Inequality and Informal Economy: The Moderating Role of Financial Technology

Abstract

Abstract Increasing income distribution gaps have become a global socio-economic problem accentuating economic and social exclusion with a potential of generating declining social cohesion and political stability. This study examines the relationship between the informal economy and income inequality, alongside the moderating effect of financial technology (fintech). The persistent prevalence of informal economies in emerging markets and developing economies (EMDE) is often associated with elevated income inequalities. Utilizing data from 2012 to 2022 across 18 African countries, this study employs the two-step system Generalized Method of Moments (GMM) to address potential endogeneity biases and to robustly estimate the relationship between the size of the informal economy and income distribution. The results indicate that a larger informal economy correlates with reduced income inequalities, acting as a buffer for marginalized communities by providing economic opportunities. Conversely, fintech initially indicates an increase in income disparities due to skill and access discrepancies. However, when functioning as a moderating factor between informal economies and income inequality, fintech demonstrates a potential to reduce the inequality gap. This study suggests that policy interventions geared towards economic formalisation need to account for the dual role of financial technologies. Further research is required to explore other socio-economic factors, including political dynamics and labour market policies, which influence income inequalities. Prominent policy decision confronting African governments is the role of the informal economy. The findings of the study advocate for a nuanced approach to addressing structural reforms within informal sectors and carefully utilise fintech as a tool for promoting equitable income distribution