Latin American and Caribbean (LAC) economies typically have a dual structure, where many small firms with low productivity, limited growth, and high informality coexist alongside a small number of larger, formal, highly productive, and fast-growing firms. How can this gap be bridged?

A new IDB Invest study suggests that access to credit plays a larger role, revealing that every additional $1 million in credit is associated with four new permanent jobs among micro, small, and medium-sized enterprises (MSMEs) in the region. 

Development Challenges of MSMEs in LAC

MSMEs represent 99% of all firms and employ two-thirds of the labor force. Despite their pivotal economic role, most MSMEs are trapped in a vicious cycle of low productivity, limited growth, and minimal creation of formal, productive jobs. 

To better understand these challenges, IDB Invest has carried out a series of studies on firm productivity, growth, and employment. Here’s a quick recap:   

Low Productivity

An IDB Invest study explores the prevailing productivity differences in the region, with three key findings: 

• There are significant differences between the most and least productive firms in the same sector.
• Productivity differences persist over time.

• Most aggregate productivity growth comes from improvements within existing firms, rather than from firm entry or exit.

   

Limited Growth

Another IDB Invest study replicates the analysis by Hsieh and Klenow (2014) on long-term firm growth, finding that:

1. In LAC, firms tend to remain small even after decades of operation. While in the U.S., the average 40-year-old firm employs more than seven times as many workers as a newly established firm. In LAC, MSMEs show significantly slower growth, only doubling in size over the same 40-year period.
2. This growth differential persists across firms of all ages. It is most pronounced in the mid-to-late stages of a firm’s lifecycle, signaling barriers to scaling rather than entry alone.

3. The flatter age–size profile of LAC firms suggests fewer scale-ups and/or many small firms surviving without growing.

    

High Levels of Informality

To explore employment trends in the region, an IDB Invest study analyzes key labor market indicators, showing that:

• The pandemic further weakened labor market participation, which, as of 2024, remained below pre-pandemic levels, and increased unemployment.
• Despite significant cross-country variation in labor market conditions across the region, all LAC countries exhibit persistently high levels of labor informality.

Barriers to MSME Growth

MSMEs face a web of mutually reinforcing internal and external factors that hinder them from reaching their full potential. Firm-level constraints and weak capabilities are amplified by market failures, information asymmetries, and institutional shortcomings, resulting in low productivity, limited growth, and persistent informality.

Can Access to Credit Help Break This Cycle?

One of the main barriers to growth is limited access to finance. At an estimated $1 trillion, the region’s MSME finance gap is the second largest in the world.

Among LAC firms, 75% consider access to finance a constraint on their operations, with 12% identifying it as their most significant obstacle.

Adequate financing is critical for alleviating liquidity constraints, enabling capital investment, facilitating technology adoption, and supporting innovation.

Improved access to finance, not only promotes firm growth, but also expands opportunities for generating higher-quality and more productive employment across the economy.  

More Credit for MSMEs, More Employment?

Establishing causal links between access to finance and economic performance is challenging given the many factors at play, and evidence from LAC is still limited.  

To contribute to the evidence, IDB Invest conducted a new study to estimate the relationship between access to credit and employment, using firm-level data from 21,696 firms across 30 countries in LAC.  

The results indicate a positive association between access to credit and employment outcomes. On average, for MSMEs in LAC, an additional $1 million in credit is associated with the creation of 4 permanent jobs per year. These results are equivalent to an annual employment increase of about 8%.

The impact is not uniform. Employment effects are strongest for smaller and faster-growing firms, especially when credit is recent, used to finance fixed assets rather than working capital, and provided in more competitive banking sectors.

Recognizing these distinctions is essential not only for increasing employment, but also for promoting higher-quality, more productive jobs that strengthen firm competitiveness and support long-term development outcomes.