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Why does financial sector growth crowd out real economic growth?

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  • Stephen G Cecchetti
  • Enisse Kharroubi

Abstract

In this paper we examine the negative relationship between the rate of growth of the financial sector and the rate of growth of total factor productivity. We begin by showing that by disproportionately benefiting high collateral/low productivity projects, an exogenous increase in finance reduces total factor productivity growth. Then, in a model with skilled workers and endogenous financial sector growth, we establish the possibility of multiple equilibria. In the equilibrium where skilled labour works in finance, the financial sector grows more quickly at the expense of the real economy. We go on to show that consistent with this theory, financial growth disproportionately harms financially dependent and R&D-intensive industries.

Suggested Citation

  • Stephen G Cecchetti & Enisse Kharroubi, 2015. "Why does financial sector growth crowd out real economic growth?," BIS Working Papers 490, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:490
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    References listed on IDEAS

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    More about this item

    Keywords

    growth; financial development; credit booms; R&D intensity; financial dependence;
    All these keywords.

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • O4 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity

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