Oliver Denk

Finance and Inclusive Growth

Finance is a vital ingredient for economic growth, but there can also be too much of it. This study investigates what fifty years of data for OECD countries have to say about the role of the financial sector for economic growth and income inequality and draws policy implications. Over the past fifty years, credit by banks and other intermediaries to households and businesses has grown three times as fast as economic activity. In most OECD countries, further expansion is likely to slow rather than boost growth. The composition of finance matters for growth. More credit to the private sector slows growth in most OECD countries, but more stock market financing boosts growth. Credit is a stronger drag on growth when it goes to households rather than businesses. Financial expansion fuels greater income inequality because higher income people can benefit more from the greater availability of credit and because the sector pays high wages. Higher income people can and do borrow more, so that they can gain more than others from the investment opportunities that they identify. The financial sector pays wages which are above what employees with similar profiles earn in the rest of the economy. This premium is particularly large for top income earners. There is no trade-off between financial reform, growth and income equality in the long term. In the short term, measures to avoid accumulating too much credit can, however, restrain growth temporarily. A healthy contribution of the financial sector to inclusive growth requires strong capital buffers, measures to reduce explicit and implicit subsidies to toobig- to-fail financial institutions and tax reforms to promote neutrality between debt and equity financing Finance et croissance inclusive La finance est un element vital pour la croissance economique, mais il arrive aussi qu’il y ait trop de finance. Cette etude analyse ce que les donnees recueillies pendant un demi-siecle sur les pays de l’OCDE ont a nous dire sur le role du secteur financier pour la croissance economique et les inegalites de revenu et en tire les consequences pour l’action publique. Au cours de ce dernier demi-siecle, les prets des banques et autres intermediaires aux menages et aux entreprises ont augmente trois fois plus vite que l’activite economique. Dans la plupart des pays de l’OCDE, de nouvelles expansions du credit risqueraient d’affaiblir plutot que de soutenir la croissance. Ce qui importe pour celleci, c’est la composition de la finance. L’expansion du credit au secteur prive freine la croissance dans la majorite des pays de l’OCDE, mais le financement par les marches boursiers est source de croissance. Le credit pese davantage sur celle-ci lorsqu’il profite aux menages plus qu’aux entreprises. Le developpement du secteur financier alimente les inegalites de revenu car les plus hauts revenus peuvent davantage tirer profit d’une offre de credit plus abondante, mais egalement parce que les remunerations versees dans le secteur de la finance sont superieures. Les plus hauts revenus ont les moyens d’emprunter davantage et le font, de sorte qu’ils peuvent gagner plus que d’autres sur les possibilites d’investissement qu’ils identifient. Le secteur de la finance verse des remunerations superieures a celles des salaries des autres secteurs de l’economie a profil equivalent. Cet avantage est particulierement marque chez les plus hauts revenus. A long terme, aucun arbitrage n’est possible entre reforme financiere, croissance et inegalites de revenu. A court terme cependant, les mesures visant a eviter un exces de credit peuvent freiner temporairement la croissance. Une saine contribution du secteur financier a la croissance inclusive necessite de solides volants de fonds propres, une reduction des subventions declarees et implicites aux etablissements financiers d’importance systemique et des reformes fiscales favorisant la neutralite entre financement par l’emprunt et financement sur fonds propres

Finance and Economic Growth in OECD and G20 Countries

This paper shows that finance has been a key ingredient of long-term economic growth in OECD and G20 countries over the past half-century, but that there can be too much finance. The evidence indicates that at current levels of household and business credit further expansion slows rather than boosts growth. Causality from more credit to slower growth is supported by a novel empirical methodology which exploits changes in financial regulation across countries and time as a source of exogenous variation in financial size. The empirical analyses point to five factors that link more credit to slower growth: i) excessive financial deregulation, ii) a more pronounced increase in credit issuance by banks than other intermediaries, iii) too-big-to-fail guarantees by the public authorities for large financial institutions, iv) a lower quality of credit and v) a disproportionate rise of household compared with business credit. By contrast, expansions in stock market funding in general boost growth.

Finance and Income Inequality in OECD Countries

Using data from OECD countries over the past three decades, this paper shows that financial expansion has fuelled greater income inequality. Higher levels of credit intermediation and stock markets are both related with a more unequal distribution of income. Greater income inequality may not reduce the welfare of even the lowest earners so long as their income growth is not negatively affected. Numerical simulations based on a novel empirical methodology indicate, however, that the financial expansion has put a brake on the income growth of many low- and middle-income households. No evidence is found that financial crises explain the observed relationships. While causality is difficult to establish beyond doubt, the paper finds credit patterns which are inconsistent with reverse causality running from greater income inequality to more household borrowing.

Optimal Social Security with Imperfect Tagging

Workers are exposed to the risk of permanent disability. We rely on a dynamic mechanism design approach to determine how imperfect information on health should optimally be used to improve the trade-off between inducing the able to work and providing insurance against disability. After deriving the fi rst-order conditions to this problem, we calibrate the model to the U.S. economy and run a numerical simulation. The government should offer back-loaded incentives and make strategic use of the difference between the age at which disability occurs and the age of eligibility to disability bene ts. Also, the able who are (mistakenly) tagged as disabled should be encouraged to work until some early retirement age. This makes a decrease in the strictness of the disability test desirable which would reduce the number of disabled who are not awarded the tag and, hence, improve insurance. Finally, we show how the first-best allocation of resources can asymptotically be implemented by making strategic use of the disability test.

Finance, growth and inequality

Finance is the lifeblood of modern economies, but too much of the wrong type of finance can hamper economic prosperity and social cohesion. We have taken a holistic approach to study the consequences of finance for the inclusiveness of growth, in the spirit of the OECD New Approaches to Economic Challenges initiative.