African Journal of Development Studies (AJDS)

ISSN 2634-3630 E-ISSN 2634-3649

Indexed by IBSS, EBSCO, ERIH PLUS, COPERNICUS, ProQuest,

SABINET and J-Gate.

Volume 12, Number 3, September 2022

pp 83-103

Financial Innovation and Income Inequality

in Upper-Middle Income Countries
DOI: https://doi.org/10.31920/2634-3649/2022/v12n3a5

Zinhle Mncube
Stellenbosch University

&

Teresia Kaulihowa
Department of Accounting, Economics and Finance
Namibia University of Science and Technology

Abstract

Financial innovation is hypothesised to enhance equitable economic

development. The paper aims to examine the relationship between financial
innovation and income inequality in four upper-middle income countries,
namely, South Africa, Brazil, China, and Turkey for the period 1986 to 2020. A
longitudinal research design was used for this study. To control heterogeneity
and cross-sectional dependency, an Augmented Mean Group estimator was
employed. The study found mixed results. Two measures of financial
innovation (bank credit extended to the private sector and the ratio of broad
money to narrow money) found evidence of a U-shaped pattern between
financial innovation and income inequality, indicating that financial innovation
helps reduce income inequality up to a certain point but would thereafter
contribute to its further widening. However, when financial innovation is
measured using ATMs, evidence of an inverse relation was found. The
exacerbation of income inequality by the first two indicators has a detrimental
effect on a country‘s societal welfare as the poorer members of the population
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are left behind in their development even when economic growth takes place.
The observed upper-middle income countries and similar countries which are
typified by relatively stable financial systems and high levels of income
inequality must financially develop their systems under an inclusive framework
to ensure growth and development benefit broader sections of the population.
By leaving this unattended, financial innovation can be an enabler and instigator
of income inequality.

Keywords: Financial Innovation, Income Inequality, Upper-middle Income Countries

1. Introduction

It has been broadly accepted that a developing or innovative financial

system is good for the economy of a country, as well as its overall
welfare. In their study of financial innovation, using endogenous growth
models, Laeven et al. (2015) discover that a developed financial system or
one that is continuously innovating in its systems‘ processes, products,
and service offering, facilitates and even leads to growth. Financial
innovations, such as mobile money in their various forms, have been
acknowledged as a catalyst for increasing financial inclusion through
account ownership, lowering the cost of accessing financial services and
making non-cash payments a reality for the previously
marginalised/unbanked in developing countries.
Financial innovation is further hypothesised to play a crucial role in
the reduction of poverty and encouraging inclusive economic growth,
especially in developing countries (Demirguc-Kunt et al., 2015).
However, although high-income developing countries such as South
Africa, Brazil, Panama, Botswana, etc., are typified by stable financial
systems, there seems to be a common problem of income inequality.
While these countries experience sustained growth, they are characterised
by high-income inequality (Fawaz et al., 2015). According to OECD
(2015), high-income inequality possesses a negative implication on
society‘s welfare. Moreover, unabated growth in income inequality has
the ability to stunt long-term growth.
Many middle to high-income developing countries suffer from
inequality issues. South Africa, as an example, has a substantial services
sector. One of the key sectors in services is its financial services which
are the most advanced and most mature in the African continent.
However, South Africa remains with several challenges, and income
inequality is and has been among its biggest challenge for decades

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(Dessus & Hanusch, 2018). The Living Conditions Survey of 2014/15

divulge that South Africa had a Gini coefficient of 0.63 which was the
highest in the world at the time. Similarly, income inequality remains a
problem in Brazil. By the year 2018, the Gini coefficient reclined to
0.54%, the top 10% of adults owned 57% of the income earned in the
country, while the bottom 50% held just over 10% of the income (Neri,
2019).
Several countries share similar profiles to Brazil and South Africa,
upper-middle income countries (as classified by the World Bank) with
GDP per capita amounts of at least US$5,000 per annum and with stable
financial systems but are hampered by high levels of income inequality as
represented by the Gini coefficient. Upper-middle income countries that
have experienced high growth through economic liberalisation and other
growth programmes are faced with the challenge of high levels of
income inequality (Shahbaz et al., 2015). This is despite these countries
having relatively well-developed financial systems. The above could be an
indication that the financial development of these financial systems,
which speaks to the process of financial innovation, might not be
structured in a conducive way to reduce income inequality. This notion
aligns with the studies of Brei et al. (2018) which indicate a U-shaped
relationship. Considering the above, it is evident that financial innovation
in its various forms does not have a clear-cut impact on income
inequality. Hence, further empirical work is required. Therefore, this
paper aims to examine if financial innovation could be used to address
socio-economic challenges of income inequality in selected upper-middle
income countries.
The rest of the paper is structured as follows. Section two presents
the literature review, and methodology and empirical results are
presented in sections three and four, respectively. The conclusion and
policy implications are discussed in the last section.

2. Literature Review

According to Blach (2011), financial innovations are characterised using

broad and narrow definitions of financial innovation. Frame and White
(2012) hypothesise that the rationale for innovation is to reduce costs,
address relevant risks, and depending on what the innovation is (an
improvement on or introduction of a new product, service, or
instrument), it should increase the satisfaction rate of the user‘s demands.
In establishing the theory of financial innovation, Ben-Horim and Silber
(1977) state that a firm‘s need to innovate goes beyond the need to
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remove or reduce the government-led constraints on firms. Therefore,

financial firms‘ constraints are both self-imposed and market-imposed.
Internal firm constraints include their target rate of growth for total
assets or internal liquidity requirements.
Ben-Horim and Silber (1977) further state that the development of
new financial instruments or financial innovation will occur when there is
an exogenous change in the constrained optimisation of the firm that
stimulates a search for new policy tools. These exogenous changes can
either make the firm reduce its productivity or increase the cost to
maintain its utility. Avais (2014) affirms this by arguing that the main
duty of financial innovation is to make markets more complete for better
financing, investing and risk-sharing amongst firms, households, and
governments. These expositions are further amplified by Redmond
(2014) who postulates that financial innovation is a new way of
distributing money, credit or risk and does not need to be complex,
confusing or need vast amounts of money.
There is a departure from the above customer-centric reasons which
is that financial innovation takes place because the market is looking for
ways to extract more profits through new (horizontal) or existing
(vertical) customers or both (Kogar, 1995). Further, a country‘s central
bank would through its monetary policies seek to change the country‘s
financial structure which would bring about stability. These changes
would encourage banks and other financial institutions to adjust to these
rules and ultimately look for means to increase profits (Akdere & Benli,
2018).
While there have not been many studies done on financial innovation
and income inequality, there are a few studies that speak to these
elements of this area of research. Ajide (2016), for example, reveals that
financial innovation is the link between sustainable development and the
financial sector. Choi and Lee (2019) provide empirical evidence that
when financial innovation broadly decreases adverse selection in banking,
it will lead to an increase in the welfare of households in the economy
whether it affects the extensive or intensive margin of adverse selection.
Conversely, Redmond (2014) found that small-scale financial
innovations, such as payday loans, increase income inequality as they
increase the indebtedness and ultimately, the state of financial distress of
already poor households in America. The possible negative impact of
financial interventions is not just restricted to certain financial products.
In another study looking at financial liberalisation and income inequality,
it was found that where there are high levels of financial development,
financial liberalisation further widens income inequality (de Haan et al.,
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2018). This view is consistent with a study on financial sector

development and its impact on income inequality in South Africa. Where
it was found that financial development in South Africa has a limited
effect on reducing income inequality (Kapingura, 2017).
In another study which sought to understand the impact a
government-sponsored microfinance programme had on financial
inclusion and its ability to improve employment chances in order to
alleviate poverty through the income earned in select Indian districts, it
was found that the microfinance programme had a positive relationship
on income, the number of days one would be employed, and financial
inclusion (Maity & Sarania, 2017). This is consistent with (Lacalle-
Calderon et al., 2019; Demirgüç-Kunt & Levine, 2009) where
microfinance could reduce income inequality in examined countries.
When observing the impact of fintech on inequality, the results are
not as positive as expected from the theoretical arguments. In a study on
the impact of M-Pesa on poverty alleviation, Bateman et al. (2019)
discover that while fintech does have the ability to meaningfully
contribute to poverty alleviation, it has no effect if the innovation is not
geared or directly targeted to the poor. Instead, what they found is that
fintech innovations are mostly structured to extract rents at the behest of
established mobile network operators or financial institutions. In other
words, fintech innovations must be financially inclusive in order for them
to yield positive social welfare gains, such as poverty alleviation and the
reduction of income inequality (Demir et al., 2020). This is in line with
Dian Saraswati et al. (2020), who in Indonesia found that the
introduction of a new variety of fintech products in the market widens
income inequality because its use is restricted to a small percentage of the
population.
Accordingly, Čihák et al. (2012) are of the view that financial
development happens when instruments, financial markets, and financial
intermediaries attempt to reduce the by-products of imperfect
information, restricted enforcement, and transaction costs.
Financial inclusion is a crucial part of making financial services
accessible and affordable, with the view to servicing the low-to-middle
income segments that are usually underserved by the financial industry.
In fact, it has been found that financial inclusion has the ability to
accelerate economic growth, reduce poverty, and promote income
equality (Omar & Inaba, 2020a). Financial inclusion is the key to a
financial system that serves all members of society. The relationship
between financial inclusion and financial innovation travels both ways
and is positive both ways, in that, by developing the financial markets
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through the introduction of financial innovations, if these innovations

encourage efficiency and wider societal access to these services, it may
lead to inclusion that ultimately reduces income inequality
(Qamruzzaman & Wei, 2019). The direct benefits of financial inclusion
are not entirely one-sided. For example, Kling et al. (2020) in their study
of financial inclusion and income inequality found that in China, access
to formal or informal loans may worsen income inequality. However,
having a bank improves the future likelihood that inequality will be
reduced. This may be where financial innovation steps in to ensure
financial inclusion by dealing with two significant barriers, namely, the
cost of providing the financial service and the high risk of servicing the
underserved (Beck et al., 2015).
Other conflicting arguments are that financial development only
encourages equality in upper-middle income nations while the reverse
holds for low and high-income countries (Thornton & Tommaso, 2019).
Similarly, de Haan and Sturm (2016) believe that where there is an
increase in financial development, income inequality is bound to rise
proportionately. This is despite the theoretical arguments that through
the opening of capital markets, increasing financial access, the deepening
of services and products, and technologies in rural areas (where a
significant proportion of Sub-Saharan Africa‘s population resides), it is
natural to think that financial innovation will translate to improved
income inequality and allows for the improvement of wellbeing.

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Table 1: Empirical Literature Summary Matrix
Author
Othman, Alhabshi, Kssim,
Abdullah and Haron (2020)
Asongu (2015)
Lacalle-Calderon, Larrú,
Garrido, Perez-Trujillo
(2019)
Demir, Pesqué-Cela,
Altunbas and Murinde
(2020)
Ali and Ghoneim (2019)
Gómez Rodríguez, Ríos
Bolívar and Aali Bujari
(2019)
Jauch and Watzka (2016)
Shahbaz, Tiwari and
Sherafatian-Jahromi (2015)
Nguyen, Vu, Vo and Ha
(2019)
de la Cuesta-González, Ruza
and Rodríguez-Fernández
(2020)
Sehrawat and Giri (2014)
Kapingura (2017)
Bara and Mudzingiri (2016)
Source: Author‘s compilation
Country & period Key findings
Global; 1980-2019 The Cryptocurrency system has the
ability to reduce income inequality.
52 African countries; Mobile phone penetration
2003-2009 aided in redistributing income
toward the poor.
85 developing countries; Microfinance has a negative
2001-2012 relationship with income inequality
140 low-income, low- Fintech reduces income
middle income, upper- inequality by indirectly enhancing
middle income, and high- financial inclusion. However, this
income economies (2011, effect was greater for higher-income
2014, 2017) countries.
30 developing Neither positive nor negative.
countries: Asia, Europe,
Africa, and Latin
America; 2013-2015
13 Latin American Financial development increases
countries; 199002015 income inequality.
138 developed and A positive relationship between
developing countries; financial development and income
1960-2008 inequality.
Iran, 1965-2011 Financial development reduces
income inequality.
21 emerging countries; Inverted U-shaped relationship
1961-2017 between financial development and
income inequality.
9 OECD countries, 2000- Excess credit through financial
2015 innovations may lead to over-
indebtedness and a reduction in the
value of assets to low-to-middle-
income investors.
India, 1982-2012 Financial development and
economic growth increase income
inequality in the long term and
short term.
South Africa; 1990-2012 Financial development, when
inclusive, has a negative relationship
with income inequality.
Zimbabwe; 1980-2013 Bi-directional relation between
financial innovation and economic
growth
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3. Research methodology

3.1 Research design

The paper employed a longitudinal research design using an Augmented

Mean Group (AMG) estimator (Eberhardt & Bond, 2009; Eberhardt &
Teal, 2010). According to Blackburne and Frank (2007), traditional panel
models are less effective when the data suffers from cross-sectional
dependency and heterogeneity issues. To address these two issues, the
AGM estimator is deemed the most suitable. In addition, the AGM
estimator can be applied to both stationary and non-stationary series.

3.2 Data sources and description

Data used in this study were acquired from several sources, namely, the
World Bank‘s Development Indicators, The Federal Reserve Bank of St.
Louis‘ Economic Data, and the Standardized World Income Inequality
Database (SWIID). These data points have been used across similar
studies (Rodríguez et al., 2019; Law et al., 2020; Omar & Inaba, 2020b).
The time-series data ranges from the period 1986 until 2020. The Gini
coefficient data are sourced from the Standardized World Income
Inequality Database (SWIID). Monetary data, such as the M1 and M2
money supply, were sourced from the World Bank‘s World
Development Indicators, as well as the Federal Reserve Bank of St.
Louis‘ Economic Data.
To identify the countries used for the study, a criterion was
developed. Each country would need to meet all, if not most of the key
requirements. A country classified as an upper-middle income country, a
Gini coefficient average of at least 0.4 over the last 20 years, a GDP per
capita of at least US$5,000 on average and a relatively developed financial
system. Based on the above criteria, countries as tabulated in Table 2
were selected for the study.

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Table 2
List of countries examined
Country Average Gini Average GDP Per Income
Coefficient Capita (US$) Classification
Brazil 0.53 8,138.47 Upper-middle
Income
China 0.412 5,020.71 Upper-middle
Income
South Africa 0.65 5,688.27 Upper-Middle
Income
Turkey 0.41 9,031 Upper-Middle
Income
Adapted from Author‘s compilation

3.3 Empirical model

To account for cross-sectional dependence and heterogeneity among the

cross-sectional units, an AMG estimator (Bond & Eberhardt, 2009;
Eberhardt & Teal, 2011) is used. The AMG model is based on cross-
sectional units denoted by where N is four in this case and
time dimensions . The model is expressed as:

Such that:

Where , represent independent and dependent observables,

respectively, captures country-specific coefficients of the independent
variables and captures both the unobservable and a stochastic residual
term . Equation 2 decomposes the unobservables into group fixed
effects denoted by the parameter that accounts for heterogeneity
among cross-sectional units and the unobserved common factor with
coefficient that accounts for both time-variant heterogeneity and
cross-sectional dependency. In equation 3, factors and may be
non-linear and/or non-stationary. Additionally, the model assumes both
and to be stochastic. With these considerations, the estimated
model is expressed as:
⁄

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Where Ginii,t refers to the Gini coefficient representing income

inequality, represents unobserved factors. While β1, to β7 are
parameters to be estimated. GBPC is the growth in bank sector credit to
the private sector as a ratio of GDP; (M2/M1) is the ratio of broad
money to narrow money which indicates money demanded in the
system. ATM refers to the financial innovation that is Automated Teller
Machines. These three mentioned variables are the key explanatory
variables in this paper. Whereas X represents a vector of control
variables which are GDP Per Capita and the inflation rate.
The quadratic terms are included to capture the non-linearity and
determine the turning point (if it exists) at which financial innovation
improves or worsens income inequality. To calculate the turning points
using gbpc as a measure of financial innovation, partial derivatives with
respect to the gbpcin equation 4 need to be evaluated to yield equation 5.
Setting equation 5 equals zero and solving for the unknown gbpc gives
the value for the turning point. Equation (5) will be repeated for all
quadratic terms.

( )

3.3 Theoretical underpinnings of the model

From the empirical literature section, the effect of financial innovation

on income inequality is not without ambiguities. Financial innovations,
such as cryptocurrency, have qualities that enable them to improve
income inequality by creating financial inclusion solutions that the
conventional financial systems would not have been able to create
(Othman et al., 2020). However, other scholars found supporting
evidence that financial innovation worsens income inequality. In their
study of financial development and inequality in Latin American
countries Rodriguez et al. (2019) reveal that when they integrated
country-specific qualities in the study, financial development would have
a positive effect on income inequality while in some of the other models
they employed, a U-shaped relationship between financial development
and income inequality existed. The expected sign is therefore uncertain.
The empirical literature has yielded no single measure of financial
innovation. An expanded view of financial innovation was provided
which went beyond it just being the introduction of new financial
instruments or anything innovative done by financial institutions, which
is instead the enhancement or augmentation of processes or elements
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found in the financial system (Laeven et al., 2015). Bara and Mudzingiri
(2016) use two measures of financial innovation. The first is the ratio of
broad money to narrow money i.e. M2/M1. The reasoning behind this is
that financial innovation brings with it technological and other financial
enhancement in the systems that require capital investment and a lesser
need for consumers to hold narrow money i.e. currency in the form of
coins or notes (Arrau et al., 1995). The more the ratio leans towards
broad money (M2/M3), the inference can be made that there is added
innovation in the financial system.
The second measure that Bari and Mudzingiri (2016) used is the
growth in financial development which is measured in their study as the
growth in the banking sector credit to the private sector as a proportion
of GDP. The latter financial development measure has been used in
other papers such as those of, but not limited to (Beck et al., 2007;
Thornton & Tommaso, 2019; Park & Shin, 2017). The initial reservations
for these measurements are the assumption that the extension of credit
or the increase in M2 money relative to M1 money is due to added
financial innovations in the financial system which is not always the case.
For this to be applicable, the observation is that consumer behaviour and
real sector developments are either stagnant or are highly influenced by
finance and financial innovation. A third and last measure to be added as
a financial innovation is automated teller machines per 100,000 people,
which is a specific and widespread financial innovation. This measure
was highlighted by (Okafor et al., 2017). With the above explanation,
these three measurements for financial innovation were used as they
capture the ways in which financial innovation influences the financial
system, as well as the ATM per 100,000 adults as an example of financial
innovation. These measures were also adopted by (Park & Shin, 2017;
Piketty & Saez, 2003; Beck et al., 2007).

4. Empirical results

4.1. Descriptive statistics

Table 3 shows that all variables with exception of real GDP per capita
are characterised by a high level of variations. These variances point to
the differences in the economic systems employed by each of the
countries despite the previously mentioned shared characteristics
amongst them. For example, Brazil and South Africa are mixed
economies, combining the free-market system along with government
controls and protections, whereas China has a socialist market with the
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government dictating large parts of the economy through state-owned

entities.

Table 3
Descriptive statistics

Adapted from Author‘s compilation and values obtained from Stata

4.2 Cross-sectional dependence

The Pesaran (2004; 2015) test for cross-sectional dependence was used to
examine the most widely assumed independence assumption. Traditional
panel models assume the cross-sectional independence property.
Assuming cross-sectional dependence when it is not the case may yield
misleading estimates. Table 4 indicates that the assumption of cross-
sectional independence does not hold. Therefore, the AMG estimator
that control for cross-sectional dependency is used.

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Table 4
Cross-sectional dependence test

Adapted from Author‘s compilation and values obtained from Stata

4.3 Empirical estimates

Table 5 presents the regression estimates showing the effect of financial

innovation on income inequality in four upper-middle income countries.
It indicates that the growth in bank credit to the private sector exhibits a
convex relationship with income inequality. It will initially reduce income
inequality. However, there is a turning point after which further increases
will exacerbate income inequality. The turning point at which bank credit
to the private sector worsens income inequality is calculated by setting
the marginals equal to zero and solve for gbcp;
yields gbcp = 42.9. This indicates that when
bank credit to private sector ratio to GDP exceeds 42.9 %, it will not aid
in addressing income inequality issues. This is consistent with the results
of the descriptive statistics in Table 3, where the mean value is reported
to be 60.83%, an indication that such a high ratio will worsen income
inequality. This finding is similar to the ratio of the broad money supply
to narrow money supply coefficient that reveals that this form of
financial innovation is also not pro-poor because it widens income
inequality. When financial innovation is measured using ATMs, there is
supporting evidence that it improves (reduces) income-inequality. The
supporting evidence that the growth in bank credit to the private sector
and the ratio of broad money to narrow money (M2/M1) exhibits a
positive relationship with the Gini Coefficient. The evidence implies that
as more innovations which lead to a reduction of liquid money supply
such as currency or demand deposits are introduced, income inequality

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worsens. Whereas, widening the availability of ATMs has a high potential

in reducing income inequality.
Notably, GDP Per Capita exerts a positive relationship with the Gini
Coefficient. This is consistent with the current trend where these
countries on average record good growth prospects, but such growth
does not address inequality issues. The other observed control variable is
inflation, which also has a positive relationship with the Gini Coefficient.
An increase in inflation, while negatively impacting the entire populace‘s
buying power, has a more detrimental effect on the poorer sections of
society, thus further widening the inequality gap.

Table 5

PMG Regression Results

Adapted from Author‘s compilation and values obtained from Stata

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Due to the paucity of research in this specific field, several research

works were used as a gauge against the findings. Ichkitidze, Lushkin,
Ungavri and Akaeva (2018) study the technological development in
financial markets (a financial innovation) and income inequality and
concur with these findings of a positive relationship between the two.
The introduction of fintech (a financial innovation) in Indonesia, a
country which shares similar qualities in its economic make-up and
financial systems, has exacerbated income inequality in the country
(Saraswati et al., 2020). Even a lower-middle income country, such as
Kenya which has seen the benefits of mobile money and fintech
(Asongu, 2015), there is a dispute with regards to fintech assisting in the
reduction of income inequality (Bateman et al., 2019). By examining the
impact of innovation on inequality, this study further adds to the
argument that was presented that innovation may further widen income
inequality where countries become more developed (Law et al., 2020).
Moreover, Law et al. (2020) further posit that a country‘s innovation
along with its level of financial development and globalisation does play
into the hands of increasing income inequality. While Law et al.‘s (2020)
study was focused on developed countries, the findings may be applied
to qualifying upper-middle income countries such as the countries
observed in this study. The four observed upper-middle income
countries have developed financial systems and markets. All these
countries are also part of the global community in economic trade.

5. Conclusion and policy implications

The study aimed to examine the relationship between financial

innovation and income inequality across four countries that are
categorised as upper-middle income and which have relatively mature
financial systems but have historically high levels of income inequality.
These countries are Brazil, China, South Africa, and Turkey. In the
examination of the relationship between financial innovation and income
inequality, three proxies for financial innovation were used, namely, the
growth in bank sector credit to the private sector (GBPC), the ratio of
broad to narrow money (M2/M1), and Automated Teller Machines
(ATM) per 100, 000 people.
As the representative of actual technology in financial innovation, the
spread of ATMs appears to have a significant impact on the reduction of
income inequality. Conversely, there is supporting evidence that financial
innovation measured using the ratio of broad to narrow money worsens
income inequality. However, when bank credit to private sector ratio to
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GDP is used, financial innovation will initially reduce income inequality,

but this will only occur until a turning point after which further increases
will exacerbate income inequality. The turning point is estimated to be
approximately 43%. This is an indication that financial innovation in
upper-middle income countries does not seem to be structured in a
manner that ensures equity. From this observation, the deduction is that
the bank credit extension to the private sector, for example in Brazil,
China, South Africa and Turkey is generally not used for purposes of
human capital formation which has the ability to reduce income
inequality (Hamori & Hashiguchi, 2012). Thus, contributing to the
increase in income inequality. This may point toward what has been
found around technology not being built for the poor, according to
Bateman et al. (2019); or it may be an allusion to the still low levels of
financial literacy that are informed by the insufficient quality of education
being offered in some of the countries observed (Demir et al., 2020).
This means the wealthier members of the population, who are better
educated and economically mobile, are naturally the first adopters of
financial innovation. However, this adoption does not trickle down as
expected or at a suitable rate due to the low levels of financial literacy
amongst the financially excluded.
The same can be said about how the ratio of broad to narrow money
has a positive relationship with income inequality. This ratio points to the
adoption of other monetary instruments besides cash. If M2/M1 has a
positive relationship with income inequality, it may mean that financial
instruments are still the preserve of wealthier members of the population
and not accessible, and thus not financially inclusive as they should be to
reduce income inequality (Demir et al., 2020). Positioned in another way,
the current make-up of financial products in the observed countries, by
and large, does not cater for the needs of those with a lower disposable
income.
Both GDP Per Capita and Inflation have a positive relationship with
income inequality which is consistent with other papers (Rodríguez et al.,
2019; Jauch & Watzka, 2016a), indicating that economic growth in these
observed countries, has a limited effect on income inequality, and
inflation worsens the living conditions of the poor, more than the well-
off.
The importance of a country working towards the reduction of
income inequality cannot be overly emphasised. High levels of inequality
restrict the ecosystem in which innovation operates and creates a perfect
environment for political upheaval and instability which stalls any form
of future development (Kabir & Ahmed, 2019). Increased income
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inequality reduces the rate of human capital development and increases

poverty (Law et al., 2020). To reduce income inequality is to
comprehensively remedy the socio-economic fabric of society, and the
continued innovations in finance can play a significant role.
Policy implications indicate that upper-middle income countries,
which have liberated their democracies and economies over the past 40
years, tend to fall into a high rate of income inequality (Ahmad & Nayan,
2019). This inequality is not necessarily abated by continued economic
growth. If this were the case, all these countries would have low levels of
income inequality (Kabir & Ahmed, 2019). While it can be seen that
financial innovation or financial development has the ability to positively
contribute to economic growth (Bara et al., 2016; Bara & Mudzingiri,
2016), it is not guaranteed that the same can be said about it reducing
inequality (Rodríguez et al., 2019; Law et al., 2020; Shahbaz et al., 2015).
The previously mentioned implications are that governments must
draft public policies that will drive inclusion in financial innovation
(Rodríguez et al., 2019). By working towards inclusion, financial
innovation and financial development will be able to address the needs
of the poor and the excluded (Demir et al., 2020; Jauch & Watzka,
2016b). Besides, when creating an environment for inclusive financial
innovation, financial literacy must be factored in. Lusardi and Mitchell
(2014) claim that a citizenry with a suitable level of financial knowledge
can effectively defend against the rapid increase or uptake of financial
products and services (financial innovations) that are ill-suited, skirt
legality and can lead to abuses.
The four observed countries are proof that financial innovation and
development that are not working under an inclusive framework do
more harm than good. To further echo what other authors have
concluded (Bateman et al., 2019; Jauch & Watzka, 2016b), financial
innovation must be carefully observed in how it will impact society and
not just naively seen as something universally positive.

99
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