The Impact of Economic Sanctions on the Size of Informal Economies in Iran

In the face of economic sanctions, most countries use methods to circumvent sanctions, including the expansion of activity in the informal sector of the economy. Sanctions affect the informal economy directly and indirectly, through the formal economy and other channels. To date, various studies on the consequences of sanctions have examined how external economic pressures affect the formal sector of the target economies. This study investigates the effect of economic sanctions on the informal economy in Iran. This study also introduces the factors that lead economic elements to activity in the informal economy. 

The research method in this study is the autoregression model with distributed intervals according to the significance of the variables. In order to determine the econometric model based on theoretical and empirical studies of Earley and Paxon, the variables affecting the shadow economy for estimation and The difference between the models is that in each model, the variable of sanctions is considered in the form of the concepts of duration of sanctions (size of sanctions period), group sanctions (sanctions with cooperation of several countries and internationally), non-group sanctions (sanctions by one country) and number of sanctions. The data used to estimate the size of the informal economy were extracted by exploratory factor analysis during the years 1978 to 2019. In addition to the sanctions, other variables affecting the size of the informal economy such as per capita GDP, the ratio of loans to the private sector, liquidity, trade openness index, tax revenue, oil and gas revenue, and exchange rates have also been considered. For statistical analysis, self-explanatory econometric method with wide intervals has been used. 

What was obtained in this study shows that different aspects of the sanctions, including Sanctions Duration, Sanctions Count and NIGO Sender or IGO Sender, have had a significant and positive impact on the size of Iran's informal economy. Also, the results show that other variables such as exchange rate gap, tax revenue, liquidity and oil and gas income have a positive effect on informal economy and the variables of per capita GDP, openness of trade, ratio of domestic credit to private sector have significant negative impact on the informal economy. 

Sanctions hinder official imports by reducing government funding, while demand still exists in the economy. This gap between formal imports and consumer demand encourages import smuggling. Sanctions also increase inflation. Increased liquidity from cash subsidies has boosted consumer demand for goods and services, but industrial capacity and imports, which have been negatively affected by trade sanctions, are not responding to growing consumer demand. As a result, the gap between the supply of goods and services and consumer demand pushes up the price level and increases inflation. Higher inflation rates reduce people's disposable income and encourage them to seek alternative sources of income through the informal economy. In response to the sanctions, the Iranian government increased restrictions on the foreign exchange market and also increased the share of taxes in the annual budget. Restrictions on the foreign exchange market increase the regulatory burden and provide new rental opportunities for traders. Increasing the tax burden has a significant effect on shifting economic factors, especially small businesses, to the informal economy.