Inclusive Growth, Institutions, and the Underground Economy.pdfVIP

WP/12/47 Inclusive Growth, Institutions, and the Underground Economy Anoop Singh, Sonali Jain-Chandra, and Adil Mohommad © 2012 International Monetary Fund WP/ 12/47 IMF Working Paper Asia and Pacific Department Inclusive Growth, Institutions, and the Underground Economy1 Prepared by Anoop Singh, Sonali Jain-Chandra, and Adil Mohommad February 2012 This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. Abstract Worldwide protests against the perceived lack of economic opportunity and failure of governance have refocused attention on the need for inclusive growth and strong institutions. In developing countries, large informal economies limit state capacity to deliver governance and strong institutions, which in turn discourages participation in and expansion of the formal economy. This paper analyzes the determinants of the underground economy, with particular emphasis on the role of institutions and the rule of law. We find that when businesses are faced with onerous regulation, inconsistent enforcement and corruption, they have an incentive to hide their activities in the underground economy. Empirical analysis suggests that institutions are a more important determinant of the size of the underground economy than tax rates. JEL Classification Numbers: O43, H2, H26 Keywords: underground economy, shadow economy, institutions Authors’ E-Mail Addresses:sjainchandra