Seminar 15 September 2014

Globalization, Financial Development, and Income Inequality.

Abstract

We analyze the effect of financial development and globalization (i.e., the reduction of trade costs) on income distribution when a financial institution is imperfect. Financial imperfection creates income inequality, by benefiting borrowers (entrepreneurs) and harming lenders through its effect of lowering the capital rental rate. We show among others that globalization changes income for both borrowers and lenders in the same direction. But its effect is greater for entrepreneurs and smaller for lenders, the poorer is the financial institution. We have examined the effect of financial development and globalization also in an enriched model where individuals are different in their abilities as well as their capital endowments. We show that financial development mitigates capital misallocation while the reduction of trade costs will not improve efficiency.