The financial origins of regional inequality

Summary

Focus

Over the last decades, regional inequality in the United States and other advanced economies has steadily increased as income growth in urban areas has outpaced that in rural areas. This geographic divergence is believed to have brought devastating economic and social cleavages, including entrenched poverty, deaths of despair and political polarisation.

Contribution

Already in the late 18th century, Thomas Jefferson and Andrew Jackson worried about financial deregulation concentrating credit and economic powers in larger cities – at the expense of rural America. We provide novel evidence on the importance of the financial sector in shaping regional inequality in the US. We highlight the crucial role banking deregulation has played in spurring differential income growth in urban versus rural regions and thereby shed new light on a long-standing debate.

Findings

We find that the income gap between urban and rural counties widened following the removal of geographic restrictions on banking. While deregulation promoted an overall increase in incomes, the increase was significantly larger in urban counties. This divergence is due to increased competition in the banking industry in cities (but not rural areas) following financial deregulation. Fiercer competition benefited financially constrained firms, thereby boosting employment and incomes in urban areas.

Abstract

An increasing number of policies addresses spatial inequality, which is believed to lie at the heart of economic and social cleavages, including entrenched poverty, deaths of despair, and political polarization. Yet little is known about the origins of the gap between prospering urban and "left-behind" rural areas that has emerged since the 1980s. We provide new evidence on the role of banking deregulation in explaining this rural-urban divergence in incomes. In particular, we show that the income gap widened following the removal of geographic restrictions on banking. While deregulation promoted an overall increase in incomes, the increase was significantly larger in urban counties. We show that this is due to increased competition in the banking industry in cities post deregulation. Competition benefited financially constrained small and young firms, thereby boosting employment and incomes in urban areas. Our findings inform the debate on regional inequality and the design of place-based policies.

JEL classification: G21, R10

Keywords: banking deregulation, credit supply, income inequality, regional inequality