Question

Over the past three decades inequality has increased in the world, and it has caused a lot of billionaires and poor to emerge all over the world. Some economists believe higher inequality has raised overall saving of the world as billionaires can save lots of money. How do you analyse the impact of this on the bond markets of strong economies?

Answer 1

How could financial development affect inequality?
There is considerable evidence that financial deepening contributes to less poverty and
inequality, even though theoretical work provides conflicting predictions. A number of models imply that financial development enhances growth and reduces
inequality. It has been argued that financial imperfections, such as information and transactions
costs, affect particularly the poor who lack collateral and credit histories. Thus, it is likely that abating credit constraints will benefit the less-privileged, enhance the efficient allocation of
capital and reduce income inequality through increased credit availability of poor individuals
with productive investments. In other words, financial development should benefit the poor both by improving the
efficiency of capital, and thus economic, allocation and by alleviating credit constraints which
disproportionally restrain the poorer parts of society, thereby reducing income inequality.
Conversely, other theories predict that financial development primarily benefits the
wealthier parts of society. This view is based on the idea that poorer individuals rely on informal
(family) connections for fund raising, which means that a larger formal financial sector more
extensively benefits the privileged. For instance, the model developed by Greenwood and
Jovanovic (1990) predicts a nonlinear relationship between financial development and income
inequality that depends on the level of economic advancement. In their model, financial
development helps improve the allocation of capital, generates economic growth, and thus helps
the poor – independent of the stage of economic development. The distributional effect of
financial development, however, depends on the level of economic development. At low levels
of prosperity, only the wealthier parts of society can afford to access and directly benefit from
financial development. Only after a certain threshold of economic development, more
individuals can access financial markets and thus a larger proportion of society benefits from
financial deepening. It is worth stressing that the positive correlation between finance and
inequality for very low level of income is difficult to detect in our database, which has very
limited coverage of countries at the early stage of financial development.
More recently, alternative theoretical justifications help to understand the link between
finance and inequality in more advanced and financially developed economies. Stiglitz (2015)
argues that the excessive remuneration of management and lenders’ rent extraction may have
been at the centre of the recent increase in inequality observed in a number of developed financial
systems. This theory seems to postulate that any link between more finance leading to more
inequality might have asymmetric underpinnings across the financial structure and the
distribution of income. First, market finance more than bank finance might be the culprit.
Second, the derived increase in inequality could lie in the increased share at the top of the income
distribution.