Can Transition Countries on the Western Balkan utilise the momentum of SMEs to facilitate economic growth?

Evidence from Serbia

Term Paper, 2018

33 Pages, Grade: 1,7


Table of Contents

1. Introduction

2. SMEs as drivers of economic growth
a. What is an SME?
b. What iseconomic growth?
c. Economic growth and economic development
d. Why are SMEs important to economic growth?

3. Serbia as the economic engine on the Western Balkan
a. Current economic situation
b. Serbia's EU relations
c. SMEs in Serbia

4. The success ofthe Baltics
a. Economic development since 1991
b. SMEs in Estonia

5. SME supportingpolicies
a. SME policies ofthe European Union
b. SME policies in the Baltics
c. SME policies in the Western Balkan countries

6. Are the Baltics and the Western Balkan comparable?

7. Conclusion

8. Bibliography

1. Introduction

Small and medium sized enterprises (SME) represent 99.8% of all businesses in the European Union (EU), provide two-thirds of the non-financial sector employment and account for 85% of the new jobs created in the past five years (European Commission, 2018a). Looking at the other side of the Atlantic, the situation is not very different: in the United Stated of America (USA) SMEs account for 99.7% of all firms and 48% of total private-sector employment (United States Census Bureau, 2016). It is fair to say that SMEs are the backbone of the two largest economic areas of the world.

Considering the enormous share that SMEs have in these economies, it becomes clear that the success of an economy largely depends on the development of its SMEs. This paper aims at examining the impact of SMEs on the development of economies in transition. Specifically, the transition countries of the Western Balkan (Albania, Bosnia and Herzegovina, Montenegro, Serbia and The Former Yugoslav Republic of Macedonia (FYRM)) (United Nations, 2017) will be subject of this paper. Due to the limited word count, Serbia will be used as example since it is the largest economy in the region (OECD, 2016). The question to be answered is: "Can transition countries on the Western Balkan utilise the economic momentum of SMEs to facilitate economic growth? Evidence from Serbia".

In order to approach the above question, this paper will

- present how SMEs benefit the economy and whether SMEs can be politically fostered,
- provide information on the current political and economic situation in Serbia,
- take a look at Estonia as an example of successful post-communist economic development,
- undertake a brief examination of SME policies in Estonia and the EU,
- analyse whether Serbia has the potential to copy the success of Estonia, and
- state whether SMEs in Serbia are strong enough to significantly boost the local economy.

In his State of the Union Address on 13 September 2017 the President of the European Commission Jean-Claude Juncker confirmed that "if we [the EU] want more stability in our neighbourhood, then we must maintain a credible enlargement perspective for the Western Balkans" (European Commission, 2017f). As the option of a Turkish EU accession has become unlikely for the foreseeable future, the countries of the Western Balkan have increasingly gained attention in the past year. Surrounded by EU member states the region is a natural candidate for the European enlargement programme. Although at different progress levels, all countries of the Western Balkan are either EU membership candidates or potential candidates (European Commission, 2017e).

Prospective EU membership candidate countries are required to fulfil basic political and economic criteria accompanied by reform measures in order to officially gain candidate status. Those criteria will be extended as soon as the country enters accession negotiations (European Commission, 2017e). Specifically, the candidate is expected to have a "functioning market economy and the capacity to cope with competition and market forces" of the European single market (European Commission, 2016a). As presented above, the European economy mainly consists of SMEs which indicates that a strong SME sector is advantageous in terms of EU accession. Therefore, a candidate has to have SMEs at EU- level in order to successfully cope with enhanced competition after EU accession. Consequently, understanding the role of SMEs in the Western Balkan countries is vital to understand the economic conditions that determine the success of EU enlargement efforts.

2. SMEs as drivers of economic growth

a. What is an SME?

The EU recommendation 2003/361 defines staff headcount as well as either turnover or balance sheet total as determining factors in order to identify SMEs (European Commission, 2003). Specifically, the European Commission considers enterprises medium­sized or smaller if they employ up to 250 people and turnover is at €50m or lower or balance sheet total is no more than €43m (European Commission, 2003).

The North American Industry Classification System (NAICS) uses a different approach to define SMEs. Businesses are classified according to their staff headcount and revenue. However, SME classification differs from industry to industry. In manufacturing for example, a business is considered small as having a staff headcount of 500 or less whereas in wholesale trading the benchmark is at 100 employees (U. S. Small Business Administration, 2016). Heavy industries such as Mining, Quarrying and Oil and Gas Extraction can employ up to 1,500 people in order to be still considered a SME (U. S. Small Business Administration, 2016). Generally, the most used indicator to identify SMEs in the USA is a staff headcount off 500 people or less (Small Business & Entrepreneurship Council, 2018).

The Organization for Economic Cooperation and Development (OECD) defines SMEs as "non-subsidiary, independent firms which employ fewer than a given number of employees" (OECD, 2005). The OECD finds that "the most frequent upper limit designating an SME is 250 employees" (OECD, 2005), as defined by the EU.

As this paper deals with countries on the European continent, SMEs will be defined as businesses that employ 250 people or less.

b. Whatis economicgrowth?

Economic growth describes the quantitative expansion of a country's economy by measuring the percentage increase in its gross domestic product (GDP) within one year. (Flynn, 2013). Economic growth can be caused by two conditions: Firstly, a nation uses more physical, natural or economic resources (extensive growth) or, secondly, a nation uses its resources more efficiently (intensive growth) (Flynn, 2013). Economic growth can be absorbed by population growth. This occurs when the population growth rate is higher than the economic growth rate leading to no increase or even a decrease in per capita income (Flynn, 2013). Economic growth is generally considered a natural result of market activity (Flynn, 2013).

The economic literature knows three main waves of theories of economic growth: the neoclassical growth theory, new growth theory, and modern political growth theory (Flynn, 2013).

The neoclassical growth theory, developed by Robert Solow and Trevor Swan, is also referred to as exogenous growth model and was the dominant growth theory from the nineteenth until mid-twentieth century. The exogenous growth model considers external factors that cannot directly be influenced by politics, crucial to economic growth. These factors are constant technological progress and quantitative enhancement of a country's human capital (Flynn, 2013). The neoclassical growth theory considers technological change as a constant process that affects a country's economy as a hole, rather than being concentrated on few innovative businesses (Flynn, 2013). This constant technological change is demonstrated bythe Kondratieff cycle.

The new growth theory is also referred to as endogenous growth model and was developed in the 1980s. The new growth theory deems factors from inside a nation essential for economic growth rather than external factors. The following factors are considered relevant to economic growth according to the new growth theory: research and development, education, and human capital (Park, 2006). In connection to the new growth model, technological innovation is considered a main determinant of economic growth (Rosenberg, 2004). An influential paper by Moses Abramovitz in 1956 found that capital labour input accounted only for 15% of the economic growth in the USA between 1870 and 1950 (Abramovitz, 1956). Consequently, 85% of the economic growth are caused by other factors than capital and labour input. Therefore, it is widely assumed that innovation and technological change are main drivers of economic growth (Rosenberg, 2004).

The modern political growth theory identifies fundamental factors such as "the quality of governance, legal origin, ethnic diversity, democracy, trust, corruption, institutions in general, geographical constraints, natural resources, and connection between international economic integration and growth" (Flynn, 2013) as the determining aspects of economic growth. Therefore, a country requires a sound set of institutions in order to grow economically. The modern political growth theory considers poor countries unable to grow, although they have the potential for economic growth, as long as these states have not developed a sufficiently sound set of institutions (Flynn, 2013).

These three theories focus different fields of the economy to explain economic growth. The neoclassical and the new growth theory focus on the conditions for economic growth whereas the modern political growth theory emphasises fundamental causes of economic growth in a country (Flynn, 2013).

This paper will consider aspects of the new growth theory, especially with regards to research and innovation as well as the modern political growth theory focussing on SME supporting policies.

c. Economic growth and economic development

Although they are clearly distinctive, economic growth and economic development are strongly connected. Economic growth transforms the economic and social framework of a country whereas economic development includes the upswing of the entire social system (Flynn, 2013). These social systems describe non-economic factors such as "education and health infrastructure, class stratification, the distribution of power, and general institutions and cultural attitudes" (Flynn, 2013). Economic growth without economic development is the sole reproduction of a country's structure. As economic growth requires the development of social factors, it is assumed that economic growth cannot occur without economic development (Flynn, 2013). This definition correlates with the modern political growth theory. Economic growth is not understood as the mere increase of production factors but rather describes a process that affects both economy and society of a nation. Therefore, conditions for economic growth are not only of economic nature.

d. Why are SMEs important to economic growth?

As initially presented, SMEs account for 99.8% of all businesses in the EU, 67% of non- financial business sector employment and 85% of the new jobs created in the past five years (European Commission, 2018a). Moreover, SMEs contribute 58% of the total gross value-added in the EU. Therefore, SMEs are the cornerstone of the European economy.

The first reason why SMEs are important to economic growth is obvious. The sheer size of the SME sector makes economic growth without a growing SME sector rather unlikely.

The second reason why SMEs are crucial to economic growth lays in the flexibility of this sector. SMEs are more flexible than larger businesses to respond to changing demands and challenges (Storey & Cressy, 1995). There are two main reasons for this phenomenon. First, management structures in SMEs tend to be flat and due to their small size, most of the employees work together on a day-to-day basis (Gupta & Cawthon, 1996). The organisational culture of SMEs is coined by cooperation rather than control (Carrie, et al., 1994). Due to less complex organisation than in larger firms and close management involvement, SMEs have tight control over production and are able to quickly adjust to demand changes (Gupta & Cawthon, 1996). This flexibility in production is considered one of the main reasons for the capability of SMEs to provide their customers with new and innovative products (Gupta & Cawthon, 1996). Second, CEOs of SMEs tend to have better knowledge of the capabilities of their business than those of larger firms enabling them to utilise these capacities more efficiently (Lefebvre & Lefebvre, 1992). Moreover, CEOs of SMEs tend to have characteristics, personalities and leadership styles that promote innovativeness (Lefebvre & Lefebvre, 1992).

The third reason explaining the importance of the SMEs sector for economic growth is linked to the second one. Due to their small size and high degree of flexibility, SMEs exhibit many attributes of firms in perfect competition (Storey & Cressy, 1995). SMEs "have little power to influence market price by altering output quantities, small shares of the market and are unable to erect barriers to entry to the industry to other firms" (Levy & Powell, 1998). Therefore, the more SMEs participate in a market the better this market works. SMEs have small market power and are required to react quickly to demand changes.

The last reason why SMEs are crucial to economies is subtler. The World Economic Forum states that "SMEs are an engine of innovation" and therefore, stimulate economic growth (World Economic Forum, 2010). Although there is no general academic agreement on a higher contribution to economic growth from SMEs than larger businesses (Eurostat, 2015), most international institutions recognise the innovative strength of SMEs and therefore, deem SMEs crucial to economic growth.

In order to explain why SMEs are considered more innovative than larger businesses this paper will focus the "Knowledge Spillover Theory of Entrepreneurship" developed by Zoltan J. Acs, Pontus Braunerhjelm, David B. Audretsch and Bo Carlsson.

Technological change or innovation is a central aspect of economic growth (Acs, et al., 2009). Technological change is mainly triggered through knowledge that is based on research and development (R&D) activities conducted by either businesses or research institutions (Acs, et al., 2009). Due to broader financial and human resources larger businesses tend to spend more on R&D than smaller businesses (Audretsch, 2009). Knowledge produced by the R&D laboratory of a large firm or a university, however, does not necessarily remain in the respective organisation. Technological change is mostly ignited through an economic opportunity that lays within a new invention or idea (Acs, et al., 2009). Perhaps due to lack of entrepreneurial skills (Michelacci, 2003), this economic opportunity is not always sufficiently recognised by the organisation that financed the R&D activities (Audretsch, 2009). This unused economic potential eventually leads to a new business founded by a former employee of the organisation that came up for the R&D costs, who recognised the economic opportunity. Therefore, economic "opportunities are created when incumbent firms invest in, but do not commercialize, new knowledge" (Acs, et al., 2009). In this theory, economic opportunities lead to entrepreneurship (Acs, et al., 2009).

According to the "Knowledge Spillover Theory of Entreprenuership" newly founded businesses, which are SMEs by definition, commercialise economic opportunities, that would have been remained unused in larger firms. Therefore, these young SMEs contribute to economic growth for an obvious reason: they ensure that fruitful investments in R&D do not vanish. From a macroeconomic point of view, the economy benefits from opportunities used by new enterprises. New enterprises create jobs, contribute to GDP and pay taxes whereas unused economic opportunities in large firms, do not generate any return (Audretsch, 2009). The money invested in R&D would have been spoiled.

Moreover, young SMEs or start-ups are considered to engage more in radical innovation that larger firms do (Acs, et al., 2009). Larger firms tend to develop incremental innovation such as product improvements whereas "start-ups with access to entrepreneurial talent [...] are more likely to engage in radical innovation leading to new industries or replacing products" (Acs, et al., 2009). Especially in relatively new industries such as software, semi­conductors, biotechnology and information and communication technologies (ICT), start­ups significantly contribute to radical innovation (Acs, et al., 2009).

All in all, it can be stated that SMEs contribute to economic growth for several reasons. First, due to their large share in total registered businesses, employment and value-added SMEs are an inevitable pillar of the European economy. Second, SMEs are highly flexible to react to a changing business environment and, therefore, quickly respond to demand changes and needs of their customers. The need for constant adaption of customer needs also promotes innovation. Third, SMEs exhibit many attributes of firms in perfect competition. SMEs have little influence on prices, normally have small market shares and are unlikely to erect entry barriers. Fourth, SMEs utilise unused knowledge and economic potential of larger businesses through knowledge-spillover effects. They ensure that promising results of R&D activities are ultimately used and, therefore, fruitful investments in R&D do not vanish. Second, young SMEs or start-ups contribute to radical innovation which may lead to a new product or even industry.


Excerpt out of 33 pages


Can Transition Countries on the Western Balkan utilise the momentum of SMEs to facilitate economic growth?
Evidence from Serbia
Berlin School of Economics
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ISBN (Book)
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Balkans, Balkan, Western, Western Balkans, Western Balkan, Westbalkan, Serbia, Serbien, SME, SMEs, EU Integration, Baltics, Baltikum, Estonia, Estland, Start Ups, Economic Growth, Wirtschaftswachstum, Start, Up, KMU, Small, Medium, Size, Enterprises, Kleine, Mittelständische, Unternehmen
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Karl Luis Neumann (Author), 2018, Can Transition Countries on the Western Balkan utilise the momentum of SMEs to facilitate economic growth?, Munich, GRIN Verlag,


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