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A theory of financial inclusion and income inequality

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  • Gerhard Kling
  • Vanesa Pesqué-Cela
  • Lihui Tian
  • Deming Luo

Abstract

We develop a theory linking financial inclusion, defined as access to formal loans and financial assets, to income inequality. Initial inequality of households is modeled by a random variable determining initial endowments. These initial endowments can be used to invest instantaneously in human capital and financial assets. Human capital translates into income based on a strictly concave production function, suggesting optimal levels of investment. Financial assets earn yields which do not depend on the amount invested by individuals. Theoretical predictions are tested using the China Household Finance Survey (CHFS) for 2011 and 2013. Initial conditions modeled by a random variable are replaced by an actual distribution of income or assets to derive theoretical predictions regarding the proportion of the population that might benefit from financial inclusion. Financial inclusion does mitigate under-investment in education – but formal loans do not contribute. Income inequality worsens if households rely on formal or informal loans, whereas access to bank accounts improves households' prospects in the future income distribution. However, households below the 40th percentile of household income do benefit from informal loans.

Suggested Citation

  • Gerhard Kling & Vanesa Pesqué-Cela & Lihui Tian & Deming Luo, 2022. "A theory of financial inclusion and income inequality," The European Journal of Finance, Taylor & Francis Journals, vol. 28(1), pages 137-157, January.
    • Handle: RePEc:taf:eurjfi:v:28:y:2022:i:1:p:137-157
    DOI: 10.1080/1351847X.2020.1792960
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    Cited by:

    1. Zhian Zhiow Augustinne Wong & Ramez Abubakr Badeeb & Abey P. Philip, 2023. "Financial Inclusion, Poverty, and Income Inequality in ASEAN Countries: Does Financial Innovation Matter?," Social Indicators Research: An International and Interdisciplinary Journal for Quality-of-Life Measurement, Springer, vol. 169(1), pages 471-503, September.
    2. Arno J. van Niekerk, 2024. "Economic Inclusion: Green Finance and the SDGs," Sustainability, MDPI, vol. 16(3), pages 1-21, January.
    3. Kebede, Jeleta & Naranpanawa, Athula & Selvanathan, Saroja, 2023. "Financial inclusion and income inequality nexus: A case of Africa," Economic Analysis and Policy, Elsevier, vol. 77(C), pages 539-557.
    4. Chenjing Zhang & Qiaoge Li & Di Mao & Mancang Wang, 2023. "Research on the Threshold Effect of Internet Development on Regional Inclusive Finance in China," Sustainability, MDPI, vol. 15(8), pages 1-20, April.
    5. Shang, Rui, 2023. "Divide or dividend: How digital finance impacts educational equality," Finance Research Letters, Elsevier, vol. 55(PA).
    6. Victoria I. Okafor & Isaiah O. Olurinola & Ebenezer Bowale & Romanus Osabohien, 2023. "Financial development and income inequality in Africa," Palgrave Communications, Palgrave Macmillan, vol. 10(1), pages 1-10, December.
    7. Erkişi Kemal & Boğa Semra, 2023. "Does Financial Inclusion Improve Income Equality? The Case of Türkiye," Economics, Sciendo, vol. 11(2), pages 79-95, December.
    8. Ahmad, Ahmad Hassan & Green, Christopher J. & Jiang, Fei & Murinde, Victor, 2023. "Mobile money, ICT, financial inclusion and growth: How different is Africa?," Economic Modelling, Elsevier, vol. 121(C).

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