In the public view, financial markets have, at times, contributed to economic turmoil that has spilled over into all classes of society. Theory, however, is relatively in agreement about the implications of how financial development affects economic growth. As early as Schumpeter (1912), economists have studied how the development of financial markets can influence economic growth rates. More recently, several theoretical and empirical studies seem to confirm the idea that finance matters when attempting to explain economic output, although identifying the direction of causality is difficult (Goldsmith (1969), McKinnon (1973), Pagano (1993), King and Levine (1993), Neusser and Kugler (1998), Rajan and Zingales (1998), Levine et al. (2000), Khan (2001), and Calderon and Liu (2003)). Levine and Zervos (1998) look beyond general financial development, per se, and instead examine whether stock markets promote long-run economic growth. Using data from 47 countries, they find that the liquidity of a country’s stock market is positively correlated with a country’s economic growth rate. These findings suggest that well-functioning stock markets are, at least, an important correlate of economic output. These results also support endogenous growth theory, which indicates that well-functioning markets allow a greater portion of gross saving to flow into capital investment, thus contributing to economic growth (Romer (1989) and Pagano (1993)). What may be more interesting than identifying the association between stock market liquidity and economic growth is determining whether or not this liquidity disproportionately affects the rich vis-
a-vis the poor. The main of objective of this study is to examine this particular question. More specifically, we test whether stock market liquidity influences the level of income inequality using a large sample of nearly 100 countries. Our tests are motivated by a broad stream of research that examines the interaction between finance, economic development, and the distribution of income. Kuznets (1955) proposes that economic growth can contribute to the level of income inequality in the early stages of development. For those well-developed countries, however, greater economic growth can reduce the level of inequality. Greenwood and Jovanovic (1990) follow Kuznets (1955) and model the growth-inequality framework while accounting for financial structure. Their theory shows that in its infancy, both economic and financial development contribute to greater income inequality while more developed countries, with mature financial structures, tend to have more stability with respect to inequality. To the contrary, Becker and Tomes (1979, 1986) show that the development of the financial system can influence the economic opportunities of the poor and subsequently decrease intergenerational inequality. Demirguc-Kunt and Levine (2009) provide a thorough and critical review of the theory related to this topic. In their review, they concede that the existing theory that speaks to the association between finance and inequality produces conflicting predictions. The empirical literature, however, seems to lean towards the idea that financial development is associated with a reduction in inequality. For example, Burgess and Pande (2005) show that the Reserve Bank of India’s decision to open banks in more rural locations resulted in an increase in the wages of the most disadvantaged workers, thus reducing both poverty and inequality.