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The hidden economy in Jordan: A MIMIC approach

Mohammed Abu Alfoul, Zakia Ahmad Mishal, Friedrich Schneider, Khaled

Magableh & Abeer Rafi Alabdulraheem

To cite this article: Mohammed Abu Alfoul, Zakia Ahmad Mishal, Friedrich Schneider, Khaled
Magableh & Abeer Rafi Alabdulraheem (2022) The hidden economy in Jordan: A MIMIC
approach, Cogent Economics & Finance, 10:1, 2031434, DOI: 10.1080/23322039.2022.2031434

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GENERAL & APPLIED ECONOMICS | RESEARCH ARTICLE

The hidden economy in Jordan: A MIMIC
approach
Mohammed Abu Alfoul1*, Zakia Ahmad Mishal2, Friedrich Schneider3, Khaled Magableh4 and
Abeer Rafi Alabdulraheem5
Received: 31 May 2021
Accepted: 16 January 2022; Abstract: This paper uses the Multiple Indicators Multiple Causes (MIMIC) approach
to determine the annual size and growth of the hidden economy in Jordan for the
*Corresponding author: Mohammed
Abu Alfoul, Department of period 1980–2018. We find that the key causal variables of the hidden economy in
Accounting, Economics, and Finance
School of Business, Law, and
Jordan are: female labor force participation, the inflation rate, the unemployment
Entrepreneurship Swinburne rate, total tax revenue, and the budget deficit. The growth of these causal variables
University of Technology, Melbourne,
Australia increases Jordan’s hidden economy. According to our findings, the estimated aver­
Email: Mabualfoul@[Link]
age of the hidden economy from 1980 to 2018 is 17.6% of the official GDP. Thus, it
Reviewing editor: comprises a large portion of the official GDP. Furthermore, our results suggest an
Robert Read, Economics, University
of Lancaster, United Kingdom increase in the size of Jordan’s hidden economy from 11.8% in 1980 to 22.4% in
Additional information is available at
2018. The overall results can assist policymakers in Jordan to combat and reduce
the end of the article the size of the hidden economy.

Subjects: Middle East Economics; Economics and Development; Macroeconomics; Labour

Economics; Development Economics

Keywords: hidden economy; MIMIC approach; SEM model; GDP growth; Jordan’s economy
JEL classification: O17; E26; C31; H11; H26

ABOUT THE AUTHOR PUBLIC INTEREST STATEMENT

Friedrich Schneider is a Professor of Economics Hidden economic activity is a global reality, and
at the Johannes Kepler University in Linz. His shows no signs of slowing. This paper examines
research interests include General Economic the size and growth of the hidden economy in
Policy, Public Finance, Shadow Economy, Jordan. A limited number of studies have
Organized Crime, Privatization and Deregulation addressed the issue of Jordan’s hidden economy
Policies, and Public Choice. Schneider has also and its effect on the national economy, as well as
published various articles in journals such as the the role of female participation in the size of the
Review of Economics and Statistics, The hidden economy. The current paper fills this gap.
Economic Journal, and Public Choice. Furthermore, our paper identifies the leading
Zakia Ahmad Mishal is a Professor of Economics causes for Jordan’s hidden economy, which has
at Yarmouk University in Jordan. Zakia is triggered a sharp deterioration in the nation’s
a specialist in Urban Economics, Economic economy: weak female labor force participation in
Development, and Women Economics. the official economy, high taxes, budget deficit,
Mohammed Abu Alfoul is a PhD candidate in the high unemployment, and inflation rate.
Department of Accounting, Economics, and
Finance School of Business, Law, and
Entrepreneurship at the Swinburne University of
Technology in Australia.
Khaled Magableh is a PhD candidate in the
Department of Business and Management,
Victoria University Business School in Australia.
Abeer Rafi Alabdulraheem is a master’s degree
lecturer of Computer science at Imam
Abdulrahman Bin Faisal University in Saudi
Arabia.

© 2022 The Author(s). This open access article is distributed under a Creative Commons
Attribution (CC-BY) 4.0 license.

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1. Introduction
A hidden economy (HE)—otherwise known as an “informal”, “shadow” or “underground” economy—
exists in any country where not all sources of income (which may or may not be taxable) have been
declared for taxation purposes. This is an essential topic for three main reasons. First, most nations’
official economic and social conditions are estimated using government statistics, but these only
reveal part of what is happening, and the existence of an HE may mean that a country’s macro­
economic policies are inappropriate. Second, there is a leakage of tax income; as hidden activities
avoid taxation, the public budget deficit increases, which may render the government unable to
support the country’s necessary goods and services. The third and final factor is that, since
a considerable amount of the income obtained from hidden activities is spent inside the formal sector,
the latter receives a bolstering effect. These expenses tend to raise consumer costs (which tends to
boost growth), as well as (mostly indirectly) raising taxable incomes, which reduces budget deficits
(Alkhdour, 2011; Medina & Schneider, 2018; Schneider & Buehn, 2013; Williams & Schneider, 2016).

One important factor that may increase the HE in Jordan is female labor force participation.
According to the Center for International Private Enterprise studies,1 with less than one-fifth of
women employed in the labor force, Jordan has one of the lowest rates of female economic
participation in the world, notwithstanding that Jordan features a highly educated female popula­
tion with great potential to contribute to Jordan’s economic, social, and political development.
Nevertheless, women have a significant gap regarding constitutional rights and social norms, with
conventional beliefs and cultural limitations limiting their options.

A limited number of studies have addressed the issue of Jordan’s hidden economy and its effect
on the national economy. In many studies, such as those by Medina and Schneider (2018),
Schneider (2007), and Schneider et al. (2010)b, Jordan has been mentioned only in passing, and
considerably more attention has been paid to other countries and economies. No previous eco­
nomic research has concentrated on Jordan, except for Alkhdour’s (2011), which examined the
period 1976–2010. Our paper not only casts further light on this underexplored topic but also runs
a set of robustness tests to assess the authenticity of our results. The expansion of the under­
ground economy warrants a deeper examination of this issue in Jordan, especially as policymakers
become more anxious about the accuracy of macroeconomic signals when attempting to confront
and overcome the structural problems facing Jordan’s economy.

Currently, in Jordan, the declining growth rate and ever-increasing budget deficit, combined with an
increasing public debt equaling about 96% of the nation’s GDP, has forced the government to raise
income tax rates to meet the requirements of the International Monetary Fund (IMF). The IMF and the
World Bank are presently concerned about whether Jordan’s leaders apply macroeconomic policies
correctly. We expect that the activities that characterize the hidden economy in Jordan will increase
significantly in the future, since higher taxes may encourage individuals to make up for lost income by
taking on other undetected employment opportunities that are not in the official sector. To obtain
a better understanding of the size of the hidden economy and the relationships between it and Jordan’s
official economy, many more studies are needed. The main objective of this paper is to measure the
annual size of the hidden economy in Jordan over the period 1980–2018, using the Multiple Indicators
Multiple Causes (MIMIC) approach. We find that high taxes, unemployment rate, and inflation rate have
increased the size of the hidden economy in Jordan. Moreover, we find that the budget deficit positively
impacts the hidden economy, which is demonstrated by the government’s attempts to reduce the
deficit by increasing the tax rate and reducing expenditure. Finally, we also find that an increased rate of
female participation in the formal economy leads to a reduction in the size of the hidden economy.

Our study contributes to the previous literature on the role of tax, inflation, budget deficit, and
female participation in the HE in Jordan. Although prior studies have estimated the hidden

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economy in Jordan (Alkhdour, 2011; Medina & Schneider, 2018; Schneider & Buehn, 2013; Williams
& Schneider, 2016), our paper is the first attempt to examine the size of its hidden economy in
terms of the role of female participation. Moreover, this study is the first to investigate how the
budget deficit may be the leading cause of Jordan’s hidden economy and the policy implications.
The paper is structured as follows: Section 2 defines the hidden economy and its estimation
methods; Section 3 attempts to measure and estimate the hidden economy; Section 4 reviews
the relevant literature; Section 5 outlines the model specification and economic methodology
using the MIMIC estimation model; Section 6 presents the results concerning the size of Jordan’s
hidden economy using the MIMIC model; Section 7 summarizes the main findings and themes of
the study; Section 8 provides conclusions.

2. Definition of hidden economy, main causes, and estimation methods

The hidden economy cannot be adequately described using a single definition. Economics research­
ers have devised many definitions, with varying labels and perspectives, using terms such as the
“hidden economy”, “shadow economy”, “black economy”, “parallel economy” and “underground
economy”. In general, the concept of an HE is defined as the “market-based production of goods
and services, whether legal or illegal, that escapes detection in the official estimates of GDP” (Smith,
1997, p. 15). Dell’Anno (2003, p. 5) defines it as “economic activities and the income derived from
them that circumvent or otherwise avoid government regulation, taxation or observation”.

The above definitions indicate that there is controversy among scholars regarding the definition
of this phenomenon. This is because the hidden economy is not limited to monetary transactions
or illicit activities, as legitimate activities and non-monetary transactions fall under the label of
hidden economic activities.

2.1. The main causes of the hidden economy

2.1.1. Tax and social security burdens

High taxes may encourage individuals to take part in the hidden economy in order to avoid paying
their taxes and thus retain a higher personal income. It has become very evident that tax systems
and the pressures being put on social security systems are the two main factors that have
encouraged people to participate in hidden economic activity. Current taxes, which are perceived
to be too high and unfair by many people, affect workers in the official economy and encourage
them to make up for lost income in other ways. Requisite increases in contributions to the social
security system can also lead businesses, institutions, and individuals to falsify their income
statements and related activities.

Experimental studies conducted by Johnson et al. (1998) and later by Williams and Schneider
(2016), confirm that expanding and inequitable tax burdens can encourage a drift towards working
in the hidden economy.

2.1.2. Government regulations

The general trend of governments around the world increasing the number and scope of regula­
tions is another important factor that influences the rise and size of the hidden economy.

Johnson et al. (1997) indicated in their study that governments that implement stricter business
regulations, more bureaucracy or “red tape” and restrictions on tax rebates, refunds, etc., are in
effect promoting the existence of hidden economies. Some examples of such restrictions include
licensing requirements, restrictions on business-related deductions, more documentation of mar­
ket activities, restrictions on foreigners, and trade barriers such as “investment restrictions” and
“trade restrictions”. These systems increase labor costs; subsequently, and not surprisingly, people
begin relying on the hidden economy to avoid such costs.

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2.1.3. Government and corruption

Studies have indicated a connection between government corruption and the hidden economy.
Johnson et al. (1997), Johnson et al. (1998), and Schneideret al. (2010)b have all indicated that
corruption and the size of the hidden economy are complementary in low-income countries,
including Bolivia, Zimbabwe, Peru, and Georgia, which have the largest shadow economies in the
world. They also indicate the absence of a strong relationship between hidden economies and
high-income states, such as Switzerland, the United States, Luxembourg, and Austria, which have
the slightest shadow economies in the world.

2.1.4. Inflation
Economists believe that a rise in the inflation rate increases the size and breadth of the hidden
economy, due to increased demand for cheaper goods and services. Inflation can trigger a decline
in the value of money over time, which then pushes people’s incomes into a higher tax bracket (the
process of “bracket creep”), constituting an additional incentive for taxpayers to work for “cash in
hand” in order to avoid paying extra tax (Cassar, 2001).

2.1.5. Social transfers

Social welfare systems are developed and supported by state bureaucracies or agencies in order to
provide, among other services, pensions, disability payments, and unemployment payments to
people who cannot look after themselves or their families financially. These systems may encou­
rage people who receive such welfare payments to cease looking for work in the formal economy
to receive welfare payments provided by the state. As pensions or welfare benefits increase below
the inflation rate, their recipients may work in the hidden economy to meet their needs. Studies by
Lemieux et al. (1994) and Schneider and Enste (2000) argue that this type of welfare has a role in
increasing the size of the hidden economy.

2.2. Measuring or estimating the hidden economy

It is difficult for economists to estimate or measure the hidden economy, due to the lack of
information available. However, despite the limited data availability, many strategies can be used
to estimate the size of hidden economies—generally, the measurement techniques are divided
into direct and indirect approaches, each with advantages and disadvantages. Most techniques
used to measure the hidden economy are indirect approaches because they use proxy variables in
their estimations. All of which will be explained in more detail in the sub-sections below.

2.2.1. Direct approaches

Direct approaches to measuring the hidden economy in surveys and field samples depend on
voluntary replies. The main advantage of this method lies in gaining a better understanding of the
structure of the HE and detailed information about the factors that help to shape it. Valuable insights
can be achieved through using such an approach—as seen, for instance, in the work of Isachsen and
Strom (1985) and Mogensen (1995) for Norway and Denmark. However, the principal disadvantage of
this technique is a lack of precision. This is an inherent consequence of the nature of a survey, which
chiefly relies on the respondents’ willingness to collaborate with researchers on issues that concern
the hidden economy. Issues around the reliability and possible ambiguity of their responses can
cause problems when analyzing the size of the part of the hidden economy that they work in.

2.2.2. Indirect approaches

The indirect approaches adopted to estimate and measure the hidden economy are sometimes
referred to as “holistic” approaches due to macroeconomic indicators for reporting information
about the HE and its development. This approach includes seven indicators: the discrepancy
between public sector expenditure and revenues; the numerical difference between the authentic
and official workforce; the money demand approach (monetary approach); the transactions
approach; the MIMIC approach (multiple indicators multiple causes); and the physical input system
(electric power consumption; Schneider, 2005).

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The indirect approach has advantages and disadvantages. While it can provide information
about the size of the hidden economy, it can be unreliable when it comes to determining the
structure of the HE. Another problem is that it often requires assumptions that must be made but
cannot be substantiated in most cases. Therefore, there is no perfect way to measure the HE’s size,
range, and depth in any one country (Schneider, 2005). In this study we will use the Multiple
Indicators Multiple Causes (MIMIC) approach, which is expanded on in more detail below

2.2.3. Multiple indicators multiple causes (MIMIC approach)

The MIMIC approach estimates the value of an unobserved (or latent) variable by using some
observed variables. This model considers a special structural equation model (SEM) case. This
approach uses the latent variable as the index of the hidden economy, while the observed
variables are divided into causes and indicators of the hidden economy. This method employs
the computer software LISREL to evaluate its covariance structures. To estimate the MIMIC model,
we employ the maximum likelihood estimator by means of exceptional software for structural
equation models, known as LISREL9.1.

The MIMIC model has many advantages for estimating hidden economic activities. Based on
Giles et al.’s (2002) work, the MIMIC approach is an overall strategy encompassing many
approaches that allow researchers to consider and develop numerous indicators and causal
variables. At the same time, it has the advantage of being flexible, enabling indicators and the
causal variables to be changed so that respective aspect of hidden economic activity can be
investigated. Schneider and Enste (2000) examined the SEM/MIMIC model and developed official
estimation and testing procedures, which are still commonly applied today. One of the character­
istics of this model is that it has flexibility in its application, which makes it suitable to estimate the
sample, providing it is sufficiently large. In addition, this model makes it possible to gauge the size
and evolution of the hidden economy.

The disadvantages or limitations of the model are similar to those of estimating hidden economy
activities using SEM—that is, the reliance on latent variables. Because the emphasis is on determining
if a particular model is robust and valid, it does not take into account other possible or more suitable
models. This means that the designated model will almost certainly include unofficial economic
activities other than those studied. For this reason, it is challenging to research hidden economies and
actual illegal activities (e.g., the drug trade, prostitution, human trafficking) as they are themselves
deeply hidden within the hidden economy. This approach is an important one in the literature, but it
remains complex to conduct, as it is based on purely theoretical premises, and it encounters the
problem of empirical restrictions on access to information (Schneider & Buehn, 2013).

On the other hand, the SEM/MIMIC method leads to unreliable coefficient estimates and is
related to alternative model specifications and changes in the sample size. However, the issue of
instability disappears when the sample size increases (Dell’Anno, 2003), and the SEM/MIMIC
approach can be a valuable tool when studying and analyzing the hidden economy. The above­
mentioned objections do not mean that the method should be abandoned but should encourage
further economic research in the field.

One important critique of the existing literature is that most of the studies determining the size of
the hidden economy take a monetary approach, which typically considers only one cause, which is
the burden of taxation. Other estimation methods consider only one indicator to estimate the effects
of the hidden economy. However, the hidden economy has effects simultaneously on all economic
markets, such as the labor, production, and money markets. In contrast, the MIMIC approach
considers multiple indicators and multiple causes for the presence of a hidden economy over time.

As the size of the hidden economy is unknown, a latent estimator approach which uses the
MIMIC model is employed. The MIMIC approach is based upon a statistical hypothesis of unob­
served variables. The relevant statistical idea behind these models is to compare a sample

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covariance matrix—for example, a covariance matrix of observable variables, with the parametric
structure inflicted on this matrix by a hypothesized model (Sauka & Schneider, 2016). Utilizing
covariance information between the observable variables, the unobservable variable is in the first
phase associated with the observable variables in a component analytical model, also known as
a measurement model. Next, the relationship between the unobservable variable and observable
variables is specified by using a structural model. Hence, a MIMIC model is concurrent.

The MIMIC approach is recognized by many scholars who estimate the size of hidden economic
phenomena. Compared with previous statistical methods, SEM/MIMIC models present several
advantages for estimating the size of the hidden economy (Sauka & Schneider, 2016). In evaluat­
ing the current, hidden economy estimates of various economists, it should be taken into con­
sideration that there is no best or generally accepted method. Hidden economy estimation is not
a straightforward or easy empirical task; indeed, “such an empirical exercise is a minefield,
regardless of which method is used” (Sauka & Schneider, 2016, p. 39).

The economic literature that uses SEMs is very conscious of these constraints. It recognizes that
applying this approach to an economic dataset is not easy, but it also contends that this does not
mean one should abandon the SEM approach. On the contrary, as part of an interdisciplinary
approach to economics, SEMs are essential tools for economic analysis, particularly when examin­
ing the hidden economy. The concerns mentioned should be considered inducements for addi­
tional research in this field instead of abandoning the technique.

3. Literature review
Many studies have discussed the phenomenon of the HE, which reflects the importance of this
issue to economists. However, these studies have mainly used indirect methods to measure what
the hidden economy entails. This section will comment on several studies that have examined
hidden economies utilizing the MIMIC approach.

3.1. Literature on the hidden economy using the MIMIC approach

Macias and Cazzavillan (2010) applied the MIMIC method to measure and examine the develop­
ment of the HE in Mexico from 1970–2006. They looked at factors such as tax burden, salary levels,
inflation, unemployment, and government regulation, while real GDP and real currency served as
an index for measuring the hidden economy. The study found a positive correlation between the
HE and official GDP. Furthermore, they discovered that the main causes of Mexico’s hidden
economy were excessive government regulations and salaries that were too low.

Vo and Ly (2014) estimated the trajectory and size of the hidden economy as it existed in the
countries making up the Association of South East Asian Nations (ASEAN), except Singapore and
Brunei. Their study covered the period 1995–2014 and applied the MIMIC approach. The results
presented evidence that labor freedoms, tax rates, and business freedoms have significantly
influenced the shadow economies of these Asian countries.

Schneider (2015) applied the MIMIC approach to gauge the nature and extent of the shadow
economy for 31 EU countries and other European nations, including Norway, Switzerland, and
Turkey. They discovered that the average size of their hidden economies was 22.6% of formal GDP
in 2003, which fell to 18.6% in 2014.

Hassan and Schneider (2016a) applied two different methods to measure the trend and size of
Egypt’s hidden economy, utilizing two methods: i) structural equation modeling, and ii) the
currency demand approach (CDA). Their study used variables relevant to Egypt’s formal economy,
such as self-employment and agriculture, which served as proxy variables to measure the quality
of democratic institutions. They found that the hidden economy decreased from approximately
50% in 1976 to about 32% in 2013.

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3.2. Literature on Jordan

Schneider (2007) estimated the hidden economy in Jordan and the hidden economy of 145
countries in various phases of economic development for 1999–2005. They used the MIMIC
model for the economic assessment—specifically, they used bank deposits as the dependent
variable and per capita income and salaries/wages as the independent variable in the currency
demand equation. Their results confirmed that the shadow economy in Jordan as a percentage of
GDP increased from 19.4% percent of GDP in 1999–2000 to 20.4% in 2004–2005, reaching a peak
value of 21.6% during 2002–2003.

Schneider et al. (2010)a later updated the Schneider (2007) study to include 162 countries,
including Jordan, for the period 1999–2006. They applied the same MIMIC model for measurement,
in addition to the currency demand approach. The authors made four different estimates because of
the limited data available. They found that the average size of the shadow economy in Jordan
reached 18.7% of formal GDP between 1999 and 2006. For the 162 selected countries, the average
size of the shadow economy rose from 33.7% in 1999 to 35.3% of GDP in 2006.

Alkhdour (2011) conducted a study on Jordan from 1976–2010. This study used the CDA and the
MIMIC approach to analyze the annual size of the HE in Jordan. In addition, this study investigated
economic consequences and the shadow economy’s policy implications. Alkhdour differentiated the
impact of customs duties on the shadow economy from taxes on income and sales. The results,
obtained through the currency demand approach, found that the average size of the HE in Jordan was
14.7% percent of GDP for 1976–2010. Based on the MIMIC approach, Alkhdour attributed Jordan’s
shadow economy to four main causes and two indicators: government regulation, the unemployment
rate, the total effective tax rate, and depreciation of the Jordanian dinar in 1988. The main two
indicators of the HE in Jordan are the growth in private consumption and the growth rate of real GDP.

A study conducted by the United Nations Development Program (UNDP) in 2013, in collaboration
with Jordan’s Ministry of Planning and Social Economic Council, set out to measure the informal
economy based on the Jordan Labor Market Panel Survey of 2010.2 It indicated that the average
size of the HE stood at 8.6% of nominal GDP. Another study for UNDP, which measured the
informal economy in Jordan during the period 1999–2010, employed the currency demand
approach. The study investigated some of the core factors affected by the HE in Jordan: total
tax revenues, unemployment, growth of real GDP, and inflation.

In a study covering 1999–2013, Hassan and Schneider (2016b) measured the development and size
of the shadow economies of 157 countries, including Jordan. Using the MIMIC approach for 1999–
2013, they found four leading factors that increased the size of the shadow economies in these
countries: i) higher tax, ii) regulatory burden, iii) unemployment, and iv) self-employment rates. These
findings confirm the results found in studies by Feige (1989), Feld and Schneider (2010), Macias and
Cazzavillan (2010), and Schneider et al. (2010)b. The average size of the shadow economies in all
sample countries over the period of study was 33.77% of official GDP.

Medina and Schneider (2018), in their study covering the years 1991–2015, estimated the HE for 158
countries, including Jordan. They employed the MIMIC approach to measuring the shadow economy
and added the currency demand approach (CDA). The authors concluded that the average size of
Jordan’s shadow economy was 14.8% of formal GDP for the period 2004–2007. In other recent studies
by Medina and Schneider (2019), they estimated the size of the shadow economy in 157 countries
from 1991 to 2017, and found that the hidden economy in Jordan was smaller than in Medina and
Schneider’s (2019) study. They said that the average size of the hidden economy in Jordan for the
period 2009–2017 was 17.3 % GDP, and it decreased a little from 15.9 percent in 2009 to 14.9 percent
in 2017. Taking the 157 selected countries as a whole, their study shows that the average size of the
world; HE was 30.9 % of GDP between 1991 and 2017. Table 1 shows the size of Jordan’s hidden
economy compared with those of other Middle East countries (Medina & Schneider, 2019).

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While many studies have estimated the size of the hidden economy in Jordan (e.g., Alkhdour,
2011; Schneider et al. 2010a; Schneider, 2007; Medina & Schneider, 2018, 2019), this paper is the
first to take into consideration the budget deficit and female participation as causes of the hidden
economy in Jordan using the MIMIC model. This is important because developing countries suffer
from low female labor force participation in the economy—especially Jordan—which has one of
the lowest rates of female economic participation in the world. Hence, this may be one of the key
factors that impact the size of the hidden economy in developing countries. Furthermore, Jordan is
suffering from a budget deficit, and this variable will lead the government to increase the tax rate,
thereby compelling some people to find work in the hidden economy. Consequently, this paper will
investigate an important gap in the literature, which concerns whether female labor force parti­
cipation and the budget deficit are one of the leading causes of the hidden economy in Jordan.

In conclusion, the hidden economy cannot be considered a temporary phenomenon. It is one in

which job creation occurs, and new income is generated to help citizens access affordable goods
and services. For this reason, the hidden economy needs to be better understood both by govern­
ments and policymakers, particularly in terms of why it exists and what draws people to it when
“official” economic policies and legislation fail to improve people’s lives.

4. Model specification, econometric methodology, and data sources

Our paper employs the MIMIC model to examine the size of the hidden economy in Jordan during
the period 1980–2018. We have identified this period based on data availability collected from
various sources, such as the Central Bank of Jordan, Jordan General Statistics Department, the
Jordanian Ministry of Finance, the World Bank, and the International Monetary Fund.

4.1. The MIMIC approach

The core idea of the MIMIC approach is to explore the connections between certain latent variables
which constitute the magnitude of hidden economic activities. Figure 1 shows the covariance matrix
by dividing the variables into two groups of latent variables—causes and indicators.

The structural equation model (SEM) approach that includes the MIMIC model uses two main
equations and two models (i.e., the measurement and structural models). The (latent) variable ηt
�
determines a p vector yt ¼ y1t ; y2t ; . . . I; ypt of indicators in the measurement model; these are
variables that denote activities in the hidden economy, subject to a p vector of random error terms
�
εt ¼ ε1t ; ε2t ; . . . . . . εpt . The unobservable variable ηt is a scalar and λ is ðpx1Þ; representing the
column vector measurement parameters. The connection between the latent variable (hidden
economy) and its indicators are defined as the below-mentioned measurement equation.

yt ¼ ληt þ εt (1)

The connection between the latent variable (hidden economy) and its causes is defined as the
structural equation. This equation determines the unobservable ηt variable by collecting the
�
exogenous cause’s xt ¼ x1t ; x2t . . . . . . :xqt ˊ, subject to the structural disturbance error term ςt
and where γ is ðqx1Þ vector of coefficients.

It is given by:

ηt ¼ γxt þ ςt (2)

The following equation represents the relationship between the measurement equation (indica­
tors) and the structural equation (causes). It is given by substituting equation (2) into (1) so that
we obtain the following multivariate regression model:

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 Table 1. Hidden economies in Jordan and Middle Eastern Countries
Country 2009 2010 2011 2012 2013 2014 2015 2016 2017 Country
[Link]

Average
Bahrain 16.4 15.9 14.6 14.4 13.9 14.1 15.4 15.6 15.1 17.3
Israel 20.5 19.2 17.7 18.3 17.7 17.1 17.6 17.6 17 21.4
Jordan 15.9 15.5 15.1 14.6 14.4 14.1 14.4 14.9 14.9 17.3
Abu Alfoul et al., Cogent Economics & Finance (2022), 10: 2031434

Kuwait 17.3 16.7 15.3 14.9 15.5 16.6 18.9 19.4 18.9 18.6
Lebanon 28.1 27.2 27.1 27.3 27.6 28.2 28.7 28.9 28.6 32.1
Oman 15.7 14.1 13.5 13.3 13.7 14.8 17.3 18.4 17.4 17.7
Qatar 16.9 15.8 13.8 13.1 13.5 13.9 16.3 16.8 16.6 17.8
Saudi Arabia 15 13.8 12.7 12.2 12.7 13.4 15.6 14.8 15.1 16.3
Syria 18.3 18.5 18.7 19.1 19.6 19.3 19.4 20 20 19.3
United Arab 26.1 25.9 23.1 22 21.5 20.8 23.1 22.7 22.1 25.7
Emirates
Yemen 24.4 23.1 23.3 22.9 21.8 21.5 22.1 25.4 26.6 26.2
Source: .
Medina and Schneider (2019)

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Figure 1. The MIMIC model.

source: .Schneider and Buehn
(2013)

yt ¼ xt þ zt (3)

Where ¼ λγ and zt ¼ λςt þ εt

Generally, the MIMIC approach aims to reduce the distance between an observed and predicted
covariance matrix; this depends on the approach the researcher requires for analyzing the data. To
find and estimate the approach with the best fit, we must reduce the residual ðψ Þ between the
� �
covariance matrix of the predicted ∑ðθÞ and observed data ð∑Þ.

� �
ð∑Þ ¼ ∑ðθÞ þ ðψ Þ (4)

The MIMIC approach needs more than one specification to find the best fitting strategy; we start
with seven causes, one latent variable, and three indicators, in effect 7-1-3 specification. Here we
use three indicators to measure the size of the hidden economy, and then we determine its
coefficient (λ1) at (+1) or (−1). The model is written in three equations, and then we gradually
omit the insignificant variables to reach the best fitting model.

y1t ¼ λ1 γ0 xt þ v1t (5a)

y2t ¼ λ2 γ0 xt þ v2t (5b)

y3t ¼ λ3 γ0 xt þ v3t (5c)

From equations (2) and (5), we see that measuring the latent variable (hidden economy) is the same
as the estimated value of both the normalized indicator variable y1 and equations (5)b and (5)c. We
can see from these two equations the measured values of y2 and y3 , which were rescaled from y1
(Alkhdour, 2011; Schneider & Buehn, 2018). By measuring the coefficients in the MIMIC approach and
utilizing the expected value of error term v = 0, we can ascertain the annual indexes, rather than the
value of the HE. These measured indexes will be identical to transform independent variables with the
same variance. The εt represents the measurement error term. Both the structural disturbance term

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ςt and the measurement error term are independent and are assumed to follow a standard normal
distribution with a mean of zero and constant variance (Dell’Anno & Schneider, 2009). Furthermore, to
change the indexes into absolute values of the hidden economy and measure its annual size, which is
also a percentage of formal GDP, we must externally estimate Jordan’s hidden economy for at least
one year. After doing so, we can use this value as the calibration method for this study.

According to Alkhdour (2011), Medina and Schneider (2018), and Schneider (2007), and Schneider,
Buehn, Montenegro et al. (2010, 2010), Jordan’s hidden economy was equal to 19.4% of GDP in 1999,
the base year of our analysis. Hence, we utilize the average size of the hidden economy as
a percentage of GDP in Jordan as the base reference point for estimating the major annual indexes
of the hidden economy.3 By applying this procedure for all years, we retrieve the annual estimates of
the hidden economy in Jordan for 1980–2018. We use the root mean square error of approximation
(RMSEA), the normed fit index (NFI), goodness-of-fit index (GFI), and the adjusted goodness-of-fit
index (AGFI). Doing so will help us generate the best fitting model for the MIMIC approach.

4.1.1. The causes of the hidden economy and hypotheses

We will use some of the cause’s variables (e.g., inflation rate, unemployment rate) that might lead
to an increase in the size of the hidden economy in Jordan.4

(1) Budget deficit (after foreign aid). This variable represents the budget deficit as a % of GDP.
Any increases in this variable will lead the government to increase the tax rate, thereby
compelling some people to find work in the hidden economy, ceteris paribus. We will include
this variable as a causal variable in the MIMIC model and inspect a positive effect on the
hidden economy in Jordan.

Hypothesis (1): A higher budget deficit positively influences the size of Hidden economy in Jordan,
ceteris paribus.

(1) Total tax revenue in the percentage of GDP: This variable positively impacts the hidden
economy. An increase in tax revenue as a percentage of GDP will increase the size of the
hidden economy, ceteris paribus. The tax variable is the significant development that leads
people to search for additional work and income inside the hidden economy umbrella. We
will include the total tax revenue as a causal variable in the MIMIC model and inspect the
effect on the hidden economy in Jordan.

Hypothesis (2): A higher total tax revenue positively influences the size of Hidden economy in
Jordan, ceteris paribus.

(1) Inflation Rate: This variable affects the size of the hidden economy as higher official inflation
will increase consumer demand for cheaper goods and services in the hidden economy,
ceteris paribus. We will include the effective inflation rate as a causal variable in the MIMIC
model and examine the effect on the hidden economy in Jordan.

Hypothesis (3): A higher inflation rate positively influences the size of Hidden economy in Jordan,
ceteris paribus.

(1) Female labor force participation. This variable represents female participation as
a percentage of the total labor force in the official economy; an increase in female partici­
pation in the official economy will decrease female participation in the hidden economy,

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which will reduce the size of the hidden economy. We will include this variable as a causal
variable in the MIMIC model and inspect the effect on the hidden economy in Jordan.

Hypothesis (4): A higher female labor force participation negatively influences the size of Hidden
economy in Jordan, ceteris paribus.

(1) Unemployment rate. The two leading causes of the hidden economy dynamics are the
unemployment rate and the level of self-employment, but unemployment wields no obvious
effect on the hidden economy for two reasons: the income effect and the substitution effect.
The former states that a higher unemployment rate leads to declining incomes and thus less
demand for goods and services in formal and informal economies; therefore, an adverse
effect ensues. Meanwhile, the latter has an effect whereby high unemployment in the formal
economy forces the unemployed to seek work in the hidden economy, ceteris paribus, which
—if they find it—has a positive effect. We will include the unemployment rate as a causal
variable in the MIMIC model and inspect the impact on Jordan’s hidden economy.

Hypothesis (5): A higher unemployment rate positively influences the size of Hidden economy in
Jordan, ceteris paribus.

(1) Interest rate on savings. Interest rate is the opportunity cost of holding cash, representing
interest on bank savings deposits. This variable has an inverse effect on the hidden econ­
omy, ceteris paribus. We will include the effective interest rate as a causal variable in the
MIMIC model and examine the impact on the hidden economy in Jordan.

Hypothesis (6): A higher interest rate positively influences the size of Hidden economy in Jordan,
ceteris paribus.

(1) A dummy variable. This variable is equal to 1 in 1989 and thereafter, but 0 in the years
before 1989. A decline in the Jordanian dinar’s value occurred in 1988. We will include this
dummy variable as a causal variable in the MIMIC model and examine the effect on the
hidden economy in Jordan.

Hypothesis (7): The decline in the Jordanian dinar’s value in 1989 positively influences the Hidden
economy in Jordan, ceteris paribus.

4.1.2. Indicators of the hidden economy

The size of the hidden economy depends on the various indicators and elements.5 This paper
utilizes three significant variables as listed below:

[Link]. Growth rate of real GDP. To cite Alkhdour (2011, p. 56), “There is no consensus among
economists about the correct relationship between the official economy (GDP) and the hidden
economy. This relationship is different from country to country”. In some studies, we find that
there is a negative relationship between the official and hidden economies, due to the decline in
the official economy where unemployment is high; hence, when there is too much competition for too
few jobs, people are forced to look for work in the underground economy (Dell’Anno, 2003; Schneider
& Enste, 2000). Other research has found a positive relationship between the official and the hidden
economies, as an improvement in the official economy means that the demand for goods and
services in both the informal and formal sectors will rise (Alkhdour, 2011; Bajada & Schneider, 2009).

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[Link]. Growth rate of real private consumption. In typical economic theory, there is a positive
relationship between income and consumption. Real private consumption is considered to be one
of the indicators of the hidden economy.

[Link]. Growth rate of real currency in circulation. To avoid paying tax, virtually no parties in the
hidden economy use bank accounts or formal documentation in their transactions and business
agreements. Instead, cash is the primary currency. Therefore, a rise in the demand for real currency in
circulation indicates the hidden economy growing in size and importance (Alkhdour, 2011).
5. Results of the size of the jordan hidden economy using the MIMIC estimation model
We use the seven causal variables and three indicators; the hidden economy is the latent variable
in this model. The non-significant variables are gradually dispensed until the best fitting model is
reached. The seven variables are as follows:

● The percentage of budget deficit to GDP (DEF)

● Total tax revenue in percent of GDP (TREV)
● Inflation rate (IN)
● The percentage of the female labor force to the total labor force (FP)
● Unemployment rate (UNEMP)
● Interest rate on savings (I)
● Dummy variable for the Jordanian dinar’s declining value in 1988 (DY = 1 for the years 1988–
2018, and DY = 0 for the years before 1988).

The following three variables are used as indicators:

● Growth rate of real GDP (GRGDP).

● Growth rate of real private consumption (GRCON).
● Growth rate of real currency in circulation (GRCR).

For the (7-1-3) specification, the number 7 indicates the number of causes, while the number 1 is
the latent variable (hidden economy), and the number 3 is the number of indicators.6 The
correlation between the latent variable (hidden economy) and its causes is defined as
a structural equation, and we have seven causal variables, which are given by:

HEt ¼ γ1 X1t þ γ2 X2t þ γ3 X3t þ γ4 X4t þ γ5 X5t þ γ6 X6t þ γ7 X7t þ ςt (6)

where HE is the scale of the hidden economy.

The Xs present the different combinations of the above causes of the hidden economy. The
correlation between the latent variable (hidden economy) and its indicators is defined as
a measurement equation, and we have in this study three indicators. We have three measurement
equations; the growth rate of real GDP gives the first measurement equation:

GRGDPt ¼ λt HEt þ εt (7)

The second measurement equation is given by the growth rate of private consumption GRCON:

GRCONt ¼ λt HEt þ εt (8)

The third measurement equation is given by the growth rate of currency circulation GRCR:

GRCRt ¼ λt HEt þ εt (9)

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It is necessary to test whether the variables (both the causes and the indicators) are co-integrated
or not. Therefore, before starting with the hidden economy estimation of equation (6), we tested
our time series for the presence of unit root. The results show that some of the variables are
stationary at their levels. As for GRCON, GRCR, I, UN, and FP, the ADF test results show that those
variables exhibit a unit root. To overcome this problem, those variables were converted to the first
difference. Consequently, ADF tests show that all variables became stationary at 1%.7

To achieve the best fitting model via the maximum likelihood estimator (MLE), we use the LISREL
9.1 program. This program estimates the structural equation model (SEM). Therefore, the results
are five causal variables, one latent variable, and a two-indicators (5-1-2) specification; this is
considered the best fitting model. Table 2 gives the MIMIC model results, which converged after six
iterations.

The LISREL 9.1 software program tests the model’s overall goodness of fit. The most popular test
is the root mean square error of approximation (RMSEA). Accepted models have an RMSEA of less
than 0.1. The results show that the value of the RMSEA is 0.01, which indicates that the model
exhibits an excellent performance fit. The other popular tests for the goodness-of-fit are the
normed fit index (NFI) which varies from 0 to 1, with 1 representing the complete fit model. The
problem with the NFI, however, is that there is no penalty for adding parameters. The value of NFI
for our study is 0.90, which indicates a good model fit. The goodness-of-fit index (GFI) and the
adjusted goodness-of-fit index (AGFI) are also used to test the model’s goodness of fit. The GFI and
AGFI are measured from 0 to 1; they reflect the percentage of observed covariance explained by
the covariance implied by the model (similar to an adjustment in the multiple regression model/s).
Our results show that the GFI and AGFI are high, at 0.95 and 0.92, respectively; this suggests
a good model fit.

As shown in Table 2, the MIMIC model for estimating Jordan’s hidden economy is determined by
substituting the estimated coefficients as shown in the following measurement equations. We use
the value λ1 = −1 because the estimation of the model illustrates that the results are consistent
with the economic theory.8

Measurement equations:

GRGDP ¼ ð 1Þ � HE (10)

GRCR ¼ 0:12 � HE (11)

Structural equation:

HE ¼ 3:69 � TREV 0:81 � FP þ 1:10 � DEF þ 0:27 � IN þ 0:19UNEMP (12)

The results indicate that the coefficient sign of the total tax revenue, budget deficit, inflation rate, and
unemployment is positive and significant at the 1% and 5% confidence levels, respectively. The
coefficient sign of female participation is negative and significant at the 1% confidence level.
According to economic theory, the effect of total tax revenue, inflation rate, and the unemployment
rate is as expected. These results are compatible with previous research findings that any increase in
these three variables leads to the HE increasing; indeed, these were, in fact, the leading causes of the
hidden economy (Medina & Schneider, 2018; Schneider & Buehn, 2013). These previous studies show
that higher tax burdens, inflation rates, and unemployment are among the main reasons people work in
the HE.

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 Table 2. The MIMIC model results for Jordan’s economy from 1980–2018
Variable/ MIMIC1 MIMIC1 MIMIC2 MIMIC3 MIMIC4 MIMIC5
Specification 7-1-3 7-1-2 6-1-2 6-1-2 6-1-2 5-1-2
[Link]

Causal Variables
Budget deficit (DEF) −1.09 0.99** −1.07 1.09*** 1.07*** 1.10***
(−1.53) (2.43) (−1.46) (3.54) (2.98) (2.49)
Total tax revenue (TREV) 3.34** 3.65*** 3.70*** 3.71*** 3.73*** 3.69***
(2.45) (12.16) (11.34) (11.72) (10.30) (9.62)
Abu Alfoul et al., Cogent Economics & Finance (2022), 10: 2031434

Inflation rate (IN) 0.25** 0.22 0.21* 0.23*** 0.25 0.27**

(1.99) (1.58) (1.86) (2.65) (0.92) (1.97)
Female participation (FP) −0.93*** −0.62*** −0.74*** −0.76*** −0.78*** −0.81***
(−7.10) (−7.10) (−8.27) (−8.56) (−8.89) (−9.09)
Unemployment rate 0.18** 0.13 0.12 0.18** 0.15*** 0.19**
(UNEMP) (2.12) (1.01) (1.11) (2.43) (2.78) (2.51)
Interest rate on savings 1.54 0.94 0.75 0.78**
(I) (1.55) (1.15) (1.38) (2.13)
Jordanian dinar’s decline 0.26 0.14 0.19**
(DY) (1.43) (1.06) (2.21)
Indicator Variables
Growth rate of real GDP −1 −1 −1 −1 −1 −1
(GRGDP)
Growth rate of private 1.32
consumption (GRCON) (1.28)
Growth rate of real 0.13*** 0.08*** 0.07*** 0.09*** 0.11*** 0.12***
currency in circulation (8.60) (7.51) (8.01) (7.93) (7.88) (7.38)
(GRCR)
Statistical Tests
RMSEA 0.16 0.15 0.21 0.19 0.21 0.01
Chi-square (P-value) 19.89 18.77 14.10 11.60 12.98 9.66
(0.0015) (0.0648) (0.0831) (0.0147) (0.0564) (0.3154)
NFI 0.73 0.85 0.93 0.93 0.87 0.90
GFI 0.77 0.87 0.88 0.91 0.86 0.95
AGFI 0.90 0.92 0.95 0.95 0.95 0.92

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Note: T statistics are in parentheses. * Significant at the 90% level; ** significant at the 95% level, and *** significant at the 99% level.
Abu Alfoul et al., Cogent Economics & Finance (2022), 10: 2031434
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The positive impact of the budget deficit on the hidden economy can be explained by the
Jordanian government’s attempt to reduce the deficit with tighter fiscal policies, such as increas­
ing tax ratios and reducing spending on essential goods and services. This forces more people to
conduct some of their economic activities in the hidden economy. This result is in line with
Schneider (2005), Schneider, Buehn, Montenegro et al. (2010), and Schneider and Enste (2000),
who argue that a continuous increase in the tax rate and reduction of domestic demand by
increasing tax, as a result of deflationary government policy (a budget deficit), leads to an increase
in the size of the hidden economy.

Female labor force participation is statistically significant and has the expected negative relation­
ship with the hidden economy. This implies that a higher level of female labor force participation in
the official economy decreases women’s reluctance to participate in the hidden economy. This result
is in line with the study by Charmes (2007), who found that in countries with low female participation
in the official economy, inequality between the sexes, and failure to empower females, there is an
increase in female participation in the hidden economy. This result, to some extent, is in line with
a United Nations study that argues that fewer women receive pensions globally, and as a result, more
elderly women are now living in poverty that may force them into the hidden economy.9 Even in
developed economies, such as France, Germany, Greece, and Italy, women’s average pensions are
more than 30 percent lower than men’s. This may force them to resort to working in the hidden
economy.

Finally, our finding of the positive and significant effect of the unemployment rate on the hidden
economy in Jordan is in line with many studies, such those by as Dell’Anno and Solomon (2008),
Dobre et al. (2010), Davidescu et al. (2015), and Mauleón and Sardà (2017), among others. They
argue that an increase in the unemployment rate results in an increase in the hidden economy
because workers prefer to work in the hidden economy rather than being unemployed.

Equation (12) above calculates the annual indices for the hidden economy in Jordan for the
period 1980–2018. As explained in the previous section on the MIMIC approach, to convert those
indices into the values of the hidden economy as a percentage of official GDP, we follow
Dell’Anno’s (2007) procedure in the benchmarking process so that we can measure the size of
the hidden economy. The annual estimated index of Jordan’s hidden economy and external
estimation of it in 1999 is equal to 19.4. Consequently, the annual ratios of the hidden economy
as percentages of GDP in Jordan can be calculated for the period 1980–2018. From those ratios,
the Jordanian dinar values of the hidden economy can be calculated for that whole period. Table 3
summarizes two factors: first, the hidden economy as a percentage of GDP in Jordan, and second,
the estimated Jordanian dinar value of the hidden economy, as previously mentioned.

The MIMIC estimates show that the average value of Jordan’s hidden economy for 1980–2018
was 17.6% of GDP. The absolute value of the hidden economy during this period rose from
134,106,486 million Jordanian dinars in 1980 to 6,623,192,234 million Jordanian dinars in 2018.
According to the MIMIC model’s estimates when applied to Jordan, these developments were due
to the changes in the previously mentioned causal factors that affect the hidden economy.

Figures 2 and 3 show that the general trend of Jordan’s hidden economy was upward during
1980–2018. Based on Table 3 and Figures 2 and 3, we can observe that the hidden economy
peaked in the periods 1989–1992 and 2004–2007, with an average of 15.3% and 19.9% of GDP,
respectively. These periods witnessed increased government budget deficit spending, prompting
the Jordanian authorities to resort to external loans to bridge the internal budget deficit.

The first peak period for Jordan’s hidden economy is 1989–1992. This period was characterized
by a decline in the value of the Jordanian dinar, which depreciated by about 50%, leading the
government to implement the first International Monetary Fund (IMF) economic adjustment
program for this period. Following the 1990 Iraq-Kuwait crisis, the government was forced to

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Table 3. The size of the hidden economy as a percentage of GDP

Year Hidden Economy GDP (%) Hidden Economy Value
(Million Jordanian Dinar)
1980 11.8 134,106,485.56
1981 12.3 156,249,135.11
1982 12.4 168,462,512.94
1983 13.1 187,254,475.96
1984 13.3 191,897,284.76
1985 13.6 264,229,994.64
1986 14.0 348,616,594.25
1987 14.3 375,547,808.09
1988 14.5 355,489,617.43
1989 15.0 246,859,436.06
1990 15.3 419,088,778.65
1991 15.8 453,333,809.37
1992 15.0 533,251,212.82
1993 15.4 577,115,075.12
1994 15.8 657,756,673.60
1995 16.3 779,582,810.72
1996 16.8 828,308,078.31
1997 17.2 885,728,008.76
1998 18.5 1,040,260,307.81
1999 19.4 1,122,240,473.91
2000 18.8 1,131,573,662.10
2001 18.5 1,181,320,329.30
2002 18.7 1,270,142,452.40
2003 18.9 1,367,524,574.78
2004 19.5 1,576,340,451.03
2005 19.9 1,773,879,033.04
2006 19.9 2,130,163,721.28
2007 20.2 2,458,622,734.43
2008 20.3 3,166,723,390.00
2009 20.5 3,471,222,063.40
2010 20.4 3,828,386,705.62
2011 20.6 4,211,284,860.61
2012 20.8 4,557,590,201.89
2013 21.3 5,070,845,933.11
2014 21.5 5,467,097,025.88
2015 21.7 5,787,028,960.36
2016 22.0 6,026,300,799.62
2017 22.2 6,325,115,483.43
2018 22.4 6,623,192,234.76
Source: Authors’ calculations.

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Figure 2. Trends in the hidden

economy in Jordan GDP (%).

Figure 3. Trends in the value of

jordan’s hidden economy
(Million Jordanian Dinar).

stop both the IMF program and most foreign debt repayments. Foreign aid from the Gulf countries
and remittances from Jordanian workers also decreased, and there was a huge exodus of
Jordanian workers from the Gulf countries. Returning Jordanians and refugees from Kuwait and
Iraq caused Jordan to experience serious economic problems.

Consequently, the government implemented many structural changes to control the budget
deficit and save the economy. This included improving the tax system and increasing the ratio of
domestic revenues to total public expenditure. During this period, the exchange rate of the
Jordanian dinar was pegged to the US dollar, and it has remained so since 1994 (JD1 = US$1.4).

The second peak period for Jordan’s hidden economy was 2004–2007, which featured the post-
economic adjustment program. This period was characterized by political, military, and economic
instability in Iraq following the end of the 2003 Iraq War. The Jordanian economy performed
remarkably well during this period, and the hidden economy flourished. An immediate effect was
the sharp rise in oil and food prices in Jordan. As a result, the average growth in real GDP was 6.3%,
and the unemployment rate decreased. The period was also marked by an increase in foreign
direct investment (FDI) and a large inflow of Iraqi investors and refugees.

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 Table 4. Comparison of the estimated hidden economy in Jordan according to various studies % of GDP
1999 2000 2001 2002 2003 2004 2005 2006 2007 Average
[Link]

Our study 19.4 18.8 18.5 18.7 18.9 19.5 19.9 19.9 20.2 19.3
Medina and - - - - - 16.09 14.91 14.71 13.66 14.8
Schneider
(2018)
Abu Alfoul et al., Cogent Economics & Finance (2022), 10: 2031434

Medina and 19.4 19.5 19.3 19.5 18.8 17.7 16.7 16.6 16 18.2
Schneider
(2019)
Alkhdour 19.4 20.4 20.2 19.7 19.7 19.5 19.8 20.2 20.8 20
(2011)
Schneider 19.4 19.4 19.6 19.9 20.1 20.6 20.9 21.4 21.7 20.3
et al. (2010)a
Schneider 19.4 19.4 20.5 21.6 21.2 20.4 - - - 20.4
(2007)

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Figure 4. Trend in the hidden

economy of Jordan and the GDP
growth rate.

Figure 5. Comparison of the

estimated hidden economy in
Jordan according to various
studies (% of GDP).

6. Results and discussion

Figure 4 shows the trend in the hidden economy of Jordan and GDP growth during the period
1980–2018, revealing that the average size of the hidden economy in Jordan was 17.6% of GDP. It
increased from 11.8% in 1980 to 22.4% in 2018. Figure 4 illustrates the inverse correlation
between the hidden economy and GDP growth. These results are in line with findings by
Dell’Anno et al. (2007) and Dell’Anno (2003), who discovered an inverse relationship between
the official and hidden economies. It can be argued that the hidden economy maintains economic
stability and that the presence of a flexible and productive hidden economy is now necessary and
important for the success of the economy (Greenidge et al., 2005).

When the estimates of the hidden economy in Jordan are compared with those reported in four
other studies that include Jordan for the same years, as shown in Figure 5 (Alkhdour, 2011; Medina
& Schneider, 2018; Schneider, 2007; Schneider et al., 2010a), estimates are very close for most
years. These are reported in Table 4 and Figure 4.

As reported in Table 5, the empirical results provide support for most of our research hypotheses.
The finding that inflation, total tax revenue, budget deficit, and the unemployment rate increased
the size of the hidden economy is consistent with the hypothesis that the inflation rate positively
influences the hidden economy in Jordan, the total tax revenue positively influences the hidden

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Table 5. Summary of results

Hypothesis Reported Sign
A higher budget deficit positively influences the size of (+)
Hidden economy in Jordan, ceteris paribus.
A higher total tax revenue positively influences the (+)
size of Hidden economy in Jordan, ceteris paribus.
A higher inflation rate positively influences the size of (+)
Hidden economy in Jordan, ceteris paribus.
A higher female labor force participation negatively (-)
influences the size of Hidden economy in Jordan,
ceteris paribus.
A higher unemployment rate positively influences the (+)
size of Hidden economy in Jordan, ceteris paribus.
A higher interest rate positively influences the size of (NS)
Hidden economy in Jordan, ceteris paribus.
The decline in the Jordanian dinar’s value in 1989 (NS)
positively influences the Hidden economy in Jordan,
ceteris paribus.
Notes: (+) = significantly positive; (-) = significantly negative; (NS) = insignificant.

economy in Jordan, and budget deficit positively influences the hidden economy in Jordan, and the
unemployment rate positively influences the hidden economy in Jordan, ceteris paribus.

According to the previous results, total tax revenues, as expected, are significantly and positively
impact the size of the hidden economy. Taxation is a significant source of revenue for the
government, accounting for over 67 percent of Jordan’s total revenue. Because tax burden
influences participation in the HE, we recommend major tax reforms and educational campaigns
to improve tax compliance and tax morale. Among its MENA neighbors, Jordan has the highest tax
revenues. Moreover, there is a lack of trust between taxpayers and tax authorities in Jordan. This
means that tax rates should be reduced and rules clarified, encouraging more tax payments and
compliance. After the reform, the size of the hidden economy will shrink. The tax burden is one of
the other significant factors that may lead people to find jobs inside the hidden economy; an
increase in the tax rate causes individuals to look for more “cash in hand” opportunities. These two
results are compatible with prior research findings that increases in taxes and inflation lead to the
hidden economy increases (Dell’Anno et al., 2018; Mazhar & Méon, 2017).

The second factor that has a significant and positive effect on the size of the hidden economy in
Jordan is inflation. The continued increase of the inflation rate leads people to find other cheap
resources compared with the formal economy. Thus, the demand for more affordable consumer
goods and services will increase in the hidden economy, which is reflected in the size of the hidden
economy. These results are in line with Schneider et al. (2010)a, who show a positive relationship
between inflation and the size of the HE in developing countries. They also demonstrate that when
wages are sticky and constantly rising, price increases may result in greater participation in the HE
than in the official economy. “It is due to the evidence that in a growing economy, people have
many opportunities to earn a good salary and ‘extra money’ in the official economy” (Schneider
et al., 2010a, p. 446).

Regarding the budget deficit, the results show that the budget deficit positively affects the hidden
economy in Jordan, ceteris paribus. The government’s attempts to reduce the deficit have a direct
positive effect on the hidden economy. That is, in implementing tighter fiscal policies such as
increasing tax ratios and cutting its spending on goods and services, the government impels indivi­
duals to earn more cash in hand by transacting in the hidden economy.

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 Table 6. The MIMIC model results
[Link]

Variables 1981–2018 1982–2018 1983–2018 1980–2017 1980–2016 1980–2015

Causes
Budget deficit (DEF) 1.476*** 1.254*** 1.012*** 1.235*** 1.006*** 1.264***
(5.02) (2.95) (3.32) (3.15) (5.82) (4.32)
Total tax revenue (TERV) 2.957 2.136*** 2.748** 2.534*** 2.152*** 2.031***
Abu Alfoul et al., Cogent Economics & Finance (2022), 10: 2031434

(1.39) (3.05) (1.99) (5.43) (3.53) (3.34)

Inflation rate (IN) 0.143** 0.121** 0.095** 0.071*** 0.043*** 0.089***
(2.31) (2.45) (1.91) (2.94) (2.85) (2.87)
Female participation (FP) −1.132*** −0.792*** −0.892*** −1.136*** −0.854** −0.846**
(−3.98) (−4.02) (−5.11) (−4.04) (−2.55) (−2.62)
Unemployment rate 0.253*** 0.395** 0.273*** 0.325*** 0.202 0.341**
(UNEMP) (3.56) (2.43) (2.89) (3.01) (1.78) (2.14)
Interest rate on savings 1.931 1.141 0.871** 0.811 0.536 0.458
(I) (1.75) (1.68) (3.38) (1.18) (1.11) (1.18)
Jordanian dinar’s decline 0.447 0.654*** 0.264 0.514 0.064 0.057
(DY) (1.35) (3.41) (1.45) (1.08) (1.14) (0.865)
Indicators
Growth rate of real GDP −1.00 −1.00 −1.00 −1.00 −1.00 −1.00
(GRGDP)
Currency in circulation 0.033*** 0.012*** 0.024*** 0.021*** 0.077*** 0.094***
(GRCR) (6.84) (5.83) (7.54) (6.92) (5.83) (5.43)
Statistical Tests
RMSEA 0.011 0.030 0.026 0.028 0.064 0.032
Chi-square (P-value) 24.47 (0.0012) 21.10 (0.0845) 20.48 (0.0535) 24.78 22.18 (0.0184) 19.45 (0.0651)
(0.0041)
NFI 0.83 0.87 0.91 0.89 0.88 0.92
GFI 0.88 0.91 0.93 0.96 0.95 0.97
AGFI 0.92 0.96 0.95 0.94 0.95 0.93
Notes: t statistics are in parentheses. * Significant 90% level; ** significant at the 95% level and *** significant at the 99%.

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The positive and significant effect of the unemployment rate on the hidden economy in Jordan is in
line with Dobre et al. (2010) and Mauleón and Sardà (2017). They argue that a rise in the level of
unemployment would lead to an increase in the hidden economy, as workers would instead be
employed than jobless. The main result is consistent with Dell’Anno (2007), who shows that the hidden
economy’s participants are diverse. Part of these participants are unemployed, while others are retired,
minors, and unemployed housewives. However, Tanzi (1999) stated that people could work in both
sectors.

Finally, the results show that the female participation variable has a negative effect on the hidden
economy in Jordan, ceteris paribus. This effect may initially seem to be expected. However, the study
by Hoyman (1987) and Schneider (2012) also showed a negative impact of a higher level of female
labor force participation on the hidden economy in their studies. They suggest that a higher level of
female participation is associated with the country’s level of equality between men and women’s
participation in the formal labor market, where more equality leads to lower female participation in
the HE. Our study shows that the effect of improving the level of female participation in the official
economy is also associated with a lower size of the hidden economy. The other hypotheses tested in
this paper did not have any statistical significance.

6.1. Robustness test

These further tests were undertaken to check the robustness of our results and further test the
validity of our results by taking the same specification of the causal variables for different sample
sizes. For instance, using the same specifications for the different samples, the first estimation
begins in 1981 and always ends in 2018, with alternative specifications such as 1981–2018, 1982–
2018, and then 1983–2018. The second estimation begins in 1980 but does not end in 2018, with
alternative specifications such as 1980–2017, 1980–2016, and 1980–2015. The MIMIC estimation
results for the period 1980–2018 for Jordan are presented in Table 6.

It is clear from Table 6 that these additional robustness tests indicate that, in most cases,
budget deficit, female labor force participation, total tax revenue, inflation rate, and unemploy­
ment rate are highly statistically significant. This shows that the MIMIC results are robust.

7. Conclusion
The purpose of this study is to estimate the hidden economy in Jordan from 1980 to 2018 using
the MIMIC estimation method. According to our findings, the average size of the hidden economy
as a percentage of Jordan’s GDP from 1980 to 2018 is 17.6%. We also find that the total increase
of tax revenue, budget deficit, unemployment rate, and inflation rate are the driving forces of the
hidden economy in Jordan. Interestingly, we observed that female labor participation negatively
affects the size of the hidden economy in Jordan.

The MIMIC estimation applied in this study of informal activities clearly provides a more com­
plete picture of the hidden side of GDP. Economists and policymakers can use the results better to
understand the causes and consequences of hidden economy and design more effective policy
measures in the future.

Our study provides some policy recommendations that can help reduce the size of Jordan’s hidden
economy. For example, from a normative standpoint, the emphasis must be placed on two main
pillars: fiscal policy (i.e., budget deficit) and macroeconomic policy (i.e., female labor participation,
unemployment, and inflation). In terms of fiscal policy, more reforms are required, with a particular
emphasis on expanding the tax base while simultaneously lowering tax rates and reducing bureau­
cracy associated with tax collection. It is necessary to expand the technological options for tax
payments that are already in place in order to ease tax payments. Government spending should be
limited to the budget’s resources to avoid ad hoc spending, which necessitates tax rate increases.

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Policymakers could convince employers in the hidden economy to enter into the official sector
and comply with the rules of the official economy through some measures: i) reducing start-up
costs and licensing fees for small businesses; ii) imposing one-time fees on investors; iii) simplifying
the tax system; and iv) reducing taxes, including the granting of tax exemptions, especially for
small businesses, to motivate them to enter the competitive market. Furthermore, policymakers in
Jordan should increase female participation in the official economy, reduce inequality between the
sexes, and empower women.

Finally, the overall results illustrate that the hidden economy can produce economic benefits for
the Jordanian economy by creating employment opportunities and producing goods and services
that benefit society. The government could manage the hidden economy through applicable
economic policies since it indirectly actively reduces the nation’s budget deficit.

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Appendix

Table A1. Causes of the hidden economy

Causes Description Sources
Inflation rate (IN) The percentage change in the Central Bank of Jordan’s monthly
consumer price index bulletins and the yearly statistical
series and IMF.
Unemployment rate (UNEMP) Represents the country’s Jordanian Department of Statistics
unemployment rate
Budget deficit after foreign aid Represents the percentage of Central Bank of Jordan’s monthly
(DEF) a budget deficit of GDP. bulletins and the yearly statistical
series.
Female labor force participation Represents the percentage of the World Bank
female labor force of total labor
force.
Total tax revenue (TREV) Represents the percentage of Central Bank of Jordan’s monthly
total tax revenue divided by GDP bulletins and the yearly statistical
series and World Bank.
Interest rate on savings (I) Represents interest paid on Central Bank of Jordan’s monthly
savings deposits (to capture the bulletins and the yearly statistical
opportunity cost of holding cash) series.
A dummy variable (DY) Jordanian dinar in 1988 (DY = 1 for -
the years 1988–2018, and DY = 0
for the years before 1988).

Table A2. Indicators of the hidden economy

Indicators Description Sources
GRCR Growth rate of the real currency in Central Bank of Jordan’s monthly
circulation can be calculated by bulletins and the yearly statistical
nominal money in circulation series a Word Bank.
divided by the consumer price
index.
GRGDP Growth rate of real GDP can be Central Bank of Jordan’s monthly
calculated by the growth rate of bulletins and the yearly statistical
gross domestic products (GDP) of series and IMF.
all goods and services in constant
prices divided by Inflation.
GRCON Growth rate of real private Central Bank of Jordan’s monthly
consumption can be calculated by bulletins and the yearly statistical
nominal private consumption series and IMF.
divided by the consumer price
index.

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Table A3. ADF test for the MIMIC approach variables

ADF test Unit Root DW-test value
Summary
Level 1st difference
GRGDP −6.126*** −4.886*** - 1.995
GRCON −0.739 −3.854*** I(1) 1.910
GRCR −1.146 −8.518*** I(1) 2.150
I −0.844 −3.677*** I(1) 2.043
TREV −2.632* −5.048*** - 2.034
UNEMP −1.868 −4.049*** I(1) 1.969
FP −1.081 −6.958*** I(1) 1.949
INF −3.855*** −4.287*** - 2.065
DEF −4.708*** −9.075*** - 2.234
Reported above are the T-statistics for the Augmented Dicky-Fuller (ADF) test. Null hypothesis: variable has a unit
root. The lag length was chosen using the Schwarz Information Criterion. *, **, *** indicate significance at the 10%,
5% and 1% respectively. Source: Authors’ calculations.

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