Unmasking the Dynamics: Drivers of the Shadow Economy in SAARC Countries

Abstract

The study aims to investigate the determinants of shadow economy in SAARC countries, during the period of 1995 to 2021. The study uses three proxies for shadow economy as dependent variables, which are the ratio of reserve to narrow money (Shadow-1), the ratio of narrow to broad money (Shadow-2), and the ratio of currency in circulation to broad money (Shadow-3), while trade, tax, unemployment, government final consumption expenditure (GFCE), governance index (GI), and economic freedom index (EFI) used as independent variables. The study applies second generation panel unit root test and method of moments-quantile regression (MM-QR) technique. The finding of the study as theoretically expected independent variables, trade, tax, unemployment, and government final consumption expenditure (GFCE) have positive and significant coefficients, while governance index (GI), and economic freedom index (EFI) have negative and significant effect on the shadow economy in SAARC countries. The study suggests that the economic freedom and governance quality should be improved and government size, tax, and unemployment should be decreased to control the shadow economy in SAARC countries.