Small and medium-sized enterprises (SMEs) represent a significant portion of the European economy. According to the “Annual Report on European SMEs” by the European Union (2022/2023), SMEs account for over 99% of all firms in the EU, contribute two-thirds (66%) of total EU employment, and generate more than half of the value added in the non-financial business sector.

In recent years, SMEs have faced numerous challenges, including the COVID-19 pandemic, supply chain disruptions, and the impact of Russia's invasion of Ukraine. These challenges have heightened economic uncertainty and instability, affecting the performance and sustainability of SMEs. Recognizing their vital economic role, policymakers prioritize these firms, acknowledging the significant barriers they face in accessing credit, which can greatly hinder their investment potential. These challenges become particularly acute during economic crises, where access to credit tightens, and the cost of capital rises.

To understand how small firms should be supported during economic crises and the importance of targeted financial support, the CUBE’s Professor Diana Bonfim and her colleagues turned to Portugal's SME-Leader Program. Initiated in 2008 to help SMEs secure loans during the global financial crisis, the program aimed to ensure that the best SMEs could still access credit despite the tightened lending environment. The program continued even as the economy began to recover from both the global financial crisis and the eurozone debt crisis.

Bonfim's analysis covered a decade, including the crisis period (2008-2013) and the subsequent recovery years (2014-2018). When the COVID-19 pandemic hit, the backbone of the program was expanded to provide government-backed loans to a wider range of businesses. Thanks to the program's existing infrastructure and experience, loans were quickly made available to companies in need during the pandemic. This program stands out for its dual approach: it offers a government loan guarantee and a credit certification (rating) issued by a government agency. A distinctive feature of the SME-Leader Program is its focus on small firms with low credit risk. Eligible firms gain access to subsidized bank credit and a public credit rating, effectively lowering their cost of debt financing​

The Price of Credit Mechanism

The SME-Leader Program has a positive impact on small firms’ investment, employment and firm growth through domestic and international markets. The effects of the program are predominantly driven by the price of credit rather than the quantity of credit. By subsidizing the marginal cost of capital, the program makes new investment projects viable, thereby fostering investment and employment. This mechanism is particularly potent during crisis periods, when the availability and cost of credit become critical constraints for small firms.

Crisis Period vs. Recovery Period

During economic downturns, the benefits of the program are particularly pronounced, but so are the costs. More frequently, loan guarantees will result in fiscal losses. In contrast, during recoveries, the targeted firms exhibit very low default probabilities. The cost-per-job created during the crisis is significantly higher than in the recovery period—€11,788 versus €5,784, respectively. Despite the higher costs during crises, the program still yields substantial benefits: for every euro spent, there is a €66 increase in Total Factor Productivity (TFP). Additionally, reputational benefits arising from certification of credit quality are important in boosting firm performance in good times.

Bonfim and colleagues conducted a survey of certified and non-certified companies, with 5,413 responses, in 2020, which reveals that among the motivations behind applications, managers emphasize the reputational benefits of the program. Fifty percent of respondents cite this as very important. This finding suggests that the overall impact of the program extends beyond credit guarantees and is also attributed to the certification itself, which may be perceived as a positive signal by other stakeholders, including clients. The second most significant reason for application is related to lower financing costs, boosting investment and employment. Furthermore, more than one-third of managers’ report an increased competitive advantage for their firm, 30% note a positive impact on their company's ability to innovate, 19% mention improved relationships with clients, and 19% cite enhanced relationships with suppliers.

In conclusion, providing subsidized credit to the best small firms during financial crises has positive and enduring effects on their investment and growth. During recovery periods, while the tangible benefits are less pronounced, the targeted support still proves cost-effective.

Policy and Societal Implications: Strategic Targeting

The implications of these findings are profound for policymakers. They suggest that targeted government programs promoting access to credit during economic downturns can effectively sustain firm investment. This approach was echoed globally at the onset of the COVID-19 pandemic, where various countries implemented similar support measures. However, a key differentiator of the SME-Leader Program is its targeted nature, which ensures support is directed towards the most viable small firms, thereby optimizing resource allocation and minimizing fiscal costs. Untargeted support programs, while well-intentioned, can lead to several adverse outcomes. They risk the proliferation of zombie firms— companies that are unable to cover their debt servicing costs with operating profits, becoming unviable and in financial distress. Moreover, untargeted programs can lead to inefficient resource allocation, where capital is not necessarily directed to the firms with the highest growth potential.

By focusing resources on the most promising SMEs, targeted programs like the SME-Leader Program not only help maintain economic stability during crises but also foster long-term growth and innovation. This ensures that financial support translates into tangible economic benefits, bolstering the resilience and competitiveness of the SME sector and, by extension, the broader economy. Such targeted approaches can serve as models for other countries aiming to balance immediate crisis management with sustainable economic development. Supporting SMEs during economic crises has significant societal benefits. These programs help maintain employment, stimulate economic activity, and preserve household incomes and consumer spending, all of which are crucial for recovery and growth. By fostering innovation and entrepreneurship, targeted support drives technological advancements and productivity, enhancing long-term competitiveness.

You can read more about Bonfim’ s work in the Journal of Financial Economics article “Supporting small firms through recessions and recoveries”, available in open access. This award-winning study was recognized as the Best Paper prize for “Internationalization of the Portuguese Economy Post-COVID-19: Opportunities and Challenges” in a competitive call recognizing four papers, organized by the Portuguese Gabinete de Estratégia e Estudos (GEE) and the Agência para o Investimento e Comércio Externo de Portugal, E.P.E. (AICEP) in 2022.