their traditional strengths in entrepot trading and built-up the city-state’s industrial base. The SME sector have certainly played their part in transforming Singapore into a highly industrialized economy. However, one of the major problems facing SMEs in Singapore (as well as the rest of Southeast Asia) is low productivity. Value added per worker for SMEs in the overall economy is less than half of other enterprises (see Table 10.2 and Figure 10.1). The productivity gap is even more marked by sector. For example, value added per worker of SMEs is 31 per cent of other enterprises in manufacturing and 33 per cent in commerce. Possible reasons for such low productivity include the lack of entrepreneurial skills, insufficient management and technical expertise, insufficient utilization of technology, skilled labour shortage as well as limited ability to tap economies of scale and expand beyond the domestic market. 3. Singapore’s SME Strategies and Policies The Economic Committee Report (ECR), which was released in 1986, proposed short term and long-term measures to stimulate economic growth

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Table 10.2 Contribution of Domestic SMEs to Singapore’s Economy in 1999 a) Overall Economy Establishments (ESB) No. %

Employment

Domestic SMEs Others

102,750 12,200

618,097 576,548

Total

114,950 100.0 1,194,645 100.0 97,725 100.0

89.4 10.6

No.

%

Value Added (VA) S$ m %

51.7 29,686 48.3 68,039

VA/ ESB S$’000

30.4 288.9 69.6 5,577.0 850.2

VA/ Worker S$’000 48.0 118.0 81.8

b) Manufacturing Establishments (ESB) No. % Domestic SMEs Others

3,115 889

77.8 22.2

Total

4,004 100.0

Employment No. 122,995 229,294

%

Value Added (VA) S$ m %

34.9 4,758 65.1 25,491

VA/ ESB S$’000

VA/ Worker S$’000

15.7 1,527.4 84.3 28,673.8

38.7 111.2

352,289 100.0 30,249 100.0 7,554.7

85.9

c) Commerce Establishments (ESB) No. % Domestic SMEs Others

48,990 4,823

91.0 9.0

Total

53,813 100.0

Employment No. 242,182 106,298

%

Value Added (VA) S$ m %

69.5 10,228 30.5 13,427

VA/ ESB S$’000

43.2 208.8 56.8 2,784.0

348,480 100.0 23,655 100.0

439.6

VA/ Worker S$’000 42.2 126.3 67.9

d) Services Establishments (ESB) No. % Domestic SMEs Others

50,645 6,488

88.6 11.4

Total

57,133 100.0

Employment No. 252,920 240,956

%

Value Added (VA) S$ m %

51.2 14,700 48.8 29,121

VA/ ESB S$’000

33.5 290.3 66.5 4,488.4

493,876 100.0 43,821 100.0

767.0

VA/ Worker S$’000 58.1 120.9 88.7

Note: The services sector include non-profit organizations but excludes financial institutions under the purview of the Monetary Authority of Singapore. Source: SPRING Singapore, annual reports 2001–02.

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Figure 10.1 Value Added per Worker of Domestic SMEs and Large Enterprises, 1994–2000 140.0 114.9

120.0 101.2

98.2

104.8

101.1

129.9

102.6

S$'000

100.0 80.0 60.0

49.5

50.6

52.2

50.5

47.3

51.0

55.5

40.0 20.0 0.0 1994

1995

1996 SMEs

1997

1998

1999

2000

LEs

Note: i) Statistics refer to establishments in the manufacturing, wholesale and retail trade, hotel and catering, financial and business services sectors only. ii) Domestic SMEs are establishments with >=30% local equity and $15 million (manufacturing) or >200 workers (wholesale and retail trade, hotel and catering, financial and business services). Source: Economic Development Board Singapore, Department of Statistics Singapore.

in Singapore. The report recognized the important role played by MNCs as a source of capital, expertise, technology and employment. But, the ECR also recognized the fact that domestic enterprises are just as important. For example, MNCs need capable and reliable supporting domestic industries in order to operate efficiently. Although the Singapore government has been providing financial and non-financial assistance to SMEs since the 1960s, it was done in a haphazard way rather than based on a focused strategy (Soon 1994). The government’s main pre-occupation was with MNCs and the development of state-owned enterprises in manufacturing, shipping, air transport, international trade, long-term finance, marine-related services, technology and defence-related industries (Lee and Tan 2002). Nevertheless, there has been an increased focus on SME development from the 1980s onwards.

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3.1. SME Master Plan In February 1987, the Singapore Economic Development Board (EDB)3 co-ordinated a multi-agency effort to draft a master plan for SME development. The Singapore government basically took this approach rather than set up a stand-alone SME agency which would have duplicated the functions and responsibilities of other government agencies. An SME Workshop that included private and public sectors was also organized by the EDB to formulate the master plan. The SME Master Plan, released in 1988, marked the first phase of the government overall strategy to develop indigenous world-class enterprises. The main objective of the master plan is to build up and strengthen the capabilities of domestic SMEs. With that in mind, the master plan aims to: • •

• •

Promote domestic entrepreneurship and innovation. Increase informational market efficiency by encouraging information exchange and improving the dissemination of information about new methods and opportunities. Promote best practices in business through easy access to consultancy adoption and training. Encourage domestic enterprise to grow and expand internationally.

The SME Master Plan has five main strategic thrusts which are: i)

ii)

iii)

iv)

v)

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Technology adoption, application and innovation — SMEs would have to adopt and apply appropriate technology to improve quality, efficiency and add value to their products and services. SMEs should also give emphasis on informations systems, automation and product design and management. Business planning and finance — as businesses grow, there will be a need for proper accounting and management systems for monitoring performance and controlling costs. Human resource management — SMEs have to recognize the need for changing labour needs at different stage of organizational development as well as to compete for talent and train their staff. Productivity improvement and training — to overcome the lack of inhouse expertise, SMEs can hire external consultants to identify and solve problems relating to productivity. Marketing and business partnership — in a world of increasing interdependence, strategic alliances via marketing and business partnerships are effective ways for SMEs to overcome size constraints as well as gain access to new markets, capital and technology.

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3.2. Singapore’s Competitiveness Report In May 1997, the Committee on Singapore’s Competitiveness was convened to prepare a report that would review Singapore’s competitiveness over the next ten years. The committee (which was largely private sector-led with support from the public sector and academia) submitted its report in October 1998. The Singapore Competitiveness Report (SCR) has recommended that Singapore should develop its services sector as a twin engine of growth to complement manufacturing. In order to become a premier hub for services in Asia, Singapore would need to build-up services such as finance and maritime services as well as new high growth areas such as information and communications technology (ICT) and media services. The SCR stressed the need to nurture domestic enterprises — particularly SMEs — to achieve this strategic goal. The SCR highlighted several weaknesses of SMEs. For example, SMEs tend to be small in terms of value added, employment and profits. They also have difficulty accessing resources such as capital, technology, skilled manpower and marketing capabilities. A major weakness among service-orientated SMEs was their inability to reap economies of scale in purchasing, distribution, inventory management or use of technology. Meanwhile, manufacturing SMEs suffer from poor access to technology and innovation which impedes them from moving up the technological ladder. They were also lagging behind in research and development (R&D) expenditure. Private R&D expenditure as a percentage of manufacturing GDP was about 1.1 per cent in 1997, compared to 3.2 per cent for the entire private manufacturing sector. Other weaknesses include labour shortages, lack of professional management expertise, and high business costs. SMEs in Singapore also face intense competition from neighbouring countries that have the advantage of lower costs and larger domestic markets. In order to overcome these weaknesses and to keep ahead of the competition, the SCR proposed the following recommendations: •

•

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Consolidation and pooling of resources to achieve synergy and competitiveness — this could involve developing clusters in related activities. Overcome skilled labour shortages by increasing students intake at tertiary institutions, accelerate immigration policies that attract relevant foreign professionals and reduce leakages of engineers to other sectors

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• •

• • •

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as well as encourage companies to establish dual-track career paths in management and technical areas for engineers. Upgrade management skills through government incentives for training in universities, polytechnics and training centres. Promote innovation and technology through government financial assistance, closer linkages with MNCs, develop new industrial clusters such as wafer fabrication, petrochemicals and bio-medical sciences. Adopt benchmarking techniques to assess technological capabilities and work practices. Build indigenous products and global brand names through innovation, product and technology development, overseas marketing and branding. Accelerate regionalization and globalization drive to broaden customer base and technology sources — there is a lot of scope for serviceorientated domestic enterprises to do this.

3.3. SME 21 In the new millennium, globalization and rapid technological advancements in ICT, biotechnology, medicine, transportation, etc. will dramatically change the economic environment in which SMEs would have to operate in. As Singapore makes the transition to a knowledge-based economy (KBE) where knowledge is the main driver of economic growth, domestic SMEs will face new challenges. For example, China’s rapid rise as an industrial powerhouse will have an impact on domestic enterprises through Southeast Asia. There was therefore a need to formulate a new strategic plan applicable to the new century. The “SME 21: Positing Singapore for the Twenty-first Century” (SME 21) was released in 2000. It is a ten-year strategic plan that builds upon 1988’s SME Master Plan. The overall vision of the SME 21 is to create vibrant and resilient SMEs in Singapore’s KBE which will be: a source of entrepreneurship and innovation; a base of strong supporting industries and strategic partners for foreign SMEs and MNCs; manufacturers of high value-added products and global providers of professional services; and robust domestic service sectors enhancing the quality of life in Singapore (SME 21, p. 5).

The SME 21 has three strategic goals that form the core of this vision. The first goal is to groom innovative high growth SMES so that they can compete globally on a sustainable basis. The target is to treble the number of domestic

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SMEs with sales turnover of S$10 million and above from 2,000 to 6,000 by 2010. Second is to enhance the productivity of service-orientated domestic SMEs by restructuring, revitalizing and upgrading the sectors particularly the retail sector (more than 90 per cent of retail establishments are SMEs). The target is to double the productivity of the retail sector from S$28,000 to S$56,000 by 2010. The third goal is to create a knowledge-based pro-enterprise environment that would encourage entrepreneurship and innovation as well as eliminate barriers to organizational growth. The key enabler would be e-commerce which would open new opportunities and get rid of traditional constraints (such as size). The target is to quadruple the number of domestic SMEs with e-commerce transactions from 8,000 to 32,000 by 2010. The SME 21 is being implemented jointly by the government, chamber of commerce, industry associations and the private sector. The Singapore Productivity and Standards Board which is now known as SPRING Singapore4 (SPRING) co-ordinates a multi-agency SME 21 Implementation Committee to oversee the implementation of the SME 21 recommendations. The SME 21 outlines a three-prong strategic approach to achieve these three goals. This comprises Enterprise-level Strategies, Sector-level Strategies and Broad-based Strategies. Each level is supported by SME development programmes. See Appendix 10.1–10.3 in the Appendix for full details. Some of the initiatives in the SME 21 that address the main problems of SMEs are highlighted below as follows: 3.3.1. Raising Capital Raising capital is a perennial problem for SMEs. Due to their limited resources, SMEs find it difficult to compete for loans with larger enterprises. The SME 21 has proposed two initiatives to deal with such financing problems — business angel networks and business to business (B2B) working capital matching scheme. Business angels can be a catalyst in starting up a business. They are wealthy individuals who are prepared to use their financial resources to make risky investments based on their business acumen, experience and interests. Besides financial support, business angels can provide expertise and business connections. Like in the US, Australia and Europe, a formal business angel network could be established to promote equity-financing for innovative and high growth firms.

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SMEs require working capital to operate their businesses. They sometimes experience cash flow shortages due to a mismatch in timing purchases and collections. However, due to the short-term and urgent nature of this matter, SMEs really cannot wait too long to get their working capital loans approved by banks. Hence, a B2B working capital matching service can be set up to assist SMEs in need of purchasing raw materials for production or to fulfil a contract. Under this initiative, a listing of companies interested in partnering SMEs with such working capital needs or wishing to get involved with supplying raw materials, could be drawn up. SMEs would then be able to approach these companies directly. 3.3.2. Technology Diffusion SMEs face constraints in know-how to develop indigenous technology. In this sense, technology is more of an enabler than a strategic tool to create comparative advantage. The SME 21 propose initiating a Technology Network (TechNet) to facilitate connections to researchers, experts and venture capital funds. It is envisaged the TechNet would accelerate the diffusion of technology to SMEs. Researcher with potential research ideas can register their interest with the programme and be matched with prospective SMEs or investors. This matching programme can be carried out through a physical place or the Internet. The TechNet programme will do the following: • • • • •

Organize overseas technology missions to study new technologies. Foster partnerships with foreign research organizations and patent holders and assist in the application of patents and trademarks. Conduct research into technology trends and forecasting. Develop a database on best practices in technology management, technology trends and marketing intelligence. Develop a listing of venture capitalists and business angels.

3.3.3. Access to Skilled Labour Attracting and maintaining skilled labour is a problem for most enterprises. This has become more acute in recent years as the competition for skilled knowledge workers have intensified around the world. SPRING will work with the chamber of commerce, industry associations and innovative high growth firms to provide more tertiary scholarships and human development

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programmes on a cost-sharing basis. Under the Promising SMEs programme (started by the agency in 1996), it can provide tertiary scholarships, internships and industrial attachments programmes to undergraduates. Training institutes and polytechnics can offer training programmes to workers in SMEs. Furthermore, SMEs can take advantage of the National Skills Recognition Systems (NSRS) which will be set-up to provide a national framework for establishing job skills, competencies and alternative skills acquisition routes, and for certifying workforce skills. SMEs can also tap the existing Skills Development Fund which provides financial incentives for training those in the workforce, those preparing to join the workforce as well as those reentering the workforce (see Section 3.4). SME can also adapt structured onthe-job training which has been developed by SPRING. To attract foreign talent and reduce costs, a pooled approach can be adopted by SMEs in the recruitment and services of foreign professionals. Measures to tap foreign talent include organizing SME career fairs overseas as well as offer scholarships and industrial attachments opportunities for foreign students. 3.3.4. Expanding Marketing Capabilities Recognizing the limited resource of SMEs, there are existing government programmes such as Business•Connect to assist Singaporean SMEs to linkup with overseas business partners. Business•Connect was launched by SPRING in November 1996 to provide a platform for local and foreign SMEs to meet directly to discuss potential business partnerships through inbound and outbound business-matching missions and activities. Since its inception, the agency has arranged about 65,000 one-to-one meetings between 45,000 local and foreign SMEs. Around the same time, SingaporeConnect (website: sgconnect.asia1. com.sg) was also launched as part of the Business•Connect programme to offer a cyber meeting place between local and foreign SMEs. It is the official website of Singapore for the “The Global Marketplace ” — a G7-led initiative to create a worldwide network for SMEs website, offering a convenient way for SMEs to form business partnerships. SMEs will also need a good branding strategy to gain a foothold in the domestic as well as international markets. Developing a unique Singapore brand image would also be important so that SMEs can leverage on this as they promote their products overseas. The International Enterprise (IE) Singapore — formerly the Trade Development Board (TDB) — plans to

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launch a series of initiatives to help domestic enterprises in brand research, train staff in brand issues and create a platform for Singapore companies to access brands resources and experts.5 3.3.5. New Centre to Assist SMEs A major initiative under the SME 21 is the establishment of a new centre solely dedicated to assist SMEs in Singapore. The NUS-SPRING Centre for Best Practices was set up with an S$2.3 million grant from the SPRINGadministered Enterprise Development Fund. In order to build a pool of world-class SMEs with core competencies, the primary focus of centre is to promote best practices among SMEs. Specifically, the centre will provide SMEs with performance scorecards, assessment tools, and best practice implementation models to emulate. Over the next three years, the main targets of the centre of best practices is to: develop performance scorecards for ten industries (in logistics, retail and precision engineering); develop thirty best practice tools; implement thirty best practice demonstration projects among SMEs; and develop training programmes on the best practice methodologies developed. In April 2002, the centre carried out a survey to ascertain the current needs and interests of SMEs in Singapore. A total of 977 SMEs participated in the survey representing a 4.28 per cent overall response rate. The main findings of the survey are as follows: •

•

•

•

•

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95 per cent of the respondents, especially in non-manufacturing, had less than 10 employees and sales turnover of less than S$1 million. The average employee size was less than or equal to 50. Out of a total of respondents, 47 per cent consisted of non-manufacturing SMEs with construction, wholesale and retail contributing the highest percentage. Manufacturing came out at 17 per cent of which fabricated metal products business has the highest percentage. Another 23 per cent came from others industries such as marine, trading, design and advertising. 46 per cent of the respondents from the non-manufacturing SMEs had in place a systematic process on total organizational learning and creativity, business directions, goals and targets, customer satisfaction process and analyse external information. In contrast, manufacturing industries were found to have hardly any systems in place. 7.8 per cent had some form of strategic alliance with other firms to compete for business in Asia. Out of the 76 SMEs, non-manufacturing

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• •

came-up the highest (28), followed by consultancy and insurance (25) and manufacturing (23). 35 per cent of SMEs were committed to employee education, training, development and growth. Many were unaware of the various government assistance schemes that were available (see also Section 3.5).

Although the SME development programmes proposed in the SME 21 are extensive, there are no action plans with specific deadlines to achieve these ambitious strategic goals. Moreover, the problems faced by SMEs are multifaceted and complex. Hence, a multi-agency approach in implementing the SME 21 may not necessarily be the most effective way in the light of the current rapidly changing global environment.

3.4. Current Government Assistance Schemes Besides the LIS and SIFS discussed in section 2, other significant government financial assistance schemes for SMEs in the 1970s included the Capital Assistance Scheme (CAS) that provided equity capital and loans at attractive terms to high technology start-ups; the Investment Allowance Scheme (IAS) that provided tax deductions for approved new fixed investments; and the Product Development Assistance Scheme (PDAS) that provided grants of up to 50 per cent of a project’s direct development costs. Apart from these schemes, Soon (1994) noted that there was little government support for SMEs until the release of the SME Master Plan in 1988. There are various government assistance schemes that are currently available to assist SMEs. For example, SPRING co-ordinates the Enterprise Development Fund (EDF) which assists SMEs to upgrade, modernize and expand their business operations. The EDF comprises two schemes which are: •

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Local Enterprise Finance Scheme (LEFS) — this is a fixed interest rate loan scheme to assists SMEs gain access to financing. LEFs assist SMEs in purchasing fixed productive assets and to access working capital loans to upgrade and expand their operations. LEFS is co-ordinated by SPRING and offered through sixteen participating financial institutions (PFIs). In September 2000, PFIs were allowed to approve loans directly for SMEs, speeding up the process time and making access to capital easier. Since its inception in 1976, the government has provided more than S$8 billion worth of loans to over 10,000 SMEs (see Table 10.3).

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Table 10.3 LEFS Loans Approved and Number of SMEs Reached 1996

1997

1998

1999

2000

2001

2002 Cumulative

1,815

1,925

1,608

1,626

2,381

2,007

3,909

33,181

Approved Amount (S$ million)

576

507

662

480

630

417

573

8,349

No. of SMEs reached

112

505

428

388

449

891

2,447

10,680

No. of LEFS Approvals

Note: Cumulative since year of inception in 1976. Source: SPRING Singapore.

•

Local Enterprise Technical Assistance Scheme (LETAS) — this scheme assists SMEs to defray up to 50 per cent of the costs of engaging an external expert to modernize and upgrade their operations. Scope of assistance include: identifying and solving technical problems; mechanization, automization or computerization of operations; quality management systems; human resource management; and product development. Since its inception in 1986, the government has provided slightly over S$450 million worth of grants to more than 13,000 SMEs (see Table 10.4).

Other government assistance schemes for SMEs include: •

•

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Skills Development Fund (SDF) — this fund has been providing financial assistance for employers to upgrade the skills of its workforce. SDF is coordinated by the Ministry of Manpower and the funds are collected from the Skills Development Levy imposed on employers who have workers earning S$1,500 or less. The levy is 1 per cent of employees’ remuneration or a minimum of S$2 whichever is greater. Since its inception, SDF has supported about 8 million training places amounting to S$1.6 billion. Corporate Advisers Programme (CAP) — launched in September 2001 and supported under LETAS. SPRING maintain a panel of business advisors to act as mentors for SMEs. This panel consists of businessmen, corporate professionals or retired civil servants with many years of corporate and professional experience. SMEs can tap this panel

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Table 10.4 LETAS Loans Approved and Number of SMEs Reached

No. of LETAS approvals Approved Amount (S$ million) SMEs reached

1996

1997

1998

1999

2000

2001

2002 Cumulative

1,089

1,400

1,331

2,645

3,555

3,942

4,889

23,404

15

21

24

52

69

72

83

454

683

785

984

1,503

1,814

2,371

3,007

13,243

Note: Cumulative since year of inception in 1986. Source: SPRING Singapore.

•

•

•

of advisors to improve their management practices, business planning and strategy formulation. Micro Loan Programme — introduced under LEFS and launched in November 2001. This programme provides greater access to funds (of up to S$50,000) for very small enterprises (10 or less employees). As at March 2002, 380 micro-loans worth S$12.6 million have been approved. Technology for Enterprise Capability Upgrading (TEC-UP) — launched in August 2002, this initiative is a collaborative effort between the Agency of Science, Technology and Research (A*Star), IDA, IE Singapore and SPRING. Under this scheme, SMEs can engage research scientists and engineers from A*Star to help identify suitable projects for upgrading their operations. Loan Insurance Scheme (LIS) — launched in September 2002 and coordinated by SPRING. LIS is currently offered through six PFIs. Unlike LEFs where funds come from the government and the interest rates are determined by SPRING, PFIs will be using their own funds and interest rates would vary depending on the risks involved. This would allow PFIs to package the loans based on the risk profile of the borrower. Part of the loans will be insured by private insurers and the government would coshare the insurance premiums with the SMEs.

From the survey undertaken by NUS-SPRING survey of SMEs in April 2002, SMEs were most aware of the SDF at 78.8 per cent. However, many were unaware of government assistance schemes such as CAP (87.8 per cent) or LEFS (62 per cent). Of those that are aware of the government schemes, 19 per cent are manufacturing SMEs while 47 per cent are non-manufacturing

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SMEs. The results from the survey seem to indicate that there is poor awareness by SMEs of the types of government assistance schemes that are available to them. This may be due to a lack of publicity on the part of agencies such as SPRING. At the moment, SPRING has services such as “SME First Stop”, which is a one-stop a telephone call centre providing SMEs with information on government assistance schemes and training programmes.

3.5. SME Development Survey In 2003, DP Information Network (with support from SPRING Singapore) undertook a survey to examine the current issues and challenges of domestic SMEs in Singapore. The key findings from the “SME Development Survey” were: •

•

•

•

•

•

Despite the tough economic climate, a majority of SMEs that responded to the survey were profitable — 85 per cent of total respondents. Thirtyfive per cent of these SMEs had a turnover of more than S$10 million while 54 per cent had turnover between S$1 to S$10 million. These SMEs were not only healthy but were also improving. Compared to the previous financial year, 30 per cent of respondents registered higher growth in turnover while 52 per cent were able to maintain the same level of turnover. Many of the SMEs surveyed were found to be very resilient. Thirty-nine per cent of SMEs have been in business for 10 to 20 years while 29 per cent have been operating for more than 20 years. Many of the SMEs were also optimistic about their business prospects. About 51 per cent are planning to introduce new products and 65 per cent aim to explore new markets overseas (especially in China and India). Two-thirds of respondents had sales generated from overseas (of which 30 per cent of these enterprises had foreign market sales contributing more than half their total sales). In terms of financing their operations and expansion, 37 per cent of SMEs were borrowing from financial institutions while another 37 per cent were relying on retained earnings.

Although this survey appears to debunk some of the myths about domestic SMEs (e.g. poor corporate performers, bleak future prospects, limited to domestic market etc.), the sample size of enterprises surveyed was relatively small — results were based on 500 enterprises or about 0.5 per cent of total domestic SMEs (based on 1999 data). The survey also highlighted some of the major concerns of these SMEs. Not surprisingly, “Cashflow” was ranked

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the highest concern among SMEs followed by “Economic Environment” and “Access to Market Opportunities”. 4. SME Linkage Development in Singapore This section will focus on Singapore’s development of linkages between SMEs and MNCs as well among SMEs themselves in Singapore.

4.1. Definition and Global Trends in Manufacturing Wong (1991) defines inter-firm linkage as all possible forms of economic relationships between firms operating within a particular economy. Interfirm linkage normally implies a continual relationship with repeated transactions (rather than individual contacts) and can be divided into various forms of contractual arrangements depending on the degree of control one party has over the other e.g. outright equity control, joint-venture, licensing and franchising etc. For example, sub-contracting is a back-end linkage relationship involving arm’s length transactions between a large buyer and an SME supplier. Close inter-firm linkages between ancillary and supporting industries and MNCs were traditionally important in the advanced industrialized countries (Porter 1990). However, globalization has resulted in evolving patterns of cross-border enterprise activities such as international trade and investment as well as strategic alliances for product development, production, sourcing and marketing (Dunning 1993). Consequently, the local sourcing strategies of MNCs have made a significant impact on host countries (Chew and Yeung 2001). Intense global competition has no longer made it cost effective for all manufacturing activities to be done in-house. In order to shorten production cycle time and speed up delivery to the market, MNCs have integrated manufacturing activities in one or more locations as well as adopt innovative Just-In-Time (JIT) management techniques and international sub-contracting (Wong 1991). As MNCs increasingly focus on decentralizing, downsizing and product differentiation as part of their competitive strategies, subcontracting becomes an attractive alternative to cut down on organizational costs (Meyanathan 1994). In the face of such global trends, opportunities exist for SMEs in developing countries to create inter-firm linkages via sub-contracting with MNCs. There are broadly three types of sub-contracting as highlighted by Perry and Tan (1998), which are:

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i) turnkey contracting — the vendor delegated full responsibility; ii) consignment contracting — the buyer provides the raw materials and the sub-contractor supplies labour and factory space; iii) hybrid contracting — raw materials and components are supplied to the vendor. Out of the three types, turnkey subcontracting is the most ideal as it allows more participation by SMEs (Chew and Yeung 2001). MNCs are an important source of capital, quality control, technology and marketing expertise. Hence, SMEs can benefit from such linkages as they receive valuable skills upgrade and technology transfer, enabling them to become world class companies in the future. Wattanapruttipaisan (2002) argues that subcontracting and supply linkages with MNCs offers a way for SMEs to leapfrog over the traditional constraints of SMEs. Such inter-firm linkages shorten the period for capacity building and ongoing learning required by SMEs to meet the required product quality and design as well as delivery timeliness.

4.2. MNC-SME Linkage Development in Singapore The Singapore government seems to have done well in promoting clusters of supporting or ancillary industries serving the MNC sector (Soon 1994). MNC-SME linkages in Singapore have rapidly expanded since the 1980s due to a combination of effective government policies that are foreign investmentfriendly and institutional arrangements that facilitate sub-contracting. The growing trend towards international subcontracting and the significant presence of MNCs operating in Singapore has had a major impact on the country’s manufacturing sector, particularly the electronics and computer industries. This has resulted in the growth of supporting industries such as printed circuit boards (PCB) assembly, electronic components, metal stamping, precision engineering, paper packaging, aluminium and plastic name plating, electroplating, mould and die making and precision tooling. In the SME Master Plan, the government emphasized strongly the development of inter-firm linkages between domestic SMEs and MNCs with the overall objective of building up a core of competent ancillary and supporting domestic industries linked to MNCs. One of the most significant initiatives to foster closer development linkages between domestic SMEs and MNCs is the Local Industry Upgrading Programme (LIUP). Initiated by the EDB in 1986, the programme encourages MNCs to basically “adopt” SMEs that are their sub-contractors with the aim of helping them improve their operational efficiency and technological capacity. The LIUP is implemented

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in three phases. Phase 1 seeks to improve the operational efficiency of participating SMEs such as production planning and inventory control, plant layout, financial and management control techniques etc. In Phase 2, new products or processes are introduced and transferred to domestic SMEs. Joint product or process research and development are undertaken with the MNC partners in Phase 3. In terms of selection criteria, the LIUP manager (normally seconded from participating MNCs to EDB) will identify and select several SMEs for assistance every year. The SMEs that are selected tend to be existing or potential suppliers to the MNC partners. A business diagnosis is then done on the selected SMEs. The general criteria in assessing the suitability of the SMEs include their performance and business plans, the attitude and receptiveness of the management as well as their capabilities in terms of the quality of their products or services, reliability, delivery and cost competitiveness. The focus would be for MNCs to assist domestic SMEs suppliers to acquire valuable technical expertise through their sub-contracting relationship. From the case studies undertaken by Wong (1991) to examines SME linkages with MNCs as a mechanism for promoting technology transfer,6 he found that direct technology transfer was less important than indirect technology transfer. Extensive technological progress of SMEs through subcontracting with MNCs were achieved mainly through indirect technological developments mechanisms such as learning facilitation (via quality testing and diagnostics feedback, know-how disclosure (via product design specifications) and exposure to “good manufacturing practice”. In fact, the dominant type of technology know-how acquisition by SMEs via subcontracting was in the area of quality assurance which was mainly achieved through technological learning. Hence, Wong (1991) concluded that the government should be more concerned with increasing opportunities for domestic SMEs to expand their capacity for technological learning rather than direct technology transfer. One of his policy recommendations was that the government could expedite the process of technological learning by domestic SMEs through the LIUP. In this light, the LIUP does appears to provide an effective way to assist domestic SMEs attain a high level of technical competence. More recently, Perry and Tan (1998) carried out a case study of linkage development in Singapore that was based on two surveys of participants in the LIUP.7 They find little evidence of greater externalization and locational agglomeration in Singapore as expected from the dominant literature on the

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evolution of industrial organizations. This was mainly due to the low priority given by MNCs to the localization of linkages between MNCs and their suppliers. The benefits of global sourcing appear to outweigh localization in Singapore as it can enhance production flexibility, enabling inputs to be relocated according to changing economic conditions and assist in maintaining consistent quality in different production sites. Also, the cost savings of moving sub-contractors to lower cost countries can outweigh the possible efficiency gains from assisting Singapore-based suppliers. For example, this flexibility would also enable MNCs to quickly respond to new opportunities from China. The policy implications with regards to the LIUP would be “careful targeting to ensure that investment is not wasted on short-lived contracting opportunities” (Perry and Tan 1998, p. 1622). Hence, in recent years, government has increasingly focused on industry-wide upgrading to raise generic business skills. For example, the S$20 million Industry Productivity Fund (IPF) was launched in 2000 to assist all industries achieve significant productivity gains. With financial support from the IPF, domestic enterprises will be encouraged to collaborate in projects to solve industry-wide problems including changing their strategies, operations and practices. Chew and Yeung (2001) provides a different perspective to the MNCSME linkage with regards to technology transfer. Based on their postal survey of forty-one SMEs and personal interviews with nine SMEs, they found that SMEs play an important role in transferring local knowledge and soft technology to their MNC customers. This so-called “reverse transfer” certainly contradicts the conventional wisdom that of the direction of technology flows from MNCs to SMEs via supplier-buyer linkages or sub-contracting relations (p. 431). Domestic SMEs are able transfer local knowledge that MNCs lack because it is only available as a result of being part of a national economy. Local knowledge includes local technical specifications and standards, management styles and local culture. Soft technology that derives from the suppliers’ experience of products and operations is vital to the product efficiency of its MNC customers. Like earlier studies, Chew and Yeung (2001) found that the Singapore government has contributed to the growth and development of MNC-SME linkages in the manufacturing sector, particularly in matching the sub-contracting demands of MNCs with the supplier capabilities of domestic SMEs. They found that successful SMEs that graduate from original equipment manufacturers (OEM) to original design manufacturers (ODM) or original brand manufacturers (OBM) tend to offer the reverse transfer of useful local know-how and expertise to their

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MNC customers. In turn, this encourages MNCs to be more proactive in technology transfer and in nurturing their SME suppliers to become more technologically sophisticated. In the IT sector, IDA co-ordinates the Infocomm Local Industry Upgrading Programme (iLIUP) which aims to nurture closer collaboration between MNCs and SMEs. The programme, which was initiated two years ago by IDA, allows participating SMEs to piggy-back on the knowledge and expertise of MNCs in the IT industry. In particular, SMEs will be exposed to state-of-the art technology and can tap on the MNCs’ global network of technical expertise which would significantly reduce their R&D costs. MNCs that have been selected by IDA for the programme include Cisco System, Apple, Hewlett-Packcard, Microsoft and Oracle. In return, as discussed by Chew and Yeung (2001), MNCs can benefit from these linkages with SMEs as it helps to “localize” their products. SMEs will be able to localize the MNC business partner’s products quicker and more efficiently since they have the advantage of local knowledge and know-how.

4.3. Developing Linkages Among SMEs Aside from linkage development between SMEs and MNCs, there are also initiatives to foster closer linkages among SMEs. 4.3.1. Business Fusion Programme SPRING has been working together with SMEs to develop business fusion groups. Business fusion is a process whereby a group of related companies come together to share knowledge, experience and ideas. Through this programme, a platform can be provided for SMEs to develop new and innovative products, services and business formats. Moreover, SMEs can receive technical assistance from specialists, facilitators and R&D centres, and be funded by LETAS. Industry-based fusion groups can also be formed so that companies within the same value chain in the industry can collaborate to develop new ideas and concepts. In Japan, for example, business fusion is widely accepted as an important business strategy among Japanese SMEs. In Singapore, the business fusion programme is promoted as a culture in which SMEs can work together by tapping on each other’s resources and expertise. By pulling their resources together, SMEs can address markets that were previously not available to them. Since, the Business fusion programme started, 288 SMEs have registered their interest to participate in the programme (SPRING Productivity Digest March 2002). Out of the 288 SMEs, 157 of them have formed 43

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fusion groups in industries such as automotive service and repairs, industrial tool calibration, logistics, construction, silkscreen printing, medical instrumentation, transportation, real estate services and education services. Meanwhile, the remaining 131 SMEs are exploring the formation of 20 business fusion groups. 4.3.2. Singapore as a SME Hub A major initiative in the SME 21 is to develop Singapore as a SME hub. To leverage on Singapore’s existing hub status in shipping, aviation and finance, a SME hub can also be developed. The SME hub would enable foreign SMEs to develop linkages among themselves as well as with domestic SMEs. In particular, it is envisaged that the SME hub will: •

• •

attract a large pool of foreign SMEs to establish their operations in Singapore and form strategic alliances with domestic SMEs to compete globally; attract innovative foreign start-ups to set-up their operations in Singapore as use it as a springboard to the ASEAN region; take advantage of Singapore’s advanced e-commerce infrastructure to undertake business transactions worldwide.

Besides SingaporeConnect and Business•Connect which was mentioned earlier, other initiatives to develop Singapore as a SME hub include: •

•

•

The Enterprise — managed by IE Singapore and JTC Corporation, this is an international SME business centre that offers a full range of services (including fully furnished offices) to help foreign SMEs set up operations in Singapore and integrate them quickly into the local business community. PartnerSingapore website — managed by IE Singapore, this portal offers information on company profiles and contacts for a host of business service providers. USPartnerSingapore website — a partnership between IE Singapore and the US Chamber of Commerce. This portal offers a platform for US companies in the areas of IT, Life Sciences and franchising to seek business collaborations and partnerships with Singapore companies.

5. Concluding Remarks Singapore suffered the worst recession since independence in 2001 when the economy shrank by almost two per cent. Economic contraction was mainly

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caused by the global drop in demand for exports especially IT and electronic products. Although the economy is expected to recover in 2002, the recession has led to a rethinking of its existing economic development strategy. An Economic Review Committee (ERC) was set-up by the government in December 2001 to examine how Singapore could transform its economy in the face of a rapidly changing global environment. The ERC (comprising members from the government, labour movement and the private sector) was to undertake a comprehensive review of existing economic strategies and policies, as well as identify new ways to develop a vibrant and competitive private sector. There has also been a growing debate regarding the role of governmentlinked companies (GLCs)8 and whether their dominance in certain industries have crowded-out the domestic SME sector. For example, Chia (1992) noted that the dominance of state enterprises has had some adverse crowding-out effects on domestic SMEs such as unfair competition and the soaking up of scarce skilled labour. Also, the high employee contribution rates of the Central Provident Fund (CPF) — Singapore’s national social security and pension scheme — have reduced disposable incomes which could have been used as entrepreneurial capital and venture capital for SMEs. Moreover, unlike Korea where many of its conglomerates have either collapsed or are deeply indebted, Singapore came out of the Asian Financial Crisis of 1997–98 relatively unscathed. In Korea, this has led to a revival of the domestic SME sector as many Koreans increasingly choose to start their own business. In contrast, joining the public sector or GLCs remains a safer employment option for most young Singaporeans. Based Deputy Prime Minister Lee Hsien Loong’s statement in strong defence of the role of GLCs in the domestic economy, it does not appear likely that GLCs will divest most of their existing business interests any time soon.9 Nevertheless, the liberalization of the telecommunication and banking sectors in Singapore have increased competition for GLCs such as Singapore Telecommunications (SingTel) and the Development Bank of Singapore (DBS). Given the saturated domestic market as well as the government’s emphasis on promoting entrepreneurship, the strategy for GLCs would be to expand their business interests overseas rather than crowd-out domestic enterprises (Low and Johnston 2001). In May and September 2002, the Entrepreneurship and Internationalization sub-committee (EISC) of the ERC made several key policy recommendations with regards to entrepreneurship and SME development:

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• •

• • • • •

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To ensure that all enterprises including GLCs are competing on an equal playing field, a competition law should be enacted to prohibit cartel activities, abuse of dominance by significant players and reviews mergers and acquisitions. Encourage a culture of partnership between GLCs, MNCs and SMEs. Raise the profile of the LIUP and highlight the possibility of larger Singapore enterprises assisting to upgrade SMEs. For example, the LIUP could be expanded to cover instances where GLCs and larger enterprises can lead a cluster of enterprises including SME to venture overseas. Encourage freer movements of talent between the public and private sector. Undertake serious efforts to attract global entrepreneurial talent to Singapore. The government should adopt a structured, institutionalized and coordinated programme to cut public sector red tape. Mechanisms to encourage more private sector financing e.g. private equity exchange, equity financing schemes for start-ups etc. Implement broad-based measures to free-up capital in the CPF and Housing Development Board (HDB) properties.

Despite more focused policies to develop domestic SMEs, there are also challenges arising from Singapore’s existing economic development strategy. For example, the emphasis on new potential growth areas such as bio-medical sciences is not likely to benefit Singapore’s supporting industries which are predominantly in the electronics sector. Even in the semiconductor industry, the government’s efforts to become a major player in wafer fabrications is not likely to benefit domestic supporting industries very much. Also, the rising cost of doing business in Singapore over the years — as a result of its success in becoming a hub for MNCs in finance, operations and manufacturing — tends to penalize domestic SMEs more than larger enterprises. There are also concerns of losing out to China. Since 1997, China has been gaining a huge slice of Asia’s FDI. According to the United Nations Conference on Trade and Development (UNCTAD), China is now the world’s largest recipient of FDI flows and is now considered the most attractive investment destination for manufacturing. More worrying, China is expected to soon be one of the world’s largest ICT manufacturer — competing not just with less developed labour-intensive Southeast Asian manufacturers but also more developed players such as Japan, Korea, Taiwan and Singapore. As policy-makers evaluate Singapore’s existing economic strategy to meet the challenges ahead, they would need to see how the domestic SME sector

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can be revitalized and contribute to the city-state’s long-term economic wellbeing. Within this context, now may be an appropriate time for the Singapore government to seriously consider setting up a dedicated agency for SMEs. Moreover, this agency will not only focus on assisting SMEs overcome persistent problems such as low productivity, lack of capital and skilled manpower but also foster closer linkages with GLCs and MNCs. Although the SME 21 has come out with very extensive programmes to help SMEs, a stand-alone agency could implement them more efficiently to achieve its ambitious objectives. In the new millennium, any “soul-searching” by policy-makers about Singapore’s place in the world should definitely include the role played by domestic SMEs in economic development. Moreover, as Singapore attempts to re-invent itself and leverage on China’s expanding economy, there are clearly opportunities for strategic alliances to be formed between its GLCs and domestic SMEs.

NOTES 1.

2.

3.

4.

5. 6.

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The first government assistance to SMEs took place in 1962 under the Light Industries Services (LIS) unit of the EDB. The LIS assisted in modernizing the operations of small manufacturing enterprises by providing them funds to purchase machinery and equipment. The LIS was active until 1972 when its activities were taken over by other units within the EDB. Established by the EDB in 1976 with collaboration from the Development Bank of Singapore (DBS), SIFS enables SMEs to gain access to financing through provisions of soft loans for equipment and machinery, industrial building, working capital and export factoring. These loans extend to SMEs in the manufacturing, construction, commerce and services sectors. The EDB is the lead agency that plans and executes strategies to sustain Singapore as a global business and investment hub. Set up in 1961, the EDB acts as catalyst and facilitator to nurture a vibrant, self-sustaining enterprise ecosystem, a conducive total environment for start-ups and companies of all sizes . SPRING serves as the first stop for SMEs that need information and assistance for upgrading. As the lead agency spearheading SME development and upgrading, SPRING adopts a total approach in building up the capabilities of SMEs. The agency’s goal is to create vibrant and resilient SMEs that will enhance Singapore’s competitiveness and economic growth. See SPRING’s website at . Singapore Business Times, 22 October 2002. His case studies covered eight MNCs in the electronics sector and sixteen of their SME suppliers (two per MNC).

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8.

9.

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The two surveys of participants in the LIUP were: i) a postal survey of buyers which were mainly foreign MNCs and subcontracters; and ii) a personal interview survey with representatives of twenty-two buyer organizations. GLCs are companies in which some of its shares are owned by the Singapore government. Most of the GLCs were established in the 1960s and 1970s to facilitate Singapore’s economic development in certain sectors such as manufacturing, transportation and telecommunication. According to the Singapore Department of Statistics (2001), GLCs account for 12.9 per cent of the economy in 1998 while MNCs account for 42 per cent. Deputy Prime Minister Lee Hsien Loong, “We’re not about to sell all the ‘the family silver’ ”. Straits Times, 29 August 2002.

REFERENCES Chew, Yoke-Tong and Henry Wai-Chung Yeung. “The SME Advantage: Adding Local Touch to Foreign Transnational Corporations in Singapore”. Regional Studies 35, no. 5 (2001): 431–48. Chia, S.Y. “Singapore: Towards A Knowledge-Based Economy”. In Industrial Restructuring in East Asia: Towards the 21st Century, edited by Seiichi Masuyama, Donna Vandenbrink and Chia Siow Yue. Singapore: Institute of Southeast Asian Studies, 2001. Chia, S.Y. and Jamus Jerome Lim. “Singapore’s ICT & SME Policies For The New Millenium”. Paper presented for the ISEAS-IAI Conference on Europe-Asia Pacific, 14–15 November 2000. Chia, S.Y. “Role of Small and Medium-Scale Enterprises in Industrial Restructuring in Singapore”. ESCAP Small Industry Bulletin for Asia and the Pacific, No. 26/27, United Nations, New York, 1992. Committee on Singapore’s Competitiveness. Report on Singapore’s Competitiveness. Singapore: Ministry of Trade and Industry, 1998. Economic Review Committee. Report of the Entrepreneurship and Internationalization Sub-committee, 13 September 2002. Economic Review Committee. Recommendations on Government Business by the Entrepreneurship and Internationalization Sub-committee, 30 May 2002. Economic Committee. The Singapore Economy: New Directions. Singapore: Ministry of Trade and Industry, 1986. Freeman, Nick J. and Denis Hew. “Introductory Overview: Rethinking the East Asian Development Model”. ASEAN Economic Bulletin (Special Focus) 19, no. 1, April 2002. Ismail, Muhd Salleh and Latifah Ibrahim. Enhancing Intra-Industry Linkages: The Role of Small and Medium Scale Industries. Kuala Lumpur: Institute of Strategic and International Studies (ISIS), Malaysia, 1992. Lee, B-C. and W.L. Tan. “Small and Medium Enterprises in Singapore and the New Economy”. In The Role of SMEs in National Economies in East Asia, edited by Charles Harvie and Boon-Chye Lee. Cheltenham: Edward Elgar, 2002.

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Low, A.M. and Tan Wee Liang, eds. “Entreprenuers, Entrepreneurship and Enterprising Culture”. Singapore: Addison-Wesley Publishing Company, 1996. Low, Linda and Douglas M. Johnston. “Singapore Inc: Public Policy Options in the Third Millenium”. Singapore: Asia-Pacific Press, 2001. Meyanathan, S.D., ed. “Industrial Structures and the Development of Small and Medium Enterprise Linkages: Examples from East Asia”. The World Bank, Washington D.C., 1994. NUS-Spring Centre for Best Practices. “Survey of Small- and Medium-Sized Enterprises in Singapore”. July 2002. Perry, M. and Tan Boon Hui. “Global Manufacturing and Local Linkages in Singapore”, Enviornmental and Planning A, 30 (1998): 1603–24. Productivity Standards Board (PSB). Annual Report 1998/1999, 1999/2000, 2000/ 2001. SME Committee. SME Master Plan: Report on Enterprise Development. Singapore: EDB, 1989. SME 21 Committee. SME 21: Positioning SMEs for the 21st Century. Singapore: PSB, 2000. Wattanapruttipaisan, T. “SME Subcontracting as a Bridgehead to Competitiveness: An Assessment of Supply-Side Capabilities and Demand-Side Requirements”. Asia-Pacific Development Journal 19, no. 1 (June 2002). Wong, P.K. “Technological Development Through Subcontracting Linkages: Lessons from Singapore”. In Enhancing Intra-Industry Linkages: The Role of Small and Medium Scale Industries, edited by Ismail Muhd Salleh and Latifah Rahim. Institute of Strategic and International Studies (ISIS), Malaysia, 1991. Singapore Department of Statistics. “Contribution of Government-Linked Companies to Gross Domestic Product”. Occasional Paper on Economic Statistics, March 2001. Soon, T.W. “Singapore”. In Industrial Structures and the Development of Small and Medium Enterprise Linkages: Examples from East Asia, edited by Saha Dhevan Meyanathan. The World Bank, Washington D.C., 1994. United Nations Conference on Trade and Development (UNCTAD), World Investment Report 2002.

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Appendix SME 21: Three-Prong Strategic Approach to SME Development Appendix 10.1: Enterprise-level Strategies and SME Development Programmes Strategies

Programmes

Developing Entrepreneurs and Employees

– SME Mentoring Programme to help SMEs map out strategic directions – SME Circles (EntreNet) to provide SMEs with learning partners – Entrepreneurship Education to equip entrepreneurs with management and leadership skills – SME Virtual University to provide IT and e-business courses to SMEs through the internet

Managing Business Excellence

– Business Excellence Framework to help SMEs manage their organizations professionally – National Best Practice Centre to help SMEs learn from and apply best practices – A pool of professional managers to help transform SMEs into professionally-run organizations – Assistance for SMEs to set-up effective value and cost management systems

Harnessing Technology and Knowledge for Growth

– SME Business Support Centres to offer a wide array of integrated business support services and advice to SMEs – Technology Network (TechNet) Programme to facilitate connections between aspiring technopreneurs, innovative SMEs, researchers and experts and venture capitalists – Technology Incubator Programme to provide SMEs with access to management assistance, finance and business and technical support services

Designing New Business Models for Competitive Advantage

– Strategic Business Planning self-help package to enable SMEs to develop their own strategic business plans – Innovative Business Concept Award to spur SMEs to continuously develop new business concepts

Source: SME 21.

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Appendix 10.2: Sector-level Strategies and SME Development Programmes Strategies

Programmes

Facilitating Collaborative Partnerships and Strategic Alliances

– Franchising and economic groupings as strategic tools to help domestic businesses become regional and global players. – Shared services to help SMEs better manage their costs and resources, and focus on core activities. – Business fusion groups for SMEs to continuously develop new business concepts.

Upgrading Domestic Service Sectors

– Industry Upgrading Programme to raise the productivity of tradeable and non-tradeable sectors. – Upgrading assistance programmes to help domestic businesses overcome the disadvantage of size, build up capabilities to grow, leverage on the internet t do business and be internationally competitive. – A comprehensive range of measures to restructure, revitalize and upgrade the retail sector. – A wide range of programmes to upgrade the construction sector.

Source: SME 21.

Appendix 10.3: Broad-based Strategies and SME Development Programmes Strategies

Programmes

Promoting Entrepreneurship

– A “SME March” with month-long activities to convey the message that SMEs need to forge ahead and change their mindset. – Media programmes to raise the profile of SMEs in Singapore. – Local SMEs promoted as preferred business partners to foreign companies.

Financing for Growth

– Business Angel Network to promote equity financing for innovative and high growth firms. – Business-to-Business (B2B) Working Capital Matching Service to help SMEs in need of working capital to purchase raw material or to fulfil a contract. – SME schemes reviewed constantly to ensure their relevance and effectiveness in the KBE. – Economic Value Added promoted as a tool for measuring the effectiveness of capital usage.

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Appendix 10.3 (continued) Strategies

SME Development Programmes

Facilitating Market Access

– Business•Connect Programme more widely promoted and enhanced. – SingaporeConnect publicized widely to more SMEs; and linkages with databases of other countries, as well as local and foreign industry associations and chambers, accelerated. – Importance of branding promoted to SMEs; and a unique Singapore brand image developed for SMEs to leverage on as they explore new markets overseas.

Strengthening Local Talent

– More SME scholarships developed to groom local talent – Effective systems put in place to facilitate lifelong learning and skills development in organizations. – Foreign talent tapped through various measures and programmes.

Accelerating E-commerce

– Promising e-commerce SMEs identifies and developed as role models. – Adoption of B2B portals by SMEs encouraged and accelerated. – One-stop SME portal for foreign and local SMEs created to access the required information and services easily. – E-commerce infrastructure in Singapore developed.

Promoting Singapore as a SME Hub

– Economic twinning progrmmes with other countries identified and pursued to establish areas for SME collaboration. – Concerted marketing effort to encourage SMEs to use Singapore as the conduit and venue for international transactions. – Chambers of commerce and industry associations as information and networking platform providers for foreign SMEs to meet up with their local counterparts. – A package of fiscal measures to attract foreign SMEs to locate in Singapore. – SME community created to attract foreign SMEs to start their operations here. – Financing for collaborations between foreign and local SMEs to take place.

Source: SME 21.

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian > 206 Studies. Individual articles are available at < http://bookshop.iseas.edu.sg Somkiat Tangkitvanich

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SME Development in Thailand’s Automotive Industry Somkiat Tangkitvanich

1. Thailand as an Asian Production Hub of Automobile Industries With four decades of foreign direct investment, Thailand has established itself as a major automobile production base in Asia. In the year 2001 the country produced about 460,000 automobiles and was ranked fifth in Asia behind Japan, Korea, China and Taiwan. Within Southeast Asia, Thailand is currently the biggest production base, particularly for light commercial vehicles (one-ton pick-up truck) for many Japanese assemblers, including Isuzu, Mitsubishi, Toyota and Nissan (see Table 11.1). Other statistics also confirm the status of Thailand as the biggest production base of automobile industry in Southeast Asia. For example, the country has the highest number of establishment and the number of employees in automobile industry in Southeast Asia. With its large and expanding automobile clusters, Thailand is often referred to as the “Detroit of Asia”. Thailand has also been transformed into an exporter of automobiles since the Asian economic crisis in 1997. In the year 2001, the country exported more than 175,000 vehicles. In addition to exporting assembled vehicles, Thailand also exports a number of automobile parts. The value of parts exported in 2001 is US$2.3 billion. Among the top exported items are

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Light commercial Light commercial Light commercial Light commercial Passenger Passenger Passenger Passenger Passenger Passenger Light commercial Passenger all vehicles

Mitsubishi Isuzu Toyota Nissan GM Honda Toyota Mitsubishi Nissan Ford All All All 75,743 66,228 45,360 21,416 52,059 42,840 34,410 8,672 3,696 1,752 298,227 156,066 459,418

Production in Thailand 378,351 292,626 787,794 568,294 4,663,399 2,608,773 4,424,676 1,242,138 1,966,844 3,699,258 14,228,951 40,144,189 56,325,267

World production

Source: International Organization of Motor Vehicle Manufacturers (OICA).

Vehicle type

Assemblers 20.0 22.6 5.8 3.8 1.1 1.6 0.8 0.7 0.2 0.0 2.1 0.4 0.8

World share (%)

Table 11.1 Thailand as a Leader in Automobile Production (Production volumes are that of the year 2001)

2 2 3 6 12 5 9 9 8 16 9 30 16

World Ranking 2 2 2 2 2 2 4 5 4 2 4 10 5

Asian Ranking

1 1 1 1 1 1 2 3 1 1 1 3 1

ASEAN Ranking

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engines, spare parts, jigs and dies and other original equipment manufacturing (OEM) parts (Table 11.2). In terms of exports, automobile and automobile parts are currently ranked fourth behind computer parts, integrated circuits and clothing. It is widely hoped that exports related to automobile industries will surpass that of integrated circuit and clothing to be the second highest exported item by the year 2007. Companies in the automobile manufacturing industries are composed of vehicle assemblers, direct suppliers (“the first-tier suppliers”), and indirect suppliers (“the second-or-third-tier suppliers”). Currently there are 16 assemblers operating in Thailand, most of which are global car manufacturers.1 According to the Thailand Automobile Institute, there are 386 direct suppliers and about 1,000 indirect suppliers in early 2002.2 Most direct suppliers are currently multinational companies that are global players, e.g., Denso, Delphi, etc., that are suppliers of important functional parts, e.g., engines, electronics, transmission, and break systems. Indirect suppliers can be further classified into raw materials and parts suppliers and equipment suppliers. Examples of the first group are suppliers that provide parts made of leather, plastic, rubber, or supplying paints or petrochemical products. The second group operates in the so-called “supporting industries”, supplying molds and dies, jigs and fixtures or providing forging, casting, tooling, cutting, surface treatment, heat treatment services. Most indirect suppliers are small- and medium-sized enterprises (SMEs), which are wholly owned or controlled by Thai investors. However, the number of foreign indirect suppliers has increased significantly after the Asian Financial Crisis through their participation in joint ventures or mergers and acquisitions with debt-ridden domestic companies. Table 11.3 summarizes the profiles of parts suppliers in Thailand, classified by products and nationality of investors. Although it appears that Thailand has successfully established itself as the regional hub of automobile production, many weaknesses will limit its longterm growth. Firstly, Thailand is likely to be no more than a production base for light commercial vehicles, a niche product for a small global market. The country will have difficulties extending its product portfolio due to the lack of qualified engineers and technicians. In addition, as the automobile clusters are being expanded, there are increasing tensions among domestic companies. While additional investment by foreign parts suppliers are welcomed by policy-makers, it is viewed as a threat by the local industry. This is exemplified by a proposal of the Thai Auto-Parts Manufacturing Association (TAPMA) to the Ministry of Industry in October 2002 calling for protection of the domestic industries. The proposed protections include limiting investment

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6,296 20,723 34,110 60,106 83,245 107,111 65,063

1996 1997 1998 1999 2000 2001 2002*

CBU

14,020 42,218 67,857 125,702 152,835 175,299 108,240

Unit

Note: * January to August. Source: Thailand Automotive Institute.

Total

Year

4,253 16,227 28,126 50,187 63,349 83,895 49,050

Value 802 2,024 1,537 3,732 7,106 7,481 4,033

Engine Unit 215 505 723 883 1,246 1,759 1,163

Parts (Unit)

5

17 6,013 177

44 56 64 141 120 141 78

Jigs & Molds Unit Value

Table 11.2 Exports of Vehicles and Parts (Value is in million baht)

374 1,038 1,347 1,424 1,556 1,989 1,876

602 845 2,288 3,679 9,531 11,749 8,771

5 28 26 58 337 97 92

Parts and Components Others Body Accessory Parts parts

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Table 11.3 Profiles of Direct Suppliers, Classified by Product Categories (Unit: Percentage of sample) Parts Engines Electronics Transmission Shock absorber and brake Body parts Interior parts Mold Others

Wholly-owned Thai

Thai Majority Shareholders

Foreign Majority Shareholders

31.7 28.8 32.7 37.1 47.9 46.2 36.4 63.0

12.7 19.2 11.5 2.9 14.3 5.1 4.5 7.0

55.6 51.9 55.8 60.0 37.8 48.7 59.1 30.0

Note: sample size is 709. Source: Thailand Automobile Institute.

privileges for foreign investors, reintroducing local content requirements and allocating at least 30 per cent of the government’s automobile procurement budget for vehicles with at least 60 per cent of local parts (TAPMA 2002). The goal of this chapter is to analyze the development of the automobile industry in Thailand, discuss the current challenges for the industry and provide some policy recommendations for responding to the challenges. The chapter will not cover the motorcycle and the replacement parts industries because of their different industry characteristics and challenges. 2. Development of the Automobile Industry in Thailand The development of the Thai automobile industry can be divided into four phases: formation, expansion, export and adjustment. The formation phase began in early 1960s when the Thai government adopted a policy to attract foreign investment. By the end of the decade, the assembly bases were put in place, thanks to investments by Japanese assemblers. The growth of the industry was further stimulated by an import-substitution policy, characterized by high import tariffs and local content requirement. During this period, an initial cluster was formed around Bangkok and Samut Prakarn, a neighbouring province. Domestic sales and production of assembled cars was still low at a level of fewer than 100,000 units per year. The expansion phase for the Thai automobile industry started in 1980s when the country experienced high economic growth rates. The rapid growth brought about steep, rising trends in the number of automobiles sold in Thailand. The number reached its peak of 590,000 units in 1996. The

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number almost doubled the sales volume of 300,000 units in 1990.3 Before the Crisis, it was predicted that the Thai domestic market would consume more than 800,000 units by the turn of the millennium. The formation of the ASEAN Free Trade Area (AFTA) also attracts further investment by global assemblers and parts suppliers. Most notably, the U.S. Big Three announced their decision to set up their assembly plants in Thailand, recognizing the country’s potential to be the export hub for Southeast Asia. Within a few years, new production capacity was added tremendously. Planned capacity exceeded one million units in 1999, as shown in Figure 11.1. During this period, the automobile cluster spread to the Eastern Sea Board area where necessary infrastructures are provided by the Thai government. The expansion phase turned into the export phase since 1997 when the financial crisis struck Thailand. The crisis forced several assemblers’ plants to reduce capacity utilization because of the depressed demand. In 1998, the utilization rate dropped to its historical low at 13 and 22 per cent for passenger and commercial cars, respectively (Table 11.4). Assemblers were forced to scale down their investment plans. The transformation of Thailand to an export base was achieved mainly through the decision by Japanese assemblers to sustain a sufficient production level in the country. The aims

Figure 11.1 Production Capacity of Automobile Industry in Thailand (Number of units)

1999F

1998F

1997F

1996

1995

0

200,000

400,000

600,000

800,000

1,000,000

Source: Poapongsakorn and Wangdee, 2000.

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1,200,000

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Table 11.4 Capacity Utilization in Auto Industries

1995 1996 1997 1998 1999 2000 2001

Vehicles and equipments

Passenger car

Commercial car

Motorcycle

Tyre

Battery

81.4 67.6 48.5 23.4 35.6 40.1 44.6

61.3 54.9 39.4 13.0 23.6 24.7 37.0

99.2 78.2 52.2 22.1 37.5 44.1 41.6

90.4 65.6 48.4 26.3 33.4 41.6 46.8

90.8 89.4 76.3 71.7 86.4 93.0 90.3

86.9 74.1 65.0 57.1 69.4 75.8 69.6

Source: Bank of Thailand.

appeared to maintain scarce skilled labour in preparation for future demand recovery, the process dubbed as “labour hoarding” (Poapongsakorn 2001). The adjustment phase, which has just begun, is driven by a number of developments. First, competition in the industry intensified after a series of merger and acquisition among global assemblers, resulting in more stringent requirements for product quality, cost and delivery time. Second, “modular parts” are gradually adopted by assemblers to cope with the complexity of global production, with a side effect of forcing existing domestic first-tier suppliers to become second-tier suppliers. The changes result in high tensions among domestic suppliers. The next section will discuss the adjustment phase in more details. Section 4 will analyze some challenges facing the Thai automobile industry. 3. The Adjustment Phase The automobile industry has witnessed major structural changes since the second half of the last decade. Two changes are worth a detailed analysis: the intensifying competition and the modularization of parts production.

3.1. Intensifying competition As automobile markets become more liberalized as a result of global and regional trade agreements, reflected in tariff reduction and the abolishment of local content requirements, competition among major assemblers is intensifying. The period since 1998 has witnessed a wave of mergers, acquisitions and strategic alliances among major assemblers. As a result, the strategies for Asian market have been increasingly viewed as part of the global

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strategies of each assembler that try to optimize their production structures from a global perspective. Pressured by intensifying competition, major assemblers are aggressively reducing the costs of parts and raw materials, improving product qualities and shortening their product life cycles. One strategy to achieve cost reduction is to increase local procurement of parts and raw materials. This is because local parts are free from tariffs, transportation cost and currency exchange rate risks. Japanese assemblers in Thailand have achieved local procurement ratios of more than 70 per cent, for parts used in light commercial vehicles. Major players such as Toyota Motor Thailand intends to procure all parts and components within Thailand and the ASEAN countries by 2003. The target will be achieved by the relocation of Japanese parts suppliers to Thailand. While localization of parts production appears to reinforce the position of Thailand as a major automobile production base in ASEAN, the relocation of parts suppliers en masse is putting a lot of pressure on domestic suppliers. In the past, foreign suppliers avoided direct operation in the Thai market since the production volume in Thailand made such operations unprofitable. Instead they opted to license their technologies in the form of technology agreements with Thai parts suppliers. Now that their customers are relocating to Thailand, Japanese small- and medium-sized suppliers have no other options but to follow their customers. It is the influx of these foreign suppliers that has threatened the viability of the domestic suppliers.

3.2. Modularization of parts production It is widely believed that, in the future, vehicles will be produced by integrating a series of self-contained functional units with standardized interfaces within one or more standardized product architectures, units conceived, manufactured or supplied, and assembled as autonomous modules (Helper et al. 1999). Such phenomenon is referred to as “modularization” of parts production. Examples of basic modules or systems are engine systems, transmission systems, steering systems, heat transfer systems, air-conditioning systems, interior systems, wiper systems, etc. The goal of modularization is to reduce complexity arises from managing the global supply chain that major assemblers are facing. Automobile production is becoming more modularized. While it is still unlikely that automobile parts will become completely modular as that of the computer industry, the degree of modularization is rapidly increasing, at least in the case of passenger car production. The trend is particularly pronounced in the case of new models jointly developed by Japanese, American and

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European assemblers. Although Japanese assemblers are slow to adopt modularization due to its disruptive nature to their relationship with suppliers in the keiretsu (a loose conglomeration of companies organized around core companies, e.g. assemblers in automotive sector), the adoption seems inevitable once production volume reaches sufficient scales. Modularization will probably be limited to small modules in the short run but will gradually grow to larger ones in the long run. The long-run implications for first-tier suppliers are that they will be required to co-ordinate their suppliers of sub-modules, manage and guarantee the overall quality of modular parts. First-tier suppliers that do not have the required capability will be downgraded to lower tier suppliers. 4. Implications for Part Suppliers As discussed in the previous section, parts suppliers in Thailand are facing unprecedented intensifying competitive pressures. To survive the competition, they must reach minimal international standards in three areas: quality, price and delivery time. In terms of product quality, a defect ratio of less than 100 parts per million (ppm) has long been a norm. Some assemblers such as General Motor have started to demand less than 20 ppm. This implies zero defects for suppliers producing fewer than 10,000 units and a 100 per cent check on their products. While the requirement places no major difficulties for most first-tier suppliers, some domestic lower-tier suppliers are struggling with the current defected rates of more than 1,000 ppm. In terms of system quality, direct and indirect suppliers are required to obtain QS 9000 and ISO 9000 certifications, respectively. Most direct suppliers have long adopted quality management systems, e.g., 5S, kaizen, total quality management (TQM) and total productivity management (TPM). They are thus well positioned to acquire the ISO 9000 or QS 9000 standards. The situation is rather different for indirect suppliers since many of them appear unable to meet the standards. So far only 25 and 80 out of 1,000 indirect suppliers are certified as QS 9000 and ISO 9000 companies (Table 11.5). The pressure to reduce cost is also intensifying. Many assemblers have set the target for their suppliers to reduce the buying price of 20 to 30 per cent within a two to three years’ timeframe. For example, Toyota has set a 25 per cent cost reduction target within three years. Isuzu and GM have adopted a target of cost reduction of about 5 per cent per year. During the bidding period, parts suppliers are required to propose price-reduction plans for the whole contract term. In the long run, the prices of parts supplied to assemblers will be benchmarked by the Cost Index Manufacturing (CIM), an equivalent

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Table 11.5 Quality Systems of Parts Suppliers in Thailand Quality Systems Suppliers

Total Number of Suppliers

Direct suppliers Indirect suppliers

Suppliers with ISO 9000 Certificates

Suppliers with QS 9000 Certificates

700

200

125

1,000

80

25

Source: Thailand Automobile Institute.

of the free-on-board (FOB) price quoted by suppliers in Japan. Suppliers with CIM ratios over 1.0 are unlikely to be tolerated. While most direct suppliers manage to reach the cost reduction targets, problems still remain for many domestic suppliers. The shortening of product life cycles and the adoption of just-in-time (JIT) procurement by assemblers also result in a more frequent delivery time and lower volume per delivery for suppliers. For example, a first-tier supplier is required to increase its frequency of delivery to its customers from twice to eight times a day, beginning from early this year. In the near future, lower-tier suppliers will also be affected by the change. In particular, they will need to adjust their production lines to be more flexible. To comply with the JIT system, suppliers also need to strengthen their product quality control since one defected part can disrupt the whole production line of their customers. Suppliers that cannot meet the required standards will be penalized and forced to propose a concrete solution to prevent future failures. The problem is that many domestic suppliers still cannot achieve the target of 100 per cent on-time delivery under the current system. Needless to say, they will have greater difficulties responding to a more frequent delivery requirement. Table 11.6 summarizes the status of direct and indirect suppliers in achieving quality, cost and delivery time targets set by their customers. For first-tier suppliers, four additional capabilities are also required. Firstly, they must have global supply systems to meet the demand of assemblers that are producing “world cars”, vehicles that are launched in multiple countries all over the world with the same model. This is particularly true for suppliers of passenger cars and to some extent for suppliers of new models of commercial vehicles. For example, Isuzu and GM have jointly developed a new one-ton pick-up truck that will go into production in 2003. One of the criteria by which they selected suppliers was the ability to supply parts to

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Table 11.6 Capabilities of Direct and Indirect Suppliers to Meet International Standards Capability Suppliers

Quality (< 100 ppm

Cost (0.7–1.2 CIM)

Delivery (100% on time)

Direct suppliers

< 100 ppm

0.4–1.5 CIM

100%

Indirect suppliers

> 100 ppm

0.3–2.0 CIM

< 100%

Source: Thailand Automobile Institute.

Thailand, North America and Brazil, where the vehicles will be produced (Mori 2002). The requirement excludes most domestic first-tier suppliers that do not have a global network. Secondly, design and test capabilities are increasingly required. Until recently, direct suppliers received orders and the related blueprints from the assemblers. All the suppliers had to do were producing parts according to the blueprints. In the modularization period, however, they will be given only functional specifications, e.g., dimension and physical properties, and are required to propose the design. The problem is that developing design and test capability requires huge investment in facilities and skill acquisitions, which are still beyond the reach of most domestic first-tier suppliers. Thirdly, with the trend towards modularization of parts, first-tier suppliers must be able to co-ordinate with their lower-tier suppliers to achieve the overall quality, cost and delivery time of the modular parts. This requires sophisticated management and co-ordination capability and imposes another difficulty for the domestic first-tier suppliers, particularly those with weak second and third-tier suppliers. Finally, first-tier suppliers will soon be required by their customers to adopt the use of information technology, particularly the Internet, in their supply chain management. The adoption is aimed at achieving better interaction between assemblers and suppliers, shorter lead times, lower inventory and improvement in procurement, production and distribution. Again, the adoption of IT will involve a fixed-cost investment that requires large production volume to be cost efficient. As discussed above, the changes appear to be more of a threat than an opportunity for domestic parts suppliers. There is no denying that parts suppliers that can meet the new requirements will enjoy larger orders and

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have an opportunity to be part of the global network. While foreign-owned companies or joint ventures appear ready to adjust to the new environment, most domestic parts suppliers will have difficulties adapting. Unable to meet the requirements, many domestic first-tier suppliers will be forced to assume the roles of indirect suppliers, while their status as first-tier suppliers will be taken over by foreign suppliers. The only product categories that domestic suppliers are still likely to maintain are body parts, stamping parts, press parts and a few non-functional parts, all of which are bulky and do not require sophisticated production technology. The root of the weaknesses of domestic suppliers lies in the weakness of human resources. Since the economic boom in the early 1990s, Thailand has been experiencing shortages of skilled labour, particularly engineers and technicians. Many medium-sized factories had to operate with little engineering support. The economic boom had diverted many engineers to work in nontradable sectors, e.g., finance, construction and telecommunications, rather than in manufacturing sectors like the automobile industry. In the past, such weaknesses could be tolerated because the industry was highly protected by tariffs and local content requirements. Now that most protections are lifted, the suppliers need to adjust themselves to the new environment to survive. 5. Policy Recommendations As discussed in this paper, SMEs in the Thai automobile industry are facing pressures from many directions. To assist the adjustment process of domestic suppliers, the government needs to take some initiatives.

5.1. Developing Design and Test Capabilities As mentioned in the last section, parts suppliers are increasingly required to have design and test capabilities. While foreign parts suppliers can develop such capabilities with the help of their parent companies, most domestic suppliers have difficulties meeting the challenges. These are due to two major reasons. Firstly, Thailand lacks qualified engineers and technicians. The problem will become more acute when the production volume expands to meet export volume in the near future. Unless the supply of human resource is expanded in time, poaching will become a common practice again, as in the pre-Crisis period. Secondly, there is currently no testing centre that meets international standards. Without local testing capabilities, it will be costly to design new parts since they have to be sent to foreign laboratories for testing. The lack of testing capability also reduces Thailand credibility as the regional hub of automobile industry as the quality of its products cannot be easily checked.

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The government, in co-operation with the private sectors, should study the feasibility of setting up an industry-wide testing centre. Private sectors should also be encouraged to contribute some funding. In the initial phase, the centre should invest in testing equipment for high volume export items that are required to meet high quality standards. The government should also put more emphasis on skill development of engineers and technicians. The proposed Skills Development Fund, modelled after the Singapore’s fund with the same name, can be a main funding mechanism towards human resource development. To further encourage private investment in design and technology development, existing financial incentives should also be reformed. As argued in Turpin et al. (2002), incentive systems in Thailand which currently aim at promoting investment in research and development activities should be expanded to cover other technology development activities, including design and testing. There is also a need to unify the highly fragmented incentive measures or provide the available supports in a more integrated way.

5.2. Promoting Linkages between MNCs and Local Suppliers Linkages between foreign assemblers and domestic suppliers have always been crucial to the competitiveness of the Thai automobile industries. Assemblers have been major sources of technology, especially management technology in the areas of quality control and production. The linkages also enabled domestic suppliers to gain a foothold in the international production network. With the increasing modularization of parts production, local suppliers will have fewer opportunities to work with the assemblers. Thus, there is a need to ensure that the first-tier suppliers will take over the roles of the assemblers in transferring the necessary technologies to lower-tier suppliers. However, as the industry is moving away from the keiretsu system toward a more marketbased approach, many first-tier suppliers may not have an incentive to engage in such activities. Large first-tier suppliers should be encouraged to actively involve in training and developing lower tier suppliers. This could be achieved through the inclusion of their representatives on the Skills Development Board and through their involvement in collaborative training arrangements. There should also be a shift away from the current supporting scheme that provides incentives to an individual firm, to one that provides incentives to groups of firms to form linkages. High priorities should be placed on providing grants to projects that include a combination of large and small firms or aim at building clusters. For example, the SDF should target specific incentives for

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in-house training by large multinational companies for staff of domestic companies.

5.3. Improving the governance and incentive systems of the TAI The establishment of the Thailand Automotive Institute in 1999 was a major step to provide an infrastructure for the development of technology and human resource in the automobile industry. However, the industry has complained that the TAI was slow to respond to their demands. In particular, the Institute’s training programmes were criticized to be shallow and not able to meet the needs of the industry. We believe that the root of the problem lies in the governance structure and the incentive systems of the TAI. With bureaucrats dominating the board of directors, the management has a tendency to serve them rather than the industry. Unless the governance structure is radically reformed, there is little chance for improvement. In particular, private sectors should have more representation in the board. A regular evaluation that measures customer satisfaction should also be conducted to provide information to the government to determine the future budget of the institute. NOTES 1. 2.

3.

The only exception is Thai Rung Union Car, a local assembler of trucks with modified bodies. The number excludes motorcycle parts suppliers. It should also be noted that some indirect suppliers also provide parts and raw materials directly to the assemblers. As a result, the quoted number is likely to be doubly counted. There are other factors that can be accounted for strong automobile sales in early 1990s. Firstly, the liberalization of taxi services boosted the demand for passenger cars with engine capacity of 1600 cc. Secondly, the expansion of automotive industry in Thailand was also fueled by the financial liberalization policy initiated in 1993. The policy allowed investors to borrow cheap fund from foreign sources.

REFERENCES Helper, Susan, John Paul Macduffy, Frits Pil, Mari Sako, Akira Takeshi and Max Warburton. “Project Report to International Motor Vehicle Program (IMVP): Modularization and Outsourcing: Implications for the Future of Automotive Assembly”. Paper prepared for the IMVP Annual Forum, MIT, Boston, 6–7 October 1999.

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Japan Automobile Manufacturers Association Inc. The Motor Industry of Japan, 2002 (available at ). Mori, Minako. “The New Strategies of Vehicle Assemblers in Thailand and the Response of Parts manufacturers”. In Sakura Institute of Research, Pacific Business and Industries RIM 2, no. 4, 2002. Poapongsakorn, Nipon. “Skill Formation in the Thai Auto Parts Industry”. Manuscript. August 2001. Turpin, Tim, Sam Garrett-Jones, Paul Robertson, Sriracha Chareonpanij, Peter Brimble, Wimolrat Sukrasebya. “Improving the Systems of Financial Incentives for Enhancing Thailand’s Industrial Technological Capabilities”. Final Report, 2002.

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Reproduced from Entrepreneurship and SMEs in Southeast Asia, edited by Denis Hew and Loi Wee Nee (Singapore: Institute of Southeast Asian Studies, 2004). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Individual articles are available at < http://bookshop.iseas.edu.sg > SMEsStudies. in Transitional Economies 221

12

Developing Entrepreneurship and SMEs in Southeast Asia’s Transitional Economies Nick J. Freeman

1. Introduction The dual issues of entrepreneurship and SME sector development are both extremely pertinent to Southeast Asia’s four transitional economies: Cambodia, Laos, Myanmar and Vietnam. In the context of developing countries undergoing economic transition, the development of a vibrant SME sector can do much to assist in the provision of jobs (particularly outside the main cities, where foreign investors and larger corporations tend to gravitate), act as a shock-absorber in the down-sizing of large state-owned enterprises (SOEs), and serve as the “seed bed” of transitional Southeast Asia’s next generation of private sector corporates.2 Indeed, for the region’s transitional economies, the question is not whether they should pursue an SME strategy, but how best to go about it. Clearly, the majority of registered companies — both SOEs and private firms alike — in Cambodia, Laos, Myanmar and Vietnam are SMEs, by whatever measure you use.3 As the term “transitional economy” implies, all four countries are undergoing a process of business liberalization and economic

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reform: moving away from the centrally planned economic models of the past that failed to deliver their intended goals, and towards more market-oriented economic systems that have already delivered commendable economic results. State enterprise sectors are gradually contracting, and new private sectors are starting to burgeon. Although some very tangible progress has been achieved in this regard, and momentum has been building, a point of critical mass has not yet been fully attained by the private sector. In Vietnam for example, it was not until January 2000 that the promulgation of a new Enterprise Law, and amendments made to the Constitution as recently as December 2001 which formally recognize the role of the private sector as an important engine of economic growth, did the playing field for private companies really begin to level out.4 But despite having crossed this particular “reform Rubicon”, there continues to be various areas where state enterprises still enjoy some privileges that are not shared with the private sector. The author is cognizant that other chapters in this volume focus on specific issues relating to the development of entrepreneurship and the SME sector in Southeast Asia as a whole, such as the important role played by financial institutions, the input of ICT, and the support provided by governments, multilateral and other external agencies. Therefore, this chapter will only try to focus on some of the themes that are particularly pertinent to Southeast Asia’s economies in transition. To a large degree, that really means focusing on the development of the fledgling private sector in the four transitional economies of the region. As intimated already, many SOEs in the transitional economies of Southeast Asia can also be regarded as SMEs. But as Hallberg (2000) notes, “an SME development strategy is in reality just a ‘private sector development strategy’ ”,5 particularly in the transitional economies of Southeast Asia.6 To pen a single chapter that adequately addresses all the issues pertinent to the development of entrepreneurship and the SME sector in these four transitional economies would require greater word length than is permitted here. The profiles of the four economies are markedly different in some ways, are set within equally different historical, political and cultural contexts, and provide differing socio-economic platforms on which their domestic corporate sectors operate. Therefore, this chapter will focus primarily on Vietnam, the largest of the four transitional economies, with some additional references made to Cambodia and Laos. However, it is hoped that the sorts of issues identified and discussed in this chapter are of pertinence to all four countries, to a greater or lesser extent. The first part of this chapter gives some brief comments on the historical context of entrepreneurial and SME sector development in Southeast Asia’s

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transitional economies. The second part briefly profiles the SME and private corporate sectors in two of these countries: Laos and Vietnam. The third part of the chapter attempts to identify some of the main obstacles currently inhibiting the development of greater entrepreneurial and SME activity in the region’s transitional economies. The fourth part provides some policyoriented suggestions on how these obstacles could be overcome. The final part of the chapter offers some concluding remarks. 2. Historical Context At first glance, one might think that the current entrepreneurial skill levels in the four transitional economies is fairly minimal, as local business people find themselves on a steep learning curve in the new market-oriented economy. To some extent this is true, but it is not entirely the case, for at least four reasons. First, in some of the region’s transitional countries the period of central economic planning was relatively brief, and was enacted with varying degrees of vigour. For example in Laos, the government’s most avid attempt at introducing Soviet-style economic methods lasted for less than four years, before a more half-hearted approach was taken. In both Laos and the southern part of Vietnam, the period of central planning lasted from 1975 until the enactment of economic reform programmes in the mid- to late-1980s; a relatively brief period. Conversely, the most damage was done in Cambodia between 1975 and 1979, where the nihilism of the Khmer Rouge did so much damage to the country, including the business community. In Laos too, a large proportion of the urban middle class left the country in the latter half of the 1970s, significantly reducing the human capital strengths of the country and hampering subsequent attempts to develop a domestic business sector. Secondly, and partly as a result of the exodus of people from some of these countries in the late 1970s and early 1980s, some of Southeast Asia’s transitional countries are currently connected to relatively substantial overseas communities, primarily through close family links, but also through a growing spectrum of business relations, education and training. These kinds of personal networks have allowed valuable business experience and entrepreneurial skills developed by members of the overseas communities (and their capital) to feed back into their “home countries”. Much of this activity happens at a very personal level and therefore goes unrecorded, but its significance should not be dismissed lightly. Thirdly, the period of central economic planning did not fully extinguish the flame of private enterprise, as the black economy continued to operate

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and illicit business transactions persisted. Indeed, this sort of challenging environment — both in terms of the unforgiving macro-economic conditions resulting from central economic planning, and the hostile regulatory environment — arguably helped cultivate some remarkably imaginative business practices and ingenious entrepreneurial approaches, perhaps most notably in trading activity.7 Further, some of the economic reform and business liberalization policies enacted in recent years have largely been the “legalization” of what was already occurring without official approval. For example in Vietnam, the equitization programme (ie. the partial divestment of non-strategic state enterprises, largely through discounted share sales to employees and managers) to some extent formalized what was already occurring: the illicit “hollowing out” of state enterprise assets into the private sector. And fourthly, having initially lacked a domestic private sector, Southeast Asia’s transitional economies opened their doors to foreign capital in the late 1980s and 1990s, and in effect “imported” a ready-made private sector from outside. This foreign-invested sector has grown to be quite a substantial part of the corporate sector in the transitional economies of the region, and its interaction with the host country economies — both through direct linkages with local firms and more personal interaction — has also assisted in the development of domestic business capacity, in a wide range of ways.8 The inputs for a host country that can come from foreign investment activity go well beyond just capital, and can (potentially at least) span a range of other non-financial attributes: new technology, skills and design, organizational and management techniques, overseas market information and access, and so on.9 To some extent at least, these inputs are transferred into the domestic corporate sector, including SMEs, through various personal and institutional transmission channels. Crucially, the transitional economies of Southeast Asia — and particularly Vietnam — are also beginning to display the sort of macro-economic stability (and growth) necessary for a domestic private sector to burgeon. The economic platform for SMEs is becoming more robust and consistent, as is the policy environment. This reduces the perceived risks that entrepreneurs face when embarking on new businesses, developing existing businesses, or branching out in new directions. 3. A Brief Profile of the SME and Private Sector in Two of Southeast Asia’s Transitional Economies The profile of SMEs and the private sector in each of the transitional countries of Southeast Asia varies markedly, albeit with some common trends.

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This section of the chapter provides a brief profile of the SME sector in two of these countries: Laos and Vietnam.

3.1. Laos Information on the SME sector in Laos is limited, and what exists at present is quite dated. To complicate matters further, the Ministry of Industry and Handicrafts in Laos does not differentiate between small enterprises and household businesses (or micro-enterprises), where a small enterprise is defined as any business with 10 employees or less. A national survey of roughly 2,799 SMEs (defined in this survey as companies with less than 30 employees), conducted in 1995, suggested that there were 146,000 SMEs in Laos. Approximately 34 per cent of these SMEs in Laos were involved in manufacturing (including food processing and textiles), 54 per cent were in commerce (over 90 per cent of which was retail trade), and 12 per cent in services (including transportation).10 These 146,000 SMEs employed just 259,000 full-time equivalent people (an average of less than two employees). A 1997 report estimated that there might be around 800 private companies in Laos with asset size above US$100,000, of which half might be trading companies, employing around 50,000 people.11 A fairly substantial proportion of private companies — including SMEs — in Laos are former state-owned firms, which were part of a relatively successful divestment programme enacted during the early 1990s that saw the large majority of non-strategic state-owned firms released into the private sector, primarily through leasing agreements. As a recent report notes, the SME sector in Laos currently “consists of a small number of very small businesses that are unable to or reluctant to grow”.12 It should be noted, however, that at the time of writing, policy-makers in Laos are reportedly developing a prime ministerial decree specifically directed at SME sector development. In the short term, this is likely to include a clearer definition of what is a SME in the Lao context, resulting in a clearer profile of the SME sector in Laos, and the identification of a single ministry to take responsibility for developing the SME sector in the country.

3.2. Vietnam In Vietnam, a small enterprise has been defined as a company with less than 30 employees and less than one billion dong (around US$65,000) in registered capital. A medium-sized enterprise is a company with between 30 and 200 employees and registered capital of between one and four billion dong (between US$65,000 and US$260,000).13 In 1998, it was estimated that

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Vietnam had around 30,000 registered companies, of which 23,000 were non-state companies and 22,000 were SMEs. About 88 per cent of SOEs and 96 per cent of private firms are SMEs.14 In the mid-1990s, it was estimated that SMEs in Vietnam employed about 25 per cent of the total workforce, contributed about 65 per cent of GDP, and generated roughly 20 per cent of total exports.15 SMEs create around 300,000 jobs each year, and are growing by 7 per cent per year on average.16 According to the World Bank, approximately one million people in Vietnam currently work in the formal private sector, compared with 32 million in the agricultural and household sectors (ie. micro-enterprises), and seven million in the state sector.17 Richards et al. (2002) note that Vietnam’s private SMEs operating in the manufacturing sector are highly export-oriented, citing a Mekong Project Development Facility survey of 1999 that identified around 460 private manufacturers with more than 100 full-time workers, operating mainly in the garment, footwear, plastics and seafood business sectors. On average, these companies exported around three-quarters of their total production, and thereby displaying a higher export orientation than both their SOE contemporaries and foreigninvested firms. As noted earlier, an epochal step in the development of the SME sector in Vietnam was the introduction of an Enterprise Law, in early 2000, which has radically improved the conditions for private firms — and SMEs — to register their operations.18 Mallon (2002) notes that “while the thrust of earlier business legislation was that private enterprises might be permitted if they complied with government controls, the Enterprise Law codified mechanisms to protect the rights of citizens to establish and operate private businesses. It also establishes the right of investors to be protected from undue interference from government or other officials, provided businesses operate legally.”19 Official figures suggest that around 40,000 new private companies were licensed in the first twenty-eight months after the Enterprise Law was introduced.20 This exceeds the number of companies established during the full nine years of the earlier Company Law. Some observers put the average growth rate for new private companies in Vietnam at an impressive 20 per cent per year. More importantly perhaps, output growth at domestic private firms is currently rivaling both state-owned firms and the foreign-invested projects. The average income, capital and fixed assets of private companies have also been growing, as have levels of value-added and labour productivity.21 A SME decree was enacted in November 2001,22 and a new SME department is being established within the Ministry of Planning and Investment to: develop policies on SME promotion; provide training for

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personnel in SME support bodies; co-ordinate external donor support for SME promotion; co-ordinate information flow and management and technical support to the SME sector; and monitor SME development in Vietnam. Further, a SME Development Promotion Council is envisaged, to advise the office of the Prime Minister on issues pertaining to SME sector development. And as Mallon (2002) notes, in March 2002, “the status of the private sector was enhanced when [the Fifth] Party Plenum resolved that the private sector is ‘an integral part of the national economy’. Stronger official endorsement of the private sector embodied in recent policy changes has helped build investor confidence.”23 4. Primary Obstacles Inhibiting the Development of Entrepreneurial and SME Activity There are broadly two kinds of obstacles inhibiting the development of greater entrepreneurial and SME activity in Southeast Asia’s transitional economies. The first are issues relating specifically to capacity weakness and practical problems found inside SMEs, and the second are more macro issues pertaining to the host country’s business environment. Let us look at these in turn, starting with some of the main capacity weakness and practical problems found inside transitional Southeast Asia’s SMEs.

4.1. Common Problems Found Inside SMEs in the Transitional Economies of Southeast Asia These kinds of internal capacity weaknesses often include the following: •

•

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A poor understanding of relevant market and industries trends (including the activities of direct competitors), particularly overseas. Many SMEs seem unaware of the significant amounts of information that can be gleaned from various sources, including the internet. As a result, their business strategies are sometimes based on incorrect or dated information, they are unable to learn from the mistakes of others that have gone before, or assess business models that have been attempted in other countries. And they can be in weak negotiating positions for business transactions. A lack of clear and focused business strategies. Some SMEs have a tendency to try and provide too many products or services, of questionable quality, rather than focus on doing one or two things very well. There is a tendency to over-estimate their ability to capture market share, and particularly to over-estimate the size and/or volatility of the domestic

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•

•

•

•

•

• •

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market. Also, the need to clearly differentiate their products or services from those of their competitors is not always apparent. Various weaknesses in the fields of sales and marketing. SMEs tend not to have a clear sales and marketing strategy, and are slow to build distribution-related partnerships. Company websites are rare, and often poorly designed. Particularly in terms of overseas sales, the founder and managing director of the SME tends to conduct all the marketing and sales work, rather than delegate. A lack of capability in human resource (HR) management (including insufficient qualified management). HR in many SMEs is a relatively unstructured affair, with clear lines of responsibility and delegation often lacking. Few companies are willing to invest in staff training, or provide higher salaries to attract and retain key managers. Remuneration systems rarely exist to motivate and incentivize capable and key staff. Consequently, recruiting qualified and/or experienced people is often difficult, particularly for management posts, as local SMEs are generally less attractive than foreign companies in terms of the salary, training, and various other opportunities offered. A lack of skills in customer relationship management. After-sales service is often poor or non-existent, and SMEs tend not to have account managers that are assigned to keeping specific clients or customers informed of progress with their orders. General weaknesses in internal organizational structures (notably communication and delegation skills). Due in part to HR problems, the founders and managing directors of SMEs are often reluctant to delegate responsibility, and lines of communication can be poor, sometimes resulting in costly errors and delays. Inadequate financial management and weaknesses in various internal controls (e.g. inventory, accounting and auditing, quality control). These kinds of weaknesses can be costly to a small company, if staff are taking illicit commissions for purchasing of inputs, for example. Few SMEs are able to properly monitor company performance and efficiency, conduct financial analysis, inventory management, or treasury and cash management. This can result in unnecessary costs, wastage, time delays, etc. Inadequate logistics planning can result in products spoiling, underutilized capacity, and extra shipping costs, amongst other things. Poor quality control. SMEs tend to under-estimate the importance of quality control and quality consistency, particularly for overseas markets. This can add to production costs and result in a loss of future sales, as

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clients judge the delays in delivery or lack of adherence to specifications as sufficient reason to cease doing business with the company. Insufficient knowledge and use of ICT hardware and software. SMEs tend to be unaware of “off the shelf ” software packages that could assist them to overcome some of the problems listed immediately above. The use of e-mail is also often limited, with the SME having just one e-mail account for the company as a whole. A general reluctance to use external service providers (eg. lawyers, accountants, and various types of technical, market, quality control and other consultants). SMEs tend to balk at the costs of using service providers, and under-estimate the value added that they can bring to a company.

Needless to say, SMEs in the transitional economies of Southeast Asia do not have a monopoly on the kinds of problems identified above, and many of the weaknesses and inadequacies identified above are also evident in SMEs in other transitional, developing and even developed countries. The sorts of internal capacity constraints identified here are common in many growing SMEs that retain some of the characteristics of their origins as a small family business. Over time, and with the valuable assistance of organizations such as the Mekong Project Development Facility (MPDF), major steps to overcome these sorts of weaknesses inside transitional Southeast Asia’s SMEs are being taken. It is part of the corporate learning curve, and progress is steadily being made in this field.

4.2. Common Problems Found in the Host Country Environment of Southeast Asia’s Transitional Economies With regard to the more macro, host country business environment issues that inhibit the development of greater entrepreneurial and SME activity, these include: •

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Inadequate access to various sources of financing. Gaining access to adequate financing sources for investment by SMEs and entrepreneurial ventures is often difficult. Beyond various informal sources (such as funds from relatives, friends or customers), financing is largely limited to bank credit, as the capital markets and financial industry in general have yet to be fully developed. Further, the banking systems in these countries are also relatively under-developed, the average maturity on bank credit tends to be relatively short-term (and therefore inappropriate for long-term investment), and providing adequate collateral for a loan

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•

•

•

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can often be difficult for SMEs. Banks are often hesitant to lend to private SMEs, due to difficulties in: assessing the general creditworthiness of such companies; concerns over enforcement of foreclosure rights on mortgaged assets; inadequate risk management systems; and the higher transaction costs that are often entailed with extending — and managing — relatively small loans. Many SMEs in transitional Southeast Asia are simply unable to access bank loans, most notably in Cambodia and Laos.24 In the case of Laos, bank credit is currently being constrained, as part of a large-scale bank restructuring and recapitalization process that will probably make bank credit a scarce commodity until end2006. In both Laos and Vietnam, the state-owned commercial banks continue to dominate the banking sector, as measured by bank assets, and they continue to have a proclivity towards lending to SOEs that they are much more familiar with. As for private banks, these tend to be SMEs themselves, and lack the resources for substantial and longterm lending activity to non-state corporates.25 Inadequate supply of trained human capital. As discussed above, many SMEs have difficulty finding well-educated and experienced staff, particularly for managerial positions, for various reasons. Skills and expertise in specific areas of business activity, such as marketing and project management, tend to be quite rare. Relatively small domestic markets for most products and services. The domestic economies are relatively small — both in terms of population and/or their aggregate spending power — and local demand for many products and services is fairly limited. This necessitates that many SMEs also look at overseas markets for their products or services, but they often lack the information, resources, marketing and sales systems (and confidence) necessary to penetrate overseas. A general preference by domestic consumers for foreign products and services. Given the choice, many consumers in these countries prefer to buy products from overseas, primarily for reasons of quality. This constrains the size of the domestic market further, as SMEs in general have yet to convince local customers of the attractions of locally-made products. Difficulties faced by SMEs in establishing strong linkages with the foreign-invested sector, and “plugging” into the cross-border production networks of transnational companies. Most SMEs in the transitional economies of Southeast Asia have yet to establish strong linkages with foreign companies, either located in the host country or overseas. Most joint ventures established between foreign and local firms have been with SOEs in these countries.26 Where non-equity based linkages might

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exist, as local firms become part of cross-border production networks, or are the local suppliers of inputs to foreign-invested companies, there have been a number of stumbling blocks, particularly related to quality, reliability and consistency issues.27 Demanding corporate tax regimes (with the possible exception of Cambodia). The official corporate income tax rates for local companies in much of transitional Southeast Asia are relatively high: 30 per cent in Myanmar, 32 per cent in Vietnam and 35 per cent in Laos. (Typically, foreign investors face a much lower rate of income tax than local firms.) Although a bewildering array of fiscal incentives can mean that some SMEs are eligible for fairly substantial tax holidays or discounts, nonetheless these “headline” rates are high. Similarly, the personal income tax rates for local individuals are quite high, thereby disincentiviszing entrepreneurial endeavour.28 A general unwillingness — compounded by various regulatory and taxation issues — to build up asset size and shareholder value over time. In order not to attract the attention of various official bodies, the owners of SMEs sometimes have a tendency to keep the scale of their business deliberately modest, and/or their precise ownership structure opaque.29 This lack of transparency then poses additional problems (and costs) in areas like financing, where investors are not confident about the true picture of the company and the main long-term intentions of its main shareholders. Burdensome bureaucracy, corruption, arbitrary enforcement by various authorities, and other host country obstacles that adversely affect the business enabling environment in general, and impede the development of SMEs and entrepreneurial activity in particular. Although some considerable advances have been made in this regard over recent years, it cannot be said that the business environments in the transitional economies of Southeast Asia are yet wholly conducive to private SMEs and entrepreneurship.

Clearly, some of the issues identified immediately above dovetail with, and often further exacerbate, the sorts of internal capacity weaknesses that are inhibiting the performance of many SMEs. A wide range of ODA support is being provided to the transitional economies of Southeast Asia in addressing the kinds of problems and obstacles currently confronting SMEs. In Vietnam alone, the following agencies currently have one or multiple programmes in the field of SME promotion and private sector development: Asian Development Bank, Canadian International Development Agency, Danida (Denmark), Department for International

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Development (Britain), the European Union, Agence Française de Développement Gesellschaft für Technische Zusammenarbeit (Germany), Japan Bank for International Cooperation, Japan International Coopration Agency, the Mekong Project Development Facility, Netherlands Development Organization (SNV), Swedish International Development Co-operation Agency (SIDA), State Secretariat for Economic Affairs (Switzerland), Swisscontact, UNIDO, and the World Bank. And as Mallon (2002) notes for Vietnam, “donor interest in supporting improvements in the enabling environment for small enterprise development … has increased substantially in recent years”.30 5. Policy-Oriented Suggestions on Overcoming the Obstacles Inhibiting the Development of Entrepreneurial and SME Activity The need to further develop entrepreneurial activity and the SME sector in the transitional economies of Southeast Asia is very clear. With the SOE sector undergoing gradual contraction, and an end to the lofty foreign capital inflow witnessed during the first half of the 1990s, much now depends on developing the domestic private sector, as: • •

• •

an additional engine of macro-economic growth; a source of jobs for both the large numbers of people entering the workforce each year (one million annually in the case of Vietnam alone), and those leaving the SOE sector; a major contributor to tax revenues, as other sources (such as the SOE sector and various trade tariffs) contract; and potentially the primary generator of export earnings and foreign exchange revenues for the economy.

Much of the economic growth and poverty reduction witnessed in Southeast Asia’s transitional economies during the late 1980s and 1990s is attributable to land-based reforms and agriculture-led growth in the first stages of the economic reform process. But diminishing returns may be setting in for these sources of economic growth, and the next phase of reforms will require increased emphasis on the SME and private sectors as the primary engine of growth. There is little doubt that significant strides have been made in improving the host country business environments in which SMEs in Southeast Asia’s transitional economies operate, albeit from a very low base point. Just a cursory glance at the sorts of issues cited by companies in a survey of

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Vietnamese non-state manufacturing companies conducted in 1991 shows marked differences from a repeat survey in 1997, and further considerable advances have been made since 1997.31 The host country business environment in the transitional economies of Southeast Asia has improved in terms of: physical infrastructure; communications and transport systems; trade and investment regimes; general perceptions and government treatment of the private sector; foreign currency and financial transactions; and so on. This has been of benefit to various elements of the corporate sector, including local SMEs. Clearly, the policy agenda is wide-ranging. However, as noted in the previous section, the obstacles currently inhibiting the development of the SME sector and entrepreneurial endeavour are both numerous and wide-ranging. A programme to tackle all these issues amounts to a substantial business liberalization and economic reform agenda of its own (and a much longer chapter). Indeed, as Mallon (2002) notes that “when planning support for SMEs, it is useful to recognize that many of the improvements in the enabling environment that are likely to have the biggest pay-offs for SMEs are not necessarily classified as SME projects”.32 Economic reforms that are likely to have a positive impact on SMEs include: public administration and regulatory reforms; land administration; business associations and advocacy support; taxation; contract enforcement; and so on. This chapter just touches on five areas where some policy emphasis might usefully be expended: promoting greater venture capital activity, taxation reform, continued reform of what is potentially a large source of “new” SMEs — the generally slothful SOE sector, building greater linkages with overseas companies and capital, and developing business development services (BDS).

5.1. The Role of Venture Capital The important role that can be played by venture capital — and other sources of equity financing — should be recognized, both in terms of assisting SMEs with their own internal capacity weaknesses, and as a force for change in the wider host country business environment; but most notably in providing long-term equity financing for companies wishing to both develop their businesses and maximize shareholder value. But unlike various other forms of financing, such as bank credit, venture capital investors can also provide additional value-added inputs to investee companies in which they invest, including guidance on overcoming a number of the capacity weaknesses identified in SMEs, such as assisting in accessing market and industry information, facilitating in the use of external service providers, and providing

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guidance on business strategy, financial management, the greater use of ICT, and so on. Unlike bank credit, venture capital shares the risks faced by investee companies, and its interests should be broadly aligned with the original owners of the company — to create shareholder value and generate a substantial return on the investment. The time horizon for venture capital also tends to be longer than the typical maturity of bank credit in Southeast Asia’s transitional economies. At present, there are relatively few “official” venture capital investors active in Southeast Asia’s transitional economies, and they are all foreign (in terms of both management and funds raised). A number of factors appear to be currently inhibiting the development of venture capital activity in these economies. In the limited space available here, we can identify some of the more immediate obstacles to greater venture capital activity. First, the current regulatory environment is not wholly conducive to venture capital activity. In the case of Vietnam, foreign venture capital investors may, under current regulations, only own up to 30 per cent of shares in unlisted local joint stock companies, and just 7 per cent of equity in listed companies.33 They may also only acquire shares in local joint stock companies operating within thirty-five selected business sectors.34 Foreign investors may not acquire stakes in limited companies, which account for a large proportion of SMEs in Vietnam. Local investee companies must also get approval from the provincial people’s committee, and possibly also the prime minister’s office, prior to selling shares to foreign investors.35 (The regulations relating to capital gains tax in Vietnam are also unclear, and the regulations on remitting the proceeds from share sales and dividends overseas are opaque.) In the case of Laos, all foreign investments in local companies must be structured as joint ventures or wholly foreign-owned entities. Secondly, the current standards of corporate accounting and levels of transparency in Southeast Asia’s transitional economies are a general deterrent to many equity investors, including venture capital funds. At the very least, the degree of opacity necessitates that venture capital investors spend substantial time and resources conducting thorough investment appraisals and due diligence of potential investee companies. The legal fees can also be substantial when the official approval process to acquire shares in local companies is complicated, and/or takes time. These sorts of obstacles and delays can add considerably to the operating costs for the venture capital firm, which then impacts on the viability of investments. High transaction costs also oblige venture capital companies to pursue larger investment deals, and thereby make it very difficult for them to invest in most SMEs in Southeast Asia’s

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transitional economies. At present, the vast majority of local companies are too small for venture capital investors to seriously consider, largely due to the combined effect of the high transaction costs (including the lengthy appraisal process) associated with each potential investment, and the 30 per cent limit on foreign shareholdings. Advances in these regards would allow equity investors to look at making smaller investments, and the universe of companies that would be potentially eligible for venture capital investment would increase substantially as a direct result. The above notwithstanding, clearly a large proportion of smaller SMEs will continue to remain beyond the viability of venture capital and other equity financing sources (such as private share placements or stock market listings). Equity financing is likely to remain the preserve of ‘M’s, whilst credit will remain the only financing options for ‘S’s, in the SME universe. This necessitates that bank credit remains a major source of financing for SMEs, and there is a need to explore ways in which the banking sectors in the transitional countries of Southeast Asia can better play the role of providing much-needed capital funding for the SME/private sector, where past performance has been mixed. This is likely to include examining ways to reduce the (official and unofficial) transactions costs entailed in small-scale loans to private corporates, helping banks improve their credit analysis techniques, and introducing instruments that would allow banks to mitigate some of the heightened risks associated with lending to SMEs,36 but in ways that do not unnecessarily distort the banking sector, the wider credit culture, and market interest rates. This might include introducing credit ratings agencies, or a widely-adopted credit scoring system that banks can utilize, or establishing credit bureaus by the banks themselves to collate and exchange information on lenders. Improvements made to the current accounting and auditing practices might also be expected to improve the conditions for bank lending to SMEs, as would steps to allow banks to foreclose on mortgaged assets more easily. Greater leasing activity might also be a very useful source of additional funding for SMEs, notably in financing machinery for expansion and upgrading.

5.2. Taxation Reform As noted above, both the official corporate and personal income tax rates in several of Southeast Asia’s transitional economies are quite burdensome, which does little to encourage SME activity and entrepreneurship. Not surprisingly perhaps, companies and individuals alike often attempt to under-

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report their income. An array of fiscal incentives is provided for local companies that meet various criteria, but these too can be abused, and it remains unclear whether they are of any real positive impact. For example, in the case of Vietnam, new companies that register under the Enterprise Law are eligible for quite considerable tax holidays. Whilst such an incentive appears to be eminently sensible, some of its impacts are not. In order to take advantage of this tax holiday, existing companies are registering new legal entities and transferring assets to the new entity. Successful companies are registering additional new or parallel businesses, rather than expanding and developing their existing operations. This leads to artificially inflated “headline” numbers for new SMEs established in Vietnam, and does little to support the longterm sustainable development of the corporate sector. With the exception of Cambodia, local companies in Southeast Asia’s transitional economies — including SMEs — generally face higher rates of corporate income tax than foreign-invested companies, as well as their counterparts in other East Asian countries. The same is broadly true for personal income tax rates faced by entrepreneurs. The array of fiscal incentives and tax holidays for local firms in Southeast Asia’s transitional economies is also less generous than for foreign investors. Further, these countries tend to have rather arbitrary tax assessment and collection systems, which are open to negotiation (at best) and vulnerable to gross abuse (at worst). The temptation to hide or under-report taxes means that companies are disincentivized from being transparent. The resultant lack of transparency among private sector companies then makes it more difficult for them to raise capital in the form of either equity or debt, and increases their cost of capital. In turn, this inhibits the ability of private sector companies to fund future growth and development.37 Therefore, transitional economies of Southeast Asia might be well advised to upgrade their tax regimes, both in terms of overall design and also administration, so as to create a more uniform and level playing field for local companies, and a more equitable system of tax administration and enforcement. Ways to reduce the number of tax regulations, such as those pertaining to VAT, would also be desirable. The current high rates of income tax — both for individuals and companies — appear to be partly a consequence of inconsistent administration and inadequate enforcement. Therefore, a more rigorous and consistent administration of tax collection should permit the current rates of corporate income and personal income tax to be revised down to regional and international norms, without adversely impacting on overall tax revenues for the government. (Indeed, it may conceivably result in an increase in tax receipts for these governments.)

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5.3. State Sector Reform Although we should not get side-tracked into a discussion of state sector reform, in many ways this is the other side of the SME/private sector “story” in Southeast Asia’s transitional economies. In broad policy terms at least, the two are closely connected. A vibrant private SME sector should make state sector reform easier to enact, and also more essential. For those SOEs that are SMEs, these should become private companies — through divestment — in the years ahead, if they have not already done so, leaving just a limited number of strategic companies within the state enterprise sector. Some countries in this region have had more success than others in enacting divestment programmes for their state enterprise sectors (e.g. Laos). However, state enterprises tend to continue to pose a shadow over some areas of the domestic business environment for private SMEs, notably in terms of being major beneficiaries of: a disproportionately large amount of commercial bank credit, some external trade quotas and privileges, government contract procurements, and so on. Having “equitized” (ie. partial divestment by the government) over 700 former SOEs in since the mid-1990s, Vietnam still has more than 5,000 state firms in operation, and state sector reform has arguably not been one of the most impressive elements of the economic reform process in the country. However, the country currently plans to divest itself of most state-owned SMEs in non-strategic sectors.38 To some extent at least, Vietnam might wish to examine aspects of the Lao privatization process, which was relatively successful during the mid-1990s, partly due to a more flexible approach taken towards asset valuation techniques (based more on past earnings, rather than fixed assets), various sale formats (including leasing), and a willingness by the government to sell major equity stakes in former SOEs to foreign investors.

5.4. Linkages with Foreign Companies Although transitional Southeast Asia has seen relatively substantial aggregate foreign direct investment (FDI) inflow pledges since the late 1980s, this influx of capital, technology, skills and expertise has not yet fully fed through to the SME sector in the host countries. There are a number of reasons for this, including the “clustering” of most FDI activity in just a few locations, and a regulatory environment that has both encouraged foreign investors to enter into joint ventures with SOEs, rather than private companies, and largely discouraged foreign investors from taking equity stakes in local firms. More should be done to encourage foreign investors to acquire shares in domestic companies, both private and state enterprises undergoing

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privatization. Greater use of the sizable overseas communities should also be made, providing an extremely useful “bridge” between these home countries and the foreign companies for which many of them now work, or companies they have established themselves. In co-operation with various local business associations (such as the chambers of commerce and industry), greater focus should also be given to assisting local companies in reaching the levels of production and service quality and consistency that would allow them to more actively provide inputs for foreign-invested companies, and participate in increasingly extensive and elaborate cross-border production networks. Considerable progress has been made in this area already, but there is still a long way to go, judging from the responses made in surveys of foreign companies active in the region. Improved linkages with foreign companies would help local firms better tap into the international business community.

5.5. Business Development Services Clearly, SMEs in the transitional economies of Southeast Asia could benefit from a greater range of business development services (BDS) to assist in overcoming several of the problems found inside their operations.39 These include: accounting and auditing; management training and advisory; market research; advertising and promotion; legal consultancy; quality management; management information system software, internet and computer related services; product design; technology and vocational training and advisory; etc. A recent, insightful study of BDS in Vietnam found that there is rapidly growing demand amongst the SME sector for BDS service providers, driven in large part by an expanding private sector and increasing integration between Vietnam’s corporate sector and the international business community. However, although SMEs and entrepreneurs are broadly aware of the services provided by BDS companies, they often lack reliable information on these service providers, they do not fully understand the direct benefits to be derived, the business culture is not conducive to outsourcing such activities, the quality of BDS products and services is frequently poor or inappropriate for clients’ specific needs, and they are concerned about certain risks (e.g. revealing proprietary information to competitors), amongst other factors. If this is true of SMEs in Vietnam, then it is probably even more apparent for their contemporaries in Cambodia, Laos and Myanmar. The development of sustainable and focused business associations could also play an important role in developing the BDS environment for SMEs in the transitional economies of Southeast Asia, through a variety of direct activities and advocacy activities. The establishment of business associations in specific areas could

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also help local companies enter overseas markets, pooling the resources and experiences of their membership. The above policy-oriented foci broadly conform to elements of the “market-oriented strategy” for SME development advocated by Hallberg (2000), with government action focused on “market-completing interventions and the elimination of policy biases”, rather than “traditional SME promotion strategies, which rely heavily on the direct and subsidized provision of financial and non-financial services to SMEs”.40 Hallberg’s (2000) “market-oriented strategy” particularly focuses on three policy areas: the general business environment; the provision of supportive financial services; and business development services. This author would broadly concur with these areas of foci, and particularly the need to address this triptych in the context of Southeast Asia’s transitional economies: •

•

•

In terms of the business environment: ridding expensive and timeconsuming regulatory requirements; official and unofficial levies that discourage SMEs from growing; and tax structures that distort incentives and discriminate against small firms. In terms of financial services: reducing the risks associated with lending to SMEs; improving laws (and the enforcement of these laws) governing contracts, forfeiture and the collection of collateral; “developing the policy, legal and regulatory frameworks that are essential to the development of innovative financial institutions and instruments, including venture capital, small equity investments, and leasing”; and “strengthening the capacity of financial institutions to evaluate SME creditworthiness in a cost-effective manner, for example through the use of credit scoring techniques”. And in terms of business development services: developing low-cost service “products” and delivery mechanisms that meet the needs of SMEs, partly through local business associations as well as various kinds of relationships with larger local and foreign companies (particularly foreign-invested companies).41

6. Concluding Remarks Development of the SME sector is a crucial part of the economic transition and business liberalization “story” currently underway in Southeast Asia’s transitional economies. Further, in the context of the region’s transitional economies, SME sector development is largely about private sector development. In the specific case of Vietnam, Richards et al. (2002) suggest

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that “improving the climate for day-to-day operations of private investors … will necessitate deep-seated behavioural changes in the way private [business] activity is perceived by the civil service, the dominant stateowned commercial banks, and, most importantly, by the political leadership. … Creating a level playing field for the private sector will require a shift in the social and administrative culture from one of reluctance and control towards one of active support and encouragement.”42 This author’s own sense is that those kinds of perceptual and behavioural changes are now occurring, and that moves in the right direction have been evident over the last two years. Right now, is the SME sector in the region’s transitional economies less well developed than most other countries in the region? The answer is probably yes. Is the level of entrepreneurial zeal — and the desire that fuels this zeal — less well developed in the transitional economies than the other Southeast Asian countries? The answer is certainly no. Given improved access to the kinds of skills necessary to help translate this entrepreneurial zeal into viable business models, and provided with a supportive enabling economic and business environment in which to function, there is no reason why some of the transitional economies could not become pace-setters in the development of the somewhat neglected SME sector in Southeast Asia. There is a discernible and admirable “can do” attitude evident in large parts of these transitional economies, along with an inspiring degree of creativity being shown by entrepreneurs, which bodes well for the future. NOTES 1. The author wishes to acknowledge the considerable insights of Chris Freund on the private sector in Vietnam, particularly in the section on the obstacles currently inhibiting the development of entrepreneurialism and SMEs in the transitional economies of Southeast Asia. However, the views expressed in this paper are those of the author, and are not necessarily shared by Mekong Capital Ltd. The author would also like to thank those participants of the ASEAN Roundtable 2002 who provided useful comments on an earlier draft of this chapter. 2. The term “seed bed” is borrowed from Homi Katrak and Roger Strange (2001), p. 1. 3. Definitions on what is a SME vary (albeit usually measured in terms of employees, asset size, or output/sales), and much depends on the economic profile of the relevant host country. See Hallberg (2000), p. 1. 4. The change to Vietnam’s constitution formally permits the private sector to compete on equal terms with the state sector, in all sectors where private firms

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5. 6. 7.

8.

9.

10. 11. 12. 13.

14. 15. 16. 17.

18.

19. 20.

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are permitted to function. See The Financial Times, 11 December 2001, “Vietnam levels playing field for private sector”, by Amy Kazmin. In another recent development, members of the Vietnam Communist Party are now permitted to own company shares. See Mallon (2002), p. 11. Hallberg (2000), p. 8. Mallon concurs, stating that “for all practical purposes, the domestic private sector is a subset of SMEs in Vietnam”. Mallon (2002), p. 2. In the same way, consumers in the transitional economies can also be surprisingly sophisticated and discerning in their tastes and preferences. For example, in the case of manufactured electrical goods, they often focus not only on the brand, but also the precise location of assembly, and are willing to pay a premium for a product of choice. In the case of Vietnam, it was estimated that around 350,000 local people were directly employed by foreign-invested firms by 2000, and this number continues to rise. This does not include employment by local companies that have business relations with foreign-invested companies in Vietnam, or with companies overseas. See Campos and Kinoshita (2002) for an interesting discussion of the impact that FDI has had on the economic growth of transitional countries in Eastern Europe and the former Soviet Union. And Huang (2001) for a parallel analysis pertaining to China’s transitional economy. See UNIDO (2002), p. 14. See MPDF (1997), p. 8. See UNIDO (2002), p. 15. See Harvie and Lee (2002), p. 5. Mallon gives a slightly different definition for SMEs: firms with registered capital of less than VND 10 billion or less than 300 employees. See Mallon (2002), p. 2. Mallon (2002) puts the current number of Vietnamese SOEs that are SMEs at 70 per cent. Harvie and Lee (2002), p. 6. Richards et al. (2002) suggest that SMEs accounted for 50 per cent of Vietnam’s GDP in 1998 (p. 103). GTZ and Swisscontact (2000), p. 1. See “Private sector must be job creator: Andrew Steer”, The Saigon Times, 28 August 2002. By 2010, Vietnam’s private sector must employ eleven million people, suggests the World Bank. The average time required to register a business has dropped from ninety days to seven days, registration costs have contracted equally dramatically, as have the number of permits and licences required from various government organizations. For more details on how the Enterprise Law has improved the business environment for private SMEs in Vietnam, see MPDF (June 2001). Mallon (2002), pp. 8–9. Such figures should be treated with caution, due to the current incentive programme for newly-registered companies, which may be inadvertently causing an inflation in these registration numbers.

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21. For a cogent review of recent developments pertaining to the private sector in Vietnam, see IMF (2002), pp. 30–36. 22. See Decree 90/2001/CP-ND, of 23 November 2001. 23. See Mallon (2002), p. iv. Further details of the relevant decisions arising from the Fifth Party Plenum are provided on p. 11. 24. The bank lending situation in Vietnam seems to have been improved in recent years, due to various factors. One has been the freeing up of interest rates on loans, in mid-2002, which now makes it easier for banks to price (that is, set the interest rate) their loans commensurate with the perceived risk of the lender. Also, due to the sharp contraction in global interest rates in 2001, it appears that a large quantity of money that was previously held offshore by Vietnamese banks and state corporations has poured back into the country. 25. That said, private banks are arguably in their natural habitat when lending to private companies, as they share similar characteristics and “speak the same language”. 26. In the case of Vietnam, it is striking to note that less than 2 per cent of all approved foreign joint ventures are with private local companies. See Doanh (2002), p. 6. 27. For example, a recent Japan Bank for International Cooperation (JBIC) survey on the host country problems faced by Japanese firms in Vietnam noted that 34 per cent of respondents complained of difficulties in procuring local parts (the third most common problem, after the under-developed infrastructure and legal system), and 23 per cent cited the under-developed state of supporting industry. See Urata (2002), p. 22. 28. For the case of Vietnam, also see Mekong Capital’s obstacle status report on the taxation system. The highest tax band for personal income tax (of locals) in Vietnam is 50 per cent, which starts at the monthly income of just VND15 million (approximately US$980). 29. Keeping a company deliberately small is sometimes referred to as the “small poppy syndrome”, as the tallest poppy flowers are more likely to be cut down. 30. See Mallon (2002), p. vi. 31. See Ronnas and Ramamurthy (2001), p. 327. For example, no longer are things like access to electrical power being cited. 32. See Mallon (2002), p. vii. 33. Under current regulations, the maximum aggregate foreign equity holding in a local (unlisted company) is 30 per cent of the investee company’s chartered capital, and a single foreign investor can hold all 30 per cent. For listed companies, no more than 20 per cent of shares may be hold by foreign individuals and institutions; of which a single foreign individual can hold no more than 3 per cent and a foreign institution can hold up to 7 per cent. 34. These sectors are listed in Decision 260, issued by the Ministry of Planning and Investment in May 2002. It replaces Decision 145, of June 1999, which identified just twelve sectors in which foreign investors could acquire shares in local firms.

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35.

36. 37.

38. 39. 40. 41.

42.

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Notably, the thirty-five sectors identified are different from those in which foreign investors may enact “conventional” FDI activity, such as joint ventures and wholly foreign-owned projects. At the time of writing, there is some confusion over whether the Prime Minister’s Office needs to approve share sales to foreign investors, as two pieces of legislation — Decree 51 of July 1999 and Decision 145 of June 1999 appear to be contradictory on this specific issue. The MPDF’s Bank Training Centre, formally established in Ho Chi Minh City in late 2001, provides very valuable input in these kinds of areas. The resultant lack of transparency also makes it more difficult to implement international standards of corporate governance, and increases the likelihood of fraud being perpetrated. For a list of those business sectors where SOEs and public utilities will remain dominant in Vietnam, see IMF (2002), p. 37. This section draws heavily on GTZ and Swisscontact (2002). See Hallberg (2000), p. 8. For example, the work of “The Global Alliance”, which has Nike and Gap as corporate members. These companies source some of their products from both local and foreign-invested sub-contractors located in Southeast Asia’s transitional economies. See: . Richards et al. (2002), pp. 106–7.

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