Bilawal Kamran

Small and Medium Enterprises (SMEs) are pivotal in the economic advancement of both developing and developed nations, driving key factors such as employment generation, innovation, and value addition to production cycles. SMEs are essential in fostering entrepreneurship, alleviating poverty, enhancing export-led growth, and facilitating trade diversification (Harvie, 2010; Harvie & Lee, 2005; Asasen et al., 2003). Globally, there exists a documented positive correlation between the growth of the economy and the contribution of SMEs to the Gross Domestic Product (GDP), as evident in leading economies like China, Malaysia, Germany, Korea, and Japan. In these nations, SMEs account for substantial portions of GDP, with figures such as 60% in China, 47.3% in Malaysia, 57% in Germany, 50% in Korea, and 55.3% in Japan (Beck et al., 2005; Levine & Renelt, 1992; Aris, 2007; Katua, 2014).

Hussain et al. (2012) categorized the role of SMEs in an economy into three critical domains: trade, technology, and investment. These domains enable SMEs to play an integral role in economic growth, fostering competition and innovation. Globalization has particularly benefited SMEs by opening up new international markets through global value chains and international production networks (Harvie, 2010). Aceleanu et al. (2014) noted that several factors contribute to the development of SMEs, including the macroeconomic environment, government policies aimed at attracting investment, structural characteristics of the economy, and microeconomic factors such as the enterprise structure.

In developing economies, SMEs are a critical source of employment. In Pakistan, for instance, SMEs are key drivers of economic growth. As Sharafat et al. (2014) highlighted, Pakistan’s SME sector plays a significant role in creating jobs and contributing to national economic growth. The country’s SME policy, established in 2007, aimed to align SME development with sectors such as technology, human resources, and marketing. In addition, the policy sought to ensure SMEs were integrated into broader policy frameworks covering labor, industrial, trade, and fiscal policies. This strategic alignment is critical, especially as Pakistan embarks on revising its SME policy with the anticipated 2021 SME policy announcement. A comprehensive evaluation of the successes and shortcomings of the 2007 policy will be necessary for improving future initiatives.

The Small and Medium Enterprise Development Authority (SMEDA), established in 1998 under the Ministry of Industries & Production (MOIP), is a key institution supporting SME growth in Pakistan. It aims to streamline and support SME operations through various programs. However, the effectiveness of SMEDA’s initiatives must be reassessed in light of changes following the 18th Constitutional Amendment. According to the National SME Policy of 2007, there were 3.2 million SMEs in Pakistan, contributing approximately 30% to GDP and 25% of the country’s exports. By 2021, this number has risen to 5.2 million SMEs, yet despite their significant role in employment generation, SMEs still face challenges related to low productivity, contributing only 40% to the economy’s value addition (MOIP, 2007).

Despite the vital role of SMEs in generating employment, contributing to GDP, and facilitating exports, SMEs in Pakistan continue to face numerous challenges. One notable concern is their low productivity levels, which affect their overall economic contribution. SMEDA has made efforts to raise awareness among local investors, but many objectives for developing SMEs remain absent, and support systems are not fully optimized. During the recent pandemic, the State Bank of Pakistan (SBP) introduced several innovative financial support programs for SMEs, which have been widely praised as crucial initiatives to alleviate financial constraints.

The significance of SMEs in achieving inclusive and sustainable economic growth is undeniable. However, in order to fully realize their potential, a closer examination of the existing policy framework and the obstacles faced by SMEs is necessary. It is crucial to assess the preparedness of SMEs to capitalize on emerging opportunities in an increasingly globalized economy and to determine the role of the government in supporting and regulating these enterprises. The development of domestic industries, particularly SMEs, should become an explicit part of national development agendas. This requires the optimal development of domestic investments and industries, ensuring SMEs are integrated into long-term sustainable development strategies. Furthermore, initiatives such as the China-Pakistan Economic Corridor (CPEC) should be leveraged to foster regional development at both the inter-regional and intra-regional levels.

In the context of Pakistan, the SME sector has evolved significantly over time. Afaqi (2010) discussed how Pakistan inherited a weak industrial base with a heavy reliance on agriculture. Initially, the country focused on large-scale manufacturing, but over time, Pakistan has made strides in developing its industrial sector. During the First Five Year Plan (1955–1960), SMEs were given particular focus for the first time. According to the Pakistan Bureau of Statistics (2008), approximately 78% of the non-agricultural labor force is employed within the SME sector, and SMEs contribute more than 30% to the manufacturing sector (GoP, 2005). The Economic Census of Pakistan in 2005 revealed that there were 2.96 million business units across the country, divided into established units and household units. These businesses were primarily concentrated in Punjab, Sindh, Khyber Pakhtunkhwa (KPK), and Balochistan, with 65.26%, 17.82%, 14.21%, and 2.09% of businesses, respectively.

Despite their importance, the majority of these SMEs remain unregistered, with more than 96% of businesses operating as sole proprietorships. Additionally, SMEs are underperforming compared to large-scale enterprises (LSEs) in terms of growth in output and employment generation. This growing gap in performance between SMEs and LSEs has been a recurring trend since the 1970s (Khawaja, 2006).

SMEs face a range of constraints, particularly in developing countries like Pakistan. These challenges include limited market access, financial barriers, lack of information, and institutional constraints such as political instability, poor infrastructure, and the energy crisis. Khan and Khalique (2014) identified these factors as critical barriers for SMEs in Pakistan, and Khattak et al. (2011) categorized these hurdles into internal and external barriers. Internal barriers involve challenges related to the firm’s operations, such as the lack of skilled personnel, limited production capacity, and insufficient capital. External barriers include challenges such as low foreign demand, legal hurdles, and intense competition. According to recent studies, approximately 68% of barriers are internal, while 32% are external. Despite improvements in financing availability, banks remain hesitant to provide loans to SMEs due to the higher perceived risks associated with their financial status.

Internationally, Pakistan’s business environment ranks relatively low, as evidenced by its position in the World Bank’s “Doing Business” index. In 2020, Pakistan ranked 108th out of 190 countries, a slight improvement from its 147th position in 2018. However, Pakistan still lags behind regional peers such as India and China, which ranked 63rd and 31st, respectively. Key indicators such as starting a business, paying taxes, and trading across borders reflect significant challenges for entrepreneurs in Pakistan. Additionally, the financing landscape for SMEs in Pakistan remains less developed compared to other countries. Naveed (2012) highlighted that countries like India, Korea, and Malaysia are investing significantly more in SME facilitation programs than Pakistan, whose expenditures remain limited at only $1.74 million.

The definition of SMEs is another area of importance in developing economies. Different countries define SMEs based on employee size, capital investment, and sales turnover. The World Bank and the International Finance Corporation (IFC) define SMEs as businesses with fewer than 250 employees and less than $100,000 in assets and annual sales. While some countries have adopted similar global standards, others define SMEs based on national economic conditions. In Pakistan, the State Bank of Pakistan (SBP) defines small businesses as those with fewer than 50 employees and capital investments of up to 25 million PKR, while medium-sized businesses can employ up to 250 people and have capital investments up to 200 million PKR.

In conclusion, SMEs hold immense potential for driving economic growth, job creation, and poverty alleviation, especially in developing countries like Pakistan. However, to harness their full potential, policymakers must address the numerous barriers SMEs face, including inadequate access to finance, lack of infrastructure, and political instability. Government support is essential in creating an environment conducive to SME growth, and initiatives like CPEC must be leveraged to promote intra-regional development. By improving the business environment, refining SME definitions, and facilitating access to resources, SMEs can become powerful engines of economic progress in Pakistan and beyond.