ABSTRACT. This paper describes how the German Mittelstand, or small- and medium-sized enterprises, are financed in Germany. The role of the German Mittelstand, both in a static and in a dynamic framework, is described and contrasted with that of the same size group in other leading industrialised countries. We find that in general, the Mittelstand has played a mmore important role in Germany than in other industrialised nations, such as the United States or the United Kingdom. The traditional success of the German Mittelstand is partly attributable to a system of finance that is richly layered by complementary institutions designed to meet the financial needs of both large and smaller enterprises. However, we find evidence that even under the German system of finance liquidity constraints exist and are greater for smaller firms. The German system of finance moreover seems particularly deficient in the channeling of funds to new firm startups in the newer industries. 1. Introduction Something of a paradox has emerged with respect to the system of financing for the German Mittelstand, or small- and medium-sized enter- prises in Germany. On the one hand, there is reason to believe that through the development of a finely layered system of institutions linking together financial institutions, governments, and private firms, that the system of finance in Germany serves as a model for providing funds to small- and medium-sized enterprises. Not only is the Mittelstand the backbone of the German Wirtschaftswunder, or economic miracle, and subsequent rise to economic power, but it also appears to have played a more important role in German economic development than in either the United States or the United Kingdom. On the other hand, while the German Mittelstand has provided the backbone for Germany’s economic success, one aspect has been noticeably lacking in recent years – the emergence of small high-technology companies in the emerging industries such as software, biotech- nology, and computers. And it may be that the lack of entrepreneurial activity in high-technology industries is directly attributable to rigidities and constraints in providing liquidity to new firms in new industries imposed by the very same system of finance in Germany. In fact, there are two institutional features of the German financial system that sharply contrast to that practised in the United States and the United Kingdom, both of which may impact the extent to which small- and medium-sized enter- prises are able to obtain access to finance. First, companies in Germany typically rely almost exclusively upon banks for external finance. The external capital market remains relatively unde- veloped in Germany. Second, not only do the banks represent the major financial intermediary supplying capital to firms, but they are also extensively represented on the supervisory boards of companies. Cable (1985, p. 119) refers to this peculiarity of the German financial system which links finance to supervision as a “quasi-internal capital market.” The purpose of this paper is to describe the Financing the German David B. Audretsch Mittelstand Julie A. Elston Small Business Economics 9: 97–110, 1997.  1997 Kluwer Academic Publishers. Printed in the Netherlands. Final version accepted on November 13, 1996 David B. Audretsch School of Policy Studies Georgia State University and Berlin Institute for Economic Studies Berlin, Germany and Julie A. Elston California Institute of Technology California United States of America and Berlin Institute for Economic Studies Berlin, Germany