Is there convergence amongst shadow economies? International evidence

Abstract

AbstractThis paper examines convergence among cross‐country shadow economies. Using the Phillips‐Sul (2007, 2009) club convergence approach and data for over 150 countries from 1991 to 2017, the results show evidence against absolute convergence for all shadow economies; however, we find evidence of multiple convergence clubs. In particular, we find evidence for seven distinct convergence clubs and six divergent shadow economies. Each club is characterised by an increasingly larger shadow economy with the countries in club 1 having the largest shadow economy and those in club 7 having the smallest shadow economy. Using a two‐way fixed effects approach, we also find that the determinants of the shadow economy are somewhat conditional on the convergence club. The existence of multiple equilibria suggests that policy makers in their attempt to combat the shadow economy would benefit by considering the different transitional paths associated with the different convergence clubs.