The Income Inequality, Financial Depth and Economic Growth Nexus in China

Income inequality has increased in China despite rapid economic growth. Income inequality could impinge on future development, leading to social tension or political instability. Our study investigates the short‐run and long‐run relationship between three important macroeconomic indicators—income inequality, economic growth and financial depth. We utilise a two‐step procedure of ARDL bounds and Granger causality for the analysis. The bounds test indicates the presence of a cointegrating relationship between income inequality, financial depth and economic growth in the long run. In the second step, we utilise the Granger causality approach. Results show a bidirectional causality between financial depth‐growth and a unidirectional causality between inequality‐growth in the short run. In the long run, results reveal that growth and financial depth determine Gini. Our findings provide support for the inequality‐widening effect due to economic growth and higher credit provided to the private sector. We find no evidence of inequality‐narrowing or income‐equalising effect in the long run for the period of study. It is possible that the government's inclusive growth policies which started less than a decade ago have not taken effect for us to capture the inverted U‐shape income equalising effect significantly.