Black Market Premium and Income Distribution

What is it about?

The literature on income inequality includes many studies that have tried to identify factors such as level of economic development, rate of economic growth, population growth, resource endowment, price instability, and openness as main determinant of income inequality. In this paper, we show empirically that income inequality is higher in countries that have black market for foreign exchange. One major policy implication of our finding is that exchange rate unification should reduce income inequality.

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Why is it important?

The literature on income inequality includes studies that have tried to identify its determinants. Economic variables such as the level of economic development, rate of economic growth, education, differences in resource endowment, price instability, and many others have been identified to have some impact on income inequality. In this paper we argue that in countries that there exists a black market for foreign exchange, income is distributed more unequally. We show this by using the black market premium from 28 developing countries. In addition to this main contribution, we also shed empirical light on a theoretical argument from the literature that devaluation of official exchange rate could have unequalizing impact on income distribution. Furthermore, strong empirical evidence is found in all the models estimated supporting the Kuznetís inverted-U hypothesis.