4.1. Baseline Estimation Results
Our baseline estimation result shows that a rise in domestic credit increases gini disposable [Table 2]. The result suggests that the financial system mobilizes resources and finances, promising business opportunities that are likely productivity-enhancing activities (King & Levine, 1993). In this regard, even though a massive business opportunity exists, the poor can not access it because most of the time, the system requires collateral. The financial development to offer a comprehensive benefit for a significant portion of the population and ensure even income distribution, the system has to be inclusive. It has proven that financial inclusion reduces poverty and income inequality in developing countries (Park & Mercado, 2015; Demir et al. 2020; Omar & Inaba, 2020).
Digital financial service growth in Africa has led to an increase in the number of people enjoying access to formal financial services (IFC, 2018). Africa now has more digital financial services deployments than any other region globally, with more than 700 million individual users worldwide. Mobile money solutions and agent banking offer affordable, instant, and reliable transactions, savings, credit, and even insurance opportunities in rural villages. However, inclusion in providing credit is still low, leaving many not benefiting from the existing development. The development of the banking sector affects income inequality through the credit or deposit channel. However, the financial depth measured by domestic credit varied within Africa and remained the lowest compared to Latin American & Caribbean, and OECD countries (Nyantakyi & Sy, 2015). This phenomenon is partly explained in [Figure 1], which shows that most African countries are at the initial level of financial development. Although the current digital technology brings enormous benefits to broaden financial inclusion, the resource mobilized to finance investment opportunities are still low.
The other side of the credit channel explains who benefits from it. The continent banking system is characterized by shallow financial access to low-income communities. The degree to which entrepreneurs from rural areas access working capital is limited by collateral requirement, which allows a significant portion of the credit to be directed to those who are relatively wealthy. As the rich people access this limited finance and get productive income gap between the poor and the rich becomes exacerbated. Our finding corroborates the hypothesis that when countries transition to an industrial society, the income distribution between the rich and poor widens (Greenwood & Jovanovic, 1990).
The other sector that is at its infancy level in Africa is the stock market. Stock market and income inequality are the least researched area in the finance-inequality literature. Little is known about its effect on income inequality in the African continent. An inverse relationship exists between stock market development and income inequality (Tsagkanos, 2017; Destek et al. 2020). However, our finding shows a positive relationship between stock value traded and gini disposable. It should be noted that only a few countries have well-established markets with dispersed distribution, ranging from a relatively developed stock market in South Africa to the least in Uganda (Ngare et al. 2014). The market coverage is only 32 percent at the geographic boundary level. On top of that, the agriculture or agri-industrial stock traded that have massive bases are limited.
The key implication is again evolving around the impact of the stock market on agricultural dwellers. Stock market in Africa is underdeveloped and have failed to meet the continent's capital needs (Uzum et al. 2021). Even though stock return prices are determined by agricultural-specific factors (Valdes et al. 2016), the existing capital represented by market capitalization negatively affects agriculture growth (Ngong et al. 2022). The result suggests that the capital raised from the stock market is not enhancing the production or productivity of the agriculture sector. Given that most of the population lives in rural areas, the result makes sense in the African context. It corroborates the claim that the financial system benefits those a lready accessing the financial service.
Our composite interaction term between domestic credit and stock value traded is positively related to gini disposable. In this specification, there is no evidence supporting the inverted U-shape hypothesis. The finding implies that previous efforts that establish a non-linear relationship between financial development and income inequality need to be checked for two reasons. First, the non-linearity is sensitive to specification differences. The banking sector specification supports the claim, but the composite index shows that the whole financial system does not. Second, since finance is endogeneous, the financial sector indicator must be confirmed by GDP controls.
There is no substantial difference between the effect running from the banking, stock market, and composite index. Moreover, the non-linearity relationship presented in [Figure 1] is reversed as we control GDP growth, Inflation, and FDI inflow and shows evidence for an inverted U shape hypothesis is supported in the finance inequality nexus in Africa. Our control variables are insignificant in most specifications also provides evidence for an inverted U shape relationship between gini disposable and GDP growth. A higher FDI inflow also raises gini disposable.
Overall our result shows that financial sector development widens income inequality in Africa. Our finding supports current literature claiming that financial sector development exacerbated income inequality and an inverted U shape relationship in the nexus finance inequality. However, the continent is big with different policies pursued in each country, stage of financial development, economic growth, socio-political conditions, and law enforcement practices. Attributing the baseline result without accounting for these structural differences becomes misleading. We handle these challenges using a subsample analysis by geographical locations. These geographical proximities allow inferring a relationship from relatively similar countries net of socio-economic and culture grounded differences in the structure of economies. Second, we exploit the existing differences in governance that may place countries in different positions in the financial sector development.
We can obtain three insights from [Figure 2 & Figure 3]. First, most countries in Northern and Southern Africa exhibit a positive correlation between gini disposable and domestic credit, whereas, in Eastern and Western Africa, the correlation is negative. It is likely that the baseline result is driven by the level of financial depth in the Northern and Southern African countries. It is also an indication that a sub-sample analysis may provide additional insight concerning the relationship. Second, the correlation in the banking sector seemingly translated into the stock market in the respective regions.
However, this phenomenon is not moving in tandem with GDP growth. For instance, among the rapidly growing economies in Africa (i.e., Morocco, Kenya, Ghana, Egypt, South Africa, Algeria, Nigeria, Ethiopia, and Angola), it is only in Ghana, South Africa, and Angola that the positive correlation has been exhibited. One characteristic of the development efforts in Africa is pooling people out of poverty. Whether we attribute the effect to the financial sector or not, evidence shows a higher economic growth narrows income inequality. We argue that the existing heterogeneity is attributed to omitted factors such as governance and geography. Given that regional institutional arrangements are geographical location-based, we configure geographical regions with governance indicators and do two empirical exercises.
4.2. The Moderating Effect of Corruption and Political Instability
The first empirical exercise considers how corruption moderates the relationship [Table 3, Panel A]. This factor plays an essential role in shaping the financial development in each region. Corruption distorts the extent to which banks provide credit to the private sector. Wei & Kong, (2017) show that corruption and financial development have significant positive influences on a company's bank loans, and its interaction does not increase a company's bank loans. Corruption asymmetrically impacts financial sector development (Alsagr & van Hemmen, 2021). Adams & Klobodu, (2016) also show that the interaction of financial development and the control of corruption affect income inequality negatively.
Corruption captures perceptions of the extent to which public power is exercised for private gain. These includes petty and grand forms of corruption and the state by elites and private (Kaufmann et al. 2010b). Our result shows that a higher level of corruption increases gini disposable. Most importantly, its interaction with the domestic credit, stock value traded, and composite index raises gini disposable [Table 3]. We also find that the specification on linear form for stock market and composite index changes sign as we interact with corruption. Under such circumstances, credit is not directed to the productive sectors that create massive employment opportunities. The implication is that bribery distorts the smooth functioning of the financial sector by rationing credit. The result further reveals small and medium-scale businesses left uncovered with the credit expansion and get the capital needed for operation.
The other omitted factor that may moderate the relationship is political instability. Political stability and absence of violence/terrorism measure perceptions of the likelihood of political instability or politically-motivated violence, including terrorism (Kaufmann et al. 2010b). The indicator is essential in Africa as most countries suffer from the political turmoil that eventually disturbs the functioning of the financial system and determines the social outcome. Political instability creates uncertainty and reduces investment; as a result, the relationship between investment and income inequality becomes affected (Alesina & Perotti, 1996). It impedes financial development and is a primary determinant of differences for financial development across countries (Roe & Siegel, 2011).
We find virtually similar findings with the corruption results [Table 3, Panel B]. Domestic credit interacted with political instability raises gini disposable. However, in the linear form of specification, the sign changed from negative to positive between stock value traded, composite index, and its interaction with political instability. Following independence, many countries exhibited a stable political environment; however, the nature has changed from the fight for independence to politically driven unrest. Still, interstate conflicts, election-related violence, longstanding ethnonational conflicts, maritime piracy, and extremism exists in the continent. As these types of instability happen, the ground for financial sector to expand becomes tinny. As a result the existing financial institutions will not provide credit to the conflict-prone community; usually the poor. Nor the financial market works efficiently in mobilizing deposits. These and other factors come together in widening income inequality in the continent.
Overall the above two omitted factors do an excellent job moderating the relationship between financial sector development and income inequality. Corruption and political instability are identified as crucial indicators because, in Africa, armed conflict, violent transitions of power, and increasing terrorist threats affect the government and private sector commitment in expanding opportunities to those who do not access finance. In relative terms, the continent comes to the front with the two indicators that show an unfavorable governance system. Even if the financial system architecture worldwide is almost similar, their function is shaped by the existing structural, socio-economic, and political situations in different regions.
Apart from a statistically significant moderating effect of corruption and political instability, other governance factors such as regulatory quality, government effectiveness, and conflict intensity provide virtually similar findings.
4.3. Estimation Results Based on Geographical Regions
Now we turn into assessing the relationship across five geographical regions. We argue that corruption and political turmoil vary across countries. The next configuration assumes that this heterogeneity could be related to geographical locations [Table 4] because neighboring countries share substantial structural and economic conditions. Our subsample analysis based on geographical regions put forward two empirical findings. The geographical location brings enormous development opportunities. In almost all regions, natural resources are abundant, and the means for livelihood is enormous.
Yet, the geographical configuration in most parts confirms the findings from the baseline results is robust. Especially in Northern, Central, and Southern Africa, there exist a positive relationship between domestic credit, stock value traded, and the composite index with gini disposable. In these areas, there also exists a non-linear relationship. Contrary to that, the result is mixed in Eastern and Western African countries. For instance, in Eastern African countries, the relationship is reversed; a higher domestic credit, stock value traded reduces gini disposable. In western Africa regions the relationship is observed only in the banking sector that a rise in domestic credit increases gini disposable.
Sub-Saharan Africa (SSA) is often known for poor economic performance. At the same time, the area is endowed with natural resources that can transform the livelihood of more than half a billion people. However, a country's geographical location alone does not determine its socio-economic development (Bosker & Garretsen, 2012). It is also an area heavily affected by poverty and inequality. Our result confirms that the baseline result is highly driven by the effect coming from Northern and Southern Africa. Besides, in Eastern and Western Africa, there is shred of evidence showing that domestic credit caused investment (Iheonu et al., 2020), contributing to the negative relationship obtained in the ECOWAS region. Concerning the relationship's magnitude, there is no significant differences across regions.
Agenda 2030 for sustainable development goals (SDGs) has drawn particular attention to reducing income inequality in Africa (UNDP, 2017). In each region, there are structural drivers of inequality. The economy is organized in a dualistic approach with limited labor employment in the agriculture sector, yet most laborers earn a low income. Also, there exists a high concentration of human and physical capital in Eastern and Southern Africa. Nevertheless, countries have limited capacity to influence distributive policies. All these bring the natural resource curse hypothesis true. Besides, policies are oriented towards urban centers to the contrary that the majority of the people live in rural areas.
As a result, when economic growth is recorded in sectors with high asset concentration, skilled labor-intensity such as finance, and capital intensive sectors, realizing an evenly distributed income becomes challenging. On the other hand, inequality gets diminishing in countries where economic growth is pro-agriculture and labor-intensive sectors. The bottom line remained in most African countries' financial development widens income inequality.
Pertinent to our control variables, we find that trade integration narrows gini disposable except in the Southern Africa region. Creating synergies across countries appeared to be a plausible way to overcome inequality. Thus, the promotion of regional economic integration has been the overwhelming African response to a surge in inequality, poverty, and economic development. It is documented that regionalism brought enormous economic development for Africa (Uzodike, 2010). In response, the newly established Continental Free Trade Agreement (CFTA) presents significant opportunities to boost intra-African trade (UNCTAD, 2017). Development-oriented regionalism can guide Africa to achieve development goals, build a resilient economy, minimize the risk associated with external financial and economic crises, and foster inclusive growth. It can also contribute to spilling over benefits in fostering peace and political stability on the continent.
4.4. Geography, Corruption, and Political Instability Configuration
The last empirical exercise assesses whether a heterogeneous effect exists across regions can provide a consistent estimate when interacting with the omitted factors in the respective regions. The geography corruption configuration shows that corruption moderates the relationship in different ways. The moderation based on the geographic regression results presents that corruption exacerbated income inequality in the Northern, South, and East African countries [Table 5]. However, there are few exceptions in Eastern, Southern, and Central Africa where the interaction between domestic credit and corruption reduces gini disposable. One way to understand the moderating effect is that corruption does not have a similar effect in all parts of Africa.
In those countries where corruption is prevalent, capital is accumulated in the hands of few who have a connection with officials. Corrupted economies have a disproportionately small middle class and significant divergence between the living standards of the upper class and lower class. Because most of the country's capital is aggregated in the hands of a few rich people, the income created in the economy also flew to these individuals. The mechanism in which corruption manifests in the financial sector is by discouraging small businesses from getting credit by credit rationing, collateralized loan requirement, unfair competition, and heavy pressure from large companies. Besides, corruption is linked with higher firms' borrowing costs, lower stock valuation, and worse corporate governance (Ng, 2006). Indirectly corruption negatively affects banks' lending through excessive risk (Ali et al. 2020).
Banks tend to prefer large-size firms or government agencies for risk aversion issues as these companies bring lower information asymmetry. As a result, capital that could have been redirected to small businesses wiped out from the financial sector by big companies. These phenomena explain why in most African countries, the impact of corruption in the financial system, among others, exacerbates income inequality.
Meanwhile, in the Western African countries, corruption is not significant in the finance-inequality nexus. Under some circumstances, there is no significant relationship between corruption and the financial sector (Ekşi & Doğan, 2020). Either the regulatory effectiveness in the financial sector is stringent, or the rule of law plays a crucial role in alleviating the distortionary effect of corruption in the financial sector. However, the result does not imply that West African countries do not suffer from corruption. Overall, corruption moderate the finance-inequality nexus by exacerbating income inequality. However, there is evidence that the subsample analysis suggests that corruption is not significant in some areas.
We also argue that political instability is another factor pronouncing the link between finance and income inequality in the respective geographical regions [Table 6]. Political instability through retarding economic growth (Ayessa & Hakizimana, 2021) affects the development of the financial sector. Ertugrul et al. (2019) show a strong effect from political risk and economic deterioration towards financial stability. On the other hand, a powerful effect on financial development runs through political stability that explains differences in financial development across countries (Roe & Siegel, 2008). Political instability hampers financial inclusion efforts (Alhassan et al., 2021).
After independence, many African countries undergo several political conflicts that affect the continent's growth potential. The cause may range from internal to external induced geopolitical and economic interests of the international community (Ong'ayo, 2008) to power struggle to rule. In addition to these factors, uneven development, poverty, disease, ethnic-based political structures, and inequality pressure some countries' stability. Africa stood first when it came to politically motivated conflicts. The forms of political instability in Africa have even further widened, including several civil wars, genocides, political assassinations, insurgencies, and terrorism. Besides, the degree of causalities places systematic implications on the nexus between finance and inequality. These phenomena create an unfavorable environment to spur the financial sector.
Our result shows that in the Northern and Southern African regions, political instability exacerbated income inequality. Political instability in isolation and its interaction with the stock value traded and the composite index raises gini disposable. However, the interaction with domestic credit is inconclusive in Southern Africa. After the Arab Spring, the political situation and violence/terrorism risk worsened for Tunisia, Libya, and Egypt in the Northern African countries. In the Southern African countries where militias spread violence along with the impact of the poor governance system in some countries worth mentioning in escalating conflicts within and between countries. Most importantly, arbitrary borders created by the colonial powers, the heterogeneous ethnic composition of African states, incompetent political leadership, and poverty are the principal causes threatening the development of the economy and the financial sector.
The evidence obtained from West African countries is insignificant. In Eastern and Central Africa, the interaction with domestic credit reduces gini disposable. However, with the composite index, the result remains robust in exacerbating gini disposable. We are not able to justify why political instability reduces income inequality in those regions. However, potential reasons could be that the peace situation in these regions has been getting better in recent years. Countries started to initiate long-term development by relying on their resources, and improved economic integration in the region contributes to becoming one of the fastest-growing economies in the continent. Even if the political situation in most countries is fragile, the macroeconomic fundamentals are still there. As a result, colossal capital flow to each country boosts small businesses, employment, and technology transfer. These, among others, although small instabilities recorded, countries are managed to develop their financial sector, capital inflow, and eventually narrow income inequality.
In a nutshell, the two predominant problems determine the relationship between financial sector development and income inequality. Although the finding revealed in most regions, the estimation is robust to the baseline estimation results.
Our result is robust for alternative gini indicators (i.e., gini market) and financial sector development indicator for banking (deposit money banks' assets to GDP) and stock market (i.e., stock market capitalization to GDP (%). Moreover, to corroborate economic transition and the impact of remittance, we control agriculture, forestry, and fishing, value-added, Bank branches per 100,000 adults, and remittance inflows to GDP.
 There are eight regional economic communities in five geographical regions.