Is GDP more volatile in developing countries after taking the shadow economy into account? Evidence from Latin America

Solis-Garcia, Mario and Xie, Yingtong (2017): Is GDP more volatile in developing countries after taking the shadow economy into account? Evidence from Latin America.

Abstract

Why is GDP more volatile in developing countries? In this paper we propose an explanation that can account for the substantial differences in the volatility of measured real GDP per capita between developing and developed countries. Our explanation involves the often overlooked fact that developing economies have a sizable shadow economy. We build a two-sector model that distinguishes between measured (formal) and total (formal and shadow) outputs; using data from Latin America, our model results suggest that developing and developed economies are fairly similar in terms of the volatility of total real GDP. We also document an apparent puzzle, in that the model suggests that the volatility of the size of the shadow economy should be substantially larger than what is observed in the real world. We believe that this may be indicative of frictions that prevent agents from optimally moving between the formal and shadow economies.

• Item Type: MPRA Paper
• Language: English
• Keywords: shadow economy, business cycles, DSGE models, Bayesian estimation
• Subjects: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E26 - Informal Economy ; Underground Economy; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O17 - Formal and Informal Sectors ; Shadow Economy ; Institutional Arrangements

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Mario Solis-Garcia and Yingtong Xie. Technical appendix: Are business cycles more volatile in developing countries after taking the shadow economy into account? Evidence from Latin America. Unpublished manuscript, 2016.