Shadow Economy in Pakistan: Its Size and Interaction with Official Economy

Mughal, Khurrum and Schneider, Friedrich (2018): Shadow Economy in Pakistan: Its Size and Interaction with Official Economy.

Abstract

Shadow economy encompasses wide array of activities that influence the official economy and government policies, either directly or indirectly. In this paper we estimate the shadow economy of Pakistan using currency demand approach with two econometric approached, i.e. one using Auto Regressive Distributed Lag (ARDL) model and two with Engel Granger two step approach. Additionally, we use a variant of currency demand approach where along with tax variable we include unemployment rate and intensity of government control as indicator variables of shadow economy, for the first time in case of Pakistan. The average shadow economy of Pakistan estimated from 1973-2015 as percentage of GDP is 26.41, 25.29, and 26.11 from Models 1, 2, and 3 respectively. Furthermore, we analyzed interaction between the official and shadow sector using ARDL model. Our results show a significantly increasing shadow economy in Pakistan with positive impact on the official sector in long run while negative impact in the short run. This again is a novelty in our paper where we observe short and long run impacts separately along with dynamic simulations to show Pakistan’s GDP per Capita in the absence of shadow economy.

• Item Type: MPRA Paper
• Language: English
• Keywords: Shadow Economy, Pakistan, Impact of the official Sector, Currency Demand Approach
• Subjects: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E26 - Informal Economy ; Underground Economy; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H26 - Tax Evasion and Avoidance; K - Law and Economics > K4 - Legal Procedure, the Legal System, and Illegal Behavior > K42 - Illegal Behavior and the Enforcement of Law; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O17 - Formal and Informal Sectors ; Shadow Economy ; Institutional Arrangements

References

Ahmed, M., and Q. M. Ahmed (1995) “Estimation of the Black Economy of Pakistan through the Monetary Approach”, The Pakistan Development Review 34: 4, 791–807.

Ahmed, Qazi Masood and M. Haider Hussain (2008). “Estimation of the Black Economy of Pakistan through the Monetary Approach: A Case Study of Pakistan.” Economic Issues, 13:1.

Ardizzi, Guerino, Petraglia, Carmelo, Piacenza, Massimiliano and TURATI, Gilberto, (2011), Measuring the Shadow Economy with the Currency Demand Approach - A Reinterpretation of the methodology, with an application to Italy, No 22, Working papers of the former Department of Economics and public finance "G. Prato", University of Torino, Department of Economics and Public Finance "G. Prato"

Aslam, S. (1998) “The Underground Economy and Tax Evasion in Pakistan: Annual Estimates (1960-1998) and the Impact of Dollarisation of the Economy”, The Pakistan Development Review 37:4, 621–631.

Dickey, D. A., & Fuller, W. A. (1979). Distribution of the estimators for autoregressive time series with a unit root. Journal of the American statistical association, 74(366a), 427-431.

Dell’Anno, Roberto (2008) “What is the Relationship between Unofficial and Official Economy? An analysis in Latin American Countries”, European Journal of Economics, Finance and Administrative Sciences, Issue 12 (2008): 185-203

Drummond, D., M. Éthier, M. Fougère, and J. Rudin (1994) “The Underground Economy: Moving the Myth Closer to Reality,” Canadian Business Economics, Volume 2, Number 4, 1994, pp. 3-17.

Engle, R. F., & Granger, C. W. (1987). Co-integration and error correction: representation, estimation, and testing. Econometrica: journal of the Econometric Society, 251-276.

Feld, Lars and Friedrich Schneider, (2010), “Survey on the Shadow Economy and Undeclared Earnings in OECD Countries”, German Economic Review, 11/2, pp. 109-149.

Frey, Bruno S. and Reto, Jegen (2001). ‘Motivation Crowding Theory’, Journal of Economic Surveys 15(5), 589–611.

Frey, Bruno S. (1997b). “Not Just for the Money”, Edward Elgar, Northampton, MA.

Gërxhani, Klarita (2004). “The Informal Sector in Developed and Less Developed Countries: A Literature Survey”, Public Choice, Volume 120 (3-4), Pg 267-300.

Gulzar, A., Junaid, N., & Haider, A. (2010). What is hidden, in the hidden economy of Pakistan? Size, causes, issues, and implications. The Pakistan Development Review, 665-704. Human and income poverty: developing countries / Population living below the national poverty line (%), Human Development Report 2007/08, UNDP.

Iqbal, S. (2015, July 5). Tax on cash withdrawals stokes dollar demand. Dawn. Retrieved from: https://www.dawn.com/news/1192489

Iqbal, Z., S. K. Qureshi, and R. Mahmood (1998). “The Underground Economy and tax Evasion in Pakistan”. Pakistan Institute of Development Economics. (Research Report No. 158.)

Johnson, Simon; Kaufmann, Daniel; Shleifer, Andrei (1997): “The unofficial economy in transition”, Brookings Papers on Economic Activity, Fall, Washington D.C.

Kemal M. Ali, (2007). “A Fresh Assessment of Underground Economy and Tax Evasion in Pakistan: Causes, Consequences and Linkages with the Formal Economy”, Pakistan Institute of Development Economics Working Paper 2007: 13, Islamabad, Pakistan.

Kemal, M. A. (2003) “Underground Economy and Tax Evasion in Pakistan: A Critical Evaluation”, Pakistan Institute of Development Economics. (Research Report No. 184.)

Kemal, M. A., & Qasim, A. W. (2012, November). Precise estimates of the informal economy. In 28th Conference of the Pakistan Society of Development Economists. Islamabad.

Khan, Ahmed, and MohsinAkhter (1993)."Taxation System of Pakistan: Structure and Trends, Economic Review”, FindArticles.com, Web. 21 May 2008.

Kiani, M., Ahmed, A., & Zaman, K. (2015). Combining qualitative and quantitative approaches for measuring underground economy of Pakistan. Quality & Quantity, 49(1), 295-317.

Loayza, Norman V. (1996): “The economics of the informal sector: a simple model and some empirical evidence from Latin America”, Carnegie-Rochester Conference Series on Public Policy 45, pp. 129-162.

Pardo, I. (1995). “Morals of Legitimacy in Naples: Streetwise about Legality, Semi- Legality, and Crime”.European Journal of Sociology36(1): 44-71.

Schneider, Friedrich, (2010), the Influence of Public Institutions on the shadow Economy: En Empirical Investigation for OECD countries, European Journal of Law and Economics, 6/3, pp. 441-468.

Schneider, Friedrich (2006). “Shadow Economies and Corruption all over the World: What do we Really know?” CESIFO Working paper No. 1806.

Schneider, F. and Dreher, A.(2006). “Corruption and the Shadow Economy: An Empirical Analysis”, Economics Department, Johannes Kepler University, Linz, Austria, Working Paper No. 0603.

Schneider, Friedrich and Enste, Dominik (2000), Shadow Economies: Size, Causes and Consequences, Journal of Economic Literature, 38/1, pp. 73-110.

Schneider, Friedrich and Hametner, Bettina (2007). “The Shadow Economy in Colombia: Size and Effects on Economic Growth”, Department of Economics, Johannes Kepler University, Linz Austria,. Working Paper No. 0703

Schneider, Friedrich and Enste, Dominik (1998). “Increasing Shadow Economies All Over the World - Fiction or Reality. A Survey of the Global Evidence, of its Size and of its Impact from 1970 to 1995”, Department of Economics, Johannes Kepler University, Linz Austria, Working Paper No. 9819

Schneider, Friedrich and Martin Halla (2005). „Taxes and Benefits: Two Distinct Options to Cheat on the State”, Department of Economics, University of Linz,Austria, Working paper 0505

Schneider, Friedrich, Andreas Buehn and Claudio E. Montenegro, (2010), New Estimates for the Shadow Economies all over the World, Interntional Economic Journal, 24/4, pp. 443-461.

Shabsigh, Giath. (1995). “The Underground Economy: Estimation, and Economic and Policy Implications—The Case of Pakistan”, IMF, Working Papers, WP/95/101.

Shahbaz, R. (2017, November 1). Pakistan now ranked 147th in World Bank’s Ease of Doing Business Index. The Express Tribunal. Retrieved from URL: https://tribune.com.pk/story/1546434/2-pakistan-now-ranked-147th-world-banks-ease-business-index/

Spiro, Peter S. (1993), “Evidence of a Post-GST Increase in the Underground Economy”, Canadian Tax Journal, vol. 41, no. 2, pp. 247-258. © 1993.

Spiro, Peter S. (1994). “The Underground Economy: Toward a More Balanced View of Alternative Methodologies”, Canadian Business Economics, Summer 1994, P- 18-21.

Tanzi, V (1980). “The underground economy in the United States: Estimates and implications”, Banca Nazionale del Lavoro, 135:4, pp. 427-453

Tanzi, V (1983). “The underground economy in the United States: Annual estimates, 1930-1980”, IMF-Staff Papers, 30:2, pp. 283-305

Tanzi, V. (1999). Uses and abuses of estimates of the underground economy. The Economic Journal, 109(456), 338-347.

Yasmin, B., and H. Rauf (2003). “Measuring the underground Economy and its Impact on the Economy of Pakistan”. The Lahore Journal of Economics. 9:2, 93–103.