05 Sep 2006Working Paper Summaries

International Financial Integration and Entrepreneurship

by Laura Alfaro and Andrew Charlton

Why does entrepreneurship flourish in some countries and struggle in others? Economists and policymakers are divided on whether the rapid rate of global financial integration, specifically the explosive growth of foreign direct investment, helps or hurts local entrepreneurs and domestic economies. To see the differential effects of restrictions on capital mobility on entrepreneurship, Alfaro of HBS and Charlton of the London School of Economics analyzed data on 24 million firms—listed and unlisted—in nearly 100 countries in 1999 and 2004. Key concepts include:

Contrary to the fears of many, capital mobility has not hindered entrepreneurship: Instead, international financial integration is related to greater firm activity.
Countries with fewer barriers to international capital have a higher proportion of small firms. By the same token, firms tend to be older in less financially integrated countries.
International financial integration might increase the total amount of capital in the economy and improve the availability of capital and credit.
Thanks to FDI, local firms could benefit from linkages with foreign firms.
This work did not look at growth or the overall welfare effects of capital liberalization on individual countries, an important area for future research.

Author Abstract

We explore the relation between international financial integration and the level of entrepreneurial activity in a country. Using a unique data set of approximately 24 million firms in nearly 100 countries in 1999 and 2004, we find suggestive evidence that international financial integration has been associated with higher levels of entrepreneurial activity. Our results are robust to using various proxies for entrepreneurial activity such as entry, size, and skewness of the firm-size distribution; controlling for level of economic development, regulation, institutional constraints, and other variables that might affect the business environment; and using different empirical specifications. We further explore various channels through which international financial integration can affect entrepreneurship (a foreign direct investment channel and a capital/credit availability channel) and provide consistent evidence to support our results.