Our Research posts are about the latest academic research being done in the School of Economics. This week:
SOUTH AFRICAN FIRM-LEVEL EVIDENCE OF THE LINKS BETWEEN FINANCE AND EFFICIENCY
By Waldo Krugell & Marianne Matthee
Small- and medium-sized enterprises are often seen as drivers of economic growth and development. SMEs contribute to the diversification of economic activities and thereby promote broad-based economic growth. They also generate employment opportunities and in this way contribute to reductions in poverty. Since the 1995 White Paper on Small Business, government has seen three key roles for SMEs: as agents of employment creation, redistribution and increased competitiveness (Rogerson, 2004:766). However, for SMEs to be successful they need finance. In earlier work access to finance has been found to be a major obstacle to SMEs’ ability to do business in South Africa. Our paper takes a closer look at firms, their access to finance and output per worker in South Africa, by using data from the World Bank Enterprise Survey 2007.
Claessens and Tzioumis (2006:8) define access to finance as “the availability of supply of quality financial services at reasonable costs”. Access to finance is a driver of growth in that finance is required for the start-up of an SME, the development of new products and the expansion of the firm. In all of these stages, finance is required for investment in equipment and employees (OECD, 2006). The need for finance depends on the size of the firm, the age of the firm and the type of firm.
The source of finance can drive or dampen firm growth. Becchetti and Trovato (2002:297-298) found that firms with greater access to external finance (i.e. firms that have adequate leverage) are able to grow faster than firms with low leverage. The significance of the source of finance also depends on the size of the firm. Malhotra et al. (2006:10) state that small firms typically obtain only 30% of their financing from external sources, whereas large firms are able to source 48% of their financing externally.
The main factors found to influence firms’ access to finance include the age and size of a firm, the development of the financial system and capital markets and the presence of private credit registries, among others. Size and age account for most of the differences in access to finance between firms. The general conclusion is that smaller firms experience greater financial obstacles in that they have more limited access to formal sources of external finance.
Our paper employs SA data from the 2007 World Bank Enterprise Survey. The survey was national in scope and covered different sectors. In total, the survey reached 375 small firms, 366 medium-sized firms and 196 large firms. The small firms were found in the retail and wholesale sectors, garments and other manufacturing. Medium-sized firms were prevalent in textiles, chemicals, plastics and rubber, as well as other services and the wholesale trade. The large firms were concentrated in base metals, non-metallic mineral products and electronics. The firms reached by the survey were well established with a mean age of 21 years. The small firms were on average nine years old, the medium-sized firms 18 years old and the large firms on average 31 years. Many of the firms were exporters and 5% of small firms, 18% of medium-sized firms and 45% of large firms had exported in 2006.
The survey was an investment climate assessment, and in addition to questions about sales and exports, the questionnaire also asked firms about supplies and imports, capacity and innovation, investment climate constraints, infrastructure and services, relations between business and government, labour relations and finance. With specific reference to finance, the survey provides information about sources of financing, current lines of credit or loans, collateral and the reasons why firms’ loan applications were rejected. Figure 1 shows firms’ view on obstacles to their operations.
The description of the data in the paper presents a clear profile of firms and their access to finance. Firms that indicate that access to finance is a constraint to their operations are typically small and less established. They are not able to allow their clients to pay after delivery and they have to pay for their purchases before or on delivery. These firms also hold a smaller stock of inventory. The firms that are constrained by access to finance are less likely to own a generator or use own transport to make shipments. These firms are also less likely to pay for security or to provide formal training. They have lower capacity utilisation and are unlikely to be exporters or to introduce new products in response to competition. All this indicate that they may be more vulnerable to shocks and competition as well as being weaker contributors to employment creation and growth.
The conclusion, for practitioners, is that finance seems to matter for a firm’s efficiency. For firms that may experience finance constraints, the results show that getting their “financial house in order” is the key to improved efficiency. For example, firms need to build a sound credit history, appoint an external auditor and foster a healthy relationship with a bank.
For researchers, the question is whether financial markets are failing to allocate scarce savings among firms that need it for operation and investment. What causes firms to be finance constrained? Should government intervene to provide firms with access to finance? To answer such questions leads back to Rogerson’s (2008:62-70) view that one should consider both the demand and supply side of issues of access to finance, which creates recommendations for further research. A supply-side view would involve a number of sub-themes, such as an assessment of government support aimed at enhancing access to finance, as well as an analysis of private sector programmes and the role of pro-poor microfinance services.
The full paper has recently appeared in the Journal of Economic and Financial Sciences, 4(2).