Does the Underground Economy Hold Back Financial Deepening? Evidence from the Italian Credit Market

Abstract

The paper investigates the relationship between underground activities and financial deepening. The access to external finance requires entrepreneurs to disclose credible information through formal documentation. This requirement may be impossible to oblige to for many informal producers who lack a proper book-keeping of their operations. For the same reason irregular workers may find difficult to borrow for financing both consumption and housing purchase. Using panel data on Italian regional credit markets we find a strong negative impact of the share of irregular employment on outstanding credit to the private sector. According to our estimates a shift of 1 per cent of the employees from regular activities to irregular ones corresponds to a decline of about 2 percentage points in the volume of business lending and of 0.3 percentage points in outstanding credit to households, both expressed as ratios to GDP. Conversely, the feedback effects from financial deepening to the size of the informal sector are weak and statistically not significant. Through a difference-in-difference approach exploiting the regularisation program for immigrant workers launched in 2002 we also identify a negative effect of the irregular labour on banks' entry decisions in the local credit markets, now defined in terms of provinces.JEL classifications: G21, O17, R23.

Tax Evasion, Investment Shocks, and the Consumption Puzzle: A DSGE Analysis with Financial Frictions

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Explaining the Shadow Economy in Europe

“…Financial access: Banks tend to avoid lending or lend less to unregistered firms and borrowers without formal jobs or declared income. This can stymie financial deepening (Gobbi and Zizza 2012) and the funding needed for capital investment, private sector expansion, and innovation.…”

The Financial Systems in Russia and Turkey: Recent Developments and Challenges

“…Many small and medium sized enterprises in the informal sectors generally operate well below their optimal size, reflecting lower productivity and profit margins. According to WB (2010) estimates, the productivity gap in the manufacturing sector between informal and formal firms is at about 19 per cent (up to 62 per cent in the service sector).77 The share of equities owned by foreign customers to total equities in custody was around 55 per cent over the last decade; in 2013, this figure had risen to about 62 per cent (CMB, 2015).78 Gobbi and Zizza (2007) provide empirical evidence that the underground economy has held back financial deepening in Italy.…”