Research On Optimal Financial Size

Historical experience shows that although financial development is the ’lubricating oil’of economic development,it is certainly not the ’oil of all kinds’,and not all economies can obtain economic boom at any time by relying on active and advanced financial strategy.Then,how to develop appropriate financial strategies according to the current stage and characteristics of the country’s economic development,on the one hand,to maximize the positive impact of financial activities on the real economy,on the other hand,to avoid the costs and risks of exceeding financial development.Is China’s current financial size in a reasonable range?Under these problems,this paper firstly constructs the general theory of optimal financial size:there is an optimal financial size for any country(economy)at any stage of development(Hypothesis 1);different countries or the same country at different stages of development have different optimal financial sizes,which depends on the country’s basic economic and social development characteristics(Hypothesis 2);in the absence of constraints,the financial sector has both a strong incentive to overexpand and an ’ability’ to inflate itself away from the real economy,and will not automatically return to its desired level when overextended.Then,as an equilibrium analysis of the above theoretical deduction,refer to DelaFuente et al.(1996),a principal-agent model is embedded in the knowledge spillover growth model,which depicts that when there is information asymmetry,the financial sector can influence the design of wage contracts of R&D enterprises by providing supervision services with cost and failure risk.So that some enterprises in the original ’slack equilibrium’ to ’effort equilibrium’,to achieve pareto improvement,and ultimately promote the production of new technology.At the same time,however,the provision of supervisory services requires the transfer of some productive resources from the real to the financial sector.It can be proved that under the general assumption,there is an equilibrium financial size,and deviation from the equilibrium financial size will reduce the output of the final-good sector.In addition,the comparative static analysis shows that the demand for financial services and technical production efficiency also depend on the cost of using financial services,characteristics of R&D projects,supervision efficiency and existing technology level,so that the equilibrium financial size varies with different economic characteristics.In order to verify the hypotheses deduced from the above theories and related aspects,the empirical research tracks,classifies,compares and summarizes the financial and economic development process of different countries around the world in the past nearly 50 years as well as all kinds of financial related events.At the same time,empirical tests are carried out by using standard econometric methods.The study found that,on a global average,the relationship between the share of added value of financial industry and per capita GDP growth became increasingly decoupling over time.At the same time,on an international comparison view,countries with a high financial industry share(especially over 6.5%)have not achieved sustainable economic growth that has attracted international attention.The regression results of the dynamic panel model show that there is a significant inverted U-shaped relationship between financial size and per capita economic growth,which is robust under exogenous legal origins as instrumental variables,the elimination of short-term economic fluctuations,the replacement of different measures of financial size and different methods.The results of mechanism test show that:(1)the expansion of financial size increases the cost of creating unit intermediate financial assets,that is,the cost of raising unit funds for the real economy.(2)When the financial size exceeds a certain threshold,its further expansion cannot enable more residents and enterprises to obtain financial services,no matter banking services or financial market services.Empirical studies also show that whether financial size expansion can promote economic growth presents obvious heterogeneity among different countries(regions)and different development stages of the same country.The regression results of the dynamic panel threshold model confirm that income level,human capital,institutional quality and technological level are the key factors detennining whether the expansion of financial sector has the effect of economic growth.This conclusion remains robust under exogenous legal origins as instrumental variables and different measures of financial size.From the perspective of growth sources,compared with promoting capital input,financial development has higher requirements on income,human capital,institutional quality and technological level in accelerating technological progress and improving production efficiency.The results of mechanism test show that:(1)With the improvement of human capital level and abundant technical reserve,the expansion of financial sector can promote economic output to a greater extent because it can cultivate more successful entrepreneurs.This effect is mainly reflected in male entrepreneurs and ’opportunity entrepreneurship’.(2)Better institutional quality,including low degree of corruption,high degree of rule of law,high bureaucratic quality and significant democratic characteristics,can reduce the monopoly power of the banking industry in the process of financial sector expansion by regulating and protecting the market system.(3)The improvement of income level can narrow the rate of return gap between physical investment and financial investment in the process of financial sector expansion,restrain the financialization of enterprises,and make more financial resources directly into the production process.Finally,when the existence of the optimal financial size and its influencing factors are confirmed,the specific value of the optimal financial size can be estimated based on the possibility frontier model.To this end,we first modified,supplemented and extended the financial possibility frontier model constructed by Beck et al.(2008)and Barajas et al.(2013),and then estimated the theoretical optimal financial size values of 55 countries from 1988 to 2019 based on the improved model.The test of the estimation results shows that when the country’s actual financial size deviates from its optimal value to a large extent,the growth rate of real per capita GDP and TFP will decrease regardless of financial overdevelopment or underdevelopment.Financial overdevelopment will also have a negative impact on the growth rate of capital accumulation and lead to an increase in the probability of crisis.These conclusions confirm that the estimation of optimal financial scale in this paper is reasonable,and it can promote optimal allocation of resources to the greatest extent,achieve balanced growth of investment,so as to obtain sustainable economic growth and avoid crisis.According to the estimation of optimal financial size,there is a risk of ’excessive financial size;in China and the share of added value of financial industry should be kept at about 5%in theory.This is a comprehensive judgment considering the international comparison and historical reference,as well as the stage and characteristics of current economic and social development.In terms of China’s development history,in the 1990s,the financial size had expanded and deviated seriously from the optimal value at that time,resulting in serious inflation,deterioration of bank operations and eventually a decline in economic growth.The situation improved only after financial size returned to its optimal value in 2002,thanks to fiscal and credit tightening measures.Therefore,after 2010,the rapid expansion of China’s financial industry again,but also from the optimal value,it has to worry people.Compared with the existing literature,the innovation of this paper is mainly reflected in the following aspects:First,it builds a theoretical framework for analyzing the appropriate financial size of a country and makes a specific estimate,which provides a more direct reference for judging whether the current financial scale of China is reasonable.Secondly,the heterogeneity of the optimal financial size in different countries and the same country in different stages of development and its reasons are investigated,and the viewpoint that the optimal financial size should be both ’dynamic’ and ’adapted to local conditions’ is put forward.Thirdly,the financial possibility frontier model proposed by Beck et al.(2008)and Barajas et al.(2013)is modified,supplemented and extended,which significantly improves the rationality of its estimation results.