The moderating role of institutional quality in shadow economy–pollution nexus in Nigeria

Purpose This study examines the moderating role institutional quality plays in shadow economy–environmental pollution nexus in Nigeria between 1984 and 2018. Further, the study also determines the threshold level of institutional quality that lessens shadow economy and abates environmental pollution. Design/methodology/approach Shadow economy is measured as a percentage of gross domestic product (GDP) using the currency demand approach while environmental pollution is proxy by carbon dioxide (CO 2 ) per capita. Autoregressive distributed lag (ARDL) is used as the estimation technique. Findings Results from the study show that shadow economy has a positive and significant effect on environmental pollution both in the short and long run, while institutional quality has a negative effect on environmental pollution. This reveals that shadow economy worsens environmental quality while institutional quality abates environmental pollution. The interactive term of shadow economy with institutional quality has a negative but insignificant effect on environmental pollution in the long run. It implies that institutional quality is weak to bring about significant reduction in shadow economy and environmental pollution. Further, the threshold level of institutional quality required to lessen the effect of shadow economy and abate environmental pollution is found to be 5.69 on an ordinal scale of 0–10. Practical implications Institutional quality in Nigeria is weak and needs to be strengthened up to the threshold level in order to effectively moderate the impact of shadow economy on environmental pollution. Originality/value The study addresses the perceived gap in the empirical literature on the emerging role of strong institution in abating environmental pollution in Nigeria. It also develops a threshold level of institutional quality capable of mediating the negative impact of shadow economy on environmental pollution. This empirical contribution is largely missing in the context of Nigeria.