Explaining the Shadow Economy in Europe

Abstract

This paper examines the drivers, and reestimates the size of shadow economies in Europe, with a focus on the emerging economies, and recommends policies to increase formality. The size of shadow economies declined across Europe in recent years but remains significant, especially in Eastern Europe. In the emerging European economies, the key determinants of shadow economy size are regulatory quality, government effectiveness, and human capital. The paper argues that a comprehensive package of reforms, focused on country-specific drivers, is needed to successfully combat the shadow economy. The menu of policies most relevant for Europe’s emerging economies include: reducing regulatory and administrative burdens, promoting transparency and improving government effectiveness, as well as improving tax compliance, automating procedures, and promoting electronic payments.

Wage regulations and shadow economy in 28 European Countries

“…In other words, only the slight difference in relation between regulations and different methods of calculated shadow economy was noticed. In case of calculation of shadow economy made by Kelmanson et al (2019), the relationship amounted to 0.3349 in 2013 and 0.3474 in 2016. In case of estimations performed by Medina & Schneider (2019), connection between two areas was quantified on 0.3609 in 2013 and 0.3387 in 2016.…”

“…Because of the challenge of observation, the sphere which is intentionally hidden, different estimations of shadow economy were used (table 1). First estimation performed by Schneider (2016), second one by Medina & Schneider (2019) and third one by Kelmanson et al (2019).…”

Republic of North Macedonia

“…1 This note was prepared by Louise Rabier (IMF Brussels Office). It builds on previous work by the North Macedonia team on the informal sector and a recent cross-country study by Kelmanson et al (2019). Informality is considered as the largest obstacle by a third of firms according to the World Bank Enterprise Surveys (see Text Figure 2).…”

“…Estimates run from 10 to 45 percent of GDP, depending on the definition of the shadow economy and methodology employed. A recent IMF study (Kelmanson et al, 2019) estimates the share of the informal economy in North Macedonia at 38 percent in 2016 (Text Figure 1). Accordingly, informal employment is also frequent.…”

“…3 Throughout this report, North Macedonia will be compared to other Western Balkan economies (Albania, Bosnia and Herzegovina, Kosovo, Montenegro, and Serbia), and new EU member states, who joined after 2004. Source: IMF staff estimates (Kelmanson et al, 2019). Western Balkans in yellow.…”