The effect of financial development on income inequality in Africa

Abstract

Extant studies on the relationship between financial development and inequality have largely adopted single financial indicators especially the private credit/GDP. Unlike these works, the present study adopts a robust total financial development indicator based on four mainstays of financial development of financial deepening, efficiency, stability and access following the World Bank recommendation on the measurement of financial development. Using this measure, the paper examines the relationship in 40 African countries. The empirical results confirm the findings of extant studies that the ratio of private credit to GDP increases inequality in high, middle-low and low-income countries. The total financial development, however, reports mixed evidence. While this measure reduces inequality in high and middle-low income countries, it does not affect inequality in low-income countries. Also, the study finds evidence of a nonlinear relationship only among the low-income countries. The paper recommends that policymakers should formulate wholesome policies that cut across all mainstays of financial development to reduce inequality, particularly, in high and middle-low African countries. Also, policymakers are advised to increase growth in low-income countries so that financial development could reduce inequality. At most, these countries should pay less attention to financial development for inequality-reduction policies among low-income countries.