Analyzing the Determinants of the Shadow Economy With a “Separate Approach”. An Application of the Relationship Between Inequality and the Shadow Economy

This paper suggests a “separate” approach to analyze the determinants of the shadow economy (SE). It is applied to investigate the relationship between inequality and the SE on a cross-section of 118 countries. We disentangle the effect of inequality on the SE ratio by estimating both direct and indirect effects on both the numerator and denominator of the ratio separately. We find that an increase in inequality increases the SE ratio. This positive correlation is primarily due to a reduction in the official GDP rather than an increase in the SE.