World Bank Reprint Series: Number 116

Barend A. de Vries

Industrializationand Employment:The Role ofSmall and Medium SizedManufacturing Firms

Reprinted wvith permission from Herbert Giersch (ed.), InlernatioinlEconomic Development and Resource Transfer: Vorkshiop 1978 (Inistitut firWeltwirtschaft an der Universit5t Kiel) (Tiibingen: J. C. B. Mohr kPaulSiebeck), 1979), pp, 47-62

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Barend A. de Vries

Industrialization and Employment:The Role of Small and Medium Sized Manufacturing Firms

I. Introduction and Summary

This paper deals with the contribution which small sized manufacturingunits can make to the creation of new employment, or more precisely withthe question: "Should small and medium sized enterprises (SMEs) be en-couraged in the interest of enhancing the employment effects of industri-alization? " It explores the importance of firm size in shaping industrialemployment policy, and in doing so it necessarily takes note of the factsthat (a) most industries with below average capital intensity have moresmall production units than industries with above average capital intensityand (b) the design of large scale firms also plays a key role in employ-ment policy since capital-labor substitution appears to be possible.

In analyzing the employment consequences of industrial development, theinvestment per job created (both direct and indirect) is a key variable.There is ample statistical evidence that firm size and investment per jobare positively correlated. But this relationship is not necessarily causal.It extends across industry: variations in investment per job across indus-try may be as large as such variations associated with firm size withinindividual industries (Sec. II) . Further, investment per job may vary withthe growth of the firm, the technological development of the product and,of course, the size and maturity of the economy. The possibility of eco-nomic capital-labor substitution in more capital intensive and larger pro-duction units also requires that attention be paid to the role of theselarge units in employment creation and hence to the question of a prop-er balance between the large and small scale sectors (Sec. III).

Several factors will need to be considered in establishing a proper balancein the industrial sector, including availability of natural and financial re-sources, both private and public, the use of domestic raw materials andcomponents and the importance of export growth. Export oriented indus-trial growth is frequently found to be more labor intensive than importsubstitution, but the role of SMEs in export development essentially re-mains to be explored.

Remark: In preparing this paper the author has benefitted from discussionswith several of his colleagues at the World Bank, including lTariluzCortes, David Gordon, Jacob Levitsky, Ian Little, Howard Pack andRobert Steinberg. The pat, ,r does not necessarily reflect the offi-cial views of the World 1sank, of which the author is a staff mem-ber.

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A positive irdustrial employment policy calls for action on several fronts:emphasis on industrial branches with below average investment per jobrequirements, institutional support to SME development and encourage-ment of capital-labor substitution in large scale units (Sec. IV). Indus-trial employment policy will hardly provide a "quick fix," and other sec-tors (construction and service industries) are often more important asemployment generators. Further, the role of industry must be seen aspart of a comprehensive macro-economic employment strategy. Withinsuch a strategy, industrial policy should be desigrned to enhance the ein-ployment elasticity of manufacturing growth over a period of years.

The final section (V) discusses some further issues and topics for re-search in industrial employment generation, including a more systematicanalysis of what is a proper balance between large and small scale sec-tors and the effect of this balance on the employment elasticity of man-ufacturing growth, the efficiency of SMEs, institutional support for .SM\TEs,and the importance of technological assistance, income distribution andregional considerations.

Many non-economic arguments have been made in favor of the dev elup-ment of small firms. MWany of these are of the "Small is Beautiful' Xvalriejtv.Others mention the adoption of "appropriate technology", quality of lifeor philosophy of development [Neck 1977, p. 11; Petersen 1977, i'. 481 .An important argument also stems from a growing hostility toward largesize in general, a feeling that large sized operations in both buisiness allndgovernment are uneconomic, inefficient and often counter-productive,operating at levels of decreasing returns to scale and subject to X-inef-ficiency. While this paper does not attempt to asses these arguments,it should be emphasized that economic reasons in themselves are sufficienltto call for strong policy support to SMEs. These reasons gc well beyondthe creation of manufacturing employment. SMEs are essenitial for thesound development of the industrial sector as a whole, innovation, entre-preneurship, more equitable income distribution and the growth of man-ufacturing production outside the main centers. In short:

(1) A healthy development of the industrial sector requires both large andsmall firms. Because of technical, managerial or market considerations,firms in some industrial branches tend to be larger than in other branches.Hence, discriminating against SMEs would bias industrial developmentin favor of those branches in which large enterprises dominate.

(2) SMEs are breeding grounds for entrepreneurs and for innrovatiorns. IPutSMEs at a disadv7antage, and the country' s industrial developm-.ent may bepoor in entrepreneurial talent and in innovations. In fact, indigenous tal-ent and techniques are likely to be found in small firms and genuine deleel-opment must start from them.

(3) Smaller firms use simpler technology, are less capital intensive and(Ihence are more effectiv,e vehicles for creation of employment in the indus-trial sector. This is a crucial consideration even if the industrial sector

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- under any policy - may be less important as a source of a new employ-ment than other sectors such as construction and services.

(4) In the absence of institutional support for small firms, the larger oneswill get all the advantages, viz in credit allocation, technological support,government procurement, provision of infrastructure, etc.

(5) Conversely despite the discrimination against small firms in manylessdeveloped countries (LDCs) they are surviving and demonstrating that theyare at least as efficient as the larger industries which receive more favor-able policy treatment.

Finally, no paper on SMEs can ignore the importance of properly definingwhat is small. Even a cursory review of the literature and some case stud-ies suggest how crucial and operationally significant definitions of sizeare. The operational relevance has also brought a great variety of defini-tions [IBRD 1978, p. 181 . This paper generally ac2epts the definitionsusedin the sources quoted. As a rough guide, the author would suggest upperlimits of 50 workers or assets of $ 250, 000' for small enterprises ancilimits roughly 4-8 times higher for medium sized firms. Firms with lessthan 5 workers or $ 25, 000 in assets are regarded in the artisan sectorwhich deserves separate analysis. Rather than agreeing on pi'ecise limits,it is important to adopt definitions which are meaningful for the implemen-tation of policies toward SMEs. Hence, the important quiestion is what typeor size of firm riequir-es special attention in the provision of credit, i. e. ,needs the support of specialized credit institutions, or technical and tech-nological assistance. The precise limits may change over time, and infact at any given time may not matter too much [Peterson 1977, pp. 58 f. I

II. The Labor Intensity of Small and Medium Sized Enterprises

There is ample statistical evidence that small and medium sized enter-prises tend to be more labor intensive - i. e., have smaller investmentper job on average or on the margin - than large scale enterprises.

The correlation between firm size and capital intensity has been establishedin several studies 2. For example, this relationship has been demonstratedfor a samnple of investment pr-ojects receiving financing from a group ofdevelopment banks in L1DCs. One such study [IBRD 1976] deserves specialattenition because it gives attention to both dirert and indirect employmnentofftcts as well as income distribution. The study analyzes the eccnomiccharacteristics of a sample of 29 investment pr-ojects. The data for aver-

I $ S

2 See: IllBII) [1978, Annex 2: "Employment Characteristics of Recent DFC Sub-projects"I - Ohkawva, Tajima [1976] . - Tajima [19771.

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age capital investment per job created (direct and total) in different sizesof enterprises were as follows (1974, US dollars):

Enterprises

small medium large__ (25-250) (250-2, 000) (2, 000 +)

Direct employment 4, 800 7, 200 8, 000Direct and indirect employment 4, 200 4, 000 15, 000

an parentheses total fixed investment in $ 1, 000.

Indirect ernployment effects were positive for investment in small and me-dium sized firms and hence the capital investment per job (direct and in-direct) was less than that for direct emrployment only.

Conversely, the indirect effects were negative for large firms, mostly be-cause of the jobs lost to importation of machinery. The study draws atten-tion to the fact that indirect effects were largest for medium sized enter-prises, caused primarily by the use of domestically produced inputs (andmachinery) . Investment cost per direct job averaged $ 7, 000, with thefollowing industries represented: metal mechanics, food and beverages,paper, chemicals, textiles, non-metallic minerals. Of those, the firsthad the lowest (below average) investment cost per direct job, while thefood and paper industries had the largest indirect employment effects (withindirect employment generation being more than double direct employ3mentgeneration). Two further findings are worth noting: For pirojects of smallfirms, a relatively larger share (22 per cent) of income accrued to un-skilled workers as compared with large firms (7 per cent), hence invest-ment by small firms had a more favorable income distribution effect 1 .Secondly, although small firms were found to procure significant amountsof their inputs from abroad, it is through the structure of their domesticinputs that they were able to achieve a more favorable imnipact in terms ofemployment generation.

It is worth noting that the $ 7, 000 average investment costs per job forColombia was low when compared with the averages established for simi-lar Bank studies on other countries, viz Korea ($ 13, 200), India ($ 9, 000),Liberia ($ 9, 200), Zaire ($ 21, 000) and Sudan ($ 34, 000) [see also IBED1978, Table 2. 81 . Inter-country comparisons are difficult to make, vary-ing with the nature of industries, the cost of new plants versus plant expan-sion, the inclusion of infrastructure and other elements (consultants, train-ing, interest during construction) . However, the high level of capital perjob created in several African countries appears to be a gener al phenonle-non of concern. J. J. Stern [1977] has calculated the capital-labor factor sfor grouips of coutiiti-ies with inc i-easing per capita income.

In acidition, on itnvestment by small firms a lar-ger proportion of income ac-crued to the government (76 per cent cornp& r ed to 54 per cent for large firms) .

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The reasons for the correlation between firm size and capital intensity arevaried - and have implications for employment policy. Among the variousreasons the following are noteworthy:

(1) The firm is in a capital-light industry (compare say the clothing withthe chemical industry) and firms in this industry tend to be smaller thanin others. In fact, many capital intensive industries intrinsically requirelarger scale operations because of the indivisibility of the capital invest-ment and the magnitude of the minimum economic output.

(2) The firm is still in an early phase of development. It may iiiitially berun by a single owner-operator. As it grows, it may have to take on moreworkers and specialist supervisors (technical, procurement, marketing),and the owner may progressively move farther away from operations. Inthe process of growth, costs per units may first rise as overhead costsincrease and subsequently fall as management becomes more able to copewith problems of size. As output expands, the firm can adopt technological-ly more advanced methods (may in fact develop them if it is an innovatingfirm) and use more capital per worker [Peterson 1977, p. 106 f.] .

(3) The country is in an early phase of industrialization, and all firms arerelatively small (e. g., most African countries) .

(4) The country has a relatively small market, and firms in smaller coun-tries tend to be smaller than their couunterparts in larger countries ',

(5) The firm is situated in an industry which permits labor-capital sub-stitution, eithler in processing or in auxiliary activities (material han-dling, packaging, shipping) . The manager (owner) is responsive to fac-tor cost considerations and the country does not interfere with economicfactor pricing.

The last of these points extends to small as well as large firms. Its rele-vance for the larger firms is elaborated in the next sectioni. The first point- the location of small firms in capital-light industries - has caused con-fusion in much of the discussion about employment generation and firmsize. The correlation between firm size and capital-labor ratios, whilestatistically significant, extends across industries and will have to be in-terpreted with care when applied to policy formulation. Variations in cap-ital-labor ratios among firms of differen-t size within an industry maywell be less marked than variations in capital intensity among industries 2

See I3ain [19661, as quote-d by Scherer et al. [1975, esp. Ch. 3: "The Deter-minants of Plant Size"] . Scherer concludes that in multiple plant operationsthe larger the market controlled by the leading three sellers, the larger werethe avei-age top 50 per cent plant sizes [p. 3841 . Systematic variables account-ing for observed vaariations in multi-plant operations were market size andrelative imoortance of tranisportation costs [p. 3861 .

z See, for example, data in tBRII) [1978, Annex Table 1:41 quoted from Govern-mient of India [1965] . Fixed capital per employee varies by a factor of 10 ormore as between small and large firms in tobacco manufacturers, basic chem-

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The fact that plants in capital-light industries tend to be smaller than thosein capital intensive industries has been known for a long time. In his 'ModI-ern Small Industry for Developing Countries," E. Staley [1965, T'able l. 2]showed that the share of small factory employmnm, in total factory ernphiNy-ment is below average for such relatively capital intensive industries aschemical, ipt roleurn, basic metals, machinery and transport e(q lip n -1t.On the otther hand, this share is above average for less capital intensiveindustries such as food products, beverages, clothing anii footwear, andfurniture.

Chenery pointed out in 1960 that on the basis of inter-country inter-indus-try comparisons, capital intensive industries (viz, chemicals, transporLequipment, metals, paper, petroleum products) have ab ove average"scale effects" and also high growth elasticities (i. e. , tend to grow morerapidly than other industries as GDP grows [Chlenery 1960, p. 638; asquoted in Staley 1965, p. 142] . On the other hand, industries with belowaverage "size elasticity" (leather products, food and beverages, clothingand wood products) do relatively we3l in small markets and are cnarac ter-ized by predorninantly small firms l

III. Large Scale Firms and Employment Generation

The arlumernt thus far is that small firms are more labor intensive thanlarge ones, and small firms will be found predominantly in selected iluS-tries - those whle'1ore capital investment per job is below average. While apositi'-e industrial employment policy calls for support for SI\TEs, thereare several reasons why the role of larger scale firms in employment gen-eration also needs to be cunsidered:

(1) There is no reason why all countries should want to confine their iinu1lis-trial development to clothing, shoes, food and wvoodworking, ol light metalwoA.Irking' and textiles. Depending on their economic size, resource endow-ment or the relative abundance of capital, countries may want to includethe 'heavier" industries, in which firms tend to be larger and more cap-ital intensive. Thuts, countries which have an inherently strong capital po-sition (e. g., Nigeria, Venezuela), those which can have resource-basedindustries (e. g., oil, gas minerals) or have large domestic markets (e. g.,13razil, India) will in any case want to include the "heavier" industries.

icals and steel. Tiut the same or larger variation facto'l s can be observedamong small firms in differnrit industries (e. g., tobacco on thle oneI hanidl and:basic chemricals and steel on the other) ; and similarly for laLrge firms.

1 I''r a rankinig of industries by direet and total (direct and indireot) employ-meiit rffect, see "iteri [1977] . Further evidence on industries in which smnallpiti.r, (lominate is give n in .StaleN [1 9.5, Table 5.2: "17. S. Srnall .Plalt Indlus-tries'I , in which small plants are defined as liavitrg less than 100 workers.

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(2) While in the early sixties, small industry could be considered a prom-ising vehicle for the small economy, many countries have since thenpassedthe threshold where industries with larger capital installations are justi-fied and hence many more large scale plants have been established'. Manycountries are anxious to diversify their industrial structure and have goodeconiomic reasons for doing so. A number of them are now engaged in thedevelopment of the heavy machinery industry (e. g. , Brazil, Korea andMexico).

(3) Within most industries, even those with high capital investment perjob, there is still a wide variation in econo - c plant size. Scherer et al.[1975, p. 301 present estimates of the percentage increase in unit pro-duction cost when plants are built at one third of minimum optimumscale in 12 industries 2. In half of these the cost rises by only 5 per centor less and in only one of them (cement) does it rise by more than 11 percent. Further, in many cases it would seem that the increase in produc-tion cost may be offset by economies in non-production activities (partic-ularly marketing or transport costs).

The search for ways of increasing labor use in large plants is an essentialelement in industrial employment policy. There is apparently wide scopefor capital saving - and employrnent enhancing - techniques in the largeplant. 1\Tuclh of the evidence has been gathered by econurmists working intan(dem with engineers. Technological considerations place less rigidclaims on capital than has cften been assumed and the decomnposition ofthe l)1odc tiUn process into its component parts permits flexibility in cap-ital-labor substitution, particularly in the auxiliary elements (e. g. , ma-terial, handling, packaging) and often also in the choice of equipment.From a survey of data in available studies on six industries, Howard Packestimates that as a result of capitall abor substitution, employment couldincrease by 2.4 times on a given amnount of investment3 . Actual achieve-ment of effects of this magnitude will obviously depend on many factors,including flexibility in industry selection, managemen-t and labor skills,equipment selection and procurement, plant and process design, adequacyof infrastructure, etc.

This author, in a 1967 study, found 10 countries out of a group of 9.9, whichexceeded the minimum economic size for large scale industrial development

1, fiziw] as 1963 GDP of $ 4 billion or about $ 7 billion in 1975 dollars) . In 1975,stmw 15, countries of this group had GDPs over this mark. See de Vries [1967].B wleer blteW ing, cigarettes, cotton and synthetic hand woven fabrics, paints,petreleum refirning, non-rubber shoes, glass bottles, portland cement, inte-grated steel, antifrictiun bearings, refrigerators, automobile storage bat-teriesThe survey, still being comp1eted at the World Banrl, is based on work byCooper, Ithee-Westphlal, F. Stevart-, Tiinmer, and a group at the VJniver-sity, of Str athcl.(le. The indu-stries are sugar lrefining, maize milling, cot-ton yarn, woven cotton clotli, beer brewing, and men' s leather shoes. - Seealso Ilichett [19771 .

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The achiievement of greater employment generation also requires a flexi-bility in attitude in the design, execution and operation of industry. In thedeveloping countries, even the relatively more abvanced ones such asBrazil, the attitude of the foreign owned (often multinational' enterpriseis particularly important. It has often been said that the harbingers of for-eign technology base their decisions on the high cost of labor elsEwh11erefand hence adopt inappropriately capital intensive solutions. It wouldi seernthat this argument is too simplistic. All too often it is the "ft,eignors'"who are inte i-sted in cost saving and have the capability of ad1ap)tLtion1 (in-eluding the application of cheaper used machinery or the lower c(ost sup-plies of capital equipment) . In practice, it may be experience with ma-chinery and older techniques which enhances the industrial operator' s abil-ity to adjust foreign techluiclugy to local circumstances [Pack 19761 . ['heltobservations are shared by the work of Little, Scituvskv, Scott [1970Jand Vernon (19771 1. This is not to deny the importatnce of encourag-

Ihe following quotes are especially noteworthy. Little, Scituvsky, Sc, rt [1'

p. .571 IIi general, however, the Latin American countries are freer froin suchproblemns. They relied primarily on private foreign capital, of which one-half(in MEIxico) to three-quarters (in South America) was direct investment 1yfr-eign cornpanies; and whatever the pollitical objections to direct itivt'Stillf , It

does bring with it mnanagerial and technical know-lhow. Part of tihis know-ho,wis inanifest in greatem' reliatnce on careful calculations of costs and pr 'fi'al,h .than is eustomary in dleveloping countries; and one of the o.)utconmes of suchi (al-culation seems to he the frequent use of second-hand equipment in the plantsowned ard managed by for'eign companies. In a worldl where equipment man-ufacturers off(er little or no choice between more and less capital-intensivemodelF, this may well be the best way of adapting production terhiqiiues to tWe

low labour and high capital costs of developing countries. 1'nfrm-tunatclN, how-ever, the -use of second-hand equipment by foreign companies is not irifr'tent-ly resented by people in the countries conc-rned, who tend to look upon second-hand eqjuipment as hand-me-down ecquipmenlt. A further advantage of second-hand P(quipment may be that it commrits its user to the method (of prodUCtiollit emibodies for a much shorter period than new and more expansive e quip-ment. In fast-developina! countries with fast-expanding markets, t..-s can bean irnportant adlvarntage.The techniical and ialanaELerial know-how of the local plants of the big interna-,iolntl companies has, of course, other advantages and manifestations as wtll.rhey are typically run with exemplary efficiency and provi(le valuable training

niot mJily for1 Tilet labour force but also for the locally recruited manageriuland1 tginic mring. staff. Many of these firms maintain a training progranmme an(dtraining school ft'l their work force; antd the foreign zn,angtemlont 's concernWithl pWofitLLi1ii.', an(I with efficiency for the sake uf pr fit:a1,il y, are no)t the

least important part of the example thev set in managerial know-how."Vernon [19771 \hiuch nh moe in disputA' is another asserted link between fmulti-

national (e ewrpr'is- atn(d the use of capital. It is contended thiat, when pi-odutnmnt.wthe same products on the same scale, mnultiniationial enterprises tend toi choose

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ing: (a) indigenous industry and technology rather than supplementingit by large units of foreign technology with minimal links to the existingsociety and economy, and (b) the ability of adapting foreign technology todomestic circumstances.

IV. Enhancing Industrial Employment Effects: Toward Balance between Large andSmall Industry

The picture emerging from the foregoing two sections suggests that a pos-itive employunenit policy must be concerned with several aspects of indus-trial development:

(1) Cuncentr ate on predominantly labor intensive industries. Firms in theseindustries are predominantly small. Hence, if public investment resourcesare involved, they may, therefore, have to be spread over many moreunits than is the case with capital intensive industry. For this - as well asother reasons - government planners and financiers have often favored thecapital intensive sector.

(2) Within each industry, encourage the adoption of low capital or laborintensive technologies in the various components of the production process.This policy objective requires a wide range of measures, often of an in-stitutional nature. "Correct" factor pricing has, of course, received muchattention among economists, and there are those that argue that this is allthat' s really necessary. In some cases lower interest rates and tax ben-efit have been granted to labor intensive industries, sometimes in an ef-fort to offset the advantages enjoyed by capital intensive industry. \Vhilecorrect factor pricing is essential, evidence suggests that other forcesare important as well: attitudes of owner-entrepreneurs, engineering con-

production techniques more capital-intensive than those chosen by nationalfirms. Such a pattern would not be surprising, since multinational enterprisesmay be paying less for their long-term capital. But the evidence in supportof the conclusion is not very consistent. Some studies support the conclusion,some are inconclusive, and some point to exactly the opposite pattern, sug-gesting that the subsidiaries of multinational enterprises are more adaptivethan their local competitors" [p. 55] .'IAlthotugh comparatively little effort has gone into innovating for the specialcondlitions of the developing countries' markets, however, in one sense theneeds of these countries are sometimes served only too wel;1 Many of the newtechnolUgies, althouglh developed in response to the needs of the rich coun-tries, have proved in dollars-and-cents terms to be the most efficient for thepoor countries as well. Technologies that are saving of labor, for instance,prove also to be saving of capital. In such cases anyone in the poor countrieschoosing a technology on the basis of simple cost considerations has to choosethe capital-intensive technology. Unless the capital so saved is then clearlyroated to othieri jub-creating uses, the choice of the investor could easily beinterpreted as aclding to the country' s unemployment problems [p. 56] .

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sultants and national and international sources of finance, rigid prescrip-tions for products or techniques, pressure from established equipment sup-pliers, the country' s ability to absorb and adopt imported technology andthe strength of its technological assistance institutions, the availability ofadequate information on simpler technologies9 (identifying the need for in-formation and delivering it when it is r equired), the ability to employ usedequipment, etc. 1. Development banks can play a role by encuut]agiiig theuse of low-capital technologies when loan applications are considered.Technological assistance agencies, if well equipped, could play a moreimportant role in the lending process.

(3) Increase the utilization of existing plant, inter alia by wvorking moreshifts [Schydlowski 1976]

(4) Provide institutional support for SMEs. Without such support the larg-er firms will get all the advantages, viz in credit and foreign exchangeallocations, technological support, government procurement, infrastruc-ture, etc. Essentially the country' s financial, technical and techiologicalassistance institutions must become equipped to deal with small firms.Encouragement should also be given to closer links between lar ge andsmall sized firms by increasing subcontracting arrangements. Mluch canbe achieved by government encouragement (in prouuremen'; persuasion)and appropriate legal arrangements. In LDCs, subcontractiing will alsostrengthen the links between the formal and informal sectors anid fi.nc,thelp develop the latter.

None of these policy areas lend themselves to quick actioni. Some of theinstitutional measures required take several years before they begin tobear fruit . Perhaps it is well to recall that manufacturing industry asa source of employment creation is usually less important than the ser-vices and construction industries. Within a framework of macro-economnicpolicies, one has to consider the policies and institutional measures men-tioned as affecting the structure and employment elasticity of industrialgrowth over a period of years.

In practice, the composition of industrial investment by branches is oftenheavily influcenced by decisions on one or a few large capital intensive

On the problems of used equipment see Cooper, Kaplinsky [1974] and James[1974] .

a For example, -ilding an effective technical and technological assistance forcerequires several years of persistent effort. Among the more promising in-stitutions, Mexico' s Infote c, a technological assistance service, is nowbeing integrated into that country' s SME development program. It is only nowstarting to build essential field offices outside the major urban areas. It wasstarted in 1972. trhe Canadian IDRC- sponsured T e c hi O n on t in 10 Asiancountries, centered in Singapore, was also started in 1972 and has been in-strumental in setting up a network of assistance and information agencies, an(dhas provided training for over 1,500 industrial extension agents in membercountries.

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projects, It is generally recognized that economic rate of return (ERR)calculations are essential in arriving at decisions on these projects. Thesecalculations will need to be supplemented by other data, in part because:(a) uncertainties involved in ERR calculations (viz, in most cases costsare underestimated and hence ERRs tend to be overstated) , and (b) wedon' t have sufficient comparable data for other l)rojects especially smallones. Thus, allowance shlould, for example, be made for (a) the directan(d indirect e mployvent effects, (b) use of local raw materials and (c)ex)purt-. IFui'ther, the decision as to one or a group of major industrialpro)jec'ts Inust, of course, be taken in the framework of a broader indus-trial sector development plan. Such a sector plan must necessarily con-sider:

(1) effects of the plan on employment, use of local raw materials and ex-ports;

(2) d(omestic and external financing r-equired for investment or lrenovation;

(3) balance between major branches of industry; inter-mediate, capital andconsumer g'(uls; capital intensive and labor intensive branches. Usuallyspecial ,att.tntion is given to "basic"t industries, e. g. , steel, chemicals,fertilizers (with high capital labor ratio); engineering (medium range ofcapital itntensity) ; textile, clthing and shoes; foodt pirocessing, wodwvor,k-:ing,; andI industries based on the couuntryn ' s spocial raw material endow-meLnt;

(4) infrastructure requiro ments;

(5) in.stitu1ti0on,al supo[)rLt, marketing; technology; design; technical assis-tance; credit a; r ianaeInents.

It is, of course, quite common that countries find themselves in a situationwhere they must econorrize on financial resources (both domestic and ex-ternal); dev elop and expand exports; and seek ways of providing more in-dustrial employment. In such a situation the government or the industrymuthoriities may be facing a choice whlIethier or not to proceed with one ormore ma jol capital intensive industrial projects. Often they may want toattain greater inaniager-ial and financial independence for major industriesnow suibject to government intervention. In practice, financial consider-ations may leadl to the postponemient of "heavy" industry projects (as, forexam,ple, the Sines IPiroject in Piortugal) . Such postponemnent is never pop-ular' but it may actually be quite consistent with the objectives of employ-ment (rieation and illdustlrial output growth, pr,ovided simultaneously at-tt it.in is given to stimulate industries with lower capital investment perjob created, partictular-ly, SME and export industries.

In these situations the choices are very difficult and decisiolns may be takenwhclih do not favor employment clreation, for example, when the country[poceed(S with some highly capital initensive projects because external fi-nhincincg is available, the project supports activities in other sectors (e.g.,fertili7er and modernization of ag,riculture) , or develops local resourcesfor expo-Jrts (e. g., in the paper and pulp industry) . In other situations the

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country may not feel the financial pinch to the same extent, or employ-ment creation has not yet received central attention. For example, Nigeriaappears to have had little concern thus far with t.he capital inter sity of itsindustrialization and has as yet given limite,E attention to "iME develop-ment.

Once external finance is available, it is often easier to proceed with cer-tain capital intensive proj ects than to develop the policies and institutionalmechanism which place greater reliance on labor intensive and export in-dustries. This consideration places a burden on governments as well asexternal finance agencies. It is for this reason that the World Bank is mak-ing a special effort to help develop capital-light small scale industries.

V. Further Issues and Topics for Research

Following are some of the topics where research would enhance under-standing of the role of SMEs in employment policy.

(1) Balance between large and small industry. Healthy in-dustrial development requires close interaction between large and smallscale industry, The significance of this interaction extends well beyondthe old backward linkage argument: training of entrepreneurs, innovationi,raising of wages and technology in the backward sectors of the economy,income distribution, regional development, integration between formaland informal sectors, etc. One can test the balance of industry and the in-teraction between large and small industry by assessing the effectivenessof supporting institutions, policies, extent of subconstracting and linkages,etc. But there is no clear-cutmeasure of what is a resasonable share forSMEs. It depends on a variety of factors, e. g., size of the economy,structure of industry, stage of development, policies, institutions, socialcustoms (paternalism), importance of artisans, etc. As countries developtheir industrial sector, SMEs may continue to be important but small fac-tories will be modernized along with the rest of the sector - hence the SMEsector in the industrial countries is quite different from that in the semi-industrial or least developed countries. It has been argued that excessivecentralism, official desire for bigness, will be detrimental to employ-ment generation and SME development in particular. On these groundsRein Peterson [1977, p. 67, Table A 2] finds that SMEs in Canada are rel-atively less important than in the United States and have in fact declinedover the years 1929-1973. But for many countries the variations in theshare of SME output and employment are not easy to explain. Th ree coun-tries in a comparable state of development, and perhaps social customIs,have sharply declining SME shares: Portugal, Argentina aitid NTe,xicoin that order. The differences might be explained in part by historic devel-opments and the impact of more recent public sector policies on industrialstructure (or conversely the lack of emphasis on SME developnienlt) . 13uteven granted this, it should be noted that Portugal' s important STME' sectorcontains many inefficient and obsolescent firms anLid has so far nado little

59

contribution toward employment creation during the recovery period since1973. And while Mexico only recently began to intensify its efforts at SMEdevelopment, it would be difficult to argue that its industrial developmenthas been less fficient than that of Argentina

(2) The foregoing observation raises a question about the e f f i c i e n c yo f SMEs. If they do promote employment, is this at the cost of efficiencyand hence of growth in output? On this point more research and surveysof SMEs experience is called for even though some tentative observationscan be made. Account must be taken of changes in efficiency as the firmgrows. SME°-, at least those that survive, are 3inost likely more efficient(and more profitable) than large scale enterprises: compared with the lat-ter SMEs and particularly the smaller scale firms, often face adverse in-stitutional support and less favorable factor prices. Many small industriesflourish despite an unfavorable policy environment. Further, as mentionedearlier, Scherer et al. [1975] found that plant size in many industries mayfall well below "minimum optimum size" without significantly increasingthe per unit production cost.

(3) The policy recommendations in Section IV suggest that countries em-phasize industry branches with below average capital intensity, provideinstitutional support for SMEs and encourage labor-capital substitution inlarge-scale units. One might add that export orientation is frequently morelabor intensive than import substitution. The impact of these policies onemploy merln growth has been analyzed for individual countries, for exam-ple, Korea. There is need for a comparative cross country analysis test-ing, for example, the relationship between the importance of the SME sec-tor or industry branches with relatively light (below average) capital in-tensity on the one hand, and the employment elasticity of man-ufacturing growth on the other

(4) A further area for research is the proper in s titution al supportfor SME development, in particular the role of technical and technologicalassistance, the function of credit and finance agencies, and special as-sistance to SMEs in the export sector. Provision of technological assis-tance appears essential in guiding SMEs toward low capital technology (orchoice of equipment) where this is indicated by market size, labor and

Staley [1965, p. 17, Table 1-21 finds that SMEs (with employees below 100)were rotuglily crniparable in the United States, the United Kingdom and West(It rmany with respect to their contribution to output and manufacturing employ-ment; SME}' labor productivity was in line with that of the larger firms. InJapan, however, the share of employment in SMEs was larger than in Europe,but labor productivity was below that in the large-scale sector. Slaley [1965,p. 19, Table I-3] also observes a large variation in the SNMEs' share in (-inmpluy-nient and( value added in different LD)Cs, as does TMTora%vetz [1974, p. 71, foot-note 691]' rhe relationislhip between trade strategies and employment growth is the sub-ject of a research project sponsored by the National Bureau of Economic Re-search under Anne C). Krueger. On Korea, see Westphal [19761

60

management skills. In this area, world wide "networking' must be an-chored into local institutions providing "fact to face" assistance. The ben-efits derived from technological assistance as distinct from the impacLof other factors (credit, factor pricing) is a virgin area for research;technical experts generally feel that SMEs benefit from more ade(quatteinformation and assistance. The reasons why in some countries (e. g.,Japan, East Asia) SMIEs became importanLt in expurts and subc)CUontlactCLigrwith large-scale firms and not in others remain to be investigated. In e x -port develoupnnt SMEs deserve special support in marketing, designas well as product development and standardization.

(5) The need for teclhnological assistance may in itself be a test in a prop-er d e f i n i t i o n of what constitutes a small enterprise. One can a rguethat once an enterprise is capable of obtaining technological informationon its own, either by direct contacts abroad (licensing, partierslhip, jointov.nership, visits) or with the assistance of a suitable technical informa-tion agency, it has moved out of the small scale category even though itmay have less than 50 workers. Many LDCs have now reached the pointwhere technological assistance is critical to the next stage of inclustrialdevelopment (and tfli provision of productive manufacturing enmplovnil en)

(6) Distribution of income and regional development haveimportant coriselllences for SME development. As is well known, an in-crease in the income of the poorer segmeiits of the popiulation mnay (lis-proportionately increase demand for labor intensive products of the .SiMI,Sector. Similarly, Ire'gJionlal develoipmetil may str-engthen smaller localmiar-kets and hbenefit SAMEs. But little empirical evideence has beet n accrumiu-lated in this area. On the other hand, in the absence of income redistribu-tion, assistance to small scale enterprises may lower the price of inputsinto capital intensive industry to the benefit of higher income consuime r-(and workers) ; hence, in the absence of acconmpanying policies to assistthe poo)rer segLnents of the populations, "interactionn between large anidsmall scale industry may primarily benefit the former.

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References:

Bain., Joe S., International Differences in Industrial Structure, NewHaven, Conn., 1966.

Chenery, Hollis B., "Patterns of Industrial Growth", The AmericanEconomic Review, Vol. 50, Menasha, Wis., 1960, pp. 624-654.

Cooper, Charles, Raphael Kaplinsky, Second Hand Equipment in aDeveloping Country, ILO, Geneva, 1974.

Government of India, Cabinet Secretariat, The Annual Survey ofIndustries, No. 161, Delhi, 1965.

International Bank for Reconstruction and Development(IBRD):

Developmental Impact of Financiera-Assisted Projects in Colombia,Washington, D.C., January 1976, mimeographed.

Employment and Development of Small Enterprises, Sector PolicyPaper, Washington, D. C., February 1978.

J ame s, Dilmus D., Used Machinery and Economic Development, EastLansing, Mlich., 1974.

Little, Ian, Tibor Scitovsky, Maurice Scott, Industry and Tradein Some Developing Countries: A Comparative Study, London, 1970.

M o r a w e t z, David, Employment Implications of Industrialization in De-veloping Countries: A Survey, World Bank Staff Working Paper, No.170, Washington, D.C., January 1974.

N e c k, Philip A. (Ed. ), Small Enterprise Development: Policies ar,\d Pro-grammes, ILO, Geneva, 1977.

Ohkawa, Kazushi, Mutsuo Tajima, Small-Medium Scale Manufac-turing Industry: A Comparative Study of Japan and Developing Nations,International Development Centre of Japan, Working Paper Series,No. A-02, Tokyo, March 1976.

P a c k, Howard, "The Substitution of Labour for Capital in Kenyan Man-ufacturing", The Economic Journal, Vol. 86, Cambridge, England,1976, pp. 45-58.

P e t e r s on, Rein, Small Business: Building a Balanced Economy, Erin,Ontario, 1977.

P i c h e t t, James (Ed.), The Choice of Technology in Developing Coun-tries, World Development, Vol. 5, Oxford, 1977, Special Issue, Nos.9/10.

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Scherer, Frederic M., Alan Beckenstein, Erich Kaufer, R.

Dennis Mui.phy, Francine Bougeon-Maassen, TheEconomics

of Multi-Plant Operation: An International Comparisons Study, Cam-

bridge, Mass., 1975.

Schydlo wski. Daniel, Capital Utilization, Growth, Employment and

Balance of Payments and Price Stabilization, Boston University, Cen-

ter for Latin American Development Studies, Discussion Paper Se-

ries, No. 22, Boston, Mass., December 1976.

Staley, Eugene, Richard Morse, Modern Small Industry for Develop-

ing Countries, Mc Graw-Hill Series in International Development, New

York, 1965.

Stern, Joseph J. , The Employment Impact of Industrial Investment: A

Preliminary Report, World Bank Staff Working Paper, No. 255, Wash-

ington, D. C., June 1977.

T aj ima, Mutsuo, Small-Medium Scale Manufacturing Industry: Further

Evidence in a Comparative Study of Japan and Developing Nations,

[1977] , mimeographed.

Vernon, Raymond, Storm over the Multinationals, The Real Issues,

Cambridge, Mass., 1977.

d e V r i e s, Barend A. , The Export Experience of Developing Countries,

Baltimore, Md., 1967.

W e s t p h al, Larry E., Korea ' s Experience with Export-Led Industrial

Development, IBRD, 1976, mimeographed.

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