967003

research-article2020
RBPXXX10.1177/0034644620967003The Review of Black Political EconomyAmin and Ahmad

Original Article
The Review of Black Political Economy
1­–22
Diversity and Informal © The Author(s) 2020
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DOI: 10.1177/0034644620967003
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Saqib Amin1 and Nawaz Ahmad2

Abstract
This article is an attempt to explain the complex relationship of ethnic diversity
and its participation in informal economy by utilizing the data of 187 countries
of the world. How ethnic diversity, whether in any shape linguistic or religious
may enhance the size and development of informal economy. The outcome of the
study reveals the significant role of ethnic diversity for the development of informal
economy.

Keywords
ethnic diversity, religious diversity, size and development of informal economy

Introduction
Informal economy is a complex, controversial, and a multidimensional phenomenon
when explained in the presence of other tangible and intangible factors, to observe
their influence on economy (Danopoulos & Znidaric, 2007; Handy, 1998; Tokman,
1989). Many researchers such as Geertz believe that informal economic activities
were an expression of “backwardness” and “underdevelopment”. A very old notion of
informal economy emerges from excluded people of capitalist nature of a society.
Immigrant and migrant groups of people, so-called “ethnic economy” (Batnitzky &
McDowell, 2013), now contribute largely to economic activities within urban areas
of the United Kingdom. Generally, it is perceived that different ethnic groups either

1
National College of Business Administration & Economics, Lahore, Pakistan
2
The University of Lahore, Pakistan

Corresponding Author:
Saqib Amin, National College of Business Administration & Economics, Gulberg III, Lahore 54000,
Pakistan.
Emails: saqib.amin000@gmail.com; phd-2163662@NCBAE.edu.pk
2 The Review of Black Political Economy 00(0)

voluntary excluded or involuntary isolated from the formal economy through legal
binding. A less explored tale is the focus of the present study in case of developed and
developing countries that how different channels of ethnic diversity affect informal
economy in the separate realm of both types of countries. Pressure of immigrants in
developed countries perhaps is one of the reasons to escape from legal binding for
being engaged in informal economy to earn their livelihood, thus leading to the
development of informal sector to absorb them, while developing countries are facing
severe ethnic diversity naturally, and thus by means of social exclusion, they are
engaged in informal economy (Amin, 2019a, 2019b).
Informal economy is well prevalent with different names such as informal sector,
gray economy, black economy, shadow economy, and underground economy
(Schneider & Enste, 2013). Informal economy is known as that type of the economy
where people do not embrace their legal responsibility to obey rules of business, such
as to pay tax and record their transactions—in simple words, those activities which do
not appear in the gross domestic product (GDP) of a country (Portes & Haller, 2010).
The reasons behind avoidance of civil responsibilities are as follows: cost of registra-
tion, unable to pay taxes/distrust of tax system, lack of education, complexity in gov-
ernment rules and regulations, cultural conflict, and misperception (Castells & Portes,
1989; Portes & Haller, 2010). In a broad sense, informal economy includes the self-
employed people in informal business and people employed in informal jobs in urban
and rural areas (Chen et al., 2006; Handy, 1998; International Labour Organization
[ILO], 2002). But the nature and size of the informal economy diverge greatly across
countries and regions, which mainly depend on enhancement of heterogeneity
society.
In contemporary world, informal sector highlights its attribute of expanding its size
and development. In case of developing countries where economic and political stabil-
ity is missing, informal sectors do not play their role efficiently and, in such situations,
become a large and more important ingredient for economic prosperity. In this context,
ethnic diversity plays a vital role in expansion of informal economy in both developed
and developing economies (Castells & Portes, 1989; Portes & Haller, 2010). The
appearance of informal economy is due to the ethnic diversity at large, and this par-
ticular phenomenon is a riddle for developing and developed nations with multiple
reasons.
At one side, informal sector may create a worse condition due to conflict between
diverse societies, exclusion, and so on, but, on the other side, it plays a prominent role
in income generation, production, urbanization, and employment creation for any
economy. Due to ever-increasing growth of population and urbanization, the informal
sector is the only source to absorb one part of the labor force, not only in rural but also
in urban areas. Informal sector somehow is necessary for low-income countries
because of missing social safety nets, less employment insurance, low wage rate, and
lack of resources. Different ethnic groups and excluded people due to the inability of
fulfilling their legal responsibility for failing to fulfill immigration laws lead to the
development of informal economy. They are mostly own brothers and sisters, former
Amin and Ahmad 3

union members, and those who have no jobs or employment anywhere. They do not
have another alternative for their survival and to engage in daily course of life.
The informal economy is highly segmented by sector, workplace, employment sta-
tus, and by social group and gender they belong to. But those who work informally
have one thing in common that they lack legal and social protection (Chen, 2012; Hart,
1973; Sethuraman, 1976; Tokman, 1989). However, informal economy is basically
more complex than we deem it on the basis of summative factors. With the increase in
heterogeneity in any society, the formation of informal sector becomes simple such as
easy entrance and, for those who need to join the sector, may find desired work for
cash earnings (Meier & Rauch, 2005). The spectrum of informal economy ranges
from self-employment or unpaid family labor (Meier & Rauch, 2005; Portes et al.,
1986) to street vendors, shoe shiners, and junk collectors (Becker, 2004).
Most of the literature available about the size and development of informal econ-
omy in terms of percentage of official GDP depicts moving from homogeneous soci-
ety to heterogeneous society (Feige, 1990; Schneider & Enste, 2000) because migrated
people mostly engage in informal sector. The literature also includes the thorough
discussion about the numerous estimation procedures regarding the size as well as a
critical evaluation and consequences of the informal economy (Feige, 1990; Schneider
& Enste, 2000). However, it is quite challenging to measure size and development of
informal economy because people engaged in this sector try to hide their activities.
At present, informal economy is intensive part of research discussion worldwide
because informal economy is emerging worldwide with new appearance and in unex-
pected part of the world. The fact also indicates that informal employment has
increased expressively during the recent economic recession (Horn, 2010). Informal
economy is getting attention of scholars belonging to multiple disciplines of econom-
ics such as anthropology, gender studies, and political sciences.
Recent literature highlights various linkages that explore the size and development of
informal economy by segmenting the situation about income, attitude, dominance in
religiosity, social capital, trust, age, and nationality (Chen et al., 2006; Schneider &
Enste, 2013; Schneider et al., 2015). However, ethnic and religious diversity also increase
social, economic, and political complexity within societies and enhance the size of infor-
mal economy. When heterogeneous individuals move from place to place, country to
country, they transmit a new level of skills and perspectives, which ultimately develop
innovation and expand informal economy. This study is going to fill the gap in literature
whether ethnic and religious diversity increase the size of informal economy by using
the data of 187 countries of the world (please see appendix for listing of countries).

Literature Review
The theories of 1950s and 1960s are based on the perception of technical change that
how low-income countries transformed into developed economies. In this context, the
original term informal sector is attributed by Arthur Lewis, to describe livelihood
which changes the economy with social aspects such as diversity (Lewis, 1954).
4 The Review of Black Political Economy 00(0)

Informal sector is getting mixed review in the domain of development which is an

economic reality.
Historically, literature of the informal economy has largely been focused by the
Hart (1973) as regards to describe the scope of unregistered economic activities. This
terminology spawned the concept of dualism (formal and informal) and various other
theories such as structural school (links between informal and formal), institutional
perspective, trust role, social capital, and informal networks to identify the socioeco-
nomic determinants of informal economy. The followers of dualist school (Chen,
2001; Chen et al., 2006) and the organization of Women in Informal Employment:
Globalizing and Organizing (WIEGO) broaden the concept of informal economy by
including the certain types of unregulated and socially unprotected employment envi-
ronment which does not cover by formal economy (ILO, 2002).
Ahlerup and Olsson (2012) observed the impact of the duration of human settle-
ments and the duration of modern sate. Reynal-Querol and Montalvo (2005) and
Alesina et al. (2003) have identified a high degree of ethnic heterogeneity as a nega-
tive factor on growth. When there are social cleavages, there are frictions among social
groups. When the society is divided by religious, ethnolinguistic, or race differences,
tensions emerge along these divisions (Ahmad & Amin, 2020; Amin, 2019c). In gen-
eral, literature provides us also negative impact on economic efficiency. Lassen (2003)
found negative impact of linguistic diversity on redistribution. Further studies confirm
its impact on poverty such as studies of Churchill and Smyth (2017). In the Churchill
and Valenzuela (2019) study, the impact on firm performance is discussed. The
Doerrenberg and Peichl (2013) study finds impact on tax moral, which may have
implications in the form of tax collection. They believe ethnically diverse society has
low tax morale. Low tax morale leads the country toward informal economy’s expan-
sion, which is the interest of the present study to explore nexus.
Although there are few studies which focus on this dimension, this debate would be
interesting and needs to be explored. De Luca et al.’s (2018) study finds that ethnic
diversity is welcomed by politicians, and explores that diversity under the consider-
ation of robustness tests to see the influences on underground economy. In the view of
Mishra and Ray (2010), size of the informal sector may increase corruption. They do
not focus to see the impact of ethnicity on informal sector but capture the effect of two
control variables. Slemrod (2004) suggests that voluntary tax compliance is associated
with social inclusion. Scholz and Lubell (1998) find that trust in others, possibly to
occur via social inclusion of ethnically diverse people, may increase tax compliance.
Lassen (2007) believes that ethnic fractionalization may affect size of the informal
sector both horizontally and vertically, because trust decreases with the increase in
ethnic diversity (Lassen, 2007; Van Groenou et al., 2006). According to the argument,
people only comply with tax when they have closed social ties.
Most of development theories explained that with the economic development,
economic activity also develops and will shift from the informal to the formal
sphere. In fact, development process engages heterogeneous people, poor people of
different localities, regions, and those associated with informal sector to come out of
poverty because poor people often engage in informal sector (Becker, 2004; Williams
Amin and Ahmad 5

& Windebank, 2002). On one hand, small-scale businesses and manufacturing activ-
ity are practiced in informal economy, and on the other hand, street vendors, junk
collectors, shoe shiner, and domestic servants type activity are followed (Becker,
2004). Irrespective of how the informal economy grows its ongoing growth cannot
be deemed a short-term phenomenon (Becker, 2004). Formalization of the informal
economy has been pushed by the cultural diversity, which provides guidance to
enable the transition of workers and economic activity from the informal to the for-
mal economy (Bangasser, 2000).
Many of the researchers such as Feige (1990), Sassen (1994), Castells and Portes
(1989), Offe and Heinze (1992), and Harding and Jenkins (1989) argued that informal
issue and characteristics start from developing economies and also exit in today’s
modern and developed world. During the last few decades, world’s interest has devel-
oped to explore the transformation process of informal economies not only to formal
one but also keen for sustainable development in different backward locations, to
engage socially excluded people involved in informal sector. A major cause of this
backwardness and exclusion is ethnic diversity, although many think diversity is one
of the main ingredients in explaining complex nature of linkages and blend of formal
and informal economy.
Schneider et al. (2015) conducted a study regarding relationship between different
dimensions of religious dominance and size of informal economy. They argued that
religion influences the level of informal transactions, albeit with several qualifica-
tions. The analysis did not support the view that countries with religious citizens have
smaller shadow economies per se. In their opinion, countries dominated by Islam or
Eastern religions are associated with smaller shadow economies compared with
Christian countries for comparable levels of economic development and government
effectiveness. Furthermore, close ties between the dominant religion and the state are
typical for countries with a lower share of economic activity in the informal sector.
Schneider and Enste (2000) pointed out that around the world, there are strong
indications for an overall increase of the shadow economy. According to them, shadow
economies mean unreported income from the production of legal goods and services,
either from monetary or barter transactions; hence, all economic activities that would
generally be taxable were reported to the tax authorities. Lassen (2003) investigates
the experimental research links and also ethnicity, trust, and tax compliance. He argued
that increasing ethnic fractionalization decreases voluntary tax compliance and, at the
macro level in a cross-section of more than 50 countries, that more ethnically frag-
mented societies have significantly larger informal sectors (Lassen, 2007). Torgler
(2006) analyzed that religiosity is a factor that potentially affects tax morale. He con-
cluded that religiosity (such as church attendance, religious education, active member-
ship in a church or a religious organization, perceived religiosity, religious guidance,
and trust in the church) raises tax morale.
However, the concept of diverse economies has been debated from different per-
spectives and has attracted fruitful and productive critical comments. Focusing on the
informal sector of the economy, Samers (2005) argues that not all economic practices
included in diverse economies are less exploitative than capitalism. Benjamin et al.
6 The Review of Black Political Economy 00(0)

(2014) conducted a study regarding size, performance, and motivation of the informal
sector, especially where the informal sector provides the livelihood and employment
for a critical segment of the population. They argued that main areas where develop-
ment policy can be improved by taking the informal sector into account by improve-
ments should be made along a continuum; the heterogeneity among informal firms
points to different policy approaches for different types of firms.
Torgler and Schneider (2009) analyzed how institutional quality and tax morale
affect the shadow economy, using an international country panel and also within coun-
try data. They found strong evidence that increases governance and institutional qual-
ity, which in turn leads to a smaller shadow economy. Moreover, an increase in tax
morale reduces the size of the shadow economy. Berdiev et al. (2020) show that
income inequality across ethnic groups increases underground activity across region
and countries.
By summing above literature, it can be argued that mixed and sufficient literature
is available to this end. Trust factor among ethnic groups can stimulate the size of
formal economy and relegate the size of informal sector. Therefore, the focus of the
present study is to see influence of ethnic and religious fractionalization on size and
development of informal sector with a new dataset in different countries.

Theoretical Framework and Hypothesis Development

While there is by now a substantial theoretical literature on tax compliance and the size
of the informal sector, comparative empirical evidence for obvious reasons is scarce. In
the study of the informal sector, Baklouti and Boujelbene (2019) and Schneider and
Enste (2000) find that the size of the informal sector increases in the level of corruption,
measured in a variety of ways. They do not, however, consider the effect of societal
heterogeneity on the informal sector and generally control only for two explanatory
variables at a time. A small, recent group of papers address issues related to the analysis
presented here. Lassen (2007) finds, linking survey data on attitudes with micro-data on
tax compliance for the United States, that trust in others increases tax compliance. La
Porta et al. (1999) consider trust in large organizations. In their analysis, they instru-
ment a survey measure of tax compliance as a proxy for trust by the degree of ethno-
linguistic fractionalization without discussing their finding.
Castells and Portes’s (1989) followers of structural school are of the view that
informal sector is comprising of subordinate activities, which decrease accomplish
costs. While the previous approaches defined the informal sector according to its char-
acteristics, such as economic activity type, company size, social status of the workers,
and the invested capital amount, this approach champions (Portes et al., 1989; Castells
& Portes, 1989; Fernandez-Kelly & Garcia, 1989; Portes & Sassen-Koob, 1987;
Sassen, 1994) a distinction concerning the informal economy by production and trad-
ing processes. Sindzingre (2006) emphasizes an idea that informal economy may be
explained by other characteristics as integrity and viability of institutions and con-
tracts, either informal or formal ones. The social capital plays an important role in the
field of informal economy when we are particularly studying it.
Amin and Ahmad 7

This article provides a framework for building hypothesis, whether ethnic and reli-
gious fractionalization enhances the size and development of informal economy or
not. The resulting hypothesis is tested using dependent variable as size and develop-
ment of informal sectoras size and development of informal sector, rather than the
qualitative survey measure, employed by La Porta et al. (1999). Finally, the empirical
analysis employs a wider set of control variables in a larger sample. Other theoretical
viewpoints have also emerged recently to expand understanding still further. The
global contemporary view about informal economy has made it quite popular and
inter-connected with the official economies. Both in the well-organized societies and
in developing economies, the informal economic arrangements due to close connec-
tion with relatives, kinships, and within their community interfered within the contem-
porary economies as illegal work, transnational migration, and so on; consequently
role of state is diminishing in the employment of labor and their welfare.

The Hypothesis
Based on the above-mentioned theoretical framework, there is an unclear sign
prediction for the overall effect of a population’s degree of ethnic and religious frac-
tionalization. However, we would expect that the positive effect on the shadow econ-
omy due to the simplification of informal transactions may well be larger than the
dampening effect from ethical convictions. Thus, we developed the hypothesis
regarding the relationship between ethnic and religious diversity and the size of the
informal sector:

Hypothesis 1: The higher the ethnic and religious diversity, the higher would be the
size of informal sector, ceteris paribus.

Ethnic and religious diversity is measured by the formula of Alesina et al.’s (2003)
ethnic fractionalization index that shows the probability that two randomly selected
individuals from a population belonged to different groups. This index indicates diver-
sity of multiple groups within area/country not by the dominance of any specific group
as claimed by Schneider et al. (2015) that more religious population seems to induce a
higher shadow economy. Increase in diversity with different ethnic or religious per-
spective increases the size and development of informal economy. The degree of ethnic
and religious fragmentation and competition could matter for policy maker to develop
any strategy to enforce state rules for cohesiveness of society. With ethnic and religious
fragmentation, any such alliance is more difficult to achieve.
Some researchers such as Roberts (1994) found that formal and informal distinc-
tion overcame the utility. According to the social capital theory, the aptitude of social
factors promising a settlement agenda which is flexible integrated within the fellow-
ship and confidence is assessed. So, the social networks are considered more a social
capital source, and able to strengthen the efficiency and independent state economic
development. Based on the theoretical framework, and to analyze the direct effect of
diversity (religious and ethnic) on informal economy, this study followed the model
8 The Review of Black Political Economy 00(0)

specified by Medina et al. (2017) and Hudson et al. (2012) by incorporating various
socioeconomic variables such as the following:

S&D IE j ,t = a + βi ED j + βi RD j ,t + βi FDI j ,t + βi EM j ,t + βi Gini j ,t + βi GDPPC j ,t

+ βi Corr j ,t + βi FDI × ED j ,t + βi EM × ED j ,t + βi Gini × ED j ,t (1)
+ βi GDPPC × ED j ,t + βi Corr × ED j ,t + ε j ,t ,

where j represents cross-sections and t indicates time in the above equation. S&D IE
is denoted as size and development of informal economy, ED stands for ethnic diver-
sity, RD is defined as religious diversity, FDI is for foreign direct investment, EM is
economic misery index, GINI is defined as inequality index, GDPPC is for income
per capita, and Corr is defined as corruption perception index. Data on all of the vari-
ables used in this study are free to access. Dependant variable is size and develop-
ment of informal economy (S&D IE), the term measuring the non-observed economy.
This study used data of Medina and Schneider (2018), which used Multiple Indicator
Multiple Causes (MIMIC) model for estimating the size and development of informal
economy (as percentage of GDP). The data of independent variable such as diversity
(ethnic and religious) were taken from the database of Cline Centre for Democracy,
The University of Illinois, Chicago, Illinois, USA. Other control variables are FDI,
EM, GINI, GDPPC, and Corr as a proxy for foreign direct investment (FDI), eco-
nomic misery (inflation + unemployment), income inequality, per capita income, and
corruption perception index, respectively.

Methodology and Data Source

In the context of diversity and informal economy, this study used panel data methodol-
ogy to explore this nexus and dynamics for empirical analysis. Basically, panel data
methodology is the mixture of cross-sectional and time-series data, which not only
increase the power and the size of the data but also restructure this effect that is diffi-
cult to distinguish with only cross-sectional or time-series data. However, panel data
techniques are increasingly being used in both macro-level and more conventional
micro-level studies of economic problems. Moreover, using both time-series and
cross-section effects can significantly address the problem of missing variables (Hsiao,
1986).
Baltagi et al. (2003) describe that the key advantage of using panel data is to elimi-
nate heterogeneity in every cross-section when using aggregate time-series data. Panel
data permit variability and less collinearity among variables, while the cross-sections
of time series provide more degrees of freedom and more efficiently when estimating
the model.
Most of the studies such as Johnston and DiNardo (1972) and Greene (2005) dis-
cuss in detail how to estimate the panel model on the equation of fixed or random
effect. Specially, when the α j is uncorrelated with X it′ random effect model is more
suitable otherwise fixed effect model. The random effect model is applicable only if
Amin and Ahmad 9

the panel data comprise N individuals randomly drawn from the large population, such
as the α j are randomly distributed across cross-sectional units. The fixed effect model
is more appropriate and the focus is on specific set of N countries that are not randomly
selected from some large population.
So, there is problematic to find the best possible methodology regarding whether
the fixed effect or the random effect is appropriate (Hsiao, 1986). The other way to
decide the best model between the two is to test the misspecification of the random
effect model, where the α j is here assumed to be uncorrelated and random with inde-
pendent variable (Hsiao, 1986). This expression is tested under the hypothesis of
H 0 :α = 0 and H1 :α ≠ 0 . This study used Hausman test to testing this hypothesis
whether variables correlated or uncorrelated. However, the interpretation of Hausman
test is easy such as if the α j is uncorrelated with independent variable so the random
effect is appropriate otherwise the fixed effect.

Data Source
The data of all the variables used in this study are free to access and are taken from
1995 to 2015, with 5-year intervals. The data of diversity (ethnic and religious) were
taken from the Database of Cline Centre for Democracy. For diversity measurement,
this study followed the same methodology of Alesina et al. (2003) for diversity calcu-
lation (on the basis of ethnic and religious) by using the following formula:
N
FRACT j = 1 − ∑S ,
i =1
2
ij

where Sij is the share of ethnic group i (i = 1,, N ) in the country j. The range of the
result is between 0 and 1; “0” means homogeneous country and “1” means total het-
erogeneous country. Economic misery is the combination of inflation and unemploy-
ment (Economic misery = Inflation rate + Unemployment rate). Data of FDI, GDP
per capita, Gini index, inflation rate, and unemployment rate have been taken from
International Monetary Fund (IMF) and World Development Indicators (WDI),
whereas the data of corruption perception index have been taken from transparency
international. The data of dependent variable such as size and development of informal
economy (as percentage of GDP) are taken from the study of Medina and Schneider
(2018).

Empirical Results
Based on the above findings, Tables 1 to 4 show the relationship between ethnic and
religious diversity with size and development of informal economy by using data of
187 countries of the world (including high-, middle-, and low-income countries). The
result shows that diversity (ethnic and religious) has a significant positive impact on
informal economy. The coefficients of ethnic and religious diversity indicate that a
10
Table 1. Diversity and Informal Economy (Model I for All Countries)—Dependent Variable: Size and Development of Informal Economy.
Dependent variable: Size and development of informal economy

Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

Ethnic group 0.581*** 0.1554** 0.0576*** 0.0595*** 0.1808*** 0.1797*** 0.0246**

(0.067) (0.1016) (0.1135) (0.3892) (0.1939) (0.1212) (0.4872)
Religious 0.141*** 0.3521*** 0.3558*** 0.3534*** 0.3508*** 0.3490*** 0.352***
group (0.082) (0.1035) (0.1028) (0.1035) (0.1039) (0.1038) (0.1045)
Misery index 0.001** 0.0001 0.0005 0.0004 0.0004 0.0004 0.0001
(0.0003) (0.0006) (0.0015) (0.0001) (0.0001) (0.0016) (0.0006)
FDI 0.0023** 0.0025 −0.0069 0.0025 0.0025 0.0026 −0.0073
(0.0011) (0.0028) (0.0066) (0.0028) (0.0028) (0.0028) (0.0068)
Gini index 0.023** 0.0001 0.0002 −0.0008 0.0002 0.0002 −0.0008
(0.0031) (0.0025) (0.0024) (0.0048) (0.0025) (0.0025) (0.0052)
Corruption 0.0177*** 0.0093*** 0.0092*** 0.0093*** 0.0091*** 0.0093*** 0.0096***
index (0.0005) (0.0017) (0.0017) (0.0017) (0.0021) (0.0017) (0.0030)
GDP per −0.0011*** −1.520*** −1.530*** −1.5300*** −1.5001*** −1.4406*** −1.3708***
capita (0.0074) (2.980) (2.930) (2.9600) (2.9505) (3.6906) (5.2501)
Misery Index −0.0019 −0.0002
× Ethnic (0.0002) (0.0012)
Group
FDI × Ethnic 0.0294 0.0309
Group (0.0188) (0.0193)
Gini × Ethnic 0.0022 0.0024
Group (0.0093) (0.0102)
Corruption 0.0007*** 0.0009***
Perception (0.0043) (0.0083)
× Ethnic
Group
GDP × Ethnic −0.0002*** −0.0005***
Group (−0.0007) (0.0010)
Constant 3.088*** 3.399*** 3.3102*** 3.3389*** 2.377*** 4.0401*** 3.586*** 3.9930*** 4.0225*** 4.0356*** 3.9831*** 3.9812*** 4.0541***
(0.034) (0.037) (0.0182) (0.0189) (0.1235) (0.0286) (0.017) (0.1179) (0.1175) (0.2033) (0.1352) (0.1221) (0.2370)
OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS FE
R2 .100767 .004242 .021138 .005498 .18726 .619208 .413108 .723514 .727135 .723567 .723526 .723718 .727825
n 670 701 723 731 247 572 759 192 192 192 192 192 192
Cross- 138 144 149 150 103 151 153 85 85 85 85 85 85
sections

Note. Regressions are estimated with White cross-section standard error correction. The t-values are in parentheses. FDI = foreign direct investment; GDP = gross domestic
product; OLS = ordinary least squares; FE = fixed effects.
**, and *** denote statistical significance at 5%, and 1% levels, respectively.
 Table 2. Diversity and Informal Economy (High-Income Countries, Model II)—Dependent Variable: Size and Development of Informal
Economy.
Dependent variable: Size and development of informal economy

Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

Ethnic group 0.2320*** 0.4856*** 0.0554*** 3.0796*** 0.1244*** 0.0541*** 3.7487***

(0.1417) (0.5567) (0.2351) (1.3731) (1.1048) (0.6571) (2.7273)
Religious 0.5815*** 0.8602*** 0.8128*** 0.9115*** 0.8342*** 0.8552*** 0.8812***
group (0.1371) (0.1881) (0.1749) (0.1778) (0.1810) (0.1915) (0.1896)
Misery index 0.0062*** 0.0226 0.0148 0.0110 0.0148 0.0134 0.0085
(0.0011) (0.0190) (0.0113) (0.0113) (0.0118) (0.0118) (0.0208)
FDI 0.0008*** 0.0050 −0.0091 0.0043 0.0051 0.0050* −0.0099
(0.0011) (0.0030) (0.0078) (0.0029) (0.0030) (0.0030) (0.0081)
Gini index 0.0163** −0.0079 −0.0062 0.0203 −0.0078 −0.0075 0.0256
(0.0080) (0.0063) (0.0061) (0.0144) (0.0064) (0.0063) (0.0171)
Corruption 0.0152*** 0.0094*** 0.0090*** 0.0083*** 0.0105*** 0.0095*** 0.0061
index (0.0013) (0.0025) (0.0024) (0.0024) (0.0038) (0.0025) (0.0045)
GDP per −6.040*** −1.2312*** −1.1634*** −1.3107*** −1.2764*** −1.5044** −1.1309**
capita (1.3703) (4.1814) (4.0686) (4.0019) (4.1693) (7.2471) (7.8978)
Misery Index −0.0242 0.0053
× Ethnic (0.0431) (0.0507)
Group
FDI × Ethnic 0.0460** 0.0449
Group (0.0238) (0.0248)
Gini × Ethnic −0.0860** −0.0962
Group (0.0405) (0.0481)
Corruption 0.0043*** −0.0075
Perception (0.0148) (0.0173)
× Ethnic
Group
GDP × Ethnic −8.1835*** −2.7121**
Group (2.0601) (2.3985)
Constant 2.7345 3.0378*** 2.7286*** 2.8200*** 2.2360*** 3.8123*** 3.0256*** 4.1008 4.1332 3.2706 4.2683 4.2774 2.9664
(0.0566) (0.0642) (0.0318) (0.0299) (0.2621) (0.0993) (0.0521) (0.3926) (0.3465) (0.5540) (0.4360) (0.4125) (0.8653)
OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS FE
R2 .014358 .083679 .109138 .002333 .044709 .400881 .077248 .664130 .683267 .687398 .662757 .663188 .709268
n 39 41 46 47 34 44 47 25 25 25 35 25 25
Cross- 186 199 228 228 90 187 234 65 65 65 65 65 65
sections

Note. Regressions are estimated with White cross-section standard error correction. The t-values are in parentheses. FDI = foreign direct investment; GDP = gross domestic

11
product; OLS = ordinary least squares; FE = fixed effects.
*, **, and *** denote statistical significance at 10%, 5%, and 1% levels, respectively.
 Table 3. Diversity and Informal Economy (Middle-Income Countries, Model III)—Dependent Variable: Size and Development of Informal

12
Economy.
Dependent variable: Size and development of informal economy

Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

Ethnic group 0.2729*** 0.1686*** 0.1079*** 0.4261*** 0.2088*** 0.1076*** 0.2810***

(0.0680) (0.1389) (0.1607) (0.5290) (0.3934) (0.2230) (0.6190)
Religious group 0.0088*** 0.0034*** 0.0029*** 0.0088*** 0.0003*** 0.0046*** 0.0125***
(0.0712) (0.1531) (0.1527) (0.1550) (0.1569) (0.1530) (0.1612)
Misery index 0.0001*** −3.5002 4.6949 4.2118 3.7384 4.1333 −0.0001
(5.1103) (0.0007) (0.0001) (0.0001) (0.0001) (0.0001) (0.0007)
FDI 0.0002 −0.0037 −0.0117 −0.0034 −0.0037 −0.0038 −0.0116
(0.0025) (0.0062) (0.0126) (0.0062) (0.0062) (0.0062) (0.0132)
Gini index 0.0007 −0.0015 −0.0017 0.0010 −0.0015 −0.0017 0.0002
(0.0025) (0.0031) (0.0031) (0.0061) (0.0031) (0.0031) (0.0065)
Corruption index 0.0095 0.0043 0.0043 0.0042 0.0039 0.0044 0.0032
(0.0018) (0.0033) (0.0032) (0.0032) (0.0054) (0.0032) (0.0064)
GDP per capita −1.690*** −2.2404*** −2.2094** −2.2101** −2.2289*** −2.6313** −2.8347**
(2.8630) (6.1202) (6.0804) (6.092) (6.1104) (1.2605) (1.4080)
Misery Index × 0.0001 0.0002
Ethnic Group (0.0013) (0.0013)
FDI × Ethnic 0.0227 0.0229
Group (0.0316) (0.0328)
Gini × Ethnic −0.0059 −0.0052
Group (0.0120) (0.0131)
Corruption −0.0011 −0.0019
Perception × (0.0117) (0.0144)
Ethnic Group
GDP × Ethnic 1.0101*** 1.5934***
Group (2.7701) (3.2187)
Constant 3.3794 3.5024 3.4863*** 3.5053 3.5332 3.7747 3.6293 3.8844 3.9088 3.7657 3.8665 3.9213 3.8358
(0.0345) (0.0308) (0.0168) (0.0189) (0.1090) (0.0600) (0.0247) (0.1547) (0.1581) (0.2841) (0.2358) (0.1856) (0.3262)
OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS FE
R2 .043003 .000042 .036491 .000018 .000659 .084284 .080821 .208459 .212340 .210261 .208441 .209402 .215987
n 360 373 377 391 138 303 397 111 111 111 111 111 111
Cross-sections 74 77 78 80 57 81 80 48 48 48 48 48 48

Note. Regressions are estimated with White cross-section standard error correction. The t-values are in parentheses. FDI = foreign direct investment; GDP = gross domestic
product; OLS = ordinary least squares; FE = fixed effects.
**, and *** denote statistical significance at 5%, and 1% levels, respectively.
 Table 4. Diversity and Informal Economy (Low-Income Countries, Model-IV)—Dependent Variable: Size and Development of Informal
Economy.
Dependent variable: Size and development of informal economy

Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

Ethnic group 0.1441*** 1.2592* 0.0565** 1.9786** 1.9255* 0.0849* 4.2547**

(0.0610) (1.8555) (0.4620) (2.1729) (2.5875) (2.0175) (5.8060)
Religious group 0.0255*** 0.1197** 0.0154** 0.0488* 0.0509** 0.0340** 0.2526**
(0.0731) (0.3540) (0.3619) (0.3385) (0.3440) (0.3529) (0.4344)
Misery index 4.3245** 0.0801 −0.0032 −0.0037 −0.0039 −0.0038 0.4254
(1.7489) (0.1034) (0.0079) (0.0076) (0.0077) (0.0080) (0.2759)
FDI −0.0008 −0.0277 0.0169 −0.0081 0.0062 −0.0084 0.1541
(0.0034) (0.0443) (0.0514) (0.0325) (0.0348) (0.0497) (0.1277)
Gini index 0.0007 0.0073 0.0030 −0.0258 0.0032 0.0011 0.0237
(0.0072) (0.0155) (0.0144) (0.0348) (0.0139) (0.0145) (0.0934)
Corruption 0.0086** 0.0086 0.0199 0.0113 0.0586 0.0168 0.0466
index (0.0036) (0.0205) (0.0198) (0.0191) (0.0665) (0.0190) (0.1763)
GDP per capita 2.6404** 5.0101 0.0001 0.0001 0.0001 0.0003 0.0067
(2.1104) (0.0002) (0.0002) (0.0002) (0.0002) (0.0013) (0.0038)
Misery Index × −0.1095 −0.5525
Ethnic group (0.1347) (0.3571)
FDI × Ethnic −0.0569 −0.2772
group (0.1160) (0.1907)
Gini × Ethnic 0.0402 0.0070
group (0.0496) (0.1166)
Corruption 0.0613 0.0942
Perception × (0.0931) (0.2217)
Ethnic group
GDP × Ethnic −0.0002* −0.0084**
group (0.0017) (0.0047)
Constant 3.8135*** 3.7035*** 3.7101*** 3.7222*** 3.6233*** 3.9222*** 3.6797*** 2.7079 3.9621 5.1919 5.1711 3.8542 5.5153
(0.0421) (0.0387) (0.0172) (0.0207) (0.3098) (0.1002) (0.0310) (1.8583) (0.8050) (1.5403) (1.7965) (1.7024) (4.3554)
OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS FE
R2 .043778 .000942 .050333 .000494 .000594 .066066 .012226 .254227 .210948 .253946 .231476 .186723 .669201
n 25 26 25 23 12 26 26 12 12 12 12 12 16
Cross-sections 124 129 118 112 19 82 128 16 16 16 16 16 34

Note. Regressions are estimated with White cross-section standard error correction. The t-values are in parentheses. FDI = foreign direct investment; GDP = gross domestic
product; OLS = ordinary least squares; FE = fixed effects.
*, **, and *** denote statistical significance at 10%, 5%, and 1% levels, respectively.

13
14 The Review of Black Political Economy 00(0)

one-unit increase in ethnic and religious diversity brings 0.024 and 0.352 unit incre-
ments in size and development of informal economy, respectively (Table 1, all coun-
tries model). Table 1 also confirms the hypothesis that ethnic and religious diversity
both are important indicators, which enhance the size and development of informal
economy.
Ethnic and religious diversification sometimes proves as an engine for productivity
and innovation because different ethnic groups have different productive skills that
complement each other. Ethnic mix is also helpful in bringing variety in abilities and
sharing their experiences and cultures that may lead to innovation and creativity,
which is ultimately the result of enhancement in informal economy. Ethnic diversity is
helpful in ensuring the emergence of stable development because the diversity by
itself call for intergroup negotiating process. Groups coming with different interests
but equal influence will compete with each other, thus forcing a conciliation on the
growth-oriented policies from which all could lead to earn profit. This diversity is a
valuable asset in promoting public discussion, which is a pillar to form a stable, non-
coercive, development-oriented state. The results obtained in all types of countries
present similar picture of positive significant role of ethnic diversity and religious
diversity to affect size of and development of informal economy. These results are
similar to Collier (1998), Collier et al. (2000b), and Watkins and Ferrara (2005).
The World Bank report (2000) concluded that diversity is a prevention mechanism
rather than a cause of civil war. Collier (2001) found that diversity in democratic coun-
tries promotes competition among private sector even in the presence of poor eco-
nomic performance of public sector.
These results are opposite to the studies of Alesina and Rodrik (1994), Alesina and
Spolaore (1997), Alesina and Tabellini (1989), Easterly and Levine (1997), La Porta
et al. (1999), and Sutherland (1997) that sometimes ethnic and religious diversity may
harmful to society. Ethnically polarized societies create impediments which are wide-
spread diseases for economic development, that is, rent-seeking and irrationality while
making public policies (Easterly & Levine, 1997). Moreover, ethnic and regional com-
petition may lead to deteriorate institutions of the economy such as capacity of public
institution and rule of law (Nafziger & Auvinen, 2003). These weak public institutions
do not contribute in economic growth due to multiple reasons emerged from diversity
(Keen, 2000; Väyrynen, 2003). Ethnic diversity usually inclines to confliction and
coercive political behavior in a society because there are usually struggles about wars
of subordination, rebellion, and hegemony (Furnivall, 1948; Ojie & Ewhrudjakpor,
2009; Otite, 2001).
Another result of misery index and FDI provides mixed consequence to affect size
of informal economies. In middle-income countries, its role is negative, whereas in
high-income countries, its role is positive but insignificant. Moreover, Gini index of
income inequality has insignificant and insensitive role to affect size of informal econ-
omy, while case of corruption index is not much different in individual cases but, in
case of all countries (see Table 4), has significant positive contribution (Baklouti &
Boujelbene, 2019). In the same table, GDP per capita plays significant negative role to
affect informal economy, and this is due to large proportion of formal economy in
Amin and Ahmad 15

GDP. As a result of this, when GDP per capita increases, its reflection comes in size of
formal economy which is proportionately more than the size of informal economy, and
thus the size of informal economy reduces. Unlike low-income countries, same results
can be viewed in middle- and high-income countries. The contradictory result of low-
income country is due to the existence of large size of informal economy in the GDP
of their countries.
There is also mixed literature available regarding the diversity relationship to
development through their socioeconomic cost (economic misery index). Higher the
diversity simple means to more chance of conflict in society as well as at marketplaces
(Alesina & Rodrik, 1994; Alesina & Spolaore, 1997; La Porta et al., 1999). Ethnic
diversity also creates weak public institutions because elites have no time or willing-
ness to contribute for the growth of the national economy and one is the involvement
of the ruling party in business activities, which dampen private investment. However,
those countries where societies are not well civilized diversity is negatively effect to
the economic development (Castells, 2011; Svizzero & Tisdell, 2016).

Conclusion and Policy Implication

This study empirically elucidates the relationship between diversity and informal
economy using panel data of 187 countries of the world (including 56 high-income,
102 middle-income, and 29 low-income countries). This study used panel data meth-
odology, that is, ordinary least squares (OLS), and fixed and random effects for empir-
ical analysis. This study has concluded that diversity (religious and ethnic) has a
significant positive relationship with size and development of informal economy.
These results are similar with the literature such as diversity enhances the formal and
informal economy (Baier & Bergstrand, 2001; Collier et al., 2000a; Watkins & Ferrara,
2005; Yanikkaya, 2003).
Tokman (2007), Brown and McGranahan (2016), Portes and Haller (2010), and
Blunch et al. (2001) considered a set of action areas aimed at leveraging the positive
contributions that informal dwellers and workers can make in the transition to an econ-
omy that is not only greener but also more inclusive.
However, in some aspect, literature also found the relationship between diversity
and informal economy through their socioeconomic cost. Roberson and Park (2007)
showed a positive and curvilinear U-shaped relationship between diversity with rev-
enues, net income, and equity. Tang et al. (2016) revealed that diversity could pro-
mote informal economy, and the effect varies from country to country. Weller and
Zulfiqar (2013) argued that greater diversity is associated with faster growth, larger
credit markets, a broader deposit base, and a smaller chance of asset bubbles, all of
which could contribute to more stability. Dutta and Mukherjee (2012) concluded that
as culture evolves in the form of greater trust, control, and other traits, individual’s
attitudes toward financial market change and they engage in greater financial
transactions.
Collier (1998) asserted that diversity has a positive role on informal economy
because it creates a stable, non-coercive, development-oriented state and it improves
16 The Review of Black Political Economy 00(0)

varied productivity and innovation, and lays a foundation for better private-sector
performance. According to the UN Report (United Nations, Department of Economic
and Social Affairs, Population Division, 2017), if the diversity is well established,
individual’s engagements focus on persuading companies to take advantage of the
benefits associated with gender diversity, including improved decision making, over-
sight, and financial performance.
This study cannot suggest to reduce diversity; however, its effects can be mini-
mized through substantial availability of equal opportunity of all individual belonging
to society. Therefore, low-income countries need to create secure and peaceful society
through strong institutional quality to shape up economic life of a country in a variety
of ways such as to promote society toward more cohesiveness.

Limitations and Prospects for Future Researches

Every study has some limitations which allow the researchers to interpret the results
within proper parameters. This study has also some limitations regarding limiting
scope to cover the ground of diversity and informal economy. In addition to this, diver-
sity is a multidimensional concept, that is, demographic, socioeconomic, political,
geographic, cultural, and dynamic in nature. So it is impossible to show that variables
included in this study are only predictors of informal economy. However, diversity not
just affects the informal economy, but it also affected the domestic legal activities,
which does not cover by this study. However, there are a number of socioeconomic
variables which affect the informal economy such as political stability, institutional
quality, and government policies, which do not cover under this study. This study takes
a macro-level/aggregate-level analysis of informal economy. Therefore, it is more
appropriate to generalize small units such as city, provinces, towns, and remarkable
places. This study uses diversity on the basis of ethnic and religious only, whereas
other determinants of diversity such as race and gender may be guidelines for further
research. Therefore, future research may analyze the data and development of infor-
mal economy, and if any discrepancy occurs, then improve the credibility and reliabil-
ity of informal economy figures for better policy implication.

Appendix
List of High-Income Countries.

Andorra Ireland Qatar

Antigua and Barbuda Israel San Marino
Australia Italy Saudi Arabia
Austria Japan Seychelles
Bahamas, The Kuwait Singapore
Bahrain Latvia Slovak Republic
(continued)
Amin and Ahmad 17

Appendix. (continued)
Barbados Liechtenstein Slovenia
Belgium Lithuania Spain
Brunei Darussalam Luxembourg Sweden
Canada Malta Hong Kong, China
Chile Monaco Hungary
Cyprus Netherlands Iceland
Czech Republic New Caledonia Switzerland
Denmark New Zealand Trinidad and Tobago
Estonia Norway United Arab Emirates
Finland Oman United Kingdom
France Palau United States
Germany Poland Uruguay
Greece Portugal

List of Middle-Income Countries.

Albania Cameroon Fiji Kiribati Morocco

Algeria Cape Verde Gabon Kyrgyz Republic Namibia
Angola China Georgia Lao PDR Nicaragua
Argentina Colombia Ghana Lebanon Nigeria
Armenia Congo, Rep. Grenada Lesotho Pakistan
Azerbaijan Costa Rica Guatemala Libya Panama
Bangladesh Cote d’Ivoire Guyana Macedonia, FYR Papua New
Guinea
Belarus Croatia Honduras Malaysia Paraguay
Belize Cuba India Maldives Peru
Bhutan Djibouti Indonesia Marshall Islands Philippines
Bolivia Dominica Iran, Islamic Rep. Mauritania Romania
Bosnia and Dominican Iraq Mauritius Russian
Herzegovina Republic Federation
Botswana Ecuador Jamaica Mexico Samoa
Brazil Egypt, Arab Rep. Jordan Micronesia, Fed. Sao Tome and
Sts. Principe
Bulgaria El Salvador Kazakhstan Moldova Serbia and
Montenegro
Cambodia Equatorial Guinea Kenya Mongolia Solomon Islands
Suriname Taiwan, China Timor-Leste Turkey South Africa
Swaziland Tajikistan Tonga Turkmenistan Sri Lanka
Syrian Arab Thailand Tunisia Ukraine St. Lucia
Republic
Venezuela, RB Yemen, Rep. Vanuatu Uzbekistan Sudan
Vietnam Zambia
18 The Review of Black Political Economy 00(0)

List of Low-Income Countries.

Afghanistan Liberia Senegal Eritrea

Benin Madagascar Sierra Leone Ethiopia
Burkina Faso Malawi Somalia Gambia, The
Burundi Mali Tanzania Guinea
Central African Republic Mozambique Togo Guinea-Bissau
Chad Nepal Uganda Haiti
Comoros Niger Rwanda Zimbabwe
Congo, Dem. Rep.

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship,
and/or publication of this article.

Funding
The author(s) received no financial support for the research, authorship, and/or publication of
this article.

ORCID iD
Saqib Amin https://orcid.org/0000-0001-5450-8457

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