Firm size, technology, and trade policy

Firm size, technological innovations and trade policy have been closely interlinked for decades. As in the past, the future competitiveness of any economy depends on the interplay between firm size, technological progress and firms’ ability to exploit the opportunities offered by global markets. The global economy has been shaped by important and disruptive technological changes in recent years. Many of these technologies have been instrumental in the global response to COVID-19 and will be an integral part of the new normal. Some technological breakthroughs were introduced by small firms which grew tremendously to turn into ‘unicorns’, i.e. companies with a global reach and high market value (over USD 1 billion).1

The relationship between firm size and disruptive technologies is complex. In sectors such as traditional manufacturing, large firms have a competitive advantage due to their ability to devote large amounts of funding to R&D activities and to the development of innovative products. In contrast to the manufacturing sector, start-ups and young firms in digital and knowledge-intensive service sectors are more likely to engage in innovative activities and, even more importantly, are more likely to successfully turn innovation into a new line of business2.

The interplay between firm size and trade policy is equally complicated. Although many trade barriers have been lowered or eliminated over time, we do not actually live in a free trade world. Today, virtually all products and services are subject to regulatory requirements. Regulations exist for good reasons but discriminatory trade policies, such as regulatory requirements, become costly non-tariff barriers (NTBs). NTBs are today’s biggest trade barriers for companies, irrespective of their size. Among NTBs, technical barriers to trade (TBTs) are the most prevalent (figure below).

This is one example where trade policy and firm size interact strongly. While NTBs are costly for all firms, they are even costlier for smaller firms. The primary reason for this is the fact that unlike tariffs, NTBs impose a fixed cost. Fixed NTB-induced trade costs have an impact on both small and large firms, but a disproportionate impact. Large firms can more easily afford to assign resources to address NTBs, and these costs can be spread over larger trade values, making them easier to absorb. SMEs tend to have limited resources or insufficient information about such NTBs, and even when they invest resources to address them, the fixed cost is spread over lower trade values, making NTBs more costly for SMEs overall. This leads to a simple but powerful first conclusion: trade policy is not firm-size neutral and the current prevalence of NTBs makes it more difficult for SMEs to engage in international trade.

The COVID crisis has further exacerbated the impact of these barriers on SMEs. Business surveys indicate that the pandemic has strongly or at least moderately affected three out of four SMEs through supply chain disruptions, employee absences and temporary shutdowns3. Already before the outbreak of the COVID crisis, EU SMEs had experienced a decline in their relative trade performance (figure below). Between 2014 and 2018, the share of EU SMEs in total extra-EU merchandise exports declined by 5 percentage points.

In this context, a “strategic trade policy” that strongly emphasizes the significance of SMEs seems warranted. If well calibrated, trade policy interventions may actually provide solutions to some longstanding problems affecting global trade. Most start-ups will remain SMEs, unable to build a virtuous circle between trade and technology, and thus become unicorns. Others might turn into “SMEs on steroids”, make use of global trade opportunities and eventually transform into unicorns.

Given their tremendous economic potential, unicorns are a fascinating economic creature, both for business and for policymakers. What used to be a rather exceptional occurrence is becoming increasingly common today, especially in the United States and China. This factor is all the more important since unicorns tend to emerge in sectors that are considered to be of strategic importance or that have a highly disruptive potential for the future global competitiveness of many sectors (figure below). For instance, there are nearly 100 unicorns specialized in the Internet of Things (IoT) and related software worldwide, and around 50 unicorns offer leading solutions based on artificial intelligence (AI). Unicorns are important for the future development of a sector, as they may be the drivers not only of new innovative solutions but also of future industry standards. A number of these emerging technologies will fundamentally change how international trade is conducted. From IoT and blockchain to 3D printing, many so-called #TradeTech applications developed by global unicorns will redefine manufacturing, supply chains and trade customs procedures.

One important question for the post-COVID future is: can SME exporters compete as successfully with unicorns as they could in the past? The answer is not necessarily gloomy, but it is also not straightforward, either. Unicorns are an important source of new technology, and new technology creates new ecosystems within which many small firms can thrive as valuable partners in the supply chains of larger companies. The answer also depends on the ability of each economy to stimulate technological diffusion within such ecosystems, from large to smaller companies.

One clear conclusion is that unicorns cannot be easily engineered via any single policy, let alone by trade policy. The question is then: how can trade policy connect SMEs to leading unicorns around the world, irrespective of their origin? Part of the answer lies in regulatory cooperation aimed at reducing the disproportionate effect of NTBs on SMEs. For instance, OECD research shows that cross-border service exports by SMEs face the equivalent of an additional 12 per cent in trade costs compared to large firms4.

One such example is provided by initiatives aimed at supporting SMEs to cope with diverse regulations and standards worldwide. Recently, the #Access2Markets portal created by DG TRADE primarily for SMEs has been voted one of the best examples of good public policy support for SMEs. The Access2Markets portal is available to both EU and non-EU firms, and aims to be one of the best trade information tools available worldwide, covering a growing range of trade policy formalities (tariffs, NTBs, services, public procurement, etc.). The Access2Market shows that digital trade facilitation tools can lower the fixed costs of trade formalities, with a net positive effect for SMEs. This is good news: we do not need to reinvent the wheel to ensure that EU SMEs remain globally competitive in the future. But we might need to think creatively about some existing trade rules. Just as companies invent and adopt new disruptive technologies, so should trade policy.

The views expressed herein are those of the author and do not reflect the official position of the European Commission.