Financial depth, income inequality, and economic transition

Abstract

Abstract This article examines the evolving finance–inequality nexus during the process of economic transition. We estimate the varying marginal effects of financial depth on income inequality in every state of the transition process. Using China as an example of transition economies, we establish the causal effects of financial depth on urban income inequality and examine the estimation biases when the evolving relationship is not appropriately characterized. Along the transition process of the Chinese economy, we identify a robustly asymmetric and roughly inverted‐L shaped relationship between financial depth and urban inequality. We find that financial depth alone accounts for 11–28% of the overall variations of urban income inequality and the marginal impacts of financial depth change with the degree of credit constraint, the fraction of state ownership, and the level of economic development.