There is no single or simple solution to ensure SMEs benefit from regional integration schemes – ASEAN economies need to fix key productivity, regulatory, infrastructure, and financing gaps.
Co-written by Madeline Dumaua-Cabauatan
ASEAN’s small and medium-sized enterprises (SMEs) could be in trouble. The ASEAN Economic Community (AEC) is gearing up following its establishment in December last year, while the Regional Comprehensive Economic Partnership (RCEP) may become effective within a year or two. However, right now most SMEs in the region are unprepared for the new business realities of these landmark pacts.
The AEC means an integrated market and production base of over 620 million people, which could expand to over 3 billion through the RCEP being negotiated between the 10 ASEAN member countries, Australia, the People’s Republic of China, Japan, India, the Republic of Korea, and New Zealand.
Both the AEC and the RCEP bring significant opportunities for ASEAN’s SMEs to realize economies of scale in production and marketing, import inputs cheaper than before, to supply to global value chains, and participate in services and the digital economy.
At the same time, though, most SMEs will face more intense competition from cheap imports and the entry of large multinational corporations, potentially murky non-tariff measures, and the pressure and cost of conforming to new trade rules and higher technical standards.
Meeting the higher price, quality, and delivery standards is fundamental to the success of ASEAN’s millions of SMEs. But it is also key to the ASEAN’s long-term economic growth and poverty reduction; SME’s make up around 96% of registered firms and employ 62% of the labor force within ASEAN, but contribute only 42% of economic output.
The experience of regional industrial powerhouses like Japan, Korea, and Singapore provide some clues on how to help SMEs reach their potential.
First, boost the productivity of SME workers. According to Canada’s Conference Board, average labor productivity—measured by GDP per person employed—in ASEAN in 2015 was equivalent to only 31% of US labor productivity. There is notable variation – Singapore’s is 112%, Thailand’s is 25%, Myanmar’s is 8%, and Cambodia’s is 5%. Training within the firms themselves would help boost labor productivity to levels needed to become suppliers in global value chains. While ASEAN has an ample supply of primary and secondary school-educated workers, few SMEs invest in specialized technical training for their workers, and large firms rarely provide training for their smaller suppliers.
An interesting exception is Denso, a Japanese supplier of parts and components for the automotive industry, which in 2005 set up the Y200 million ($1.89 million) Denso Training Academy in Thailand. This academy has helped create a pool of skilled engineers and workers for Thailand’s automotive industry. For governments, providing tax breaks for technical education and attracting training-minded multinationals would encourage this.
Second, streamline regulations. SMEs in many ASEAN economies are hampered by cumbersome business requirements including for setting up a company. World Bank data show that an average of 47 days is required for the 13 procedures needed to start a business in Indonesia and 73 days for 6 procedures in Laos PDR, compared with just 3 days to complete 3 procedures in Singapore where online electronic applications are made to a single authority. There are, clearly, notable time—and cost—savings from using Singapore-style streamlined business regulations and processes. SMEs could benefit further gains from simplified customs procedures, tax administration, and local government regulations.
Third, raise spending for physical and IT infrastructure. Modern, high-quality cross-border roads, railways, and ports would help SMEs better link to suppliers and customers as well as facilitate easier flow of workers within ASEAN. Investment in Internet and digital infrastructure is central to the development of services, e-commerce and the software industry, with a strong SME presence.
Improved infrastructure would provide significant cost savings for SMEs with limited financial and other resources. The Philippines, for example, has emerged as a global center of business process outsourcing, with SMEs playing a strong role. This is partly due to a ready supply of English-speaking graduates as well as tax and fiscal incentives, but above all good-quality IT infrastructure. ADB estimates that $100 billion is needed annually for infrastructure investment in ASEAN economies, but actual spending is about half this figure. Public-private sector partnerships are one way to draw in infrastructure financing.
Fourth, boost financial access. SMEs typically have little start-up capital and are underserved by the banking system. According to the International Finance Corporation, the estimated credit gap for SMEs in ASEAN is as much as $12 billion in Indonesia and Thailand each, $8 billion in Malaysia, $4 billion in Viet Nam, and $2 billion in the Philippines. Spurring the entry of reputable foreign financial providers, stock and bond market development and better regulation of commercial banks is vital to increase the supply of SME finance. Complementary measures include the introduction of better credit rating systems, expansion of partial credit guarantees, alternative collateral schemes, and financial education.
There is no single or simple solution to ensure SMEs benefit from the AEC and the RCEP; rather it is a case of ASEAN economies going back to basics to fix key productivity, regulatory, infrastructure, and financing gaps.
Madeline Dumaua-Cabauatan is a consultant with ADB’s Economic Research and Cooperation Department.