The complex trilogy of shadow economy, inflation, and economic growth: evidence from MENA countries
Article Sidebar
Main Article Content
DOI:
https://doi.org/10.17979/ejge.2026.15.1.12398Abstract
This article investigates the dynamic interrelationships between the shadow economy, inflation, and economic growth in 15 countries of the Middle East and North Africa (MENA) region over the period 1991–2017. The study employs a simultaneous equations framework estimated through the Three-Stage Least Squares (3SLS) method, complemented by system GMM to address potential endogeneity issues. Empirical results reveal a bidirectional causal link between the shadow economy and inflation, highlighting their mutual reinforcement: the expansion of informal activities intensifies inflationary pressures by eroding public revenues and prompting monetary financing, while rising inflation encourages informal sector growth as agents seek protection against purchasing power erosion. Additionally, a two-way relationship between inflation and economic growth emerges, where moderate inflation can stimulate economic activity, but persistent high inflation hampers growth through price distortions and reduced real incomes. The shadow economy negatively impacts economic growth, with evidence showing that higher GDP levels reduce informality by expanding formal employment and compliance incentives. Nonetheless, the persistent size of the informal sector poses significant challenges for fiscal capacity and public investment, affecting infrastructure and social services. The robustness of these findings is confirmed through complementary estimation techniques. The article provides insights into the complex macroeconomic interactions characteristic of MENA economies, with important implications for policy aimed at promoting formalization, price stability, and sustainable growth.
Keywords:
Article Details
References
Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277–297. https://doi.org/10.2307/2297968
Asea, P. K. (1996). The informal sector: Baby or bath water? Carnegie-Rochester Conference Series on Public Policy, 45, 163–171. https://doi.org/10.1016/S0167-2231(96)00022-X
Bailliu, J., & Fujii, E. (2005). Exchange rate pass-through and the inflation environment in industrialized countries (Bank of Canada Working Paper No. 2004-21). https://doi.org/10.2139/ssrn.560762
Baklouti, N., & Boujelbene, Y. (2020). A simultaneous equation model of economic growth and shadow economy: Is there a difference between the developed and developing countries? Economic Change and Restructuring, 53, 151–170. https://doi.org/10.1007/s10644-018-9235-8
Barbour, A., & Llanes, M. (2013). Supporting people to legitimise their informal businesses. Joseph Rowntree Foundation.
Belghiti, A., & Kchiri, A. (2022). Impact of public spending on education on GDP per capita growth in Morocco: A stochastic econometric approach. International Journal of Accounting, Finance, Auditing, Management and Economics, 3(3-2), 464–476.
Bourbonnais, R. (2002). Econometrics: Manual and exercises. Dunod.
Bourbonnais, R. (2009). Econometrics. Dunod.
Brill, A. (2011). Taxes and the underground economy. Tax Foundation.
Burdekin, R. C. K., Denzau, A. T., Keil, M. W., Sitthiyot, T., & Willett, T. D. (2004). When does inflation hurt economic growth? Journal of Macroeconomics, 26(3), 519–532. https://doi.org/10.1016/j.jmacro.2003.03.005
Cavalcanti, T. V. V., & Villamil, A. P. (2003). Optimal inflation tax and structural reform. Macroeconomic Dynamics, 7(3), 333–362. https://doi.org/10.1017/S1365100502020096
Davidescu, A. A., Strat, V. A., & Paul, A. (2015). Shadow economy and unemployment in Romania. Procedia Economics and Finance, 32, 694–701.
Elgin, C., & Oztunali, O. (2014). Institutions, informal economy, and economic development. Economic Modelling, 42, 308–318.
Ergene, S. (2015). Growth, inflation, interest rate and informality: Panel VAR evidence from OECD economies. Economics Bulletin, 35(1), 750–763.
Esaku, S. (2021). Is informality a barrier to economic growth in Uganda? Empirical analysis. Development Studies Research, 8(1), 109–121. https://doi.org/10.1080/21665095.2021.1919167
Fetai, B., Koku, P. S., Caushi, A., & Fetai, A. (2016). The relationship between exchange rate and inflation: The case of Western Balkans countries. Journal of Business, Economics and Finance, 5(4), 360–364. https://doi.org/10.17261/Pressacademia.2017.358
Friedman, M. (1968). The role of monetary policy. American Economic Review, 58(1), 1–17.
Ghosh, A., & Phillips, S. (1998). Warning: Inflation may be harmful to your growth. IMF Staff Papers, 45(4), 672–710. https://doi.org/10.2307/3867589
Grimes, A. (1991). The effects of inflation on growth: Some international evidence. Weltwirtschaftliches Archiv, 127(4), 631–644. https://doi.org/10.1007/BF02707413
Gujarati, D. N. (2012). Econometrics by example. Macmillan.
Ha, J., Stocker, M. M., & Yilmazkuday, H. (2020). Inflation and exchange rate pass-through. Journal of International Money and Finance, 105, Article 102187. https://doi.org/10.1016/j.jimonfin.2020.102187
Hansen, B. E. (1999). Threshold effects in non-dynamic panels: Estimation, testing, and inference. Journal of Econometrics, 93(2), 345–368. https://doi.org/10.1016/S0304-4076(99)00025-1
Huynh, C. M., Nguyen, V. H. T., Nguyen, H. B., & Nguyen, P. C. (2020). One-way effect or multiple-way causality: Foreign direct investment, institutional quality and shadow economy? International Economics and Economic Policy, 17, 219–239. https://doi.org/10.1007/s10368-019-00454-1
Imbs, J. (2004). Trade, finance, specialization, and synchronization. Review of Economics and Statistics, 86(3), 723–734. https://doi.org/10.1162/0034653041811707
Khan, M. S., & Senhadji, A. S. (2001). Threshold effects in the relationship between inflation and growth. IMF Staff Papers, 48(1), 1–21. https://doi.org/10.2307/4621658
Kim, S. J., & Willett, T. D. (2000). Is the negative correlation between inflation and growth real? Is the negative correlation between inflation and growth real? An analysis of the effects of the oil supply shocks, Applied Economics Letters, 7(3), 141-147. https://doi.org/10.1080/135048500351681
Koreshkova, T. A. (2006). A quantitative analysis of inflation as a tax on the underground economy. Journal of Monetary Economics, 53(4), 773–796. https://doi.org/10.1016/j.jmoneco.2005.02.009
Levine, R., & Zervos, S. (1993). What we have learned about policy and growth from cross-country regressions. American Economic Review: Papers and Proceedings, 83(2), 426–430
Loayza, N. A. (1997). The economics of the informal sector: A simple model and some empirical evidence from Latin America. Carnegie-Rochester Conference Series on Public Policy, 45, 129–162. https://doi.org/10.1016/S0167-2231(96)00021-8
Loayza, N. V. (2016). Informality in the process of development and growth. The World Economy, 39(12), 1856–1916. https://doi.org/10.1111/twec.12480
Lucas, R. E., Jr. (1988). On the mechanics of economic development. Journal of Monetary Economics, 22(1), 3–42. https://doi.org/10.1016/0304-3932(88)90168-7
Marquardt, D. W. (1970). Generalized inverses, ridge regression, biased linear estimation, and nonlinear estimation. Technometrics, 12(3), 591–612. https://doi.org/10.1080/00401706.1970.10488699
Mazhar, U., & Méon, P.-G. (2017). Taxing the unobservable: The impact of the shadow economy on inflation and taxation. World Development, 90, 89–103. https://doi.org/10.1016/j.worlddev.2016.08.019
Medina, L., & Schneider, F. (2018). Shadow economies around the world: What did we learn over the last 20 years? (IMF Working Paper No. 18/17). International Monetary Fund. https://doi.org/10.5089/9781484338636.001
Mosikari, T. J., & Eita, J. H. (2018). Estimating threshold level of inflation in Swaziland: Inflation and growth (MPRA Paper No. 88728). Munich Personal RePEc Archive.
Nabi, M. S., & Drine, I. (2009). External debt, informal economy and growth. Economics Bulletin, 29(3), 1695–1707.
Ndoricimpa, A. (2017). Threshold effects of inflation on economic growth. African Development Review, 29, 471-484. https://doi.org/10.1111/1467-8268.12282
Nicolini, J. P. (1998). Tax evasion and the underground economy. Journal of Development Economics, 55(1), 215-232.
Phelps, E. S. (1973). Inflation in the theory of public finance. The Swedish Journal of Economics, 75(1), 67–82. https://doi.org/10.2307/3439275
Rdhaounia, N., Kouni, M., & Chenini, T. (2022). The informal economy and inflation in Tunisia.
Romer, P. M. (1990). Endogenous technological change. Journal of Political Economy, 98(5, Pt. 2), S71–S102. https://doi.org/10.1086/261725
Roubini, N., & Sala-i-Martin, X. (1995). A growth model of inflation, tax evasion, and financial repression. Journal of Monetary Economics, 35(2), 275–301. https://doi.org/10.1016/0304-3932(95)01192-Q
Schneider, F. (1998). Further empirical results of the size of the shadow economy of 17 OECD countries over time. Paper presented at the Annual Public Choice Meeting, New York, United States.
Schneider, F. (2005). Shadow economies around the world: What do we really know? European Journal of Political Economy, 21(3), 598–642. https://doi.org/10.1016/j.ejpoleco.2004.10.002
Schneider, F. (Ed.). (2011). Handbook on the shadow economy. Edward Elgar. https://doi.org/10.4337/9780857930880
Wang, X., Xu, Z., Qin, Y., & Skare, M. (2022). Foreign direct investment and economic growth: A dynamic study of measurement approaches and results. Economic Research-Ekonomska Istraživanja, 35(1), 1011–1034. https://doi.org/10.1080/1331677X.2021.1952090
Williams, C. C. (2006). The hidden enterprise culture: Entrepreneurship in the underground economy. Edward Elgar. https://doi.org/10.4337/9781847201881
Williams, C. C., et al. (2011). The informal economy: Causes and consequences. OECD Working Papers on Employment, Migration and Development, No. 80. OECD Publishing
Wu, D. F., & Schneider, F. (2019). Nonlinearity between the shadow economy and level of development (IMF Working Paper No. 19/48). International Monetary Fund. https://doi.org/10.5089/9781484399613.001
Yabu, N., & Kessy, S. S. A. (2015). The effect of the informal sector on economic growth. Economic Research Papers.
Zhang, D., Mohsin, M., Rasheed, A. K., Chang, Y., & Taghizadeh-Hesary, F. (2021). Public spending and green economic growth in BRI region: Mediating role of green finance. Energy Policy, 153, Article 112256. https://doi.org/10.1016/j.enpol.2021.112256