Economic development, corruption, and income inequality: The role of the informal sector

Abstract

This article investigates how the relationship between economic development and income inequality is conditioned by corruption and the informal sector. While corruption has traditionally been believed to worsen inequality through resource concentration, this study suggests that it can also lead to the opposite through the informal sector. In countries with a high level of corruption or a large informal sector, individuals can bypass regulations and barriers by offering bribes or participating in the informal economy; this allows the benefits of economic development to be widely distributed, thereby reducing inequality. The reverse is true when corruption is low or the informal sector is small. However, at low levels of economic development, an increase in informal economy or corruption alone would not lead to a more egalitarian distribution without an economic expansion. The arguments are supported with a time-series cross-sectional analysis of 127 countries from 1964 to 2007. This study contributes to the literature by clarifying the relationship between corruption and the informal sector and how they affect inequality jointly with economic development.