Institutional Quality and Income Inequality in Developing Countries: A Dynamic Panel Threshold Analysis

Abstract

This study investigates whether there is an institutional quality threshold effect on income distribution. We employ the dynamic panel threshold model developed by Kremer et al. (2013: Empirical Economics 44(2): 861–878) and a panel of both developing and advanced countries from 1995 to 2017. Our findings suggest the inequality-reducing effect of institutional quality is disproportionate. More specifically, we find two-pronged results: (i) when institutional quality is measured by World Governance Indicators, we find quadratic effect for advanced countries, but a monotonic negative effect for developing countries; (ii) when the International Country Risk Guide-based measure of institutional quality is used as the threshold variable, we find a Kuznets inverted U-shaped relationship between institutions and income inequality for both advanced and developing countries. The results also show a higher threshold value for developing countries compared to advanced economies. These results are robust to both measurement and endogeneity issues. The results have interesting policy implications for income inequality in developing economies.