Financial inclusion and micro, small, and medium enterprises.

Extensive evidence shows that investment climate and in particular financial inclusion is critical to firm growth.Footnote1 This issue is even more important in developing countries where markets and institutional infrastructure are less developed (Aterido, Hallward-Driemeier, & Pagés, 2009). Olawale and Garwe (2010) identify lack of finance as a key factor constraining micro, small, and medium enterprises (MSMEs) growth in sub-Saharan Africa (SSA). The importance of finance to firms is documented by Beck and Demirguc-Kunt (2006) who asserts that financial inclusion helps alleviate MSMEs growth constraints and increases their access to external finance, thus leveling the playing field between firms of different sizes.

In addition, enterprise growth is hindered by non-financial constraint of a regulatory nature. For instance, Djankov, La Porta, Lopez-De-Silanes, and Shleifer (2002) find that sub-Saharan countries tend to have heavier regulation of entry due to higher corruption, informality, and poor infrastructure. However, this phenomena is not unique to sub-Saharan countries. Klapper, Laeven, and Rajan (2004) find that costly regulations constrain the entry of new enterprises in Europe, especially in sectors that should normally have high entry. Regulatory barriers force enterprises to be larger and cause incumbent firms in naturally high-entry industries to grow more slowly.

In Uganda, MSMEs contribute close to 90% of private sector production and play a crucial role in income generation, especially for the poor (UIA, 2008). Yet, enterprises are largely informal focused on low productivity activities. Entrepreneurship in Uganda is largely a by-product of poverty and a lack of accessible formal employment (World Bank, 2017). Enterprises in Uganda are largely micro: according to GoU (2014), more than 50% of the firms in Uganda employ five or less people. Importantly, 69% of firms in Uganda generate UGX10 million or less in annual turnover. Indeed, only 10% of firms have a bank loan or line of credit. Adverse business environment have been blamed for low rate of survival of firms in Uganda (World Bank, 2014a).Footnote2 Indeed, Turyahikayo (2015) finds the cost and reliability of electricity as a major constraint to doing business in Uganda. Egesa (2010) confirms correlation between technological uptake and a high failure rate of firms in Uganda. Buyinza (2011) finds that integration of East Africa has adversely affected the survival of Ugandan firms. Nevertheless, firms with the ability to export, especially to the advanced markets, have a higher chance of survival compared to the non-exporting ones.

Given this background, the first objective of this paper is to assess whether there are differences in growth across firms of different size when exposed to financial inclusion and other factors affecting the business environment such as regulatory environment, corruption, and access to infrastructure. Differential effects across firms of different size can stem from the fact that there can be differences in the underlying objective conditions faced by firms. Thus, it could be that the same extent of financial inclusion is more beneficial to smaller firms or that the same extent of power outages is less damaging to larger firms because they have access to generators. The second objective is to test the hypothesis that financial inclusion and its impacts on firm growth are dependent on the interplay between financing and other investment climate factors. A poor business environment raises cost and risk associated with doing business thus diminishing the impact of finance. In this regard, the extent of corruption, the state of infrastructure, property rights, enforcement of business regulations, and the overall openness in the management of public resources can affect the impact of finance on firms’ growth (World Bank, 2004).

Unlike most existing studies, which rely on macro level data, this paper exploits firm level data on finance and business environment conditions. Firm level data allows the paper to interrogate whether the impact of the business environment is unbiased across firm size. Most importantly, this paper mitigates the risk of the potential measurement error, omitted variable bias, and endogeneity. First, we utilize a full set of sector-survey interaction dummies to deal with measurement error. Second, and in addition to financial inclusion, we include other dimensions of the broader business environment to concurrently deal with concerns of omitted variable bias. Last, we use location-sector-size averages less individual firms’ own responses of the business environment measures to tackle endogeneity.

Micro, small, and medium enterprises (MSMEs) are an important generator of jobs. Hence, insights into the determinants of enterprise growth are important from a policy perspective. There is a growing literature that assesses the effects of the set of factors, policies, and institutions that affect enterprise growth. Generally, the determinants of enterprise growth are characterized as either being external or internal to the firm. Most studies summarize and classify the determinants of enterprise growth into three broad dimensions: individual, organizational, and investment climate factors

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