Document Type : Research Paper

Authors

• Shahryar Zaroki ¹
• Ahmadreza Ahmadi ²

¹ Associate Professor in Energy Economics, Faculty of Economics and Administration Sciences, University of Mazandaran, Babolsar, Iran.

² Ph.D. Student in Econometrics, Faculty of Economics, Allameh Tabataba'i University, Tehran, Iran.

Abstract

 Crude oil and the rents derived from it can present both advantages and disadvantages for oil-rich countries. Numerous studies have examined the impact of oil rents on various variables such as economic growth, inflation, and financial development. Among these, the potential role of oil rents in income inequality, particularly in light of the underground economy, appears to have been overlooked in previous domestic studies. To address this gap, the present research first calculates the relative size of the underground economy using a MIMIC method, revealing an average of 16.8% in Iran’s economy. Subsequently, employing a nonlinear autoregressive distributed lag (NARDL) approach, the study investigates and tests the effect of oil rents on income inequality while considering the underground economy over the period from 1978 to 2022. The long-run results indicate that positive shocks in oil rents are associated with a desirable (negative) effect on income inequality, while negative shocks lead to an undesirable (positive) effect. Furthermore, the underground economy acts as a double-edged sword; that is to say, an increase in the relative size of the underground economy has the potential to turn the favorable (negative) impact of positive oil rent shocks on income inequality into an unfavorable one, and conversely, it can transform the unfavorable (positive) impact of negative oil rent shocks on income inequality into a favorable one. Additionally, real GDP per capita exhibits an inverse U-shaped relationship with income inequality, while unemployment positively influences income inequality.
 
 
Introduction
A country’s progress toward social justice can be quantitatively assessed through indicators such as income distribution, poverty, and welfare. In recent years, rising concerns over income inequality have expanded the discourse on how natural resource rents—particularly oil revenues—shape economic growth and development. While resource abundance is often perceived as a blessing, its effects on economic development have been uneven and, at times, contradictory.
Since the 1973 oil shock, Iran’s economic performance has been closely tied to its natural resource wealth. Moreover, a historical review of oil price trends reveals significant volatility, making it an unreliable source for financing national expenditures. According to theoretical foundations, natural resource rents should enhance the economic and social welfare of local communities. Ross (2007) notes that surprisingly little information exists about the relationship between natural resources and income inequality. However, it appears that resource-rich countries are, on average, neither more nor less unequal. Countries with abundant natural resources are often considered fortunate because these resources are valuable capital that can be transformed into essential infrastructure, fostering economic development and progress. Among natural resources, mineral resources—particularly hydrocarbons such as oil and gas—hold exceptional importance.
The underground economy further complicates this relationship. As a parallel economic sector often linked to oil dependence, it diverts financial flows from formal oversight, undermining equitable wealth distribution. This not only deepens inequality but also erodes institutional quality and discourages human capital investment. In effect, overreliance on oil rents traps economies in cycles of distorted specialization and sluggish growth, perpetuating disparities.
Despite these dynamics, few studies have examined the asymmetric effects of oil rents on income inequality or the mediating role of the underground economy—a critical gap this study addresses. Focusing on Iran (1978–2022), we investigate two central questions: First, does oil rent have an asymmetric effect on income inequality? Second, does the size of the underground economy influence how oil rent affects income inequality, and if so, how?
Methods and Material
First, the relative size of the underground economy is calculated using the MIMIC method. The structural equation model illustrates the relationship between the unobservable latent variable and observed indicators and causes. This model is widely used in various social sciences and economics. The MIMIC model consists of two main components: a structural equation and a measurement equation. As mentioned in the introduction, the primary objective of this study is to analyze and examine the asymmetric effect of oil rents on income inequality, with a focus on the role of the relative size of the underground economy in Iran. Therefore, the research model is designed to investigate and explain how increases and decreases in oil rents impact income inequality, emphasizing the relative size of the underground economy. To elaborate further, the reason for employing an asymmetric model lies in the limitations of symmetric or linear models, where the absolute magnitude of the independent variable's effect during an upward trend is assumed to be identical to its effect during a downward trend. In other words, in a symmetric estimation of oil rents impact on income inequality, it is conventionally interpreted that if an increase in oil rents leads to a rise (or fall) in income inequality by units, then simultaneously, a decrease in oil rents would result in a reduction (or increase) in income inequality by  units. However, what occurs in reality may differ, as the effect of increasing oil rents on income inequality might not be identical to that of decreasing oil rents. In other words, in Iran’s economy, it is expected that income inequality will respond differently to increases in oil rents compared to decreases. Considering the explanations provided, as well as the potential delay in the impact of explanatory variables on income inequality and the influence of other variables affecting income inequality, a nonlinear autoregressive distributed lag (NARDL) approach is utilized. The asymmetric model specification is based on the study by Shin et al. (2014), which addresses the asymmetry in the coefficient of an influencing factor on the dependent variable under conditions of boom and recession. Drawing insights from the work of Pesaran et al. (2001), they define a model referred to as the nonlinear autoregressive distributed lag (NARDL) model.
Results and Discussion
The findings of the study, based on the estimation of the research model in the long run, indicate that: 
Firstly, positive shocks (increases) in oil rent have a favorable (negative) effect, while negative shocks (decreases) in oil rent have an unfavorable (positive) effect on income inequality. The difference in the magnitude of the impacts of positive and negative shocks highlights the asymmetric effect of oil rent on income inequality. Secondly, the favorable impact of increases in oil rent on income inequality diminishes as the size of the underground economy grows.
Thirdly, the unfavorable impact of decreases in oil rent also weakens when the size of the underground economy increases. In a general summary and more detailed explanation, it can be stated that the underground economy acts as a double-edged sword in the relationship between oil rent and income inequality. Specifically, an increase in the size of the underground economy from 12.43% during increases in oil rent and 14.93% during decreases in oil rent makes the favorable (negative) impact of positive shocks in oil rent on income inequality unfavorable and turns the unfavorable (positive) impact of negative shocks in oil rent on income inequality into a favorable one. The inverse relationship between increases in oil rent and income inequality in Iran can be explained through channels such as increased government consumption expenditures, transfer payments and subsidies to lower-income deciles, and improved human development for the poor via government social spending. Furthermore, the results from the research model indicate that when disregarding the size of the underground economy, the favorable impact of increases in oil rent is less significant than the unfavorable impact of decreases in oil rent on income inequality, which confirms the presence of asymmetry in effects. Other findings show that real GDP per capita has an inverted U-shaped effect on income inequality, while unemployment has a positive effect on it.
Conclusion
Given the findings of this study, it must be acknowledged that oil rents are an unreliable resource. Therefore, adopting policies to reduce the country’s budgetary dependence on rents derived from natural resources, including oil, is essential. Additionally, it should be emphasized that to maximize the favorable impact of oil rents on income inequality during positive shocks, policymakers must account for the relative size of the underground economy and implement measures to reduce its scale (e.g., streamlining government regulations and bureaucratic hurdles for formal business entry, reducing trade restrictions, fostering formal-sector employment through prudent management of oil revenues, etc.). Furthermore, since the adverse effect of oil rent declines—which lies beyond the managerial capacity of oil-producing countries (assuming the underground economy’s size is disregarded)—exceeds the favorable effect of oil rent increases, establishing a foreign exchange reserve or national development fund is imperative.

Keywords

• Income Inequality
• Oil Rent
• Underground Economy
• MIMIC
• NARDL
• Iran