The Impact of Financing on Labor Markets in Developing Countries

Most firms in today’s economy are dependent on financial services such as lending or insurance.  Developed countries are at the forefront of financial availability in terms of both institutions and regulations. By ensuring broad access to finance, countries provide support to the firms that operate within their borders, supporting economic growth. A recent study by Meghana Ayyagari, Pedro Juarros, María Soledad Martínez Peria, and Sandeep Singh sheds light on the interaction between financial services’ availability and a country’s labor market. The authors examine whether improved access to financial products has any effect on employment growth in developing countries with weak financial institutions, and they pay particular attention to how these effects vary by firm size between large firms and micro, small, and medium enterprises (MSMEs). The implications of a possible relationship between job growth and financial product availability are particularly meaningful for MSMEs, which contribute to job creation in developing countries and also tend to be more vulnerable to shortages in financing.

Using data from the World Bank Enterprise Survey (ES) and the commercial database Orbis, Ayyagari et al. conducted a firm-level comparison of financing availability and job growth in developing countries. To measure employment growth, the authors quantified the change in firm size over the period evaluated, which, depending on the database, was a one- or two-year period. To determine the impact of access to finance on job growth, the authors analyzed how employment growth varied between firms that reported having access to loans and lines of credit and those that reported otherwise. The preliminary results indicate a positive relationship between access to finance and employment growth.

The authors incorporated the fact that there are multiple factors that affect both a firm’s financial needs and its labor demand when constructing their research design. For instance, it is likely that a firm that applies for a loan to expand its operations will also need more employees to run this expansion. To compare access to finance and employment growth while allaying these endogeneity concerns, the authors use an external tool that is correlated with an increase in the overall financing availability in a country: the introduction of a credit bureau. A credit bureau is a private company that collects and distributes the credit history information of individuals and firms. By making this data accessible, the information asymmetries between lending institutions and borrowers decrease, which improves overall options for financing. The study reveals a positive correlation between a firm’s access to finance and the existence of a credit bureau: Firms in countries that have established a credit bureau report having significantly higher access to loans than those that are located in countries without a credit bureau. Specifically, the results show that access to finance increases by six percentage points when a law creating a credit bureau passes.

After establishing a positive correlation between credit accessibility and the establishment of a credit bureau, the authors analyze how credit bureau reform affects job growth. They find that, for all firm sizes, countries where a credit bureau reform takes place exhibit a 5.29 percentage point increase in annual employment. They also study how this impact varies across firms with different traits: firms in industries that depend more on external financing are found to exhibit higher levels of employment growth; with regards to differences in firm size, the authors find that the rise in job growth for MSMEs is six times greater than that of large firms. Specifically, they find that the annual average firm size of MSMEs increases at a rate six times higher than that for larger firms when a credit bureau is established in a country. The authors conclude that these results show clear evidence of a causal relationship between increased credit supply and employment growth.

Policymakers interested in job growth should take the results of this study into account, as policies that increase financing availability to firms in general, and MSMEs in particular, will likely contribute to job creation. Developing countries usually have weaker financial institutions, which constitutes a greater obstacle for MSMEs than for larger firms. By strengthening these institutions and providing better credit services, not only will these countries enhance growth opportunities for MSMEs, but they will also improve their employment rates and have a positive impact on economic development.

Article source: Ayyagari, Meghana, Pedro Juarros, María Soledad Martinez Peria, and Sandeep Singh. “Access to Finance and Job Growth: Firm-Level Evidence Across Developing Countries.” World Bank Policy Research Working Paper No. 7604, 2016.

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