Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/145201
Authors: 
Manes, Eran
Schneider, Friedrich
Tchetchik, Anat
Year of Publication: 
2016
Series/Report no.: 
IZA Discussion Papers 10067
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.
Subjects: 
shadow economy
boundaries to the shadow economy
unemployment
taxation
regulation
JEL: 
C32
H11
H26
I2
O17
P16
P48
Document Type: 
Working Paper

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