The Relationship between Financial Development and Entrepreneurship Emphasizing Institutional Quality in the Middle East and North Africa Countries

Document Type : Research Paper

Authors

1 Assistant Professor of Economy, Gonbad-e Kavous University, Gonbad-e Kavous, Iran.

2 M.A. of Economy, Gonbad-e Kavous University, Gonbad-e Kavous, Iran.

Abstract

Objective: Entrepreneurship is a crucial engine for economic growth, job creation, and innovation. However, limited access to financial resources remains a significant barrier for aspiring entrepreneurs. This study builds on the established link between financial development and entrepreneurship by exploring the crucial role of institutional quality in this relationship. We posit that a robust and well-functioning financial system alone may not be sufficient to foster entrepreneurship in the absence of strong institutions. Extensive research has documented the positive impact of financial development on entrepreneurship. Increased access to financial resources through developed financial institutions and markets empowers individuals to pursue entrepreneurial ventures (Dutta & Meierrieks, 2021; Ajide & Ojeyinka, 2022). However, the effectiveness of financial development can be contingent on the prevailing institutional environment (Beck et al., 2002). Strong institutions, characterized by good governance, rule of law, and property rights enforcement, create a conducive environment for entrepreneurial activity by reducing uncertainty and mitigating risks.
 Method: This study employs a two-pronged approach to analyze the relationship between financial development, institutional quality, and entrepreneurship in MENA countries. First, a system GMM model is estimated to examine the direct effects of financial development (FD) and institutional quality (GQ) on entrepreneurship (EN), measured by the Early-stage Entrepreneurial Activity (TEA) rate.
 (1)                         
Where i and t represent country and year, respectively. Xit is a vector of control variables including GDP per capita, GDP growth rate, government size, trade openness, business startup costs, foreign direct investment, and tax burden.
Second, a panel threshold model is employed to investigate the conditional effect of institutional quality on the relationship between financial development and entrepreneurship. This model allows us to identify whether the impact of financial development on entrepreneurship differs depending on the level of institutional quality (good vs. poor).
 (2)
Here, δ is an indicator function that takes a value of 1 when institutional quality is good and 0 otherwise.
The institutional quality data is constructed from six sub-indicators extracted from the World Governance Indicators (WGI) dataset: control of corruption, rule of law, quality of regulations, government effectiveness, voice and accountability, and political stability.
 Findings: The empirical results confirm the hypothesized relationships. Financial development, measured by various indicators, has a positive and statistically significant impact on entrepreneurship in MENA countries. This finding aligns with existing literature (Dutta & Meierrieks, 2021; Ajide & Ojeyinka, 2022). Importantly, the study reveals a critical role for institutional quality. The positive effect of financial development on entrepreneurship is amplified in countries with strong institutions, particularly those characterized by good governance. Conversely, the impact of financial development is weaker, and statistically insignificant, in countries with weak institutional environments. These findings highlight the conditional nature of the relationship between financial development and entrepreneurship.
Discussion and Policy Implications
This study offers valuable insights for policymakers in developing economies, particularly those in the MENA region. The results underscore the importance of a two-pronged approach for fostering a thriving entrepreneurial ecosystem. First, promoting financial development through initiatives that enhance access to finance, deepen financial markets, and improve the efficiency of the financial sector is crucial. This could involve supporting the development of a diverse range of financial institutions, including venture capital firms, microfinance institutions, and angel investor networks.
Second, the study emphasizes the critical role of institutional reforms in maximizing the positive impact of financial development on entrepreneurship. Policymakers should prioritize measures to strengthen governance, combat corruption, uphold the rule of law, and streamline regulations. Additionally, fostering political stability and promoting democratic practices can create a more predictable and secure environment for entrepreneurs.
Limitations and Future Research
This study offers valuable insights, but it also has limitations that pave the way for future research.

Limited Sample: The analysis focuses on 11 MENA countries. Expanding the sample to include a broader range of developing economies could provide a more generalizable understanding of the interplay between financial development, institutional quality, and entrepreneurship.
Data Availability: The study relies on existing datasets to measure financial development and institutional quality. Future research could explore alternative or more nuanced measures to capture the complexities of these concepts.
Endogeneity: A potential issue of endogeneity exists between financial development and entrepreneurship. Future research could employ advanced econometric techniques to address this potential bias.

Future research directions could explore the following:

The Role of Specific Financial Instruments: Investigate how different types of financial instruments, such as venture capital, microloans, or angel investments, influence entrepreneurial activity under varying institutional contexts.
The Impact of Technological Advancements: Examine how the emergence of Fintech (financial technology) solutions can potentially improve access to finance and foster entrepreneurship in MENA countries, particularly in light of institutional constraints.

The Entrepreneurship Ecosystem: Explore the broader entrepreneurial ecosystem beyond financial development and institutional quality. This could include investigating the role of social capital, cultural attitudes towards entrepreneurship, and educational systems in fostering entrepreneurial activity.
 Conclusion: In conclusion, this study sheds light on the crucial interplay between financial development, institutional quality, and entrepreneurship in the MENA region. The findings underscore the necessity of a comprehensive approach that simultaneously promotes financial development and strengthens institutional frameworks. By implementing these recommendations, policymakers can create an environment that fosters a vibrant entrepreneurial ecosystem, leading to sustainable economic development and prosperity.

Keywords

Main Subjects

References

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  • Receive Date: 02 February 2023
  • Revise Date: 26 April 2023
  • Accept Date: 29 April 2023

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