Analysis of the Effects of Industrialization on the Shadow Economy in Africa

ABSTRACT Africa urgently needs to develop its industrial sector to create jobs, stimulate growth, and reduce poverty. In this regard, the study of the effect of industrialization on the shadow economy remains an area that has not yet been explored in the existing literature. The objective of this study is therefore to fill this gap by analyzing the effect of industrialization on the shadow economy in Africa. More specifically, it examines the effect of manufacturing value added on the share of the informal sector in the total economy and identifies the channels through which industrialization influences the shadow economy. The methodology is based on the Driscoll and Kraay method, the Generalized Least Squares (GLS) method, and the two‐stage Generalized Method of Moments (SGMM) method. The study period covers 2000 to 2020 for a sample of 48 African countries. The results of this study show that industrialization has a negative and statistically significant effect on the size of the shadow economy in Africa. This result suggests that a strong presence of industrialization in Africa will reduce the size of the shadow economy. This result is robust when using the alternative measure of industrialization. In addition, variables such as democracy, foreign direct investment, and education are the channels through which industrialization influences the shadow economy. Thus, by establishing special economic zones or industrial parks open to small businesses and workers in the informal sector, governments have the opportunity to promote their integration into the formal industrial sector.