Does Financial Development Improve Income Inequality in Latin America?

Abstract

Latin America has experienced a trend of substantial reduction in inequality over last few decades. We investigate the effects of rapid development of financial sector on inequality in the region. In particular, we estimate a panel with country fixed effects based on a newly compiled dataset for time period of 1990 – 2017. First, the main finding is that financial deepening has exacerbated income inequality on the continent during studied period indicating skewed distribution of benefits of this development across population. The reasons vary from relatively limited education (including low literacy rates), low collateral, demographic and geographic characteristics, and lack of tacit knowledge pertaining to access to financial services. Second, educational attainment seems to be a major contributor to lowering Gini coefficients. The countries in the region on average added about 3 years to education during this period and estimates suggest reduction of Gini coefficients of about 0.7 percentage points per additional year of schooling. Third, as expected, aggregate income level and its growth seem to significantly contribute to reduction of inequality in Latin America. In contrast, poverty rates are associated with worsening of income gap. Fourth, we found no evidence of a traditional Kuznetz curve for Latin America in this dataset. Finally, while exports seem to be neutral, FDI through raising high skill premia and taxes through low efficiency of public services aggravate inequality.