Financial Globalization and Inequality
by Joseph Joyce
Financial Globalization and Inequality
The global financial crisis slowed the pace of financial globalization, while the impact of the pandemic on its future course is unclear. But enough time has elapsed to assess the record of integrated financial markets that greatly expanded in the 1990s and early 2000s. The evidence on one issue—financial openness and inequality—is clear: financial globalization has increased inequality.
Enrico D’Elia of the Italian Ministry of Economy and Finance and the Italian Institute of Statistics (ISTAT) and Roberta De Santiss, also of ISTAT, analyzed this issue in their 2019 working paper, “Growth Divergence and Income Inequality in OECD Countries: The Role of Trade and Financial Openness.” They used an error-correction model to differentiate between short- and long-run effects on the Gini index, and divided the OECD countries into low-, middle- and high income over the period of 1995-2016. Increases in financial integration, as measured by foreign assts and liabilities scaled by GDP, increased income disparities in both the short- and long-run in the total sample. In the long-run there is a negative effect on the Gini index within the low-income countries, but there is a much larger positive impact within the high-income group. They attribute this finding to the advantage that the financial sector derives from financial innovation in those countries. In their results relating to growth, they reported that financial openness had a positive impact on the economic growth of the middle-income group alone, and it only occurred in the short-run.
Xiang Li of the Halle Institute for Economic Research and Dan Su of the University of Minnesota investigated the impact of capital account liberalization in their 2020 article, “Does Capital Account Liberalization Affect Income Inequality?” in the Oxford Bulletin of Economics and Statistics. They used several measures of capital account openness, and both Gini coefficients and the income shares of different groups as their measures of inequality in samples of OECD and non-OECD countries. In their panel data analysis, they found that capital account liberalization had positive impacts on the Gini coefficients in the non-OECD countries, but not the OECD sample. They also found that capital account liberalization increased the income share of the top 10% of households. They reported similar results from a difference-in-differences analysis.
Philipp Heimberger of the Vienna Institute for International Economic Studies offered a summary of the empirical analyses of economic globalization and inequality in his paper, Does Economic Globalisation Affect Income Inequality? A Meta-analysis, which was published in The World Economy in 2020. He undertook a meta-analysis of 123 peer-reviewed papers and a meta-regression empirical analysis. In his results he found that financial globalization has had a sizeable and significant inequality-increasing impact, which is not true of trade globalization. Moreover, this result holds for advanced countries as well as developing nations.
The evidence, therefore, seems clear: increased capital flows do lead to more income inequality. But what are the channels of transmission? Barry Eichengreen of UC-Berkeley, Balazs Csonto and Asmaa A. El-Ganainy of the IMF, and Zsoka Koczan of the European Bank for Reconstruction and Development investigate this issue in their IMF working paper, “Financial Globalization and Inequality: Capital Flows as a Two-Edged Sword.” They point out that the various types of capital flows will have different effects and review the separate impacts to explain why inequality increased in both advanced and developing economies.
In the case of inward FDI in developing economies, the inflow of foreign capital could increase the return to labor. But, the authors point out, if capital substitutes for labor or works with skilled labor, then wage inequality will increase amongst laborers. This effect will be magnified when foreign capital flows to sectors that are dependent on external capital and are also complementary with skilled labor. Similarly, outward FDI reduces the demand for less skilled labor in the home countries of the multinationals responsible for the FDI. The outflows can also lower the bargaining power of labor in those countries.
The authors also examine portfolio capital, which can have many of the same distributional consequences as FDI in the host countries. Moreover, inflows of portfolio capital can lead to increased macroeconomic and financial volatility, and culminate in crises. Aggregate volatility heightens inequality because the poor suffer more the effects of economic downturns. In addition, portfolio flows can lead to increased demand for assets and higher prices. A rise in housing prices helps their owners, and the distributional impact depends on the pattern of ownership. In the case of higher stock prices, the benefits flow to stockholders who almost always are located in high-income households.
FDI, portfolio capital and bank flows also affect tax payments. Multinationals can use financial centers with low tax rates to minimize their tax liabilities across nations. Portfolio and bank flows can be used by the rich to shelter their asset holdings to avoid taxes. The loss of tax revenues decreases the ability of governments to deliver services that may benefit poorer households.
What can be done in the face of these impacts on income inequality? The authors of the IMF paper point out that adverse consequences are lessened when there are higher levels of educational achievement in the population. More educated workers benefit from the increased skill premium paid by multinationals. Capital flow measures can be used to control short-run inflows that can lead to “sudden stops” that overwhelm domestic financial markets.
A multilateral initiative seeks to reform the tax treatment of multinationals to avoid base erosion and profit shifting (BEPS) that result in lower tax revenues for governments. The OECD has organized negotiations amongst governments to coordinate the tax treatments of multinational firms. The OECD proposals have two sections: the first deals with the allocation of the right to levy taxes on corporations by nations and the second would establish a minimum global tax. These issues are particularly relevant for digital companies that have minimum physical presence in many countries where they do business. U.S. Treasury Secretary Janet Yellen has announced that the U.S. would reverse its position under the Trump administration and engage in these talks.
Finance, if designed properly, need not be exclusionary. Indeed, in some countries financial inclusion has helped low-income households to increase their living standards. International financial flows are not the only cause of increased inequality, but they have played a role. International finance in all its forms can have adverse consequences and governments need to acknowledge these and plan to offset them if/when financial globalization resumes.
Who would have thunk it?
Finance is my name and global price arbitrage is my game.
Yep. Still works. Post again and the dog barfs up its last meal along with the new post.
Ron:
I suck at interpretations, A degree of clarity please. I noticed my commenting here is slow. With the old circle going on for several seconds till the comment posts.
Run,
No change. I post only to return later to nada. Then I post again and it all shows back up. Magic. Yet this is the only trick the dog knows.
ok, thank you.
Run,
BTW, posting is usually fast, less than 2 seconds for me since I drowned my old keyboard and had to buy a new laptop. Now I am using Edge and McAfee on a Lenovo Core i3 10G. Was using Firefox and Kaspersky on a Dell Core i3 Inspiron 3000.
Ron:
Thank you. I am on an old Gateway I5 desktop which I upgraded the ram to 12GB. I use a gaming keyboard as I was having issues with USB ports till MS fixed their programs then I was fine. My traveling laptop is a solid state drive I7 Samsung and light weight. Your laptop is probably faster than my old desktop (a decade).
I noticed the slow down on posting comments and mentioned it. Thank you for the feedback.
Run,
I just returned from mixing up 72 pounds of bagged dry cat food into a trash can, my custom blend of 28 pounds 9-lives complete with 44 pounds special kitty outdoors. When I displayed this thread there were no comments (0) on the tread. After posting “Dog is hounding me again,” then there was magically 7 replies on “Financial Globalization and Inequality.” Between my prior last comment and returning 37 minutes had elapsed. I have seen the same occur overnight.
Ouch! These comments should have been about financial globalization instead of the comments eating hound.
Although a well written article there seems to be some disconnect between the reality of financial globalization that is closely coupled with arbitraged “financialization” that is pervasive in global production of goods via channels of IP rents and offshore partnerships, IOW rentier industrial capitalism. FDI can play a pervasive role in herding EMs into the arms of their first world overlords. The US has come a long way since the foreign aid of the Marshall Plan by taking the government out of the way of corporations exploiting low income nations for their own profits. The EM’s that had the foresight to engage corporate America in rent sharing arrangements have done the best by far.
The EM’s that had the foresight to engage corporate America in rent sharing arrangements have done the best by far.
[ Please explain this important argument further. What would be the examples?
This essay is worth considerable thought and comment. ]
While the Marshall Plan was a superb investment spur even through the 1960s, American foreign investment would become increasingly limited as a development spur from the 1970s. Chinese foreign investment has in turn becomes an increasing development spur since the 1990s and especially so with coming of the Belt and Road Initiative.
Branko Milanovic looks at the BRI as a form of Marshall Plan.
Also, as the Chinese financial sector is being built, investment from the sector is being expressly directed to domestic development. The Chinese financial sector has been critical in successful efforts to end severe poverty, and even now is being directed to strengthen this focus. This was the prime reason for the limiting of Ali Baba or Ant financial for several months; the finance efforts of the company are being carefully regulated to directly contribute to development.
Again, I think this post quite important and worth considerable discussion.
Anne,
Back in the day (so to speak) China partnered with US firms (e.g., GE, US auto makers, Intel) that were providing patents and capital FDI while gaining access to US markets and also providing those partnered US firms access to markets in SE Asia. Well that was then and this is now. Now China has overtaken the US in developing patented technology and needs partnerships with US firms less and less. Trump worked out some deals with China that have softened the blow to US firms, but US dominance in both finance and product development is coming to an end. China made itself a partner in the market making and rent taking instead of just allowing itself to be exploited..
Ron:
Your comment was always here. I read it a while back.
The un-un-comment of March 14, 2021 5:26 pm brought my comment in reply to Anne of March 14, 2021 3:34 pm back from the ozone. Pretty sure when I go to add the potatoes and cabbage to the simmering corned beef brisket that slimy comment eating hound dog will snarf both of the again.
Happy Saint Patties eve-eve-eve (eve cubed) to yall.
Run,
If a prior comment only shows up when a new comment is posted and then disappears again after exiting and rejoining its thread, then of course it was always there. However, it was not always being retrieved with its thread. The bug is in reading comments (presumably from cache buffer before being written to disk since eventually they become permanent instead of transient) rather than posting comments. There WAS once (or twice or more) a bug failing to post at all, but I have not seen that one for quite a while.
Ron:
Thanks and can you take this to open thread. I hate to gum up someone’s post. I will pass this along
Ron:
China has overtaken the US in developing patented technology and needs partnerships with US firms less and less. Trump worked out some deals with China that have softened the blow to US firms, but US dominance in both finance and product development is coming to an end. China made itself a partner in the market making and rent taking instead of just allowing itself to be exploited.
[ Important and interesting comment. China is emphasizing globalizing and no matter the response of the US from here, the response from developing countries is going to be highly sympathetic. The question for the US will be whether to trade fairly with and fairly invest in developing countries from here.
This was an excellent post and I wish the comments by Ron on the topic could be continued since I learned quite a bit from them even though they were limited by the posting problems. I wish this discussion could be much extended. ]