Tobias Axelsson

This article examines why some economies sustain large financial sectors without experiencing the negative effects on economic performance predicted by the finance-threshold literature. It analyzes South Korea and Taiwan during their economic transformations from the 1960s to early 2000s, combining descriptive statistics on financial depth (private credit-to-GDP) and economic shrinking (years of negative per capita GDP growth) with a structured, comparative-historical analysis of financial sector characteristics. The study makes two contributions. First, it documents how both economies sustained strong economic performance despite credit ratios well above the commonly cited threshold of 100% private credit-to-GDP during their economic transformations, while displaying significant differences in terms of the nature of their financial sectors. Second, it develops a theoretical perspective suggesting that the relationship between finance and economic performance is shaped by a country’s resilience to economic shrinking (defined as the ability to avoid or recover from negative per capita growth episodes), which in turn is associated with its social capabilities (following the existing literature that defines this as the state of inclusion, transformation, autonomy and accountability in a country). This perspective reframes the finance threshold as context-dependent rather than universal, offering a historically grounded interpretation of when financial expansion helps or harms economic performance.