Does infrastructure development matter for the shadow economy in African countries?

ABSTRACT

Understanding the determinants of the informal economy is a crucial issue in economic development due to its far-reaching effects on development efforts. Previous studies focused exclusively on factors that can potentially reduce the relative size of the shadow economy. However, these attempts have not enjoyed much success to date in Africa, where informality has continued to thrive. We contend that realistic medium-term goals, as opposed to obligatory formalisation, could increase the output of informal businesses by providing enough infrastructure and a welcoming business climate, which would at the same time foster formalisation. Using OLS, FE and system GMM with data on 42 African countries covering 2003–2018, we find that infrastructure development reduces the relative size of the shadow economy in African countries. Our results remained consistent when we controlled for the effects of other determinants of the informal economy, employed other estimators, and used an alternative measure of the informal economy.

KEYWORDS:

• Informal economy
• shadow economy
• infrastructure development
• Africa
• GMM

JEL CLASSIFICATION:

• C23
• O17
• O18
• O55

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Algeria, Benin, Botswana, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Comoros, Congo. Dem. Rep., Cote d’Ivoire, Egypt. Arab Rep., Equatorial Guinea, Eritrea, Ethiopia, Gabon, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mali, Mauritania, Mauritius, Morocco, Mozambique, Namibia, Niger, Nigeria, Rwanda, Senegal, Sierra Leone, South Africa, Tanzania, Togo, Tunisia, Uganda, Zambia and Zimbabwe.

2. Generally, the literature suggests GMM approach or instrumental variable (IV) to circumvent endogeneity problems (Farhadi et al. 2015). However, the difficulty with the latter approach is to find purely external instruments that vary both across groups and over time. Also, the IV do not account for the endogeneity of other regressors. Therefore, in this study, the GMM is preferred over IV approach.