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Efficiency of Credit Allocation and Effectiveness of Government Credit Guarantees:

Evidence from Japanese Small Businesses

February 2008
Iichiro Uesugi*1

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This paper empirically examines the development of credit allocation amongst Japanese small- and medium-sized enterprises (SMEs), and the relationship between credit allocation and economic efficiency. We first investigate whether the credit market is inefficient, in that the survival of underperforming firms force better-performing firms to exit the market. Secondly, we test whether government credit guarantee programs are beneficial. In other words, do these programs increase the funds available to SMEs, and, more importantly, do they significantly impact the profitability of program users? Using a pair of unique firm-level datasets, we come to two major conclusions. (1) The selection mechanism in the Japanese credit market is efficiency-improving in that lower quality firms with higher borrowing costs are more likely to default. (2) The massive credit guarantee program implemented by the Japanese government in the late 1990s did result in the increased availability of funds to SMEs, and to the greater profitability of creditworthy firms. Moreover, interest rates do not decrease among program users indicating that government interest payment subsidies are not attributed fully to borrowers.

The paper is mainly based on Sakai, Uesugi, and Watanabe (2005) and Uesugi, Sakai, and Yamashiro (2006). The author wishes to thank Wako Watanabe (discussant) and participants at the conference on the "Economic Costs during the Deflationary Period," cohosted by the Bank of Japan and University of Tokyo for valuable comments. Also, the author is grateful to the members of the Corporate Finance Study Group in RIETI and the members of the Research Office of the Small and Medium Enterprises Agency for useful comments and discussions.

  • *1 Hitotsubashi University


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