Handbook on the Shadow Economy
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Handbook on the Shadow Economy

Edited by Friedrich Schneider

The shadow economy (also known as the black or underground economy) covers a vast array of trade, goods and services that are not part of the official economy of a country. This original and comprehensive Handbook presents the latest research on the size and development of the shadow economy, which remains an integral component of the economies of most developing and many developed countries.
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Chapter 13: The Impact of Institutions on the Shadow Economy and Corruption: A Latent Variables Approach

Axel Dreher, Christos Kotsogiannis and Steve McCorriston


13 The impact of institutions on the shadow economy and corruption: a latent variables approach Axel Dreher, Christos Kotsogiannis and Steve McCorriston 13.1 INTRODUCTION Corruption has always been present in societies, in one form or another.1 It is, in general, a significant contributor to low economic growth, to distortionary investment and provision of public services. As such it increases inequality to such an extent that international organizations have identified it as ‘the single greatest obstacle to economic and social development’ (World Bank, 2001).2 This view is not, however, supported unanimously. Routine corruption may be efficiency enhancing. As Leff (1964, p. 11) puts it: ‘If the government has erred in its decision, the course made possible by corruption may well be the better one’. Corruption may also ‘grease the wheels’ in the rigid public administration, a view that, recently, has been supported empirically in the contributions of Dreher and Gassebner (2007) and Méon and Weill (2008), who provide evidence in favour of the ‘grease the wheels’ hypothesis.3 An important and, up until recently, relatively unexplored element of corruption is its relationship with the shadow economy. Unquestionably, corruption and shadow economy share a common characteristic: they are both, in general, illegal.4 In understanding the relationship of corruption with the shadow economy, it is important to understand what causes the shadow economy. With the risk of over-simplification, two schools of thought can be identified. One school of thought identifies high tax and social security burdens as the principal causes.5 Economic agents,...

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