FOSTERING SMALL AND MEDIUM SIZED ENTERPRISES (SMEs) PARTICIPATION IN GLOBAL MARKETS

FOSTERING SMALL AND MEDIUM SIZED ENTERPRISES (SMEs) PARTICIPATION IN GLOBAL MARKETS PROJECT REPORT FEBRUARY 2012 OECD SECRETARIAT

Table of Contents Chapter 1 Introduction 1. Background of the project: (1) Polarization of world economy after the financial crisis 1 (2) Participation in emerging economies by foreign countries 2 (3) Recent trends in SMEs participation in global markets 4 (4) Benefits and barriers to SMEs participation in global markets 5 2. Purpose of the report 7 3. Target countries in the report 8 Chapter 2 Trends of SME and entrepreneur internationalisation in emerging markets 1. Trend of export and FDI from OECD member countries to non OECD countries (1) Exports 11 (2) FDI 14 2. Findings from the literature on firms internationalisation and issues to be addressed (1) Firm heterogeneity and export 17 (2) Self selection and learning by exporting 20 (3) Issues to be analyzed 21 3. Characteristics of SMEs entering emerging markets 21 (1) Description of the Dataset 22 (2) Foreign Investment Activities and Firm Size 22 (3) Foreign Direct Investment to BRIC countries by Firm Size 28 (4) Premia for Foreign Direct Investment 30 4. Determinants of growth for SMEs and entrepreneurs in emerging markets (1) Methodology 38 (2) Empirical Results 39 (3) Policy implications from the results 41

Chapter 3 Barriers for SMEs to participate in emerging markets 1. A Survey of SME Perceptions of Barriers to Access to High-Growth Markets 44 2. Results of the Survey 44 (1) Target countries 44 (2) External Barriers for SMEs in emerging markets 45 3. Business conditions for starting a business in the emerging markets 48 Chapter 4 Recommended policy measures to encourage SMEs participation in emerging markets 1. Point of View 50 2. Policy recommendation (1) Prioritizing policy measures to promote SMEs internationalisation 51 (2) Segment support for diversified SME seeking support for internationalisation 51 (3) Removing trade barriers through negotiations between governments 53 (4) Establish a local office in emerging markets 53 ANNEX 1 Country Data of Firms with Foreign Affiliates (Used in section 3, Chapter 2) 55 ANNEX 2 Questionnaire of A Survey of SME Perception of Barriers to Access to High-Growth Markets 60 ANNEX 3 Policy measures to promote SMEs internationalisation in Korea, Germany, UK and US 71

2006q1 2006q2 2006q3 2006q4 2007q1 2007q2 2007q3 2007q4 2008q1 2008q2 2008q3 2008q4 2009q1 2009q2 2009q3 2009q4 2010q1 2010q2 2010q3 2010q4 2011q1 2011q2 2011q3 2011q4 2012q1 2012q2 2012q3 2012q4 2013q1 2013q2 2013q3 2013q4 Chapter 1 Introduction 1. Background of the project: (1) Polarization of world economy after the financial crisis After the occurrence of the financial crisis in 2008, OECD economies experienced a sharp shrink in short term and long lasting problems such as increase of the unemployed and national debt crisis. Though there is time of recovery in 2010, the recovery now slowed to a crawl. As OECD (2011a) forecasts, the economic outlook is more uncertain than usual, with a number of possible events related to the euro area debt crisis and fiscal policy in the United States likely to dominate economic developments in the coming two years. In contrast, emerging economies sustained steady economic growth which they experienced after the 1990s and led the world economic growth, especially the period of recovery after the crisis. Looking at the contribution to annualized quarterly world real GDP growth by area, non-oecd countries contributed much before and after the crisis, except the 4 th quarter of 2008 and 1st quarter of 2009, and their contribution is forecasted to continue (Figure 1.1). (%) 6 Figure 1.1 Contribution to annualized quarterly world real GDP growth OECD Non-OECD 4 2 0-2 -4-6 -8 Note: Calculated using moving nominal GDP weights, based on national GDP at purchasing power parities. Source: OECD (2011) Now, because of the sustained economic growth, emerging economies have become a source of expanding market opportunities for firms in OECD countries as well as domestic firms in the emerging markets. 1

(2) Participation in emerging economies by foreign countries In the 2000s, the rapid growth of developing countries had a considerable effect on the trade structure of OECD countries. Regarding exports, from 2000 to 2009, in almost all OECD countries the annual average growth rate of exports to non-oecd countries exceeded that to OECD countries (Figure 1.2), with the share of exports to non-oecd countries increasing dramatically in some OECD countries (Figure 1.3). Figure 1.2 Average Annual Growth rate of Export of OECD Countries toward OECD and Non-OECD countries (2000-2009) Non OECD countries OECD countries 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% Source: OECD Stan Bilateral Trade Database The growth of South-South trade demonstrates that these new opportunities of internationalisation are also the domain of firms in emerging economies themselves. In 1990, only USD 300 billion in trade occurred between emerging markets. By 2008, this figure had risen to USD 3 trillion. During the same period, the proportion of total world trade that took place between developed markets (North-North trade) fell from 58% to 41% (OECD, 2010a). 2

Figure 1.3 Share of Export to Non OECD Countries 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Source: OECD Stan Bilateral Trade Database As many governments in OECD countries search for new sources of economic growth, in the context of stagnant domestic demand and public sector budget cuts, participation in these expanding growth markets is increasingly perceived as an important strategy to re-activate growth dynamics. Some governments have already announced new support measures for SMEs exports and/or FDI towards growth markets. And firms in some OECD countries are aggressively expanding their activity in non-oecd countries in the wake of the crisis (Figure 1.4). Figure 1.4 Growth Rate of Outward Foreign Direct Investment of OECD countries toward OECD and Non OECD countries (2009, Current US Dollar) Source: OECD Stan Bilateral Trade Database 3

(3) Recent trends in SMEs participation in global markets It is impossible to see the trend of firms participation in emerging markets by firm size from public data such as export and FDI due to lack of country-by-country information of firms international activity. However, the general trend of firms internationalization can be seen by firm size from governmental investigation of firm activity. Although SMEs play a significant role in OECD countries in terms of the number of firms, total employment and value added in national and regional economies, they are largely underrepresented in cross-border activities. SMEs typically comprise 99% of all firms, approximately 65% of employment and 50% of value added in OECD countries (OECD, 2010a). On the other hand, their export propensity is quite low in many OECD countries (Figure 1.5). For example, only 4.5% of US firms sell to foreign markets and only 2.7% of EU firms export to non-eu member countries (OECD, 2011b). Figure 1.5 Export Propensity by Firm Size 100.0% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Furthermore, the share of exporting firms is highly skewed. Among exporters, only a few firms (most likely large enterprises given the value of export) dominate the share of export. Figure 6 shows the shares of top exporters in the aggregate export. In Austria, Czech Republic, Denmark, Canada and Finland the top 10 firms account for more than 50% of total export, and in almost all countries top 100 firms account for more than 50%. 4

Figure 1.6 Top 10 and Top 100 Exporters' Share in Total Export (2007, Manufacturing) 100% Top 10 Top 100 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Source: OECD Statistics (Trade by Enterprise Characteristics) On the other hand, it is interesting to note that in the case of France and Italy, medium-sized firms (50-249 employees) outperform their larger counterparts in terms of the percentage of firms which export (Figure 5). Likewise, in the Czech Republic, the Slovak Republic and the United States, the proportion of medium-sized firms which export is close to that of large firms. Better understanding of what is driving these trends could shed light on the drivers and factors that enable SME internationalisation. (4) Benefits and barriers to SMEs participation in global markets Fostering SME internationalisation - to reap the numerous benefits that accrue to firms engaged in international activity - represents an opportunity for growth and job creation in OECD and non-oecd economies. Increased trade and exchange can lead to overall improvements in the range and quality of exports, greater technological dynamism, better prospects for doing business and a larger consumption base for all (OECD, 2010b). Exporting firms have higher value added, employ more and are more capital-intensive and productive than non-exporting firms (Mayer and Ottaviano, 2007)). For SMEs specifically, benefits also accrue in the forms of exposure to international best practice; the absorption of excess production capacity or output; improved resource utilisation and productivity and higher wages (Ministry of Economic Development, 2002; Baldwin and Gu, 2003). In short, exporting SMEs consistently outperform their non-exporting peers. This finding may be of particular relevance when studying SMEs participation in high-growth markets, since firms exporting to higher income regions tend to experience a higher productivity gains (De Loecker, 2007). 5

SME internationalisation increasingly takes place through participation in global value chains and foreign direct investment. New niches for the supply of products and services continuously emerge from the international fragmentation of production. Participation in global value chains can bring stability to SMEs, allow them to increase productivity, introduce innovation and expand markets, although it generally entails greater demands on their managerial and financial resources (OECD, 2008a). Despite these numerous benefits, only a minority of firms including SMEs export (Figure 5). There is a well-established trade literature on the determinants of exporting firms (see chapter 2 for a summary of this literature), which has important implications for the design of policies and measures to support firms in internationalisation activities. For example, it is not clear whether exporting firms do so because they are already highly productive (the self-selection hypothesis), or whether the process and experience of exporting brings productivity benefits (the learning by exporting hypothesis). Shedding light on these questions can help governments design the right programmes and measures to help improve SMEs performance domestically and internationally. The low degree of SMEs internationalisation can be attributed to a number of internal and external barriers. The WPSMEE study on Removing Barriers to SMEs Access to Global Markets (OECD, 2008b) identified in particular: inadequate quantity of and/or untrained personnel for internationalisation; a shortage of working capital to finance exports; limited information to locate/analyse markets; and problems identifying foreign business opportunities (Table 1). The compliance costs of international trade are also a heavier burden on SMEs than on large companies, due to tighter resource constraints (Fujita, 1995; Bickerdyke and Lattimore, 1997; Statistics Canada, 2006). Table 1.1 Top ten barriers to SME internationalisation as reported by member economies Rank-Weighted Factor Description of Barrier 1 Inadequate quantity of and/or untrained personnel for internationalisation 2 Shortage of working capital to finance exports 3 Limited information to locate/analyse markets 4 Difficulty in identifying foreign business opportunities 5 lack of managerial time to deal with internationalisation 6 Inability to contact potential overseas customers 7 Difficulty in developing new products for foreign markets 8 Unfamiliar foreign business practices 9 Meeting export product quality/standard/specifications 10 Unfamiliar exporting procedures/paperwork Source: OECD (2008b). Furthermore, when looking at high-growth markets in particular, the regulatory framework of these economies may make it more difficult for SMEs to enter the markets, which can be characterised by an unpredictable business environment (e.g. frequent regulatory changes, weak protection of property rights, non-transparent judicial systems and inadequate enforcement of 6

commercial law), and specific institutional constraints (Luo and Tung, 2007). All these factors create additional challenges for foreign investors and pose an even greater challenge to SMEs, which are typically resource constrained and inexperienced. 2. Purpose of the report As presented in the previous section, drastic changes in global growth and trade dynamics, mainly driven by sustained economic growth in emerging economies, have opened up opportunities for SMEs in international markets, but also pose a new challenge to policy makers in the need to design, adapt and implement effective policies to facilitate internationalisation and enable SMEs to take full advantage of its benefits. To address this need, this report will: 1) Highlight the trends of SME and entrepreneur internationalisation in emerging markets; 2) Explore the drivers of competitiveness and determinants of growth for SMEs and entrepreneurs in these markets; 3) Identify and suggest ways to overcome the barriers to SMEs and entrepreneurs participation in emerging markets; 4) Identify innovative practices and policies, and offer policy recommendations, that support and encourage SME entry and competitiveness in emerging markets; The report is organized as follows. In chapter 2, we will see the macroeconomic trend of the target countries participation in emerging markets and compare the trend of firms (from target countries) in emerging markets with firms without foreign subsidiaries and firms with foreign subsidiaries in developed countries. Also, the trend of financial data of foreign firms (from target countries) in emerging markets is extracted and we will see the determinants of performance. To take the limit of public data into consideration, Bureau Van Dijk Orbis database is used. In chapter3, the result of the questionnaire survey about internal and external barriers to begin activity in emerging markets will be shown and we will highlight the difference of barriers between emerging markets and overall foreign countries, by comparing the result of CFE s past work on Removing Barriers to SME Access to international Markets. We also compare the business conditions of emerging markets for starting a business by using data including the World Bank s Starting a business index, one of ten indices of Doing Business ranking. In chapter 4, taking into consideration the results of chapter 2 and 3, policy measures which in which have been taken to encourage SMEs participation in emerging markets will be introduced, along with any available assessments of the effectiveness of these measures. In chapter 5, we will conclude the report. 7

3. Target countries in the report In the following chapters, we will focus on five countries as target countries; we analyze the international activity of firms in United States, United Kingdom, Germany, Korea and Japan because of the following reasons. 1) These countries have large volume of exports (Figure 1.7). 2) Some of these countries (Korean and Japan) aggressively export to non OECD countries (Table 2.1). 3) Some of these countries (UK and US) have a relatively large portion of exporting micro firms (Figure 1.5). (US Million Dollars) 2,000,000.0 1,800,000.0 1,839,520.6 Figure 1.7 Top 10 Export Countries (2010) 1,600,000.0 1,400,000.0 1,200,000.0 1,244,356.2 1,214,816.2 1,000,000.0 800,000.0 800,581.6 600,000.0 400,000.0 534,116.7 527,197.7 478,683.4 438,226.5 399,606.8 393,950.3 200,000.0 0.0 China, P.R.: Mainland Germany United States Japan France Netherlands Korea, Republic of Italy United Kingdom Russian Federation Source: IMF Direction of Trade Statistics (DOTS) We also focus four countries as emerging market: China, India, Brazil and Russia in terms of market size. Among non OECD countries, they are top four countries in terms of nominal GDP in 2010 (table 1.2). 8

Table 1.2 Top 30 Non OECD Countries of Nominal GDP Rank Country Nominal GDP (Billion USD) 1 China 5,878.3 2 Brazil 2,090.3 3 India 1,632.0 4 Russia 1,479.8 5 Mexico 1,034.3 6 Turkey 735.5 7 Indonesia 706.8 8 Poland 469.4 9 Saudi Arabia 448.4 10 Islamic Republic of Iran 407.4 11 Argentina 370.0 12 South Africa 363.7 13 Thailand 318.9 14 United Arab Emirates 302.0 15 Venezuela 293.3 16 Colombia 289.4 17 Malaysia 238.0 18 Egypt 218.5 19 Chile 203.3 20 Nigeria 202.6 21 Philippines 199.6 22 Pakistan 176.9 23 Romania 161.6 24 Algeria 157.8 25 Peru 153.8 26 Kazakhstan 148.0 27 Ukraine 137.9 28 Kuwait 132.6 29 Hungary 130.4 30 Qatar 127.3 Source: IMF World Economic Outlook Database, September 2011 9

References Baldwin, J. and Wulong Gu (2003), Participation in Export Markets and Productivity Performance in Canadian Manufacturing, Ottawa, Statistics Canada Economic Analysis Research Series, Paper 011. Bickerdyke, Ian. and Ralph Lattimore. (1997), Reducing the Regulatory Burden: Does Firm Size Matter? Industry Commission Staff Research Paper, Government of Australia, Canberra. De Loecker, Jan. (2007), Do Exports Generate Higher Productivity? Evidence from Slovenia, Journal of International Economics, 73, pp.69-98. Fujita, Masahisa. (1995), Small and medium sized transnational corporations: trends and patterns for foreign direct investment, Small Business Economics, 7(3), pp.183-204. Mayer, Thierry and Gianmarco I.P. Ottaviano. (2007), The Happy Few: The Internationalisation of European Firms. Bruegel Blueprint Series. Ministry of Economic Development. (2002), Firm Foundations 2002 A Study of New Zealand Business Practices and Performance, Government of New Zealand, Wellington. OECD, (2008a), Enhancing the Role of SMEs in Global Value Chains, OECD Centre for SMEs, Entrepreneurship and Local Development, Paris. OECD, (2008b), Removing barriers to SME access to international markets, OECD Centre for SMEs, Entrepreneurship and Local Development, Paris. OECD, (2010a), SMEs, Entrepreneurship and Innovation, OECD Centre for SMEs, Entrepreneurship and Local Development, Paris. OECD, (2010b), Perspectives on Global Development 2010, OECD Development Centre, Paris. OECD, (2011a), OECD Economic Outlook 2011, OECD Economics Directorate, Paris. OECD (2011b), OECD Statistics Brief: Selling to foreign markets: A portrait of OECD exporters, Statistics Directorate, Paris. Statistics Canada. (2006), Survey of Regulatory Compliance Cost, Government of Canada, Ottawa. 10

Chapter 2 Trends of SME and entrepreneur internationalisation in emerging markets In Chapter 2, we mainly analyze the trend of SME and entrepreneur internationalisation in the selected emerging markets by using firm level data. Before starting the data analysis, we review briefly the macroeconomic trend of the target five countries participation in emerging markets, after the financial crisis in 2008, and findings of recent literature on firms internationalisation. Then, we compare the characteristics of firms in the selected five countries with foreign affiliate(s), which are classified by partner area, and domestic firms. Finally, determinants of growth for SMEs and entrepreneurs in emerging markets will be also analyzed. 1. Trend of export and FDI from OECD member countries to non OECD countries (1) Exports Table 2.1 indicates the export data of the selected five countries between 2008 and 2010, classified by top 10 destination countries and the selected emerging markets. The data indicates several common points across the five countries. (a) The main partner countries for them are still developed (OECD) countries but their exports to developed countries grow at a sluggish pace. Even in the recovery period after 2008, shrinks of exports to some developed countries are also seen. (b) Among the four emerging markets, China has already established its place as an important importer for most of the countries. Contrast to exports toward developed countries, exports to China increases at a high pace. (c) The share of the other three emerging markets is still small. Especially, the decrease of exports towards Russia is drastic. On the other hand, the following points are different among the selected countries. (d) The major export partners are different. Germany and UK mainly exports to other European countries while the main partners for Japan and Korea are other Asian countries. 1 For US, the top export partners are Canada and Mexico. Geographic proximity seemingly has a significant role in deciding their main export partners. (e) The recovery of exports varies among the countries. Germany and UK: their exports are seriously damaged and cannot recover yet. The recession of European countries, their main partners of exports, affect heavily. Their exports toward emerging markets are stagnant. Japan and US: their exports are seriously damaged but in 2010 they recovered to the same level of 2008. 1 However, it is common that US is the important partner for these four countries. 11

Korea: The exports are expanding compare to the level of 2008. Contrast to UK and Germany, the steady economic growth of the main export partners, including China, Hong Kong, India and Viet Nam, enables Korea to expand its exports. Table 2.1 Top 10 export partners and emerging markets of target countries (a) Germany Export (Million US dollar) Country 2008 2009 2010 Share in 2010 (%) 2010/2008 (%) 1 France 137,945.8 113,257.0 118,821.7 9.9-13.9 2 Netherlands 96,699.6 73,816.5 83,475.9 7.0-13.7 3 United Kingdom 94,651.7 74,159.0 77,801.0 6.5-17.8 4 Italy 91,347.4 70,426.7 77,760.5 6.5-14.9 5 Austria 80,449.8 63,543.2 69,154.2 5.8-14.0 6 United States 104,665.9 75,474.3 65,619.8 5.5-37.3 7 Belgium 73,561.0 58,221.6 59,714.0 5.0-18.8 8 China, P.R.: Mainland 50,087.3 52,227.4 58,544.0 4.9 16.9 9 Switzerland 57,757.3 49,936.2 54,560.1 4.6-5.5 10 Poland 60,080.6 43,421.9 49,906.7 4.2-16.9 Brazil 12,726.2 10,150.5 12,107.8 1.0-4.9 India 11,983.2 11,315.2 11,723.5 1.0-2.2 Russia 47,503.1 28,781.7 32,123.7 2.7-32.4 Rest of the world 529,982.5 396,004.5 425,032.0 35.5-19.8 Total 1,449,441.2 1,120,735.5 1,196,344.9 100.0-17.5 (b) Korea Country Export (Million US dollar) Share in 2010 2008 2009 2010 (%) 2010/2008 (%) 1 China, P.R.: Mainland 91,388.9 86,703.2 116,837.8 24.8 27.8 2 United States 46,500.9 37,802.9 49,991.9 10.6 7.5 3 Japan 28,252.5 21,770.8 28,176.3 6.0-0.3 4 China, P.R.: Hong Kong 19,771.9 19,661.1 25,294.3 5.4 27.9 5 Singapore 16,293.0 13,617.0 15,244.2 3.2-6.4 6 India 8,977.1 8,013.3 11,434.6 2.4 27.4 7 Germany 10,522.7 8,820.9 10,702.2 2.3 1.7 8 Vietnam 7,804.8 7,149.5 9,652.1 2.0 23.7 9 Indonesia 7,933.6 5,999.9 8,897.3 1.9 12.1 10 Mexico 9,089.9 7,132.8 8,845.5 1.9-2.7 Brazil 5,925.9 5,311.2 7,752.6 1.6 30.8 Russia 9,748.0 4,194.1 7,759.8 1.6-20.4 Rest of the world 164,553.4 147,030.9 170,482.7 36.2 3.6 Total 426,762.5 373,207.4 471,071.4 100.0 10.4 12

(c) Japan Export (Million US dollar) Country 2008 2009 2010 Share in 2010 (%) 2010/2008 (%) 1 China, P.R.: Mainland 124,968.8 109,632.1 149,626.1 19.4 19.7 2 United States 138,931.7 95,343.1 120,483.4 15.6-13.3 3 Korea, Republic of 59,425.5 47,237.3 62,270.2 8.1 4.8 4 China, P.R.: Hong Kong 40,286.9 31,875.1 42,303.0 5.5 5.0 5 Thailand 29,494.9 22,259.0 34,222.3 4.4 16.0 6 Singapore 26,630.7 20,701.7 25,225.8 3.3-5.3 7 Germany 23,986.8 16,653.0 20,316.2 2.6-15.3 8 Malaysia 16,439.4 12,863.5 17,636.8 2.3 7.3 9 Netherlands 21,080.1 13,518.3 16,346.2 2.1-22.5 10 Indonesia 12,608.6 9,334.0 15,918.2 2.1 26.2 Brazil 5,926.6 4,236.1 6,194.6 0.8 4.5 India 6,810.6 4,799.8 5,571.6 0.7-18.2 Russia 16,489.1 3,291.8 8,059.2 1.0-51.1 Rest of the world 259,778.7 189,834.1 247,545.9 32.1-4.7 Total 782,858.5 581,578.9 771,719.6 100.0-1.4 (d) United Kingdom Export (Million US dollar) Country 2008 2009 2010 Share in 2010 (%) 2010/2008 (%) 1 United States 63,768.8 48,637.6 42,547.3 11.4-33.3 2 Germany 52,954.4 36,647.8 41,656.8 11.2-21.3 3 Netherlands 36,042.4 27,529.2 31,703.1 8.5-12.0 4 France 34,871.6 26,006.3 28,685.9 7.7-17.7 5 Ireland 34,506.0 24,068.0 25,343.5 6.8-26.6 6 Belgium 24,285.5 16,398.2 19,990.1 5.4-17.7 7 Spain 18,764.5 13,916.4 14,818.1 4.0-21.0 8 Italy 17,387.4 12,594.1 13,237.4 3.5-23.9 9 Switzerland 8,364.1 6,442.9 8,545.1 2.3 2.2 10 Sweden 9,497.0 6,371.0 8,322.1 2.2-12.4 Brazil 2,939.6 2,616.3 2,168.4 0.6-26.2 China, P.R.: Mainland 9,024.6 7,840.7 7,898.2 2.1-12.5 India 7,458.4 4,274.4 5,350.7 1.4-28.3 Russia 7,530.5 3,449.2 3,288.3 0.9-56.3 Rest of the world 133,637.3 116,578.7 119,964.2 32.1-10.2 Total 461,032.1 353,370.8 373,519.4 100.0-19.0 13

(e) United States Country Export (Million US dollar) Share in 2010 2008 2009 2010 (%) 2010/2008 (%) 1 Canada 260,914.3 204,728.0 248,194.2 19.4-4.9 2 Mexico 151,538.6 128,997.8 163,320.6 12.8 7.8 3 China, P.R.: Mainland 71,457.0 69,576.0 91,878.3 7.2 28.6 4 Japan 66,579.2 51,179.7 60,545.4 4.7-9.1 5 United Kingdom 53,775.1 45,713.7 48,496.7 3.8-9.8 6 Germany 54,732.3 43,298.4 48,201.2 3.8-11.9 7 Korea, Republic of 34,807.4 28,640.0 38,843.9 3.0 11.6 8 Brazil 32,910.1 26,175.1 35,357.4 2.8 7.4 9 Netherlands 40,223.1 32,347.0 34,997.7 2.7-13.0 10 Singapore 28,809.7 22,278.6 29,149.8 2.3 1.2 Brazil 32,910.1 26,175.1 35,357.4 2.8 7.4 India 18,666.4 16,462.4 19,222.8 1.5 3.0 Russia 9,335.2 5,382.8 5,968.0 0.5-36.1 Rest of the world 443,532.9 356,099.1 418,098.3 32.7-5.7 Total 1,300,191.4 1,057,053.7 1,277,631.7 100.0-1.7 Source: IMF Direction of Trade Statistics (DOTS) It is found that exporting to emerging markets becomes the key of the revitalization of exports for these countries while the recovery of exports to developed countries is sluggish. (2) FDI Looking at outward FDI positions by partners of the selected five countries, the diversity across countries is clear. (a)first, the different recovery process of outward FDI position across countries is apparent. Korea and the US aggressively invest in foreign countries while the outward FDI of UK is stagnant. (b) The main host countries are also different. As in case of exports, geographic proximity seemingly has a noteworthy role in deciding a country for investment. (c) The status of the developing countries including the selected emerging markets as a host country is different country by country. For example, China is the top host country for Korea and the third important country for Japan while the share of FDI position is quite small in Germany, the UK and US. 14

But it is common that FDI toward developing countries including the selected four countries is generally increasing in a stable pace. 2 This fact implies the attractiveness of these countries as a host country and encouraging the business activity in these countries is one of the most essential policy issues for the five countries. Table 2.2 Top 10 Outward FDI partners and emerging markets of target countries (a) Germany Country FDI (Million euro) 2008 2009 Share in 2010 (%) 2010/2008 (%) 1 United States 145,606 145,561 16.3 0.0 2 Netherlands 133,806 143,923 16.1 7.6 3 United Kingdom 87,478 86,648 9.7-0.9 4 Luxembourg 52,017 67,420 7.6 29.6 5 France 43,782 44,000 4.9 0.5 6 Belgium 30,949 33,489 3.8 8.2 7 Austria 32,880 32,779 3.7-0.3 8 Spain 27,259 29,926 3.4 9.8 9 Italy 25,634 29,826 3.3 16.4 10 Switzerland 24,643 24,395 2.7-1.0 Brazil 8,092 9,128 1.0 12.8 China 18,721 20,737 2.3 10.8 India 4,250 4,898 0.5 15.2 Russian Federation 13,240 12,993 1.5-1.9 Rest of the world 206,558 206,373 23.1-0.1 TOTAL 854,915 892,096 100.0 4.3 (b) Korea Country FDI (Million US dollar) Share in 2010 2008 2009 2010 (%) 2010/2008 (%) 1 China 31,823 31,388 57,278 22.5 80.0 2 United States 15,059 18,210 47,921 18.8 218.2 3 Hong Kong 7,014 8,229 14,129 5.5 101.4 4 United Kingdom 1,020 2,888 10,618 4.2 940.9 5 Canada 1,010 3,566 10,012 3.9 891.0 6 Viet Nam 4,220 4,997 8,272 3.2 96.0 7 Netherlands 1,901 2,339 6,197 2.4 226.0 8 Malaysia 1,832 1,560 5,427 2.1 196.3 9 Germany 1,363 2,056 5,313 2.1 289.9 10 Singapore 2,720 2,785 5,295 2.1 94.7 Brazil 745 1,648 5,062 2.0 579.9 India 2,233 2,331 4,934 1.9 121.0 Russian Federation 792 963 3,505 1.4 342.4 Rest of the World 26,752 32,490 70,752 27.8 164.5 TOTAL 98,483 115,450 254,716 100.0 158.6 2 There are some exceptions. The FDI from the UK and US is shrinking. 15

(c) Japan Country FDI (Million JP yen) 2008 2009 2010 Share in 2010 (%) 2010/2008 (%) 1 United States 20,458,400 21,277,200 2,0524,600 30.3 0.3 2 Netherlands 6,515,700 7,137,300 6,194,400 9.2-4.9 3 China 4,423,900 5,071,300 5,418,700 8.0 22.5 4 Cayman Islands 5,555,000 6,021,000 5,104,400 7.5-8.1 5 Australia 1,724,900 2,999,500 3,248,700 4.8 88.3 6 United Kingdom 2,940,900 2,882,000 3,093,800 4.6 5.2 7 Thailand 1,853,300 2,095,700 2,265,100 3.3 22.2 8 Singapore 1,761,500 2,175,000 2,241,700 3.3 27.3 9 Brazil 1,488,900 1,965,800 2,203,900 3.3 48.0 10 France 1,347,000 1,548,800 1,321,400 2.0-1.9 India 852,300 827,500 1,105,100 1.6 29.7 Russian Federation 60,300 87,900 99,400 0.1 64.8 Rest of the world 1,2757,900 1,4120,700 14,869,900 22.0 16.6 Total 61,740,000 68,209,700 67,691,100 100.0 9.6 (d) United Kingdom Country FDI (Million GB pound) 2008 2009 2010 Share in 2010 (%) 2010/2008 (%) 1 United States 258,555 252,289 277,416 26.8 7.3 2 Netherlands 160,172 154,767 149,682 14.4-6.5 3 Luxembourg 137,065 126,143 130,179 12.6-5.0 4 France 42,111 41,027 41,476 4.0-1.5 5 Hong Kong 28,666 29,398 29,440 2.8 2.7 6 Germany 30,550 29,372 28,102 2.7-8.0 7 Canada 29,216 29,462 24,567 2.4-15.9 8 Cayman Islands 16,880 23,395 24,024 2.3 42.3 9 Switzerland 15,790 20,443 21,801 2.1 38.1 10 Ireland 30,529 29,095 20,618 2.0-32.5 Brazil 6,502 4,956 6,313 0.6-2.9 China 4,571 4,474 5,244 0.5 14.7 India 3,475 9,310 9,594 0.9 176.1 Russian Federation 10,380 10,053 3,342 0.3-67.8 Rest of the world 299,151 265,490 265,008 25.6-11.4 Total 1,073,613 1,029,674 1,036,806 100.0-3.4 16

(e) United states Country FDI (Million US dollar) 2008 2009 2010 Share in 2010 (%) 2010/2008 (%) 1 Netherlands 423,059 481,140 521,427 13.3 23.3 2 United Kingdom 448,412 458,536 508,369 13.0 13.4 3 Canada 246,483 266,577 296,691 7.6 20.4 4 Luxembourg 172,251 206,133 274,923 7.0 59.6 5 Bermuda 207,547 254,541 264,442 6.8 27.4 6 Ireland 150,131 160,232 190,478 4.9 26.9 7 Cayman Islands 134,298 139,880 149,039 3.8 11.0 8 Switzerland 133,222 149,772 143,627 3.7 7.8 9 Australia 92,668 109,827 133,990 3.4 44.6 10 Japan 99,803 96,015 113,263 2.9 13.5 Brazil 43,953 55,176 66,021 1.7 50.2 China 53,927 49,799 60,452 1.5 12.1 India 18,354 20,894 27,066 0.7 47.5 Russian Federation 19,777 19,945 9,880 0.3-50.0 Rest of the World 988,608 1,078,571 1,148,563 29.4 16.2 Total 3,232,493 3,547,038 3,908,231 100.0 20.9 Source: OECD.Stat 2. Findings from the literature on firms internationalisation and issues to be addressed There is a significant body of trade literature on common characteristics of firms internationalisation using firm-level data of trade and/or FDI. We provide a short overview of this literature for the analysis in this chapter. (1) Firm heterogeneity and export Since the 1990s, empirical analyses using firms panel data were gradually implemented. The results of revealed that only a handful of firms export 3 and exporting firm are larger and more productive than non exporting firms 4. These facts, however, did not attract attention of many researchers because of lack of the theoretical background, which Melitz (2003) established. Melitz (2003) developed a theoretical model with heterogeneous firms to analyze the intraindustry effects of international trade. He introduced firm heterogeneity of productivity and fixed cost of export in trade model 5 6 and revealed new theoretical consequences of firms export, which are: 3 For the United States, see Bernard and Jensen (1999). 4 For example, Roberts and Tybout (1997) indicates this phenomenon by using data of Colombia. 5 The fact that many of exporting firms have high productivity has been recognized for a long time. But, many trade models omitted this fact and assumed that every firm has the same productivity in each country. This convenient assumption enabled researchers to treat a country as a unitary production unit. 17

1. Only firms with high productivity can export because they finance a fixed cost of export. Firms with low productivity cannot afford to export. 2. Trade liberalisation makes high-productivity firm produce more and forces lowproductivity firms to exit from market. The firm heterogeneity approach adopted by Melitz (2003) became mainstream in trade analysis, and much empirical research focusing on firms behaviour of internationalisation followed. As a result, some common facts, which are important for SMEs internationalisation, were established across countries: a. Exporting firms are rare. The share of exporting firms among all firms (exporting propensity) is low. Bernard et al. (2007) pointed out that in U.S., 18 % of manufacturing firms exports in U.S in 2002. Mayer and Ottaviano (2007) and Wakasugi et al. (2008) indicated that that of Norway and Japan is 39.22% (in 2003) and 31.7% (in 2005), respectively. 7 b. Exporting firms are highly skewed. Among exporters, only a few firms (considered as large enterprises from the value of export) dominate the share of export. Table A-1 shows the shares of top exporters in the aggregate export. In Austria, Czech Republic, Denmark, Canada and Finland only top 10 firms account for more than 50 % of total export, and in almost all countries top 100 firms account for more than 50%. c. Exporting firms have higher value added, employ more, and are more capital-intensive and productive than non exporting firms. There is a permanent difference of characteristics between exporting and non-exporting firms. Table 2.3 shows exporting firms premia 8 of value added, employment, wage, capital intensity 9 and skill intensity 10. In every country and term, export firms have premia more than one. That is, exporters are better performers (Mayer and Ottaviano (2007)). Looking at firm size, exporting firms are larger than non exporting firms. Productivity premia is also confirmed by lots of researches. For instance, Mayer and Ottaviano (2007) indicates that there is a positive productivity premia of French exporting firms in many 6 The idea of fix cost of export is also an important device which generates a situation where a part of firms export (if there is no fix cost, even firms with low productivity can export). Some researches paid attention oh the idea (for example, Roberts and Tybout (1997)) but it was not adopted broadly by researchers in the 1990s. 7 Mayer and Ottaviano (2007) also indicate the number for other European countries: Germany 59.34%, France 67.30%, United Kingdom 28.33%, Italy 74.44% and Hungary 47.53%. But the data of these countries include only large firms. 8 Premia is the ratio of the average value of exporters to the average value of non-exporters. 9 Capital intensity is the ratio of asset value to sales. 10 Skill intensity is the ratio of skilled labour to unskilled labour. The number of non production workers and that of production workers are used as proxies of skilled and unskilled labour. 18

sector of manufacturing industry, in term of labour productivity and estimated total factor productivity. Table 2.3 Export Premia and FDI Premia Country Export premia Employment Premia Value added Premia Wage premia Capital Intensity Premia Skill Intensity Premia Japan 3.02(3.76) 5.22(6.06) 1.25(1.10) 1.29(1.00) 1.58(1.30) Germany 2.99(4.39) 1.02(0.06) France 2.24(0.47) 2.68(0.84) 1.09(1.12) 1.49(5.6) United Kingdom 1.01(0.92) 1.29(1.53) 1.15(1.39) Italy 2.42(2.06) 2.14(1.78) 1.07(1.06) 1.01(0.45) 1.25(1.04) Hungary 5.31(2.95) 13.53(23.75) 1.44(1.63) 0.79(0.35) Belgium 9.16(13.42) 14.8(21.12) 1.26(1.15) 1.04(3.09) Norway 6.11(5.59) 7.95(7.48) 1.08(0.68) 1.01(0.23) FDI premia Japan 4.79(8.71) 8.79(12.52) 1.26(1.24) 1.53(1.23) 1.52(1.52) Germany 13.19(2.86) France 18.45(7.14) 22.68(6.1) 1.13(0.9) 1.52(0.72) Belgium 16.45(6.82) 24.65(11.14) 1.53(1.2) 1.03(0.82) Norway 8.28(4.48) 11(5.41) 1.34(0.76) 0.87(0.13) Note: The original data source for all countries except Japan is Mayer and Ottaviano (2007). Figures in parentheses are the ratio of standard deviations. The figures for Japan, France, Germany, Hungary, Italy and the UK are based on large firms only, while those for Belgium and Norway cover all firms. Source: Wakasugi, et al. (2008) d. Firms conducting FDI have higher premia than exporting firms. Table 2.3 also indicates premia of firms conducting FDI (FDI premia) of five countries. Almost all FDI premia in the table exceed export premia. The fact supports an intuitive idea that FDI is more difficult than export for firms. 11 e. Export propensity is proportional to firm size (and exporting SMEs are quite rare). The findings above (b. and c.) imply that exporting SMEs are extremely rare and this is borne out by recent data for many OECD countries. Especially in the smallest category (firms with 1~9 employees) less than 10 % of firms can export in many countries. Considering the share of SMEs in the distribution of firms, SMEs are quite under-represented in cross-border activities. 12 11 Helpman, et al. (2004) expands the firm heterogeneity model of Melitz (2003) and allow firms to choose export or FDI. They accommodate the idea that FDI requires more cost than export by assuming larger fix cost for FDI. 12 We can see the same trend in term of export value. OECD (2011b) shows that smaller firms have smaller share of export value. 19

(2) Self selection and learning by exporting The fact that exporting firms are larger and more productive than non exporting firms raises a new question of causality: does firm with high productivity start exporting or does export raise firms productivity? The former idea that only firms with high productivity decide to export (productivity causes export) is referred to as the self-selection hypothesis because each firm self-selects whether it exports or not. The latter idea that exporting firms can improve their productivity through export 13, referred to as the learning by exporting hypothesis. From the viewpoint to realize economic growth through firms internationalisation, the empirical verification of the latter hypothesis is essential. Table 2.4 summarizes the empirical researches regarding both hypotheses. Table 2.4 Summary of Empirical Test of Self -selection and Learning-by-Exporting Author Country Methodology Self Selection Learning by Exporting Bernard and Jensen(1999) US VAR Wagner(2002) Germany matching - Girma, Greenway and Kneller(2004) UK matching Irac(2008) France matching Pisu(2008) Belgium matching Damijian, Kostevc and Polanec(2008) Slovenia matching Hahn and Park(2009) Korea matching - Eliasson, Hansson and Lindvert(2009) Sweden matching Note: matching means propensity score matching. :statistically significant, :statistically insignificant 13 In fact, the mechanism how export improves firms productivity is not still clear. Competition in a foreign country is a possible reason. Scale of production realized by export may also reduce average production cost and improve productivity. 20

By econometric causality analysis, many researches confirm the existence of self selection of exporting firms. 14 Regarding the small export propensity of SMEs (table), the examined hypothesis of self selection implies that most of SME decide not to export because of their low productivity. The hypothesis of leaning by exporting is not always confirmed, but it is also verified in the recent researches. (3) Issues to be analyzed Despite of a lot of trade researches on firms internationalisation using firm-level data of trade, the following issues are critical but not investigated. a. Comparison of characteristics of SMEs having foreign affiliates in different countries Though lots researches paid attention on firms internationalisation using firm-level data of trade and/or FDI, there are few which focus on SMEs internationalisation by export/fdi partner country. 15 It is partially because government statistics have no information of destination of export and host country of FDI. Taking the background of the project, we will look at the firms which have foreign affiliate(s) in foreign countries. b. Determinants of growth for SMEs and entrepreneurs in emerging markets Many previous researches show the causal relationship between firms productivity and their international activity recently. In this context, productivity means a productivity of firms in investing countries. The performance, including productivity and growth rate of sale/employees, of the firms in host countries was almost not an objective of analysis. Here, we research the performance in the emerging markets and analyze the factor to make them grow. In the following sections, our analysis focuses on the two issues. 3. Characteristics of SMEs entering emerging markets In this section, we provide information on the pattern of FDI activities of SMEs from Great Britain, Germany, USA, Korea and Japan. The analysis is structured as follows. After describing the dataset, we show recent FDI trends by firm size at the aggregate level and disaggregated for the 20 most important destination countries. Then, FDI activities in BRICs countries are analyzed. Next, we classify destination markets into three groups, according to their level of 14 For example, Bernard and Jensen (1999) estimated Vector Auto-regression (VAR) model with 3 lags of each of productivity growth and export growth, using 50-60,000 data of manufacturing plants in the United States. They indicated that the sum of the productivity lag coefficients is positive in the regression of export growth. In contrary, their results showed that that the sum of the export lag coefficients is negative in the regression of production growth, meaning that export has no effects on productivity growth. 15 De Loecker (2007) is one of the exceptions. 21

development: (i) developed countries (OECD), (ii) emerging markets (Brazil, Russia, India, China, BRIC ) and (iii) developing countries. In the following, multinational firms are compared to firms which have no affiliates abroad, paying particular attention to the region in which the foreign investment has taken place. Dimensions according to which these comparisons occur are several measures of firm size and firm performance. Throughout the analysis, particular attention is given to the size of investing firms, which allows disentangling SMEs from their larger counterparts. (1) Description of the Dataset The data used in our analysis comes from ORBIS. The ORBIS database contains comprehensive balance sheet data on companies worldwide. We extract data on firm size, the stock of tangible and intangible assets, value added, profits and the industry in which the firm operates (NACE Rev 1.1). 16 Beside balance sheet data, ORBIS provides detailed information on the ownership structure of firms, allowing us to identify foreign affiliates. This information comes from the BvD Ownership Database in which 21 million active and archived links provide ownership information over 7 million companies. We define an investment abroad as foreign direct investment if the investor has acquired at least 10% of the equity of the foreign company. Both balance sheet and ownership information refer to the year 2009. (2) Foreign Investment Activities and Firm Size a. Foreign Direct Investment to all countries First, we provide evidence on the relationship between firm size and investment abroad. Figure 2.1 shows the number of foreign affiliates by firm size for each country. Firms are classified into the following 4 size bins: micro firms (less than 10 employees), small firms (between 10 and 49 employees), medium firms (50-249 employees) and large firms (more than 250 employees. The figure reveals that the extent of FDI activity displays huge variation across the 5 countries. The US is the country which has by far the highest investment activity in foreign countries, as measured by the number of foreign affiliates, followed by Germany, Japan, and Great Britain. Compared to these countries, the number of foreign affiliates is extremely low in Korea. 16 We clean the data in order to remove extreme values. A value is classified as extreme if it is below the 0.5 th percentile and above the 99.5 th percentile of its distribution. 22

Figure 2.1: Number of Foreign Affiliates by Firm Size, all countries 14000 12000 10000 8000 6000 4000 2000 0 DE GB JP KR US Micro (<10) Small (10-49) Medium (51-250) Large (>250) Moreover, the Figure reveals that FDI is predominantly undertaken by large firms. In all 5 countries, firms with more than 250 employees own by far the largest number of foreign affiliates. More generally, the number of foreign affiliates decreases as firms get smaller This pattern becomes even clearer in Figure 2.2 which shows the contribution of each firm size class to FDI in percentages. 17 90 80 70 60 50 40 30 20 10 0 Figure 2.2 Foreign Affiliates by Firm Size, all countries (in %) DE GB JP KR US Micro (<10) Small (10-49) Medium (51-250) Large (>250) 17 In Figure 2, the bars for each country add up to 100%. 23

The participation of SMEs in FDI activities varies substantially across countries. In Japan, the share of foreign affiliates owned by SMEs reaches a mere 22%. On the other hand, the participation of SMEs is more pronounced in other countries. In Korea, the US, and Germany, roughly half of all affiliates abroad are owned by SMEs. In Great Britain, the share of SMEs affiliates exceeds 60%. The dominance of FDI by large firms has been well established in the literature, stressing the role of fixed costs to internationalisation. The acquisition of an affiliate in a foreign country requires substantial investment, which exceeds the fixed costs of other forms of internationalisation such as exporting or importing. Large firms are much better able to overcome these barriers. In section 2.5, we shed more light on this issue by comparing firms which own a foreign affiliate to those which have not invested in foreign countries. b. Foreign Direct Investment by Firm Size and Destination Country Germany Figure 2.3 shows the number of foreign affiliates owned by German firms in the 20 most important destination countries. Moreover, for each destination country, the contribution of each firm size class is depicted. Confirming the evidence in Section 2, investment activities to each of these destinations is dominated by large firms, followed by medium sized firms. The pattern reveals that German foreign affiliates are predominantly located in other European countries: less than one third of the countries are non-european. As for the importance of BRICs, the most popular emerging market is Russia, ranked 8 th, followed by Brazil (14th) and China (18 th ). All 20 markets are either OECD member countries or BRICs. Participation of SMEs in BRICs countries is well below the mean: Whereas on average 50% of all German affiliates abroad are owned by German SMEs, only 40% of German foreign affiliates in Russia are owned by small or medium sized firms. The corresponding figures for China, Brazil and India are even lower, reaching 24%, 20%, and 24%, respectively. 18 18 India is ranked 29 th in the list of most important FDI destination countries for German firms. Hence, it is not included in the figure. 24

Figure 2.3 Number of German Foreign Affiliates by Firm Size and Destination Country 800 700 600 500 400 300 200 100 0 AT GB US PL FR ES CZ RU CH IT JP LU DK BR MX BE SK CN CA GR Micro (<10) Small (10-49) Medium (50-249) Large (250 or more) Great Britain In our sample, foreign affiliates of British firms are predominantly located in Germany and the US, hosting roughly 800 affiliates. The subsequent countries are Ireland, France and Spain, each hosting about 400 affiliates. Interestingly, for the central European markets Germany, Austria and Poland the number of foreign affiliates of large and medium sized firms is roughly the same. Figure 2.4 Number of British Foreign Affiliates by Firm Size and Destination Country 900 800 700 600 500 400 300 200 100 0 US DE IE FR ES CA IT AU PL JP RU DK CH NO LU HK ZA IN CZ AT BE CN SG VG BR Micro (<10) Small (10-49) Medium (50-249) Large (250 or more) Among BRIC countries, Russia is the most important destination of British FDI (ranked 11 th ). China and India, ranked 13 th and 18 th take the following places. The least important emerging market is Brazil. Among the 25 most important destination countries for British FDI, South 25

Africa is the only country which is neither an OECD member state nor figures among the BRIC countries. As shown above, the participation of British SMEs in foreign direct investment activities amounts to 60%. However, their participation in BRICs is substantially smaller. Only 17% of British affiliates in India are owned by SMEs. In China and Brazil, the number rises to 24% and 31%, respectively. It is only in Russia, the most important BRIC country for British firms where the share of SMEs affiliates reaches 61%, i.e. the national average. Japan Foreign affiliates of Japanese firms are heavily concentrated in the United States, where almost one third of all foreign affiliates are located. Not surprisingly, neighbouring China is the second most important destination for Japanese FDI, followed by Germany and Great Britain. Figure 2.5 again depicts the dominance of Japanese FDI by large firms. For example, a mere 2% of affiliates in China are owned by Japanese SMEs. As for the other BRIC countries, Brazil is the 12 th most popular destination market of Japanese affiliates, followed by Russia (16 th ) and India (19 th ). 2500 Figure 2.5 Number of Japanese Foreign Affiliates by Firm Size and Destination Country 2000 1500 1000 500 0 US CN DE GB TH AU SG FR ID KR CA BR HK TW MY RU MX ES IN VN Micro (<10) Small (10-49) Medium (50-249) Large (250 or more) Among the 20 most important target markets for Japanese FDI figure Indonesia (ranked 9 th ), Hong Kong (12 th ), Taiwan (13 th ), Malaysia (14 th ) and Vietnam (20 th ) which do belong neither to the OECD nor to the BRICs. Compared to other countries, SMEs are relatively underrepresented among foreign investment firms: almost 80% of Japanese affiliates abroad are owned by large firms. This tendency is even more pronounced when looking at BRICs countries. In China, a tiny 2% of affiliates belong to SMEs, in Brazil and India, these figures are even smaller, reaching 1.5%. In Russia, the second most important BRIC country for Japanese FDI, the corresponding number is 9%. 26