Essays on the Macroeconomic Effects of the Underground Sector

Date of Completion

January 2011


Economics, General




The underground, shadow, irregular or unofficial sector comprises all value-adding activities that are unregistered and unlicensed. This is an extensive and increasing phenomenon worldwide. Furthermore, it poses several questions concerning macroeconomic performance. This dissertation contributes to understand the implications of unofficial activities for business cycle fluctuations. In particular, it examines how the hidden sector and its intrinsic characteristics are related to fluctuations in aggregate variables. ^ At an empirical level, the first chapter determines how business cycle stylized facts vary across countries with the extent of the shadow economy and compares the resulting patterns with predictions from models featuring underground activities. While this procedure allows to confirm the irregular sect or is actually related with the cyclical properties of a number of aggregate variables, the evidence is not entirely of the sort suggested in models of macroeconomic fluctuations. ^ More theoretical in character, chapter 2 incorporates an irregular sector into a real business cycle model to challenge the notion that fluctuations in the official and unofficial sectors are negatively correlated. To this end, the distinguishing elements of the model economy preclude such a notion. The model replicates the cyclical properties of average hours and labor productivity fairly well. Moreover, the hidden sector turns out to be weakly countercyclical. Computational experiments further analyze how taxes, enforcement and tastes for underground work affect the volatility and comovements of aggregate variables. These experiments offer a comprehensive view of the cyclical implications of the shadow economy. ^ Using a similar framework, the third chapter addresses how informal firms' limited access to external finance affects macroeconomic volatility. In the proposed model, registered production not only is subject to taxation, but also serves to ensure creditors that debts will be hilly secured. Thus, one might conjecture the higher the extent of tax evasion, the lower the implied value of firms' assets, the lower the amount of credit provided by the financial system, and larger the cyclical volatility of output and investment. Computational experiments contrastingly show credit-constrained informal activities do not influence aggregate fluctuations, yet they seem to play a non-negligible role as regards firm volatility. ^