Modeling Firm Dynamics to Identify the Cost of Financing Constraints in Ghanaian Manufacturing

Abstract

Economic development requires the growth of productive firms. However, financing constraints may limit firms? investment abilities. This paper estimates the cost of financing constraints to firms, for example in terms of idle investment opportunities, and their aggregate implications. To this end, I develop and estimate a dynamic model of firm-level investment. The model allows me to deal with the main identification problem faced by work that studies financing constraints, namely to identify the investment opportunities and the constraints of a firm separately. The model also allows for other potential explanations of the observed phenomenon, in particular adjustment costs and uncertainty. I solve the model using dynamic programming methods and estimate it via simulation methods, using firm level data from Ghana. Counterfactual analyses are then carried out to quantify the importance of financing constraints. These counterfactuals indicate that removing the constraints would imply economically significant increases in investment that are associated with higher levels of consumption.

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