Combining qualitative and quantitative approaches for measuring underground economy of Pakistan

Abstract

The concern for underground, unofficial or shadow economy by researchers and practitioners has been enlarged in the past few decades. The existence and widespread findings of shadow economies is a growing problem around the world. In this study, we draw on insights from an active and growing economic literature on demand for currency approach and the underground economy. The study addresses the policy relevant issues in a technical fashion by using monetary approach with some extensions in the developing countries context like Pakistan over a period of 1975–2010. The study at first finds the long-run relationship between the currency in circulation and other variables (i.e., GNP, tax revenue as percentage of total revenue, interest rate on saving deposits and inflation rates) and subsequently used their results to infer the size of the informal sector in Pakistan’s economy. The result shows that GNP and inflation rate both have a positive relationship with currency circulation, however, the magnitude of both variables on currency circulation is different, as if there is 1 % increase in GNP and price level, currency circulation increases by 0.86 and 0.091 % respectively. The other variables i.e., tax revenues and interest rates are negatively associated with the currency circulation in the long-run. However, these results are disappearing in the short-run. On the basis of cointegration results, the study concludes that Pakistan’s underground economy increases from less than 30 % in 1975 to 19.8 % in 2010. A change in the size of the shadow economy reflected in a change in monetary indicators. Rising activity in the shadow economy is likely to push up the demand for currency in Pakistan.