Market selection and the role of SMEs
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The previous chapter highlighted the importance of competition in spurring restructuring, innovation and growth at the enterprise level. Achieving these dynamic benefits from competition is fundamental to a successful transition, but in many countries they have not yet been realised. Competition not only encourages existing firms to innovate and adapt to changing market conditions, it also brings about appropriate selection of producers in the market, weeding out inefficient firms and rewarding efficient firms that innovate and take risks. But how well has this process of market selection worked in practice across transition economies? In particular, what have been the important factors influencing the closure or downsizing of existing firms and the establishment and expansion of new ones? This chapter seeks to answer these fundamental questions.
For new enterprises to enter the market and expand, the business environment should not impose barriers that prevent enterprises from responding to changing consumer demands and the introduction of new technology. A significant obstacle to entry, particularly in transition economies, can be the continued presence of nonviable firms in the market, often made possible by the persistence of soft budget constraints and other discriminatory policies. Uneven advantages for some favoured existing firms can significantly distort the functioning of markets and dilute the potential benefits of competition. It is therefore as important to facilitate the closure or contraction of inefficient firms as it is to allow expansion by the new private sector, particularly new business start-ups. Moreover, the business environment should encourage the right types of firms to enter and expand.
This chapter assesses the process of market selection that has developed across the transition economies, the factors that have facilitated or hindered this process and some policy options to improve it. The focus is on non-financial enterprises and the factors influencing their contraction and expansion. The analysis is based largely on the Business Environment and Enterprise Performance Survey undertaken by the EBRD in cooperation with the World Bank for this Report (see Annex 2.1 to Chapter 2 for a brief introduction to the survey). To supplement this evidence, existing studies of job creation and job destruction in transition economies are reviewed.
The chapter consists of five sections. Section 8.1 reports on the general process of market selection and how it varies across countries. Section 8.2 examines exit from the market (including closure as well as downsizing) by state-owned enterprises (SOEs) and looks at the connection between contraction and exit barriers. Section 8.3 examines the entry of new firms into the market, focusing on the private sector. It identifies the most important entry barriers, and examines how they affect expansion. Section 8.4 assesses the key policy priorities for competition and support for small and medium-sized enterprises (SMEs). Section 8.5 concludes the chapter.
The main findings from this analysis of market selection are that start-ups act as the main spur for employment expansion and growth, while severe impediments to efficient exit in transition economies act as a major barrier to the entry and expansion of newcomers. The analysis also highlights the significance of corruption and anti-competitive practices as the most difficult obstacles to the operation and growth of start-ups. The key priorities are to introduce policies aimed at improving the business environment and creating an even playing field for SMEs. These policies should also aim to improve competition among providers of business inputs, focusing on access to essential business services, especially infrastructure services such as telecommunications and transport.
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