The Dual Impact of the Informal Economy on Formal Growth in Nigeria: Evidence from ARDL Bounds Testing

Nigeria’s informal economy (IE) employs a sizable portion of the labour force. It contributes more than half of the nation’s gross domestic product (GDP), but little is known about how it interacts with the formal economy. This study aims to bridge that gap by examining the short-term and long-term effects of informality on Nigeria’s formal economy. The autoregressive distributed lag (ARDL) model and annualized data analysis were used to establish a nuanced interaction between informality and the formal economy. According to the findings, a one percent increase in the size of the IE is associated with a 0.38 percent increase in long-run formal GDP per capita, but a 0.03 percent decrease in the short run. The IE has a significant impact on the formal economy over the long run, promoting growth through job creation, increased demand, and entrepreneurial endeavors. Conversely, IE activities typically have a negative impact in the short term, highlighting issues such as unfair competition, limited access to financing, and tax evasion. These results underscore the importance of policymakers to distinguish between short-term and long-term impacts when developing policies. Based on the study, policymakers should consider a dual-horizon strategy that addresses short-term issues while leveraging long-term growth prospects, supported by institutional reforms, financial inclusion, and the gradual integration of informal enterprises into the formal economy, rather than striving for total eradication.