Mu unga, James; Mu ii hi, Moses Kinyanjui; Wawi e, Nelson We e
A icle
Es ima ing he size o he in o mal sec o in Kenya
Cogen Economics & Finance
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Sugges ed Ci a ion: Mu unga, James; Mu ii hi, Moses Kinyanjui; Wawi e, Nelson We e (2021) :
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Es ima ing he size o he in o mal sec o in Kenya
James Mu unga, Moses Kinyanjui Mu ii hi & Nelson We e Wawi e |
To ci e his a icle: James Mu unga, Moses Kinyanjui Mu ii hi & Nelson We e Wawi e | (2021)
Es ima ing he size o he in o mal sec o in Kenya, Cogen Economics & Finance, 9:1, 2003000,
DOI: 10.1080/23322039.2021.2003000
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Published online: 22 No 2021.
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GENERAL & APPLIED ECONOMICS | RESEARCH ARTICLE
Es ima ing he size o he in o mal sec o in
Kenya
James Mu unga
1
*, Moses Kinyanjui Mu ii hi
2
and Nelson We e Wawi e
3
Abs ac : In Kenya, e y li le esea ch has been ca ied ou on he opic o he
in o mal sec o . This pape es ima es he size o he Kenyan in o mal sec o o he
pe iod 1970–2018. In ligh o ou analysis o he s a iona y p ope ies o he da a,
which sugges s a mix u e o I(0) and I(1) a iables, his s udy speci ies an
Au o eg essi e Dis ibu ed Lag Model (ARDL), which is applied o a iables ha pose
such a ibu es. In addi ion, he model is good o small sample size obse a ion,
a cha ac e is ic ha is common among de eloping coun ies. Ou es ima es indica e
ha his sec o is qui e la ge and has g own o e ime o abou 32% o he coun y’s
GDP o nea ly one- hi d o he size o he eco ded GDP. These esul s a e consis en
wi h he s ylized ac abou he Kenyan economy, in pa icula he la ge numbe o
indi iduals employed in small businesses and ading as well as he numbe o ax
e u ns iled on an annual basis e sus he s a ed le el o employmen . The inding o
a signi ican in o mal sec o also has implica ions o he conduc o iscal policy. The
sec o should no be wound ab up ly since i p o ides employmen o many Kenyans.
The iscal policy should aim a educing he ax bu den so ha he pa icipan s in he
in o mal sec o g adually o malize hei businesses.
Subjec s: De elopmen Economics; Finance; Public Finance
Keywo ds: Kenya; in o mal sec o ; Au o eg essi e Dis ibu ed Lag; cu ency; ax a io
ABOUT THE AUTHOR
The main au ho is James Mu unga. He is a PhD
candida e pu suing a deg ee ha will lead o
a deg ee in Doc o o Philosophy in Economics o
he Uni e si y o Nai obi. His PhD hesis is in o m
o essays and he a icle he submi ed is he i s
essay o he PhD hesis. The o he wo au ho s
a e his hesis supe iso s. D . Moses Kinyanjui
Mu ii hi is a senio lec u e in he Depa men o
Economics, Popula ion and De elopmen S udies
o he Uni e si y o Nai obi. Nelson We e
Wawi e, is a p o esso o Economics in he
School o Economics o Kenya a Uni e si y.
James Mu unga is he one who w o e he pape
andanalysed he da a. The ole o he o he wo
au ho s was o assis in shaping he esea ch
idea based on hei as expe ience in he a ea
o public economics.
PUBLIC INTEREST STATEMENT
The in o mal sec o is conspicuous in Kenya.
The majo i y o he employmen oppo uni ies a e
in he in o mal sec o . Al hough he sec o boos s
he economy due o he p o ision o job oppo -
uni ies, he go e nmen ails o ge ax e enue
om i . This is due o he ac ha he sec o is
ha d o ax since ansac ions occu in cash o m.
This s udy, he e o e, uses cu ency demand
app oach o es ima e he mone a y alue o all
he goods and se ices p oduced in he sec o .
The cu ency demand app oach is app op ia e
gi en ha economic ansac ions in he sec o
occu in cash o m. The s udy es ablishes ha he
sec o accoun s o abou 32% o Kenya’s GDP.
This inding is impo an o Kenya Re enue
Au ho i y because i shows how big he sec o is,
so ha app op ia e ac ion is aken o educe i .
Mo ing some o he pa icipan s in he sec o o
he o mal sec o will lead o an inc ease in ax
e enue collec ion in Kenya.
Mu unga e al., Cogen Economics & Finance (2021), 9: 2003000
h ps://doi.o g/10.1080/23322039.2021.2003000
Page 1 o 15
Recei ed: 30 Augus 2021
Accep ed: 01 No embe 2021
*Co esponding au ho : James
Mu unga, Tu o ial Fellow,
Depa men o Economics, Machakos
Uni e si y, Kenya
E-mail: [email p o ec ed]
Re iewing edi o :
Ch is ian Nsiah, School o Business,
Baldwin Wallace Uni e si y,
Ken ucky, USA
Addi ional in o ma ion is a ailable a
he end o he a icle
© 2021 The Au ho (s). This open access a icle is dis ibu ed unde a C ea i e Commons
A ibu ion (CC-BY) 4.0 license.
1. In oduc ion
The in o mal sec o is a ype o economy ha applies o all income classes and all sec o s o he economy.
I is comp ised o a ious ypes o economic ac i i ies, spanning om he sel -employed such as second-
hand clo hes deale s, hawke s, d essmake s, wage wo ke s, housekeepe s, secu i y gua ds, ca pen e s o
he egis e ed businesses, o example, law i ms, p i a e hospi als, p i a e schools ha unde es ima e
hei incomes and o e es ima e hei expendi u e (G eenidge e al., 2009; Ngui e al., 2014). Howe e ,
he e ha e always been p oblems in a emp ing o es ima e i s size. Acco ding o Dellas e al. (2017),
in o mal sec o da a a e no included in he na ional s a is ics and hus may lead o inaccu a e mac o-
economic indica o s. No aking in o conside a ion he economic ac i i ies in he in o mal sec o can lead
o he le el o eco ded GDP and o he impo an da a being unde epo ed. Such da a may p esen an
inaccu a e imp ession o an economy. Since eco ded GDP is impo an o in e na ional anking, inaccu-
a e da a p esen s a w ong imp ession o an economy. Fu he , G eenidge e al. (2009) asse ed ha
end es ima es migh also be a ec ed i he economic ac i i ies excluded in he eco ded GDP g ow a
di e se a es om hose included. Fo example, i is o en shown ha in o mal sec o ac i i ies g ow a
he same ime ac i i ies in he o icial economy a e sh inking. The e o e, elying on da a ha does no
cap u e bo h sec o s o he economy may lead o e oneous policy decisions.
This pape es ima es he size o Kenya’s in o mal sec o using he ARDL model. This model p o ides
a use ul link be ween long- un equilib ium ela ionships and sho - un disequilib ium dynamics. To
he bes o ou knowledge, his is he i s ime such an app oach has been used o es ima e he size
o he in o mal sec o in Kenya. This p ocedu e was chosen since he s a iona i y esul s e ealed
a mix u e o a iables ha we e in eg a ed o o de ze o I (0) and one I (1). I is also a gued ha his
model is good o p ocedu e in dealing wi h small da a samples (Pesa an & Shin, 1995).
The nex sec ion p esen s he main causes, ad an ages and disad an ages o he in o mal
sec o and an o e iew o he in o mal sec o in Kenya. Sec ion 3 deals wi h some o he s udies
ha we e conduc ed on he opic and gi es a e iew o hei esul s. In Sec ion 4, he size o he
in o mal sec o in Kenya is es ima ed using he cu ency demand app oach. The pape concludes
wi h some ema ks and policy implica ions.
2. Causes, ad an ages and disad an ages o he in o mal sec o
The inc ease in he size o he in o mal sec o has become a conce n among many go e nmen s in
bo h de eloped and de eloping coun ies. This g owing size o he in o mal sec o is linked o many
easons, o ins ance, ising ax bu dens, poo go e nance and high le els o co up ion in he
public sec o (G eenidge, 2009). A high ax bu den widens he gap be ween e o o he wo ke
and his pay. This, he e o e, ac s as an incen i e o he wo ke o eso o he in o mal sec o . This
he e o e implies ha a ax egime is a majo de e minan o he size o he in o mal sec o
(Schneide & Ens e, 2002). Dha mapala, Slem od & Wilson (2011) showed ha a low ax bu den
could mo e i ms om he in o mal sec o o he o mal sec o among he de eloping coun ies.
This in o mal sec o is essen ial in he p o ision o employmen among de eloping coun ies. The
sec o p o ides a conduci e en i onmen o en ep eneu s and hose who may wan o inno a e.
The sec o also gi es indi iduals who lose jobs in he o mal sec o an oppo uni y o gene a e
income o hei wel a e. The sec o has also eme ged as an al e na i e sou ce o employmen o
a g owing numbe o indi iduals mo ing om educa ional ins i u ions. In addi ion, he p oceeds
ob ained om his sec o a e spen in he o mal sec o . Las ly, he sec o compe es wi h he
o mal sec o hus leading o educed p ices and imp o emen in he quali y o he goods and
se ices p oduced in he o mal sec o (Muchi i, 2014).
Though he in o mal sec o is a sou ce o employmen among de eloping coun ies, i is no
sui able o he economic p ospe i y o an economy due o ax e asion. Failu e by p oduce s and
households o decla e hei economic ac i i ies educe ax e enue aised in an economy (Dellas
e al., 2017). To b idge he gap in e enue collec ion, ax au ho i ies usually eso o imposing highe
axes in he o mal sec o . Such ac ion ein o ces he size o he un epo ed incomes as he axpaye s
Mu unga e al., Cogen Economics & Finance (2021), 9: 2003000
h ps://doi.o g/10.1080/23322039.2021.2003000
Page 2 o 15
eel o e axed and u n o he in o mal sec o , hus exace ba ing he si ua ion (Gunes, S a zec &
Ga des, 2013). This means ha apping ax om he in o mal sec o may be impo an in sus aining
ax mo ale and ax compliance among la ge i ms (Joshi, P icha d & Heady, 2012). In addi ion, he
in o mal sec o p esen s a challenge o policymake s by dis o ing economic in o ma ion since i
o e s a es key a ios, o ins ance, unemploymen a es and deb - o GDP. The implica ion o hese
sho comings means ha policies made in coun ies wi h high size o he in o mal sec o may be
e oneous, hus causing ad e se eac ions. The sec o also compe es un ai ly wi h he o icial
economy, hus educing he o icial economy’s income. Las ly, he sec o may lead o inc eased
co up ion as he pa icipan s seek o con inue e ading axes (G eenidge, 2009).
3. O e iew o he in o mal sec o in Kenya
In Kenya, he in o mal sec o s a ed o lou ish in he 1970s wi h he boom in co ee smuggling along he
Kenya-Uganda bo de in sea ch o he ma ke by Ugandans ollowing he imposi ion o a ade emba go
on Ugandan co ee by he USA. Cu en ly, a signi ican p opo ion o he in o mal sec o includes ac i i ies
ha a e un eco ded and p o i able en e p ises. This includes sel -employed such as second-hand clo hes
deale s, hawke s, d essmake s, wage wo ke s, housekeepe s, secu i y gua ds and ca pen e s (Masinde &
Makau, 2010). Acco ding o he Ins i u e o Economic A ai s (IEA)—Kenya (2012), mos o hese ac i i ies
a e highly p o i able and e enue ob ained om hem exceeds he minimum s a u o y axable income o
Kshs. 11,135 pe mon h a he same ime employing housands o Kenyans majo i y who do no keep
p ope eco ds and do no epo hei incomes o ele an au ho i ies. Despi e he high ax po en ial,
KRA’s e o o educe he size o he in o mal sec o , o ins ance, ein oduc ion o u no e ax in 2019,
has been unsuccess ul (Republic o Kenya, 2019). This inabili y o b ing mo e indi iduals in o he ax ne is
a ibu ed o he high adminis a i e cos s in ol ed.
In Kenya, he in o mal sec o employs app oxima ely 77% o he o al wo k o ce. O he wo k o ce in
his sec o , 60% a e you h be ween he age o 18 and 35 yea s. O his, 50% a e women (Republic o
Kenya, 2017). The g ow h o his sec o can be linked o libe aliza ion and p i a iza ion policies ha led o
educed job oppo uni ies in he o mal public sec o . The o mal p i a e sec o could no abso b he
inc easing numbe o job seeke s. The e o e, he in o mal indus y eme ged as an al e na i e sou ce o
employmen o a g owing numbe o indi iduals mo ing om educa ional ins i u ions. Thus, he in o mal
sec o should be suppo ed due o i s ole in he Kenyan economy (Muchi i, 2014). Howe e , i is a gued
ha economic agen s choose o ope a e in he in o mal sec o o e ade axes. Inc eased ax e enue
mobilized om his expansi e and un apped ax base would signi ican ly con ibu e o he coun y’s GDP,
hus alle ia ing po e y and consequen ly imp o ing he li ing s anda ds o he ci izen. Howe e , he
sec o poses ax adminis a i e and compliance challenges. I is a gued ha he weal hy indi iduals in
Kenya a e g adually shi ing hei weal h o his sec o by pu chasing mo o cycles and hi ing you h o
e y passenge s a a commission (Wawi e, 2020). Though he indus y is sui able o c ea ing job
oppo uni ies, i s expansion can lead o low ax e enues, hus nega i ely impac ing he p o ision o
public goods by he go e nmen o Kenya (Pe e s, 2017). Figu e 1 shows he ends in he size o he
in o mal sec o in Kenya.
The ends in Figu e 1 co obo a e he asse ion ha libe aliza ion and p i a iza ion policies as
ensh ined in he S uc u al Adjus ed P og ammes (SAPs). F om his igu e, i can be obse ed ha
om 1970 o 1988, he numbe o indi iduals employed in he in o mal sec o was low. A d as ic
inc ease in he numbe o people employed in he sec o is obse ed om 1989 onwa ds. This
coincided wi h 1988 and especially 1991 when he Kenyan go e nmen emb aced hese economic
and social e o ms ini ia ed by Wo ld Bank and In e na ional Mone a y Fund (IMF) commonly e e ed
o as SAPs. The numbe o people employed in he in o mal sec o adop ed a posi i e ajec o y o
2018. This can be linked o an inc easing numbe o indi iduals exi ing e ia y ins i u ions and
uni e si ies who he o mal sec o canno abso b ully, hus u ning o he in o mal sec o .
4. The s a emen o he p oblem
The ex en o he in o mal sec o is a cause o conce n in Kenya. The ac i i ies o he in o mal
sec o ha e se e al implica ions o he coun y’s sus ainable economic managemen . These
Mu unga e al., Cogen Economics & Finance (2021), 9: 2003000
h ps://doi.o g/10.1080/23322039.2021.2003000
Page 3 o 15
ac i i ies ha e implica ions o he ax e enue and de e mining wha he op imal ax should be. In
addi ion, he in o mal sec o is cha ac e ized by un eco ded ac i i ies which alsi y na ional
accoun s, hus ende ing policies de i ed om such s a is ics ine icien . Gene ally, he subjec o
es ima ing he size o he in o mal sec o has no been widely s udied. The ew s udies ha ha e
in es iga ed he size o he in o mal sec o include Bajada and Schneide (2018), Pe e s (2017),
and G eenidge e al. (2009). Locally, e y li le in o ma ion is known abou he size o he in o mal
sec o . Ngui e al. (2014) a emp ed o in es iga e he sec o , bu he s udy ocused mainly on he
de e minan s o he in o mal sec o . I is on his basis ha his s udy sough o es ima e he size o
he size in o mal sec o in Kenya so as o in o m policy o be aken.
5. Empi ical li e a u e e iew
Ahmed and Hussain (2008), while es ima ing he black economy in Pakis an, e ealed ha he size
o he in o mal sec o in Pakis an was less han 5% o he o mal GDP o e e y yea o he pe iod
o s udy unning om 1960 o 2003. G eenidge e al. (2009) es ima ed he size o he in o mal
sec o in Ba bados. The s udy es ablished ha he in o mal sec o accoun ed o mo e han one-
hi d o he coun y’s GDP in Ba bados. In ano he s udy, Phi i and Kabaso (2012) s udied axa ion
o he in o mal sec o in Zambia o he pe iod be ween 1973 and 2010. The s udy esul s e ealed
ha he Zambian in o mal sec o accoun ed o abou 42% o he GDP. In ano he s udy, Hassan
and Schneide (2016) modelled he Egyp ian shadow economy o he pe iod unning om 1976 o
2013 using he cu ency demand app oach. The s udy’s indings e ealed ha he in o mal sec o
accoun ed o abou 20% o GDP be ween 1990 and 2013. The s udy showed ha hough he e
had been a declining end in he size o he in o mal sec o , he le el was s ill high o Egyp as
a de eloping coun y and was a s umbling block o economic de elopmen . Though he cu ency
model has been widely used in he es ima ion o size o in o mal sec o , a di ec app oach such as
a su ey based on a ques ionnai e may gi e a clea poin e o he in o mal sec o .
Ano he me hodology o es ima ing he size o he in o mal sec o is he Mul iple Indica o s
Mul iple Causes (MIMIC). This model was used by Dell’Anno (2007) o es ima e Po ugal’s size o
he shadow economy o he pe iod be ween 1997 and 2004. The causes o he in o mal sec o
conside ed included he a io o go e nmen employmen o he o al labou o ce, a io o
subsidies o GDP, ax bu den, a io o social bene i s o GDP, a io o sel -employmen o he labou
o ce and unemploymen . The indica o s conside ed include eal GDP, labou o ce pa icipa ion.
The s udy esul s showed ha he in o mal sec o in Po ugal dec eased om abou 30% o he
coun y’s GDP in 1978 o abou 18% o he coun y’s GDP in 2004. Hassan and Schneide (2016)
modelled he Egyp ian shadow economy by adop ing he MIMIC app oach o he pe iod be ween
1976 and 2013. This s udy adop ed a s uc u al equa ion model in modelling e ec o a ious
causes, namely sel -employmen , sha e o ag icul u al sec o in GDP and ins i u ional quali y on
shadow economy. In s uc u al equa ion model, he shadow economy was ep esen ed by he
0
2
4
6
8
10
12
14
16
1970 1980 1990 2000 2010 2020
Employmen (million)
Yea
Figu e 1. T ends o size o
in o mal sec o (1970–2018).
Sou ce o he da a: Republic o
Kenya; Va ious Issues o
Economic Su ey.
Mu unga e al., Cogen Economics & Finance (2021), 9: 2003000
h ps://doi.o g/10.1080/23322039.2021.2003000
Page 4 o 15
ollowing indica o s: eal GDP, cu ency ou side banks, and o al employmen . The s udy indings
e ealed ha he Egyp ian shadow economy was declining o e he s udy pe iod. The size o his
economy a e aged 30% o GDP o 37 yea s. Though he s uc u al equa ion model (SEM) is
p e e ed as an al e na i e o he cu ency demand model, i equi es a la ge da a size which
may no be a ailable among he de eloping coun ies.
In ano he s udy, Cas o and A anda (2018) es ima ed he size o he in o mal sec o among
OECD membe s and La in Ame ican coun ies be ween 1995 and 2016 using he MIMIC app oach.
The esul s on es ima ion o he size in o mal sec o showed ha in o mal sec o in he La in
Ame ica coun ies was 34% o GDP while ha o OECD was 19% o GDP. The s udy a ibu ed he
di e ences in he size o he in o mal sec o be ween he wo egions o di e ences in quali y o
ins i u ions and le el o economic p ospe i y. Among causes o he in o mal sec o conside ed by
he s udy included ax bu den, co up ion, go e nmen in eg i y and unemploymen . The indica-
o s o he in o mal sec o conside ed in he s udy had GDP g ow h, labou eedom and go e n-
men expendi u e on educa ion. This s udy inding showed ha he size o he in o mal sec o is
la ge among de eloping coun ies han in de eloped coun ies. This inding mo i a ed he need o
es ima e he size o he in o mal sec o in Kenya, a de eloping coun y bu in a di e en con inen .
6. Me hodology
6.1. Theo e ical amewo k
Hibbs and Piculescu (2013) heo e ical amewo k in o med he model chosen in es ima ing he
size o he in o mal sec o in Kenya. I is pos ula ed ha he p e ailing ax a e de e mines he
numbe o ou pu i ms decide o p oduce in he in o mal sec o . The ela ionship be ween ax a e
and ou pu in an economy is shown in Figu e 2.
Pa e ns o p oduc ion op ions as ax a es oscilla e a ound a h eshold ax a e * a e illus a ed
in Figu e 2. F om he igu e, o al ou pu (Q o al) ep esen s ou pu p oduced by o mal and
in o mal sec o s. The igu e egion whe e < * illus a es a si ua ion whe e all p oduc ion akes
place in he o mal sec o since o al ou pu in an economy (Q o al) is equal o o mal sec o
ou pu /GDP (Q o mal sec o ). This means he in o mal sec o ’s ou pu is equal o ze o. As he ax
a e inc eases beyond *, i ms s a o ind ac i i ies in he in o mal sec o p o i able. I can be
obse ed ha as he ax a e is beyond *, p oduc ion in he o mal sec o begins o decline and
eaches ze o (0) when he ax a e eaches one (1). The s age be ween * and = 1 is comp ised o
he in o mal p oduc ion sec o (Q o mal sec o ) and in o mal sec o (Q in o mal sec o ) simul a-
neously. F om Figu e 2, i is seen ha once he ax a e eaches one (1), all economic ac i i ies
occu in he in o mal sec o ; ha is, o al ou pu in an economy (Q o al) is equal o he in o mal
sec o ou pu /GDP (Q in o mal sec o ). This means he in o mal ou pu sec o is equal o ze o
implying ha he go e nmen ob ains ze o ax e enue.
The same idea can be linked o cu ency demand. The Keynesian heo y s a es ha indi iduals hold
money due o h ee mo i es: ansac ion, p ecau iona y, and specula i e (Blanka d, 2017). Acco ding
o Hend iks and Myles (2013), mos o ansac ions in he in o mal sec o a e in cash. Cu ency
ou side he bank can be used o measu e ou pu in he in o mal sec o . F om Figu e 2, i ’s obse ed
ha ax a e is he p ima y de e minan o he ou pu in he in o mal sec o and, he e o e, mus be
inco po a ed in he model. An es ima e o cu ency ou side he bank is i s ob ained when he ax
a e is included in he model o es ima e ou pu in he in o mal sec o . This can be deno ed by C1.
Secondly, an es ima e o cu ency ou side he bank is again ob ained when he model assumes he
ax a e o be ze o. This can be deno ed by C2. F om Figu e 2, we expec cu ency ou side he bank o
be high when he e is a ax a e in he model han when i is assumed o be ze o. The di e ence
be ween C1 and C2 gi es cu ency ci cula ing in he in o mal sec o (Cin ), as shown in Equa ion 1.
Cin ¼C1C2(1)
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Assuming ha he eloci y o money ci cula ing in he in o mal sec o (Cin Þis simila o ha o he
o mal sec o , an es ima e o in o mal sec o ou pu (GDPin ) is ob ained by ge ing he p oduc o
cu ency ci cula ing in he in o mal sec o (Cin Þand eloci y o money (V) as shown in Equa ion 2
GDPin ¼V�Cin (2)
To es ima e he e ec o he size o he in o mal sec o on ax e enue, ax e asion expec ed u ili y
heo y was conside ed. The heo y shows ha he choice o e ade axes is made by weighing he
gains and losses in ol ed. The heo y en isages a p e e ence o a dominan al e na i e ha
p oduces g ea e u ili y is picked ones wi h less u ili y. This heo y makes assump ion o decision-
make s being awa e o mul iple ou comes, and can de e mine a p e ailing iew (Sebo a &
Co nwall, 1995). Thus, he indi iduals who play a pa in he in o mal sec o ac a ionally. Thei
p ima y in e es is maximizing he expec ed bene i om economic ac i i ies hey do. Fo
a a ional indi idual who e ades ax, he income unde s a ed will maximize hei ne an icipa ed
e enue. This e ade compa es ne gain expec ed om ax e asion wi h wha would be ob ained
by doing legal ac i i ies in o mal sec o .
6.2. Empi ical model
In es ima ing he size o he in o mal sec o , he cu ency demand me hod, as sugges ed by Tanzi
(1983), was adop ed. The app oach in ol es speci ying cu ency equa ions ha can in e he e ec
o ax on demand o cu ency. The undamen al assump ions made is ha high axes ac as an
incen i e o indi iduals o shi hei economic ac i i ies o he in o mal sec o and ha cu ency is
he main o m o ca ying ou day o day ansac ions o used as a s o e o weal h. In he equa ion,
he na u al loga i hm o cu ency ou side banks deno ed as c is dependen a iable while ax a io,
ax, is independen a iable. The con ol a iables a e pe capi a GDP, deposi a e o in e es ,
in la ion, and inancial inno a ion deno ed as pgdp,in , in and inno , espec i ely. The cu ency
demand unc ion is shown in Equa ion 3.
Re enue
Q o al
Q o mal
sec o
Q In o mal
sec o
1
*
Tax a e ( )
Ou pu (Q)
Figu e 2. The ela ionship
be ween ax a e and ou pu in
an economy.
Sou ce: Hibbs and Piculescu
(2013)
Mu unga e al., Cogen Economics & Finance (2021), 9: 2003000
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Page 6 o 15
lnc ¼β0þβ11þ axð Þ þβ2ln pgdpð Þ þβ3in þβ4in þβ5 inno þε (3)
whe e ln, subsc ip and ε a e na u al loga i hms, ime componen s, and e o e ms, espec i ely. β0,
β1, β2, β3, β4 and β5 a e coe icien s o be es ima ed. One (1) is added o independen a iable ax o
es ima e when he ax a io is assumed o be minimum ha is ze o. The na u al loga i hm o he
independen a iable is hen ob ained. This is aking cognizan ha he na u al loga i hm o one is
ze o.
Once Equa ion 3 has been es ima ed o 1970–2018, cu ency demanded can be ob ained,
assuming ha he ax a iable assumes a alue o ze o. The di e ence be ween he cu encies
in he wo models gi es he cu ency ha ci cula es in he in o mal sec o . As discussed in he
analy ical amewo k sec ion, he in o mal sec o ’s size can be es ima ed by ge ing he p oduc o
excess cu ency and eloci y o money.
6.3. Desc ip ion o he a iables, hei measu emen and he expec ed signs
Va iables, desc ip ions, measu emen s, and a p io i expec ed signs a e discussed in Table 1.
Table 1. The a iables de ini ion, measu emen and p io i expec ed signs
The Va iable and
Abb e ia ion
De ini ion and
Measu emen
Uni o Measu emen P io i Expec ed Signs
and Sou ce
Cu ency ou side a bank
a ime (c )
The a iable measu es
he amoun o no es and
coins ci cula ing adjus ed
o in la ion.
KES Dependen Va iable
Pe capi a GDP a ime
(pgdp )
The a iable measu es
indi idual pe son
con ibu ion o he
coun y’s GDP.
KES +G eenidge (2009)
ax a io a ime ( ax ) This measu es incen i e
o pa icipa e in he
in o mal sec o . I is
measu ed as a a io o
ax e enue in GDP.
Ra io +Faal (2003)
Ra e o in e es a ime
(in )
The a iable measu es
he e u ns one ge s by
in es ing money in
in e es yielding bonds.
Pe cen +Faal (2003)
Financial inno a ion a
ime ( inno )
This a iable shows he
s ides made o c ea ing
and making new inancial
ins umen s popula ,
echnology in oduced in
inance, new inancial
ins i u ions and new
inancial ma ke s. I is
measu ed by he a io o
b oad money o na ow
money.
Ra io -Hassan and Schneide
(2016)
In la ion a ime .(in ) The CPI measu es
in la ion. I cap u es
p opo iona e a ia ion in
he cos o ob aining
some speci ied
commodi ies by an
a e age consume du ing
a gi en yea .
Pe cen +G eenidge (2009)
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Page 7 o 15
o employmen o he majo i y o Kenyans. The bes policy should aim a emo ing high ax bu den
ha ac as an incen i e o indi iduals o eso o he in o mal sec o . The adop ion o lowe ax
bu den can g adually in eg a e he in o mal sec o in o he o mal sec o .
Funding
This wo k was unded by A ican Economic Resea ch
Conso ium (AERC) (2019).
Au ho de ails
James Mu unga
1
E-mail: [email p o ec ed]
Moses Kinyanjui Mu ii hi
2
E-mail: [email p o ec ed]
Nelson We e Wawi e
3
E-mail: [email p o ec ed]
1
Tu o ial Fellow, Depa men o Economics, Machakos
Uni e si y, Machakos, Kenya.
2
Senio Lec u e , School o Economics, Uni e si y o
Nai obi, Nai obi.
3
P o esso o Economics, School o Economics, Kenya a
Uni e si y.
Disclosu e s a emen
No po en ial con lic o in e es was epo ed by he
au ho (s).
Ci a ion in o ma ion
Ci e his a icle as: Es ima ing he size o he in o mal
sec o in Kenya, James Mu unga, Moses Kinyanjui Mu ii hi
& Nelson We e Wawi e, Cogen Economics & Finance
(2021), 9: 2003000.
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