Empirical analysis of the interplay between shadow economy and pollution: With panel data across the provinces of China

This paper provides a pioneering study of the interactive relationship between shadow economy and environmental pollution by applying the data of the 31 provinces in China from 2005 to 2015. Side effects of shadow economy including environment pollution have been proved by plenty of articles, yet still have not attracted enough public attentions. If the severe pollution will in turn further increase the size of the shadow economy, then the environmental situation in the present will lead to an even worse unhealthy economy growth path. This paper firstly adopts MIMIC (Multiple Indicators Multiple Causes) method to calculate the size of shadow economy, then uses the Generalized Method of Moments (GMM) specification to analyze the interplay between shadow economy and pollution in association with environmental regulation, economic growth, foreign direct investment and educational level. The results show that shadow economy and pollution do have a positive interaction between each other, statistically significant at 1% level. Also, both pollution and shadow economy have a U-shaped non-linear relationship with environmental regulation, but an inverse U-shaped non-linear relationship with economic growth. Finally, foreign direct investment (FDI) and education level have positive linear impacts on both pollution and shadow economy, too. But the effect from FDI is weak and less significant. [Display omitted] •The percentage of shadow economy on GDP is calculated based on MIMIC model.•The possible interaction relationship between shadow economy and pollution is explored.•Environmental regulation and economic growth have non-linear effect on both shadow economy and pollution.•FDI and education level have linear effect on both shadow economy and pollution.