Does access to credit improve labour productivity?

If credit rationing justifies public intervention in credit markets, it should be the case that unconstrained firms should result in higher productivity. In this paper, we use a longitudinal SME dataset for the UK to empirically test whether this is true. Our findings are nuanced and show that SMEs subject to quantity rationing suffer from productivity declines of up to 40%, which is more important than full rationing in the determination of labour productivity. We suggest that partial rationing forces firms to undertake second-best investment projects that limits their ability to become more productive. This implies that the returns to capital would increase if small firms that are of sufficient quality to pass banks screening tests received all the funds they applied for. This suggests that loan guarantee schemes may play a fundamental role in removing quantity rationing barriers for SMEs. We also find that discouragement can have a positive effect on productivity, and this suggests that firms reconfigure their capital structure by retaining more cash to avoid engaging with debt markets.