Finance and Income Inequality: Test of Alternative Theories

George Clarke, Lixin Xu and Heng-Fu Zou ()

No 493, CEMA Working Papers from China Economics and Management Academy, Central University of Finance and Economics

Abstract: Although theoretical models make distinct predictions about the relation between finance and income inequality, little empirical research has been conducted to compare their relative explanatory power. We examine the relation between financial intermediary development and income inequality in a panel data set of 91 countries for the period of 1960-95. Our results provide reasonably strong evidence that inequality decreases as economies develop their financial intermediaries, consistent with Galor and Zeira (1993) and Banerjee and Newman (1993). Moreover, consistent with the insight of Kuznets, the relation between the Gini coefficient and financial intermediary development depends on the sectoral structure of the economy: a larger modern sector is associated with a smaller drop in the Gini coefficient for the same level of financial intermediary development. However, there is no evidence of an inverted-U shaped relation between financial sector development and income inequality, as suggested by Greenwood and Jovanovic (1990). The results are robust to controlling for biases introduced by simultaneity.

Keywords: Income inequality; financial intermediary development; Kuznets curve (search for similar items in EconPapers)
JEL-codes: D3 G2 O1 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2003
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (76)

Published in Policy Research Working Paper Series 2984, The World Bank.

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Persistent link: https://EconPapers.repec.org/RePEc:cuf:wpaper:493

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