By Professor Saibal Kar, Centre for Studies in Social Sciences, Calcutta (CSSSC), India
The prevalence of high corruption can dissuade firms from innovations. On the other hand, perceptions about higher corruption might make a firm innovate more, or at least, not dampen the probability considerably.
By Professor Saibal Kar
Centre for Studies in Social Sciences, Calcutta (CSSSC), India
For countries like India where a large number of small and medium-sized entrepreneurs cannot access formal credit and are exposed to widespread bureaucratic corruption, long-run survival and consequent distributional implications are both considered important.
Interestingly, a recent account (jointly written with Hamid Beladi and Nabamita Dutta) utilizes company-level unit information and shows that obstacles as perceived by firm owners in the form of regulatory corruption and access to finance jointly reduce the firm’s probability to innovate.
If perceptions somewhat reflect the actual conditions observed, then with worsening perceptions about both obstacles, firms are less likely to innovate. For industries like automobiles, where constant innovation is key to success and often survival, negative perceptions could lead to an industrial slowdown.
What is this about?
While the implications of actual obstacles like corruption have been studied extensively in view of the negative influence on a firm’s prospect and growth, a recent concern is whether perceptions about obstacles are equally damaging for important aspects of the business. Indeed, one such aspect receiving attention is about how the perception of obstacles influences innovation activities for firms in India.
Since the scope of formal businesses in India is still limited by bureaucratic red-tape and rent extraction by regulators, prevailing perceptions regarding obstacles could be treated as important signals. It is reasonable to consider that firms will perceive obstacles to accessing credit since even in recent times as low as 10% of the population has access to formal credit in the country. With a tightly controlled and risk-averse banking (overwhelmingly nationalized public sector undertakings and not too keen on extending loans to all sectors) practice in India, shallow stock markets (Bombay Stock Exchange and National Stock Exchange together has less than a fifth of the domestic market capitalization of NYSE), and negligible presence of corporate debt market (which could have offered cheaper sources of credit) firms in India, particularly medium to small firms, are usually credit rationed.
In other words, not all firms would get loans, or get the desired amount from the bank. A survey by American Express finds that 42% of small and medium enterprises (SMEs) consider access to finance to be a vexing problem. Coupled with this, corruption in India continues to pose a major challenge typically owing to the prevalence of poor institutions all around.
Remember, Transparency International, an independent organization collecting and processing national-level information on corrupt practices, principally based on perceptions of various economic actors in the society, ranks India at 78 along with countries like Kuwait, Turkey, Ghana, Burkina Faso, etc. Notably, this is a poorer rank compared to the global rank of India according to indicators of Ease of Doing Business, implying that doing business could be a complex affair. Clearly, firms are likely to perceive corruption as a contemporary obstacle.
As mentioned, this communication draws from a recent study in India where we statistically calculated how the perceptions about obstacles in accessing finance and losses incurred due to rent extraction by the authority affect a firm’s chances of innovation. It is only psychological that perception of a particular obstacle on its own may both deter and enhance the innovation efforts of firms.
Prevalence of high corruption can dissuade firms from innovations, since corruption in general hurts growth and lowers the returns from innovations for entrepreneurs. Conversely, however, innovative firms might be the ones that are more willing to bribe their way ahead of other firms. Therefore, perceptions about higher corruption (as compared to the difficulty associated with getting finance) might make a firm innovate more, or at least, not dampen the probability considerably.
But what happens when firms perceive both obstacles? Do they continue to innovate?
There is no prior about whether the situation worsens when both (negative) perceptions get stronger and lead to decay of firms. The many possible outcomes associated with consequent production re-organization and changes in factor demands typically constitute the overall impact assessment feeding into the policy designs at the national level.
Source of Information
The World Bank Enterprise Survey Database offers information for the year 2014 covering a large number of enterprises across India. The company-level information for India was collected between June 2013 and December 2014. The information set consists of 9,281 companies from 23 major states of India and these companies belong to 26 different industries like food, textiles, automobile, garments, leather, wood, paper, chemicals, etc. Among service industries, major services like hotels and restaurants are included.
The target issue as chosen for the exercise was based on the question: ‘In the last three years, has this establishment introduced new products or services?’. The responses were naturally yes, or no. Out of the 9281 observations, approximately 44% of responses were ‘yes’. Looking across industries, we find that some of the most innovative industries are leather (56%), hotels and restaurants (54%), garments (52%), electronics (57%), etc.
One of the main responses to the above question is expected to come from an entry that reports perceived difficulties in accessing finance for firms. The category is constructed on the basis of the following question: ‘how much of an obstacle is access to finance?’. As stated in the survey, difficulty in accessing finance by companies includes availability as well as cost, interest rates, fees, and collateral requirements. The survey categorizes difficulty in accessing finance under 5 heads — no obstacle, minor obstacle, moderate obstacle, major obstacle, and very severe obstacle. On average the responses suggest that companies faced a moderate obstacle. Obviously, like all averages, it means that some faced a severe obstacle and some little or none.
As pointed out earlier, the other variable of interest is the perception of corruption among company owners. The specific question asked to the owners is: ‘how much of an obstacle is corruption?’. For owners of companies corruption typically pertains to issues about licensing, adherence to rules and regulations, maintenance of proper accounts, etc., and these individually or in combinations lead to periodic harassment by regulators, tax officials, auditors, and so. A large majority of firms (approximately 46%) reported that they perceive corruption as a moderate to major obstacle.
What did we observe?
After crunching and analyzing a lot of information we observe that both the ‘perceptions to obstacle’ – access to finance or corruption – do affect the probability to innovate on its own. We also note that it can even benefit the process sometimes. However, the main highlight of our contribution is finding that the perceived obstacles jointly decrease a company’s chances of innovating new processes or techniques.
Let us elaborate on the mechanism of how this operates. In the face of rising (harmful) perceptions about corruption, a company is less likely to innovate when it also senses a higher obstacle to accessing finance. The same is true about the combination of perceived obstacles to accessing finance, and the sense of corruption prevailing.
To augment the policy debate, we do find that the results are stronger and more harmful for small and medium-sized businesses as compared to large companies. Further, since export-oriented companies are more likely to innovate, we also account for such companies and report that poor perceptions on these two fronts are equally dampening and this is true regardless of young and old businesses, or whether they are located in metro cities or outskirts.
Overall, we account for the fact that a company’s chance of innovation is seriously damaged by the perception of obstacles when firms face both obstacles at severe to very severe levels. It is well-known that financial institutions shy away from financing smaller businesses and at the same time often make complaints about the lack of businesses. The businesses consequently resort to high-cost private sources of finance owing to what we observed as the perceived hurdles.
In terms of policy questions, this might offer some directions for possible intervention which must begin with acknowledgment from the public authorities regarding the extent of hold-backs and inequality of access to finance. In addition, the bank and non-bank financial institutions should also take into cognizance that relaxing the loan restrictions and easing out the procedure should help to change the class and network dimensions connected with entrepreneurship.
The psychological barriers to businesses have never been given adequate emphasis, although, in terms of regional disparities in business concentration or simply growth of start-ups, this poses reasonable chances of non-participation owing to behavioral traits. This is a step preceding more intriguing questions about company-level best practices, innovations, etc. With an initial public intervention, the confidence in the institutions will have to be restored in order to spread entrepreneurial choices.
This article was first published on AutoFinTechs.com.
About the Author:
Saibal Kar is a professor of economics at the Centre for Studies in Social Sciences, Calcutta (CSSSC), and a Research Fellow of the Institute of Labor Economics (IZA) in Bonn, Germany. He is the Director of the Eastern Regional Centre of ICSSR. He has been associated with Calcutta University, Presidency University, Jadavpur University, IIT Kharagpur, Alexander von Humboldt Foundation in Germany, University of Amsterdam, Santa Fe Institute, Hamburg University, University of East Anglia, United Nations University, etc. He is the Managing Editor of the South Asian Journal of Macroeconomics and Public Finance.
DISCLAIMER: The views expressed in this insight piece are those of the author and do not necessarily reflect the official policy or position of IndraStra Global.
