The “Too Much Finance” literature


A large and growing body of academic research supports the finance curse analysis: academics sometimes call it the “Too Much Finance” (TMF) literature.  The core proposition is that as a country’s financial sector grows it helps the local economy, but only up to an optimal point, after which it turns bad. Most advanced countries, and some developing countries, passed that point long ago.

This graph, from the IMF, illustrates the trend. This page contains a number of similarly-shaped graphs from a range of different studies.

The explanation for the “too much finance” thesis is, put crudely, as follows.

With no finance, little more than subsistence farming is possible. Then, as finance develops, it helps an economy become more sophisticated, channelling savings to productive investments and providing other useful services, and supporting the creation of wealth. The financial sector may reach an optimal size, where it is providing the useful services an economy needs.

But if it grows beyond this optimal level, it starts to inflict damage, for example as profitable techniques to extract wealth from other parts of the economy begin to dominate over traditional financial activities that support the creation of wealth, as talented people are drawn out of productive activities and into ‘socially useless’ or extractive ones, and as other harmful pathologies emerge.

Many harms are unmeasurable — such as damage to democracy or to the rule of law, or rising citzen anger at the expansion of wealth-extracting activities.  The list of studies below mostly looks at the more measurable aspects, such as economic growth, or inequality. The Finance Curse analysis thus overlaps with the TMF literature but is broader, investigating the multiple political, economic, cultural, democratic and social effects that oversized finance can have on a country, using a cross-disciplinary approach. 

The Finance Curse can be framed or visualised in several ways, available here.

How much is too big? There are many possible measures of financial sector size: stock market capitalisation, private sector credit as a share of GDP, pension fund assets to GDP, and plenty more (the IMF provides a range of variables here). Two leading studies estimate, for instance, that finance passes its ‘optimal’ point once private credit exceeds around 100 percent of GDP, suggesting that the financial sectors in both the United Kingdom and the United States expanded past that point in the 1980s – then kept expanding.

The Finance Curse book develops the theme, and provides many real-world examples and deeper analysis. A film is on its way.




Finance and Inequality

Martin Čihák and Ratna Sahay, IMF, Jan 2020

This IMF Staff Discussion Note finds that more financial depth (that means the size of a country’s financial sector relative to its economy, using a special IMF data set) reduces income inequality in a country up to a point, but after that point, inequality starts rising. This is consistent with the finance curse thesis: that a larger financial sector helps their host countries up to an optimal point, after which it starts to inflict economic and other damage. It also finds that higher inequality is associated with greater financial crises, and finds that “financial inclusion” (giving individuals and businesses access to finance) reduces inequality. (The Gini Index is controversial, as it does not adequately reflect the top or bottom of the income distribution.). For a summary, click here. For a speech on this by IMF boss Kristalina Georgieva, click here.

Financial structure and income inequality

Michael Brei, Giovanni Ferri and Leonardo Gambacorta, Bank for International Settlements, Nov 2018

This paper, also directly in line with the finance curse thesis, says: “we find evidence of a U-shaped relationship between financial development and inequality. . . . Up to a point, more finance is associated with lower income inequality. Beyond that point, further financial development correlates with higher income inequality. The beneficial-to-detrimental pattern applies only to market-based financial development and not significantly to bank-[based] finance.

The UK’s Finance Curse? Costs and Processes

Andrew Baker, Gerald Epstein and Juan Montecino, SPERI, Oct 2018 

Building on Epstein’s and Montecino’s 2016 paper Overcharged (which estimates the damage to the US economy inflicted by an oversized financial sector,) this report will calculate the damage inflicted on the UK, in terms of lost GDP accumulated over 1995-2015 due to finance being too big, compared to what GDP would have been had finance been its optimal size.

The role of institutions in finance curse: Evidence from international data

Siong Hook Law, Ali M.Kutan, N.A.M.Naseem, Journal of Comparative Economics, 2018

Looking at the effect of banking sector development on economic growth in a panel of 87 mostly lower-income countries. It finds that “The marginal effect of financial development on economic growth is statistically significant [and] too much financial development tends to retard economic growth” but adds that “the finance curse occurs when institutions are weak.” Having more effective institutions can improve outcomes. [This is similar to some findings in the Resource Curse literature.]

Superstar (and Entrepreneurial) Engineers in Finance Jobs

Nandini Gupta and Isaac Hacamo, March 2018

We find that financial sector growth attracts highly talented engineers into financial sector occupations that do not fully use their skills, which leads these engineers to engage in less innovative entrepreneurship in the long-run, compared to their classmates who remain in engineering.”

Non-linearities in the Relationship between Finance and Growth

Ugo Panizza, Graduate Institute of International and Development Studies, Geneva, 2017

Exploring criticisms of the “too much finance” / Finance Curse strand in the literature, specifically rebutting a report by William Cline of the Peterson Institute for International Economics, which argues that the “too  much finance” results are just spurious statistical correlations. “There is convincing evidence of an inverted U-shaped relationship between financial depth and economic growth. However, there is no consensus on the drivers of this result.” [NB Cline has served as Chief Economist of the Institute of International Finance, a pro-finance lobby group.]

Household debt, growth and stability

IMF Global Financial Stability Report, Oct 2017 (full text here.)

Martin Sandbu summarised Chapter Two of this IMF report in the Financial Times: “a rise in household debt can boost economic growth in the short run, but it makes growth three to five years down the line lower than it would otherwise have been. On top of that, it substantially increases the risk of a banking crisis.” Two graphs illustrate this.

Finance and growth: The direction of causality

Eilyn Yee Lin Chong, Ashoka Mody, Francisco Varela Sandoval 17 January 2017

This study documents a negative relationship between credit and growth that emerged strongly after 1990 and was particularly pronounced in the Eurozone, consistent with the idea that an overgrown financial sector weakens economic growth potential. The negative relationship between credit and growth in the advanced economies begins even before the 90% credit-to-GDP threshold. However, it also argues that slower growth has created greater demand for finance, leading to more rapid financial sector expansion. So causality may run in both directions.

Overcharged: the High Cost of High Finance

Gerald Epstein and Juan Antonio Montecino, Roosevelt Institute, 2016

In Overcharged, Gerald Epstein, Professor of Economics at the University of Massachusetts, Amherst, and Juan Antonio Montecino, also at Massachusetts, Amherst, estimate the costs to the U.S. economy of the financial sector growing above its optimal size and beyond its healthy functions. They estimate

  1. One aspect of the damage

    Rents, or excess profits;

  2. Misallocation costs, or the price of diverting resources away from non-financial activities;
  3. The costs of the 2008 financial crisis.

They check for possible “double counting” between these three dimensions and conclude: “Adding these together, we estimate that the financial system will impose an excess cost of as much as $22.7 trillion between 1990 and 2023, making finance in its current form a net drag on the American economy.”

Watch Prof. Epstein discuss his research at Sheffield University in November 2017.

The Finance Curse: Britain and the World Economy

John Christensen, Nick Shaxson, Duncan Wigan, The British Journal of Politics and International Relations, Jan 5, 2016

The first academic outing of the finance curse concept. Building on an earlier document laying out the thesis for the first time, written by John Christensen and Nicholas Shaxson for the Tax Justice Network.

Labour reallocation and productivity dynamics: financial causes, real consequences

Claudio Borio, Enisse Kharroubi, Christian Upper and Fabrizio Zampolli, 2016

Looking at a sample of 21 advanced economies over forty years, they produce two key findings. First, credit booms tend to undermine productivity growth by inducing labour to be reallocated towards lower productivity-growth sectors – such as a temporarily bloated construction sector. Second, the impact of reallocations that occur during a boom, and during economic expansions more generally, is much larger if a crisis follows. In other words, when economic conditions become more hostile, misallocations beget misallocations.


Why Does Financial Sector Growth Crowd Out Real Economic Growth?”

Cecchetti, Stephen G. and E. Kharroubi. 2015, BIS, 2015

Building on their earlier work (see below.) “An increase in finance reduces total factor productivity growth. . . where skilled labour works in finance, the financial sector grows more quickly at the expense of the real economy. Financial growth disproportionately harms financially dependent and R&D-intensive industries.”

Finance and economic growth in OECD and G20 countries

Boris Cournède, Oliver Denk, OECD, 2015

The paper shows that financial development benefits growth – up to a point, after which it becomes harmful. It points to five factors that link more credit to slower growth: i) excessive financial deregulation, ii) a more pronounced increase in credit issuance by banks than other intermediaries, iii) too-big-to-fail guarantees by the public authorities for large financial institutions, iv) a lower quality of credit and v) a disproportionate rise of household compared with business credit. By contrast, expansions in stock market funding in general boost growth. 

Finance and Inclusive Growth

Boris Cournède, Oliver Denk, Peter Hoeller, OECD, 2015

Complementing the above study, this OECD report concludes:

Finance is a vital ingredient for economic growth, but there can also be too much of it. . . . Over the past fifty years, credit by banks and other intermediaries to households and businesses has grown three times as fast as economic activity. In most OECD countries, further expansion is likely to slow rather than boost growth. The composition of finance matters for growth.”

It explores which kinds of financial sector growth are more and less harmful:

“More credit to the private sector slows growth in most OECD countries . . credit is a stronger drag on growth when it goes to households rather than businesses.”

The study also finds that oversized finance contributes to inequality, and concludes that:

“There is no trade-off between financial reform, growth and income equality in the long term.”

Did Ireland’s 12.5 percent corporate tax rate create the Celtic Tiger?

Tax Justice Network, 2015.

This is not an academic paper: it’s a blog. However, the core graph tells a clear story about the ingredients of Ireland’s economic success, which run contrary to the mainstream story that the “Celtic Tiger” economy was down to Ireland’s corporate tax haven activities and corporate tax-cutting attracting healthy investment. The reality is that Ireland started trying to be a corporate tax haven in 1956 – and on the relevant measure, GNI per capita as a share of the European average, its economy flatlined until the early 1990s – then suddenly took off. The biggest reason for the sudden take-off was Ireland joining the EU Single Market, but a range of other factors also contributed. The blog outlines some factors, but the Celtic Tiger chapter in the Finance Curse book provides a wider set of explanations.


Rethinking Financial Deepening: Stability and Growth in Emerging Markets

Ratna Sahay and co-authors, 2015

This IMF discussion note looks at the effects of financial sector growth on emerging markets / developing countries. It finds that most of these countries’ financial sectors are small, with outstanding private credit to the economy averaging 50 percent of GDP, which is roughly half the growth-maximising level in the TMF literature. So further growth in finance seems to enhance economic growth. But there are diminishing returns. “The effect of financial development on economic growth is bell-shaped: it weakens at higher levels of financial development.”

Note: this graph is from an article I wrote for the IMF in 2019, updating the 2015 article’s data.

Does too much finance harm economic growth?

Siong Hook Law and Nirvikar Singh, Journal of Banking & Finance, 2014

(Alternative full pdf available here.) They study 87 developed and developing countries. “The empirical results indicate that there is a threshold effect in the finance–growth relationship. In particular, we find that the level of financial development is beneficial to growth only up to a certain threshold; beyond the threshold level further development of finance tends to adversely affect growth. These findings reveal that more finance is not necessarily good for economic growth and highlight that an “optimal” level of financial development is more crucial in facilitating growth.” The results are robust to three 18 measures of finance indicators, additional explanatory variables, sub-sample countries, as well as estimation procedures.

Finance vs. Wal-Mart: Why are Financial Services so Expensive?

Thomas Philippon, 2014

“In the absence of evidence that increased trading led to either better prices or better risk sharing, we would have to conclude that the finance industry’s share of GDP is about 2 percentage points higher than it needs to be and this would represent an annual misallocation of resources of about $280 billions for the U.S. alone.”

Has the U.S. Financial Sector become less efficient?
Thomas Philippon, Sept 2014

The unit cost of financial intermediation does not seem to have decreased significantly over the past 130 years, despite advances in information technology and re-organization of the finance industry. On average, the unit cost is 1.5-2.0 percent of intermediated assets. “Financial services are produced under constant returns to scale.” The question is: why?


An International Look at the Growth of Modern Finance

Thomas Philippon and Ariell Reshef,

Spring 2013

The available evidence at present suggests that at the very high end of financial development, rapidly diminishing social returns may have set in.
. . .
There is no particular correlation between the size of the financial sector and economic growth in time series data. Moreover, the correlation between financial output and per capita income varies considerably over the last 130 years. While there is a positive relationship between credit and income in the period after 1950, this relationship changes considerably after 1980 when income grows more slowly relative to credit.
. . .
The secular rise in the financial sector does not seem to deliver deliver faster growth.

The Finance Curse

John Christensen, Nicholas Shaxson, May 2013

Click to enlarge

The first finance curse publication. 

“There is strong evidence that above a certain size relative to the local economy, growth in a financial sector harms the country that hosts it, ‹ƒ…‹ƒŽ•‡…–‘”Šƒ”•–Š‡…‘—–”›–Šƒ–Š‘•–•‹–in a wide variety of ways.” 

This graph provides evidence for a “weak” version of the curse (finance dependent countries don’t harness their financial wealth for national development), but the text argues for a ‘strong’ version, (too much finance actually delivers worse outcomes.)

Too Much Finance?

Jean-Louis Arcand, Enrico Berkes and Ugo Panizza, IMF, 2012

“This paper examines whether there is a threshold above which financial development no longer has a positive effect on economic growth. We use different empirical approaches to show that there can indeed be “too much” finance. In particular, our results suggest that finance starts having a negative effect on output growth when credit to the private sector reaches 100% of GDP.”


Reassessing the impact of Finance on growth.

Cecchetti, S. and E. Kharroubi, BIS, 2012

“With finance you can have too much of a good thing. That is, at low levels, a larger financial system goes hand in hand with higher productivity growth. But there comes a point – one that many advanced economies passed long ago – where more banking and more credit are associated with lower growth.”  They also look at how growth in a financial system – measured as growth in either employment or value added – impacts real productivity growth. “We find evidence that is unambiguous: faster growth in finance is bad for aggregate real growth.”

“Finance literally bids rocket scientists away from the satellite industry. The result is that erstwhile scientists, people who in another age dreamt of curing cancer or flying to Mars, today dream of becoming hedge fund managers.”


Credit Booms Gone Bust, 1870-2008

Moritz Schularick, Alan M. Taylor, 2012

Their findings, especially in light of the above, are hardly surprising. “We find some support for the notion that financial stability risks increase with the size of the financial sector and that boom-and-bust episodes in stock markets become more problematic in more financialized economies. . . . Credit growth is a powerful predictor of financial crises, suggesting that policymakers ignore credit at their peril.” (quote is partly drawn from an earlier version of the paper in 2011.)

The $100 billion question

Andrew Haldane, Bank of England, March 2010.

The costs of a financial crisis go far beyond the immediate bailout costs: it can also damage output across an economy. Haldane’s paper looks at the value of output losses for the world and the UK, assuming different fractions of the 2009 loss are permanent – 100%, 50% and 25%. “These losses are multiples of the static costs, lying anywhere between one and five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy.” (See also Haldane’s 2010 speech The contribution of the financial sector – miracle or mirage?)

How to Tame the Financial Sector

Adair Turner, Prospect Magazine, August 2009

“I think the fact that the financial services sector can grow to be larger than is socially optimal is a key insight. There clearly are bits of the financial system, and particularly the bits that relate to fixed income securities, trading, derivatives, hedging, but possibly also aspects of the asset management industry and equity trading, which have grown beyond a socially reasonable size. To see this you can simply take measures such as wholesale financial services as a share of GDP or consider what percentage of highly intelligent people from our best universities went into financial services.”  – Adair Turner.

Wages and Human Capital in the U.S. Financial Industry

Thomas Philippon, Ariell Reshef, January 2009

“Finance creates rising inequality. The relative earnings of finance professionals exploded upwards in the 1980s with the deregulation of finance. They estimated that “rents” — earnings over and above those needed to attract people into the industry — accounted for 30-50 per cent of the pay differential between finance professionals and the rest of the private sector.” (This concise summary is copied from a 2019 overview by Martin Wolf, which is worth reading in its own right. )


Historical Patterns of Inequality and Productivity around Financial Crises

Pascal Paul, Federal Reserve of San Francisco, Oct 2018

This paper considers changes originating in the real economy as drivers of financial instability. Using a novel data set, I find that rising top income inequality and low productivity growth are robust predictors of crises, and their slow-moving trend components explain these relations. Recessions preceded by such developments are deeper than recessions without such trends.

Analyses before the global financial crisis

While the “Too Much Finance” literature highlighted here was published after the global financial crisis, there is a much older tradition of publications exploring the damage that oversized finance can do. In reverse chronological order, we might mention:

  • Raghuram Rajan in 2005, in a paper that was widely attacked at the time, argued that letting finance grow too large posed risks of a financial meltdown. Very soon, his words would prove prophetic.
  • The IMF followed this in 2006 with Financial Globalization: A reappraisal, which highlighted many problems even before the global financial crisis. Other thinkers such as Dani Rodrik or Steve Keen also provided trenchant critiques of finance ahead of the crisis.
  • Susan Strange’s 1986 seminal book Casino Capitalism foresaw the tremendous dangers from cross-border finance, long before almost anybody else. “The international financial system,” she wrote, “is the rootstock, from whose disorders stem the various problems which afflict the international political econonmy, just as blight, disease or mildew attack the different branches of a plant.” (p3). Her wider body of work, including the classic Mad Money, explores the damage.
  • Charles Tobin in 1984, described how oversized financial systems could cause resources to be misallocated in an economy.
  • A large part of the Bretton Woods architecture after the Second World War was designed specifically to restrict reduce the size and power of the financial sector – and during the roughly quarter century of this “financial repression” was effective, economic growth was higher and more broad-based in most western countries than at any time in world history, before or since.
  • Adam Smith, Karl Marx and John Maynard Keynes all warned of the perils of too much finance, cross-border finance, and of the wrong kind of finance.

Further reading

The aggregate and distributional effects of financial globalisation
Davide Furceri, Prakash Loungani, Jonathan D. Ostry, Dec 2019