The Small and Medium Enterprise Sector in the Emerging Economies of Eastern Europe and Russia

Nancy Lockhart, Chief Administration Officer, Frum Development Corporation and President-Elect, The Canadian Club of Toronto; The Reverend Prue Chambers, St. Nicholas Anglican Church, Birchcliffe; Shelly Wu, OAC Student, North Toronto Collegiate Institute; Leslie Rebanks, Architect, Rebanks Pepper Littlewood Boyd Architects Inc.; Suzanne Davis, President, Christie's Canada Inc.; Max Chauvin, National President, Royal Life Saving Society; LCol. Phil Berthiaume, Commanding Officer, The Essex and Kent Scottish Regiment, Windsor; John F. Bankes, Managing Director, Artemis Management Group Inc., National Chair, Royal Life Saving Society and Past President, The Empire Club of Canada; Kathy M. Whidden, President, Second Sight Innovation; Charlie S. Cutts, President, Corporation of Massey Hall and Roy Thomson Hall; Jill Hermant, Executive Director, Duke of Edinburgh Awards; and Gordon K. Mclvor, Vice-President, Canada Lands Company Limited and President, The Canadian Club of Toronto.

Introduction by Gareth Seltzer

Anthony Crickmay--Prince Michael--we are delighted that you are our guest today. Prince Michael, if you will allow me to say, is the grandson of George V and a cousin to both the Queen and the Duke of Edinburgh, who has also been a guest of our clubs. Prince Michael has served in the United Nations peacekeeping forces in Cyprus in the early 1970s--and among other tours of duty, Prince Michael is now the Honorary Commodore of the re-structured Royal Naval Reserve.

As chairman of his own company, I was impressed to read that he offers consultancy advice with respect to the construction, telecommunications, insurance, finance and tourism sectors as well as the medical, aviation and automotive industries. I am pleased to say that you still have time to master nuclear fusion and subsurface ecosystems. I jest, of course, as His Highness is also a race-car driver and a qualified pilot. A qualified Russian interpreter, also fluent in French and with a working knowledge of German and Italian, the Prince travels extensively on business and has led delegations of British businessmen to both China and Russia. Basically, it looks to me as if you just travel around making the rest of us look bad.

His Highness is also a keen sportsman, having represented Great Britain as a bobsleigh driver for many years, and was a reserve for the 1972 Olympics.

His Highness has very strong and active associations with Russia which he first visited in 1992, following the collapse of communism. Now patron of the Russo-British Chamber of Commerce, he has returned to the country many times since then on business. He is also closely involved with a number of charity, arts and humanitarian organisations in Russia, including The Friends of Russian Children of which he is a particularly concerned and committed patron.

Your Highness, it is with a deep sense of appreciation and honour that I express how pleased we are that you are here today and 1 ask the room to please extend a warm welcome to His Highness, Prince Michael of Kent, to the podium.

Prince Michael of Kent

Thank you very much for your kind invitation to address this joint meeting of the Canadian Club and the Empire Club. It is a great joy for me to be back in Toronto, a city about which I have so many fond memories. I am so glad we all had a chance to see the Queen's Baton and to speed it on its way to Manchester.

I have decided today to concentrate on two subjects which fascinate me, and which I see as interconnected in many important ways--the development of the small and medium enterprise (SME) in Europe and its role and significance for us all in the emerging economies of Eastern Europe and Russia.

You may well wonder what that has to do with Canada. Well, SMEs have played a vital role in the development of the post-industrial world. As we all know, the SME sector has been perhaps the greatest engine for growth in western economies, but it has also played a big part in mobilising the democratic instincts of people in the free world and generated a desire for them to manage their own futures. That is only now becoming a matter of prime importance in the development of Russia, and is one in which I feel we all have a part to play, not only out of purely commercial interests but as a means of helping to spread democracy amongst "the family of nations."

The last 20 years have seen some of the most exciting examples of the influence that the vision of individuals and tiny companies has had on a world which so often seems to have been dominated by multi-nationals. That influence will flourish in an atmosphere of freedom of thought, with a minimum of government red tape and legislation and where the true entrepreneur can have his head. Innovation has long been a characteristic of the British peoples, but it will be stifled unless there is a move in the European SME sector towards a more enlightened and less bureaucratic environment. Without that, the SME sector will stagnate, and so a number of initiatives have been set in train in the United Kingdom which might be of interest to you as you consider investment into the SMEs in Europe.

In researching this talk, I was struck by the diverse range of factors that have contributed to making Canada the champion of the entrepreneur on an international scale. A combination of fiscal incentives and educational policies has transformed the country into the second most successful small-business environment in the world in terms of the number of adults setting up new businesses. Seven per cent of adults actively participated in business start-ups in Canada in 1999 compared with a European Union average of 2 per cent. Canada's performance as a creator of small-business opportunities makes a laudable and compelling case.

That Canada has a culture more intrinsically suited to entrepreneurs than that of many European Union (EU) countries was borne out in a survey conducted recently by a joint Anglo-American team of academics. They measured the enterprise spirit across 23 countries worldwide by asking the simple question: "Suppose you were working and could choose between different kinds of jobs, which would you prefer: being an employee or being selfemployed?" Over 57 per cent of the Canadian respondents preferred being self-employed--well ahead of the proportions registered by respondents in the EU.

One of the main reasons why Canada so attracts the entrepreneur has been the assertive policies pursued by the authorities, particularly in education and training, to bring out the creative spirit and develop relevant skills. The percentage of people in Canada between the ages of 25 and 64 with tertiary-level education is a staggering 39 per cent, compared to an EU average of 22 per cent.

So I know that I am speaking in a country with innovation close to its heart. Moreover, it has been copied by the United States and, in Europe, by Italy, the Netherlands, France, Spain and the United Kingdom.

By the way, did you hear about the investment banker who hired a plumber to repair a tap? He took 10 minutes on the job and charged $50. "I say," said the investment banker, "I couldn't make $50 for 10 minutes work." "Nor could I," said the plumber, "when I was an investment banker."

One of the many advantages our two countries share is this: in a recent update on a KPMG survey used by companies all over the world to determine the best place to locate businesses, Britain was shown to be the secondcheapest out of nine industrial countries, behind only Canada. We ranked as the best place in Europe, our labour costs being the second-lowest anywhere. You might be interested to know that Edmonton ranked as the least expensive city in this survey! I'm sorry about that!

We in the EU--and those in the emerging economies of Eastern and Central Europe--have a lot to learn from Canada's experience and would do well to adopt your best practices and emulate the encouragement you give to the entrepreneur. That has allowed Canada to be successful, over time, in the most important measures of small-business performance, and ultimately, prosperity.

Within the EU, it is now widely recognised that SMEs (or those employing less than 250 people) constitute the key to future economic growth. European heads of government have started the ball rolling by committing themselves to "open and competitive markets" as a means of removing unnecessary barriers to trade and encouraging trade links between the EU member states.

The economic reforms enacted by European states have the strong support of the large corporations, anxious to exploit economies of scale and critical mass. But it is easy to forget that SMEs can also benefit from the removal of trade barriers, and, in fact, prosper if the appropriate framework is put in place to cultivate trade within the EU itself.

An important step towards stimulating small-business growth emerged at the Lisbon Summit of EU heads of state in March 2000, when the EU SME Charter was adopted empowering EU States to take measures to become "the most competitive and dynamic, knowledgebased economy in the world by 2010." The Charter implicitly recognised the role of small businesses in European economic growth. The Charter has become the building block of the European Commission's enterprise policy.

Consider the facts. Twenty million small businesses in the EU today provide employment for 65 million people. They account for 99 per cent of all businesses. Do you know how many people the average European business provides employment for, including the owner/manager? Two.

SMEs provide some 53 per cent of all jobs in the EU--a percentage that is predicted to rise as larger companies face threats, mainly from e-commerce and greater Internet usage by entrepreneurs. In the last decade, SMEs were the principal creators of new jobs, whilst on average, big industry has reduced employment. EU SMEs currently generate an impressive 56.2 per cent of the private-sector turnover.

And yet, SMEs continue to face substantial problems in the EU, not seen in big industry. They can be summarised under four broad headings:

Inadequate legislative, fiscal and financial measures exist across the EU to encourage small businesses to stay in business.

• Few European small businesses actually grow into bigger ones. Fast-growth firms account for only 4 per cent of businesses in Europe compared to 19 per cent in the United States.

• There are still serious time, cost and capitalrequirement obstacles to setting up a business in the EU.

• More than three-quarters of total venture capital investments in Canada finance the early stages of a business start-up and expansion, as compared to less than half in the EU.

These problems are now being addressed by European heads of government and the European Commission, but not necessarily through further legislation.

For example, in Britain there are over four million SMEs and they contribute 40 per cent to our Gross National Product; this in a country whose economy is the fourthlargest in the world despite being only twentieth in terms of population. The spirit of enterprise has long been a feature of our national landscape and small firms now employ over half of our private-sector work force. Small business tax now has a starting rate of 10 pence in the pound; a new R&D tax credit will mean that this year a quarter of the new investment in SME business research is underwritten before a penny of profit is made. No wonder, then, that the British stock of inward direct investment has risen 45 per cent in the last five years.

Which reminds me... actually it doesn't, but I thought you would like to hear this story anyway:

A young police constable, giving evidence in a magistrate's court for the first time was very nervous.

The case was of a "lady" charged with indecent behaviour and offensive language. The Chairman of the Bench, a woman, asked the policeman what the defendant said.

He replied: "I don't think I can mention this in open court, Your Worship."

The Chairman said: "Very well, Officer, write it down and hand it up."

He did so. The Chairman read the offending words and passed them to her immediate colleague on the right. He, unfortunately, had just "dropped off" for a moment. She therefore nudged him in the ribs.

He woke up, saw the piece of paper, read the words on it, and said with surprise: "What, now?"

To energise the SME sector in Europe, the drive must come from a top-level cross-parliamentary co-ordination, national and Pan-European, aimed at implementing a range of measures to encourage SME start-ups, as well as contributing to their growth.

I therefore want to draw your attention to an exciting new British initiative focused on boosting European small business growth called The Genesis Initiative, of which I am founder patron.

We have constituted in the United Kingdom, an AllParty Parliamentary Small Business Group to galvanise cross-party political skills aimed at promoting small-business growth. Drawn from the ranks of all British political parties, (which is very unusual in Europe), the group acts as a catalyst driving key policy issues through Westminster and providing feedback for SMEs on smallbusiness issues. A consensus-based approach to the development of government SME policy has been secured by forging a partnership with key British non-profit-making representative organisations. Parliamentarians and the SME bodies have now consolidated their efforts by forming The Genesis Initiative to ensure that small business speaks with one voice.

One of the central issues The Genesis Initiative has concentrated on in the United Kingdom is the need to identify impediments preventing SMEs from fully exploiting the European single market. Many of them are of European origin, and therefore need to be addressed very early on. In the past six months, we have taken The Genesis-Initiative concept into the heart of Europe by creating a grouping of cross-national and European parliamentarians that we call The Pan-European Genesis Initiative. Its structure is designed to act in the collective interests of small-business owners, SME policy agencies and legislators at the national and European level.

The Pan-European Genesis Initiative was officially launched in London last September. In a concerted effort to accelerate the pace of small-business reform across the EU, so as to create a dynamic EU economy by 2010, The Pan-European Genesis Initiative is designed to work as an advocacy body.

It would represent an important departure from existing practices in the history of European industry policy. In time, it is our hope that The Pan-European Genesis Initiative will be at the forefront in driving the debates at European level, and become the cornerstone on which European small businesses can build.

So what role can Canada play in this new initiative and how will she stand to benefit if we are successful?

The potential for direct investment into the EU SME sector is enormous. In 1999, foreign direct investments grew by 27 per cent. Almost half of them came from nonEU countries. Canada's direct investment is part of this growth trend-rising from around C$1.25 billion in 1998 to C$2.75 billion in 1999. This still only represents 1 per cent of the total foreign direct investment into the EU based on 1999 figures.

I was talking just now of the need to move to a less bureaucratic environment. I heard a story last week about Russia in the old communist days--a true story--which shows what can happen if bureaucracy goes to extremes.

A consignment of pig-iron was taken by train from Vladivostock to Moscow and when it arrived there the railway authorities asked the engine driver for his papers. When he produced them, the officials said: "These papers are not in order: you have told us you are carrying 12,500 tons of pig-iron, but 1,250 tons is written here. You are not permitted to discharge your cargo in Moscow" So what did the driver do? He turned his locomotive round, took the entire train back to Vladivostock, went to head office, got the comma put in the right place and brought the whole train back to Moscow again. That's a 3,500 mile journey, multiplied by three--and you can imagine the expense!

Well I have been going there regularly for the last 10 years and Russia has changed 180 degrees. And I put it to you:

Alongside the potential for Canadian investment into the SME sector in the United Kingdom and Europe, there must also be a strong argument in 2002 for putting money into the emerging economy of Russia. You may not have given it much thought, but there is not only the commercial opportunity but the chance to contribute towards the reintegration of a significant new market into the global economy. SMEs will have a disproportionate influence on the development of Russia in the next 10 years. So let's have a look at their role in today's Russia and some other areas in Eastern Europe.

After more than a decade of transition, there is a clear economic divide between the leading reformers in Eastern Europe and the countries of the former Soviet Union. Compared to Eastern Europe, where SMEs accounted for about 60 per cent of GDP by 1998, the former Soviet Union accounted for only 10 to 20 per cent in Russia, Belarus, Kazakhstan and Ukraine.

The emphasis of future policy in the former Soviet Union must be on the development of SMEs. I would like to build on this theme with particular reference to SMEs in Russia and why foreign investors should begin to pay close attention to this sector of Russia's economy.

The resistance to restructuring within industry and government that prevailed before 1998 has changed and there is a new sense of realism. The exchange rate crisis of August 1998 cut off external financing with the consequent imposition of financial discipline at all major levels of the Russian economy. In effect, the 1998 rouble crisis shook Russia out of its dilatory attempts at reform. But the current move to real market reform will make things worse before they start getting better. Restructuring the big old industries will bring higher unemployment and diminish the traditional role of the company in the old Soviet times as the provider of social security. The risks still exist and, as foreign investors, you are most exposed if reform stalls and people are left with no job, no prospects and insufficient welfare support. The key to reducing that risk is a vibrant local enterprise sector, which can utilise the unemployed workers and the nonperforming assets.

An example of that is Poland, where the drop in GDP at the beginning of transition lasted only two years--the shortest period in the region--because SMEs took up the slack created by the decline of the big old industries. By 1998 SMEs generated 48 per cent of GDP and in terms of employment, seven out of the 11 million people working in the Polish economy were in the SME sector. The SMEs created the growth and employment opportunities that enabled the initial losers--those who had lost their jobs in the large industrial and manufacturing sectors--to gain in the long term.

It could be tempting to imagine that the Polish model applies also to Russia. With policies of financial discipline and a credible modernising government now in place in Russia, similar growth in SMEs as Poland could be expected. After all, from 1991-1994 the number of SMEs in Russia grew from 250,000 to around 900,000. But unfortunately, that growth ceased in the mid-1990s when vested interests came to dominate the business environment. The high level of risk and the insecurity of property rights stunted the development of the Russian SME sector.

Clearly, to encourage a new stage of SME development in Russia, there has to be reform in the legislative, regul& tory and taxation systems so that SMEs can join the real, not the shadow, economy. There must be legal reforms focusing on the issue of contract enforcement. Removal of administrative interference and streamlining of regulatory state functions must be priorities. The concerns of SMEs mirror the concerns of foreign investors. But the real question is how these reforms can be achieved. Fortunately the first steps have already been taken.

The new tax (a 13-per-cent flat tax on personal income) and licensing reforms are paving the way for the growth of SMEs in the short term. Addressing an all-Russian convention of Russian entrepreneurs in March 2001, Prime Minister Kasyanov publicly expressed his support for introducing a special section on small business taxation into the tax code. But in the medium term this new SME movement must become a force for market competition for influencing the government and resisting vested interests. And it is the foreign investors who are in a position to help them succeed by forming business associations with SMEs, leveraging the expertise of international institutions and playing an important role in creating fairer business conditions.

An important part of the development of SMEs as a group in Russia is their ability to voice their concerns at a political level. Last December lobbyists representing the Russian Entrepreneurial Organization's Union hosted a conference and met with President Putin. Founded last spring, the union is the largest small-business lobby in Russia. It formed the backdrop to the meeting of the Russian Federation State Council which was attended by all but seven of the 89 regional leaders, as well as Prime Minister Mikhail Kasyanov, Finance Minister Alexei Kudrin and Economic Development and Trade Minister German Gref. At this meeting President Putin called on the government to create a legal, regulatory and financial environment friendly to entrepreneurs and reaffirmed his belief that SMEs are the key to a stable economy.

For the last 10 years Russia has been in a state of flux. But there is greater optimism today than ever before that she has set her strategic course towards the market economy. It will by no means be easy. Russia has yet to go through many of the painful changes that the countries of Central and Eastern Europe experienced in the process of transition.

Nevertheless, whether it be in Russia, Europe or Canada, there is no doubt that the driving force in this shrinking world will continue to be the SME sector. In Europe as a whole, we will need to take a leaf out of the Canadian book and adapt our variety of cultures to take advantage of the renowned entrepreneurial skills of our separate populations.

SMEs will play a key role in the successful economic development of Russia as they already have elsewhere. In spite of the slow start, Russia will undoubtedly embrace the benefits which accrue from a successful small-business sector. There may come a time when your interests diverge and when the focus is on competition rather than co-operation. But that will only happen after international investors have helped Russia create a fair legal system, clear tax rules and simple regulations.

There is a great opportunity now if those in the West, who have experienced the contribution which the SME sector can make to their own commercial landscape, can involve themselves profitably in the same way in the emerging economy of Russia and thus help to participate in the development of closer international ties to the benefit of us all.

Small will then, undoubtedly, be beautiful.

Of course, no enterprise no matter how original, well planned and brilliantly executed, can succeed without the base of a stable political environment in which it can operate according to a predictable and impartially administered set of rules established by democratic processes and known to all.

That is why I must close by reflecting on how happy I am to be in Canada in this year of The Queen's Golden Jubilee. Throughout Canada's history, as today, the Crown has offered the Maple Kingdom a distinct sense of nationhood amidst a sea of continentalist influences; parliamentary government under the rule of law; provincial autonomy reconciled with federal authority.

Even above and beyond these political considerations, Canadians in common with Britons share a deep admiration for the decades of service by Her Majesty The Queen. In an era of the transitory and ephemeral, where the typical worker will change his employment seven times over the course of his career, the Queen's constant and unselfish service and total commitment to the interests and well-being of the entire community stands as an example and challenge to us all. It is why you, as I, can be proud to give her our allegiance.

The Golden Jubilee celebrations offer all of us an opportunity to reflect on the many advantages of our enjoying a stable environment in which to raise our children and conduct our business lives. They also suggest that by possessing a sound base of knowledge about our institutions we shall preserve that tolerant, inclusive and generous spirit that is typical of Canada and the Commonwealth at its best.

The appreciation of the meeting was expressed by Gordon K. Mclvor, Vice-President, Canada Lands Company Limited and President, The Canadian Club of Toronto.