Finance-Inequality Nexus: the long and the short of it

Abstract

Financial development affects income inequality differently in the short and in the long term. Investigating OECD countries from 1870-2011, we find in the short run, an improvement in financial development tends to reduce inequality, while in the long run, more finance contributes to more inequality. The short-run effect concurs with theories advocating financial development increases the availability of financial services, primarily for the poor. However, this effect becomes nil within a few years. Results thus imply that policies aimed at reducing inequality through improving access of the poor to finance need to be carefully designed to ensure longevity of impact. (JEL O15, O16, D31, G20, E44) I. INTRODUCTION The finance-inequality nexus has been the subject of extensive discussions for a long time (e.g.,

Corporate governance and wealth and income inequality

“…For 14 OECD countries over the 1992–2014 period, Köhler et al (2019) find that financial liberalization—the opening of domestic financial markets to foreign capital—and the financial payments of nonfinancial corporations (NFCs) exert a downward impact on the wage share that is of comparable magnitude to the effects of globalization. Makhlouf et al (2020) investigate the short‐ and long‐term effects of finance on inequality for a sample of 21 OECD economies over 1870–2011. Their results show that whereas financial development tends to reduce inequality in the short run, financial deepening leads to more inequality in the long run.…”

Two faces of financial systems: Provision of services versus shock-smoothing

“…All in one, we obtain a clear dichotomy of the roles markets and banks play: banks protect developing economies from exogenous shocks while markets promote growth in better-developed economies. Dissecting the market size measure into total capitalization (measures the ability of firms to obtain funds 3 Similar approach is used in Demirgüç-Kunt et al (2013) and Makhlouf et al(2020) although their focus is different from ours; in particular they do not study the shock-smoothing role of financial systems.…”

“…Finally, financial volatility such as the global financial crisis in 2008, may affect the nexus between financial system and growth, thus we re-estimate the model using bank z-score as a proxy of financial stability (Sahay et al 2015) and, separately, stock price volatility as an alternative proxy (Makhlouf et al, 2020). The source of both measures is Global Financial Development.…”