There is a continuous debate amongst economists and policy-oriented researchers regarding the relative impact of international financial flows on economic performance in both developing and developed countries. The interest is mainly on what can be done on economic performance to fight escalating inequality, increase economic growth and maintain low inflation amongst other economic indicators. It is observed that the Southern African Development Community (SADC) region has high income inequality that has detrimental effects towards governments (Linardi & Rudra 2016). Income inequality is high in the SADC because of past policy failures of the post-colonial governments despite a rapid increase in economic growth (Ostry, Berg & Tsangarides 2014). This article aims to find if external financial flows can reduce income inequality. This is pursued in the SADC with some selected countries, namely South Africa, Botswana, Tanzania, Malawi, Mauritius, Zambia, Angola, Mozambique and Madagascar. These countries are selected on the basis of availability of data (World Bank 2020).

This article attempts to solve challenges of the SADC region as the most unequal region as reported in the World Bank (2020). For instance, South Africa, Namibia and Botswana are at the top of the world’s most unequal countries, South Africa leading the group with the Gini coefficient of 69.6. Additionally, the level of income inequality in the region is on the perpetual rise. For instance, income distributed of the SADC member states is skewed in that, the income share of the 10% at the top continuously increase by 15% at the expense of the states in the bottom 50% (World Bank 2020; Figure 1). Figure 1 shows that the bottom 50% of the population has suffered a perpetual decline in income share from 1994 to 2017. The bottom 50% of the population has lost approximately 7.9% of income between 1995 and 2017 in the SADC region, in the progress making it the most unequal region in the world. The higher income inequality in the SADC region reflects negatively in opportunities to produce, which in this case results in lowering economic growth in the region (Claessens & Perotti 2005).

Financial flows refer to the movement of money for the purpose of investment, trade or business production, including the flow of capital within corporations in the form of investment capital (Adams & Klobodu 2017).

Several studies documented contradicting views between financial flows and income inequality. For instance, some noted that financial flows could assist in reducing income inequality amongst other economic ills (Anyanwu 2011; Herzer, Hühne & Nunnenkamp 2014; Koechlin & Leon 2007; Shafiullah 2011). Other scholars like Adams and Klobodum (2017) found no effects of financial flows on income inequality, and Anyanwu (2011) found a positive relationship in North Africa between the two. These contradicting findings indicate that there is a research gap with respect to this relationship especially in the SADC region. Moreover, the novelty rests on the findings of which financial flow indicator can drastically reduce income inequality, particularly when the robust econometric methodologies are employed in this study.

Financial flows adopted in this study are remittances, foreign direct investment (FDI), foreign aid and cross border bank lending. Remittances are a transfer of money from international migrants to an individual member in their country of origin (Bang, Mitra & Wunnava 2016). Foreign direct investment is an investment in a business by an investor from another country for which the foreign investor has control over the company purchased (Sylwester 2005). Foreign aid refers to money that one country voluntarily transfers to another, which can take the form of a gift, a grant or a loan (Easterly 2008). Cross border bank lending refers to a measure of foreign bank lending to finance the country’s balance sheet account, especially if there was a financial crisis in the foreign exchange reserves (Bremus & Fratzscher 2015). Many economies around the globe strengthened their financial sectors and embarked on market reforms to attract the inflow of external capital.

The external financial flows are of paramount importance for the developmental purposes of host countries in terms of skill advancement, accelerating cross-border transfer of technology, knowledge and advanced financial markets (Bremus & Fratzscher 2015). Additionally, it is alluded in Bansal (2004) that financial flow can be a channel to transfer managerial skills, integration into international marketing, production networks, improving the international competitiveness of firms and ultimately the economic performance of host countries. The empirical evidence from studies confirms that financial flows lead to improved domestic investment, and increase aggregate stock and productivity to host countries (Bremus & Fratzscher 2015; Sylwester 2005). Hence, this article aims to investigate effects of external financial flows such as remittances, FDI, foreign aid and cross border bank lending on income inequality in the SADC region. The article is structured as follows: this section is followed by ‘Literature review’, then the ‘Methodology’ section, and thereafter ‘Empirical results and discussion’ section follows, and finally is the ‘Conclusion and recommendations’ section.

This section discusses both the theoretical and empirical literature on the role which external financial flows can play on income inequality.

This section addresses issues of data, the estimated model and the estimation techniques using econometric methods in some selected SADC member states. The quantitative econometric analysis adopted a panel autoregressive distributed lag (ARDL) of the SADC region.

The initial step towards realising the principal aim of the empirical analysis is to establish the unit root properties of the panel series employed. Therefore, the analysis utilised several panel stationarity techniques to test for panel stationarity on all variables employed in the study. Table 1 presents the panel unit root results for all variables employed using three various panel techniques.

In Table 1, the LLC, IPS and Fisher-ADF test results confirmed that income inequality is integrated at order 1.

This means that income inequality becomes stationary after the first difference. All other variables are confirmed to be integrated at order I (0). The IPS confirms that remittances have some cross sections without unit root whilst other depicts unit root. The study recognised that variables employed are integrated at both I (0) and I (1). After realisation that there are different orders of integration in the variables under study, the test of cointegration was undertaken. The cointegration tests are useful to determine if there are long-run effects in the chosen series (Breitung & Pesaran 2008). Tables 2–4 report cointegration test results of Kao, Pedroni and Fisher.

In Table 2, the Kao cointegration test indicates that there is cointegration. In Table 3, out of the seven Pedroni statistics, four indicate presence of cointegration. Table 4 indicates two co-integrating vectors both at trace and at maximum-Eigen tests. These cointegration results imply that there is a long-run relationship between the chosen external financial flows and income inequality. This is supported in literature by Jalil and Feridun (2011), Heshmati (2003), Koechlin and Leon (2007), and Ang (2010), who discovered that finance indicators can influence income inequality in the long term.

The existence of long-run effects in the external financial flow-inequality nexus allows for determination of both short- and long-run estimates. On that regard and based on the results of the unit roots, the panel ARDL estimator is used to find the estimates. Table 5 reports short-run, long-run and error correction term results.

Table 5 shows that remittances can strongly reduce income inequality in the long run, but are insignificant in the short run. These results are in line with the findings of Bang et al. (2016) and Koechlin and Leon (2007) amongst others that remittances play an important role in reducing income inequality. This is more beneficial to the SADC region which comprises of countries with many rural villages as alluded in Jones (1998). Additionally, Table 6 strengthens this relationship in that there is a bidirectional causality between remittances and income inequality. This implies that remittances can reduce income inequality as much as a less unequal state can increase remittances. This is more valuable to the SADC region as there is mobility across states and can eradicate the issues of xenophobia and allow foreigners to live in peace in the region.

Foreign direct investment can strongly influence income inequality both in the short and long run (Table 5). In the short run, FDI can reduce income inequality whereas in the long run, it has an increasing effect. It was mentioned in literature that the behaviour of the FDI effects depend on issues such as the development state of a country, level of education of citizens and the country’s absorption capacity (Choi 2006; Wu & Hsu 2012). This study found that the increasing effect of FDI on income inequality, in the long run, is strongly affected by poor economic development of the SADC region. Table 6 further indicates a unidirectional causation from FDI to income inequality. Foreign aid yielded insignificant results both in the long and short run. The weak link between foreign aid and income inequality has been documented in literature (Saidon et al. 2013). In Table 6, there is a unidirectional causality between foreign aid and income inequality.

Although cross border bank lending yielded strong effects on income inequality, results are contradicting in the long run and short run. In the short run, it can reduce income inequality, but opposite effects are found in the long run. It has been instituted that cross border bank lending can reduce income inequality in developed countries, which might be the reason for the increasing effect in the SADC as these are less developed countries (Focarelli & Pozzolo 2001). Furthermore, the less developed SADC region is characterised by high levels of inequality as illustrated in the income distributed analysis of Milanovic (1999). The causality results impose that there is a bidirectional causality between this lending and income inequality (see Table 6).

The effects of external financial flows on income inequality can significantly converge to equilibrium at a speed of 46% as illustrated by the error correction term in Table 5. The series is further tested for stability and results are reported in Figure 2. The figure indicates that all the dots are inside the circle, and therefore the model is stable.

The study examined the effects of external financial flows on income inequality in the SADC region for the period 1994 to 2018. For this study, external financial flows were measured by remittances, FDI, foreign aid and cross border lending, and income inequality was measured by Gini coefficient. The panel ARDL and panel causality techniques were used to examine long- and short-run coefficients and the causality relationship, respectively.

Panel cointegration techniques of Kao, Pedroni and Fisher yielded a long-run relationship in the series. The panel ARDL results yielded that in the long run, remittances can strongly reduce income inequality, and FDI and cross border bank lending have an increasing effect and foreign aid can weakly reduce inequality. In the short run, FDI and cross border bank lending can strongly explain income inequality, though negative remittances and foreign aid are insignificantly explaining income inequality. Furthermore, the evidence from panel causality confirms the bidirectional causality amongst remittances, cross border bank lending and income inequality, and unidirectional causality in other set of variables.

The article concludes that external financial flows can play a vital role in reducing persistent income inequality in the SADC region. However, the advantages and benefits of the financial flows are not automatic; sound policies and good implementation are vital to realise equal distributed of income, especially in the SADC countries. It is recommended that the SADC governments need to formulate policies on remittances, as they have positive returns on human capital, strengthen foreign aid institutions and create conducive environment to attract FDI.