Estimating the size of the shadow economy in Spain: a structural model with latent variables

There has recently been a revival of international interest in measuring the size of the shadow economy. The current study adopts an approach to the Spanish case that is based on the theory of unobservable variables. This methodology involves the estimation of structural models (MIMIC) which analyses a set of causes of the shadow economy while simultaneously taking into account its influence upon a series of indicators. The proposed model permits the determination of a relative evolution over time of the size of the shadow economy, which requires the calibration of the model with an exogenous estimation in order to obtain real values. The exogenous estimation employed is that obtained by a monetary method based on a money demand function. The results show a considerable shadow economy, measuring between 8 and 18.8% of GDP in the period 1976–2002, and demonstrate that the shadow economy is significantly influenced by the tax burden, the degree of regulation and unit labour costs. A positive correlation is obtained between GDP, money demand and the level of the shadow economy.