The non‐linearity between finance and economic growth: a literature review and evidence from China

Abstract

The influence of finance on the economy has been shown to be non-linear. When financial development exceeds the needs of the real sector, an economy will face the challenge of 'too much finance', which may generate problems such as rent-seeking, asset price bubbles, or even financial crises. China seems to have followed the 'too much finance' pattern in the most recent decade, during which a fast-expanding financial sector and a slowly growing economy coexisted. The empirical part of this study supports a non-linear (S-shaped) relationship between financial development and GDP per capita; in addition, the two financial development indicators used (total loans and private credit) appear to have opposite effects on economic growth.

From financial structure to economic growth: Theory, evidence and challenges

“…Nevertheless, it appears that the evidence as a whole indicates that stock market development is comparatively more favourable for economic growth, particularly for high-income countries, than banking development. In contrast, the beneficial effects of bank development are limited to low-income countries and environments characterized by a modest level of financial development, a finding that is compatible with the recent literature showing the detrimental consequences of 'too much finance (credit)' (Arcand et al, 2015;Xu & Gui, 2021).…”

“…Exploring the relationship between financial structure and economic growth is not only academically meaningful but also policy‐relevant. As the recent literature has shown, excessive financial development, particularly excessive credit expansion, may not only damage economic growth (Arcand et al, 2015; Xu & Gui, 2021) but also lead to serious economic and social problems, such as inequality, banking crises and political instability (Bazillier & Hericourt, 2017; Funke et al, 2016; Kauko, 2014). Policy‐makers may, therefore, be forced to consider curbing banking development to a certain extent and instead promoting the development of financial markets as an alternate means to finance the economy.…”

“…These studies use different methodologies, cover different sample countries, introduce different control variables and even employ different dependent variables (GDP level vs. GDP growth). In addition, except for Chu (2020), none of these studies consider the potential nonlinearity in the connection between finance and the economy, although this nonlinearity has been repeatedly confirmed by recent literature examining the connection between aggregate financial development and economic growth (Xu & Gui, 2021). These studies also fail to consider the interactions between the banking sector and stock markets, which will be discussed in Section 3.2.…”

On the relationship between financial inclusion and bank performance

“…Some studies have found that it may lead to over-indebtedness for micro-borrowers with low returns on investments, in case of using loans for non-productive sources; this is particularly true for borrowers with low financial literacy (Schicks, 2014). Other studies find a nonlinear relationship between finance and growth (Arcand et al, 2015;Beck et al, 2014;Panizza, 2018;Xu & Gui, 2021). 3 The CGAP is a global partnership of more than 30 leading development organisations that works to advance the lives of poor people through financial inclusion.…”

Understanding the Finance–Growth Nexus from a Multidimensional Perspective

“…However, it seems that there is a paradigm shift in the aftermath of the 2008 financial crisis. As generalized by Xu and Gui (2021, p. 6), “the new generation of finance-growth literature forcefully challenges the conventional wisdom that finance unconditionally, linearly, and monotonically contributes to or even causes economic growth. The finance-growth nexus is now shown to be nonlinear, nonmonotonic, and context dependent.”…”