Evidence review
Business investment is a key driver of productivity and local economic growth. Unless a business can self-fund investment, it will need access to external finance, normally debt finance. Businesses can struggle to access debt finance for a number of reasons including information asymmetries, being assessed as higher risk or a lack of collateral. Depending on the nature of the constraints and the returns to investment, this may mean business investment is below the socially optimal level.
This briefing provides a framework to help policymakers think through some of the local economic impacts of improving business access to debt finance including through community finance institutions.
Summary of findings
Potential local economic impacts will depend on how many businesses experience improved access to debt finance or lower borrowing costs. Few businesses seek external finance and most that do are successful. Given the need for institutions to be responsible lenders, the proportion of local businesses that might benefit from support could be limited in most cases. Debt finance used for cash flow is, at best, likely to sustain outcomes, whilst funding that is used for business development may improve outcomes.
Debt finance used to increase the amount of capital per worker or to deliver organisational change or innovation that improves efficiency has the potential to increase business productivity. Consider the profile of supported businesses, how debt finance will be used, and the likelihood and timescales of this leading to productivity improvements when assessing the potential impact on the productivity of supported businesses.
Debt finance that is used for business development may lead to employment growth in supported businesses – but not all projects will lead to employment growth. Finance used for cash flow is more likely to sustain current employment levels, if it has any effect on employment. Increases in employment in supported businesses may displace employment in other local businesses. Targeting support at tradeable sectors will help minimise displacement but businesses in these sectors may not need support. Additional local jobs can also be created if supported businesses develop local supply chains or if those newly employed in the area spend some of their income locally. Understanding supply chains, travel-to-work patterns, and spending patterns will help with assessing how many additional jobs will be created.
Consider whether additional jobs at supported businesses, displaced jobs, and jobs created as a result of multiplier effects are likely to be filled by local residents. The impact on the local economy will be greater if jobs created (or sustained) are filled by local residents. Impacts on employment should be compared to total employment in the area. Unless the programme is large, support is likely to have a modest impact on local employment levels.
There is good evidence that access to debt finance interventions can lead to increased turnover. Increased turnover within supported businesses may displace turnover of other businesses, reducing the effect on the local economy. Increasing profit margins will depend on the ability to increase turnover, reduce costs or both, alongside the level of competition faced by supported businesses, and the overall state of economy. In most cases, it is reasonable to assume that the impacts on profits will be small.
In supported businesses, the effect on wages is likely to depend on the effects on productivity, turnover, and profits. At the local level, it is unlikely that there will be effects on wages unless supported businesses account for a large proportion of local employment or support leads to a large increase in local employment.
If supported businesses increase their use of capital assets such as buildings, machinery, data, patents or brands, this will increase the incomes of asset owners. The extent to which this benefits the local economy depends on whether the assets are locally owned.
As businesses often play important roles in their communities, improving access to debt finance that strengthens the business base may also have wider benefits. Support to social enterprises or community enterprises could have wider social benefits as they play an important role in providing social infrastructure.
Also consider the potential costs for policymakers and businesses. As there are diverse policy options, potential costs for policymakers are highly variable. Increased risk and higher costs of borrowing are the main potential costs for businesses.
Rapid evidence review
To support the drafting of the evidence briefing, we undertook a rapid evidence review of the evaluation evidence on community finance.
Community finance institutions (CFIs) are an alternative to commercial financial institutions. CFIs normally have organisational structures that are mutual – profits are shared amongst members – or non-profit distributing – profits are reinvested into the businesses. They are more likely to be locally or regionally based. In the UK, types of CFI include credit unions, community development finance institutions, mutual societies, and co-operative banks.
Our search identified nine studies. Two studies consider the activities of CFIs in relation to access to finance (for example, are they more likely to lend to small businesses) and one looks at behaviour of borrowers. For other outcomes (employment, inequality, and economic growth), there are a mix of studies looking at the activities of CFIs, and at whether their presence in an area has an impact.
Key findings
This evidence suggests CFIs may be more willing to lend to local businesses and that lending may be more stable than from commercial providers, and that CFIs have a positive effect on employment stability and reducing income inequality.
There is also evidence that CFIs may help increase economic growth. However, care should be taken because the method used in these studies to deal with ‘reverse causality’ – from higher economic growth to more CFIs – is problematic for outcomes that evolve slowly over time (such as economic growth).
Need for more evidence
- We need more evaluations, particularly of impacts on access to finance, business performance, employment, and productivity.
- Given variations in banking systems across countries, there is a need for UK-based CFIs to be evaluated. None of the studies we identified are from the UK.
- We did not find any studies that evaluated CFIs that provided other types of finance (for example, insurance, social bonds, etc.) or about the impact of using other financial resources, such as local pension schemes, to benefit local communities. Again, it would be good to fill these gaps.
Access to finance evidence review
The briefing also draws on the findings of our access to finance evidence review.
