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Competitiveness of Turkish SMSEs in the Customs Union
EUROPEAN ii?iz%Mc ELSEVIER
European Economic Review 41 (1997) 88 l-892
Competitiveness of Turkish SMSEs in the Customs Union ’ Refik Erzan, Alpay Filiztekin
*
BogaziCi University, Dept. of Economics: KOF University, Dept. of Economics, Istanbul, Turkey Center for Economics and Econometrics, Bogazid University, Istanbul, Turkey
Abstract As a basis for adjustment policies in Turkey, it is assumed that the impact of the Customs Union will be more severe on small- and medium-scale enterprises (SMSES) in comparison with large establishments. The paper first studies growth in value added and productivity in Turkish manufacturing with respect to industry and size; then scrutinizes the hypothesis above by analyzing the vulnerability of firms depending on their sizes. The effects of the Customs Union on economic environment manifest themselves in terms of the level of protection, import penetration, the wage level, exchange rates and exchange rate volatility; and, changes in domestic and foreign demand, and credit availability. The paper
analyzes the impact of these changes on firms’ performances. Panel data techniques are used in the estimations.
0 1997 Elsevier Science B.V.
JEL classification: L6; 047; 052 Keywords: Small- and medium-scale
enterprises;
Customs Union; Competitiveness;
Turkey
1. Introduction As a basis for adjustment policies in Turkey, it is assumed that the impact of the Customs Union (CU) with the European Union (EU) will be more severe on small- and medium-scale enterprises (SMSES) in comparison with large establish-
* Corresponding author. ’ An earlier version of the paper was presented gence?” held in June 1996, at the LSE, London. 0014-2921/97/$17.00 Copyright Z’ZZSOO14-2921(97)00045-7
at the conference
“Europe
and Turkey:
0 1997 Elsevier Science B.V. All rights reserved.
Conver-
882
R. Erzan, A. Filiztekin / European Economic Review 41 (1997) 881-892
ments. The paper scrutinizes this hypothesis by analyzing: (i) whether size was a significant factor in explaining the performance of firms in Turkish manufacturing industry during the 1980s and the early 1990s; and (ii) the vulnerability of firms with respect to their sizes. The effects of the CU on economic environment may manifest themselves in terms of import penetration, changes in demand conditions, inflation, exchange rates, credit availability and the level of wages. The paper analyzes the impact of these changes on firms’ performances captured by growth in value added, productivity and hence employment. In comparison with the EU economies, Turkish manufacturing industry experienced a robust growth in the 1980s in terms of output, employment, and most remarkably productivity (Fig. 1). Outward orientation of the economy was achieved through trade liberalization, a conducive exchange rate policy, export subsidies and suppressed wages as labor union activity was curtailed (see, e.g., Togan, 1993). Exports jumped from $3 billion in 1980 to $10 billion in 1987, while the share of manufactured goods in exports increased from 30% to 70%. As real wages were suppressed until 1989, there were major gains in employment. But starting in 1989, the loss in the purchasing power of the workers was more than compensated with a wage hike. Firms responded by substituting capital for labor and trimming other costs, resulting in an acceleration of productivity
sourcemm0
IMobosp
1
Fig. 1. Comparison of Turkish Katircioglu et al. (1995).
manufacturing
industry
with some European
counterparts.
Source:
R. Erzan, A. Filiztekin/
European Economic Review #i (1997) 881-892
883
growth. Despite this increase in real wages, the labor share in manufacturing dropped from 30% in 1980 to about 20% by the early 1990s. As the CU came into effect in January 1996, the SMSEs captured the center of attention in public policy. The argument follows that the Turkish SMSEs, which account for about 60% of employment in m~ufact~ng (in the EU countries as well) *, would come under dispropo~ionate strain compared to large enterprises. Presumably, a large number of SMSEs in both Spain and Portugal were wiped out as these countries entered the EU. The major weaknesses of the SMSEs are listed as their limited access to financial markets and the returns to scale in R&D and in marketing activities, particularly overseas. In declaring 1996 “the year of the SMSEs”, the Prime Minis~ aims at tapping their export potential. SMSEs account for only 10% of Turkish exports ‘. As the means, industrial policy is being modified to subsidize the R&D and marketing activities of the SMSEs and the Eximbank is instructed to allocate a greater share of the credits to these firms. Another potential resource is the EU funds and other facilities earmarked for the SMSEs. There is growing competition among various official and se~of~cial agencies in opening SMSE offices in Brussels. While this lobbying is intensifying on behalf of the SMSEs, the SMSEs’ main concern seems to be the macroeconomic environment. Their argument is that the SMSEs have great difficulty in insulating themselves from the adverse consequences of macroeconomic instability while large establishments may even profit from such conditions 4. The counter argument to the vulnerability of the SMSEs is based on their flexibility. Their overhead costs are lower, they do not have the same constraints imposed by the labor regulations and unions, and they have a taxation advantage as some of them operate in the gray or black economy.
There is no standard or generally accepted definition of the SMSEs. This goes for Turkey, the EU countries and the EU secretariat (see, e.g., TGSD, 1995). While the most common definitions are based on number of employees or persons engaged, the EU cut-off points inco~orate balance sheet and turnover figures as well. In this study, due to data limitations, firms engaging less than 10 persons which are sometimes considered “micro” establishments - had to be disre-
’ The figure includes “micro” es~blishments as well, see TGSD (1995) and TOBB (1996). 3 The (unpublished) estimates of the Prime Ministry, Undersecretariat for Foreign Trade, range from 8% to 12%. 4 In 1994, about two-thirds and in 1995 nearly half of the total profits of the largest 500 firms in Turkey were from non-operational sources, i.e. interest earned on Government bills and bonds (I.S.O.).
884
R. Erzan, A. Filiztekin / European Economic Reuiew 41 (1997) 881-892
Share of Number of Firms
Share of Labor
Share of Value Added
Productivity Relative to ManufactuiiKg industry
120%
Fig. 2. The profile of Turkish manufacturing Tiirkiye Isveren Sendikalari Konfederasyonu
industry by size classes, 1980-1992 (1994).
t 40%
averages,
%. Source:
garded (see the appendix on data ‘>. Hence the figures reported for industry totals cover firms with 10 persons or more. Firms engaging 10 to 24 persons are considered as “small”, while those with 200 and more persons are classified as “large”. The in-between categories (25-49, 50-99 and 100-199) were aggregated to constitute the “medium” size class of 25-199 6.
2. The profile and performance
of Turkish manufacturing
industry by size of
filXklS
While large firms (200 + > in number account for 7.1% of the industry total, their employment and value added shares are, respectively, 53.2% and 68.8% (Fig. 2). The employment share of small firms (lo-241 which stands at 10% is a major understatement of the importance of small firms in general - as those with 1 to 9 persons had to be disregarded ‘. For the 1981-1992 period, manufacturing industry’s value added growth was on average 11.6% per annum (Fig. 3). While this figure was 13.6% in large tkrns, in medium and small tkrns it was, respectively, 8.1% and 9.7%. Similarly, average annual productivity growth was 10.1% in large firms, and about 5% in the other firm sizes.
5 A data appendix is available from the authors upon request. ’ The results reported in this study are robust with respect to the definition of the medium-sized firms. Earlier estimations which treated the in-between size categories separately generated similar results. ‘In 1990, TOBB (1996) estimated the employment share of the “micro” firms engaging l-9 persons at about 36% of total employment in manufacturing.
R. Erz.an, A. Filiztekin / European Economic Review 41 (1997) 881-892
885
14% 12% 10%
9% 8% 4% % 0% Value Added
P~CXJtiiVll
n lO-24 025199 q200+ Soonx: Annual Manufactuhg industryStatistics,State lnatttuteot Stattstks, They WAllSizes
Fig. 3. Growth of value added and productivity by size classes, Tiirkiye Isveren Sendikalari Konfederasyonu (1994).
1980-1992
averages,
%. Source:
Value added and productivity growth and the performance of firms with respect to their sizes differed considerably across industries ‘. To identify the industry and size effects an “error components model” is estimated.
3. Identification
of industry and size effects
3.1. The model To identify industry and size effects an error components model is employed such that changes in value added and productivity that are due to industry specific disturbances are distinguished from changes in both variables that are due to size specific disturbances. The goal is to determine the fraction of the variation in growth of value added and productivity that can be attributed to industry, and the fraction to size specific shocks. It amounts to identifying the importance of distinct shocks on both variables. This analysis is similar to that of Stockman (1988) and Costello (1993), except nations in their model are replaced by size classes here. The statistical model is as follows: Yi,, =
“in
+
g,t
+fit
+
eint
where Yi,, represents either the growth rate of value added or growth rate of productivity of size n in industry i at time t. The term min is a constant term specific to size n in industry i. The term g,, represents the interaction of a fixed size effect and a fixed time effect. More specifically, it is a set of dummy variables, multiplied by their coefficients, for each size at each time but common for all industries. It is meant to capture differences in technology and/or
’ Tables are available
from the authors upon request.
886
R. Erzan, A. Filiztekin / European Economic Reoiew 41 (1997) 881-892
structure of various size classes. The term fir, on the other hand, is a vector of dummy variables specific to industry i at time t, but common to all sizes. It represents disturbances to production function, input prices or product demand that would have an impact on output in industry i for all size classes. The model in this form is not identifiable due to perfect collinearity among sets of dummy variables unless one imposes some normalization. To avoid this problem first g,. I is set to zero where IZ* is a specific size category (in this paper, it is the large fiis that employ more than 200 persons). Second fir and gn, are set to zero where T is the last period in the sample (in this paper 1992). After these normalization, the effects represented by g,, have to be interpreted as a time-varying nation effect relative to the largest size class. Similarly, the second normalization implies that the estimated effects are relative to year T. Furthermore, the industry and size effects are correlated. A certain level of growth in industry i, for size n at time t can be attributed either to industry specific shocks or size specific shocks. Therefore, the fractions of value added and productivity growth explained by orthogonal components, and the fraction explained by both are estimated. The idea behind this model is as follows: If the main exogenous forces driving short-run variations in growth rates are due to disturbances in technology or preferences, then those shocks are concentrated in a set of industries regardless of size. However, if the main exogenous forces are due to structure of the size classes, then the g,, terms must be significant.
Table 1 Estimation
results of the error components
model (1981-1992)
Value added growth Total SS
Model SS
199.48
128.06 ss
Size effect Industry effect Productivity
14.01 89.73
R2 0.642
SS attr. to f+g 115.40
(%I
F
P-value
12.1 77.8
4.569 2.258
0.0000 0.0000
R2
SS attr. to f + g
growth
Total SS 90.03
Model SS 46.97 ss
Size effect Industry effect
1.80 39.03
0.522
43.15
(%o)
F
P-value
4.2 90.4
0.970 1.629
0.5015 0.0000
R. Erzan, A. Filiztekin/European
Economic Reuiew 41 (1997) 881-892
887
350
1980
1981
1982 -Real
1983
1984
Wage Index
1985
1986
1987
1988
Sizes
-All
1989
1990
1991
1992
-10-24
Soum:Turhiye,sveren SendihelanKonfedemsyano
Fig. 4. Real wage index and productivity
indices by size classes, 1980-1992
(1980 = 100).
3.2. Data The main source of data is the Annual Manufacturing Industry Statistics published by State Institute of Statistics @IS) of Turkey (see appendix on data, see footnote 5>. The analysis uses only data for private firms. After a through examination of the data, certain observations are found to be unreliable and extremely influential. Therefore, to avoid mismeasurement problems, 2% of the sample, 1% from the top and 1% from the bottom was trimmed based on productivity growth rates. 3.3. Estimation
results
In value added growth, industry and size explain 64.2% of the variation (Table 11. While both effects are significant, 77.8% of this is accounted by industry characteristics and 12.1% is due to size. The results are similar for productivity growth where the combined explanatory power of industry and size is 52.2%, 90.4% of it is attributed to industry and 4.2% to size (the latter being insignificant). The conclusion is that size matters - the bigger the better in terms of value added and productivity growth - but much less importantly compared to industry characteristics. This result modifies the picture emerging from Figs. 2 and 3 which only depict size differences, disregarding the industry effect. 3.4. Structural
change due to wage hike
As a result of the jump in real wages starting 1989 (Fig. 4) 9, firms substituted capital for labor and increased their overall efficiency. Wage increases were more substantial in large firms where labor is better organized. Also, large firms having access to financial markets have greater factor substitution possibilities. Conse-
9
The real labor cost index reported in Fig. 4 is the manufacturing
industry average.
R. Erzan, A. Filiztekin/ European Economic Reuiew 41 (1997) 881-892
888
quently, it can be expected that productivity growth in large firms had a level jump from 1989 onwards. This structural break can be observed in Fig. 4. When the error components model was estimated for the two sub periods, 1981-1988 and 1989-1992, the results corroborate the observation made in Fig. 4. The overall explanatory power of the model increased somewhat (Table 2). More importantly, however, the importance of the size effect in value added growth increased substantially in the 1989-1992 period, explaining 25% of the Table 2 Estimation
results of the error components
model for two sub-periods
1981-1988 Value added growth Total SS
Model SS
145.28
98.67
Size effect Industry effect productivity
R2 0.679
SS attr. tof+g 81.88
ss
(o/o)
F
P-value
6.08 73.64
7.43 89.94
3.012 2.813
0.0002 0.0000
Model SS
R2
growth
Total SS 59.14
29.96
Size effect Industry effect
0.507
SS attr. to f + g 25.60
ss
(o/o)
F
P-value
0.90 23.73
3.53 92.72
0.710 1.448
0.7645 0.0020
Model SS
R2
SS am. to f + g
1989- 1992 Value added growth Total SS 53.52
34.16
Size effect Industry effect Productivity
0.64
27.99
ss
(o/o)
F
P-value
6.99 11.98
25.0 42.8
8.488 1.119
0.0000 0.2804
Model SS
R2
SS attr. to f+g
growth
Total SS 28.16
Size effect Industry effect
16.91
0.60
12.23
ss
(o/o)
F
P-value
0.52 11.05
4.2 90.4
1.085 1.777
0.3746 0.0016
889
R. Erzan, A. Filiztekin/European Economic Review 41 (1997) 881-892
variation. In productivity growth, the size effect remained insignificant phenomenon which is explained by the findings of the following section.
-
a
4. The impact of environment on performance of small and large firms The economic environment captured by sectoral protection levels, import penetration, the wage rate, inflation and changes in the exchange rate, domestic and foreign demand and credit availability may affect the performance of small and large tirrns differently. Entering the CU, border protection is removed or reduced considerably, implying deeper penetration of imported goods. Concerning the impact of the CU on macroeconomic variables, however, the relationship is not straightforward. In the short term, volatility in the exchange rate and in demand conditions may increase. In the long term, wages would converge to the level of the Southern members of the EU. These are adverse developments for the firms. On the other hand, to avoid a balance of payments crisis, the policy makers have to put the fiscal policy under discipline, and there would also be more constraints on monetary policy. In the long run, this would bring about macroeconomic stability, lower inflation, less exchange rate volatility and better credit terms. To make conjectures concerning the impact of the CU on the performance of small and large firms via the economic environment, variables capturing the main elements of the environment were introduced to the original error components model. 4.1. “Environmental”
variables
Exchange rate is defined as Turkish Liras (TL) per basket of 0.60 US $ plus 0.40 DM. A higher exchange rate favors tradables. Exchange rate volatility is measured by the variance in the monthly average exchange rate during the year. Inflation is the wholesale price index. Domestic demand is approximated by real final consumption (private plus public). Foreign demand is captured by the real GDP of the European OECD countries. Total amount of credits represent credit availability. The real cost of labor index, which includes taxes and social security contributions, is the average for manufacturing industry, to capture the economywide labor cost push. Sectoral average nominal tariffs (including all border charges) represent protection, while penetration ratios proxy import competition. 4.2. The modified model
The error components model of the previous section is a statistical model. To refine the findings and to capture the effect of environmental variables, a fixed effect model with the variables described above was estimated: qnt = min + X, + Zi, + eint
890 Table 3 Estimation
R. Erzan. A. Fiiiztekin / European Economic Review 41 (1997) 881-892
results with “environmental”
variables a
Small
Medium
sign
P-value
sign
Large P-value
sign
P-value
+
0.094
+
0.052
Dependent variable: Value added growth: Exchange rate Exchange volatility Inflation Real wages Change in credits Change in domestic demand Change in foreign demand Import penetration Tariffs
+ _ _ -
0.000 o.ooQ 0.011 0.000 0.032 0.001 0.000 0.055
-
0.074
+ +
0.069 0.027
-
0.074
Dependent uariuble: Prod~tj~j~ growth: Exchange rate Exchange volatility Inflation Real wages Change in credits Change in domestic demand Change in foreign demand Import penetration Tariffs
_
0.0611
Dependent variable: Change in man-hours: Exchange rate Exchange volatility Inflation Real wages Change in credits Change in domestic demand Change in foreign demand Import ~ne~tion Tariffs
+
0.000
+
_ _ _ -
o.ooo
-
0.000 0.009
-
0.000
-
0.028 0.032
_
0.005 0.000 0.017 0.000 0.000 0.059
a The table reports only those cases where the coefficients
are significant
at the 10% level.
where X, are those variables common to all industries and size classes, and Zi, are the variables specific to industry but common to all sizes. 4.3. Estimation results The most striking result emerging from the estimations was that the environmental variables had significant effects on value added growth in small firms while they had no effect on large firms. In Table 3, the signs of the environmental
R. Erzan, A. Filiztekin / European Economic Review 41 (1997) 881-892
891
variables which were significant at the 10% level are given. Concerning value added growth, the small firms suffered from exchange rate volatility, inflation, wage hikes and import penetration lo. Changes in credit availability and changes in domestic and foreign demand also had a negative influence on the value added growth of small firms. The adverse impact of this latter set of environmental variables can be explained by large firms’ competition for scarce inputs when the economy is heated. During the 1980-1992 period, annual GNP growth fluctuated between 0 and 10%. It seems that the small firms had difficulty in competing for inputs in peak periods. This phenomenon can also be interpreted as a negative consequence of macroeconmic instability. Large firms are not affected significantly from any of the environmental variables except the positive impact of changes in credit availability. The latter underlines the fact that both state and private credits are predominantly geared to larger enterprises. In productivity growth, none of these environmental variables mattered for small firms. The cause of this apparent disparity was the sensitivity of employment with respect to the environmental variables in small versus large firms. The estimation of the impact of the environmental variables on changes in employment (measured by man-hours) revealed this phenomenon. In small firms, and to a lesser extent in medium sized firms, employment responded significantly to adverse economic conditions while this was not the case in large firms.
5. Conclusions In explaining value added and productivity growth, industry characteristics appeared to be more important than firm size. In one respect, in the face of wage hikes it was found that the larger enterprises had much greater possibilities of substituting capital for labor and increasing productivity despite of the increases in factor costs. Reduction in protection and increases in import penetration probably the most straightforward immediate impact that would be felt as a result of the CU - had some negative effect on the performance of the SMSEs. The most important finding of the study was that, unlike large firms which could insulate themselves from adverse macroeconomic conditions and fluctuations, SMSEs suffered from economic instability. Particularly, it had a depressing effect on small firms’ employment and value added growth SMSEs managed to maintain their productivity by labor reduction. Hence, the “flexibility” advantage attributed to the SMSEs seems to originate from the leaner impact of labor regulations and union activity on smaller establishments. An implication of this 7
Small firms also appeared
to have benefited from an exchange
rate which favored exportables.
892
R. Erzan, A. Filiztekin/European
Economic Review 41 (1997) 881-892
finding is that, adverse economic conditions would lead to employment and production losses in the SMSEs rather than firm closures. In terms of both the impact of import penetration and adverse economic conditions and fluctuations, the findings give support to the argument that SMSEs might be more vulnerable in the initial phase of adjustment to the CU. In the longer term, however, to the extent that CU will contribute to macroeconomic stability in Turkey, SMSEs would be better off. Probably the only robust policy recommendation that can be drawn from this analysis in support of the SMSEs is giving high priority to macroeconomic stability, particularly in the initial phase of the adjustment to the CU. The results also give some support to the generally held view that the SMSEs are at a disadvantage in input markets, particularly in credits. Hence, policies geared to increasing their access to the financial markets seem appropriate.
Acknowledgements The excellent research assistance provided by Nurbanu Akgit, Kemal Badur, Niltifer Candar and Serhan O&r is gratefully acknowledged.
References Costello, D., 1993, A cross-country, cross-industry comparison of productivity growth, Journal of Political Economy 101, 207-222.. I.S.O., Istanbul Sanayii Odasi Dergisi, various issues. Katircioglu, E., N. Engin and C. Akqay, 1995, The impact of trade liberalization on the Turkish manufacturing industry: An empirical assessment, in: R. Erzan, ed., Policies for competition and competitiveness: The case of industry in Turkey (United Nations Industrial Development Organization, Vienna). OECD, National Income Accounts, various issues. State Institute of Statistics, Annual Manufactnring Industry Statistics, various issues. Stockman, A., 1988, Sectoral and national aggregate disturbances to industrial output in seven European countries, Journal of Monetary Economics 21, 387-409. TGSD, 1995, Kll@ik ve orta boy isletmeletin avrupa toplulugu’nda ve Tiirkiye’de tesviki (Tlrkiye Giyim Sanayicileti Demegi, Ankara). TOBB, 1996, Tllrkiye ekonomisinde kli@lk ve orta Gl9ekli isletmeler (Tiikiye Odalar ve Borsalar Birligi, Ankara). Togan, S., 1993, 198O’li yillarda Tllrk dis ticaret rejimi ve dis ticaretin liberalizasyonu (Eximbank, Ankara). Tbrkiye Isveren Sendikalari Konfederasyonu, 1994, Ttrkiye Isveren Sendikalari Konfederasyonu’nun ‘Tlrkiye’deki &ret Sistemine’ Iliskin Giiriisleridir, Ankara.
European Economic Review 41 (1997) 88 l-892
Competitiveness of Turkish SMSEs in the Customs Union ’ Refik Erzan, Alpay Filiztekin
*
BogaziCi University, Dept. of Economics: KOF University, Dept. of Economics, Istanbul, Turkey Center for Economics and Econometrics, Bogazid University, Istanbul, Turkey
Abstract As a basis for adjustment policies in Turkey, it is assumed that the impact of the Customs Union will be more severe on small- and medium-scale enterprises (SMSES) in comparison with large establishments. The paper first studies growth in value added and productivity in Turkish manufacturing with respect to industry and size; then scrutinizes the hypothesis above by analyzing the vulnerability of firms depending on their sizes. The effects of the Customs Union on economic environment manifest themselves in terms of the level of protection, import penetration, the wage level, exchange rates and exchange rate volatility; and, changes in domestic and foreign demand, and credit availability. The paper
analyzes the impact of these changes on firms’ performances. Panel data techniques are used in the estimations.
0 1997 Elsevier Science B.V.
JEL classification: L6; 047; 052 Keywords: Small- and medium-scale
enterprises;
Customs Union; Competitiveness;
Turkey
1. Introduction As a basis for adjustment policies in Turkey, it is assumed that the impact of the Customs Union (CU) with the European Union (EU) will be more severe on small- and medium-scale enterprises (SMSES) in comparison with large establish-
* Corresponding author. ’ An earlier version of the paper was presented gence?” held in June 1996, at the LSE, London. 0014-2921/97/$17.00 Copyright Z’ZZSOO14-2921(97)00045-7
at the conference
“Europe
and Turkey:
0 1997 Elsevier Science B.V. All rights reserved.
Conver-
882
R. Erzan, A. Filiztekin / European Economic Review 41 (1997) 881-892
ments. The paper scrutinizes this hypothesis by analyzing: (i) whether size was a significant factor in explaining the performance of firms in Turkish manufacturing industry during the 1980s and the early 1990s; and (ii) the vulnerability of firms with respect to their sizes. The effects of the CU on economic environment may manifest themselves in terms of import penetration, changes in demand conditions, inflation, exchange rates, credit availability and the level of wages. The paper analyzes the impact of these changes on firms’ performances captured by growth in value added, productivity and hence employment. In comparison with the EU economies, Turkish manufacturing industry experienced a robust growth in the 1980s in terms of output, employment, and most remarkably productivity (Fig. 1). Outward orientation of the economy was achieved through trade liberalization, a conducive exchange rate policy, export subsidies and suppressed wages as labor union activity was curtailed (see, e.g., Togan, 1993). Exports jumped from $3 billion in 1980 to $10 billion in 1987, while the share of manufactured goods in exports increased from 30% to 70%. As real wages were suppressed until 1989, there were major gains in employment. But starting in 1989, the loss in the purchasing power of the workers was more than compensated with a wage hike. Firms responded by substituting capital for labor and trimming other costs, resulting in an acceleration of productivity
sourcemm0
IMobosp
1
Fig. 1. Comparison of Turkish Katircioglu et al. (1995).
manufacturing
industry
with some European
counterparts.
Source:
R. Erzan, A. Filiztekin/
European Economic Review #i (1997) 881-892
883
growth. Despite this increase in real wages, the labor share in manufacturing dropped from 30% in 1980 to about 20% by the early 1990s. As the CU came into effect in January 1996, the SMSEs captured the center of attention in public policy. The argument follows that the Turkish SMSEs, which account for about 60% of employment in m~ufact~ng (in the EU countries as well) *, would come under dispropo~ionate strain compared to large enterprises. Presumably, a large number of SMSEs in both Spain and Portugal were wiped out as these countries entered the EU. The major weaknesses of the SMSEs are listed as their limited access to financial markets and the returns to scale in R&D and in marketing activities, particularly overseas. In declaring 1996 “the year of the SMSEs”, the Prime Minis~ aims at tapping their export potential. SMSEs account for only 10% of Turkish exports ‘. As the means, industrial policy is being modified to subsidize the R&D and marketing activities of the SMSEs and the Eximbank is instructed to allocate a greater share of the credits to these firms. Another potential resource is the EU funds and other facilities earmarked for the SMSEs. There is growing competition among various official and se~of~cial agencies in opening SMSE offices in Brussels. While this lobbying is intensifying on behalf of the SMSEs, the SMSEs’ main concern seems to be the macroeconomic environment. Their argument is that the SMSEs have great difficulty in insulating themselves from the adverse consequences of macroeconomic instability while large establishments may even profit from such conditions 4. The counter argument to the vulnerability of the SMSEs is based on their flexibility. Their overhead costs are lower, they do not have the same constraints imposed by the labor regulations and unions, and they have a taxation advantage as some of them operate in the gray or black economy.
There is no standard or generally accepted definition of the SMSEs. This goes for Turkey, the EU countries and the EU secretariat (see, e.g., TGSD, 1995). While the most common definitions are based on number of employees or persons engaged, the EU cut-off points inco~orate balance sheet and turnover figures as well. In this study, due to data limitations, firms engaging less than 10 persons which are sometimes considered “micro” establishments - had to be disre-
’ The figure includes “micro” es~blishments as well, see TGSD (1995) and TOBB (1996). 3 The (unpublished) estimates of the Prime Ministry, Undersecretariat for Foreign Trade, range from 8% to 12%. 4 In 1994, about two-thirds and in 1995 nearly half of the total profits of the largest 500 firms in Turkey were from non-operational sources, i.e. interest earned on Government bills and bonds (I.S.O.).
884
R. Erzan, A. Filiztekin / European Economic Reuiew 41 (1997) 881-892
Share of Number of Firms
Share of Labor
Share of Value Added
Productivity Relative to ManufactuiiKg industry
120%
Fig. 2. The profile of Turkish manufacturing Tiirkiye Isveren Sendikalari Konfederasyonu
industry by size classes, 1980-1992 (1994).
t 40%
averages,
%. Source:
garded (see the appendix on data ‘>. Hence the figures reported for industry totals cover firms with 10 persons or more. Firms engaging 10 to 24 persons are considered as “small”, while those with 200 and more persons are classified as “large”. The in-between categories (25-49, 50-99 and 100-199) were aggregated to constitute the “medium” size class of 25-199 6.
2. The profile and performance
of Turkish manufacturing
industry by size of
filXklS
While large firms (200 + > in number account for 7.1% of the industry total, their employment and value added shares are, respectively, 53.2% and 68.8% (Fig. 2). The employment share of small firms (lo-241 which stands at 10% is a major understatement of the importance of small firms in general - as those with 1 to 9 persons had to be disregarded ‘. For the 1981-1992 period, manufacturing industry’s value added growth was on average 11.6% per annum (Fig. 3). While this figure was 13.6% in large tkrns, in medium and small tkrns it was, respectively, 8.1% and 9.7%. Similarly, average annual productivity growth was 10.1% in large firms, and about 5% in the other firm sizes.
5 A data appendix is available from the authors upon request. ’ The results reported in this study are robust with respect to the definition of the medium-sized firms. Earlier estimations which treated the in-between size categories separately generated similar results. ‘In 1990, TOBB (1996) estimated the employment share of the “micro” firms engaging l-9 persons at about 36% of total employment in manufacturing.
R. Erz.an, A. Filiztekin / European Economic Review 41 (1997) 881-892
885
14% 12% 10%
9% 8% 4% % 0% Value Added
P~CXJtiiVll
n lO-24 025199 q200+ Soonx: Annual Manufactuhg industryStatistics,State lnatttuteot Stattstks, They WAllSizes
Fig. 3. Growth of value added and productivity by size classes, Tiirkiye Isveren Sendikalari Konfederasyonu (1994).
1980-1992
averages,
%. Source:
Value added and productivity growth and the performance of firms with respect to their sizes differed considerably across industries ‘. To identify the industry and size effects an “error components model” is estimated.
3. Identification
of industry and size effects
3.1. The model To identify industry and size effects an error components model is employed such that changes in value added and productivity that are due to industry specific disturbances are distinguished from changes in both variables that are due to size specific disturbances. The goal is to determine the fraction of the variation in growth of value added and productivity that can be attributed to industry, and the fraction to size specific shocks. It amounts to identifying the importance of distinct shocks on both variables. This analysis is similar to that of Stockman (1988) and Costello (1993), except nations in their model are replaced by size classes here. The statistical model is as follows: Yi,, =
“in
+
g,t
+fit
+
eint
where Yi,, represents either the growth rate of value added or growth rate of productivity of size n in industry i at time t. The term min is a constant term specific to size n in industry i. The term g,, represents the interaction of a fixed size effect and a fixed time effect. More specifically, it is a set of dummy variables, multiplied by their coefficients, for each size at each time but common for all industries. It is meant to capture differences in technology and/or
’ Tables are available
from the authors upon request.
886
R. Erzan, A. Filiztekin / European Economic Reoiew 41 (1997) 881-892
structure of various size classes. The term fir, on the other hand, is a vector of dummy variables specific to industry i at time t, but common to all sizes. It represents disturbances to production function, input prices or product demand that would have an impact on output in industry i for all size classes. The model in this form is not identifiable due to perfect collinearity among sets of dummy variables unless one imposes some normalization. To avoid this problem first g,. I is set to zero where IZ* is a specific size category (in this paper, it is the large fiis that employ more than 200 persons). Second fir and gn, are set to zero where T is the last period in the sample (in this paper 1992). After these normalization, the effects represented by g,, have to be interpreted as a time-varying nation effect relative to the largest size class. Similarly, the second normalization implies that the estimated effects are relative to year T. Furthermore, the industry and size effects are correlated. A certain level of growth in industry i, for size n at time t can be attributed either to industry specific shocks or size specific shocks. Therefore, the fractions of value added and productivity growth explained by orthogonal components, and the fraction explained by both are estimated. The idea behind this model is as follows: If the main exogenous forces driving short-run variations in growth rates are due to disturbances in technology or preferences, then those shocks are concentrated in a set of industries regardless of size. However, if the main exogenous forces are due to structure of the size classes, then the g,, terms must be significant.
Table 1 Estimation
results of the error components
model (1981-1992)
Value added growth Total SS
Model SS
199.48
128.06 ss
Size effect Industry effect Productivity
14.01 89.73
R2 0.642
SS attr. to f+g 115.40
(%I
F
P-value
12.1 77.8
4.569 2.258
0.0000 0.0000
R2
SS attr. to f + g
growth
Total SS 90.03
Model SS 46.97 ss
Size effect Industry effect
1.80 39.03
0.522
43.15
(%o)
F
P-value
4.2 90.4
0.970 1.629
0.5015 0.0000
R. Erzan, A. Filiztekin/European
Economic Reuiew 41 (1997) 881-892
887
350
1980
1981
1982 -Real
1983
1984
Wage Index
1985
1986
1987
1988
Sizes
-All
1989
1990
1991
1992
-10-24
Soum:Turhiye,sveren SendihelanKonfedemsyano
Fig. 4. Real wage index and productivity
indices by size classes, 1980-1992
(1980 = 100).
3.2. Data The main source of data is the Annual Manufacturing Industry Statistics published by State Institute of Statistics @IS) of Turkey (see appendix on data, see footnote 5>. The analysis uses only data for private firms. After a through examination of the data, certain observations are found to be unreliable and extremely influential. Therefore, to avoid mismeasurement problems, 2% of the sample, 1% from the top and 1% from the bottom was trimmed based on productivity growth rates. 3.3. Estimation
results
In value added growth, industry and size explain 64.2% of the variation (Table 11. While both effects are significant, 77.8% of this is accounted by industry characteristics and 12.1% is due to size. The results are similar for productivity growth where the combined explanatory power of industry and size is 52.2%, 90.4% of it is attributed to industry and 4.2% to size (the latter being insignificant). The conclusion is that size matters - the bigger the better in terms of value added and productivity growth - but much less importantly compared to industry characteristics. This result modifies the picture emerging from Figs. 2 and 3 which only depict size differences, disregarding the industry effect. 3.4. Structural
change due to wage hike
As a result of the jump in real wages starting 1989 (Fig. 4) 9, firms substituted capital for labor and increased their overall efficiency. Wage increases were more substantial in large firms where labor is better organized. Also, large firms having access to financial markets have greater factor substitution possibilities. Conse-
9
The real labor cost index reported in Fig. 4 is the manufacturing
industry average.
R. Erzan, A. Filiztekin/ European Economic Reuiew 41 (1997) 881-892
888
quently, it can be expected that productivity growth in large firms had a level jump from 1989 onwards. This structural break can be observed in Fig. 4. When the error components model was estimated for the two sub periods, 1981-1988 and 1989-1992, the results corroborate the observation made in Fig. 4. The overall explanatory power of the model increased somewhat (Table 2). More importantly, however, the importance of the size effect in value added growth increased substantially in the 1989-1992 period, explaining 25% of the Table 2 Estimation
results of the error components
model for two sub-periods
1981-1988 Value added growth Total SS
Model SS
145.28
98.67
Size effect Industry effect productivity
R2 0.679
SS attr. tof+g 81.88
ss
(o/o)
F
P-value
6.08 73.64
7.43 89.94
3.012 2.813
0.0002 0.0000
Model SS
R2
growth
Total SS 59.14
29.96
Size effect Industry effect
0.507
SS attr. to f + g 25.60
ss
(o/o)
F
P-value
0.90 23.73
3.53 92.72
0.710 1.448
0.7645 0.0020
Model SS
R2
SS am. to f + g
1989- 1992 Value added growth Total SS 53.52
34.16
Size effect Industry effect Productivity
0.64
27.99
ss
(o/o)
F
P-value
6.99 11.98
25.0 42.8
8.488 1.119
0.0000 0.2804
Model SS
R2
SS attr. to f+g
growth
Total SS 28.16
Size effect Industry effect
16.91
0.60
12.23
ss
(o/o)
F
P-value
0.52 11.05
4.2 90.4
1.085 1.777
0.3746 0.0016
889
R. Erzan, A. Filiztekin/European Economic Review 41 (1997) 881-892
variation. In productivity growth, the size effect remained insignificant phenomenon which is explained by the findings of the following section.
-
a
4. The impact of environment on performance of small and large firms The economic environment captured by sectoral protection levels, import penetration, the wage rate, inflation and changes in the exchange rate, domestic and foreign demand and credit availability may affect the performance of small and large tirrns differently. Entering the CU, border protection is removed or reduced considerably, implying deeper penetration of imported goods. Concerning the impact of the CU on macroeconomic variables, however, the relationship is not straightforward. In the short term, volatility in the exchange rate and in demand conditions may increase. In the long term, wages would converge to the level of the Southern members of the EU. These are adverse developments for the firms. On the other hand, to avoid a balance of payments crisis, the policy makers have to put the fiscal policy under discipline, and there would also be more constraints on monetary policy. In the long run, this would bring about macroeconomic stability, lower inflation, less exchange rate volatility and better credit terms. To make conjectures concerning the impact of the CU on the performance of small and large firms via the economic environment, variables capturing the main elements of the environment were introduced to the original error components model. 4.1. “Environmental”
variables
Exchange rate is defined as Turkish Liras (TL) per basket of 0.60 US $ plus 0.40 DM. A higher exchange rate favors tradables. Exchange rate volatility is measured by the variance in the monthly average exchange rate during the year. Inflation is the wholesale price index. Domestic demand is approximated by real final consumption (private plus public). Foreign demand is captured by the real GDP of the European OECD countries. Total amount of credits represent credit availability. The real cost of labor index, which includes taxes and social security contributions, is the average for manufacturing industry, to capture the economywide labor cost push. Sectoral average nominal tariffs (including all border charges) represent protection, while penetration ratios proxy import competition. 4.2. The modified model
The error components model of the previous section is a statistical model. To refine the findings and to capture the effect of environmental variables, a fixed effect model with the variables described above was estimated: qnt = min + X, + Zi, + eint
890 Table 3 Estimation
R. Erzan. A. Fiiiztekin / European Economic Review 41 (1997) 881-892
results with “environmental”
variables a
Small
Medium
sign
P-value
sign
Large P-value
sign
P-value
+
0.094
+
0.052
Dependent variable: Value added growth: Exchange rate Exchange volatility Inflation Real wages Change in credits Change in domestic demand Change in foreign demand Import penetration Tariffs
+ _ _ -
0.000 o.ooQ 0.011 0.000 0.032 0.001 0.000 0.055
-
0.074
+ +
0.069 0.027
-
0.074
Dependent uariuble: Prod~tj~j~ growth: Exchange rate Exchange volatility Inflation Real wages Change in credits Change in domestic demand Change in foreign demand Import penetration Tariffs
_
0.0611
Dependent variable: Change in man-hours: Exchange rate Exchange volatility Inflation Real wages Change in credits Change in domestic demand Change in foreign demand Import ~ne~tion Tariffs
+
0.000
+
_ _ _ -
o.ooo
-
0.000 0.009
-
0.000
-
0.028 0.032
_
0.005 0.000 0.017 0.000 0.000 0.059
a The table reports only those cases where the coefficients
are significant
at the 10% level.
where X, are those variables common to all industries and size classes, and Zi, are the variables specific to industry but common to all sizes. 4.3. Estimation results The most striking result emerging from the estimations was that the environmental variables had significant effects on value added growth in small firms while they had no effect on large firms. In Table 3, the signs of the environmental
R. Erzan, A. Filiztekin / European Economic Review 41 (1997) 881-892
891
variables which were significant at the 10% level are given. Concerning value added growth, the small firms suffered from exchange rate volatility, inflation, wage hikes and import penetration lo. Changes in credit availability and changes in domestic and foreign demand also had a negative influence on the value added growth of small firms. The adverse impact of this latter set of environmental variables can be explained by large firms’ competition for scarce inputs when the economy is heated. During the 1980-1992 period, annual GNP growth fluctuated between 0 and 10%. It seems that the small firms had difficulty in competing for inputs in peak periods. This phenomenon can also be interpreted as a negative consequence of macroeconmic instability. Large firms are not affected significantly from any of the environmental variables except the positive impact of changes in credit availability. The latter underlines the fact that both state and private credits are predominantly geared to larger enterprises. In productivity growth, none of these environmental variables mattered for small firms. The cause of this apparent disparity was the sensitivity of employment with respect to the environmental variables in small versus large firms. The estimation of the impact of the environmental variables on changes in employment (measured by man-hours) revealed this phenomenon. In small firms, and to a lesser extent in medium sized firms, employment responded significantly to adverse economic conditions while this was not the case in large firms.
5. Conclusions In explaining value added and productivity growth, industry characteristics appeared to be more important than firm size. In one respect, in the face of wage hikes it was found that the larger enterprises had much greater possibilities of substituting capital for labor and increasing productivity despite of the increases in factor costs. Reduction in protection and increases in import penetration probably the most straightforward immediate impact that would be felt as a result of the CU - had some negative effect on the performance of the SMSEs. The most important finding of the study was that, unlike large firms which could insulate themselves from adverse macroeconomic conditions and fluctuations, SMSEs suffered from economic instability. Particularly, it had a depressing effect on small firms’ employment and value added growth SMSEs managed to maintain their productivity by labor reduction. Hence, the “flexibility” advantage attributed to the SMSEs seems to originate from the leaner impact of labor regulations and union activity on smaller establishments. An implication of this 7
Small firms also appeared
to have benefited from an exchange
rate which favored exportables.
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R. Erzan, A. Filiztekin/European
Economic Review 41 (1997) 881-892
finding is that, adverse economic conditions would lead to employment and production losses in the SMSEs rather than firm closures. In terms of both the impact of import penetration and adverse economic conditions and fluctuations, the findings give support to the argument that SMSEs might be more vulnerable in the initial phase of adjustment to the CU. In the longer term, however, to the extent that CU will contribute to macroeconomic stability in Turkey, SMSEs would be better off. Probably the only robust policy recommendation that can be drawn from this analysis in support of the SMSEs is giving high priority to macroeconomic stability, particularly in the initial phase of the adjustment to the CU. The results also give some support to the generally held view that the SMSEs are at a disadvantage in input markets, particularly in credits. Hence, policies geared to increasing their access to the financial markets seem appropriate.
Acknowledgements The excellent research assistance provided by Nurbanu Akgit, Kemal Badur, Niltifer Candar and Serhan O&r is gratefully acknowledged.
References Costello, D., 1993, A cross-country, cross-industry comparison of productivity growth, Journal of Political Economy 101, 207-222.. I.S.O., Istanbul Sanayii Odasi Dergisi, various issues. Katircioglu, E., N. Engin and C. Akqay, 1995, The impact of trade liberalization on the Turkish manufacturing industry: An empirical assessment, in: R. Erzan, ed., Policies for competition and competitiveness: The case of industry in Turkey (United Nations Industrial Development Organization, Vienna). OECD, National Income Accounts, various issues. State Institute of Statistics, Annual Manufactnring Industry Statistics, various issues. Stockman, A., 1988, Sectoral and national aggregate disturbances to industrial output in seven European countries, Journal of Monetary Economics 21, 387-409. TGSD, 1995, Kll@ik ve orta boy isletmeletin avrupa toplulugu’nda ve Tiirkiye’de tesviki (Tlrkiye Giyim Sanayicileti Demegi, Ankara). TOBB, 1996, Tllrkiye ekonomisinde kli@lk ve orta Gl9ekli isletmeler (Tiikiye Odalar ve Borsalar Birligi, Ankara). Togan, S., 1993, 198O’li yillarda Tllrk dis ticaret rejimi ve dis ticaretin liberalizasyonu (Eximbank, Ankara). Tbrkiye Isveren Sendikalari Konfederasyonu, 1994, Ttrkiye Isveren Sendikalari Konfederasyonu’nun ‘Tlrkiye’deki &ret Sistemine’ Iliskin Giiriisleridir, Ankara.