Shadow economy in Africa: how relevant is financial inclusion?
| DOI | https://doi.org/10.1108/JFRC-10-2020-0095 |
| Published date | 08 April 2021 |
| Date | 08 April 2021 |
| Pages | 297-316 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Folorunsho M. Ajide |
Shadow economy in Africa: how
relevant is financial inclusion?
Folorunsho M. Ajide
University of Ilorin, Ilorin, Nigeria
Abstract
Purpose –This study aims to investigatethe possible relationship between financialinclusion and shadow
economyin selected African countries.
Design/methodology/approach –The study uses panel data estimation technique and Toda and
Yamamoto causalityapproach. The data of selected African counties over a periodof 2005–2015 are sourced
from World Bank Development Indicators, International Monetary Fund International Financial statistics
databaseand International Country Risk Guide.
Findings –The results show that financial inclusion reduces the size of shadow economy. The causality
results show thatthere is a unidirectional causality movingfrom financial inclusion to shadow economy. The
results demonstratethat a country with lower level of corruption and higher level of growth can benefitmore
in reducing the size of shadoweconomy through financial inclusion.
Originality/value –This study provides the first evidence of the link between financial inclusion and
shadow economy from theSub-Saharan Africa perspective. The study suggeststhat financial inclusion may
be useful in affectingthe size of shadow economy in Africa.
Keywords Financial inclusion, Informality, Panel data, Africa
Paper type Research paper
1. Introduction
This study examines the impact of financial inclusion on shadow economy in African
countries. It is motivated by a number of issues. First, shadow economy accounts for more
than 38% of GDP in Africa; engaging approximately 90% of youth in non-agricultural
activities (Medina and Schneider, 2018;Njangang, 2018). The existence of informality in
African economy has a number of serious implications to the performance of economy. For
instance, growth prospect is compromised which may not work well for policy analysis
when planning the economy for infrastructural development and for conducive business
environment. A continuous increase in the size of African shadow economy would reduce
the size of government finance because of inability to capture the tax base appropriately
(Blackburn et al.,2012).Shadow economy is said to be complex with many side effectsin the
society. It may offer social self-protection as an alternative solution to the higher level of
unemployment rate in Africa through informal entrepreneurship (Blackburn et al., 2012;
Njangang, 2018).
As they operate in informal setting, individuals enjoy tax evasion and avoidance,
reduction in transaction cost, social security spending and other costs, which may result
from the regulations in the formal economic settings but missing cheaper formal financing
and the possibility of lowering efficient productivity (Medina and Schneider, 2018;Bayar
and Ozturk, 2019). Higher size of shadoweconomy may further bring burden to the society.
It may slow down investment and reduce the extent of adopting advanced technology
JEL classification –C23, G20, H26, O17
Shadow
economy in
Africa
297
Received3 October 2020
Revised10 January 2021
Accepted1 February 2021
Journalof Financial Regulation
andCompliance
Vol.29 No. 3, 2021
pp. 297-316
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-10-2020-0095
The current issue and full text archive of this journal is available on Emerald Insight at:
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couple with the limitation it imposes on the government’s ability to generate sufficient
revenue to cater for the needed public goods and services (Capasso and Jappelli, 2013;
Njangang, 2018). However,financial inclusion has the tendency to reduce the size of shadow
economy by bringing individuals out of the informal sector into the formal sector of the
economy. It focuses on ensuring that a greater proportion of the population is
actively engaged in the opportunities and processes available in the formal economic
activities through mainstream financial system (Ababio et al., 2020). It is a situation where
individuals and firms (small or medium) have access to useful and affordable financial
products and services that meet their needs. It is a policy tool to improve the welfare of
citizens, reduce poverty and enhance other economic objectives. As citizens become
financially included and their revenue grows intensely, it may in turn improve the tax
revenue to the government, thereby bringing more citizens to the tax net (Oz-Yalaman,
2019). This happens when the financial inclusion is developed and financial intermediation
system becomes more effective and efficient. The cost of obtainingcredits is reduced which
leads to an increase in opportunity cost of operating in shadow economy. This means that
financial inclusion mayhave a negative relationship with the size of shadow economy (Ellul
et al., 2012). Capasso and Jappelli (2013) illustrate that trade-off exists when an economic
agent operates in a shadoweconomy by either getting a reduction in the cost of finance or by
granting credit to already credit constrained agents. Meanwhile, finance can affect this
relation by increasing the motivation to operate in the formal economic system of the
country.
Despite the improvement in African financial inclusion,little or nothing is known on the
importance of financial inclusionas a veritable tool in affecting the size of shadow economy.
We contribute to this ongoing debate in a number of ways. First, this study argues and
investigates whetherfinancial inclusion is correlated with shadow economy. Furthermore,it
introduces financial inclusion as a determinant of shadow economy which has not been
previously examined in Africa. We measure financial inclusion using Sarma’s (2008)
methodology with six financial inclusion dimensions. This is because the literature on
financial inclusion provides insight that when financial inclusion indicators are used
separately, it may lead to partial and incomplete information on the nature of inclusiveness
of a financial system (Sarma, 2012). Using the indicators individually may lead to mislead
interpretation of the extent of financial inclusionin an economy. In addition, we investigate
whether there is causality between financial inclusion and shadow economy in Africa. Our
study brings to the attention of policymakers on how they can use the opportunities of
financial inclusion dimensions to reduce the size of shadow economy. In this study, we
document that financial inclusion is relevant and serve as a veritable tool for reducing the
size of shadow economy in Africa. This submission is robust to alternative estimation
techniques.
Apart from the introduction of the paper, the rest is organized into four sections. In
Section 2, we briefly discuss the literature review. In Section 3, we present the data and
methodology of the study. In Section 4, we discuss the empirical results while Section 5
concludes the paper.
2. Literature review
2.1 Concept of shadow economy in Africa
The concept of shadow economy can as well be called illegal economy, black economy,
undeclared economy, unrecorded economy, unreported economy and informal economy. In
shadow economy, illegal activitiesare very easy to perpetrate and the usual practice may as
well include non- declarationof income acquired from production of legal goods and services
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