Economic freedom and the informal economy

This paper empirically investigates the effect of economic freedom on the informal economies in a sample of 112 countries over the period 2000-2007. We employ two methodologies: fixed effect and the GMM models. We find a statistically significant negative relationship between economic freedom and the informal economy. This conclusion indicates that the nature of the economic system plays an important role in seizing the informal economy. Further, our results demonstrate that the formal and informal economies are substitutes. The policy implication is that economies with high share of informal economy should work with fewer economic restrictions.