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Mostafazadeh M, Davoodi P, Arabmazar A, Samsami H. The Effect of Political Stability, Governance Conditions, and Risk on the Formal and Informal Sectors of Iran’s Economy. QJER 2024;
URL: http://ecor.modares.ac.ir/article-18-75243-en.html
URL: http://ecor.modares.ac.ir/article-18-75243-en.html
1- Ph.D. Student in Economics, Faculty of Economic and Political Sciences, Shahid Beheshti University, Tehran, Iran , M_mostafazadeh@sbu.ac.ir
2- Professor, Faculty of Economic and Political Sciences, Shahid Beheshti University, Tehran, Iran
3- Assistant Professor, Faculty of Economic and Political Sciences, Shahid Beheshti University, Tehran, Iran
2- Professor, Faculty of Economic and Political Sciences, Shahid Beheshti University, Tehran, Iran
3- Assistant Professor, Faculty of Economic and Political Sciences, Shahid Beheshti University, Tehran, Iran
Abstract: (146 Views)
Aim and Introduction
Economic and social instability, insecurity, and poor governance significantly increase transaction costs and investment risks while reducing incentives for productive economic activities. Institutional conditions and the political environment are fundamental factors influencing economic growth, as they affect the motivations of economic agents and thereby influence investment decisions, production organization, and overall economic performance. Macroeconomic instability, as an undesirable phenomenon, imposes both economic and social costs on society. Its persistence disturbs the national economic structure and diminishes household welfare by undermining financial security and increasing economic uncertainty.
Furthermore, effective economic policy-making and national development planning require a comprehensive understanding of the economy’s formal and informal sectors. The informal or underground economy includes activities outside the scope of official oversight, such as unregistered income, tax evasion, and operations beyond legal, social, and economic regulations. These activities are typically excluded from official GDP calculations but represent a significant share of economic production.
Modern definitions of economic growth encompass not only increases in GDP but also broader improvements in societal economic well-being. Notably, economic production occurs in both formal and informal sectors; thus, a thorough analysis of both is essential for developing effective and inclusive growth strategies. This study aims to evaluate the influence of political and economic risk, instability, and governance quality on both sectors of Iran’s economy over the period 1370–1401 (1991–2022). To achieve this, relevant indices were constructed to measure risk and instability in economic, financial, and social domains, as well as Iran’s governance performance, with the goal of identifying key determinants of formal sector strengthening and informal sector reduction.
Methodology
This research employs an endogenous growth model to investigate the factors influencing economic growth in Iran. Data on the underground economy are drawn from estimates produced using the Multiple Indicators and Multiple Causes (MIMIC) model. The methodological framework combines econometric techniques, notably Principal Component Analysis (PCA) and the Autoregressive Distributed Lag (ARDL) model.
PCA is applied to construct composite indices where multiple explanatory variables are involved, particularly in capturing instability and governance indicators. ARDL is used to examine relationships among variables, given the mixed order of integration in the time series data. This dual approach enables the study to assess the impact of governance, risk, and economic instability on both the formal and informal economic sectors.
Results and Discussion
The results show that within the economic growth function, property rights and political management exert a positive influence, while economic instability and international sanctions negatively affect Iran’s economic growth. Specifically, an increase of one unit in the political management index results in a 3.0033% increase in economic growth, whereas a one-unit rise in the economic instability index leads to a 0.1935% decline in growth.
In analyzing the informal (underground) economy, the study finds that increased risk and instability, unemployment, government size, tax revenues, and sanctions all contribute to the expansion of the informal sector. Conversely, improvements in political management reduce informal economic activities. Notably, the risk and instability index shows a high impact, with a coefficient of 3.99, signifying its strong correlation with the growth of Iran’s underground economy.
Conclusion
Improved political management enhances formal economic activity while suppressing informal sector expansion. Specifically, advancements in governance indicators—such as political participation, accountability, and rule of law—help reduce the size of the underground economy and promote formal sector growth. On the other hand, economic and social instabilities, including financial market volatility, inflation, speculation, and societal insecurity, incentivize informal economic behavior, thereby undermining the formal structure of the economy.
To address these challenges, the study recommends implementing comprehensive governance and economic reforms. On the governance side, strategies should include corruption control, enhanced oversight, legal enforcement, public trust-building, and increased legitimacy of political institutions. On the economic front, stabilizing inflation, exchange rates, and market speculation—as well as improving social cohesion through targeted policies—can mitigate the growth of informal economic activities. A balanced, multi-pronged approach will foster sustainable economic development and enhance the resilience of Iran’s formal economy.
Economic and social instability, insecurity, and poor governance significantly increase transaction costs and investment risks while reducing incentives for productive economic activities. Institutional conditions and the political environment are fundamental factors influencing economic growth, as they affect the motivations of economic agents and thereby influence investment decisions, production organization, and overall economic performance. Macroeconomic instability, as an undesirable phenomenon, imposes both economic and social costs on society. Its persistence disturbs the national economic structure and diminishes household welfare by undermining financial security and increasing economic uncertainty.
Furthermore, effective economic policy-making and national development planning require a comprehensive understanding of the economy’s formal and informal sectors. The informal or underground economy includes activities outside the scope of official oversight, such as unregistered income, tax evasion, and operations beyond legal, social, and economic regulations. These activities are typically excluded from official GDP calculations but represent a significant share of economic production.
Modern definitions of economic growth encompass not only increases in GDP but also broader improvements in societal economic well-being. Notably, economic production occurs in both formal and informal sectors; thus, a thorough analysis of both is essential for developing effective and inclusive growth strategies. This study aims to evaluate the influence of political and economic risk, instability, and governance quality on both sectors of Iran’s economy over the period 1370–1401 (1991–2022). To achieve this, relevant indices were constructed to measure risk and instability in economic, financial, and social domains, as well as Iran’s governance performance, with the goal of identifying key determinants of formal sector strengthening and informal sector reduction.
Methodology
This research employs an endogenous growth model to investigate the factors influencing economic growth in Iran. Data on the underground economy are drawn from estimates produced using the Multiple Indicators and Multiple Causes (MIMIC) model. The methodological framework combines econometric techniques, notably Principal Component Analysis (PCA) and the Autoregressive Distributed Lag (ARDL) model.
PCA is applied to construct composite indices where multiple explanatory variables are involved, particularly in capturing instability and governance indicators. ARDL is used to examine relationships among variables, given the mixed order of integration in the time series data. This dual approach enables the study to assess the impact of governance, risk, and economic instability on both the formal and informal economic sectors.
Results and Discussion
The results show that within the economic growth function, property rights and political management exert a positive influence, while economic instability and international sanctions negatively affect Iran’s economic growth. Specifically, an increase of one unit in the political management index results in a 3.0033% increase in economic growth, whereas a one-unit rise in the economic instability index leads to a 0.1935% decline in growth.
In analyzing the informal (underground) economy, the study finds that increased risk and instability, unemployment, government size, tax revenues, and sanctions all contribute to the expansion of the informal sector. Conversely, improvements in political management reduce informal economic activities. Notably, the risk and instability index shows a high impact, with a coefficient of 3.99, signifying its strong correlation with the growth of Iran’s underground economy.
Conclusion
Improved political management enhances formal economic activity while suppressing informal sector expansion. Specifically, advancements in governance indicators—such as political participation, accountability, and rule of law—help reduce the size of the underground economy and promote formal sector growth. On the other hand, economic and social instabilities, including financial market volatility, inflation, speculation, and societal insecurity, incentivize informal economic behavior, thereby undermining the formal structure of the economy.
To address these challenges, the study recommends implementing comprehensive governance and economic reforms. On the governance side, strategies should include corruption control, enhanced oversight, legal enforcement, public trust-building, and increased legitimacy of political institutions. On the economic front, stabilizing inflation, exchange rates, and market speculation—as well as improving social cohesion through targeted policies—can mitigate the growth of informal economic activities. A balanced, multi-pronged approach will foster sustainable economic development and enhance the resilience of Iran’s formal economy.
Keywords: Economic growth, Governance institutions, Political management, Risk and instability, Underground economy
Article Type: Original Research |
Subject:
Economic Development and Growth
Received: 2024/05/21 | Accepted: 2024/06/16
Received: 2024/05/21 | Accepted: 2024/06/16
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