Comp Econ Stud (2018) 60:3–14 https://doi.org/10.1057/s41294-017-0046-0
Growth and Inequality Effects of Decades of Financial Transformation in OECD Countries Boris Courne`de1 • Catherine L. Mann2
Published online: 15 December 2017 Association for Comparative Economic Studies 2018
Abstract Finance has massively expanded and deeply changed across OECD countries over the past 50 years. Rapid growth of finance has been accompanied by a debt shift away from business towards household credit and, after 2000, a withering of equity capital. Econometric investigations indicate that these changes have contributed to slowing down potential growth. In OECD countries, higher credit/ GDP ratios imply slower trend growth, especially when lending goes to households; by contrast, additional stockmarket funding boosts growth. Moreover, these trends have contributed to widening inequalities. There is a case for policymakers to focus on macro-prudential policy tools that optimise growth-stability trade-offs. Keywords Finance Growth Inequality Credit Equity JEL Classification D14 D63 G1 G2
Credit and equity markets have massively expanded and deeply changed over the past half century. In particular, the share of credit going to households, mainly for home purchases, has widened, while that allocated to non-financial businesses has shrunk. These transformations have been accompanied by a slowdown in real growth and a rise in income inequality. The Great Financial Crisis has triggered a
& Boris Courne`de
[email protected] 1
OECD Economics Department, 2 rue Andre´ Pascal, 75775 Paris Cedex 16, France
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ECO/PED, OECD Economics Department, 2 rue Andre´ Pascal, 75775 Paris Cedex 16, France
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deep real-economy crisis, which entailed large, often persistent, losses in jobs and incomes. This sequence of events raises questions about the role that finance plays in the growth process and how it influences income distribution. The present article addresses these questions mainly by drawing from recent OECD economic research (especially Caldera Sanchez et al. 2016; Courne`de et al. 2015; OECD 2015). It first documents the massive trend rise of finance (‘‘The financial sector has considerably grown and changed over the past fifty years’’ section) before considering impacts on growth (2) and income inequality (3). The concluding ‘‘Financial sector reform can tackle these challenges’’ section draws insights from OECD research about how economic reform can create a favourable framework where financial activities contribute to inclusive growth, in particular pros and cons of a number of macroprudential instruments.
The Financial Sector has Considerably Grown and Changed Over the Past 50 Years The share of financial activities in GDP has strongly increased over the past five decades (Fig. 1, Panel A). Measuring the size of finance in value-added terms provides an indicator that summarises a wide range of financial services. Financial sector value added encompasses banks, insurers, pension funds, asset managers and other financial institutions (clearing houses, stock exchanges and financial auxiliaries). Banks and other lenders make up the largest component of the financial sector, accounting for two-thirds of its value added on average across OECD countries. Banks, insurers and other financial institutions have expanded at comparable rates in most OECD countries in value-added terms as measured in national accounts. The USA are an important exception, as they have witnessed a remarkably fast rise in asset management (Greenwood and Scharfstein 2013). Value-added statistics, however, involve consequential measurement issues. First, nominal value added hinges on assumptions chosen about the credit intermediation margin such as the scope of credit activities included and the reference rate against which lending rates are compared. Moreover, splitting credit margins between prices and volumes is very challenging, therefore involving methodological choices that complicate comparability across countries.1 For these reasons, direct indicators of financial activity are more informative, especially for cross-country comparisons. Two specially important indicators allow directly gauging the extent of financial activity: bank credit (taken in a broad sense to include loans made by banks and other lenders) to the non-financial private sector and stockmarket capitalisation. Bank credit is an essential service that the financial sector provides to the real economy. Stockmarket capitalisation measures an essential service that the financial
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Annex 1 of Courne`de et al. (2015) and Box 2 of van de Ven (2015) provide more details about these measurement issues.
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Fig. 1 Finance has massively expanded in OECD countries. A Value added, % of GDP. B Bank credit, % of GDP. C Stockmarket capitalisation, % of GDP. Source: Courne`de et al. (2015)
sector provides to the real economy in the form of either fresh equity capital or higher share prices (which imply lower equity costs for public companies). Similarly to value added, bank credit and stockmarket capitalisation have very substantially expanded over past decades (Fig. 1, Panels B and C). The history of credit over the past five decades has also been characterised by a strong shift from
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businesses towards households. Stockmarket capitalisation strongly grew in the 1980 and 1990s before a period of rough trend stability, when looking through high volatility (Fig. 1, Panel C). The periods of rapid stockmarket expansion have involved large bubbles in Japan in the 1980s and globally in the late 1990s. Since the early 2000s, stockmarkets have lost much of their capacity to bring fresh equity funds to the real economy: in the USA, for instance, the number of initial public offerings has dwindled from an average of 525 per year in 1993–2000 to 166 in 2001–2012 (Isaksson and C ¸ elik 2013).
Finance has Expanded in a Way that has Slowed Down Long-Term Growth First principles suggest that more finance boosts growth through multiple channels. Greater financial development alleviates the need to fund projects from own resources, which makes it possible to allocate capital to the most productive projects rather than within firms or families with existing resources. More finance should also enable households and firms to better smooth temporary shocks, thereby reducing adjustment costs. Nevertheless, excessive, unbalanced financial sector growth can hold back growth (Rousseau and Wachtel 2011; Cecchetti and Kharroubi 2012). Such trends can result in capital misallocation by facilitating the funding of insufficiently productive projects. Tax policy bears a significant responsibility in this respect: many countries implement corporate income tax regimes that reward business leverage. Meanwhile, tax benefits such as mortgage interest relief while owneroccupiers’ imputed rents remain untaxed create a bias towards household leverage. Another source of debt bias stems from implicit subsidies that banks get when deposit insurance is underpriced or when some of them are deemed systemically important (Denk et al. 2015).2 OECD econometric investigations show that, by their size and nature, the abovedescribed financial sector trends have contributed to holding back long-term growth. At the margin from the levels observed in OECD countries, an increase in the financial sector share in GDP slows down trend growth (Fig. 2, first bar). This slowdown is economically larger if the estimation excludes large financial centres, which benefit from the process of financial expansion (Fig. 2, second bar). Estimates using value-added data, however, remain relatively imprecise because of the previously mentioned measurement problems and also because changes in the structure of finance matter. This marginal negative effect of expanding financial sector value added masks heterogeneous effects. Starting from the levels observed in OECD countries, more credit holds backs trend growth (Fig. 2, bars 3–7). By contrast, more stockmarket funding (looking through cyclical effects) boosts trend growth (Fig. 2, bar 8). 2
For a more detailed discussion of the benefits and risks of financial expansion and a survey of the literature, see Courne`de et al. (2015) as well as the references therein, especially Arcand et al. (2012), Levine (2005), and Beck (2012).
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Fig. 2 Different forms of financial expansion have different effects on long-term growth. Estimated percentage point change in GDP growth per capita. Note The chart shows point estimates and 90% confidence intervals. The ‘‘All bank credit to the non-financial private sector’’ uses different data sources (with broader coverage) from the breakdowns by borrower (households and non-financial businesses) and lender (banks and other sources): it should therefore not be regarded as a weighted mean. Source: Courne`de and Denk (2015)
Structural changes in credit distribution have played an important role in creating this unfavourable link between credit accumulation and trend growth. The past five decades have witnessed a deep shift from business towards household lending, mainly to finance house purchases. This trend has contributed to slowing down trend growth, inasmuch as real estate and homebuilding activities do not deliver as much future growth as the investment projects that business lending typically funds (Bezemer et al. 2016). OECD estimates indicate that an increase in household debt typically slows down growth twice as much as an increase in the same size in business debt (Fig. 2, bars 4 and 5). The negative impact of too much bank lending seems for a good part related to the distortions that come from de facto subsidies to systemically important banks. Market expectations that public authorities will rescue such banks if they were to fail allow them to borrow at much lower rates than their smaller, or less interconnected, competitors. This competitive advantage is highly valuable, as these implicit subsidies can be worth as much as 1–3% of GDP (Schich and Aydin 2014). These subsidies encourage credit over accumulation as well as its mispricing (Denk et al. 2015). If econometric analyses exclude countries where bank creditors have been systematically shielded from principal losses, the negative effect of more bank credit on long-term growth goes away (Fig. 3, left bar).
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Countries where bank creditors have experienced losses
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Fig. 3 Considering banks as too big to fail appears to hurt long-term growth. Estimated percentage point change in GDP per capita growth when the credit/GDP ratio rises by 10% points. Note The chart shows point estimates surrounded by 90% confidence intervals. The left bar refers to countries where bank creditors have experienced losses in the 2008–2012 global financial crisis; the right bar refers to the other OECD countries. Source: Denk et al. (2015)
These results are very robust. Numerous sensitivity tests have been conducted (Courne`de and Denk 2015). Several of these tests detect a causal link running from financial deregulation towards more credit, which in turn results in a slowdown of long-term growth. These results about the negative effects from too much or unbalanced credit accumulation apply to OECD countries but not necessarily to developing economies and especially not to the least advanced ones. All the previously mentioned effects are estimated at the margin, starting from the levels observed in the OECD area. By contrast, a positive effect of more credit on long-term growth can be expected at earlier stages of economic development. Arcand et al. (2012) obtain a result in this direction. OECD econometric investigations also detect a positive link between more credit and GDP per capita growth, when they focus only on the lowest values of credit/GDP ratios that have been observed across OECD countries over the past 60 years (Fig. 4).
Low-Income People Bear a Disproportionate Part of the Costs of Financial Excess In addition to growth, finance can also influence income distribution. OECD empirical analyses show that faster increases in credit and stockmarket capitalisation than GDP are linked with a more uneven income distribution. The uncertainty
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Fig. 4 Long-term growth effect of more credit depends on the starting point. Estimated percentage point change in GDP per capita growth when the credit/GDP ratio rises by 10% points. Note Each point on the black line refers to an econometric estimation conducted by including only countries and years where and when the credit/GDP ratio was below the value shown on the x-axis. Consequently, the point at the right end of the chart is equal to the one on the third bar of Fig. 2. The dotted lines delineate the 90% confidence interval. The sample comprises 34 OECD countries. Source: Courne`de and Denk (2015)
Fig. 5 Increases in bank credit and stockmarket capitalisation are linked with greater income inequality. Estimated change in household disposable income Gini coefficients, in Gini points, when the credit/GDP ratio rises by 10% points. Note The chart depicts point estimates surrounded by 90% confidence intervals. Source: Denk and Courne`de (2015)
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associated with these estimates is, however, quite large (Fig. 5). Further analyses indicate that financial expansion generally reduces income growth for low-income growth, even if more stockmarket funding boosts average incomes (Denk and Courne`de 2015). Empirical analyses uncover three main channels behind this link: •
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First, financial sector employees are highly concentrated at the top of the income ladder (Denk 2015). Financial sector employees make up 20% of the top income decile against only 4% of total employment. Strong concentration of financial sector workers among high-income earners can be an efficient outcome, if strong productivity underpins their elevated compensation levels. Micro-data econometric analyses, however, reveal that financial companies pay their employees more than firms in other sectors do for workers with similar education, experience, age, gender and other observable characteristics. This wage discrepancy is particularly large at the top. Second, high-income people can and do borrow more. In euro area countries, credit is twice as unevenly distributed across households as income (Fig. 6). Consequently, credit expansion fuels income inequality, since higher-income people are better placed than others to gain from the promising investment projects that they can identify. Credit-risk management considerations can explain this uneven distribution of credit. Nevertheless, rather than working as an equaliser by disconnecting investment decisions from existing resource ownership, credit distribution across income groups instead exacerbates income disparities. Credit share, %
Income share, %
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Fig. 6 Household credit is more unevenly distributed than disposable income. Average across OECD countries that are euro area members, 2010. Source: Denk and Cazenave-Lacroutz (2015)
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Third, bigger stockmarkets are associated with more income inequality. The chances that a household holds shares substantially rise with the income level. In euro area countries, the distribution of stock holdings is four times as uneven as that of household income (Denk and Cazenave-Lacroutz 2015). As a result, larger stockmarkets, which generate higher amounts of dividends and capital gains, contribute to widening income disparities.
Financial Sector Reform can Tackle These Challenges The economic research on which this article builds shows a link running from financial deregulation to financial expansion to slower long-term growth. Consequently, effective reforms that curb financial sector excess and make it more stable have the potential to boost long-term economic growth while helping to reduce income disparities. Such reforms could, however, temporarily reduce growth during the adjustment period. The previous analyses did not trace the effects of specific financial policies on long-term growth for lack of the necessary indicators over a sufficiently long period and large number of countries. For a number of policies, however, policy-by-policy impacts can be estimated and separated between effects on growth and crisis risk (Fig. 7; Caldera Sanchez et al. 2016).
Fig. 7 Effects on growth outside crises and crisis risk can be evaluated for a number of financial policies. Note Location on the x-axis shows the effect of financial policies on the risk to experience a financial crisis or a large GDP drop. The y axis shows the effect on growth. The co-ordinates are elasticities or marginal effects depending on the policy (see Caldera Sanchez et al. 2016). Source: Caldera Sanchez et al. (2016)
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Economic reform can help the financial sector contribute to making growth sounder, stronger and more inclusive by preventing the emergence of excess and improving the structure of finance. Preventing Excess The links from too much credit to slower growth and wider income inequalities highlight the benefits of policies to prevent excessive debt accumulation. Macroprudential measures provide tools to avoid excess credit. Caps on debt-to-income ratios have proven particularly effective in this respect (Fig. 7). When overall credit increases, too much capital flows into home building through housing loans. This observation points to an additional benefit of macro-prudential measures: the possibility to target specific sectors, such as housing. In the USA, especially, reforms to reduce support to government-sponsored housing finance companies would help to reduce the risk concentration and capital misallocation that too much mortgage lending typically generates. Macro-prudential measures and reduced support to housing loans, however, run into the political-economy obstacle that, when introduced, they temporarily make it more difficult for low-income or low-savings households to buy their first homes. Ambitious capital requirements, especially for systemically important lenders, are another important measure to avoid financial excess (Fig. 7). Higher capital ratios, in particular, reduce the extent to which banks can fund their lending activities though liabilities that benefit from public support. Basel III agreements have led to substantial advances in this direction, though much remains to be done to wind down implicit public subsidies to systemically important financial institutions and make competition fairer between large and other banks. One way to eliminate public support for systemically important financial institutions is to break them into sufficiently small institutions that the failure of one of them would not entail systemic consequences. An alternative approach, which has been followed since the crisis, is to require credible resolution pans (so-called living wills) from systemically important financial institutions, encourage structural separation between utility and riskier activities, and ensure greater private sector participation in the costs of bank failure. Most OECD countries have gone a long way towards enacting such reforms, with a great degree of international coordination through the Financial Stability Board, the Basel Committee on Banking Supervision and the European Union. Tightening bank regulation could make risk migrate towards other segments of capital markets, prompting the emergence of ‘‘shadow banks’’. A migration of risk from institutions that enjoy substantial public sector backing towards parts of the market where investors are more likely to shoulder losses is a desired rather than unintended consequence of reform. Such a migration of risk is problematic only if the destination market segments themselves become sources of instability. This possibility calls for supervisors to monitor financial markets in an encompassing way rather than focussing on particular categories of institutions or markets, as was sometimes the case before the Global Financial Crisis.
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Fig. 8 Corporate income tax generates a debt bias for firms. Percentage point difference between the effective tax rates on equity and debt finance, 2011. Note The bars show the tax consequences for firms of debt compared with equity funding. This approach takes the perspective of firms rather than investors; accordingly, it does not take into account personal income tax on interest payments, dividends and capital gains. Source: Courne`de et al. (2015)
Improve Financial Structure Most OECD countries apply tax systems that are not neutral between debt and equity and favour leverage (Fig. 8). Reducing this debt bias, which arises from the interplay between corporate and personal income tax, could improve financial structure by favouring greater equity funding. Besides, measures to encourage wider access to stockmarkets, for instance through nudging in occupational pension plans, could help to a more even sharing of the economic gains from larger stockmarkets. Improving financial structure also requires reviewing housing policy. Many policies aimed at helping households to become home owners ultimately fuel boombust housing cycles. Tax and regulatory reform to establish full neutrality between loans contracted for housing and other purposes would take away the incentives that favour the concentration of credit in housing. Neutrality between housing and other loans also requires removing government guarantees for mortgages or their derivatives and ensuring that central banks, when they hold private sector loans, do not favour mortgage-backed assets. Consumer protection and financial education can also help households to avoid taking too much debt.
References Arcand, J.-L., E. Berkes and U. Panizza. 2012. Too Much Finance?. IMF Working Papers, No.12/161. Bezemer, D., M. Grydaki, and L. Zhang. 2016. More Mortgages, Lower Growth ? Economic Inquiry 54(1): 652–674. Beck, T. 2012. The Role of Finance in Economic Development: Benefits, Risks, and Politics. In The Oxford Handbook of Capitalism, ed. D.C. Mueller. New York: Oxford University Press.
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Caldera Sanchez, A., A. de Serres, F. Gori, M. Hermansen and O. Ro¨hn. 2016. Strengthening Economic Resilience: Insights From the Post-1970 Record of Severe Recessions and Financial Crises. OECD Economic Policy Papers, No. 29, OECD Publishing, Paris. Cecchetti, S.G., and E. Kharroubi. 2012. Reassessing the Impact of Finance on Growth. BIS Working Papers, No. 381. Courne`de, B., and O. Denk. 2015. Finance and Economic Growth in OECD and G20 Countries. OECD Economics Department Working Papers, No. 1223, OECD Publishing, Paris. Courne`de, B., O. Denk and P. Hoeller. 2015. Finance and Inclusive Growth. OECD Economic Policy Papers, No. 14, OECD Publishing, Paris. Denk, O. 2015. Financial Sector Pay and Labour Income Inequality: Evidence from Europe. OECD Economics Department Working Papers, n1 225, OECD Publishing, Paris. Denk, O., and A. Cazenave-Lacroutz. 2015. Household Finance and Income Inequality in the Euro Area. OECD Economics Department Working Papers, No.1226, OECD Publishing, Paris. Denk, O., and B. Courne`de. 2015. Finance and Income Inequality in OECD Countries. OECD Economics Department Working Papers, No. 1224, OECD Publishing, Paris. Denk, O., S. Schich, and B. Courne`de. 2015. Why Implicit Bank Debt Guarantees Matter: Some Empirical Evidence. OECD Journal: Financial Market Trends. https://doi.org/10.1787/fmt-20145js3bfznx6vj. Greenwood, R., and D. Scharfstein. 2013. The Growth of Finance. Journal of Economic Perspectives 27(2): 3–28. Isaksson, M., and S. C ¸ elik. 2013. Who Cares? Corporate Governance in Today’s Equity Markets. OECD Corporate Governance Working Papers. https://doi.org/10.1787/5k47zw5kdnmp-en. Levine, R. 2005. Finance and Growth: Theory and Evidence. In Handbook of Economic Growth, ed. P. Aghion and S. Durlauf. Philadelphie: Elsevier. OECD. 2015. How to Restore A Healthy Financial Sector That Supports Long-Lasting, Inclusive Growth? OECD Economics Department Policy Note, No. 27, OECD Publishing, Paris. Rousseau, P.L., and P. Wachtel. 2011. What is Happening to the Impact of Financial Deepening on Economic Growth? Economic Inquiry 49(1): 276–288. Schich, S., and Y. Aydin. 2014. Measurement and Analysis of Implicit Guarantees for Bank Debt: OECD Survey Results. OECD Journal Financial Market Trends 1: 39–67. Van de Ven, P. 2015. New Standards for Compiling National Accounts: What’s the Impact on GDP and Other Macro-Economic Indicators? OECD Statistics Brief, No. 20, OECD Publishing, Paris.