Economic Fluctuations and the shadow Economy: A global study

Abstract The recent economic crisis re-emphasizes the importance of the economic fluctuations. This study investigates the role of shadow economy in combination with economic factors on the economic instability for 133 economies between 1991 and 2015. Using the system-GMM estimations, this article shows that a larger shadow economy increases the fluctuations of GDP growth rate in relation to the size and the volatility of shadow economy. Notably, the shadow economy presents an inverted-U relationship with economic instability and this relationship is strongest for low- and lower-middle income economies. Our results identify two categories of drivers for economic fluctuations: the stabilizing factors (the labour force and the TFP) and the enhancing factors (capital investment, consumption, government spending, trade and FDI inflows). Interestingly exports increase economic fluctuations while imports decrease them. Finally, we discuss differences in the determinants of economic instability across low, middle and high incomes countries.