The effect of financial constraints on innovation in developing countries

Abstract

Purpose The purpose of this paper is to investigate the effect of financial constraints on innovation in developing countries. It also examines how the effect of financial constraints varies by sector and with main firm characteristics such as size and age. Design/methodology/approach The study utilizes matched firm-level data from two sources; the World Bank Enterprise Survey and the Innovation Follow-Up Survey. From 11 African countries, 4,720 firms have been included in the sample. A recursive bivariate probit model is used. Findings The result shows that financial constraints adversely affect a firm’s decision to engage in innovative activities and the likelihood to have product innovation and process innovation. The results point out that the extent of the adverse effect of financial constraints on innovation differs across the sectors, firm size and age groups. A firm’s innovation is also explained by firm size, R&D, cooperation/alliance, the human capital of the firm, staff training, public financial support and export. At last, the probability of encountering financial constraints is explained by firms’ ex ante financing structure, amount of collateral, accounting and auditing practices and group membership. Practical implications Managers should strengthen the internal and external financing capacity to reduce financing constraints and their adverse effect on innovation. Social implications A pending policy task for African leaders is to design and evaluate reforms that reduce the adverse effects of financial constraints on innovation. Originality/value This study contributes to the existing literature on financing of innovation by examining how and to what extent financial constraints affect innovation across various sectors, size and age groups.