Academic journal article The Journal of Developing Areas

Access to Finance and Small Enterprise Growth: Evidence from East Java

Academic journal article The Journal of Developing Areas

Access to Finance and Small Enterprise Growth: Evidence from East Java

Article excerpt

ABSTRACT

The widespread acknowledgement of the centrality of micro and small businesses in the development process has led to a proliferation of projects and programs designed to assist and promote these businesses. This research examines the common assumption that access to credit from formal financial institutions is an important determinant of growth at the firm level. Our data are from a recent survey of 858 small businesses in East Java. We employ a full information maximum likelihood approach known as discrete factor method. The results indicate that access to credit is not a significant determinant of small firm growth; instead, other observable and unobservable characteristics of firms appear to cause growth.

JEL Classifications: O1, O2

Keywords: Micro and Small Enterprises, Credit, Growth

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

The centrality of micro and small enterprises (MSEs) in the process of economic development is by now widely recognized and essentially beyond debate. While countries are heterogeneous in the regard, it is not uncommon for such businesses to employ one quarter of the working age population in developing countries. Estimates of the contribution of the sector to GDP are probably less reliable, but typically fall in the 10% to 15% range.1 In addition, the MSE sector may serve as an entrepreneurial training ground in which tomorrow.s business leaders can find success and gain valuable experience.2 As the role of the MSE sector has become clearer, policy makers in developing countries, as well as donors and others organizations, have expended increasing amounts of scarce development resources on MSE support and promotion. A tremendous and increasing amount of attention has been paid in recent years to the legal and regulatory framework that may constrain MSE expansion. Similar attention has been given to programs promoting the training of entrepreneurs and workers that may enable MSEs to grow. Still, although many programs and policies have been implemented in these areas, perhaps even more attention has been paid to the area of micro and small firm finance. The success of the Grameen Bank in Bangladesh and its clones all over the world, as well as the awarding of the 2006 Nobel Peace Price to Grameen Bank founder Muhammad Yunus have made micro and small firm finance one of the principal development topics of the day. According to a recent special report in the Economist, microfinance institutions worldwide may number in the hundreds of thousands. (The Economist, 2005).

Indonesia is certainly no exception to these trends. The Government of Indonesia, in conjunction with donors and nongovernmental organizations, has been more diligent than most developing country governments in promoting such programs, and by most accounts a higher proportion of MSEs in that country has received loans from formal financial institutions than is the case in many places.3 Recent estimates claim that the government of Indonesia regulates some 60,000 microfinance institutions (The Economist, 2005). In recent years it has been taken as a given that poor access to formal credit sources constrains MSE growth. However, for the most part, empirical evidence supporting such an assumption has been weak. Nevertheless, millions of dollars have been spent on programs that seek to mitigate this perceived obstacle. Typical examples include programs that involve subsidized credit for certain MSEs, programs that encourage banks to lend to MSEs by providing repayment guarantees, and programs such as the Grameen Bank that channel loans specifically to MSEs.

This paper seeks to address empirically the assumption that firms with access to formal credit sources are more likely to grow as a result. Certainly, such an assumption is intuitively appealing, and there is at least some empirical support for it. However, perhaps instead MSEs tend to grow because of factors not related to credit, such as entrepreneurial skill or the presence of human capital, opportunities in the subsector in which the firm operates, etc. …

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