Determinants of shadow economy in OIC and non-OIC countries: the role of financial development

Abstract

PurposeThe purpose of this paper is to empirically investigate the determinants and the impact of financial development on shadow economy in OIC countries and then compared with non-OIC countries.Design/methodology/approachThe study applies advanced panel GMM technique.FindingsThe study finds that macro-variables (unemployment, economic growth, money supply and foreign trade) and institutional variables reduce shadow economy both in OIC and non-OIC countries. The study also explores that financial development mitigates shadow economy; however, its impact is significantly less in case of OIC economies compared to the non-OIC countries.Research limitations/implicationsSince the focus of this study is OIC countries vs non-OIC countries, the research only includes discussion about shadow economy in 42 OIC member states and 99 non-OIC economies. The decision to restrict the study to 42 OIC economies and 99 non-OIC nations is due to the availability of data.Practical implicationsThe study suggests that free market and good business environment in the formal economy are the keys to have less shadow economy. Good institutional setup and ease in regulations can attract firms and businesses from informal sector to the official economy, while political instability is one of the main factors for having large size of shadow economy.Social implicationsThe OIC member countries should implement policies which improve accessibility to finance of every citizen of the country.Originality/valueDespite the growing importance of shadow economy, the literature investigating determinants and the role of financial development in shadow economy is scarce. To the best of the authors' knowledge, there is no literature that examined the shadow economy in the context of OIC member countries. Furthermore, this study has covered a large number of OIC and non-OIC economics over time and across different groups using largest data and advanced panel GMM techniques.