What impedes SMEs from joining Asian supply chains?

While Small and Medium Enterprises play a significant role in job creation at the country level in Asia, they are underrepresented in Asian supply chains. This column analyses data from 5,900 manufacturing enterprises from five Southeast Asian economies - Malaysia, Thailand, Indonesia, the Philippines and Vietnam - to assess the extent of and constraints on SME participation in Asian supply chains.

East Asia’s transformation within a few decades from a poor underdeveloped backwater to the world’s factory offers fascinating lessons for developing countries like India. The creation of ‘Factory Asia’¹ is associated with global production networks and supply chains (hereafter supply chains) – the slicing of production activities across geographical space and linked by trade in intermediate goods. Amidst a world economy in recovery mode from the global financial crisis, rising inequality and social unrest are increasing concerns in Asia. It is possible that greater participation of small and medium enterprises (SMEs) in supply chains can support more inclusive growth as they are the backbone of employment in many Asian economies. Little is known, however, on whether SMEs are active players in Asia’s supply chains, and the various influences on their engagement.

Mapping SMEs’ role in supply chains

Empirical research2 on SMEs in Asian supply chains, up till now, has been constrained by an absence of comparable published data at the industry-level. To overcome this limitation, my study used micro-level data from 5,900 manufacturing enterprises from five Southeast Asian economies - Malaysia, Thailand, Indonesia, the Philippines and Vietnam - at different levels of economic development (Wignaraja 2014). The micro data from several manufacturing industries was collected by the World Bank in the late-2000s as part of their regular enterprise surveys exercise. SMEs are defined in my study as enterprises having less than 100 employees and large firms as having more than 100 employees. The study focuses on three issues concerning SMEs: (i) How much do SMEs engage in supply chains? (ii) What factors influence SME participation in supply chains? (iii) What implications can be drawn for supporting SMEs to join supply chains?

Several findings from the study are noteworthy. First, in terms of firm size, the dominance of large firms and the minor role of SMEs in supply chains show up in the data. About 72% of all large firms in the sample engage in supply chains while 22% of all SMEs in the sample participate in such supply chains (as direct exporters or suppliers to Multinational Corporations (MNCs)).

Second, higher SME participation rates are visible in more industrially developed Southeast Asian economies (example, Malaysia and Thailand) with more Foreign Direct Investment (FDI) and exposure to supply chains than other Southeast Asian economies. As much as 46.2% of all Malaysian SMEs and 30% of Thai SMEs engage in supply chains. These figures compare with lower SME participation rates in other Southeast Asian economies like 21.4% for Vietnam, 20.1% in the Philippines, and 6.3% in Indonesia.

Third, SMEs are involved in exporting directly to international markets but their share is less as compared to large firms in the five Southeast Asian economies. SMEs account for 23% of direct exports from all Southeast Asian sample firms compared with 77% for large firms. Malaysia (28.1%) and Thailand (34.7%) are Southeast Asia’s leaders in terms of SME shares of direct exports. Vietnam has an SME export share of 16.8% while Indonesia has 9.3%.

Fourth, data analysis underscored the notion of firm variation in supply chains in Southeast Asian economies – this means that firms involved in supply chains are different in terms of efficiency and fixed and variable costs. Reflecting economies of scale to overcome entry costs, large and medium-sized SMEs are better able to join supply chains than smaller ones. Although firm size matters, it is not the whole story of joining supply chains. Efficiency - particularly investment in building technological capabilities to use imported technologies efficiently and skills – and access to commercial bank credit also influence joining supply chains.

Fifth, the exploration of policy influences on business activity in Southeast Asian economies provides additional insights. This was done by examining enterprise perceptions of impediments in the policy environment. A trust deficit seems to hamper the requisite intra-firm cooperation needed for effective SME participation in supply chains. For instance, it is possible that large firms may feel that SMEs are unreliable as suppliers of industrial parts and components while SMEs feel that large firms may exploit them by paying low prices for industrial parts and components. Supply-side factors like lack of access to finance, high electricity costs, variable quality of transport systems, and inadequately educated workers are additional constraints on SME participation. On the policy and incentive side, behind-the-border issues³ like high corporate tax rates as well as economic uncertainty also play their part. Finally, the limited evidence from Malaysia and Thailand suggests that the affordability and quality of business support services (particularly marketing and technology support) are an issue.

Policy implications

Evidence on SME participation in supply chains, particularly in more developed Southeast Asian economies, is encouraging and can lay the foundation for future inclusive growth. Nonetheless, it seems that SMEs in Southeast Asian economies are at a disadvantage in participation in production networks compared with large or medium firms. SMEs face greater resource constraints in terms of finance, information, management capacity and technological capability, as compared to larger firms. Moreover, SMEs suffer disproportionately from external barriers like market imperfections and regulations.

Three policy implications from the research may be drawn for developing countries including India. First, policy and incentive reforms are necessary but not sufficient to promote firms to join supply chains. The myriad of supply-side obstacles and other issues identified by firms in Southeast Asia suggests that transparent and comprehensive national policies (which integrate supply-side and incentive interventions) are crucial to support the participation of firms in supply chains (for a conceptual discussion see Wignaraja, 2003). Specific policies to support SMEs (example, to form industrial clusters) could be useful, but further research is required on what works as there is a risk of government failure⁴.

Second, private sector representatives such as business associations should be involved in formulating policies for supply chains in Southeast Asia as they have first-hand knowledge and experience of rapidly evolving supply chains.

Third, to facilitate effective policy development for supply chains, national statistics need to take better account of trends in supply chains and firm size. Noteworthy initiatives include using a consistent definition of firm size across countries to enable better mapping of exports by firm size, attempting to incorporate the contribution of small enterprise suppliers and subcontractors to the exports of larger firms and, ultimately, measuring value-added trade by firm size rather than the value of gross trade.

Notes:

‘Factory Asia’ refers to East Asia’s growing emergence as the world’s centre of manufacturing through the formation of production networks and supply chains over geographical space.
Interested readers can look at references in Wignaraja 2014.
"Behind-the-border" refers to issues pertaining to domestic structural reform such as deregulation, competition policy, economic legal infrastructure, transparency, and financial sector reforms etc. These are different from traditional barriers at the border such as high tariffs.
Government failure can occur if government policies cause a worse allocation of resources than would happen without such policies.
Goods and services traded internationally comprise inputs from different economies. However, such flows within global production networks are typically not captured in standard measures of trade flows based on the gross value of exports and imports. New developments in international economics are attempting to address this gap by examining the value added by each economy in the production of goods and services which are traded internationally.