The Measurement of Pakistan's Black Economy: A Modified Currency Demand Approach.

Abstract

The study re-examines the size of Pakistan’s informal sector using the dynamic monetary method. It investigates the relationship between the tax burden and currency ratio by controlling the impact of education, financial development, interest rate and strength of government regimes. Previous work on Pakistan indicates that most of the studies used traditional currency demand approach, which involves a number of problems and henceforth give spurious results. Study applied Auto Regressive Distributed Lag (ARDL) bound test approach to estimate dynamic monetary model and unearth the existence of volume of shadow economy in Pakistan. The empirical results of the study revealed a positive and significant long-run equilibrium relationship between tax burden and currency ratio. Besides, it is also observed that financial development, regime strength, education and interest rate have inverse linkage with money demand. Results of the study predict that size of Pakistan’s informal sector was at its highest 49.38% of GDP in 1998 and reduced to 27.16% of GDP in 2015. Besides, it is also observed that volume of shadow economy remained less during the era of dictatorship as compared to democracy. Empirical findings of the study envisage that economic managers of Pakistan’s economy should work on readjusting tax brackets and focus on increasing tax base rather than tax rates.