Turbulent times for SMEs
In recent years, the global economy has experienced a number of deep shocks, with a marked impact on firms. Swift and substantial government support helped protect small businesses from the economic impact of the pandemic. However, new threats have emerged in the wake of Russia’s unprovoked aggression against Ukraine.
The economic environment has become more challenging due to escalating geo-political tensions, global financial risks, high inflation, tighter monetary and fiscal policy stances, financial-sector stress, labour shortages, trade barriers and slowing integration in global value chains. As interest rates rise, debt repayment will become more burdensome, especially for heavily indebted SMEs and entrepreneurs.
Drawing on the Timely Indicators of Entrepreneurship and the first chapter of the OECD SME and Entrepreneurship Outlook 2023, this article examines recent developments in business dynamism. It then delves into the main challenges firms, and SMEs in particular, will face in the coming years.
Following the invasion of Ukraine, firm entry growth has decelerated while exits and bankruptcies have accelerated
Since the start of the war in Ukraine in February 2022 firm entries have grown at much slower rates, partly reflecting the relatively high growth rates observed in most countries as they recovered from the pandemic shock (Figure 1). This slowdown was broad-based, with Portugal, Slovenia and Türkiye being the exceptions.
Firm exits have risen substantially since the start of the war in Ukraine, driven by the ensuing energy crisis and high inflation, combined with the tightening of monetary policies and the withdrawal of fiscal support. This uptick in firm exits was widespread, observable across all business sectors for which data are available (Figure 2).
In 2021, about 40% of the countries for which data are available registered an increase in bankruptcy rates, compared to only 20% in 2020. The most pronounced increases were recorded in the Slovak Republic, Spain and the Czech Republic. Conversely, noticeable decreases in bankruptcies were observed in other economies, notably Estonia, Sweden, the Netherlands, and the United States.
In several European countries, the pace of bankruptcies accelerated in 2022. While bankruptcies continued to fall in the United States on average during 2022, they have risen in the most recent period. Developments in bankruptcies also reflected policy changes. For instance, the number of bankruptcies in the United Kingdom can be partly explained by a change in eligibility limits for Debt Relief Orders in England and Wales which came into effect on 29 June 2021 (UK Insolvency services, 2022).
SMEs face many challenges ahead, including the fallout of the war in Ukraine and the energy crisis
While SMEs are generally only marginally directly exposed to the war in Ukraine, they have been significantly impacted by the sharp increases in energy and commodity prices, economic uncertainties and tightening financial conditions, and widespread labour shortages. The twin transition and integration in sustainable global value chains pose additional challenges.
Inflation remains elevated, which together with heightened uncertainty has hampered firm performance. Inflation began to climb at the end of 2020, with continuing geopolitical tensions maintaining inflationary pressures through energy and commodity prices. Even with falling inflation since the end of 2022, attributable to falling energy prices, it has remained at high levels in most OECD countries. Core inflation (which excludes food and energy) has remained elevated, in line with tight labour markets. The trajectory of inflation over the medium term will hinge on Central Banks’ ability to keep inflation expectations anchored and whether the rise in price inflation will spiral into a surge in wages.
Monetary policy stances have tightened to counter inflation in both developed and some emerging-market economies, exacerbating difficulties accessing finance for highly indebted firms. The share of zombie firms – indebted firms that earn just enough money to operate and service debt, but are unable to pay off their debt – in assets, capital and debt is much higher among SMEs than among large companies.
Recent credit shocks have amplified financial uncertainties and blurred signals on expected interest rates, against the backdrop of still elevated core inflation. This scenario, together with political uncertainty and increased firm indebtedness as a result of the COVID-19 crisis, could lead to increased risk premia in loans and other forms of external financing. It may also dampen demand and sales expectations, all other factors being equal. These elements are likely to deter investment, particularly as the digitalisation and decarbonisation transitions are increasing investment needs. Tightened financial conditions could lead to lower lending and activity if they persist (IMF Global Financial Stability Report, 2023).
Retaining and attracting staff has become a major issue in OECD countries. The number of firms reporting labour shortages rose significantly in the second half of 2021 and early 2022, in many countries and industries. Alongside these economic shocks, digitalisation and the green transition are expected to drive durable sectoral changes by altering business models and the way firms operate (OECD SME and Entrepreneurship Outlook 2019), thereby intensifying labour market pressures. Labour shortages and the competition for skills are likely to persist over time, placing SMEs at an even greater disadvantage. These challenges are likely to exacerbate the traditional difficulties SMEs face in attracting and retaining skilled employees, as they tend to offer less attractive remuneration and working conditions than large firms and lack the capacity and networks needed to identify and access talent.
The pace of digitalisation accelerated during the first phase of the COVID-19 crisis, helping many firms weather the economic shock. However, many small firms continue to lack the necessary skills to make the most of the digital transition, increasing risks of deepening digital gaps. Moreover, while small firms have significant potential to drive and benefit from the green transition and the deployment of more sustainable, responsible and circular value chains, these transitions also present significant challenges.