When ‘uncertainty’ becomes ‘unknown’: Influences of economic uncertainty on the shadow economy

Abstract

The literature has documented the negative impacts of economic uncertainty on output, investment and employment; however, no current study considers the influence of economic uncertainty on the informal sectors. This study investigates the effects of both the level and volatility of economic uncertainty on the shadow economy, through a global sample. Various econometrical techniques and estimation strategies are applied to panel data of 116 countries from 2002 to 2015, and show three interesting findings. First, increases in both the level and volatility of economic uncertainty are found to increase the size of the shadow economy. These effects are documented consistently over the long-term. Second, the impact of volatility is dominant over the impact of the level of economic uncertainty in increasing the size of the shadow economy. Third, the effects of economic uncertainty in increasing the size of the shadow economy are strong in low- and lower-middle-income economies, but less so in upper-middle-income economies, particularly in high-income economies.