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Financial Sector Development and Income Inequality: Is There a Financial Kuznets Curve?

The existing empirical knowledge in the area of financial sector development and income inequality finds evidence for the theoretical work of Banerjee and Newman (1993) and Galor and Zeira (1993) who posit a simple, linear relationship between the two variables. In this paper, we subject the extant empirical knowledge to close scrutiny and point out to a potential dynamic and endogenous relationship between financial sector development and inequality. By using dynamic multivariate panel data analysis on a carefully selected dataset of income inequality data for developed and developing countries spanning the period 1962-2006, we find robust empirical evidence for the existence of an inverted U-curve relationship between financial sector development and income inequality. The results are robust to inclusion of different control variables and different lag structure in the estimation method. In that token, we confirm the theoretical stipulations of Greenwood and Jovanovic (1990) for an inverted U-curve relationship between the financial sector and income inequality.