Sectoral allocation of credit and economic growth

From factories to mortgages: credit allocation and long-term growth

Dai et al.  examine how credit allocation across sectors evolves with economic development and its implications for long-term growth. Below is a summary of its methodology and key findings:

Methodology

1. Data sources:
   – Novel dataset covering 120 countries (1940–2020) from the Global Credit Project, tracking sectoral credit (manufacturing vs. real estate), value added, employment, and collateral usage.
   – House price indices, BEEPS survey data on collateral, and input-output tables for sectoral linkages.
   – New narrative-based chronology of  directed credit policy liberalizations in 37 countries.
2. Theoretical framework:
   – A two-sector model (manufacturing and real estate) integrates:
   – Collateral constraints (à la Kiyotaki and Moore, 1997), where real estate serves as collateral.
   – Structural change dynamics (à la Ngai and Pissarides, 2007), driven by sectoral productivity differences.

Key findings:

• Financial Kuznets facts:
  As countries develop:
  – (i) The manufacturing credit share declines faster than its value-added share.
  – (ii) The real estate credit share rises disproportionately relative to its economic footprint.
  – (iii)The real estate collateral becomes more prevalent, with rising house prices and mortgage reliance.
• Mechanisms driving structural change:
  – Collateral channel: Sectors with higher real estate collateral reliance (e.g., construction) see stronger credit growth after house price shocks.
  – Productivity divergence: Manufacturing TFP grows faster than real estate TFP, pushing resources toward real estate due to Baumol’s cost disease.
  – Intangible assets: Manufacturing’s shift to intangible capital (harder to collateralize) reduces its debt capacity, unlike real estate.
• Quantitative results:
  – 68% of credit reallocation to real estate is explained by financial factors (collateral constraints), while 57% of output reallocation stems from productivity differences.
  – Real estate credit growth correlates with lower future GDP growth, while manufacturing credit predicts higher growth (suggesting sectoral externalities).
• Directed credit policies:
  – Governments historically directed credit to manufacturing (e.g., East Asian “growth miracles”).
  – Liberalizing these policies leads to credit reallocation to real estate and higher credit-to-output ratios in that sector.
• Policy implications
  – Early-stage development: Subsidizing manufacturing credit may boost growth via productivity spillovers.
  – Advanced economies: Excessive real estate credit risks growth slowdowns, highlighting trade-offs in financial liberalization.

Finance, Structural Change, and Growth
Authors: Paul W. Dai, Karsten Müller, Emil Verner
From: MIT Sloan School of Management, National University of Singapore

Sectoral credit, land speculation, and growth dynamics

Tomohiro Hirano and Joseph E. Stiglitz, in this paper, examine how sectoral credit allocation and monetary policy influence long-term growth through a two-sector endogenous growth model. The paper provides theoretical grounding for the empirical findings of the above paper as well for  Verner 2019 and Müller and Verner 2023.  The authors are using a two-sector overlapping generations model that features a productive sector (manufacturing) and a real estate sector. Growth is endogenous and driven by spillovers from manufacturing, which enhance productivity in both sectors. The model also includes borrowing constraints that limit entrepreneurs’ ability to leverage investments and collateral requirements differing across manufacturing and real estate. Finally, entrepreneurs allocate portfolios between capital (productive sector) and land (real estate), while workers/savers cannot participate in real estate markets.

Key findings:

• Sectoral credit allocation matters:
  -Real estate credit expansions crowd out productive investment, reducing long-run growth. This aligns with empirical evidence linking real estate credit booms to growth slowdowns.
  -Manufacturing credit expansions enhance growth by relaxing borrowing constraints for productive capital.
• Interest rates and monetary policy:
  – Low interest rates can reduce growth as cheaper credit fuels land speculation over productive investment.
  – Monetary expansion lowers real interest rates but may harm growth if real estate collateral values dominate, contrasting Tobin’s traditional view that monetary easing boosts capital investment.
• Welfare implications:
  –Real estate booms: Even temporary productivity increases in real estate can lower long-run growth by diverting resources from manufacturing, reducing wages for future generations.
  –Policy design: Financial regulations targeting real estate (e.g., taxes, collateral limits) are critical to prevent growth-retarding speculation.

The paper underscores the importance of directing credit toward productivity-enhancing sectors and designing monetary policies that account for sectoral collateral disparities.

Credit, Land Speculation, and Long-Run Economic Growth
Authors: Tomohiro Hirano, Joseph E. Stiglitz
From: University of London, Columbia University