Analysing the effects of capital flows on income inequality in Africa: Does institutional quality matter?

Abstract African countries are usually associated with poverty and rising income disparities. Foreign capital flows have been identified as potent sources of finance to stimulate economic growth and employment and alleviate poverty and inequality. However, their effects on economic outcomes such as income inequality are relatively underexplored in Africa. Therefore, this study examines whether capital flows (remittances, foreign direct investment, and foreign aid) and institutional settings enhance income distribution using data from 32 African countries from 1996 to 2022. The study controls for the influence of cross-sectional dependence and the distributional effect of flows on inequality using second-generation estimation techniques. Findings from robust econometric approaches support the worsening effect of foreign capital inflows on income inequality in Africa. The findings are consistent across different estimators and models. Further evidence from the study shows that institutional quality plays a strong moderating role in the connection between capital flows and income inequality in Africa. The outcome is consistent and robust across all the dimensions of institutional architecture. This implies that the institutional settings matter in optimising the economic outcome of external capital flows on income inequality. The study highlights some recommendations for African countries to achieve SDG-10 goals for reducing income inequality through the lens of capital inflows and a strong institutional environment.