The Effects Of Financial Development On Income Distribution Based On SVAR Model

China has gained remarkable economic achievements since reforming and opening,the average income of rural and urban residents has increased steadily while China ispaying a steep cost for its fast rapid economic growth-the widening income gap, whichhas already been becoming a big issue. This will not only cause negative influence onsocial development and stability, but it will restrict the stable development of theeconomy as well. Financial sector as the core of the economy, strongly related to thenational income distribution. Many scholars have attempted to investigate the reasonsfor the growing income inequality from various perspectives. However, there is notenough attention paid to analyze the effects of financial development on incomeinequality theoretically and empirically. As China’s financial reform is in a crucialperiod, a multi-directional and multi-level financial system is emerging, which willpromote the efficiency of the allocation of financial resources to boost the economy.This paper, however, attempts to fill the gap in the literature on financial developmentand income inequality in China, providing suggestions to narrow the income gap andpromote the development of financial sectors.Firstly, this paper briefly reviews the theory of financial development and incomedistribution respectively, and then gives out three schools of thought about therelationship between financial development and income inequality, the invertedU-hypothesis, the inequality-narrowing hypothesis and the inequality-broadeninghypothesis. Meantime, a considerable number of empirical works based on variouseconometric models are also reviewed.Secondly, this paper investigates the status quo of financial development from theperspective of scale and efficiency, and the present condition of income distribution isalso analyzed including the urban-rural gap, region and industry gap, which laid thefoundation for the following theoretical and empirical models.Then, this paper constructs a general equilibrium model studying the effects offinancial development on income distribution, which examines the how the change ofthe financial development affects the income gap through investment channel. Thismodel shows that in the face of credit market imperfections, the distribution of wealthaffects not only aggregate economic growth but also individual’s future income. Furthermore, it demonstrates that in the presence of indivisibilities in the capitalrequirement of entrepreneurial activity, these effects are carried to the long run as well.Next, this paper empirically examines the relationship of financial developmentand income inequality by employing the structural vector auto-regression (SVAR)approach to co-integration. The sample period used in this paper covers the data from1978to2013. In addition, effects of both urbanization and fiscal expenditures are takeninto consideration during the empirical process. An economy in its initial stages offinancial development would present increasing inequality and only in a second or eventhird stage of development would inequality actually decrease. Financial development,no matter the expansion of the scale or the improvement of the efficiency, is animportant determinant of income inequality dynamics. And income inequality dependsmore on the features of financial scale than on financial efficiency. Interestingly, I alsofound income inequality is increased by fiscal expenditures in the short run.Lastly, this paper provides some policy implications to narrow the income gap.Besides promoting urbanization, financial reform aimed at forming an appropriatefinancial system should be accelerated to help to reducing income inequality in China.More financial resources should be allocated to those who need them most, e.g. thesmall and medium-sized enterprises who create an increasing number of employmentopportunities, which will make a great contribution to the growth of the income for themajority and narrowing the income gap. What’s more, fiscal policy discriminationagainst rural areas need to be eliminated and more capital, including fiscal expendituresand private investments, should be encouraged to support the development of thecountryside.