Investigating the Determinants of the Shadow Economy: The Baltic Region

Abstract

This study investigates the drivers of the shadow economy within the Baltic region, emphasizing the role of financial development, a missing feature from the extant literature. To this end, we analyzed an annual dataset covering the 2009-2019 period for Estonia, Latvia, and Lithuania using panel ARDL and obtained Pooled Mean Group (PMG) estimates. Empirical findings indicate that a rise in the tax burden, further financial development, and institutional development results in the expansion of the shadow economy. However, the establishment of the rule of law and political stability contribute to the contraction of the shadow economy.