Re-evaluating the Malaysian shadow economy: evidence from public expenditure patterns

Amera Mohammed Ahmed Amer, Awadh Ahmed Mohammed Gamal, Norasibah Abdul Jalil, Gan Pei-Tha, Zainzam Zakariya and Mohammed Umar

Journal of Financial Crime, 2025, vol. 32, issue 4, 950-969

Abstract: Purpose - While financial crime theory posits that systemic vulnerabilities in fiscal governance enable illicit enrichment, prior studies disproportionately attribute shadow economy (SE) growth to tax burdens. This study aims to re-evaluate Malaysia’s SE (1970–2022) through a financial crime lens, arguing that inflated public expenditure (PE) fosters institutionalized fraud, where officials exploit fiscal expenditures to obtain illicit incomes. Design/methodology/approach - Using a modified Pickhardt−Pons currency demand approach (CDA), this study integrates Gregory-Hansen cointegration and autoregressive distributed lag bounds testing to quantify SE size amid structural breaks. Findings - Results reveal SE averages 24.2% of gross domestic product (RM117.42bn), peaking during PE spikes related to infrastructure booms and opaque tendering processes. This aligns with institutional anomie theory, where Malaysia’s growth-centric bureaucracy diverting PE into informal networks. Unlike tax-centric models, the PE framework exposes how SE actors exploit lax oversight in high-spending environments to legitimize illicit flows. The findings counter traditional tax-burden narratives, showing that variability in SE are primarily driven by PE growth rather than by taxation. Originality/value - This study reinterprets the SE in Malaysia by focusing on the misuse of public expenditure rather than tax evasion. Grounded in financial crime theory, it reveals how weak enforcement and political incentives contribute to the persistence of informal activities. The analysis shifts attention from traditional tax-based explanations to institutional vulnerabilities that enable financial misconduct. By highlighting these dynamics, the research offers valuable insights for policy reform. It supports anti-corruption strategies focused on improving transparency in public procurement and strengthening expenditure audits, rather than relying on tax increases to control SE growth.

Keywords: Shadow economy; Financial criminological theory; Currency demand function; Public expenditure; Malaysia; C22; E41; K42; O17 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jfcpps:jfc-08-2024-0246

DOI: 10.1108/JFC-08-2024-0246

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