On the shadow economy-environmental sustainability nexus in Africa: the (ir)relevance of financial development

ABSTRACT Recent studies suggest that shadow economy has several implications for environmental sustainability. However, the relevance of financial development in the nexus between shadow economy-environmental sustainability remains an open question. This study examines the role of shadow economy and financial development in addition to economic growth, trade openness, and urbanization on the environmental sustainability of a panel of 30 African countries from 1991 to 2017. Specifically, the study investigates the effect of these variables on African countries’ ecological footprint and bio-capacity. Findings based on the augmented mean group estimator reveal that shadow economy, financial development, economic growth, and urbanization intensify ecological footprint, while trade openness reduces it. Further investigations reveal that shadow economy, economic growth, and urbanization reduce bio-capacity while trade openness increases it. The interactive term of the shadow economy and financial development shows that a strong financial system significantly moderates the adverse impact of shadow economy on environmental degradation. These results persist when common correlated effect mean group is used to re-estimate the models. Furthermore, Dumitrescu and Hurlin’s non-causality tests show two-way causality between ecological footprint and shadow economy, bio-capacity and shadow economy, and financial development. Nevertheless, unidirectional causality is found from financial development to ecological footprint and shadow economy, economic growth to ecological footprint, biocapacity, and financial development. Lastly, the policy implications of the results are discussed in line with these economies.