Institutional Quality and Income Inequality in Developing Countries: A Dynamic Panel Threshold Analysis

This study investigates whether there is an institutional quality threshold effect on income distribution. We employ the dynamic panel threshold model developed by Kremer et al. (2013: Empirical Economics 44(2): 861-878) and a panel of both developing and advanced countries from 1995 to 2017. Our findings suggest the inequality-reducing effect of institutional quality is disproportionate. More specifically, we find two-pronged results: (i) when institutional quality is measured by World Governance Indicators, we find quadratic effect for advanced countries, but a monotonic negative effect for developing countries; (ii) when the International Country Risk Guide-based measure of institutional quality is used as the threshold variable, we find a Kuznets inverted U-shaped relationship between institutions and income inequality for both advanced and developing countries. The results also show a higher threshold value for developing countries compared to advanced economies. These results are robust to both measurement and endogeneity issues. The results have interesting policy implications for income inequality in developing economies.

Automated summary

The study found that the impact of institutional quality on income distribution is uneven, with differences between advanced countries and developing countries in the effect of institutional quality on income inequality. For advanced countries, institutional quality has a quadratic effect, while for developing countries, it exhibits a monotonic negative effect. Additionally, under different threshold variables, there are variations in the relationship between institutions and income inequality.