Finance and Income Inequality: Test of Alternative Theories

25 Pages Posted: 5 Mar 2003

See all articles by George R. G. Clarke

George R. G. Clarke

Texas A&M International University - A.R. Sanchez Jr., School of Business

Lixin Colin Xu

World Bank - Development Research Group (DECRG)

Heng-Fu Zou

World Bank - Development Research Group (DECRG); Peking University

Date Written: 2003

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

JEL Classification: D3, G2, O1

Suggested Citation

Clarke, George and Xu, Lixin Colin and Zou, Heng-Fu, Finance and Income Inequality: Test of Alternative Theories (2003). World Bank Policy Research Working Paper No. 2984. Available at SSRN: https://ssrn.com/abstract=364160 or http://dx.doi.org/10.2139/ssrn.364160

George Clarke (Contact Author)

Texas A&M International University - A.R. Sanchez Jr., School of Business ( email )

5201 University Blvd.
Laredo, TX 78041-1900
United States

Lixin Colin Xu

World Bank - Development Research Group (DECRG) ( email )

1818 H Street, N.W.
MC 3-427
Washington, DC 20433
United States
202-473-4664 (Phone)
202-522-1155 (Fax)

HOME PAGE: http://econ.worldbank.org/staff/cxu

Heng-Fu Zou

World Bank - Development Research Group (DECRG) ( email )

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

HOME PAGE: http://econ.worldbank.org/staff/hzou

Peking University

No. 38 Xueyuan Road
Haidian District
Beijing, Beijing 100871
China

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