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Finance and Employment

Finance and Employment. Marco Pagano University of Naples Federico II, CSEF, EIEF and CEPR Giovanni Pica University of Salerno and CSEF Economic Policy, 53 rd panel meeting 15 and 16 April 2011 - Magyar Nemzeti Bank. Is finance the enemy of labor?.

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Finance and Employment

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  1. Finance and Employment Marco Pagano University of Naples Federico II, CSEF, EIEF and CEPR Giovanni Pica University of Salerno and CSEF Economic Policy, 53rdpanel meeting 15 and 16 April 2011 - Magyar Nemzeti Bank

  2. 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…

  3. Outline • How does financial development (FD) affect employment, wage and productivity growth? • How does it affect the variability of employment? • Does it magnify the employment losses at times of banking crisis?

  4. 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: • 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

  5. 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

  6. 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:

  7. Data • Value added, employment and wage bill (Yjc): 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)

  8. Finance, employment and wages: all countries Effect is between 0.23% and 0.83% as FD rises from 25th to 75th percentile

  9. Finance, employment and wages: OECD

  10. Finance, employment and wages: non-OECD

  11. 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

  12. 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)

  13. 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 where sd = cross-industry st. dev. deviation of Yjct(industry j’s growth in VA, L or w) in country c and year t

  14. Finance and reallocation: augmented specification

  15. 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

  16. Evidence on banking crises Two empirical strategies: • Kroszner et al. (2007): re-estimate Rajan-Zingales regressions before, during and after a financial crisis: • 1 crisis observation per country, averaging crisis episodes for countries that experience more than one crisis • Panel data approach similar to Braun & Larrain (2005): Financial crisis data from Laeven and Valencia (2010): universe of banking crises (1970-2009)

  17. Panel data evidence on severe banking crises

  18. 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

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