NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Friday, January 30, 2015

Economists are paying increasing attention to the link between financial inclusion—greater availability of and access to financial services—and economic development. In anew paper, we take a closer look at exactly how financial inclusion impacts a country’s economy and what policies are most effective in promoting it.

The new framework developed in this paper allows us to identify barriers to financial inclusion and see how lifting these barriers might affect a country’s output and level of inequality. Because the more you know about what stands in the way of financial inclusion, the better you can be at designing policies that help foster it.

We found the lack of financial inclusion contributes to persistent income inequality and slower growth.

Why financial inclusion matters

Large gaps exist in worldwide access to finance. Slightly more than half of the firms (58 percent) in developing countries and only one-fifth of those in low-income countries have access to bank credit (Figure 1). Firms—particularly small and medium-sized enterprises—continue to face barriers that further impede access to finance, such as high costs, travel distance, and onerous paperwork. Limited credit, high collateral requirements, and high interest rates also hamper companies’ growth.

What this means, as detailed in our recent work (and in a National Bureau of Economic Research Working Paper), is that individuals must rely on limited savings to become entrepreneurs. Once established, their fledgling enterprises tend to depend on self-financing to meet investment needs. This, in turn, limits the overall size of the firm, the ability to innovate, and productivity.

Examining country cases

To examine how best to increase financial inclusion, we applied our framework to three low-income countries: Kenya, Mozambique, and Uganda. We also applied it to three emerging market countries: Egypt, Malaysia, and the Philippines. Here’s what we found: