Financial development and income inequality in Africa: A panel heterogeneous approach

Although the financial sector of Africa has witnessed massive reforms to enhance its ability to support economic activities, reduce poverty and lower income inequality, Africa remains the poorest region and the second most unequal region in the world after Latin America. Despite these established facts, little empirical research exists on the relationship between financial development and income inequality in Africa. This study investigates the finance-income inequality nexus in a balanced panel of 15 African countries using the Augmented Mean Group estimator to determine if there is a threshold level of financial development or income inequality is related to the sectoral structure of the economy.

Overall evidence suggests that the finance-inequality relationship in the sample of African countries studied is non-linear and ranges from an inverted u-shape to a u-shape depending on the measure of financial development. Policies to boost financial development should be preceded by financial inclusion but these policies should be separated. Financial inclusion policies should focus on the quality and suitability of financial products to ensure usage and avoid dominant accounts as well as consumer protection.

Working paper 614
1 June 2016