Reassessing the impact of finance on growth Stephen G Cecchetti - - PowerPoint PPT Presentation

• Reassessing the impact of

finance on growth

Stephen G Cecchetti

Bank for International Settlements

• The views expressed in these slides are those of the presenter and do not necessarily reflect those of the Bank for International Settlements.

Financial development: a double-edged sword

Contributes to growth

• Reduces transactions costs
• Improves distribution of capital and risk

Detracts from growth

• Competes for resources
• Creates vulnerability
• Can misallocate resources

When does the dark side of finance dominate?

• 1. Can the size of the financial sector be bad for productivity?
• 2. Does the growth rate of the financial sector become damaging?
• 3. Are some sectors more exposed than others?

When does the dark side of finance dominate?

• 1. Can the size of the financial sector be bad for productivity?

Yes, when credit exceeds 100% of GDP.

When does the dark side of finance dominate?

• 1. Can the size of the financial sector be bad for productivity?

Yes, when credit exceeds 100% of GDP.

• 2. Does the growth rate of the financial sector become damaging?

Yes, a typical boom can reduce trend growth by ½ pp per year.

When does the dark side of finance dominate?

• 1. Can the size of the financial sector be bad for productivity?

Yes, when credit exceeds 100% of GDP.

• 2. Does the growth rate of the financial sector become damaging?

Yes, a typical boom can reduce trend growth by ½ pp per year.

• 3. Are some sectors more exposed than others?

Yes, financially dependent and R&D intensive industries

Productivity growth & financial sector size

Size cuts both ways:

• Fixed costs → increasing returns → bigger more efficient
• But it diverts resources, reducing growth

The empirical questions: Can we find a turning point?

Productivity growth & financial sector size

• Real growth & financial sector size

Turning point: private credit around 100% of GDP Impact is large:

• New Zealand:
• Mid-1990s to 2006: Credit from 90% to 150% of GDP

⇒ Drag of nearly -0.50 percentage points

• Thailand:
• Post-crisis: Credit from 150% to 95% of GDP

⇒ Benefit of +0.50 percentage points

• United States:
• 2007: Credit >200% of GDP

⇒ Returning to 100% → +1.50 percentage points

• Productivity Growth and Financial Sector Employment

Controls: Investment to GDP, employment growth, openness to trade, initial labour productivity, country dummies.

• Productivity Growth and Financial Sector Value Added

Controls: Investment to GDP, employment growth, openness to trade, initial labour productivity, country dummies.

• The size of the financial sector and growth

Turning point:

• 3.2% of employment
• 6.5% of value added

In 2008:

• Employment:
• Canada: 5.7%
• Ireland: 4.5%
• US: 4.1%
• UK: 3.5%
• Value added:
• Ireland:10.4%
• US: 7.7% ⇒

⇒ ⇒ ⇒ Reduce value added from 7.7% to 6.5%: Productivity growth + 0.14 pp/yr

• Productivity growth & financial sector growth

Finance consumes scarce resources Competes for inelastically supply inputs What is the relationship of trend growth to employment growth?

• Productivity growth & financial sector growth

• Productivity growth & financial sector growth

Typical boom:

• Financial Sector Share in Total Employment grows +1.6 pp

⇒ 0.50 pp decline in trend productivity growth

(sample average productivity growth rate: 1.3%)

From 2005 to 2009:

• Productivity growth and financial sector share in employment

growth:

• Ireland: -2.7% and +4.1%
• Spain: -1.4% and +1.4%
• What if financial sector share in employment had been

stable?

• Ireland: -1.3% instead of -2.7%
• Spain: -0.8% instead of -1.4%

• Industry growth and financial sector growth

Financial sector growth affects sectors that compete for inputs

• Finance is capital intensive:

Financially dependent sectors, likely more affected.

• Finance is skilled-labour intensive:

R&D intensive sectors

(most likely to be skilled-labour intensive)

• –50

–25 25 50 75 100 125 1600 1700 1718 1719 1800 1900 2000 2100 2122 2200 2300 2325 2400 2401 2423 2500 2600 2700 2728 2800 2900 3000 3033 3100 3200 3300 3400 3435 3500 3510 3529 3530 3637

Tobacco Pharmaceuticals Aircraft

Financial dependence in manufacturing industries

10 20 30 40 1 6 1 7 1 7 1 8 1 7 1 9 1 8 1 9 2 2 1 2 1 2 2 2 2 2 3 2 3 2 5 2 4 2 4 1 2 4 2 3 2 5 2 6 2 7 2 7 2 8 2 8 2 9 3 3 3 3 3 1 3 2 3 3 3 4 3 4 3 5 3 5 3 5 1 3 5 2 9 3 5 3 3 6 3 7

Medical instruments Textile Computing machinery

R&D intensity in manufacturing industries

• Industry growth and financial sector growth

Main result: Financially dependent or R&D intensive industries

are more harmed by financial sector booms.

Compute difference in productivity growth b/w:

• Financially dependent or R&D intensive industry

in a country w/ a financial sector boom

• Financially independent or low R&D intensive industry

in a country w/ a slow growing financial sector

Difference is 2 to 3 pp! (av. of 2.1%, std.dev. of 4.3%) Example:

Spanish transport vs Swiss chemical industry: 4.5pp difference Almost all (4pp) due to Spain’s financial sector boom

• Conclusions

Financial sector can be a drag on productivity growth

• When private credit exceeds 100% of GDP
• When the financial sector grows quickly
• Financial booms are especially bad for
• Financially dependent sectors
• R&D intensive industries

More finance is definitely not always better

• Thank you.