Ebook Short- Versus Long-Term Credit and Economic Performance: Evidence from the WAEMU
The finance–growth nexus has been a long-standing economic issue. Since the seminal paper of King and Levine (1993) revived interest in studying how financial development affects economic growth, more than 200 research papers have considered the topic, and about half have been published in academic journals. The mainstream view argues for a positive and linear impact, on the grounds that banks stimulate growth by improving capital allocation, reducing transaction costs, and monitoring projects.
Subsequent studies point out that the finance–growth relationship is not linear, arguing that it depends on the level of financial development itself, the level of economic development, or inflation. For instance, Gaytan and Ranciere (2004) find that financial development has more impact on growth up to a certain level of per capita income but declines thereafter. On the other hand, Wachtel and Rousseau (2000) have shown that high inflation significantly reduces the effect of finance on growth, and high inflation may be more common in lower-income countries with less developed financial markets.
Despite the rich literature, the complexity of the finance–growth nexus is yet to be fully understood. Past studies used monetary aggregates or credit to the private sector to measure financial development. Less attention has been paid to the type of banking system credit (short-, medium-, and long-term) and its suitability to private sector needs. A mismatch between credit supply and demand may have implications for how bank financing translates into economic growth, especially if high-return projects are financially constrained because banks are reluctant to provide medium- and long-term credit (henceforth both are treated as long-term credit). Certainly, the scarcity of long-term credit makes it harder for firms to use external sources to finance investments that are critical to increase their production capacity.
This issue is acute in developing countries, in particular in the West African Economic and Monetary Union (WAEMU), where banks either lack access to long-term resources or choose to avoid long-term commitments because contract enforcement is weak. Another factor makes WAEMU particularly interesting: the eight countries belonging to the zone are a relatively homogenous group because they share the same currency, a unique central bank and bank regulator, and a similar legal environment. Yet disparities in member financial development and its trend are still noticeable, as is the distribution of private credit between short- and long-term.
Financial development in the WAEMU is low, though comparable with other sub-Saharan African (SSA) countries. In the WAEMU short-term credit accounts for the bulk of bank financing to the private sector, averaging 70 percent of private credit, and ranging from 60 percent in Togo and Senegal to nearly 90 percent in Guinea-Bissau. Against this background, this paper aims to assess whether more financially developed WAEMU countries tend to growth faster than the others. Moreover, it goes beyond past studies by analyzing whether banking systems that provide more short-term credit than long-term undermine the contribution of financial development to economic growth, and why they are doing so.
In what follows, Section II presents arguments for the importance of long-term bank financing for economic growth and discusses factors that undermine incentives for banks to provide long-term credit. Section III describes the banking system in the WAEMU, emphasizing the distribution of short- and long-term credit to the private sector, the sectoral allocation of credit, and its trend in the past decades. Section IV presents the model and the results. Finally, Section V concludes and offers policy recommendations.
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