Informality, Inequality and Profit Rate

ABSTRACT

Using two novel datasets of the size of the informal economy and income inequality, this study examines the effect of informality on income and wage inequality with special attention to the rates of profit. Covering 86 countries for 1960–2016, the study shows that informality and the rates of profit are positively associated with income inequality; however, the positive impact of profit rate on income inequality decreases as the size of informal economy increases.

KEYWORDS:

• Informal sector
• panel data
• income inequality
• profit rates

JEL CLASSIFICATION:

• E26
• H26
• J16
• O17

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Roodman (2006) develops ‘the xtabond2ʹ command for use with STATA 14.

² This is also not surprising considering that the correlation between the two series is about 0.97. Due to space constraints, we do not report regression results using this alternative measure, however, our results are available upon request from the corresponding author.

³ SWIID reports Gini series calculated using both disposable and market income. Here, we use the Gini constructed by market income. The results are very similar to the case of the Gini based on disposable income. Our results are available upon request from the corresponding author.

⁴ The general rate of profit is the ratio of the difference between total product and the current cost of labour to the current cost of capital stock. While there are different ways of calculating profit rate, we adopt two formulas used in major studies (Foley and Michl 1999; Shaikh 2016).

⁵ We also have conducted additional estimations without the interaction term between informal sector size (% GDP) and GDP per-capita and profit but instead using two different stratified subsets one with informal sector size below the median and one above. The results are similar to the one using the interaction term, i.e. the regression conducted with the small informal sector subset yield a larger estimate for the coefficient of profit rate GDP per-capita.