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Access tofinance as a growth constraint for SME

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Date added: 17-06-26


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Introduction

Many researchers have proved that small and medium size firms faces more constraints to access external finance as compare to large size firms. However there is no research on the factors which effects on the growth of SMEs in developing economy of Pakistan. Study shows that SME plays a key role in the economic development of the country but due to the lake of developed financial institutional structures SME sector faces obstacles to access the external sources of finance. Government should take serious steps for the monitoring and development of financial institutional system. Regardless of the increasing interest in the development of community by providing funds to SMEs there are different views regarding to the effectiveness of Pro-SME policies. older in terms of years of incorporation, large size firms and foreigh-owned firms less hurdles to access the external sources of finance as compare to the new small size and locally owned firms. Many researchers stress on the importance of all other factors which effects the business environment for all firms. These factors includes entry and exit barriers for the new entrants in the business, presence and implementation of property rights, contract enforcement, presence of information related to the firms like credit bureau, channels for external finance. Presence of competitive business environment which allows encourages the new innovative entrepreneurs. Furthermore, access to finance plays a very key role in the overall business environment rather then constructive destruction in which a large number of inefficient and low growth SMEs . This paper is going to contribute in the policy making for the SMEs.

Literature review

SMEs, business environment and growth

Studies shows that SMEs play a vital role in the economic development of the country but the imperfections in the financial institutional structure impede the progress of SMEs. Many studies at country level ad microeconomic level have reviewed the importance of SME in the industrialization process which leads to economic development ( Snodgrass and Biggs, 1996 ), on the other hand Beck et al. (2005a) studied the relationship between SME, poverty alleviation and economic growth using a cross country data base and found a signification relationship. Same sort of work has been done by Ayyagari et al. (in press) by using Cross-country data and applying regressions between GDP per capita growth and SMEs share in manufacturing Employment and showed a strong positive relationship between GDP per capita and SME share. In his study he not only controlled other variable which may effect the growth of that country but also control those variables which may become reason for reverse causation and simultaneity biases he still found a strong relationship between economic growth and SMEs. On the basis of results from this study we can conclude that SMEs do not foster the economic growth but a large share of SMEs is a characteristic of growing economy. Result of this finding is consistent with the results of Beck et al. (2005a) that a large SME sector in the economy is a characteristic of fast-growing economies, but this is not a reason of the growth of economy. Furthermore he didn't find any evidence for the relationship between large SME sector in the economy and faster income growth. Klapper et al. (in press) used firm level data of Europe and found that regulations related to entry of new businesses effects the economic development. A regulation related to the entry of new businesses is one of key element of business environment and was measured by the cost of registration for a firm, because a high registration fee may act as a barrier for the entrance of new firms. Mean while he considered property right protection and access to finance as those variables which may help the new firms to enter in the business. Further he concluded that low entry barrier and healthy business environment results high productivity, more employment and economic growth. The paper concluded that poor business environment have adverse effect on the SME sector performance because they are more sensitive to the business environmental factor such as market imperfection and dampen competition as compare to large size firms. A comparison study of Italy and UK was conducted to study the effect of entry barrier on the SME sector growth. In Italy the entry cost is 20% of GNP where as it is 1.4% of GNP in UK but the growth rate of smaller firms in Italy is slower then UK. The reason for slower growth of Italy small firms is the existence of many old and inefficient firms. But due to low entry barrier at beginning a larger number of small size firms starts out in Italy but they grow more slowly as compare to UK. These finding are complementary to the results of Beck et al. (2005a) and also helps to understand that why a large size SME is improbable to be linked with faster growth, Large SME sector is result of low entry barriers but also with better business environment. Firms are more likely to enter in those economies where they can easily access to external finance better property right laws and better investor protection. (Demirguc-Kunt et al., 2006 ) used firm level data from 52 different countries and found that firms are more likelihood of incorporating in those area where they face less hurdles to their growth, well developed financial institutional sector, presence and implementation of laws, investors protection in terms of strong shareholder and creditor rights, low tax rates and easy bankruptcy process. In those countries where financial and legal institutional are more developed and have favorable business environment, corporations in those countries reports less financing, legal and regulatory hurdles. Djankov et al. (2004) used survey data by interviewing with the entrepreneurs and non-entrepreneurs form seven cities across Russia and found that beside personal characteristics business environment is also one of the most important factor for a entrepreneurs to take decision to become the entrepreneur. The study also found several significant evidences that perception related to the corruption and attitude of government officials towards entrepreneurship encourage or discourages the entry of new firms in economy. These results are similar to the results of Johnson et al. (2002). Cull and Xu (2005) studied the behavior of Chinese entrepreneurs and found that Chinese entrepreneurs are more willing to reinvest their earnings if they feel confident and secure about legal system specially property right protection and have easier access to external finance. To study the different dimensions of business environment and to check that are all these dimensions are equally important Ayyagari et al. (2005) used firm level survey data of 80 countries and found that out of different variables like access to finance, legal and taxation system, corruption macroeconomic and political stability only finance and political instability have greater impact on the firms growth and finance is the most strong among all these. By combining all these results we can conclude that the presence of competitive business environment which allows encourages the new innovative entrepreneurs. Furthermore, access to finance plays a very key role in the overall business environment. In many poor countries or in developing economies the enterprises and SMEs holds a very large share and form the base for private sector-led growth (Hallberg, 2001 ). Ayyagari et al.(in press) found that SME plays a key role in the employment rate of any country he found that enterprises with up to 250 countries holds the overall 60% of the total employment in manufacturing countries. (Ber-ger and Udell, 1998; Galindo and Schiantarelli, 2003) studied both the developing and developed economies and found that in both economies small size firms have less access to the external fiancé and their growth is more effected with this constraint. Schi er and Weder (2001) show that older in terms of years of incorporation, large size firms and foreigh-owned firms less hurdles to access the external sources of finance as compare to the new small size and locally owned firms. The result of the studies were not only statistically but also economically significant. Kumar et al. (1999) studied the Indian firms and find that the average size of firms in human capital-intensive and R&D intensive industries is larger in countries with better property rights and patent protection.

Conclusions

This article summarizes recent empirical research which shows that access to finance is an important growth constraint for SMEs, that financial and legal institutions play an important role in relaxing this constraint, and that innovative financing instruments can help facilitate SMEs' access to finance even in the absence of well developed institutions. The research has a number of important policy implications. The research summarized here suggests that a competitive business environment, of which access to finance is an important component, facilitates entry, exit and growth of firms and is therefore essential for the development process. A focus on improving the business environment for all firms is more important than simply trying to promote a large SME sector which might be characterized by a large number of small but stagnant firms. Although SMEs constitute a significant part of total employment in many countries, one of the reasons they may not be able to contribute to economic growth is because they face greater growth obstacles. Indeed, compared to large firms, SMEs are more constrained by different obstacles, and limited access to finance is an important one of these. Research suggests improving legal and financial institutions helps all deserving firms access finance and grow, but the effect is greatest on smaller firms. Both firm-level and industry-level studies suggest that small firms do relatively better compared to large firms in countries with better-developed institutions. Furthermore, we see that in the absence of well developed financial markets and legal systems, it is difficult for firms to grow to their optimal size since outside investors cannot prevent appropriation by corporate insiders, limiting firm size. This is important for The literature suggests that a focus on improving the institutions and the overall business environment is probably the most effective way of relaxing the growth constraints SMEs face and facilitate their to contribution to economic growth. However, institution building is a long term process and in the interim innovative lending technologies hold promise, providing market-friendly ways of relaxing the constraints SMEs face. A contestable financial system makes it more likely that such technologies will be adopted more rapidly, with foreign banks playing an important role in facilitating this process, whereas public banks have been less useful in the past.
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