Financial structure and growth revisited
by Sam Langfield and Marco Pagano, VoxEU.org
“Growth is too low everywhere in Europe”. In 2015, ECB President Mario Draghi thus bemoaned Europe’s systematically dismal economic performance. Over the preceding eight years, EU GDP had expanded by 2%, compared to more than 9% in the US. Why was Europe’s crisis-induced recession so severe, and why has the subsequent recovery been so weak (Wren-Lewis 2015)?
Many factors have contributed to this transatlantic divergence. Among others, economists point to Europe’s ageing population, monopolistic firms, and public policy failures as proximate causes. In recent work, we highlight the additional role played by financial structure (Langfield and Pagano 2016).
Firms in Europe are known to rely mostly on banks to fund inventory and investment, in contrast to their US counterparts. To see this, one can measure financial structure by the size of the banking sector relative to the size of equity and bond markets – what we call the ‘bank-market ratio’. Figure 1 plots this ratio over the past 100 years. Since 1960, Germany and the UK – along with the rest of Europe – have become more bank based than the US, with this divergence accelerating in the 1990s. A similar picture emerges when financial structure is alternatively measured from the perspective of firms’ liabilities (rather than banks’ assets), using national financial accounts data. In the Eurozone, two-thirds of firms’ external funding comes from loans, compared with just 20% in the US.