Wednesday, November 7, 2012

What drives the size of the shadow economy?

Why is the size of the informal sector larger in some countries than others? While it is easy to think what can drive off formal activities is easy, quantifying the contribution of each is difficult, foremost because we do not have much information about the informal sector, it is escaping the vigilance of the government, after all.

Friedrich Schneider and Andreas Buehn have a go at it. Schneider has made a living in computing and improving proxies for the size of the informal sector. They use his latest estimates for 39 OECD countries and regresses them on various indicators. While one may have doubts about the power of such estimates given the small sample lengths and the obvious uncertainty about the validity of the data, especially in a time series, one can still learn a few things, hopefully. In order of importance, these are the major factors for informality: indirect taxes, self-employment, unemployment, income tax and tax morale. But beyond doubts about sample size and degrees of freedom (what fixed factors are used in the panel regressions?), I am mostly concerned that the informality proxy used here (MIMIC) is constructed with some of the very variables (or close correlates) that are used in the regressions of the paper, namely the tax burden. I would have expected that you would use a different measure in this context, like a survey-based one or currency demand. Or used a different method than plain old OLS.

1 comment:

Anonymous said...

Another paper with a somewhat larger dataset is here