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

This paper examines the role of the business environment in promoting and restraining firm growth. Firms report many features in their business environment as obstacles to growth. These include:

• Inefficient functioning of financial markets;
• Inadequate security and enforcement of property rights;
• Poor provision of infrastructure;
• Inefficient regulation and taxation;
• Broader governance features such as corruption and macroeconomic stability.

The study uses firm level survey data, Directed Acyclic Graph methodology, regressions and robustness tests to present evidence on the relative importance of different features of the business environment. It reveals that:

• Although firms report many obstacles to growth, not all obstacles are equally constraining;
• Some affect firm growth only indirectly through their influence on other obstacles;
• Obstacles related to finance, crime and policy instability directly affect the growth rate of firms, with finance result being the most robust of the three.

These results have policy implications for the priority of reform efforts. They show that 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.