Financial development and income inequality in Latin American countries: an instrumental variables estimation

Abstract

Latin America has made significant progress in financial development and poverty reduction in recent decades. Nevertheless, its persistent levels of inequality have further potential to be reduced, and financial development could be an effective way to accomplish this. This paper analyzed the causal relationship between income inequality and financial development in 15 Latin American countries between 1990 and 2020 by applying an instrumental variables model that addresses the limitations of some previous studies on the subject. The results showed a significant negative relationship between these two variables, mainly due to the impact of financial institutions, rather than financial markets, on income inequality. However, this negative relationship declines at a higher level of financial development. These results suggest that development must promote a deeper, more accesible, and more efficient financial sector in an inclusive and sustainable manner, at both the institutional and market levels, in order to achieve a greater equalization of financial opportunities and a reduction in income inequality in the Latin American population.