Financial Development and Income Convergence: A Non‐parametric Approach

This paper addresses the issue of whether the financial environment is a mechanism determining club formation and membership. It first reviews the convergence debate and empirical approaches to the convergence issue. Then the empirical work follows Quah’s non‐parametric approach and mirrors, to some extent, the work on international openness and convergence carried out by Proudman, Redding and Bianchi. The findings from the first stage of the study corroborate some previous studies in establishing twin‐peak dynamics in cross‐country income distribution evolution. Then 73 countries with financial data for the initial year are divided into two groups, one with a high degree of financial intermediation and a low level of financial repression and the other with the opposite features. It is found that countries in the former group tend to converge to the top end of income distribution while countries from the latter converge to the lower end. The empirical results give support to the belief that financial environment is an important factor influencing economic growth and shaping world income distribution.