This paper examines recent European policy changes designed to support small and medium size enterprises (SMEs). These changes have resulted in both the development of specific support programs for SMEs and more general deregulatory measures to improve the economic environment for business. The rationale often provided is that SMEs contribute to a dynamic and innovative environment and generate high quality employment. An analysis of OECD material and a review of the literature on SMEs reveals that their role in innovation, employment growth and the adoption of new forms of work organisation is often over-emphasised. The vast majority of SMEs do not carry out research and development and are associated with low quality and insecure employment. Policies in support of SMEs need to be formulated with an awareness of the diversity of SMEs. There are only a very limited number of SMEs which make an important contribution to employment and innovation. Efforts to facilitate the establishment and growth of these high quality SMEs need to be based on targeted programs rather than general measures such as tax reduction or labour market deregulation. Targeted policies include R&D support, the improvement of SMEs' intangible investments and regional access to capital and technology. General measures are more likely to create an environment in which low quality, low wage employment is generated in SMEs with little future.