Is Small Beautiful and Worthy of Subsidy ? Literature Review

This literature review was commissioned as part of an evaluation of IFC Project Development Facilities. In supporting Project Development Facilities to assist small and medium enterprises (SMES), IFC presumed that (i) development of SMES is important for achieving sustainable job creation and poverty reduction and (ii) subsidies are needed and justified to foster their development. As part of the evaluation effort, a literature review was needed to assess the weight of the empirical evidence underpinning these assumptions. The terms of reference for the review asked three important questions: What empirical evidence exists (if any) to support the belief that SMES make special contributions to employment, growth and poverty reduction? What are the rationales that have been used to justify subsidies to foster the development of SMES? And what empirical evidence exists (if any) to support or substantiate these rationales for intervention? The paper has three sections. Section 1 reviews the evidence for the assertion that SMES make special contributions to the economy. Section 2 examines the rationales often made for subsidies to support the development SMES and reviews the empirical evidence underpinning these rationales. The “bottom line” case for subsidies is then presented in section 3. We begin with a brief word about the definition of SME and the correlation of firm-size with behavioral characteristics of the firm. The definition of SME varies by country, or more specifically, by market size. Countries with large economies like the US and member states of the EU use cut-of points of fewer than 500 workers to describe SMES. In developing countries, where market size and average firm size are both much smaller, cut-of points of fewer than 100 workers or 250 workers are often used. Although these