A Spatial Analysis of Financial Development and Income Inequality in Indonesia

Abstract

The role of financial development in reducing income inequality is still a much-heated discussion among policymakers, as the literature provides mixed findings. Focusing on the inclusiveness of the financial market, we contribute to the discussion on the relationship between financial development and income inequality by incorporating spatial considerations into the analysis. We examine the occurrence of spatial autocorrelation and its influence on the relationship by employing spatial panel analysis covering municipality-level data of Indonesia from the period 2018-2020. This research found the presence of spatial dependency on income inequality among municipalities and clusters of regions with relatively high and low Gini coefficients. Furthermore, our spatial econometrics analysis using the Spatial Durbin Model reveals a positive relationship between financial development and income inequality. The significant indirect effects indicate that financial development in a region affects the income inequality of the neighbouring regions.