OECD Parliamentary days 2016 - Finance and Inclusive Growth (Part 1)
Too Much Finance is Bad for Economy
1. Too Much Finance is Bad For
Economy
Presented by
Kazi Rashedul Haque (22-021)
Muhammad Tanvir Islam (22-040)
Udhyab Roy (22-070)
Md. Mehedy Hasan (22-090)
Department of Management Information Systems
University of Dhaka
2. In 2008 the global financial crisis shone a spotlight on
the dangers of financial systems that have grown
exponentially and beyond traditional banks.
A new study, by Stephen Cecchetti and Enisse Kharroubi
outlined a negative link between the financial growth
and real economical growth.
Inception
3. The term “too much finance” reflects the impact of a
country’s financial development at a certain point
where high financial development leads to low
productivity growth.
What do we mean by “too much
finance”?
4. The new IMF (International Monetary Fund) study,
using data from 176 countries, shows that beyond a
certain level of financial development, economic
growth begins to decline.
In other words, when private sector debt passes 100% of
GDP, the “too much finance” point is reached.
Why “too much finance” is bad for
economy?
5. High-skilled workers are lured into finance sector for
higher salaries.
The finance sector usually lends money to the
builders and property developers.
Businessmen are lured into this sector rather than
high R&D projects that have less collateral to pledge.
How “too much finance” takes place?
6. So, a property boom develops and it can lead to the
misallocation of financial resources.
As a result, R&D intensive industries like aircraft and
computing will be disproportionately harmed when
the financial sector grows quickly.
How “too much finance” takes place?
(Contd.)
7. There is not an exact numerical value at which we can
tell whether a country has reached its “too much
finance” point or not, it varies from country to country.
Consideration
10. Financialisation
Brain drain
Financial instability
Inefficient investment
More Effects at the “too much
finance” Point
11. Developing financial institutions first, and then
markets.
Ensuring strong regulatory and supervisory
environment.
Ensuring the capital and liquidity reserves.
Suggestions
12. Diversification of investments.
Encouraging financiers to finance more in less risky
industries.
Suggestions (Contd.)
13. Higher growth in the financial sector reduces real
growth, by competing with the rest of the economy for
resources. Winston Churchill, spotted this problem
nearly 90 years ago when he said that,
“I would rather see finance less proud and
industry more content”
So, it is time to reassess the relationship of finance and
real growth in modern economic systems.
Summary
The world still lives in the shadow of the global financial crisis that began in the United States in 2008. The U.S. experience shone a spotlight on the dangers of financial systems that have grown exponentially and beyond traditional banks.
A new study from the Bank for International Settlements shows exactly why rapid finance sector growth is bad for the rest of the economy.
The study, by Stephen Cecchetti and Enisse Kharroubi outlined a negative link between the financial growth and real economical growth, after a certain point at which “too much finance” takes place.
We measure financial development by a combination of three elements:
Depth – the size and liquidity of financial institutions and markets;
Access – the ability of individuals to access financial services; and
Efficiency – the ability of institutions to provide financial services at low cost and with sustainable revenues, and the level of activity of capital markets.
The term “too much finance” reflects the impact of a country’s financial development at a certain point where high financial development leads to productivity growth.
According to the new IMF (International Monetary Fund) study, using data from 176 countries dating back to 1980, the authors construct a “financial development index” which shows that beyond a certain level of financial development, economic growth begins to decline, while costs in terms of economic and financial volatility begin to rise.
When an economy is immature and the financial sector is small, then growth of the sector is helpful.
But, when private sector debt passes 100% of GDP, the “too much finance” point is reached.
The finance sector lures away high-skilled workers from other industries. The finance sector then lends the money to businesses, but tends to favor those firms that have collateral they can pledge against the loan. This usually means builders and property developers. Businessmen are lured into this sector rather than into riskier projects that require high R&D spending and have less collateral to pledge.
So, a property boom develops. But property is not a sector marked by high productivity growth; it can lead to the misallocation of financial resources.
As a result, R&D-intensive industries - aircraft, computing and the like - will be disproportionately harmed when the financial sector grows quickly. By contrast, industries such as textiles or iron and steel, which have low R&D intensity, should not be adversely affected.
There is not an exact numerical value at which we can tell whether a country has reached its “too much finance” point or not, because then the demographic variables come into play.
In comparison with another country exactly at the same “too much finance” point, a country can still achieve its optimum economic growth in spite of a financial development boom.
Countries at the lower end of the spectrum like Gambia still stand to benefit from a stronger financial sector. Emerging economies enjoy rising incomes and higher-returning investments when their banking industry matures.
But as advanced economies like the U.S. and Japan round the top of the curve, the relationship between financial depth and economic well-being reverses. Productivity suffers, investments become less efficient and the threat of financial crises looms larger.
Another way of looking at the same topic is the proportion of workers employed by the finance sector. Once that proportion passes 3.9%, the effect on productivity growth turns negative. During the five years beginning 2005, Irish and Spanish financial sector employment grew at an average annual rate of 4.1% and 1.4% respectively; output per worker fell by 2.7% and 1.4% a year over the same period.
Financialisation - When financial activities take precedence and start to damage genuine productive activities.
Brain Drain - Higher salaries in finance lures the most skilled and educated people away from other sectors.
Financial instability – When financiers take more risks it can increase the total debt, which in turn can lead to financial instability.
Inefficient investment - Allocation of financial resources toward productive activities begins to decline, which leads to a loss of efficiency in investment.
It is better for countries to develop financial institutions first, and then markets.
Strong institutions, a sound regulatory and supervisory environment can increase the benefits from financial development while reducing the risks.
Ensure the capital and liquidity reserves to mitigate the effects of financial crisis.
Diversification of investment.
Encourage financiers to finance more in less risky industries.
The growth of a country’s financial system is a drag on productivity growth. Higher growth in the financial sector reduces real growth. In other words, financial booms are not, in general, growth-enhancing, likely because the financial sector competes with the rest of the economy for resources. So, there is a pressing need to reassess the relationship of finance and real growth in modern economic systems. At the end, it will be better to agree with Winston Churchill, who spotted this problem nearly 90 years ago when he said that,
“I would rather see finance less proud and industry more content”
