Military Expenditures and Shadow Economy in the Central and Eastern Europe: is There a Link?

Abstract

Abstract The main goal of our paper is to determine the existence of a link between government (military) expenditures and the shadow economy in the Central and Eastern European countries, which are the members of the European Union. The empirical investigation is conducted for the years 2003–2015. We show that there is a high statistically significant positive dependence between the size of the shadow economy and military expenditures in the Baltic States. Our conclusion is that higher military expenditures indeed lead to a larger shadow economy and this result is robust to different model specifications. In order to demonstrate the importance of our results, we undertook a simulation, where we calculated how much the size of the shadow economy would increase if the size of military expenditure as a percentage of GDP were to double. For example, in the Czech Republic, such an expansion would have led to an increase in the size of the shadow economy from 11.50% to 12.96%, and in Estonia, from 18.34% to 22.72% in 2012.