Economic Growth, Financial Development and Income Inequality in BRICS Countries: Evidence from Panel Granger Causality Tests

Younsi, Moheddine and Bechtini, Marwa (2018): Economic Growth, Financial Development and Income Inequality in BRICS Countries: Evidence from Panel Granger Causality Tests.

Abstract

The purpose of this paper is to examine the causal relationship between economic growth, financial development and income inequality for the BRICS countries, namely; Brazil, Russia, India, China, and South Africa, using annual panel data covering the period 1995-2015. We construct a composite financial sector development index for these countries by applying the principal component method on the main four proxies of financial development, that is, domestic credit to private sector to GDP ratio, domestic credit given by banks sector to GDP ratio, M2/GDP, and stock market capitalization to GDP ratio. Results of Pedroni panel cointegration and Kao residual panel cointegration tests confirm the valid long-run cointegration relationship between the considered variables. Fixed effects estimation results show that GDP per capita growth has a positive and significant effect on income inequality, while the coefficient of its squared term has negative and significant effect on income inequality. Similarly, financial development index appears to have a positive and statistically significant effect on income inequality, while its squared term has negative and statistically significant effect on income inequality. Our empirical findings support the financial Kuznets hypothesis of an inverted U-shaped relationship between economic growth, financial sector development and inequality in the BRICS countries over the study period. Our results are robust by employing POLS and GMM estimators. Results of Granger causality test shown that there is a unidirectional causality running from financial development index to income inequality, but a bidirectional causality between inflation and income inequality is found. However, there is no causal relationship between income inequality and economic growth. These findings are expected to help policymakers to reduce inequality in these countries through the improvement of taxation policies financial system.

• Item Type: MPRA Paper
• Language: English
• Keywords: Economic growth, financial development, income inequality, financial Kuznets hypothesis, BRICS countries.
• Subjects: D - Microeconomics > D6 - Welfare Economics > D63 - Equity, Justice, Inequality, and Other Normative Criteria and Measurement; G - Financial Economics > G2 - Financial Institutions and Services > G20 - General; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O11 - Macroeconomic Analyses of Economic Development

References

Agnello, L., Sousa, R. M. 2012. How do banking crises impact on income inequality? Applied Economics Letters 19(15): 1425-1429.

Ahmed, A. D. 2007. Potential impact of financial reforms on savings in Botswana: an empirical analysis using a VECM approach. The Journal of Developing Areas 41(1): 203-220.

Ang, J. B. 2010. Finance and inequality: the case of India. Southern Economic Journal 76(3): 738-761.

Arellano, M., Bond, S. 1991. Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations. The Review of Economic Studies 58(2): 277-297.

Bahmani, O. M., Zhang, R. 2015. On the impact of financial development on income distribution: time-series evidence. Applied Economics 47(12): 1248-1271.

Batuo, M., Mlambo, K., Guidi, F. 2010. Financial development and income inequality: Evidence from African Countries. MPRA Paper No. 25658. http://mpra.ub.uni-muenchen.de/25658

Beck, T., Demirguç-Kunt, A., Levine, R. 2007. Finance, inequality and the poor. Journal of Economic Growth 12(1): 27-49.

Bittencourt, M. 2010. Financial development and inequality: Brazil 1985-99. Economic Change and Restructuring 43(2): 113-130.

Blundell, R., Bond, S. 1998. Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics 87(1): 115-143.

Burgess R., Rohini, P. 2005. Do Rural Banks Matter? Evidence from the Indian Social Banking Experiment. American Economic Review 95(3): 780-795.

Clarke, G. R., Xu, L. C., Zou, H-F. 2006. Finance and Income Inequality: What Do the Data Tell Us? Southern Economic Journal 72(3): 578-596.

Clarke, G., Xu. L. C., Zou, H-F. 2013. Finance and Income Inequality: Test of Alternative Theories. Annals of Economics and Finance 14-2(A): 493-510.

Daisaka, H., Furusawa, T., Yanagawa, N. 2014. Globalization, Financial Development and Income Inequality. Pacific Economic Review 19(5): 612-633.

Giri, A. K., Sehrawat, M. 2015. Financial development and income inequality in India: An application of ARDL approach. International Journal of Social Economics 42(1): 64-81.

Granger, C. W. J. 1969. Investigating Causal Relations by Econometric Models and Cross-spectral Methods. Econometrica 37(3): 424-438.

Greene, W. H. 2000. Econometric Analysis. Upper Saddle River, N.J.: Prentice Hall.

Greenwood, J., Javanovic, B. 1990. Financial Development, Growth and Distribution of Income. Journal of Political Economy 98(5): 1076-1107.

Gujarati, D. 2003. Basic econometrics. Singapore: McGraw-Hill Companies, Inc.

Hausman, J. A. 1978. Specification tests in econometrics. Econometrica 46(6): 1251-1272.

Hoi, L. Q., Hoi, C. M. 2013. Financial Sector Development and Income Inequality in Vietnam: Evidence at the Provincial Level. Journal of Southeast Asian Economies 30(3): 263-277.

Hoi, L. Q., Hoi, C. H. 2016. Credit Market Depth and Income Inequality in Vietnam: A Panel-Data Analysis. Journal of Economics and Development 18(2): 5-18.

Hye, Q. M. A. 2011. Financial development index and economic growth: empirical evidence from India. The Journal of Risk Finance 12(2): 98-111.

Hye, Q. M. A., Islam, F. 2013. Does financial development hamper economic growth: empirical evidence from Bangladesh. Journal of Business Economics and Management 14(3): 558-582.

Im, K. S., Pesaran, M. H., Shin, Y. 2003. Testing for unit roots in heterogeneous panels. Journal of Econometrics 115: 53-74.

Jalil, A., Feridun, M. 2011. Long-run relationship between income inequality and financial development in China. Journal of the Asia Pacific Economy 16(2): 202-214.

Kao, C. 1999. Spurious regression and residual-based tests for cointegration in panel data. Journal of Econometrics 90(1): 1-44.

Kappel, V. 2010. The effects of financial development on income inequality and poverty. Working Paper, 10/127, CER-ETH-Center of Economic Research at ETH Zurich.

Kim, D. H., Lin., S. C. 2011. Nonlinearity in the financial development and income inequality nexus. Journal of Comparative Economics 39(3): 310-325.

Kuznets, S. 1955. Economic Growth and Income Inequality. American Economic Review 45 (1): 1-28.

Law, S. H., Azman-Saini, W. N., Tan, H. B. 2014. Financial Development and Income Inequality at Different Levels of Institutional Quality. Emerging Markets Finance and Trade 50(1): 21-33.

Levine, R. 1997. Financial Development and Economic Growth: Views and Agenda. Journal of Economic Literature 35(2): 688-726.

Levine, R., Beck, T., Loayza, N. 2000. Financial intermediation and growth: Causality and causes. Journal of Monetary Economics 46(1): 31-77.

Levin, A., Lin, C. F., Chu, C. S. 2002. Unit root tests in panel data: asymptotic and finite-sample properties. Journal of Econometrics 108(1): 1-24.

Li, H., Squire, L., Zou, H. F. 1998. Explaining International and Intertemporal Variations in Income Inequality. The Economic Journal 108(446): 26-43.

Liang, Z. 2006a. Financial development and income inequality in rural China 1991-2000. Research Paper No. 2006/96. United Nation University-World Institute for Development Economics Research (UNU- WIDER), Helsinki. http://hdl.handle.net/10419/63268

Liang, Z. 2006b. Financial development and income distribution: A system GMM panel analysis with application to urban China. Journal of Economic Development 31(2): 1-21.

Ling-Zheng, Y., Xia-Hai, W. 2012. Has financial development worsened income inequality in China? Evidence from threshold regression model. Journal of Finance and Economics, CNKI-SUN: CJYJ.0.2012-03-009.

Mansur, M., Azleen, R. 2017. What is the link between financial development and income inequality? Evidence from Malaysia. MPRA Paper No. 79416. http://mpra.ub.uni-muenchen.de/79416

McKinnon, R. I. 1973. Money and capital in economic development. Brookings Institution Press.

Mookherjee, D., Ray, D. 2003. Persistent Inequality. The Review of Economic Studies 70(2): 369-393.

Nikoloski, Z. 2013. Financial sector development and inequality: is there a financial Kuznets curve? Journal of International Development 25(7): 897-911.

Odhiambo, N. M. 2010. Finance-investment-growth nexus in South Africa: an ARDL bounds testing procedure. Economic Change and Reconstructing 43(3): 205-219.

Pedroni, P. 1999. Critical Values for Cointegration Tests in Heterogeneous Panels with Multiple Regressors. Oxford Bulletin of Economics and Statistics 61(S1): 653-670.

Rehman, H., Khan, S., Ahmed, I. 2008. Income distribution, growth and financial development: a cross countries analysis. Pakistan Economic and Social Review 46(1): 1-16.

Shahbaz, M., Islam, F. 2011. Financial development and income inequality in Pakistan: An application of ARDL approach. Journal of Economic Development 36(1): 35-58.

Shahbaz, M., Loganathan, N., Tiwari, A. K., Sherafatian-Jahromi, R. 2015. Financial Development and Income Inequality: Is There Any Financial Kuznets Curve in Iran? Social Indicators Research 124(2): 357-382.

Shahbaz, M., Bhattacharya, M., Mahalik, M. K. 2017. Finance and income inequality in Kazakhstan: Evidence since transition with policy suggestions. Applied Economics 49(52): 5337-5351.

Shaw, E. S. 1973. Financial deepening in economic development. New York: Oxford University Press.

Tan, H. B., Law, S. H. 2009. The role of financial development on income inequality in Malaysia. Journal of Economic Development 34(2): 153-168.

Tan, H. B., Law, S. H. 2012. Nonlinear dynamics of the finance-inequality nexus in developing countries. Journal of Economic Inequality 10(4): 551-563.

Westley, G. D. 2001. Can Financial Market Policies Reduce Income Inequality? Technical Paper Series, No. MSM-112. Inter-American Development Bank, Washington, D.C.

WDI. 2016. World Development Indicators. World Bank. http://data.worldbank.org/indicator

Zhang, Q., Cheng, R. 2015. Financial Development and Income Inequality in China: An Application of SVAR Approach. Procedia Computer Science 55: 774-781.