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3  THE SIZE OF THE SHADOW ECONOMY AROUND THE WORLD

Source: Own calculation by authors

The results show that the shadow economy in percent of official GDP has on average increased remarkably in all country groupings during the 1990s but also empirical evidence for the hypothesis that highly developed OECD countries and Asian countries typically have lower shadow economies while transition and developing countries have higher shares can be found. A detailed list of the size of the shadow economy for each country over time can be found in Schneider et al. (2004) and Schneider (2005).

Generally the view prevails that the informal sector influences the tax system and its structure, the efficiency of resource allocation between sectors and the official economy as a whole in a dynamic sense. In order to study the effects of the shadow economy on the official sector, several studies integrate underground economies into theoretical and/or empirical macroeconomic models where ambiguous results have been found so far (Adam et al. 1985, Loayza 1996 or Neck et al. 1989).

Further, in the neoclassical view the hidden economy is optimal in the sense that it responds to the economic environment's demand for urban services and small-scale manufacturing. From this point of view the informal sector provides the economy with a dynamic and entrepreneurial spirit that can lead to more competition, higher efficiency and stronger boundaries for government activities. Put it differently, the informal sector may help to create markets, increase financial resources, enhance entrepreneurship and transform the legal, social and economic institutions necessary for accumulation (Asea 1996). It may be such that in highly developed countries people and entrepreneurs are overburdened by taxes and regulation so that a rising shadow economy stimulates the official growth as additional value added is created and additional income earned in the shadow economy is spent in the observed official sector. On the other hand in developing countries a rising shadow economy leads to a considerable erosion of the tax base with the consequence of a lower provision of public infrastructure and basic public services with the final consequence of lower official growth [4]

In order to empirically test the relationship between economic growth, the shadow economy and other possible factors in developing, transition und developed countries a panel data set containing variables[5] that growth theory suggests to be relevant for economic growth (Barro et al. 1995) for 104 countries [6] for the time period from 1990 to 2000 is used. A basic equation with the average annual growth rate of GDP per capita as the dependent variable is estimated and we found a highly interesting and statistically significant influence of the shadow economy on (official) economic growth for the entire sample. In industrialized countries this influence is positive while in developing countries the opposite holds. In particular this means:

• If the shadow economy in industrialized countries rises by 1 percentage point of GDP, official growth increases by 7.7 percent.
  
• In contrast, for developing countries an increase of the shadow economy by 1 percentage point of official GDP is associated with a decrease in the official growth rate by 5.2 percent.

All other variables (except the inflation rate in other countries) have plausible signs and are statistically significant on a 5 percent confidence level (for details see Table 1 in the Appendix).

Further two separate sub-samples of 21 OECD countries and 83 developing/transition countries were estimated because such a splitting up is an additional test of robustness for the findings from the total sample. When one focuses now more narrowly on 21 highly developed OECD countries similar results appear. The trend variable clearly has a negative and statistically significant influence on the official growth rate in OECD countries – a result which is not unusual for 1990s as it reflects the overall poor economic performance of most OECD countries during this period. Again the shadow economy has a positive and statistically significant influence on the official growth rate of GDP per capita in industrialized countries and an increase in the shadow economy by 1 percentage point of official GDP is associated with an increase in the annual GDP growth rate of 7.8 percent. In addition all other variables are statistically significant on a 5 percent confidence level and have plausible signs as theory would suggest (details see Table 2 in the Appendix).

The estimation of a sub-sample consisting of 83 transition and developing countries only also supports the findings from the total sample. Once again an increase of 1 percentage point in the relative size of the shadow economy increases official growth in transition countries by 9.9 percent and decreases growth in developing countries by 4.5 percent. As for other variables the inflation rate in other countries, the capital accumulation rate and foreign direct investment lagged for one period have no statistical significant influence, all other variables have plausible signs and a statistically significant influence (details see Table 3 in the Appendix).

Footnotes