Essays on the size of the financial aector, financial liberalization and growth

Financial systems have grown dramatically over the decade leading up to the Global Financial Crisis. This thesis explores some of the channels through which large financial systems might hurt the economy. The first part focuses on the composition of financial services. It examines whether intermediation services and “non-intermediation” activities have differential effects on economic growth and growth volatility. It is found that intermediation activities increase growth and reduce volatility in the long run. An expansion of the financial sectors along other dimensions has no long-run effect on real sector outcomes. Over shorter time horizons non-intermediation activities stimulate growth at the cost of higher volatility especially in high-income countries. The second part examines how the absorption of talent into the financial sector affects productivity and growth of real sectors. My evidence shows that financial liberalization is associated with skill-upgrading in the financial sector. I exploit variation in financial liberalization patterns across US states and across a sample of 13 mostly European countries to identify the effect of the absorption of talent into finance. Consistent with the existence of a brain-drain effect, my estimates show that financial liberalization decreases productivity and growth disproportionally in manufacturing industries which are skill-or R&D-intensive.