Finance, the Business Environment, and Firm Growth in Mexico

The connection between financial market development and economic growth was established long ago, and there is evidence that the direction of causation goes from financial market development to growth, rather than the other way around. Financial market development matters because financial capital is channeled to more efficient use. But is the supply of capital sufficient to ensure rapid growth? Under what circumstances does the firms’ demand for capital play a predominant role in determining investment levels of firms? Data from recent cross-country surveys suggests that Mexico is a country in which the business environment may be sufficiently hostile to constrain the demand for investment. This paper explores the relevance of both the demand for investment finance and the access to capita in Mexico, using data from a new firm level survey on the business environment, the “Survey of Governance and Development of Enterprises in Mexico” (EGDE). Data from the EGDE survey indicate that the quality of the business environment is not homogeneous across regions and states in Mexico. Access to external financial capital also varies across states and regions, especially among the small and medium sized firms that make up our sample. We exploit these regional differences in this paper to examine the extent to which the growth of Mexican firms is associated with regulation/corruption costs and access to finance. The data suggest that financial constraints matter, but only once the business environment is good enough to stimulate robust demand for investment by firms.