Helping small business in Eastern Europe

Since the collapse of the Communist bloc, and despite four decades in which entrepreneurship was rigorously suppressed, private enterprise has flourished rapidly in Hungary, Poland and the Czech and Slovak Republics. Central planning and the prohibition of private property seem to have been unable to destroy the entrepreneurial spirit that had existed there before the Second World War. Several lessons can be drawn from the experience of the first five years of transition.

Small and medium-sized enterprises (SMEs) have a central role to play in the transition to a market economy. The creation of entrepreneurs is fundamental to the entire process of transition. If market principles are to be anchored in the attitudes of ordinary people, entrepreneurs are role models who give practical meaning to otherwise abstract concepts. In addition, SMEs step up competition in markets, thus keeping pressure on prices and ensuring regular supply. They have considerable innovative potential which will have to be harnessed if the transition economies are to emerge from this period of restructuring and become fully competitive in world markets. Finally, the growth of SMEs helps absorb the labour shed by the shrinking public sector.

The starting conditions in 1989 in each of the four `Visegrad countries - Hungary, Poland and the Czech and Slovak Republics - had a powerful influence on the first five years of transition and on the success of policies intended to stimulate entrepreneurship. All four had a broad spectrum of activity in the black economy, ranging from the partially legal and officially tolerated to the completely illegal and covert. Hungary and Poland already had some legal private-sector activity, as a result of reforms introduced by the Communists (Table 1). In the Czech and Slovak Republics, by contrast, private enterprise held only a marginal position at the start of transition.

More importantly, these countries had a tradition of entrepreneurship dating from before the Communist period. Unlike the experience of the former Soviet Union, where the state had been directing the economy for seventy years, the history of private enterprise in the Visegrad countries was a thing of living memory, maintained by cultural and economic links with western Europe.

The number of small businesses started since 1989 has been high, but many of them fold rapidly or move out of the market again. This is not surprising: many entrepreneurs are not well versed in business management, and market conditions are often far from transparent, making it difficult to estimate demand, for example, or to obtain an overview of current and likely competition. The sectorial distribution of start-ups reflects the capacity of new entrepreneurs to overcome barriers to entry not least the extent to which high initial investment is required. The largest proportion of start-ups (between 3;% and 48% of the total) is commercial, often small retail kiosks, or services (between 20% and 25%), such as restaurants, reflecting relative ease of entry. Activities demanding higher start-up capital, such as manufacturing (between 17% and 20%) and construction (between 9% and 17%), account for much smaller shares. There is nonetheless an increasing number of SMEs in manufacturing, perhaps indicating that these countries are entering a new phase of transition: the initial over-representation of commercial activities among SMEs would seem to be an unavoidable and temporary phenomenon of transition.

Policy Tools

How should policies encourage the growth of SMEs? There are two areas for action. The first concerns the `framework conditions' for entrepreneurship: stable macro-economic conditions of growth, with low inflation; a clear and enforceable legal framework; the privatisation of state enterprises; minimum bureaucracy; little corruption; competitive market conditions; no subsidies for large public enterprises; well-balanced social and fiscal laws; good infrastructure; and the availability of appropriate human resources.

The second area for policy involves more direct instruments to promote SMEs: loan and guarantee programmes; interest-rate subsidies; employment subsidies; tax relief; equity programmes and grants; training, advice and consuiting; information offices; industrial parks and business incubators; and regional-development agencies.

It is clear that these direct tools are interdependent and their impact closely linked to the framework conditions. Efficient SME policy has, therefore, to take all these factors into account. So how have the two categories of policy been implemented? As a first step, in all the Visegrad countries attempts have been made to give an institutional base to entrepreneurship policy and political responsibility for SME development. Departments have been created in ministries of economy and of industry and trade to draft legislation for SME promotion, co-ordinate with other ministries on relevant policies, and to establish an infrastructure for entrepreneurial development.

But these departments mostly come low in the ministerial hierarchy and face fundamental difficulties in co-ordinating activities in other ministries, a situation exacerbated in the past by frequent changes of staff and of ministerial responsibility. Nevertheless, there are now signs of improvement as departments become more stable.

Framework Conditions

The framework conditions for successful entrepreneurship have often been overlooked in national strategies to promote SMEs because of problems of co-ordination both inside government and with the private sector. Those responsible for SME development now understand this link better and see their role as that of an agent of change, convincing and co-ordinating other players, such as ministers of finance, regional governments and so on.

But there are still a number of aspects which retard SME development. Contract and bankruptcy laws have been designed, yet it is still difficult for SMEs to collect their dues through state enforcement mechanisms. Taxes and social-security contributions are other areas for possible improvement, although constraints on public budgets have to be taken into account. The banking system remains far from being the financial intermediary necessary for comprehensive SME development and the micro-adjustment of this sector still requires considerable time and effort. And two other elements are essential: selfhelp organisations for private business and SMErelated vocational training.

Chambers of commerce and self-help business associations assume an important role in the transition from a planned to a market economy. Ideally, they serve as a source of information and services and fulfil an important lobbying function by giving SMEs collective weight with which to protect their interests against government and large industry. But in spite of wide agreement on their desirability, none of the four countries yet has a comprehensive network of self-help organisations strong enough to make a direct impact on SME development.

Funding and credibility are central problems in setting up such organisations. Many of the organisations are successors to former Communist chambers of commerce and find it difficult to win the confidence of private entrepreneurs. Moreover, the abolition of compulsory membership of the bodies that do exist in the Czech Republic, Hungary and Poland has limited the services that chambers can offer and they are thus less attractive to entrepreneurs. Business associations - where membership is generally voluntary - face the problem of fragmentation. with a large number of small and often competing associations, most of which lack the political clout to influence government decisions.

Education, vocational and entrepreneurial training tend to be neglected in SME policy since most of the benefits are long-term and because SME issues are still of little interest to ministries of education. The Communist education system was characterised by values largely incompatible with the requirements of SMEs in a market economy. And it seems still that the public education and vocationaltraining system has not taken into account the new requirements of the market economy, particularly those of SMEs. Public vocational training is not yet directly linked to the enterprise culture and it is facing considerable funding problems, with the result that teachers are badly paid, learning materials are obsolete and machinery defective. Increasingly, qualifications for entrepreneurs and managers are offered by private suppliers. Here one can observe an enormous diversity in quality which the users find difficult to assess. Unfortunately, the market for private entrepreneurial training is still in its infant stages indicating that low-standard institutions of further education are not yet being driven out of the market. Unfortunately, the self-help organisations, those best placed to take over some kind of quality-control for such services, are not yet able to do so.

Direct Instruments

There have been numerous initiatives, both public and private. to set up nonfinancial services for new businesses and existing SMEs, frequently offering advice, counselling and training for would-be entrepreneurs on such topics as finance, marketing and managing human resources. Many of these services focus on helping entrepreneurs apply for financial assistance (for example, by drawing-up business plans, cash-flow analyses and credit requests). An overview of assistance programmes and the services of newly created business parks or incubators is also often made available.

These organisations frequently receive considerable foreign help, in the form of both cash and expertise, from bilateral donors and multilateral institutions. But in many cases the organisations took two or three years to become operational and to meet the requirements of local entrepreneurs.

The extensive use of foreign expertise was probably necessary to launch SME-related services. But, too often, western concepts - business incubators, for example - were simply copied without adaptation to local social and institutional conditions, let alone awareness of what entrepreneurs were really lacking. \Western consultants often spend fairly brief periods in the countries in transition before making their pronouncements. Co-operation and the transfer of experience between western and local consultants has not been sufficiently promoted, an oversight that is now becoming increasingly apparent.

Preferential loans and credit guarantees have been used in the design of many SME programmes, since most private banks in the countries in transition require 200-300% collateral from SMEs applying for credit. But even with a range of programmes offering advantageous credit terms, the number of SMEs receiving support is still low (Table 2). Figures for start-ups from scratch are even lower (at around 2%), since most of the support reaches the longer-established medium-sized enterprises, those created through privatisation. Major international funding organisations tend to invest in mediumsized companies or infrastructure projects, rather than to lend money to small business. Moreover, applications for financial support from local programmes are often bureaucratic and protracted, preventing credit reaching the very entrepreneurs who could use it most effectively those who can afford the delays and cope with the red tape are probably able to find funding elsewhere.

Some types of tax relief can also be seen as a financial tool that directly supports SMEs. In the four Visegrad countries, the most generous taxbreaks have been allowed to boost exports, for SMEs in less-developed regions and to stimulate job-creation. But there are no general tax-breaks for SMEs. The importance of fiscal stabilisation may counsel against comprehensive tax breaks; yet the extensive black market suggests that the present heavy burden of corporate, income and payroll tax is a disincentive to entering the official economy.2

There are clear lessons from the first five years of transition in the four Visegrad countries. Higher priority in national strategies should be given to SME promotion if it is to make a real impact on their development. Political instability and changing responsibilities hinder the national implementation of coherent SME policy. Regional aspects of SME development and related policies are critical for successful development as a whole. More coherence is necessary, not only nationally, regionally and locally but also between the ministries and agencies concerned with entrepreneurship promotion.

SME development is still impeded by a number of adverse framework conditions, not least in fiscal policy. education and training policy, subsidies for large enterprises and competition policy. Lastly, increased monitoring and evaluation are required. Programmes are often designed, and redesigned, and redesigned, without sufficient knowledge of what would really help entrepreneurs.

1. Small Business in Transition Economies, OECD, Pans. 1996 available free of charge from the CCET section of the OECD Territorial Development Senice.

2.David Holland and Jeffrey Owens, Tax. Transition and Investment; The OECD Observer. No. 19, Al pril/ MaY 1995.

Martin forst works in the Programme onLocal Economic and Employment Development (LEED) of the OECD Territorial Development SErvice.

Copyright Organisation for Economic Cooperation and Development Feb/Mar 1996
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