Does Financial Development and Improved Institutions Really Advance Formal Entrepreneurship in Developing Countries?

Abstract

To effectively combat poverty worldwide, many development policies place particular emphasis on entrepreneurship, thanks to its ability to drive economic growth. However, there is the challenge of reducing the informal sector and promoting the formal sector. Many initiatives have therefore, been undertaken to promote formal entrepreneurship in developing countries, but little is known about the role of institutions and financial development. The aim of this article is to analyze the effects of financial development and institutions on formal entrepreneurship in developing countries. To achieve this, the system GMM method was applied to a sample of 94 developing countries between 2006 and 2018. It yielded the following results: financial development has a positive effect on formal entrepreneurship; institutions have mixed effects on formal entrepreneurship; institutions encourage financial development to foster formal entrepreneurship; and, other macroeconomic magnitudess have mixed effects. The study recommends that the leaders of these countries develop their financial systems, fight corruption more effectively, reduce regulatory constraints on business start-ups and encourage the achievement of economic policy objectives, in order to expand the size of the formal sector.