Nonlinearity in the nexus between financial development and wealth inequality

Abstract

Rising income and wealth inequality have renewed interest in their determinants, positioning the financial sector as a central focus of the ongoing debate. Nevertheless, controversy persists regarding the relationship between financial development and economic inequality. While much of the empirical literature focuses on income inequality, wealth inequality has received comparatively less attention. Given the extreme concentration of wealth and its influence on economic opportunity and political power, this paper explores whether it is excessive or insufficient financial development that contributes to the widening disparities in wealth distribution. Using a cross-country panel data framework, the study finds that financial development exacerbates wealth inequality by increasing wealth concentration at the top and diminishing wealth shares in the bottom 50% up to a certain threshold. Beyond this point, financial development results in a reduction of top wealth shares and an increase in the wealth shares of the bottom 50%, thereby narrowing wealth inequality. A similar pattern is observed for income inequality. Pathway analyses indicate that these effects are partially mediated through entrepreneurship. Insufficient financial development adversely impacts both wealth and income distribution.