CONFERENCE PAPER Globalization, SMEs and Sustainable Development: The Evidence from Turkey

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1 CONFERENCE PAPER Globalization, SMEs and Sustainable Development: The Evidence from Turkey International Scientific Conference of Globalization and Sustainable Development, Varna Free University, Varna, BULGARIA July 2004 Alovsat MUSLUMOV Dogus University, Istanbul Güler ARAS Yildiz Technical University, Istanbul

2 The Place of SMEs in Turkish Economy Small and medium sized enterprises (SMEs) in Turkish Economy account for 99% of established enterprises 55% of the labor force 30% of investments 27.3% of total value-added

3 Research Goals To analyze the performance of Turkish economy and SMEs in recent years To present the effects of globalization and regionalization process on Turkish economy and Turkish SMEs To discriminate SMEs from larger firms based on their financial performance variables To identify the financial problems of SMEs.

4 Transformation of Turkish Economy and Macroeconomic Instabilities Turkish economy followed inward-oriented economic development strategy which is based on protectionism and import-substituting industrialization policies until The globalization process in the world has managed Turkey to integrate its economy to the international markets and to follow export-oriented development strategy. Many economic reforms have been implemented for transforming Turkish economy since 24 January However, economic stabilization couldn t be sustained in this transformation process and Turkey has faced the adverse effects of the three serious economic crises within last eight years. One of the main causes of the economic crises in Turkey is the weak competitiveness of Turkish manufacturing industries. The analysis of the distribution of Turkish foreign trade according to product categories shows that Turkey is the exporter of labor-intensive, low value-added products such as textile and clothing materials, whereas it is the importer of technology-intensive, high value-added products such as machinery and chemical materials. The overwhelming majority of the firms operating in textile and clothing industries are SMEs, whereas most of the SMEs undertake subcontractor role.

5 Foreign Trade of Turkey Other Consumer Goods Clothing Textiles Machinery and Transport Equipment Other Semi-Manufactures Chemicals Iron and Steel Non-Ferrous Metals Mineral Fuels, Lubricants and Related Materials Metalliferous Ores and Metal Scarp Agricultural Raw Materials Import Export Food 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000

6 Transformation of Turkish Economy and Macroeconomic Instabilities The specialization of Turkish firms, especially SMEs on low value-added, labor intensive products make them more vulnerable to international contagion effects through foreign trade channels. Since competition power of Turkish companies mostly relies on the cost advantage, the instabilities in real exchange rates cause to periodic contractions in the foreign trade. Muslumov and Aras (2002) shows that profitability of Turkish SMEs is favorably affected by devaluations in the real exchange rates, whereas the appreciation of the real exchange rates cause to the loss of the profitability. However, devaluation policies have adverse effects on the inflation and increase the vulnerability of short-term capital inflows. Therefore, when Turkish government authorities set an economic stabilization plan to fight with the inflation, its local currency becomes overvalued which leads to the increasing current account deficits and eventually to financial and economic crisis.

7 Transformation of Turkish Economy and Macroeconomic Instabilities The study of the recent crises suggests that the starting point of the crises is most probably low-level of the productivity of Turkish manufacturing industries. Therefore, rehabilitation process of the economy should first start with the rehabilitation of the manufacturing sector of the economy. For this purpose, Turkish economy should try to allocate its limited sources to the companies in competitive and high value-added industries in order to feed sustainable development. A priority may be given to the competitive SMEs in this rehabilitation process.

8 Return on Assets Large Medium Small

9 Profitability Margin Large Medium Small

10 Total Asset Turnover Large Medium Small

11 Financial Leverage Large Medium Small

12 Current Ratio Large Medium Small

13 The Results of the Financial Discrimination Study The trend analysis conducted in this study shows that manufacturing industries experienced sharp decrease in return and increase in risk measures. Average return on assets of SME s showed continuously decreasing trend. The financial leverage ratio and the ratio of short-term debts to total debts have increased sharply, where the liquidity of SME s declined drastically. These results imply that SME s of manufacturing industries in Turkey is standing in a very difficult position and the situation may become worse if a serious rehabilitation process will not be implemented.

14 The Financial Problem Of Turkish SMEs The financial problem remains to be most important problem of SMEs. The most cited financial problems of Turkish SMEs are inadequate finance sources and higher borrowing costs. SMEs usually operate with internally generated funds. SMEs look for outside financing, especially bank credits and public offerings through capital markets in their growth stages Since funding costs from capital markets are subject to the scale economies, in other terms since high fixed costs makes low volume fund demands infeasible, SMEs do not much prefer initial public offerings through capital markets. There are only 8 publicly held SMEs in the Istanbul Stock Exchange out of the total 180 manufacturing publicly held companies whose data is available. This situation is the indicator of the fact that SMEs in Turkey do not fully exploit capital market facilities

15 The Financial Problem Of Turkish SMEs Similar problem is observed in the bank credits. SMEs benefit from only 10-15% of total bank credits. The scale disadvantages of SMEs heighten their bankruptcy risk and eventually, capital cost. In the other hand, since capital cost is the decreasing function of required funds, the capital cost of SMEs remains higher because of fixed costs. Turkish SMEs retain higher capital costs than larger firms Because of abnormally higher real interest rates in the Turkish economy ( period average is equal to 32%), the capital cost of Turkish SMEs escalated to very high levels which damaged their economic activities. Another important problem that SMEs face in the credit markets is the credit rationing problem that is the result of asymmetric information.

16 The Financial Problem Of Turkish SMEs The financial problem of the SMEs calls for the government intervention to the market in order to alleviate the problem. However, it should be denoted that the financial problem of SME s in Turkey is just the reflection of their all remaining marketing, management, production and technological problems. Therefore, government intervention is only necessary for creating equal conditions for smaller and larger firms, whereas other types of the intervention that will create exclusive parts in the economy will be harmful for the health of the whole.

17 Conclusion Turkish economy has been specialized in the production of labor-intensive and low value-added products, whereas Turkish SME s mainly undertakes subcontractor role. This role attributed to the Turkish economy and SME s contribute to the collapse of the economy when government ceases to support manufacturing industries through devaluations. Turkish economy should try to allocate its limited sources to the SME s in competitive and high value-added industries in order to feed sustainable development.

18 Conclusion The downturn of the economy has deteriorated the financial and operating performance of manufacturing industries, including SME s. Manufacturing industries experienced sharp decrease in return and increase in risk measures. Average return on assets of SME s showed continuously decreasing trend. The financial leverage ratio and the ratio of short-term debts to total debts have increased sharply, where the liquidity of SME s declined drastically. These results imply that SME s of manufacturing industries in Turkey is standing in a very difficult position and the situation may become worse if a serious rehabilitation process will not be implemented.

19 Conclusion The financial problem of Turkish SME s is the reflection of all remaining problems of SME s such as marketing, management, production and technological. However, SME s suffer from credit rationing and high capital cost problems due to their scales, which require government s intervention in the market for creating equal conditions for smaller and larger firms, whereas other types of the intervention that will create exclusive parts in the economy will be harmful for the health of the whole.