SMEs in the services sector – A new pathway to development in the LDCs?

Photo © Chris Kirchhoff/ MediaClubSouthAfrica

It is common knowledge that SMEs make a significant contribution to their countries’ economies, but they often operate in a kind of twilight zone — seen and acknowledged, but not properly understood or catered for at the policy level.

The 2016 WTO Public Forum staged at the end of September in Geneva with the theme of ‘Inclusive trade’ lifted the lid on the hurdles that SMEs face in trying to turn entrepreneurial ideas into viable businesses. However, the services sector offers new hope to small businesses in LDCs (least-developed countries) where weak manufacturing potential is a constraint to further development.

Technological advances are having a profound effect on how and where people work. In an international context, technology is a key driver of the global value chain (GVC) phenomenon, whereby traditional production processes are carved up into ‘tasks’ and outsourced to entities with distinct cost advantages in different parts of the world. Value chains favour specialisation, thus creating opportunities even for small businesses with limited production capabilities but with a product or service that could contribute to the value addition process.

Despite these opportunities, LDCs remain weakly integrated into the global economy, with many still dependent on low-value exports such as raw materials or simple manufactures. Without sizeable foreign investment, these countries are finding it increasingly difficult to build or overhaul their manufacturing sectors.

However, the services sector (including ICT, financial services, transport, energy and healthcare) could usher in a new era for LDCs, as it is often easier to transition to varied service delivery than to value-added industrial output. Globally, services account for two-thirds of employment, 60% of FDI and nearly 50% of trade (in value-added terms). Importantly, while services account for 50% or more of GDP in many poor countries, their service exports are insignificant by global standards. One reason for this is that the tradeable, high-value service sectors are very skill intensive, which puts LDCs at a distinct disadvantage.

While more people are joining the global conversation about the potential of the services sector to boost the economies of poor countries, the role of SMEs in this sector receives little formal attention. Unfortunately, SMEs face serious constraints, from infrastructural and institutional shortcomings (which hinder productivity and raise costs) to a difficult policy/regulatory environment. As a result, many SMEs are driven into the informal sector.

They also largely fall into the vulnerable ‘micro enterprise’ category (typically fewer than 10 employees). There is a dearth of medium-sized firms with a reasonable market following, representing attractive investment prospects and being well-placed to create meaningful and sustainable jobs.

Can LDCs survive largely on services? An initial reaction to this question might be ‘yes’, particularly as some LDCs generate most of their revenue from tourism. However, unless a good proportion of their service offerings is of the high-value, exportable variety, the country is unlikely to thrive. This is because prosperity in any economic sector comes from progressively moving up the value chain.

This prompts another question: should SME service providers in LDCs attempt to get involved in international trade? Direct exporting is generally difficult without a niche service offering and an arsenal of skills. Yet there is much untapped opportunity in indirect exporting. For example, the labour-intensive portion of the textile GVC is being outsourced to countries like Lesotho where labour costs are low. However, supporting services such as computer-assisted design and quality control are often brought in from other countries because of deficient local skills. If the necessary technical training were provided, SME service providers in LDCs could play a more visible and valuable role in global textile production.

Cape Town’s allure as a location for foreign film productions has opened up many opportunities for local restaurateurs, guesthouse owners, film extras, lighting and sound technicians, and make-up artists. Most LDCs have one or other unique comparative advantage (e.g. scenic beauty, a sought-after commodity or inexpensive labour) that could form the core of an intensive SME development strategy in the services sector. The challenge, though, is to find ways to move up the value chain. In the Cape Town film industry, more local skills are needed in high value-added activities, such as screenplay and script writing.

Priority areas for LDC policymakers in developing their SME services sector include: ensuring that SMEs have easy and affordable access to the internet for the purposes of marketing and e-commerce; driving a skills development agenda with entrepreneurship at its core; seriously addressing physical infrastructure and institutional shortcomings to bring down the costs of doing business; and creating an SME-friendly policy environment. Of course, good policies must be backed up by good government, implying that strategies and initiatives must be well informed, clearly articulated and decisively implemented.

Many see SMEs as holding the key to higher economic growth and, in turn, more jobs. Yet higher growth does not necessarily translate into more jobs. For example, growth-enhancing automation is making the landscape increasingly bleak for many in the financial services and other sectors who are losing their jobs to machines. Clearly, the vision should not simply be to create jobs in the short term; it should be to create sustainable and inclusive economic momentum. This is the growth and development formula that so often eludes policymakers in the developing world.