Financial Innovation and Income Inequality in Upper-Middle Income Countries

Financial innovation is hypothesised to enhance equitable economic development. The paper aims to examine the relationship between financial innovation and income inequality in four upper-middle income countries, namely, South Africa, Brazil, China, and Turkey for the period 1986 to 2020. A longitudinal research design was used for this study. To control heterogeneity and cross-sectional dependency, an Augmented Mean Group estimator was employed. The study found mixed results. Two measures of financial innovation (bank credit extended to the private sector and the ratio of broad money to narrow money) found evidence of a U-shaped pattern between financial innovation and income inequality, indicating that financial innovation helps reduce income inequality up to a certain point but would thereafter contribute to its further widening. However, when financial innovation is measured using ATMs, evidence of an inverse relation was found. The exacerbation of income inequality by the first two indicators has a detrimental effect on a country’s societal welfare as the poorer members of the population are left behind in their development even when economic growth takes place. The observed upper-middle income countries and similar countries which are typified by relatively stable financial systems and high levels of income inequality must financially develop their systems under an inclusive framework to ensure growth and development benefit broader sections of the population. By leaving this unattended, financial innovation can be an enabler and instigator of income inequality.