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Chapter 3
Various Explanations to the Philippine SME Sector’s Weak Performance: A Review of Literature
Private sector, particularly SMEs, development has been a longstanding preoccupation of those in the academic and policy-making circles. This attention largely stems from the belief that SME sector development, as discussed in the initial chapter, is a way for countries to achieve development, given the sector’s enormous potential in stimulating employment, investment, and innovation. However, like in any other disciplines, scholars and pundits alike vary in their analysis and perception of the problem, offering different theories (and variables) to explain the variation in the performance of the SME sector.
In the international development community, the dominant school of thought zeroes in on the technical and economic components of the conundrum. Espoused by various multilateral agencies such as the World Bank, Asian Development Bank, and USAID, this approach, to put it succinctly, attributes the weak performance of the SME sector to the constraints (or market failures) that impede the proper functioning or—in the words of neoclassical economists—the Pareto efficiency of the market. Not surprisingly, most of the scholarly works on small-scale enterprise sector development in the Philippines echo this perspective.
In addition to the technical-economic school, some studies regarding the Philippine SME sector have concentrated on the internal capacity of firms. While the previous perspective underscores market variables in analyzing the sector’s performance, the firm-oriented approach focuses on the orientation, skills, practices, and networks of the businesses and their owners.
Whereas the two previously mentioned theories are often helpful in finding out market failures and entrepreneur-specific limitations, limiting one’s analysis to the technical-economic and firm-centered schools would result in overlooking important factors that affect the economy in general and the economic behavior of its actors (including the state) in particular, such as ideas, interests, and institutions. In an attempt to overcome this limitation, a handful of scholars have attempted to go beyond these perspectives and analyze the performance of the Philippine SME sector in light of the political economy approach.
In this chapter, these different theories to SME sector development in the Philippines are discussed. This section commences with a review of the relevant extant literature on the dominant narrative, the technical-economic school, in explaining the poor performance of the
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Philippine SME sector. This is then followed by a discussion of works in another perspective, namely, the firm-oriented view. The final section of this chapter introduces a minority perspective, one which suffers from a lack of scholarly attention in the country and which this thesis’s theoretical framework and analysis build upon. Before proceeding, however, it is worth mentioning that given the sheer volume of studies previously conducted on the topic internationally, the discussion will underline the works done in relation to the Philippine SME sector, with non-Philippine related literature only serving as a backdrop for each subsection.
The Dominant Perspective: The Technical-Economic School in Small Enterprise Sector Development
Bringing the dominant approach to the fore is crucial as it helps us understand the policies that have served as the strategy of the Philippine government vis-à-vis SME sector development (see Chapter 2). This approach, which is widely used by those in the development and aid-granting institutions, underscores the technical and economic facets of the problem.
Phrased succinctly, the technical-economic school in SME sector development attributes the poor performance of SMEs to the constraints that impede the proper functioning of the market.
As the mainstream approach, there is an extensive body of work done exploring the issue of SME sector’s poor performance vis-à-vis various technical and economic constraints:
access to finance (Beck & Demirguc-Kunt, 2006; Berger & Udell, 1998; Chittithaworn et al., 2011; Harvie et al., 2013), market access (Rogerson, 2013), and regulations (Klapper et al., 2006; World Bank, 2020a).14 For reasons of economy, these components are elaborated in a thematic manner in light of the literature on the Philippine SME sector.
Access to Finance
Finance is regarded as the lifeline of any business, whether LEs or SMEs. As such, most of the analyses in the private sector development have delved into the domain of determining the constraints related to SMEs’ access to finance. In the Philippines, the majority of the ‘access to finance’ literature are in accord that SMEs, in general, lack formal means to credit, thereby resulting in lower profitability, productivity, and innovation (Harvie et al., 2013;
Khor et al., 2013). Many SMEs in the country tend to rely on internal sources for financing, with 53% to 73% of SMEs sourcing their initial capital internally and 52% to 78% relying from the same for operation and expansion (Nangia & Vaillancourt, 2007).
14 The cited works are based on Canare, Francisco, and Price’s (2017) review of non-Philippine-context literature.
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The Magna Carta for MSMEs (see preceding chapter), a landmark legislation requiring financial institutions to allocate at least 10% of their loan portfolios to the sector, was not able to significantly stimulate bank lending to the small businesses. In fact, the ratio of SME lending vis-à-vis the banks’ total bank portfolio has declined for the past several years (Khor et al., 2015) and is expected to decline even more pursuant to the implementation of Basel III (Casaclang, 2018). Theoretically, the reason for the banks’ aversion to lending to SMEs, according to Harvie, Narjoko, and Oum (2013) and Yoshino and Taghizadeh-Hesary (2018), is the notion that SME lending entails more risks on the part of financial institutions, given that small-scale enterprises have higher default rates in light of their weaker financial, managerial, and business positions. Furthermore, Saito and Villanueva (1981) estimated that the transaction costs for extending credit to Philippine SMEs are at least twice that of providing loans to big businesses, suggesting the unprofitable nature of the SME lending industry in the country.15
Aldaba’s (2011) survey of Philippine SMEs confirms these assertions, finding that poor credit history, inadequate income flow, and unstable operations as reasons for the banks’
reluctance to lend to SMEs. To overcome default risks, banks have “continued to impose [high]
collateral… and other stringent conditions such as minimum loan requirements” (p. 344).16 Although there is generally a consensus that an accessible and inclusive financial system is a sine qua non for the development of the SME sector, analysts tend to differ on the approaches to solve the problem. Aldaba (2011), for instance, recommends the institutionalization of a credit information facility to facilitate more lending from financial institutions. What her proposal tells us is the widespread anti-SME bias in the financial sector, which is perhaps rooted in the “information asymmetries” brought by limited commercial, operational, and financial capacities of small-scale businesses (Mahari, 2017, p. 141).
Khor, Jacildo, and Tacneng (2015), on the other hand, argue for the expansion of alternative means of credit access, particularly equities markets. They found that there is a vast untapped opportunity for the sector to venture into equity financing, considering that SMEs only accounted for 0.005% of the Philippine Stock Exchange’s (PSE) total capitalization by
15 Contrary to conventional wisdom, Jagtap (2019) finds that SME lending can be profitable for some Asian financial institutions, provided that interventions, such as the application of technology in operations, are applied.
16 Other factors that discourage banks from expanding financial services to SMEs include macroeconomic instability, inadequate regulation on deposits, capital shortage, competition with government banks, and weak supervision from the Central Bank (Lamberte, 2001).
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the end of 2012.17 Their proposal, albeit appealing, appears to be unrealistic in the context of Asia, as financial systems in the region, including that of the Philippines, are bank-dominated.
Recognizing the limitations of the ‘equity market’ proposal, Yoshino and Taghizadeh-Hesary (2018) offer the state-led provision of credit guarantee schemes (CGS) to minimize the gap between SMEs’ credit demand and supply.18 Though their activist prescription is arguably the most realistic for developing countries, a question that needs to be asked is if such proposal is compatible with the institutional configuration of the country and acceptable to the actors in the economy—an inquiry that cannot be answered if we limit our analysis to economics.
Access to Expanded Markets and Value Chains
Another way to analyze the performance of SMEs through the lens of the technical-economic school is to determine SMEs’ exposure to expanded markets. Due to the potential of internationalization in improving SMEs’ technology and scale economies (Arudchelvan &
Wignaraja, 2015; Asian Development Bank, 2015; Borazon & Supangco, 2018; Canare et al., 2017), a burgeoning number of literature has explored the issue of SMEs’ lack of market access and linkages with regional and global value chains (GVCs) in the country.
One of the most influential studies in this regard is by Canare, Francisco, and Labios (2018b). By surveying SMEs and interviewing several key informants in Manila, the authors found that Philippine SMEs are weakly linked to GVCs. This finding is corroborated by Aldaba (2017), who discovered that a substantial number of SMEs in the country are unaware of the potential of trade agreements and linkage to GVCs; and Tambunan and Chandra (2014), who likewise found that SMEs are the least active users of trade agreements, such as the ASEAN Economic Community. Needless to say, their findings imply that LEs’ manufactures comprise the majority of the country’s export portfolio—a point echoed by Tamangan et al. (2004).19
In order to explain the reluctance of Philippine SMEs to internationalize, Francisco and Canare’s survey (2019) identified the following variables hindering SMEs’ market expansion:
17 As of the time of writing, SMEs account for roughly 0.007% of the PSE’s total market cap of USD 305 billion (Bangko Sentral ng Pilipinas, 2020).
18 A CGS is comprised of three parties: borrower, lender, and guarantor. Guarantors facilitate finance to the borrower by “providing lenders with the comfort of a guarantee for a substantial portion of debt” (Yoshino &
Taghizadeh-Hesary, 2018, p. 6).
19 Notwithstanding, the state of Philippine SMEs’ internationalization has been improving recently, with small firms increasingly entering partnerships with foreign partners (Bautista & Manzano, 2018).
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(1) inadequate business operations (e.g., capacity to scale), (2) human resource constraints, (3) difficulties in complying with international standards and government regulations, (4) inability to compete with domestic and international competitors (e.g., Vietnam, Thailand, and China), (5) marketing and branding constraints, (6) poor infrastructure, (7) lack of access to finance and collateral, (8) lack of access to market information, and (9) shifting consumer preferences.
To promote Philippine SMEs expand their markets, analysts have proposed more awareness programs on government’s GVC initiatives (Aldaba, 2017); establishment of an office that would coordinate policies on SME integration with GVCs (Aldaba, 2008);
negotiation with other countries to open their markets to Philippine SMEs’ products (Bautista
& Manzano, 2018); and reforms such as the expansion of entrepreneurial skill training programs, reduction of cost for SMEs to participate in fairs, incentivization of exports of higher-value products, and improvement of credit terms for SMEs (Francisco et al., 2018).
One weakness of these prescriptions, however, is that almost all of these have already been touched, to a certain extent, by the current initiatives of the government (see Chapter 2).
Similar to the critique of the current paper’s author on the ‘access to finance’ literature, works on the ‘access to market’ approach still seem to be unable to answer the question of why the sector performs poorly despite the plethora of policies ‘passed’ by the Philippine government.
Business Environment Reform
From a technical-economic point of view, a conducive regulatory environment is an important growth factor for SMEs, as inefficient—or in some cases, inadequate—investment climate, such as the presence of bureaucratic red tape, increase transaction costs for small firms and impact the ease of doing business perversely (World Bank, 2020a). In the Philippines, several scholars share this perspective. For example, Pernia and Salas’ (2005) investigation of national and provincial investment climate has led them to conclude that inadequate infrastructure, inflexible labor markets, and high regulatory burden and corruption have negatively affected SMEs’ productivity, investment, and employment and sales growth. A decade after, their findings still appear to be relevant, as Luna, Canare, and Francisco (2018), after surveying SMEs in Manila, found that ‘hostile business environment,’ which is operationalized as an environment where tight competition, corruption, and poor infrastructure are present, affect the competitiveness of SMEs. Agreeing with the previous scholars, Laylo (2018) suggests that there is a positive relationship between enterprise formation and macro-level conditions (e.g., good governance, inclusive financial services) in the Philippines.
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While these studies are right to point out that eliminating market impediments resulting from “bad institutions” matters, they were not able to consider the differences in the dynamics between national and local contexts. In light of this gap, Gumasing (2013) investigated the business environment of a municipality in Antique and discovered that after the government simplified its business permit processes, the number of registrants increased, improving local entrepreneurial environment. Thus, the author recommends the easing of administrative procedures (e.g., licensing) as a way to improve the business climate at the local level.
In contrast, whereas this approach of minimizing the overreaching hand of the state dominates the discourse on business environment reform both domestically and internationally, scholars like Altenburg and von Drachenfels (2006) contend that the “new minimalist approach”
lacks empirical grounding and is insufficient in creating a competitive SME sector. Instead, for the authors, certain ‘activist’ policies (e.g., state’s assistance in R&D, provision of incentives for LEs to transfer technology to SMEs) must be enacted in view of SME sector development.20
The lack of consensus on business environment reform indicates the need for initiatives that take other factors, such as politics and governance, into consideration. In spite of its limitations, this strand is still worth noting as it pays attention, albeit limitedly, to institutions—
a variable that is examined more closely, but differently, in the political economy approach.
Firm-based Explanation to the Performance of Philippines SMEs
Similar to the foregoing school, the entrepreneur or firm-oriented approach has increasingly being adopted by management scholars. However, unlike the technical-economic lens, this approach, as its name implies, centers its analysis on the internal capacity of SMEs, specifically the orientations, skills, and practices of the firms and their owners. It needs to be emphasized however that although this thesis prioritizes macro-level explanations, an examination of works in this perspective is in order, as it allows us to have a more holistic understanding of the issue. For brevity, this section is subdivided into three: (1) owner’s orientation, (2) financial literacy and decision-making style, and (3) firm’s characteristics.
Orientation and Characteristic of the Owners
A logical starting point in analyzing SMEs at the firm-level is the owners of the businesses themselves. The orientation and characteristics of owners are regarded as important
20 The context of this study is not in the Philippines. Nevertheless, its findings are still relevant given the country’s adherence to neoliberalism, as evidenced by Raquiza’s work (2016) and the other studies discussed herein.
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determinants of business decision-making and, as such, have an implication on the performance of the sector. Regarding owner’s orientation, analysts such as Daño-Luna, Canare, and Francisco (2018), Milagrosa-Hampel, Loewe, and Reeg (2014), Roxas (2009), and Sarreal and Reyes (2019) are all in accord that SMEs’ likelihood to succeed is a product of skills, age, higher motivation, and risk-taking ability of the owners.
Furthermore, linkage and networking were found to be vital in improving SMEs’
performance, as both (e.g., family members, associations) are usually sources of wherewithal for capital needs of small businesses (Hampel-Milagrosa et al., 2014; Miranda & Miranda, 2018). These findings are significant because they suggest that firm performance is not merely a function of individual’s skills, as argued by the authors in the foregoing paragraph.
In brief, although all these scholars have made a solid point in tracing causality between success and individual orientation and characteristics, their findings still beg the question as to how these variables, say, risk-taking orientation of owners, come about. That being said, examining the impact of external variables such as institutions (e.g., cultural, social and political environment) may perhaps be more worthwhile and illuminating.
Financial Decision-making Style and Literacy of Owners
As discussed earlier, access to finance is a crucial success factor of SMEs. While an inclusive financial system is a prerequisite to a productive SME sector, it is nevertheless insufficient. Equally germane is the financial capacity and literacy of the owners. According to Guliman and Uy (2019), the sustainability of small businesses is affected by their owners’
financial decision-making knowledge such as basic accounting, time value of money, and risk diversification. In contrast, Mendoza (2015) found no relationship between financial decision-making and profitability when he sampled SMEs near the capital, prompting him to opine the need for revisiting SMEs’ ability to connect to a broader external environment.
Firm-specific Traits and Characteristics
Another stream of relevant firm-based factors are the traits and characteristics of the firms themselves. Certain characteristics like ownership structure, membership in an industry association, communication systems, and engagement in innovative activities (e.g., utilization of digital technologies) are correlated with the performance of small-scale businesses (Aldaba, 2014, 2017; Daño-Luna et al., 2018; Flaminiano & Francisco, 2019; Miranda & Miranda, 2018;
Tuaño et al., 2014).
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Further, in two studies of Philippine SMEs vis-à-vis free trade agreement (FTA) and globalization, Aldaba (2014, 2017) found that size has a positive and significant relationship with the survivability and SMEs’ utilization of FTAs. This finding is supported by Tuaño, Manzano, and Villamil (2014), whose work determined that size has a significant positive correlation with export propensity. The relationship between size and performance implies that smaller firms are at an inherent disadvantage in line with the notion of economies of scale, which can only be remedied, as per Aldaba (2014) and Tuaño et al. (2014), by having foreign equity. However, as discussed earlier in this chapter, this variable still has something to do with politics and institutions, especially in a mixed economy like the Philippines. For instance, the ability to have foreign equity depends on whether the legal system—and thus, political elites—
allows for such an investment.
The criticisms in the works cited in the current and previous sections indicate the need to relate SME performance to a broader environment. This backdrop, particularly political and institutional facets of the conundrum, will be the subject of the following section.
The Political Economy Perspective to SME Sector Development
Although the previously discussed approaches are valuable in determining the market and entrepreneurial variables that affect SMEs’ performance, using these lenses does not help ascertain the process or forces behind the adoption, as well as the credible implementation, of policies that could improve firms’ performance. Alternatively, a more comprehensive analysis, argues Skocpol (1985), “requires an examination of the organization and interest of the state, specification of the organization and interests of socio-economic groups, and inquiries into the [relations] of state and societal actors” (p. 20). In other words, these political and institutional components, in addition to neoclassical economics’ ‘utility,’ must be examined, as they influence the behavior of these political and economic actors.21
Unfortunately, in the Philippines, only few studies have been conducted utilizing this approach. Given the meager number of political economy literature on Philippine SMEs, the following discussion, which is divided into three subsections—idea-based, institutional, and
Unfortunately, in the Philippines, only few studies have been conducted utilizing this approach. Given the meager number of political economy literature on Philippine SMEs, the following discussion, which is divided into three subsections—idea-based, institutional, and