The nexus between unemployment rate and shadow economy: A comparative analysis of developed and developing countries using a simultaneous-equation model

This paper studies the effects and causal links between the shadow economy and the unemployment rate using a dynamic simultaneous-equation panel data model for 38 developing and 40 developed countries over the 2000−2015 period. The analysis suggests that there is a unidirectional and negative causality running from the unemployment rate to the shadow economy in the developing countries. However, in the developed countries, there is a bidirectional and negative causal relationship between the shadow economy and unemployment rate. The sensitivity of the results makes the authors realize that institutional quality interacts strongly with the relationship between the shadow economy and the unemployment rate. In countries with a good institutional quality, the unemployment rate is associated with a weak informal economy, whereas in countries with low institutional quality, it strongly drives the informal economy.