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Decomposing the impact of financial openness on finance and income inequality: principle vs. outcome-based approaches from Africa

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  • Biruk Birhanu Ashenafi

    (Southwestern University of Finance and Economics)

  • Yan Dong

    (Southwestern University of Finance and Economics)

Abstract

This paper investigates the impact of financial openness on financial sector development and income inequality. We use two approaches to capture financial openness for a panel dataset of 52 African countries from 1980–2019 and find that: (1) Principle-based financial openness policy negatively affects financial sector development and widens income inequality. In contrast, the outcome-based measures positively affect banking sector development and narrow income inequality. (2) Capital inflow to African countries is not merely pulled a vibrant macroeconomic fundamental. Only schooling and governance factors facilitate the impact of financial openness on financial sector development. (3) Adverse non-policy factors play an insignificant role in moderating the impact of financial openness. This implies that the impact of financial openness on financial sector development and income inequality is weak in countries experiencing a banking crisis or passing through a lengthy conflict. Our finding is consistent with the institutional quality theory, which claims robust institutions are needed. We underline that countries should take caution in implementing principle-based reforms. Particularly, there is an alternative policy path for African countries to optimize the benefit by pursuing outcome-based financial openness measures.

Suggested Citation

  • Biruk Birhanu Ashenafi & Yan Dong, 2024. "Decomposing the impact of financial openness on finance and income inequality: principle vs. outcome-based approaches from Africa," Economic Change and Restructuring, Springer, vol. 57(2), pages 1-32, April.
    • Handle: RePEc:kap:ecopln:v:57:y:2024:i:2:d:10.1007_s10644-024-09638-5
    DOI: 10.1007/s10644-024-09638-5
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