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.

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:
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