Estimating the Volume of the Hidden Economy in Yemen, 1995-2009: Evidence from ARDL Approach of Cointegration

Knowing the size of the hidden economic activities is very important for economists as well as policy makers for economic development and planning. The expansion of the activities in hidden economy has become a competing economy with the official activities. This study aims to shed light on the hidden economy’s phenomena in Yemen as a one of the least developing countries. It attempts to measure the size of the hidden economy based on the size of tax evasion by measuring the currency in circulation and the ratio of newly-printed banknotes to the public expenditure. The study uses quarterly data over the period of 1995Q1 to 2009Q4. In this study, the ratio of newly-printed banknotes to the public expenditures which are issued increasingly by monetary authorities over the period are as indicative a wrong monetary policies in Yemen. The study investigates whether there is a long- run relationship in the money demand function which is used as a measurement of the Yemen’s hidden economy. The ARDL bound testing approach for cointegration test is adopted in this study. The empirical results show that there is a unique and stable long-run relationship among currency in circulation and its determinants, which indicates a growing activities of hidden economy in Yemen. It confirmed that the growing of the hidden economy is associated with the weakness in the tax system and corruption in Yemen. The average volume of the hidden economy related to the official GDP has grown steadily from 78.25% in 1995 to 94.1% in 2009. The results also reveal that after incorporating the CUSUM and CUSUMSQ tests, the Yemen’s money demand function is stable between 1995:1 and 2009:4.