The Impact of Financial Development on Income Inequality

The need to reduce income inequality occupies the attention of policymakers and researchers around the world. However, there is no consensus in the literature about the nature of the relationship between Financial Development (FD) and income inequality. Therefore, this thesis contributes to the debate by evaluating the impact of FD on income inequality in South Africa. It focuses on the test of financial Kuznets curve Hypothesis. Using yearly series from 1975 to 2018, the thesis employed Augmented Dickey Fuller (ADF) and Phillips-Perron (PP) unit root tests, Johansen cointegration test, Granger causality and fully modified OLS (FMOLS) regression technique. The findings reveal that the relationship between FD and income inequality is negative, whereas its square positively relates to income inequality in South Africa. This indicates the existence of U-shape (inverted Kuznets curve) relationship between FD and income inequality. The turning point is found to be about 4.47%. This thesis therefore, concludes that FD is a significant determinant of income distribution and its impact is contingent upon the stage of FD and income inequality in South Africa. It is thus recommended that policymakers in South Africa and probably other emerging markets should prioritize the development of financial sector, entrench policies that promote economic growth, embrace economic liberalization with caution, adopt expansionary fiscal policies and control inflation to reduce income inequality in the country. Keywords: Income inequality; Financial development; Economic growth; Economic globalization; Time series analysis