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Nonlinear dynamics of the finance-inequality nexus in developing countries

Abstract

This study examines the dynamics of the finance-inequality nexus in 35 developing countries during the past two decades, using two data sets of income inequality: the University of Texas Inequality Project (UTIP) and the Standardized World Income Inequality Database (SWIID). The empirical results of this study, based on the dynamic panel models, provide new evidence that highlights the nonlinear U-shaped relationship between financial deepening and income distribution. It implies the narrowing of the income-inequality gap at the early stage of financial development of the countries. This improvement, however, will only be sustainable dynamically below a certain threshold level. Further deepening above that level will lead to a reverse effect, which deteriorates income inequality. This reflects the inefficiency of financial markets in improving economic inequality when the threshold level is overshot.

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Correspondence to Hui-Boon Tan.

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We are grateful to the two anonymous referees and to the participants at the Oxford 2009 Conference for Economists: New Directions in Welfare for their insightful comments. Usual disclaimers apply.

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Tan, HB., Law, SH. Nonlinear dynamics of the finance-inequality nexus in developing countries. J Econ Inequal 10, 551–563 (2012). https://doi.org/10.1007/s10888-011-9174-3

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Keywords

  • Financial deepening
  • Income inequality
  • Gini coefficient
  • Dynamic panel analysis

JEL Classification

  • E0
  • G0
  • O15