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The Economic Impact of SMEs in the Economy Research Paper

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Updated: May 29th, 2020

Introduction

The definition of the term SMEs usually differs from one country to another, and most countries define the term depending on three criteria. These criteria are based on the size of the firm including micro, small or medium enterprise. In addition, SMEs usually have three main characteristics. To begin with, SMEs are mostly characterized with an independent management where the owner of the business is also the manager. Another important property of SMEs is that, money or funds or capital in the enterprise is usually and mostly in the hands of the one or a small group of individuals. Lastly, SMEs conduct their operations in the local region or area while workers of the business and owners usually come from the same locality or society (Khaja, 2013).

The size of SMEs usually depends on the number of employees and the worth or value of assets owned by the SMEs, hence, there are both minimum and maximum sizes of SMEs. Moreover, different countries have different sizes of SMEs depending on the country’s development level and availability of resources. It is also usually clear that SMEs’ operations mostly involve sectors such as manufacturing, trade, agribusiness, transport, and even communication among many other sectors. Even though some SMEs are innovative, growth-oriented, and flexible, others are usually less dynamic and are usually owned by families. Lastly, SMEs operate in formal sector and in most cases, majority of employees and workers usually earn wages (Rody and Stearns, 2013).

Macroeconomic Analysis of Key Variables

Various macroeconomic variables play an important role in an economy in relation to SMEs, including unemployment, inflation, and economic output. These macroeconomic variables mostly and usually have a key role in the economic development of many countries. For example, the financial markets of many developed countries such as Sri Lanka and India indicate that more economic tools and financial markets results into challenges to SMEs.

There are a number of critical macroeconomic roles of SMEs in different countries. These vital roles of SMEs usually result into the economic development of the countries they are based in. To begin with, SMEs usually contribute to the creation and generation of employment to a larger population of citizens worldwide. According to various researches, it is clear that about 40% of the total population of various countries globally is mainly employed in local SMEs although the performance and employment creation differs from one country to another. For example, in the year 2009, around 40% of the population in Germany and Australia was employed through SMEs (Khaja, 2013).

Again, data from other countries like UAE usually indicate that majority of people in these countries are employed by the micro, small and medium enterprises. Therefore, from these data sources, it is clear that SMEs play a very important and key role in the macroeconomic development of various countries. Furthermore, SMEs provides employment in almost all sectors of economy such as trade, hotels, industries, transport and communication, construction, agriculture, fishing, tourism and other services that lead to economic development of various countries (Khaja, 2013).

Secondly, SMEs promote macroeconomic development by generating economic wealth in various countries. Here, money generated from SMEs in various countries is usually used in the development of various sectors of economy of a country. In addition, the money obtained from SMEs is also used in uplifting and raising people’s living standards. Besides, SMEs sector is seen to easily generate capital that contributes to economic wealth. Wholesale and retail stores are among the leading sections of SMEs contributing to economic development by generating huge capital and enhancing other economic aspects in a country (Oncioiu & Oncioiu, 2012).

Thirdly, SMEs contribute to creativity and innovation in the use of local resources of various countries worldwide. Again, the creativity in use of resources and innovation of ideas usually result to the economic development, as the resources that would have been otherwise wasted are innovatively modified to produce useful products. These products are then exported to other areas and countries, thus earning the country valuable foreign exchange. Furthermore, SMEs provide proper and advantageous competition in various countries that brings and makes individuals to work hard, leading to economic development (Khaja, 2013).

SMEs are also very important in that, they contribute largely in eradication of poverty level in various countries worldwide by promoting economic growth. Generally, one of the main benefits from the existence of SMEs is wealth and employment creation, thereby providing a source of income to individuals of the country. As a result of these wealth and employment creation, SMEs reduce poverty level of various countries. It is also important that owners of SMEs know their resources as well as how to use them appropriately in order to create competitive advantage. This will make SMEs use appropriate knowledge and skills in improving their operations, hence achieving competitive advantage that will not only aid the growth of specific SMEs, but also increase aggregate demand, leading to economic development of the country.

Other important macroeconomic development impacts SMEs include, the promotion of technological innovation, as most technological advancement in the world is attributed to the SMEs. Again, SMEs aid in increasing export growth and productivity in various countries, leading to growth in GDP. Therefore, as a result of SMEs, there has been more knowledge-based economy due to information, communication, and technological advancements witnessed recently from SMEs. Due to this, there is continuous innovation of various technologies taking place worldwide every day. Therefore, it is important that various countries’ governments provide conducive environments for SMEs to apply and use technological growth strategies in their businesses (Shaikh, Shafiq, and Shah, 2011).

The Impact of the Financial Sector on SMEs

From the discussion of the economic impacts of SMEs to the economy, especially in UAE, it is clear that SMEs play a very important role in the economic development. Therefore, it is important that the governments of these countries put in place various important policies and programs of promoting SMEs in their countries. These may include providing conducive and favorable environment that will promote the SMEs sector as well as enhance fair competition in the markets. Again, the government must move forward and provide and support innovative strategies that will allow various SMEs to have confidence in the government, hence promoting the entire SMEs sector (Khaja, 2013). In addition, the government should avoid interfering with markets, as this usually discourages owners and investors of SMEs, a situation that may bring adverse effects to the country’s economy.

Besides, the governments should also try to provide financial support to SMEs through monetary and fiscal policies such as tax concessions, allowing them to participate in Open Market Operations. Therefore, government support to the SMEs will provide economic growth and promote GDP of the country. Again, this government support will also enable owners and innovators in these SMEs to have confidence and trust in the government, thus aiding in effective utilization of local and national resources in improving people’s living standards. Furthermore, technological importance on the SMEs cannot be ignored; hence, the government should enhance technological competitiveness in order to promote SMEs (Hodorogel, 2011).

There are various challenges that affect the SMEs sector in various developing countries as well as developed countries. To begin with, there is the problem of access to credit by the SMEs from various banks. For example, various researches and data publications show that SMEs experience difficulties in accessing credit facilities from financial institutions due to their low endowment in terms of resources and collateral (Hutchinson and Xavier, 2006). Generally, various banks fear that these SMEs may fail to pay back loans and other credits advanced to them. As a result of this, many capable SMEs have failed to grow, leading to poor living standards and low economic growth. Besides, due to poor accessibility of credit, research shows there is low lending rates to SMEs due to previous rejections they fear they might face in banks again (Hutchinson and Xavier, 2006).

Secondly, there is poor saving practices by SMEs in banks, as policies and procedures regulating them are ineffective, especially in matters related to financials. This again is caused by low consumption and poor government marketing regulations that at times cause low demand for local products (Badulescu and Badulescu, 2012).

There are various reasons why various regular banks usually do not allow the SMEs to access credit from them. This has resulted into financial gap in the SMEs sector due to lower returns and lack of adequate skills, capacity, and experience. In addition, there are also other factors such as higher risks of perceptions and uninspiring government regulatory environment policies leading to this financial gap. To begin with, in various developing countries, banks are usually unwilling to provide SMEs with capital to support their businesses. This has caused a large financial gap for SMEs in developing countries (Hodorogel, 2011).

Secondly, banks rarely give SMEs loans, and if in any case they give, they usually charge high interests rates, making the SMEs to lack interest in applying for loans from banks. For example, research shows that African banks are among the leading banks globally that charge high interest rates, thereby discouraging SMEs from applying for loans. Besides, banks usually argue that they rarely give SMEs loans and other credit facilities, and this is evidenced by the fact that loans given to SMEs are usually very small, hence making the transactional cost to be very high in terms of interest rates and other fees charged. Furthermore, banks in Africa and other developing countries usually do not give long-term loans, since there are few long-term borrowers of loans in these countries.

In other countries such as those in West Africa, local regulations usually discourage banks from giving long-term loans to borrowers. Moreover, banks experience challenges providing foreign exchange services, especially due to the fact that most of SMEs that have income and capital earning in terms of foreign currencies usually want funds in such same form of currency, leading to foreign exchange problems in the exchanging rates. In addition, most SMEs operating locally usually avoid a currency that is not used locally due to local regulation problems and limited forex availability (Pisoni, Fratocchi, and Onetti, 2013).

Another problem is due to the limited and lack of enough information, regulatory support, and even skills and knowledge to involve SMEs in the learning and teaching borrowers in various SMEs lending and borrowing procedures and programs. For example, in most developing countries, most SMEs usually lack accurate standard accounting procedures to provide accurate financial analysis on their revenues, interests, profits, and even bank statements. Again, there is little or no market information available on issues dealing with SMEs’ marketing issues. This leads to lack of collateral forms and ability of SMEs to claim their collaterals, hence causing banks to invest only in high government parastatals to avoid potential risks that may occur on SMEs due to lack of repayment of principal and interest. Again, charging rates by banks usually lead to high cost and high risk of investment, hence scaring SMEs’ owners from borrowing (Jekanyika, 2012).

Economic Impact of SMEs in GCC countries

SMEs in Gulf Cooperation Countries (GCC) play a crucial role in their economies, leading to economic stability. For example, Oman studies show that SMEs sector is the largest contributor to the country’s economic progress (Ashrafi and Murtaza, 2008). Therefore, it is important for GCC countries to encourage expansion of SMEs in providing development in both public and private sectors. In other countries such as Egypt, Tunisia, and Morocco, data shows that SMEs contribute largely in the provision of jobs and other employment opportunities, hence leading to economic development. Again, in countries such as Bahrain, Kuwait and Oman, various researches show that they largely depend on SMEs for economic development, as most of the people are employed by SMEs in these GCC countries.

SMEs usually refer to small and medium enterprises that employ not less than 10 and not more than 250 employees in most cases. In GCC countries such as UAE, SMEs sector is among the sectors that contribute largely to economic development in those countries (Pisoni, Fratocchi, and Onetti, 2013). This comes in the form of creating employment, generating economic wealth, and contributing to innovative and creative utilization of local and national resources in the countries where those SMEs operate. Although there are many challenges and problems, including financial problems facing SMEs, it is clear that, with appropriate government policies and programs, SMEs can be used to produce more economic development in their countries.

Again, SMEs are vital in growth and development of economies, especially the high-income countries such Germany and Australia. On the other hand, SMEs do not contribute too much to economic development of less developed and low income countries when compared with the highly developed countries. Again, in high-developed countries, SMEs usually provide economic development in terms of innovative technological ideas and other current technological advancements, whereas in less developed countries, SMEs only provide economic development in terms of employment, hence they do not contribute largely to development. Nevertheless, some researches indicate that SMEs contribute to employment creation, wealth creation, and economic development in both developed and less developed countries (Shah, Mehmood, Hashmi, Shah, and Shaikh, 2011).

For proper provision of economic development, there is need for financial support in the SMEs sector in various countries worldwide. This is due to the fact that various failures of entrepreneurial businesses and other SMEs have been attributed to lack of enough financial support to steer their growth. Again, studies show that financial support and access to finances is one of the best strategies that can be used in order to help SMEs to grow faster and stimulate economic growth and development (Shah, Mehmood, Hashmi, Shah, and Shaikh, 2011). Besides, there is also evidence in various countries showing that there is a big financial gap in the various SMEs globally. These financial problems are more prevalent among SMEs in low-income counties than in highly developed countries.

Furthermore, studies also indicate that smaller SMEs are affected by financial problems globally; however, when given enough financial support, they usually produce stronger boost and response in growth than large firms or SMEs do. Therefore, it is important that governments give enough financial support to various small firms by providing appropriate policies and systems that encourage people to invest in SMEs to boost economic growth. Finally, it is clear from various studies that provision and growth rate of SMEs have direct effect on the economic growth of various countries, since it will result into rising GDP growth (Shah, Mehmood, Hashmi, Shah and Shaikh, 2011).

There are various factors affecting the development of SMEs such as macroeconomic factors, growth opportunities, and the business environment. Macroeconomic factors it largely depend on government expenditures and government procurement procedures in the registration of SMEs in various countries. Therefore, legal requirements of the government regulations need to be considered in the process of registering SMEs in order to allow them provide sound taxation and proper contract terms. In addition, low-inflation economic environment has been found to be one of the ways through which growth of SMEs can be encouraged, given that high inflation rates usually lead to slow growth rate of SMEs. Moreover, there is need for creation of a stable exchange rate regime to encourage SMEs engage in effective and efficient operations; this allows them to engage in stable exchange currencies, leading to economic development.

The level of education in a country also plays a very crucial role in the development of SMEs, as high education level contributes to high level of development and growth of SMEs. Besides, there is need for the promotion of SMEs to acquire and access credit services from banks and other financial institutions, as it has been found that this promotes the growth of small firms, leading to more economic development. Therefore, banks should be encouraged to provide loans at low rates in order to attract more small firms to apply for loans and in the process increase the rate of investment in the country.

Other factors such as the black market premiums, including land rates and rents, also affect the development of SMEs; hence, the government should properly regulate the black market policies. Again, startup costs in the registration of SMEs usually differ from country to country. In addition, in all countries, SMEs are usually required to have license in order to operate freely without interferences. Again, studies show that corruption and other labor market operations affect the operations of SMEs. It is also found out that the political stability of various countries contribute largely to the development of SMEs. Moreover, it is clear that SMEs also contribute to infrastructural development of various countries both locally and nationally (Steinerowska-Streb, 2012).

SMEs face some challenges and problems in their operations such lack of credit and other financial support. Again, lack of access to modern technology is also another common problem facing various SMEs worldwide. Training of individuals in order to improve human resource development is also a problem that faces SMEs. Other problems that are common to SMEs globally include lacks of funds to improve research and development on matters dealing with SMEs, limited information, skills, and knowledge on the possible market changes, and poor government policies and regulations.

Therefore, to solve these problems, the government must put in place policies and systems that will give SMEs a conducive environment to promote and develop their entrepreneurial businesses. To begin with, the paper suggests that the governments should provide support to SMEs development by providing conducive environment for them to operate (Pisoni, Fratocchi, and Onetti, 2013). Again, the government should provide policies and regulations, including regular opportunities to share market information with the SMEs firms and to involve the firms in developing various policies and regulations affecting them. In addition, there is need for more links between the private sectors and the governments in order to provide mutual understanding between them.

Due to the problem of finances and limited funds facing SMEs, the government can provide loans to various small firms and encourage banks to start giving loans to these small firms, as that will result into more economic development. Furthermore, the government should also ensure that the level of education is elevated and improved in their countries in order to provide more knowledge and skills to SMEs. Besides, the problem of infrastructure can be solved through promoting local infrastructural development and other technological advancement in order to promote the development of SMEs.

If possible, it is important for the government to fund various research and developments activities in order to encourage new ideas for these SMEs. Again, it is also important that the government provide good and sound regulations, including taxation policies and regulations that will not only provide more transparency, but also will be less expensive for the operations of SMEs. Therefore, the government policies seem to be among the factors that largely affect the operations of SMEs globally. Banks should also be encouraged to provide enough information to SMEs and reduce their interest rates to attract more firms into the investment and lending field (Akanbi. 2013).

Conclusion

The paper has clearly discussed economic impacts of SMEs in the economy of various countries globally. Again, it is clear from the paper that SMEs have a great influence in the economic direction of a country, which may be in form of reducing unemployment and eradicating poverty, thus resulting to higher standards of living. However, it is important to note that, SMEs tend to promote economic development more in developed countries than in low-income countries. In addition, SMEs promote wealth creation and lead to competitive advantage, which results into more innovation and creativity in various firms.

Besides, it is clear from the paper that SMEs provide opportunities to improve infrastructural development and promotes local economy in the countries in which they operate. Despite all these contributions of SMEs to economic development, it is found out that SMEs face challenges in terms of access to credit and capital from banks and other financial institutions. Therefore, the paper recommends government intervention in order to promote the development of SMEs. This will include providing policies that promote economic growth of SMEs. Further, the paper recommends that more research and development must be encouraged and funded by the government in order to provide adequate ideas for the development of SMEs.

There is also need for awareness by various SMEs to be involved in global markets in order to improve their market value. The government should also provide room for the development of private sectors through correcting potential market and creating conducive business environment where there is fair competition and a level playing field. Again, the government should be involved in the upgrading of technological skills of its citizens. This will also require the involvement of citizens in the operations of global markets by providing them with access to information and finances.

This may include providing both long-term and short-term funding to the people at a good rate in order to encourage investment. In addition, advisory assistance in times of crisis is also very important for the SMEs, including provision of broad economic exposure. Besides, it is important for the government to provide sustainable strategies that would promote the development of SMEs. Therefore, SMEs’ importance in the economic development should not be ignored; instead, the government should support the SMEs in order to provide more economic growth.

From the macro-analysis of key variables such as capital access by SMEs, it is clear that lack of funds has been one of the huge challenges to small firms. Therefore, with provision and financial support, these firms will promote their economic development. It is also clear that in some SMEs in some countries contribute to loss of employment opportunities, especially where technology is highly advanced. For example, with the innovation of new technological ideas such as computers, many individuals lose their jobs, as less labor is needed.

Furthermore, SMEs also sometimes lead to poor marketing trends, as most SMEs usually sell their goods at low prices, leading to low economic development. Therefore, it is important that proper policies be put in place in order to enable SMEs engage in productive and effective operations that involve use of proper management skills that is geared towards boosting economic development of countries they operate in. In addition, government interventions and policies are important factors that can largely promote the development of SMEs. Finally, it is clear that there are many economic impacts of SMEs in the economy of countries they operate in; hence, these SMEs should be encouraged in order to enable and to promote economic development of those countries.

References

Akanbi, T.A. (2013). Customer Perceptions of GSM Impact on Service Delivery of Small and Medium Enterprises (SMEs) In Nigeria. Journal of Emerging Trends in Economics & Management Sciences, 4(1), 80-86.

Ashrafi, R., & Murtaza, M. (2008). Use and Impact of ICT on SMEs in Oman. Electronic Journal of Information Systems Evaluation, 11(3), 125-138.

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Oncioiu, I., & Oncioiu, F. (2012). Impact of creativity and innovation of SMEs on economic growth development in the knowledge society in Romania. Global Conference on Business & Finance Proceedings, 7(2), 184-190.

Pisoni, A., Fratocchi, L., & Onetti, A. (2013). Subsidiary autonomy in transition economies: Italian SMEs in Central and Eastern European countries. Journal for East European Management Studies, 18(3), 336-370.

Rody, R. C., & Stearns, T. M. (2013). Impact of Entrepreneurial Style and Managerial Characteristics on SME Performance in Macao S.A.R., China. Journal of Multidisciplinary Research (1947-2900), 5(1), 27-44.

Shah, A., Mehmood, T., Hashmi, M., Shah, S., & Shaikh, F. (2011). Performance of SMEs in Export Growth and Its Impact on Economy of Pakistan. International Journal of Business & Management, 6(7), 287-297.

Shaikh, F. M., Shafiq, K., & Shah, A. (2011). Impact of Small and Medium Enterprises SMEs on Rural Development in Sindh. Modern Applied Science, 5(3), 258-272.

Steinerowska-Streb, I. (2012). The determinants of enterprise profitability during reduced economic activity. Journal of Business Economics & Management, 13(4), 745-762.

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