Financial openness, capital rents and income inequality

Abstract

This study presents an institutional analysis using a dynamic overlapping generations model with capital rents and technological change to assess the impact of financial reforms on income inequality. We contribute to the growing research by examining the hypothesis in which capital rents are the underlying cause of income inequality resulting from financial openness, through changing the relative market power of capital and financial market structure, which affects investment activities. We find that i) in a closed economy, income inequality rises as capital rents decrease; ii) in a small open economy, income inequality falls when the capital rent ratio between entrepreneurs and investors increases; and (iii) financial openness can amplify the effect of technological changes on income inequality, although the ultimate effect is nonlinear. These findings provide valuable insights for further research and for policymakers to adjust capital rents in the interest of reducing income inequality.