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Productivity and the Financial Sector – What’s Missing?

Jeremy Kronick

C.D. Howe Institute Commentary, 2018, issue 508

Abstract: Productivity improvement is considered the primary driver of economic growth in advanced countries because labour and capital are finite resources generating diminishing returns as their utilization increases. The financial services sector contributes to productivity growth in two ways: first, by improving its own output per worker and capital input (internal productivity) and, second, as a byproduct of the financial intermediation services it provides to the rest of economy (external productivity). Using OECD aggregate and sectoral productivity data, and performing a series of novel calculations, my analysis indicates that Canada’s financial sector over the last 15 years has lagged behind other OECD countries in its contribution to productivity growth. As well, Canada has experienced low aggregate productivity levels and growth rates over the same time period. Improving the financial sector’s productivity would boost not only the sector’s performance but also the economy as a whole. This Commentary shows that part of the explanation for these relatively poor results include a policy approach that does not properly evaluate the link between competition and productivity, a regulatory structure that does not always reflect international best practices, and less efficient allocation of capital. As a result, this Commentary recommends the following: • Remove barriers to the development of fintechs through a functional approach to regulation; • Implement regulatory oversight that is proportionate to functional risk; • Consider whether a more explicit productivity mandate is useful for Canadian regulators, in part based on the innovative ideas coming out of the UK’s Financial Conduct Authority’s focus on competition and productivity; • Revise the Bank Act and Insurance Companies Act to allow more flexibility for banks and insurance companies to make substantial investments in fintechs and insuretechs; • Since it is unlikely politically to have one (or twin) national financial-sector regulator(s) with legislative/ statutory powers, focus on achievable goals such as making clear what arrangements are in place between federal and provincial regulators for the sharing of market data related to, for example, the analysis of financial stability in capital markets, and strengthen links between market-conduct regulators across provinces and functions; and • Reduce incentives for banks to lend to less productive residential mortgages by charging lenders mortgage-insurance premiums that reflect idiosyncratic risk beyond just loan-to-value ratios.

Keywords: Financial; Services; and; Regulation (search for similar items in EconPapers)
JEL-codes: G15 G18 G28 (search for similar items in EconPapers)
Date: 2018
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