Impulse Effects of Income Inequality and Financial Development on Economic Growth (Case Study: Provinces of the Country) Using the PVAR Approach

Abstract

Economic growth has consistently been one of the primary objectives of policymakers and economic researchers, and numerous factors can either facilitate or hinder its trajectory. Income inequality and financial development are among the most critical factors exerting significant effects on economic growth. Income inequality may reduce economic growth by constraining the consumption and investment capacity of a substantial portion of the population, whereas financial development, by providing access to financial resources, facilitating investment, and enhancing productivity, can act as a driver of growth. Examining the impulse effects of these two factors at the provincial level enables the analysis of regional disparities and the identification of appropriate policies to enhance social equity and sustainable economic growth. This study aims to investigate the short-term and long-term effects of income inequality and financial development on the country’s economic growth using provincial data. The study analyzes the impulse effects of income inequality and financial development on economic growth across the country’s provinces over the period 2006–2024 using the Panel Vector Autoregression (PVAR) approach. For panel data analysis, the stationarity of variables was first examined using the LLC and IPS tests, and the results indicated that all variables are stationary or integrated of order zero, I(0). Cointegration tests confirmed the existence of a long-term relationship among the model variables. The optimal lag length, determined using the AIC, SC, and HQ criteria, indicated that a one-period lag is appropriate for the VAR model. The PVAR estimation results showed that income inequality has a negative and statistically significant effect on economic growth, while financial development, private investment, and education level have positive and growth-enhancing effects. Inflation and unemployment were also found to have negative effects on economic growth. The error correction coefficient (ECM) was estimated at −0.097 and was statistically significant, indicating that approximately 9.7% of short-term disequilibrium is corrected toward long-term equilibrium each year. Dynamic shock analysis and variance decomposition demonstrated that provincial economic growth responds gradually to shocks in inequality, financial development, and macroeconomic variables, with substantial long-term effects on growth. Model stability was also confirmed through the AR characteristic polynomial. The findings suggest that reducing inequality and strengthening financial development, domestic investment, and education can improve provincial economic growth, while controlling inflation and unemployment is essential for economic stability.