The long-run effects of financial development on income inequality: Evidence from the Asia-Pacific countries

Abstract

Income inequality is a vexing developmental challenge for governments and policymakers as it impedes social transformation and economic growth and development. Meanwhile, promoting financial development is generally regarded as an effective way to achieve inclusive and sustainable growth. This study examines the long-run effects of financial development, economic growth, and their combined effects on income inequality for 12 Asia-Pacific countries from 1990 to 2021. This paper employs various econometric techniques and different financial development proxies to ensure the findings’ robustness. The paper also constructs a financial development index using the principal component analysis to fully capture the comprehensive effect of financial development on income inequality. Empirical results reveal that the impact of financial development on income inequality follows the inverted U-shaped relationship – financial development widens income inequality and only reduces income when surpassing its turning point. Findings further reveal that the nonlinear effect of financial development on income inequality is contingent upon the level of per capita income. Thus, policies promoting financial development to reduce income inequality should consider the existing level of per capita income.