13 December 2013

Commission publishes Product Market Review 2013: Financing the real economy

This edition of DG ECFIN's biannual PMR focuses on the interaction between the real economy and the financial sector. It explores the extent to which the crisis in the financial sector casts a shadow on economic activity. (Includes link to Commissioner Barnier's speech.)

The theme of this Product Market Review (PMR) is the interrelationship between access to finance and economic activity, a timely issue at the current juncture with signs of economic recovery but also persistent fragilities in the financial system which may slow down economic growth. By doing so, the PMR builds forth on the work presented in the previous issue (Product Market Review 2010-11).

The impact of external financing difficulties on the real economy is studied in the context of the need for structural reforms, particularly in product markets. Guidance to policy-makers is provided by EU's Europe 2020 strategy, and the accompanying European Semester process where the EU institutions and the Member States work together to achieve smart, sustainable and inclusive growth.

This Review aims to provide robust economic analyses to underpin further the ongoing policy discussions in the Member States and at EU level. 

Reading guide

The chapters in this PMR each highlight the central research question on access to finance and the real economy from a different perspective, are logically related to each other, but can be read stand-alone.

Chapter 1 in part I starts with a description of the process of business dynamics (i.e. market entry and exit of firms) in the EU, and then links this process to allocative efficiency (based on a newly developed indicator to measure allocative efficiency using publicly available sector data from Eurostat). Birth of new firms has strongly fallen during the crisis, possibly related with access to finance difficulties, and this hampers an allocation of productive resources to their most efficient use. The potential benefits from product market reforms seem especially large in service sectors, which typically suffer from low allocative efficiency.

Chapter 1 in part II is about the role of the banking sector for firm-level productivity and exporting status. Countries with a stronger financial development and higher supply of bank loans, have higher average firm-level total factor productivity. The exporting status of a firm is largely explained by firm productivity levels, and thus indirectly by the financial conditions under which firms operate. In addition, when domestic demand turns weak, firms are more likely to be exporters. This may explain why in countries where the crisis hit particularly hard, like Spain, more firms were encouraged to export.

Chapter 2 in part II investigates capital reallocation into tradable sectors in the vulnerable Member States (Greece, Spain, Cyprus, Ireland, Portugal, Slovenia and Italy). While the relative profitability of firms in tradable sectors has recently been restored in most vulnerable MS, there has, however, not yet been a significant relative increase in tradable sectors' fixed investment. The chapter shows that companies in tradable sectors of vulnerable Member States under-invest compared to their peers in non-vulnerable Member States, even after taking into account their current operating performance and financial health. The degree of firm underinvestment is significantly related with the estimated probability of facing financing difficulties.

Chapter 3 in part II studies the question whether growth in sectors that are more dependent on external funding has been more adversely affected during the sharp downturn of 2008-09. In the euro area more developed financial markets (as measured by the size of bank loans, bond markets or equity markets) have helped to mitigate the impact of the crisis on growth in externally dependent sectors. However, this effect varies depending on the phase of the crisis. In particular, well developed markets for bank loans seem to have been a supporting factor in the early stages of the crisis, but not over the most recent 2010-11 period. In countries where the monetary and financial institutions have entered the crisis with a higher degree of diversification of balance sheets away from traditional bank lending and a higher leverage, the impact of the crisis on the growth of industries more dependent on external funding has been magnified during the second phase of the crisis.

Finally, Chapter 4 in part II searches for determining factors of firms' perceived bank lending difficulties. In particular the firm's age, size and its growth performance are important explanatory variables. Also the financial health of the banking sector plays a role in the formation of perceptions. In particular the return on equity of the banking sector turns out to be a relevant explanatory factor. Firms operating in countries where the banks' return on equity is relatively low more often face external financing difficulties. This may signal some form of systemic failure within the banking industry.

Full review

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See also: Commissioner Barnier: Financing of the real economy is key to accelerating recovery in Europe

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