Using Dynamic Panel Methods to Estimate Shadow Economies Around the World, 1984-2006

The article estimates the size of shadow economy for 111 countries for the years 1984-2006 based on the currency demand approach. An important innovation is our use of dynamic panel data methods, which allows us to make several important contributions. First, we estimate the shadow economy for a range of heterogeneous countries that previously could not be included in the same regression. Second, we include variables that measure institutional quality in countries, including a variable that measures enforcement efforts. Third, we account for the persistence of currency demand as it evolves over time. Our results indicate a substantial shadow economy across countries, ranging from 10 to 86 percent of gross domestic product (GDP), with some tendency to grow over time. We also find that the shadow economy varies significantly by country income group. The mean shadow economy is 17 percent of GDP for Organisation for Economic Co-operation and Development (OECD) countries, 24 percent for non-OECD high-income countries, 33 percent for upper-middle-income countries, 37 percent for lower-middle-income countries, and 38 percent for low-income countries.