What Makes Hungarian SMEs Perform Poorly?

Small and medium-sized enterprises (SMEs) have been the target of supportive government policies since economic transformation began in Hungary although the birth of a strong and healthy layer of SMEs has not been observed in the country up to now. In this article the issue of why this has not happened is addressed. Empirical evidence suggested that Hungarian SMEs are not usually driven by the corporate values of Max Weber's “protestant ethics”; instead, they aim at short-term financial enrichment. Hungarian SMEs cannot usually “climb the ladder” and turn into large enterprises - indeed, their survival period is relatively short. Nickell (1996) argued that (total factor) productivity rather than profitability would reflect a company's efficiency level. Using frontier production and frontier profit functions there is an attempt here to prove that “technical (or allocative) efficiency” and “profit efficiency” both have a distinct role to play in explaining a firm's economic performance; and by applying limited information maximum likelihood models of SME profit gaps it will be shown that cost inefficiencies and unfavourable market conditions - alongside the inefficient allocation of factors of production - inevitably lead to the fairly low level of SME profitability. The most important finding of the analysis is that employment has been a crucial factor in explaining the profit deviation of companies. Building on the results of Köllo (2001) the article argues that SMEs regard labour as flexible stock. Companies will seek out new labour if they find new market opportunities - but until these appear, they tend to remain in the arena of diminishing returns, this being the easiest way for them to maximise profits. Downgraded production activities do not attract substantial external financing. Yet a lack of financial resources when new market opportunities do emerge will prevent an SME from exploiting the chance