Unemployment, official economy and the dimension of the shadow economy: an empirical analysis for Sri Lanka using <em>SEM</em> approach

Abstract

This study attempts to estimate the share of Sri Lankan shadow economic activities as a percentage of official estimates, while revolving the wheel of non-clarified zones and market functions through overstepping the traditional official estimates. The methodology involves the estimation of structural models to analyse a set of causes of the shadow economy and its influence upon a series of indicators. The study introduces three Multiple Indicator Multiple Cause (MIMIC) models namely MIMIC 5-1-2a, MIMIC 4-1-2b and MIMIC 3-1-3a. The benchmark calculations for each model derives a series of average values for the Sri Lankan shadow economy (SE) in the period from 1990 to2012. Estimated data in model MIMIC 5-1-2a suggests to evidence that the average size of shadow economy in the country is ranging between 91% and 32% in the period from 1990 to 2012 with a decreasing trend. By contrast, calculations for MIMIC 4-1-2b and MIMIC 3-1-3a demonstrate a size of 14% and 52% with an increasing trend respectively. In-depth analysis further reveals the facts that effect the share of tax on goods and services to the government revenue and the level of public employments tend to undermine the increasing pattern of shadow economy. Since the unemployment rate and private employment is playing a charismatic role in the economy, shadow economy tends to increase. Eradicating the workplace enforcement crisis and underemployment issues may hinder the increasing pattern. The results from re-examination of Okun’s law supports for the idea that, less interdependence of the growth of shadow economy and official economy and a parallel growth with shifting stages in market functions.