Abstract
AbstractWe build a heterogeneous firms model with firm‐specific wages and credit frictions to study the role of financial development for inequality in the global economy. If there are many small (non‐exporting) firms, better access to external funds reduces wage and profit inequality as well as unemployment. In contrast, if there are many large (exporting) firms, financial development might have opposite effects – especially if trade costs are low. In summary, the implications of financial development for inequality depend on the size distribution of firms and on the costs of exporting. Trade liberalization, however, raises inequality unambiguously.
Highlights
Financial markets have grown rapidly over the last decades, especially in high-income countries
While better access to external finance exerts ambiguous e↵ects on wage inequality in general, we show that financial development reduces inequality if there are relatively more small firms
Turning to the e↵ects of financial development, we find that lowering agency costs generally has ambiguous e↵ects on wage inequality in the open economy
Summary
Financial markets have grown rapidly over the last decades, especially in high-income countries. Credit frictions a↵ect the distribution of firms by excluding the least-productive enterprises from external finance and entry This mechanism is in line with empirical evidence that small firms benefit most from financial development. Financial development is modelled as a reduction in agency costs such that lowproductivity firms get access to external finance to enter the market. Financial development leads to firm entry and a lower unemployment rate, but has no e↵ect on the ratio between average and marginal wages in our model. While better access to external finance exerts ambiguous e↵ects on wage inequality in general, we show that financial development reduces inequality if there are relatively more small (low productive) firms. Financial development amplifies wage inequality, if the size distribution of firms is more homogeneous and the costs of exporting are low
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