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Does informality hinder financial development convergence?

Author

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  • Sever, Can
  • Yücel, Emekcan

Abstract

This paper sheds light on the role of informal economy, defined as all economic activities that are hidden from official authorities for various reasons, in financial development convergence. Using panel data from 156 countries over the period of 1991–2017, we find that financial development (as measured by credit as share of GDP) tends to converge across countries over time, particularly when informality is lower. As the size of informal economy becomes larger, however, financial development convergence weakens, and eventually can turn out to be divergence. This finding suggests that policies addressing informality can help countries with lower levels of financial development catch up with the countries with more developed financial systems. It also has implications for the evolution of cross-country income differences, considering the role of financial development in economic performance. In the last part of the paper, we find evidence consistent with this. The results show that higher informality is also associated with weaker income convergence across countries over time.

Suggested Citation

  • Sever, Can & Yücel, Emekcan, 2024. "Does informality hinder financial development convergence?," Economic Systems, Elsevier, vol. 48(2).
    • Handle: RePEc:eee:ecosys:v:48:y:2024:i:2:s0939362523001139
    DOI: 10.1016/j.ecosys.2023.101174
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    More about this item

    Keywords

    Financial development; Informality; Shadow economy; Convergence; Banking; Credit; International finance;
    All these keywords.

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • N20 - Economic History - - Financial Markets and Institutions - - - General, International, or Comparative
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • O47 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence

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