Financialization, Income Inequality and the Role of Institutions in the Developing and Emerging Economies

Abstract

An extensive literature in Sociology highlights a strong positive association between financialization and income inequality. Using a panel dataset of developing and emerging economies, this paper investigates the relationship between financial activities and the extent of income inequality. The analysis reveals a direct link between the two, showing that financialization tends to exacerbate inequality. However, the presence of higher-quality institutions can significantly moderate—and, in some cases, reduce—the distributional effects of financialization. Additionally, rising female labor force participation and the rapid growth of the service sector are found to be significant drivers of social stratification in these economies. The interaction of financialization with both service sector employment and female labor participation shows a significant positive association with income inequality, suggesting that finance’s tendency to amplify elite incomes intensifies the inequality effects of the transition to a service-oriented economy. Importantly, these interactions are significantly moderated when institutional quality is accounted for, underscoring the critical role of resilient institutions in mitigating the inequality-enhancing effects of financial development.