Banking

Lend me a hand—bank market power and firm creation in innovative industries

High-growth start-ups disproportionately contribute to economic growth and job creation in developed countries. Academic studies estimate that in the United States they account for about 50% of job creation. Likely, high-growth innovative young companies will play a central role in the post-COVID-19 recovery. In a context in which the pandemic fundamentally shook traditional business models, economies will need the input and flexibility of young innovative start-ups. Among developed countries, there is a significant degree of heterogeneity in the contribution and success of start-ups. Although we are all well aware of success stories from Silicon Valley or Israel, the so-called start-up nation, European start-ups, albeit notable exceptions, face significant hurdles.

To address these problems, most governments of European countries have implemented ambitious policies. The majority of such government inventions are centred around two pillars: on the one hand, they aim at reducing the stigma of failure and cost of experimentation for the entrepreneur; on the other hand, they try to ease the financial constraints of young firms, facilitating their access to external capital. To date, such policy stimuli have yielded mixed results, and we know little about what affects the success of these policies. 

In a recent working paper titled “Lend Me a Hand — Bank Market Power and Innovative Firm Creation,” I study the importance of bank market power and lack of banking competition. Stemming from a stylized theoretical framework, I predict that bank market power could discourage potential entrepreneurs from entering the market, in fear of not being able to secure funding.  As a result, policy stimulus aimed at fostering firm creation of innovative firms is deemed to fail.

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To test this prediction, I study the Italian setting. Back in late 2012, the Italian government launched the Start-Up Italy Act (SIA). SIA, which was rolled over in subsequent years, is aimed at young innovative firms. It exempts entrepreneurs of qualifying innovative start-ups from red tape, stringent employment law, and failure procedures. Furthermore, SIA allows for tax deductibility of equity investments in qualifying start-ups, and it gives them preferential access to the Public Guarantee Fund. The latter allows qualifying start-ups to obtain public guarantees on their bank debt, for up to 80% of the loan, and it is meant to help young innovative firms obtain access to finance in a bank-centric system, like the Italian one.

In the paper, I document that SIA has been so far a very successful policy. Following the launch of the program, firm entry rates in innovative industries increased by 50%, meaning that the number of firms created in a quarter in innovative industries grew by 30%. To estimate the effect of the policy, I compare firm creation rates in industries in which qualifying start-ups are more likely to be active (that is, innovative industries, like ICT and R&D), and in industries where qualifying start-ups are less likely to be active (that is, non-innovative industries, like construction or retail trade), before and after the launch of SIA (a difference-in-differences approach). In this way, I can account for changes in the business cycles, as well as local and industry-specific differences.

Source : blogs.worldbank.org

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