Modelling the nexus between income inequality and shadow economy in Nigeria

Purpose — This paper aims to examine the relationship between the shadow economy and income inequality in Nigeria.Method — The paper employed Autoregressive Distributed Lag (ARDL), Fully Modified Ordinary Least Square (FMOLS), and Granger causality. This methodology is used to avoid endogeneity and heterogeneity in the model. This paper gauged income inequality using two diverse indicators of the Gini coefficient: the Gini index in proportion to household disposable income and the Gini index in proportion to household market income. In accordance with the literature, our empirical analysis draws on data from the Standardized World Income Inequality Database (SWIID), the World Bank, World Development Indicators, and the International Country Risk Guide (ICRG) for Nigeria from 1991 to 2018.Result — The findings of ARDL and FMOLS suggested a positive relationship between income inequality and the shadow economy, based on both measures of income inequality. In the short term, however, the shadow economy and income inequality are negatively correlated. Furthermore, we discovered a one-way causal relationship exists in Nigeria between the shadow economy, household disposable income, institutional democracy, household market income, and corruption control (CCI).Recommendation — Shadow economy has been regarded as an avenue to create job opportunities and raise poverty-income levels. It is critical that, for the shadow economy to reduce income inequality in Nigeria, policymakers should develop much better policies aimed at addressing income inequality.Contribution — In order to understand the relationship between income inequality and shadow economy activities in Nigeria, this study employed three methodologies, namely: Autoregressive Distributed Lags (ARDL), Fully Modified Ordinary Least Squares (FMOLS), and Granger Causality. The result offers reliable recommendations for pro-poor interventions that aim to limit the growth of informality via redistributing incomes.