MittelstandsMonitor 2005: Revitalising the Economy – Strengthening Domestic Economy and Competitiveness

Annual report by ZEW, KfW Group, IfM Bonn, RWI Essen and information service provider Creditreform on economic and structural issues facing small and medium-sized enterprises

Small and Medium-Sized Enterprises Benefit from Improved Business Situation

The moderate economic upturn, which started at the end of 2003, has consolidated over the past year. Initial signs indicate that weak domestic demand may be partly overcome this year, which would be particularly beneficial for small and medium-sized companies in Germany. This is the result of the current MittelstandsMonitor 2005, which was presented today in Frankfurt by the KfW Group in collaboration with the research institutes IfM Bonn, RWI Essen and ZEW as well as the information service provider Creditreform. The joint report on economic and structural issues addresses the SME business climate as well as start-up and liquidation activities. This year’s MittelstandsMonitor also focuses on the innovation activities of small and medium-sized enterprises as well as on the opportunities and risks of the EU’s eastward enlargement. The MittelstandsMonitor combines exclusive, complementary data sets taken from Creditreform, IfM Bonn, KfW Bankengruppe, RWI Essen and ZEW Mannheim to create an extensive, empirical data base. The joint publication aims to provide the public with comprehensive information on the current situation and prospects of the mid-tier business sector. The following provides an overview of the main results of the MittelstandsMonitor 2005:

Business Situation of Small and Medium-Sized Companies

The business situation of small and mid-sized enterprises improved very gradually throughout 2004. Mid-tier businesses benefited much less from the export-driven recovery in 2004 than did large companies, which are better integrated into global division of labour. Among mid-sized enterprises, it was only wholesale trade and manufacturing companies with a relatively strong international involvement, which profited from the economic tailwind. The weak domestic economy kept retail, construction and service providers, however, from recording more than just a slight increase. Experts expect that the moderate economic development will continue in 2005. The revitalisation of the domestic economy is likely to enable small and mid-sized enterprises to make up ground which has been lost to large companies. However, rising investments or greater employment impulses are not to be expected until mid-sized companies are convinced that the forces behind domestic recovery are sustainable.

Company Fluctuation – New Trends in the Start-Up Business

In 2003, the annual number of newly founded businesses began rising again for the first time. The positive development continued throughout 2004. One reason for this trend is the increasing number of start-ups resulting from unemployment. Since early 2003, such projects have been funded by the Federal Employment Agency in the form of bridging allowances (Überbrückungsgeld) and start-up allowances (Ich-AG). Start-ups resulting from unemployment now account for more than half of all newly founded full-time businesses. But the number of companies exiting the market also increased in 2003. Business insolvencies, which make up only a fraction of liquidations, remained at a high level. The past year was most probably marked by a further increase in liquidations. Still, 2003 closed with a positive number of young businesses. One can assume that the 2004 balance of start-ups and market exits has also risen.

Innovations - Challenges for Mid-Tier Companies

Small and medium-sized enterprises yield approximately a third of the innovation expenditures in the German economy. Their innovation activities, however, are in decline, leaving a great deal of untapped potential. This development results from high economic risks and from specific financing issues. Unlike large companies, SMEs rarely have the opportunity to draw on internal financing and they are unable to spread their risks over multiple innovation projects, making it more difficult for them to gain access to external capital. Moreover, insufficient capacities for research and development or scientific collaborations lead to a lack of innovation-related knowledge. Successful innovations, however, enable companies to remain internationally competitive and to create long-term employment. SMEs must therefore tackle the innovation backlog.

SMEs and the Eastward Enlargement of the EU

The public often associate the EU’s eastward enlargement with a number of risks for German SMEs or individual sectors. A large proportion of mid-tier companies are also sceptical about the enlargement. According to the MittelstandsMonitor, 40 per cent see more risks than opportunities. Examination also shows, however, that the number of companies shifting production from Central to Eastern Europe is rather low. SMEs are not relocating from Germany. Just one in a thousand SMEs holds a majority stake in Central or Eastern European companies. Direct investments and exports to accession countries, however, open up economic opportunities, especially for larger mid-tier enterprises. Essentially, safeguarding jobs in Germany depends on whether these opportunities will be seized. Throughout the eastward enlargement, however, Central and Eastern European companies will also enter the German market and compete with German companies. Consequently, there will also be losers among German SMEs. Construction and transport business, for instance, may face critical developments. Taking a pragmatic view of the opportunities and risks of the eastward enlargement, one may conclude that the opportunities clearly outweigh the risks.