Measuring the size of the shadow economy using a dynamic general equilibrium model with trends

Abstract

We propose a methodology for measuring the size and properties of the shadow economy. We use a two-sector dynamic deterministic general equilibrium model with four different trends: hours worked, investment-specific productivity, formal productivity, and shadow productivity. We find that the shadow productivity trend is endogenous, in the sense that it is an exact function of model parameters and the other three trends. We also document that, in order to be consistent with observed (real-world) trend growths, the shadow sector needs to exhibit increasing returns to scale, which is contrary to the standard procedure of imposing decreasing returns to this sector. We apply our methodology to a set of seven Latin American and Asian countries and document several empirical regularities that emerge from our analysis, the most important one being that the volatility of shadow sector output is considerably larger than the one in formal sector output.JEL codes: E26, E32, O17.

Measuring the size of the informal tourism economy in Thailand

“…The production technology in the informal sector is given by , where y i , t is the informal output, a i , t is total factor productivity in the informal sector, l i , t is the hours worked in the informal sector and γ measures returns to scale 2 . In assuming that the production technology in the informal sector abstracts from informal capital, the paper stays closer to the literature (Ihrig & Moe, 2004; Solis‐Garcia & Xie, 2018). Moreover, taking into account that the capital data (even for industrialized countries) are very noisy, this assumption simplifies the analysis enormously.…”

“…To rectify these weaknesses, Solomon (2011) uses a dynamic general equilibrium model as a theoretical basis, identifying the causes and indicators in estimating the size of the informal economy. The method of Orsi, Raggi, and Turino (2014) and Solis‐Garcia and Xie (2018) is similar in this vein. In estimating the size of the informal GDP in Thailand, this study follows the approach of Orsi et al (2014) and Solis‐Garcia and Xie (2018).…”

“…The method of Orsi, Raggi, and Turino (2014) and Solis‐Garcia and Xie (2018) is similar in this vein. In estimating the size of the informal GDP in Thailand, this study follows the approach of Orsi et al (2014) and Solis‐Garcia and Xie (2018). Although this study uses a similar estimation method, yet, neither Orsi et al (2014) nor Solis‐Garcia and Xie (2018) provide an estimation of the size of informal economy in Thailand.…”

“…The production technology in the formal sector is given by , where y f , t is the formal GDP, a f , t is total factor productivity in the formal sector, k t is the stock of capital, l f , t is hours‐worked in the formal sector, and α is the share of capital in the formal GDP. As in Orsi et al (2014), Solis‐Garcia and Xie (2018), the government runs a budget in each period 1 . The assumption of a balanced government budget follows much of the macroeconomics literature and greatly simplifies the analysis.…”

“…In estimating the size of the informal GDP in Thailand, this study follows the approach of Orsi et al (2014) and Solis‐Garcia and Xie (2018). Although this study uses a similar estimation method, yet, neither Orsi et al (2014) nor Solis‐Garcia and Xie (2018) provide an estimation of the size of informal economy in Thailand. For comparison purposes, this study also adds the widely used Schneider et al (2010) estimate for Thailand and assesses the model's performance.…”