5/5/2019 Financial dependence and industry growth in Europe: Better banks and higher productivity Robert Inklaar and Michael Koetter University of Groningen 2008 World Congress on Measurement 14 May 2008

Motivation Better financial development stimulates growth 5/5/2019 Motivation Better financial development stimulates growth Broad evidence (Levine, 2005) Three questions: What aspects of the financial system? How is growth affected? How broadly across Europe?

5/5/2019 Main results Bank efficiency explains industry growth alongside financial volume measures Bank efficiency stimulates industry productivity Growth benefits concentrated in new EU Member States

Methodology: finance and growth 5/5/2019 Methodology: finance and growth Key problem: causality of finance-growth relationship We rely on Rajan and Zingales (1998) methodology: Uses industry data and information on dependence on external finance Assumption: externally dependent industries are more affected by financial development Uses industry variation to identify the effects of cross-country differences in financial development Basic estimating equation: Growth(ij)=b*FinDependence(i)*FinDevelopment(j)+e

Methodology: growth Estimate three equations: 5/5/2019 Methodology: growth Estimate three equations: Output growth=b(1)*FinDep*FinDev+e Positive b(1) => confirms Rajan/Zingales Labour productivity growth=b(2)*FinDep*FinDev+e Positive b(2) => not just effect on labour growth Investment growth=b(3)*FinDep*FinDev+e Positive b(3) => capital accumulation higher Positive b(2), insignificant b(3) => productivity growth higher

Methodology: financial development 5/5/2019 Methodology: financial development ‘True’ financial development not observable, so use of proxies: Private loans and stock market capitalization to GDP Proposed here: cost and profit efficiency of banks How high are costs or profits relative to best performers? ‘Quality’ rather than quantity measure Estimate stochastic frontier: explains banks costs/profits by observed outputs (loans, securities), input costs (wages, interest expenses) & time trend (translog function) Residual can be random error or inefficiency

Methodology: financial dependence 5/5/2019 Methodology: financial dependence Rajan/Zingales: share of investment not financed out of cash flow Here: debt-asset ratio Mainly European data limitations To avoid endogeneity concerns, apply financial dependence of benchmark country Rajan/Zingales: US Here: UK (France as robustness check) Exclude country in question from regressions

Data: growth EU KLEMS database 5/5/2019 Data: growth EU KLEMS database Developed in Groningen, internationally comparable industry data Value added and labour productivity growth: 25 industries, EU-25 Investment growth: 25 industries, EU-25 excl. Baltics, Cyprus, Malta Almost balanced for 1994-2004

Data: financial dependence 5/5/2019 Data: financial dependence Amadeus database: financial accounts for 5mln European firms Substantial coverage of the economy (Klapper et al. 2006) Use debt-asset ratios for UK and France All firms with positive debt and assets UK: 2.7mln firm-year observations France: 3.5mln firm-year observations Use debt-asset ratio of average firm in each industry, averaged over 1994-2004 period Use UK as benchmark because of high financial development

Data: financial development 5/5/2019 Data: financial development Private loans and stock market capitalization (Beck et al.) Cost efficiency and profit efficiency by country

Results: output growth 5/5/2019 Results: output growth * 10%; ** 5%; *** 1% significant, includes industry & country dummies Bank efficiency important added dimension Marginal effect of efficiency higher than for volumes

Results: sources of growth 5/5/2019 Results: sources of growth Higher labour productivity, not investment => higher multifactor productivity Volume measures less important

Results: EU-10 rather than EU-25 5/5/2019 Results: EU-10 rather than EU-25 Stronger results for profit efficiency for EU-10 EU-15: most results disappear => consistent with literature

5/5/2019 Robustness checks Exclude single industry or country => very similar France vs. UK as benchmark => very similar Traditional panel estimates of efficiency scores vs. latent-class estimates => very similar Growth of gross output vs. value added => very similar Growth opportunities vs. debt-asset ratios => similar but weaker

5/5/2019 Conclusions Bank efficiency important in addition to financial volumes for growth Productivity-enhancing effect mostly from bank efficiency Growth benefits from financial development improvements concentrated in new EU member states