Abstract
Advanced market economies are characterized by a continuous process of creative destruction. Market forces and technological developments play a major role in shaping this process, but institutional and policy settings also influence firms' decision to enter, to expand if successful and to exit if competition becomes unbearable. In this paper we focus on the effects of financial development on the entry of new firms and the expansion of successful new businesses. Drawing from harmonized firm-level data for 16 industrialized and emerging economies, we find that access to finance matters most for the entry of small firms and in sectors that are more dependent upon external finance. This finding is robust to controlling for other potential entry barriers (labour market regulations and entry regulations). On the other hand, financial development has either no effect or a negative effect on entry by large firms. Access to finance also helps new firms expand if successful. Both private credit and stock market capitalization are important for promoting entry and post-entry growth of firms. Altogether, these results suggest that, despite significant progress over the past decade, many countries, including those in Continental Europe, should improve their financial markets so as to get the most out of creative destruction, by encouraging the entry of new (especially small) firms and the post-entry growth of successful young businesses.
Highlights
There is growing empirical evidence suggesting that market economies are characterized by a continuous process of reallocation of resources and that this process play a major role for aggregate productivity and output growth (e.g. Olley and Pakes, 1996; Foster et al 2002; Griliches and Regev, 1995; Bartelsman et al 2004; and Aghion and Howitt, 2006)
The analysis developed in this paper is motivated by growing empirical evidence suggesting large firm dynamism in all market economies and a significant role that this dynamism plays in promoting reallocation of resources and productivity growth
How can we formalize the links between financial development – and other business regulations – and entry and post entry growth? To address this question, we present a simple model which draws from Aghion et al (2006)
Summary
There is growing empirical evidence suggesting that market economies are characterized by a continuous process of reallocation of resources and that this process play a major role for aggregate productivity and output growth (e.g. Olley and Pakes, 1996; Foster et al 2002; Griliches and Regev, 1995; Bartelsman et al 2004; and Aghion and Howitt, 2006). Country-specific factors explain more of the variation in entry rates than the industry factors, but the dominant role is played by the size dimension that alone accounts for about one-third of the total variance, while the combined industry*size effects account for more than 40 percent These results clearly indicate the importance of exploiting the size dimension in the analysis of firm turnover data. It can reflect better business environment conditions that allow new firms to enter relatively small and, if successful, expand rapidly to approach the minimum efficient scale This finding suggests that the analysis of firm dynamics and its links with financial development and other institutional factors cannot only focus on entry, but should explore the development of new ventures in the first years of their life. It clearly indicates large variations in the post entry behavior of firms, which can again be influenced by access to credits of new small businesses as well as by regulatory conditions
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