finance2

IS FINANCE A VITAL INGREDIENT FOR ECONOMIC GROWTH ?

 

Since the 1970s, the financial sector has expanded massively in many developed countries.

Because of the rise of the financial sector, profits have been the main source of the rising share of finance in GDP over the last four decades.

The financial crisis has raised deep questions about the role of the financial sector and its impact on growth and income distribution.

According to a recent OECD Economic Policy Paper ( Finance and Inclusive Growth – ISSN 2226583X ) published in June 2015, stock market capitalisation has tripled relative to GDP over the past forty years while on average across the OECD, banks and similar institutions are now providing more than three times as much private -sector credit relative to GDP as half a century ago.

 

If finance is a vital ingredient for economic 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.

The crisis has also stimulated reforms to help the sector contribute to growth that is strong, sustainable and inclusive.

However, there can be too much finance.

When the financial sector is well developed, further increases in its size usually slow long -term growth.

Still based on the recommendations of the OECD Economic Policy Paper # 14  ( ISSN 2226583X ), a healthy contribution of the financial sector to inclusive growth requires strong capital buffers, measures to reduce explicit and implicit subsidies to too-big-to-fail financial institutions and tax reforms to promote neutrality between debt and equity financing.