Rapid rise in private-sector borrowing bad for growth
Rich countries are at risk of long-term economic damage if lending to households and businesses grows faster than the economy as a whole
Rich countries are at risk of long-term economic damage if lending to households and businesses grows faster than the economy as a whole, the Organization for Economic Cooperation and Development (OECD) said on Wednesday.
The international think-tank said growth in borrowing as a share of the economy brought short-term economic gains but longer-term harm through looser financial regulation, lower credit quality and bank bailouts by the public sector.
"Over the past 50 years, credit by banks and other intermediaries to households and businesses has grown three times as fast as economic activity. In most OECD countries, further expansion is likely to slow rather than to boost growth," the report said.
Increases in household borrowing were the most dangerous, while big rises in corporate bond issuance and bank lending to businesses caused less harm.
Overall, if borrowing's share of the economy rose by 10 percentage points, this tended to reduce long-term economic growth by 0.3 percent, the OECD said.
By contrast, rapid increases in stock market capitalization were linked to modestly faster growth, the OECD said.
The OECD also said that rapid growth in borrowing tended to worsen inequality. Rich people were better placed to borrow to fund investments, and excessive pay in the financial sector also worsened inequality, the report said.
The findings chime with an International Monetary Fund report last month. The authors of the IMF report argued that "too much finance" beyond a certain level of financial development was linked to economic and financial volatility.
Since the financial crisis most countries have sought to toughen bank regulation to ensure they do not need to rely on bailouts in a future economic crisis.
In 2013, Bank of England Governor Mark Carney said the prospect of Britain's financial sector growing rapidly as it serviced the global economy was not one which should be regarded "with horror".
The OECD said macroprudential measures to control lending, reforming too-big-to-fail institutions and tax changes should help to improve the financial sector's contribution to growth.
It acknowledged that in the short run, such measures would prevent some people from buying homes, but said that would change over the medium term as house prices fall.
“Macroprudential measures, however, often encounter the political economy difficulty that, at the time of their adoption, such reforms make it more difficult for buyers with limited resources to buy residential property, although this distributive effect should wane once prices adjust,” the OECD said.
The cost to taxpayers of bailing out failing banks during the financial crisis brought home the dangers of having an enlarged financial system. Many of the countries that suffered most in the aftermath of the crisis had banking systems that were very large relative to their economies, such as the U.K., Ireland and Iceland.
But the OECD’s research suggests that even without financial crises, large banking systems damage growth by financing too many projects that offer low returns, and absorbing too many talented people, thereby creating skills shortages in other sectors. And when there are crises, the money paid out by taxpayers to support the banks means there is less funding available to upgrade infrastructure and make other investments that boost productivity.
“If there’s really too much provision of credit, too many projects are undertaken at too low a rate of return, which is a misallocation of capital,” said Catherine Mann, the OECD’s chief economist.
The research body said that while there are differences between economies, on average across its 34 members a 10% of GDP increase in the stock of bank credit is associated with a 0.3 annual percentage point reduction in long-term growth.
However, it said that more finance in the form of equity investment is good for growth. One of the OECD’s key recommendations is that tax systems should be reformed to eliminate the “debt bias” in the way business are funded. Under many tax systems, interest payments are considered a cost of doing business, while equity returns are treated as a reward for the owner. The latter are therefore taxed as profits, while the former reduce the tax bill.
“Facilitating stock market funding through lowering the costs of equity flotation and making taxation more neutral between debt and equity, is linked with higher GDP growth,” the OECD said.
The research body also suggested changes to the tax system to discourage lending to households, and called for sales tax to be charged on bank deposit taking and lending in the same way it is applied to other goods and services.
In addition to harming growth, the OECD said overly large financial systems have contributed to rising income inequality. Bank workers are paid more than similarly skilled employees in other industries, while bank lending favors already wealthy individuals, the research body said.
“Credit expansion fuels income inequality as the well-off gain more than others from the investment opportunities they identify,” it said
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