How Important are Financing Constraints? The Role of Finance in the Business Environment

Abstract

What role does the business environment play in promoting or 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 all discussed without any comparative evidence on their ordering. Using firm-level survey data on the relative importance of different features of the business environment, the article finds 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. Analyses using directed acyclic graph methodology and regressions find that only obstacles related to finance, crime, and policy instability directly affect firm growth. The finance result is shown to be the most robust. The results have important implications for the priority of reforms. Maintaining policy 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.

Keywords: D21, G30, O12