Robust determinants of the shadow economy

Abstract

This study examines the determinants of the shadow economy by employing Bayesian Model Averaging technique, which allows taking into account model uncertainty. Having estimated millions of combinations of models, the study revealed that while higher GDP growth rate, trade openness, and better institutional quality lead to the reduction of the informal sector, higher rate of unemployment, complicated regulations, and the large size of government are associated with a greater size of the shadow economy. Lessening bureaucratic complexity by eliminating burdensome regulations could help to reduce both wasteful spending of government on operating these regulations and the size of the underground economy.