Income Inequality, Financial Systems, and Global Imbalances: A Theoretical Consideration
| Published date | 01 September 2014 |
| DOI | http://doi.org/10.1111/1758-5899.12126 |
| Date | 01 September 2014 |
| Author | Li Sheng |
Income Inequality, Financial Systems, and
Global Imbalances: A Theoretical
Consideration
Li Sheng
Macao Polytechnic Institute
Abstract
This paper illustrates the effects of two major macroeconomic factors on global imbalances with regard to China as a
growing giant in the global economy. The country has observed a continuous drop in the labor income share of GDP
and a considerable rise in income inequality, giving rise to a savings glut and high investment rates. China’sinflation,
housing bubble, and capital losses in foreign markets are attributable to its rushed transition to market-based financing
and its inherent vulnerability to international capital flows. The US is also experiencing a rise in inequality, although this
rise is associated with a decline in savings as a fundamental cause of its current account deficit, whereas its exorbitant
privilege from the dollar’s reserve currency status is accompanied by increasing difficulties posed by the Triffin
dilemma. It is shown that global imbalances may be less related to misaligned exchange rates than to distorted wage
differences.
Policy Implications
•Financial losses from capital outflows into international markets are the price that must be paid for global imbal-
ances when relatively poor countries with surplus savings lend to relatively rich countries with saving deficiencies.
•Adequate social security for ordinary people will greatly alleviate pressures to save for precautionary purposes, and
lower savings will effectively reduce trade surpluses and mitigate financial losses associated with lending to foreign
economies.
•It is unwise for China to abruptly transition to a market-based financial system under a poor legal infrastructure or
to prematurely open up its capital markets while seeking exchange rate stability.
•Healthy relationships require that dominant powers not force financially underdeveloped foreign countries to fully
float their exchange rates or dismantle their limited capital controls.
Motivation and Review of Literature
The past few decades have witnessed remarkable tech-
nological progress and output growth in many countries
as a result of economic globalization. However, the
recent spectacular expansion in trade has been accompa-
nied by financial crises in not only developing but also
developed countries since the 1980s. The current crisis
exposes the severity and consequences of accumulated
global imbalances. The world economy has experienced
not only real imbalances in saving/investment and cur-
rent account positions, mirrored by net capital flows, but
also financial imbalances in soft budget constraints, large
asset bubbles, and rampant speculative activities across
borders regardless of economic fundamentals (Collignon,
2012; Pauly, 2009). The present crisis in the developed
world may presage a new era that will be less hospitable
to the growth of developing countries for two reasons:
first, global macro stability must be restored to prevent
current account surpluses or deficits from swelling fur-
ther; and second, developing countries’high growth due
to their manufacturing export expansion may no longer
be accommodated by the willingness of key developed
countries to run large trade deficits.
The inequality-saving relationship is by no means a
new subject of policy concern or academic research. The
implications of inequality for savings and growth have
been explored for at least 50 years (Kaldor, 1957; Alesina
and Rodrik, 1994). However, previous analytical and
empirical studies have not generated any conclusive or
consistent results. Consumption theory indicates that
inequality may affect household saving positively,
whereas political economy theory establishes a negative
effect of inequality on aggregate saving. This theoretical
Global Policy (2014) 5:3 doi: 10.1111/1758-5899.12126 ©2014 University of Durham and John Wiley & Sons, Ltd.
Global Policy Volume 5 . Issue 3 . September 2014 311
Research Article
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