Financial Development, Corruption and Shadow Economy:Evidence from MENA Countries

This paper examines the relationship between financial development (FD), corruption, and the size of shadow economies in the MENA region from 1996 to 2018. An important contribution is the study of how FD and corruption can interplay to affect informality. Several pooled regressions are run on the entire sample and various subsamples in order to understand the heterogeneity that might exist among countries. Even after addressing the potential endogeneity problem of the variables, we find robust results showing that increases in corruption and FD reduce the size of the informal sector. Therefore, corruption plays the role of “greasing the wheels” in the Middle East and North Africa (MENA) region. Moreover, these two dimensions are substitutable in relation to the unofficial economy; the marginal impact of increasing along one dimension is higher when the other dimension is low. The subsample analysis reveals that the impacts of FD and corruption can be remarkably different between low-corruption and highly corrupt countries. Interestingly, the statistical significance of these two factors vanishes for the high-income countries. Obviously, the efforts against informality in the MENA region are multidimensional and dynamic. Further, at each stage of economic, financial, and institutional development, new factors may appear and gain importance.