Too Much Finance: Evidence of Pure Negative Effects on Growth

Abstract

This paper takes the ‘Too much finance’ (TMF) literature further by focussing on data for value added in financial services. This broad measure has been much less used in the literature than total private or bank credit, on the one hand, or stock market capitalisation or activity, on the other. We investigate whether those data are consistent with the standard TMF result, and we consider various alternative measures of financial activity including domestic production, domestic consumption and exports and imports. We also use two stratifications of the data, OECD versus non-OECD and the World Bank's income categories, to see if the relevant relationships differ clearly between different groups, and examine whether results are affected by curtailing the sample to exclude the global financial crisis that began in 2008. We confirm the core TMF result for private credit, including for many stratified groups and regardless of the inclusion of the crisis and later years. However, the findings for value added of the financial sector are less consistent, with more support for a purely negative, linear association with growth. This finding is also echoed for some measures of the international trade in financial services. While the provision of private credit appears to strengthen the economy until a tipping point is reached, the expansion of much other financial sector activity may simply be detrimental. We suggest the need for further research to develop understanding of the impact of growth in different elements of the financial sector, in order to support granular policy prioritisation.