In a groundbreaking new study published in Humanities and Social Sciences Communications, researchers have delivered compelling evidence on how two powerful and intertwined phenomena—the shadow economy and financial inclusion—play pivotal roles in shaping economic growth trajectories in developing countries. The study confronts the persistent challenge of informality, commonly known as the shadow economy (SE), which has long vexed policymakers and economists alike due to its detrimental effects on institutional quality and public finances. More importantly, the research offers fresh insights into how expanding financial inclusion (FINI) can act as a crucial mechanism for mitigating these adverse impacts and fostering sustainable economic progress.
The shadow economy, which consists of informal, untaxed, and often unregulated economic activities, poses a substantial obstacle to development by eroding the institutional framework that underpins effective governance and economic management. This study reaffirms that in developing countries, the size and prevalence of the shadow economy exert a consistent and significant negative impact on economic growth (ECOG). By leveraging multiple proxies for the shadow economy, including the MIMIC (Multiple Indicators Multiple Causes) model and direct estimates through disaggregated economic data, the researchers confirm the robustness of this negative relationship across a diverse sample of developing nations.
At the core of this dynamic lies the erosion of tax revenues, as informal activities largely evade fiscal obligations. This revenue leakage severely constrains governments’ ability to invest in critical public infrastructure and deliver essential services, thereby perpetuating economic inefficiencies and dampening growth potential. The insights align with long-standing theories—often summarized as the “sands in the wheels” hypothesis—that view informality as a drag on institutional development and, consequently, on economic performance. Influential studies, including those by Schneider and Enste (2000), alongside more recent cross-country analyses by Baklouti and Boujelbene, have similarly underscored the economic costs imposed by widespread informality in contexts marked by fragile institutions.
Conversely, financial inclusion emerges as a beacon of hope within this challenging landscape. Higher degrees of accessibility, efficiency, and inclusiveness in financial systems consistently correlate with stronger economic growth outcomes in developing nations. The study highlights that well-developed financial sectors facilitate investment by alleviating information asymmetries and lowering transaction costs in the market. This resonates with the work of Ehigiamusoe and Lean (2018), as well as Pradhan and colleagues (2019), who demonstrated how financial deepening enhances innovation and capital accumulation by improving resource allocation efficiencies.
Crucially, the study distinguishes between two key dimensions of financial inclusion: financial institutional depth (FID) and financial market development (FMD). The findings reveal that while both dimensions positively influence economic growth, institutional access, such as the availability and penetration of banking services, appears to exert a more pronounced effect in many developing countries. This nuance is particularly important, as it suggests that broadening the reach of formal financial services may have a more immediate and direct impact on growth than the development of capital markets. These results echo Beck et al. (2000), who emphasized the importance of inclusive financial systems as engines of broad-based economic participation and resilience.
A novel and significant contribution of this research is its examination of the moderating effect that financial inclusion exerts on the negative relationship between the shadow economy and economic growth. The data supports the proposition that higher levels of financial inclusion—embodied by enhanced access to formal financial products and services—can substantially weaken the detrimental influence of informality on growth. This attenuation occurs primarily through increased transparency and accountability, as financial inclusion promotes formalization by making legal, recorded transactions more attractive and accessible, reducing reliance on cash-based, informal exchanges.
Enhanced financial inclusion provides enterprises and households with risk management mechanisms and formal credit options, which incentivize greater compliance with regulations and diminish the attractiveness of operating within the informal sector. As financial infrastructure advances, the scope for unmonitored transactions shrinks considerably. This finding resonates strongly with prior studies led by Khan et al. (2023), Sharma and Kautish (2020), and Younas et al. (2022), affirming the institutionalist assertion that limited access to formal financial systems perpetuates informality (La Porta and Shleifer, 2014).
However, the study also cautions against overly optimistic interpretations of financial inclusion’s benefits. Merely expanding financial access does not automatically guarantee growth enhancement unless these services reach the marginalized and underserved communities, who are often entrenched within the informal economy. This nuance corroborates research by Capasso and Jappelli (2013) as well as Berdiev and Saunoris (2016), both of whom stress the critical importance of not just access but actual usage and integration of financial services into economic activities for meaningful developmental impact.
These insights carry profound implications for policymakers and development practitioners, underscoring the critical necessity of a multifaceted and targeted approach toward financial inclusion expansion. Simplifying regulatory frameworks, embracing digitization for identity verification, and integrating informal actors into formal credit networks emerge as priority strategies. Governments must also consider incentives such as tax reliefs for micro-enterprises alongside mobile registration platforms to stimulate uptake and participation in formal financial systems.
Financial institutions and central banks, too, have a pivotal role to play by designing and disseminating tailored low-cost financial products geared toward the informal sector—ranging from microloans, savings accounts without minimum balance requirements, to insurance schemes for informal workers. By doing so, they can lower barriers and encourage greater formal engagement from populations traditionally excluded from mainstream finance.
On the international front, organizations like the World Bank and the International Monetary Fund are called upon to invest in robust, inclusive financial infrastructure and facilitate the creation of cross-national comparative data systems. Their role in providing technical assistance and capacity-building support is vital for fostering resilient and inclusive financial ecosystems in fragile and developing economies.
Complementing these efforts, the private sector, particularly fintech innovators, holds enormous promise in transforming financial access through innovative digital solutions. Mobile banking applications, expansive agent networks, and blockchain-based credit scoring models exemplify cutting-edge opportunities to lower service delivery costs and extend outreach to hard-to-reach populations, thereby catalyzing broader formalization and economic participation.
Despite the optimism these insights offer, the study emphasizes the essential need for context-specific, data-driven policy approaches. Generic, one-size-fits-all prescriptions risk entrenching existing disparities and failing to address nuanced institutional realities unique to each country or region. Crafting tailored strategies informed by robust empirical evidence is imperative to ensure that financial inclusion acts as a genuine catalyst for economic growth and institutional strengthening.
Taken together, the research profoundly enriches the growing literature on the economic interplay between informality, financial access, and growth. It highlights the indispensable role of inclusive financial systems not simply as a tool for economic empowerment but as a strategic channel to curtail the shadow economy and unlock latent growth potential within developing countries.
As governments and development stakeholders grapple with complex socio-economic challenges, this study offers a rigorously substantiated roadmap: to confront informality and stimulate sustained growth, proactive steps toward deepening comprehensive financial inclusion are not optional—they are foundational. Only through collaborative, adaptive, and evidence-based policies can developing nations hope to build more equitable and vibrant economies in the decades ahead.
Subject of Research:
The interrelationships between the shadow economy, financial inclusion, and economic growth in developing countries.
Article Title:
Shadow economy, financial inclusion and economic growth Nexus: evidence from developing countries.
Article References:
Fu, J., Ahmad, W., Hussain, B. et al. Shadow economy, financial inclusion and economic growth Nexus: evidence from developing countries. Humanit Soc Sci Commun 12, 1724 (2025). https://doi.org/10.1057/s41599-025-05995-2
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