Effects of Financial Development on InCome Inequality in the Philippines

EFFECTS OF FINANCIAL DEVELOPMENT ON INCOME[pic 1]

INEQUALITY IN THE PHILIPPINES

by

Fatima Jean A. Okyo and Purisima G. Bayacag, PhD^[1]

Abstract

This study investigated the effects of financial development on income inequality in the Philippines using Generalized Least Squares Method covering the period 1985-2011. Specifically, it presented the trends of financial development in terms of financial sector development index and income inequality in terms of Gini coefficient. Moreover, it tested for the existence of the inverted-U relationship between the two variables. The study used Maximum Likelihood Estimation to test the non-linear empirical model.

Results revealed that financial development is a significant factor to the country’s income inequality. The results of Generalized Least Squares estimation show that financial development increases income inequality. The testing of the non-linear hypothesis showed that the relationship of the said variables is “U” shaped, an empirical evidence that the inverted “U” Kuznets Curve failed to manifest in the Philippines.

INTRODUCTION

There have been researches regarding economic growth today. These studies tend to emphasize particular aspects of the growth process. Among the important correlates of economic growth that have been studied are growth and the extent of financial development.

        A solid and well-functioning financial sector is a powerful engine behind economic growth. There are plenty of evidences regarding this matter. Few of these are the works of Schumpeter (1911), Robinson (1952), and Levine (1997) where they found out that financial development promotes economic growth.

        Financial development can be defined as the policies, factors, and the institutions that lead to the efficient intermediation and effective financial markets. A strong financial system offers risk diversification and effective capital allocation. The greater the financial development, the higher would be the mobilization of savings and its allocation to high return projects (Adnan, 2009).

According to World Economic Forum (WEF, 2008), a country’s financial development is determined based on six pillars namely: (1) institutional environment – which includes prudent regulations, corporate governance and financial sector liberalization; (2) business environment – which encompasses human capital, taxes, infrastructure and cost of doing business; (3) financial stability – which covers banking and financial services; (4) non-banking financial services – which cover insurance, securitization and service that aid in initial public offerings, and in mergers and acquisitions; (5) financial markets – which include foreign exchange, equity, and bond markets among others;  and lastly, (6) financial access (http://business.inquirer.net, 2011).