"Too Much Finance" Theory And Empirical Evidence

Finance-growth nexus achieve great attention in the 1990s,following its core proposition "more finance,more growth",many policymakers in the developing countries have adopted extensive way of marketization,liberalization,and financialization,unfortunately what they have got is more frequent business disturbance than their 1960s and 1970s.The global financial crisis in 2008 has led academics to reconsider their prior conclusions.Arcand et al.(2012)argue that there is indeed "too much finance",they show that finance can enhance innovations activities,facilitate efficient allocation of resources and reduce risk only up to a point.Based on this non-linear relationship,they find finance starts having a negative effect when credit to the private sector reaches 110%of GDP.As literature accumulates,researchers extend "too much finance" beyond its original quantity view to the imbalance of financial structure,distortions of financial function and failure of financial position.Recent study show that too much finance may lead to overheated economic capacity,suboptimal low savings,inefficient resource allocation,and high system risk."Too much finance" highlight financial development should be kept in an optimal boundary.It is a revised way of viewing finance-growth nexus and become one of the most attractive topics among financial development researches.Over 30 years of economic reforms,financial system in China has flourished as it successfully implemented a series of reforms.The total RMB loans in the financial institution has skyrocketed from 189 billion yuan in 1978 to 81677 billion yuan in 2014,which increases 431 times and shows an average rate of growth of 18.36%.Financial sector value-add also soars from 2.1%of GDP to 7.3%,meanwhile the financial sector valued-add in USA just increase from 4.9%to 7%.Despite this great development,the increasing gap of financial development and real sector growth,the fast raise price of house and financial asset,and the serious financial constrains of R&D intensive industries and SMEs are also non-ignorant,which reminds us there may exist potential "too much finance" in China.Based on the above background,this paper applies this new theory-"too much finance" and advance econometric instrument to study the potential "too much finance"problem,its mechanism,and economic influence in China both carefully and formally.This paper contributes to the broader literature of "too much finance" literature and has strong policy implications for keeping finance to an optimal level.This study is conducted to solve the following 3 problem,"Whether China has too much finance problem?" "If it has,what is its mechanism?" "And what is its influence to the real economic sector?" This paper contains 8 chapters,which is laid out as follows:Chapter one is introduction,which briefly introduces the concept of "too much finance",research background,research contribution and implication.As an inductor section,this chapter also shows how this paper organized and research framework.Chapter two is literature review,which extensively reviews the development and the critique of finance-growth nexus,how "too much finance" is proposed and related literature involves.By carefully compare Chinese related researches,the limits of the existing work and main content of this paper are also identified.Chapter three briefly illustrates the research background.This chapter first provides discussion of the concept and implicit meaning of "too much finance".Then it reviews the"too much finance" history of some main developed and emerging market countries.The development of financial system is also reviewed in this chapter.The aim of this chapter is to conclude the common features of "too much finance" and explain the reason why bank system is focused to study the "too much finance" problem in China.Chapter four studies the vanishing effect of financial development in China.By introducing financial development into the standard growth accounting framework,this paper shows as other endogenous growth element,financial development also cost scared resources.Therefore,there exists substitution effect between finance and other endogenous growth element."Too much finance" will crowed out other element,this proposition is supported by using dynamic panel threshold method.This chapter provides new evidence on the existence of "too much finance" problem in China,and also estimates the beneficial financial development threshold.Chapter five studies "too much finance" problem in the view of credit structure imbalance.According to the asset bubble theory,credit-fed boom and asset price tend to strongly interdependent with each other.Distinguishing credit according to their different economic functions,this paper sorts credit into two categories including loans financing good and service and loans financing assets transactions.By using Vector Autoregressive model,this paper finds loans financing assets transactions cannot fully response to observed growth opportunities,on the contrary,it is largely explained by price level and its past value.Chapter six studies the resource misallocation among different industries which "too much finance" may exert.Assuming there exits financial frictions and different collateral ability among industries,this chapter begins by showing that by disproportionately benefiting high-collateral but low-productivity industries,an exogenous increase in finance reduces total factor productivity growth.Dynamic panel date model imply this hypothesis by showing financial development could benefit the capital intensive industry which owns a higher proportion of fix asset by improving its growth and profitability.However,the similar effect is not found in the technology intensive industry.Additionally,this paper also examine whether this situation could be alleviated by the resource reallocation owing to the finance development.Unfortunately,this paper finds financial development affects industry labor productivity growth mainly through capital accumulation rather than resource allocation efficiency.Chapter seven studies the resource misallocation among different enterprise which"too much finance" may impose.After reviewing special institution arrangement such as stated-owned bank and SOEs,this chapter argues private SOEs in China tend to be more seriously financial constrained due to the two folded credit discrimination.This indication is proved by both investment sensitivity to cash model and cash sensitivity to cash flow model.To additionally check whether this result is misleading by the potential agency problem,firm investment is characterized into over-investment or under-investment according to their unexpected investment and free cash flow.Empirical study shows financial development aggravate both over-investment or under-investment behavior by tightening financial constrains and exerting agency cost respectively,which may bring more serious resource misallocation.Chapter eight sums up the research findings of this paper,discusses its policy implication and points out future research direction.This paper sheds light on several issues.Firstly,this paper applies this new theory-"too much finance" to study the thereshold effect of finance growth in China from a macro perspective.By introducing finance growth into classic new growth theoretical production model of Lucas(1988),Barro(1990),this paper shows finance and other endogenous growth element are co-determined in economy."Too much finance" will crow out other element and result in undesirable outcome for economic prosperity and sustainable economic growth.Moreover,this paper uses a dynamic panel threshold method developed by Kremer et al.(2013)that extends Hansen's(1999)original static setup to endogenous repressors.With this method,social optimal threshold of financial development could be more precisely estimated.Secondly,this paper initially highlights the importance of credit structure imbalance to "too much finance".According to the asset bubble and historical overview of some countries' "too much finance" problem,this paper finds asset price rise including house and financial asset tends to be credit-fed,which makes finance-growth relationship turn insignificant.Following Bezemer and Grydaki(2014),Beck(2012),Buyukkarabacak and Valev(2010),this paper distinguishes different categories of credit based on different economic functions into loans financing good and service and loans financing assets transactions.This paper explores the changing relations between different categories of credit,economic growth,and asset price in the context of a VAR model.Results show that loans financing assets transactions is no mainly driven by economic fundamentals,but more by its own past dynamics and price levels,which suggests speculation inducing effect of "too much finance" rather than growth enhancing function.Thirdly,this paper contributes to "too much finance" literature by investigating resource misallocation on industry level.Extending the classical method suggested by Rajan and Zingales(1998)to exploit the specific mechanisms,this paper finds that financial development can supply abound credit to the capital intensive industry through collateral channel,however,technology intensive industry cannot disproportionately beneficial from research channel by financial development.In addition,this paper also examine whether this situation could be alleviated by the resource reallocation function played by the financial development.Building on Olley and Pakes(1996),this paper decompose industrial labor productivity growth into a common component and an allocation component.Using this industry-level decomposition of labor productivity growth,this paper finds the industry productivity growth mainly accounts for scale effect carried out by capital accumulation and has little relationship with technology progress fostered by resource reallocation.All these results indicate that the growth of financial system is not always growth-enhancing and can turn to be a drag on productivity growth.Fourthly,this paper also provides micro evidence on how "too much finance" affects firm level agency problem and financial constrains.By adopting the framework proposed by Richardson(2006),this paper constructs firm level under-and over-investment and free cash flow measures.Empirical results show that both under-and over-investment firms present higher free cash flow sensitivity to the financial development.Despite the same status,different theoretical may apply.For the under-investment firms,the higher free cash flow sensitivity may reflect the tightening financial constrains due to serious credit discrimination.However,for the over-investment firms,the higher sensitivity may respond to the failing to perform their monitoring role due to the disincentive between the banks and the firms,which would intensity the exiting agency problem and cause the minority investors' benefits to be expropriated.