In the midst of heated debates about trade deals, there’s one trade topic that everyone seems to agree on: we need to encourage more exports by small and medium-sized enterprises (SMEs, defined as firms with fewer than 500 employees).
In Canada, the push for SME trade is often coupled with the long-standing desire to diversify our exports beyond the US market into faster-growing emerging economies. When Justin Trudeau’s government took office in 2015, the mandate letter to Chrystia Freeland, the minister of international trade, identified as a top priority developing “a targeted strategy to promote trade and investment with emerging markets,” and added that this strategy, “should include the mobilization of our SMEs” [emphasis added].
Before we can design specific policies to support these goals, we first need a solid grasp of fundamental issues such as the following:
- What are the trade patterns of Canadian SMEs? How are these patterns evolving and how do they differ from those of large firms?
- How large are the performance premiums for those that export to emerging markets?
- How do different export strategies and firm characteristics impact the chances of success in these markets?
We find that, over the past decade, the share of Canada’s total exports destined for emerging markets has risen from around 4 percent to 10 percent (see figure). SME advocates will be happy to hear that these markets have increasingly become the first stop in the export journeys of Canadian SMEs.
Differences in SMEs trade
Canadian SMEs are less likely to export than large firms and they reach fewer markets (often only the United States). What are the reasons for this? Fixed trade costs — such as the time required to learn about new markets or the effort needed to apply for government trade support programs — disproportionately restrain SME trade, particularly lower-value shipments. (Average costs associated with trade fall as the size of the firm increases.)
Small firms also have much lower average export revenues than large firms, partly because of the composition of exports in different industries. SME exports are more concentrated in sectors with low export revenues, such as wholesale trade, whereas large firms dominate in high-value export sectors like mining, transportation equipment and finance. We estimate that, in 2014, if the SME export basket had had same industrial composition as that of large firms, SME exports would have been 56 percent greater.
The good news for SME trade advocates, according to our findings, is that SME trade is more “inclusive” — it has many more participants and less concentrated market outcomes than trade by large firms, which helps explain its strong political appeal. SME trade is perceived as benefiting the much-loved “middle class,” whereas trade by large multinationals is viewed as increasing the wealth of the top 1 percent.
Another encouraging finding for trade advocates is the large performance premium that SME exporters enjoy relative to non-exporters. SME exporters have higher revenues and profit margins and they invest more in research and development and other innovative activities.
When we look specifically at SMEs that export to emerging markets, we see that they perform slightly better on average than SMEs that export to other foreign destinations. But there’s a catch: in seeking the larger rewards in these faster-growing markets, firms incur higher risks — the performance gap between the top and bottom Canadian exporters is particularly pronounced in emerging markets. Evidently there are important risk-reward trade-offs to consider, and some caution is warranted.
Are there ways for SMEs improve their chances of success in these markets? Yes, but unfortunately, there is no advice that applies to all firms. In general, the chances of surviving in emerging markets are better for firms that are more experienced in the domestic market and those that export first to other advanced economies before they enter emerging markets. Being larger and more productive, as well as introducing more new products and having greater access to external financing, also helps.
At the same time, we also identify some “born global” firms operating out of Canada that have successfully reached emerging markets quite early in their operations. These firms are more likely to be in high-technology service sectors and in the e-commerce of niche products (where start-up production costs are lower than those for standardized goods that rely on economies of scale to lower costs).
Some role for government policy
We find some evidence that government support has helped increase exports for existing exporters, though whether it has helped first-time exporters is unknown. There are several potential roles governments can play to support exporters. One obvious role is to provide information — to survey market conditions and inform potential market entrants about their chances of success in a given market. Such information would allow firms to make decisions based on their specific circumstances.
Government can also act as a “trouble shooter”; it can help to solve problems existing exporters might have; for example, help them resolve customs clearance or unfair business treatment issues. More work needs to be done to make firms aware of existing government assistance programs, and these programs should be better tailored to the needs of younger, smaller firms and first-time traders.
Another important role for government is to lower the costs for Canadian firms to enter emerging markets. This could include negotiating trade and investment agreements — such as the Trans-Pacific Partnership — simplifying customs procedures and promoting cross-border electronic commerce (see the chapter in the trade volume by Ahmed and Melin, which analyzes eBay data involving small Canadian firms).
Trade policy in Canada shouldn’t focus only on how direct SME exports to emerging markets can be increased and less experienced and less competitive SMEs shouldn’t be pushed into emerging markets too soon. Often, a gradual export strategy is better, focusing first on the local, national or North American market, building up capabilities, resources and knowledge before trying to expand into riskier, further away emerging markets. Other strategies can also allow Canadian SMEs to seize the benefits of growth in emerging markets, but with less risk. For instance, Canadian SMEs also could sell intermediate goods or services into the global supply chains of multinationals based in North America that are directly engaged with emerging markets, or take part in international joint ventures or franchising and licensing arrangements.
In current trade discussions, SME trade is something everyone can get behind. Our research suggests that we can and should design policy to encourage SME trade, including that with emerging markets. But government action should be based on solid information tailored to the unique circumstances of different firms, rather than on hope and anecdotes. This is the best way to set realistic expectations of the potential advantages and risks involved in trading with emerging markets.
Photo: Asia Travel / Shutterstock.com
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