Shadow Economy and Environmental Pollution in West African Countries: The Role of Institutions

Abstract

This study deviates from extant studies by examining the effect of shadow economy (SE) on environmental pollution, and the role institutional indicators play in moderating the effect in West Africa between 1992 and 2015. Specifically, the study employed three institutional indicators (corruption control [COR], law and order [LAW], and bureaucratic quality [BUQ]) to mediate the effect and also determine its threshold values. SE is measured using Multiple Indicators Multiple Causes (MIMIC) while environmental pollution is proxy by carbon dioxide (CO2) per capita. Two step system Generalized Method of Moments (GMM) is used to drive out the conclusions of the study. The findings reveal that SE, COR and LAW contribute significantly to environmental pollution, while BUQ though not significant, reduces environmental pollution in the region. Further, the interactive effect of SE with all the institutional indicators shows that strong institutional indicators abate environmental pollution through reduction in the presence of SE. The threshold value of institutional indicators, which reduces SE and abates environmental pollution, are 3.8 and 3.7 for COR, and LAW, respectively, on an ordinary scale of 0–6, while 2.8 for BUQ on an ordinary scale of 0–4. Nevertheless, most of the countries in the region operate below the threshold level of institutional indicators in the region. The results are robust to different proxies of environmental pollution. The implications of the study are discussed.