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Shadow Economy in three very different Mediterranean Countries: France, Spain and Greece. a MIMIC Approach Roberto Dell’Anno†, Miguel Gómez, Angel Alañon Pardo♦ February 2004 Abstract This paper offers estimations of shadow economy in three very different Mediterranean countries: France, Spain and Greece. A multiple indicator and multiple choice model based on the latent variable structural theory has been applied using cointegration techniques to control for stationarity problems. The model includes tax burden (as a whole and decomposed in indirect taxes, direct taxes and social security contributions), regulation, unemployment rate and self-employment as causes of shadow economy and the participation ratio and currency ratio as indicator of the underground economy. Results confirm that unemployment, fiscal burden and self-employment are relevant causes of shadow economy. The level of GDP per head and political stability may also be important causes of hidden economy. Keywords: Shadow Economy, Structural Equation Model, JEL Classification: O17, C39, H26. † Dipartimento di Scienze Economiche e Statistiche, Università degli Studi di Salerno, Via Ponte Don Melillo, 84084 Fisciano (Sa) – Italy; e-mail: [email protected] Departamento de Economía Aplicada VI Facultad de Ciencias Económicas y Empresariales, Universidad Complutense de Madrid – Spain; e-mail: [email protected] ♦ Departamento de Economía Aplicada I Facultad de Ciencias Económicas y Empresariales, Universidad Complutense de Madrid – Spain; e-mail: [email protected] 1 Introduction The effects of the existence of shadow economy are numerous and relevant, it determines a very important loss in public revenues, misleading official indicators (growth, income distribution etc…), changes in individual incentives and factors remuneration etc. That is the reason why interest in shadow economy, both from an academic and a political point of view, has grown exponentially in OCDE countries during last decades. Whereas most researches are devoted to a pool of countries or to a single country1, in this paper we estimate the determinants of shadow economy in three countries which share very important cultural roots, but which recent economic performance is very different: France, Spain and Greece. The methods usually applied to estimate shadow economy can be classified into direct or indirect approaches. Direct methods are based on contacts with or observations of persons and/or firms, to gather direct information about not declared income. There are two kinds: (1) the auditing of tax returns and (2) the questionnaire surveys. Indirect methods try to determine the size of hidden economy, by measuring the “traces” it leaves in the official statistics. They are often called “indicator” approaches and use mainly macroeconomics data. This kind of methods include six categories: (1) Discrepancy between national expenditure and income statistics; (2) The discrepancy between the official and actual statistics of labour force; (3) The transaction approach; (4) The currency demand (or cash-deposit ratio) approach; (5) The physical input (e.g. electricity) method; (6) The model approach or MIMIC (Multiple Indicator and Multiple Choice) method. In this paper the MIMIC approach is applied for estimating the evolution of shadow economy in three Mediterranean countries. The model approach is based on the statistical theory of latent variables, which considers several causes and several indicators of the hidden economy. The model approach or MIMIC approach considers the dimension of the hidden economy like a “latent variable”, therefore it applies the statistical modelling, namely Structural Equation Modelling (SEM), usually utilised by social research (psychology, sociology, marketing, etc.) to explore unobservable variables like attitudes, personality, belief, satisfying, etc. The paper is organised as follows. In section 2 SEM is presented and MIMIC method is analysed, in section 3 the specification of the models and the structural relationships between causes and indicators are discussed, for being identified and estimated in section 4. Results are presented in section 5, and finally, the main conclusions are presented in section 6. Five statistical appendixes are supplied. 1 See Schneider (1997) or Tedds (1998). -2- 2 The Structural Equation Approach and Shadow Economy The Structural Equation Model (SEM) are statistical relationships among latent (unobserved) and manifest (observed) variables. It implies a structure of the empirical covariance matrix2 which, once the parameters have been estimated, can be compared to the resulting model-implied covariance matrix. If both matrices are consistent, then the structural equation model can be considered as a likely explanation for the relations among the examined variables. The structural equation models are “regression equations with less restrictive assumptions that allow measurement error in the explanatory as well as the dependent variables”3. So this method is theoretically superior than regression analysis as it explores all information contained in the covariance matrix and not only in the variance, and also because it allows variables to be measured with error, but compared with regression and factor analysis, SEM is a relatively unknown tool in economics4. In this paper, one special case of SEM is applied, the Multiple Indicators and Multiple Causes model5. The first to consider the size of hidden economy as an “unobservable variable” were Frey and Weck-Hanneman (1984), they introduced the MIMIC model of Zellner (1970), Goldberger (1972), Jöreskog and Goldberger (1975) and others in this field6. This kinds of models is composed by two sort of equations, the structural one and the measurement equations system. The equation that captures the relationships among the latent variable (η) and the causes (Xq) is named “structural model” and the equations that links indicators (Yp) with the latent variable (underground economy) is called the “measurement model”. So the shadow economy (η) is linearly determined, subject to a disturbance ζ, by a set of observable exogenous causes x1, x2, … , xq : 1 x1 2 x2 .... q xq (1) Hence an alternative name for this field is "analysis of covariance structures". Bollen K.A. (1989), pp. v. 4 Just to cite the most comprehensive discussions of its applications: for the sociology: Bielby and Hauser (1977), for the psychology: Bentler (1986), for the economics: Goldberg (1972), Aigner et al. (1984) and for an overview about SEM: Hayduk (1987), Bollen (1989), Hoyle (1995), Maruyama (1997), Byrne (1998). 5It is a member of the LISREL “Linear Interdependent Structural Relationships” family of models (see Jöreskog and Sörbom, 1993) An analytical derivation of MIMIC method is exposed in appendix B. 6 Following Frey and Weck-Hanneman’s, other economists have used this approach for their statistical analysis of the “unofficial” economy: Aigner, Schneider and Ghosh (1988), Helberger and Knepel (1988), Loayza (1996), Pozo (1996), Giles (1995, 1998, 1999a 1999b), Tedds (1998), Eilat and Zinnes (2000)6, Salisu (2000)6, Cassar (2001), Prokhorov (2001), Giles and Tedds (2002), Chatterjee, Chaudhuri and Schneider (2003), Dell’Anno (2003), Dell’Anno, Schneider (2003), Alañón y Gómez-Antonio(2003). 2 3 -3- The latent variable (η) determines, linearly, subject to a disturbances ε1, ε2, … , εp, a set of observable endogenous indicators y1, y2, … , yp : y1 1 1 , y2 2 2 , .... , y p p p . (2) The structural disturbance ζ, and measurement errors ε are all normal distributed, mutually independent and all variables are taken to have expectation zero. Considering the vectors: x’ = (x1, x2, … , xq) observable exogenous causes γ’ = (γ1, γ 2,.. , γ q) structural parameters (Structural Model) y’ = (y1, y2, … , yp) observable endogenous indicators λ’ = (λ1, λ 2,.. , λ p) structural parameters (Measurement Model) ε’ = (ε1, ε2,..., εp) measurement errors υ = (υ 1, υ 2,..., υ p) standard deviations of the ε’s The (1) and (2) are wrote as: x (3) y (4) by assuming E 0 and defining E 2 2 and E 2 , where is diagonal (pxp) matrix with , displayed on its diagonal7. The model can be solved for the reduced form as function of observable variables: y x x v (5) the reduced form coefficient matrix and disturbance vector are respectively: , and v . In the standard MIMIC model the measurement errors are assumed to be independent of each other, but this restriction could be relaxed. (see Stapleton D.C. 1978, pp. 53). The assumption on independence between structural disturbance ζ, and measurement errors ε is central to the reliability of estimates. Unluckily, the SEM packages, do not perform this kind of test. Hayduk (1987) explains it“…is purely a matter of arbitrary convention”7 and is possible through a model re-parameterisation to test this assumption. An attempt to tests the hypothesis of independence between structural and measurement errors, is supplied in Dell’Anno (2003). In our analysis, greater number of models estimated, the covariance among the indicators is often not statistically different from zero. Yet, in the models where this assumption is relaxed the changes in the estimates of structural coefficients are slightness, therefore the standard restriction is hold in order to have more degrees of freedom. 7 -4- Therefore, the covariance matrix (model-implied) is obtained: ˆ E(vv) 2 2 . (6) To facilitate the identification of SEM some conditions are available but, unfortunately, none of these are necessary and sufficient conditions (Bollen, 1989). Especially in the case of this work the following restrictions are respected: The necessary (but not sufficient) condition, so-called t-rule, enunciates that the number of nonredundant elements in the covariance matrix of the observed variables must be greater or equal to the number of unknown parameters in the model-implied covariance matrix8. A sufficient (but not necessary) condition of identification, is that the number of indicators is two or greater and the number of causes is one or more, provided that is assigned a scale to (MIMIC rule). For assigning a scale to the latent variable it is needed to fix one λ parameter to an exogenous value. Although several econometric improvements are introduced in the last years9, in our opinion, the most important criticism to the MIMIC method is the strong dependence of the outcomes by the (exogenous) choice of the coefficient of scale (λ). The criticism rises against the difficulty to assign a “exact” size to the values of structural parameters10. We have that ˆq q* 11 , where ˆq indicate the estimated coefficients, and q* are the “not-definite-scale” coefficients. This could be clearer by means of a comparison to the classic linear regression. In the Structural Equation Approach the estimated coefficients are not calculated in order to minimize the differences between estimated series and the observed one (as in the linear regression by the OLS), but to duplicate the implicit covariance matrix. The different estimation strategy and the necessity to choice an exogenous value (λ11) to identify the system, produce often estimated coefficients that make hard to calculate a (realistic) index of the hidden economy as ratio to the Official GDP, because numerator and denominator have different unit of measure. In our case, for instance, the causes variables are measured as ratio, while the indicators are measured as monetary quantities. In conclusion, as Giles and Tedds (2002) state: the model approach is a work in progress and supplementary improvements are “not only possible but necessary”. That is the reason why we do not estimate real values of underground economy as a percentage of GDP Bollen K.A. (1989), pp. 93. More clearly, the number of observed variances and covariances must be equal to or greater than the number of parameters to be estimated (including variance of latent factor, variances of disturbances, covariances among observed variables, etc.). 9 See Dell’Anno (2003) for more details. 10 The size of variability and the relative estimates (but not t-value) of the determinants of hidden economy are proportional to the λ that have been fixed exogenously. 8 -5- and we only offer an index that reports the evolution of shadow economy in the three countries. We think this is of sufficient interests as we can derive policy implications about the results of the fight against shadow economy in these countries during the period analyzed (1968-2004). 3 Theoretical background behind the choice of variables In this section we expose the theoretical model applied to estimate underground economy taking into account that as Duncan (1975) points out: “The meaning of the latent variable depends completely on how correctly, precisely and comprehensively the causal and indicator variables correspond to the intended semantic content of the latent variable”11, likewise Thomas (1992) we think that the choice of variables the only real limit of this approach. As we mentioned before this kind of models are determined by several causes of the latent variable and several indicators. 3.1 Explanatory variables (Causes) a) Tax burden In literature the most popular determinant of tax evasion is fiscal burden. The common hypothesis is that an increase of tax burden furnishes a strong incentive to work in the unofficial market, so a positive sign for the parameter associate to this variable is expected. In all MIMIC applications this variable is included as a cause of underground economy and always a strong (direct) effect on the shadow economy, is confirmed. In the econometric framework, tax burden is measured by means of the total share of total taxes in gross domestic product. This indicator has been also decomposed into different partial proxies like direct, indirect taxes and social contributions, as a percentage of gross domestic product, in order to test if all components of tax burden has the same effects on shadow economy. The theoretical analysis tell us that direct taxes and social contributions are more visible than indirect taxes, because indirect taxes suffers from fiscal illusion Therefore a positive sign in all the indicators of tax burden is expected but a greater one in the direct ones. We also want to determine if the effects of each fiscal component differs or have the same importance in the three countries analysed. 11 Duncan O. D. (1975), pp. 149, cited in Giles D.E.A., Tedds L.M. (2002), pp. 103. -6- b) Employment of the Government on Labour Force We introduce this variable in order to take into account the degree of regulation in the economy. The expected sign for this indicator is ambiguous. Some authors find a negative sign arguing that, in some sectors, the presence of the state could disincentive people to incorporate in the shadow economy. Other papers find a positive relation, arguing that we are capturing the degree of regulation in the economy, so the most regulated the economy is, firms find more incentive to develop their activities in the underground economy. Following Aigner et al. (1988), we think that a rise in the size of public sector, and/or the degree of regulation of the economic system, gives a relevant incentive to enter in the informal economy. Therefore, an eventual positive sign of this coefficient will support the hypothesis that “more State” in the market, and subsequently an increase in regulation, gives an incentive to operate in the unofficial economy, and a negative sign will support the hypothesis that a greater presence of state in some activities disincentive people to evade taxes. c) Unemployment rate As Giles and Tedds (2002) state, there are two antagonistic forces which determine the relationship between unemployment rate and shadow economy. By one side an increase in unemployment could imply a decrease in the black economy as underground economy could be positively related to the growth rate of GDP and the latter is negatively correlated to unemployment. On the other side some “official” unemployed spend a part of their time working in the black economy12, thus we may find a positive correlation. Tanzi (1999) writes that “…the relation between the shadow economy and the unemployment rate is ambiguous”13. He remarks that the labor force of hidden economy is composed by very heterogeneous people: unemployed and non official labor force (retired people, illegal immigrants, minors or housewives) and, furthermore, there are people who have at the same time an official and unofficial job14. In this sense, the official unemployment rate is weakly correlated with the shadow economy. In the same work, Tanzi states that “...for OECD countries there seems to be a broad relation between the panel data of the size of underground economy and the official unemployment rates”15. Giles D.E.A., Tedds L.M. (2002), pp. 127. Tanzi V. (1999), pp. 341. 14 Tanzi V. (1999), pp. 343. 15 Tanzi V. (1999), pp. 343 12 13 -7- Therefore, economic theory does not give a clue to determine whether the expected sign of this variable is positive or negative, it has to be solved by the empirical analysis in each country. d) Self-employment The rate of self-employment as a percentage of the labor force is considered as a determinant of informal economy. According to Bordignon and Zanardi (1997) the significant diffusion of small firms and the large proportion of professionals and self-employed respect to the total workforce are important characteristics that justify higher level of the Shadow Economy. This kind or workers have more possibilities to evade as they usually have greater number of deductions in base and deductions in quote in personal income taxes. They are also very close to the customers so they can collude with them and evade in indirect taxes. Finally, these people have the possibility to employ irregular workers, because they do not have the same internal and external auditing control than bigger firms. Therefore, ceteris paribus, the higher the rate of self-employed the larger the shadow economy would be. 3.2 Indicators As we argued in previous paragraphs the model approach is superior from a theoretical point of view than other indirect methods because it combines much more information than the others, in this case three indicators at a time are introduced instead of only one as the other indirect methods do. a) Real Gross Domestic Product (variable of scale) As have been mentioned previously in the MIMIC approach we need to fix a scale variable to estimate the rest of the parameters as a function of this scale variable. The value of fix parameter is arbitrary, but using a positive (or negative) unit value is easier to find out the relative magnitude of the other indicator variables16. The choice of the ‘sign’ of coefficient of scale (λ11) is based on theoretical and empirical arguments. In the literature there is no agreement about the effects of the shadow economy on economic growth. On the one hand Adam, Ginsburgh (1985), Tedds (1998), Giles (199b), Giles, Tedds (2002), Chatterjee, Chaudhuri, Schneider (2003) and Alañón y Gómez-Antonio (2003), estimate a positive relationship between official and unofficial economy. And on the other hand Frey and Weck-Hannemann (1984), Loayza (1996), Kaufmann and Kaliberda (1996), Eilat and Zinnes (2000), Dell’Anno (2003), Dell’Anno, Schneider (2003) 16 “For instance if the estimate of one of the other elements of λ is 3, then the corresponding indicator variable is 3 times as important as the variable that is the basis for normalization.” Giles D.E.A., Tedds L.M. (2002), pp. 109. -8- find an inverse relationship between these variables. In this work the second hypothesis is held, meaning that there is a flow of resources from legal to underground economy. That means that many activities goes underground when we are in the recession part of the cycle. b) Participation Ratio of the Labour Force Some authors have estimated the size of the Hidden Economy from changes in the labour force participation rate. A decline in this rate over time or a low rate relative to those in comparable economies may reflect a movement of the workforce from the measured economy into hidden activities. The labour force participation rate is calculated as the ratio between labour force total (LF) / the total working age (15-64 years old), and the expected sign for this variables is theoretically ambiguous. The literature does not agree on whether or not changes in this rate reflect changes in the hidden economy. There is, however, a tendency to conclude that people do not withdraw from the measured labour market in order to participate in the hidden economy. There is evidence that much unrecorded economy activity is undertaken by members of the measured workforce. Following Schneider and Bajada (2003), it is possible that the participation rate as well as the number of hours worked may be unaffected by shadow economy activity if such activities are undertaken after hours or on weekends when individuals are not working in the legitimate economy. However, we include this variable as indicator in order determine empirically if there is a flow of resources between official and underground economy. If we find a positive sign it means that official workers are not incorporating to shadow economy in recession cycles and a negative sign would mean that there is a flow of worker from official to shadow economy. Therefore, the participation ratio is considered a weak indicator for the Shadow Economy. Anyway, in the cases where this indicator is excluded by the estimation method (MIMIC 5-1-2, 4-1-2, 3-1-2, etc.) the estimated coefficients are very similar (to the MIMIC 5-1-3, 4-1-3, 3-1-3, etc.). c) Currency in circulation outside of banks This indicator is the basis of the monetary approach to estimate the size of shadow economy activities. Its use is based on the assumption that irregular transactions are only paid by cash instead of by check or credit card in order to circumvent the auditing controls. Hence, if this -9- assumption is accepted, it is possible to estimate the hidden economy by comparing the actual demand for cash with the demand that could be expected if there were no shadow economy, and the expected sign is positive. In the estimated models the ratio between the time series (seasonally adjusted) of the aggregate M1 and M3 is utilized. 4. Model Identification and estimates of the Shadow Economy The identification procedure starts from the most general specification (MIMIC 6-1-2) and continues leaving out the variables which have not structural parameters statistically significant17 (Graph 1). Graph 1: MIMIC 6-1-3 X1 +γ11 X2 Real GDP pro-capita +γ21 Y1 -1 X3 +γ31 Shadow Econ. X4 X5 +γ41 λ12 Partecipatio Ratio of Labour Force Y2 +γ51 λ13 Currency ratio Y3 +γ61 X6 A relevant point, often undervalued in the previous analyses of shadow economy with SEM, is the detection of multivariate normality. This assumption is central to preserve the 17 The SEM permits to consider and estimate the correlations between the X-variables. In my analysis as expected is statistically different from zero the correlation between tax burden and government consumption. - 10 - statistical properties of estimators, as well as the “chi-square” tests used to evaluate the fit of models with the dataset. This choice is based on: the statistical significativity of parameters, the parsimony of specification, the p-value of “chi-square” and the Root Mean Square Error of Approximation (RMSEA) test. The models are not multinormally distributed, therefore regarding the selection of the kind of estimators, it is risky (but inevitable) to apply the Maximum Likelihood Estimator. When the variables are not (multivariately) normally distributed, then it is possible for maximum likelihood estimators, to produce biased standard errors and an illbehaved “chi-square” test of overall model fit. To determine whether multivariate nonnormality is present, Mardia’s test (1970)18 is used. It is important to highlight that, the maximum likelihood estimations, are quite robust to several types of violations of multivariate normality19. Given an unacceptable level of non normality, we have some possible corrections. Among these, Bollen (1989) suggests to employ another estimator that, in spite of the nonnormality, keeps the asymptotic efficiency, for instance the Generalized (or Weighted) least squares estimator. This strategy is not available in our analysis because the GLS requires a very large sample. For the analysis of the Mediterranean Shadow economy a different strategy proposed by Bollen is followed, consisting in transforming the time series in order to solve both the non-stationarity and non-multi-normality altogether. Table 1, 2(a), 2(b) and 2(c), reports the estimates of several specifications for the French, Spanish and Greek informal economy are presented. First, in table 1, a general model which includes 4 cause variables (Tax burden, Unemployment, Self employment and Employment of government) and 3 indicator variables (Real GDP, Currency and the Participation ratio of labor force) is estimated for every country. For the French case all the causal variables included are significant but public employment ratio, indicating that this variable is not capturing the grade of regulation in the economy. The sign of the unemployment rate is positive, indicating that there is a flow of resources from official to shadow economy in recession cycles. When the fiscal burden is decompose20 only the direct fiscal burden is significant, in table 2(a) it can be seen how the influence of tax burden in French shadow economy is due to direct taxation, since nor social security contributions neither indirect taxes coefficients are significant. The indicator of labor force participation became also significant and positive, indicating that there is not a flow of This test is performed by PRELIS 2.53. It is a computer software that accompanies LISREL 8.53 and performs normality diagnostics. It provides measures of univariate and multivariate skewness and kurtosis. In addition, a test “chi-square” can be used to check whether there is statistically significant difference from multivariate normality. 19 Jaccard J., Wan C.K. (1996), pp. 75. 20 From all the presented models, the selected one appears always at the end raw of each table, that is F8 for France, S11 for Spain and G10 for Greece. 18 - 11 - resources between official economy and hidden economy. The self employment variable is always significant in all the models and with a positive sign acting a one of the main causes of shadow economy in this country. For the Spanish case the results in table 1 all the variables have the expected sign by the theory and the unemployment causal variable present a positive sign according with the negative one obtained by the indicator labor participation rate. That means that in Spain many workers from the official economy go underground when they are laid off. As can be seen in table 2(b) direct taxation is not an important cause of hidden economy in Spain, whereas social security contributions and indirect taxation coefficients are significant. The rest of causes of hidden economy in Spain are the employment of the government, with a positive sign meaning that this causal variable is acting as a good proxy of the grade of regulation in the economy. A surprising thing in this model is the non significance of self employed variable in explaining the shadow economy because it is thought that for the Spanish Economy most of the underground activities are developed by this collective. Unlike French and Spanish cases fiscal burden, as a whole, is not significant for the Greek case (table 1). Anyway when this variable is decomposed into direct taxation, indirect taxation and social security contributions only the latter are significant in most of models. The best Greek model in terms of fit is g10, where only social security contributions, unemployment rate and self employed causal variables are significant. These results could reflect that Greek regulations and tax burden are weaker than in the Spanish an the French cases, since neither direct an indirect taxation nor employment of the government are relevant causes of shadow economy. However these results, though statistically significant, should be interpreted carefully. It is due to the unexpected negative sign of currency in circulation indicator variable. According to our theoretical assumptions most of hidden economy actors prefer paying in cash better than using credit cards of other means of payment which are more transparent to fiscal authorities. Therefore shadow economy and currency in circulation should be positively correlated. - 12 - Table 1: Output LISREL - Coefficients and Tests – FRANCE-SPAIN-GREECE Particip. Currency RMSEA Tax Employ Self Chi-square Multi Models1 Unemploy. ratio L.F. (pDf5 Burden Governm. employment (p-value)2 Normal value)3 0,44* 0,53 1,16* 2,74* -2,59 17,60 42,14 0,16 F1: MIMIC 4-1-3 0,000 (2,48) (0,41) (3,73) (5,21) (-1,10) 1,42 (0,00012) (0,0011) 0,52* 2,07* 1,03* 0,15 -33,18* -8,96 13,11 0,0 S1: MIMIC 4-1-3 0,000 (3,17) (4,26) (6,99) (0,65) (-5,00) (0,68) (0,52) (0,69) -0,09 -2,68* 0,86* 0,83* 66,41* -40,92* 43,89 0,17 G1: MIMIC 4-1-3 0,000 (-1,15) (-2,84) (2,73) (2,65) (3,19) (-2,29) (0,00) (,00063) Models1 Direct Tax 0,89* (3,05) 0,88* F3:MIMIC 5-1-3 (3,19) 0,75* F4:MIMIC 4-1-3 (2,80) 0,80* F5:MIMIC 5-1-2 (2,81) 0,79* F6:MIMIC 4-1-2 (2,82) 0,63* F7:MIMIC 3-1-2 (2,34) 0,80* F8:MIMIC 3-1-3 (2,98) F2:MIMIC 6-1-3 Table 2 (a): Output LISREL - Coefficients and Tests - FRANCE Partp. Social Sec.Indirect Employ. Unempl. Self Chi-square Ratio Currency Contr. Tax Govern. rate Employ. (p-value)2 L.F. 0,54 -0,05 -1,58 1,30* 2,49* 2,86 4,26 44,47 (1,62) (-0,14) (-1,25) (4,35) (4,89) (1,04) (0,64) (0,007) 0,53 -1,52 1,28* 2,52* 2,74 3,17 43,49 -(1,62) (-1,20) (4,28) (4,93) (0,98) (0,53) (0,001) -1,25 1,40* 2,45* 2,96 4,04 43,33 --(-0,99) (4,71) (4,75) (1,04) (0,60) (0,000) 0,53 0,16 1,30* 2,67* 22,56 10,67* --(1,58) (0,12) (4,24) (5,15) (1,72) (0,638) 0,54 1,31* 2,64* 22,58 4,93* ---(1,64) (4,62) (5,37) (1,71) (0,840) 1,47* 2,54* 22,27 4,68* ----(5,35) (5,11) (1,64) (0,456) 0,91 1,31* 2,73* 0,50 16,76* ---(1,90) (4,89) (5,61) (0,22) (0,053) For notes 1,2,3,4,5 see table 2 (c) RMSEA Multi (p Normal Df5 value)3 .4 0,107 0,000 24 (0,040) 0,129 0,000 19 (0,009) 0,173 0,000 13 (0,000) 0,000* 0,000 13 (0,780) 0,000* 0,000 9 (0,910) 0,000* 0,000 5 (0,560) 0,105* 0,000 9 (0,120) Table 2 (b): Output LISREL - Coefficients and Tests - SPAIN Models1 Direct Tax Social Sec.Indirect Contr. Tax S2:MIMIC 6-1-3 -0,54 (-1,63) 0,77* (2,18) 0,93* (3,22) 0,90* (3,17) 0,72* (2,01) 0,62 (1,64) S3:MIMIC 5-1-3 -S4:MIMIC 4-1-3 -S5:MIMIC 6-1-2 -0,56 (-1,66) S6:MIMIC 5-1-2 -S7:MIMIC 4-1-2 -0,50 (-1,44) S8:MIMIC 4-1-2 -S9:MIMIC 5-1-2 -S10: MIMIC 5-1-2 S11: MIMIC 4-1-2 0,08 (0,31) -- -0,62 (1,60) 0,93* (3,20) 0,89* (3,03) 0,90* (2,97) For notes 1,2,3,4,5 see table 1 (c) 0,64 (1,78) 0,59* (2,03) 0,61* (2,12) 0,59 (1,61) 0,57 (1,43) 0,64 (1,75) -0,60* (2,02) 0,62* (2,11) 0,62* (1,99) Particip. RMSEA Multi Employ. Unempl. Self Chi-square ratio L.F. Currency (pNormal Df5 Govern. rate Employ. (p-value)2 3 value) .4 1,47* 1,08* 0,48 0,12 -1,33* 58,80 0,136 0,000 24 (2,75) (7,97) (1,76) (1,24) (-4,33) (0,000) (0,002) 1,99* 0,98* 0,18 -34,14* -1.00 14,66* 0,000* 0,000 20 (4,27) (6,84) (0,84) (-5,02) (-0,08) (0,795) (0,91) 1,96* 0,97* -35,05* -1,23 11,48* 0,000* -0,001 14 (4,21) (6,70) (-5,01) (-0,09) (0,648) (0,79) 1,28* 1,03* 0,49 -6,79* 12,86* 0,000* -0,000 17 (2,37) (7,61) (1,76) (-4,55) (0,746) (0,870) 1,43* 1,09* 0,54 --8,60 3,14* 0,000* 0,000 14 (2,41) (7,02) (1,79) (-0,67) (0,999) (1,00) 1,28* 1,03* -6,07* 10,99* 0,053* --0,000 10 (2,31) (7,36) (-4,47) (0,276) (0,420) 1,52* 1,08* 0,60* -9,39 1,60* 0,000* -0,000 9 (2,52) (6,92) (1,97) (-0,73) (O,997) (1,000) 1,99* 0,98* 0,18 -34,13* 4,95* 0,000 -0,000 14 (4,24) (6,80) (0,83) (4,97) (0,987) (0,990) 1,95* 0,98* -34,92* 2,40* 0,000* --0,000 14 (4,18) (6,67) (-4,96) (1,000) (1,000) 1,95* 0,97* -35,05* 3,68* 0,000* --0,001 10 (3,99) (6,57) (-5,27) (0,961) (0,980) Table 2 (c): Output LISREL - Coefficients and Tests - GREECE Models 1 G2:MIMIC 6-1-3 Direct Tax Social Sec.Indirect Contr. Tax 0,14 (1,18) 0,59 (1,96) 0,67* (2,12) G3:MIMIC 5-1-3 -G4:MIMIC 4-1-3 -- -- 0,08 (0,55) 1,04* G6:MIMIC 6-1-2 (2,04) 0,79* (2,11) 3,83* (3,48) 3.94* (3,59) 3,72* (3,39) 3,97* (3,65) 4,01* (3,69) G5:MIMIC 5-1-3 G7:MIMIC 5-1-2 -0,99 (1,96) 0,93 G9:MIMIC 4-1-2 (1,84) G10: -MIMIC 3-1-2 G8:MIMIC 5-1-2 -0,39* (-2,57) -0,38* (-2,56) -0,39* (-2,50) -0,30 (0,71) 0,21 (0,51) ---- Partecip. RMSEA Multi Employ. Unempl. Self Chi-square ratio L.F. Currency (pNormal Df5 Govern. Rate Employ. (p-value)2 3 value) .4 -2,65* 0,81* 0,97* 67,56* -42,10* 55,88 0,114 0,000 28 (-2,94) (2,78) (2,88) (3,24) (-2,30) (0,001) (0,013) -2,77* 0,81* 0,95* 65,79* -42,29* 47,56 0,135 0,000 20 (-3,00) (2,80) (2,91) (2,30) (-2,31) (0,000) (0,005) -2,56* 0,87* 0,89* 68,54* -39,90* 27,78 0,114* 0,000 14 (-2,87) (2,80) (2,78) (3,19) (-2,28) (0,015) (0,053) -2,99* 0,82* 0,98* 60,86* -39,23* 53,30 0,148 0,000 20 (-3,06) (2,76) (2,89) (3,43) (-2,30) (0,000) (0,001) 1,82 2,51* 1,50* -20,34* 16,74* 0,000* -0,000 20 (1,07) (3,68) (2,13) (-2,38) (0,670) (0,830) 1,55 2,55* 1,38* -26,67* 11,24* 0,000* -0,000 14 (0,91) (3,73) (2,02) (-2,98) (0,667) (0,810) 1,98 2,67* 1,64* -21,04* 15,06* 0,007* -0,000 15 (1,16) (3,99) (2,36) (-2,45) (0,447) (0,63) 2,19* 1,32* -20,49* 14,70* 0,091* --0,000 9 (4,03) (2,03) (-2,35) (0,995) (0,190) 2,24* 1,21 -25,70* 4,49* 0,000* --0,000 5 (4,08) (1,91) (-2,82) (0,482) (0,590) Notes: t-statistic are given in parentheses. * Means |t-statistic|>1,96. 1 The Estimation procedure presents for some MIMIC specifications of the French and Spanish shadow economy convergence problems. For Lisrel users, the matrix PSI is not positive definite. Anyway, in the case in which exists the inverse of matrix PSI (e.g. MIMIC 5-1-2, etc.) the estimates of the coefficients are very alike to the others models. 2 If the structural equation model is correct and the population parameters are known, then the matrix S (sample covariance matrix) will equal to Σ(θ) (model-implied covariance matrix) therefore the perfect fitting correspond to p-value=0,000. This test has a statistical validity if there are large sample and multinormal distributions. 3 p-value for Test of Close Fit (RMSEA < 0,05) 4 Is reported the output of PRELIS 2.53: Test of Multivariate Normality for Continuous Variables, p-value of skewness and kurtosis (Mardia, 1970). D’agostino (1986, pp. 391) recommends N > 100 for this test. In our case the sample is approximately eighty for this, the results should be interpreted cautiously. 5 The degrees of freedom are determined by 0,5(p+q)(p+q+1)-t, where “p” is the number of indicators, “q” the number of causes and “t” is the number of free parameters. 5 Results Once the models have been selected and identified, an index of shadow economy can be constructed. The index of shadow economy is estimated by equation (5), the structural coefficients are multiplied for the “filtered” data for stationary 21, therefore the latent variable is estimated in the same transformation of independent variables (first difference): ˆ ˆ11 X 1 ˆ12 X 2 ˆ13 X 3 ˆ14 X 4 ˆ15 X 5 ˆ16 X 6 (5) Graphs 2, 3 and 4 show the evolution of shadow economy indexes for France, Spain and Greece respectively. Whereas in the French case Shadow economy index follows a decreasing path, the Spanish and Greece ones are rising. This difference may be due to the level of development of these economies, since richer economies may have less incentives or chances to go underground than the less developed ones. Allthough we have focused on fiscal burden as one of the main causes of shadow economy, economic agents in a less developed country with non progressive taxes and soft regulations could also have stronger incentives to join underground such as low incomes and not enough provision of public goods and services. Sectoral composition of labour force also helps to explain differences in shadow economy behaviour according to the level of economic development, since agriculture and related sectors employ a high share of non declared workers. Whereas the participation of labour force in agriculture in the french and in the spanish cases is low, in Greece it still accounts for a half. As it is shown in table 3, the differences in gross domestic product per head betwen France, decreasing shadow economy path, and Greece and Spain, rising shadow economy paths, are very significant over the period of time analysed. However this hypothesis is only tentative since further research is nedded to test it. It also can be noted that the evolution of shadow economy is more volatile and abrupter in Greece than in Spain or in France. One possible reason which could explain part of this volatile behaviour is the low level of political stability of Greece over the period, above all, if it is compared to France. This hypothesis needs to be tested by futher research again. Graph 2 Shadow Economy Index: France 21 Cointegration analysis is carried out in appendix C - 18 - - 19 - Graph 4 Shadow Economy Index: Greece 2002s1 2000s1 1998s1 1996s1 1994s1 1992s1 1990s1 1988s1 1986s1 1984s1 1982s1 1980s1 1978s1 1976s1 1974s1 1972s1 1970s1 1968s1 index Shadow Economy Graph 3 Shadow Economy Index: Spain 2002s1 2000s1 1998s1 1996s1 1994s1 1992s1 1990s1 1988s1 1986s1 1984s1 1982s1 1980s1 1978s1 1976s1 1974s1 1972s1 1970s1 1968s1 index Shadow Economy 2002s1 2000s1 1998s1 1996s1 1994s1 1992s1 1990s1 1988s1 1986s1 1984s1 1982s1 1980s1 1978s1 1976s1 1974s1 1972s1 1970s1 1968s1 index Shadow Economy Table 3 Gross domestic product per head at current market prices and pps; relative level EU-15=100. France Spain Greece 1967-76 108 75 65 1977-86 109 73 67 1987-91 107 75 59 1992-96 105 79 64 2002 103 84 67 Source: EC Economic Data pocket book, (7-8, 2003) European Communities 2003, Luxembourg Successively, the index may be converted in a “level” time series. In order to obtain the actual values of the underground economy in term of official GDP, a priori known value is required. As discussed at the end of section 2 we think more reasonable showing only the evolution of shadow economy indexes, since graphs of shadow economy as a percentage of GDP may be misleading 6 Conclusions In this paper we have estimate MIMIC models to explain shadow economy evolution in France, Spain and Greece, using cointegration techniques to control for stationarity problems The main conclusion that can be drawn are the following: 1) Unemployment appears as one of the main causes for the existence of shadow economy. This indicator presents a positive sign in all the models and for all the countries. This aspect is very important if we have into account that these workers suppose a double cost for the state. - 20 - In one hand they receive monetary perceptions from state and in the other hand the state is losing the taxes they should be paying for their incomes. 2) There is a positive relationship between size economy and the self employment indicator. It reflects that this collective is one of the main contributors to the existence of shadow economy irrespective of GDP per head of the economy. 3) Social contributions are a significant cause of shadow economy for the three countries. So, job market regulations becomes a common cause of shadow economy in Spain, Greece an France. 4) In Spain indirect taxes are the main fiscal determinants for the appearance of shadow economy, by contrast in France direct taxes are the main contributors to the existence of shadow economy and we find no evidence in Greece. So we can conclude that the more developed the fiscal system is and the bigger is the growth in a country it seems that agents perceive clearer the taxes paid and try to evade in different kind of taxes. 5) The level of development of a country, measured in terms of gross domestic per head, and of political stability seems plausible explanations of shadow economy. Low incomes per head, and non enough provision of public good and services (education, health, security, etc) may foster the need of additional and non declared sources of income. 6) Greek results, although statistically significant, should be interpreted with caution, due to unexpected sign of currency indicator variable. - 21 - References Adam Markus, Ginsburgh C. Victor (1985). The Effects of Irregular Markets on Macroeconomic Policy: Some Estimates for Belgium. European Economic Review, 29/1, pp. 15-33. 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Estimation of regression relationships containing unobservable variables, International Economic Review, 11, pp. 441-454. Appendix A – Sources of Data – Appendix B – Analysis of Normality – Appendix C – Analysis of Non-Stationarity – - 26 - Appendix A - Sources of data – Var. CAUSES X1 X2 X3 X4 X5 X6 Sources OECD – Outlook. Social Security Contributions received OECD by Government /GDP Outlook. OECD Total Indirect Tax/GDP Outlook. OECD Self Employment/Labour Force Outlook. OECD Unemployment rate Outlook. Government Employment /Labour OECD Force Outlook. Total Direct Tax/GDP Economic Economic Economic Economic Economic Economic Transf. Used1 Annotations Δ(X1) - Δ(X2) Social security contributions /GDP Δ(X3) - Δ(X4) - Δ(X5) - ΔLN(X6) - INDICATORS Y1 Y2 Y3 Real Gross Domestic Product pro- OECD capita Outlook. OECD Participation ratio of Labour Force Outlook Currency ratio (M1/M3) OECD Outlook - Economic - Economic – Notes: (p-value are calculated on transformed data). 1 “Δ” means first difference, “LN” means natural logarithm. Economic ΔLN(Y1) [GDP market price value /deflator of GDP]/ Population in working age (15¬64 years old) ΔΔ(Y2) The frequency is modified from monthly to half-annual. There are missing values from 1965 to 1980 and from 1998 to 2003. For Greece the missing values are from 1965 to 1980 and from to 2000 to 2003. Money supply M1 -SA/Money supply M3 -SA Appendix B -Analysis of Normality - The following tables present the tests of Normality (Univariate) of the most general model estimated: the MIMIC 6-1-3. For the tests of multivariate normality distribution, the results are reported in tables 2(a), 2(b) and 2(c). The sample size is about 79. Causes Δ[Direct Tax/GDP] Δ[Indirect Tax/GDP] Δ[Social S. Contr./GDP] Δ[Empl.Gov./Lab. For. ] Δ[Unemployment rate] Δ[Self Empl./Lab. For. ] Indicators Δ LN[Real GDP pro capita] Δ Δ [Curr. ratio (M1/M3)]a Δ[Part. ratio Lab. Force] France 0,000 0,000 0,000 0,548 0,860 0,000 Spain 0,000 0,146 0,001 0,126 0,145 0,001 Greece 0,185 0,052 0,080 0,000 0,000 0,000 0,000 0,067 0,029 0,484 0,763 0,233 0,112 0,038b 0,000 Notes: a p-value of the Jarque-Bera Test. This test is used instead of Skewness and Kurtosis test because PRELIS does not perform normality test for the sample size smaller then 51 observtions. To obtain J-B test has been used Eviews 4.1. b The trasformation is the first difference. - 28 - Appendix C - Analysis of Non-Stationarity – In this appendix, the tests to detect the order of integration in the time series are shown. Pioneer to tackle the problem of non-stationary in the MIMIC models has been Giles (1995). To find out the unit roots, the Augmented Dickey-Fuller (ADF) Test and the Philliphs-Perron (PP) Test are used, to choose a number of lags sufficient to remove serial correlation in the residuals, are applied the the Schwarz information criterion. In the following tables the p-value of over mentioned tests are reported, the null hypothesis is the presence of unit root, therefore a value larger than 0,05 means non-stationary time series. The plot graphs relate to raw data, the econometric software Eviews 4.1 is used in order to carry out this analysis. As Giles and Tedds (2002) point out the more appropriate way “…to consider the nonstationary is consider the possibility of cointegration. Unfortunately, there is no established literature to serve as a guide to this procedure in the context of the MIMIC model”. France – Variable Include in equat. Causes Direct Tax/GDP Empl.Gov./Lab. For. Indirect Tax/GDP Self Empl./Lab. For. Unemployment rate Social S. Contr./GDP - 29 - T&C T&C C T&C T&C T&C Level First difference Second difference ADF P.P. ADF P.P. ADF P.P. 0,957 0,999 0,008 0,817 0,969 0,983 0,579 0,999 0,099 0,889 0,980 0,994 0,018 0,000 0,029 0,000 0,001 0,000 0,000 0,009 0,000 0,000 0,011 0,001 0,016 0,001 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,000 Include in equat. Variable Indicators Real GDP pro capita Curr. ratio (M1/M3) Part. ratio Lab. Force T&C T&C T&C Level First difference Second difference First differ. LogN ADF P.P. ADF P.P. ADF P.P. ADF P.P. 0,529 0,031 0,422 0,485 0,986 0,970 0,000 0,104 0,000 0,000 0,221 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,084 -- 0,000 0,1961 -- – Spain – Variable Include in equat. Causes Direct Tax/GDP Empl.Gov./Lab. For. Indirect Tax/GDP Self Empl./Lab. For. Unemployment rate Social S. Contr./GDP - 30 - T&C T&C T&C T&C T&C T&C Level First difference Second difference ADF P.P. ADF P.P. ADF P.P. 0,919 0,989 0,736 0,780 0,642 0,378 0,935 0,969 0,857 0,780 0,897 0,690 0,019 0,000 0,000 0,000 0,084 0,026 0,000 0,000 0,000 0,000 0,069 0,005 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,000 0,000 Variable Include in equat. Indicators Real GDP pro capita Curr. ratio (M1/M3) Part. ratio Lab. Force - 31 - T&C C T&C Level First difference Second difference First differ. LogN ADF P.P. ADF P.P. ADF P.P. ADF P.P. 0,677 0,106 1,000 0,823 0,256 1,000 0,042 0,120 0,002 0,042 0,298 0,002 0,000 0,000 0,000 0,000 0,000 0,000 0,054 --- 0,051 -- Greece Include in equat. Variabile Causes Direct Tax/GDP Empl.Gov./Lab. For. Indirect Tax/GDP Self Empl./Lab. For. Unemployment rate Social S. Contr./GDP Variabile Include in equat. Indicators Real GDP pro capita Curr. ratio (M1/M3) Part. ratio Lab. Force - 32 - T&C T&C C T&C T&C T&C T&C T&C T&C Level First difference Second difference ADF P.P. ADF P.P. ADF P.P. 0,004 0,927 0,066 0,001 0,146 0,075 0,605 0,895 0,552 0,311 0,422 0,155 0,258 0,001 0,031 0,005 0,056 0,002 0,000 0,061 0,033 0,000 0,146 0,099 0,545 0,000 0,000 0,000 0,000 0,002 0,000 0,000 0,000 0,000 0,000 0,000 Level First difference Second difference First differ. LogN ADF P.P. ADF P.P. ADF P.P. ADF P.P. 0,130 0,129 0,572 0,683 0,003 0,228 0,378 0,054 0,001 0,035 0,003 0,002 0,000 0,000 0,000 0,000 0,000 0,000 0,457 --- 0,047 ---