The impact of financial development on labour share: a cross country study
Our study investigates the impact of financial development on functional income inequality. Unlike financial development and personal income inequality, this nexus has received little interest. But this nexus is equally important and requires serious exposition given the close association between personal and functional income inequality and the much documented global post 1980s increase in functional income inequality—this as revealed by trends of declining labour share.
To investigate this nexus, our study utilises a heterogenous set of mostly high and middle income countries and implements static as well as dynamic models; moreover, the study also includes a selection of factors studied in the past, technological progress, globalisation etc. as controls, and redresses issues of labour share underestimation by utilising labour share measures that include the income of the self-employed.
On our main result, it underscores that, in high income countries, financial development reduces functional income inequality whilst, in middle income countries, its impact is unclear. This finding is robust (to some extent) to different measures of financial development and labour share, as well as, to static and dynamic specifications. Hence, our results stress that loosening regulations on credit intermediation and developing incentives that boosts savings and lending in the economy has short and medium run positive impact on countering increasing functional income inequality in most countries.
On the other variables, our results suggest that, they also tend to impact countries differently. On technological progress, our results strongly suggest that, in high income countries, capital augmenting technological progress increases functional income inequality, though greater government economic involvement redresses this. In contrast, in middle income countries, financial globalisation increases functional income inequality, though, educational development reverses this.
