GLOBALIZATION, FINANCIAL DEVELOPMENT AND INCOME INEQUALITY

We analyse 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 that globalization changes income for both borrowers and lenders in the same direction. However, the poorer is the financial institution, the greater its effect for entrepreneurs and the smaller for lenders. We also examine the effect of financial development and globalization 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.