A theory of financial inclusion and income inequality

Gerhard Kling* (Corresponding Author), Vanesa Pesque-Cela, Lihui Tian, Deming Luo

*Corresponding author for this work

Research output: Contribution to journalArticle

Abstract

We develop a theory linking financial inclusion, defined as access to formal loans and financial assets, to income inequality. Initial inequality of households is modeled by a random variable determining initial endowments. These initial endowments can be used to invest instantaneously in human capital and financial assets. Human capital translates into income based on a strictly concave production function, suggesting optimal levels of investment. Financial assets earn yields which do not depend on the amount invested by individuals. Theoretical predictions are tested using the China Household Finance Survey (CHFS) for 2011 and 2013. Initial conditions modeled by a random variable are replaced by an actual distribution of income or assets to derive theoretical predictions regarding the proportion of the population that might benefit from financial inclusion. Financial inclusion does mitigate under-investment in education - but formal loans do not contribute. Income inequality worsens if households rely on formal or informal loans, whereas access to bank accounts improves households’ prospects in the future income distribution. However, households below the 40th percentile of household income do benefit from informal loans.
Original languageEnglish
Number of pages21
JournalEuropean Journal of Finance
Early online date21 Jul 2020
DOIs
Publication statusE-pub ahead of print - 21 Jul 2020

Keywords

  • Financial inclusion
  • income inequality
  • theory
  • education
  • theory of financial inclusion
  • CAPITAL ACCUMULATION
  • CHINA
  • GROWTH
  • SAVINGS
  • OCCUPATIONAL CHOICE

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