This chapter assesses key enabling conditions for FDI spillovers on SMEs in Portugal as described in the conceptual framework in Chapter 1. It first examines Portugal’s economic context and structure and then moves to key factors related to the potential for FDI spillovers (FDI trends, local embeddedness and capacity premia of foreign firms), SME absorptive capacities and Portugal’s economic geography. The chapter points to Portugal’s strengths, challenges and opportunities in these enabling conditions.
Strengthening FDI and SME Linkages in Portugal
2. Enabling conditions for FDI spillovers on Portuguese SMEs
Abstract
2.1. Summary of strengths, challenges and opportunities
The diagnostic assessment of key enabling conditions for FDI spillovers on SMEs in Portugal reveals a number of strengths in current conditions and points to challenges and opportunities to further improve these fundamental conditions for spillovers to take place (Table 2.1). The subsequent chapters (Chapters 4-6) pick up on these challenges and opportunities, identifying policy actions to address them
Table 2.1. Strengths, challenges/opportunities of enabling conditions for FDI spillovers in Portugal
Note: See Box 2.1 clarifying sectoral groupings (i.e. lower and higher technology manufacturing and lower and higher technology services) used in this table.
2.2. Portugal’s economic context and structure
Before assessing strengths, challenges and opportunities of other key enabling conditions for FDI-SME spillovers – namely the potential for FDI spillovers, SME absorptive capacities and Portugal’s economic geography – it is important to assess the broad economic context of Portugal. This section assesses (1) recent macroeconomic trends, pre- and post-COVID-19, (2) Portugal’s sectoral growth drivers and structure; and (3) its integration in the global economy through trade. FDI is an additional key ingredient for internationalisation, which is assessed in the next section.
Portugal has had robust growth over recent years but has been hit hard by the pandemic
Portugal was heavily affected by the 2008 global financial crisis but economic conditions had improved markedly over the past few years, before the COVID-19 outbreak in 2020 (OECD, 2019[1]). The unemployment rate declined 10 percentage points over 2013-19 to below 7%, one of the largest reductions in any OECD country over the past decade. Like in other small economies, growth in Portugal depends less on domestic consumption, although rising private earnings have led to a solid contribution of consumption to GDP growth over recent years as well.
The pandemic and related travel restrictions and severe supply chain disruptions have led to the most severe economic shock in decades with severe implications on trade, investment, jobs and livelihoods in Portugal. The OECD estimates that real GDP fell by more than 8% in 2020 relative to 2019; a stronger decline than the OECD average decline of 5.5% given the relative exposure of Portugal in pandemic affected industries such as tourism and manufacturing (OECD, 2021[2]). After a strong recovery of employment since 2013, unemployment is expected to increase again in the coming years and put pressure on livelihoods and well-being.
Improving macroeconomic fundamentals during the pre-COVID-19 years indicate that Portugal’s recovery from the ongoing economic crisis could be faster than that from the 2009 crisis (OECD, 2019[1]). However, ongoing pandemic-related economic uncertainty in Europe and globally may harm a fast recovery.
Portugal has a dynamic start-up and entrepreneurial ecosystem, which could support the recovery from the pandemic crisis. Unlike most economies (OECD, 2021[3]; OECD, 2019[4]), new firm creations in Portugal have increased steadily over the last decade, notwithstanding the dips around the time of the 2008 financial crisis (Figure 2.1, Panel A). Job destruction due to bankruptcies has accompanied job creation further revealing the dynamic entrepreneurial ecosystem in Portugal (Figure 2.1, Panel B). In recent years, it was net employment change by incumbent firms that has led to a net increase of jobs in Portugal.
Figure 2.1. Enterprise and job creation/destruction over time in Portugal
Source: OECD (2019d), OECD SME and Entrepreneurship Outlook 2019
Jobs in sectors that were expanding pre-pandemic are now most at risk. Much of the job creation since the 2008 financial crisis has taken place in low-productivity sectors, e.g. wholesale and retail trade (21% of total jobs created since 2008), accommodation and food services (20%), construction (12%), or in low-tech manufacturing (10%) (OECD, 2019[4]). Job creation in higher productivity and higher wage sectors such as ICT (3%) and professional, scientific and technical activities (8%) was limited. During the ongoing pandemic, it is those jobs in lower productivity sectors that are most at risk (OECD, 2020[5]).
Portugal could further expand high-tech activities to match its European peers
Growth in the pre-pandemic period was driven by the fast expanding tourism sector. It contributed to almost 10% of GDP in recent years and grew twice as fast as the rest of the economy (OECD, 2020[6]). Beyond tourism, Portugal benefited from a boost in a variety of export-oriented manufacturing sectors during the pre-pandemic period (OECD, 2019[1]; Westmore and Adamczyk, 2019[7]). Some of which included lower-tech activities such as mineral and metal products, agri-food, and transport material. Other growth sectors included higher-tech activities such as pharmaceuticals, chemicals and machinery.
Growth in manufacturing was driven by relatively low labour costs, investments in digital infrastructure, access to knowledge-based capital, such as big data analytics, average skills at par with levels seen elsewhere in the OECD, strong R&D skills, a stable financial system and a fairly strong regulatory environment for business and investment (see more details on relative assets of the Portuguese economy in Section 2.4 on absorptive capacities of local SMEs and Chapter 5 on the regulatory environment and policy mix for FDI-SME diffusion) (OECD, 2019[8]).
Understanding technology intensity of economic activity is important to assess the potential FDI and SMEs and their linkages have to drive productivity in Portugal, which is the key endeavour of this report. Higher technology manufacturing and services help to differentiate, customise and upgrade products and often drive aggregate productivity and innovation, particularly in advanced economies like Portugal (OECD, 2020[9]). Box 2.1 clarifies sectoral classifications based on technology intensity used in this report.
Box 2.1. Classification of economic activities by technology-intensity
The conceptual framework described in Chapter 0 explains that FDI’s local embeddedness and absorptive capacities of SMEs are key determinants for FDI spillovers on SME productivity and innovation to take place. They depend, among other things, on the economic sectors and activities in which investment takes place and SMEs are operating. Given the focus on productivity and innovation spillovers, the sectoral analysis in this and the following chapters is based on technology- or R&D-intensity. As such, most analysis based on sectors (e.g. regarding economic structure, including of SMEs; GVC integration both through trade and FDI; and FDI-SME diffusion channels) focuses on four main sectoral groupings based on R&D-intensity, which are adapted from Galindo-Rueda and Verger (2016[10]): higher technology manufacturing, lower technology manufacturing, higher technology services and lower technology services. Table 2.2 provides an overview of the industries covered in these groupings. R&D-intensity is measured by the ratio of business R&D expenditure relative to gross value added in each industry covered in a given group. It is important to note that sectoral classifications may vary across data sources covered in this report. Table 2.2 lists industries based on ISIC Rev. 4 two-digit sectors, which is the classification applied for most of the data used (e.g. OECD and Eurostat data). Commercial datasets like Financial Times’ fDi Markets and Refinitiv have their own classification of sectors but for the purpose of this report they were also classified according to the four groupings described above.
The classification has the caveat that R&D-intensity is an imperfect measure of innovation and innovation potential across industries. Not all firms that are successful at developing or implementing innovation are necessarily R&D performers. Many of these firms are successful adopters of technology which they have not developed. Measuring R&D intensity or embedded R&D in their purchases may not effectively characterise the innovative performance of firms or industries. Other OECD indicators measure skill intensity, patenting activities and innovation by industries that facilitate a more refined description of the overall knowledge intensity in different economic activities, although these measures are not always widely available across a majority of OECD countries and partner economies (OECD, 2015[11]). Another caveat of this classification is related to the fact that it is not entire sectors that involve either higher or lower technologies but it is specific activities or segments within these sectors that involve different technology intensities. For example, in textiles, most surviving companies in Portugal are no longer low-tech. On the other hand, many of the outsourced segments in the automobile industry, for example, are not exactly high-tech but involve standard processes with no R&D involved. This caveat needs to be considered for any conclusions made in this report.
Table 2.2. Sectoral groupings based on R&D-intensity
Note: A number of industries are not classified into these four groupings as the analysis in this report deliberately avoids focusing on these industries. They include: Mining and extraction (Mining and extraction of energy producing products; Coke and refined petroleum products); Infrastructure (Electricity, gas, water supply, sewerage, waste and remediation services; Telecommunications); Other services (Accommodation and food services; Public admin. and defence; compulsory social security; Education; Human health and social work; Arts, entertainment, recreation and other service activities; Private households with employed persons). These industries are either highly specialised and would require a more focused analysis, or their role/potential for FDI-SME linkages and spillover is limited.
Figure 2.2. Economic structure, by key sectoral groups (% of total value added), 2016
Note: See Box 2.1 clarifying sectoral groupings used in this figure.
Source: OECD based on the OECD Analytical AMNE database, 2019, https://www.oecd.org/sti/ind/analytical-AMNE-database.htm
Despite recent expansion of some advanced manufacturing and high-tech (including digital) services, Portugal still has the potential to further expand in this area. Some comparators such as Ireland, the Czech Republic and the Slovak Republic report larger shares of both higher technology manufacturing and services (Figure 2.2).1 The services sector is large but dominated in relatively low productivity activities in Portugal. The sector includes a large share of lower technology activities such as wholesale and retail trade, transport and other logistics services (35% of total value added), which are reported as lower productivity activities in Portugal and are dominated by SMEs. The services sector also includes other activities (25% of total value added), driven by tourism. These services and some other industries (agriculture, mining and extraction, infrastructure, construction) are not classified into the four groupings based on technology intensity (Box 2.1). These industries are either highly specialised and would require a more focused analysis, or their role/potential for FDI-SME linkages and spillover is limited. These activities are not in the focus for the remainder of this report.
Portugal is a highly globalised economy and thus the speed of economic recovery also depends on that in its exporting markets
The favourable economic context, pre-COVID-19, led to a boost in foreign investment inflows in manufacturing activities, enabled linkages and diffusion channels between foreign affiliates and domestic SMEs and led to an export boom, including for domestic SMEs (OECD, 2019[1]; OECD, 2019[8]). Section 2.3 emphasises the important role of inward FDI for Portugal’s internationalisation process, while Section 2.4 clarifies the important role of SMEs in exporting – which is also an important indicator of absorptive capacity of SMEs.
Strong exports sustained economic activity in the decade prior to COVID-19 and helped expand a variety of manufacturing sectors with rising revealed comparative advantage2 (e.g. mineral and metal products, chemicals, machinery, agri-food, transport material) (Westmore and Adamczyk, 2019[7]; Fontoura Gouveia, 2018[12]). Rising export competitiveness was driven by improved product quality, weak domestic demand that prompted firms to increase their focus on foreign markets (e.g. through dedicated marketing activities) and decreasing relative export prices. It also coincided with increased integration in global value chains (GVCs), including through growth in inward FDI (see Section 2.3) (Adamczyk and Westmore, 2020[13]).
In line with the value added structure, lower technology activities are responsible for higher shares of exporting in Portugal compared to peers such as Ireland, the Czech Republic and the Slovak Republic (Figure 2.3). Lower technology manufacturing exports include food, textiles and apparel, wood and paper, plastics and metal products and are responsible for about 35% of all exports in Portugal compared to 20% or less in peer countries. On the contrary, the export share of high-tech manufacturing is at about 20% of total exports lower in Portugal compared to other countries reporting shares between 50-60%. Portugal also participates in some lower technology services GVCs, such as wholesale and retail trade and transport logistics. These services amount to almost 20% of total exports in Portugal, at par with the share in Ireland. Exports of knowledge services such as research and development (R&D), design and process management, however, remain relatively small in Portugal and are much more developed in Ireland (almost 30% of total exports).
Portugal’s export exposure to lower technology activities, both in manufacturing and services, is a concern for its economic recovery. For example, lower technology manufacturing is more affected by the crisis compared to high-end services related to the digital economy. While Portugal has made strains in expanding more advanced sectors, the bulk of the economy and employment in Portugal depends on the recovery of exports of these lower technology sectors and thus on the recovery of demand in its exporting markets in Europe and beyond.
Figure 2.3. Export structure, by key sectoral groups (% of total exports*), 2016
Note: *In this figure, total exports refers to the total of the four industrial groupings. See Box 2.1 clarifying sectoral groupings used in this figure. Covered exports are responsible for approximately 80% of total exports in Portugal.
Source: OECD based on the OECD Analytical AMNE database, 2019, https://www.oecd.org/sti/ind/analytical-AMNE-database.htm
2.3. Potential for FDI spillovers in Portugal
This section clarifies the potential for FDI spillovers in Portugal. Firstly, it illustrates that spillovers are possible due to the capacity or productivity premia of foreign firms compared to domestic ones in Portugal. Secondly, it shows that knowledge and technology transfers from FDI are likely due to significant FDI inflows in recent years and, thirdly, the section explains how FDI is embedded in Portugal, helping to identify strengths, challenges and opportunities for FDI spillover potential.
Foreign firms exhibit important productivity premia over domestic SMEs
Labour productivity, defined as value added per person employed, serves as a good indicator to measure performance differences between foreign and domestic firms. If differences exist, FDI spillovers are possible as foreign firms can transfer their knowledge and technology to domestic firms. Comparing productivity differences doesn’t allow to make conclusions on whether or not SME absorptive capacities are sufficient, but identifying differences in capacities allows to infer that the potential for spillovers exists.
There are significant productivity gaps between foreign and domestic firms in Portugal, as in many EU economies. Using Eurostat’s Foreign Affiliates Statistics (FATS) shows that affiliates of foreign firms in Portugal are on average 70% more productive than an average firm in Portugal (Figure 2.4, Panel A). This gap is particularly high in Cyprus3 and Bulgaria and fairly low in economies like Austria and France. While this aggregate indicator provides some insights on potential challenges related to SME capacities to benefit from foreign firms’ presence, it is important to dig deeper into sectoral specificities and firm characteristics to better understand domestic capacities in Portugal (see Section 2.4).
Studying labour productivity levels of foreign firms – which are typically larger than average domestic firms (but not always) – and SMEs across value chain functions reveals that foreign firms outperform local ones across all key economic activities in Portugal, in line with countries like Ireland (Figure 2.4, Panel B) (OECD, 2020[14]). This gap is lowest in higher technology manufacturing, where foreign firms are 30% more productive than an average firm in Portugal and 50% more productive than SMEs. Relatively low differences in productivity could illustrate that foreign and domestic firms are operating at par in comparable activities/functions within these industries and thus knowledge exchange is likely. The gap is highest in lower technology manufacturing and services where foreign firms are twice as productive as SMEs. The bulk of fairly low productivity domestic firms (especially SMEs) are operating in these lower value added activities in Portugal (both in terms of value added and employment (see Section 2.4).
The productivity distance between foreign and domestic firms, based on Eurostat’s FATS data, has declined only marginally over recent years (Figure 2.4, Panel A) but micro and small firms have seen some progress in closing the gap with medium sized and large domestic firms in some industries. However, using OECD Structural and Demographic Business Statistics to take a closer look at SMEs and specific sectors shows that their productivity levels have increased over the past decade, especially among micro- and small-firms. In this period, labour productivity grew across all SME size classes in the manufacturing sector. It also grew significantly among micro- and small firms in wholesale and retail trade, as well as in professional, scientific and technical activities, closing the gap with large and medium-sized firms (OECD, 2019[8]).
Figure 2.4. Labour productivity differences between foreign and domestic firms
Note: See Box 2.1 clarifying sectoral groupings used in this figure. The information in this document with reference to “Cyprus” relates to the southern part of the Island. There is no single authority representing both Turkish and Greek Cypriot people on the Island. Turkey recognises the Turkish Republic of Northern Cyprus (TRNC). Until a lasting and equitable solution is found within the context of United Nations, Turkey shall preserve its position concerning the “Cyprus” issue.
Source: OECD based on Eurostat’s FATS data, 2020.
FDI has been on the rise before the pandemic, with potential for further growth
FDI can have a leverage on SMEs if foreign firms not only have a performance advantage but they also need to have enough economic weight in the host economy. The volume of foreign investment can be illustrated with FDI stocks relative to GDP, foreign firms’ share in total value added and employment for example.
Despite rising importance of FDI, there is potential for further FDI growth in Portugal. In Portugal, the share of inward FDI stocks as a percentage of GDP increased from approximately 30% in 2005 to above 60% in 2019, with much of the increase occurring predominately during the post 2008 crisis recovery (Figure 2.5, Panel A). FDI was enabled by increasing efforts to position Portugal as an attractive location for investment and innovation in Europe (see Chapter 5), although it also reflects a general globalisation of investments in Europe and beyond. While its FDI share in GDP is above the EU and OECD average, the stock of FDI remains below that of comparable small European economies such as Hungary, the Czech Republic or Belgium (OECD, 2021[15]). This suggests that there is further potential for FDI growth in Portugal.
Based on available data on immediate origins of investors, FDI diversification in Portugal appears limited with more than 50% of investments coming from the Netherlands, Spain and Luxembourg and almost all investments have their origins within Europe (Figure 2.5, Panel B). However, some FDI in Portugal may originate from immediate investing countries through which investments have been channelled. Investors may channel their investment through different countries globally for strategic reasons related to policy and market conditions in these countries. It is likely that the 20% FDI share of Luxembourg points to this problem, for example. Portugal does not yet publish FDI data in terms of ultimate investing country. Data by ultimate investing country tend to show a more diversified source of FDI and show a greater role for US investors within Europe than would be suggested in the bilateral data. Recent research finds that the more diverse is FDI in terms of country of origin, the higher the positive effect on domestic firm productivity (Zhang and Zhao, 2010[16]).
FDI has been more resilient in Portugal during the COVID-19 crisis compared to the OECD and EU average. The sudden halt of economic activity in important sectors, such as tourism and manufacturing supply chains, along with important demand contractions has led to an almost free fall of inward investment flows in Portugal (OECD, 2021[15]). In 2020, Portugal’s FDI inflows fell by almost 50% relative to 2019. This decline was lower relative to the average FDI fall in the OECD and EU where FDI declined by above 50% and 70% relative to 2019 (Figure 2.5, Panel C).
Despite the relative resilience of FDI in Portugal, its sharp drop adds strain to the economic situation and prospects for a fast recovery. Yet, Portugal’s existing and significant FDI position can help it during the economic recovery. Evidence from past crises has shown that foreign affiliates, including SME investors, often show greater resilience during crises thanks to their linkages with, and access to the financial resources of, their parent companies (Alfaro and Chen, 2012[17]) (Desai, Foley and Forbes, 2008[18]). Additionally, delayed reinvestments of earnings of foreign firms often materialise after crisis peaks (OECD, 2020[19]).
Figure 2.5. Short- and medium-term inward FDI trends in Portugal
Note: FDI exclude resident special purpose entities (SPEs). Statistics follow OECD Benchmark Definition 4 (BM4).
Source: OECD based on OECD International Direct Investment Statistics and OECD FDI in Figures April 2021, https://www.oecd.org/investment/FDI-in-Figures-April-2021.pdf
Local embeddedness of FDI supports other aspects of spillover potential in Portugal
The potential for FDI spillovers is further influenced by a number of FDI characteristics that illustrate to what extent FDI is effectively embedded in the local economy. These characteristics include (a) the sector in which the investment occurs and the activities that the foreign company undertakes, (b) the type of FDI (e.g. greenfield versus mergers and acquisitions), and (c) the main motives behind the FDI decision (e.g. market-seeking, resource-seeking, asset-seeking, efficiency-seeking) (Box 2.2). They are discussed in this section, while local embeddedness relative to the location of FDI within Portugal is discussed in Section 2.5.
Portugal is revealed to have strong FDI spillover potential in higher technology manufacturing, given extensive operations of foreign firms in these activities. Foreign firms in Portugal are contributing to value added and exports across all sectors. They are responsible for at least 15% of value added and at least 45% of exports within each sectoral grouping based on technology intensity (Figure 2.6). In high technology manufacturing such as electronics and pharmaceuticals, foreign firms are responsible for almost all exports. They account for 80% of total exports, up from around 70% in 2006, and for 50% of total value added, up from 40% in 2006. Existing research shows that FDI spillovers on SME productivity are often observed in higher technology sectors (Nicolini and Resmini, 2010[20]; Keller and Yeaple, 2009[21]), suggesting that Portugal’s FDI dominance in these activities further supports the spillover potential of FDI.
Box 2.2. FDI motivations: Key concepts in the literature
The Ownership-Location-Internalisation (OLI) paradigm proposed by Dunning (1977[22]) provides a useful way of thinking about MNEs and what determines their internationalisation decisions. Ownership advantages are assets that enable firms to overcome the costs associated with setting up affiliates abroad. Location advantages originate from the characteristics of a specific country or region – for instance, natural resources, manpower and skills on the supply side, or a large consumer base on the demand side. Internationalisation advantages exist in the presence of high transaction costs, which induce the firm to internalise activities through affiliates, rather than purchasing goods or services through trade. According to this framework, trade and investment are either complementary (vertical FDI) or substitutes (horizontal FDI), and why companies invest abroad is tied to the hold-up problem: the impossibility of writing complete contracts imposes high transaction costs (Grossman and Hart, 1986[23]).
Global production networks have undergone a profound transformation in terms of firms’ internationalisation strategies. The OLI paradigm formulated 40 years ago remains a useful tool but shows several limitations when confronted to today’s business reality. Horizontal and vertical FDI are not the only strategies behind investment, and trade and investment are not simply substitutes or complements (Alfaro and Charlton, 2009[24]; Herger and McCorriston, 2016[25]). MNEs combine horizontal strategies of FDI in some countries and vertical strategies in others (Buckley and Casson, 1976[26]). In some cases, MNEs might decide to concentrate their value chain abroad (vertical investment) while at the same time serving proximate foreign markets through horizontal investment as in the case of “export-platform FDI” (Ekholm, Forslid and Markusen, 2003[27]).
Another limitation is that a significant share of investment is neither purely vertical nor horizontal (Herger and McCorriston, 2016[25]), which raises the question as to why MNEs establish affiliates that do not provide inputs to the parent company and do not serve foreign markets. A fourth category of ‘strategic asset-seeking’ FDI was later acknowledged by Dunning (1993[28]) himself, as somehow neglected by the traditional OLI framework. This is because MNEs are understood to have ownership advantages ex ante which allow them to overcome the costs associated with setting up an affiliate abroad. The strategic asset seeking motive describes rather the opposite phenomenon: MNEs try to access assets and capabilities which are not inside the firm. This acknowledgment of MNEs seeking new and complementary assets is an important extension of the OLI framework (Castro, 2000[29]).
Figure 2.6. Foreign firms’ value added and exports, by sectoral groups (in % of total)
Note: See Box 2.1 clarifying sectoral groupings used in this figure.
Source: OECD based on the OECD Analytical AMNE database, 2019, https://www.oecd.org/sti/ind/analytical-AMNE-database.htm
Greenfield investments are concentrated in higher technology manufacturing and transport and other logistics services; they are more likely to involve transfers of knowledge and technology than acquisitions (particularly in the short-run), further supporting FDI spillover potential. The establishment of subsidiaries of foreign MNEs in Portugal (greenfield investment) is most prevalent in higher technology manufacturing and lower technology services (particularly transport and other logistics services) (Figure 2.7). Taken together, these activities are responsible for more than 80% of all greenfield investments made since 2003. As greenfield investments are likely to involve productivity spillovers, and these spillovers are often larger in higher technology sectors, Portugal’s type of FDI and sectoral positioning seems to be well formed to enable diffusion of knowledge.4
Acquisitions of domestic firms by foreign investors almost exclusively occur in lower technology services in Portugal, where spillovers may occur in the longer term. Close to 90% of all deals have taken place in lower technology services since 2003; mainly in banking, logistics and consumer services. In the case of acquisitions, the deployment of the foreign investor’s technology is likely to be implemented more gradually, making knowledge spillovers to domestic firms less likely in the short-term but they may still occur in the longer term (Crespo, Fontoura and Proenca, 2009[30]; Braconier, Ekholm and Knarvik, 2001[31]; Branstetter, Fisman and Foley, 2006[32]). Foreign entry in these services is also likely to enhance competitive pressure in the market and thus involve more indirect spillover potential (OECD, 2019[33]).
Figure 2.7. Distribution of greenfield FDI and cross-border M&A stocks, 2020
Note: See Box 2.1 clarifying sectoral groupings used in this figure. Detailed sector/activity classifications from Financial Times’ fDi Markets and Refinitiv data underlying the analysis in this figure differ marginally from standard classifications based on ISIC rev. 4 used in other figures in this report. Percentages are based on total capital investment (greenfield FDI) and total M&A deal values over 2003-2020.
Source: OECD based on Financial Times fDi Markets database and Refinitiv.
The small Portuguese market and its labour and administrative cost advantage relative to larger markets within Europe (e.g. Germany or France) make it particularly attractive for efficiency-seeking FDI. While less developed countries may attract efficiency-seeking FDI in lower technology manufacturing, Portugal does so at the higher technology end, including services activities. This is also related to Portugal’s relatively high level of advanced skills combined with relatively low labour costs (see discussion in Section 2.4). Dominance of efficiency-seeking FDI in knowledge-intensive activities in Portugal is further supported when examining FDI across all sectors in the economy. FDI is concentrated in sectors with higher average labour productivity and higher R&D-intensity levels relative to the rest of the economy (Figure 2.8, Panel A and B), while relative wages in FDI-dominated activities are lower compared to activities in other sectors (Panel C). It is important to recall that the analysis on technology-intensity in this report is based on fairly aggregate sector data. Analysis based on detailed firm activities would allow to further examine the types of FDI in Portugal (see Box 2.1)
Dynamic and innovative clusters in the higher technology manufacturing segment – involving competitive domestic firms – is emerging in Portugal, shifting future FDI motives from efficiency-seeking to technology-exploiting FDI, which is shown to have the highest FDI spillover potential (Driffield and Love, 2007[34]). In general, FDI motives are often interlinked, so that they cannot be fully separated but rather emerge in combination.
Figure 2.8. FDI concentration in terms of sectoral labour productivity, R&D-intensity and wages
Note: See (OECD, 2019[35]) for a description of the methodology and data. Labour productivity = value added per employee; R&D intensity = R&D expenditures per unity of value added; wages = wage per employee
Source: OECD FDI Qualities Indicators based on Financial Times’ fDi Markets database, 2020, OECD National Accounts and OECD MSTI database, 2020
2.4. Absorptive capacities of Portuguese SMEs
Global production networks and the presence of MNEs provide local SMEs with an important opportunity to increase productivity and acquire knowledge. Technology transfers are more effective when firms possess previously accumulated knowledge and innovative capabilities. This set of knowledge and capabilities is generally identified by the literature as absorptive capacity (OECD, 2020[9]). More specifically, absorptive capacity is defined as the ability of the firm to utilise available information or knowledge that comes through the interaction with other firms (Cohen and Levinthal, 1990[36]). It involves the ability to acquire, assimilate and exploit the value of the information and knowledge (Todorova and Durisin, 2007[37]).
Using the conceptual framework of the OECD SME and Entrepreneurship Outlook (OECD, 2019[4]), this section starts with an overview of SMEs contribution to Portugal’s economy and trade and then provides an analysis of absorptive capacities, including comparisons with other OECD countries and across economic activities.
Low productivity micro firms make up most of Portugal’s business population
Portuguese micro-firms account for a very large share of the total number of enterprises as compared to micro-firms in other OECD and EU economies (OECD, 2021[3]).5 Portugal also counts relatively more self-employed compared to the rest of the OECD. On the other hand, SMEs (excluding micro firms and self-employed) account for only 4% of the total business population, which is lower than shares seen in many other OECD countries, raising the question of “missing middle” firms in Portugal and their lower capacity to scale up (OECD, 2021[3]). This is further supported by micro firms’ large share of employment (above 40%), but relatively small share in total value added (25%) (Figure 2.9, Panel A). Their labour productivity is also below the OECD average, weighing down productivity of the entire economy. Conversely, Portuguese medium-sized firms are comparatively more productive than their OECD counterparts.
In terms of employment, the share of SMEs is generally high in Portugal and in fact higher compared to the OECD average in selected manufacturing industries (e.g. basic metals, chemicals and machinery) (OECD, 2019[4]). In services, employment shares of SMEs are more aligned with services sectors in other OECD economies.
In term of value added, SMEs are less represented in higher technology manufacturing compared to other sectors, which is less the case in some comparator economies like Ireland (OECD, 2020[38]). SMEs in Portugal – in line with other OECD countries – are most present in services but also account for an important share in manufacturing (Figure 2.9, Panel B). SMEs in Portugal are concentrated in domestically-oriented services such as advertising, legal, accounting, management, scientific and technical services but also in larger service sectors such as logistics and transport. In both lower and higher technology services, SMEs’ share in value added is above 70%. While this is significant due to the very large lower technology services sector in Portugal, SME dominance in higher technology services takes a smaller weight for the economy as a whole.
Figure 2.9. Employment and value added by firm size and sectoral groups
Source: OECD based on OECD Structural and Demographic Business Statistics Database, 2020, https://www.oecd.org/sdd/business-stats/structuralanddemographicbusinessstatisticssdbsoecd.htm
Many SME exporters in services and manufacturing are foreign-owned
Except in higher technology manufacturing, most exporters in Portugal are SMEs (Figure 2.10, Panel B). SMEs in Portugal are responsible for more than 70% of exports in services and 60% of exports in lower technology manufacturing; these export shares are similar to SMEs’ contribution to total value added in these value chain functions. In services, almost half of all Portuguese exports are due to foreign firms (see Section ), which further illustrates that many SME exporters in services (at least 20%) are actually foreign-owned.6
Due to its capital intensity, high technology manufacturing is dominated by large foreign investors in Portugal and SMEs have not been able to fully establish their footprint in this export market, unlike in some other economies such as Ireland, Germany, and Switzerland. SMEs are responsible for approximately 25% of all exports in high technology manufacturing of which some SMEs are foreign-owned. In terms of value added, SMEs in high technology manufacturing are responsible for a larger share (approximately 50%), illustrating the role SMEs may play to supply domestic demand in this sector.
While SMEs play an important role for internationalisation in Portugal, they are currently one of the weakest performers in this area in the EU (EC, 2019[39]). A relatively high percentage of Portuguese businesses are micro-businesses that do not have the capacity to become significant exporters.
Figure 2.10. Value added and exports of SMEs, by value chain function (in % of total of each value chain function), 2018
Note: See note in Figure 2.2 for detailed classification of value chain functions.
Source: OECD based on OECD Structural and Demographic Business Statistics Database, 2020, https://www.oecd.org/sdd/business-stats/structuralanddemographicbusinessstatisticssdbsoecd.htm, and OECD Trade by Enterprise Characteristics Database, 2020, https://www.oecd.org/sdd/its/trade-by-enterprise-characteristics.htm.
Portugal has competitive financial, knowledge-based and human capital with potential for improvement
In Portugal, access to bank credits has potential to improve. Accessing appropriate sources of finance across all stages of their life cycle is critical for SMEs to start, innovate and grow. Bank lending as the most common source of external finance for SMEs has largely recovered after the financial crisis, making it easier for SMEs to access credit in the OECD. Despite decreasing interest rate spreads and rejection rates in Portugal, SMEs face tightening lending conditions. SME lending decreased over 2009-18, in line with a drop in total business credits and a sharp decline in short-term SME loans (-62% in 2010-2018) (OECD, 2019[8]; OECD, 2020[40]). However, SMEs in Portugal are facing competitive interest rates (3% in 2018) and are more likely to receive new bank credits compared to SMEs in many other OECD economies (Figure 2.11, Panel A).
Access to venture capital is at the lower end in the OECD. Alternative sources, including asset-based and equity funding, have also become more widespread across the OECD, offering multiple and competing options to different profiles of firms and investors. Yet, SMEs remain undercapitalised and heavily reliant on straight debt. Barriers both on the supply side (i.e. information asymmetries, lack of collateral and higher transaction costs, etc.) and on the demand side (i.e. lack of awareness and financial skills, etc.) persist, and recent evidence suggests that financial institutions have become even more risk-averse, placing an extra burden on high-risk SMEs or on firms without collateral. In Portugal, venture capital recovered in 2017 (+58%) after the fall in 2016 and experienced a boost of four-fold growth in 2018 (OECD, 2020[40]). Yet, challenges remain – access to venture capital for Portuguese SMEs is at the lower end in the OECD (Figure 2.11, Panel A). The government has put high priority on securing SME access to finance, which is discussed in more details in Chapter 5.
Portuguese SMEs are relatively more innovative and digitised than those in many other OECD economies. Portuguese SMEs are proactive in adopting high-speed broadband and new digital technologies, but they remain weakly integrated into innovation networks compared to SMEs in most other OECD economies (Figure 2.11, Panel B). SMEs in Portugal are, however, performing fairly well compared to peers in other economies in terms of R&D and innovation outputs. SMEs have considerably improved their innovation performance relative to EU peers over the last decade both in terms of introducing new processes and products, developing new marketing and organisational approaches and collaborating with other firms to produce innovation outputs (Figure 2.12). SMEs in Portugal do relatively better across these metrics of innovation performance compared to SMEs in other small open economies in Europe, such as the Czech Republic, Ireland, Lithuania and the Slovak Republic. This reflects Portugal’s determined efforts in recent years to develop an innovation ecosystem for SMEs (see Chapters 4 and 5).
The quality of entrepreneurial skills in Portugal is at par with those in peer countries, but gaps remain in terms of access to training within firms. In Portugal, student proficiency in core disciplines and adult entrepreneurial abilities are in line with the OECD average (OECD, 2020[41]), but a large gap still exists in the number of adults who are highly educated or who access training (Figure 2.11, Panel C). SMEs, particularly micro businesses, perform weakly compared to SMEs in other EU economies in terms of providing life-long learning opportunities for their workers (EC, 2019[39]). Skills acquired at the work place are key assets for technology and innovation absorption, managing organisational changes or enabling integration in GVCs through exports or linkages with foreign affiliates at home.
In the area of innovation and digitalisation skills, a number of sources point to weaknesses that hamper the potential for innovation and further productivity gains in Portugal: Portugal is a rather low performer in the area of computer and electronics skills and complex problem solving (OECD, 2021[3]). The share of businesses that provide ICT skills training to their employees has been falling since 2014 but remains at par with EU average levels. The share of firms providing digital training across firm size classes is also in line with EU comparators like the Czech Republic, Ireland and Finland, for example (Figure 2.13). Nonetheless, evidence indicates that the resources devoted to continuous training and the percentage of staff trained are relatively low in Portugal, particularly in micro-enterprises (EC, 2019[39]).
Figure 2.11. SMEs’ access to strategic resources in Portugal
Note: See methodology in (OECD, 2019b). Index of benchmark (OECD median = 100), from more stringent or less supportive framework conditions or lower country value (low) to less stringent or more supportive framework conditions or higher country value (high). Indicators that reflect potential barriers to SME performance are marked with * and are reversed, so that, when a country ranks high, it effectively performs well as compared to the OECD median.
Source: OECD (2019b), OECD SME and Entrepreneurship Outlook 2019.
Figure 2.12. SME innovation performance (Index, 100= EU average)
Note: Underlying data relate to share of SMEs who introduced product/process, marketing/organisational innovations or that engage in innovation cooperation activities with other firms (https://ec.europa.eu/docsroom/documents/36282/attachments/1/translations/en/renditions/native).
Source: OECD based on Eurostat, 2020, https://ec.europa.eu/eurostat/de/home
Figure 2.13. Firms providing ICT skills training (% of firms in each size class), 2019
Source: OECD based on Eurostat, 2020, https://ec.europa.eu/eurostat/de/home
2.5. Economic geography factors and FDI-SME spillovers in Portugal
When deciding where to invest, foreign firms are increasingly considering region - rather than just country - specific factors. SME activity is also unevenly distributed within countries. Whilst it was traditionally thought that this is only applicable for specific sectors e.g., the location of natural resources for mining projects, as firms’ production processes become more disaggregated, they are progressively placing functions in the most suitable locations. As such, a region’s economic, social and structural features are being scrutinised. This is why it is essential for a country to look beyond the national level and understand their regions’ relative strengths and weaknesses. Given the importance of locations in the discussion, Chapter 6 is dedicated to FDI-SME diffusion and related policy in Alentejo and Norte.
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Notes
← 1. These three countries are considered as comparators in this report, together sometimes with Hungary and Lithuania. They were chosen based on their economic size, outward orientation driven by foreign investors and EU membership.
← 2. A country has a revealed comparative advantage in international trade when the export share of a product in their export basket is higher than the corresponding share of that product in world exports.
← 3. The information in this document with reference to “Cyprus” relates to the southern part of the Island. There is no single authority representing both Turkish and Greek Cypriot people on the Island. Turkey recognises the Turkish Republic of Northern Cyprus (TRNC). Until a lasting and equitable solution is found within the context of United Nations, Turkey shall preserve its position concerning the “Cyprus” issue.
← 4. A greenfield investment is likely to involve the introduction of a new technology in the host country and is therefore accompanied by a direct transfer of knowledge and technology from the parent firm to the new affiliate. However, greenfield FDI can pull skilled workers away from domestic firms, which may involve that incumbent firms are lowering their absorptive capacities and therefore this argument needs to be taken with a pinch of salt. See discussion on labour mobility in Chapter 3.
← 5. Micro firms have 1-9 employees; small firms have 10-49 employees; and medium sized firms have 50-249 employees; SMEs have 10-249 employees, excluding micro firms. See for details: https://www.oecd.org/sdd/business-stats
← 6. Portuguese SME exports are also important in the mining, agriculture and construction. These sectors are not covered in Figure 2.10.