Insights
Business investment – in new machinery, software, branding, product development or in expanding into new markets – is an important driver of productivity. But UK business investment and productivity growth are sluggish, constraining economic growth and limiting improvements in living standards.
Unless a business can self-fund investment, they will need to access external finance. Whilst equity finance – business angels, venture capital, and private equity – gets lots of attention, for 99 percent of businesses, external finance is debt finance (loans, credit cards, trade finance, etc.). So, could a local policy to improve access to debt finance lead to more business investment and higher productivity? Our recent briefing on improving access to debt finance can help policymakers think through this question, and the other potential impacts on local economic growth.
Can improving access to debt finance increase business investment and productivity?
Several factors will determine the size of the impact on business investment and productivity. First, the number of businesses that experience improved access to debt finance or lower borrowing costs. Only around 10 percent of businesses seek external finance in any given year and around two-thirds are successful. So only a small number of businesses will benefit.
Second, not all debt finance will be used for investment. Only around a third of businesses seeking finance want it to assist with business growth, with most looking for working capital. Even where finance is for investment, it won’t always translate into improved productivity – as some investments will increase capacity, and others may fail to deliver the expected productivity gains.
Is there an alternative case for improving access to debt finance?
Does this mean that policymakers shouldn’t invest in improving access to debt finance? Not necessarily.
One reason for intervening is that some businesses find it more difficult to access finance. Typically, the smaller the businesses, the harder it can be to secure debt finance. In 2023, 94 percent of medium-sized businesses that applied for debt finance were successful, compared to 87 percent of small businesses, 76 percent of micro-businesses and 56 percent of businesses with no employees. As micro and small businesses play important roles in local economies, policymakers may wish to support them.
However, small businesses are less likely to seek finance, and are less likely to use it for business development. This means that if policymakers target small businesses, the impact on productivity is likely to be small. But the impact may be felt in other ways – for example, by helping them sustain current levels of turnover, profits, and employment.
Similarly, policymakers may wish to support groups – such as women or ethnic minorities – or organisations – such as social enterprises and community enterprises – that may find it more difficult to secure investment from commercial lenders.
Is there a potential role for community finance institutions?
Possible interventions include supporting businesses to improve financial readiness, directly lending to or investing in businesses, guaranteeing loans provided by commercial lenders or supporting alternative sources of finance to develop. Recently, there has been increasing interest in the last of these – specifically in the supporting the development of community finance institutions (CFIs) – in response to concerns that commercial banks, are not adequately serving the needs of communities. Examples of CFIs include credit unionsand community development finance institutions.
We published a rapid evidence review on community finance alongside our briefing on improving access to debt finance. The evaluation evidence on CFIs – though limited – is generally positive. We find CFIs are more likely to lend to local businesses than commercial providers, lending is more stable in difficult economic times, and employment is more stable in the local economies where they operate. One Italian study even links them to reduced inequality. This suggests CFIs could play a useful role in supporting small businesses and social enterprise in local economies.
One additional potential benefit of supporting CFIs is that they are generally mutuals or non-profit distributing, and tend to be locally or regionally based. This means profits are more likely to be retained or reinvested locally than for commercial banks.
Before policymakers pursue this, there are two issues to consider. Firstly, it is important to be realistic about the requirements on businesses receiving finance. While CFIs may help finance firms overlooked by other lenders, they still provide debt finance and not free money. Supported local businesses need to be able to pay back the loan.
Secondly, whilst the evidence on CFIs is generally positive, there are no studies that compare them to other policy options such as direct lending or providing loan guarantees – so they should be appraised alongside other policy options such as direct lending or providing loan guarantees.
Thirdly, for all the reasons discussed above, overall economic impacts are likely to be quite small.
As with any policy, the decision to support access to finance should depend on the benefits relative to the costs. With overall impact on the local economy likely to be small, this is a policy that focuses support on particular types of local business. As a result, the decision may depend on the mix of local businesses, whether they need finance to stay open and invest, and whether they are in a position to pay back debt finance.
