How do institutions affect corruption and the shadow economy?

Abstract

This paper analyzes a simple model that captures the relationship between institutional quality, the shadow economy, and corruption. It shows that an improvement in institutional quality reduces the shadow economy and affects the corruption market. The exact relationship between corruption and institutional quality is, however, ambiguous and depends on the relative effectiveness of institutional quality in the shadow and corruption markets. The analytics also show that the shadow economy and corruption are substitutes. The predictions of the model are empirically tested and confirmed.