Nexus of Shadow Economy and Corruption Control: Evidence from Developing Country’s Sample

Abstract

The current literature shows the ambiguous relationship between corruption and shadow economy, specifically in the case of developing countries, because most of the earlier research system on judicial corruption was not incorporated while measuring different corruption indices. This study has used dynamic judicial indicators to observe corruption control as a latent variable to contribute to an advanced analysis of the nexus between shadow economy and corruption. It has employed an unbalanced panel data of 65 developing countries from 2000-2019 to investigate this relationship empirically. Confirmatory Factor Analysis and Multiple Indicator and Multiple Causes Models are used to estimate the magnitudes and signs of various dimensions and causes of corruption control, shadow economy, and their nexus. The results of this study suggest that robust judicial indicators and a more independent judicial system significantly reduce corruption and consequently shrink the shadow economy. Thus, it supports the maxim that the shadow economy and corruption, particularly those in developing countries, are complementary while empirically contradicting the notion that the shadow economy and corruption are substitutes. This study finds a substantial and positive connection between cash holdings and labor force participation rate with shadow economic activities and also predicted an inverse relationship between GDP per capita with the shadow economy.