On the contributing factors to shadow economy in Africa: Do natural resources, ethnicity and religious diversity make any difference?

Abstract

Many factors influencing shadow economy, including foreign direct investment, economic complexity, and financial development, have been well acknowledged in the literature. However, little attention has been given to the roles of natural resources, ethnicity, and religious diversity as the intense factors affecting the size of shadow economy in developing countries. Our study provides fresh empirical evidence that answers whether ethnicity and religious diversity affect the shadow economy in developing regions. It also examines the role of natural resources on shadow economy. Drawing on data from 31 African nations, the study addresses conditional distribution of shadow economy and the endogenous nature of the relationship between dependent and key independent variables. It documents that ethnic diversity and resource rents increase the size of shadow economy while religious diversity reduces it. This result is robust to alternative estimation techniques. Our result argues in favour of policies that promote religious diversity and reduce ethnic groups' marginalisation in a heterogeneous society like Africa. It also advances the many possible reasons for the result and suggests policy implications.