Social Capital and the Shadow Economy

In this work, we look at the relationship between social capital, measured by generalized trust, and the size of the shadow economy, an institutional characteristic which reflects the inability of a society to successfully cooperate. An inverse relation arises, in a cross-country sample. Using several instruments, and especially a linguistic rule, we overcome endogeneity concerns and try to establish a causal relation arising from trust. Findings (1) suggest a 1 percentage point increase in trust (the share of trusting population) reduces the shadow economy by almost half a percentage point of GDP, (2) indicate a decreasing marginal effect of trust over the shadow economy. Overall, (3) these results further motivate low-medium trust countries to invest in policies aiming at increasing trust