The Shadow Economy and Economic Growth in Developing Countries: An Analysis of its Implications for Gross Domestic Product with an Application to the Libyan Case (2014–2025)
DOI:
https://doi.org/10.64943/ajhas.2026.020241Keywords:
Shadow economy, informal economy, Libya, GDP, institutional fragility, oil rentier economy, MIMIC modelAbstract
This research examines the phenomenon of the shadow economy in Libya during the period from 2014 to 2025. It analyzes the nature of this parallel economy and its role in shaping economic activity patterns within an environment characterized by weak institutions, declining state regulatory capacity, and challenges to political and security stability. The research aims to explain the factors that contributed to the expansion of the shadow economy, considering it a form of economic adaptation adopted by broad segments of society to cope with economic imbalances and the decline in formal economic activity opportunities The study employs an analytical and econometric methodology that combines the Multi-Indicator and Cause Inherent Variables (MIMIC) model to estimate the size of the shadow economy, the Ordinary Least Squares (OLS) linear regression model to measure its impact on economic performance, and the Granger causality test to reveal the nature of the temporal relationship between the variables under study. It also relies on a set of official economic data issued by the Central Bank of Libya, the International Monetary Fund, and the World Bank during the study period The analysis revealed that the shadow economy represents a significant portion of economic activity in Libya, averaging approximately 43.2% of official GDP during the study period. This figure peaked in 2020, exceeding 54%, due to the escalation of armed conflict, declining oil production, and worsening institutional and economic imbalances. The econometric model also demonstrated a statistically significant inverse relationship between the expansion of the shadow economy and the real economic growth rate. A one percentage point increase in the shadow economy leads to a decrease in the economic growth rate of approximately 0.43 percentage points. Furthermore, the continued prevalence of informal activities is estimated to have resulted in a cumulative loss of over $19.6 billion in tax revenue during the study period The study concludes that addressing the shadow economy in Libya cannot be achieved through regulatory measures alone. A comprehensive reform approach is required, combining strengthening confidence in public institutions, reforming the subsidy system, unifying the exchange market, expanding financial inclusion, and developing the tax system. This approach will contribute to integrating informal economic activities into the formal economy and achieving greater stability and sustainable development.
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