In this research spotlight, a study by Evelyne Huber, Bilyana Petrova, and John D. Stephens shows how labor can limit the effects of the financial sector.
 
Just four years ago, presidential candidate Bernie Sanders blamed Wall Street for “destroying the very fabric of our nation” — specifically lambasting “the extraordinary power [of a handful of people in the banking sector]” for manipulating the U.S. economy and political system to benefit the wealthiest Americans at the expense of everyone else.
 
This accusation is recalled by the authors of a recent study that is among the first to take an in-depth look at the specific channels through which financialization — a process that captures the growing importance of financial motives, markets, actors, and institutions in the functioning of modern-day economies — has contributed to the soaring increase in inequality in advanced capitalist democracies. The study is also one of few to examine the ability of institutions to rein in the financial sector and limit its impact on income differentials. “Financialization, Labor Market Institutions and Inequality,” by Stone Center postdoctoral scholar Bilyana Petrova and Professors Evelyne Huber and John D. Stephens of the University of North Carolina, Chapel Hill, was published in August in the Review of International Political Economy.
 
Financialization has resulted in tangible changes in modern capitalist democracies, including expanded access to credit, greater participation of nonfinancial firms in financial markets, the rise of the shareholder value model of corporate governance, and higher shares of national income and employment generated by the financial sector. But how, exactly, has it increased inequality? And how have institutions, which vary across capitalist democracies, mediated the effects of financialization?
 
To answer these questions, Huber, Petrova, and Stephens conducted an empirical analysis of 18 postindustrial democracies. Unlike previous studies, they found that financialization does not necessarily lead to higher income inequality. Rather, the institutional context  in which the financial sector develops and expands — in particular, the institutional strength of labor — influences the magnitude of its effect on inequality.  
 
The authors posit that there are two key mechanisms that link financialization to increasing inequality: the shareholder value model of corporate governance and the rising demand for financial professionals. The first mechanism drives disproportionate income growth for the top 1 percent of income earners. It doesn’t, however, affect the economic fortunes of the next 9 percent. The second increases incomes for both the top 1 percent and the next 9 percent.
 
The institutional strength of labor is the critical element that can limit the extent to which these two mechanisms increase top incomes. Although rent-seeking by financial institutions, corporations’ increasing reliance on the stock market, and corporate governance’s shift to a shareholder value orientation can generate disproportionate growth in the income of the top 1 percent, this effect is much more pronounced in economies with weaker organized labor. “This is because a stronger institutional position of labor moderates these transformations, limiting their inegalitarian consequences, constraining the rise of the top 1 percent income share and boosting the earnings of the median worker,” the authors write. “In the absence of strong labor, the expansion of the financial sector concentrates the benefits of rising demand for financial professionals among relatively few highly paying jobs, contributing to widening income differentials.”
 
“Our findings suggest that structural transformations, such as financialization, do not necessarily exacerbate income differentials,” the authors conclude. “Institutions are political creations which can be protected or undermined. Specifically, labor rights at the enterprise level and at the societal level can be strengthened or weakened by national legislation. Our findings thus illuminate important dynamics related to the ability of national governments to ameliorate the rise in income inequality in an age of intensifying globalization, when this ability is often put into doubt.”