Black Gold or Black Hole? The Effects of Oil on the Informal Economy

Abstract

Does oil revenue enlarge or diminish the size of a country’s informal economy? I examine the effects of oil revenue on informal economy size for all available countries and by studying the case of Ghana, which had little oil before a large find in 2007. I first construct an estimate of the informal economy using a confirmatory factor analysis modeling approach based on robust model runs and careful theoretical consideration. Then I analyze the domestic determinants of the informal economy and add to the literature by finding that oil revenues do negatively impact a country’s informal economy through the rentier effect channel. This is to say that if taxes go down as a result of oil rents, the informal economy will grow larger. Next, I analyze foreign determinants and find the oil rents have a larger negative impact on the informal economy in countries with lower levels of industrialization. I augment these findings with a case study of Ghana, and use process tracing and qualitative methods to analyze the oil find’s effects on the Western Region. The relationship between a country’s oil rents and its informal economic activity has not been studied to this point, and these results can help policymakers understand and prevent oil rents from creating a larger informal economy. Utilizing exogenous variation in oil revenues, I find strong support for my hypothesis