Aid providers seeking to promote employment often target their aid towards small and medium-sized businesses. This is because, globally speaking, these firms are responsible for a large part of employment in the formal sector, in low-income countries their share of employment is nearly 80 per cent. Due to the high failure rates and low wages of small and medium size enterprises (SMEs) focusing on them may not be the most productive use of aid and firm size alone is too crude a measure to be of much use to policy makers. A better alternative would be to use aid to promote the growth of firms of all sizes.
Aid and small and medium-sized enterprises
At the end of 2010 the total commitments of multilateral development banks, bilateral donor agencies, and development finance institutions to support SMEs totalled around US$ 24.5 billion. This attention is seen as warranted both because SMEs are responsible for a high percentage of jobs in low-income countries, and because they generate a large number of new jobs. When SMEs are defined as firms with less than 100 employees, then they account for around 50 per cent of employment and firms with 5-19 employees generate a disproportionate 47 per cent of new jobs in the region.
The belief in the importance of SMEs then, is not completely unwarranted. However there are two potential problems that much of the existing literature on jobs and job creation does not address; firm survival, and the quality of jobs. Evidence from enterprise surveys of nine African countries, as well as panel data of Ethiopia shows us three key things about the role SMEs play in creating new jobs and providing quality jobs.
The positive and negative sides of SME job creation balance each other out
If SMEs survive, they tend to grow faster than larger firms and therefore create more jobs. However SMEs have a higher failure rate than larger firms. These two effects roughly balance each other out; consequently the expected rate of growth is similar between SMEs and larger firms.
Larger firms provide better job security
Larger firms are more stable and less likely to fail. Due to this higher survival rate larger firms offer much more job security than SMEs.
Larger firms provide better wages
In fact larger firms provide significantly higher wages. A firm 10 per cent larger than another will typically provide wages that are 2.9 per cent higher. Part of this discrepancy is due to higher worker skill in larger firms, but it is...