Regional implications of financial market development: Industry location and income inequality

- Model with heterogeneous firms, trade, credit constraints and labor mobility.
- Financial development reduces regional income inequality.
- Less clustering with better access to external finance.
- Deeper financial markets have opposite effects to trade liberalization.
- More scope for deeper goods market integration without jeopardizing cohesion.

We develop a heterogeneous-firms model with trade in goods, labor mobility and credit constraints due to moral hazard. Mitigating financial frictions reduces the incentive of mobile workers to migrate to one region such that an unequal distribution of industrial activity becomes less likely. Hence, financial market development has opposite regional implications as trade liberalization. While the former leads to more dispersion of economic activity across space, the latter tends to drive clustering. This has immediate implications for income inequality both between regions and workers. According to our model, financial development reduces inequality in both dimensions.