Does Direct Foreign Investment Affect Domestic Firms' Credit Constraints?

41 Pages Posted: 20 Aug 2001 Last revised: 22 Jan 2022

See all articles by Ann E. Harrison

Ann E. Harrison

University of California, Berkeley; National Bureau of Economic Research (NBER)

Margaret McMillan

Tufts University - Department of Economics; International Food Policy Research Institute (IFPRI); National Bureau of Economic Research (NBER)

Date Written: August 2001

Abstract

Firms in developing countries cite credit constraints as one of their primary obstacles to investment. Direct foreign investment, by bringing in scarce capital, may ease domestic firms' credit constraints. Alternatively, if foreign firms borrow heavily from domestic banks, they may exacerbate domestic firms' credit constraints by crowding them out of domestic capital markets. One plausible mechanism by which this may happen is indirect. Foreign firms may be more experienced and have better financial ratios and thus, be a safer bet for lending institutions. Using firm-level data from the Ivory Coast for the period 1974-1987 we test the following hypotheses: (1) domestic firms are more credit constrained than foreign firms and (2) borrowing by foreign firms exacerbates the credit constraints of domestic firms. Results suggest that domestic firms are significantly more credit constrained that foreign firms and that borrowing by foreign firms aggravates domestic firms' credit constraints. By splitting the sample into state-owned (SOE) and privately owned domestic enterprises we are able to show that SOEs are less financially constrained than other domestic enterprises, consistent with the notion of a 'soft budget constraint'. Borrowing by foreign firms affects only privately owned enterprises. Finally, we explore possible explanations for the crowding out effect.

Suggested Citation

Harrison, Ann E. and McMillan, Margaret, Does Direct Foreign Investment Affect Domestic Firms' Credit Constraints? (August 2001). NBER Working Paper No. w8438, Available at SSRN: https://ssrn.com/abstract=280291

Ann E. Harrison (Contact Author)

University of California, Berkeley ( email )

Giannini Hall
Berkeley, CA 94720-3880
United States

National Bureau of Economic Research (NBER)

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Margaret McMillan

Tufts University - Department of Economics ( email )

Medford, MA 02155
United States

International Food Policy Research Institute (IFPRI) ( email )

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Washington, DC 20005
United States

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

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