Financial Development And Income Gap: Evidence From China In 1978-2004

Whether financial development will decrease income gap and bring social harmony and all-around prosperity does not draw economists'enough attention in the past. Financial development and income distribution relationship was not paid attention until 1990. Greenwood and Jovanovic (1990) discuss the relationship among economic growth, financial development and income distribution in a dynamic model. They find that in the early age of economic growth, financial development will broaden income distribution gap. However, as the income increases, more people begin to enter financial market and financial development will gradually narrow down income gap, that is, the relationship between financial development and income distribution obey the reverse"U"curve. The theoretical model constructed by Galor and Zeira (1993), Banerjee and Newman (1993) suggests that financial development will shorten income gap only after financial system becomes more efficient.In China, Zhang Qi (2003) does some research on the relationship between bank credit and urban and rural income distribution in each province based on provincial data in 1978-1998. They find that the development of financial medium broadens urban and rural income gap to a great degree. The research made by Lu Ming and Chen Zhao (2004) claims that financial development level does not influence urban and rural income gap too much. Yao Yaojun (2005), in contrast, indicates that the scale and efficiency of financial development have a Granger cause-and-effect relationship; also, financial development scale and urban and rural income gap are positively correlated while financial development efficiency and urban and rural income gap, negatively.This paper tries to conduct a research in view of financial development history and reasons for income gap in China. It is found that the most critical reason of income gap in China is urban and rural income gap and regional and industrial differences are secondary. In addition, urban and rural, regional and industrial development imbalance is closely related to financial resource distribution. This paper analyzes the relationship between financial development and income gap in China and proposes a long-term cause-and-effect relationship among financial development scale, financial development efficiency and income gap and a theoretical assumption, that is, financial credit scale and income distribution gap are positively correlated while efficiency of financial medium development and income gap are negatively correlated.Using macroeconomic data from 1978 to 2004 in China, this paper adopts Johanson cointegration technique to empirically test the assumption through constructing VECM and eventually find there is a long-term cointegration relationship among these four factors, financial development scale and income distribution gap are positively correlated while financial development efficiency and income gap are negatively correlated, financial development scale is the Granger reason for income gap and income gap is the Granger reason for financial development efficiency.From the analysis of this paper, it can be concluded that financial deepening and financial medium efficiency have a positive impact on eliminating income inequality. Eliminating income gap and constructing harmonious society is the emphasis of present economic policy in China. According to the conclusion it derives, the revolution of financial system should be carried out in two ways: on one hand, improving rural financial efficiency to make peasants enjoy financial service and then elevate their income; on the other hand, improving the efficiency of bank system and weakening governmental influence on bank operation so that private sectors which gain a higher investment revenue can obtain loans.