The sectoral composition of credit and long-run growth
In this paper Paul W. Dai, Karsten Müller, and Emil Verner are addressing the question of whether the composition of credit, and not just its overall level, shape the relationship between financial deepening and long-run economic growth, and if so, what forces drive the reallocation of credit across sectors over the course of economic development.
The authors assemble a new cross-country panel covering 79 countries from 1970 to 2020, using an updated version of the Global Credit Project database (Müller and Verner, 2024) that breaks outstanding firm credit into four broad sectors: agriculture, manufacturing (incl. mining), construction and real estate, and services. They combine this with sectoral value-added and employment data from EU KLEMS, Groningen GGDC, UN, UNIDO, OECD STAN, WIOD, and ECLAC. They also develop a two-sector general-equilibrium model combining a Kiyotaki–Moore (1997) collateral constraint with a Ngai–Pissarides (2007) supply-side structural-change setup, where real estate serves as both production input and collateral.
Findings
- Financial deepening is highly unbalanced. As countries get richer, total firm credit/GDP rises, but this masks a large reallocation from manufacturing to real estate that substantially outpaces structural change in the real economy.
- Credit-to-value-added diverges sharply. Real estate credit/VA rises steeply with income, while manufacturing credit/VA rises modestly and then declines in high-income countries.
- Three drivers of the reallocation:
1. A collateral channel: the elasticity of credit growth to house-price shocks is higher in real estate than in manufacturing, so rising real-estate prices with development disproportionately relax real-estate firms’ constraints.
2. Rising intangible intensity in manufacturing reduces pledgeability and shifts credit away from the sector.
3. Liberalization of directed-credit policies (historically biased toward manufacturing/exports, e.g. East Asian miracles, postwar France, UK) is followed by higher total credit but a pronounced reallocation toward real estate. - Heterogeneous growth implications. A one-standard-deviation increase in manufacturing credit/GDP predicts +1.1% higher real GDP-per-capita growth over the next five years; the same increase in real-estate credit/GDP predicts −3.5% growth — results robust to controls for development level, real structural change, global shocks, and alternative credit measures.
The composition of credit, not just its level, matters for growth. Financial deepening boosts growth primarily at lower income levels, when it channels resources into manufacturing. At higher income levels, credit increasingly finances real estate, which is associated with weaker subsequent growth. This helps explain the “too much finance” finding and provides empirical grounding for renewed interest in industrial and credit-allocation policies.
Unbalanced Financial Deepening
Authors: Paul W. Dai, Karsten Müller, Emil Verner
From: MIT, National University of Singapore
