Financing of Small firms in Latvia: Evidence from SIBiL

Financing of Small firms in Latvia:Evidence from SIBiL Vyacheslav Dombrovsky, SSE-Riga and BICEPS

Outline of the talk • What is SIBiL? • Performance, innovations of small businesses, 2007-2010 • Bank financing, 2008-2010 • Some thoughts on policy implications

Survey of Innovative Businesses in Latvia (SIBiL) • Innovations (technological catching-up) is economic development • Survey of small (<50 employees) businesses, focusing on innovative behavior, exports, access to finance, etc. • Dissatisfaction with the CSB’s (and EuroStat’s) Community Innovation Survey; using the same questionnaire but different survey method • Data opportunities provided by Lursoft (Business Registry database) • Generous financial support from the TeliaSonera

LURSOFT DATABASE Stratified random sampling Wave 2 completed interviews N=940 Initial Sample N=2,571 Bankrupt or lost: N=210 Survey of owners Final Sample, Wave 1 N=1,267 Refusal to participate: N=117 Survey of the same firms 2008 2010 TIME

SIBiL vs CSB:Percentage of firms with product or process innovations in manufacturing

How accessible is bank financing? • During the last two years the banks were often accused of denying credit to businesses • Banks’ counter-argument is that there are too few ‘good’ investment projects • SIBiL’s 2nd Wave has a large section on financing, adapted from U.S. Federal Reserve’s Survey of Small Business Finance • Specifically, the survey focuses on businesses’ credit lines, loan applications, and trade credit with suppliers • It appears that the ‘bad banks’ view is somewhat exaggerated

Access to credit lines • In 2010 survey, about 22% of SIBiL firms reported having credit lines with banks • Of those with credit lines, 49% attempted to renew those within the last two years. • of which most (74%) report successful renewal, • only 12.5% report requests were “always denied”

Access to credit lines • In 2010 survey, about 22% of SIBiL firms reported having credit lines with banks • Of those with credit lines, 49% attempted to renew those within the last two years. • of which most (74%) report successful renewal, • only 12.5% report requests were “always denied” • There is little evidence that banks asphyxiated small businesses by not renewing, or unilaterally terminating credit lines. Of course, there are still those that were gone…

Loan applications • Also, SIBiL shows there is little evidence that banks have totally shut down access to loans to (surviving) businesses in 2008-2009

Loan applications • Also, SIBiL shows there is little evidence that banks have totally shut down access to loans to (surviving) businesses in 2008-2009 • All in all, SIBiL lends support to the view that investment during the crisis fell because of reduced demand for loans from businesses, rather than because the banks put a freeze on credit

What are the policy implications?

Financial markets, economic development, and policy response • There is substantial evidence that financial development facilitates economic growth • There is also substantial evidence that financial frictions are an important obstacle to small firms, especially when it comes to financing innovation activities

Financial Constraints and Macroeconomic Outcomes(graph from Gorodnichenko and Schnitzer, 2010)

Financial markets, economic development, and policy response • There is substantial evidence that financial development facilitates economic growth • There is also substantial evidence that financial frictions are an important obstacle to small firms, especially when it comes to financing innovation activities • The response of policy-makers throughout the world (including Latvia), has been to throw money at small businesses • However, how realistic is this approach in the “age of austerity”?

Is there a “prosperity through austerity”? • Latvian government faces and, in the foreseeable future, is likely to continue to face serious fiscal challenges • Indiscriminately throwing money at small businesses was always a bad idea; now it is no longer affordable • Can government do more with less? • The key is “smart interventions”

Doing more with less: Is reduced VAT for milk a good idea? • What do we really want? Shortfall in the tax revenue will have to be made up somewhere else • Perhaps we want poor families with kids to be able to afford more milk • A targeted subsidy, or a more progressive tax system would enable these families to afford more, but not necessarily milk… • A reduced VAT for milk is likely to reduce the price of milk and make it more affordable… but to everyone • A ‘food stamp’ (e.g. a ‘milk stamp’) for poor families with kids would achieve this objective at a smaller cost to the tax payer

Does every small business need ‘state support’ to grow? • This is what every small business owner would tell you, if asked. Collectively, it implies high taxes, which they don’t like either. But individually, it’s hard to say no to money • SIBiL lends some support to the view that access to financing is an important obstacle to some firms • About 36% of SIBiL small business owners named “lack of funds within your own enterprise” having a “high” degree of influence on hampering innovation activities, or a decision not to innovate • About 25% named “lack of finance sources outside your enterprise” as having “high” influence • However, even fewer indicate that access to bank loans is a problem

What makes interventions SMART? • Asking the businesses directly probably isn’t very smart • Need research to understand causal mechanisms of the underlying market failures that prevent capable small businesses from growing • Need competent public officials capable of guiding and using the research efforts to create smart policies • Need competent politicians to ensure competence and performance of public officials • Need demanding voters to reward competent politicians • Maybe this is all a bit of a tall order…

Financing of Small firms in Latvia: Evidence from SIBiL