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Shadow Economy and Entrepreneurial Entry


  • We have received useful comments from Zoltan Acs, Christopher Gerry, Simon Parker, Paul Reynolds, Karsten Staehr, Mark Schaffer, Jan Svejnar, Utz Weitzel, and participants at the CEAD conference at Imperial College London, the University of Michigan School of Public Policy Conference on Enforcement, the ACE-FEB Workshop in Amsterdam and Tartu University. Any remaining errors are our own. We acknowledge the EU support (Seventh Framework Programme, Grant 225134, Project EAGIS).

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The impact of the shadow economy on entrepreneurial entry across countries is analyzed utilising 1998–2005 individual-level Global Entrepreneurship Monitor data and national macro-economic variables. A simple correlation coefficient suggests a positive relationship between the size of the shadow economy and the likelihood of entrepreneurial entry. However, this masks more complex relationships, if, as argued, the shadow economy is an embedded social phenomenon. With appropriate controls and instrumenting for potential endogeneity, the impact of the shadow economy on entry in a linear specification is found to be negative. Further, there is evidence of a U-shaped relationship: entrepreneurial entry is least likely when the shadow economy amounts to about a quarter of gross domestic product (GDP). At the individual level, an extensive shadow economy has a more negative impact on respondents who are risk averse. In addition, in the economies where property rights are stronger, the negative impact of the shadow economy is weaker.