The Quality of SME Growth Is Low

The growth in the number of SMEs over the past few years is impressive. In the first quarter of 2023 alone, the number of registered entities rose by 121 thousand, and the total exceeded 2 million. True, most of them are sole proprietors, who number more than 1.6 million.

There is such a thing as survivorship bias, which occurs when we analyze those who survived, whereas we should be analyzing those who did not. To make sound decisions on developing any given segment, we need to build the right indicators, ones that allow us to draw reliable conclusions. The growth in the number of SMEs tells us nothing about the quality of growth, and here is why.

According to research by Jusan Analytics, the five-year survival rate of entrepreneurs is only 18%, compared with a global average of 50%. Labor productivity in SMEs is more than 5 times lower than in large business.

I also looked at the statistics on registered legal entities as of 1 April 2023, and they upset me just as much.

Of 513 thousand legal entities, almost 100 thousand, or 19.5%, are dormant. Of the remaining operating legal entities, only 208.5 thousand, or 40.6% of all registered legal entities, are active. The bulk of these legal entities belong to the small business segment.

It is also painful to look at our medium-sized and large businesses. Over the 10 years from 2012 to 2022, the number of enterprises grew by only 9.6%, or less than 1% a year.

At the same time, 54% of medium-sized businesses and 46% of large businesses are state-owned companies. In other words, we had state capitalism, and state capitalism is what we still have.

If I were to draw brief conclusions from these figures, I would say that growth comes mainly from the registration of new companies. I attribute this largely to tax optimization (the splitting up of businesses) and to a number of sole proprietors coming out of the shadow economy in order to obtain loans (the Kaspi effect and its lending programs). But this has nothing to do with sustainable SME growth or with an increase in their contribution to the country's GDP.

Unfortunately, cheap lending does not help SMEs grow, because lending is not tied to any criteria for improving labor productivity. It is aimed more at supporting particular sectors of the economy, which pushes up quantitative indicators rather than qualitative ones. Take a simple example: an economy of simple things. The production of simple goods cannot, by definition, achieve high labor productivity without scale. Scale of production is possible only in large business, and the simpler the product, the greater the volume of output needed to be competitive.

Monetary and fiscal easing does not stimulate higher labor productivity and does not make production more technologically advanced.

In developing SMEs, we need to pay more attention to non-monetary and institutional incentives, and direct financial support only toward raising labor productivity.

Let me give some examples which, in my opinion, would have more effect than simply subsidizing loans.

A platform for SMEs offering financial products such as factoring, invoice discounting and pre-shipment financing. This would significantly improve access to working capital by allowing businesses to monetize their receivables. Competition among banks on the platform would substantially reduce funding costs for entrepreneurs.

A fully digital mechanism for obtaining technical specifications for utility connections through the e-government system, so as to eliminate the human factor entirely in allocating access to them. At present, connection points are determined subjectively, which means access to the same capacities is not equal.

Building infrastructure and additional capacity. We have good examples of infrastructure projects that have delivered results. One is the Almaty industrial zone, which is practically full and fully operational. We need more such industrial zones.

Stronger creditor rights, to make collateral more liquid. Collateral should be enforceable within the shortest possible time. More liquid collateral would raise the loan-to-value ratio, increase the volume of credit available to good entrepreneurs and make borrowers more responsible for repaying their loans.

Subsidizing not the loans but the assets purchased with them. For example, if an entrepreneur takes out a loan to buy advanced software or equipment, the subsidy should go to that software or equipment. This would raise labor productivity in industries in a targeted way. This is how the EBRD, IFC and ADB work.

More support for large and medium-sized businesses. Small business is always a derivative of large business, never the other way round. Unfortunately, much of the attention goes to supporting micro and small business. Micro and small businesses cannot possibly compete with large business on labor productivity. Large business creates stable domestic demand, through both intermediate and final consumption, and this would automatically stimulate the development of micro and small business.

Development programs need to be substantially reworked, and support should be built not only on interest rate subsidies but also on creating an institutional environment.