Bank Credit Shocks and Employment Growth: An Empirical Framework for the Case of Brazil

Existing evidence from the literature on financial intermediaries and economic development suggests that resource-constrained firms can growth faster in the presence of more financial services. With the new macroeconomic environment after 1994 and the institutional reforms in the Brazilian financial sector, there was an important expansion in the availability of bank resources. The process of financial deepening occurred simultaneously to sustained growth in formal employment. This paper studies the relationship between bank credit growth and formal employment growth from 1995 to 2015. The article combines two sets of administrative data: i) private and public banks’s balance sheets collected by the Brazilian Central Bank, and; ii) employment in formal establishments recorded by the Ministry of Labor. The empirical model exploits the large cross-sectional and timeseries variation in financial resources to build a Bartik-instrument for credit growth that interacts the country-wide increase in credit and the participation of different banks in local economies. The identification strategy relies on an auxiliary regression separating supply and demand of credit at the local level. This strategy bypasses some of the concerns with simultaneity bias in articles using aggregate data, and measurement issues of cross-country studies. Regression results indicate that a one percentage point increase in credit growth rates is associated with a 0.12 percentage point increase in employment growth rates. In areas with a prevalence of private banks, an acceleration in credit growth is also associated with a reduced number of establishments and higher average establishment size. The results are consistent with external financing incentivizing establishments to expand, displace other businesses without funds, and increase their size. This study employs aggregated data at the micro-region level, which limits a more detailed characterization of credit shocks effects at the individual establishment level. We have found that the relationship between credit and employment growth is weaker in micro-regions with smaller establishments, suggesting to policy-makers that further reforming the financial system can unleash the potential for more formal jobs in small firms in Brazil. Some microeconomic reforms such as the creation of nation-wide credit score records are already taking place and should possibly bear fruits in the futu