This article investigates the role of financial liberalization as a determinant of income inequality, both theoretically and empirically. The authors focus on two financial liberalization policies: lowering the reserve requirement of the banking sector and decreasing international capital controls. A tractable economic model features heterogeneous agents with different investment abilities. Only high-ability agents borrow and invest; others save. Profitability is fully reflected by the levels of financial liberalization and financial development. Savers and investors generate different levels of income, implying income inequality. The proposed model predicts that financial liberalization, in the form of reserve requirements, can lower income inequality, if the overall degree of financial liberalization is not too high. Moreover, financial development helps spread the proceeds of financial liberalization equally across the income distribution. However, in financially liberalized economies, further liberalizations will have a negative effect on income distribution. A cross-country empirical analysis supports these theoretical findings.
Baumann, S.; Lensink, R. Financial liberalization and income inequality: channels and cross-country evidence. (2013) 40 pp.