Finance and Income Inequality: What Do the Data Tell Us?

• Published in: Southern economic journal Vol. 72; no. 3; pp. 578 - 596
• Main Authors: Clarke, George R. G., Xu, Lixin Colin, Zou, Heng-fu
• Format: Journal Article
• Language: English
• Published: Stillwater Southern Economic Association 01-01-2006
• Subjects: Bank assets; Capital markets; Collateral; Correlation analysis; Credit; Data analysis; Economic development; Economic growth; Empirical tests; Finance; Financial development; Financial intermediaries; Financial services; Financial services industry; Financial systems; Forecasts and trends; Gini coefficient; Gross domestic product; Households; Hypotheses; Income distribution; Income inequality; International economics; International finance; Low income groups; Securities markets; Statistical significance; Studies; United States economic conditions; Wealth distribution; World Bank; United States
• ISSN: 0038-4038; 2325-8012
• DOI: 10.1002/j.2325-8012.2006.tb00721.x

Although there are distinct conjectures about the relationship between finance and income inequality, little empirical research compares their explanatory power. We examine the relationship between finance and income inequality for 83 countries between 1960 and 1995. Because financial development might be endogenous, we use instruments from the literature on law, finance, and growth to control for this. Our results suggest that, in the long run, inequality is less when financial development is greater, consistent with Galor and Zeira (1993) and Banerjee and Newman (1993). Although the results also suggest that inequality might increase as financial sector development increases at very low levels of financial sector development, as suggested by Greenwood and Jovanovic (1990), this result is not robust. We reject the hypothesis that financial development benefits only the rich. Our results thus suggest that in addition to improving growth, financial development also reduces inequality.