Inequality, Financial Development and Government in Low-Income Developing Countries

Abstract

The purpose of this study is to examine the impact of financial and economic development on cross-country income inequality using a panel data set from 50 low-income developing counties over a long period, 1970-2008. The results show that financial development helps in reducing inequalities, but a non-monotonic relationship between financial development and inequality does not hold. The study, however, finds a non-monotonic relationship between inequality and the level of economic development, which supports Kuznet's inverted-U hypothesis. The government emerges as a major player in reducing income inequalities as its role is significant in all models. The study suggests that the policy makers must focus primarily on economic development to reduce inequalities. Since financial development, irrespective of its level, also reduces inequalities, policy makers also need to encourage financial reforms.