Such questions as how financial mechanisms could be improved or what cost-efficient schemes could be implemented in order to encourage lending to SMEs could thus best be addressed once there is a clear picture of the role played by SMEs in an integrated development strategy. This role can differ from one country to another. Some countries (for example, Japan and the Republic of Korea) at the beginning of their industrialization process had based their strategy on the development of large industrial conglomerates. However, the role of SMEs as sub-contractors or as producers of specialized products, or even as competitors with large enterprises was subsequently recognized and particular attention was donated to this aspect. Other countries, in contrast, started their industrialization process on the strength of SMEs (which could be regrouped in a cooperative structure). These subsequently expanded and became large industrial complexes (as was the case in Taiwan Province of China). It is important to note that the distribution of finance and credit is a determinant in the shaping of these industrial strategies. Between these two extremes, however, there are other successful models of industrial development that have relied on the constitution of both large enterprises and SMEs.
Large-scale production derives its efficiency from such factors as economies of scale and improved business and production organization through the possibilities of interlocking interest in various plants and firms. In these circumstances, what then explains the strength of SMEs ? A number of factors may be cited:
(f) Large enterprises can rely on subcontracting networks with SMEs to increase overall efficiency in the whole production chain, especially as industrial competition now emphasizes non-price factors, product differentiation and creation of new products. Japanese large corporations have traditionally established such business relations with smaller enterprises supplying specialized components; other countries, such as Republic of Korea, have likewise favoured subcontracting relations on a large scale.
Alongside a "modern" small-scale industrial sector, in many developing countries micro-enterprises of the informal sector play an important role in short-term poverty alleviation and the containment of unemployment. It is often believed that this sector produces for the poor and needs much technological upgrading in order to be integrated into the formal industrial sector.
Although the role of SMEs in the development process is increasingly recognized, it is less clear why special measures should be taken to promote SMEs. In the case of micro-enterprises in the poor informal sector, the rationale for special support is obviously based on socio-economic and income redistribution considerations. It is less clear why small firms in the "modern" industrial sector deserve special promotion measures. Employment generation is not a sufficient argument: maintaining inefficient small firms to protect employment will create stagnation and retard development of the economy as a whole. The rationale for promotion of SMEs might perhaps also be based on arguments related to "infant-industry" protection and market imperfections and failures. The first argument would explain the protection and assistance of SMEs to help build up their competitiveness until they reach a self-sustaining growth level. The second argument lends support to special measures to correct market imperfections and failures (especially in capital markets), in order to reduce any bias against small-scale industry.
The heterogeneity of SMEs might complicate the design and implementation of support policies, in particular in the financing area. All types of SMEs might not respond in the same way to a set of financial support measures. It is, therefore, important to have in mind some kind of functional classification of SMEs which could be relevant for promotion policies. Furthermore, it should be noted that the small-scale industry is an easy-entry sector (barriers to entry are low, owing to low start-up capital requirements). It can therefore be prone to overcrowding (and excess capacity) a tendency that might be accentuated by support measures, thus, nullifying the impact of assistance.
Surveys of SMEs in developing countries have highlighted the problem of financing as the major obstacle for their development and expansion. SMEs have generally limited access to sources of finance, especially finance from formal financial institutions. There are myriad reasons for this:
These difficulties are compounded in countries where the financial systems are weak and capital markets nonexistent. Moreover, problems are exacerbated when tapping sources of long-term finance, as commercial banks provide mostly short-term loans while specialized institutions which provide long-term finance are scarce. SMEs, consequently, have to rely primarily on the proprietors' own resources and retained earnings to finance their operations. Money-lenders and curb financial markets often provide bridging finance, but at a substantial cost. In these circumstances, what mechanisms and policies should be implemented to enhance SMEs' access to finance from financial institutions ? In countries where the informal sector plays an important role, is it necessary to increase the linkages between the formal and informal sectors so as to improve the supply of finance to SMEs ?
However, as government resources are limited, their cost-efficient use would require that the assistance provided to SMEs be well integrated into the overall industrial policy of the country, aiming at assuring the viability of SMEs and strengthening their development. In this respect, governments needs to have clear ideas about target groups and their specific need, as well as encouraging backward and forward linkages between enterprises. The usefulness of schemes which link savings with credit supply could be further explored, especially as SMEs have amply demonstrated their capacity to save through the financing of their enterprises by their own resources.
As the economy grows and the financial system is deepened, made more diversified and competitive, SMEs' access to finance will also become easier and there will be less government involvement in enhancing this access. Efforts to develop a viable domestic financial system could yield great benefits for the small business sector in particular.