New IMF study explores links between finance and inequality

If you support a free market, or mixed economy, you should be comfortable with a certain amount of inequality. Having said that, searing disparities, such as those that disfigure South Africa's body politic, are clearly legitimate causes for concern.

Inequality is again in focus at the moment with gazillionaires descending on Davos, and Oxfam reporting that the world's 22 richest men have more wealth than all of the women in Africa. 

Against this backdrop, the International Monetary Fund (IMF), has published one of its periodic “staff discussion notes”, this one focused on the role of the financial sector in reducing or increasing inequality. 

The paper looked at three broad issues: Firstly, does greater financial depth – essentially, the size and sophistication of the financial sector – curb or exacerbate inequality? Secondly, does greater financial inclusion lower income inequities within countries? Finally, the study examined the relationship between financial stability and income inequality.

On the first question, the researchers found that:

“Initially, financial depth is associated with lower inequality, but only up to a point, after which inequality rises. As other researchers have pointed out, at high levels of development, deeper financial systems are associated with a surge in top incomes and financial sector rents.”

In other words, certified financial analysts, fund managers, investment bankers and the like make money by the bakkie-load. Most other professions, not so much.

On the question of financial inclusion, the study unsurprisingly found that “greater financial inclusion tends to be associated with reductions in inequality”. It notes that in Sweden, which has one of the most even distributions of income in the world, the percentage of people with bank accounts was unchanged between the rich and the poor. This is not the case in countries with high levels of inequality. The authors mention Indonesia, but South Africa readily comes to mind.

The study also found that extending financial services to women has a greater impact on this front than it does for men. “Both men and women benefit from financial inclusion, but the effect for women’s financial inclusion is quantitatively larger.”

Looking at the issue of financial stability, the study found, “higher inequality is associated with greater financial risks. When inequality increases, credit tends to rise. For example, in the United States, too much credit, including to lower-income households, contributed to the 2007–08 crisis.” This may sound familiar to a South African audience, where social as well as financial stability is threatened by the growing debt burden of the poor. The rise of the Association of Mineworkers and Construction Union and labour unrest on the platinum belt have been linked to such trends.

For South African policymakers, one should point out – perhaps surprisingly – that the study also found that, “expansions in credit-related aspects of inclusion that favour small firms lower the overall risk of credit allocation. A pro-small-firm bias in expanding financial inclusion is beneficial for financial stability: The greater the increase in inclusion of small, relative to larger firms, the smaller the change in riskiness.”

So lending to small businesses can help stabilise the financial sector. The really big banks certainly played an outsized role in the global financial crisis a decade ago.  

It is also worth noting that inequality in itself appears to be a threat to financial stability and obviously the wider economy, and society, as well. Sadly, with an economy that is barely growing and unemployment on the rise, South Africa's already glaring disparities of wealth and income look set to widen even further. Combine that with credit rating downgrades and soaring debt levels, and you have the recipe for a potential financial crisis. Clues to an impending one may be detected in where, and how much, credit is being extended, so watch that space. BM