Analysing the impact of the financial services sector on income inequality: A panel data approach

Abstract

Various studies provide evidence of the importance of the financial services sector for economic growth. The link between the financial services sector and the distribution of income is less clear. This dissertation aims to empirically analyse how the financial services sector impacts income inequality, what is the form of this relationship and how income inequality interacts with other variables. For this purpose, a panel data approach based on three econometric models was adopted based on data from 23 European countries for the period between 2005 and 2012. The results indicate that the financial services sector is positively related with income inequality. Furthermore, the results indicate that the same relationship is inversely “U” shaped; however this was not statistically significant in all models considered. Income inequality was positively related with poverty and government expenditure on health. On the other hand, inflation, gross domestic product and government expenditure on social protection and education prove to decrease income inequality. The models had issues of multicollinearity, autocorrelation, and heteroscedasticity which remained present even after the implementation of the remedies. Due to these issues and other limitations, caution need to be taken when interpreting the results. This dissertation provides recommendations aimed to improve the current income distribution policies while taking into account the impact of the financial services sector on income inequality. Since the results prove that income inequality is positively related with poverty, these recommendations are also aimed to reduce poverty and to make society more egalitarian.