DP17342 Income Inequality and Job Creation
We propose a novel channel through which rising income inequality affects job creation and macroeconomic outcomes. High-income households save relatively more in stocks and bonds but less in bank deposits. A rising top income share thereby increases the relative financing costs for bank-dependent firms, which in turn create fewer jobs. Exploiting variation across US states and an instrumental variable strategy, we provide evidence for this channel. To study its aggregate implications, we build a general equilibrium macro model with heterogeneous households and heterogeneous firms. Calibrating the model to our empirical estimates, we show that growing top incomes account for 16% of the decline in the employment share of small firms since 1980, in part through less entry. Rising inequality also reduces the labor share and lowers aggregate output. Our model exercises highlight that ignoring the link between inequality and job creation understates welfare effects of income redistribution.
