The impact of shadow economy on environmental degradation: empirical evidence from Pakistan

Pollution and environment degradation have become serious challenges for the entire world, especially for developing countries. Shadow economy is viewed one of the key factors which can significantly affect environmental quality due to its close and direct relationship with environmental degradation. This study contributes by testing whether an enormous informal sector may be accompanied by higher environmental degradation and investigates the relationship between shadow economy and the prominent sources of environmental degradation. While utilizing data from 1966 to 2008 by accounting an ideal region (Pakistan) as highly exposed to environmental risks, we arrive at several important conclusions. Through the lens of ARDL bound testing procedure, we found that there is significant co-integration association between shadow economy and environmental degradation. The same also holds between shadow economy and the prominent sources of CO2 emissions. While controlling for other determinants of pollution, our estimates confirm that shadow economy not only boosts CO2 emissions but also the various sources of environmental degradation are induced through higher informal sector. The estimated results are robust to alternative estimators such as fully modified least squares (FMOLS) and dynamic OLS (DOLS). Consequently, this study put forward policy recommendations aimed at plummeting the size of informal economy through implementing robust regulating policy instruments to minimize the environmental degradation.