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OECD Parliamentary days 2016 - Finance and Inclusive Growth (Part 1)

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Session by Christian Kastrop, Director, Policy Studies Branch, OECD Economics Department The OECD’s research on Finance and Inclusive Growth has shown that over the past fifty years, credit by banks and other intermediaries to households and businesses has grown three times as fast as economic activity. While greater levels of stock market financing can boost growth, at today’s level of financial development further expansion of bank credit to the private sector is shown to not only slow growth in most OECD countries but also contribute to inequality as better-off households tend to benefit more from financial leverage. Therefore, policy makers should i.a. implement measures to reduce explicit and implicit subsidies to too-big-to-fail financial institutions and reduce the tax bias against equity. To make the financial sector more inclusive and work for people, we must also ensure that companies invest in the real economy. Data analysis of 11 000 of the world’s largest companies has shown that there is a misallocation of capital that needs to be improved in order to foster productivity growth and long-term value creation that can allow for inclusive growth. Promoting competition can support such efforts and also limit unproductive concentration of profits and wealth. New analysis also shows a fragmentation of productivity that needs to be addressed, with a majority of companies sitting in a ‘trough’ of low productivity levels and moderate growth from which it is hard to exit. The current low-interest, low-growth environment makes it also more difficult for pension funds and life insurers to keep their financial promises of providing adequate retirements incomes. These institutional investors are thus driven to pursue higher-risk investment strategies that could ultimately undermine their solvency. This potentially jeopardises the secure retirement especially of the poorest of our citizens.

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FINANCE, GROWTH AND INEQUALITY Christian Kastrop Director of Policy Studies OECD Economics Department OECD, 5 February 2016
1. Finance and growth 2. Finance and inequality 3. Policies for a healthy financial future Structure of the presentation 2
• Reducing the need for self-financing, hence – allocating capital more efficiently – monitoring investments more professionally • Facilitating international trade • Smoothing cash-flow shocks • Facilitating monetary policy transmission Finance boosts growth by: 3
• Misallocating capital • Magnifying the cost of implicit guarantees • Distorting allocation of talented labor • Generating boom-bust cycles • Heightening the risk of regulatory capture Too much finance can harm growth by: 4
Increases in credit and stockmarket funding have opposite growth effects -0.6 -0.4 -0.2 0 0.2 0.4 Increase in bank credit by 10% of GDP Increase in stock market capitalisation by 10% of GDP Estimated link with economic growth, in percentage points, of an: The error bars show 90% confidence intervals. Bank credit includes credit by other intermediaries. 5
1. Excessive financial deregulation 2. Too-big-to-fail guarantees 3. Bank lending outpacing bond financing 4. Household credit outpacing business credit Channels behind the negative link between bank credit and growth 6
Treating banks as too-big-to-fail appears to hurt growth Percentage point change in real GDP per capita growth when bank credit rises by 10% of GDP The error bars show 90% confidence intervals. 7 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 Countries where bank creditors incurred losses due to bank failure (2008-12) Countries where they did not Source: Denk, Schich and Cournède (2015).
Increases in bank lending have a more negative link with growth than other debt -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 Increase in bank lending by 10% of GDP Increase in other debt by 10% of GDP Estimated link with economic growth, in percentage points, of an: The error bars show 90% confidence intervals. 8 Source: Cournède and Denk (2015).
Business credit has a more favourable link with growth than household credit -1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 Increase in credit to households by 10% of GDP Increase in credit to businesses by 10% of GDP Estimated link with economic growth, in percentage points, of an: The error bars show 90% confidence intervals. 9 Source: Cournède and Denk (2015).
More finance can promote income • equalisation if: – It relaxes consumption constraints on poor – It encourages work in the formal sector • inequality if: – It flows more freely to the better off – Finance pays particularly dispersed wages Finance can shape inequality both ways 10
Credit and stock market expansions are linked with greater income inequality Change in Gini coefficients for disposable income for a 10 % of GDP increase in: The error bars show 90% confidence intervals. -0.1 0 0.1 0.2 0.3 Credit by banks and other intermediaries Stock market capitalisation Ginipoints 11 Source: Cournède, Denk and Hoeller (2015).
Credit is more unequally distributed than disposable income Credit and income shares across the income distribution in euro area countries, 2010 0 10 20 30 40 50 Bottom quintile Second quintile Third quintile Fourth quintile Top quintile Credit share, % Income share, % 12 Source: Denk and Cazeneuve-Lacroutz (2015).
Finance pays more than other sectors for similar profiles, especially at the top Estimated financial-sector wage premium across the income distribution, European countries, %, 2010 0 5 10 15 20 25 30 35 40 45 Bottom decile Second decile Third decile Fourth decile Fifth decile Sixth decile Seventh decile Eighth decile Ninth decile Top decile Dotted lines show 90% confidence intervals. 13 Source: Denk (2015).
• Withdraw implicit too-big-to-fail subsidies – break-ups, capital surcharges, structural separation, resolution plans • Implement macro-level financial supervision – debt-service-to-income caps • Improve compensation practices – clawbacks • Reduce tax biases against equity – corporate income tax, lending to businesses (VAT) A healthy future for finance 14
Financial reform is compatible with inclusive growth Growth Equality Win-win Enforce strong macro-prudential controls + + Split TBTF banks or reduce TBTF support through other means + + Recuperate TBTF subsidies through taxation + + Income-enhancing Reduce the debt bias in corporate taxation + Reduce the bias against business loans in VAT + Trade-off Lower barriers to stock market financing + - 15 Source: Cournède, Denk and Hoeller (2015).
• Cournède, B., O. Denk and P. Hoeller (2015), “Finance and Inclusive Growth”, OECD Economic Policy Papers, No. 14. • Cournède, B. and O. Denk (2015), “Finance and Economic Growth in OECD and G20 Countries”, OECD Economics Department Working Papers, No. 1223. • Denk, O. (2015), “Financial Sector Pay and Labour Income Inequality: Evidence from Europe”, OECD Economics Department Working Papers, No. 1225. • Denk, O. and A. Cazenave-Lacroutz (2015), “Household Finance and Income Inequality in the Euro Area”, OECD Economics Department Working Papers, No. 1226. • Denk, O. and B. Cournède (2015), “Finance and Income Inequality in OECD Countries”, OECD Economics Department Working Papers, No. 1224. • Denk, O., S. Schich and B. Cournède (2015), “Why Implicit Bank Debt Guarantees Matter: Some Empirical Evidence”, OECD Journal: Financial Market Trends, Vol. 107. The following reports detail the results: 16

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OECD Parliamentary days 2016 - Finance and Inclusive Growth (Part 1)

  • 1. FINANCE, GROWTH AND INEQUALITY Christian Kastrop Director of Policy Studies OECD Economics Department OECD, 5 February 2016
  • 2. 1. Finance and growth 2. Finance and inequality 3. Policies for a healthy financial future Structure of the presentation 2
  • 3. • Reducing the need for self-financing, hence – allocating capital more efficiently – monitoring investments more professionally • Facilitating international trade • Smoothing cash-flow shocks • Facilitating monetary policy transmission Finance boosts growth by: 3
  • 4. • Misallocating capital • Magnifying the cost of implicit guarantees • Distorting allocation of talented labor • Generating boom-bust cycles • Heightening the risk of regulatory capture Too much finance can harm growth by: 4
  • 5. Increases in credit and stockmarket funding have opposite growth effects -0.6 -0.4 -0.2 0 0.2 0.4 Increase in bank credit by 10% of GDP Increase in stock market capitalisation by 10% of GDP Estimated link with economic growth, in percentage points, of an: The error bars show 90% confidence intervals. Bank credit includes credit by other intermediaries. 5
  • 6. 1. Excessive financial deregulation 2. Too-big-to-fail guarantees 3. Bank lending outpacing bond financing 4. Household credit outpacing business credit Channels behind the negative link between bank credit and growth 6
  • 7. Treating banks as too-big-to-fail appears to hurt growth Percentage point change in real GDP per capita growth when bank credit rises by 10% of GDP The error bars show 90% confidence intervals. 7 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 Countries where bank creditors incurred losses due to bank failure (2008-12) Countries where they did not Source: Denk, Schich and Cournède (2015).
  • 8. Increases in bank lending have a more negative link with growth than other debt -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 Increase in bank lending by 10% of GDP Increase in other debt by 10% of GDP Estimated link with economic growth, in percentage points, of an: The error bars show 90% confidence intervals. 8 Source: Cournède and Denk (2015).
  • 9. Business credit has a more favourable link with growth than household credit -1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 Increase in credit to households by 10% of GDP Increase in credit to businesses by 10% of GDP Estimated link with economic growth, in percentage points, of an: The error bars show 90% confidence intervals. 9 Source: Cournède and Denk (2015).
  • 10. More finance can promote income • equalisation if: – It relaxes consumption constraints on poor – It encourages work in the formal sector • inequality if: – It flows more freely to the better off – Finance pays particularly dispersed wages Finance can shape inequality both ways 10
  • 11. Credit and stock market expansions are linked with greater income inequality Change in Gini coefficients for disposable income for a 10 % of GDP increase in: The error bars show 90% confidence intervals. -0.1 0 0.1 0.2 0.3 Credit by banks and other intermediaries Stock market capitalisation Ginipoints 11 Source: Cournède, Denk and Hoeller (2015).
  • 12. Credit is more unequally distributed than disposable income Credit and income shares across the income distribution in euro area countries, 2010 0 10 20 30 40 50 Bottom quintile Second quintile Third quintile Fourth quintile Top quintile Credit share, % Income share, % 12 Source: Denk and Cazeneuve-Lacroutz (2015).
  • 13. Finance pays more than other sectors for similar profiles, especially at the top Estimated financial-sector wage premium across the income distribution, European countries, %, 2010 0 5 10 15 20 25 30 35 40 45 Bottom decile Second decile Third decile Fourth decile Fifth decile Sixth decile Seventh decile Eighth decile Ninth decile Top decile Dotted lines show 90% confidence intervals. 13 Source: Denk (2015).
  • 14. • Withdraw implicit too-big-to-fail subsidies – break-ups, capital surcharges, structural separation, resolution plans • Implement macro-level financial supervision – debt-service-to-income caps • Improve compensation practices – clawbacks • Reduce tax biases against equity – corporate income tax, lending to businesses (VAT) A healthy future for finance 14
  • 15. Financial reform is compatible with inclusive growth Growth Equality Win-win Enforce strong macro-prudential controls + + Split TBTF banks or reduce TBTF support through other means + + Recuperate TBTF subsidies through taxation + + Income-enhancing Reduce the debt bias in corporate taxation + Reduce the bias against business loans in VAT + Trade-off Lower barriers to stock market financing + - 15 Source: Cournède, Denk and Hoeller (2015).
  • 16. • Cournède, B., O. Denk and P. Hoeller (2015), “Finance and Inclusive Growth”, OECD Economic Policy Papers, No. 14. • Cournède, B. and O. Denk (2015), “Finance and Economic Growth in OECD and G20 Countries”, OECD Economics Department Working Papers, No. 1223. • Denk, O. (2015), “Financial Sector Pay and Labour Income Inequality: Evidence from Europe”, OECD Economics Department Working Papers, No. 1225. • Denk, O. and A. Cazenave-Lacroutz (2015), “Household Finance and Income Inequality in the Euro Area”, OECD Economics Department Working Papers, No. 1226. • Denk, O. and B. Cournède (2015), “Finance and Income Inequality in OECD Countries”, OECD Economics Department Working Papers, No. 1224. • Denk, O., S. Schich and B. Cournède (2015), “Why Implicit Bank Debt Guarantees Matter: Some Empirical Evidence”, OECD Journal: Financial Market Trends, Vol. 107. The following reports detail the results: 16