Why Does Financial Sector Growth Crowd Out Real Economic Growth?

33 Pages Posted: 9 Jun 2015

See all articles by Stephen G. Cecchetti

Stephen G. Cecchetti

Brandeis International Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Enisse Kharroubi

Bank for International Settlements (BIS)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2015

Abstract

We examine the negative relationship between the rate of growth of the financial sector and the rate of growth of total factor productivity. Using a panel of 20 countries over 30 years, we establish that there is a robust correlation: the faster the financial sector expands, the slower the real economy grows. We then proceed to build a model in which this relationship arises from the fact that investment projects that are easier to pledge as loan collateral have lower productivity. As the financiers improve their ability to recover collateral in default, entrepreneurs expect credit to grow more quickly. As a consequence, they choose to invest in more pledgeable/less productive projects, reducing total factor productivity growth. We take this theoretical prediction to the data and find that financial growth disproportionately harms industries the less tangible their assets or the more R&D intensive they are.

Keywords: asset tangibility, credit booms, financial development, growth, R&D intensity

JEL Classification: D92, E22, E44, O4

Suggested Citation

Cecchetti, Stephen G. and Kharroubi, Enisse, Why Does Financial Sector Growth Crowd Out Real Economic Growth? (June 2015). CEPR Discussion Paper No. DP10642. Available at SSRN: https://ssrn.com/abstract=2615882

Stephen G. Cecchetti (Contact Author)

Brandeis International Business School ( email )

415 South Street
Waltham, MA 02453
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
212-720-8629 (Phone)
212-720-2630 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Enisse Kharroubi

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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