Tuesday 22 May 2018

Analysis: Chances go missing as sector swerves investment risks

Access to finance is another key issue and one where policy could potentially play a role. Photo: Reuters
Access to finance is another key issue and one where policy could potentially play a role. Photo: Reuters

Conor O'Toole, Martina Lawless and Rachel Slaymaker

A major OECD study of Ireland published last week drew particular attention to the performance of domestic SMEs relative to foreign firms and raised concerns about developments in their productivity.

As a vibrant SME sector is central to balanced and sustainable economic growth, this begs the question as to whether Irish SMEs are investing enough to generate growth.

Following the onset of the financial crisis, Irish SMEs faced major challenges. Consumer demand fell and Irish households had less cash to spend.

As most SMEs do not export to foreign markets, their reliance on the spending of Irish households left them very exposed.

On the financial side, the high debt incurred during the boom became difficult to service, arrears rates increased, and new credit flows were restricted due to the banks' own challenges.

More recently, the Irish economy has begun to recover strongly. Over time, this growth has been experienced by smaller firms: survey evidence suggests SME profitability, employment and turnover are all increasing.

While many continue to face challenges, the focus is now moving onto how best to maximise the growth potential of these companies.

A question arises as to whether Irish SMEs have sufficient capacity to capitalise on opportunities following years of low investment.

To shed light on this issue, ESRI researchers have examined whether the investment activity of Irish SMEs is in line with what might be expected given the fundamental performance levels of the firms.

Using data on approximately 10,000 firms from the Department of Finance credit demand survey over the period 2013-2016, the results indicated that actual investment is below what would be expected.

The magnitude of this "investment gap" is estimated to be just over 30pc in 2016.

There are many reasons for this underinvestment (such as uncertainty and the risk appetite of entrepreneurs).

Access to finance is another key issue and one where policy could potentially play a role.

Given the difficulties in the banking sector in Ireland, the research investigated whether part of the gap could be explained by difficulties in accessing finance, indebtedness or the cost of credit.

Most of the gap is not explained by these issues and they accounted for approximately 20pc of the underinvestment.

As the Irish SME sector looks to the future, it will need to address this investment gap and ensure it has the productive capacity to continue to grow.

Uncertainties such as Brexit and the legacy of the crisis may make this more difficult but it is a critical challenge for the Irish economy.

Conor O'Toole is a senior research officer at the ESRI, Martina Lawless is an associate, and Rachel Slaymaker is a postdoctoral research fellow at the ESRI

Irish Independent

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