We develop a theory linking financial inclusion, defined as access to formal loans and financial assets, to income inequality. Initial inequality of households is modeled by a random variable determining initial endowments. These initial endowments can be used to invest instantaneously in human capital and financial assets. Human capital translates into income based on a strictly concave production function, suggesting optimal levels of investment. Financial assets earn yields which do not depend on the amount invested by individuals. Theoretical predictions are tested using the China Household Finance Survey (CHFS) for 2011 and 2013. Initial conditions modeled by a random variable are replaced by an actual distribution of income or assets to derive theoretical predictions regarding the proportion of the population that might benefit from financial inclusion. Financial inclusion does mitigate under-investment in education - but formal loans do not contribute. Income inequality worsens if households rely on formal or informal loans, whereas access to bank accounts improves households’ prospects in the future income distribution. However, households below the 40th percentile of household income do benefit from informal loans.
Bibliographical noteWe are very grateful for the financial support provided by the ESRC and NSFC (Newton Fund). This paper is part of the research project entitled Research on China’s Financial System towards Sustainable Growth: The Role of Innovation, Diversity and Financial Regulation (ESRC: ES/P005241/1 and the National Natural Science Foundation of China: 71661137002. In addition, this research was supported by the National Social Science Foundation of China (Project Number: 17ZDA071).
- Financial inclusion
- income inequality
- theory of financial inclusion
- CAPITAL ACCUMULATION
- OCCUPATIONAL CHOICE