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How important are financing constraints ? The role of finance in the business environment

  • Ayyagari, Meghana
  • Demirguc-Kunt, Asli
  • Maksimovic, Vojislav

What role does the business environment play in promoting and 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. In this paper, we use firm level survey data to present evidence on the relative importance of different features of the business environment. We find 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. Using Directed Acyclic Graph (DAG) methodology as well as regressions, we find that only obstacles related to Finance, Crime and Policy Instability directly affect the growth rate of firms. Robustness tests further show that the Finance result is the most robust of the three. These results have important policy implications for the priority of reform efforts. Our results show that maintaining policy stability, keeping crime undercontrol, and undertaking financial sector reforms to relax financing constraints are likely to be the most effective routes to promote firm growth.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3820.

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Date of creation: 01 Jan 2006
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Handle: RePEc:wbk:wbrwps:3820
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