Financial development, income inequality and governance institutions

Cristiano Perugini,İpek Tekin

doi:10.2298/pan191022004p

Cristiano Perugini, İpek Tekin

Open Access

https://doi.org/10.2298/pan191022004p

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Abstract

The paper investigates empirically how governance institutions mediate the link between financial development and inequality. To this aim, we assemble a dataset of 48 middle- and high-income countries for the period 1996-2014. Results, obtained by means of instrumental variables dynamic panel data models, reveal that financial development is pro-inequality; however, the strength of the relationship is attenuated in contexts with stricter control of corruption, better regulatory quality, political stability and rule of law. Institutional domains less directly related to the market economy ? political voice and accountability and government effectiveness ? do not play any mediating role.

Highlights

The global financial crisis exploded in 2008 and its devastating consequences on the real economy have revived the interest of the scientific community on the effects and the risks associated to the development of the financial sector
Our empirical results support the side of the literature for which financial development increases income inequality; we find that better quality of some specific governance indicators is able to mitigate the magnitude of this pro-inequality effect
Columns 3 in Table 2 displays the results obtained with the Hansen Generalized Methods of Moments (GMM) estimator described in section 3.2, which is able to address issues related to the dynamic panel bias and to potential endogeneity of the regressors of main interest here

Summary

Introduction

The global financial crisis exploded in 2008 and its devastating consequences on the real economy have revived the interest of the scientific community on the effects and the risks associated to the development of the financial sector. Hui Boon Tan and W.N.W. Azman-Saini (2014) investigate the effect of financial development on inequality and, by means of static threshold regression methods, identify the possible mediating role of an aggregate institutional measure (the sum of five different governance indicators: corruption, law and order, bureaucratic quality, government repudiation of contracts, and risk of expropriation). De Haan and Sturm (2017) sum up single indicators (bureaucratic quality, corruption and rule and order) to generate one aggregate measure of the quality of economic institutions, whereas democratic accountability is employed as a proxy for political institutions Their empirical analysis is based on a panel fixed effects model augmented with interaction terms, applied on year averages of data on 121 countries from 1975 to 2005. Our empirical methods (section 3.2) allow, compared to previous studies, addressing simultaneously various challenges posed by the data, related to identification issues due to omitted variable bias and endogeneity

Data and methods

Results

Conclusions