This paper examines the development of manufacturing SMEs (small- and medium-scale enterprises) in Indonesia during 1986-96, using unpublished data of BPS (Statistics Indonesia). The contribution of SMEs to total manufacturing value added has remained relatively small, but their contribution to the Indonesian economy in terms of employment generation is significant. The analysis suggests that, in broad terms, SMEs can coexist with LEs (large-scale enterprises), by producing a unit of output with less capital but more labour than LEs. Labour productivity in SMEs and LEs increased at a similar rate during the period under study. Increase in labour productivity of SMEs in the machinery industry was faster than in other main product sectors. SMEs in the machinery industry also increased their TFP markedly, compared with both SMEs in other sectors and LEs in the same sector. Overall, these results question whether subcontracting can support the development of SMEs and improve their performance.