Does economic openness matter in the impact of financial development on income inequality?

Despite increasing academic attention on the income distributional impact of financial development, the debate has remained controversial. Hence, this study argues that economic openness to international trade and capital flows may impact the nexus between financial development and income inequality. Using a panel of 71 developing and developed countries for 1994–2017, we first use split-sampling and interaction analyses to examine the role of the country's level of openness on the relationship between financial development and income inequality. However, these two approaches do not provide specific information on the threshold value, if any, at which the effect changes. For this reason, we also employ the dynamic panel threshold method to investigate whether a financial or trade openness threshold exists beyond which financial development worsens income inequality. We find evidence that financial development generally fosters income inequality, but the level of financial and trade openness impacts the inequality effect of financial development. Our results assert that a higher level of financial and trade openness strengthens the pro-inequality impact of financial development.