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Finance and income inequality : test of alternative theories

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  • Clarke, George
  • Xu, Lixin Colin
  • Zou, Heng-fu

Abstract

Although theoretical models make distinct predictions about the relationship between financial sector development and income inequality, little empirical research has been conducted to compare their relative explanatory power. The authors examine the relation between financial intermediary development and income inequality in a panel data set of 91 countries for the period 1960-95. Their results provide evidence that inequality decreases as economies develop their financial intermediaries, consistent with the theoretical models in Galor and Zeira (1993) and Banerjee and Newman (1993). Moreover, consistent with the insight of Kuznets, the relation between the Gini coefficient and financial intermediary development appears to depend on the sectoral structure of the economy: a larger modern sector is associated with a smaller drop in the Gini coefficient for the same level of financial intermediary development. But there is no evidence of an inverted-U-shaped relation between financial sector development and income inequality, as suggested by Greenwood and Jovanovic (1990). The results are robust to controlling for biases introduced by simultaneity.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2984.

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Date of creation: 31 Mar 2003
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Handle: RePEc:wbk:wbrwps:2984

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Keywords: Poverty Impact Evaluation; Environmental Economics&Policies; Health Economics&Finance; Economic Theory&Research; Payment Systems&Infrastructure; Inequality; Economic Theory&Research; Poverty Impact Evaluation; Environmental Economics&Policies; Health Economics&Finance;

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  1. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 1998. "Law and Finance," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 106(6), pages 1113-1155, December.
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