Accepted Manuscript

Financial Structure, Bank Competition and Income Inequality

Joyce Hsieh, Ting-Cih Chen, Shu-Chin Lin

PII: S1062-9408(18)30352-8
DOI: https://doi.org/10.1016/j.najef.2019.03.006
Reference: ECOFIN 941

To appear in: North American Journal of Economics & Finance

Received Date: 24 July 2018

Revised Date: 1 February 2019
Accepted Date: 12 March 2019

Please cite this article as: J. Hsieh, T-C. Chen, S-C. Lin, Financial Structure, Bank Competition and Income
Inequality, North American Journal of Economics & Finance (2019), doi: https://doi.org/10.1016/j.najef.
2019.03.006

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 Financial Structure, Bank Competition and Income Inequality

Joyce Hsieh
Department of International Business, Tamkang University
151, Yingzhuan Rd., Tamsui Dis., New Taipei City 25137, Taiwan (R.O.C.)
Email: chsi9094@mail.tku.edu.tw

Ting-Cih Chen
Department of Economics, Tamkang University
151 Ying-Chun Road, Tamsui 25137, Taipei County, Taiwan
Email: 696570042@s96.tku.edu.tw

and

Shu-Chin Lin*
Department of Economics, SungKyunKwan University
25-2 SungKyunKwan-ro, Jongno-gu, Seoul 03063, Korea
Email: sclin@skku.edu

__________________________
*Corresponding Author: Shu-Chin Lin, Department of Economics, SungKyunKwan
University, 25-2, SungKyunKwan-ro, Jongno-gu, Seoul 03063, Korea. Phone: +82-2-
760-0410; Email: sclin@skku.eduw. This paper was supported by Sungkyun
Research Fund, Sungkyunkwan University, 2018.
The authors declare that they have no conflict of interest. The usual disclaimer
1
applies.
Financial Structure, Bank Competition and Income Inequality

Abstract
This paper empirically investigates the contribution of finance to income inequality
with particular emphasis on the role of financial structure (i.e., stock market orientation)
and banking market structure (bank market power), an aspect that has been overlooked
in the literature. It employs recently developed cointegration techniques that take into
account cross-section correlation and simultaneity in non-stationary panels. The paper
finds that income inequality increases with financial deepening but decreases with a
more market-oriented financial system. It is also found that greater concentration, less
competition in the banking sector strengthens income inequality. These effects are
found stronger during the banking crisis period, for high-income countries or countries
with better quality of political institutions. The data thus suggest that financial reform
toward promoting stock market development, enhancing competition or lessening
concentration in the banking sector is beneficial to income distribution.

Keywords: Income inequality; financial development; financial structure;

concentration; competition
JEL Classification: G00, O16

2
1 Introduction

The recent decades have witnessed drastic changes in income inequality and financial

development. As financial development becomes widespread, increasing the possibility

of credit and intertemporal trade for households and firms, income inequality exhibits

a clear upward trend which has led to frequent protests and demonstrations (such as

Occupy Wall Street and Arab Spring) in advanced industrialized countries and some

developing countries, particularly since the 2008 global financial crisis. This

observation has led to a growing concern as to whether financial overdevelopment and

malfunction is partially responsible for rising income inequality. However, both

theoretical analyses and empirical investigations have arrived at very diverse

conclusions. While some economists see the finance–inequality relationship as

monotonically positive or negative, others consider it as an inverted U-shaped curve,

i.e., income inequality increases and then decreases during the process of financial

deepening. Some even argue that the nexus depends on economic and political

institutions. Please see Claessens and Perotti (2007) and Demirgüç-Kunt and Levine

(2009) for excellent reviews of the literature. Pinpointing the influence of finance on

income inequality is thus critical from the policy perspective.

This paper evaluates the finance-inequality nexus but differs from previous

empirical research in several respects. First, we examine whether financial structure,

the extent to which a country’s financial system is bank- or market-oriented, affects

income inequality. While most studies focus on the distributional consequences of

development in banking or stock markets, less documented is whether the extent of

stock-market orientation would influence disparities in income distribution. This

ignorance is not surprised as a large body of empirical literature on financial

development and economic growth concludes that it is neither banks nor markets but

creating an environment in which intermediaries and markets provide sound financial

3
services, such as law and enforcement mechanisms, that promotes economic growth

(Levine, 2005). However, a parallel literature on corporate finance suggests that firms’

finance choices determine the evolution of financial structure, which in turn determines

firms’ access to credit and investment. This implies that financial structure should also

play a role in shaping income distribution. For instance, in Demirgüç-Kunt, Feyen and

Levine (2013)’s review of a vast body of theoretical work, stock markets have a

comparative advantage in designing customized products that can finance high-risk

long-term projects with limited collateral (such as small or new firms) whereas banks

are better suited to provide low-cost standardized products that can finance lower risk

projects (such as large and old firms). As a society grows economically and financially,

more investment projects require customized financial arrangements rather than

standardized contracts and more projects rely on intangible assets rather than on easily

collateralized capital inputs (Boyd and Smith, 1998). This leads enterprises to switch

their borrowing away from bank intermediated debt finance toward more direct equity

finance (Boot and Thakor, 1997, 2000). If the optimal mixture of banks and markets

shifts with economic development, such a change implies the costs of policy and

institutional impediments to the evolution of the financial system. This change also

suggests potential biased estimates from previous research regarding the inequality

effect of changes in bank or stock market development because of neglecting

potentially relevant information. It is thus important to include financial structure and

check how income inequality responds to changes in the mix of banks and stock

markets. The investigation is critical as a global trend toward stock markets has

emerged over the last three decades. This is true not only for traditionally bank-based

developed countries such as France and Japan but also for developing and transition

countries because of widespread banking crises (Allen and Gale, 2000; Demirgüç-Kunt

and Levine, 2001).

4
 Second, the paper brings banking market structure into the picture and investigates

its direct consequence on income inequality for the first time. Frequent banking crises

have also led to privatization, deregulation, financial integration and bank consolidation,

and changed the competitive conditions in the banking sectors of both developed and

developing countries. This has raised concerns among policymakers and academics

over the impact of bank market power. Most research emphasizes the importance of

banking structure in determining efficiency and stability (e.g., Allen and Gale, 2004;

Boyd and De Nicolo, 2005; Schaeck, Cihak and Wolfe, 2009; Rice and Strahan, 2010;

Beck, De Jonghe and Schepens, 2013). Surprisingly little is known about the impact of

bank competition/concentration on income inequality, however. To the extent that bank

market power determines credit availability and investment, particularly of small and

medium-sized enterprises (SMEs), bank competition should be relevant for

employment and income distribution. As argued, SMEs are more vulnerable to

information problems and much more bank-dependent than large enterprises, and are

increasingly being recognized as productive drivers of economic growth and a major

source of job creation. However, the issue of competition among banks has always

been controversial. Major competing hypotheses are that greater bank market power

can either lead to more credit rationing, or increase lending to firms that are

informationally opaque because of incentives to produce information on potential

borrowers. Our investigation on the inequality consequence of banking competition

may provide fresh insight to the debate.

In order to address the above issues, we employ the continuously updated (CUP)

estimators suggested by Bai, Kao and Ng (2009) to overcome certain drawbacks of

previous research approaches. Most previous empirical work is based on time-series

country-specific data or cross-country data in a cross-section or panel context. Time-

series studies are often plagued by small sample problems linked to the short time span
5
of the data and fail to generalize the results, whereas cross-section studies suffer from

endogeneity due in large part to the omitted variable bias. Panel data studies tackle the

endogeneity problems by including country- and time-specific effects but the use of

averaged data that mitigates economic fluctuations tends to suffer from information loss

and run into the spurious regression problem due to the stochastic dynamic nature (i.e.,

nonstationarity) of macro data. The recent advance in panel cointegration techniques

circumvents possible biases associated to the presence of unit roots. However, these

panel-data approaches assume cross-section error dependence which may not hold in

the real world with more integrated trade and financial markets. Cross-section

dependence/correlation could arise from unobserved common shocks, such as

technology shocks and spatial spillover shocks through trade and FDI linkages, which

might affect each country or region to a different extent. Neglecting such dependency

could result in biased estimates and spurious inference (Pesaran, 2006). CUP estimators

developed by Bai, Kao and Ng (2009) improve upon these dimensions and allow us to

obtain better estimates.

In a sample consisting of 86 developed and developing countries over the period

1989-2014, the paper finds that income inequality increases with financial deepening

but decreases with a more market-oriented financial system. It is also found that greater

concentration, less competition in the banking sector strengthens income inequality.

These effects are found stronger during the period of banking crises, for high-income

countries or countries with better quality of political institutions. The data thus suggest

that financial reform toward promoting stock market development, enhancing

competition or lessening concentration in the banking sector is beneficial to income

distribution.

The remainder of the paper is organized as follows. Section 2 provides a brief

overview of related literature. In Section 3 we discuss our empirical model, introduce

6
estimation strategies and describes the data. Section 4 analyzes the statistical properties

of time series as well as the cointegration analysis, describes long-run estimates, and

performs a battery of sensitivity tests. Section 5 addresses nonlinearity and Section 6

concludes.

2 A Brief Review of Related Literature

Although research shows that financial development accelerates economic growth,

economists have not resolved conflicting theoretical predictions about the distributional

consequences of financial development. Some theories imply that financial

development disproportionately helps the poor. If poor people and entrepreneurs find it

more difficult to access financial services due to greater information and transaction

costs, then financial development that ameliorates these frictions will exert an

especially positive impact on the poor via improving collateral use and credit histories

(Galor and Zeira, 1993; Aghion and Bolton, 1997; Galor and Moav, 2004). By contrast,

some studies posit that improvements in financial services will disproportionately help

the rich and well politically connected if fixed costs prevent the poor from accessing

financial services, and/or if skewed political participation allows the political elite to

protect their rents by limiting financial access through direct control or regulatory

capture of the financial system (Greenwood and Jovanovic, 1990; Rajan and Zingales,

2003; Rajan and Ramcharan, 2011). This is particularly so at the early stages of

economic development with weak legal and political institutions (Greenwood and

Jovanovic, 1990; Rajan and Zingales, 2003; Oechslin, 2009).

From a different perspective, recent studies, particularly in the literature of

financialization, also suggest that highly financialized countries tend to have higher

income inequality (Zalewski and Whalen, 2010; Lin and Tomaskovic-Devey, 2013;

Kohler, Guschanski and Stockhammer, 2016). Financialization—growing importance

7
of financial activities and transactions in the overall economy—shifts the economy

from the real sector towards the financial sector, increases shareholder power relative

to management and workers, rises rentiers’ profit claims, and increases the alignment

of shareholder and manager interests. All these would increase the reliance of firms to

generate profit away from long-term market share, sales, and productive investment

towards short-term financial operations (van Treeck, 2009). As a result, workers’

bargaining power drops, and with it, wages and employment stagnate (Crotty, 2003).

This division exists also in empirics. Based on time-series, cross-country or panel

data, Li, Squire and Zou (1998), Clarke, Xu and Zou (2006), Beck, Demirgüç-Kunt and

Levine (2007), Ang (2010), Liu, Liu and Zhang (2017), and Blau (2018) provide

evidence to support the inequality-narrowing hypothesis. However, studies including

Rodriguez-Pose and Tselios (2009), Roine, Vlachos and Waldenstrom (2009), Gimet

and Lagoarde-Segot (2011), Kus (2012), Jauch and Watzka (2016), Seven and Coskun

(2016), and de Haan and Sturm (2017) find evidence for the inequality-widening

argument in a panel context. Nonlinearity is also detected. Jalilian and Kirkpatrick

(2005) show that the positive effect of financial development turns negative at higher

levels of per-capita income. Kim and Lin (2011) find that the benefits of financial

development on income distribution occur only when the country has reached a

threshold level of financial development, below which financial development

exacerbates income inequality. Tan and Law (2012) show the opposite. Law, Tan and

Azman-Saini (2014) find a minimum threshold level of institutional quality for

financial development to reduce income inequality, below that level, financial

development has no significant effect.

8
 When it comes to the potential effect of financial structure, much of the extant of

literature has focused on either economic growth or the ease of access to finance,1 but

its direct impact on income inequality remains scant. Moreover, the few studies which

look into this domain are far from reaching a consensus. For instance, Aggarwal and

Goodell (2009) point out that market-based economies tend to be more unequal due to

the fact that large firms benefit disproportionately from stock market development.

Likewise, Gimet and Lagoarde-Segot (2011) indicate that banks play a stronger role

than markets in reducing income inequality. By contrast, Liu, Liu and Zhang (2017)

show that improving the relative importance of stock markets to banks is conducive to

alleviating income inequality, but the effect weakens by financial deepening and a more

market-oriented financial system. Hou, Li and Wang (2018) find that relative to total

bank credit, stock market capitalization reduces income inequality whereas stock

market turnover augments income inequality.

The inconclusive results are not surprising. It reflects how split among academics

and practitioners about the role played by banks and markets in mitigating credit market

imperfections and in providing financial services to constrained firms. Some argue that

banks are better at mobilizing savings, identifying good investments, and exerting

sound corporate control, particularly for countries with low-income or weak

institutional setting (Stulz, 2002). However, others emphasize the advantage of stock

markets in allocating capital, providing risk-management tools, and alleviating the

problems associated with excessively powerful banks (Boot and Thakor, 1997). Still,

work such as Levine (2002) maintain that banks and stock markets act as complements

and hence neither has relative efficacy in the provision of financial services. It is also

argue that bank finance is a preferred means of funding small and start-up ventures

1 Please see Kim, Chen and Lin (2016) for discussions and references therein.
9
considering their need for financial flexibility and their relative lack of access to

securities markets, whereas equity finance is more suitable for large and creditworthy

firms, with solid reputation and tangible assets (Petersen and Rajan 1995). However,

counter arguments exist as well. In Allen and Gale (1999), for instance, relative to

delegated bank finance, stock markets have merits in avoiding diversity of opinions as

every investor makes his own investment decision. Since small firms are more

informationally opaque and have less collateral, investors are more likely to have

diverse opinions on their projects. In this sense, equity finance is more suitable to small

firms.

As far as banking market structure is concerned, again, the theoretical predictions

and the empirical evidence on the impact of bank competition on financial constraints,

and thus income inequality, are mixed. According to the traditional market power

hypothesis, increased market power would result in restricted loan supply and higher

lending rates, thereby intensifying financing constraints. Greater competition broadens

access to finance and should reduce income inequality. In contrast, the information

hypothesis (Petersen and Rajan 1995; Marquez 2002; Hauswald and Marquez 2006)

argues that market power would result in greater investment in banking relationships,

reducing information asymmetries and agency costs and thus improving access to debt

finance by potential borrowers, especially relatively opaque or risky firms such as

young, small and/or distressed firms. Conversely, in the presence of competition, banks

cannot capitalize on this informational advantage and fail to establish close

relationships. Greater competition deepens access to finance, leading to a rise in income

inequality.

Empirically, Petersen and Rajan (1995, 2002) and Álvarez and Bertin (2016) find

that creditors are more likely to finance credit constrained firms when credit markets

are concentrated. However, Black and Strahan (2002), Cetorelli and Strahan (2006),
10
Carbo, Rodriguez-Fernandez and Udell (2009) and Kim, Lin and Chen (2016) show

that increased market power results in increased financing constraints for SMEs. From

a different perspective, Levine, Levkov and Rubinstein (2008) find that greater

competition in banking that intensifies economy-wide competition tends to reduce the

effects of racial discrimination, disproportionately helping disadvantaged groups.

Nonlinear effects are detected. Beck, Demirgüç-Kunt and Maksimovic (2004) show,

for instance, that bank concentration increases financing obstacles, with a stronger

effect for small and medium compared to large firms, and this relation only holds for

low-income countries. Ryan, O’Toolea and McCann (2014) find that bank market

power is associated with lower levels of SME investment, and this adverse impact

increases in financial systems that are more bank dependent. Love and Martinez Peria

(2015) find that low competition diminishes firms’ access to finance, the effect that is

mitigated by greater financial development and better credit information but is

exacerbated by higher government bank ownership.

3 Data and Methodology

3.1 Data

We consider a panel of 86 developed and developing countries over the period

1989-2014. The data are balanced and the choice of countries is guided by the

availability of data, particularly on income inequality and stock markets. Table A1 lists

countries in the sample. To measure income inequality, we follow de Haan and Sturm

(2017) and many others to consider the Gini coefficient from the Standardized World

Income Inequality Database (SWIID, 2017) developed by Solt (2009). The SWIID

combines information from the Luxembourg Income Study (LIS) with United Nations

University-World Institute for Development Economics Research (UNU-WIDER)

World Income Inequality Database (WIID) to create an improved data set with greater
11
coverage than the LIS data and greater comparability than the UNU-WIDER data. The

SWIID is our preferred measure of income inequality because it provides comparable

Gini indexes of net income inequality based on disposable household income. A

problem with the SWIID is that they are estimated and that, furthermore, missing values

are imputed. Therefore, as a robustness check, we consider also the Gini coefficients

from WIID (UNU-WIDER, 2017).2 Data classified as the lowest quality is excluded

and only those data that cover both the entire population and the whole area of the

country are used. Gini coefficients are based on income rather than consumption

because of data constraints.

Financial data are taken from the Global Financial Development Database (GFDD,

2017) of the World Bank. Since there is no widely accepted empirical definition of

financial structure, we follow Beck and Levine (2002), Levine (2002) and Tadesse

(2002) to use a composite measure of the comparative role of banks and markets as our

indicator of financial structure (FS). Specifically, FS is the first principal component of

two variables that measure the comparative activity and size of markets and banks. The

first variable, FS_activity, measures the relative importance of markets to banks in

terms of the size and equals the log of the ratio of value traded to bank credit. Value

traded is the value of stock transactions as a percentage of GDP. Bank credit is the

claims of the banking sector on the private sector as a percentage of GDP. The second

variable, FS_size, measures the importance of markets relative to banks in light of the

activity and equals the log of the ratio of market capitalization to bank credit. Market

capitalization is calculated as the value of listed shares divided by GDP. The higher

values of FS indicate larger, more liquid and active stock markets, and hence more

2 Available at http://www.wider.unu.edu/research/Database/en_GB/database/.
12
market-based financial systems.3

Similarly, since there is no perfect measure of the extent to which the financial

sector, both banks and stock markets, mitigates credit market frictions, we follow Beck

and Levine (2002), Levine (2002), and Tadesse (2002) to use the first principal

component of two underlying measures of financial development as our indicator of

financial development (FD). The first one (FD_activity) is a measure of the overall

activity of the financial intermediaries and markets and equals the log of the product of

private credit and value traded. Private credit is the value of credits by financial

intermediaries to the private sector divided by GDP. The second one (FD_size) is a

measure of the overall size of the financial sector and equals the log of the sum of

private credit and market capitalization. The higher values of FD suggest more

developed financial systems

Regarding banking market structure, the traditional measure of bank market power

is concentration in the banking sector, typically calculated as the sum of market shares

(in terms of total assets) of the three or five largest banks. More concentration is

considered as less competition. Since concentration is a measure of market structure

whereas competition is a measure of market conduct, there can be competition in

concentrated markets if there is a credible threat of entry and exit (i.e., if markets are

contestable). We then follow Carbo, Rodriguez-Fernandez and Udell (2009) and Love

and Martinez Peria (2015) to use pricing behavior measures such as the Lerner index

3 As noted in Levine (2002), previous empirical research mostly involves rigorous country studies and
uses country-specific measures of financial structure. For instance, studies of Germany typically
emphasize the extent to which banks own shares or vote proxy shares. Studies of Japan frequently stress
whether a company has a main bank. Studies of the United States sometimes highlight the role of market
takeovers as corporate control devices. While these country-specific measures are very useful, they are
difficult to use in a broad cross-country analysis. One advantage of the broad cross-country approach is
that it permits a consistent treatment of financial system structure across many countries.

13
and the Boone as indicators of bank competition. The Lerner index measures bank

competition based on markups in banking and is defined as the difference between

output prices and marginal costs (relative to prices). The Boone indicator measures the

effect of efficiency on performance in terms of profits and is calculated as the elasticity

of profits to marginal costs. Higher values of both the Lerner index and the Boone

indicator signal lower levels of competition.

To strengthen our empirical results, we consider control variables including one-

period lagged (log) real income per capita to account for the impact of economic

development on distribution and trade, the (log of the) sum of exports and imports as a

percentage of GDP, to capture the effect of trade openness on income inequality. Both

are sourced from the World Development Indicators (WDI) of the World Bank. Also,

included is a composite indicator of regulatory quality taken from the Fraser Institute’s

Economic Freedom of the World database to evaluate the inequality effect of

government regulation. This composite measure is composed of three sub-indices

measuring the freedom from government regulations and controls in the labor market,

credit markets, and price controls in the markets for goods and services, with higher

values of indicating more friendly regulation. Finally, to account for the effect of

education, we use the (log of) secondary education enrollment from WDI. Table A2

presents the summary statistics.

3.2 Methodology

The long-run finance-inequality coefficient for the sample is estimated using the

panel CUP estimators. An important feature of this procedure is that it generates

unbiased estimates for variables that cointegrate even with endogenous regressors.

Consequently, in contrast to cross-section and conventional panel approaches, the

approach does not require exogeneity assumptions nor does it require the use of
14
instruments. In addition, the CUP estimator is consistent under cointegration, and it is

also robust to the omission of variables that do not form part of the cointegrating

relationship. Specifically, to investigate the long-run relationship of income inequality

(ineq) with financial development (FD) and financial structure (FS), we estimate the

following regressions with a multifactor error structure:

ineq it   i  d i t  1 FD it   2 FS it   3 controlsit   it
(1)
εit  λi f t  eit

for i  1, 2, ..., N and t  1, 2, ..., T , where  i denotes the country-specific fixed

effect, dit represents heterogeneous country specific deterministic trends,

controlsit are a set of control variables, and  it is the error term. f t is a vector of

unobserved common factors, which can be stationary or nonstationary, with country-

specific factor loadings’ i . eit is an idiosyncratic error component. These common

factors drive not only income inequality but also financial development and structure,

which leads to endogeneity.

In a compact form, Eq. (1) can be rewritten as

ineq it  xit   λit f t  eit (2)

where xit  ( i , t , FDit , FS it , controlsit ). In the presence of endogeneity,

nonstationarity and cross-section dependence, Bai, Kao and Ng (2009) propose the

Cup-BC (continuously-updated and bias-corrected) and the Cup-FM (continuously-

updated and fully-modified) estimators for  . Both estimators are asymptotically

unbiased and normally distributed and are valid when there are mixed stationary and

non-stationary factors, as well as when the factors are all stationary. The CUP

estimators of Bai, Kao and Ng (2009) minimize the following concentrated least square

function:
15
 N
1
( ˆcup , Fˆcup )  argmin 2
 ,F nT
 (ineq
i 1
it  xit  )M F (ineqit  xit  )

where M F  I T  T 2 FF . ( ˆcup , Fˆcup ) is the solution to the following two nonlinear

equations:

 N

ˆ    ( xiM Fˆ xi ) 1 ( xiM Fˆ yi )  (3)
 i 1 

 1 N 
FˆVnT   2  (ineqit  xit  )M F (ineqit  xit  ) Fˆ (4)
 nT i 1 

where VnT is the diagonal matrix of the  largest eigenvalues of the matrix inside

the brackets, arranged in decreasing order. The estimator is obtained by iteratively

solving for ˆ and F̂ using (3) and (4). It is a nonlinear estimator even though linear

least squares estimation is involved at each iteration. An estimate of  can be obtained

as:

ˆ  (ˆ1, ˆ2 ,..., ˆN )  T 2 Fˆ (ineq  X ˆ )

While the CUP estimator of  is consistent, there is an asymptotic bias arising

from endogeneity and serial correlation, and thus the limiting distribution is not

centered around zero. Bai, Kao and Ng (2009) consider two fully-modified estimators

which correct the asymptotic bias. The first one, the Cup-BC estimator, does the bias

correction only once, at the final stage of the iteration while the second one, the Cup-

FM estimator, corrects the bias at every iteration. While the Cup-FM estimator is

computationally more costly it may have better finite sample properties. Please see Bai,

Kao and Ng (2009) for details.

Although our estimation of the long-run relationship between inequality and

finance does not require the regressors to be exogenous, we are interested in detecting

the direction of long-run causality. Toward the end, we conduct the long-run weak
16
exogeneity test. This test examines the absence of long-run levels of feedback due to

exogeneity (Johansen and Juselius, 1992). Specifically, we estimate the following

vector error correction model:

J
Yit  A i   B j Yit  j   ecit 1  vit (5)
j 1

where Yit  ( ineqit , FDit , FSit , controlsit ), and the error term

ecit 1  ineq it 1 xit 1ˆ is obtained from Cup-FM represents the deviation from the

equilibrium. The speed-of-adjustment parameters   (1 ,  2 ,...,  4 ) capture how

ineq it , FDit , FSit and controlsit respond to deviations from the equilibrium

relationship. A significant adjustment parameter suggests long-run Granger causality,

and thus long-run endogeneity, whereas a non-significant adjustment parameter implies

weak exogeneity and no long-run Granger causality running from the independent to

the dependent variable(s). A conventional likelihood ratio test can be used to test the

null hypothesis of weak exogeneity, H 0 :   0.

4 Empirical Results

As the first step, we consider the CD statistics of Pesaran (2004) to test for cross-

section dependence in the data. The results, reported in Table 1, show substantial

existence of cross-section dependence in the data. The presence of cross-section

dependence would invalidate commonly used panel unit root and cointegration tests

that based on the assumption of cross-section independence. We then consider cross-

sectionally augmented panel unit root (CIPS) test proposed by Pesaran (2007) to check

for the presence of unit roots in the data. The unit root test results, also reported in Table

1, indicate that all variables are nonstationary and follow the I (1) process. Therefore

we proceed to test for cointegration. Given substantially cross-section dependence in

the data, we use Westerlund (2007)’s bootstrap method. The results of the tests,
17
reported at the bottom of tables 2-5, support the long-run cointegrating relationship

among variables considered.

Table A3 reports the long-run weak exogeneity test results. As shown, the null of

weak exogeneity cannot be rejected except for the inequality equation, implying that

all regressors can be regarded as weakly exogenous with respect to the cointegrating

relationship. Thus, we can conclude that there is a strong causal relation from financial

development, financial structure, competition, concentration, and lagged GDP per

capita to income inequality and not vice-versa, when accounting for unobserved factors.

Before turning to our main long-run results, in Table 2 we report CUP estimates

of financial intermediary and stock market development as typical in the literature for

a comparison purpose. As indicated in columns (1), (2), (7) and (8), financial

intermediary development raises income inequality as the estimate on private credit is

positive and statistically significant. The evidence contradicts the view that banks are

especially important for financing the operation of small firms and the creation of new

firms, and banks can establish close relationships with their customers, which reduces

banks’ cost of making loans, and increases credit availability (Petersen and Rajan, 1994;

Berger and Udell, 1995, 1996). However, it is consistent with Jauch and Watzka (2016)

and de Haan and Sturm (2017) and supports the inequality-widening hypothesis that

limited access to funding and financial services not only reflects economic constraints

but also barriers erected by insiders (Claessens and Perotti, 2007). Concerning stock

market development, while the size measure, market capitalization, improves income

distribution, the activity (liquidity) measure, value traded, strengthens income

inequality. The findings seem not to contradict Hou, Li and Wang (2018). Despite so,

the overall level of financial development is found to exacerbate income inequality as

the estimate on FD is positive and significant, shown in columns (3)-(6) and (9)-(12),

regardless of model specifications, inequality measures and estimation methods.

18
 Move to our main long-run estimates in Table 3. Columns (1) and (7) report our

baseline regression estimates from CUP-FM and CUP-BC. FD is positive and

statistically significant, meaning development in both financial intermediaries and

stock markets is associated with higher income inequality. Moreover, if the financial

sector accounts for an extra 10% in GDP, this corresponds to a greater Gini coefficient

by approximately 1.2%. FS is negative that is statistically significant, implying that a

market-led financial system is correlated with lower income inequality. A 10% increase

in stock-market orientation would lead to a lower Gini coefficient by approximately

0.7%. The evidence is in line with Liu, Liu and Zhang (2017) and Hou, Li and Wang

(2018) finding that a market-led financial system plays an important role to equalize

economic opportunities and hence reduce income inequality. It is also noted that lagged

GDP per capita is negative and statistically significant. Countries with higher economic

development tend to have lower income inequality.

We then check whether our findings are robust to an alternative measure of income

inequality and adding control variables. Columns (2) and (8) consider the Gini

coefficient from WIID and point to a positive and statistically significant correlation

between the Gini coefficient and financial development. According to CUP-FM and

CUP-BC estimates, the Gini coefficient would rise by 1.8%-2.1% following a 10%

increase in the income share of the financial sector. On the other hand, the Gini

coefficient and financial structure are positively and significantly correlated. The Gini

coefficient would be lower by 22%-24% following a 10% increase in stock-market the

importance of stock markets relative to banks.

Next, we add government regulation, in general, in columns (3) and (9) and labor

regulation, in particular, in columns (4) and (10) as an additional control variable. We

find both regulation variables to be negatively and significantly associated with income

inequality, suggesting market flexibility would improve income distribution. It is in

19
sharp contrast with the political economy argument that an elite gains most of the

benefits of deregulation initiatives while the risks are shared by a larger group

(Claessens and Perotti, 2007). Deregulation promotes more widespread economic

opportunities and allows a large share of people to realize their potentials, reducing

income inequality. In columns (5) and (11), we also introduce trade openness. We find

that trade openness is positively correlated with income inequality. The finding is

consistent with Barro (2000) and Lundberg and Squire (2003) and supports the popular

globalization view that an expansion of international openness would benefit most the

domestic residents who are already relatively well off, perhaps because the relatively

sophisticated, rich groups would be most able to take advantage of the opportunities,

including access to foreign technology and managerial knowhow as well as culture,

offered by global commerce, and because globalization reduces the abilities of

governments to offset market determinants of income distribution. Columns (6) and (12)

add education as an additional explanatory factor behind cross-country variation in

income inequality. We find education to have a negative correlation with income

inequality, consistent with the common view that education serves as an equalizer.

However, the corresponding coefficient is statistically insignificant. As indicated,

across different model specifications, income inequality increases with financial

development but decreases with stock-market orientation. Furthermore, based on CUP-

FM and CUP-BC estimates, when the financial sector accounts for an extra 10% in

GDP, this corresponds a rise in income inequality by 1.3%-1.6%. However, a 10%

increase in stock-market orientation leads to a decrease in income inequality by 0.8%-

1.0%.

Table 4 reports the estimated impact of bank market power with Panel A focusing

20
on concentration and Panel B on competition.4 As illustrated, for both CUP-FM and

CUP-BC estimates, countries with a more concentrated and more competitive banking

sector tend to experience higher income inequality. The estimate of concentration based

on the largest three banks or five banks is positive and statistically significant. Across

alternative measures of inequality, concentration and estimation methods, a 10%

increase in bank concentration would cause the Gini index higher by 0.9% to 7.0%. The

data confirm the view that increased concentration in banking can hurt small and young

firms by reducing the incentive for banks to establish long-term relationships with them,

because small banks are better than large banks at relationship lending that depends on

soft information (Berger et al., 2005). Greater concentration raises income inequality

by reinforcing financial constraints of small and new firms (Black and Strahan, 2002;

Cetorelli and Strahan, 2006; Kim, Lin and Chen, 2016). Likewise, the estimate on

competition based on the Lerner or Boone index is positive and statistically significant.

For alternative measures of inequality, competition and estimation methods, a one-

standard-deviation increase in bank competition would lead the Gini index to lower by

0.03% to 87.5%. The evidence seems to support the market power hypothesis that less

competitive banking markets lead to more credit rationing. Put differently, high

competition broadens access to credit, reducing income inequality. Again, financial

development is associated with higher income inequality, so does GDP growth, albeit

with lower statistical significance.

It may be argued that the impact of finance on inequality can differ across

countries because of heterogeneous economic conditions and institutional settings.

CUP estimators capture such variations via country-specific deterministics,  i and

4 Because of limited observations on government regulation, particularly when considering the WIID
inequality measure, we control only real GDP per capita for the following empirical analyses.
21
 d i t. Further, the unobserved common components of  it , f t , absorb a number of

different factors that drive income inequality but are simultaneously difficult to measure

precisely. Despite so, the assumption of slope homogeneity can lead to incorrect

conclusions if the true relationship is heterogeneous. As a robustness check, in Table 5

we experiment with alternative estimation methods, heterogeneous panel cointegration

techniques. The first three columns show the estimates from the group-mean fully

modified ordinary least squares (FMOLS) and the second three columns report the

group-mean dynamic OLS (DOLS) estimates. Both FMOLS and DOLS developed by

Pedroni (2001) allow for parameter heterogeneity and correct for autocorrelation and

endogeneity, but do not account for cross-section dependence. As illustrated, all

financial variables retain their signs and significance at the conventional level. The third

three columns of Table 5 consider Pesaran (2006)’s common correlated effects mean

group (CCEMG) estimator and the last three columns employs the dynamic CCEMG

estimator of Chudik and Pesaran (2015). Both estimators consider parameter

heterogeneity and account for the presence of cross-section dependence by augmenting

the regression equation with cross-section averages of all variables in the model. While

the validity of CCEMG requires exogenous regressors, the dynamic CCEMG performs

well in a dynamic model with weakly exogenous regressors (Chudik and Pesaran, 2015).

As shown, all financial variables keep their signs and remain significant at the

conventional level. GDP growth now is not statistically significant. Overall, the data

support our previous findings that income inequality increases with financial

development but decreases with market orientation, less bank concentration, or more

bank competition, even when considering heterogeneity in the inequality effect across

countries.

In Table 6, we check potential mechanisms for the financial sector to affect income

22
inequality. The first three columns (1)-(3) check the top marginal tax sourced from the

Fraser Institute’s Economic Freedom of the World database. According to the coupon

pool literature, financial deregulation/liberalization is usually associated with a

decrease in top income taxes to provide the savings pool for the market (van Treeck,

2009). This would benefit the rich and hence widens income inequality. As expected,

financial development lowers the top marginal tax rate and hence raises income

inequality as 𝐹𝐷 is negative and statistically significant. However, a more market-

based financial system or greater bank competition rises the top marginal tax rate and

thus mitigates income inequality. Both 𝐹𝑆 and the Boone indicator are positive and

statistically significant.

The second three columns (4)-(6) look at labor’s share of income, the share of

labor compensation in GDP sourced from Feenstra, Inklaar and Timmer (2015).

According to the mainstream view, financial development relaxes financial constraints

of firms and allows them to access credit to support greater production, raising workers’

wages and labor’s share of income. However, if financial development leads to resource

reallocation toward financially oriented activities and away from manufacturing and

service production, this would reduce workers’ bargaining power and stagnate wages

and employment. The labor’s income share drops as suggested in the financialization

literature (e.g., Hein, 2013). We find that the labor share decreases with financial

development but rises with increased market orientation and banking competition.

The last three columns (7)-(9) consider investment measured by gross capital

formation as a percentage of GDP and obtained from WDI. Greater credit availability

due to a decrease in credit market imperfections allows previously constrained firms to

finance their investment and grow in their size. This may lead to higher employment

and wages and hence to lower income inequality. However, during the process of

financialization, the increasing orientation of the non-financial sector towards financial

23
activities may ultimately shift management attention and investment away from the

core business and hence stagnate growth and employment. This may raise income

inequality. Consistent with Orhangazi (2008) and Tori and Onaran (2018), we find that

investment falls with financial development. However, greater market orientation and

banking competition are found to raise investment.

5 Nonlinearity

This section checks potential nonlinearity in the finance-inequality nexus based on

CUP-FM. Table 7 reports the results. We first look at whether banking crises change

the relationships in the first three columns by adding the interaction term between the

financial variable and the crisis dummy which takes one if there is a banking crisis and

zero if no crisis for each country-year pair. Data on banking crises are sourced from

GFDD. The Column (1) regression suggests that a more market-based financial system

mitigates income inequality, the more so during the period of banking crises. Both the

estimate on financial structure and on its interaction with the crisis dummy are negative

and statistically significant. Also, financial development strengthens income inequality,

the more so during the period of banking crises. The estimate on financial development

and on its interaction with the crisis dummy are positive and statistically significant.

The relatively big effect of financial development and financial structure is not

surprising. On the one hand, the poor are more vulnerable to banking crises and, on the

other hand, the rich have more assets including education and skills and better access

to a variety of options than the poor do, and the government tends to allocate losses of

financial crises to groups according to their power positions (Halac and Schmukler,

2004). Besides, a more market-based financial system provides a better shelter against

banking crises, as expected. In Column (2), a more concentrated banking system

reinforces income inequality, the less so during the period of banking crises. The
24
respective estimate on banking concentration and on its interaction with the crisis

dummy is positive and negative, and both are statistically significant. On the contrary,

as shown in Columns (3), a more competitive banking system mitigates income

inequality, the more so during the crisis period. The estimate on bank competition and

on its interaction with the crisis dummy are positive and statistically significant.

It is argued that as economies develop, their financial sectors, both the banking

sector and stock markets, represent larger shares of the overall economy (Demirgüç-

Kunt, Feyen and Levine, 2013). Also, as countries become richer, their domestic

financial systems tend to become more stock-market-oriented because firms tend to

change the method by which they acquire external funds, switching borrowing from

banks toward stock markets (Boot and Thakor, 1997, 2000). It is also argued that

political capture and direct control of the financial sector is more relevant for countries

with weak institutional setting, where skewed political participation allows powerful

groups to affect the regulatory and judicial environment, and control the allocation of

finance directly through bank ownership or indirectly through political connections

(Claessens and Perotti, 2007). Hence, in the remaining columns of Table 7 we examine

how economic development and political institutional quality influence the finance-

inequality nexus. The second three columns of Table 7 look at the differences between

OECD and non-OECD countries by including the interaction term between the financial

variable and the OECD dummy which takes one for OECD countries and zero for non-

OECD countries. Column (4) suggests that a more market-based financial system

mitigates income inequality, and the effect is stronger in OECD countries. The estimate

on financial structure and on its interaction with the corruption dummy are negative and

statistically significant. Column (5) implies that a more concentrated banking structure

widens income inequality, the effect that is weaker in OECD countries. The respective

estimate on banking concentration and on its interaction with the OECD dummy is
25
positive and negative, both of which are statistically significant. By contrast, in Column

(6), a more competitive banking market decreases income inequality, with a stronger

impact for OECD countries. The estimate on bank competition and on its interaction

with the OECD dummy are positive and statistically significant.

The third three columns of Table 7 consider the quality of political institutions

proxied by corruption control. The data on corruption control are obtained from ICRG

with larger number indicating lower levels of corruption.5 We then use the mean of

corruption as a dividing line to create the dummy for corruption. Specifically, the

corruption dummy takes one for countries with corruption control larger than the mean,

i.e., less corrupt governments, and zero for those with corruption control less than the

mean, i.e., more corrupt governments. Again, we include the interaction term between

the financial variable and the corruption dummy into the regression equations. Column

(7) suggests that a more market-based financial system mitigates income inequality, the

more so in countries with less corrupt governments. The estimate on financial structure

and on its interaction with the corruption dummy are negative and statistically

significant. Column (8) implies that a more concentrated banking structure widens

income inequality, the less so for low corruption countries. The respective estimate on

banking concentration and on its interaction with the corruption dummy is positive and

negative, both of which are statistically significant. Equally, in Column (9), a more

competitive banking market lowers income inequality, the more so for countries with

less corrupt governments. The estimate on bank competition and on its interaction with

the corruption dummy are positive and statistically significant.

In all cases, financial development aggravates income inequality, the more so for

5 Corruption proxies actual or potential corruption in the form of excessive patronage, nepotism, job
reservations, ‘favor-for-favors’, secret party funding, and suspiciously close ties between politics and
business.
26
OECD, less corrupt or less open countries. The estimate on financial development and

its interaction with OECD and corruption dummies are positive and statistically

significant.

The even bigger inequality-increasing effect of financial development in OECD

countries and countries with low corruption seems in line with Arcand, Berkes and

Panizza (2015) that finance is too much as it distracts resources from other more

productive activities toward inefficient rent-seeking activities and Beck et al. (2012)

that more credit goes to the households relative to enterprises that want to finance their

production or investment projects as the economies develop, thereby strengthening the

gap between the rich and the poor. On the other hand, the larger inequality-decreasing

effect of market-led financial systems in OECD countries and less corrupt countries

might be indicative of a more optimal mixture of banks and stock markets, which is

better able to effectively allocate finance and allows even broader access to finance. As

for the greater inequality-decreasing effect of banking competition in OECD and less

corrupt countries, it is perhaps because better corruption control and government

supervision in these countries mitigate corruption in bank lending and reduce politically

connected lending.

6 Conclusion

We study the finance-inequality nexus, placing particular emphasis on financial

structure and banking market structure, which has been overlooked in the literature.

Specifically, we control for economic growth and financial development and check how

financial structure and banking structure would affect income inequality. It is found

that a more market-based financial system is conducive to a more equitable distribution

of income. Moreover, less concentration, more competition in the banking sector is

shown to alleviate income inequality. Besides, overall financial development is found

27
to exert an adverse impact on income distribution. While there might be other channels,

these effects operate possibly through the mechanisms of top income tax, labor’s

income share and investment. Finally, these effects are strengthened by banking crises,

economic development, or better quality of political institutions. Our data thus suggest

that overdevelopment or malfunction in the financial sector can be, in part, responsible

for rising inequality. Our data also suggest that a market-based financial system gives

policymakers a better position to fight against income inequality and to skirt banking

crises but cast doubts on bank market power in terms of income distribution.

28
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36
Appendix: A Country List, Summary Statistics, and Weak Exogeneity Tests

Table A1: A List of Countries

country classification country classification
Argentina 2 4 6 Korea Rep. 1 4 6
Australia 1 3 6 Kyrgyz Rep. 2 -- 5
Austria 1 3 5 Lebanon 2 4 5
Bangladesh 2 4 6 Lithuania 2 4 5
Barbados 2 -- 5 Luxembourg 1 3 5
Belgium 1 3 5 Macedonia 2 -- 5
Bolivia 2 4 6 Malaysia 2 4 5
Botswana 2 3 5 Malta 2 3 5
Brazil 2 4 6 Mauritius 2 -- 5
Bulgaria 2 4 5 Mexico 1 4 6
Canada 1 3 6 Mongolia 2 4 5
Chile 1 3 6 Morocco 2 4 6
China 2 4 6 Namibia 2 4 5
Colombia 2 4 6 Nepal 2 -- 6
Costa Rica 2 3 5 Netherlands 1 3 5
Cote d'Ivoire 2 4 5 New Zealand 1 3 6
Croatia 2 4 5 Nigeria 2 4 6
Cyprus 2 3 5 Norway 1 3 6
Czech Rep. 1 4 5 Pakistan 2 4 6
Denmark 1 3 5 Panama 2 4 5
Ecuador 2 4 6 Peru 2 4 6
Egypt 2 4 6 Philippines 2 4 5
El Salvador 2 4 6 Poland 1 4 6
Estonia 1 3 5 Portugal 1 3 6
Finland 1 3 6 Romania 2 4 6
France 1 3 6 Russia 2 4 6
Germany 1 3 6 Singapore 2 3 5
Ghana 2 4 5 Slovak Rep. 1 4 5
Greece 1 3 6 Slovenia 1 3 5
Hong Kong 2 3 5 South Africa 2 3 6
Hungary 1 3 5 Spain 1 3 6
Iceland 1 3 5 Sri Lanka 2 4 6
India 2 4 6 Sweden 1 3 5
Indonesia 2 4 6 Switzerland 1 3 5
Iran 2 4 6 Thailand 2 4 5
Ireland 1 3 5 Trinidad and Tobago 2 4 5
Israel 1 3 6 Tunisia 2 4 5
Italy 1 4 6 Turkey 1 4 6
Jamaica 2 4 5 Ukraine 2 4 5
Japan 1 3 6 United Kingdom 1 3 6
Jordan 2 4 5 United States 1 3 6
Kazakhstan 2 4 5 Venezuela 2 4 6
Kenya 2 4 6 Zambia 2 4 6
Note: 1 = OECD, 2 = non-OECD, 3 = less corruption control, 4 = high corruption control,
and 5 = high trade openness, 6 = less trade openness.

37
Table A2: Summary Statistics
variables definition/calculation obs. mean median std. dev. min max
Gini index SWIID 2236 3.589 3.583 0.251 2.900 4.099
Gini index WIID 1352 3.623 3.616 0.261 2.917 4.186
the value of credits by financial intermediaries to the private
private credit 2236 3.761 3.867 0.971 -3.300 5.570
sector divided by GDP
value traded the value of stock transactions as a percentage of GDP 2236 1.369 1.455 2.286 -7.213 6.712
market capitalization the value of listed shares divided by GDP 2236 3.075 3.296 1.525 -4.605 6.990
a composite measure of banks and markets calculated as the 2236 0.029 0.096 1.352 -5.456 3.656
FD
first principal component of 𝐹𝐷_𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 and 𝐹𝐷_𝑠𝑖𝑧𝑒
A composite measure of the comparative role of banks and 2236 0.015 0.190 1.258 -7.422 5.792
FS markets calculated as the first principal component of
𝐹𝑆_𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 and 𝐹𝑆_𝑠𝑖𝑧𝑒
real GDP per capita GDP per capita (constant 2010, US$) 2236 9.030 9.027 1.323 5.858 11.626
a composite measure of three sub-indices measuring the 1586 6.630 6.748 1.111 1.002 9.429
freedom from government regulations and controls in the
government regulation
labor market, credit markets, and price controls in the
markets for goods and services
a measure of freedom from government regulations and 1586 5.622 5.490 1.544 0.012 9.456
labor regulation
controls in the labor market
trade the sum of exports and imports as a percentage of GDP 2210 4.275 4.252 0.570 2.621 6.092
education the secondary education enrollment 1872 4.433 4.514 0.305 3.058 5.104
the sum of market shares (in terms of total assets) of the 1460 4.129 4.172 0.337 2.850 4.605
3-bank concentration
three largest banks
the sum of market shares (in terms of total assets) of the five 1300 4.310 4.370 0.249 3.108 4.605
5-bank concentration
largest banks
the difference between output prices and marginal costs 1420 0.198 0.230 1.229 -44.640 4.984
Lerner index
(relative to prices)
Boone indicator the elasticity of profits to marginal costs 1240 -0.050 -0.050 0.184 -1.830 1.910
Note: All variables are in logs except for government regulation, labor regulation, the Boone indicator and Lerner index.

38
Table A3: Long-Run Weak Exogeneity Tests
SWIID WIID
weak exogeneity of weak exogeneity of
Panel A: financial structure
real GDP real GDP
inequality FD FS inequality FD FS
per capitat-1 per capitat-1
χ2(1) -7.343*** 0.121 -0.222 -0.170 -15.864*** -0.450 0.336 -1.027
Panel B: 3-bank concentration
3-bank real GDP 3-bank real GDP
inequality FD inequality FD
concentration per capitat-1 concentration per capitat-1
χ2(1) -6.205*** -0.084 0.260 1.557 -18.783*** -1.169 -1.121 0.845
Panel C: 5-bank concentration
5-bank real GDP 5-bank real GDP
inequality FD inequality FD
concentration per capitat-1 concentration per capitat-1
χ2(1) -5.571*** 0.655 0.234 1.506 -18.189*** -0.908 -1.575 0.893
Panel D: Lerner index
real GDP real GDP
inequality FD Lerner index inequality FD Lerner index
per capitat-1 per capitat-1
χ2(1) -5.674*** -1.158 -1.632 1.119 -16.025*** -0.718 -1.065 -0.018
Panel E: Boone indicator
Boone real GDP Boone real GDP
inequality FD inequality FD
indicator per capitat-1 indicator per capitat-1
χ2(1) -3.877*** -0.922 -1.403 1.533 -17.813*** -0.682 -0.737 -0.130
Note: The number of degrees of freedom ν in the standard χ2(ν) tests correspond to the number of zero
restrictions. The number of lags was determined by the general-to-specific procedure with a maximum of three
lags. *** denotes significance at the 1 % level.

39
Table 1: Pesaran’s CD and Panel Unit Root Tests
CD CIPS
level difference
SWIID 28.088*** -1.233 -2.838***
WIID 25.274*** -1.819 -5.906***
private credit 111.615*** -1.642 -3.234***
value traded 88.735*** -1.840 -3.866***
market capitalization 133.935*** 2.610 -3.854***
FD 164.125*** -1.834 -3.651***
FS 65.116*** -1.718 -3.594***
real GDP per capita 244.922*** -1.761 -3.491***
government regulation 98.169*** -1.800 -5.774***
labor regulation 103.901*** -1.848 -5.724***
trade 108.321*** -1.663 -4.191***
education 113.502*** -1.791 -4.438***
3-bank concentration 13.193*** -1.843 -4.454***
5-bank concentration 2.505** -1.691 -4.648***
Lerner index 30.480*** -1.878 -4.778***
Boone indicator 27.121*** -1.641 -4.924***
Note: ***, **, and * indicate significance at 1%, 5%, and 10%, respectively.

40
Table 2: Baseline Estimates on Financial Development
CUP-FM CUP-BC
SWIID WIID SWIID WIID
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
private credit 0.027*** 0.027*** 0.031*** 0.030***
(3.017) (3.077) (3.394) (3.358)
value traded 0.017*** 0.025*** 0.019*** 0.030***
(6.804) (9.201) (7.545) (11.043)
market capitalization -0.028*** -0.036***
(-7.272) (-9.121)
FD 0.057*** 0.062*** 0.140** 0.189* 0.066*** 0.062*** 0.172** 0.169*
(4.048) (10.945) (2.001) (1.865) (4.592) (10.873) (2.470) (1.701)
real GDP per capitat-1 -0.082** -0.082** -0.711*** -0.410*** -1.821*** -2.536*** -0.079** -0.089** -0.822*** -0.451*** -1.551*** -1.796***
(-2.276) (-2.307) (-9.040) (-11.710) (-9.055) (-6.545) (-2.183) (-2.498) (-10.378) (-12.753) (-8.262) (-5.162)
government regulation -0.030*** 0.105 -0.032*** 0.170*
(-7.415) (1.041) (-7.943) (1.774)
trade 0.071*** 0.132 0.077*** 0.288
(4.978) (0.437) (5.368) (0.999)
education 0.039 -1.237*** 0.033 -1.192***
(1.451) (-2.735) (1.239) (-2.751)
Westerlund (2007) cointegration tests
Group  -1.442 -1.235 -1.692 -1.559** -2.216* -2.434** -1.442 -1.235 -1.692 -1.559** -2.216* -2.434**
Group  -3.754** -2.416* -5.904* -0.760*** -7.741 -7.101 -3.754** -2.416* -5.904* -0.760*** -7.741 -7.101
panel  -13.939*** -9.862*** -20.904*** -12.216*** -16.663*** -14.838*** -13.939*** -9.862*** -20.904*** -12.216*** -16.663*** -14.838***
panel  -3.692** -3.023** -7.947*** -0.816** -7.912** -6.805* -3.692** -3.023** -7.947*** -0.816** -7.911* -6.805*
N T ( N ) 2236 (86) 2236 (86) 2236 (86) 1482 (57) 1352 (52) 988 (38) 2236 (86) 2236 (86) 2236 (86) 1482 (57) 1352 (52) 988 (38)
Note: t statistics are in Parentheses. ***, **, and * indicate significance at 1%, 5%, and 10%, respectively.

41
Table 3: Considering Financial Structure
CUP-FM CUP-BC
government labor government labor
SWIID WIID trade education SWIID WIID trade education
regulation regulation regulation regulation
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
FD 0.114*** 0.176** 0.160*** 0.162*** 0.148*** 0.159*** 0.119*** 0.206*** 0.150*** 0.151*** 0.131*** 0.140***
(7.091) (2.368) (7.486) (7.607) (6.960) (8.386) (7.322) (2.798) (7.054) (7.136) (6.167) (7.409)
FS -0.069*** -0.246*** -0.096*** -0.096*** -0.092*** -0.104*** -0.065*** -0.259*** -0.080*** -0.080*** -0.076*** -0.092***
(-7.207) (-5.621) (-7.585) (-7.629) (-7.348) (-9.235) (-6.674) (-5.943) (-6.381) (-6.387) (-6.064) (-8.151)
real GDP per capitat-1 -0.767*** -2.441*** -0.835*** -0.842*** -0.747*** -0.772*** -0.861*** -2.215*** -0.852*** -0.867*** -0.717*** -0.711***
(-10.098) (-10.786) (-8.181) (-8.332) (-7.395) (-8.530) (-11.281) (-10.415) (-8.381) (-8.578) (-7.051) (-7.825)
regulation -0.040*** -0.034** -0.029** -0.040*** -0.037** -0.033**
(-2.623) (-2.229) (-2.166) (-2.583) (-2.426) (-2.459)
labor regulation -0.051*** -0.056***
(-4.127) (-4.506)
trade 0.215*** 0.213*** 0.270*** 0.273***
(4.672) (5.141) (5.841) (6.553)
education -0.110 -0.116
(-1.474) (-1.555)
Westerlund (2007) cointegration tests
Group  -1.4755 -3.114 -1.410 -1.292 -1.486 -1.318 -1.475 -3.113 -1.419 -1.298 -1.486 -1.318
Group  -3.9374** -8.972* -1.567** -1.646** -2.208 -0.808 -3.937** -8.976* -1.567** -1.645** -2.208 -0.808
panel  -18.3023*** -25.126** -9.761*** -11.910** -15.850*** -16.451** -18.302*** -25.126** -9.761*** -11.917** -15.850*** -16.451**
panel  -6.0894*** -13.324*** -4.287*** -4.685** -3.563* -1.365** -6.089*** -13.324*** -4.281*** -4.686** -3.563* -1.365**
Obs.: N  T (N) 2236(86) 1352(52) 1586(61) 1586(61) 1586(61) 1482(57) 2236(86) 1352(52) 1586(61) 1586(61) 1586(61) 1482(57)
Note: t statistics are in Parentheses. ***, **, and * indicate significance at 1%, 5%, and 10%, respectively.

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Table 4: Considering Banking Structure
CUP-FM CUP-BC
3-bank concentration 5-bank concentration 3-bank concentration 5-bank concentration
SWIID WIID SWIID WIID SWIID WIID SWIID WIID
(1) (2) (3) (4) (5) (6) (7) (8)
Panel A: bank concentration
FD 0.025*** 0.265*** 0.018** 0.949*** 0.034*** 0.311*** 0.024*** 0.925***
(2.978) (2.595) (2.270) (35.772) (4.039) (3.051) (2.955) (35.767)
concentration 0.086*** 0.475** 0.134*** 0.173*** 0.100*** 0.696*** 0.156*** 0.181***
(5.164) (2.207) (6.020) (2.712) (6.023) (3.198) (6.958) (2.882)
real GDP per capitat-1 -0.364*** 1.491*** -0.388*** -2.361*** -0.402*** 1.581*** -0.401*** -2.989***
(-6.543) (12.671) (-7.410) (-21.331) (-7.230) (14.132) (-7.621) (-25.647)
Westerlund (2007) cointegration tests
Group  -1.274 -2.773** -1.618 -2.837*** -1.274 -2.773** -1.618 -2.837***
Group  -1.179*** -4.594*** -1.007*** -1.344 -1.179*** -4.594*** -1.001*** -1.344
panel  -8.466*** -16.522** -9.119*** -10.757* -8.466*** -16.522** -9.119*** -10.757*
panel  -2.004** -4.499** -2.121** -1.452* -2.004** -4.499** -2.121** -1.452*
Obs.: N  T (N) 1460(73) 980(49) 1300(65) 920(46) 1460(73) 980(49) 1300(65) 920(49)
Lerner index Boone indicator Lerner index Boone indicator
Panel B: bank competition
FD 0.009*** 0.240*** 0.071*** 0.195*** 0.013*** 0.314*** 0.074*** 0.211***
(4.272) (3.651) (24.203) (2.995) (5.775) (5.840) (25.290) (3.224)
competition 0.008*** 0.346*** 0.002** 0.309*** 0.021*** 0.712*** 0.003*** 0.276**
(2.803) (4.320) (2.015) (2.625) (6.783) (10.965) (3.004) (2.352)
real GDP per capitat-1 0.052*** -0.247* -0.264*** -1.115*** 0.045*** -0.807*** -0.222*** -1.479***
(3.915) (-1.800) (-16.660) (-6.283) (3.339) (-6.667) (-14.506) (-7.571)
Westerlund (2007) cointegration tests
Group  -3.670 -2.822** -1.538 -2.934* -3.670 -2.822** -1.538 -2.934*
Group  -0.568 -1.435 -2.465** -3.324* -0.568 -1.435 -2.465** -3.324*
panel  -9.505** -13.858** -10.843*** -15.171** -9.505** -13.858** -10.843*** -15.171**
panel  -2.442** -1.470* -2.594*** -4.376* -2.442** -1.470* -2.594*** -4.376*
Obs.: N  T (N) 1420(71) 900(45) 1240(62) 840(42) 1420(71) 900(45) 1240(62) 840(42)
Note: t statistics are in Parentheses. ***, **, and * indicate significance at 1%, 5%, and 10%, respectively.

43
Table 5: Robustness Checks, alternative estimators
FMOLS DOLS CCEMG Dynamic CCEMG
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
FD 0.083*** 0.052*** 0.981*** 0.196*** 0.024*** 1.249*** 0.086** 0.083** 0.075** 0.078*** 0.067** 0.123**
(14.930) (5.388) (5.309) (14.825) (9.198) (34.557) (1.968) (2.000) (1.988) (2.752) (1.983) (2.545)
FS -0.048*** -0.033*** -0.050** -0.029**
(-7.831) (-4.370) (-1.994) (-1.978)
3-bank concentration 0.230** 0.150*** 0.090** 0.206**
(2.145) (-9.281) (2.056) (2.080)
Lerner index 0.005*** 1.174*** 0.161** 0.259**
(-6.418) (-30.186) (2.235) (2.187)
real GDP per capitat-1 -0.493*** -0.361*** -1.203*** -0.765*** -0.647*** -1.796*** -0.475** -0.106 -0.150 0.084 0.349* -0.026
(-11.020) (-14.265) (-9.252) (-18.507) (-37.072) (-27.213) (-2.482) (-0.416) (-0.656) (0.531) (1.679) (-0.139)
inequalityt-1 0.631*** 0.471*** 0.028
(18.309) (8.543) (0.299)
Westerlund (2007) cointegration tests
Group  -1.475 -1.270 -3.670 -1.475 -1.274 -3.670 -1.475 -1.274 -3.670 -1.475 -1.274 -3.670
Group  -3.934** -1.1794*** -0.568 -3.937** -1.179*** -0.568 -3.937** -1.179*** -0.568 -3.937** -1.179*** -0.568
panel  -18.303*** -8.460*** -9.505** -18.302*** -8.466*** -9.505** -18.302*** -8.466*** -9.505** -18.302*** -8.466*** -9.505**
panel  -6.084*** -2.004** -2.442** -6.089*** -2.004** -2.442** -6.089*** -2.004** -2.442** -6.089*** -2.004** -2.442**
Obs.: N  T (N) 2236(86) 1440(72) 1240(62) 2210(85) 1360(68) 1380(69) 2054(79) 1320(66) 1220(61) 2210(85) 1400(70) 1340(67)
Note: The dependent variable is the Gini coefficient from SWIID. For DOLS and dynamic CCEMG, the lag and lead order is based on the Schwarz Criterion subject to a
maximum lag of three. t statistics are in Parentheses. ***, **, and * indicate significance at 1%, 5%, and 10%, respectively.

44
Table 6: Other robustness checks, mechanisms
top marginal tax labor share investment
(1) (2) (3) (4) (5) (6) (7) (8) (9)
FD -0.002*** -0.015** -0.372*** -0.016*** -0.090** -0.056** -0.133** -0.103*** -0.123***
(-3.603) (-2.105) (-7.672) (-3.291) (-1.989) (-1.989) (-2.432) (-2.766) (-4.233)
FS 0.024*** 0.012*** 0.113***
(72.566) (4.861) (3.244)
3-bank concentration -0.025** -0.357*** -0.754***
(-2.244) (-3.901) (-12.307)
Lerner index -0.185** -0.130*** -1.192***
(-2.495) (-3.315) (-4.612)
real GDP per capitat-1 -0.052*** -0.506*** 1.440*** 1.801*** 0.555*** 1.009*** 1.912*** -2.559*** 0.318***
(-16.251) (-14.100) (13.804) (102.092) (3.336) (9.240) (30.245) (-18.423) (41.014)
Westerlund (2007) cointegration tests
Group  -2.504*** -1.677** -1.763*** -2.039** -1.467 -1.891 -2.505*** -2.197* -2.702**
Group  -10.002*** -3.573 -3.659 -7.042 -3.538 -3.444 -4.971*** -4.206 -4.137
panel  -18.244*** -12.642** -13.102*** -16.955** -13.616*** -19.435*** -18.824*** -77.437*** -20.345***
panel  -8.083*** -3.364** -3.247** -6.844*** -4.421** -4.004*** -6.590*** -19.206** -7.663***
Obs.: N  T (N) 2080 (80) 1400 (70) 1340 (67) 2080 (80) 1400 (70) 1320 (66) 2184 (84) 1460 (73) 1420 (71)
Note: t statistics are in Parentheses. ***, **, and * indicate significance at 1%, 5%, and 10%, respectively.

45
Table 7: Impacts of Banking Crises, Economic Development, and Quality of Political Institutions
Crisis dummy OECD dummy corruption dummy
(1) (2) (3) (4) (5) (6) (7) (8) (9)
financial development 0.035*** 0.019*** 0.006** 0.016*** 0.012*** 0.004* 0.061*** 0.037*** 0.009***
(28.510) (7.879) (2.396) (8.697) (4.542) (1.710) (5.109) (6.372) (5.593)
financial structure -0.009*** -0.015*** -0.060***
(-10.253) (-15.067) (-8.505)
3-bank concentration 0.039*** 0.043*** 0.027***
(10.850) (9.033) (2.990)
Lerner index 0.036*** 0.009*** 0.109***
(7.797) (2.769) (35.240)
financial development × dummy 0.019*** 0.002* 0.003** 0.064*** 0.014** 0.040*** 0.175*** 0.025** 0.042***
(30.654) (1.703) (2.351) (12.806) (2.340) (7.460) (7.007) (2.400) (13.735)
financial structure × dummy -0.007*** -0.029*** -0.031**
(-11.344) (-11.552) (-2.019)
3-bank concentration × dummy -0.004*** -0.024*** -0.035**
(-8.814) (-3.386) (-2.118)
Lerner index × dummy 0.026*** 0.019** 0.139***
(4.870) (2.151) (27.012)
real GDP per capitat-1 -0.056*** -0.029** 0.065*** -0.078*** -0.076*** 0.043*** -0.607*** -0.002 -0.030***
(-9.924) (-1.992) (5.084) (-9.322) (-5.160) (3.390) (-12.218) (-0.068) (-4.048)
N T ( N ) 2236 (86) 1460 (73) 1420 (71) 2236 (86) 1460 (73) 1420 (71) 2106 (81) 1400 (70) 1360 (68)
Note: The crisis dummy is one if there is a banking crisis and zero if no banking crisis for each country-year pair. The OECD dummy takes
one for OECD countries and zero for non-OECD countries. The corruption dummy takes one for less-corrupt countries and zero for more
corrupt countries. t statistics are in Parentheses. ***, **, and * indicate significance at 1%, 5%, and 10%, respectively.

46