Can Microcredit projects pro innovation influence the European Integration Process?

Samuele Centorrino – ID 993683  
Can Microcredit projects pro innovation influence the European Integration process? 
INTRODUCTION 
 
 
“The partnership for growth and jobs is the flagship policy of the European 
Commission. Its success depends on Europe’s small and medium-sized enterprises (SMEs) 
achieving their potential, for they are crucial in fostering the entrepreneurship, competition 
and innovation that leads to sustainable growth and development. (…) The Lisbon 
process offers a framework within which to improve access to finance, through reforms at 
national and EU levels.”
1
  
“Financing innovative SMEs is considered by many finance providers as a risky 
activity due to high transaction costs and low average expected returns especially for 
investments in early stage firms. This leads to gaps of finance provision in the marketplace. 
(…) Guarantees and other risk sharing mechanisms can be used to facilitate access 
to bank lending. Improved policies on the provision of guarantees and microcredits will 
allow more people to become entrepreneurs.”
2
 The two documents above mentioned introduce the idea that applying microcredit and 
other kind of different risk sharing mechanisms can improve SMEs’ access to financial markets 
and therefore foster development and, consequently, competition and innovation.  
 As far as microcredit is considered, this paper concern will not be to show that it can 
ensure a better integrated and more accessible financial market. I will investigate here 
whether this financing mechanism applied to SMEs can foster innovation and growth and 
therefore can help achieve a better cohesion among the EU countries. In order to display my 
results, I will use a two locations model.  
 Before starting I think that some clarifications and remarks are needed to achieve my 
goal and to avoid any kind of misunderstanding and misjudgement.  
                                                 
1
  Commission of the European Communities -  COMMUNICATION FROM THE COMMISSION TO THE COUNCIL, 
THE EUROPEAN PARLIAMENT, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE 
OF THE REGIONS - Implementing the Community Lisbon Programme: Financing SME Growth – Adding European Value, 
Brussels 29/06/2006 
2
 Commission of the European Communities - COMMISSION STAFF WORKING DOCUMENT, ANNEX II to the 
COMMUNICATION FROM THE COMMISSION TO THE COUNCIL, THE EUROPEAN PARLIAMENT, THE 
EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS - Implementing the 
Community Lisbon Programme: Financing SME Growth – Adding European Value {COM(2006) 349 final} IMPACT 
ASSESSMENT, Brussels 29/06/2006 
Università Commerciale L. Bocconi – a.y. 2005-2006 
7
Samuele Centorrino – ID 993683  
Can Microcredit projects pro innovation influence the European Integration process? 
 First of all, which kind of microcredit am I talking about? The word microcredit is often 
misused and misperceived.  
I will base my analysis on the usual definition of microcredit as group credits, as from 
Muhammad Yunus’ experience at the Grameen Bank
3
. Loans can be obtained by groups of at 
least 5 people and without using any collateral. Group’s members are jointly liable for the 
sum they receive: if just one member is not repaying is loan, the entire group shall not obtain 
credit anymore.
4
  
  Second, this credit system has been widely and successfully used in developed and 
developing countries. Perhaps for that reason, it is considered by many as a sort of panacea. 
I want to make clear from the beginning that this is not the point I want to emphasise in this 
paper.  
Small and medium enterprises struggle to enter the financial market because they 
have not collateral to offer in order to receive loans.  
Microcredit can be applied in two main directions: on the one hand, it can fulfil the 
need for capital of this kind of enterprises (especially of those that are working in the 
innovation sector); and, on the other hand, while these enterprises are jointly liable for the 
loan they receive, it can push them working together and therefore achieving better results. 
This co-operation can foster innovation and growth and therefore reduce the output gap 
between richer and better performing, and poorer and stagnating European regions.  
Further, it has to be considered that in order for microcredit to work, authorities need 
to implement a strong enforcement system. This enforcement system is mainly based on two 
kind of potential sanctions: economic and social. It is often stressed that social sanctions are 
more important than economic ones: society reactions to hazardous behaviour could be a 
strong incentive to repay the debt.  
When there is a lack of cohesion in the social structure and society is justifying, in a 
way, every misbehaviour against institutions, the social based micro-finance system will not 
lead to any improvement, just to a waste of resources.   
                                                 
3
 Muhammad Yunus – Banker to the poor, edited in US by Perseus Books Group, 1999;  
4
 For more and better insights in joint liabilities see: M. Ghatak, T.W. Guinname – The economics of lending with joint 
liability: theory and practice, in Journal of Development Economics Vol. 60 (1999) 195-228 
Università Commerciale L. Bocconi – a.y. 2005-2006 
8
Samuele Centorrino – ID 993683  
Can Microcredit projects pro innovation influence the European Integration process? 
It is not unlikely that poverty and lack of growth may lead to this kind of scenario. This 
does not allow microcredit to work, where it is more necessary.   
I tried to take into account all these peculiarities of joint liabilities. But in some case I 
need to make some assumptions about them in order to simplify the analysis. 
In this paper I merge an integration framework and a simple microcredit market 
analysis. The two frameworks which I will mainly use are Martin and Ottaviano (1996)
5
 and 
Masciandaro and Dalla Pellegrina (2004)
6
.  
Martin and Ottaviano show, in a two location economy, that forward and backward 
linkages at work in the model may lead one of the two locations to become the one where all 
productive activities are concentrated.  
Masciandaro and Dalla Pellegrina, instead, show the differences between the informal 
credit and the micro-lending activities in a framework where money borrowers act in a 
competitive market.  
The idea that led me to carry on this kind of analysis is the following.  
One of the main objectives of the European Union is to achieve a better integration 
and cohesion among the members by reducing regional disparities.  
Martin and Ottaviano prove that a bivariate correlation between agglomeration and 
growth exists.  This relationship is obtained in a model where labour is immobile across 
regions and there is no need for any capital endowment.  
Khan and Sehadji (2000)
7
 prove a positive and statistically significant relationship 
between financial depth and growth in a cross-sectional analysis. 
Hence, I introduce a micro-lending sector in Martin and Ottaviano, to assess whether it 
can induce a different source of growth in the economy and therefore influence the 
relationship between agglomeration and growth.  
The aim is to verify whether micro-lending policies and projects might be useful in 
order to boost the economy of Objective 1 regions in the European Union as claimed by the 
two documents that I cited above.  
                                                 
5
 Philippe Martin and Gianmarco I P Ottaviano – Growth and Agglomeration, International Economic Review 42(4), pp. 
947-968, 1996; 
6
 Lucia Dalla Pellegrina e Donato Masciandaro – “Nuova Microfinanza”? Credito informale e credito di gruppo in 
mercati competitivi, Rivista Italiana degli Economisti, a. IX, n. 1, Aprile 2004; 
7
 Mohsin S. Khan and Abdelhak S. Senhadji – Financial Development and Economic Growth: An overview, IMF 
Working Paper, December 2000; 
Università Commerciale L. Bocconi – a.y. 2005-2006 
9