Credit constraints, labor productivity, and the role of regional institutions: Evidence from manufacturing firms in Europe

Abstract

Abstract This paper examines the relationship between credit constraints—proxied by the investment‐to‐cash flow sensitivity—and firm‐level economic performance— defined in terms of labor productivity—during the period 2009–2016, using a sample of 22,380 manufacturing firms from 11 European countries. It also assesses how regional institutional quality affects productivity at the level of the firm both directly and indirectly. The empirical results highlight that credit rationing is rife and represents a serious barrier for improvements in firm‐level productivity and that this effect is far greater for micro and small than for larger firms. Moreover, high‐quality regional institutions foster productivity and help mitigate the negative credit constraints–labor productivity relationship that limits the economic performance of European firms. Dealing with the European productivity conundrum thus requires greater attention to existing credit constraints for micro and small firms, although in many areas of Europe access to credit will become more effective if institutional quality is improved.