The Role of Long-Term Finance: Theory and Evidence

Improving the supply of long-term credit to industrial firms is considered a priority for growth in developing countries. A World Bank multicountry study looks at whether a long-term credit shortage exists and, if so, whether it has had an impact on investment, productivity, and growth. The study finds that even after controlling for the characteristics of individual firms, businesses in developing countries use significantly less long-term debt than their counterparts in industrial countries. Researchers are able to explain the difference in debt composition between industrial and developing countries by firm characteristics; by macroeconomic factors; and, most importantly, by financial development, government subsidies, and legal and institutional factors. The analysis concludes that long-term finance tends to be associated with higher productivity. An active stock market and an ability to enter into long-term contracts also allow firms to grow at faster rates than they could attain by relying on internal sources of funds and short-term credit alone. Importantly, although government-subsidized credit markets have increased the long-term indebtedness of firms, there is no evidence that these subsidies are associated with the ability of firms to grow faster. Indeed, in some cases subsidies are associated with lower productivity.