Informality, financial development and income inequality in South Africa

Purpose The study investigates the link between the informal economy, financial development and income inequality in South Africa over the period 1991–2020. Design/methodology/approach The study employs the ARDL and Dynamic OLS techniques. Also, the Toda-Yamamoto (TY) causality test is employed to determine the direction of causality between the informal economy and income inequality. Findings The study reveals that the informal economy and financial development narrow the income gap between the rich and the poor. However, financial development plays a substitutability role in the relationship between the informal economy and financial development, limiting the informal economy's ability to alleviate income inequality. The TY causality test indicates a one-way causal relationship between the informal economy and income inequality. Originality/value The study examines the moderating effect of financial development on the association between the informal economy and income inequality, given the limited research on this topic in South Africa. Also, it employs a robust measure of financial development developed by Svirydzenka (2016). Finally, the study focuses on the South African economy, given its high-income inequality and the large proportion of its black population in the informal sector.