Free Social and Economic Importance of SMEs Essay Sample

The term Small and medium-sized enterprise (SME) is in widespread use across the European countries. However, none of these countries have a single official standard definition which can quantitatively describe this term. Therefore, for practical purposes it is always easier to describe what does not qualify as an SME than to say what an SME is. Companies that are quoted on a major stock exchange are not counted as SMEs. Subsidiaries of the quoted companies should also not be included. An SME should be independently owned or managed by its owners. It may be incorporated or unincorporated. Self employed businesses without employees are also put into this category and are normally referred to as the zero-employee class. However, such an enterprise should be the principal source of income for its owner. Farmers or any non-governmental business units formed with the purpose of making a profit are also counted as SMEs. According to European standards, for a company to qualify as an SME, its workforce should not exceed 500 personnel. The net fixed assets should not exceed ECU 75 million and must not have 75% of its capital held in a larger firm.

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In 2003, the European commission on enterprise and industry set the criteria for distinguishing between micro, small and medium-sized enterprises which is summarized in the table below.

Enterprise category

Number of employees

Annual turnover

(million Euros)

Balance sheet

(million Euros)


Less than 250

Less than or equal to 2

Less than or equal to 2

Small enterprise

Less than 50

Less than or equal to 10

Less than or equal to 10

Medium enterprise


Less than or equal to 50

Less than or equal to 43

Importance of SMEs in the creation of employment

SMEs contribute immensely to the factor productivity (efficiency) of an economy and generation employment. They also contribute a hugely to the distributional equality. The main reason for this is their choice of technology. SME technology usually lies between highly labor-intensive technologies that characterize the micro-enterprises, and the highly capital-intensive technologies, which characterize the large firms. The labor-intensive technologies achieve low average labor productivity while the capital-intensive technologies achieve high labor productivity. Therefore, if an economy applies high capital to its small group of workers, then it must have a large micro-enterprise economy that uses little capital so as to employ the labor not used up by the larger firms. A large SME sector is a better alternative to the dualistic economy, characterized by combining much large enterprise and much micro enterprise, which leads to high level of primary inequality. When too many jobs are in the micro-enterprise sector, many of them will be low income due to their low primary productivity adequate. Its use of intermediate technology makes the SME sector crucial in the generation of decent employment. This sector can compete with the government and large private firms in terms of potential to create decent jobs.  Its main advantage is that it has the capacity to do this while using a relatively lower capital input.

Countries that have embraced policies that encourage micro enterprise development provide excellent examples for this point. Taiwan has built economy on a platform of highly dynamic SME sector. It is no surprise that it is the most successful developing country over the last 50 years. It has produced unusually fast growth rates while maintain remarkably low levels of inequality. The experiences of Korea, another country among the nations dubbed Asian Tigers, also illustrates that inequality can drop significantly when the number of SMEs increases. This occurred during the mid 70s. Colombia experienced era of unprecedented growth between the late 1960s to the 1970s. This was the period when Columbia experienced ultra fast expansion of the manufacturing SME sector. This was accompanied with the decline in urban inequality.

Current employment prospects of the SMEs

The ability of SMEs in employment creation has been considerably enhanced by the recent trends in global markets. This has led most countries to develop policies that help to prop up SMEs. Large firms have started outsourcing most of their functions to the SMEs. This has further stimulated their rapid emergence. Spectacular emergence of SMEs has also been caused by the policies that allow small firms to win market niches. The SMEs are key employment generators in the OECD. Their net job creation rates exceed that of larger firms. SMEs account for approximately half of employment in the OECD area. About 19 million SMEs exist in European Union(less than 250 employees), which represents 99.8% of the total number of enterprises, while in the US (less than 500 employees), it accounts for 99% of all enterprises. The SMEs experience more turbulent lives than the larger farms. Therefore, the rates of entry and exit of labor into and out of this sector are higher which contributes to churning out of new labor into the market. In the European Union, smaller firms contribute to the employment of more than 70 million people. This accounts for about 75% of the total EU employment situation. In the US, the SMEs provide employment for about 50% of the private sector workers. Japan dwarfs these two examples with 78% of the total employment provided by the SMEs. These Small firms major in the service economy. High employment is witnessed in the construction, sales (whole sale and retail), hotel, restaurants, communication, and business services; providing up to 95% of the jobs.

In the United Kingdom, there are approximately 3.7 million businesses. This number includes the zero-employee class businesses. About 99% of these businesses employ less than 50 people. They provide 46% of the no-government employment and 42% of turnover.

Apart from their functions of absorbing the excess employment in an economy, the SMEs perform other equally essential functions.

Economic and social functions of SMEs

As already discussed earlier, the SMEs and large firms are complementary to each other. The larger firms are involved in capital intensive activities that are subject to the economies of scale. On the other hand, SMEs are crucial for activities that result from the large scale firms. As large firms substitute capital for labor, the smaller firms are stimulated by the rising incomes of the consumers. The SME also benefits from the increased demand from the larger firms fro the sub-contracted or outsourced goods and services. Eventually, SMEs become vital in the establishment of business relationships and collaborations. This is a fundamental attribute of SMEs, especially in the face of globalization of markets. As larger multinational companies try to cut their operational costs, they focus their attention on outsourcing to smaller more efficient companies. This is informed by the fact that individual companies cannot be good and efficient. Therefore, SMEs enables companies to specialize and focus on what they know best. It also enables them to learn to collaborate and combine their capabilities with those of other organizations and firms. SMEs are a very fundamental in stimulating advances in technology that will enable companies to work in a virtual world. Rapid increase in internet use gives a reason to suggest that there can be cost-effective and efficient collaboration between SMEs.

SMEs are critical in Fostering of a Commercial culture and as well as playing a massive role in providing training, especially for personnel who are just out of school. The SMEs act as a practical instrument for recent school leavers to learn employability skills before embarking on new jobs. They provide an avenue through which people who do not or cannot work in large and impersonal organizations to get employment. Creativity and talent that would otherwise have been wasted is harnessed and utilized towards building the economy.

With the increased income and reduction in equality that results from SMEs, the quality of life members of a society improves. This has the effect of reducing crime and other socially inappropriate activities.  This is because as inequality increases the sense of frustration, anomie and criminal opportunity increase.

They may also provide a platform for political stability and diffusing economic power. SMEs also allow the members of the society to integrate with each other. SMEs tend to be embedded in the local culture of the people. As a consequence, they enjoy close relationships with customers and benefit from the informality that comes with being well acquainted with the customers. This is an advantage that may favor women with key domestic responsibilities such as child care where short working hours and being close to the home is of significant importance. SMEs may also be essential in bringing together rural and urban communities or rural to urban transitions. This is because they provide a flexible diversification mechanism for income. SMEs are also vital in transitioning from a state controlled to open market driven economies. This may be because they stimulate the proprietors to be flexible in learning and change which are all key characteristics of an open market economy. In addition, they help to stem the continuous cycle of rural-urban migration if they are situated in the rural areas.

SMEs and their role in sustainable development

Sustainable development is at the forefront of the world agenda. This is especially in light of the prevailing problems of environmental degradation and climate change. It has been argued by many experts that SMEs provide the best way of ensuring sustainable development. Sustainable development is the development that meets the needs of today’s generation without compromising the capacity of future generations to meet their needs. Sustainable development encompasses ecological sustainability, economic sustainability, social equity and ethical responsibility.

The best illustration of the ability of the SMES to adhere to the sustainable development blueprint lays in the comparison between large agricultural farms visa vie the small scale farms.  In large scale farms, focus is put on intensive monoculture. Large tracts are cleared in the process which results in colossal losses of vegetation cover. As mentioned earlier, these farms are capital intensive. Inputs such as chemicals and pesticides are a significant component of the production of these farms. Recently GMOs have been added into the mix. This technology may have massive consequences on the health of the soil, human beings and the general environment. These large scale farms also have a tremendous impact on the community’s social welfare. Some of the greatest social impacts include loss of employment; impoverishment and undermining of the rural community; and rural urban migration. Rural-urban migration ends up compounding problems such as lack of proper housing, health care and crime that are already persisting in the urban areas.

In contrast, there is growing evidence that small scale farms have the best potential of enabling countries to achieve sustainable development goals. These farms are characterized by low inputs. They have higher overall output and total factor productivity per unit of land cultivated compared to the larger farms. Hence, they are more sustainable economically and ecologically than the large mechanized farms. Experts believe that these small enterprises present a key to unlocking the food shortage puzzle that has engulfed the world, especially the third world countries. According to these experts, the issue of food scarcity is a myth since some parts of the world have surpluses. The key is to have better food distribution mechanisms. SMEs provide the best way out of this conundrum. SMEs ensure that more people have rights to income and resources. They also ensure that people have reliable and sustainable means of production.

One of the best examples regarding the ability of SMEs to improve the food security status of a nation may be found in Cuba. When the USSR fell; Cuba which had relied heavily on the union experienced a shortage of production inputs, materials, and export market. At the time, Cuba’s policies were skewed towards large mechanized farms. The state embarked on a program to divert land from large state farms to small cooperative and individual farming. People were encouraged to grow their own food. The agricultural production system was transformed from highly mechanized capital intensive (involving production of sugar and rice for export) to relying on low input organic and natural farming.  This production system was meant to stimulate mixed cropping and encourage direct consumption and sale in local markets. This led to smaller production and more direct incentive for increasing output. China and Eastern European countries also followed the same model.

In industry, the same can also be seen. SMEs have changed the dynamics of production and communication. Scaling down would ensure better use of resources and skills, reduce effluent discharge and improve energy efficiency as well as lowering the capital labor ratio.

Improvement of response time and variety of products

SMEs have been shown to improve the time in which customers are served with what they require. They also make a certain product to be available at any time. The best examples are the pizza home delivery and home baking services. SMEs can offer competitive product and services while offering a variety of employment opportunities. In the process, they will enhance development of a diversified economy that is resistant to fluctuations. They also have the ability to stimulate development subcontracting and auxiliary resources and hence robust supply chain.


The importance of SMEs cannot be underestimated.  On the “static” front, SMEs increase the output and assist in the creation of “decent” jobs1. On the dynamic front, they act as a stepping stone for the bigger firms of the future. Almost every company we know of began as an SME. Apple was started in the garage belonging to young man by the name of Steve Wozniack; Nordstrom was started by John W. Nordstrom from his $1300 savings; Vodafone was a spin-off from Racal; Coors Brewing Company was started by a German-born immigrant to the US called Adolf Coors. Microsoft, Google, eBay media, Starbucks; the list could go on forever. The SMEs are also precursor for expanding micro enterprises, and they significantly contribute to aggregate savings and investment. They are also huge participants in the development of appropriate technology.

It is evident that these enterprises hold the key to a better future. Therefore, they should be promoted in terms of development of appropriate policy and incentives.


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