Wealth Inequality and the Political Economy of Financial and Labor Markets

We examine the role of wealth inequality in the political process that determines financial and labor market regulations. We study a two factor model with credit restrictions, where political groups: labor, SMEs and large... [ view full abstract ]

We examine the role of wealth inequality in the political process that determines financial and labor market regulations. We study a two factor model with credit restrictions, where political groups: labor, SMEs and large firms arise endogenously and have opposing interests with respect to structural variables such as employment protection and creditor protection. We embed these groups in a political model and obtain the prediction that in poor countries an increase in wealth inequality will lead to lower employment protection and worse creditor protection as result of the political platforms of the parties. The negative effect of inequality is smaller for wealthier countries. We perform a preliminary empirical test across countries, obtaining good agreement with predictions of the model.