How Important are Financing Constraints? The Role of Finance in the Business Environment
University of Maryland - Robert H. Smith School of Business
World Bank - Financial and Private Sector Development; World Bank
George Washington University - School of Business
World Bank Policy Research Working Paper No. 3820
What role does the business environment play in promoting and restraining firm growth? Recent literature points to a number of factors as obstacles to growth. Inefficient functioning of financial markets, inadequate security and enforcement of property rights, poor provision of infrastructure, inefficient regulation and taxation, and broader governance features such as corruption and macroeconomic stability are discussed without any comparative evidence on their ordering. In this paper, the authors use firm level survey data to present evidence on the relative importance of different features of the business environment. They find that although firms report many obstacles to growth, not all the obstacles are equally constraining. Some affect firm growth only indirectly through their influence on other obstacles, or not at all. Using Directed Acyclic Graph methodology as well as regressions, the authors find that only obstacles related to finance, crime, and political instability directly affect the growth rate of firms. Robustness tests further show that the finance result is the most robust of the three. These results have important policy implications for the priority of reform efforts. They show that maintaining political stability, keeping crime under control, and undertaking financial sector reforms to relax financing constraints are likely to be the most effective routes to promote firm growth.
Number of Pages in PDF File: 59
Keywords: Pro-Poor Growth and Inequality Inequality Economic Conditions and Volatility Private Participation in Infrastructure Economic Growth
JEL Classification: D21, G30, O12
Date posted: November 14, 2005
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