While financial development may foster economic, social and sustainable development, unregulated financialization can undermine these same developments and exacerbate inequality. This research aims to contribute to the existing literature by analyzing how institutional quality – democracy, corruption control and property rights – moderates the finance–inequality relationship across different income groups in Türkiye (1987–2021).
Unlike aggregate studies that rely solely on the Gini coefficient, this study analyzes distributional impacts across five income groups (top 1%, top 10%, middle 40%, bottom 50% and the Gini) using the IMF Financial Development Index and 19 V-Dem institutional indicators. It employs ARDL methodology with institutional interaction terms to capture short-run and long-run dynamics.
The findings reveal a nonlinear relationship between the financial development index and income inequality, characterized by diminishing returns at higher levels of the index. Furthermore, through interaction analysis, the study demonstrates that institutional factors significantly influence the extent to which financial development improves (or worsens) income distribution.
This study has several limitations that should be acknowledged. First, the analysis focuses only on Türkiye, which may limit the generalizability of the findings to other countries with different institutional and financial structures. Second, the V-Dem indicators used in this study measure the formal quality of institutions – such as the existence of accountability mechanisms or democratic procedures – rather than the extent to which these institutions are effectively enforced or accessible to all income groups in practice. Consequently, a recorded improvement in an institutional indicator may not necessarily translate into tangible distributional gains for lower-income groups, who may face greater barriers to accessing legal, financial and political institutions in everyday life. Third, while the ARDL framework captures long-run equilibrium relationships and short-run dynamics, it does not establish strict causal identification; reverse causality – whereby rising inequality may itself erode institutional quality or suppress political demand for financial inclusion – cannot be fully ruled out. Fourth, the sample size of 35 annual observations, necessitated by data availability, limits degrees of freedom and may affect the precision of some estimates.
The results suggest that institutional reforms should precede or accompany financial development to ensure broad-based distributional gains.
This study is one of the first studies to decompose the finance–inequality relationship across income groups while systematically testing 19 V-Dem institutional moderators. The study reveals that aggregate studies mask heterogeneous distributional effects; financial development benefits different income groups differently depending on the institutional context.
