January 31, 2008 Addres by Naoko Ishii, Country Director, World Bank, Sri Lanka
It is a pleasure for me to be here tonight and an honor to have the opportunity to say a few words to the distinguished guests. I would like to focus on small and medium sized enterprises—or SMEs for short.
Why do SMEs deserve special attention you might ask? For one important reason, I would say, namely that in almost all countries around the World SMEs are critical for job creation, entrepreneurship and income generation. Let me begin by illustrating how important SMEs are in various countries around the World. In India, SMEs account for 45 percent of all jobs, and contribute 40 percent of GDP. In so different countries as the Philippines and South Africa, SMEs provide more than 60 percent of all jobs. SMEs have also played a key role in propelling some of today’s most advanced economies forward. In my own home country, Japan, for example, a rapid growth in the number of SMEs in the first few decades after the Second World War was a key factor behind the spectacular growth that Japan experienced in this period. Similarly in Taiwan—an economy with approximately the same number of people as Sri Lanka, but with 10 times higher average incomes—SMEs have been critical to modernization and economic growth in the past five decades. SMEs are also important in Sri Lanka. In Sri Lanka, SMEs make up more than 80 percent of all businesses, account for about 35 percent of employment and about 20 percent of total industrial value added. The World Bank’s private sector arm, the International Finance Corporation last year did a survey of Sri Lankan SMEs. For the purposes of the IFC survey SMEs was defined as having turnover between 5 million Rupees and 150 million Rupees in 2005. The IFC survey provided a rich picture of the characteristics of the SME sector in the country. It showed for example that half of the companies have less than 20 employees; that half of the SMEs legally are sole proprietorships; and that 25 percent of the owners are less than 40 years of age. What is special about SMEs, apart from the fact that they by definition are small? Perhaps the most important aspect of SMEs is that SMEs are at the heart of one of the most famous concepts in economic theory. The concept was conceived by Joseph Schumpeter in 1942 and is called Creative Destruction. Put simply, Schumpeter’s fundamental insight was that better and cheaper products make previous products obsolete. This dynamism, created by the arrival of new products or new methods of production, is a critical factor behind economic growth and welfare. The dynamism of SMEs in Sri Lanka is reflected in the IFC survey, which found that in 2005 a quarter of SMEs had turn-over growth of more than 20 percent, while at the same time 15 percent of SMEs had negative turn-over growth. The survey also found, though, an astonishing resilience of Sri Lankan SMEs: 70 percent of all SMEs had been in existence for more than 10 years. Globalization reinforces Creative Destruction. In recent decades, the World has witnessed a rapidly increasing international integration of markets for consumer goods, technology, and factors of production. Global trade has vastly outpaced global production since 1960. Cross-border flows of financial capital have exploded. Labor is also becoming more mobile. The implication of all this is that the competitive pressure on businesses today is probably stronger than ever before. The rise of China as a global power in export markets is only the most recent addition to a long line of outward-oriented economies, in particular from Asia. But international integration does not only mean increased competition. It also means that businesses have unprecedented opportunities for expansion by taking advantage of international demand for their products. And businesses can tap international markets for new technology, knowledge, and finance. The challenges of globalization are particularly felt by SMEs. In many cases, SMEs are an easy prey for foreign competitors because their limited size prevents them from exploiting economies of scale in their production. To make matters worse, for the very same reason of their limited size, SMEs may find it more difficult to exploit the opportunities for increased trade that international integration bring. However, there are many examples from around the World where SMEs not only have coped with the challenges of globalization, but have thrived and expanded in the spirit of Creative Destruction. The last few years of development in Korea is a good example. SMEs in Korea have faced the same external changes as many other countries: on the one hand, price competition from especially China has become ever fiercer, but on the other hand the investment climate for foreign firms to invest in China has gradually improved. How did Korean SMEs react in this environment? A couple of Korean economic researchers have analyzed this in detail, and I would like to spend a few minutes to summarize their findings. The first major finding is that—perhaps not surprisingly—Korean SMEs are extremely sensitive to competition from Chinese exports: product-level data shows that if a Chinese exporter enters into the market for a particular product, Korean SMEs producing the same product significantly cut back production. The analysis also shows that increases in Chinese exports in a particular product category substantially increase the tendency of Korean SME to relocate their production to China. This is the “destruction” part of Schumpeter’ argument—low-price Chinese export results in death and relocation of Korean businesses. So what happened to the “creative” part of Schumpeter’s history? Here the remarkable part is that the export from Korean SMEs to China has also increased rapidly. Some of the products that Korean SMEs export are intermediate goods used by the very same Korean firms which relocated to China in the face of increased competition. But other exports are due to rising Chinese incomes and an expansion in the variety and quality of goods demanded by Chinese consumers. The results for the Korean economy have been remarkable: In 2003, Korea—a country with only 48 million people—had become the second leading exporter to China. I believe that the experience of Korean SMEs provides some lessons—and possibly inspiration—for Sri Lanka. I don’t have to tell you that Sri Lanka is located right next to one of the most dynamic and fastest growing economies in the World at the moment, namely India. Like China, India has a competitively advantage from relatively low labor cost. Like China, India is also becoming gradually more open for foreign businesses. And, also like China, consumer demand for better quality and a wider variety of goods and services in India are expanding rapidly. If Sri Lankan SMEs can exploit these opportunities, the SMEs sector can be a true engine of growth for Sri Lanka in the 21st century. I shall be the first to admit that the challenges are large, and that not all obstacles can be overcome by SMEs themselves. For example, the World Bank’s own research show that Sri Lankan SMEs suffer from difficulties in accessing finance—the IFC survey showed that only 29 percent of SMEs has managed to obtain a loan from a commercial bank. This makes it more difficult for SMEs to upgrade their production facilities and invest in new technology. Sri Lanka SMEs also tell us that they find it difficult to market their goods, both domestically and internationally, and that they face serious difficulties in attracting staff with appropriate skills. To overcome these challenges would require increased professionalism by SMEs, improved Government regulation and policies, and a financial sector better equipped to support SMEs. I believe, however, that the resilience and entrepreneurship of Sri Lankan businessmen, including all of you who are present here tonight, provides a lot of reasons for optimism, and I am confident that you will be up to the challenge. Thank you. |
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