Unveiling the Shadows: Corruption, Informal Economies, and Income Inequality in Low-Income Countries

Objective: The objective was to analyze how corruption, the informal economy, and their interaction influence income inequality in 43 low-income countries between 1990 and 2019. Method: The study uses Machado and Silva's Quantile via Moments regression and fixed-effects models with Driscoll and Kraay's robust standard errors. The quantile approach is used to test whether effects vary across different levels of income inequality. Results: In lower income countries, corruption, the informal economy, and their interaction generally reduce income inequality, especially at higher inequality quantiles, suggesting a moderating effect when income disparities are larger. However, when examined together, the interaction of corruption and the informal economy can exacerbate inequality. In higher income countries, both corruption and the informal economy consistently increase inequality, showing a contrasting dynamic. Conclusion: The findings suggest corruption acts as “grease” in lower income countries with weak institutions by expanding opportunities for poorer groups, while in higher income countries with stronger institutions, corruption and the informal economy function as “sand,” undermining institutions and distorting benefits toward the wealthy.