Reducing Income Inequality

If I told you what it takes to reach the highest high
You'd laugh and say nothing's that simple
--The Who

Interesting article in the most recent Journal of Finance by Beck, Levine, and Levkov (2010). The researchers assess the impact of banking deregulation from 1976 to 1994 on income distribution.

Common wisdom is that industry regulation is necessary to improve social welfare. Otherwise the rich get richer at the expense of the poor.

The researchers found the opposite. After controlling for various economic and sociodemographic variables, income disparity actually narrowed during the study period. Social welfare, as reflected by income inequality, improved with bank deregulation.

While surprising to some, these findings should actually be expected. Regulation squelches competition and raises barriers to entry in an industry--effectively protecting the franchises of incumbents. A mountain of research suggests that innovation and efficiency gains are most often achieved by new enterprises rather than by the entreched establishment.

Cutting regs encourages Schumpeter's (1942) capitalistic 'process of creative destruction.' This process pushes general standards of living higher, not lower.

We're doing the opposite currently--saddling economic environments with ever more interventionary action by government. And the chasm between rich and poor widens...

Another laughably sad situation.

position in XLF

Reference

Beck, T., Levine, R., & Levkov, A. 2010. Big bad banks? The winners and losers from bank deregulation in the United States. Journal of Finance, 65: 1637-1667.

Schumpeter, J.A. 1942. Capitalism, socialism & democracy. New York: Harper & Brothers.