Development strategy and the MSMEs finance gap

Abstract

In this paper, we investigate the root cause for large MSMEs finance gap. We advance five propositions for the mechanism through which the distorted financial structure generated by a comparative-advantage-defying strategy leads to large MSMEs finance gap. We then use panel data from 115 countries to test the propositions and find that, the adoption of a comparative-advantage-defying strategy accelerates the development of state-owned enterprises in capital-intensive industries, leading to concentrated banking sector and oversized state-owned enterprises obtaining high proportions of loans and enjoying low interest rate on borrowings. Finally we use cross-sectional data in 2017 to show that the adoption of a comparative-advantage-defying strategy is associated with large MSMEs finance gap. The paper suggests that the root cause for large MSMEs finance gap is the government's inappropriate development strategy.

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