## ppea2019040 - EXECUTIVE SUMMARY

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### Role and current status of SMEs in the Arab World
- SMEs are a cornerstone of Arab economies, "accounting for over 90 percent of all businesses and providing a major source of new job creation."
- MSMEs account for "80–90 percent of businesses in the MENA region" (Saleem/IFC 2017) and "around 97 percent in the Arab World" (MSME Country Indicators, 2014).
- MSME density examples in 2011:
  - Jordan: "around 25 MSMEs per 1,000 people" (23 were microenterprises).
  - Tunisia: "around 56 MSMEs per 1,000 people" (55 were microenterprises).
- SMEs’ contribution to GDP in Arab economies ranges "between 4 and 40 percent."
- SMEs are a major source of new job creation in emerging and developing countries, "accounting for some 45 percent of new jobs" (Ayyagari et al., 2014).
- In several economies (Iraq, Lebanon, Sudan, West Bank and Gaza, and Yemen) "over 50 percent of private sector employment is in SMEs."
- Female entrepreneurship indicators:
  - The Arab World has one of the lowest shares of women-owned SMEs at "14 percent", compared to the world average of "34 percent."
  - The Female Entrepreneurship Index (FEI) ranks the Arab World near the bottom among regions (Global Entrepreneurship and Development Institute, 2015).
- Labor market context:
  - Youth and female unemployment rates have persisted "above 20 and 17 percent (ILO), respectively, since 2010."
  - Labor force participation rates have not exceeded "34 and 27 percent (ILOSTAT), respectively" over the same period.
  - Youth comprise "around one third of the population."

### Main constraints and outcomes
- Progress in SME development has been "patchy" despite government recognition and initiatives.
- Key constraint areas identified: access to finance; productive capacity (education, technology, infrastructure); and business environment (legal, regulatory, taxation, governance).
- Private investment performance:
  - Between 2000–2017, annual private investment in the Arab region averaged "15.1 percent of GDP", with other EMDEs outperforming by "as much as 3 percentage points."
  - Private investment declined in the Arab region since the global financial crisis, in contrast with most other regions.
- Public sector and market structure issues: dominance of state-owned firms, governance weaknesses, limited competition, and informality.
- Financial inclusion and credit information:
  - Credit registries are "almost universal" across the Arab World; credit bureaus are less prevalent ("8 Arab countries have established credit bureaus").
  - Example: Jordan—Credit Bureau coverage (percent of adults) increased from "15.3 percent in 2017 to 19.9 in 2018" and the Depth of Credit Information index improved "from 6 to 7" over the same period.
  - Saudi Arabia recently launched a commercial collateral registry.
- Credit guarantee schemes (CGS) exist in Algeria, Djibouti, Jordan, Lebanon, Morocco, Qatar, Saudi Arabia, Tunisia, and West Bank and Gaza; structures vary (public/private shareholding, public financial institutions, donor-funded).
- Insolvency and bankruptcy laws have been passed in Bahrain, Egypt, Jordan and Saudi Arabia.

### Quantified potential gains from policy action
- "Increasing SMEs’ access to finance in the MENA region to the average level of emerging and developing economies would raise annual growth by up to 1 percent, according to IMF analysis."
- "Giving SMEs access to formal finance could create up to 8 million jobs in the Arab World by 2025."
- IMF staff projection in Figure 9: 7.7 million additional jobs in Arab countries by 2025 under higher SME financial inclusion.
- Projection assumption: 0.7 percent additional growth in employment due to higher SME financial inclusion.
- Baseline labor force entrants and employment context: 19.5 million new entrants to labor force by 2025.

### Public sector dominance and its effects
- Key sectors—oil and gas production, electricity, transport, and, to some extent, telecoms—are dominated by state-owned companies.
- Large public sectors create uneven playing fields for SMEs through:
  - Preferential treatment of large enterprises in government procurement.
  - Tax and transfer schemes favoring large firms.
  - Large public sector financing needs that may crowd out credit to the private sector, including SMEs.
  - Large public sector employment, often with generous compensation, that may prevent SMEs from attracting needed talent (Tamirisa et al, 2018).

### Access to finance (detailed constraints and impacts)
- SMEs in the Arab region have the largest gap in financial inclusion in the world; financial inclusion (access and usage of financial services by SMEs) lags the rest of the world (Blancher et al., forthcoming).
- Arab countries lag peers with similar income per capita on SME financial inclusion; credit concentration has been rising while the share of SMEs in lending has been decreasing.
- Bank credit to SMEs in the Arab region is the lowest in the world.
- Average shares of SMEs in total bank lending:
  - Arab World average: 7 percent.
  - GCC average: 3 percent.
  - Non-GCC Arab region average: 9 percent.
- Survey evidence:
  - About 30 percent of firms in the Arab World report access to credit as a major constraint (World Bank Enterprise Survey data), versus a world average of 26 percent.
  - Arab World Competitiveness Index (2018) entrepreneurs’ survey: 42 percent of respondents cite lack of access to finance as the most severe obstacle.
- Binding institutional and macro-financial constraints:
  - Credit information weaknesses—better credit information reduces collateral requirements and borrowing costs.
  - Financial sector characteristics—soundness and bank competition matter; Arab countries lag other regions in bank competition and exhibit high banking sector concentration, associated with higher interest margins and disincentives to lend to smaller firms.

### Productive capacity constraints
- Skills mismatch:
  - Education systems generally do not equip workers with skills relevant for private sector productivity and adaptation to technological change; education attainments still lag peers and quality remains weak (EBRD et al., 2016).
- Infrastructure and technology gaps:
  - Large infrastructure investment gaps and falling productivity restrain private sector activity.
  - Estimated cumulative investment gaps by 2040 (selected examples from Purfield et al, 2018): Morocco 36 percent of GDP; Egypt 69 percent of GDP.
  - Labor productivity has been declining in the Arab World since the global financial crisis; the GCC saw declines even earlier.
  - Low R&D expenditure and weak adoption of new technologies constrain private growth.
  - Conflict-affected countries face decimated infrastructure.
- ICT and broadband deficits:
  - Broadband access: only 6 percent of the population in the Arab World have access, versus 11 percent in other emerging markets and 33 percent in advanced economies.
  - ICT Development Index and Human Capital Index indicate substantial room to develop and increase use of information and communication technologies in the majority of Arab economies.
- R&D and high-technology exports:
  - High-income Arab economies: 0.5 percent of GDP on R&D (average).
  - Advanced economies: 2 percent of GDP on R&D (average).
  - Arab EMDEs (available data): 0.4 percent of GDP on R&D (average) versus 0.5 percent for emerging markets.
  - High-technology exports account for 2 percent of manufactured exports from Arab economies on average, versus nearly 19 percent in emerging markets.

### Business environment, entrepreneurship, and governance
- Operating environment weaknesses that stifle SME entrepreneurship and innovation:
  - Most Arab countries rank below advanced economies and top emerging markets on registering property, starting a business, paying taxes, trading across borders, enforcing contracts, and resolving insolvency (Doing Business indicators).
  - Public procurement practices substantially lag peer countries and may discourage SME engagement in public contracts.
  - Tax administrations in many countries are perceived to exercise significant discretion, potentially leading to unfair treatment of taxpayers (Jewell et al. 2015).
- Entrepreneurship indicators:
  - Low rates of firm entry in the region relative to other regions.
  - Arab World entrepreneurship ecosystems are underdeveloped with significant gaps in risk acceptance, technology absorption, and competition (Global Entrepreneurship Index 2018).
  - Global Entrepreneurship Monitor (GEM, survey of seven Arab countries): on average, almost three-quarters view entrepreneurship as a good career choice; intentional entrepreneurship relatively high, but proportion of early-stage entrepreneurs substantially lower than in Africa and Latin America and the Caribbean.
- Governance:
  - Government effectiveness, regulatory quality, the rule of law, and control of corruption are low by international comparison and have worsened over the last decade (World Bank, 2017c).
  - High perceived corruption is associated with low employment growth and labor productivity (World Bank, 2016).

### Policy implications and recommended strategic thrusts
- Overarching recommendation: a holistic, comprehensive approach addressing access to finance, human capital, infrastructure/ICT, business environment, and governance.
- Facilitate access to finance:
  - Ensure availability of adequate funding adapted to SME needs.
  - Provide a supporting framework for enhanced credit information and bank competition.
  - Develop capital markets to broaden access to new sources of finance for SMEs.
- Enhance SME capabilities and access to high-quality factors of production:
  - Efficient expenditure in education, technology and key infrastructure.
  - Targeted investment in education to better meet labor market needs and build entrepreneurial skills.
  - Ensure access to reliable key infrastructure, such as broadband, to reduce SME production costs.
  - Promote policies that facilitate adoption of technology and expand access to inputs and new markets to improve productivity.
- Develop a conducive business-friendly environment:
  - Establish robust legal, regulatory and taxation frameworks for SMEs.
  - Ensure a level playing field so SMEs face fair competition.
  - Improve governance, including in tax administration and public procurement.
  - Reduce the role of the public sector as a competitor in the economy.
- Ensure coherence, effectiveness, and sustainability of SME support schemes:
  - Give careful consideration to funding, administration, communication, and evaluation when designing SME support schemes.
  - Avoid one-size-fits-all approaches; tailor support to country contexts and firm development stages.
- Emphasize country-specific and firm-specific design:
  - International experience can inform policy, but "a 'one size fits all' approach is unlikely to succeed," and even within a country SME needs may differ requiring customized solutions.

### Designing SME support schemes — design, evidence, and lessons
- Alleviating SME finance constraints requires addressing broader economy-wide characteristics: a large informal sector, low financial literacy, market regulations, and concentration.
- Partial approaches (solely direct public financing or guarantees or only supply-side measures) are unlikely to yield large benefits.
- Alternative channels that could increase SME financial inclusion:
  - capital markets to expand access to equity and private capital (including venture capital) for later-stage SMEs;
  - fintech to reduce constraints on bank credit (e.g., credit information, competition) and open new financing channels.
- Productive capacity measures:
  - Reorient education toward private-sector needs via private-sector partnerships; emphasize soft skills, critical thinking, problem solving, STEM, and sector-specific technical skills.
  - Reallocate from unproductive uses (e.g., untargeted subsidies and high wage bills) toward investment when fiscally constrained, while protecting well-targeted social service spending.
  - Reduce information frictions and enable SMEs to access international markets.
- Evidence on effectiveness (Mouqué, 2012) from seven EU members, 12 support schemes, 235,000 SMEs:
  - Financial support: every euro of public support increased investment by EUR 1.3; jobs created were durable and of good quality.
  - Cost-effectiveness: some schemes were as effective (or nearly as effective) when grants were reduced or substituted by loans.
  - Productivity effects: purely financial support reliably increased production but in most cases hardly improved productivity; the most effective schemes included nonfinancial elements (business advice, networking, innovation promotion).
  - Firm-size differentiated effects: for medium-sized enterprises, innovation support, networking and innovation consortia increased long-term growth and productivity; for small and micro enterprises, basic business advice may be the single most cost-effective form of support.
- Design and implementation cautions:
  - Challenges include treating heterogeneous SMEs as homogeneous, complex/unclear tools, communication gaps, and fragmented/weak monitoring of policy impact.
  - Transparency of public costs and risks for SME funding schemes is essential; safeguard central banks from contingent liabilities where central banks’ balance sheets and reserve positions are not strong.
  - Direct fiscal costs and contingent liabilities of government SME schemes should be estimated and weighed against opportunity costs and performance.
- Evaluation methods:
  - Counterfactual impact evaluation studies can help isolate policy effects by using control and comparison groups.

### Case example — Malaysia (SME and Entrepreneurship Development)
- Malaysia’s SME Master Plan 2012–20 focuses on innovation and technology; access to financing; human capital; market access; legal and regulatory environment; and infrastructure.
- Six programs under the Master Plan include Integration of Business Registration and Licensing; Technology Commercialization Platform; SME Investment Partner; Going Export; Catalyst Program; Inclusive Innovation.
- Specific measures: encourage automation and ICT, strengthen technical and vocational education and training, create an entrepreneurial culture, encourage procurement of local SME products and supplier development.
- Malaysia outcomes and funding:
  - contribution of SMEs to overall GDP increased from 32.2 percent in 2010 to 37.1 percent in 2017;
  - contribution of SME employment to total employment increased from 63.8 percent in 2014 to 66 percent in 2017;
  - in 2017, Malaysia’s government funding of various SME support programs amounted to 0.4 percent of GDP (SME Corp. Malaysia, 2018);
  - financial commitments in 2018 suggest that government funding for SME support programs may more than double in this year to 1 percent of GDP with the lion’s share allocated to providing access to financing.

### Concluding remarks and policy considerations
- A multipronged approach can catalyze SME development in Arab countries by addressing access to finance gaps, fostering an enabling business environment, and improving human capital and infrastructure; promoting entrepreneurial mindsets and reducing the public sector’s role as a competitor can bolster these efforts.
- Key guiding principles for policymakers:
  - boost financial access by improving availability of funding adapted to SME needs (including new capital sources such as capital markets) and enhancing bank competition;
  - develop SME capacity through targeted public and private expenditure on education and key infrastructure;
  - foster an enabling business environment by developing business-friendly legal, regulatory and taxation frameworks to foster job creation and ensure a level playing field for SMEs, with special focus on start-ups and young firms;
  - improve governance, including in tax administration and public procurement.
- Ensure coherence and effectiveness in SME support scheme design with careful consideration of funding, administration, communication, and evaluation; schemes should promote entrepreneurship, access to information and markets, and adoption of new technologies.
- Governments should improve SME data availability and dissemination.

*Source: ENHANCING THE ROLE OF SMES, INTERNATIONAL MONETARY FUND.*

### EXECUTIVE SUMMARY

### ppea2019040 - EXECUTIVE SUMMARY

### Role and current status of SMEs in the Arab World
- SMEs are a cornerstone of Arab economies, "accounting for over 90 percent of all businesses and providing a major source of new job creation."
- MSMEs account for "80–90 percent of businesses in the MENA region" (Saleem/IFC 2017) and "around 97 percent in the Arab World" (MSME Country Indicators, 2014).
- MSME density examples in 2011:
  - Jordan: "around 25 MSMEs per 1,000 people" (23 were microenterprises).
  - Tunisia: "around 56 MSMEs per 1,000 people" (55 were microenterprises).
- SMEs’ contribution to GDP in Arab economies ranges "between 4 and 40 percent."
- SMEs are a major source of new job creation in emerging and developing countries, "accounting for some 45 percent of new jobs" (Ayyagari et al., 2014).
- In several economies (Iraq, Lebanon, Sudan, West Bank and Gaza, and Yemen) "over 50 percent of private sector employment is in SMEs."
- Female entrepreneurship indicators:
  - The Arab World has one of the lowest shares of women-owned SMEs at "14 percent", compared to the world average of "34 percent."
  - The Female Entrepreneurship Index (FEI) ranks the Arab World near the bottom among regions (Global Entrepreneurship and Development Institute, 2015).
- Labor market context:
  - Youth and female unemployment rates have persisted "above 20 and 17 percent (ILO), respectively, since 2010."
  - Labor force participation rates have not exceeded "34 and 27 percent (ILOSTAT), respectively" over the same period.
  - Youth comprise "around one third of the population."

### Main constraints and outcomes
- Progress in SME development has been "patchy" despite government recognition and initiatives.
- Key constraint areas identified: access to finance; productive capacity (education, technology, infrastructure); and business environment (legal, regulatory, taxation, governance).
- Private investment performance:
  - Between 2000–2017, annual private investment in the Arab region averaged "15.1 percent of GDP", with other EMDEs outperforming by "as much as 3 percentage points."
  - Private investment declined in the Arab region since the global financial crisis, in contrast with most other regions.
- Public sector and market structure issues noted: dominance of state-owned firms, governance weaknesses, limited competition, and informality.
- Financial inclusion and credit information:
  - Credit registries are "almost universal" across the Arab World; credit bureaus are less prevalent ("8 Arab countries have established credit bureaus").
  - Example: Jordan—Credit Bureau coverage (percent of adults) increased from "15.3 percent in 2017 to 19.9 in 2018" and the Depth of Credit Information index improved "from 6 to 7" over the same period.
  - Saudi Arabia recently launched a commercial collateral registry.
- Credit guarantee schemes (CGS) exist in several Arab economies: Algeria, Djibouti, Jordan, Lebanon, Morocco, Qatar, Saudi Arabia, Tunisia, and West Bank and Gaza; structures vary (public/private shareholding, public financial institutions, donor-funded).
- Insolvency and bankruptcy laws have been passed in Bahrain, Egypt, Jordan and Saudi Arabia.

### Potential gains from policy action (quantified findings)
- "Increasing SMEs’ access to finance in the MENA region to the average level of emerging and developing economies would raise annual growth by up to 1 percent, according to IMF analysis."
- "Giving SMEs access to formal finance could create up to 8 million jobs in the Arab World by 2025."

### Strategic policy thrusts recommended
- Facilitate access to finance:
  - Ensure availability of adequate funding adapted to SME needs.
  - Provide a supporting framework for enhanced credit information and bank competition.
  - Develop capital markets to broaden access to new sources of finance for SMEs.
- Enhance SME capabilities and access to high-quality factors of production:
  - Efficient expenditure in education, technology and key infrastructure.
  - Targeted investment in education to better meet labor market needs and build entrepreneurial skills.
  - Ensure access to reliable key infrastructure, such as broadband, to reduce SME production costs.
  - Promote policies that facilitate adoption of technology and expand access to inputs and new markets to improve productivity.
- Develop a conducive business-friendly environment:
  - Establish robust legal, regulatory and taxation frameworks for SMEs.
  - Ensure a level playing field so SMEs face fair competition.
  - Improve governance, including in tax administration and public procurement.
  - Reduce the role of the public sector as a competitor in the economy.
- Ensure coherence, effectiveness, and sustainability of SME support schemes:
  - Give careful consideration to funding, administration, communication, and evaluation when designing SME support schemes.
- Emphasize country-specific and firm-specific design:
  - International experience can inform policy, but "a 'one size fits all' approach is unlikely to succeed," and even within a country SME needs may differ requiring customized solutions.

### Paper structure (as organized in the source)
- Section II: Stylized facts on SMEs, SME development, and main constraints.
- Section III: Assessment of potential benefits from removing key impediments and discussion of related policy actions.
- Section IV: Concluding remarks and policy considerations.

*Prepared for the Annual Meeting of Arab Finance Ministers on April 25, 2019; team led by Vahram Stepanyan, comprising Gohar Abajyan, Marwa Alnasaa, and Anta Ndoye, under the supervision of Ali Al-Eyd (all MCD).*

### 12.      Large public sectors also impede private sector development in the Arab region

### 12.      Large public sectors also impede private sector development in the Arab region

### Public sector dominance and its effects
- Key sectors—oil and gas production, electricity, transport, and, to some extent, telecoms—are dominated by state-owned companies.
- Large public sectors create uneven playing fields for SMEs through:
  - Preferential treatment of large enterprises in government procurement.
  - Tax and transfer schemes favoring large firms.
  - Large public sector financing needs that may crowd out credit to the private sector, including SMEs.
  - Large public sector employment, often with generous compensation, that may prevent SMEs from attracting needed talent (Tamirisa et al, 2018).

### Access to finance (major constraint)
- SMEs in the Arab region have the largest gap in financial inclusion in the world; financial inclusion (access and usage of financial services by SMEs) lags the rest of the world (Blancher et al., forthcoming).
- Arab countries lag peers with similar income per capita on SME financial inclusion; credit concentration has been rising while the share of SMEs in lending has been decreasing.
- Bank credit to SMEs in the Arab region is the lowest in the world.
- Average shares of SMEs in total bank lending:
  - Arab World average: 7 percent.
  - GCC average: 3 percent.
  - Non-GCC Arab region average: 9 percent.
- Survey evidence:
  - About 30 percent of firms in the Arab World report access to credit as a major constraint (World Bank Enterprise Survey data), versus a world average of 26 percent.
  - Arab World Competitiveness Index (2018) entrepreneurs’ survey: 42 percent of respondents cite lack of access to finance as the most severe obstacle.
- Consequences:
  - Large shares of firms are disconnected from the formal financial system and rely on their own capital (Purfield et al, 2018).
  - High unemployment, low private investment, and wide financial inclusion gaps stifle SME innovation and development.
- Estimated macro-financial benefits of improving SME financial inclusion:
  - Increasing SME access to finance in the MENA region to the average level for emerging and developing economies would increase growth by up to 1 percent annually (Blancher et al., forthcoming).
  - Firm-level analyses indicate access to formal finance leads to employment gains larger for SMEs than for large firms and could potentially create up to 8 million jobs in the Arab World by 2025 (Figure 9).
  - IMF staff projection in Figure 9: 7.7 million additional jobs in Arab countries by 2025 under higher SME financial inclusion.
  - Projection assumption: 0.7 percent additional growth in employment due to higher SME financial inclusion.
  - Baseline labor force entrants and employment context: 19.5 million new entrants to labor force by 2025.
- Binding institutional and macro-financial constraints to SME access to finance include:
  - Credit information weaknesses—better credit information reduces collateral requirements and borrowing costs and is identified as a key factor for SME access to formal finance (Blancher et al., forthcoming).
  - Financial sector characteristics—soundness and bank competition matter; Arab countries lag other regions in bank competition and exhibit high banking sector concentration, associated with higher interest margins and disincentives to lend to smaller firms.

### Productive capacity constraints
- Skills mismatch:
  - Education systems generally do not equip workers with skills relevant for private sector productivity and adaptation to technological change; education attainments still lag peers and quality remains weak (EBRD et al., 2016).
- Infrastructure and technology gaps:
  - Large infrastructure investment gaps and falling productivity restrain private sector activity.
  - Estimated cumulative investment gaps by 2040 (selected examples from Purfield et al, 2018): Morocco 36 percent of GDP; Egypt 69 percent of GDP.
  - Labor productivity has been declining in the Arab World since the global financial crisis; the GCC saw declines even earlier.
  - Low R&D expenditure and weak adoption of new technologies constrain private growth.
  - Conflict-affected countries face decimated infrastructure.
- ICT and broadband deficits:
  - Broadband access: only 6 percent of the population in the Arab World have access, versus 11 percent in other emerging markets and 33 percent in advanced economies.
  - ICT Development Index and Human Capital Index indicate substantial room to develop and increase use of information and communication technologies in the majority of Arab economies.
- R&D and high-technology exports:
  - High-income Arab economies: 0.5 percent of GDP on R&D (average).
  - Advanced economies: 2 percent of GDP on R&D (average).
  - Arab EMDEs (available data): 0.4 percent of GDP on R&D (average) versus 0.5 percent for emerging markets.
  - High-technology exports account for 2 percent of manufactured exports from Arab economies on average, versus nearly 19 percent in emerging markets.

### Business environment, entrepreneurship, and governance
- Operating environment weaknesses that stifle SME entrepreneurship and innovation:
  - Most Arab countries rank below advanced economies and top emerging markets on registering property, starting a business, paying taxes, trading across borders, enforcing contracts, and resolving insolvency (Doing Business indicators).
  - Public procurement practices substantially lag peer countries and may discourage SME engagement in public contracts.
  - Tax administrations in many countries are perceived to exercise significant discretion, potentially leading to unfair treatment of taxpayers (Jewell et al. 2015).
- Entrepreneurship indicators:
  - Low rates of firm entry in the region relative to other regions.
  - Arab World entrepreneurship ecosystems are underdeveloped with significant gaps in risk acceptance, technology absorption, and competition (Global Entrepreneurship Index 2018).
  - Global Entrepreneurship Monitor (GEM, survey of seven Arab countries): on average, almost three-quarters view entrepreneurship as a good career choice; intentional entrepreneurship relatively high, but proportion of early-stage entrepreneurs substantially lower than in Africa and Latin America and the Caribbean.
- Governance:
  - Government effectiveness, regulatory quality, the rule of law, and control of corruption are low by international comparison and have worsened over the last decade (World Bank, 2017c).
  - High perceived corruption is associated with low employment growth and labor productivity (World Bank, 2016).

### Policy implications and easing SME constraints
- A holistic, comprehensive approach is required to create an enabling environment for SME activity by addressing:
  - Access to finance (improving credit information systems, promoting competition in banking, addressing credit concentration).
  - Human capital (aligning education outputs with private sector skill needs, improving education quality).
  - Infrastructure and ICT (expanding broadband, reliable electricity, and ICT adoption).
  - Business environment and governance (streamlining business regulations, improving bankruptcy and insolvency frameworks, promoting rule of law, reducing corruption, ensuring fair competition, and scaling back state-owned firm dominance).
- Additional measures to foster SME capabilities:
  - Promote entrepreneurship, management, and organizational capacity of SMEs.
  - Enhance SMEs’ capacity to innovate and adopt technology.
- Quantified potential gains:
  - Moving a country one point up the World Economic Forum’s Global Competitiveness Index could raise productivity growth by 1.4 percentage points (Purfield et. al, 2018).

*International Monetary Fund — Enhancing the Role of SMEs (chapter: Large public sectors also impede private sector development in the Arab region)*

### 26.      Fostering the development of a vibrant and competitive SME sector requires a

### Fostering the development of a vibrant and competitive SME sector requires a comprehensive approach

### Main elements of an enabling environment
- Governments should focus on three main elements: the adequate provision of funding; productive capacity; and conducive legal and regulatory frameworks and governance practices.
- To achieve these goals, governments can:
  - prioritize expenditure on growth-enhancing and high-quality investment in human capital and infrastructure, while sustaining well-targeted social spending;
  - ensure strong and stable governance frameworks; and
  - carefully design SME support schemes to avoid market distortions and contingent fiscal risks.

### Adequate provision of funding
- Alleviating SME finance constraints requires addressing broader economy-wide characteristics: a large informal sector, low financial literacy, market regulations, and concentration.
- Partial approaches (solely direct public financing or guarantees or only supply-side measures) are unlikely to yield large benefits.
- A holistic approach is needed covering macroeconomic to legal and regulatory aspects; this can increase SME transparency, reduce informality, and strengthen demand for credit.
- Alternative channels that could increase SME financial inclusion:
  - capital markets to expand access to equity and private capital (including venture capital) for later-stage SMEs;
  - fintech to reduce constraints on bank credit (e.g., credit information, competition) and open new financing channels.

### Productive capacity
- Well-targeted public spending on education and infrastructure is paramount to build human and physical capital and enhance competitiveness and productivity.
- For fiscally constrained countries, reallocation from unproductive uses (e.g., untargeted subsidies and high wage bills) toward investment is recommended, while protecting well-targeted social service spending.
- Educational programs should be reoriented to align with private job market needs via private-sector partnerships, focusing on soft skills, critical thinking, problem solving, and increased emphasis on STEM and sector-specific technical skills.
- Measures that reduce information frictions and enable SMEs to access international markets can support SME growth through trade network engagement.
- Entrepreneurship development programs can foster entrepreneurial mindsets and skills; evidence indicates participants develop more entrepreneurial attitudes, get jobs earlier, and start more companies (European Union, 2012).
- Regional status: many Arab countries (Algeria, Egypt, Jordan, Lebanon, Morocco, Tunisia) encourage entrepreneurship through education programs, but entrepreneurship is not yet embedded as a key competence in upper secondary national curricula in the region (OECD, 2018).

### Conducive legal and regulatory frameworks and governance practices
- Improving government effectiveness—by reducing bureaucracy, streamlining business regulations, enhancing transparency and accountability, and strengthening legal and regulatory frameworks—would improve fairness and governance practices and complement productive-capacity measures.
- Reforms to business registration, taxation, and labor administrative procedures would improve SME performance.
- Governments should remove obstacles to entry, create a level playing field, foster competition (including in sectors benefiting from public procurement), and pursue legal and judiciary reform to improve contract enforcement and foster risk taking.

### Designing SME support schemes
- SME needs differ by country and by stage of firm development; “one size fits all” approaches are unlikely to succeed.
- Support should be tailored to SME stages (start-up versus mature firms), and should promote access to global markets, value chains, and knowledge networks.
- Promoting digital technology adoption by SMEs can improve access to skills, markets, and new technologies.
- Success of support schemes depends on design, implementation, and impact assessment; attention required to administration, communication, monitoring, and evaluation.
- Challenges identified in SME policies (European Economic and Social Committee, 2017):
  - treating heterogeneous SMEs as a homogeneous group;
  - tools that are complex, unclear, and bureaucratic;
  - communication gaps with intended beneficiaries and lack of user-friendly approaches;
  - fragmented and weak monitoring of policy impact.
- Transparency of public costs and risks for SME funding schemes is essential:
  - majority of SME public instruments are funded by government agencies with budget allocations and limited central bank involvement;
  - safeguard central banks from contingent liabilities where central banks’ balance sheets and reserve positions are not strong;
  - direct fiscal costs and contingent liabilities of government SME schemes should be estimated and weighed against opportunity costs and performance.

### Evidence on effectiveness and impact assessment (lessons)
- Counterfactual impact evaluation studies can help isolate policy effects by using control and comparison groups.
- Evidence summarized (Mouqué, 2012) from seven EU members, 12 support schemes, 235,000 SMEs:
  - Financial support: every euro of public support increased investment by EUR 1.3; jobs created were durable and of good quality.
  - Cost-effectiveness: some schemes were as effective (or nearly as effective) when grants were reduced or substituted by loans.
  - Productivity effects: purely financial support reliably increased production but in most cases hardly improved productivity; the most effective schemes included nonfinancial elements (business advice, networking, innovation promotion).
  - Firm-size differentiated effects: for medium-sized enterprises, innovation support, networking and innovation consortia increased long-term growth and productivity; for small and micro enterprises, basic business advice may be the single most cost-effective form of support.

### Case example — Malaysia (SME and Entrepreneurship Development)
- Malaysia’s SME Master Plan 2012–20 focuses on innovation and technology; access to financing; human capital; market access; legal and regulatory environment; and infrastructure.
- Six programs under the Master Plan include Integration of Business Registration and Licensing; Technology Commercialization Platform; SME Investment Partner; Going Export; Catalyst Program; Inclusive Innovation.
- Specific measures include encouraging automation and ICT, strengthening technical and vocational education and training, creating an entrepreneurial culture, encouraging procurement of local SME products and supplier development.
- Malaysia outcomes and funding:
  - contribution of SMEs to overall GDP increased from 32.2 percent in 2010 to 37.1 percent in 2017;
  - contribution of SME employment to total employment increased from 63.8 percent in 2014 to 66 percent in 2017;
  - in 2017, Malaysia’s government funding of various SME support programs amounted to 0.4 percent of GDP (SME Corp. Malaysia, 2018);
  - financial commitments in 2018 suggest that government funding for SME support programs may more than double in this year to 1 percent of GDP with the lion’s share allocated to providing access to financing.

### Concluding remarks and policy considerations
- A multipronged approach can catalyze SME development in Arab countries by addressing access to finance gaps, fostering an enabling business environment, and improving human capital and infrastructure; promoting entrepreneurial mindsets and reducing the public sector’s role as a competitor can bolster these efforts.
- Key guiding principles for policymakers:
  - boost financial access by improving availability of funding adapted to SME needs (including new capital sources such as capital markets) and enhancing bank competition;
  - develop SME capacity through targeted public and private expenditure on education and key infrastructure;
  - foster an enabling business environment by developing business-friendly legal, regulatory and taxation frameworks to foster job creation and ensure a level playing field for SMEs, with special focus on start-ups and young firms;
  - improve governance, including in tax administration and public procurement.
- Ensure coherence and effectiveness in SME support scheme design with careful consideration of funding, administration, communication, and evaluation; schemes should promote entrepreneurship, access to information and markets, and adoption of new technologies.
- Governments should improve SME data availability and dissemination.

*Source: ENHANCING THE ROLE OF SMES, INTERNATIONAL MONETARY FUND.*

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_Source: https://www.imf.org/-/media/files/publications/pp/2019/ppea2019040.pdf_