Remittances, shadow economy and financial development: global evidence from a Bayesian model

Purpose The interplay of remittances, the shadow economy and financial development remains a subject of ongoing debate, with the shadow economy’s moderating role largely unexplored. This study aims to address this research gap by analyzing their impacts and the shadow economy’s moderating effect across 56 developed and developing countries. Design/methodology/approach This study leverages the advantages of a Bayesian approach over traditional frequentist methods to assess the impact of remittances and the shadow economy on financial development. Findings Empirical results reveal both remittances and the shadow economy significantly negatively impact financial development in the full sample. Furthermore, the results reveal that the shadow economy plays a mitigating role, where the adverse effect of remittances on financial development weakens as the size of the shadow economy increases. In addition, income-based subsample analyses reveal notable variations, indicating that these empirical relationships are heterogeneous across different economic development levels. Research limitations/implications The study’s sample could be expanded further or focused on countries with the highest remittances and shadow economy activity. More diverse policy implications could be derived by implementing these changes. Practical implications Governments should recognize the nuanced role of the shadow economy; while it generally hinders financial development, it acts as a buffer that cushions the financial system against the negative shocks of remittance inflows. Therefore, policies should focus on integrating informal remittance channels into the formal system rather than solely suppressing the shadow economy. Originality/value Remittances and the shadow economy are both crucial factors in the economic development and financial systems of every nation. Assessing their impact on financial development provides a solid basis for governments to enact appropriate policies. This allows them to best leverage the value of remittances while mitigating the negative aspects of the shadow economy, ultimately aiming for financial development and economic growth.