Omar Al Ubaydli, who writes the weekly Economics 101 column in The National, recently offered readers a two-part series on the need for a greater role for SMEs in the GCC countries. Here we bring together the two parts; the first half diagnoses the problem, the second half offers solutions (and one path to avoid).
Small and medium-sized enterprises are a critical component of traditional economies, accounting for about 65 per cent of jobs in the OECD member nations and representing a key source of innovation. In the GCC, they employ a much lower percentage of the workforce (60 per cent in Saudi Arabia, 43 per cent in Oman, and 20 per cent in Qatar), with a disproportionate representation of cheap foreign labour, and their contribution to innovation is almost nil. Why is this the case?
All economies and workforces are inherently dynamic – tastes, global commodity prices, technology, and labour skills are all constantly changing. While big companies have the financial means to adapt to these changes swiftly, they suffer from an administrative sclerosis that makes them unresponsive to the market.
In particular, protecting shareholder rights in large organisations necessitates the establishment of cumbersome decision-making processes that emphasise transparency and contain many checks and balances, turning even trivial decisions, such as changing the lunch menu in the corporate cafeteria, into yawn-inducing bureaucratic nightmares.
Small companies often centralise authority into a handful of people at most, rendering decisions almost instant, helping them to swiftly adapt to new consumer tastes, and rapidly adopt new production processes. Moreover, because the chief executives are so close to the front line, they are well placed to anticipate changes and to innovate preemptively.
The difficulty of securing finance and the frequency of errors made on the cutting edge means that a majority of new start-ups fail to transform into sustainable enterprises. However, the successful ones are critical in helping the economy to adapt, as in the case of many innovations, it is easier to get existing companies to go bankrupt and get replaced by newer ones that appreciate the new technology than it is to try to get the rigid incumbents to adapt directly (e.g. MySpace and Facebook).
All economies require a blend of SMEs and corporate behemoths to thrive. And while the stability of a job in a large organisation is attractive to most workers, for many the excitement and potential riches associated with small companies ensure that there is a healthy supply of entrepreneurs to establish and operate SMEs.
In the GCC, SMEs make a modest contribution to the economy, especially in the employment of nationals, and only rarely do you hear about a GCC start-up delivering innovations that form the basis of a company that can compete globally. The GCC countries’ efforts at transiting to knowledge economies are unlikely to bear fruit unless SMEs expand their contribution to employment and innovation. What accounts for their underperformance?
The biggest reason is the public sector, which strips SMEs of the supply of entrepreneurs and employees. In particular, GCC public sectors typically employ over 80 per cent of nationals, and pay them wages that far exceed the amount that could be earned in the private sector given workers’ skills and qualifications, partially out of a desire to provide comfortable lives for their citizens.
The result is that those who would otherwise be innovative and determined enough to be entrepreneurs opt for the comfort of a government job. Moreover, the ones who maintain the drive to establish their own start-ups find that they are priced out of hiring non-entrepreneurial nationals by the luxurious work conditions in the public sector.
Beyond this, GCC entrepreneurs often find that learning how to secure lucrative government contracts is a far quicker route to riches than the toil of developing cutting-edge technology that contributes to new products and production processes.
This is why GCC exports are even more reliant on petrochemicals than the local economy is – competing in global markets where producers are stripped of the advantage of physical proximity to buyers requires higher degrees of innovation than serving domestic clients.
Admittedly there are other barriers to SME growth, such as financing problems, and the need to develop more educated labour forces. However, most of these problems exist across the entire world; it is in the size and generosity of the public sector that the GCC distinguishes itself globally.
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What are the potential remedies?
Before I propose specific policies, a key theme is that governments in general should avoid the business of picking “winners”. Throughout history, governments have demonstrated that their best role is to enable the private sector and to create an environment where competition in a level playing field determines the success of commercial projects.
Government bureaucrats exchanging memoranda about what they think is commercially valuable based on non-market criteria is a recipe for an ineffective private sector, because bureaucrats lack the financial incentives necessary for making wise commercial decisions.
In contrast, competitive markets motivate entrepreneurs to address their clients’ needs. Swapping market forces for government decisions encourages entrepreneurs to shift resources away from satisfying clients toward building a rapport with the bureaucrats picking winning projects. GCC governments should heed this warning as they seek to increase the private sector’s role in employing nationals, as too often in the past, their zeal for assisting nascent private-sector projects encourages white elephants dependent upon government support.
Thus, even when the government does provide direct assistance to SMEs, it should build upon a competitive market decision over which projects merit support. An example is loan guarantees, whereby creditors provide loans to SMEs under the standard terms but the government secures the loan on behalf of the borrowing SME, eliminating the risk faced by creditors. This way, private, for-profit creditors are still competing to offer loans to private, for-profit SMEs and civil servants are kept far away from commercial decisions. Another common example is tax breaks for SMEs.
In both cases, GCC governments can amplify the benefits accruing to SMEs by shifting funds away from public-sector employment to SME support. Much to the chagrin of many GCC citizens, making public-sector employment less attractive is critical to empowering SMEs.
GCC entrepreneurs often suffer from a lack of training in accounting and business essentials. Governments should consider giving SMEs vouchers they can use to attend privately run workshops in a competitive educational market.
Government regulations also constitute a significant hurdle for SMEs, which cannot afford the lawyers and industry specialists necessary to navigate a Byzantine legal environment. In many cases, regulations become unsuitable with the passage of time, but they remain in place because governments focus more on the act of promulgating new legislation than on eliminating defunct old legislation.
How can GCC governments tackle this problem?
The Netherlands offers the sunsetting of legislation as a potential solution – regulations automatically expire and have to be reenacted by the government. The UK’s approach has been to establish deregulation units to weed out laws that have become inappropriate. SMEs in the GCC would surely benefit from such initiatives.
GCC governments should also consider giving SMEs a larger role in official trade missions.
Vincent van Gogh once remarked: Great things are done by a series of small things brought together. The GCC’s oil means that its economy has the potential to be great; realising that potential requires SMEs to play a larger role.
Omar Al Ubaydli is the programme director for international and geopolitical studies at the Bahrain Center for Strategic, International and Energy Studies, and an affiliated associate professor of economics at George Mason University in the US. He welcomes economics questions from readers via email (omar@omar.ec) or tweet (@omareconomics).
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