Finance and Opportunity Financial Systems and Intergenerational Persistence of Relative Incomes

We care about income distribution because … People care about relative incomes. Beyond the level of income & growth Beyond poverty

Same person with the same income Utility differs due to income distribution Person i is happier in the red economy Person j is happier in the blue economy Person i Person j

We care about income distribution because … People care about relative incomes. Beyond the level of income & growth Beyond poverty People care about poverty Beyond average income & growth. Beyond relative incomes

Same median income Poverty differs due to income distribution More people live in poverty in the red economy than the blue economy Poverty Line

We care about income distribution because … People care about relative incomes. Beyond the level of income & growth Beyond poverty People care about poverty Beyond average income & growth. Beyond relative incomes People care about growth Beyond poverty (and because of poverty)

Two Income Distributions: Different rates of growth & poverty alleviation Wider income distribution might spur growth Savings Incentives Poverty Line

Two Income Distributions: Different rates of growth & poverty alleviation So, potentially enormous benefits from: promoting growth alleviating poverty while reducing income differences Narrower distribution: Could improve resource allocation Poverty Line

But, enormous complications too … People’s policy recommendations and political philosophies depend on whether Income distribution reflects talent or parental wealth Individuals have equal opportunities Reducing income differences reduces growth We study how only one set of policies

Our message: Little research on how finance policies impact: Equality of opportunities Intergenerational income dynamics Yet, finance is a keystone in theories of intergenerational persistence. Financial frictions are key, but Financial frictions taken as fixed, unchanging Finance policies might exert a 1st order impact on: Equality of opportunities & Growth & Poverty Alleviation

How would financial reforms work? Rather than provide a balanced review of the literature, we simply advertise a few possibilities …

Finance & intergenerational persistence y(i,t) = h(i,t)*w(t) + a(i,t)*r(i,t) h(i,t) = H{b(i,t),s(i,t)}; H/b > 0, H/s > 0, H/bs > 0 Efficiency  allocate school based on brains But: s(i,t)=S{b(i,t), a(i,t-1)} Slower growth, less poverty alleviation Unequal opportunities Intergenerational persistence of relative incomes Successful Financial Reforms Reduce information and transactions costs s(i,t)=S{b(i,t)}

Finance & intergenerational persistence y(i,t) = h(i,t)*w(t) + a(i,t)*r(i,t) r(i,t) = R{e(i,t), a(i,t)} Efficiency  returns {entrepreneurial/investment talent} But: information / transactions costs  collateral / wealth Slower growth, less poverty alleviation Unequal opportunities Intergenerational persistence of relative incomes Successful Financial Reforms Reduce information and transactions costs r(i,t)=R{e(i,t)}

But, need lots more rigor & detail Specific financial policies Interaction with other policies / initial conditions Schooling Redistributive Stage of economic development Labor market Is it really schooling & entrepreneurship? How will more efficient capital allocation affect income distribution?

Turning to empirical evidence The paper provides an extensive review. Plus, this conference will present new evidence. So, we will use our own paper to: Advertise the promise of this line of inquiry Advertise directions of future work

Financial development reduces Gini

Financial development reduces poverty At median, 45-50% of finance’s reduction of poverty operates through income distribution Financial development reduces poverty

But, Better measures? Policy reforms? Financial development? Access to financial services Better identification strategies? Mechanisms?

In sum, We do not claim financial reforms are the answer. Rather, we argue that economists have not adequately addressed a central question: Do financial policies substantially affect economic opportunities & income distribution?