The Impact of Competitiveness on the Shadow Economy

The shadow economy absorbs critical resources from the formal economy and to a certain extent impedes the implementation of policies that are necessary for the common good. Its size varies and even exceeds one-fourth of gross domestic product (GDP) in certain European Union (EU) member states. Although some shadow economies may have beneficial effects for some citizens, or even the formal economy of a country, overall the shadow economy harms that country’s competitiveness as it reduces external parties’ trust in that country, and thus their likelihood to cooperate. On the other hand, competitiveness could offer incentives to bring underground operations to the surface and thus fight the undeclared economy. Using appropriate econometric approaches, this study finds evidence that the more competitive a member country of the EU is, with respect to the global competitiveness index, GDP per capita, exports as a percent of GDP and unemployment rate, the smaller its shadow economy (as a percent of GDP) becomes. More precisely, as anticipated, there is a negative relationship between the shadow economy and global competitiveness, GDP per capita and exports. There is a positive relationship between the shadow economy and unemployment. These results could assist relevant authorities in containing the shadow economy by appropriately steering the selected competitiveness drivers of the country.