A well-functioning financial system and a vigorous private sector are important drivers of growth and poverty reduction. Finance is central to private sector development and vice versa, and large parts of both sub-disciplines revolve around the behavior and performance of firms. In the financial sector, our work has focused on understanding just how an effective financial system contributes to economic development and identifying which policies work best to improve the efficiency, stability, and reach of the financial system in developing countries. Currently our research program in finance is organized around two issues of significant policy interest: access to financial services and risk management.
In the private sector, our work focuses on understanding the determinants of firm entry, exit and performance, which are central to understanding the microeconomics of the growth process. With the recent worldwide collection of firm-level data and systematic measurement of the business environment, our research has now begun to explore the role of policies in aiding private sector development at the micro level. In our research program special areas of investigation are the determinants and consequences of entrepreneurship and innovation, informality, and corporate governance. Finally, we also study the impact of business environment and its reforms on firm performance to identify the most effective reforms and help prioritize them.
Access to Financial Services
Access refers to the need to ensure that financial services essential for growth reach widely through the economy, thereby ensuring the foundations for broad-based, inclusive growth. Recognizing serious data and research gaps and lack of policy guidance in this area, a Policy Research Report (2007), documents and benchmarks differential access to financial services by small firms and the poor, identifying underserved groups and barriers to building inclusive financial systems.
Ongoing work is further evaluating the channels through which access to finance can contribute to the growth process such as promoting entrepreneurship, innovation and the process of technology adoption. The role of financial literacy and gender differences in this process will also receive significant attention. Ultimately we seek to evaluate the impact of firms’ financing constraints and households’ inability to access financial services on economic growth and poverty alleviation, and better identify different ways to improve this access, ranging from microfinance innovations to making improvements in the functioning of mainstream financial institutions and systems.
Deepening finance and expanding access are not enough, given the fragility of finance. Most countries, even including those which have experienced rapid development success underpinned by financial deepening, have suffered from financial crises interrupting the growth process, and sometimes setting it back for a decade or more. In addition, heightened risks at the level of the individual firm and households have reinforced the role of financial instruments and markets for hedging and managing risk also at the micro level. This is why risk management, including crisis prevention, remains a central part of the financial development agenda and hence of our research program. Our research will investigate the impact of supervision strategies as well as impact of compliance with Basel Core Principles on bank stability, the interaction of bank insolvency resolution and deposit insurance policies, and the impact of financial globalization on bank efficiency and access to financial services. We will also initiate work in the area of capital market development and insurance.
Entrepreneurship and Innovation
An area that has not received enough attention is the study of entrepreneurship and the environment that motivates and supports the creation of self-employment and new firms. Many economists also consider innovation and technological progress essential for economic growth and development. Hence it is important to study the determinants of entrepreneurship as well as the rate at which firms across developing countries innovate and adapt their organizations to meet market conditions. Our research will use the investment climate firm surveys and individual country databases to investigate the role of different policies in influencing entrepreneurship and the innovation process.
Informal firms account for roughly one-third of production and one half to three-quarters of the non-agricultural labor force in developing countries and the informal sector is particularly important as a source of employment for the poor. However limited data and a focus on formal firms mean that relatively little is known about the productivity of these firms, the barriers they face for growth, and their spillover effects on the formal economy. Our research on determinants and consequences of informality includes coupling the detailed business environment data collected by the Bank with analysis of detailed firm-level cross-country data, and the development and analysis of new in-depth single country surveys.
Corporate governance covers a broad range of issues of allocation of control rights within a firm, and thus defines how the authority is exercised and the quasi-rents generated by firm are allocated among different classes of stakeholders. A more narrow definition of governance covers the mechanisms in which suppliers of finance to corporations assure themselves of getting a return on their investment. Our work in this area investigates the impact of the institutional development and business environment on firms’ governance structures, and how internal and external governance affects firm performance. Our ongoing research focuses on detailed firm surveys in China and Russia, countries in which many firms have experienced rapid changes in corporate governance.
Business Environment and its Reforms
Finally, the existing literature has only recently began to study the role of the business environment in driving firm dynamics and entrepreneurship, and our ongoing work seeks to prioritize the types of policy interventions which can have the greatest impact in unlocking these drivers of private sector development. Our research here therefore has two focuses. The first is seeking to identify binding constraints to firm growth, which has important policy implications for the priority of reform efforts. Secondly, the use of natural and randomized experiments to evaluate the impact of reform efforts will enable us to provide policy advice on which reforms work, which don’t, and why. Our findings in this area can help policymakers develop policies to encourage new firm entry, promote self-employment, and enhance the growth of firms, both small and large.