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The Influence of Economic Freedom on the Shadow Economy in Developed and Developing Countries

  • Andreas Freytag EMAIL logo , Friedrich Schneider and Sebastian E. Spiegel
Published/Copyright: September 16, 2022
The Economists’ Voice
From the journal The Economists’ Voice Volume 19 Issue 2

Abstract

We empirically analyze to what extent economic freedom can explain the size and development of the shadow economy in OECD and other European countries. We econometrically examine the relation between a change of the overall index of economic freedom and the change of the shadow economy. We undertake an econometric panel estimation of 141 countries over the period 2000–2007. Our results demonstrate that first, the higher the economic freedom, the lower is the shadow economy. This holds especially for the index-sub-component legal structure and security of property rights. The sub-component freedom to trade internationally provides further support for this relation, limited to cases of positive changes of economic freedom. Second, the effects are asymmetrically, they are stronger when economic freedom increases than in the case of a decrease.

Keywords: shadow economy; economic freedom; economic policy
JEL Classification: O17; P16; H11; H26
Corresponding author: Andreas Freytag, Department of Economics, Friedrich-Schiller University Jena, Carl-Zeiss-Str. 3, D-07743 Jena, Germany; and University of Stellenbosch, Stellenbosch, South Africa, E-mail:

Appendix

List of Countries

Albania, Algeria, Angola, Argentina, Armenia, Australia, Austria, Azerbaijan, Bahamas, Bahrain, Bangladesh, Belgium, Belize, Benin, Bolivia, Bosnia and Herzegovina, Botswana, Brazil, Bulgaria, Burkina Faso, Burundi, Cambodia, Cameroon, Canada, Central Afr. Rep., Chad, Chile, China, Colombia, Congo Dem. R., Congo Rep. Of, Costa Rica, Cote d’Ivoire, Croatia, Cyprus, Czech Rep., Denmark, Dominican Rep., Ecuador, Egypt, El Salvador, Estonia, Ethiopia, Fiji, Finland, France, Gabon, Georgia, Germany, Ghana, Greece, Guatemala, Guinea-Bissau, Guyana, Haiti, Honduras, Hong Kong, Hungary, Iceland, India, Indonesia, Iran, Ireland, Israel, Italy, Jamaica, Japan, Jordan, Kazakhstan, Kenya, Korea South, Kuwait, Kyrgyz Republic, Latvia, Lesotho, Lithuania, Luxembourg, Macedonia, Madagascar, Malawi, Malaysia, Mali, Malta, Mauritania, Mauritius, Mexico, Moldova, Mongolia, Morocco, Mozambique, Myanmar, Namibia, Nepal, Netherlands, New Zealand, Nicaragua, Niger, Nigeria, Norway, Oman, Pakistan, Panama, Pap. New Guinea, Paraguay, Peru, Philippines, Poland, Portugal, Qatar, Romania, Russia, Rwanda, Saudi Arabia, Senegal, Sierra Leone, Singapore, Slovak Rep, Slovenia, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Syria, Taiwan, Tanzania, Thailand, Togo, Trinidad & Tobago, Tunisia, Turkey, Uganda, Ukraine, United Arab Emirates. United Kingdom, United States, Uruguay, Venezuela, Vietnam, Zambia, Zimbabwe.

Tables and Figures

Table A1:

Descriptive statistics.

Variable Obs Mean Std. Dev. Min Max
d_shadow 969 −0.319195 0.6029738 −2.7 6.1
d_EcFreedom 854 0.0388056 0.219421 −1.14 0.92
d_1SizeGovernment 854 0.0798244 0.5140254 −2.28 3.92
d_2LegalStructure PropertyRights 854 0.0011475 0.4317611 −2.43 1.76
d_3AccessSoundMoney 854 0.0664286 0.4896749 −2.44 3.09
d_4TradeFreedom 847 −0.012314 0.3421208 −3.5 2.65
d_5Regulation 854 0.0563466 0.4218577 −1.67 2.02
Table A2:

Relation between changes in the shadow economy and changes in economic freedom (sub-index 2: legal structure and property rights); all countries.

Estimation d_Shadow
L.d_2LegalStructure PropertyRights −0.220**
(−2.20)
L.Inter_a2 −0.124
(−0.56)
Constant −0.348***
(−10.63)
Observations 719
Adjusted R 2 0.050
AIC 1088.0
BIC 1097.2

  1. t statistics in parentheses. *p < 0.10, ** p < 0.05, *** p < 0.01.

Table A3:

Relation between changes in the shadow economy and changes in economic freedom; different groups of countries.

Estimation All countries OECD DCs EU 27
L.d_ECFREEDOM −0.0180 −0.0438 0.0267 −0.0598
(−0.11) (−0.42) (0.11) (−0.36)
L.Inter −0.621* −0.432** −0.745* −0.333
(−1.86) (−2.44) (−1.69) (−1.08)
Constant −0.365*** −0.193*** −0.440*** −0.235***
(−14.22) (−16.27) (−11.46) (−9.72)
Observations 719 204 441 162
Adjusted R 2 0.014 0.062 0.012 0.031
AIC 1114.9 −178.3 876.6 −117.4
BIC 1124.1 −171.7 884.8 −111.2

  1. t statistics in parentheses. *p < 0.10, ** p < 0.05, *** p < 0.01.

Table A4:

Relation between changes in the shadow economy and changes in economic freedom (sub-index 1 size of government); different groups of countries.

Estimation All countries OECD DCs EU 27
L.d_1SizeGovernment −0.0794** −0.0147 −0.0998* 0.0177
(−2.20) (−0.55) (−1.95) (0.54)
L.Inter_a1 0.267** −0.115 0.349** −0.101
(2.25) (−1.16) (2.46) (−1.17)
Constant −0.289*** −0.176*** −0.331*** −0.232***
(−19.21) (−18.45) (−15.39) (−21.44)
Observations 719 204 441 162
Adjusted R 2 0.003 0.006 0.004 −0.007
AIC 1122.8 −166.6 880.5 −111.2
BIC 1131.9 −159.9 888.6 −105.1

  1. t statistics in parentheses. * p < 0.10, ** p < 0.05, *** p < 0.01.

Table A5:

Relation between changes in the shadow economy and changes in economic freedom (sub-index 3 access to sound money); different groups of countries.

Estimation All countries OECD DCs EU 27
L.d_3AccessSoundMoney 0.239** 0.0823 0.370** 0.0142
(2.23) (0.84) (2.19) (0.33)
L.Inter_a3 −0.198 −0.0258 −0.380 0.119
(−0.94) (−0.13) (−1.35) (0.60)
Constant −0.364*** −0.176*** −0.457*** −0.218***
(−12.62) (−13.38) (−9.73) (−18.67)
Observations 719 204 441 162
Adjusted R 2 0.022 0.004 0.030 −0.006
AIC 1109.1 −166.0 868.5 −111.4
BIC 1118.3 −159.4 876.7 −105.2

  1. t statistics in parentheses. * p < 0.10, ** p < 0.05, *** p < 0.01.

Table A6:

Sources of included datasets.

Data Source
Shadow economy Schneider, Buehn, and Motenegro (2010)
Economic freedom Gwartney, Lawson, and Hall (2011)

Figure A1: Fitted (pluses) versus real (circles) values of the estimation depicted in estimation 8 restricted to OECD countries.
Figure A1:

Fitted (pluses) versus real (circles) values of the estimation depicted in estimation 8 restricted to OECD countries.

Figure A2: Fitted (pluses) versus real (circles) values of the estimation depicted in estimation 9 restricted to OECD countries.
Figure A2:

Fitted (pluses) versus real (circles) values of the estimation depicted in estimation 9 restricted to OECD countries.

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Received: 2022-05-04
Accepted: 2022-06-29
Published Online: 2022-09-16

© 2022 Walter de Gruyter GmbH, Berlin/Boston

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  10. The Influence of Economic Freedom on the Shadow Economy in Developed and Developing Countries
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  15. Green Finance and the EU-Taxonomy for Sustainable Activities: Why Using More Direct Environmental Policy Tools Is Preferable
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https://doi.org/10.1515/ev-2022-0008
Keywords for this article
shadow economy; economic freedom; economic policy

Articles in the same Issue

  1. Frontmatter
  2. Editorial
  3. The Economists’ Voice, December Issue 2022, Editorial
  4. Policy Papers
  5. Sanctions are Costly for Citizens but Beneficial for Autocrats: A Political-Economic Perspective
  6. The New Advocacy for Autarky: Self-Sufficiency is Now Once Again Becoming Popular for Geopolitical Reasons
  7. Policy Rules Consistent with the FOMC’s Longer-Run Goals and Monetary Policy Strategy
  8. Monetary Policy Normalization and Central Bank Profits: A Break-Even Point Perspective
  9. Does Financial Dominance Explain the Recent Rise in Inflation?
  10. The Influence of Economic Freedom on the Shadow Economy in Developed and Developing Countries
  11. Policy Forum
  12. EU Green Taxonomy Data – A First Vendor Survey
  13. EU Taxonomy: Mission Impossible
  14. Will the EU Taxonomy Impact the Trade Specialisation of European Economies?
  15. Green Finance and the EU-Taxonomy for Sustainable Activities: Why Using More Direct Environmental Policy Tools Is Preferable
  16. EU Taxonomy and ECB Monetary Policy: Moving Towards Centrally-Directed Green Capital Allocation?
  17. The EU Taxonomy’s (Potential) Effects on the Banking Sector and Bank Lending to Firms
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