Economics 101: What SMEs need if they are to flourish in the Gulf

As sources of innovation, smaller companies are a vital component in the food chain of economies throughout the GCC. But for them to prosper, current restrictions and regulations must be examined – in some cases perhaps overhauled entirely.

All economies require a blend of SMEs and corporate behemoths to thrive. Ravindranath K / The National

Small and medium-sized enterprises (SMEs) are a critical component of traditional economies, accounting for about 65 per cent of jobs in the OECD member nations and representing a key source of innovation. In the GCC, they employ a much lower percentage of the workforce (60 per cent in Saudi Arabia, 43 per cent in Oman, and 20 per cent in Qatar), with a disproportionate representation of cheap foreign labour, and their contribution to innovation is almost nil. Why is this the case?

All economies and workforces are inherently dynamic – tastes, global commodity prices, technology, and labour skills are all constantly changing. While big companies have the financial means to adapt to these changes swiftly, they suffer from an administrative sclerosis that makes them unresponsive to the market.

In particular, protecting shareholder rights in large organisations necessitates the establishment of cumbersome decision-making processes that emphasise transparency and contain many checks and balances, turning even trivial decisions, such as changing the lunch menu in the corporate cafeteria, into yawn-inducing bureaucratic nightmares.

Small companies often centralise authority into a handful of people at most, rendering decisions almost instant, helping them to swiftly adapt to new consumer tastes, and rapidly adopt new production processes. Moreover, because the chief executives are so close to the front line, they are well placed to anticipate changes and to innovate preemptively.

The difficulty of securing finance and the frequency of errors made on the cutting edge means that a majority of new start-ups fail to transform into sustainable enterprises. However, the successful ones are critical in helping the economy to adapt, as in the case of many innovations, it is easier to get existing companies to go bankrupt and get replaced by newer ones that appreciate the new technology than it is to try to get the rigid incumbents to adapt directly (e.g. MySpace and Facebook).

All economies require a blend of SMEs and corporate behemoths to thrive. And while the stability of a job in a large organisation is attractive to most workers, for many the excitement and potential riches associated with small companies ensure that there is a healthy supply of entrepreneurs to establish and operate SMEs.

In the GCC, SMEs make a modest contribution to the economy, especially in the employment of nationals, and only rarely do you hear about a GCC start-up delivering innovations that form the basis of a company that can compete globally. The GCC countries’ efforts at transiting to knowledge economies are unlikely to bear fruit unless SMEs expand their contribution to employment and innovation. What accounts for their underperformance?

The biggest reason is the public sector, which strips SMEs of the supply of entrepreneurs and employees. In particular, GCC public sectors typically employ over 80 per cent of nationals, and pay them wages that far exceed the amount that could be earned in the private sector given workers' skills and qualifications, partially out of a desire to provide comfortable lives for their citizens.

The result is that those who would otherwise be innovative and determined enough to be entrepreneurs opt for the comfort of a government job. Moreover, the ones who maintain the drive to establish their own start-ups find that they are priced out of hiring non-entrepreneurial nationals by the luxurious work conditions in the public sector.

Beyond this, GCC entrepreneurs often find that learning how to secure lucrative government contracts is a far quicker route to riches than the toil of developing cutting-edge technology that contributes to new products and production processes.

This is why GCC exports are even more reliant on petrochemicals than the local economy is – competing in global markets where producers are stripped of the advantage of physical proximity to buyers requires higher degrees of innovation than serving domestic clients.

Admittedly there are other barriers to SME growth, such as financing problems, and the need to develop more educated labour forces. However, most of these problems exist across the entire world; it is in the size and generosity of the public sector that the GCC distinguishes itself globally. Next week, we explore potential remedies.

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