Definitions and Estimation Models of Shadow Economy

A Systematic Literature Review

Abstract

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This study is an attempt to understand the divergence between different definitional approaches and measuring methods to estimate the shadow economy through extensive review of literature. The misunderstandings in the definition of shadow economy are underpinned in the contradictory views of researchers belonging to different academic backgrounds. Although reconciliation attempts were made to mitigate the difference between these conflicting definitional approaches but there is still non-availability of common ground. This variation in definitional approaches has resulted in researchers taking different routes for estimating the size of shadow economy. Literature identifies three approaches taken by researchers to measure the informal sector i.e. direct, indirect and model approach. After an extensive evaluation, the current study identifies many advantages and disadvantages for each of the methods. The direct approach is highly useful when a specific sector and specific time-period is into play but fails to deliver when estimating the size of an aggregated shadow economy. The indirect approach is often criticized for taking only one factor into account while calculating the black economy but also praised for its simplicity. The model approach considers multiple cause and indicating variable for the estimation of shadow economy, but these models tend to be unstable and overly complicated. The current study suggests there are broken links between the theory and estimation techniques of informal economy which needs to be addressed for true estimation of shadow economy.