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Part I
Financial globalization and stability
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1 Financial liberalization and income inequality in Asia
Fengbao Yin and Shigeyuki Hamori
1.1 Introduction
Recently, the 18th National Congress of the Communist Party of China (CPC) drew worldwide attention. An opening report delivered by the party head, President Hu Jintao, signaled the next leadership’s policy priority—namely, improving the Chinese people’s livelihoods, and social structuring. The report uses the word “equality” more than 20 times, and it stresses a need “to allocate more of the fruits of development more equally throughout the nation.” The CPC has emphasized equality in society and assurance of justice as vital elements, ever since the goal of a “harmonious society” was announced at the 4th Plenary Session of the 16th CPC Central Committee. While China has experienced remarkable growth in the years since the implementation of the Chinese economic reform, the affluent in China have become even more so. According to a report by China’s Ministry of Human Resources and Social Security, in 2011, the incomes of senior company executives were 4,553 times greater than were those of migrant workers. There seems to be a serious income inequality problem associated with development in China, and a considerable body of research has examined its impact in the country.1
China is not alone in facing income inequality issues; other developing countries and regions—such as India (James, 2009), Latin America (Lopez and Perry, 2008), certain American states (Ashby and Sobel, 2008), and member-countries of the Organisation for Economic Co-operation and Development (OECD) (Smeeding, 2002)—have been struggling with this problem since the mid-1970s. According to these studies, globalization has been one of the causes of inequality. Branko Milanović, a lead economist at the World Bank, has stated that “There are at the beginning of the second decade of the 21st century hardly two more politically charged economic terms than ‘globalization’ and ‘inequality’” (Milanović, 2012, p. ix).
However, the nature of the relationship between globalization and inequality has not been conclusively defined. Some argue that globalization is an inevitable and irreversible part of economic development that generates the benefits of a global economy. Others criticize it, stating that globalization leads to inequality, threatens employment and living standards, and destroys communities and the global environment. Globalization2 has been increasingly progressing since 1980, as goods, people, money, and information started to mobilize on a large scale worldwide, due to the rapid developments in information and transportation technology, deregulation, liberalization of trade and investment, and the like. Finally, it should be noted that globalization affects the lives of people primarily through two aspects: economy and finance.
Among the most prevalent topics of interest in international economics in the recent past has been the global links between economic liberalization and growth. Doucouliagos and Ulubasoglu (2006) conduct a meta-study of 52 studies dealing with the impact of economic freedom on economic growth, and conclude that economic freedom has a robust positive effect on economic growth regardless of how it is measured. Similarly, Dreher (2006) surveys the literature and presents results based on the newly developed KOF Index of globalization, arguing that globalization as measured by this index is about growth promotion. Other relevant studies include those of Edwards (1998), Frankel and Romer (1999), and Berggren and Jordahl (2005). Rising incomes, however, have been unequally shared among the population. Bergh and Nilsson (2010), using the KOF Index of globalization and the Economic Freedom Index in panel analysis, find that the freedom to trade, social globalization, and deregulation all relate to equality, or the lack thereof. Empirical evidence is also available from Scully (2002) and Cater (2007), among others.
The general thinking is that financial liberalization stimulates growth through financial development. Indeed, empirical studies affirm these expectations. Bekaert et al. (2005) augment the standard set of variables used in economic growth research by introducing an indicator variable for equity market liberalization. They conclude that equity market liberalization leads to an approximate 1 percent increase in annual real per-capita gross domestic product (GDP) growth. Hermes and Lensink (2005) reflect on the strong and positive effect of liberalization on growth. More recently, Quinn and Toyoda (2008) show that both developed and developing economies grow more quickly in the presence of a more open capital account and more open equity markets. However, Ito (2006) finds that a higher level of financial openness can spur equity market development, but only if a threshold level of legal development has been attained, particularly among emerging market Asian countries.
Many countries started liberalizing their financial sectors in the 1980s, based on the premise that the free movement of capital would foster financial development and economic growth. Three decades later, many of these countries find themselves in rather difficult economic conditions, with income inequality at record-high levels. Although there has been growing interest in the social impact of financial deregulation in economies across the world, there has been very little empirical work addressing the distributional consequences of a liberal financial regime.3 There are many reasons for this neglect, but a notable one is that researchers have been hampered until recently by the unavailability of comparable data on inequality, poor measures of financial liberalization, and the recency of reforms in many parts of the world.
The current study aims to fill this literature gap by analyzing the relationship between financial liberalization and income inequality, and especially, it looks to assess the linkages between capital account liberalization and income inequality. The remainder of the chapter is organized as follows. In Section 1.2, we discuss the body of literature that relates to financial liberalization; the discussion in subsection 1.2.1 provides the reader with background analysis, prior to discussing the relationship between capital account liberalization and poverty. This latter discussion is undertaken in subsection 1.2.2, where the theoretical basis of the relationship between capital account liberalization and inequality is discussed. In Section 1.3, we describe how to measure inequality and capital account liberalization. In Section 1.4, we present the empirical strategy followed and the findings. We conclude, by exploring in Section 1.5, the implications and possible research extensions.
1.2 Theoretical considerations
1.2.1 Financial liberalization and poverty
The theoretical argument for financial liberalization can be traced back to the seminal contributions of McKinnon (1973) and Shaw (1973), who advocated financial market liberalization to combat financial repression, which, they argued, would in turn spur investment and economic growth. In broad terms, “financial liberalization” refers to a set of official government policies that focus on deregulating credit as well as interest rate controls, removing entry barriers for foreign financial institutions, privatizing financial institutions, and lifting restrictions on foreign financial transactions.
Several channels exist, by which financial liberalization could affect income distribution and poverty. Macroeconomic volatility is one. Kose et al. (2003) examine the macroeconomic volatility experienced by a large group of industrial and developing economies during 1960–99. They find that, on average, the volatility of consumption growth relative to that of income growth had increased in the 1990...
