Finance and Growth in China, 1995-2013: More Liquidity or More Development?

Abstract

We study the relation of financial development with income growth in China over 1995-2013. We distinguish between the ratio of credit stocks to GDP, the traditional measure of financial development, and credit flows. In panel and GMM analyses of province-level data, we observe a positive effect of credit flows on growth, which captures a short-term spending effect. Accounting for this, the effect of financial development is negative or insignificant. To identify the channels, we study the effects on GDP aggregates. Our findings suggest that by claiming resources for investments in gross capital formation and net exports, credit expansion held back the growth of consumption by households and government. We also exploit cross-province variation in credit growth rates to find that the effects are stronger with more rapid credit growth. The findings are consistent with an investment bias in China’s development path. They suggest that more gradual and more balanced allocation of credit would benefit growth.