Public inputs and the credit market

Public inputs like infrastructure used collectively by firms also contribute towards reducing the heterogeneity among firms in an economy. This has important implications for allocations in the credit markets, which are besieged by information asymmetries among such firms who are the borrowers and the banks who are their lenders. This crucial "micro" link between public and private investment via the credit market, has been explored in the first chapter of this dissertation. In a model island economy of sea faring entrepreneurs, we trace the effect of an archetypal public good---a lighthouse, on the credit market equilibrium of this hypothetical economy. Results indicate that the effects of the lighthouse on the credit market equilibrium not only have an impact on the optimal level of public inputs in an economy, but they also say something about the 'targeting' of public inputs in an asymmetrically informed world. Public goods that are targeted to the low ability may dominate those available to all types. Thus, this chapter contributes to the debate on the precise linkages between infrastructure and economic development.; The second chapter explores the role of "social infrastructure" of an economy on shaping its business environment. Social infrastructure includes not only the physical infrastructure of an economy, but also its legal framework, business regulations, scope for corruption and need for irregular payments by firms etc.... It has been observed that those economies ranking high on this social infrastructure index consistently attract higher levels of domestic and foreign investment, as compared to economies plagued with corruption and poor social infrastructure. In a simple theoretical model that explicitly takes into account such factors, it is shown why a lender (presumably a bank) would look to these economy wide indicators instead of firm-specific indicators to determine its lending decisions. It is concluded that in contrast to private signaling by firms in the credit market, these factors will increasingly be looked upon as 'public' signals, which improve allocational efficiency in the credit market.; In the third chapter of the dissertation, the hypothesis about public inputs and its effect on the credit market proposed in the two chapters above is tested using world wide firm-level data based on a survey carried out by the World Bank Group (World Business Environment Survey (WBES), 2000). We concentrate on two sets of constraints faced by firms---financial constraints and the quality of public services. We show that the quality of infrastructure faced by firms crucially affects the financial constraints they face in the credit markets. Both Ordered Logit and Ordered Probit estimates validate the conclusion that taking care of all region specific and firm specific constraints, firms facing high infrastructural constraints are most likely to have high financial constraints as well. This link is seen to be stronger in the case of smaller and medium sized firms.