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Top1. Introduction
Income inequality is a persistent phenomenon and a fundamental issue of concern. In the last few decades, researchers have tried to search out for the many sources of income inequality and subsequently, the adverse consequences it has on the social and economic conditions of the world. It behoves the researchers to carefully examine the link between financial sector development and income inequality as financial systems have the potential to equalize opportunities across people, communities, and nations of differing income groups. On the contrary, even due to the increasing financial liquidity and size of financial system the poorer section of the society may not always be benefitted. This is due the fact that access to financial services and knowledge about them is not yet democratized. In other words, if the access to financial services for the poor is limited compared to the rest of the population, financial development may not contribute to reducing income inequality.
It was in the early 1970s that the prevalence of high-income inequality within developing countries attracted attention of many economists. Notwithstanding this, most of the economists held the view that ensuring economic growth was far more important and effective that tackling income inequality for poverty reduction. Fortunately for the poor, this long-standing view has been contested since 2000. Importance of equity of income levels has been associated with lowering poverty and human development broadly. It is more evident today than ever before that high levels of income inequality, though by-product of sustainable past economic progress, are an obstacle to an inclusive future development.
Levine (2005) states that a large section of literature points to the direction that development of financial sector leads to faster economic growth though researchers are inconclusive as to whether this development benefits the entire population equally or not. If the financial development enhances the levels of income inequality, this setback will offset the gains to the society resulting from the financial development itself (Ang, 2010; Beck et al., 2007). Additionally, it is a widely acknowledged fact that widespread corruption in societies breaks down governance systems at the grassroot and that in turn exacerbates income inequality. This may happen in spite of increased financial development.
The paper is structured with Introduction discussed above in Section 1, followed by Literature Review in Section 2. The Data and Model is elaborated in Section 3 while Section 4 talks about the Empirical Analysis and Discussion. Finally, Conclusions and Policy Implications have been mentioned in Section 5.
Top2. Literature Review
Widening income inequality, with significant and adverse implications for economic growth and macroeconomic stability, is the defining challenge of present times. Income inequality can have numerous far-reaching effects such as: sub-par allocation of human resources, political and economic instability leading to reduction in investments, increased crisis risk, etc. The global financial crisis of 2008 and the concomitant reduction in economic growth and increased unemployment have directed the attention to rising income inequality. Levine (1999, 2005) states that a voluminous literature has found a strong and robust link between financial development and economic growth. Even recent studies such as Beck, Kunt and Levine (2007), and Clark, Xu and Zou (2006) have come to the same conclusion. Earlier theoretical works by Galor and Zeira (1993) and Banerjee and Newman (1993) emphasise the importance of financial development in eradicating income inequality. Both the above studies conclude that there exists an inverse relationship between financial development and income inequality due to financial market imperfections and lumpy investments.