Abstract
Using panel data for a large cross-country sample, we consider the influences of FDI inflows, inward development aid, and immigration on the informal sector. Both FDI and immigration increase the informal sector, with the effect of immigration being relatively more robust. Aid inflows reduce the informal sector, but the statistical significance is low. Among the control variables, government size persistently increases the informal economy, while inflation sometimes lowers the informal sector. As a secondary exercise, we consider the effect of globalization and note the informality-increasing role of social and overall globalization, with economic and political globalization being statistically insignificant.
Similar content being viewed by others
Notes
Strictly speaking, some AID or FDI might be in-kind, involving some movements of personnel.
An important aspect, although difficult to grapple with both theoretically and empirically, is the dualism between the formal sector and the informal sectors (see Rauch 1991), especially when one examines linkages with foreign countries.
To empirically estimate the size and development of a shadow economy is a very challenging task, as there are no direct observations about shadow economy issues. Surveys about this issue can be found in Feld and Schneider (2010); Schneider and Enste (2000); and Williams and Schneider (2016). In these surveys, the interested reader can evaluate how difficult it is to estimate the shadow economy and what are the strengths and weaknesses of the various approaches involved.
Our selection of control variables is also limited, because the shadow economy variable is not directly observable; it has to be calculated, where direct and indirect tax burden variables, good governance regulation, unemployment, etc., (to cite some important variables), are used to calculate the size of the shadow economy for a country. In order to avoid an identification problem, we cannot use these variables twice.
Another potential issue is the possibility of bi-directional causality between the shadow economy and some of its determinants (see Ali and Bohara 2017; Hassan 2017; Nikopour et al. 2009; Schneider and Enste 2000). With regard to our three focus determinants, FDI, AID and MIG, the possibility of reverse feedback seems relatively more likely with regard to migration - i.e., the presence of shadow economy in a country might induce some migrants in the hope of easy employment entry in the informal sector (see Bacchetta et al. 2009; Banerjee 1983). On the other hand, decisions about FDI or foreign aid seem less likely to be affected by the presence of the informal sector. These aspects are addressed in Section 4.4.
A historical perspective on the development of the informal sector in a few nations is provided by Géidigh et al. (2016).
The prevalence of the shadow economy can also be seen as capturing tax avoidance, although some informal activity may be to avoid stringent regulations.
The migration variable used (MIG) captures net migration per capita (Table 1); however, given the clandestine nature of illegal immigration, reliable and comparable cross-country data on illegal immigration are not available.
One could, alternatively, estimate single-year cross sections. However, that would not provide insights that pooling the dataset provides.
Note that MIG has a fewer number of years of data available than the other variables (Table 1).
A part of the reason for the insignificance of the coefficient on FDI might be the qualitative differences across types of FDI (see Harms and Méon 2018).
A negative effect of democracy on the shadow economy was shown by Schneider and Teobaldelli (2012) in a sample of 56 nations, while a larger sample of nations considered by Goel and Nelson (2016) found the effect to be mixed across alternate measures of the underground sector. Further, the aggregate index of economic freedom might mask certain aspects of economic freedom (e.g., tax complexity, labor market regulations, etc.) that could significantly affect the shadow economy (see Goel and Nelson 2016; Neck et al. 2012).
FDI would also figure in the overall index of globalization – GLOBidx, but its weight is considerably smaller there (see KOF Index of Globalization for details).
In a recent study, Pham (2017) also found informality to be significantly affected by social globalization.
The effects of globalization on the shadow economy are somewhat different from those found by Berdiev and Saunoris (2018) who use a different model, and their data covers a small number of countries over the period 2000–2007.
In particular, a rejection of the null hypothesis of the under-identification test implies that the model is identified, and the weak- and over-identification test results show that the instruments are valid.
We also considered combinations of these instruments along with religious fractionalization (see Roodman 2009). Additional details are available upon request.
An earlier study by Nikopour et al. (2009) notes the two-way causality between FDI and the shadow economy.
Additional details are available upon request.
One could, alternatively, use the highest marginal tax rate as a regressor in place of tax burden. However, given the variance in tax laws and related exemptions across nations, data on international tax rates are not consistently comparable.
Note that since tax burden is a component of economic freedom and that tax burden and government size are related, we dropped EF and GCONS as regressors in Models A.3 and A.4.
References
Alesina A, Devleeschauwer A, Easterly W, Kurlat S, Wacziarg R (2003) Fractionalization. J Econ Growth 8:155–194
Ali M, Bohara AK (2017) How does FDI respond to the size of shadow economy: an empirical analysis under a gravity model setting. Int Econ J 31:159–178
Bacchetta M, Ernst E, Bustamante JP (2009) Globalization and informal jobs in developing countries. International Labour Organization and World Trade Organization. http://www.oecd.org/site/tadicite/48133875.pdf. Accessed August 2017
Banerjee B (1983) The role of the informal sector in the migration process: a test of probabilistic migration models and labour market segmentation for India. Oxf Econ Pap 35:399–422
Berdiev AN, Saunoris JW (2018) Does globalisation affect the shadow economy? World Econ 41:222–241
Buehn A, Schneider F (2012) Shadow economies around the world: novel insights, accepted knowledge, and new estimates. Int Tax Public Financ 19:139–171
Caballe J, Panadés J (1997) Tax evasion and economic growth. Public Finance/Finances Publiques 52:318–340
Cebula RJ (2004) Income tax evasion revisited: the impact of interest rate yields on tax-free municipal bonds. South Econ J 71:418–423
Cebula RJ (2013) New and current evidence on determinants of aggregate federal personal income tax evasion in the United States. Am J Econ Sociol 72:701–731
Dreher A (2006) Does globalization affect growth? Evidence from a new index of globalization. Appl Econ 38:1091–1110
Dreher A, Gaston N, Martens P (2008) Measuring globalisation – gauging its consequences. Springer, New York
Elgin C (2013) Internet usage and the shadow economy: evidence from panel data. Econ Syst 37:111–121
Feld LP, Schneider F (2010) Survey on the shadow economy and undeclared earnings in OECD countries. Ger Econ Rev 11:109–149
Frey BS, Weck-Hanneman H (1984) The hidden economy as an ‘unobserved’ variable. Eur Econ Rev 26:33–53
Friedman E, Johnson S, Kaufmann D, Zoido-Lobaton P (2000) Dodging the grabbing hand: the determinants of unofficial activity in 69 countries. J Public Econ 76:459–493
Géidigh DM, Schneider F, Blum M (2016) Grey matters: Charting the development of the shadow economy. CESifo working paper # 6234, December
Gërxhani K (2004) The informal sector in developed and less developed countries: a literature survey. Public Choice 120:267–300
Giles DEA (1999) Measuring the hidden economy: implications for econometric modelling. Econ J 109:F370–F380
Goel RK (2012) Effects of generic cigarettes on U.S. cigarette demand and smuggling. Econ Lett 115:114–117
Goel RK, Nelson MA (2016) Shining a light on the shadows: identifying robust determinants of the shadow economy. Econ Model 58:351–364
Goel RK, Saunoris JW (2014) Global corruption and the shadow economy: spatial aspects. Public Choice 161:119–139
Goel RK, Saunoris JW (2018) Cigarette smuggling: using the shadow economy or creating its own? J Econ Financ, in press
Gozgor G (2018) Robustness of the KOF index of economic globalisation. World Econ 41:414–430
Harms P, Méon P-G (2018) Good and useless FDI: the growth effects of greenfield investment and mergers and acquisitions. Rev Int Econ 26:37–59
Hassan M (2017) The impact of shadow economy on aid and economic development nexus in Egypt. MPRA paper #80990, August
Hassan M, Schneider F (2016) Size and development of the shadow economies of 157 worldwide countries: updated and new measures from 1999 to 2013. J Glob Econ 4(3). https://doi.org/10.4172/2375-4389.1000218
Kirchgässner G (2016) On estimating the size of the shadow economy. CESifo working paper #5753, February
Neck R, Wächter JU, Schneider F (2012) Tax avoidance versus tax evasion: on some determinants of the shadow economy. Int Tax Public Financ 19:104–117
Nikopour H, Habibullah MS, Schneider F, Law SH (2009) Foreign direct investment and shadow economy: a causality analysis using panel data. MPRA paper #14485, March
Pham THH (2017) Impacts of globalization on the informal sector: empirical evidence from developing countries. Econ Model 62:207–218
Potrafke N (2015) The evidence on globalization. World Econ 38:509–552
Rauch JE (1991) Modelling the informal sector formally. J Dev Econ 35:33–47
Restrepo-Echavarria P (2015) Measuring underground economy can be done, but it is difficult. The Regional Economist, January, 10-11. www.stlouisfed.org
Roodman D (2009) A note on the theme of too many instruments. Oxf Bull Econ Stat 71:135–158
Sandmo A (2005) The theory of tax evasion: a retrospective view. Natl Tax J 53:643–663
Schneider F (2005) Shadow economies around the world: what do we really know? Eur J Polit Econ 21:598–642
Schneider F (ed) (2011) Handbook on the shadow economy. Edward Elgar, Cheltenham
Schneider F (2012) The shadow economy and work in the shadow: what do we (not) know? IZA discussion paper # 6423, March
Schneider F, Buehn A (2013) Estimating the size of the shadow economy: methods, problems and open questions. CESifo working paper #4448, October
Schneider F, Enste DH (2000) Shadow economies: size, causes, and consequences. J Econ Lit 38:77–114
Schneider F, Teobaldelli D (2012) Beyond the veil of ignorance: The influence of direct democracy on the shadow economy. CESifo working paper #3749, February
Skinner J, Slemrod J (1985) An economic perspective on tax evasion. Natl Tax J 38:345–353
Tanzi V (1999) Uses and abuses of estimates of the underground economy. Econ J 109:F338–F347
Williams CC, Schneider F (2016) Measuring the global shadow economy: the prevalence of informal work and labour. Edward Elgar, Cheltenham
Acknowledgment
We thank James Payne, Niklas Potrafke, James Saunoris, anonymous referees and seminar participants at the Western Economics Association International meetings and CNR/ISSM, Napoli for helpful comments and Thuy Dung Ngo and Abenaa Birago for research assistance.
Author information
Authors and Affiliations
Corresponding author
Additional information
Publisher’s note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
Appendix
Appendix
Rights and permissions
About this article
Cite this article
Goel, R.K., Ram, R., Schneider, F. et al. International movements of money and men: impact on the informal economy. J Econ Finan 44, 179–197 (2020). https://doi.org/10.1007/s12197-019-09480-w
Published:
Issue Date:
DOI: https://doi.org/10.1007/s12197-019-09480-w