Statistical Insights: Inclusive Globalisation, does firm size matter?

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OECD Statistics Directorate

The rapid increase in global value chains (GVCs) in the last two decades, in response to falling communication costs and reductions in trade barriers, has in large part been fuelled by large and multinational enterprises.  But across the OECD, 99.8% of enterprises are classified as SMEs, very few of which engage in international trade. Yet collectively, SMEs are responsible for two-thirds of employment and over half of economic activity in the OECD. This has raised policy concerns about the inclusive nature of globalisation and more specifically whether SMEs, and their employees, are less able to benefit from GVCs. While it is clear that SMEs face particular and more significant challenges to exporting compared to larger firms  (see for example the OECD Statistical Insights Who’s Who in International Trade) it is also true that direct export channels are not the only mechanism available to SMEs for integration into GVCs. A new report by the OECD, Nordic Countries in Global Value Chains, developed in collaboration with national statistical offices in the Nordic countries, shows that SMEs play an important role in GVCs as suppliers of larger exporting enterprises. In particular, it highlights that in the Nordics, more than half of the domestic value added of exports originates in SMEs.

In the Nordic countries, indirect exports through GVCs by Independent SMEs are around twice as important as their direct exports…

A significant share of total value-added (and hence employment) generated by SMEs is dependent on foreign markets, with the contribution of exports provided via indirect channels rising the smaller the firm. For example, while only 5% of value added generated by independent micro SMEs (SMEs with less than 10 employees) in Sweden is exported directly, an additional 24% of their value added is generated through value chains of downstream exporters, highlighting the significant dependencies of these firms on foreign markets. Figure 1 further illustrates this by separating dependent SMEs (firms with fewer than 250 employees which are part of a larger enterprise group) from independent SMEs (similar firms that do not have such ties). It shows that for the latter category, indirect exports are more than twice as important as direct exports.

Figure 1. Share of domestically produced value added that is exported

….reflecting the important channels provided by larger firms and MNEs…

Larger enterprises provide important channels for SMEs to access foreign markets and benefit from international growth, in particular in emerging economies where barriers to direct exports may be onerous for SMEs. Figure 2 illustrates that 28% of all SME’s exports are channelled through larger firms, with a significant share reflecting MNEs (both foreign and domestically owned).

Figure 2. Channels through which SMEs link to foreign markets

….which generate significant spillovers for jobs and income…

In turn, a quarter of every dollar of GDP created by exports of large firms reflects the value of goods and services provided by upstream SMEs (Figure 3), thus highlighting the important role larger firms can play in generating upstream spillovers in the form of income and employment. Indeed, in the Nordic countries, on average, each unit of value added by large exporting firms generates an additional 0.66 units of value-added in upstream (large and small) suppliers. This partly reflects the stronger focus of large firms on their core business functions. In this respect, it is also useful to mention that larger firms also typically include a larger share of imports in their exports: in other words, a higher import content of exports can go hand in hand with strong domestic supply chains.

Figure 3. Upstream contribution to exports of large enterprises: per cent of total domestic value added

..…particularly for SMEs in the services sector.

Upstream spillovers generated by larger firms are especially important for SME services providers. As Figure 4 illustrates, around 20% of the domestic value added exported by large manufacturing firms consists of services provided by upstream SMEs. Overall, services account for over 4o% of the gross exports of the main manufacturing industries. This shows the importance of e.g. efficient logistic services providers, and specialised business services such as accounting and legal services, for manufacturing exports.

Figure 4. SME services providers’ contribution to exports of large manufacturers

Policy relevance

The findings in the report Nordic Countries in Global Value Chains summarised above highlight the importance of policy measures (e.g. improved access to finance, skills and technology transfers that recognise the upstream role of SMEs in driving competitiveness of downstream exporters, as well as their ability to disperse the benefits of trade more widely), as complements to more ‘traditional’ measures that focus on direct exporters, such as removing red tape, special (export) financing schemes, and facilitating match-making with business partners abroad.

The measure explained

The indicators on the role of SMEs in GVCs have been developed via a unique and innovative collaboration between the OECD and the Statistical Offices in Denmark, Finland, Norway and Sweden. This cooperation allowed for the linking and integration of detailed and harmonised micro data into the Inter-Country Input-Output (ICIO) table that underpins the OECD-WTO Trade in Value Added (TiVA) indicators. Building upon standardised national linked micro datasets in all four countries, a shared SAS program ensured that identical calculations were performed in all countries without the microdata having to leave National Statistical Offices. The full report includes a detailed methodological annex that describes how data were combined and indicators derived.

The domestic value added in exports reflects the value of exports that is domestically produced (i.e. not imported), either by the exporting firm itself, or by its upstream suppliers (i.e. value that is indirectly exported).

Useful links

This Statistics Insights accompanies the report “Nordic Countries in Global Value Chains”, which examines the role of SMEs, MNEs and trading enterprises Nordic Global Value Chains. The report can be downloaded here.

More information on Trade in Value Added (TiVA), the indicators and the ICIO table can be found at

Stimulating SME Equity Financing? Change The Culture

Would you have invested in this SME?

On October 23rd, the OECD Financial Roundtable (FRT) dealt with public SME equity financing with a special focus on exchanges, platforms and players. In today’s post, Markus Schuller of Panthera Solutions gives us his personal view on the meeting.

Let’s face it: the bulk of small and medium-sized entreprises (SMEs) are still financed mainly by bank credit. However, as bank finance is harder to come by in the current post-crisis environment, fostering non-bank financing alternatives may help closing an SME financing gap. The OECD has been looking into such issues, also with input from the private sector via its Financial Roundtables. After the one held in April that discussed SME non-bank debt financing, this one, held in October, explored impediments and possibilities for public equity financing for SMEs.

Banks represented at the discussion naturally pleaded their cause, namely for debt financing, some even arguing that there is no shortage of SME debt financing, but only of risk financing. I allowed myself to add that this insight comes rather late. Too late actually, to stop the BoE and ECB in rolling out their securitisation support (asset backed securities purchase programme and covered bond purchase programme) that may be pointless if the analysis that the Eurozone suffers mainly from a demand-side problem is correct – as we have been highlighting over the last three years.

But back to the actual Roundtable topic. The overall challenge was described as how to stimulate equity financing for a segment that is characterised by low survival rates and a large diversity of entities, the two main drivers that make it difficult to assess risk. The focus of the debate was more on analysing the current drivers of a challenging environment for SME equity financing and less on solutions.

The limitations in the ecosystem (exchanges, platforms, brokers, market-makers, advisors, equity research) necessary both for the development of SME equity finance and the maintenance of liquidity in such markets can definitely be named as impediments. Having said that, those are technicalities that can be resolved quickly by market forces, given sufficient investor interest in allocating to this segment. It appears to be a chicken or egg situation, but it isn’t. If investors are intrinsically motivated to seeking exposure in SME equity investments, the supply side will follow.

Let me focus on a more fundamental driver of an investor´s motivation to ensure a sustainable flow in SME equity investments: cultural change.

In my FRT contribution I highlighted the lack of a risk equity culture across Europe as an important obstacle. In Germany, only 13,8% of the population invests directly (7,1%, 2013) or indirectly via funds (6,7%, 2013) in listed equity securities. Compared with around 50% in the US (45% in 2008, ICI Survey / 52% in 2014, Gallup Survey). Both the US and Germany saw a slight deterioration in equity ownership from 2000 until today, explained by the long-term effects of the dot-com bubble during the 2000s and the pro-cyclical behaviour of retail and institutional investors, leading to a reduction in their exposure caused by the Great Recession.

On top of shying away from the volatility in asset pricing, equity exposure in Germany is significantly linked to the educational attainment of the individual. In 2013, investors with vocational baccalaureate diplomas achieved an exposure of 25,9%, with secondary school leaving certificate only 11,8% and secondary modern school qualification alarmingly 6,5%.

How to reverse this trend of sinking equity ownership in Germany and neighbouring countries? By reframing the question. Let’s analyse what drove the rise of equity owners in Germany from 3,9 million (1992) to 6,2 million (2000) and back to 4,5 million (2013). Two main factors can be named for the rise: pro-equity friendly sentiment in politics; and accessible home bias led to a low entry barrier for investors.

The dot-com bubble burst deformed the first. Since then politicians harvest low hanging populist points by stigmatising equity markets as too dangerous to get exposed to. The Great Recession acted as reaffirmation of their convictions. Some even enacted policies to forcefully dry up market liquidity as seen in Austria with its stock exchange tax.

The dot-com bubble also caused millions of Germans to divest their home bias. Home bias is a well-researched cognitive dissonance in behavioural finance, driven by both rational and irrational factors. Local bias in SME investments is driven by pride of local ownership; ambiguity aversion (investors are more likely to choose an option with known risks over unknown risks, and with fewer unknown elements rather than many); identification with product, service or entrepreneur; reduced information asymmetry through local knowledge.

Sourcing information globally on listed companies works well thanks to its digital distribution, identifying yourself with them doesn’t. Investors reject exposure to risk if they cannot judge the situation, or do not know the relevant risk drivers. This behavioural pattern can be traced back to the individual’s need for control (as von Nitzsch points out).

The affinity to an equity home bias for both institutional and retail investors can be used as entry point for changing the lack of equity culture in Europe.

The same cultural change was needed in Europe for SME debt financing. For corporate debt markets it needed the Great Recession and banks unwilling to or incapable of lending to trigger the change. Since then, starting with large corporations, a trickle down effect is starting – see German “Mittelstandsanleihen” and their friendly welcome by investors. In short, cultural change is possible.

A potential trigger for cultural change in equity markets can be found in the ongoing financial repression and negative interest on savings accounts. Less a carrot, more a stick.

In my profession as asset allocation advisor, I cannot recommend a home-biased portfolio as being well diversified. Scientific evidence opposes this view. My point is to only use this bias as an entry point for inducing cultural change. It needs to be followed by a further increase in sophistication levels of market participants, enabling them to properly invest in a risk factor diversified, global, multi-asset portfolio.

Which leads to my second FRT contribution, namely on calling for increased education regarding equity investments for all market constituencies (SMEs, individual investors and advisors alike). Only increased levels of sophistication allow a responsible extension of alternative equity financing options in the ecosystem – see the delicate, little plant called “crowdinvesting” for example.

As cultural changes and educational effects only pay a dividend in the medium term, I suggested at the FRT to leverage the activities of an existing EU institution, namely the European Investment Fund (EIF).

It acts under the umbrella of the European Investment Bank (EIB). The EIF is a specialist provider of risk finance to benefit SMEs across Europe, including equity financing via more than 350 privately managed private equity funds. Its equity activity encompasses the main stages of SME development. In total it runs a book of EUR 5.6 billion in outstanding commitments, leveraging EUR 20,7 billion from other investors. In 2013, the EIF committed EUR 1.5 billion to mobilize EUR 7.1 billion in other resources.

In its announcement of a EUR 300 billion stimulus package for EU28, the Juncker commission should increase the EIF allocation power by a multiple. Positive real economic effects are guaranteed.

Useful links

OECD work on financial markets

Financial Market Trends OECD Journal

Small firms are bigger than you think

The world's biggest employer started here
The world’s biggest employer started here

Today’s post is by Chiara Criscuolo of the OECD’s Science Technology and Industry Directorate.

In September last year, Universum Global published a list of the world’s 50 most attractive employers in business and engineering, based on a survey of 200,000 students. Well-known multinationals top the list, since they seem to respond best to the students’ desire for market success, professional training and development, and secure employment. As Universum CEO Petter Nylander says, “This might come as a surprise as there is a view of Gen Y valuing more corporate social responsibility, a friendly work environment and flexible working conditions”.

Another surprise would be if they all got hired by their favourite firm. Google, Coca-Cola, Ernst & Young and the rest are certainly huge companies, but if you have a job, the chances are you work for a small or medium-sized enterprise (SME). SME’s employ 63% of the workforce in OECD countries and they are also the source of much turbulence: they contribute for three-quarters of total job destruction as well as job creation, according to new data from the OECD’s DynEmp (Dynamics of Employment) project.

With employment high on the agenda of governments everywhere, we looked at which firms were the ones creating those jobs to see what lessons we could learn from the successes and failures.

The full results are in a report we’ve just published, The Dynamics of Employment Growth: New Evidence from 18 Countries, but one of the most interesting trends to emerge is thatyoung SMEs (firms no more than five years old) have been the most dynamic job creators over most of the past decade and across the 18 countries we analysed. These firms only represent on average 17% of employment, but they contribute more than twice as much to job creation (42% of the total). Of course not all young firms survive and not all the jobs created are “permanent”. However, young SMEs account for only 22% of all job destruction, making them net job creators. This was the case even during the Great Recession, despite the fact that younger firms were hit harder than older ones.

Micro start-ups are particularly dynamic, and a small number of them far outperform all other firms in their category. While only 5% of micro start-ups overall grow to employ more than 10 workers after 3 years, this small minority accounts for 37% of all jobs created by micro start-ups.

Our findings on the importance of young firms are encouraging, but there is some bad news in the report too. While young SMEs “punch above their weight” as far as employment creation is concerned, the share of start-ups has been steadily decreasing over the past decade. This is in line with recent evidence from the United States that pointed to a significant decline in business dynamism over the past 30 years.

In a dynamic economy, the disproportionate contribution of young firms to job creation is a reflection of what’s sometimes called the “up-or-out” dynamics. Young firms either go “up”, resulting in higher than average growth rates after they get started, or they go “out”, with the entrepreneurs responsible perhaps re-emerging with a new start-up soon afterwards.

But this varies widely across countries, with some characterised more by “stay-and-stall” rather than “up-or-out”. For example, when you compare the situation internationally, the size of start-ups when they enter the market is much the same (although there are some differences of course). But after a few years, we begin to see a significant change, and it’s the change in the size of firms over time as they evolve from start-up to young firm to older business that explains the differences between countries. For example, an older manufacturing business in France is half the size of one in the US on average, even though start-ups in France are somewhat larger than in the United States.

Young firms are more likely to experiment with disruptive technologies and business models and this experimentation may be particularly important during periods of extensive technological change, when the success of new business models and applications may only become apparent through testing in the market. We used firm-level data from different countries to examine the extent to which innovative firms (firms seeking patents) attract the resources they need to implement new ideas and bring innovations to market. Despite concerns about the decline in business dynamism mentioned earlier, the extent to which capital flows to patenting firms in the United States is twice as large as in France and Germany, and four times as large as in Italy.

Government policy can play a role in encouraging start-ups to experiment and grow, but it can be hard to get the right balance between the interests of the various actors involved in creating and promoting young firms. For example, lenient bankruptcy regimes enable firms to experiment with risky technologies, but if creditors feel they are too exposed to risk they may not be willing to lend money. There can also be unintended consequences of what seems a good policy at first sight. The most striking example is generous fiscal incentives such as tax breaks to encourage R&D. You would think this would help boost dynamism, but in fact such incentives are correlated with less dynamism in R&D intensive sectors, suggesting that R&D fiscal incentives may protect incumbents and slow down the reallocation of resources towards more innovative entrants.

Practically all the companies that attracted students in Universum’s survey were SMEs and start-ups at one time, some only a few decades ago. In the next phases of our work, we’ll analyse in more detail how national policies and other factors affect entrepreneurship, experimentation and the growth of firms. We’ll also try to gain a better understanding of the link between employment dynamics and economic growth and productivity.

Useful links

Cutting the Gordian knot in SME financing: the power of information

Click to see the Financial Market Trends journal
Click to see the Financial Market Trends journal

On April 3rd, the OECD Financial Roundtable (FRT) dealt with SME financing beyond traditional bank loans, emphasising the role of securitisation, private placements and bonds. In today’s post, Marcus Schuller of Panthera Solutions gives us his personal view on the meeting in this article we’re co-publishing with Panthera.

The crisis saw traditional channels of credit for SMEs drying up or becoming restricted. Deleveraging became the order of the day for governments, consumers and banks. And yet, although many SME managers think that banks won’t lend to them, a recent ECB/EC SME survey suggests that nearly two-thirds of SMEs in the EU who applied for external finance got everything they applied for. The actual bottleneck comes from increasing interest rates and even more so increasing non-interest related costs (fees, charges, commissions) which make bank loans increasingly unattractive for SMEs.

Non-bank financing alternatives need to be strengthened

So what alternative financing sources are available?

In Europe, short-term options are limited due to the missing culture of direct market financing. Bank loans account for around 50% of firms’ external financing, whereas in the US, around 80% of firms’ financing comes from capital markets (equity and debt securities). Therefore SME financing in Europe via private placements or corporate bond issuances is unknown territory for many. The German Mittelstand tries to change this by placing an increasing amount of corporate bonds (Mittelstandsanleihen) especially in the retail segment. Since 2010 about 150 issuances worth EUR 7.26 billion were offered, of which EUR 5.77 billion were placed. At a first glance, it looks like a success story. However, as this market segment lacks transparency, standardisation and creditor protection, we have seen retail investors being burnt. Almost every tenth issuer has defaulted by now, although for most of the bonds, repayment will only kick in in 2015. In short, the worst is yet to come.

Which leads to a first insight into SME financing: it lacks of standardisation. SMEs are difficult to analyse due to their heterogeneous character. Small companies have different needs than medium-sized ones. Financing differs strongly between sectors and countries.

False promises of securitisation?

No wonder the large banking institutions were lobbying strongly at the FRT for an instrument they know very well how to make money with, namely securitisation. Securitisation is the practice of pooling various types of contractual debt and selling it in various forms to investors. In theory, this sounds like an elegant solution for all parties involved. But if the term “securitisation” is now known outside specialist circles, it’s because of the disreputable reputation it acquired during the Great Recession.

The representative of a large banking institution at the Roundtable didn’t see it like this, arguing that the bad reputation was due to a conspiracy of governments and regulators, driven by a “hostile sentiment”, and that securitisation did not contribute to the severity of the Great Recession.

Others may be more persuaded by what happened to subprime mortgage securitisation, or the numerous SEC mortgage fraud settlements with large banking institutions. Thanks to the settlement culture, especially in the United States, no institution had to admit any intentional wrongdoing, which makes their claim to have changed for the better not necessarily trustworthy. To be clear, securitisation is not harmful per se. It has been misused.

If we should ever again consider securitisation as part of the solution and not the problem, investors need better tools to distinguish good products from bad. In recent years, regulators and the more reasonable industry representatives have worked on those tools. Several financial regulations and other initiatives have already been implemented in the EU. Only days after the OECD FRT, the Bank of England and the ECB published their joint paper on securitisation.  The paper supports strongly the value of high quality securitisation.

Could the securitisation market in Europe be large enough to solve SME financing issues? The outstanding amount of asset-backed securities (ABS) in the EU is currently about EUR 1500 billion, or around one quarter of the size of the US ABS market. Since its peak in 2009, the outstanding amount has decreased by half, to EUR 750 billion. Apart from investor-placed issuances remaining far below pre-crisis levels, secondary market activity is thin in many segments.

Residential Mortgage Backed Securities (RMBS) form by far the largest securitisation segment, accounting for 58%; SME ABS are second, but account only for 8 % of the market. The SME ABS market volume stands at EUR 120 billion. In comparison, for the EU as a whole, the aggregate volume of credit supplied to non-financial corporations was close to EUR 6 trillion in 2011. Even with the exact amount lent to SMEs remaining unknown, it is obvious that SME ABS will not be strong enough to substitute for impaired lending channels all alone.

Information is power

Instead of elaborating on available alternatives like private placements, corporate bonds or shadow banking options (crowd-investing, SME financing via hedge funds, etc.), I sensed the necessity during the FRT to highlight a prerequisite before alternative sources can be considered. In my experience SME managers and owners are experts in their field, but not in corporate finance. They don’t know the technical vocabulary and lack knowledge about available alternatives.

And although banks like to talk about servicing clients in advising them on financing, information asymmetry between the bank and an SME representative puts the latter at a disadvantage. By not asking the right questions and not knowing the limits in negotiations, the agreement automatically favours the bank. SME managers and owners need to be supported by independent advice, no matter if it is coming from the regulator or an independent market participant.

In short, educate and empower the SME entrepreneur and manager. If this succeeds, financing options will become significantly more diverse. The single offering, be it a bank loan or something more sophisticated, will have to compete with viable alternatives. Like that, market forces on relatively level playing fields would take over again. A solution that is as desirable as it is sustainable.

Useful links

SMEs and the credit crunch: Current financing difficulties, policy measures and a review of literature Gert Wehinger Financial Market Trends (OECD journal), March 2014

Financing SMEs and entrepreneurs 2013: An OECD scoreboard

OECD work on SMEs and entrepreneurship

OECD work on financial markets