Trade openness, growth, and informality: Panel VAR evidence from OECD economies

This paper analyzes empirically the linkages between trade openness, economic growth. and the size of the informal economy. I employ panel VAR techniques in a quarterly panel data set composed of 12 advanced economies over the period from 1964:1 to 2010:4 allowing bi-directional interaction between the variables in the system in order to address the endogeneity problem. The results provide evidence that there is a positive bi-directional relationship between GDP growth and trade openness. Second. fluctuations of GDP growth are explained by the size of the informal economy, while the impact of GDP growth on the size of the informal economy is not found to be robust with respect to change in VAR order. Moreover, the size of the informal economy affects GDP growth more than openness, and the causality from openness to GDP growth is slightly stronger than the causality from GDP growth to openness. Finally, there is no conclusive, robust evidence regarding the interaction between the size of the informal economy and trade openness.