EMANES Working Paper No 62

This paper studies the impact of productive investment subsidies on firms’ production decisions under credit market frictions. Through the practice of secured borrowing, collateral constraints present a friction in external credit markets, which substantially affects access to credit by smaller firms located in economically depressed areas. Productive investment subsidies are able to smooth out these frictions and stimulate marginal investment by firms which would have otherwise remained unfunded, thus supporting private capital development. Empirical evidence is obtained from a productive investment subsidies programme, to support recovery following two major earthquakes in Italy. The identification design facilitates recognition of the impact of subsidies across a random sample of firms, including firms that are generally not targets of traditional subsidy programmes for development. Furthermore, the absence of conditionality clauses for employment allows an unbiased estimate of the impact on labour input decisions. The results suggest the effectiveness of investment subsidies in supporting capital development and employment generation in the case of SMEs, with firm location playing a significant role in determining the relative impact strength.

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