Alleviating the Financial Capital Barriers Impeding Business Development in Inner Cities

Problem: In his “Competitive Advantages of the Inner City” papers, Michael Porter maintained that comparative advantages of inner-city economies, once recognized, would lure profit-motivated investors to start new ventures and expand existing businesses in these areas. Porter stressed limited access to financing as a major barrier to inner-city economic development and its expanded provision as a remedy. Purpose: I consider whether Porter's claims match the evidence. Methods: I investigate both private and government-assisted providers of debt and equity capital to inner-city businesses that appear to exhibit Porter's competitive advantages. I distinguish successful inner-city business financing operations from those that are unsuccessful and use these results to draw lessons about effective and ineffective strategies for increasing inner-city businesses’ access to financing. Results and conclusions: Lack of financing appears to be an important barrier to inner-city economic development, as Porter concluded, but the comparative advantages he thought made the inner city attractive to profit-seeking investors have not been demonstrated. Porter asserted that inner-city households seeking to buy consumer products were underserved by local firms. However, other researchers did not find this to be the case and new business ventures serving this market have had poor profits and poor rates of survival over time. Porter's revitalization blueprint aimed to create jobs and sustainable businesses to benefit inner-city residents, yet evidence indicates that inner-city firms largely meet their staffing needs by employing workers living outside the inner city. Private venture capital investment in the inner city has not generated attractive returns. However, inner-city lending can be profitable under the right conditions. Takeaway for practice: There is a lack of business financing available to fund the creation and expansion of inner-city ventures, creating a barrier to inner-city economic development. However, my case studies illustrate that private lenders can be profitable in this market if they have: (a) a sufficiently large and diverse portfolio of investments; (b) lending policies requiring sufficient collateral or loan guarantees to offset defaults; and (c) skilled, experienced, professional managers. Research support: None.