The Shadow Economy, Institutional Quality and Public Debt: Evidence from Emerging and Developing Asian Economies

Shadow economy is a major determinant of the economy since this informal sector has an intimate link with sources of government revenue. In addition, good governance can make significant contributions to public debt management by controlling borrowing cost. This research aims to assess the effect of the shadow economy and institutional quality on public debt of 19 emerging and developing economies in Asia during the period from 2002 to 2017. The research analyzed the data derived from the World Bank and the International Monetary Fund. Pooled-OLS, fixed effects and GMM regression methods are employed to measure the relationship between the shadow economy, institutional quality and public debt. The findings of this research show that both shadow economy and rule of law have a positive and statistically significant relationship with public debt. Indeed, increasing the size of the shadow economy and enhancing the rule of law result in a higher level of public debt while improving control of corruption has a negative relationship with public debt. The research could make substantial contributions to the economies in emerging and developing Asian countries. Based on the findings, policy makers in these countries can seek effective solutions for raising institutional quality, and minimizing the size of shadow economy in order to manage public debt.