CHAPTER ONE INTRODUCTION             Background of the study

The relationship between financial growth and economic development has been extensively studied in literature over the years. There exists an extensive consensus from most findings that financial growth results in an increment in economic development through the productivity of firms and the general wellbeing of households. Much empirical evidence (World Bank, 2008; Beck & Laeven, 2006; King & Levine, 1993; Schumpeter, 1911) has documented this fact. However, the direct relationship between financial access and employment is ambiguous, because increasing access to finance will not directly lead to employing additional workers. Increasing investment could expand firms and thus output from a better financial access without even increasing labour, a case of “jobless growth” (Ayyagari et al., 2016).

In addition, the financial growth effect on labour markets has received increasing attention in the recent literature, particularly since unemployment has become a dominant problem for governments of various countries in the world due to the global financial crisis (Garmaise, 2008). Most empirical studies estimate the impact of financial access on employment by comparing the labour market conditions before and after financial regulation changes.

However, some studies argue that constraints in the financial sector should not directly affect labour; this is because unlike capital, labour does not entail financing. Other theoretical literature on the linkages between the capital and labour market suggest that since labour has a fixed cost component, it entails direct financing to take care of the upfront costs that comes with the training and hiring (Ayyagari et al., 2016). Therefore, we should presume that the credit market has an impact on employment decision and thus better access to finance may permit firms to

employ more workers. This may also encourage firms to invest in more capital, hence, directly translate into greater job creation. In some cases, in which firms uses a production technology with capital and labour being substitutable, an increment in capital investment may reduce firms’ level of employment, lowering job creation. The net effect may therefore, depend on firm level characteristics and production structure (Dao et al., 2017). While better financial access may permit firms to hire additional labour, it also encourages firms to invest in more capital, which may not automatically translate into greater job creation.

Furthermore, the size of a firm influences the finance-employment relationship greatly and indeed several empirical studies have found that firms with different sizes may face different operational and institutional constraints (Oi, 1983). More to the point, small and medium-sized enterprises (SMEs) are adversely affected more by financial, institutional and legal obstacles and may have a larger undesirable impact on their development, especially in countries with underdeveloped financial systems (Beck et al, 2005). Deficiency in access to credit remains a major obstacle for many firms, especially SMEs (Baah-Nuakoh, 2003; Osei-Assibey, 2014). In addition, since small firms are more labour intensive as compared to the large ones, the expected finance-employment connection is stronger than it is for larger firms. Ayyagari et al. (2016) shows that, increase in supply of credit results in higher employment growth especially among small firms in developing countries.

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