Finance and the Poor

In this paper, I argue that the operation of the formal financial system is profoundly important for the poor. It influences how many people are hungry, homeless and in pain. It shapes the gap between the rich and the poor. It arbitrates who can start a business and who cannot, who can pay for education and who cannot, who can attempt to realize one’s dreams and who cannot. Finance affects the degree to which economic opportunities are defined by talent and initiative or by parental wealth and social connections. Moreover, I stress that the profession has done a stunningly inadequate job of examining how formal financial systems affect the poor. This deficiency is stunning because extensive theoretical work clearly advertises the central role of financial market imperfections in shaping poverty. Rather than dissecting the impact of financial sector policies on poverty, however, researchers too frequently take financial market frictions as given and examine how changes in schooling, savings behavior and fertility decisions influence poverty. Yet, these analyses, and resultant policy recommendations, are based on the erroneous treatment of financial market frictions as unchanging features of the economy. Financial market frictions are not immutable. Although a considerable body of evidence indicates that the formal financial system affects aggregate economic growth (Levine, 1997, 2005), this paper focuses on the poor. Finance might help the poor by expanding the overall economy. Or, finance might boost aggregate growth by disproportionately benefiting the rich without expanding the economic opportunities of the poor. In other words, financial development might increase income inequality. A small, but growing, body of evidence, however, suggests just the opposite: financial development boosts growth by disproportionately