The promotion of small and medium-sized enterprises in the EU

Contents

Part 1 The Promotion of SMEs as a Part of the Industrial Policy
Chapter 1 Rationale for Industrial Policy
Market-based Industrial Policy
Interventionist Industrial Policy
Strategic Industrial Policy
Chapter 2 The Evolution of EU Industrial Policy

Part 2 The Nature of SMEs
Chapter 3 The Definition of SMEs
Chapter 4 Statistics on SMEs
Chapter 5 Conclusion

Part 3 The Promotion of SMEs in the EU
Chapter 6 The European Charter for Small Enterprises
Adoption of the Charter
Contents of the Charter
Implementation of the Charter
Chapter 7 The Multiannual Programme for Enterprises and Entrepreneurship
Contents of the Programme
The Euro Info Centres Network
The Financial Instruments
Policy Development
Evaluation of the Programme
Chapter 8 Programmes to Promote Conditions Conducive to Entrepreneurial Activity
The Entrepreneurship Action Plan
eEurope 2005 Action Plan and Go Digital

Part 4 EU Industrial Policy and the Lisbon Strategy

Abbreviations

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List of Tables

Table 2.1: Definition of SMEs

Table 2.2: Roles of SMEs, Europe-19, 2003

Table 2.3: Roles of SMEs in European Countries, 2003

Table 2.4: Roles of SMEs by sector of industry, EU-19, 2003

List of Figures

Figure 1.1: Externalities and industrial policy

Figure 1.2: Industrial policy as a means of boosting employment

Figure 1.3: The strategic case for industrial policy

Part 1 The Promotion of SMEs as a Part of the Industrial Policy

The 21st Report on Competition Policy of the EC entails a definition of industrial policy:

“Industrial Policy concerns the effective and coherent implementation of all those policies which impinge on the structural adjustment of industry with a view to promoting competitiveness. The provision of a horizontal framework in which industry can develop and prosper by remedying structural deficiencies and addressing areas where the market mechanism alone fails to provide the conditions necessary for success in the principal means by which the Community applies its industrial policy.”

This definition comprises

- general measures for the further development of the internal market (in this sense, industrial policy forms part of the general economic policy),
- external commercial policy (anti-dumping policy, bilateral and multilateral trade agreements with implications for individual industrial sectors),
- social and regional policy (when the industrial reconversion process has unacceptable social and regional consequences),
- competition policy (legal instruments for intervention in market mechanisms that are not functioning well and for monitoring state aid),
- R&D policy, and
- the strengthening of cooperation among European enterprises.

In general, the aim of industrial policy is to improve competitiveness.

The EU has been active in all these areas and has developed a variety of programmes that influence a wide range of industries. The emphasise in the EU industrial policy is especially on helping SMEs to develop, improving competitiveness in European companies, and promoting innovation and R&D among them.^[1]

Chapter 1 The Rationale for Industrial Policy

Mainly, there are three different approaches to industrial policy:

- market-based industrial policy,
- interventionist industrial policy, and
- strategic industrial policy.

Market-based Industrial Policy

If a country pursues a market-based industrial policy, it is believed that the market mechanisms are in general effective in generating an efficient and vibrant industrial structure. Intervention only is necessary in considerable cases of market failure, i.e. when there is an imperfection in the price system that prevents an efficient allocation of resources. Market failure can take the form of externalities^[2], market power^[3], imperfect competition^[4], and public goods^[5]. The most widely accepted rationale for public intervention are externalities that trigger under-provision of R&D expenditures or training for labour (see figure 1.1). With regard to R&D we can observe the so-called free-rider problem: Companies will only invest heavily in R&D if they can appropriate all the benefits of the new knowledge for themselves. Though, some of these accrue to other firms or sectors, there is little incentive for companies to produce new knowledge, as the social return on investment on R&D and knowledge creation is larger than the private return. As a consequence, there is a role for the public sector to organise publicly funded R&D or to enhance the incentives of private companies to invest in knowledge creation, for instance via the patent system.^[6]

However, there are some reservations about the ability of governments to correct market failures successfully, and some even argue that government intervention often leads to a worse outcome than that which arises from the imperfect market process. Therefore, in this approach the industrial policy is primarily negative. Consequently, competition policy, the removal of state aids to promote competitive markets, and deregulation programmes are regarded as the basis of industrial policy.^[7]

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MPB = marginal private benefit MSB = marginal social benefit

MSC = marginal social cost E = expenditure on R&D

Maximisation of net benefits is in A (the marginal cost to society of R&D expenditures equals the marginal benefits to society). Therefore, the optimal level of R&D expenditures is E2. However, if the spill-over effects of R&D expenditures (the difference between MPB and MSB) are not considered, R&D expenditures will be sub-optimal (at E1). In order to reach the optimal level of R&D expenditures, a subsidy would be necessary to compensate the company engaging in R&D expenditures for the spill-over effects.

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Interventionist Industrial Policy

This kind of industrial policy is founded on the opinion that market failure in areas like R&D and labour training are important obstacles to the development of a dynamic industrial base. In addition, this approach may be used to favour certain companies and industries. It is sometimes advocated in order to support declining industries and to avoid the loss of jobs. Furthermore, social and regional considerations are deemed to be important factors in formulating a ‘good’ industrial policy. For instance, an industrial policy that enhances the productive capacity of poorer regions or sectors of economies with success can boost employment levels and income (see figure 1.2).

The essential part of this industrial policy are positive action and financial support by governments to guarantee sufficient R&D and training expenditures and to offer aid to poorer groups and regions. In addition, this approach to industrial policy tends to see a need for intervention in a wide range of industries and sectors embracing declining as well as emerging industries.^[8]

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Figure 1.2: Industrial policy as a means of boosting employment

In (a) the level of national income (Y) is determined by national expenditure (E) at Y1.This will correspond to an employment level (with a given relationship between employment and income shown by the production function in (b)) of N1 on production function Y = f(K,L,T), where K = amount of capital, L = amount of labour, and T = state of technology. This production function is based on a fixed amount of capital and a given state of technology.

If parts of the economy have poor levels of technology because of structural deficiencies such as low skill levels in parts of the labour force, it may be possible to improve technology in these areas by use of industrial policy (e.g. help with labour training).

This will shift the production function to Y = f(K,L,T)*. In these circumstances, to produce an income level of Y1 would require employment of N2 (less than N1). Consequently, the first result of this policy would be to trim down employment. However, the improvement in technology should also initiate lower costs and therefore to lower prices for products. This will promote higher expenditure. Expenditure would shift to E2, leading to a higher income Y2. This would entail a higher employment level N3.

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Source: McDonald/Potton (2005), p. 177

Strategic Industrial Policy

This approach takes a more strategic view on industrial policy. The core role for industrial policy is to support the growth of emerging industries to replace those that are weakening. The need for such an approach arises form the imperfect nature of the competitive environment. Therefore, selective help by use of state aids can provide competitive advantages to companies. These state aids can also be utilised to help companies to catch up on foreign competitors that are established in the market (see Figure 1.3).

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Figure 1.3: The strategic case for industrial policy

P = price AC = average cost Q = quantity

If a company sets up a plant in country A with average cost given AC1, and it was the first company to produce this product, it would have a first mover advantage. The company will operate on P1:Q1 (assuming that the company sets price equal to average cost). As a result, although the company in country B has lower costs than the company in country A (AC2 rather than AC1), it will not be able to enter the market as the company in country A has a fist mover advantage. At the price P1 the company in country B cannot sell output at less than, or equal to, its average cost unless it enters the market with an output level of Q2 or above. To be able to realise such an outcome the company in country B would have to take market share from the first mover and it would make losses until it reached an output level of Q2. Furthermore, as the company in country B entered the market it would put downward pressure on the market price and would therefore worsen its position with regard to the difference between price and its average cost.

However, the government in country B could help the company to enter into the market by strategic industrial policy. Thus, subsidies could be given or other types of help to allow company B to offset the first mover advantage of the company in country A. If such help was given, the company in country B would eventually replace the company in country A with price and output given by P2:Q3. This policy would be beneficial as it would allow the most efficient producer to supply the market and increase output.

Source: McDonald/Potton (2005), p. 178

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However, this kind of industrial policy faces some difficulties. On the one hand, it may trigger retaliation from competitors, and on the other hand, it is very difficult for governments to gather and assess the appropriate information.^[9]

Chapter 2 The Evolution of EU Industrial Policy

The first treaty provision for an industrial policy was the Treaty of Paris, which set up the ECSC in 1952. The approach used was essentially ‘dirigiste’, with an active role envisaged for public intervention.

At the time when the Treaties of Rome were signed, there were substantial differences between the industrial policies of the two dominant member states, France and Germany. Whereas, the French government pursued a dirigiste policy, Germany was more inclined towards a laissez-faire regime wedded with market forces. As a result, the Treaties of Rome scarcely mentioned industrial policy. But a legal basis for it can be found in several articles. The Treaties appear to be based on a market-oriented approach: the elimination of barriers to trade was seen as the means of encouraging competition and efficiency, and the role of public intervention was to remove impediments to the functioning of the market.

In the 1960s, the market-oriented view of the role of the Community remained to prevail and in 1967 the Directorate-General for Industry (DG III) was established.

As the market-oriented approach was not realizing the expected results, in 1970 the Commission published a Memorandum on Industrial Policy that called for a policy aimed at economic expansion and technological development. Nonetheless, there was no change in approach as the member states had very differing ideologies. In the years of Europessimism after the 1973 oil crisis, the Community industrial policy was mainly characterized by crisis management for specific sectors.

At the Copenhagen European Council of 1982, agreement was reached on reinforcing the Single Market, boosting research, and providing more funding for investment. Interventionist measures for declining industries continued, but on the other hand, from about 1985, there occurred a shift away from saving declining industries towards promoting high-technology industries. In addition, during the early 1980s, the first Community R&D programmes were launched, such as ESPRIT, JET, BRITE/EURAM, RACE, and ACTS (that replaced RACE). Furthermore, in 1985, Eureka was established as a French initiative to reduce the fragmentation of European industry. While these early R&D programmes had a fairly limited bearing on competitiveness, they set up the tradition of companies collaborating with the Commission, and laid the basis for the Single Market.

A significant step was achieved with the Single European Act signed in 1986 that tackled the causes of fragmentation directly. It also called for measures to promote RTD, to assist SMEs, and to encourage co-operation between companies from different regions of the Community. The Single European Act added Title V on economic and social cohesion to the Treaty of Rome and Title VI, which deals with RTD.

However, the flood of cross-border mergers and acquisitions in the prospect of the Single Market paved the way for a reassessment of the industrial policy within the Community. Some industries in difficulty and even some member states called for Community support in favour of certain industries. But the Commission held the position that effective competition was the best way of assuring the success of industry.

This was laid down in the Bangemann Memorandum of 1990^[10]. According to it, a competitive position could best be ensured by measures to control state aid, avoid abuse of dominant position and eliminate barriers to international trade. In order to step up the process of structural adjustment, measures sould be initiated to promote research and technology, encourage a better use of human resources, ensure the conditions for the development of business services, and favour SMEs.

The Treaty on European Union, also know as the Maastricht Treaty, entrusted the Community for the first time with the responsibility for industrial policy. Article 130 calls on the Community and its member states to ‘ensure the conditions needed to make the Community competitive are met in a system of open and competitive markets’. Therefore, a significant step was taken in the Single European Act as well as in the Treaty on European Union to set up a foundation for an industrial policy focused on programmes for RTD.

In the following years, the horizontal approach remained to characterize the Community’s industrial policy: two Commission documents of 2002 demand more effort in:^[11]

- Knowledge,
- Innovation, and
- Developing entrepreneurial capacity better able to take bigger risks and set up new businesses and expand existing ones.

SMEs are deemed to be central to the realisation of the third goal. Therefore, the European Charter for Small Enterprises was adopted at the Fiera European Council in 2000. We will deal with this charter in detail in chapter 6.

So, following the Bangemann Memorandum, the EU moved away from a selective industrial policy, but it nevertheless still continued to take measures aimed at the specific requirements of several sectors. In addition, thanks to the Commission’s policies, the EU has shifted, slowly but surely, away from support ‘sunset’ industries to sponsoring ‘sunrise’ sectors. The EU funding of research continued to be covered by Framework Agreements – the first covering the 1984-87 period, the sixth covering the 2003-06 period.^[12]

And finally, Article 130 of the Treaty on European Union was replaced by Article 157 of the Treaty of Nice:

‘The Community and the Member States shall ensure that the conditions necessary for the competitiveness of the Community’s industry exist.

For that purpose, in accordance with a system of open and competitive markets, their action shall be aimed at:

- speeding up the adjustment of industry to structural changes,
- encouraging an environment favourable to initiative and to the development of undertakings throughout the Community, particularly small and medium-sized undertakings,
- encouraging an environment favourable to cooperation between undertakings,
- fostering better exploitation of the industrial potential of policies of innovation, research and technological development.’

Part 2 The Nature of SMEs

“Micro, small and medium-sized enterprises are the engine of the European economy. They are an essential source of jobs, create entrepreneurial spirit and innovation in the EU and are thus crucial for fostering competitiveness and employment.”^[13]

Günter Verheugen,

Member of the European Commission

Responsible for Enterprise and Industry

Chapter 3 The Definition of SMEs

In 2003 the European Commission adopted a new Recommendation on the definition of SMEs^[14]. Three main categories of SMEs have been created, for the first time including precise financial thresholds for micro-enterprises. All the thresholds related to SMEs, valid from 1 January 2005, are as follows:

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Table 2.1: Definition of SMEs

Source: europa.eu.int/comm./enterprise/enterprise_policy/sme_definition/index_en.htm

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This definition must be respected by all Community Institutions in their policies in favour of SMEs applied in the EEA.

Chapter 4 Statistics on SMEs

On the definition above, in the enlarged EU there are some 23 million SMEs representing more than 99% of all enterprises in the Union.^[15] But not only are most of the enterprises in Europe small, they also account for a significant amount of European work experience and economic activity. In 2003 there were more than 19 million SMEs in Europe-19^[16], providing a job for almost 140 million people. By contrast, there are only about 40 000 large enterprises existing, which account for only 0.2 % of all enterprises.

Therefore, on the European level, SMEs are, on the one hand, by far the most prevalent form of enterprise, but on the other hand, they tend to exhibit lower levels of productivity and generate, on the average, lower levels of profitability. This is particularly true for micro enterprises, as many differences between small, medium-sized and large enterprises are mitigated when sectoral effects are taken into account.^[17]

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Table 2.2: Roles of SMEs, Europe-19, 2003

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Source: Estimated by EIM Business & Policy Research; estimates based on Eurostat’s Structural Business Statistics and Eurostat’s SME Database; also based on European Economy, Supplement A, May 2003, and OECD: Economic Outlook, No. 71, June 2003; due to rounding, totals may differ slightly from constituent parts.

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However, the several countries of the EU differ distinctively with respect to the average size of their enterprises. This is because in Europe there is a strong correlation between average enterprise size and economic prosperity, as measured by GDP per capita. Table 2.3 also confirms the results of the macro-economic analysis at the Europe-19 level shown above. In most countries, labour productivity as well as profitability in SMEs in below average.^[18]

Table 2.3: Roles of SMEs in European Countries, 2003

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Source: Estimated by EIM Business & Policy Research; estimates based on Eurostat’s Structural Business Statistics and Eurostat’s SME Database; also based on European Economy, Supplement A, May 2003, and OECD: Economic Outlook, No. 71, June 2003; due to rounding, totals may differ slightly from constituent parts.

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Moreover, the role of SMEs not only differs by countries but also by industrial sector. With regard to enterprise size, sectors of industry differ significantly, primarily as a result of the nature of the production processes in these industries. For example, extraction, manufacturing, and the energy sector are large-scale industries, and thus are characterised by a greater role for large enterprises. The same holds for the transport and communication sectors. Other industry groups (construction, trade, hotels and restaurants, and personal services) tend to be small-scale activities. This is reflected by a relatively low number of occupied persons per enterprise, and a greater share of SMEs. Of course, large differences between sub-sectors as well as between individual enterprises still exist.^[19]

[...]

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^[1] cp. European Parliament(2006a), McDonald/Potton (2005), p. 174, and Nello (2005), p. 322

^[2] Externalities are activities that affect others for better or worse, without those others paying or being compensated for the activity. Externalities exist when private costs or benefits do not equal social costs or benefits. (cp. Samuelson/Nordhaus (2001), pp. 36-37)

^[3] When a company or a group of companies has a high degree of control over the price and production decisions in an industry.

^[4] Imperfect competition refers to markets in which perfect competition does not hold because at least one seller (or buyer) is large enough to affect the market price and therefore faces a downward sloping demand (or supply) curve. Imperfect competition refers to any kind of imperfection – pure monopoly, oligopoly, or monopolistic competition. (cp. Samuelson/Nordhaus (2001), p. 36)

^[5] Public goods are commodities whose benefits are invisibly spread among the entire community, whether or not particular individuals desire to consume the public good. Private enterprises do not have the incentive to produce these goods.

^[6] cp. Price (2004), p. 214-216, McDonald/Potton (2005), pp. 175-176, Nello (2005), p. 322, and Navarro (2003), p. 3

^[7] cp. McDonald/Potton (2005), pp. 175-176

^[8] cp. McDonald/Potton (2005), p. 176 and Nello (2005), pp. 322-323

^[9] cp. McDonald/Potton (2005), p. 176

^[10] cp. European Commission (1990)

^[11] cp. European Commission (2002a and b)

^[12] cp. Nello (2005), pp. 323-327, McDonald/Potton (2005), pp. 179-181, and Price (2004), p. 235

^[13] cp. European Commission (2006a), p. 3

^[14] European Commission (2003a)

^[15] cp. European Commission (2006a), p. 5

^[16] The expression Europe-19 is used to indicate the 15 member states of the EU before the 2004 enlargement, the three other countries of the EEA (Norway, Liechtenstein, and Iceland), together with Switzerland.

^[17] cp. European Commission (2004a), pp. 25-28

^[18] cp. European Commission (2004a), p. 28

^[19] cp. European Commission (2004a), pp. 29-30