The Effect of Informal Economy on Income Inequality: Evidence from Turkey

Abstract

By considering the manufacturing pay inequality index as a proxy for overall income inequality and a novel index for the informal economy, this study analyzes the relationship between income inequality and the size of the informal economy in Turkey for the first time during the period of 1963-2008. For this purpose, we employ a time-series analysis with the Johansen cointegration test, a vector error correction model and the Granger causality tests. The findings suggest that while an increase in income inequality and foreign trade competitiveness leads to an expansion of the informal sector, unemployment has negative effects on the informal sector.