Labor Institutions and Their Impact on Shadow Economies in Europe

This paper analyzes the role of labor market institutions in explaining developments of shadow economies in European countries. We use several alternative measures of the shadow sector to examine the effects of labor market institutions on shadow sector in two specific regions, the old and the new European Union member states. Comparing alternative measures of the shadow sector allows a more granulated analysis of the effects of labor market institutions. Our results indicate that the one institution that unambiguously increases shadow economy is the strictness of employment protection legislation. Other labor market institutions have less straightforward and statistically robust effects, and their impact often differs in the old and new EU member states.