FINANCIAL DEVELOPMENT, GOVERNANCE AND INCOME INEQUALITY: A COMPARATIVE ANALYSIS BETWEEN OECD COUNTRIES AND DEVELOPING COUNTRIES

Abstract

This study re-examines the role of financial development in reducing income
inequality by using a broader measure of financial development and a
comparable Gini coefficient to represent income inequality. In addition, the
direct effects of six dimensions of governance and the interactive effects of
five dimensions of it with the left one namely corruption control on income
inequality have been examined. The study utilizes a sample of 81 countries
over a period of 17 years and applied a two-step system GMM method. The
study confirms the U-shaped hypothesis of finance-income inequality nexus
in the whole sample as well as in subsamples of Organisation for Economic
Co-operation and Development (OECD) countries and developing countries.
Among the six dimensions of governance, Corruption Control reduces income
inequality directly only in developing countries and Government Effectiveness
remains insignificant across all country groups. Regulatory Quality can
reduce income inequality while combined with Corruption Control. This
result is true in the whole sample and subsample of developing countries but
not in OECD countries. The interactive effect of Rule of Law with Corruption
Control contributes in reducing income inequality in general but this becomes
insignificant in subsample analysis. Political Stability directly improves income
distribution in general and when combined with Corruption Control it reduces
income inequality in developing countries. In developing countries, its direct
effect is found to be worsening income inequality which could be mitigated
when it interacted with Corruption Control. Finally, only the interactive effect
of Voice and Accountability with Corruption Control reduces income inequality
in general but not in any subsample. Hence, government policies designed to
handle intense income inequality would be effective under strong Corruption
Control. Therefore, study suggests simultaneous improvement of corruption
control and some specific government policies.