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Finance and Employment M arc o P agan o University of Naples Federico II, CSEF, EIEF and CEPR Giovanni Pica University of Salerno and CSEF E c o n o m i c P o l i c y , 5 3 rd p a n e l m e e t i n g 1 5 a n d 1 6 A p r i l 2 0 11 - M a g y a r N e m z e t i B a n k Is finance the enemy of labor? Textbook vision of the role of finance: efficient allocation of capital optimal risk sharing Probably most workers instead view finance as: creating employment risk via corporate restructuring, bankruptcies, and financial crises enabling or spurring firms to maximize share value at labor’s expenses allowing bankers to earn astronomical bonuses, etc. The crisis has reinforced this negative vision of finance. Good time to think about this… Outline 1. How does financial development (FD) affect employment, wage and productivity growth? 2. How does it affect the variability of employment? 3. Does it magnify the employment losses at times of banking crisis? Toy model of labor market response to FD For a start, consider case of identical firms 1-size continuum of firms with Cobb-Douglas technology: Y K L1 Entrepreneur has wealth A He can “steal” (at most) fraction 1 of revenues (net of wages: no stealing from workers) Better investor protection more funding to firms (henceforth = degree of FD) Competitive credit and labor markets FD also amplifies employment response to shocks FD raises the response of employment to changes in: growth opportunities : firms can better exploit them hire more labor, offer higher wages initial cash flow A: it allows firms to lever more on its cash hire more labor, offer higher wages This result hinges on firms being finance-constrained. True with CRS: firms always want to expand If there is an efficient scale K*, once firms are past K*: effect of FD abates as economy grows FD no longer affects employment response to cash-flow shocks Evidence on finance, employment and wages We extend the approach by Rajan and Zingales (1998): FD should matter more for industries that are more “dependent on external finance” External dependence = reliance on external finance by U.S. listed companies in the Compustat database Baseline specification: Y jc ( FDc ED j ) SHARE1970 jc j c jc Data Value added, employment and wage bill (Yj c): UNIDO INDSTAT3 2006 database, 1970-2003 yearly data for 28 three-digit-industries 63 countries External dependence (EDj): Rajan and Zingales (1998) Financial development (FDc): private credit/GDP stock market capitalization/GDP (1980–95 averages) Finance, employment and wages: all countries Dependent variable: Industry’s share in 1970 External dependence stock market capitalization (80-95) Growth of Value Added Wage Growth Labor Productivity Growth -0.156*** 0.204*** 0.141*** 0.167*** 0.020*** 0.022*** 0.002*** 0.002*** (0.030) (0.027) (0.026) (0.029) (0.003) (0.003) (0.001) (0.001) 0.026* (0.014) External dependence claims of banks and other fin. inst. (80-95) Observations R-squared Employment Growth 0.037*** (0.013) 0.034** (0.016) 1533 0.32 1637 0.33 0.00004 (0.004) 0.055*** (0.014) 1447 0.42 1526 0.39 0.002 (0.011) 0.008 (0.013) 0.002 (0.004) 1293 0.72 1370 0.68 1428 0.29 Effect is between 0.23% and 0.83% as FD rises from 25th to 75th percentile 1505 0.30 Finance, employment and wages: OECD Dependent variable: Industry’s share in 1970 External dependence stock market capitalization (80-95) Growth of Value Added 0.212*** (0.054) 0.212*** (0.055) 0.022 (0.018) External dependence claims of banks and other fin. inst. (8095) Employment Growth 0.153*** (0.044) 0.155*** (0.045) 0.011 (0.012) 0.011 (0.011) Wage Growth Labor Productivity Growth 0.022*** (0.004) 0.022*** (0.004) 0.001 (0.001) 0.010 (0.007) 0.002 (0.004) 0.021** (0.011) 0.001 (0.001) 0.012* (0.007) 0.009 (0.008) Observations 628 628 624 624 594 594 622 622 R-squared 0.48 0.48 0.55 0.55 0.70 0.70 0.34 0.34 Finance, employment and wages: non-OECD Dependent variable: Industry’s share in 1970 External dependence stock market capitalization (80-95) Growth of Value Added Employment Growth Wage Growth 0.161*** 0.213*** (0.032) (0.030) 0.163*** 0.185*** (0.033) (0.037) 0.021*** 0.023*** (0.003) (0.003) 0.041*** (0.015) 0.003 (0.004) 0.037** (0.016) External dependence claims of banks and other fin. inst. (8095) Observations R-squared 0.091** (0.036) 905 0.30 1009 0.32 0.133*** (0.033) 823 0.31 902 0.30 Labor Productivity Growth 0.003*** (0.001) 0.008 (0.013) 0.000 (0.030) -0.000 (0.010) 699 0.64 0.003*** (0.001) 776 0.62 806 0.24 883 0.27 Effect on employment reallocation Extend model to 2 industries with different prospects: strong industry H with high expected profitability H weak industry L has low expected profitability L Labor flows freely between them: single equilibrium wage w Now FD affects not only total employment but also its distribution between industries – in favor of industry H ! With higher FD, industry H attracts more funds than L: employment in industry H grows by more than in industry L employment in industry L may drop (if Ls is sufficiently inelastic) sufficiently high FD will eventually “shut off” industry L Response to growth shocks and to cash flow shocks With greater FD, sectoral growth shocks entail more cross- industry employment reallocations But as FD proceeds, more and more firms achieve their efficient scale and become unconstrained: these firms stop reacting to cash flow shocks… As FD rises, it lowers the effect of cash flow shocks on job reallocations (eventually eliminates it) Evidence on finance and labor reallocation Strategy: regress a measure of inter-industry reallocation on measures of FD FD cross-industry dispersion of stock returns: FD should amplify response of sd to growth shocks but lower it to cash flow shocks sd (Y jct ) FDct sd ( DRI jct ) FDct c t jct where sd = cross-industry st. dev. deviation of Yjct (industry j’s growth in VA, L or w) in country c and year t Finance and reallocation: augmented specification Dependent variable: standard deviation by year and country of Private credit by deposit money banks and other financial institutions to GDP Stock market capitalization to GDP Stock market total value traded to GDP Standard deviation of continental price shocks Fin. Dev. Observations R-squared Value added growth Value added growth Value added growth 0.097 (0.064) Employment growth Employment growth Employment growth 0.013 (0.043) 0.072*** (0.025) Wage growth Wage growth Wage growth 0.054* (0.029) 0.053*** (0.017) 0.089* (0.045) 0.011 (0.008) 0.069*** (0.024) 0.029** (0.012) 0.152 (0.191) 0.236** (0.118) 0.383 (0.250) 0.069 (0.123) 0.182** (0.074) 0.247** (0.110) 0.153** (0.073) 0.063** (0.032) 0.100* (0.054) 1281 0.02 874 0.03 893 0.03 1246 0.02 857 0.04 875 0.04 1207 0.03 824 0.03 846 0.03 Crises: the “dark side” of financial development? FD may become a handicap in a crisis because they create “dependence”: the more financial markets are trusted in normal times, the greater the damage to output and employment when a crisis hits Most clearly seen by looking at liquidity provision: in normal times banks allow firms to save on liquidity deploy more resources to production But when banks are hit by a liquidity shortage, the damage can be more severe Evidence on banking crises Two empirical strategies: 1. Kroszner et al. (2007): re-estimate Rajan-Zingales regressions before, during and after a financial crisis: o 1 crisis observation per country, averaging crisis episodes for countries that experience more than one crisis 2. Panel data approach similar to Braun & Larrain (2005): Y jct 0 SHAREcjt 1 1 ( ED j crisisct ) 2 ( FDc ED j ) 3 ( FDc ED j crisisct ) ct j jct Financial crisis data from Laeven and Valencia (2010): universe of banking crises (1970-2009) Panel data evidence on severe banking crises Value Added growth Employment growth Wage growth Value Added growth Employment growth Wage growth Lagged industry's share of value added (cols 1-4) / Lagged industry's share of employment (cols 2-5) / Lagged ratio of industry's wage to average wage (cols 3-6) -0.547*** (0.085) -0.234*** (0.053) -0.098*** (0.011) -0.660*** (0.089) -0.233*** (0.048) -0.101*** (0.011) External dependence × Banking crisis External dependence × Stock market capitalization 0.026 (0.027) 0.052** (0.021) 0.023 (0.015) 0.033** (0.016) -0.001 (0.012) 0.002 (0.007) 0.068* (0.036) 0.049** (0.023) -0.014 (0.016) External dependence × Stock market capitalization × Banking crisis 0.024 (0.069) -0.015 (0.030) 0.006 (0.021) 0.065*** (0.019) 0.046*** (0.013) 0.005 (0.006) -0.055* (0.030) -0.050** (0.022) 0.016 (0.015) 47431 0.01 45533 0.01 44265 0.05 External dependence × banks and other fin. inst. claims External dependence × banks and other fin. inst. claims × Banking crisis Observations R-squared 44856 0.01 43293 0.01 42033 0.05 Conclusions Financial development is associated with more employment growth, but only in non-OECD countries less employment reallocation (cross-industry dispersion of employment growth) but more employment reallocation in response to greater variability of shocks to growth opportunities (cross-industry dispersion of stock returns) Some evidence of a “dark side” of financial development: during crises, employment growth drops more in financially dependent sectors of countries with more developed financial markets