The Underground Economy and the Credit Market
21 Pages Posted: 29 Dec 2005
Date Written: December 2005
In this paper we measure the impact of underground activities on financial deepening. Access to external finance requires entrepreneurs to disclose credible information through formal documentation. This may be impossible for many informal producers who lack a proper book-keeping system for their operations. For the same reason irregular workers may find it difficult to borrow in order to finance consumption and house purchases. Using a panel of data on Italian regional credit markets we find a strong negative correlation between outstanding credit to the private sector and the share of irregular employment. According to our estimates, a shift of 1 per cent of employees from regular to irregular work is accompanied by a decline of about 2 percentage points in business lending and of 0.2 percentage points in outstanding credit to households, both expressed as a ratio to GDP. Conversely, the feedback effects from financial deepening to the size of the informal sector are weak and not statistically significant.
Keywords: underground economy, irregular employment, credit markets, bank lending
JEL Classification: G21, O17
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