On the Boundaries of the Shadow Economy: An Empirical Investigation

39 Pages Posted: 8 Aug 2016

See all articles by Eran Manes

Eran Manes

Ben Gurion University of the Negev

Friedrich Schneider

Johannes Kepler University Linz - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Institute for the Study of Labor (IZA)

Anat Tchetchik

Ben-Gurion University of the Negev

Abstract

A large number of empirical studies pointed to the ongoing expansion of the shadow economy in many countries around the globe. A robust finding in these studies is the positive association between unemployment rates and the size of the unofficial sector. However, with consistent estimates of the size of the unofficial sector only available from the late 1980s, a lack of sufficient time span dictated the use of static models, allowing only a limited understanding of its temporal behavior and interdependence with other covariates. In this paper, we offer a first systematic attempt to estimate the dynamics of the shadow economy, using advanced dynamic panel techniques. Based on insights from a simple job search model of unemployment that features decreasing returns to unofficial activities and congestion effects in job searching, we conjecture a long-run equilibrium relationship between unemployment and the size of the shadow economy. Our empirical model lends strong support to this view. We find that in countries with less stringent job market regulation the long-run impact of Unemployment, the tax burden, and GDP on the shadow economy, while positive and significant, is much smaller than in heavily regulated countries Moreover, the speed of adjustment back to long-run equilibrium following temporary shocks is shown to be three times faster in countries with looser job-market regulation, compared with countries with stricter regulation. These findings have important policy implications.

Keywords: shadow economy, boundaries to the shadow economy, unemployment, taxation, regulation

JEL Classification: C32, H11, H26, I2, O17, P16, P48

Suggested Citation

Manes, Eran and Schneider, Friedrich G. and Tchetchik, Anat, On the Boundaries of the Shadow Economy: An Empirical Investigation. IZA Discussion Paper No. 10067, Available at SSRN: https://ssrn.com/abstract=2819348

Eran Manes (Contact Author)

Ben Gurion University of the Negev ( email )

Israel

Friedrich G. Schneider

Johannes Kepler University Linz - Department of Economics ( email )

Altenbergerstrasse 69
A-4040 Linz, 4040
Austria
+43 732 2468 8210 (Phone)
+43 732 2468 8208 (Fax)

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Institute for the Study of Labor (IZA)

P.O. Box 7240
Bonn, D-53072
Germany

Anat Tchetchik

Ben-Gurion University of the Negev ( email )

1 Ben-Gurion Blvd
Beer-Sheba 84105, 84105
Israel

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