August 2008

MSMEs in Latin America

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MSMEs in Latin America enjoy a number of advantages with respect to the possibilities for both creating and adopting innovations; at the same time, they face major disadvantages


Josef Schumpeter pointed out in the early 20th century that innovation rates increase more than proportionally with firm size and market concentration; he thus established that large firms were the engines of innovation in capitalist economies. Given Schumpeter's intellectual influence, the dominant doctrine for most of that century was that innovation was an ability reserved for large companies. This doctrine came to reinforce the tenets of Fordist industrial organisation, which praised the wonders of vertical integration and so the superiority of large, vertically integrated enterprises of which Ford Motor Co. was the symbol par excellence.

But things have changed over the last decades. Small companies have proved to be as innovative and efficient as their larger counterparts given the advantages their size entails. The fact that some of today's most advanced and innovative industries are largely made up of micro, small and medium-sized enterprises (MSMEs) is a clear evidence of that trend. Nonetheless, innovation ability and production efficiency still tends to vary with firm size. This occurs particularly in Latin American countries where micro businesses account for the largest proportion of MSMEs which in turn constitute by far the largest segment of national company populations, as the case of Mexico illustrates.

Defining Innovation

Innovation has traditionally been regarded as the development and introduction of new production technologies. However, Schumpeter argued that innovation is rather the innate entrepreneurial drive that impels some individuals to upgrade their business. He accordingly conceived of the entrepreneur as an innovator that introduces new combinations of products, production methods, markets, input sources, and organisational structures, and innovation as the development of new value-creating activities (Schumpeter, 1934). Drawing on those views, a broader concept of innovation has emerged in recent years, which assigns a key role to the acquisition and absorption of new technologies and the development of non-technological innovations (e.g. new marketing strategies, new organisational structures and models) on a par to hard technological breakthroughs (Ocampo, 2007). Therefore, innovation is no longer regarded as just the creation of new technologies or the conduction of research and development (R&D) activities but rather as a series of 'innovation efforts' that also encompass activities such as the search for and the purchase of new technologies and the acquisition of tacit knowledge required to assimilate those technologies (Ernst, 2001). Nonetheless, innovation continues to be a relative concept. In developing countries it usually takes place as the purchase of machinery and equipment designed and built in advanced countries, which is known as embedded innovation (Observatorio PyME, 2004). In developed economies innovation mainly involves moving up the technological ladder and/or pushing up the technological frontier (Ocampo, 2007). In both cases, innovation can also mean developing non-technological innovations, also known as soft technologies (innovations in organisational structures, marketing strategies or business models), which may be more important than hard technological innovations proper.

MSMEs' innovation ability in developing economies

As noted, MSMEs account for a bulk of national company populations in all latitudes. Less known but equally significant is that micro businesses and small enterprises make up the bulk of the
MSME basket.

This is especially the case in developing countries where this size category tends to account for even larger proportions, with the additional circumstance that many micro and small companies dwell in the unwieldy circuits of the informal economy.

In that context, firm size and innovation ability tend to be more directly related than in developed economies. This is because the amount of resources required for generating innovations is directly proportional to the size of business establishments.

Therefore the chances for small and micro businesses to improve their productivity and enhance their ability to innovate largely depend on the extent to which they are able to become suppliers of medium-sized and large companies, insofar as the latter require their suppliers to show the quality standards they have achieved, mainly those awarded by the International Standards Organisation (ISO) (Ruiz, 2001).

Those chances are enhanced from the outset when small and micro companies are born into high-technology industries like electronics and ICTs, designing or making components or else developing software.

In general, MSMEs in developing countries and particularly in Latin America, enjoy a number of advantages as to their possibilities for both creating and adopting innovations; at the same time, though, they face major disadvantages. The advantages include the following (Ruiz, 2001):

  • Ability to respond quickly to changes in demand and to adapt to these changes given the close relationship between management and employees and the absence of bureaucratic structures
  • Ability to use their working capital for the development of new product lines and production processes
  • Ability to change their size or their organisational structure in response to changes in the market or challenges in the business environment where they operate
  • Ability to generate more innovations per unit of financial capital than larger enterprises given their adaptability to changes and the need for them to use their resources with extreme care
  • Ability to be aware of changes in consumer demand given their closer communication with customers
  • Ability to supply small but sophisticated markets
  • Ability to perform well in new industries like software and scientific instruments
  • Ability to outperform large firms in operations such as design and new product development

Their main disadvantages include:

  • Lack of financial and venture capital and banking credit to engage in R&D and other activities leading to innovation
  • Lack of highly skilled personnel required for innovation
  • Inability to communicate sufficiently with other companies, foreign markets, and government agencies
  • Inability to reap the benefits of increasing returns to scale given their small size
  • Lack of capital to grow in response to an increased demand
  • Inability to register patents and exposure to constraints derived from other companies' patents
  • Difficulty to comply with regulations

In practice, the advantages of MSMEs tend to be the disadvantages of large firms and vice versa. Micro and small businesses face less favourable environments than medium-sized and large firms, although they can slip easily into informality which enables them to avoid taxes, regulations and other burdens such as social security payments. On the other hand, medium-sized companies face more obstacles than large firms as regards financing, taxes, regulations, inflation, corruption, crime and anti-competitive practices, especially in Latin America and Central and Eastern Europe (Schiffer and Weder, 2001).

That is why the best way for micro, small businesses to become more efficient and more innovative in developing countries is by becoming part of the supplier networks of global medium-sized and large companies, which forces them to adopt the latter's higher quality standards enforced by international organisations like ISO.

The case of MSMEs in Mexico

The heavy economic weight of micro, small and medium-sized enterprises in developing economies is particularly evident in Latin American countries like Mexico. According to the National Institute for Statistics, Geography and Informatics (INEGI), MSMEs account for at least 50 per cent of Mexico's gross domestic product (GDP) and generate as much as 72 per cent of total employment (Castro Reyna, 2008). In terms of number of establishments, MSMEs account for virtually all



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