Small Businesses and the Shadow Economy
Year: 2008 Volume: 58 Issue: 1 -2 Pages: 68-81
Abstract: This paper investigates causalities between small businesses and the shadow economy in ten New Member States of the European Union in the years 2000–2005. The transition from a centrally planned to a market economy, with deregulation and privatization of economic activities, has yielded new opportunities for small businesses, new entrepreneurial ideas, and new income sources in these countries. Yet, rigid legislation, high tax wedges, and transaction costs of government institutions have increased the incentives for people to take their work into the shadow economy. To account for the simultaneity and latent variable effects we apply the instrumental variables econometric approach to study the association between small business and the shadow economy. We find that these variables are (weakly) negatively correlated, implying that the macroeconomic environment and institutional framework have improved, encouraging entrepreneurial activities while somewhat impeding the further development of the shadow economy.
JEL classification: O17, M21, L29, K49
Keywords: small business, self-employment, shadow economy
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