Income Inequality, Financial Systems, and Global Imbalances: A Theoretical Consideration

Income Inequality, Financial Systems, and Global Imbalances: A Theoretical Consi

This paper illustrates the effects of two major macroeconomic factors on global imbalances with regard to China as a growing giant in the global economy. The country has observed a continuous drop in the labor income share of GDP and a considerable rise in income inequality, giving rise to a savings glut and high investment rates. China's inflation, housing bubble, and capital losses in foreign markets are attributable to its rushed transition to market-based financing and its inherent vulnerability to international capital flows. The US is also experiencing a rise in inequality, although this rise is associated with a decline in savings as a fundamental cause of its current account deficit, whereas its exorbitant privilege from the dollar's reserve currency status is accompanied by increasing difficulties posed by the Triffin dilemma. It is shown that global imbalances may be less related to misaligned exchange rates than to distorted wage differences.

Policy Implications

  • Financial losses from capital outflows into international markets are the price that must be paid for global imbalances when relatively poor countries with surplus savings lend to relatively rich countries with saving deficiencies.
  • Adequate social security for ordinary people will greatly alleviate pressures to save for precautionary purposes, and lower savings will effectively reduce trade surpluses and mitigate financial losses associated with lending to foreign economies.
  • It is unwise for China to abruptly transition to a market-based financial system under a poor legal infrastructure or to prematurely open up its capital markets while seeking exchange rate stability.
  • Healthy relationships require that dominant powers not force financially underdeveloped foreign countries to fully float their exchange rates or dismantle their limited capital controls.
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