The Shadow Economy in International Comparison: Options for Economic Policy Derived from an OECD Panel Analysis

Abstract

Building on new behavioral theories, using a data set of about 450 variables and augmenting the Sala-i-Martin definition of robustness, we find evidence in support of the hypothesis that the standard causes of the shadow economy (SE), taxes, the administrative burden and labor market regulations, are not per se crucial in determining the size of the SE. Many of the robust influences emanate from relatively new theories such as elements of direct democracy, social interaction effects, and happiness, and from the institutional literature on the relative importance of specific institutions for economic performance. Most of them can well be affected by governments. Hence, if one believes the SE to be a problem in high income industrial countries, governments could address it through many ways, including their own behavior. And these could be more successful than a strategy built on more government control, increased punishment and less freedom, as adopted by some OECD countries. Simulations of the size of the SE demonstrate their sensitivity to the required velocity assumption and show that previous estimates, including those of the so-called Mimic model, appear to be based on very high velocity assumptions. A moderate velocity assumption yields macro estimates of the SE consistent with the micro evidence, i.e. not more than a few percent of official GDP. Finally, for the first time, we separate the relatively large ‘crime-related’ shadow activity from the ‘non-criminal’ one.