Size and Causes of the Shadow Economy in Iran: An Analysis with the MIMIC Approach

This study aims to estimate the size of the Iranian Shadow Economy (SE) using the multiple indicators multiple causes (MIMIC) approach, a variant of the structural equation modeling (SEM) approach. The application of the MIMIC approach allows for the consideration of established drivers of the SE as well as potential causes that might be of particular importance to the Iranian SE, namely inflation and the size of the construction sector in the economy, the latter of which is considered in this study for the first time. The significant determinants of the Iranian SE are found to be inflation, unemployment, trade openness, and the size of the construction sector. The SE is also found to be positively related to cash usage and negatively related to the labor force participation rate and the Iranian GDP. Using annual data for the 1979-2019 period, our empirical results show that after an initial surge in SE size during the Iran-Iraq war (1980-1988), the Iranian SE generally decreased, although fluctuations were also present. The average SE size during the entire studied period of 1979-2019 is found to be 31.83% of GDP.