Firm Entry Barriers, Growth Constraints, and Job Creation

This project aims to investigate the importance of financial constraints as a barrier to entry and as a barrier to growth.

Barriers to firm entry are pervasive across developing countries. Financial constraints may not only limit growth among existing firms but also distort entry decisions among otherwise productive entrepreneurs. Existing evidence, however, is mixed.  It has been shown that banking deregulation (and growth in credit) in the United States induced substantial entry of small, short-lived firms but also increased the size at entry of longer-lived firms. However, recent randomized experiments in developing countries find that microfinance access is relatively more likely to cause growth among existing informal microenterprises than entry of productive, new ones. These stylized facts call for new theoretical models and empirical analyses that focus on the start-up process.

The researchers, using a model where entrepreneurs that have difficulties accessing credit take strategic decisions to lead their firms in the best possible way, suggest a novel channel through which easing credit constraints can induce entry of more dynamic start-ups with greater long-run growth potential than would be unlocked by easing conventional entry barriers. They will test for this growth mechanism by combining new data on credit access with longitudinal employment records for the universe of formal sector firms in Brazil from 1986–2009. Their main identification strategy exploits predetermined variation in interbank lending relationships with the National Development Bank and policy-induced shocks to the national supply of credit for small and medium enterprises (SMEs). The study promises new insights into the importance of financial frictions for SME growth and employment generation in developing countries.

Although the project focuses on Brazil due to its remarkably rich data and credit environment, this research is highly relevant to many low- and lower-middle income countries. Hopefully, the study will reveal successful credit policies that can then be piloted and tested in these settings where take-off in the formal sector is most constrained. Moreover, the theoretical framework and proposed empirical strategies can be readily applied elsewhere as additional administrative data become available.