Human Capital, Trade Openness and Informal Economy: Evidence from Pakistan
Author: Beenish Javed

Many countries around the world have an informal economy which operates outside government regulations. It is more widespread in developing than developed countries. Informal economy comprises of illegal activities as well as unreported income from legal activities either through barter or monetary transactions. Expansion of informal economy is on the rise in Pakistan. The growth rate of 5% has failed to improve the socio-economic indicators such as human capital and trade performance. Hence growing informal economy could be associated with the socio-economic indicators such as human capital, trade openness and economic growth. Therefore the study is conducted to examine the link between human capital, trade openness, growth and informal economy for Pakistan for the period 1975-2014. By using the ARDL approach, the study revealed that there exists a significant short-run and long-run relationship between the variables of interest. In other words, improvements in human capital index reduce informal economy in the longrun while it increases it in the short-run. In contrast, trade openness and growth expand the informal economy in the long-run and vice-versa in the short-run. The study also conducted a robustness analysis whereby Human Development Index (HDI) was used as an alternate proxy to human capital. The sensitivity analysis revealed the same results for the variable of human capital and growth but trade openness was statistically insignificant both in the short and long-run which can be attributed to high correlation between HDI and trade openness. Given these findings, the study suggests that the state should prioritize investment in human capital to make growth inclusive and sustainable as well as to enhance the competitive advantage of the domestic firms so as to control the expanding informal economy. Supervisor:- Dr. Muslehuddin

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Supervisor: Musleh ud Din

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