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FINANCIAL DEVELOPMENT AND WAGE INEQUALITY: THEORY AND EVIDENCE

Authors


  • We thank Daren Acemoglu, Roland Benabou, Jim Feyrer, Phil Levine, Ross Levine, and David Weil for helpful comments and suggestions. Participants at the Western Economic Association Meetings, 2006; Mid West Macro Meetings, 2007; North American Summer Meetings of the Econometric Society, 2007; the Society for Economic Dynamics (SED), 2007; the NBER Summer Institute (Income Distribution and Macroeconomics Group), 2007; and the Clemson Brownbag Group provided valuable comments and feedback at various stages of this research. All errors are our own.

Abstract

We argue that financial market development contributed to the rise in the skill premium and residual wage inequality in the United States since the 1980s. We present an endogenous growth model with imperfect credit markets and establish how improving the efficiency of these markets affects modes of production, innovation, and wage dispersion between skilled and unskilled workers. The experience of U.S. states following banking deregulation provides empirical support for our hypothesis. We find that wages of skilled workers increased by between 0.5% and 6.3% following deregulation while those of unskilled workers fell by between 3.5% and 8.7%. Similarly, residual (or within-group) inequality increased; the 90–50 percentile ratio of residuals from a Mincerian wage regression and their standard deviation increased by 4.2% and 1.7%, respectively. (JEL E25, J31, G24)

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