Allegato n.5
Research project on Income Distribution, Poverty and Growth
Alexandra D'Onofrio
1
∗
Introduction
The goal of this research project is to investigate causes and implications of the growing disparity in the
income distribution between the rich and the poor in many countries around the world in order to design
the most ecient policies to reduce the negative eects on poverty incidence and economic development.
The suggested focus is on the nature of the links between the intensity of nancial intermediation, the
distribution of income and the incidence of poverty. Financial sector policy has been shown to be highly
eective in promoting economic growth, thus suggesting the importance of a deeper analysis of how it can
be used to alter income distribution in order to foster pro poor economic growth. Some of the economic
questions of this project are whether nancial development always reduce income inequality in a society,
whether there are important dierences across and within countries based on their stage of economic
development and what kind of nancial policy reforms promote growth, reduce poverty and tighten income
inequalities. Empirically assessing the link between nancial development and the distribution of income
in an economy would give many useful insights to review and extend the theoretical frameworks on how
formal nancial sector policies aect inequality and how more eective pro-poor macroeconomic policies
can be implemented.
2
Motivation
In most advanced and emerging economies, the rise in income inequality in favour of the upper quintile
of the distribution since the 1980s has been unprecedented.1 The most recent data on the distribution of
income show how the highest 20 percent of the population held more than 40 percent of the total income
while the poorest 20 percent less than the 10 percent of the income in many regions around the world.2 In
developing countries the disparity is even sharper making it less likely that economic growth can reduce
poverty.3
Department of Economics, University of Rome Tor Vergata, Via Columbia, 2 00133 Roma, Italy, and Department of Economics, Vanderbilt University, Nashville TN 37235, USA. Email: [email protected]; [email protected].
1
See IMF 2007, OECD 2008.
2
Data on the distribution of income worldwide are available from the World Bank World Development Indicators database.
3
In Latin America and Sub Saharan Africa the share of income held by the richest quintile is higher than 55 percent
while the share of income held by the poorest quintile is lower than 4 percent.
∗
Addressing growing income inequalities in advanced countries is as important as addressing the same trend
within developing nations given the persistence of high inequality both in high and low income countries
and the increasing globalization and interconnections among countries around the world. Research on
income distribution, poverty and growth has to aim to the nal goal of designing eective policies to limit
the negative eects of growing income inequalities on economic development and poverty reduction, hence
nancial sector policy represents a fundamental tool to alter income distribution and generate pro-poor
economic growth.
There is an extensive literature that studies the relationship between nancial development and economic
growth and a growing literature on nance and inequality.4 Financial development is expected to enhance
growth by enabling the ecient allocation of capital and reducing borrowing and nancing constraints.
The issue of which segments of the population prot from the growth induced by nancial development has
not been conclusively addressed and there are many potential channels to be considered. Higher economic
growth leads to an expansion in the demand for labor and in the creation of new opportunities in small
and medium-sized rms and in the informal private sector. Hence, it could benet the poor through the
creation of more employment opportunities but it could also benet the entrepreneurs generating higher
prot margin. Growth also implies a reduction in the wage dierentials between skilled and unskilled
labor. Higher growth results in higher tax revenues that allow the government to allocate more scal
resources on social spending. Overall, high economic growth means capital accumulation that generates
greater availability of funds for the poor for investment purposes, in particular human capital investment.
More important, nancial sector development directly creates improved access to nancial services by the
poor and underprivileged and it aects how those categories can exploit economic opportunities relying on
their individual skills and initiatives. In fact, where there are credit market imperfections there is unequal
access to credit that implies that individuals are not able to invest productively because they do not
have enough resources for collateral or because of imperfect information by nancial institutions. Hence,
it is clear how nancial market imperfections are closely linked to inequality and income distribution
and why they are considered a central point in theories of persistent inequality. When credit markets
are underdeveloped, access to nance is dependent and conditional on personal assets, such as parental
wealth, social status and political connections.5
Economic theory suggests that nancial development enlarges the set of economic opportunities of the
poor, thus reducing the intergenerational persistence of relative incomes, however it also suggests that the
relationship is non linear and conditional on the level of economic development. Greenwood and Jovanovic
(1990) show how the interaction of nancial and economic development generates an inverted U shaped
relationship between income inequality and nancial sector development that closely reminds the earlier
view of the growth-poverty nexus and in particular the popular Kuznets' inverted U hypothesis and the
idea that economic growth may increase income inequality at the early stage of development and reduce it
at the mature stage of industrialization.6 This observation further motivates a closer and deeper analysis
of the topic in countries still at the early stages of development.
As developing and emerging countries become more integrated into international nancial markets, they
are increasingly exposed to both the positive and negative eects of nancial development. If from one
side, nancial development can be eective in promoting economic growth and reducing income inequality
and poverty, from the other side along with nancial development it comes nancial instability. The last
4
Levine (2005) oers a comprehensive survey of the theoretical and empirical literature on nance and growth while
Demirguc-Kunt and Levine (2009) review the theoretical and empirical literature on nance and inequality.
5
See Banerjee and Newman (1993), Aghion and Bolton (1997) and Galor and Zeira (1993) for the theoretical foundations
of these ideas. See Tonwsend and Ueda (2006) for a study of the eects of nance on the labor market that shows how
improvements in nance lead to an increase in the demand for low-skilled workers.
6
See Greenwood-Jovanovic (1990) and Kuznets (1955).
nancial crisis, as well as the nancial crises in Asia in 1997, in Mexico in 1994, in the Russian Federation
in 1998, and in Argentina and Brazil in 2001 and 2002 have revealed how vulnerable are those economies
to similar shocks and how nancial instability can be detrimental to the poor. Financial instability and
the incidence of nancial crises might aect the operation of the nance-growth linkage.7 It is also likely
that they are altering the nance-inequality nexus as well. Financial shocks typically worsen inequality,
growth and poverty especially in developing economies given that the poor are more vulnerable to unstable
nancial system and to a disruption in the provision of credit.
Despite the huge and inuential literature on nance and growth, the issue of whether nancial development helps reducing poverty and what is the relationship uniting nancial development and income
distribution are still underinvestigated empirically. Researchers have shown that nancial depth is particularly benecial for the poor and it reduces income inequality. On that point seminal and important
contributions are those of Beck, Demirguc-Kunt and Levine (2007) and Honohan (2004) that conrm the
earlier cross-sectional ndings of Li, Squire and Zou (1998) that nancial depth is associated with lower
inequality and also higher income of the lower 80 percent of the population.
More recent contributions in this eld are Guillaumont Jeanneney and Kpodar (2011), that investigate
how nancial development helps to reduce poverty directly through a distributional eect showing that
the poor benet from the ability of the banking system to facilitate transactions and provide saving opportunities and that those benets are partially oset by nancial instability, as in the last crisis, and Gimet
and Lagoarde-Segot (2011), that attempt to model the complex transmission mechanisms uniting banks,
capital markets and income distribution using a panel Bayesian structural vector autoregressive (SVAR)
model nding signicant causality running from nancial sector development to income distribution.
3
Contribution
From the existing literature, it clearly emerges that nance has a central role in explaining economic inequality, however the complete understanding of the particular mechanisms linking nance and inequality
and in particular how formal nancial sector policies, in particular banking sector and securities markets
regulations, aect inequality is still a gap in this eld. While theory focuses on the importance of broader
access, i.e. nancial inclusion, there is relatively little empirical evidence linking access to nance to
development outcomes, and little guidance for policies on how best to promote access.
Cross-country regressions show that nancial development is likely to promote not only growth but lower
income inequality and higher poverty reduction.8 However, if pro-poor nancial development requires
expanding the access to nancial intermediation by a growing number of poor households, it becomes
important to address the issue of what are the main obstacles that discriminate the poor from entering
nancial intermediation. Theoretical models suggest many potential sources of nancial market imperfections, such as adverse selection, moral hazard, transactions costs, entry fees, connections. The relative
importance of those potential sources of credit market imperfections could vary from one country to another, hence it becomes crucial to move from cross-country studies and look into country-level studies.
Cross-country regressions are important to emphasize between country variation although it is the within
country variation that can tell us more about how nance aects income distribution. Institutional and
comparative analyses could better answer the economic question of how nance interacts with the real
sector to alter the distribution of income in the economy.
In particular, in one of the most underdeveloped region in the world, such as Sub-Saharan Africa, where
7
Rousseau and Watchel (2011) found that there is a dampening of the positive eect of nancial deepening on growth
due to the increased incidence of nancial crises in the last 20 years.
8
Beck et al. (2007) show this exact result in a sample of 72 developing and developed countries.
there is an urgent need to promote growth and ght poverty, the phenomenon has received very few
attention due to scarcity of relevant data on inequality.
In my previous research I focused on whether nancial development promotes economic growth in SubSaharan Africa.9 Using a modern time series methodology and data for 22 countries over the period from
1960 to 2009, we nd unidirectional links from nancial development to measures of real activity for about
two-thirds of them. In most cases the eects come from narrow money rather than more broadly-dened
nancial aggregates. This suggests that monetization retains a distinct role in capital accumulation and
growth in many of these countries. Given the diculties related to data for developing countries, and in
particular for sub-Saharan Africa, our ndings are meant to be suggestive but they lead to a cautiously
optimistic view of nance and growth in the region.
Given those observations, I think it is important to further extend the research on nancial development
in the region looking at how nancial sector policies operate on the distribution of income and the level of
poverty. Investigating whether nancial development has an impact on income inequality, drawing on the
experience of a continent that has been implementing nancial reforms since the 1980s and is experiencing
persistently high level of inequality represents an important challenge.10
From an empirical point of view, it would be interesting to examine the relationship between dierent
proxies of nancial intermediation and income inequality using a series of comparative vector autoregressive and error correction models in each country and then combine the countries in the region in a dynamic
panel to have an aggregate picture of the trend in the area. Dierent specications of the models could
be estimated to examine the nature of the statistical causality between nancial development and income
distribution in each country. I would start my analysis from a trivariate baseline model considering two
measures of nancial variables, narrow money M1, that has shown to be the main variable of interest in
my previous study, and a broader measure of nancial intermediation, either M2 or private credit, and in
turn a measure of income distribution and poverty incidence. More complex specications of the models
would then include as a fourth variable of interest output in order to also capture the interactions between
economic growth and income distribution by themselves.
However, the big limitation for such analysis comes from the availability of data. Most existing empirical
research studies on nance and inequality rely on GINI coecients as a measures of income inequality.
However, in the case of African countries there are not enough data to conduct a similar study. Recently,
researchers have started using an alternative inequality indicator named Estimated Household Income
Inequality. 11 This dataset contains long enough time series for many African countries and for at least
ten of them the series are long enough to allow us to conduct a time series study and to build a dynamic
panel.
A study of nancial development and income distribution dynamics in Sub Saharan Africa would be just
a rst step of a comprehensive and general research project on nance and inequality. I would like to
further extend the analysis to other developing regions in order to nd similarities and dierences among
countries at similar stages of economic development.
Moreover, given the observation that nancial instability is altering the operation of the nance and growth
linkage, I would like to consider also this dimension in the future research by studying, for example, how
the incidence of nancial crises is aecting the distributional eects of nancial development. Research in
this direction would also allow to capture the implications in terms of income distribution of the growing
interconnection among industrialized, emerging and developing countries resulting from the higher global
9
See Rousseau and D'Onofrio (2012).
One of the few studies on the topic is Kai and Hamori(2009) that examine the link between nancial deepening and
inequality in sub-Saharan Africa between 1980 and 2002 and nd that nancial depth helps mitigate inequality.
11
This indicator was originally developed by Galbraith and Kum (2003) and subsequently updated by Daymon and Gimet
(2009) and it is publicly available.
10
integration of nancial markets.
4
Expected Results
This research project will contribute to the literature on nance and inequality by empirically addressing
the relationship between nancial development and income distribution in developing countries. The
ndings of this project would be used to isolate the most relevant features for the design of eective
nancial sector policies that are able to limit the negative consequences of the growing disparities between
the rich and the poor and in particular the harmful eects on the people on the bottom of the income
distribution.
Empirically assessing the link between nancial development and the distribution of income in an economy
would give many useful insights to review and improve upon existing theoretical frameworks on how
formal nancial sector policies, including for example banks regulation and securities law, aect persistent
inequality and how more eective pro-poor macroeconomic policies can be implemented.
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