The Long-run Effect of Financialization and Labor Market Institutions on Inequality, Investment, and Growth : Panel Cointegration Approach

This dissertation analyzes the long-term effect of financial and labor market institutions on inequality, investment, and growth. Prior to this analysis, I examine the dynamic evolution of capitalism in terms of growth, employment, and inequality using cluster analysis in the first section. My investigation shows that the type of capitalism in most European countries differs from Anglo-Saxon capitalism since the 1990s. This distinction is relatively stable over time despite globalization and rising inequality around the world. However, compared with European countries, East Asian and emerging economies have shown a more dynamic evolution of capitalism over time. Korea, Japan, Russia, and Brazil have converged to AngloSaxon capitalism, which is characterized by slow growth and high inequality while Taiwan converged to Northern European capitalism, which is characterized by moderate growth and low inequality over time. The reason for these different evolutions between European countries and emerging countries might be that path dependency or institutional complementarity are relatively weak in emerging economies than in European countries due to the relatively short history of capitalism in the former. The second section investigates the long-term effect of financialization, financial development, and labor market institutions, such as minimum wage and union density, on inequality, investment, growth, and consumption using data of Organization for Economic Cooperation and Development (OECD) member countries since the 1970s. I used various measures of financialization and financial development. Labor market institution variables are used to test arguments on wage-led growth theory. To investigate the long-run effect of these variables, I used panel cointegration approach. Results of estimation show evidence of cointegration between financial and labor market institutions and each economic outcome such as inequality, labor income share, investment, growth, and consumption. Group mean fully modified ordinary least squares (FMOLS) results, which is robust of endogeneity problem, show that high dividend tendency in the nonfinancial corporations is positively correlated to inequality in the long run. It also shows that financial globalization is negatively correlated to private investment and financial development is positively correlated to private investment in the long run. Results of panel vector error-correction model (VECM) show the existence of unilateral Granger causality from financial globalization to private investment. No direct effect of financialization and financial development on growth is observed, but their indirect effect occurs via private investment. However, estimation results for labor market institutions suggest that they are not robustly correlated to macroeconomic outcomes in the long run. This condition is not in accordance with the findings of proponents and critics of wage-led growth. No robust evidence exists to show that increasing minimum wage and union density, which are representative policies for wage-led growth, are correlated to inequality and labor income share in the long run. Similar to what wage-led growth theory posits, there is weak evidence that the increase of minimum wage is related to the increase of private consumption in the long run. However, these results are not robust to the change of specification. Similar to criticism of wage-led growth theory, there is weak evidence that an increase in minimum wage and union density is related to a decrease in private investment, but these results are not robust to the change of specification either. Estimation results of this study suggest that the empirical basis of both support and criticism for wage-led growth theory is weak.