Godechot, Olivier. 2020. “Financialization and the Increase in Inequality” in:

Recent literature provides substantial evidence that the growth of financial activity has led to more inequality in market societies in recent decades. The most obvious channel is that financial market activity, fuelled by an ongoing process of financial deregulation, created a niche with very high wages. In those niches, financiers exercise a “hold up power” over their firm: they appropriate key assets (knowledge, teams and clients) and can move them or efficiently threaten to move them to a competitor offering higher wages. This bargaining power increases the finance wage premium gap and is sufficient to produce, on its own, a sharp increase in wage inequality. Other channels also indirectly affect inequality beyond the financial sector. The growing submission of non-financial firms to shareholder value imperatives increases within-firm inequality. Households investment in financial securities and moreover their growing indebtedness have contrasted effects. Inequality fuels in return, however in modest proportion, securitization and indebtedness. Two major evolutions of capitalism marked the two decades preceding the global financial crisis: financialization and a severe increase of inequalities. On the one hand, finance has a growing hold on economic activity, both directly, as shown by near doubling of its share of GDP (moving hence from 5 to 8% in the United States between 1980 and 2007), and indirectly by transforming the management of firms and the savings of households. On the other hand, inequalities in income, wealth and even more wages increased sharply in developed countries, with the top 0.1% of the highest paid workers in the United States tripling their share of income, from 1.6% in 1980 to 5% in 2007. The temporal coincidence of these two transformations did not go unnoticed. On the one hand, social movements such as Occupy Wall Street accused finance of being the main vector for increasing inequality. On the other hand, some have also argued that rising inequality was at the root of the 2008 financial crisis: faced with the obvious enrichment of the elite, modest US households reportedly tried to maintain their position by resorting massively to debt. Does this temporal coincidence imply correlation? Does correlation imply causality? And, if there is a causal link between the two trends, what is its direction? This chapter summarizes recent literature that has studied the link between finance and inequality. It will provide substantial evidence that the growth of financial activity led to more inequality in market societies in recent decades. The most obvious channel is that financial market activity, fuelled by an ongoing process of financial deregulation, created niches with very high wages for some of its professionals. Indeed, in those niches, financiers acquire a “hold-up power” over their firm: they appropriate key assets (knowledge, teams, and clients) and can move them or efficiently threaten to move them to a competitor. This enhanced bargaining power increased the finance wage premium and can already produce on its own a substantial increase in inequality. Other channels, more indirect, also count. The growing submission of non-financial firms to “shareholder value” imperatives increases within-firm inequality. Households’ investments in financial securities and, moreover, their growing indebtedness have contrasting effects: the development of credit cards and subprime mortgages enabled lower-income households to access credit. However, this access comes with higher risks of over-indebtedness and higher financial costs than for higher-income households. Finally, it can be seen that inequality conversely contributed (albeit modestly) to financialization, through increased securitization as well as growing indebtedness via “keeping up with the Joneses” mechanisms. More Finance, More Inequality Cross-country Evidence The growth of finance and the growth of inequality are clearly correlated in developed countries. Many studies have documented this phenomenon for OECD countries with various aggregate measures of national inequality and of financial activities, such as volume of stocks traded, bank profitability, and securities under bank assets (Kus 2012), capitalization and financial incomes of non-financial firms (Dünhaupt 2014), credit intermediation and capitalization (Denk and Cournède 2015), capitalization and finance’s operating surplus (Flaherty 2015), and size of the FIRE sector and of its labor force (Roberts and Kwon 2017). In my own research (Godechot 2016), which I will summarize below, I offer a systematic comparison of the relative impact of a set of measures of financial activities on a set of measures of inequality. My study focuses on 18 OECD countries for which I have measures of both inequality and financialization.1 As dependent variables I used the OECD income inequality decile ratios such as the ratio of the median to the bottom 10% threshold (i.e. D5/D1), the ratio of the top 10% threshold to the bottom 10% threshold (i.e. D9/D1) and the ratio of the top 10% threshold to the median (i.e. D9/D5), and from the World Top Income Database the top 10%, 1%, 0.1% and 0.01% of income shares. The increase in inequality over my sample has been general and obvious from 1980 to 2007: the ratio D9/D1 multiplied by 1.1, moving from 2.9 to 3.2, the top 1% income share multiplied by 1.6, moving from 6.5% to 1 I used the following countries: Australia, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom, and the United States. The top 0.1% share is not defined for Finland, nor is the top 0.01% share for Finland, Ireland, New Zealand or Norway. 2 Cf. http://topincomes.parisschoolofeconomics. eu/ 10.2% and that of the top 0.01% multiplied by 2.7, moving from 0.5% to 1.4%. As a first proxy, financialization can be measured using the evolution of the share of the financial sector (comprising both finance and insurance) in economic activity (i.e. GDP), as reported in industry national accounts gathered and standardized by the OECD. Three arguments support this approximation. First, the most iconic financial transformations of financialization (like the financial markets boom) occurred precisely in the finance sector. Second, most financial transformations taking place outside the financial sector also translate into financial transactions and therefore contribute to the value added of this sector. Third, the finance and insurance sectors have the advantage of being more precise than the often used “FIRE” sector – finance, real estate and service to business – (Krippner 2005; Flaherty 2015; Roberts and Kwon 2017) which also includes many subsectors unrelated to finance. Looking across the 18 countries, financialization has no effect on inequality at the bottom of the income hierarchy (i.e. D5/D1 ratio) but it drives inequality at the top: an increase in the share of finance in GDP by one standard deviation increases the top 10% share by 0.12 standard deviation, the top 1% share by 0.23, the top 0.1% share by 0.28 and the top 0.01% share by 0.41. To put this another way, if one focuses on the 1980–2007 sequence of rising inequality, based on my regressions, one can estimate that one fifth of the increase of the incomes of the top 1%, one quarter of that of the top 0.1% and fully two fifths of that of the top 0.01% share can be attributed to the increase in the size of the financial sector (Table 34.1). These first results show that the impact of the size of finance on inequality grows stronger as one moves up the income distribution scale. It increases the income gap between the top and the very top much more than the gap between the middle and the bottom strata. Table 34.1. Contribution of Financialization to the 1980–2007 Period of Increasing Inequality in 18 OECD Countries 198