Insiders, outsiders, and the underground economy

This paper considers whether labour market rigidities lead to more underground economic activities. This is suggested by aggregate cross-country data which show that underground economic activities are more strongly correlated with a commonly used index of employment protection than with effective tax rates. A simple theoretical model is constructed to support this finding. The model, contrary to many models of equilibrium unemployment (in addition to underground economic activities). Finally affect employment, incentives, and underground economic activities.