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Using Dynamic Panel Methods to Estimate Shadow Economies Around the World, 1984–2006

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The article estimates the size of shadow economy for 111 countries for the years 1984–2006 based on the currency demand approach. An important innovation is our use of dynamic panel data methods, which allows us to make several important contributions. First, we estimate the shadow economy for a range of heterogeneous countries that previously could not be included in the same regression. Second, we include variables that measure institutional quality in countries, including a variable that measures enforcement efforts. Third, we account for the persistence of currency demand as it evolves over time. Our results indicate a substantial shadow economy across countries, ranging from 10 to 86 percent of gross domestic product (GDP), with some tendency to grow over time. We also find that the shadow economy varies significantly by country income group. The mean shadow economy is 17 percent of GDP for Organisation for Economic Co-operation and Development (OECD) countries, 24 percent for non-OECD high-income countries, 33 percent for upper-middle-income countries, 37 percent for lower-middle-income countries, and 38 percent for low-income countries.
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... This study is in line with recent studies that have uncovered evidence of widespread informality in Uganda (Esaku, 2021a;Mugoda et al., 2020) and across the world (Medina and Schneider, 2019). A large informal sector has been shown to create a number of challenges to the growth of the formal sector and the economy as a whole (Esaku, 2021b) on account that this sector (informal) undermines governments' fiscal policy targets (Alm and Embaye, 2013;Esaku, 2021i). ...
... The pattern shows that a substantial level of production of goods and services occurs in both the formal and informal sectors of the economy across the world (Medina and Schneider, 2019). In both the developed and developing economies, the size of the shadow economy is relatively large and in many cases its activities go unnoticed because they are quite hidden and difficult to trace (Alm and Embaye, 2013;Buehn and Schneider, 2012a;Esaku, 2021i). Recent estimates of the size of the shadow economy by Medina and Schneider (2019) show that in many countries across the world, informality is still a substantial part of the economy which drives the production and distribution of goods and services. ...
... First, these results seem to suggest that improvement in the state of democracy is important for extending social and economic services to the citizens leading to improvement in their welfare (Teobaldelli and Schneider, 2013). Improvement in welfare reduces the incentive of individuals to operate in the informal economy since the formal sector provides the necessary support needed to operate legally (Alm and Embaye, 2013). This then reduces the size of the shadow economy. ...
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