Empirical predictions of the model

Given that in developed countries financial wealth has increased more than GDP since the 1980s (Piketty & Zucman, 2014) and that financial deregulation has helped financial intermediaries to realize important gains from arbitrage and market-based activities, the empirical predictions of the model are the following: (i) House-hold income from financial wealth management should have decreased while (ii) the transfer of income from households to the financial sector, (iii) the share of risky investment and (iv) bank capital income should have increased, especially for bank-based financial system; (v) depending on households’ financial wealth, the credit intermediation index should have decreased—or stagnated depending on the amount of other financial services—(w∈ [L; ˆw]) then increased (w>w), especiallyˆ after financial deregulation due to raising incentive to invest on trading activities.

(vi) Financial efficiency (measured through the cost of finance and the effect of finance on GDP growth) should be negatively correlated to arbitrage income and financial intermediation intensity.

Do the data confirm these predictions? To look at prediction (i) and (ii) I review data in Piketty and Zucman (2014) and Greenwood and Scharfstein (2014). In

or-der to measure unit income from financial wealth management, I use the ratio of household financial income to household financial wealth. In the case of prediction (ii) I use financial industry income from security management to measure the fees paid through the ratio of securities industry output to financial wealth. Unfortu-nately, the US is the only country for which such information exists. Controlling for inflation, Figure 3.1.2.1 shows that household unit income from wealth man-agement in the US has decreased, while the cost of households’ financial wealth management has increased. An important fact is that the costs of financial wealth management tend to increase after 1996, along with the emergence of new market-based activities, securitization and active financial management (Greenwood &

Scharfstein, 2013). Figure 3.1.2.2 presents gains from financial wealth in the US and France⁵. The return from financial investment has decreased over the past 30 years in all countries and tends even to be close to zero by 2007 in the US once GDP-growth and financial management costs are taken into account.

Because risk is hard to measure, prediction (iii) is difficult to capture in the data.

However, other studies have provided useful information as to the amount of delin-quency rate, especially in the US before the subprime mortgage crisis. Demyanyk and Van Hemert (2009) document that the quality of loans deteriorated for six consecutive years between 2001 and 2006. This confirms risk-taking from idiosyn-cratic characteristics of loans, since increasing housing prices delayed household insolvencies and their related catastrophes.

Prediction (iv) comes from the development of securitization and securities trad-ing. With financial regulation tight, financial wealth small and GDP growth high, there is no reason for banks to invest household wealth in risky projects (equa-tion (4) does not hold). On the other hand, deregula(equa-tion helped increase arbitrage opportunities and thereby arbitrage gains variance. Bank incentives to raise their profits then encouraged the development of loans securitzation and securities

trad-5Data is not available in other countries for this calculation to be proposed.

ing. This ties in with increasingly intense intermediation and the development of securities income. Bazot (2014) provides data on banking income excluded from banking VA—which mostly comes from capital income—and shows that it dramat-ically increased from the mid-1990s to 2007, at least in Germany and the UK.⁶ To measure the intensity of intermediation, I use the Credit Intermediation Index (CII) proposed by Greenwood and Scharfstein (2013). The logic of the CII is straight-forward: it measures the number of steps a monetary unit takes as it passes from investors (households or enterprises) to end-users. It is defined as the total lia-bilities of all sectors (including the financial sector) to total end-users lialia-bilities.⁷ Figure 3.1.2.3 displays the series for France, Germany, Italy, Spain, the UK and the US. The CII decreases from 1980 to 2000, then increases thereafter in French civil law countries, whereas it is quite stable till the late 1990s and increases thereafter in all other countries (Germany, the UK and the US). The CII data thus matches the model expectation. It is worth noting that the CII decreases rather than stagnates in countries where the state was highly involved in banking business—especially France and Italy. A process of dis-intermediation occurred during the 1980s dur-ing which bankdur-ing privatization and the end of credit control decreased mandatory transactions and helped the decompartmentalization of the banking system. Bank interconnections vanished and so reduced the number of step to end-users of credit (see Bertrand et al., 2007 on the consequences of the French banking liberalization of 1985).

The effect of arbitrage and intermediation intensity on financial efficiency is more ambiguous as it depends on other parameters. For example, the reduction of nominal rates during the 1990s concealed the increase of financial intermedia-tion costs thereafter (Bazot, 2014). Controlling for this effect, Bazot (2014) shows

6The case of the US is special as it mostly depends on fees rather than direct arbitrage gains. This also helps to explain why financial sector weight is better measured through value added in the US than in Europe.

7Details of the calculation are provided in the data appendix.

that the part of the unit cost of finance unexplained by nominal rates of interest increases from 1990 to 2007 in Germany, the UK, and Europe. While this coincides with the financial deregulation period, other covariates might explain this trend.

This is why econometric devices are needed to look at predictions (vi).