The Role Of Small And Medium Enterprises In Structural Transformation And Economic Development

Developing countries often face a difficult task of balancing rapid economic growth with equitable growth. The inequalities that arise during the course of rapid economic growth are a cause of serious concern as they are not temporary but are structural in nature. Our study directs attention to the role of Small and Medium Enterprises (SMEs) in overcoming these structural rigidities and ushering-in structural transformation in an economy. To explore the issue of structural transformation, and alleviation of poverty and structural inequalities, we posit a dual-economy framework, where a less productive traditional sector coexists with a highly productive and skill-intensive modern sector. Indivisibility of investments for skill formation combined with credit market imperfections leads to a poverty trap in the economy (Galor and Zeira, 1993). In this context, the appeal of SMEs lies in their role in providing alternative employment opportunities to low skill workers and facilitating transition of workers out of the traditional sector even when credit constraints are binding. However, the history of an economy, in terms of the initial distribution of education of its workforce, has a major role in determining the persistence of structural poverty and inequalities. We show that removal of educational inequalities is a prerequisite for overcoming other forms of inequality in the economy. Further, SMEs while acting as a bridge also raise the overall income in the skill-intensive modern sector. However, such process of structural transformation gets throttled if the initial size of the highly educated agents is too small. Thus this study underscores the need for a holistic approach in terms of development policies which focus not just on the SMEs as a vehicle of structural transformation but also emphasizes the importance of promoting higher education for the process of structural transformation.