Public procurement for SME growth

Updated 04 May 2020

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Due to their higher vulnerability to shocks, SMEs are expected to get the hardest hit of an economic meltdown. — Reuters/File
Due to their higher vulnerability to shocks, SMEs are expected to get the hardest hit of an economic meltdown. — Reuters/File

THE ensuing uncertainty coupled with the initial soft advisories and later strict restrictions following the Covid-19 outbreak has brought the economic system to a virtual halt. The adverse impact on the goods market has quickly spread to the labour market and some credible studies project the unemployment figures to rise by at least 4 million in the next few months.

One important segment of the economy that is going to receive a significant blow comprises of small and medium enterprises (SMEs). Although it is standard at the policy level to club both the small and medium enterprises, there exists significant heterogeneity in the sector. Within the SME sector the “small” enterprises, due to their higher vulnerability to shocks, are expected to get the hardest hit of the economic meltdown.

Amongst the various official definitions in vogue, the State Bank’s umbrella definition using the employment criterion classifies an entity as SMEs if it engages up to 250 employees, where “small” firms are the ones whose employment number ranges between 1 and 50. However, to understand the true employment impact against any firm’s closure or downsizing, seasonal, contractual and part-time employees also need to be considered.

Data from the last economic census published in 2005 by the Pakistan Bureau of Statistics shows that except for the mining and quarrying sector, around 90 per cent of businesses in all other industries employ up to 5 people (microenterprises) and around 98pc of all enterprises in the country fall in the “small” category. Also, according to statistics shared on the website of Small and Medium Enterprises Development Authority, SMEs contribute 40pc to national GDP and constitute about 80pc of non-farm employment.

Keeping in consideration their significance and potential vulnerability, the government has announced several relief measures. While it can be argued that this type of direct income support can help the sector to withstand the shock in short term and keep the workers afloat, it does not in any way guarantee that businesses will be able to capture their market shares once normalcy returns.

One potential avenue that can provide some hand-holding for the SMEs in the medium- to long-run is to open up business opportunities for them through a public procurement process. This refers to the acquisition or the purchase of goods or services by a public sector organisation using funds or resources from the public exchequer. Sizable public procurement can be used as a policy tool to not only compensate for the slump in the private market but also provide support for investment in innovation by small firms.

Realising the magnitude of transactions and their potential to deliver on social and economic fronts, many countries use public procurement to strategically support an inclusive pattern of growth. Preferential public procurement entails that necessary goods and services are procured through a process where small enterprises are not hindered by the regulatory barriers.

World Bank’s 2017 Benchmarking Public Procurement report shows that 47pc of the 180 national economies analysed provide some preferential treatment to SMEs in public procurement. The United States federal government allocates 23pc of all federal contracts to American SMEs. In recent years, interest has grown in several European Union and Organisation for Economic Cooperation and Development countries in using public procurement as a tool to foster innovation and support SMEs.

Research provides evidence of growth and employment generation impact of linking public procurement with SMEs. Using data from Brazil, a National Bureau of Economic Research paper published in 2015 found that “winning at least one [government] contract in a given quarter increases firm growth by 2.2 percentage points over that quarter, with 93pc of the new hires coming from either unemployment or the informal sector. These effects also persist well beyond the length of the contracts.”

Granting preferential treatment to SMEs in public procurement, besides a policy commitment, shall also require extending institutional and administrative support. State help at different stages of the procurement process such as overcoming hurdles against restricted advertisement, narrow pre-qualification criteria, requirement of bid-security deposit, cumbersome documentation and delayed payments shall ensure that SMEs cross these entry barriers.

The statistics collected by World Bank show that the share of public procurement to GDP is 19.8pc for Pakistan. A back-of-the-envelope calculation indicates that if only 10pc of public procurements are reserved for SMEs, a pecuniary support that is eight to nine times larger than the relief package can be easily generated. Also because of their purchasing power, governments can influence the pattern and direction of innovation in industry directly and indirectly. A government order for an innovative product would cover risks and help SMEs invest in their productivity enhancement.

The writer is an assistant professor in Lahore University of Management Sciences

Published in Dawn, The Business and Finance Weekly, May 4th , 2020