The HKMA has been conducting a survey on the financing situation of small and medium-sized enterprises (SMEs) and expects to make known its findings quite soon. In this week's Viewpoint, Tony Latter, Deputy Chief Executive of the HKMA, examines the "problem" in its historical context.
Throughout most of history, economies functioned mainly on the basis of small businesses. Even when, in the more recent centuries, large corporations emerged, small firms continued to play an important role, and appeared for most of the time to prosper.
So, why is it that during the past decade or so there has been so much talk - certainly not confined to Hong Kong - about the SME (small and medium-sized enterprises) "problem"?
I can think of two reasons. One is globalisation. Traditionally, a small business might have enjoyed a near monopoly in supplying goods or services in its locality. Nowadays, ease of communication and transportation means that few can expect to be protected from competition in that way. Progressively fewer business relationships require the parties to maintain a continuing physical contact. A lower-cost rival may be no more than an e-mail away. This can be seen as presenting great opportunities for some, but it also presents challenges. Profitability is put under pressure, and the very incentive to run small businesses, at least in their more traditional mode, may have suffered as a result.
The second reason concerns expenditure on capital. But I don't mean equipment, because computers and other electronic goods, which are likely to represent much of hardware requirement nowadays, are relatively cheap. I mean human capital. Because of heightened competition, a small business nowadays needs skills in design, marketing, sales, finance, etc - aspects which may have demanded much less attention in previous generations. And these are skills which family members - traditionally a prime source of labour to small business - may not possess. Moreover, one of the paradoxes of prosperity and of our society of high aspirations is that able-bodied family members are expected to (and want to) bring in a salary rather than work virtually for free in the family business. Thus, the costs of running a small business have probably risen and the nature of those costs has changed. And it is probably more difficult to raise funding to cover staff costs than to install machinery.
Thus, there are secular forces challenging SMEs around the globe. If on to these, in Hong Kong, you superimpose conjunctural factors ?notably the level of interest rates and the reduced value of collateral (notably property) which a SME may be able to offer to lenders, it is not hard to understand why we read much about the plight of SMEs.
The knee-jerk reaction has been to look to the banks to lend more, with or without support from the government by way of subsidies or guarantees. While this may be an avenue worth exploring, such a focus misses at least half the target. Businesses require equity funding as much as loans. This is because no business can prudently afford to incur more than a certain amount of interest-bearing debt, and because potential lenders are wary for that reason too.
However, not everyone has a rich uncle to provide the venture capital to launch or expand a business. And banks should not, by their nature, be significant suppliers of equity capital, although some set up subsidiaries for that purpose. What are the alternatives?
In Hong Kong, the Growth Enterprise Market may prove an important new source of equity for SMEs, but for the bigger ones rather than for the smaller, and for those with some track record rather than for those starting up. There are also professionally run venture capital funds, but these again tend to favour the bigger and established firms; it is an understandable though regrettable fact of life that professional fund managers, because they are so painstaking in their investment appraisals, seldom consider it cost-effective to bother with relatively small investments. In the United States, "business angels" - networks of high-net-worth individuals who are willing to invest in new enterprises - have proved quite successful, but somehow the formula has not been replicated with parallel success elsewhere. Finally, in many countries there have been experiments with tax incentives for equity investors into SMEs, for start-ups or expansion, but experience suggests that such schemes run the danger of forgoing a lot of government revenue for relatively little additionality to enterprise activity.
There are many challenges here, and they are certainly not unique to Hong Kong. At the HKMA we have been talking to both SMEs and financiers in order to gain a fuller understanding of the issues. We expect soon to make known our findings - as a contribution to what may, I hope, be a continuing and informed discussion of this important subject. For the moment, however, we know of no magical solutions.
Tony Latter
Deputy Chief Executive
25 May 2000
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