Exploring Informal–Formal Economy Linkages: New Evidence from the MIMIC Model Approach

This study investigates the size, dynamics, and macroeconomic implications of the informal economy (IE) in Nigeria, using a structural macro-modelling approach. The motivation stems from persistent macroeconomic underperformance in Nigeria, even with its rich resource endowments. This situation raises important questions about the economic activities that go unaccounted for outside of formal systems. While existing literature recognizes the importance of the informal sector in developing economies, it often lacks detailed, country-specific modeling frameworks that weave the IE into broader macroeconomic analysis. This study aims to bridge that gap by constructing and estimating a macroeconomic model that explicitly includes the informal economy to understand its interactions with key macroeconomic variables. Using the Multiple Indicators Multiple Causes (MIMIC) model, the study measures the size of Nigeria’s informal economy and simulates the impacts of changes in macroeconomic policy variables. The findings reveal that the size of the IE ranged from 27.8% to 65.61% of the official GDP. However, its existence outside the tax and regulatory framework undermines fiscal performance and the effectiveness of monetary policy. Moreover, the model illustrates how shocks in the formal economy affect the informal economy differently, emphasizing the importance of dual-sector policy consideration. This study adds to the existing literature by offering a robust modeling framework for analyzing informality in an oil-dependent economy. The policy implications suggest that reforms in tax administration, financial inclusion, and targeted formalization strategies are essential for enhancing macroeconomic management and fostering inclusive growth in Nigeria.