“If… the ‘services’ of a landlord or hedge fund manager are treated as productive, they magically become part of GDP.” (Mazzucato 2018:97).

SDG10 and the Financial System

One of the Sustainable Development Goals (SDG) is number 10: Reduce inequality within and between countries. Like many other SDGs, it is ambitious and ambiguous. Is there an ‘optimal’ inequality, as many economists claim? What are proper indicators of inequality and should it be on income or wealth or both? Among the many questions, one seems to be lacking: what is the role of the International Financial System (IFS) in relation to inequality? Careful reading of the SDGs shows that the role of finance is confined to a couple of statements about strengthening the capacity of financial institutions and their regulation (SDG#8-10), expanding financial services and assistance (SDG#8-11-13-15-17) and reduce illicit financial flows (SDG#16). But recent investigations provide evidence that it is the very set-up of the IFS which is contributing to the inequality in income and wealth in the world – and its increase.

Conventional wisdom among economists is that credit creation tends to reduce income inequality, as it facilitates the realization of business opportunities. This is borne out by several econometric analyses of aggregate data on finance and inequality. For instance, Beck et al. (2007) find, in an econometric analysis of incomplete sets of aggregate data for the period 1960-2005, that about one-third of changes in inequality measures can be explained by the change in Private Credit (the other two third stemming from aggregate GDP-growth). However, apart from the need for an update, the use of ‘total credit to the private sector’ as a proxy for financial development is questionable. Not surprisingly, other and more recent analyses show mixed findings (e.g. Kus 2012).

Bezemer and Samarina (2016) find that, once the credit is divided into bank lending for non-financial economic sectors and bank lending to real-estate markets in the form of mortgages, the data tell a different story. They start their analysis with the hypothesis that the debt shift, i.e. the shift in bank credit allocation from nonfinancial business towards household mortgages, is an important factor in explaining income inequality. It turns out that mortgage household credit correlates significantly positively with the income inequality measured as Gini-coefficient for a sample of 40 countries in the period 1990-2013, whereas business credit correlates significantly negatively. Because in this period the credit for non-financial sectors has hardly risen whereas credit for household mortgages has nearly doubled as fraction of GDP (the above-mentioned debt shift), there is clear evidence that the money creation by commercial banks has contributed to increasing inequality.

A second line of research offers a more qualitative, inference-based analysis of the processes in the IFS in the last decades (Hodsgon 2013). Two mechanisms for the relation between credit creation and inequality are proposed. A first, positive feedback loop is: money creation by commercial banks for mortgages causes real-estate prices – mostly dwellings – to increase, which leads to high profits for investors who, in turn, reward excessively paid fund managers to spur further credit creation. A second, also positive feedback loop stems from the higher debts of households which decrease discretionary income and stimulates, given a keeping-up-with-the-Jones kind of imitation, credit creation. Both loops, in combination with other psychological mechanisms, tend to accumulate money in the hands of small groups of bankers, managers and CEOs. Both mechanisms are, implicitly, part of the econometric analysis of Bezemer and Samarina (2016) and are corroborated in a series of illustrative simulation experiments (Van Egmond and De Vries 2019).

Another set of statistics suggests that inequality has also increased due to yet another, third mechanism: tax evasion. Very wealthy people and large corporations have ample opportunity to escape tax payments, Apart from the moral aspect of benefitting from public services without the due contribution, the mechanisms of tax evasion by wealthy individuals and the profit-shifting by multinationals is another determinant of rising income and wealth inequality, as Zucman (2015) has shown in his book Hidden Wealth of Nations. In Europe alone, tax evasion by individuals may amount to a lost tax revenue of 75 bln $/yr. US corporations managed to book 20% of their profits in offshore tax havens and even 50% of profits made outside the US. Indeed, the Netherlands plays with the thousands of intermediaries in its jurisdiction an important role in facilitating these huge money transactions, for corporations as well as for wealthy sportspeople, artists and dictators (Kleef et al. 2013). According to Zucman, it’s high time to start up a World Financial Register for more transparency and for a reform of the corporate tax regime in the US. It is a similar but more activist call for change than Shiller did in his 2012 book Finance and the Good Society.

One general aspect in all three research strands is that basic asymmetries in access to the financial system, in terms of understanding and affordability, systematically put the poor at a disadvantage. This is true for the low-income consumer to whom intransparent loans are offered, for the millions in poor countries where elites are facilitated in siphoning off state revenues, and for the workers in a globally competitive world who are unable to maintain their share in the rise of productivity (Kunieda et al. 2014, Panico and Pinto 2018).

Given these insights, how is it possible or defensible to formulate a lofty goal about reducing inequality without a thorough analysis and associated policy recommendations of the ways in which the existing structure of the IFS operates – and aggravates inequality? A good start would be to propose more relevant research, with an explicit focus on socio-economic feedbacks and on the power position of the banking sector, and indicators for SDG number 10 which account more explicitly for those dynamic and political features. Most other SDGs will benefit in turn from such an endeavour, as they are in one way or another related to the structure of the (I)FS.

This article has been published as: Vries, B. de (2019). Inequality, SDG10 and the financial system. Global Sustainability 3 june 2019, e9

Literature:

Beck, T., A. Demirgűç-Kunt and R. Levine (2007). Finance, Inequality and the Poor. Journal of Economic Growth (2007)12:27-49

Bezemer, D. & Samarina, A. (2016) Debt Shift, Financial Development and Income Inequality in Europe. SOM Research Reports; vol. 16020-GEM. University of Groningen, SOM research school.

Egmond, N. van, en B. de Vries (2019). Modeling the dynamics of the financial-economic system: understanding the current ‘money as debt’ crisis. Journal of Banking, Finance and Sustainable Development

Egmond, N. D., and B. J. M. de Vries (2023). Reforming the Eurozone financial system: A system-dynamics approach. International Review of Financial Analysis 93(2024)103192

Hodgson (2013). Banking, Finance and Income Inequality. PositiveMoney (https://positivemoney.org/2018/01/inequality/)

Kleef, J. van, H. Smits en M. van Geest (2013). Het belastingparadijs. Atlas Contact, Amsterdam

Kunieda, T., K. Okada, and A. Shibata (2014). Finance and inequality: How does globalization change their relationship? Macroeconomic Dynamics 18(5), 1091–1128.

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Panico, C, and A. Pinto (2018). Income Inequality and the Financial Industry. Metroeconomica 2018:69:39-59

Shiller, R. (2012). Finance and the Good Society. Princeton University Press, Princeton

Zucman (2015). Hidden Wealth of Nations.  University of Chicago Press (http://gabriel-zucman.eu/hidden-wealth)